E24 2 post balance sheet events

B EXERCISES

E24-1B (L02) (Post-Balance-Sheet Events) Cola Corporation issued its financial statements for the year ended December 31, 2017, on February 25, 2018. The following events took place early in 2018.

(a) On January 29, the company purchased 50,000 shares of its $1 par value common stock for $23 per share. (b) On February 15, Cola determined after negotiations with the other party in a lawsuit that Cola should pay $500,000. At

December 31, 2017, a litigation liability was recorded at $200,000.

Instructions

Discuss how the preceding post-balance-sheet events should be reflected in the 2014 financial statements.

E24-2B (L02) (Post-Balance-Sheet Events) For each of the following subsequent (post-balance-sheet) events, indicate whether a company should (a) adjust the financial statements, (b) disclose in notes to the financial statements, or (c) neither adjust nor disclose.

______ 1. Settlement of prior year’s litigation against the company at no cost. ______ 2. Sale of a 10% of the company’s assets. ______ 3. Gain a significant customer. ______ 4. Filing for protection under Chapter 11 of the Bankruptcy Code. ______ 5. Loss of an overseas plant due to expropriation. ______ 6. Dismissal of the company president. ______ 7. Issuance of a significant number of shares of preferred stock. ______ 8. Prolonged employee strike. ______ 9. Charges of fraud filed against a vice-president. ______ 10. Acquisition of another company with sales of approximately one-half of the company.

E24-3B (L02) (Segmented Reporting) Lancers Inc. is involved in five separate industries. The following information is available for each of the five industry segments.

Operating Segment Total Revenue Operating Profit (Loss) Identifiable Assets

A $140,000 $25,000 $240,000 B 40,000 8,000 11,000 C 26,000 (5,000) 36,000 D 190,000 (2,000) 59,000 E 2,000 500 15,000

$398,000 $26,500 $361,000

Instructions

Determine which of the operating segments are reportable based on the:

(a) Revenue test. (b) Operating profit (loss) test. (c) Identifiable assets test.

*E24-4B (L06) (Ratio Computation and Analysis; Liquidity) As loan analyst for Second Bank, you have been presented the following information.

Era Co. McCoy Co.

Assets

Cash $ 220,000 $ 150,000 Receivables 108,000 241,000 Inventories 505,000 390,000

Total current assets 833,000 781,000 Other assets 230,000 405,000

Total assets $1,063,000 $1,186,000

Liabilities and Equity

Current liabilities $ 241,000 $ 401,000 Long-term liabilities 200,000 300,000 Capital stock and retained earnings 622,000 485,000

Total liabilities and equity $1,063,000 $1,186,000

Annual sales $1,300,000 $2,300,000 Rate of gross profit on sales 35% 25% 1

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2 Chapter 24 Full Disclosure in Financial Reporting

Each of these companies has requested a loan of $200,000 for 6 months with no collateral offered. Inasmuch as your bank has reached its quota for loans of this type, only one of these requests is to be granted.

Instructions

Which of the two companies, as judged by the information given above, would you recommend as the better risk and why? Assume that the ending account balances are representative of the entire year.

*E24-5B (L06) (Analysis of Given Ratios) Sea Tech Company is a wholesale distributor of scuba diving equipment and sup- plies. The company’s sales have averaged about $2,000,000 annually for the 3-year period 2015–2017. The firm’s total assets at the end of 2017 amounted to $1,250,000. The president of Sea Tech Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s operations for the past 3 years. This report will be presented to the board of directors at their next meeting. In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios which can assist in the identification and interpretation of trends. At the request of the controller, the accounting staff has calcu- lated the following ratios for the 3-year period 2015–2017.

2015 2016 2017

Current ratio 1.60 1.62 1.56 Acid-test (quick) ratio 0.90 0.96 1.07 Accounts receivable turnover 9.7 9.8 8.1 Inventory turnover 4.8 5.1 4.3 Total debt to total assets 50.0% 42.0% 39.0% Long-term debt to total assets 30.0% 25.0% 30.0% Sales to fixed assets (fixed asset turnover) 1.78 1.69 1.60 Sales as a percent of 2015 sales 1.00 1.01 1.02 Gross margin percentage 36.0% 34.7% 33.8% Net income to sales 9.4% 9.9% 9.8% Return on total assets 15.0% 15.1% 15.6% Return on stockholders’ equity 30.9% 29.5% 26.4%

In preparation of the report, the controller has decided first to examine the financial ratios independent of any other data to determine if the ratios themselves reveal any significant trends over the 3-year period.

Instructions

(a) The current ratio is constant while the acid-test (quick) ratio is increasing. Using the ratios provided, identify and explain the contributing factor(s) for this apparently divergent trend.

(b) In terms of the ratios provided, what conclusion(s) can be drawn regarding the company’s use of financial leverage during the 2015–2017 period?

(c) Using the ratios provided, what conclusion(s) can be drawn regarding the company’s net investment in plant and equipment?

*E24-6B (L06) (Ratio Analysis) Voda Link Corp. is a manufacturer of communciations components and accessories, with total assets of $10,000,000. Selected financial ratios for Voda Link and the industry averages for firms of similar size are presented below.

Voda Link

2017 Industry 2015 2016 2017 Average

Current ratio 2.32 2.20 2.11 2.22 Quick ratio 1.16 1.15 1.25 1.30 Inventory turnover 2.90 3.72 3.80 5.90 Net sales to stockholders’ equity 4.12 4.39 4.49 4.30 Net income to stockholders’ equity 0.24 0.26 0.30 0.15 Total liabilities to stockholders’ equity 1.31 1.27 1.39 1.00

Voda Link is being reviewed by several entities whose interests vary, and the company’s financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Voda Link’s finan- cial position.

National Bank: The bank is processing Voda Link’s application for a new 5-year term note. National has been Voda Link’s banker for several years but must reevaluate the company’s financial position for each major transaction.

AT&B Company: AT&B is a new supplier to Voda Link and must decide on the appropriate credit terms to extend to the company.

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B Exercises 3

First Brokerage: A brokerage firm specializing in the stock of communication firms that are sold over-the-counter, First Broker- age must decide if it will include Voda Link in a new fund being established for sale to First Brokerage’s clients.

Executive Committee: This is a committee of Voda Link’s management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the company’s working capital position, comparing actual data against budgets, and recommending changes in strategy as needed.

Instructions

(a) Describe the analytical use of each of the six ratios presented above. (b) For each of the four entities described above, identify two financial ratios that would be most valuable as a basis for its

decision regarding Voda Link. (c) Discuss what the financial ratios presented in the question reveal about Voda Link. Support your answer by citing spe-

cific ratio levels and trends as well as the interrelationships between these ratios. (CMA adapted)

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