JRE300: Fundamentals of Accounting and Finance
MIDTERM EXAMINATION (30% of Final Grade): Fall 2015
Time Allowed: 2 Hours
LAST NAME _________________________________________
FIRST NAME_________________________________________
STUDENT NUMBER:__________________________________
PLEASE INDICATE YOUR INSTRUCTOR:
S. Douglas___________
F. Tolias___________
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 or typed 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.
Question
Marks
1
17
2
17
3
11
4
10
5
15
6
30
Total
100
Marks Awarded
1
QUESTION 1 – Total of 17 Marks
You are the sole shareholder of a merchandising company called JBS Resellers Inc. The
company began operations on January 1, 2015. You have just approached the bank seeking
an operating line of credit. The bank has asked for a set of current quarterly financial
statements as a starting point in negotiations. The following business transactions occurred
during the first quarter ended March 31, 2015:
Jan 1
Shareholder invested $100,000 in exchange for common shares.
Jan 1
Signed a lease for office space on January 1st. The lease stipulated quarterly
payments, due at the beginning of each quarter, of $12,000. The first payment
was made at the time of signing.
Jan 3
Purchased 1000 units of inventory on account for $20,000.
Jan 20
Purchased office equipment for $6,000, paying $2,500 in cash and signing a 30
day note payable for the remainder.
Jan 26
Paid $20,000 in full settlement of the inventory purchase on January 3rd
Feb 20
Purchased 500 units of inventory on account for $12,000.
Feb 24
Paid the remainder to the amount owing on the equipment purchased on January
20th.
Mar 9
Received and paid bill for $1,500 for advertising for the current month.
Mar 20
Hired a part-time employee to assist with marketing. His start date is April 1st.
Mar 23
Sold 1200 units of inventory on account for $43,000. The terms of the shipment
were fob shipping point. The company uses a perpetual inventory system with a
first-in, first out policy for inventory.
Mar 31
Paid $1,000 cash dividends to shareholder.
The company intends to depreciate its office equipment on a straight-line basis over 5 years. It
is anticipated that the equipment will be worth $1,000 at the time it is sold. The CFO has
determined that bad debts average 2% of sales in this industry.
PART A (9 marks)
Journalize the transactions above using the correct account names. Be sure to include any
year-end adjusting entries. Also, if an entry is not required for a transaction, please explain.
2
JOURNAL ENTRIES – .5 mark each entry (except march 23 COGS entry= 1 full mark) = 6.5 (6 mark max)
Jan
1
1
3
20
26
Feb 20
24
Mar 9
Cash ...........................................................................................
Common Shares ...................................................................
100,000
Prepaid Rent ..............................................................................
Cash .....................................................................................
12,000
Inventory ...................................................................................
Accounts Payable .................................................................
20,000
Office Equipment .......................................................................
Note Payable ........................................................................
Cash......................................................................................
6,000
Accounts Payable .......................................................................
Cash .....................................................................................
20,000
Inventory ...................................................................................
Accounts Payable ..................................................................
12,000
Note Payable ..............................................................................
Cash .....................................................................................
3,500
Advertising Expense ...................................................................
Cash .....................................................................................
1,500
100,000
12,000
20,000
3,500
2,500
20,000
12,000
3,500
1,500
20
NO ENTRY – NOT AN ECONOMIC EVENT .....................................
23
Accounts Receivable ..................................................................
Sales Revenue .......................................................................
43,000
Cost of Good Sold .......................................................................
Inventory
24,800
23
43,000
24,800
($20 x 1000 + $24 x 200)
31
Dividends ...................................................................................
Cash .....................................................................................
1,000
1,000
ADJUSTING ENTRIES – 1 mark each entry = 3 TOTAL
31
31
Rent Expense .............................................................................
Prepaid Rent .........................................................................
12,000
Depreciation Expense .................................................................
Accumulated Depreciation ....................................................
250
12,000
250
3
($6,000-1,000)/5*3/12months (also accept 5,000/5*70/365days)
31
Bad Debt Expense ......................................................................
Allowance for Doubtful Accounts ..........................................
(2% * 43,000)
860
860
PART B (8 marks)
Prepare an income statement and balance sheet for the quarter ended March 31, 2015.
Statement of Earnings, quarter ended March 31, 2015
Sales revenue
Cost of Goods Sold
Gross Margin
$ 43,000
24,800
$ 18,200
Expenses
Advertising expense
Rent Expense
Depreciation Expense
Bad Debt Expense
Net earnings
$1,500
12,000
250
860
14,610
$ 3,590
Balance Sheet, as at March 31, 2015
Current assets
Cash
Accounts receivable
Inventory
Property, plant, and equipment
Trucks and Equipment
Accumulated Depreciation
Total Assets
Liabilities
Accounts payable
Shareholder’s equity
Common shares
Retained earnings
Total liabilities and shareholder’s equity
$ 59,500
$ 42,140
$ 7,200
$ 6,000
(250)
$108,840
5,750
$ 114,590
$ 12,000
$100,000
2,590
102,590
$ 114,590
4
QUESTION 2 - Total of 17 Marks
Part A (12 marks)
Terry Ltd. (“Terry”) is looking for ways to improve its working capital position and reduce its
reliance on external financing to fund operations. To that end, Terry is considering a change in
its credit policy. Terry currently offers terms of 2/10, net 45 to its credit sales customers, which
is more lenient than other companies in the same industry. Unfortunately, Terry has seen its
bad debt costs increasing and sales volume has leveled off despite growth in the industry. Terry
is considering changing its trade credit terms to be more in line with their competitors. The new
credit terms would be 1/10, net 30.
The management at Terry has provided the following information:
1. Sales are expected to decrease by 5% from the current level of $26,000,000 annually.
Variable costs on sales will remain at 40%. Assume all sales are on credit.
2. Terry currently has bad debts of 3.25% of sales. It is estimated that the new policy will
decrease bad debts to 1.5% of sales.
3. Cost of goods sold is 35% of sales and Terry has an inventory turnover of 6.5, which
is in line with industry standard. Terry expects to continue this inventory turnover rate
even if the policy is changed.
4. Currently Terry has an average collection period of 50 days with 30% of customers
taking the discount. With the change in credit terms it is estimated that 30% of
customers will take advantage of the discount period, 25% will pay within 30 days,
25% will pay within 60 days and the remaining 20% will pay in 90 days.
5. The rate of return Terry expects from any investment in working capital is 5%.
Based on this information, should Terry change its credit terms?
See attached excel workbook for solution
Part B (3 marks)
How many days on average is Terry relying on external financing under the current policy?
Assume that, on average, Terry has an accounts payable balance of $1,200,000.
Cash conversion cycle =
days in inventory + days in receivables – days in payables
56 (365/6.5) + 50 (Part A) – 48 [365/[(9,100,000/1,200,000)] = 58
days
5
Part C (2 marks)
Assuming Terry does not change its credit policy, what other things can Terry do to improve is
cash position?



Negotiate extended credit terms with suppliers to pay later
Charge interest and penalties for late payments from customers to encourage prompt
payment
Other acceptable answers
QUESTION 3 – Total of 11 marks
Calculate the missing amounts for items (a) to (k). Show all your work.
Sales
Cost of goods sold
Inventory, beginning of year
Inventory, end of year
Average inventory
Gross profit margin
Inventory turnover
Days in inventory
Sales
Cost of goods sold
Inventory, beginning of year
Inventory, end of year
Average inventory
Gross profit margin
Inventory turnover
Days in inventory
(11 mark each)
A
$100,000
(a)
23,000
17,000
(b)
46%
(c)
(d)
B
$239,000
122,000
45,000
39,000
(e)
(f)
(g)
126
C
$438,000
345,000
(h)
105,000
101,500
(i)
(j)
(k)
A
$100,000
54,000
23,000
17,000
20,000
46%
2.7
135
B
$239,000
122,000
45,000
39,000
42,000
49%
2.9
126
C
$438,000
345,000
98,000
105,000
101,500
21%
3.4
107
6
QUESTION 4 – Total of 10 marks
Marrycroft Ltd. markets and distributes plastic yo-yo’s. The revenue per unit is $2.60 and the
variable selling and distribution costs are $0.90 per unit. The fixed selling and administrative
costs for this product amount to $250,000 and $90,000, respectively.
Required:
Consider each of the following questions separately:
a) What is the breakeven quantity in units? (2 marks)
CM/unit = $2.60 – 0.90 = $1.70
Fixed costs = $250,000 + 90,000 = $340,000
Break-even quantity = $340,000 / 1.70 = 200,000 units (2 marks)
a) If the company tax rate is 35%, what is the required revenue to earn a target after-tax profit
of $125,000? (3 marks)
Pre-tax income = $125,000 / 0.65 = $192,308 (1 mark)
CM Ratio = (1.70/2.60) = .6538 (1 mark)
Revenue = ($340,000 + 192,308) / 0.6538 = $814,175 (1 mark)
b) If management estimates the margin of safety percentage as 20%, what is its expected level
of sales in units? (3 marks)
Sales level – 0.20 × sales level = 200,000 (the break-even point)
0.8 × sales level = 200,000
Sales level = 200,000 / 0.8 = 250,000 units (3 marks)
c) Marrycroft is considering signing a contract to deliver 190,000 units of this product at a price
of $2.40 per unit. Total fixed costs associated with this contract will be $297,000. Variable
selling costs are expected to be $0.55 per unit. What is the maximum that Marrycroft would
be willing to spend on shipping the product to the customer? (2 marks)
Profit before shipping costs (2.4 – 0.55) × 190,000 – 297,000 = $54,500
Maximum that can be paid for shipping is $54,500. (2 marks)
7
QUESTION 5 – Total of 15 marks
Donaldson Enterprises is the exclusive manufacturer of “Line Drive” baseballs. Presented
below are the comparative balance sheets as at December 31, 2013 & 2014.
Assets
Cash
Accounts Receivable
Prepaid Insurance
Inventories
Land
Equipment (net of accumulated depreciation)
Buildings (net of accumulated depreciation)
Total
Liabilities and Shareholders Equity
Accounts Payable
Unearned Revenue
Long-Term Note Payable
Common Shares (11,000 shares outstanding)
Retained Earnings
Total
$
2014
34,300
191,000
7,700
246,000
75,000
517,500
122,000
$
2013
18,000
117,000
5,000
265,000
75,000
400,000
127,000
$ 1,193,500
$ 1,007,000
$
$
$
$
91,000
9,000
14,000
177,000
902,500
$ 1,193,500
76,000
36,000
55,000
150,000
690,000
$ 1,007,000
Additional information related to 2014:




Donaldson decided to upgrade its manufacturing equipment in 2014. On January 1st,
the old manufacturing facility was sold for $375,000. The original cost of the equipment
was $525,000 and the accumulated depreciation at the time of the sale was $125,000.
The new equipment was also purchased on January 1st at a cost $575,000. The new
equipment is being depreciated evenly over 10 years and there is no expected salvage
value. There were no other acquisitions or disposals of any capital assets in 2014.
On December 31st, Donaldson declared and paid a cash dividend in the year of $1.50
per share.
Net income for 2014 was $229,000.
On August 23rd, Donaldson issued 1,000 in common shares (fair market value =
$27,000) in full satisfaction of a note payable that had been entered into early in 2014.
8
Part A (10 marks)
What is Donaldson’s cash flow from operating activities in 2014?
Net income
$229,000
Add: Depreciation
$62,500* (2)
Add: Loss on Equipment
$25,000** (2)
Deduct: Increase to A/R
$74,000
Deduct: Increase to Prepaid
$ 2,700
Add: Decrease to Inventory
$19,000
Add: Increase in AP
$15,000
Deduct: Decrease in Unearned Rev
$27,000
Cash from Operations
$246,800
Part B (2 marks)
What is Donaldson’s cash flow from investing activities in 2014?
Proceeds from sale of Equipment
$375,000
Purchase of new equipment
($575,000)
Cash from Investing Activities
($200,000)
Part B (3 marks)
What is Donaldson’s cash flow from financing activities in 2014?
Cash Settlement of Notes Payable
($14,000)***(2)
Dividends Paid
($16,500)****
Cash From Financing Activities
($30,500)
*($575,000/10 = $57,500) new equipment + $5,000 (building) = $62,500
**Proceeds on sale minus net book value = $375,000 – ($525,000-125,000) = $25,000 loss
*** Decrease in notes payable ($41,000) – amount settled with common shares ($27,000)
**** 1.50 x 11,000 shares outstanding
9
QUESTION 6 – Total of 30 marks
Appendix A contains the 2007 and 2008 Balance Sheet, Income Statement and Statement of
Cash Flows for Ford Motor Company. Please fill out the table below and note that you can
detach (“rip out”) Appendix A for easier analysis.
a) (16 marks) Calculate the following ratios for 2007 and 2008. 1 mark per ratio calculation (2
marks per year)
From the Selected General Motors Financial Statements
Ratios to be calculated
Year End 2008
Year End 2007
234,444/218,328 = 1.0738
272,215/279,264=0.9748
Debt to Total Assets =
Total Liabilities/Total
Assets
(179)/234,444=-0.0008
17,074/272,215=0.0627
127,103/8618=14.74x
142,587/10,121=14.0x
Days in Inventory= 365
days/Inventory Turnover
365 days/14.74=24.76 days
365 days/14.0x=26 days
Receivables Turnover=
Net credit Automotive
Sales/accounts receivable
129,166/93484=1.3817 x
154,379/109053=1.4156x
Cash to Total Debt
Coverage: Cash provided
by Operating
Activities/Total Liabilities
Inventory Turnover
=COGS/Inventory
10
Average Collection Period
= 365 days/receivables
turnover
365/1.3817=264 days
365/1.4156=257.8 days
Accounts Payable deferral
period = COGS/Payables
127,103/14772=8.6x
142,587/20832=6.844
Days in Payables=365
days/Accts Payable Def.
Period
365/8.6x=42.44 days
365/6.844=53.33 days
b) (4 marks) Using two ratios calculated in part a) comment on Ford's liquidity in 2008 as
compared to 2007. Please identify the ratios that you are using as a reference. Do not
exceed 4-5 sentences in your answer!
Cash to Total Debt Coverage using Total Liabilities Measures short-term debt
paying ability (cash basis): negative in 2008 and very low for 2007 (2 marks)
Debt to Total Assets (2 marks)
c) (5 marks) Using the ratios calculated in part a) can you identify a problem with Ford's
cash cycle? Please identify the ratios that you are using as a reference. Do not exceed
4-5 sentences in your answer!
Receivables Turnover -(1 mark)
Average Collection Period (1 mark)
Accts Payable Deferral Period - (1 mark)
Days in Payables (1 mark)
Ford pays their suppliers much more quickly than they are paid on their
receivables. (1 mark)
d) (4 marks) In the notes to the financial statements, under Inventories (Note 8) the
following appears:
11
Explain in your own words the 'LIFO' adjustment and its impact on inventory versus using FIFO
for inventory valuation.
With LIFO the most recent inventory item is sold first therefore resulting in a lower
ending value for inventory on the balance sheet (1 mark). Under FIFO, the ending
inventory amount will be higher as the first items purchased in inventory are sold first (1
mark) - therefore the LIFO adjustment reconciles the inventory value using FIFO vs. LIFO.
( 2 marks)
12
Appendix A: Ford Motor Company
13
Appendix A: Ford Motor Company
14
Appendix A: Ford Motor Company
15