Case Study: Finding values, recording transactions and preparing financial statements.
Eiffel Manufacturing Company makes small replicas of major landmarks that it sells to souvenir shops. The company was started on January 1, 2003 when it acquired $60,000 cash from the issue of common stock. During 2003 the company purchased and used raw materials that cost $16,000 cash. It paid wages to workers who made the replicas $22,000 cash. Finally, manufacturing overhead costs, including rental fees paid for facili-ties and equipment, amounted to $12,000 cash. The company started and completed the production of 1,000 replicas during 2003.
a. Determine the amount of expense Eiffel incurred in 2003 assuming none of the repli-cas were sold in 2003.
b. Record the accounting events associated with making the 1,000 replicas in a financial statements model like the one shown below. The event pertaining to the issue of common stock is recorded in the model as an example.
Assets = Equity
Events Cash + Inv. = Stk. + Ear. Rev. - Exp. = Net Inc. Cash Flow
1 60,000 + = 60,000 + - = 60,000 FA
c. Determine the cost per unit of the 1,000 replicas. Determine the sales price per unit assuming the products are sold for cost plus 40% of cost.
d. Record the sale of 800 replicas.
e. Record the payment of a $4,000 sales commission to the salesperson who sold the replicas.
Handcappi Manufacturing Company experienced the following accounting events during its first year of operation. Except for the depreciation adjusting entries, all transactions are cash transactions.
1. Acquired $61,000 cash from the issue of common stock.
2. Paid $6,800 for the materials that were used to make its products. All products started were completed during the period.
3. Paid salaries of $4,300 to selling and administrative employees.
4. Paid wages of $7,200 to production workers.
5. Paid $9,000 to buy furniture used in selling and administrative offices. The furniture was acquired on January 1. It had a $1,000 estimated salvage value and a 5-year use-ful life. Code the furniture purchase as Event No. 5a. Code recognition of the annual depreciation as Event No. 5b.
6. Paid $23,000 to buy manufacturing equipment. The equipment was acquired on Jan-uary 1. It had a $3,000 estimated salvage value and a 4-year useful life. Code the equipment purchase as Event No. 6a. Code recognition of the annual depreciation as Event No. 6b.
7. Completed 4,000 units of product. Determine the cost per unit and the sales price per unit assuming the sales price is cost plus 60% of cost. Record the sale of 3,000 units of product. Code the recognition of revenue as Event No. 7a. Code the recognition of cost of goods sold as Event No. 7b.
Show how these events would affect the balance sheet, income statement, and statement of cash flows by recording them in a horizontal financial statements model like the one shown below. The first event is recorded as an example.
Horizontal Statements Model
Assets = Equity
Event Office Manuf. Com. Ret.
No. Cash + Furn.* + Equip.* + Inv. = Stk. + Ear. Rev. - Exp. = Net Inc. Cash Flow
1 61,000 61,000 61,000 FA
Art On Tour, Inc. (AOTI) contracts with artists to exhibit their works to the public. AOTI has agreed to pay a well known artist a $20,000 commission for the right to exhibit his work for one month.
Part a - Identifying Cost Behavior
1. Determine the total commission cost and the commission cost per person if 1,000 / 2,000 / 4,000 people attend the exhibition. Is the commission cost fixed or variable?
2. AOTI provides patrons with books illustrating the artist's work. The books cost $5 each. Determine the total cost of books and the cost per person if 1,000 / 2,000 / 4,000 people attend the exhibition. Is the book cost fixed or variable?
Part b - Operating Leverage and Risk/Reward Relationship
1. AOTI pays an artist a $20,000 commission. It sells 4,000 tickets at $6 each. Prepare an income statement. Then prepare revised income statements assuming 10 percent more than 4,000 and 10 percent fewer than 4,000 patrons attend the exhibition. Cal-culate the percentage change in revenue and net income if attendance increases or de-creases 10 percent.
2. Alternatively, AOTI pays the artist a commission of $5 per ticket sold. It sells 4,000 tickets at $6 each. Prepare an income statement. Then prepare revised income state-ments assuming 10 percent more than 4,000 and 10 percent fewer than 4,000 patrons attend the exhibition. Calculate the percentage change in revenue and net income if attendance increases or decreases 10 percent.
Part c --Fixed and Variable Cost Definitions are Context Sensitive
1. AOTI pays the artist a commission of $20,000 per exhibition. What is the total com-mission cost and the commission cost per person if 1,000 / 2,000 / 4,000 people attend the exhibition? (Same as part a.1.)
2. AOTI pays the artist a commission of $20,000 per exhibition. What is the total com-mission cost and the commission cost per exhibition if AOTI sponsors 1, 2, or 3 exhi-bitions?
My Company / Your Company
My Company and Your Company provide rafting tours on Big Bear River. My Company pays tour guides fixed salaries. It budgets salaries expense at $160,000 per year. Your Company pays tour guides $40 per rafter served. Rafters are charged $50 per tour. Both companies expect to carry approximately 4,000 rafters during the year.
a. Prepare budgeted annual income statements for the two companies.
b. In an effort to lure rafters away from Your Company, My Company lowers the price per rafter to $39. Prepare revised income statements for both companies. Assume that My Company serves 6,000 rafters who each pay $39 per tour, while Your Com-pany serves only 2,000 rafters who pay $50 per tour.
c. Assume you are president of Your Company. Offer defensive strategies.
d. Suppose Your Company matches the $39 price set by My Company. Prepare income statements for both companies assuming that each company serves 4,000 customers.
Sharon Virgil owns a delivery service company. She charges customers $10 per delivery. The company's variable expenses average $2 per delivery and fixed costs are $600 per month. Ms. Virgil provided 100 deliveries during the most recent month.
a. Prepare an income statement using a contribution margin format.
b. Determine the magnitude of operating leverage. Use your answer to determine the percentage change in net income if sales increase by 10%.
c. Assume that sales increase by 10% (deliveries increase to 110). Calculate the percentage change in net income and compare your answer with your solution to
Problem 6 Contrast Relevance, Cost Behavior, and Cost Type
Pass Fast, Inc. is considering two alternative locations in which to conduct its CPA re-view course. One alternative is an exclusive hotel; the other is a moderately priced train-ing facility. The hotel is in a central location easily accessible to potential students. The training facility is in a less desirable location. Pass Fast has gathered the following cost data regarding the two locations.
Rental Fee for Classroom $2,000 $1,500
Twenty Advertising Brochures Distributed to each Student for Referrals
Cost of Instruction 5,000 5,000
Books (per student) 100 100
Refreshments (per student) 5 4
Depreciation on Instructional Equipment 400 400
Allocated Portion of Accounts Receivable
a. In the column titled "Relevant?" indicate whether each cost is relevant (Yes) or not relevant (No) to deciding which facility to rent for the course.
b. In the column titled "Cost Behavior" indicate whether each cost is fixed, variable, or mixed relative to the number of students attending the course.
c. In the column titled "Product or GS&A" indicate whether each cost would be classi-fied as a product cost or a general, selling, and administrative (GS&A) cost.
Problem 7 Analyzing Financial Statements
Information below comes from the financial statements of Rosson Company.
Net Sales $299,000 $246,000
Other Revenues 8,000 9,000
Total Revenues 307,000 255,000
Cost of Goods Sold 172,000 138,000
S,G&A Expenses 44,000 40,000
Interest Expense 4,000 4,500
Income Tax Expense 31,000 25,400
Total Expenses 251,000 207,900
Income Before Extraordinary Items 56,000 47,100
Extraordinary Gain (net of tax) 9,000 0
Net Income $ 65,000 $ 47,100
Cash $ 7,500 $ 12,500
Marketable Securities 1,000 1,500
Accounts Receivable 50,000 47,500
Inventories 150,000 145,000
Prepaid Expenses 5,000 2,500
Total Current Assets 213,500 209,000
Plant and Equipment (net) 147,000 157,000
Intangibles 30,500 0
Total Assets $391,000 $366,000
Accounts Payable $ 58,000 $ 79,500
Other Accrued Liabilities 25,000 22,500
Total Current Liabilities 83,000 102,000
Bonds Payable 90,000 100,000
Total Liabilities 173,000 202,000
Common Stock ($5 par) 130,000 130,000
Paid-In Capital in Excess of Par of Par 20,000 20,000
Retained Earnings 68,000 14,000
Total Stockholders' Equity 218,000 164,000
Total Equities $391,000 $366,000
Market price at year-end $14.00 $8.55
Dividend payments amounted to $11,000 in 2004 and $5,000 in 2003.
Perform the following analyses. If you have insufficient data to use averages in ratio computations, use year-end balances in the calculations.
a. Perform horizontal analysis of the income statement and balance sheet data. Use 2003 as the base year.
b. Perform vertical analysis of the income statement and balance sheet data for 2003 and 2004. Use sales revenue as the base figure for the income statement. Use total assets as the base figure for the balance sheet.
c. Calculate the following liquidity ratios for 2004 and 2003: (1) working capital, (2) current ratio, (3) quick (acid-test) ratio, (4) accounts receivable turnover, (5) average collection period, (6) inventory turnover, (7) number of days required to sell invento-ry.
d. Calculate the following solvency ratios for 2004 and 2003: (1) liabilities to total equi-ty, (2) stockholders' equity ratio, (3) debt/equity ratio, (4) number of times interest earned, (5) plant assets to long-term liabilities.
e. Calculate the following profitability ratios for 2004 and 2003: (1) net margin, (2) turnover of assets, (3) return on investment, (4) return on equity.
f. Calculate the following stock market ratios for 2004 and 2003: (1) earnings per share, (2) book value per share, (3) price-earnings ratio, (4) dividend yield.
For the seven problems presented, the solution discusses and explains the concepts as well as the answers to all the problems.