Questions of Chapter two

Question One:

Construct the B/S common size and analyze the performance of the company with the industry
average. The industry average indicators will be provided below.

Solution:
Chester Co.
Balance Sheet at December 31, 20XX
Assets Common size % Average industry
Current Assets
Cash $1,500 2.8 2.1
Accounts receivable 6,200 11.6 7.9
Inventory 12,400 23.2 5.3
Prepaid expenses 700 1.3 3.7
Total Current Assets $20,800 38.9 19
Property, plant and equipment 34,000 -
Less accumulated depreciation (10,500) -
Property, plant and equipment, net $23,500 44 60
Land held for sale 9,200 17.1 21
Fixed Assets 32,700 61.1 81
Total Assets 53,500 100% 100%
Liabilities and stockholders' equity
Current liabilities
Accounts payable $4,300 8 3
Notes payable 8,700 16.2 10
Accrued interest payable 1,400 2.6 2.1
Current portion of long-term debt 1,700 3.2 1.3
Total current liabilities $16,100 30 16.4
Deferred taxes payable 1,600 3 5.5
Bonds payable 14,500 27.1 13.5
Total liabilities $32,200 60.1 35.4
Stockholders' equity
Common stock 2,500 7.7 33
Additional paid-in capital 7,000 13.1 16.5
Retained earnings 11,800 22.1 15.1
Total stockholders' equity 21,300 39.9 64.6
Total liabilities and stockholders' $53,500 100% 100%
equity

The company is more liquid than the industry average. It is obvious from the indices related to
the current assets indicating the company should be able to pay current liabilities as they come
due. However, the company has lower investment in the fixed assets since they have more
liquidity than the industry level.

Consequently, the company’s short term liabilities are more than from the industry’s level
depending more on buying through credit from the suppliers. The industry level focus on long
term equities while covering capital expenditures indicating that the company has high leverage
in debts compared to the industry level.
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Question Two:
The king Co. has total annual revenue of $800,000, expenses other than depreciation of
$350,000, depreciation expenses of $200,000 for tax purposes and the depreciation expense of
$130,000 for reporting purpose. The tax rate is 34%. Calculate net income for reporting purpose
and for tax purpose. What is the deferred tax Liability?

Solution:
Tax Purposes Reporting Purposes
Revenue $800,000 $800,000
Expenses 550,000 480,000
Earnings before Taxes $250,000 $320,000
Tax Expense (34%) 85,000 108,800
Net Income $165,000 $211,200

Reported Tax Expense $108,800

Actual Taxes Paid (85,000)
Deferred Tax Liability $23,800
……………………………..……………………………………………………………….
Question Three:
Given the data below of the net income and Balance sheet of Segma Co. at 31/Dec 2012 and
2013, analyze the A/R and the allowance accounts in terms of the trend with sales for the two
years.
Item 2013 2012
 Net sales in $ 1,038,159 996,168
Total accounts receivables, net allowance for doubtful 176,917 168,732
accounts of 453 in 2013 and 669 in 2012 in $
Solution:
Change from
2012 to 2013
Net sales 4.2%
Total accounts receivables 4.7%
Allowance for doubtful accounts (32.3%)

Allowance account as a percentage of receivables:

Allowance for doubtful accounts Percentage of

Net Receivables + Allowance Receivables

$453
2013 0.26%
$176,917 + $453
$669
2012 0.39%
$168,732 + $669
Sales and accounts receivable have increased which is an expected pattern; however, it is
unusual for the allowance account to decrease. The allowance account as a percentage of total
accounts receivables indicates that the management at Segma believes that a higher percentage
of receivables will be collected compared to prior years as evidenced by the drop in the
allowance/accounts receivables ratio from 0.39% to 0.26%.
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Question Four

Solution:
(a) Information to be used for all methods of inventory valuation:

Units x Cost = Total

Beginning inventory 100 x $ 5 = $ 500
 Purchase 140 x 7 = 980
Purchase 200 x 8 = 1,600
Purchase 160 x 8.50 = 1,360
Total 600 $4,440
Sales for the year = 530 units
Ending inventory = 600 - 530 = 70 units
Weighted average cost per unit:
$ 4 ,440
=$ 7.40
600
COGS = $7.40 x 530 units = $3,922
EI = $7.40 x 70 units =$ 518
Total goods available for sale = $4,440

FIFO
COGS: EI:
100@$5 = $ 500 70@$8.50 = $ 595
140@$7 = $ 980
200@$8 = $1,600
90@$8.50 = $ 765
530 units $3,845
Check answer: COGS $3,845
+EI 595
Total goods available $4,440

LIFO
COGS: EI:
160@$8.50 = $ 1,360 70@$5 = $ 350
200@$8 = $ 1,600
140@$7 = $ 980
30@$5 = $ 150
530 units $4,090

Check answer: COGS $4,090

+EI $ 350
Total goods available $4,440

(b) FIFO

(c) LIFO

(d) During inflationary periods, LIFO assumes the last goods purchased have been sold and
the first goods purchased remain in ending inventory, therefore, LIFO produces an understated
inventory valuation on the balance sheet but a currently valued cost of goods sold on the income
statement, matching current costs with current revenues; FIFO which assumes the first goods
purchased have been sold and the last goods purchased remain in ending inventory results in a
currently valued balance sheet inventory but an understated cost of goods sold expense and thus
an overstatement of net income; average cost falls in between LIFO and FIFO.

Question Five

Solution:

Information to be used for all methods of inventory valuation:

Units x Cost = Total

Beginning inventory 10,000 x $3.00 = $ 30,000
January 10 purchase 4,000 x 3.50 = 14,000
April 25 purchase 10,000 x 4.00 = 40,000
July 10 purchase 6,000 x 4.50 = 27,000
October 15 purchase 8,000 x 5.00 = 40,000
Total 38,000 $151,000

Sales for the year = 8,000 + 11,000 + 3,000 + 9,000 = 31,000 units
Ending inventory = 38,000 - 31,000 = 7,000 units

FIFO

COGS: EI:
10,000@$3.00 = $ 30,000 7,000@$5.00 = $35,000
4,000@$3.50 = $ 14,000
10,000@$4.00 = $ 40,000 Check answer: COGS $116,000
6,000@$4.50 = $ 27,000 +EI 35,000
1,000@$5.00 = $ 5,000 Total goods available $151,000
31,000 units $116,000
LIFO (periodic)

COGS: EI:
8,000@$5.00 = $ 40,000 7,000@$3.00 = $21,000
6,000@$4.50 = $ 27,000
10,000@$4.00 = $ 40,000 Check answer: COGS $130,000
4,000@$3.50 = $ 14,000 +EI 21,000
3,000@$3.00 = $ 9,000 Total goods available $151,000
31,000 units $130,000

(b) LIFO produces an understated inventory valuation on the balance sheet but a currently valued
cost of goods sold on the income statement, matching current costs with current revenues; FIFO
results in a currently valued balance sheet inventory but an understated cost of goods sold
expense and thus an overstatement of net income; average cost falls in between LIFO and FIFO
and is a good choice for companies with volatile inventories.
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Question Six:

Solution:

(a) FIFO is probably used for the rest of Chemco's inventories. Companies using LIFO must
disclose the value of those inventories as if FIFO had been used, which Chemco has done in
this case.

(b) Finished goods include inventories that are complete and ready for sale. Work in process is
comprised of inventories currently in the manufacturing process, but not yet complete. Raw
materials and supplies have not been put in the manufacturing process. The amount closest to
current cost would be the FIFO inventory value. Under FIFO, the first goods purchased are
assumed sold, so the last goods purchased would be included in the inventory valuation and
would have been purchased at amounts closest to current costs. The LIFO valuation reduction
is a result of the impact of inflation on inventory values. Since the first goods purchased using
LIFO remains in inventory, LIFO inventories would be valued at a lower amount than FIFO
inventories during an inflationary period. Chemco's inventories are lower in 2015, ($447,866)
than they would have been if reported using FIFO ($531,695).
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Question Seven:

Solution:

$ 60 , 000
=$12 ,000
(a) 5 per year

(b) Year 1 $60,000 x 2/5 = $24,000

Year 2 ($60,000 - $24,000) x 2/5 = $14,400
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Question Eight:

Solution:
Using the equation from Chapter 2, the calculations to determine dividends are as
follows:

Beginning Ending retained

+ net income - dividends =
retained earnings earnings

2013 700 + 250 - 60 = 890

2014 890 + 225 - 70 = 1,045
2015 1,045 + 40 - 75 = 1,010