ACCT1021 Final: Final Exam Chapter Notes

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greywildebeest867

4 Dec 2016

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Creditor: lender to a company, gives money with aim to receive it back later: make money by charging interest, wanted to receive dividend (portion of profits) once they join the company. Managers: internal decision makers: need information to manage firm. External decision makers: need information to determine whether to help company. See if can pay back the debts and determine from that if they should lend them money. Balance sheet: purpose: report financial position (assets, liabilities, and stock holder equity) at a point in time, structure. Unit of measure: accounting entity: organization for which information is collected, basic accounting equation. Asset = liabilities stockholders equity: financial position: economic resources the company owns and sources, elements. Expected to provide future benefits to the firm. Liabilities: amount of financing provided by creditors. Stockholders" equity: amount of financing provided by owners of the business and reinvested earnings. Common stock: investment in business by stockholders.

Related Questions

1. Creditors' claims on the assets of a company are called: (Points : 2)

2. The primary objective of financial accounting is: (Points : 2)

To serve the decision-making needs of internal users

To provide financial statements to help external users analyze and interpret an organization's activities

To monitor and control company activitiesTo provide information on both the costs and benefits of managing products and services

To know what, when and how muchto produce

3. Assets created by selling goods and services on credit are: (Points : 2)

4. The debt ratio is used: (Points : 2)

To measure the amount of equity relative to the expenses

To reflect the risk associated with a company's debts

Only by banks when a business applies for a loan

To determine how much debt a firm should pay off

5. Net Income: (Points : 2)

Decreases equity

Represents the amount of assets owners put into a business

Equals assets minus liabilities

Is the excess of revenues over expenses

Represents the owners' claims against assets

6. Internal users of accounting information include: (Points : 2)

Shareholders

Customers

Creditors

Government regulators

Line Supervisor

7. Risk is: (Points : 2)

Net income divided by average total assets

The reward for investment

The uncertainty about the expected return that will be earned from an investment

Unrelated to expected return

8. An example of an operating activity is: (Points : 2)

Paying wages

Purchasing office equipment

Borrowing money from a bank

Selling stock

Paying off a loan

9. Which accounting assumption assumes that all accounting information is reported monthly or yearly? (Points : 2)

Business entity assumption

Monetary unit assumption

Value assumption

Cost assumption

Time period assumption

10. Distributions of assets by a business to its stockholders are called: (Points : 2)

This term you have learned to understand a companyâs financial story using the language of accounting. The recording and reporting of information is essential to decision makers and other users of financial information; numbers on the various financial statements are used to help further understand the financial condition of the business. This process is known as financial ratio analysis and allows us to analyze the companyâs financial position in relation to other organizations in the industry. In this final assignment, you will apply the concepts you have learned throughout the term to perform financial statement analysis and to offer some recommendations.

Assume that you are a health care consultant hired by the Dependable DME Company. DME is Durable Medical Equipment and includes all equipment that benefits patients who have certain medical conditions. The owner of the company, David Smith, is interested in applying for a loan to expand his business; he desires to open a second location in another city. He is preparing to apply to a local bank for a loan.

The bank will base its decision on the following averages for the DME industry:

Ratio	Industry Average
Current ratio	1.50
Quick ratio	0.80
Receivables turnover ratio	18.0
Inventory turnover ratio	20.0
Debt to assets ratio	0.56
Profit margin	10.25%

The balance sheet data for Dependable DME Company follows:

	December 31, 2017	December 31, 2016
Cash	$75,000	$60,000
Accounts receivable	40,000	20,000
Inventory	30,000	20,000
Prepaid insurance	5,000	5,000
Total current assets	140,000	105,000
Property and equipment	600,000	550,000
Accumulated depreciation	140,000	110,000
Total property and equipment	460,000	440,000
Total assets	$600,000	$545,000
Accounts payable	$60,000	$60,000
Other current liabilities	40,000	45,000
Total current liabilities	100,000	105,000
Bonds payable	150,000	150,000
Total liabilities	250,000	255,000
Common stock	250,000	250,000
Retained earnings	100,000	40,000
Total stockholdersâ equity	350,000	290,000
Total liabilities and stockholdersâ equity	$600,000	$545,000

The income statement data for Dependable DME Company follows:

Sales	$600,000
Cost of goods sold	350,000
Gross profit	$250,000
Operating expenses	100,000
Operating income	$150,000
Interest expense	25,000
Income before taxes	$125,000
Income tax expense	65,000
Net income	$60,000

Required:

Calculate the following six (6) ratios: Current Ratio, Quick Ratio, Receivables Turnover Ratio, Inventory Turnover Ratio, Profit Margin Ratio and Debt to Assets Ratio. Be sure to show the actual calculation as well as your final answer.

You are only required to calculate the ratios for 2017; however, for two of the ratios (Receivables Turnover Ratio and Inventory Turnover Ratio), you will need data from 2016 for the formula. When calculating the Quick Ratio, please note that Short-Term Investments are $0 in this scenario. (24 points; 4 points for each ratio calculation)

Below each ratio, comment on the interpretation of the ratio. In other words, what does the result tell you, specifically? (8 points)

Based upon the industry averages upon which the bank relies, should they approve the loan to Mr. Smith? Why or why not? (7 points)

In one-half page, comment on what financial aspect of Dependable DME Company looks good and where can Mr. Smith make some improvements. Specifically identify at least two recommendations to Mr. Smith that can be made to improve the financial position of his business. (8 points)

Bond Accounting

In December 2014, Rene Cook sat in her cubicle trying to remember what she had learned in business school about bonds and bond accounting. Ms. Cook, a new CPA and special assistant in a training assignment with the company president, had just met with David Lyons, president of Lyons Document Storage Corporation. Interest rates had fallen over recent years and he had asked her to think about the consequences issuing new bonds at a lower rate of interest and using the proceeds to repurchase the higher coupon rate bonds that are currently outstanding. My Lyons had asked Rene to focus on how much the companyâs annual interest payments could be reduced, how reported earnings would be affected, and how the refunding would change the companyâs financial position as referenced on the balance sheet, if at all.

The Company

The Lyons Company was a family business in the stationary supply business until the document storage opportunity appeared in the early 1990âs. Lyons Document Storage Corporation was incorporated in 1993 to compete in the emerging and rapidly growing industry that provides secure, off-site storage of documents for other corporate customers. The demand for storage was fueled by the need for corporations to retain records of sales contracts, employment records, compliance records, and other documents. The convenience of secure storage and easy recovery in professionally managed warehouses appealed to corporate clients that wanted to save space in their more expensive office buildings. At the same time, the stationary supply business was growing more competitive with the entrance of Staples, Office Depot and Office Max.

The early 2000âs were difficult for Lyons because there were still differences among management about directions and the companyâs future. A large competitor, Iron Mountain, was expanding rapidly in the United States and internationally. When the decision to focus on document storage was made, it was imperative to move quickly to secure storage space and transportation equipment. Management decided to fund the companyâs growth by issuing debt rather than by issuing additional equity. Lyons had operated conservatively without any long-term debt until it issued bonds in January of 2005. The bonds issued were $10 million in 20-year bonds, offering a coupon rate of 8%, with interest paid semiannually, and sold to yield the 9% market rate of interest at the time.

Current Situation

David Lyons had told Rene Cook that he felt the time might be ripe to refund the 2005 bond issue and replace it with bonds bearing lower interest rates. He had talked with the companyâs investment bankers who had told him that $10 million in new 6% bonds with semiannual interest payments could be issued to provide the company with exactly $10 million, not considering underwriting costs and legal fees that were expected to be nominal. The bonds would pay $300,000 of interest every June 30 and December 31 with a payment of $10 million in principal at the end of 10 years. The new interest payments would be $200,000 less each year than those due on the old bonds, which still had 10 years before they would be paid off. To Lyons, that seemed to offer a saving over the old bonds.

The existing bonds had been issued on January 1, 2005 and would be due December 31, 2024. Interest was paid semiannually to holders of the bonds.

Beginning her research, Rene reached for her copy of Lyons Document Storageâs 2013 Annual Report. (See Exhibit 1 for the Liabilities section of the 2013 Annual Report.) She was confused as to why the liability for the $10 million bonds was only $9.3 million at the end of 2013.

To clarify her understanding, Rene called the companyâs controller, Eric Petro, and learned that the 2005 bonds had been issued at a discount. Only about $9.1 million was received when the bonds were issued. For further information, Petro referred Rene to footnote 8 of the companyâs 2013 financial statements (Exhibit 2).

Next, Rene went to the Internet to determine the market price of the companyâs bonds. The current price was shown as 114.88 â reflecting the 6% yield the market for bonds was currently supporting. This meant that each $1,000 bond would have to be repurchased for $1,148.77. The company would have to spend $11.5 million to retire bonds that would be listed on the December 2014 balance sheet at less than $10 million. The resulting loss would shrink the 2015 projected earnings and slow the growth rate in earnings about which David Lyons was so proud. Rene knew this would not make Mr. Lyons happy. However, the lower interest payments associated with the new bonds would help reduce cash outflows in future years.

1. There is no indication in this case that the 2005 bonds were âcallableâ. Assume that the bonds are callable at 102. That is, there is a 2% call premium over par value. What accounting loss would result if the bonds were called at this price? If the bonds were in fact callable, how would this impact your analysis and recommendation?

ACCT1021 Final: Final Exam Chapter Notes

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