Reference no: EM131126186

Problem 1

Conaway Company purchased a machine for cash on January 1, 1998. The price was $31,000. In addition, Conaway incurred costs of $200 in transporting the machine to the factory site and a further $800 in installing the machine. The machine was expected to produce 100 million meters of electric cable over its useful life of 5 years, at the end of which time it was expected to have scrap value of $2,000. 30 million meters of cable were produced in 1998.

In early January 1999, the motor of the machine burnt out unexpected¬ly. Conaway replaced the motor at a cost of $5,000. The useful life of the machine was not expected to be extended by the new motor. In 1999 Conaway produced 20 million meters of cable.

On January 1, 2001, Conaway sold the machine to Baril Inc. for $25,000.

Conaway's income tax rate is 40 percent. Conaway uses straight line depreciation.

Required

1. What was the cost assigned to the machine on Conaway's books when it was purchased?

2, Make the journal entry for the replacement of the motor in 1999.

3. What is the depreciation that Conaway recorded on the machine in 1998 and 1999?

4. Make the journal entry for depreciation of the machine for the year 1998.

5. What is the gain or loss that Conaway recorded on the sale of the machine?

6. What is the depreciation that Conaway would have recorded on the machine in 1998 and 1999 if it had used (a) the units of production method, (b) the sum of the years digits method and (c) the double declining balance method?

7. Assume that when the motor burnt out and the new motor was put in, Conaway reassessed the remaining useful life of the machine to be 3 years rather than 4, with no salvage value. Compute depre¬ciation for 1999, using the straight line method.

Problem 2

Basic Research Corporation (BRC) was in the business of develop¬ing new products for the pharmaceutical industry. Amounts spent on research and development were expensed as incurred. In 1999, Giant Drug Co (GDC) acquired BRC for $20 million, GDC acquired tangible assets worth $1.2 million and intangible assets valued at $17.8 million (consisting of patents developed by BRC). GDC chooses to amortize the acquired patents over five years and goodwill over forty years, both on a straight line basis.

Required:
A. Compute the amount assigned to goodwill in GDC's books as a result of the acquisition.

B. What is the explanation for GDC's accounting for the patents, considering that these did not appear as assets on BRC's books?

C. Compute GDC's amortization expense for 2000, assuming that the only relevant items are the assets acquired in the BRC transaction.

 

Problem 3

Klaxon Action, Inc. (KA) operates a string of video game arcades. KA is currently revising its policy on depreciating the video game units. KA's experience has shown that the useful economic life of the typical game machine is three years. Although the game will physically last much longer, it generally does not hold enough interest for the clientele to justify occupying the floor space after three years. Given the obsolescence factor, used machines can typically be sold for only five to ten percent of their original purchase price.

In general, a new game takes in the most cash, since it takes a while for their "regulars" to learn to master it. Also, once mastered, a game remains popular for a while since the "pros" like to show off and set records. These two phases of a game's life take up about one year and account for about one-half the game's lifetime (i.e., three-year) revenues.

KA's management wishes to establish a depreciation policy that will match the cost of the machine to the revenues produced by the machine on a more-or-less relative basis. However, they want a time-based approach (i.e., not "units-of-production").

REQUIRED:

(a) KA has just purchased "77 Moebius Strip" for $3200. They expect to use it for three years and then scrap it for $200. Calculate the depreciation expense for year two for this machine under straight-line, double declining balance, and sum-of-years-digits methods.

(b) Which method would you recommend to KA? Why?

Problems to Chapter 11:

Problem 1

On January 1, 1995, Megafloat Corporation sold 100,000 bonds
with the following characteristics:

1. Face value, $1000 each
2. Coupon rate of 13%
3. payment schedule 1/1 and 7/1
4. maturity date January 1, 2005
5. effective interest rate (yield) of 12%

REQUIRED:

(1) What was the total amount received for the bonds?

(2) What was the total interest expense related to this bond on Megafloat's 1995 income statement?

(3) Disregard your answers to parts (1) and (2). Assume that the market rate was not 12% and the issue sold at a dis¬count. Network television financial commentator Flint Buckmeister interpreted the result as follows: "It is evident that the Street doesn't have much confidence in Megafloat. Their bonds wouldn't sell without a dis¬count."

Is Flint right? If so, explain what he is talking about. If not, give the correct explanation.

Problem 2

On June 1, 19x2, Boston Beanery Inc. issued $10 million of 20 year, 10% coupon bonds. The semiannual interest bonds sold at face value.

REQUIRED: (1) In 19x4, the prevailing interest rate had increased to 12%. At what price could a single bond be purchased on the open market?

(2) In 19x6, rates were down to 8%. How much would a $1000 bond sell for under those circumstances?

(3) How would these changes in the prevailing interest rate affect the interest expense reported by Boston Beanery on its income state¬ment?

(4) Bonds are said to be relatively risk free investments in compari¬son to common stock. Is this true? Explain your position.

Problem 3

On January 1, 19x8, SBC issued bonds with face amounts total¬ling $1 million. The bonds had a 20 year term to maturity and a coupon rate of 10%, with annual payments on December 31. SBC received proceeds such that the effective yield was calculated to be 12%. SBC's fiscal year corresponds to the calendar year. Thus annual financial state¬ments are dated December 31.

REQUIRED:

(a) How much did SBC receive for the bonds?

(b) What interest expense related to the bonds did SBC report in 19x8?

(c) What did the net bond liability total on January 1,19x9?

(d) SBC had considered issuing zero coupon bonds instead of the standard bonds. Given the same market conditions, what would be the face value of zero coupon bonds that SBC would have had to issue in order to receive $1 million in proceeds?

Problem 4

"Steel" Wheeler, your obnoxious classmate, was reading the Wall Street Journal the other day in the MBA lounge. He peered over the top of the paper and said, to no one in particular," I see MegaTrump Co just issued its 10 year, 10 percent bonds at 12%. As you know, this will yield them a premium, indicating that the market thinks they are a solid bet in the future. It's a good deal for them, too, because their interest expense will only be 10% while their competi¬tors will have to borrow money in the bond market at the prevailing rate of 12%."

REQUIRED:In your most efficient style, avenge yourself for the embarrassment "Steel" caused you in last week's OB class by pointing out three serious misconceptions in his statement in front of the MBA Association president, Stephanie Goodfund, who has just walked in with a cup of coffee.

Problem 1

Joyful Company's December 31, 19x6 balance sheet shows the following in the stockholders' equity section:

Stockholders' Equity:
Paid-in-capital:
Preferred stock, 10 percent, $10 par,
authorized, issued and outstanding
50,000 shares $ 500,000
Common stock, $1 par, authorized
and issued 100,000 shares 100,000
Additional paid in capital 1,000,000
Retained earnings 1,400,000
less Treasury stock, 10,000 shares (300,000)
Total stockholders' equity $2,700,000

Net income in 19x7 was $250,000. At the end of 19x7, Joyful declared a cash dividend of $1 per share on common stock, in addition to the dividend on preferred stock.

Required

1. Compute earnings per common share for 19x7.

2. What will Joyful report on its December 31, 19x7 balance sheet as the retained earnings balance?

3. In early 19x8, when the price of Joyful's common stock was about $70, Joyful considered two choices, (1) issuing a 2-for-1 stock split or (2) issuing a 100 percent stock dividend. What is the likely effect of each alternative on (a) the market price per share of Joyful's common stock, (b) the book value per share of Joyful's common stock, (c) total stockholders' equity (d) the retained earn¬ings account.

4. "If the company goes into liquidation, each common shareholder will be paid the following amount: Par value per common share plus the proportionate (per share) amount of additional paid in capital plus the proportionate amount of retained earnings." Do you agree with this statement?

Problem 2

On December 31, 19x7, the stockholders' equity section of C'est Ennui, Inc. consisted entirely of the following items:

Common stock ($1 par, 15 million shares authorized) . 4,500,000
Additional paid-in capital . . . . . . . . . . . . . 96,250,000
Retained earnings . . . . . . . . . . . . . . . . . . 175,250,000
Total stockholders' equity . . . . . . . . . . . . .$276,000,000

During 19x8, the following events took place (treasury stock policy is to use the cost method):
MARKET PRICE
DATE: ACTIVITY: PER SHARE:
April 1, 19x8: Issued 450,000 shares. $50
August 28, 19x8: Issued 550,000 shares. $75
October 31, 19x8: Declared a two-for-one stock split.
Par value split as well. $50
November 10, 19x8: Bought back 20,000 shares from holders $52
December 7, 19x8: Declared dividends of $1.50 per share. $55 (ex dividend)
December 31, 19x8: Announced net income of $25.5 million. $58

"Market price per share" refers to the price at which the share was trading on the particular day.

REQUIRED

Prepare the stockholders' equity section, in good form, of C'est Ennui's December 31, 19x8 balance sheet.

Problem 3

Prey Inc's common shares were trading at $30 per share in January 19x9. The December 31, 19x8 balance sheet of Prey Inc. included the following information in the Stockholders' Equity section:
(thousands of dollars)

8% preferred stock, $100 par; 5,000,000 shares
authorized; 100,000 issued and outstanding $10,000
Common stock, $1 par; 10,000,000 shares
authorized; 2,000,000 issued 2,000
Additional paid in capital 21,200
Retained Earnings 16,000
Treasury Stock (200,000 shares) (7,000)
Total Stockholders' equity $42,200
Net Income in 19x8 amounted to $15,200,000

Required

1. Compute Prey Inc's book value per common share. Suggest two reasons why it may not be equal to the market price of the share?

2. Prey Company uses LIFO in accounting for its inventories, and additionally uses accelerated depreciation methods. Would the book value of common shares have been higher, lower or unaffected if it had used FIFO and straight line depreciation instead? Explain.

3. Compute Prey's earnings per common share in 19x8. What is the price-earnings ratio in January 19x9?

4. Assume that Prey Inc. declares a 2-for-1 stock split in January 19x9. How would this transaction affect (a) the market price, (b) the book value per share.

Problems to Chapter 14

Problem 1

Pearson Company supplies parts and products to Fee Line, Inc. and to Kay Nine & Co., manufacturers of pet products. Pearson buys standard parts and products from other sources, adapts them for use in pet products, and then sells them to manufacturers.

The market for pet products is experiencing rapid growth, and both Fee Line and Kay Nine, as well as six other large manufacturers of pet products, are expanding their operations. Claus Sharpe, the CEO of Pearson, believes that the time is right for Pearson to expand also.

In reviewing the financial statements for Pearson, Sharpe noted that the reported income was $10,000 and yet cash decreased. Being a bit confused by the apparent contradiction, Sharpe asked to see a state¬ment of cash flows. The accountant had not quite finished preparing this statement.

The statements prepared by the accountant appear on the next page.

REQUIRED:

(a) Complete the statement of cash flows in the space provided.

(b) How would you explain to Sharpe the "contradiction" he noticed?
(c) Comment on Pearson's ability to expand, citing evidence from:
(1) operating activities
(2) investing activities
(3) financing activities

Pearson Company
Income Statement
for the year ended December 31, 19x8

Net Sales $100,000
Cost of Goods Sold (45,000)

Gross Profit 55,000
Operating Expenses:
Depreciation expense $6,000
Other operating expenses 24,000 (30,000)

Income before taxes 25,000
Income Tax Expense (10,000)

Net Income $15,000

Pearson Company 

Comparative Balance Sheet
as of December 31, 19x8 and December 31, 19x7

December 31 December 31 1 19x8 19x7
¬ ASSETS
Cash $11,000 $15,000
Accounts Receivable 40,000 35,000
Inventories 110,000 100,000
Buildings & Equipment 300,000 260,000
less Accumulated Depreciation (81,000) (75,000)

net Buildings & Equipment 219,000 185,000
Land 25,000 35,000

Total Assets $405,000 $370,000
========= =========
LIABILITIES & OWNERS' EQUITY
Accounts Payable $68,000 $64,000
Accrued Wages Payable 2,000 1,000
Net Bonds Payable 80,000 90,000
Common Stock 200,000 170,000
Retained Earnings 55,000 45,000

$405,000 $370,000
========= =========

Pearson Company
Statement of Cash Flows
for the year ended December 31, 19x8

CASH FLOWS FROM OPERATIONS

CASH FLOWS FROM INVESTING ACTIVITIES
Sale of Land 10,000
Acquisition of Equipment (40,000)
-
Net Cash Used by Investing Activities (30,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of Common Stock 30,000
Retirement of Bonds (10,000)
Payment of Dividends (5,000)
-
Net Cash Provided by Financing Activities 15,000
INCREASE (DECREASE) IN CASH

Beginning Balance (cash)

Ending balance (cash)

Problem 2

GDM Company has the following balance sheet (in millions) on December 31, 19x7, shown with comparative numbers for 19x6.

19x7 19x6
Assets
Current assets:
Cash $ 25 $ 35
Accounts receivable 30 35
Inventory 50 35
Noncurrent assets:
Building and equipment
(net of accumulated depreciation) 100 80
Land 30 30
Investments 40 80
$ 275 $ 295

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable 35 25
Unearned revenue 10 35
Long term liabilities:
Notes payable 80 50
Stockholders' equity:
Common stock 50 50
Preferred stock 40 20
Retained earnings 60 115
$ 275 $ 295

The company had a net loss in 19x7 of $45 million, but it distributed a dividend of $10 million. Capital was raised by issuing notes for $40 million and preferred stock for $20 million. Payment of $10 million was made to retire long term debt during the period. Pro¬ceeds from the capital issues were used in part to acquire a building for $35 million. There was no sale of land or building during the year. Depreciation of $15 million was recorded. Investments were sold at a gain of $5 million.

Required

1. Prepare a Statement of Cash Flows, using the indirect method. Be sure to show working capital from operation clearly in computing cash from operations.

2. Briefly comment on the trends revealed by the statement you prepared in part 1.

Problem 3

The president of Watertown Wallets Company came to Midstate Bank for a loan. Watertown Wallets had been having a problem with cash. Despite growth in profits, the company had been facing a dwindling cash position, which puzzled the president. The president had prepared an estimate of the amount the company would need to borrow for the coming year, 19x9. The estimate is based on the following schedule.

Schedule of Cash Flows:

Cash Inflows:
Income $20,000
Depreciation 4,000
Gain on sale of old equipment 3,000
Proceeds on sale of old equipment 8,000
Bank Loan 12,000
$47,000

Cash Outflows:
Purchase equipment $30,000
Dividends 10,000
$40,000

"A loan of $12,000 will increase our cash position by $7,000," said the president. "As you can see from the statement, we plan to sell some of our old equipment for $8,000 to help out. We also plan to acquire some treasury stock for $5,000, but I haven't put that down on the schedule because that really is something that only affects the stockholders."

The bank manager determined that the amounts mentioned by the presi¬dent were correct. However, he also found out that Watertown Wallets Company's accounts receivable and inventory would increase by a total of $10,000 in 19x9, while current liabilities would increase by $5,000 over the same period. "I think that you may require more than $12,000 ," he said. "In that case," said the company president "perhaps we should increase depreciation by $5,000, and increase our funds that way."

Required
A. Prepare a projected Statement of Cash Flows in proper form, using the indirect method. (Include the amount of bank loan necessary to increase cash by $7,000. Use the old depreciation figure.)
B. What percentage of total uses of cash does the company intend to spend on stockholders? What percentage of total sources comes from operations?
C. Comment on the company president's suggestion to increase funds by increasing depreciation.

Problem 4

Venture Group, a venture capital organization, is considering whether to provide financing for Minitel Company. You are required to put together a cash flow statement for Minitel on the basis of the company's 19x9 income statement and balance sheet.
Minitel's income statement is summarized below:

Revenues $380,000
Expenses
Cost of goods sold $140,000
Selling and administrative exp 70,000
Depreciation 50,000
Income tax expense 45,000
305,000
Net income $ 75,000

Changes in the balance sheet amounts from the beginning of the year to the end of the year are summarized below:

1. Changes in assets:
Increase in cash $ 12,000
Increase in other current assets 30,000
Increase in land 150,000
Increase in equipment 15,000 *

* Increase in cost of equipment was $65,000 and increase in accumulated depreciation was $50,000

2. Changes in liabilities:
Increase in current liabilities $ 47,000
Decrease in note payable 60,000

3. Changes in stockholders' equity:
Increase in common stock and
additional paid in capital $145,000
Increase in retained earnings 75,000

The cash balance at the end of the year was $18,000.

Required

Prepare a cash flow statement in proper form, using the indirect method. Briefly comment on any interesting features of the state¬ment.