ACCT 1A Lecture Notes - Lecture 25: Book Value
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Modern Building Supply sells various building materials toretail outlets. The company has just approached Linden State Bankrequesting a $300,000 loan to strengthen the Cash account and topay certain pressing short-term obligations. The company'sfinancial statements for the most recent two years follow:
This Year | Last year | |
Assets | ||
Current assets: | ||
Cash | $63,000 | $135,000 |
Market securities | 0 | 19,000 |
Accounts receivable, net | 471,000 | 289,000 |
Inventory | 935,000 | 597,000 |
Prepaid expenses | 17,000 | 24,000 |
Total current assets | 1,486,000 | 1,064,000 |
Plant and equipment, net | 1,539,810 | 1,445,550 |
Total assets | $3,025,810 | $2,509,550 |
Liabilities and Stockholders' Equity | ||
Liabitities: | ||
Current liabilities | $812,000 | $438,000 |
Bonds payable, 10% | 617,000 | 617,000 |
Total liabilities | 1,429,000 | 1,055,000 |
Stockholders' equity: | ||
Pereferred stock, $25 par, 7% | 255,000 | 255,000 |
Common stock, $10 par | 507,000 | 507,000 |
Retained earnings | 834,810 | 692,550 |
Total stockholders' equity | 1,596,810 | 1,454,550 |
Total liabilities and stockholders equity | $3,025,810 | $2,509,550 |
This year | Last year | |
Sales | $5,007,000 | $4,356,000 |
Cost of goods sold | 3,866,000 | 3,443,000 |
Gross margin | 1,414,000 | 913,000 |
Selling and administrative expenses | 635,000 | 539,000 |
Net operating income | 506,000 | 374,000 |
Interest expense | 61,700 | 61,700 |
Net income before taxes | 44,300 | 312,300 |
Income taxes (40%) | 177,720 | 124,920 |
Net income | 266,580 | 187,380 |
Dividends paid: | ||
Preferred dividends | 17,850 | 17,850 |
Common dividends | 106,470 | 70,980 |
Total dividends paid | 124,320 | 88,830 |
Net income retained | 142,260 | 98,550 |
Retained earnings, beginning of year | 692,550 | 594,000 |
Retained earnings, end of year | $834,810 | $692,550 |
During the past year, the company has expanded the number oflines that it carries in order tostimulate sales and increaseprofits. It also moved aggressively to acquire new customers. Salesterms are 2/10, n/30. All sales are on account.
Assumer that the following ratios are typical of companines inthe building supply industry:
Current ratio | 2.5 |
Acid-test ratio | 1.2 |
Average collection period | 18 days |
Average sale period | 50 days |
Debt-to-equity ratio | 0.75 |
Times interest earned ratio | 6.0 |
Return on total assets | 10% |
Price-earnings ratio | 9 |
Assume that you have just inherited several hundred shares ofModern Building Supplu stock. Not being acquainted with thecompany, you decide to do some analytical work beofer making adecision about whether to retain or sell the stock you haveinherited.
Required:
1. You decide first to assess the well-being ofthe common stockholders.For both this year and last year, computethe following:
a. The earnings per share (Round your answer to2 decimal places.)
This year | Last year | |
Earnings per share | $ ? | $ ? |
b. The dividend yield ratio for common stock.The company's common stock is currently selling for $33.39 pershare; last year it sold for $25.72 per share (Round youintermediate calculations to 2 decimal palces and final answers to1 decimal place.)
This year | Last year | |
Dividend yield ratio | ? % | ? % |
c. The dividend payout ratio for common stock(Round you intermediate calculations to 2 decimal places and finalanswers to 1 decimal place.)
This year | Last year | |
Dividend payout raito | ? % | ? % |
d. The price-earnings ratio (Round yourintermediate calculations to 2 decimal places and final answers to1 decimal place.)
This year | Last year | |
Price-earnings ratio | ? times | ? times |
e. The book value per share of common stock(Round your ansers to 2 decimal places.)
This year | Last year | |
Book value per share | $ ? | $ ? |
2. You decide next to assess the compay's rateof return. Compute the following for bothe this year and lastyear:
a. The return on total assets (Total assets atthe beginning of last year were $2,270,000) (Round yourintermediate to whole numbers and final answer to 1 decimalplace)
This year | Last year | |
Return on total assets | ? % | ?% |
b.The return on common stockholders' equity.(Stockholders' equity at the beginning of last year was $1,319,000)(Round you intermediate calculations to whole numbers and finalanswer to 1 decimal place.)
This year | Last year | |
Return on common stockholders' equity | ?% | ?% |
Question 1 (40 marks)
You are the audit manager of a medium-sized firm and have just received a package from Rachel Jones, the financial controller of KidSpace Ltd., an electronic toy manufacturer. This is your firmâs first year as auditor of KidSpace Ltd. The information below was prepared for a board meeting and Rachel, the acting Chief Financial Officer, felt it might be useful to you in preparation of the forthcoming audit for the year ended 30 June 2017.
KidSpace Ltd. | |||
Statement of Financial Position $'000s | |||
Current assets | 2017 | 2016 | 2015 |
Cash | 1,586 | 1,743 | 830 |
Accounts receivable and other receivables | 13,734 | 11,200 | 9,623 |
Inventory | 16,498 | 11,731 | 7,197 |
Total current assets | 31,818 | 24,674 | 17,650 |
Non-current assets | |||
Property, plant and equipment | 14,606 | 12,840 | 9,572 |
Long-term loan receivable | 5,200 | 3,600 | 3,300 |
Intangible assets | 1,400 | ||
Total non-current assets | 21,206 | 16,440 | 12,872 |
Total assets | 53,024 | 41,114 | 30,222 |
Current liabilities | |||
Trade payables and other payables | 9,012 | 6,288 | 2,021 |
Provisions | 4,875 | 3821 | 4577 |
Total current liabilities | 13,887 | 10,109 | 6,598 |
Non-current liabilities | |||
Long-term loan | 20,000 | 16,000 | 12,000 |
Total liabilities | 33,887 | 26,109 | 18,598 |
Net assets | 19,137 | 15,505 | 11,624 |
Shareholder's equity | |||
Share capital | 2,000 | 2,000 | 2,000 |
Retained earnings | 17,137 | 12,505 | 9,624 |
Total shareholder's equity | 19,137 | 14,505 | 11,624 |
KidSpace Ltd. | |||
Income Statement $'000s | |||
2017 | 2016 | 2015 | |
Sales revenue | 76,945 | 74,927 | 89,735 |
Cost of sales | 51,840 | 51,765 | 63,066 |
Gross profit | 25,105 | 23,162 | 26,669 |
Depreciation | 5,595 | 4,332 | 2,796 |
Inventory obsolescence | 990 | 1,173 | 670 |
Selling expenses | 2,405 | 3,153 | 3,317 |
Administrative expenses | 8,925 | 8,727 | 11,516 |
Finance costs | 1,040 | 1,275 | 1,140 |
Total expenses | 18,955 | 18,660 | 19,439 |
Profit before tax | 6,150 | 4,502 | 7,230 |
Tax expense | 1,518 | 1,621 | 2,386 |
Profit after tax | 4,632 | 2,881 | 4,844 |
Notes: | |||
Trade Receivables | 12,034 | 10,655 | 9,300 |
Pre-paids | 1,600 | 500 | 300 |
Other receivables | 100 | 45 | 23 |
Total Trade & other receivables | 13,734 | 11,200 | 9,623 |
Inventory | |||
Raw Materials | 6,599 | 5,866 | 3,845 |
WIP | 4,333 | 2,588 | 1,550 |
Inventory held for sale | 6,699 | 3,520 | 1,972 |
17,631 | 11,974 | 7,367 | |
Provision for Inventory obsolescence | (1,133) | (243) | (270) |
Total inventory | 16,498 | 11,731 | 7,197 |
Ratios | 2017 | 2016 | 2015 |
Profit ratio | 7.99% | 6.01% | 8.06% |
Return on shareholder equity | 24.20% | 19.86% | 41.67% |
Quick Ratio | 0.99 | 1.18 | 1.54 |
Times Interest Earned | 6.91 | 4.53 | 7.34 |
Accounts Receivable Turnover (times) | 6.78 | 7.51 | 9.33 |
Asset Turnover | 1.45 | 1.84 | 2.94 |
Inventory Turnover (times) | 3.50 | 5.35 | 8.76 |
During a brief telephone call with Rachel, you made the following notes:
1. One of the conditions of the long-term loan is that the company is not to exceed a debt-to equity ratio of 2:1 at any time and they must maintain a current ratio of 2:1. The loan is reviewed each year on 31 July.
2. Provision for obsolescence of finished inventory held for sale and work-in-progress is provided for at a flat rate of 10%. The amount provided in previous years was 20%. Rachel said that the company believes it has been overly conservative in previous years and 10% is a more realistic level, given the nature of its products.
3. To combat declining sales a senior management incentive scheme based on sales and profit levels was introduced in July 2016.
4. The long-term loan receivable is from a company involved in the development and production of computer software. It is owned by one of the directors.
Required:
a) Identify and explain what the inherent risks for KidSpace Ltd. that you will need to consider. (6 marks)
b) From the information provided, perform additional preliminary analytical procedures:
i) Simple comparison (3 marks)
ii) Current ratio (1 mark)
iii) Return on assets (1 mark)
iv) Gross profit ratio (1 mark)
v) Debt-to-equity ratio. (1 mark)
c) Drawing on information from a) & b), identify and justify:
i) Three key account areas that would require special attention during the audit of the 30 June 2017 financial statements. Also, indicate if those accounts are likely to be over or understated. (12 marks)
ii) Two key assertions at risk for each of those account areas. (12 marks)
d) Identify and discuss any going concern issues to be considered at this stage?. (3 marks)