SUGGESTED ASSIGNMENTS
P3-2.
Financial statement account identification
LG 1; Basic
Account Name
Accounts payable
Accounts receivable
Accruals
Accumulated depreciation
Administrative expense
Buildings
Cash
Common stock (at par)
Cost of goods sold
Depreciation
Equipment
General expense
Interest expense
Inventories
Land
Long-term debt
Machinery
Marketable securities
Notes payable
Operating expense
Paid-in capital in excess of par
Preferred stock
Preferred stock dividends
Retained earnings
Sales revenue
Selling expense
Taxes
Vehicles
*
P3-6.
(a)
Statement
(b)
Type of Account
BS
BS
BS
BS
IS
BS
BS
BS
IS
IS
BS
IS
IS
BS
BS
BS
BS
BS
BS
IS
BS
BS
IS
BS
IS
IS
IS
BS
CL
CA
CL
FA*
E
FA
CA
SE
E
E
FA
E
E
CA
FA
LTD
FA
CA
CL
E
SE
SE
E
SE
R
E
E
FA
This is really not a fixed asset, but a charge against a fixed asset, better known as a contra-asset.
Income statement preparation
LG 1; Intermediate
Owen Davis Company
Balance Sheet
December 31, 2012
Assets
Current assets:
Cash
Marketable securities
Accounts receivable
Inventories
Total current assets
Gross fixed assets
Land and buildings
Machinery and equipment
Furniture and fixtures
Vehicles
Total gross fixed assets
Less: Accumulated depreciation
$ 215,000
75,000
450,000
375,000
$1,115,000
$ 325,000
560,000
170,000
25,000
$1,080,000
265,000
Net fixed assets
Total assets
$ 815,000
$1,930,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term debt
Total liabilities
Stockholders’ equity
Preferred stock
Common stock (at par)
Paid-in capital in excess of par
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
$ 220,000
475,000
55,000
$ 750,000
420,000
$1,170,000
$ 100,000
90,000
360,000
210,000
$ 760,000
$1,930,000
P3-17. Interpreting liquidity and activity ratios
LG 3; Intermediate
a.
Bluegrass appears to be holding excess inventory relative to the industry. This fact is
supported by the low inventory turnover and the low quick ratio, even though the current
ratio is above the industry average. This excess inventory could be due to slow sales
relative to production or possibly from carrying obsolete inventory.
b. The accounts receivable of Bluegrass appears to be high due to the large number of days
of sales outstanding (73 vs. the industry average of 52 days). An important question for
internal management is whether the company’s credit policy is too lenient or customers are
just paying slowly—or potentially not paying at all.
c. Since the firm is paying its accounts payable in 31 days vs. the industry norm of 40 days,
Bluegrass may not be taking full advantage of credit terms extended to them by their
suppliers. By having the receivables collection period over twice as long as the payables
payment period, the firm is financing a significant amount of current assets, possibly from
long-term sources.
d. The desire is that management will be able to curtail the level of inventory either by
reducing production or encouraging additional sales through a stronger sales program or
discounts. If the inventory is obsolete, then it must be written off to gain the income tax
benefit. The firm must also push to try to get their customers to pay earlier. Payment
timing can be increased
by shortening credit terms or providing a discount for earlier payment. Slowing down the
payment of accounts payable would also reduce financing costs.
Carrying out these recommendations may be difficult because of the potential loss of
customers due to stricter credit terms. The firm would also not want to increase their costs
of purchases by delaying payment beyond any discount period given by their suppliers.
P3-21. Ratio proficiency
LG 6; Basic
a. Gross profit  sales  gross profit margin
Gross profit  $40,000,000  0.8  $32,000,000
b.
Cost of goods sold  sales  gross profit
Cost of goods sold  $40,000,000  $32,000,000  $8,000,000
c.
Operating profit  sales  operating profit margin
Operating profit  $40,000,000  0.35  $14,000,000
d.
Operating expenses  gross profit  operating profit
Operating expenses  $32,000,000  $14,000,000  $18,000,000
e.
Earnings available for common shareholders
 sales  net profit margin  $40,000,000  0.08  $3,200,000
sales
$40,000,000

 $20,000,000
total asset turnover
2
earnings available for common shareholders
g. Total common equity 
ROE
$3,200,000
Total common equity 
 $16,000,000
0.20
sales
h. Accounts receivable  average collection period 
365
$40,000,000
Accounts receivable  62.2 days 
 62.2  $109,589.041  $6,816,438.36
365
Classifying inflows and outflows of cash
LG 2; Basic
f.
P4-5.
Total assets 
Item
Change
($)
Cash
100
Accounts
1,000
payable
Notes payable
500
Long-term debt 2,000
Inventory
200
Fixed assets
400
I/O
Item
Change
($)
I/O
O
O
Accounts receivable
Net profits
700
600
I
I
I
O
O
O
Depreciation
100
Repurchase of stock
600
Cash dividends
800
Sale of stock
1,000
I
O
O
I
Note 1: Think of cash in terms of money in a checking account.
Note 2: As a non-cash charge depreciation is not really an I/O at all, but it will be reported as
a
positive amount on the statement of cash flows.
P4-6.
Finding operating and free cash flows
LG 2; Intermediate
a. NOPAT  EBIT  (1  t)
NOPAT  $2,700  (1  0.40)  $1,620
b. OCF  NOPAT  depreciation
OCF  $1620  $1,600
OCF  $3,220
c. FCF  OCF  net fixed asset investment*  net current asset investment**
FCF  $3,220  $1,400  $1,400
FCF  $420
Net fixed asset investment  change in net fixed assets  depreciation
Net fixed asset investment  ($14,800  $15,000)  ($14,700  $13,100)
Net fixed asset investment  –$200  $1,600  $1,400
** Net current asset investment  change in current assets  change in
(accounts payable and accruals)
*
Net current asset investment  ($8,200  $6,800)  ($100  $100)
Net current asset investment  $1,400  0  $1,400
d. Keith Corporation has positive cash flows from operating activities. Depreciation is
approximately the same size as net operating profit after tax, so the operating cash flow is
about twice the NOPAT. The FCF value is very meaningful since it shows that the cash
flows from operations are adequate to cover both operating expense plus investment in
fixed and current assets.
P4-9.
Cash budget—basic
LG 4; Intermediate
Sales
Cash sales (0.20)
Lag 1 month (0.60)
Lag 2 months (0.20)
Other income
Total cash receipts
Disbursements
Purchases
Rent
Wages & salaries
Dividends
Principal & interest
Purchase of new equipment
Taxes due
Total cash disbursements
Total cash receipts
Total cash disbursements
Net cash flow
Add: Beginning cash
Ending cash
Minimum cash
Required total financing
(notes payable)
Excess cash balance
(marketable securities)
March
April
May
June
July
$50,000
$10,000
$60,000
$12,000
$70,000
$14,000
36,000
10,000
2,000
$62,000
$80,000
$16,000
42,000
12,000
2,000
$72,000
$100,000
$ 20,000
48,000
14,000
2,000
$ 84,000
$50,000
3,000
6,000
$70,000
3,000
7,000
3,000
4,000
$ 80,000
3,000
8,000
6,000
$59,000
6,000
$93,000
$97,000
$62,000
59,000
$ 3,000
5,000
$ 8,000
5,000
$72,000
93,000
($21,000)
8,000
($13,000)
5,000
$84,000
97,000
($13,000)
(13,000)
($26,000)
5,000
$18,000
$31,000
0
0
$ 3,000
The firm should establish a credit line of at least $31,000, but may need to secure three to four
times this amount based on scenario analysis.
P4-16. Pro forma income statement—scenario analysis
LG 5; Challenge
a.
Pro Forma Income Statement
Allen Products, Inc.
for the Year Ended December 31, 2013
Sales
Less cost of goods sold (45%)
Gross profits
Less operating expense (25%)
Operating profits
Less interest expense (3.2%)
Net profit before taxes
Taxes (25%)
Net profits after taxes
Pessimistic
Most Likely
Optimistic
$900,000
405,000
$495,000
225,000
$270,000
28,800
$241,200
60,300
$180,900
$1,125,000
506,250
$ 618,750
281,250
$ 337,500
36,000
$ 301,500
75,375
$ 226,125
$1,280,000
576,000
$ 704,000
320,000
$ 384,000
40,960
$ 343,040
85,760
$ 257,280
b. The simple percent-of-sales method assumes that all costs are variable. In reality some of
the expenses will be fixed. In the pessimistic case this assumption causes all costs to
decrease with the lower level of sales when in reality the fixed portion of the costs will
not decrease. The opposite occurs for the optimistic forecast since the percent-of-sales
assumes all costs increase when in reality only the variable portion will increase. This
pattern results in an understatement of costs in the pessimistic case and an overstatement
of profits. The opposite occurs in the optimistic scenario.
c.
Pro Forma Income Statement
Allen Products, Inc.
for the Year Ended December 31, 2013
Pessimistic
Most Likely
Optimistic
Sales
$900,000
$1,125,000
$1,280,000
Less cost of goods sold:
Fixed
250,000
250,000
250,000
Variable (18.3%)a
164,700
205,875
234,240
Gross profits
$485,300
$ 669,125
$ 795,760
Less operating expense
Fixed
180,000
180,000
180,000
Variable (5.8%)b
52,200
65,250
74,240
Operating profits
$253,100
$ 423,875
$ 541,520
Less interest expense
30,000
30,000
30,000
Net profit before taxes
$223,100
$ 393,875
$ 511,520
Taxes (25%)
55,775
98,469
127,880
Net profits after taxes
$167,325
$ 295,406
$ 383,640
a
Cost of goods sold variable percentage  ($421,875  $250,000) / $937,500
b
Operating expense variable percentage  ($234,375  $180,000) / $937,500
d. The profits for the pessimistic case are larger in part (a) than in part (c). For the optimistic
case, the profits are lower in part (a) than in part (c). This outcome confirms the results as
stated in part (b).
EXTRA END-OF-CHAPTER PROBLEM ANSWERS
P3-10. Statement of retained earnings
LG 1; Intermediate
a.

Cash dividends paid on common stock Net profits after taxes – preferred
dividends – change in retained earnings

$377,000 – $47,000 – (1,048,000 – $928,000)
$210,000
Hayes Enterprises
Statement of Retained Earnings
for the Year Ended December 31, 2012
Retained earnings balance (January 1, 2011)
Plus: Net profits after taxes (for 2012)
Less: Cash dividends (paid during 2012)
Preferred stock
Common stock
Retained earnings (December 31, 2012)
b.
Earnings per share 
$ 928,000
377,000
(47,000)
(210,000)
$1,048,000
Net profit after tax  Preferred dividends (EACS* )
Number of common shares outstanding
Earnings per share 
$377,000  $47,000
 $2.36
140,000
*
Earnings available to common stockholders
c.
Cash dividend per share 
Total cash dividend
# shares
Cash dividend per share 
$210,000 (from Part a)
 $1.50
140,000
P3-22. Cross-sectional ratio analysis
LG 6; Intermediate
a.
Fox Manufacturing Company
Ratio Analysis
Industry Average
2012
Current ratio
Quick ratio
Inventory turnover
Average collection period
Total asset turnover
Debt ratio
Times interest earned
Gross profit margin
Operating profit margin
Net profit margin
Return on total assets
Return on common equity
Earnings per share
2.35
0.87
4.55 times
35.8 days
1.09
0.30
12.3
0.202
0.135
0.091
0.099
0.167
$3.10
Actual
2012
1.84
0.75
5.61 times
20.5 days
1.47
0.55
8.0
0.233
0.133
0.072
0.105
0.234
$2.15
Liquidity: The current and quick ratios show a weaker position relative to the industry
average.
Activity: All activity ratios indicate a faster turnover of assets compared to the industry.
Further analysis is necessary to determine whether the firm is in a weaker or stronger
position than the industry. A higher inventory turnover ratio may indicate low inventory,
resulting in stockouts and lost sales. A shorter average collection period may indicate
extremely efficient receivables management, an overly zealous credit department, or credit
terms that prohibit growth in sales.
Debt: The firm uses more debt than the average firm, resulting in higher interest
obligations that could reduce its ability to meet other financial obligations.
Profitability: The firm has a higher gross profit margin than the industry, indicating
either a higher sales price or a lower cost of goods sold. The operating profit margin is in
line with the industry, but the net profit margin is lower than industry, an indication that
expenses other than cost of goods sold are higher than the industry. Most likely, the
damaging factor is high interest expenses due to a greater than average amount of debt. The
increased leverage, however, magnifies the return the owners receive, as evidenced by the
superior ROE.
b. Fox Manufacturing Company needs improvement in its liquidity ratios and possibly a
reduction in its total liabilities. The firm is more highly leveraged than the average firm in
its industry and therefore has more financial risk. The profitability of the firm is lower
than average but
is enhanced by the use of debt in the capital structure, resulting in a superior ROE.
P3-24. Integrative—complete ratio analysis
LG 6; Challenge
Sterling Company
Ratio Analysis
Ratio
Current ratio
Actual
2010
1.40
Actual
2011
1.55
Quick ratio
1.00
0.92
Inventory turnover
9.52
9.21
Average collection
period
Average payment
period
Total asset turnover
45.6 days
36.9 days
59.3 days
0.74
61.6 days
0.80
Debt ratio
0.20
0.20
Times interest earned
8.2
7.3
Fixed payment
coverage ratio
Gross profit margin
4.5
0.30
4.2
0.27
Operating profit
Actual
2012
1.67
Industry
Average TS: Time-Series
2012
CS: Cross-Sectional
1.85
TS:
CS:
0.88
1.05
TS:
CS:
7.89
8.60
TS:
CS:
TS:
29.2 days 35.5 days CS:
TS:
53.0 days 46.4 days CS:
0.83
0.74
TS:
CS:
0.35
0.30
TS:
CS:
6.5
8.0
TS:
CS:
TS:
2.3
4.2
CS:
0.25
0.25
TS:
CS:
TS:
Improving
Fair
Deteriorating
Poor
Deteriorating
Fair
Improving
Good
Unstable
Poor
Improving
Good
Increasing
Fair
Deteriorating
Poor
Deteriorating
Poor
Deteriorating
Average
Improving
margin
Net profit margin
Return on total
assets
Return on common
Equity
Earnings per share
(EPS)
Price/earnings
(P/E)
Market/book ratio
(M/B)
0.12
0.062
0.12
0.062
0.13
0.066
0.10
0.053
0.045
0.050
0.0508
0.040
0.061
0.067
0.0782
0.066
$1.75
$2.20
$3.05
$1.50
12.0
10.5
13.0
11.2
1.20
1.05
1.16
1.10
CS:
TS:
CS:
TS:
CS:
TS:
CS:
TS:
CS:
TS:
CS:
TS:
CS:
Good
Stable
Good
Stable
Good
Improving
Good
Improving
Good
Unstable
Good
Deteriorating
Fair
Liquidity: Sterling Company’s overall liquidity as reflected by the current ratio and quick
ratio appears to be following different trends, but is below the industry average.
Activity: The activity of accounts receivable has improved, but inventory turnover has
deteriorated and is currently below the industry average. The firm’s average payment period
appears to have speeded up from 2010, although the firm is still paying more slowly than the
average company.
Debt: The firm’s debt ratios have increased from 2010 and are very close to the industry
averages, indicating currently acceptable values but an undesirable trend. The firm’s fixed
payment coverage has declined and is well below the industry average figure, indicating a
deterioration in servicing ability.
Profitability: The firm’s gross profit margin, while in line with the industry average, has
declined, probably due to higher cost of goods sold. The operating and net profit margins have
been stable and are also above industry averages. Both the ROA and the ROE appear to have
improved slightly and are better than the industry averages. EPS made a significant increase
in 2011 and 2012. The P/E ratio indicates an increasing degree of investor confidence in the
firm’s future earnings potential.
Market: The firm’s P/E ratio was good in 2010, fell significantly in 2011, but recovered in
2012. The ratio is now above the industry average. The market to book ratio initially showed
signs of improving in 2011 and 2012. The market’s interpretation of Sterling’s earning ability
indicates a lot of uncertainty. The fluctuation in the M/B ratio also shows signs of uncertainty.
In summary, the firm needs to attend to inventory and accounts payable and should not incur
added debts until its leverage and fixed-charge coverage ratios are improved. Other than these
indicators, the firm appears to be doing wellespecially in generating return on sales. The
market seems to have some lack of confidence in the stability of Sterling’s future.
P4-6.
Finding operating and free cash flows
LG 2; Intermediate
a. NOPAT  EBIT  (1  t)
NOPAT  $2,700  (1  0.40)  $1,620
b. OCF  NOPAT  depreciation
OCF  $1620  $1,600
OCF  $3,220
c. FCF  OCF  net fixed asset investment*  net current asset investment**
FCF  $3,220  $1,400  $1,400
FCF  $420
Net fixed asset investment  change in net fixed assets  depreciation
Net fixed asset investment  ($14,800  $15,000)  ($14,700  $13,100)
Net fixed asset investment  –$200  $1,600  $1,400
** Net current asset investment  change in current assets  change in
(accounts payable and accruals)
Net current asset investment  ($8,200  $6,800)  ($100  $100)
Net current asset investment  $1,400  0  $1,400
*
d. Keith Corporation has positive cash flows from operating activities. Depreciation is
approximately the same size as net operating profit after tax, so the operating cash flow is
about twice the NOPAT. The FCF value is very meaningful since it shows that the cash
flows from operations are adequate to cover both operating expense plus investment in
fixed and current assets.
P4-11. Cash budget—advanced
LG 4; Challenge
a.
Xenocore, Inc.
($000)
Sept.
Forecast Sales
Cash sales (0.20)
Collections
Lag 1 month (0.40)
Lag 2 months (0.40)
Other cash receipts
Total cash receipts
Forecast Purchases
Cash purchases
Payments
Lag 1 month (0.50)
Lag 2 months (0.40)
Salaries & wages
Rent
Interest payments
Principal payments
Dividends
Taxes
Purchases of fixed assets
Total cash disbursements
Total cash receipts
Less: Total cash
disbursements
Net cash flow
Add: Beginning cash
Ending cash
Less: Minimum cash
balance
b.
Required total financing
(notes payable)
Excess cash balance
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
$210 $250
$170
$ 34
$160
$ 32
$140
$ 28
$180
$ 36
$200
$ 40
$250
$ 50
100
84
68
100
$218
$140
$ 14
$200
$100
$ 10
64
68
15
$175
$ 80
$ 8
56
64
27
$183
$110
$ 11
72
56
15
$183
$100
$ 10
80
72
12
$214
$ 90
$ 9
75
48
50
20
70
60
34
20
50
56
32
20
10
40
40
28
20
55
32
36
20
50
44
40
20
10
30
20
80
$120 $150
20
$207
25
$219
$196
$139
$153
$303
$218
$200
$175
$183
$183
$214
207
11
22
33
219
(19)
33
14
196
(21)
14
(7)
139
44
(7)
37
153
30
37
67
303
(89)
67
(22)
15
15
15
15
15
15
1
22
37
(marketable securities)
c.
18
22
52
The line of credit should be at least $37,000 to cover the maximum borrowing needs for
the month of April.
P4-19. Integrative—pro forma statements
LG 5; Challenge
a.
Pro Forma Income Statement
Red Queen Restaurants
for the Year Ended December 31, 2013
(percent-of-sales method)
Sales
Less: Cost of goods sold (0.75  sales)
Gross profits
Less: Operating expenses (0.125  sales)
Net profits before taxes
Less: Taxes (0.40  NPBT)
Net profits after taxes
Less: Cash dividends
To Retained earnings
$900,000
675,000
$225,000
112,500
$112,500
45,000
$ 67,500
35,000
$ 32,500
b.
Assets
Cash
Marketable securities
Accounts receivable
Inventories
Current assets
Net fixed assets*
Total assets
Pro Forma Balance Sheet
Red Queen Restaurants
December 31, 2013
(Judgmental Method)
Liabilities and Equity
$ 30,000
Accounts payable
18,000
Taxes payable**
162,000
Other current liabilities
112,500
Current liabilities
$322,500
Long-term debt
375,000
Common stock
Retained earnings***
External funds required****
Total liabilities and
$697,500
stockholders’ equity
*
Net fixed assets (January 1, 2013)
Plus: New machine
Less: Depreciation
Ending net fixed assets (December 31, 2013)
**
$350,000
42,000
(17,000)
$375,000
Taxes payable = $45,000 x 0.25 = $11,250
***
Beginning retained earnings (January 1, 2013)
Plus: Net profit after taxes
Less: Dividends paid
Ending retained earnings (December 31, 2013)
****
External funds required = $697,500 - $686,250 = $11,250
$175,000
67,500
(35,000)
$207,500
$112,500
11,250
5,000
$128,750
200,000
150,000
207,500
11,250
$697,500
c.
Using the judgmental approach, the external funds requirement is $11,250.
P4-20. Integrative—pro forma statements
LG 5; Challenge
a.
Pro Forma Income Statement
Provincial Imports, Inc.
for the Year Ended December 31, 2013
(percent-of-sales method)
Sales
Less: Cost of goods sold (0.35  sales  $1,000,000)
Gross profits
Less: Operating expenses (0.12  sales  $250,000)
Operating profits
Less: Interest expense
Net profits before taxes
Less: Taxes (0.40  NPBT)
Net profits after taxes
Less: Cash dividends (0.40  NPAT)
To Retained earnings
$6,000,000
3,100,000
$2,900,000
970,000
$1,930,000
200,000
$1,730,000
692,000
$1,038,000
415,200
$ 622,800
b.
Assets
Cash
Marketable securities
Accounts receivable
Inventories
Current assets
Net fixed assets
Total assets
Pro Forma Balance Sheet
Provincial Imports, Inc.
December 31, 2013
(Judgmental Method)
Liabilities and Equity
$ 400,000
Accounts payable
275,000
Taxes payable (same percentage as prior year)
Notes payable
750,000
Other current liabilities
1,000,000
Current liabilities
$2,425,000
Long-term debt
1,646,0002
Common stock
Retained earnings
External funds required
Total liabilities and
$4,071,000
stockholders’ equity
$ 840,000
138,4001
200,000
6,000
$1,184,400
500,000
75,000
1,997,8003
313,800
$4,071,000
1
Taxes payable for 2012 are nearly 20% of the 2012 taxes on the income statement. The pro forma
value is obtained by taking 20% of the 2013 taxes (0.2  $692,000  $138,400).
2
Net fixed assets (January 1, 2013)
Plus: New computer
Less: Depreciation
Net fixed assets (December 31, 2013)
$1,400,000
356,000
(110,000)
$1,646,000
3
Beginning retained earnings (January 1, 2013)
Plus: Net profit after taxes
Less: Dividends paid
Ending retained earnings (December 31, 2013)
$1,375,000
1,038,000
(415,200)
$1,997,800
c.
Using the judgmental approach, the external funds requirement is $313,800.