LINGNAN UNIVERSITY

DEPARTMENT OF ACCOUNTING AND FINANCE

DIPLOMA IN FINANCE PROGRAMME

FINANCIAL REPORTING AND FINANCIAL STATEMENT ANALYSIS

EXAMINATION, 2001-2002

TIME ALLOWED: 2 HOURS

Lecturer : Dr. Shimin Chen

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PART A : MULTIPLE CHOICES (2.5 marks each)

1.

B

Which of the following is not characteristic of financial accounting?

a. Information used in financial statements is prepared in conformity with generally accepted accounting principles.

b. The information is confidential and is intended for use only by company management.

c. The information is used in a wide variety of business decisions.d. The information is developed primarily by “private accountants” that is,

accountants employed by business organizations.

2.

A

Each of these categories of assets is shown in the balance sheet at current value, except:

a. Inventories.b. Accounts Receivable.c. Short term investments in marketable securities.d. Cash

Use the following data for questions 3 to 5.

At the end of January, the unadjusted trial balance of Viewpoint, Inc., included the following accounts:

Debit CreditSales (90% represent credit sales) …………………… $800,000Accounts Receivable ………………………………… $550,000Allowance for Doubtful Accounts …………………… 4,280

3.

D

Refer to the above data. Viewpoint uses the balance sheet approach in estimating uncollectible accounts expense, and aging the accounts receivable indicates the estimated uncollectible portion to be $16,600. What is the amount of uncollectible accounts expense recognized in Viewpoint’s income statement for January?

a. $14,940.b. 20,880.c. $16,600.d. $12,320.

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4.

A

Refer to the above data. Viewpoint uses the balance sheet approach in estimating uncollectible accounts expense, and aging the accounts receivable indicates the estimated uncollectible portion to be $16,600. The net realizable value of Viewpoint’s accounts receivable in the January 31 balance sheet is:

a. $533,400.b. $537,680.c. 545,720.d. 529,120.

5.

C

Refer to the above data. Viewpoint uses the income statement approach in estimating uncollectible accounts expense, and uncollectible accounts expense is estimated to be 2% of credit sales. What is the amount of uncollectible accounts expense recognized in Viewpoint’s income statement for January?

a. $10,120.b. $11,000.c. $14,400.d. $16,000.

6.

B

In a perpetual inventory system, an inventory flow assumption is used primarily for determining which costs to use in:

a. Recording purchases of inventory.b. Recording the cost of goods sold.c. Recording sales revenue.d. Forecasts of future operating results.

7.

D

Which of the following results in the cost of goods sold being stated at the most current acquisition costs?

a. Average cost.b. Specific identification.c. FIFO.d. LIFO.

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Use the following data for questions 8 and 9.

Chang Wholesale Co. started carrying a new product in December. Purchases and sales of this product during the month were:

Dec 20 Purchased 100 units at $90 per unit.Dec 26 Sold 80 units.Dec 28 Purchased 100 units at $100 per unit.

8.

B

Refer to the above data. Assuming the LIFO flow assumption is in use, the perpetual inventory records will indicate an ending inventory of this product of:

a. $11,000.b. $11,800.c. $12,000.d. Some other amount.

9.

A

Refer to the above data. At year-end, Chang restates the carrying value of its inventory using periodic LIFO costing procedures. Under periodic costing procedures, the LIFO cost of the inventory is:

a. $11,000.b. 11,800.c. $12,000.d. Some other amount.

10.

A

Global Industries acquired new electrical generating equipment. During installation of the equipment, a number of regulating circuits were accidentally damaged by Global employees. The cost to replace these circuits totaled $3,750. One of Global’s accountants recorded the $3,750 as a capital expenditure. As a result of this accounting treatment:

a. Net income for Global will be overstated in the current year and understated in each year of the equipment’s economic lifetime.

b. Net income for Global will be understated in the current year and overstated in each year of the equipment’s economic lifetime.

c. The balance in the equipment account will be overstated but net income will be unaffected.

d. The balance in the equipment account will be understated but net income will be unaffected.

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11.

B

Carter Co. and Greer Corp. purchased identical plant assets, and both companies estimated the useful life at 10 years with no salvage value. Cater uses straight-line depreciation in its financial statements, whereas Greer uses an accelerated method.

a. Over the life of the asset, Greer will recognize more depreciation expense than Carter.

b. In the tenth year of ownership, Carter will recognize more depreciation expense on this asset than Greer.

c. If the asset is sold after 4 years, Carter is more likely to report a gain than is Greer.

d. In its income tax return, only Greer may depreciate this asset by the MACRS method.

12.

A

Lawson Instrumentation sold a depreciable asset for cash of $200,000. The original cost of the asset was $500,000. Lawson recognized a gain of $10,000 on the sale. What was the amount of accumulated depreciation on the asset at the time of its sale?

a. $310,000b. $190,000c. $490,000d. $300,000

13.

D

From the viewpoint of stockholders or potential investors, which of the following cash flow measurements would be of least importance?

a. The dollar amount of net cash flow from operating activities for the current year.

b. The trend in net cash flow from operating activities from year to year.c. The corporation’s free cash flow for the current year.d. The dollar amount of overall increase or decrease in cash for the current

year.

14.

C

During 2001, Garwood Corporation made loans of $150,000 to a major customer. By the end of 2001 the customer had paid back $60,000 of the loan plus interest of $12,000. In the statement of cash flows for 2001, Garwood Corporation would report:

a. A net decrease in cash and cash equivalents of $78,000 for 2001.b. $78,000 net cash used for investing activities.c. $90,000 net cash used for investing activities, and $12,000 cash received

from operating activities.d. $150,000 net cash used for investing activities, and $72,000 net cash

provided by financing activities.

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15.

D

Johnson Company reported net income of $520,000 for 2001. Balances of selected current asset and current liability accounts are as shown on the indicated dates:

Jan. 1, 2001 Dec. 31, 2001Accounts receivable $60,000 $69,200Inventory 130,000 142,000Accounts payable 54,000 49,000

Depreciation expense for 2001 amounted to $68,000. Using only the above information, compute Johnson’s net cash flow from operating activities (indirect method) for 2001:

a. $595,000.b. $425,800.c. $571,800.d. $561,800.

16.

A

DataLife Company uses the indirect method to prepare its statement of cash flows. The following information has been gathered for the current period:

Gain on sale of marketable securities $62,000Net income 142,000Depreciation expense 54,000Cash received from sale of marketable securities 303,000Increase in inventory 8,000Decrease in accounts receivable 3,000Decrease in accounts payable 10,000

On the basis of the above information only, DataLife Company’s statement of cash flows shows net cash flow from operating activities to be:

a. $119,000.b. $181,000.c. $522,000.d. $249,000.

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PART B: QUESTIONS

QUESTION 1 (20 marks)

Given below are comparative balance sheets and an income statement for the Richmond Corporation:

Richmond CorporationBalance Sheets – 2000 Richmond Corporation

Income Statement for 2000Dec.31 Jan. 1Cash $30,000 $28,000 Sales $410,000

Accounts receivable 90,000 74,000 Cost of goods sold (234,500)

Inventory 64,000 70,000 Gross profit on sales $175,500

Equipment (net) 110,000 130,000 Operating expenses (115,900)

$294,000 $302,000 Operating income $59,600

Accounts payable 50,000 56,000 Interest expense and income taxes (12,450)

Dividends payable 16,000 8,000 Net income $47,150

Long-term note

payable

28,000 28,000

Capital stock, $10 par 140,000 140,000

Retained earnings 60,000 70,000

$294,000 $302,000

All sales were made on account. Cash dividends declared during the year totaled $57,150.

1. Compute the following:

a Average accounts receivable turnover: 410,000/82,000 = 5

b Average inventory turnover: 234,500/67,000 = 3.5

c Earnings per share of capital stock: 47,150/14,000 = $3.37

d Book value per share of capital stock at year-end: 200,000/14,000 = 14.29

e Current ratio at year-end: 184,000/66,000 = 2.79

f Quick ratio at year-end: 120,000/66,000 = 1.82

g Debt ratio at year-end: 94,000 / 294,000 = 32%

h Operating expense ratio: 115,900/410,000 = 28%

i Return on assets: 59,600/298,000 = 20%

j Return on common stockholders’ equity: 47,150/205,000 = 23%

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2. Assume the role of a short-term creditor for the following:

a. If this company grants 30-day credit terms to its customers, did it do a good job in accounts receivable collection during 2000? Explain.

Days in accounts receivable is 365/5 = 73, which is more than double the 30-day credit term. The collection of receivables must be lagged.

b. Determine days in operating cycle for this company. Briefly discuss how this company can shorten its operating cycle.

Operating cycle = (365/5) + (365/3.5) = 73 + 104 = 177 daysFirst, the company should try to cut down inventory on hand to improve inventory turnover. Second, the company can improve on accounts receivable collection.

c. Explain whether you feel safe to lend this company $50,000 for six months.

The company is in a good liquid position right now. Even with this additional loan, the current and liquid ratios will still be around 1.59 and 1.03. So it is safe to lend to this company.

3. Explain whether you are willing to lend this company $50,000, which is your lifetime saving, on a long-term basis to earn 10% annual interest.

Yes, I will be willing to lend to this company on a long-term basis to earn 10% interest. The company’s debt ratio is only 32% and the interest coverage ratio is more than 4.79 (59,600/1,245).

4. Assuming the current stock price of $50, explain whether this company’s stock is attractive to a potential equity investor.

The company’s P/E ratio of 50/3.37 = 15 is very reasonable and its profitability is very high. Thus, the stock price seems attractive.

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QUESTION 2 (20 marks)

1. The balance sheet was as follows for Hartman Ceramics on February 1, 2000:

HARTMAN CERAMICSBalance Sheet

February 1, 2000

Assets Liabilities & Stockholder’s EquityCash $7,000 Liabilities:Accounts receivable 5,200 Notes payable $40,000Land 80,000 Accounts payable 6,000 Building 50,000 Total liabilities $46,000Equipment 30,000 Stockholder’s equity:

Capital stock $100,000Retained earnings $26,200 $126,200

Total assets $172,200Total liabilities and Stockholder’s equity $172,200

During the first week of February, the following transactions occurred:

- The business collected $4,000 of its accounts receivable.- Additional capital stock was issued to Dee Hartman for $15,000 cash.- Equipment was purchased on credit for $1,800.- The business paid off $5,000 of its accounts payable. (No payment was made on

the notes payable.)

Complete the balance sheet for Hartman Ceramics at February 8.

HARTMAN CERAMICSBalance Sheet

February 8, 2000

Assets Liabilities & Stockholder’s EquityCash $21,000 Liabilities:Accounts receivable 1,200 Notes payable $40,000Land 80,000 Accounts payable ____2,800Building 50,000 Total liabilities $42,800Equipment 31,800 Stockholder’s equity:

Capital stock $115,000Retained earnings __26,200 __141,200

Total assets $184,000Total liabilities and Stockholder’s equity $184,000

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2. Several years ago, Ecology Systems issued $100 million of 30-year, 7% bonds payable at a small premium. Since the bonds were issued, Ecology’s financial strength and credit rating have actually improved, but today the bonds are trading among investors at a price of 98% of the face value.

a. Explain the most probable reason why the market price of these bonds has declined, even though Ecology’s credit rating has improved.

The market interest rates must have increased since the issuance of the books.

b. How will the drop in the market value of these bonds be reported (if at all) in Ecology’s income statements and balance sheets? Explain.

The drop in market value affects investors directly. There is no direct impact on the company’s financial statements.

3. Shown below is information relating to the stockholders’ equity of Business Products, Inc.:

6% cumulative preferred stock, $100 par, callable at $105 $1,800,000Common stock, $5 par, 500,000 shares authorized 2,000,000Additional paid-in capital: common stock 6,800,000Retained earnings 850,000Dividends in arrears on preferred stock, 1 full year ?

From the above information, compute the following:

A Number of shares of preferred stock issued and outstanding:1,800,000/100 = 18,000

B Average issue price per share of common stock:(2,000,000+6,800,000)/400,000 = 22

C Total paid-in capital: 10,600,000

D Total stockholders’ equity: 11,450,000

e Book value per share of common stock:(11,450,000 – 6% x 1,800,000 – 105 x 18,000) / 400,000 = 23.63

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QUESTION 3 (20 marks)

Shown below is information relating to operations of Talbot Industries for 2001:

Continuing operations: Net sales $7,000,000 Costs and expenses (including income taxes) 6,100,000Other data: Current-year loss from the segment discontinued at the end 2001 (net of income tax benefit) 100,000Gain on disposal of discontinued segment (net of income taxes) 200,000Prior-period adjustment (decrease in prior years’ income net of tax benefit) 500,000Cumulative effect of change in accounting principle (decrease in net income, net of related income tax benefit) 250,000Extraordinary loss (net of income tax benefit) 350,000Cash dividends declared 600,000

1. Complete the income statement including earnings per share figures. Talbot has 100,000 shares of $1 par value common stock and 20,000 shares of 10%, $100 par value preferred stock outstanding throughout the year.

TALBOT INDUSTRIESCondensed Income Statement

For the Year Ended December 31, 2001

Net salesCosts and expensesIncome from continuing operationsDiscontinued operations

Operating loss (net of tax)Gain from disposal (net of tax)

Income before extraordinary itemsExtraordinary loss (net of tax)Accounting changes (net of tax)Net income

(100,000) 200,000

(350,000)(250,000)

$ 7,000,000 (6,100,000)

900,000

100,0001,000,000

(600,000) 400,000

Earnings per share:Earnings form continuing operations

(900,000 – 200,000) / 100,000Gain from discontinued operations (100,000/100,000)Earnings before extraordinary itemsExtraordinary loss (350,000/100,000)Accounting charge (250,000/100,000)Net income

$ 7.00 1.00 8.00

(3.50) (2.50)

2.00

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2. Briefly explain why non-recurring items are presented net of income tax.

The income tax expense on the income statement is based on income from continuing operations, but the income tax is assessed based on net income.

3. Compute dividends per share of common stock.

(600,000 – 200,000) / 100,000 = $4

4. What would Talbot’s net earnings per share have been for 2001 if it had not sold the segment at year-end?

$2 - $2 = 0

5. Assume that for 2002 you expect a 5% increase in Talbot’s profitability. Given all the other information in the original question, what would you forecast as the company’s estimated net earnings per share for 2002?

(900,000 x 1.05 – 200,000) / 100,000 = $7.45

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