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15.515
Mid-term Examination
October 26, 1999
Student Name: _____________ANSWER KEY___________________________
Section/Sea:__ __________________________________________________
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•
•
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The exam consists of
1. This question and answer booklet numbered pages 1-8
2. A 3-page supplement with financial statement excerpts that are needed to answer questions
3, 4, and 5.
There are 100 points in total -- point allocations are stated at the beginning of each question.
Write your answers in the space provided, and show any computations you make.
Write as legibly as possible -- we can’t grade what we can’t read!
If a question is unclear, make an appropriate assumption that does not contradict any information
given in the question.
When you are finished, hand in BOTH the exam booklet AND the supplement material. Make
sure your name is written on the supplement.
Page 2 of 10
GOOD LUCK !!
Page 3 of 10
Question 1 (40 points)
For each of the following five transactions on pages 2, 3 and 4:
(a) record the accounting effect using EITHER a journal entry OR the Balance Sheet Equation (BSE). If you use the BSE approach,
be as specific about the accounts affected, and the amounts, as you would for a journal entry.
(b) Indicate the transaction’s effect on the Cash Flow Statement. Assume the indirect method for the Cash Flow Statement. If the
transaction does not affect the Statement of Cash Flows, then write “No effect.” Also, indicate the net cash effect on the section(s)
of the indirect Statement of Cash Flow affected by the transaction.
The first transaction is provided as an example.
Transaction
Cash Flow Statement
Accrue $80,000 of SG&A Expense, of which $25,000 is paid
Cash (A) = Accrued Expenses (L) + Ret. Earnings (E)
-25,000
+55,000
-80,000
Operating Section
Net Income 9 by $80,000
Add back $55,000 8 in
accrued expenses
OR
CFO 9 $25,000
Dr. SG&A Expense (E)
Cr. Cash (A)
Accrued Expenses (L)
$80,000
$25,000
55,000
Company receives $400,000 in exchange for stock and purchases $400,000 in
PP&E
Cash
+400,000
(400,000)
+
PPE
400,000
=
L
+
CC
+400,000
Investing Section
Purchase of PP&E
CFI 9 $400,000
(400,000)
Financing Section
Proceeds from issuance of stock
CFF 8 $400,000
400,000
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Transaction
Cash Flow Statement
Return period expires for previously delivered goods. No estimate of returns could
be made at the time when the goods were delivered to the customer, so profits were
deferred until after the return period expires. Invoice amount was $25,000; transfer
from Inventory was $7,000.
A
=
Deferred Income
(25,000)
7,000
+
OL
+
RE
25,000 Revenue
(7,000) CGS
Operating Section
Net Income 8 18,000
change in deferred income (18,000)
CFO unaffected
Company sells PP&E with net Book Value of $10,000 for $10,000 in cash. Asset
has been fully depreciated for tax purposes.
With an assumed tax rate of 0% (we will assume that was your explicit assumption)
Cash + NetPP&E = DTL + OL + RE
10,000
(10,000)
Investing Section
Proceeds from sale of PP&E
10,000
CFI 8 10,000
with taxes at an assumed rate of 30% you also have:
With an assumed tax rate of 30%
Cash + NetPP&E = DTL + OL +
10,000
(10,000)
RE
Operating Section
Change in other liabilities (3,000)
Page 5 of 10
(3,000)
CFO 9 3,000
(3,000)
Transaction
Cash Flow Statement
Sell Available-for-Sale Securities for $120,000. Purchase price of the securities was
$90,000; market value at the end of the last reporting period was $130,000. The tax
rate is 35%.
This is a bit complicated, so let’s break-out all the things that happen so you can see
the pieces:
Cash
RE
BB
120,000
30,000
(10,500)
(10,500)
+
AFS
+
AFSadj
+ OA
= DTL + OL + UG/L(SE)
Operating Section
Net Income 8 19,500
Gain on sale of AFS
Change in deferred tax liability
+
CFO 9
90,000
(90,000)
40,000
(10,000)
(30,000)
14,000
(3,500)
(10,500)
26,000
(6,500)
(19,500)
(19,500)
(10,500)
10,500
Investing Section
Proceeds from sale of AFS
CFI 8 120,000
120,000
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Company pays off outstanding long-term debt of $25,000.
Cash + OA
(25,000)
= LTDebt + OL
(25,000)
+ RE
Financing Section
Retirement of long term debt
CFF 9 25,000
Question 2: (30 points)
The following three ratios are commonly used in financial statement analysis:
• Current ratio (CR) = Current Assets/Current Liabilities, representing the company’s relatively
liquid resources available to meet the financial demands of the operating cycle;
• Return on Assets (ROA) = Net income/Total Assets, a profitability measure used to evaluate the
firm independent of capital structure;
• Debt to Equity (DE) = Total Long-term Debt/Total Shareholders Equity, a measure of long-run
solvency
For each of the 10 events shown below, indicate by a “+” (increase), “-” (decrease) or “0" (no effect)
how the events affect each of the three measures.
Treat each event independently, as the event occurs. The balance sheet accounts are calculated
using the most recent recorded amount (ending balance as of the event), while income statement accounts
are calculated from the start of the fiscal period through the event date. Any adjusting entry an event may
require at some later date should not affect your answer. The tax consequence of the transaction should
also not affect your answer, unless the transaction specifically involves taxes.
Assume that prior to each event, the firm has positive values for current assets, current liabilities, longterm liabilities, total assets, total equity and net income, while CR > 1, ROA < 1 and DE < 1.
The first transaction is provided as an example.
Transaction
CR > 1
ROA <
1
DE <
1
0. Rent prepaid in the previous year is expensed this year.
-
-
+
1. Trading securities portfolio increase in value by $10,000.
+
+
-
2. A machinery is acquired by issuing a $50,000 long-term bond.
0
-
+
3. The company sells $100,000 worth of merchandise at 50% gross
margin. All sales are on account.
+
+
-
4. Merchandise worth $50,000 is purchased by the company for
cash. The company uses LIFO.
0
0
0
(
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5. The company estimates that 2% of credit sales will not be
collected. The allowance method is used.
-
-
+
6. Payment from customer receivables received, total $75,000.
0
0
0
7.Income tax expense of $50,000 was recognized. Of this amount,
$35,000 is taxes payable and the rest is deferred to account for
differences in the tax accounting for depreciation.
-
-
+
8. Depreciation of $6,500 for equipment unrelated to manufacturing is
charged for the period.
0
-
+
9. Obsolete merchandise worth $2,000 written off as worthless.
-
-
+
10. Cash payment of $10,000 received from customers who elected
to have extended warranty on their purchased goods. These
warranties are likely to be serviced next year.
-
-
0
Question 3 (10 points)
In answering this question refer to the excerpts of the financial statements from The Gap, Inc. and
Land’s End. Be sure to identify where you found the information.
a.
Calculate a comparable measure of gross margin for The Gap, Inc and Land’s End for fiscal year
1996 (ending in January or February of calendar year 1997) for each company. (5 points)
Ending inventories were found in the Balance Sheet, with the Inventory Method and LIFO
Reserve are found in the Notes. CGS are found in the Income Statement.
GAP
Land’s End
(5,284,381 - 3,285,166) / 5,284,381
(1,118,743 - (609,168 - )LIFO Reserve)) / 1,118,743
= 37.8%
(1,118,743 - (609,168 - 100,700)) / 1,118,743
(1,118,743 - 508, 468) / 1,118,743
610,275 / 1,118,743
= 54.6%
Note: if you fail to convert Land’s End from LIFO to
FIFO you would get a Gross Margin of
509,575 / 1,118,743 = 45.5%
While still greater than The GAP’s, understates their
relative profitability.
b.
Land’s End is often cited by the financial press as the industry leader in the management of
inventory. One such measure is inventory turnover, which is calculated by taking the ratio of cost of
goods sold and the average inventory. Using The Gap, Inc. as a base case, evaluate whether
Land’s End’s reputation for the best company in the industry in the efficient handling of their
inventory is supported by the fiscal year 1996 numbers in the financial statements. (5 points)
First, we make the numbers comparable by calculating the ITO as if each were on FIFO,
which is the GAP’s method.
For The GAP
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CGS = 3,285,166
Avg Inventory (FIFO) = (578,765 + 482,575) /2 = 530, 670
ITO(FIFO) = 3,285,166 / 530,670 = 6.19
For Land’s End
CGS (LIFO) = 609,168
CGS (FIFO) = 508, 468
Avg Inventory (LIFO) = (142,445 + 164,816) /2 = 153,630.5
Avg Inventory (FIFO) = [(142,445 + 123,100) + (164,816 +
22,400)] /2
= 226,380.5
ITO(LIFO) = 609,168 / 153,630.5 = 3.97
ITO(FIFO) = 508, 468 / 226,380.5 = 2.25
Independent of the adjustment, Land’s End’s ITO is lower that The GAP. At
least in this dimension, Land’s End does not seem better than The GAP.
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Question 4 (10 points)
In answering this question refer to the excerpts of the 1998 financial statements from Green
Mountain Coffee, Inc. Be sure to identify where you found the information.
a.
Record in the balance sheet equation (or journal entry) the transaction to record bad debt expense in
1998. (3 points)
Cash + AR - Allowance for doubtful accounts + OA = L + SE
577 from SCF
(577)
b.
How much were Accounts Receivable (A/R) write-offs in 1998? (3 points)
BB and EB are found in the Balance Sheet.
BB + Bad Debt Expense - Write-Off = EB
116 +
577
X
= 378
So X = 315.
c. Were cash collections from customers above or below sales in 1998? By how much? (4 points)
You could do this intuitively by examining “Receivables” of 1,247 as the adjustment to Net
Income in the SCF. You subtract this because this amount represents increases in Net Income
that did not involve cash. Note: this is not equal to the change in Net AR on the Balance Sheet
because that amount includes, among other things, the estimated Bad Debt Expense. For
those of you who do recreational math, the derivation comes from the components of AR and
ADA:
AR gross98 = ARgross97 + Credit Sales - Cash Collections - Write-Offs + Reinstatements
ADA gross98 = ADA gross97 + Bad Debt Expense - Write-Offs + Reinstatements
AR gross98 - ADA gross98 = ARgross97 - ADA gross97 - + Credit Sales -Bad Debt Expense - Cash
Collections
AR gross98 - ADA gross98 and ARgross97 - ADA gross97 are just the Balance Sheet entries for Net AR
so, 4,789 = 4,119 - 577 + Credit Sales - Cash Collections, Y Credit Sales exceeded Cash
Collections by 1,247.
Question 5 (10 points)
The following questions related to excerpts from the financial statements of Lillian Vernon included
in the supplement. Be sure to identify where you found the information.
In 1998, the company sold fixed assets.
a. What was the net book value of the assets at the time of the sale? (4 points)
Proceeds - BV asset = Gain on sale of asset
7
X
= 7
BV asset = 0
b. What was the original purchase price of the assets that were sold? ( 3 points)
BB
+ additions
- depreciation
- disposals
= EB
PPE
66,519
3,122
AccDepr
27,146
4,672
(16)
69,625
(16)
31,802
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c. Record the sale of fixed assets in the Balance Sheet Equation (or journal entry). (3 points)
Cash
7
+
PPE
(16)
-
AccDepr +
(16)
OA
=
L
+
SE
7