Statement of Cash Flows - Assignment Example

ACCT500 – Financial & Management Accounting 27 November ment of Cash Flows Listed below are eight technical accounting terms introduced in this chapter:    Each of the following statements may (or may not) describe one of these technical terms. For each statement, indicate the term described, or answer "None" if the statement does not correctly describe any of the terms. Debt ratio _ (a) The percentage of total assets financed by creditors. The formula for the debt ratio is total debt/total assets (BPP 2009) Return on assets _ (b) A measure of the effectiveness with which management utilizes a company's resources, regardless of how those resources are financed. The formula for the return on assets is Net income divided by total assets (BPP 2009). Market share _(c) A company's percentage share of total dollar sales within its industry. Working capital _ (d) Current assets less current liabilities. Price-earnings ratio _ (e) A measure reflecting investors' expectations of future profitability. The formula for the price-earnings ratio is price per share divided by earnings per share (EPS) (BPP 2009). Quick ratio _ (f) A measure of short-term solvency often used when a company has large inventories that cannot be quickly converted into cash. The formula for the quick ratio finds the total of all current assets with the exception of inventories and divides the result by the total of all current liabilities. This ratio is the acid test for short term solvency. It takes into consideration the cash cycle of turning inventory into cash, the fact that it may take a while before the inventory and the cash s received by way of cash sale or credit sale. Additionally, inventory can become obsolete. Earnings per share _ (g) A ratio that helps individual stockholders relate the net income of a large corporation to their equity investment.  The formula for earnings per share EPS is: Net income divided by number of issued shares. 2- The balance sheet of Red Missile Company contained the following items, among others: (a) From the above information compute: (1) Current assets: $388,000 Current assets include cash, accounts receivable and inventory i.e. $180,000 + $84,000 + $124,000 = $388,000. (2) Current liabilities: $259,000 Current liabilities include Note payable in 10 days and Accounts payable i.e. $163,000 + $96,000 = $259,000 (3) The current ratio: 1.5 to 1 i.e. the ratio of current assets to current liabilities - $388,000/259,000 = 1.5 (4) Net Working capital: $129,000 i.e. $388,000 - $259,000 (b) Assume that Red Missile Company pays the note payable of $163,000, thus reducing cash to $17,000. Compute the following after the completion of this transaction: (1) The current ratio: 2.34 to 1 – i.e. 225,000 ($388,000 – 163,000) divided by 96,000 ($259,000 – 163,000) Calculation of current assets: Cash ($180,000 - $163,000) $17,000 Accounts Receivable $84,000 Inventory $124,000 Current assets $225,000 Calculation of current liabilities: Accounts Payable $96,000 Current liabilities $96,000 (2) Net Working capital: $129,000 - i.e. current assets minus current liabilities – $225,000 - $96,000 3- Shown below are selected items appearing in a recent balance sheet of Grant Products. (Dollar amounts are in thousands.)    (a) Compute the following: (1) Total quick assets $2,770 and is calculated as follows: Calculations of Total quick assets: Cash and cash equivalents $620 Investments in marketable securities $300 Receivables $1,400 Prepaid expense and other current assets $450 Quick assets $2,770 (2) Total current assets $3,870 and is calculated as follows: Calculation of total current assets: Cash and cash equivalents $620 Investments in marketable securities $300 Receivables $1,400 Inventories $1,100 Prepaid expenses and other current assets $450 Current assets $3,870 (3) Total current liabilities $2200 i.e. $1,600 + $300 + $300 Calculation of current liabilities: Accounts payable $1,600 Bank loans payable within a year $300 Income tax payable $300 Total current liabilities $2,200 (4) Quick ratio 1.26 to 1 (5) Current ratio 1.76 to 1 (b) Research indicates an industry average quick ratio is 1.3 to 1, and a current ratio of 2.3 to 1. Based upon this information, does Grant Products appear more or less solvent than the average company in its industry? Explain briefly.  Explanation Grant Products appears less solvent than the average company in its industry. Grant has a quick and current ratio of 1.26 to 1 and 1.76 to 1 compared to the industry average of 1.3 to 1 and 2.3 to 1. Both of Grant Products quick and current ratio are below the industry average. Grant Products quick ratio which is a better measure of the firm’s ability to pay its debts as they fall due is not very different from the industry average. In fact, the difference may just be due to rounding. The quick ratio is also called the acid test as it is a more stringent measure of a firm’s ability pay up its short term debts without waiting on inventories to be sold off. It takes the cash cycle into consideration the fact that inventories can take a long time before they can be sold and turned into cash. The current ratio is the ‘standard’ test for short solvency of liquidity (BPP 2009). The company’s current ratio on the face of things may appear worse than the industry average. However, what is clear from a comparison of the quick and current ratio of the industry is that the inventory levels on average are very high. In fact, inventory is equal to the total current liabilities. This may suggest that on average firms in the industry are overtrading. Additionally, it suggests poor management of inventories. Grant product’s inventory is 50 per cent of its current liabilities and suggests that the firm is managing its working capital much better than average. BPP (2009) indicates that an acceptable current and quick ratio is 1.5 and 0.8 respectively. However, a comparison with the industry is important at all times as it gives an indication of how effectively other players in the industry are managing their working capital. Furthermore, the best practices of other players in the industry provides a benchmark for Grants Products.    4- Shown below is a recent income statement for Phaeton, Inc.:    Prepare an income statement for the year in a multiple-step format. (Use the grid provided below.)   Phaeton, Inc Income Statement For the Year Ended December 31, 2010   $ $ Net sales 6,000,000 Cost of goods sold (4,200,000) Gross Profit 1,800,000 Operating expenses (900,000) Earnings before interest and tax (EBIT) 900,000 Interest expense (150,000) Earnings before tax (EBT) 750,000 Income taxes (360,000) Net earnings 390,000              5-   Shown below are selected data from a recent annual report of Quality Service. (Dollar amounts are in millions.)    Compute for the year:   (a) Return on average total assets = Net income/Average total assets x 100% = $1,900/$6,300 = 30.2% (Average total assets = (Total assets at the beginning of the year + Total assets at the end of the year)/2 (b) Return on average total equity = Net Income/Average total stockholders’ equity = $1,900/$3,450 x 100% = 55% (Average total stockholder’s equity = (Total stockholders’ equity at the beginning of the year + Total stockholders’ equity at the end of the year)/2 6- Shown below are selected data from a recent annual report of Tall Oaks Co. (Dollar amounts are in thousands.)    Compute for the year the company's: (a) Gross profit rate = Gross profit/Net sales = $5,000/$14,000 x 100% = 35.7% (b) Return on average total assets = Net income/Average total assets = $1,000/$7750 x 100% = 12.9% (c) Return on average total stockholders’ equity = Net income/Average total shareholders’ equity = $1,000/$4,250 x 100% = 23.5%           7- Shown below is a recent income statement for B-D Electric.    Net Income $970,000 Assume that comparative balance sheets for B-D Electric indicate average total assets for the year of $2,500,000, and average total equity of $2,050,000. Compute the following: (a) Gross profit rate = Gross profit/Net sales = 3,400,000/$7,500,000 x 100 = 45.3% (b) Net income as a percentage of net sales = $970,000/7,500,000 x 100 = 12.9% (c) Return on assets = $970,000/$2,500,000 x 100 = 38.8% (d) Return on equity = $970,000/$2,050,000 x 100 = 47.3%       8- Given below are comparative balance sheets and an income statement for the Excellent Corporation:    All sales were made on account. Cash dividends declared during the year totaled $58,550. Compute the following: (a) Average accounts receivable turnover = Net credit sales/Average accounts receivable = $524,000/$86,000 = 6.09 = 6 times (Average accounts receivable = [(Accounts receivable on January 1 + Accounts receivable on December 31)/2] (b) Average inventory turnover = Cost of goods sold/Average inventory = $328,000/71,000 = 4.62 = 4 times (Average inventory = [(Inventory on January 1 + Inventory on December 31)/2] (c) Earnings per share of capital stock = Net income/Number of capital stock = $48,550/14,000 = $3.47 (Number of capital stock = Capital stock/par value of each stock i.e. $140,000/$10 (d) Book value per share of capital stock = Common stockholders’ equity/Number of capital stock = $204,000/14,000 = $14.57 (e) Current ratio at year-end = current assets/current liabilities = 196,000/74,000 = 2.65:1 (f) Quick ratio at beginning of year = (current assets – inventory)/current liabilities = 128,000/74,000 = 1.73:1 (g) Debt ratio at year-end = Total debt/total assets = 106,000/310,000 = 34.19% (h) Operating expense ratio = Operating expense/Gross profit = 118,700/196,000 = 60.56% (i) Return on assets = (Net income/Total assets) x 100 = $48,550/$310,000 x 100 = 15.66% (j) Return on common stockholders’ equity = (Net income/Common stockholders’ equity) x 100 = ($48,550/$204,000) x 100 = 23.8%          9- Carter Corporation financed construction of a new addition to its facilities with a large long-term note payable. As a condition of obtaining the loan, Carter agreed to maintain a current ratio at year-end of at least 1.7 to 1. If Carter fails to maintain this ratio, the lender may demand immediate repayment of the principal amount of the note and all unpaid accrued interest. As the end of the year approaches, Carter is concerned about the magnitude of its current ratio. Suggest some actions that the company might take to increase the magnitude of the current ratio.  There are a number of options available to Carter Corporation. They include: Paying off some of the company’s current liabilities with cash Using a medium term loan to pay up some of the current liabilities Managing working capital efficiently and effectively Carter Corporation could pay up a portion of the company’s current liabilities using cash if there is sufficient to serve as a buffer against unforeseen events. Although the difference between current assets and current liabilities would be the same because of the double entry effect, there would be an improvement in the current ratio. For example, if the total of all current assets is 180,000 and the total of all current liabilities is $120,000 then the current ratio is: Current assets to current liabilities - $180,000 to $120,000 = 1.5:1. However, if $60,000 of the cash included in current assets is used to pay trade creditors then the current ratio is: $120,000 to $60,000 = 2:1. Therefore, paying up some of the current firm’s liabilities would have positive implications for the business Carter Corporation could also obtain a medium term loan in order to reduce the current liabilities. This transaction would change the structure of the company’s balance sheet as some current assets would be financed by liabilities of a different maturity term. This would require effective and efficient management of current assets especially inventory and receivables. Large volumes of inventory may indicate overinvesting (BPP 2009). A company that has Management of inventory would involve setting a minimum re-order level to avoid tying up too much funds in inventory or to prevent inventory becoming obsolete. Receivables could be managed by creating a list of aged debtors and making an effort to collect debts on time. It would also involve taking steps such as providing incentives to collect debts; especially the older ones. This would help to ensure that sufficient cash is on hand to pay debts including interest expenses as they fall due. The management of working capital is important for a business to survive. In order to survive it means achieving the goals set out by management in an efficient and effective manner. This can be done by efficient management of both inventory and receivables. Works Cited BPP (2009). 3rd ed. Paper F7 Financial Reporting. London: BPP Learning Media, 2009. Print Read More