JRE300: Fundamentals of Accounting and Finance

JRE300: Fundamentals of Accounting and Finance

MIDTERM EXAMINATION (30% of Final Grade): Fall 2014

Time Allowed: 2 Hours

SOLUTIONS

FIRST NAME ______

LAST NAME ______

STUDENT NUMBER:______

PLEASE INDICATE YOUR SECTION:

F. Tolias ______S. Douglas______

Instructions:

• Write all of your answers on the examination paper. If you need additional space, use the back of the page facing the question and clearly identify the question being answered.
• This is a closed book exam. One double-sided 8.5'x11' hand-written aid sheet containing formulas/notes is permitted. Non-programmable calculators are permitted.
• Pencil or pen may be used. However, papers written in pencil or papers with white outs will not be re-marked.

QuestionMarksMarks Awarded
1 25
2 30
3 20
4 15
5 10
Total100

• There are 14 pages in this exam.

QUESTION 1 – Total of 25 Marks

The Appendix (found on pages 12 to 14) contains financial statements for Mattel, Inc. Mattel is an American toy company. Use those financial statements to answer the questions below. Please note that you can detach (“rip out”) the Appendix for easier analysis.

a) Fill out the table below. For each of the 10 required ratios show the the calculation (i.e. which numbers you used in arriving to the final figure), and the result for fiscal years 2013 and 2012). (10 marks)

Ratio/Value / 2013 calculation and answer / 2012 calculation and answer
1. Current Ratio / 3378/1047=3.23x / 3557/1716=2.07x
2. Receivables Turnover / 6485/1260=5.15x / 6421/1227=5.23x
3. Average Collection Period / 365/5.15= 71 / 365/5.23x=70
4. Inventory Turnover / $3,006.0/569=5.28
/ $3,012.0/465=6.48
5. Average Days Sales in Inventory / 365/5.28= 69 days / 365/6.48=56.3 days
6. Payables Turnover / $6,485.0/375=17.3
/ $6,421.0/385=16.7
7. Average Days Sales in Payables / 365/17.3= 21.1 / 365/16.7= 21.8
8. Return on Common Shareholders' Equity / $904.0/3252=27.8%
/ $776.0/3067=25.3%
9. Free Cash Flow / $698.0-252 494= (-48)
/ $1,276.0-219-423= $634
10. Profit Margin / $904.0/6485=13.9%
/ $776.0/6421=12.1%

b) Given your analysis in (a) above, calculate Mattel's Operating Cycle and Cash Cycle for 2013. What can you conclude about the company? (6 marks)

• Operating cycle = Days in inventory + Days in receivables

= 69 days + (365/5.15 = 71 days. (2 marks)

• Cash cycle = Operating cycle – Days in payables

= 71 days - 21 days = 50 days (2 marks)

The company pays its suppliers about 30% more quickly than it gets paid on its receivables - inventory turnover is slowing down all of which can possibly explain the negative free cash flow in 2013 (2 marks)

c) Mattel uses the FIFO (First-in First-out) method to determine its cost of inventory. Briefly explain how this method would impact the company's Cost of Goods Sold, Profit Margin, Ending Inventory and Retained Earnings? (5 marks)

Cost of Goods Sold - lowest (1 mark)

Profit Margin - highest (1 mark)

Ending inventory - highest (1 mark)

Retained Earnings - highest (2 marks)

d) At what point should Mattel recognize revenues from toy sales? Make sure you justify your answer with references to all GAAP requirements for revenue recognition. (4 marks)

Recognize when: (3 marks)

1) Performance complete / Earned (risks and rewards transfer to buyer upon sale)

2) Measurable (at sale, know price)

3) Collectible (paid at sale, so no questions)

Therefore, at sale (1 mark)

Question 2 – Total of 30 Marks

NewCompany Incorporated (NCI) began operating on May 1, 2014. The transactions for the month of May are presented below.

1. May 1Shareholders invested $30,000 cash in the business and were issued common shares.
2. May 2Purchased land costing $25,000 for cash.
3. May 4Purchased equipment costing $8,000 for $3,000 cash and the remainder on account.
4. May 5 Purchased inventory on account for $2,000.
5. May 10 Paid $1,000 rent for the month of May.
6. May 15 Received $3,000 cash for inventory sold.
7. May 17 Invoiced a customer for $4,000 for sale of merchandise.
8. May 31 Paid wages to employees for $4,000.

a) Prepare journal entries for each of the above transactions using the table format below. If you need to make any assumptions, please state them clearly. (9 marks)

1 mark each (except for May 4th entry – 2 marks)

May. 1Cash ...... 30,000

Common Shares ...... 30,000

2Land ...... 25,000

Cash ...... 25,000

4Equipment ...... 8,000

Cash ...... 3,000

Accounts Payable ...... 5,000

5Inventory ...... 2,000

Accounts Payable ...... 2,000

10Rent Expense ...... 1,000

Cash ...... 1,000

15Cash ...... 3,000

Sales Revenue ...... 3,000

17Accounts Receivable ...... 4,000

Sales Revenue ...... 4,000

31Wages Expense ...... 4,000

Cash ...... 4,000

b) Prepare an income statement, balance sheet and cash flow statement for May as at May 31, 2014. (17 marks)

Statement of Earnings, Month Ended May 31, 2014

Revenues

Sales revenue$ 7,000

Expenses

Wages expense$4,000

Rent expense 1,000 5,000

Net earnings$ 2,000

(4 marks)

Balance Sheet, as at May 31, 2014

Current assets

Cash $0

Accounts receivable $ 4,000

Inventory $ 2,000 $6,000

Property, plant, and equipment

Land $25,000

Equipment 8,000 33,000

Total Assets$ 39,000

Liabilities

Accounts payable$ 7,000

Shareholder’s equity

Common shares$30,000

Retained earnings 2,000 32,000

Total liabilities and shareholder’s equity$ 39,000

(8 marks)

Cash Flow Statement, Month Ended May 31, 2014

Operating Activities

Net earnings2,000

Change in non-cash working capital

Increase in assets(6,000)

Increase in liabilities 7,0001,000

Cash Flows from Operating Activities3,000

Investing Activities

Fixed asset purchases(33,000)

Cash Flows from Investing Activities(33,000)

Financing Activities

Common shares issued30,000

Cash flows from Financing Activities 30,000

Cash, beginning of month0

Cash, end of month0

(5 marks)

a)

b)

c) Given your results from part b) can you spot a potential problem for NewCompany? What should the company be doing at this point? Propose 3 possible solutions to their problem. (4 marks)

company has a cash position of 0 and should be ordering more inventory for sale to customers (1 mark)

Solutions:

1) company can issue more equity or 2) get a bank loan or 3) speed up receivables or 4) not pay its employees (delay wages) (any 3 of the 4)

Question 3 – Total of 20 Marks

Shifting Gears Inc. (“SGI”) manufactures transmissions for North American car manufacturers. Presented below is a variable costing income statement for the most recent year ended December 31, 2013:

Bundy Corporation

Income statement

For the year ended December 31st

Sales $1,800,000

Variable costs:

Manufacturing 630,000

Selling and administrative 360,000

990,000

Contribution margin 810,000

Fixed costs:

Manufacturing 180,000

Selling 225,000

Administration 90,000

495,000

Operating income 315,000

Income taxes (40%) 126,000

Net income $189,000

SGI sold 900 units during 2013 and has a capacity to produce 1500 units/year.

Required

(Answer each question independently based on the original data)

a) What is the break-even point in units for SGI? (3 marks)

CM / unit = $810,000 / 900 units = $900 (1 mark)

Break-even point = $495,000 / $900 = 550 units (2 marks)

b) SGI predicts sales of 1,050 units next year. If prices and costs remain consistent, what will after-tax net income be? (3 marks)

[(1,050 units × $900) – $495,000] (2 marks) × (1 – 40%) (1 mark) = $270,000

c) A company executive has suggested that SGI can increase sales by 10% if they cut the selling price by 7% and incur additional promotion expenses of $35,000. Is this recommended? (5 marks)

(0.93(2000) – 1100) × (900 × 1.1) – 495,000 – 35,000 =

(760 × 990) – 595,000 = 224,200 (new operating income) (4 marks)

This is not recommended (1 mark) as it operating income from $315,000 to $224,200

d) SGI is planning to market and sell its transmissions to foreign car manufacturers and estimates that marketing in these new locations will cost the company an additional $123,000 for each of the next three years. SGI also expects to pay a $50 per unit commission to the salespeople in these new locations. Assuming all other costs remain the same, how many units would need to be sold in the foreign countries to maintain SGI’s current after-tax net income? (3 marks)

To maintain current income level, we just to break even in the foreign countries. Break-even point in the new location:

CM / unit = $900 – 50 = $850 (1 mark)

Incremental fixed costs = $123,000

Break-even point for new location = $123,000 / $850 = 144.71 units (round up to 145) (2 marks)

e) SGI estimates that the selling price for products will decrease by 10 per cent this year while variable costs will increase by $80 per unit and fixed costs would remain the same. What sales volume in dollars would be required in order to achieve a target after-tax net income of $195,000? (6 marks)

New selling price = $1,800,000 / 900 units = $2,000 × 90% = $1,800 new price (1 mark)

New variable cost per unit = $990,000 / 900 units = $1,100 variable costs + $80 = $1,180 (1 mark)

New CM / unit = $1,800 – $1,180 = $620 (1 mark)

CM ratio = $620 / $1,800 = 34.44% (1 mark)

Operating (before tax) income = 195,000/.6 = $325,000 (1 mark)

Sales = ($495,000 + $325,000) / 34.44% = $2,380,952 (1 mark)

Question 4 – Total of 15 Marks

Holy Cow Manufacturing Company uses a special alloy in its manufacturing process. In 2013, the beginning inventory and the purchases of the special alloy during the year were as follows:

kg Price/kg

January 1 Inventory 300 $11.50

April 12 Purchase 400 12.00

July 7 Purchase 240 11.70

November 2 Purchase 320 12.30

Holy Cow uses a periodic inventory system. A physical inventory count of the inventory showed that 360 kg of the special alloy were still on hand as at December 31, 2013.

Instructions

a) Determine the dollar value of the December 31, 2013, ending inventory and cost of goods sold using:

i) FIFO (5 marks)

FIFO Ending Inventory

320 kg at 12.30 = $3,936 (1 mark)

40 kg at 11.70 = 468 (1 mark)

360 kg $4,404

Cost of Goods Sold (FIFO): $14,994 (available for sale) – 4,404 = $10,590 (3 marks)

ii) Weighted Average Cost (6 marks)

Weighted Average Cost Ending Inventory

kg Cost/kg

January 1 Inventory 300 x $11.50 = $3,450

April 12 Purchase 400 x 12.00 = 4,800

July 7 Purchase 240 x 11.70 = 2,808

November 2 Purchase 320 x 12.30 = 3,936

1,260 $14,994

$14,994/1,260 kg = $11.90/kg (2 marks)

Ending Inventory: 360 kg x $11.90/kg = $4,284 (2 marks)

Cost of Goods Sold (WA): $14,994 (available for sale) – 4,284 = $10,710 (2 marks)

b) Assume that the accountant did not take into account the fact that a portion of the 360kg on hand on December 31, 2013 was actually being held on consignment for another company. What impact would this error have Holy Cow’s financial statements in both 2013 and 2014, assuming that the error was not discovered and corrected until the inventory was counted again in December 2014? (4 marks)

Overstate ending inventory 2013 (1 mark)

Understate cost of goods sold in 2013 (1 mark)

Overstate opening inventory in 2014 (1 mark)

Overstate cost of goods sold in 2014 (1 mark)

Question 5 – Total of 10 Marks

a) Explain the difference between a “product cost” and a “period cost” from a financial reporting perspective. (4 marks)

Product cost (2 marks)

– Appear “above the line” in calculation of gross margin

– Inventoried if unsold at end of period.

Period cost (2 marks)

– Appear “below the line” in calculation of operating income.

– Expensed in the period they are incurred (regardless of whether inventory is sold)

b) Classify each of the costs below as a period cost or a product cost. (6 marks)

Cost Item / Product Cost? / Period Cost?
Raw materials used in production / 
Cost of shipping a product to a customer /  / 
Factory utility costs / 
Salary of the CEO /  / 
Salary of the factory supervisor / 
Depreciation of office equipment /  / 

1 mark for each correct answer = total of 6 marks

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