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ACC/400
Final Exam
Name: ______
Part / I / II / III / TotalPoints / 20 / 60 / 20 / 100
Score
Part I – 20pts
Multiple Choice: (2 pt each)
1. The best definition of assets is the
a. cash owned by the company.
b. collections of resources belonging to the company and the claims on these resources.
c. Owners’ investment in the business.
d. resources belonging to a company have future benefit to the company.
2. Liabilities
a. are future economic benefits.
b. are debts and obligations.
c. possess service potential.
d. are things of value owned by a business.
3. Notes to the financial statements
a. are optional.
b. help clarify information presented in the financial statements.
c. are generally brief and few in number.
d. need not be read in detail if an unqualified opinion accompanies the financial statements.
4. The liability created by a business when it purchases coffee beans and coffee cups on credit from suppliers is termed a(n)
a. account payable.
b. account receivable.
c. revenue.
d. expense.
5. An income statement
a. summarizes the changes in retained earnings for a specific period of time.
b. reports the changes in assets, liabilities, and stockholders’ equity over a period of time.
c. reports the assets, liabilities, and stockholders’ equity at a specific date.
d. presents the revenues and expenses for a specific period of time.
6. Liabilities
a. are future economic benefits.
b. are debts and obligations.
c. possess service potential.
d. are things of value owned by a business.
7. Payments to stockholders are called
a. expenses.
b. liabilities.
c. dividends.
d. distributions.
8. The discontinued operations section of the income statement refers to
a. discontinuance of a product line.
b. the income or loss on products that have been completed and sold.
c. obsolete equipment and discontinued inventory items.
d. the disposal of a significant segment of a business.
Use the following information for questions 9-10.
The following amounts were taken from the financial statements of Alien Company:
2007 2006
Current liabilities $280,000 $220,000
Long-term liabilities 800,000 600,000
Interest Expense 100,000 50,000
Income tax expense 120,000 58,000
Net income 300,000 170,000
Net cash provided by operating activity 480,000 270,000
9. The times interest earned ratio for 2007 is
a. 3.0 times.
b. 4.8 times.
c. 4.0 times.
d. 5.2 times.
10. The cash debt coverage ratio for 2007 is
a. 50.5%.
b. 44.4%.
c. 31.6%.
d. 62.5%.
Part II – 60pts
Problems
11. Selected data taken from the 2006 financial statements of trading card company Bottoms Company, Inc. are as follows (in millions). 10pts
Net sales $295.9
Current liabilities, February 28, 2005 39.5
Current liabilities, February 28, 2006 47.5
Net cash provided by operating activities 23.0
Total liabilities, February 28, 2005 64.2
Total liabilities, February 28, 2006 71.2
Capital expenditures 2.6
Cash dividends 6.5
Instructions
Compute these ratios at February 28, 2006:
(a) Current cash debt coverage ratio
(b) Cash debt coverage ratio
(c) Free cash flow
Provide a brief interpretation of your results.
12. The comparative balance sheet of Stuart Company appears below: 20pt
STUART COMPANY
Comparative Balance Sheet
December 31,
Assets 2007 2006
Current assets $ 340 $280
Plant assets 675 520
Total assets $1,015 $800
Liabilities and stockholders' equity
Current liabilities $ 180 $120
Long-term debt 250 160
Common stock 325 320
Retained earnings 260 200
Total liabilities and stockholders' equity $1,015 $800
Instructions
(a) Using horizontal analysis, show the percentage change for each balance sheet item using 2006 as a base year.
(b) Using vertical analysis, prepare a common size comparative balance sheet.
13. The Brawn Company had a $400 credit balance in Allowance for Doubtful Accounts at December 31, 2007, before the current year's provision for uncollectible accounts. An aging of the accounts receivable revealed the following: 20pts
Estimated Percentage
Uncollectible
Current Accounts $140,000 1%
1–30 days past due 15,000 3%
31–60 days past due 12,000 6%
61–90 days past due 5,000 12%
Over 90 days past due 7,000 30%
Total Accounts Receivable $179,000
Instructions
a) Prepare the Estimated Uncollectible schedule for each percentage.
b) Prepare the adjusting entry on December 31, 2007, to recognize bad debts expense.
a)
b)
14. Shown below are data from recent reports of two publicly owned bakeries. Dollar amounts are stated in thousands. 10pts
HomeStyle Bakery / Sweet and Sassy’sTotal Assets / $755,000 / $3,127,150
Total Liabilities / 327,925 / 2,105,000
Interest Expense / 35,000 / 47,508
Operating Income / 20,550 / 375,090
Instructions
a. Compute for each company (1) the debt ratio and (2) the interest coverage ratio. (Round the debt ratio to the nearest percent and the interest coverage ratio to two decimal places.)
b. In your opinion, which of these companies would a long-term creditor probably view as the safer investment? Explain.
a)
1) Debt Ratio:
HomeStyle Bakery:
= $327,925 / $755,000 = 43.43%
Sweetand Sassy’s:
= $2,105,000 / $3,127,150 = 67.31%
2) Interest Coverage Ratio:
HomeStyle Bakery:
= $20,550 / $35,000 = 0.59
Sweetand Sassy’s:
= $375,090 / $47,508 = 7.9
b)
I would feel safer investing in HomeStyle Bakery as it has a lower debt ratio, and although Sweetand Sassy has a higher interest coverage ratio, this is an indication that the firm can cover its interest obligations, but not its debt obligations. A high debt ratio can be dangerous as it exposes the company to the threat of bankruptcy if it cannot meet its obligations.
Part III – 20pts
15. Your friend, Mark, has opened a movie theater. Mark states that he does not have
time to develop and implement a system of internal controls. 10pts
a. Provide Mark with the objectives of a system of internal control.
Internal control is the whole set of procedures and controls taken by a firm to safeguard its assets and help achieve the corporate objectives.
The major objectives, of internal control, is:
1. to safeguard property
2. ensure that the firm is achieving its stated goals.
3. ensure that staff are working coherently.
4. safeguard business information.
b. Explain to Mark why he should develop a system of internal control.
As explained above, a system of internal control helps a firm achieve its objectives. If the system is not implemented then the theatre may not be successful.
Without the system of control all the employees would behave in a different manner that will be opposite to the company’s objectives.
Similarly the system helps the theatre maintain all its assets and ensure that each is in a stable and adequate condition.
16. A large stock dividend and stock split can frequently have the same effect on the market price of a corporation’s stock. Explain how stock dividends and stock splits affect the market price of a corporation’s stock. 10pts
A stock dividend is the payment made to the shareholders of a firm while a stock split is the process of creating more shares by replacing current ones through a certain multiple.
Investors utilize the information, on dividends, to estimate the likely price of a share. Prior to the stock dividend the price is usually higher than before and once the dividend is declared the inventors may adjust their estimates based on the amount. If the amount is substantial then the price may be higher vice versa for lower dividends.
Similarly, a stock split creates more stock. The additional stock available according to the laws of demand and supply would affect the estimates made by the investors.
E10.13
On July 1, Pine Region Dairy leased equipment from Farm America for a period of three years. The lease calls for monthly payments of $2,500 payable in advance on the first day of each month, beginning July 1.
Prepare the journal entry needed to record this lease in the accounting records of Pine Region Dairy on July 1 under each of the following independent assumptions:
a. The lease represents a simple rental arrangement.
Rent Expense / 2,500Cash / 2,500
To record monthly rental expense on equipment under an operating lease agreement.
b. At the end of three years, title to this equipment will be transferred to Pine Region Dairy at no additional cost. The present value of the 36 monthly lease payments is $76,021, of which $2,500 is paid in cash on July 1. None of the initial $2,500 is allocated to interest expense.
Leased Equipment / 76,021Lease Payment Obligation / 73,521
Cash / 2,500
To record the acquisition of equipment through a capital lease agreement.
c. Why is situation a, the operating lease, sometimes called off-balance-sheet financing?
Under an operating lease, no asset or liability (other than perhaps a short-term liability for accrued rent payable) relating to the lease appears in the lessee’s balance sheet.
By structuring the terms of the lease so that it qualifies as an operating lease, the lessee avoids having to include the asset and the liability in the balance sheet. Exclusion of these items creates more favorable financial ratios, such as rate of return on investment, the current ratio, and the ratio of debt to equity. This, in turn, may increase the borrowing capacity of the lessee. The lessee is practicing "off balance sheet financing."
d. Would it be acceptable for a company to account for a capital lease as an operating lease to report rent expense rather than a long-term liability?
If the lease is unquestionably a capital lease, it would be unacceptable, unethical and possibly illegal for a publicly owned company to account for it as an operating lease. Such presentation would understate the company’s total liabilities.
E10.16
To answer the following questions use the annual report for Tootsie Roll Industries, Inc., in Appendix A at the end of the textbook:
a. Compute the company’s current ratio and quick ratio for the most recent year reported. Do these ratios provide support that Tootsie Roll is able to repay its current liabilities as they come due? Explain.
b. Compute the company’s debt ratio. Does Tootsie Roll appear to have excessive debt? Explain.
c. Examine the company’s statement of cash flows. Does Tootsie Roll’s cash flow from operating activities appear adequate to cover its current liabilities as they come due? Explain.
a. / Current Ratio:(1) Current assets 12/31/02 / $224,948
(2) Current liabilities 12/31/02 / 63,096
Current ratio (1) ¸ (2) / 3.57:1
Quick Ratio:
(1) Financial assets 12/31/02 / $173,003
(2) Current liabilities 12/31/02 / 63,096
Quick ratio (1) ¸ (2) / 2.74:1
Given these strong ratios, and the fact that the company has over $146 million in cash, cash equivalents, and marketable securities, it appears that it will have no problem repaying its current liabilities as they come due.
b. / Debt Ratio:
(1) Total liabilities 12/31/02 / $119,340
(2) Total assets 12/31/02 / 646,080
Debt ratio (1) ¸ (2) / 18.5%
The company has a very low debt load. Only 18.5% of each asset dollar is debt financed. Of this amount, most is short-term.
c. / The company reports current liabilities of approximately $63.1 million at the end of 2002. Cash flows from operating activities for the year amount to $71.2 million. If similar cash flows are generated in 2003, no problems should be encountered in paying these liabilities.