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Problem 8-6 Cost of Assets, Subsequent Book Values and Balance Sheet preparation

The following events took place at Pete's Painting Company during 2008.
a. On January 1, Pete bought a used truck for \$14,000. He added a tool chest and side-racks for ladders for \$4,800. The truck is expected to last four years and then be sold for \$800. Pete uses straight-line depreciation.
b. On January 1, he purchased several items at an auction for \$2,400. These terms had fair market values as follows:

10 cases of paint trays and roller covers \$200
Storage cabinets 600

Pete will use all of the paint trays and roller covers this year. The storage cabinets are expected to last nine years; the ladders and scaffolding four hears.

c. On February 1, Pete paid the city \$1,500 for a three year license to operate the business.
d. On September 1, Pete sold an old track for \$4,800. The truck had cost \$12,000 when it was purchased on September 1, 2003. It had been expected to last eight years and have a salvage value of \$800.

Required
1. For each situation, explain the value assigned to the asset when it is purchased [or for (d), the book value when sold].
2. Determine the amount of depreciation or other expense to be recorded for each asset for 2008.
3. How ould these assets appear on the balance sheet as of December 31, 2008?

Exercise 8-13 Research and Development and Patents

Erin Company incurred the following costs during 2008 and 2009.

a. Research and development costs of \$20,000 were incurred. The research was conducted to discover a new product to sell to customers in future years. A product was successfully developed, and a patent for the new product was granted during 2008. Erin is unsure of the period benefitted by the research but believes the product will result in increased sales over the next five years.
b. Legal costs and application fees of \$10,000 for the patent were incurred on January 1, 2008. The patent was granted for a life of 20 years.
c. A patent infringement suit was successfully defended at a cost of \$8,000. Assume that all costs were incurred on January 1, 2009.

Required

Determine how the costs in (a) and (b) should be presented on Erin's financial statements as of December 31, 2008. Also determine the amount of amortization of intangible assets that Erin should record in 2008 and 2009.

Problem 13-5 Basic Financial Ratios

The accounting staff of CCB Enterprises has completed the financial statements for the 2008 calendar year. The statement of income for the current year and the comparative statement of financial position for 2008 and 2007 follow:

CCB Enterprises
Statement of Income
For the Year Ended December 31, 2008
(thousands omitted)

Revenue:
Net sales \$800,000
Other 60,000
Total revenue 860,000

Expenses:
Cost of goods sold \$540,000
Research and development 25,000
Interest 20,000
Total expenses: \$740,000
Income before income taxes 48,000
Net income \$ 72,000

CCB Enterprises
Comparative Statements of Financial Position
December 31, 2008 and 2007
(thousands omitted)

2008 2007
Assets
Current assets:
Cash and short term investments \$26,000 \$21,000
Receivables, less allowance for doubtful accounts 48,000 50,000
(\$1,100 in 2008 and \$1,400 in 2007)
Inventories, at lower of FIFO cost or market 65,000 62,000
Prepaid items and other current assets 5,000 3,000
Total current assets \$144,000 \$136,000
Other assets:
Investments, at cost \$106,000 \$106,000
Deposits 10,000 8,000
Total other assets \$116,000 \$114,000
Property, plant, and equipment:
Land \$12,000 \$12,000
Buildings and equipment, less accumulated depreciation
(\$126,000 in 2008 and \$122,000 in 2007) 268,000 248,000
Total property, plant, and equipment \$280,000 \$280,000
Total assets \$540,000 \$510,000

Liabilities and Owner's Equity
Current liabilities:
Short term loans \$22,000 \$24,000
Accounts payable 72,000 71,000
Salaries, wages, and other 26,000 27,000
Total current liabilities \$120,000 \$122,000
Long-term debt 160,000 171,000
Total liabilities \$280,000 \$293,000
Owner's equity:
Common stock, at par \$44,000 \$42,000
Paid in capital in exceeds of par \$64,000 \$61,000
Total paid in capital \$108,000 \$103,000
Retained earnings \$152,000 \$114,000
Total owner's equity \$260,000 \$217,000
Total liabilities and owner's equity \$540,000 \$510,000

Required
1. Calculate the following financial ratios for 2008 for CCB Enterprises
a. Times interest earned
b. Return on total assets
c. Return on common stockholder's equity
d. Debt-equity ratio (at December 31, 2008)
e. Current ratio (at December 31, 2008)
f. Quick (acid test) ratio (at December 31, 2008)
g. Accounts receivable turnover ratio (Assume that all sales are on credit)
h. Number of days' sales in receivables
i. Inventory turnover ratio (Assume that all purchases are on credit)
j. Number of days' sales in inventory
k. Number of days in cash operating cycle
2. Prepare a few brief comments on the overall financial health of CCB Enterprises. For each comment, indicate an
Information that is not provided in the problem and that you would need to fully evaluate the company's financial health.

Decision case 13-5: Acquisition Decision

Diversified Industries is a large conglomerate that is continually in the market for new acquisitions. The company has grown rapidly over the last 10 years through buyouts of medium-size companies. Diversified does not limit itself to companies in any one industry, but looks for firms with a sound financial base and the ability to stand on their own financially.
The president of Diversified recently told a meeting of the company's officers: "I want to impress two points on all of you. First, we are not in the business of looking for bargains. Diversified has achieved success in the past by acquiring companies with the ability to be a permanent member of the corporate family. We don't want companies that may appear to be a bargain on paper but can't survive in the long run. Second, a new member of our family must be able to come in and make it on its own the parent is not organized to be a funding agency for struggling subsidiaries".
Ron Dixon is the vice president of acquisitions for Diversified, a position he has held for five years. He Is responsible for making recommendations to the board of directors on potential acquisitions. Because you are one of his assistants, he recently brought you a set of financials for a manufacturer, Heavy Duty Tractors. Dixon believes that Heavy Duty is a "can't miss" opportunity for Diversified and asks you to confirm his hunch by performing basic financial statement analysis on the company. The most recent comparative balance sheets and income statement for the company follow:

Heavy Duty Tractors Inc.
Comparative Statements of Financial Position
(thousands omitted)

December 31, 2008 December 31, 2007
Assets
Current assets:
Cash \$48,500 \$24,980
Marketable securities 3,750 0
Accounts receivables, net of allowances 128,420 84,120
Inventories 135,850 96,780
Prepaid items 7,600 9,300
Total current assets \$324,120 \$215, 180
Long-term investments \$55,890 \$55,890
Property, plant, and equipment:
Land \$45,000 \$45,000
Buildings and equipment, less accumulated
Depreciation of \$385,000 in 2008 and
\$325,000 in 2007 545,000 605,000
Total property, plant, and equipment \$590,000 \$650,000
Total assets \$970,010 \$921,070

December 31, 2008 December 31, 2007

Liabilities and Stockholder's Equity
Current liabilities
Short term notes \$80,000 \$60,000
Accounts payable 65,350 48,760
Salaries and wages payable 14,360 13,840
Income taxes payable 2,590 3,650
Total current liabilities \$162,300 \$126,250
Long-term bonds payable, due 2015 \$275,000 \$275,000
Stockholder's equity:
Common stock, no par \$350,000 \$350,000
Retained earnings 182,710 169,820
Total stockholder's equity \$532,710 \$519,820
Total liabilities and stockholders' equity \$970,010 \$921,070

Heavy Duty Tractors Inc.
Statement of Income and Retained Earnings
For the Year Ended December 31, 2008
(thousands omitted)

Sales revenue \$875,250
Cost of goods sold 542,750
Gross profit \$332,500
Selling, general, and administrative expenses 264,360
Operating income \$ 68,140
Interest expense 45,000
Net income before taxes and extraordinary items \$ 23,140
Income tax expense 9,250
Income before extraordinary items \$ 13,890
Extraordinary gain, less taxes of \$6,000 9,000
Net income \$ 22,890
Retained earnings, January 1, 2008 169,820
\$192,710
Dividends paid on common stock 10,000
Retained earnings, December 31, 2008 \$182,710

Required
1. How liquid is Heavy Duty Tractors? Support your answer with any ratios that you believe are necessary to justify your conclusion. Also indicate any other information that you would want to have in making a final determination on its liquidity.
2. In light of the president's comments, should you be concerned about the solvency of Heavy Duty Tractors? Support your position with the necessary ratios. How does the maturity date of the outstanding debt affect your answer?
3. Has Heavy Duty demonstrated the ability to be a profitable member of the Diversified family? Support your position with the necessary ratios.
4. What will you tell your boss? Should he recommend to the board of directors that Diversified put in a bid for Heavy Duty Tractors?

#### Solution Summary

Discussion explains answers. Each problem has its own sheet in Excel as a template for future work.

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