Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter Income Measurement and Profitability Analysis QUESTIONS FOR REVIEW OF KEY TOPICS Question 5-1 The realization principle requires that two criteria be satisfied before revenue can be recognized: The earnings process is judged to be complete or virtually complete There is reasonable certainty as to the collectibility of the asset to be received (usually cash) Question 5-2 At the time production is completed, there usually exists significant uncertainty as to the collectibility of the asset to be received We don’t know if the product will be sold, nor the selling price, nor the buyer if eventually the product is sold Because of these uncertainties, revenue recognition usually is delayed until the point of product delivery Question 5-3 If the installment sale creates a situation where there is significant uncertainty concerning cash collection and it is not possible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed beyond the point of delivery Question 5-4 The installment sales method recognizes gross profit by applying the gross profit percentage on the sale to the amount of cash actually received each period The cost recovery method defers all gross profit recognition until cash has been received equal to the cost of the item sold Question 5-5 Deferred gross profit is a contra installment receivable account The balance in this account is subtracted from gross installment receivables to arrive at installment receivables, net The net amount of the receivables represents the portion of remaining payments that represent cost recovery Question 5-6 Because the return of merchandise can retroactively negate the benefits of having made a sale, the seller must meet certain criteria before revenue is recognized in situations when the right of return exists The most critical of these criteria is that the seller must be able to make reliable estimates of future returns In certain situations, these criteria are not satisfied at the point of delivery of the product Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 5-7 Sometimes a company arranges for another company to sell its product under consignment The “consignor” physically transfers the goods to the other company (the consignee), but the consignor retains legal title If the consignee can’t find a buyer within an agreed-upon time, the consignee returns the goods to the consignor However, if a buyer is found, the consignee remits the selling price (less commission and approved expenses) to the consignor Because the consignor retains the risks and rewards of ownership of the product and title does not pass to the consignee, the consignor does not record revenue (and related costs) until the consignee sells the goods and title passes to the eventual customer Question 5-8 For service revenue, if there is one final service that is critical to the earnings process, revenues and costs are deferred and recognized after this service has been performed On the other hand, in many instances, service revenue activities occur over extended periods and recognizing revenue at any single date within that period would be inappropriate Instead, it’s more meaningful to recognize revenue over time in proportion to the performance of the activity Question 5-9 The completed contract method of recognizing revenues and costs on long-term construction contracts is equivalent to recognizing revenue at point of delivery, i.e., when the construction project is complete The percentage-of-completion method assigns a fair share of the project’s expected revenues and costs to each period in which the earnings process takes place, i.e., the construction period The “fair share” means the project's costs incurred each period as a percentage of the project's total estimated costs The completed contract method should only be used when the lack of dependable estimates or inherent hazards cause forecasts of future costs to be doubtful Question 5-10 The billings on construction contract account is a contra account to the asset, construction in progress At the end of each reporting period, the balances in these two accounts are compared If the net amount is a debit, it is reported on the balance sheet as an asset Conversely, if the net amount is a credit, it is reported as a liability Question 5-11 An estimated loss on a long-term contract must be fully recognized in the first period the loss is anticipated, regardless of the revenue recognition method used Question 5-12 These SOP’s require that if an arrangement includes multiple elements, the revenue from the arrangement should be allocated to the various elements based on the relative fair values of the individual elements, “regardless of any separate prices stated within the contract for each element.” © The McGraw-Hill Companies, Inc., 2007 5-2 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 5-13 Specific guidelines for revenue recognition of the initial franchise fee are provided by SFAS 45 A key to these guidelines is the concept of substantial performance It requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue The term “substantial” requires professional judgment on the part of the accountant In situations when the initial franchise fee is collectible in installments, even after substantial performance has occurred, the installment sales or cost recovery method should be used for profit recognition, if a reasonable estimate of uncollectibility cannot be made Question 5-14 Receivables turnover ratio = Net sales Average accounts receivable (net) Inventory turnover ratio = Cost of goods sold Average inventory Asset turnover ratio = Net sales Average total assets Activity ratios are designed to provide information about a company’s effectiveness in managing assets Activity or turnover of certain assets measures the frequency with which those assets are replaced The greater the number of times an asset turns over, the less cash a company must devote to that asset, and the more cash it can commit to other purposes Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (concluded) Question 5-15 Profit margin on sales = Net income Net sales Return on assets = Net income Average total assets Return on shareholders' equity = Net income Average shareholders' equity A fundamental element of an analyst’s task is to develop an understanding of a firm’s profitability Profitability ratios provide information about a company’s ability to earn an adequate return relative to sales or resources devoted to operations Resources devoted to operations can be defined as total assets or only those assets provided by owners, depending on the evaluation objective Question 5-16 These perspectives are referred to as the discrete and integral part approaches Current interim reporting requirements and existing practice generally view interim reports as integral parts of annual statements However, the discrete approach is applied to some items Most revenues and expenses are recognized in interim periods as incurred However, if an expenditure clearly benefits more than just the period in which it is incurred, the expense should be spread among the periods benefited Examples include annual repair expenses, property tax expense, and advertising expenses incurred in one quarter that clearly benefit later quarters These are assigned to each quarter through the use of accruals and deferrals On the other hand, major events such as discontinued operations, extraordinary items, and unusual or infrequent items should be reported separately in the interim period in which they occur © The McGraw-Hill Companies, Inc., 2007 5-4 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com BRIEF EXERCISES Brief Exercise 5-1 2006 gross profit = $3,000,000 – 1,200,000 = $1,800,000 2007 gross profit = Brief Exercise 5-2 2006 Cost recovery % : $1,200,000 = 40% (gross profit % = 60%) $3,000,000 2006 gross profit = 2006 cash collection of $150,000 x 60% = $90,000 2007 gross profit = 2007 cash collection of $150,000 x 60% = $90,000 Brief Exercise 5-3 No gross profit will be recognized in either 2006 or 2007 Gross profit will not be recognized until the entire $1,200,000 cost of the land is recovered In this case, gross profit recognition will equal 100% of the cash collected beginning with the ninth installment payment ($1,200,000 ÷ $150,000 = payments to recover the cost of the land) Brief Exercise 5-4 Initial deferred gross profit ($3,000,000 – 1,200,000) Less gross profit recognized in 2006 ($150,000 x 60%) Less gross profit recognized in 2007 ($150,000 x 60%) Deferred gross profit at the end of 2007 Solutions Manual, Vol.1, Chapter $1,800,000 (90,000) (90,000) $1,620,000 © The McGraw-Hill Companies, Inc., 2007 5-5 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 5-5 The seller must meet certain criteria before revenue can be recognized in situations when the right of return exists The most critical of these criteria is that the seller must be able to make reliable estimates of future returns If Meyer’s management can make reliable estimates of the furniture that will be returned, revenue can be recognized when the product is delivered, assuming the company has no additional obligations to the buyer If reliable estimates cannot be made because of significant uncertainty, revenue and related cost recognition is delayed until the uncertainty is resolved Brief Exercise 5-6 % of completion = $6 million ÷ $15 million = 40% Total estimated gross profit ($20 million – 15 million) = multiplied by the % of completion Gross profit recognized the first year $5,000,000 40% $2,000,000 First year revenue = $20,000,000 x 40% = $8,000,000 Brief Exercise 5-7 Assets: Accounts receivable ($7 million – million) Cost plus profit ($6 million + $2 million*) in excess of billings ($7 million) * Total estimated gross profit ($20 million – 15 million) = multiplied by the % of completion Gross profit recognized in the first year $2,000,000 1,000,000 $5,000,000 40% $2,000,000 Brief Exercise 5-8 © The McGraw-Hill Companies, Inc., 2007 5-6 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Year = Year = $4 million Revenue Less: Costs in year Costs in year Actual profit $20,000,000 (6,000,000) (10,000,000) $ 4,000,000 Brief Exercise 5-9 The anticipated loss of $3 million ($30 million contract price less total estimated costs of $33 million) must be recognized in the first year applying either method Brief Exercise 5-10 Specific conditions for revenue recognition of the initial franchise fee are provided by SFAS 45 A key to these conditions is the concept of substantial performance It requires that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee can be recognized as revenue The term “substantial” requires professional judgment on the part of the accountant Often, substantial performance is considered to have occurred when the franchise opens for business Continuing franchise fees are recognized over time as the services are performed Brief Exercise 5-11 Receivables turnover ratio = Solutions Manual, Vol.1, Chapter Receivables turnover ratio Net sales © The McGraw-Hill Companies, Average accounts receivable (net) Inc., 2007 5-7 = $600,000 [$100,000 + 120,000] ÷ Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Inventory turnover ratio Inventory turnover ratio = Cost of goods sold Average inventory = $400,000* [$80,000 + 60,000] ÷ = 5.71 times *$600,000 – 200,000 © The McGraw-Hill Companies, Inc., 2007 5-8 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 5-12 Profit margin Return on assets Return on shareholders’ equity = Net income Sales = $65,000 $420,000 = 15.5% = Net income Average total assets = $65,000 $800,000 = 8.1% = Net income Average shareholders’ equity = $65,000 $522,500* = 12.4% Shareholders’ equity, beginning of period Add: Net income Deduct: Dividends Shareholders’ equity, end of period $500,000 65,000 (20,000) $545,000 *Average shareholders equity = ($500,000 + 545,000) ÷ = $522,500 Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-9 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 5-13 Inventory turnover ratio = Cost of goods sold ÷ Average inventory 6.0 = x ÷ $75,000 Cost of goods sold = $75,000 x 6.0 = $450,000 Sales $600,000 - Cost of goods sold = Gross profit $450,000 = $150,000 © The McGraw-Hill Companies, Inc., 2007 5-10 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 5-2 Requirement While revenue often is earned during a period of time, revenue usually is recognized at a point in time when both revenue recognition criteria are satisfied These criteria usually are satisfied at the point of delivery The revenue has been earned and there is reasonable certainty as to the collectibility of the asset (cash) to be received Usually, significant uncertainties exist at the time products are produced At point of delivery, the product has been sold and the price and buyer are known The only remaining uncertainty involves the ultimate cash collection, which can usually be accounted for by estimating and recording allowances for possible return of the product and for uncollectibility of the cash Requirement It would be useful to recognize revenue as the productive activity takes place when the earnings process occurs over long periods of time A good example is longterm projects in the construction industry Requirement Some revenue-producing activities call for revenue recognition after the product has been delivered These situations involve significant uncertainty as to the collectibility of the cash to be received, caused either by the possibility of the product being returned or, with credit sales, the possibility of bad debts Usually, these remaining uncertainties can be accounted for by estimating and recording allowances for anticipated returns and bad debts, thus allowing revenue and related costs to be recognized at point of delivery But occasionally, an abnormal degree of uncertainty causes point of delivery revenue recognition not to be appropriate Revenue recognition after delivery sometimes is appropriate for installment sales and when a right of return exists Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-67 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 5-3 The revenue recognition policy is questionable The liberal trade-in policy causes gross profit to be overstated on the original sale and understated on the trade-in sale This results from the granting of a trade-in allowance for the old computer that is greater than the old computer's resale value Using the company's recognition policy, gross profit recognized on the two sales would be as follows: Sales price Cost of goods sold Gross profit Gross profit percentage Original sale $2,000,000 1,200,000 $ 800,000 Trade-in sale $2,380,000 1,500,000 $ 880,000 40% 37% Of course, there is no guarantee that the customer will exercise the trade-in option If, however, a large percentage of customers exercise the option, and the distortion in gross profit is material, the company should adopt a revenue recognition policy that results in a more stable gross profit percentage for the two transactions © The McGraw-Hill Companies, Inc., 2007 5-68 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Communication Case 5-4 The critical question that student groups should address is how to match revenues and expenses There is no right or wrong answer The process of developing the proposed solutions will likely be more beneficial than the solutions themselves Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole Solutions could take one of two directions: Deferral of revenue recognition As each ice cream cone is sold, a portion of the sales price is deferred and a liability is recorded This liability will then be reduced and revenue recognized when the free ice cream cone is awarded The accrual of estimated cost This direction views the free ice cream cone as a promotional expense The estimated cost of the free cone should be expensed as the ten required cones are sold A corresponding liability is recorded which should increase to an amount equal to the cost of the free cone When the free cone is awarded, the liability and inventory are reduced In either case, the accounting method must consider the fact that not all customers will take advantage of the free cone award It is important that each student actively participate in the process Domination by one or two individuals should be discouraged Students should be encouraged to contribute to the group discussion by (a) offering information on relevant issues, and (b) clarifying or modifying ideas already expressed, or (c) suggesting alternative direction Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-69 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Research Case 5-5 (Note: This case requires the student to reference a journal article.] Fifty-five firms reported the use of one of the two long-term contract accounting methods Twenty-seven of the firms are manufacturing companies Only one company uses the completed contract method That company reported using both methods The most frequently used approach to estimating a percentage-of-completion is the cost-to-cost method © The McGraw-Hill Companies, Inc., 2007 5-70 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Ethics Case 5-6 Discussion should include these elements Facts: Horizon Corporation, a computer manufacturer, reported profits from 2001 through 2004, but reported a $20 million loss in 2005 due to increased competition The chief financial officer (CFO) circulated a memo suggesting the shipment of computers to J.B Sales, Inc., in 2006 with a subsequent return of the merchandise to Horizon in 2007 Horizon would record a sale for the computers in 2006 and avoid an inventory write-off that would place the company in a loss position for that year The CFO is clearly asking Jim Fielding to recognize revenue in 2006 which he knows will be reversed as a sales return in 2007 Ethical Dilemma: Is Jim's obligation to challenge the memo of the CFO and provide useful information to users of the financial statements greater than the obligation to prevent a company loss in 2006 that may lead to bankruptcy? Who is affected? Jim Fielding CFO and other managers Other employees Shareholders Potential shareholders Creditors Auditors Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-71 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 5-7 Requirement The three methods that could be used to recognize revenue and costs for this situation are (1) point of delivery, (2) the installment sales method, and (3) the cost recovery method 2006 gross profit under the three methods: (1) point of delivery: $80,000 - 40,000 = $40,000 (2) installment sales method: $40,000 = 50% = gross profit % $80,000 50% x $30,000 (cash collected) = $15,000 (3) cost recovery method: No gross profit recognized since cost ($40,000) exceeds cash collected ($30,000) Requirement Customers sometimes are allowed to pay for purchases in installments over long periods of time Uncertainty about collection of a receivable normally increases with the length of time allowed for payment In most situations, the increased uncertainty concerning the collection of cash from installment sales can be accommodated satisfactorily by estimating uncollectible amounts In these situations, point of delivery revenue recognition should be used If, however, the installment sale creates a situation where there is significant uncertainty concerning cash collection making it impossible to make an accurate assessment of future bad debts, revenue and cost recognition should be delayed The installment sales method and the cost recovery method are available to handle such situations These methods should be used only in situations involving exceptional uncertainty The cost recovery method is the more conservative of the two © The McGraw-Hill Companies, Inc., 2007 5-72 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 5-8 Question No In the SEC's view, it would be inappropriate for Company M to recognize the membership fees as earned revenue upon billing or receipt of the initial fee with a corresponding accrual for estimated costs to provide the membership services This conclusion is based on Company M's remaining and unfulfilled contractual obligation to perform services (i.e., make available and offer products for sale at a discounted price) throughout the membership period Therefore, the earnings process, irrespective of whether a cancellation clause exists, is not complete In addition, the ability of the member to receive a full refund of the membership fee up to the last day of the membership term raises an uncertainty as to whether the fee is fixed or determinable at any point before the end of the term Generally, the SEC believes that a sales price is not fixed or determinable when a customer has the unilateral right to terminate or cancel the contract and receive a cash refund Question No Products delivered to a consignee pursuant to a consignment arrangement are not sales and not qualify for revenue recognition until a sale occurs The SEC believes that revenue recognition is not appropriate because the seller retains the risks and rewards of ownership of the product and title usually does not pass to the consignee Question Provided that the other criteria for revenue recognition are met, the SEC believes that Company R should recognize revenue from sales made under its layaway program upon delivery of the merchandise to the customer Until then, the amount of cash received should be recognized as a liability entitled such as "deposits received from customers for layaway sales" or a similarly descriptive caption Because Company R retains the risks of ownership of the merchandise, receives only a deposit from the customer, and does not have an enforceable right to the remainder of the purchase price, the SEC would object to Company R recognizing any revenue upon receipt of the cash deposit This is consistent with item two (2) in the SEC's criteria for bill-and-hold transactions that states that "the customer must have made a fixed commitment to purchase the goods." Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-73 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Research Case 5-9 Requirement The standard lists the following factors that may impair the ability to make a reasonable estimate: a The susceptibility of the product to significant external factors, such as technological obsolescence or changes in demand b Relatively long periods in which a particular product may be returned c Absence of historical experience with similar types of sales of similar products, or inability to apply such experience because of changing circumstances, for example, changes in the selling enterprise’s marketing policies or relationships with its customers d Absence of a large volume of relatively homogeneous transactions Requirement The six criteria are: a The seller’s price to the buyer is substantially fixed or determinable at the date of sale b The buyer has paid the seller and the obligation is not contingent on resale of the product c The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product d The buyer acquiring the product for resale has economic substance apart from that provided by the seller e The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer f The amount of future returns can be reasonably estimated Requirement Both companies recognize revenues from products sold when persuasive evidence of an arrangement exists, the price is fixed or determinable, shipment is made and collectibility is reasonably assured However, for sales to distributors under terms allowing the distributors certain rights of return and price protection on unsold merchandise held by them, AMD defers recognition of revenue and related profits until the merchandise is resold by the distributors © The McGraw-Hill Companies, Inc., 2007 5-74 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 5-9 (concluded) Requirement The two revenue recognition policies differ with respect to AMD’s sales to distributors Revenue for these sales is deferred until the merchandise is resold by the distributors On the other hand, HP recognizes all sales when products are shipped even though they offer price protection as well as the right of return to customers Estimates are recorded for customer returns, price protection, rebates and other offerings Reasons for the difference in policies could relate to the types of products sold by the two companies, the distribution channels, and the actual agreements with customers AMD sells semiconductors, a highly volatile industry It may be more difficult for AMD to see through the distribution channels to reasonably estimate returns Also, the agreements with distributors of AMD’s products may be more liberal than those of HP with respect to things like price protection and returns For example, AMD might offer a longer time period for customers to return product than does HP Also, AMD’s sales to distributors might be contingent on resale of the product to end users, one of the six criteria that must be met before revenue can be recognized when the right of return exists Judgment Case 5-10 Delta should recognize the $425 as revenue on May 15, the date the flight commences Revenue should be recognized evenly over the period beginning after Thanksgiving and ending April 30 The $5,000 monthly charge is recognized as revenue each month The $12,000 fee must be recognized evenly over the 36-month lease period Janora Hawkins should recognize the $60,000 as revenue on August 28, the date the case is settled successfully This assumes reasonable certainty as to the collection Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-75 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 5-11 Bill’s argument is that the completed contract method is preferable because it is analogous to point of delivery revenue recognition That is, no revenue is recognized until the completed product is delivered John’s argument is that the important factor is the earnings process and that revenue should be recognized as the process takes place John’s argument is correct In situations when the earnings process takes place over long periods of time, like long-term construction contracts, it is preferable to recognize revenue during the earnings process, rather than to wait until the process is complete © The McGraw-Hill Companies, Inc., 2007 5-76 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Communication Case 5-12 Suggested Grading Concepts and Grading Scheme: Content (70%) _ 45 Income differences Percentage-of-completion recognizes gross profit during construction based on an estimate of percent complete The completed contract method recognizes no gross profit until project completion For both methods, estimated losses are fully recognized in the first period the loss is anticipated _ 10 Balance sheet differences The two methods are similar However, for profitable projects, the construction in progress account during construction will have a higher balance when using the percentage-of-completion method due to the inclusion of gross profit _ 15 According to generally accepted accounting principles, the percentage-of-completion method should be used in most situations The completed contract method distorts income when long-term projects span more than one accounting period _ 70 points Writing (30%) _ Terminology and tone appropriate to the audience of a company controller _ 12 Organization permits ease of understanding Introduction that states purpose Paragraphs that separate main points _ 12 English Sentences grammatically clear and well organized, concise Word selection Spelling Grammar and punctuation _ 30 points Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-77 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com International Case 5-13 Electrolux's revenue recognition policies for products and services are similar to revenue recognition policies in the U.S Sales of products are recorded when goods have been put at the disposal of the customers in accordance with agreed terms of delivery and when the risks and rewards of ownership have been transferred to the buyer The terminology is somewhat different, but the end results, as compared to U.S policies, should be similar in most cases Trueblood Accounting Case 5-14 A solution and extensive discussion materials can be obtained from the Deloitte Foundation Real World Case 5-15 Requirement The following is from the 2003 10K of Jack in the Box, Inc The responses to the question will vary if the company has since changed its revenue recognition policy a These fees are recognized as revenue when the company has substantially performed all of its contractual obligations This policy agrees with SFAS No 45 guidelines b Continuing payments are based on a percentage of sales Requirement Answers to this question will, of course, vary because students will research financial statements of different companies Likely candidates for comparison include most of the fast-food chains such as McDonalds and Wendys © The McGraw-Hill Companies, Inc., 2007 5-78 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Analysis Case 5-16 This case encourages students to obtain hands-on familiarity with an actual annual report and library sources of industry data They also must apply the techniques learned in the chapter You may wish to provide students with multiple copies of the same annual reports and compare responses Another approach is to divide the class into teams who evaluate reports from a group perspective Judgment Case 5-17 Apparently, a significant increase in assets occurred during the last quarter Total assets were $324 million and now they total $450 million, as can be calculated as follows: Return on shareholders’ equity = Net income ÷ Shareholders’ equity = 14% Shareholders’ equity = $21 million ÷ 14% = $150 million Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = Total liabilities = $150 million x = $300 million Total assets = Total liabilities + Shareholders’ equity = $300 million + 150 million = $450 million Integrating Case 5-18 Balance Sheet Assets Cash Accounts receivable (net) Inventory Prepaid expenses and other current assets Current assets Property, plant, and equipment (net) Liabilities and Shareholders’ Equity Accounts payable Short-term notes Current liabilities Bonds payable Shareholders’ equity $ 15,000 12,000 30,000 3,000 60,000 140,000 $200,000 given (e) (d) (i) (h) (j) (b) $ 25,000 5,000 30,000 20,000 150,000 $200,000 (g) given (f) (l) (k) (b) Income Statement Sales Cost of goods sold Gross profit Operating expenses Solutions Manual, Vol.1, Chapter Interest expense Tax expense Net income $300,000 (a) (180,000) (c) 120,000 (c) © The McGraw-Hill Companies, Inc., 2007 (96,000) (o) 5-79 (2,000) (m) (7,000) (n) $ 15,000 given Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 5-18 (concluded) Calculations ($ in 000s): a Profit margin on sales = Net income ÷ Sales = 5% Sales = $15 ÷ 5% = $300 b Return on assets = Net income ÷ Total assets = 7.5% Total assets = $15 ÷ 7.5% = $200 c Gross profit margin = Gross profit ÷ Sales = 40% Gross profit = $300 x 40% = $120 Cost of goods sold = Sales – Gross profit = $300 – 120 = $180 d Inventory turnover ratio = Cost of goods sold ÷ Inventory = Inventory = $180 ÷ = $30 e Receivables turnover ratio = Sales ÷ Accounts receivable = 25 Accounts receivable = $300 ÷ 25 = $12 f Acid-test ratio = Cash + AR + ST Investments ÷ Current liabilities = Current liabilities = ($15 + 12 + 0) ÷.9 = $30 g Accounts payable = Current liabilities – Short-term notes = $30 – = $25 h Current ratio = Current assets ÷ Current liabilities = Current assets = $30 x = $60 i Prepaid expenses and other current assets = Current assets – (Cash + AR + Inventory) = $60 – ($15 + 12 + 30) = $3 j Property, plant, and equipment = Total assets – Current assets = $200 – 60 = $140 k Return on shareholders’ equity = Net income ÷ Shareholders’ equity =10% Shareholders’ equity = $15 ÷ 10% = $150 l Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1/3 Total liabilities = $150 x 1/3 = $50 Bonds payable = Total liabilities - Current liabilities = $50 - 30 = $20 m Interest expense = 8% x (Short-term notes + Bonds ) Interest expense = 8% x ($5 + 20) = $2 n Times interest earned ratio = (Net income + Interest +Taxes) ÷ Interest = 12 Times interest earned ratio = ($15 + + Taxes) ÷ = 12 Times interest earned ratio = ($15 + + Taxes) = 24 Tax expense = $24 – ($15 + 2) = $7 o Operating expenses = (Sales – Cost of goods sold – Interest expense – Tax expense) – Net income = ($300 - 180 - - 7) - 15 = $96 © The McGraw-Hill Companies, Inc., 2007 5-80 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Analysis Case 5-19 Requirement Revenue is recognized upon delivery of shipments or the completion of the service for their office and print services, logistics and trade services businesses For shipments in transit, revenue is recorded based on the percentage of service completed at the balance sheet date Requirement ($ in millions) $ 6,067 = 25% $24,710 Requirement ($ in millions) a Receivables turnover ratio $24,710 ÷ [($3,027 + 2,627) ÷ 2] = 8.74 b Profit margin on sales $838 ÷ $24,710 = 3.39% c Return on assets $838 ÷ [($19,134 + 15,385) ÷ 2] = 4.86% d Return on shareholders’ equity $838 ÷ [($8,036 + 7,288) ÷ 2] = 10.9% Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-81 ... for each element.” © The McGraw-Hill Companies, Inc., 2007 5-2 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions... more cash it can commit to other purposes Solutions Manual, Vol.1, Chapter © The McGraw-Hill Companies, Inc., 2007 5-3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com... in which they occur © The McGraw-Hill Companies, Inc., 2007 5-4 Intermediate Accounting, 4/e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com BRIEF EXERCISES Brief