12.9: Exercises

Exercises

EXERCISE 12–1 (LO1)

The following are condensed comparative financial statements of Stockwell Inc. for the three years ended December 31, 2015.

Balance Sheet
At December 31
Assets
	2024	2023	2022
Current
Cash	$ 21	$ 8	$ 17
Accounts Receivable	38	30	20
Merchandise Inventory	60	40	30
Prepaid Expenses	1	2	3
Total Current Assets	120	80	70
Property, plant and equipment assets, at carrying amount	260	150	76
Total Assets	$380	$230	$146
Liabilities
Current
Accounts Payable	$100	$ 80	$ 50
Non-current
Bonds Payable, 4%	50	50	-0-
	150	130	50
Equity
Common Shares	200	80	80
Retained Earnings	30	20	16
	230	100	96
Total Liabilities and Equity	$380	$230	$146

Income Statement
For the Years Ended December 31
	2024	2023	2022
Sales	$210	$120	$100
Cost of Goods Sold	158	80	55
Gross Profit	52	40	45
Operating Expenses	35	32	33
Income from Operations	17	8	12
Interest Expense	2	2	-0-
Income before Income Taxes	15	6	12
Income Taxes	5	2	4
Net Income	$ 10	$ 4	$ 8

Additional information:

1. The company's accounts receivable at December 31, 2012 totalled $20.
2. The company's merchandise inventory at December 31, 2012 totalled $20.
3. The company's property, plant and equipment assets at December 31, 2012 totalled $70.
4. Credit terms are net 60 days from date of invoice.
5. Number of common shares outstanding: 2013–80, 2014–80, 2015–400.

Required:

1. Calculate liquidity ratios and discuss.
2. What is your evaluation of
   1. The financial structure of the corporation?
   2. The proportion of shareholder and creditor claims to its assets?
   3. The structure of its short-term and long-term credit financing?
3. What are some other observations you can make about the financial performance of Stockwell?

EXERCISE 12–2 (LO1)

The following information relates to three companies in the same industry:

Company	Latest market price	Earnings per share	Dividends per share
A	$ 35	$ 11	$ -0-
B	40	5	4
C	90	10	6

Required: Explain and calculate the price-earnings and dividend yield ratios. On the basis of only the foregoing information, which company represents the most attractive investment opportunity to you? Explain.

EXERCISE 12–3 (LO1)

Consider the following information:

Salinas Limited
Balance Sheet
At December 31, 2012
Assets		Liabilities and Equity
Cash	$ 72	Accounts Payable	$ 60
Accounts Receivable	88	Bank Loan, non-current	150
Merchandise Inventory	100	Preferred Shares	60
Prepaid Expenses	40	Common Shares	250
Property, Plant, and Equipment, at carrying amount	320	Retained Earnings	100
Total Assets	$620	Total Liabilities and Equity	$620

Salinas Limited
Income Statement
For the Year Ended December 31, 2012
Sales		$240
Cost of Goods Sold		144
Gross Profit		96
Operating Expenses
Salaries	$ 44
Depreciation	6	50
Income from Operations		46
Less: Interest		8
Income before Income Taxes		38
Less: Income Taxes		18
Net Income		$ 20

Assume that 80% of sales are on credit, that the average of all balance sheet items is equal to the year-end figure, that all preferred share dividends have been paid and the total annual preferred dividend entitlement is $6, and that the number of common shares outstanding is 10.

Required: Calculate the following ratios and percentages

1. Current ratio
2. Return on total assets
3. Sales to total assets
4. Acid-test ratio
5. Times interest earned
6. Earnings per common share
7. Accounts receivable collection period
8. Return on equity

EXERCISE 12–4 (LO2)

The following data are taken from the records of Cronkite Corp.:

	2024	2023
Sales	$2,520	$1,440
Cost of Goods Sold	1,890	960
Gross Profit	630	480
Other Expenses	510	430
Net Income	$ 120	$ 50

Required: Perform horizontal analysis on the above date and interpret your results.

EXERCISE 12–5 (LO2)

Assume you are an accountant analysing Escalade Corporation. Escalade has expanded its production facilities by 200% since 2010. Its income statements for the last three years are as follows:

Escalade Corporation
Comparative Income Statements
For the Years Ending December 31
	2024	2023	2022
Sales	$250	$150	$120
Cost of Goods Sold	190	100	60
Gross Profit	60	50	60
Other Expenses	35	34	35
Net Income	$ 25	$ 16	$ 25

Required:

1. Prepare a vertical analysis of Escalade Corporation's income statement for the three years.
2. What inferences can be drawn from this analysis?

EXERCISE 12–6 (LO1)

The following information is taken from the partial balance sheet of Quail Productions Corp.

	2023		2022
Current assets
Cash	$	10	$	15
Marketable investments		35		35
Accounts receivable		200		150
Inventory		600		400
Current liabilities
Accounts payable		500		400
Borrowings		245		180

Required:

1. Describe the purpose of and calculate the current ratio for each year.
2. Describe the purpose of and calculate the acid-test ratio for both years.
3. What observations can you make from a comparison of the two types of ratios?

EXERCISE 12–7 (LO1)

The following information is taken from the records of Black Spruce Co. Ltd.:

	2024		2023		2022
Sales	$	252	$	141	$	120
Gross profit		63		48		54
Net income		12		5		15

Required: Analyse the gross profit and net profit ratios using the above data. Comment on any trends that you observe.

EXERCISE 12–8 (LO1)

In the left-hand column, a series of independent transactions is listed. In the right-hand column, a series of ratios is listed.

Transaction	Ratio	Effect on ratio
Declared a cash dividend	Current ratio
Wrote-off an uncollectible account receivable	Accounts receivable collection period
Purchased inventory on account	Acid-test ratio
Issued 10-year bonds to acquire property, plant, and equipment	Return on total assets
Issued additional shares for cash	Debt to shareholders' equity ratio
Declared a share dividend on common shares	Earnings per share
Purchased supplies on account	Current ratio
Paid a current creditor in full	Acid-test ratio
Paid an account payable	Number of days of sales in inventory

Required: For each transaction indicate whether the ratio will increase (I), decrease (D), or remain unchanged (No Change). Assume all ratios are greater than 1:1 before each transaction where applicable.

EXERCISE 12–9 (LO1)

Consider the following financial statement data:

Balance Sheet
Cash	$20
Accounts receivable	20
Merchandise inventory	40
Plant, at carrying amount	140
	$220
Accounts payable	$20
Non-current borrowings	60
Common shares (8 shares issued)	80
Retained earnings	60
	$220

Income Statement
Sales	$100
Cost of goods sold	50
Gross profit	50
Operating expenses	14
Income from operations	36
Less: Interest	6
Income before income taxes	30
Less: Income taxes	10
Net income	$20

Assume that the average of all balance sheet items is equal to the year-end figure and that all sales are on credit.

Required:

1. Calculate the following ratios:
   1. Return on total assets (assume interest has been paid)
   2. Return on shareholders' equity
   3. Times interest earned ratio
   4. Earnings per share
   5. Number of days of sales in inventory
   6. Accounts receivable collection period
   7. Sales to total assets ratio
   8. Current ratio
   9. Acid-test ratio
   10. Debt to shareholders' equity ratio.
2. Which of these ratios are measures of liquidity?

EXERCISE 12–10 (LO1)

Assume a company has the following financial information:

Cash and short-term investments	$6
Prepaid expenses	-0-
Capital assets	90
Total liabilities	40
Shareholders' equity	140
Sales	420
Credit sales	300
Current ratio	2.5:1
Acid-test ratio	1:1
Gross profit ratio	30%

Assume current assets consist of cash, short-term investments, accounts receivable, inventory, and prepaid expenses, and that ending balances are the same as average balances for the year.

Required: Calculate

1. Current liabilities
2. Inventory
3. Accounts receivable collection period
4. Number of days of sales in inventory
5. Revenue operating cycle

EXERCISE 12–11 (LO1)

A company began the month of May with $200,000 of current assets, a 2.5 to 1 current ratio, and a 1.25 to 1 acid-test ratio. During the month, it completed the following transactions:

Transaction	Effect on current ratio
i. Bought $20,000 of merchandize on account (the company uses a perpetual inventory system)
ii. Sold for $10,000 cash, merchandize that cost $5,000
iii. Collected a $2,500 account receivable
iv. Paid a $10,000 account payable
v. Wrote off a $1,500 bad debt against the allowance for doubtful accounts
vi. Declared a $1 per-share cash dividend on the 10,000 outstanding common shares
vii. Paid the dividend declared above
viii. Borrowed $10,000 from a bank by assuming a 60-day, 10-per cent loan
ix. Borrowed $25,000 from a bank by placing a 10-year mortgage on the plant
x. Used the $25,000 proceeds of the mortgage to buy additional machinery

Required:

1. Indicate the effect on current ratio assuming each transaction is independent of the others: Increase, Decrease, or No Change.
2. At the end of May, and taking all the above transactions into account, what was the current ratio and acid-test ratio?

Use the following format. The opening current ratio calculation and effects of the first transaction are provided:

Current ratio:

In thousands of dollars

Bal May 1

i

ii

iii

iv

v

vi

vii

vii

ix

x

Bal May 31

Current assets

x

200

+20

Current liabilities

y

80

+20

Current ratio

x/y

2.5

Acid-test ratio:

In thousands of dollars

Bal May 1

i

ii

iii

iv

v

vi

vii

viii

ix

x

Bal May 31

Quick assets

x

Current liabilities

y

Acid-test ratio

x/y

Problems

PROBLEM 12–1 (LO1)

Belafonte Corporation's books were destroyed in a fire on April 20, 2011. The comptroller of the corporation can only remember a few odd pieces of information:

1. The current ratio was 3.75 to 1.
2. Sales for the year were $73,000.
3. Inventories were $20,000 and were equal to property, plant and equipment at carrying amount, and also equal to bonds payable.
4. The accounts receivable collection period was 40 days.
5. The bonds payable amount was 10 times cash.
6. Total current assets were twice as much as common shares.

Required: Using this information, prepare Belafonte Corporation's balance sheet at April 30, 2011. Assume balances at April 30, 2011 are the same as average balances for the year then ended, and besides retained earnings, there are no accounts other than those mentioned above.

PROBLEM 12–2 (LO1)

The incomplete balance sheet of Hook Limited is given below.

Hook Limited
Balance Sheet
At December 31, 2011
Assets
Current
Cash	$30,000
Accounts Receivable	?
Merchandise Inventory	?
			$ ?
Property, plant and equipment assets	?
Less: Accumulated Depreciation	100,000		?
Total Assets			$ ?
Liabilities
Current
Accounts Payable	$50,000
Accrued Liabilities	?
			$120,000
Non-current
8% Bonds Payable			?
Equity
Common Shares			?
Retained Earnings			?
Total Liabilities and Equity			$ ?

Additional information for 2011 year-end:

1. The amount of working capital is $150,000.
2. The issued value of the shares is $10 per share.
3. Market price per share is $15.
4. Price-earnings ratio is 3.
5. Income before payment of interest and income tax is $80,000.
6. The ratio of shareholder's equity to total assets is 0.60 to 1.
7. Income tax expense equals $30,000.
8. The acid-test ratio is 1.5 to 1.
9. The times interest earned ratio is 8 to1.

Required: Complete Hook Limited's balance sheet.

1. Any ratio in the form X:1 can be expressed as a percentage by multiplying both the numerator and denominator by 100. For example, a 0.25:1 ratio would equal 25% []

2. Average balance sheet amounts are used when income statement amounts are compared to balance sheet amounts in a ratio. This is because the income statement item is realized over a fiscal year, while balance sheet amounts are recorded at points in time at the end of each fiscal year. Averaging opening and ending balance sheet amounts is an attempt to match numerators and denominators to an approximate midpoint in the fiscal year.

3. ($420 + 544)/2 = $482

4. ($257 + 420)/2 = $338.5

5. ($503 + 833)/2 = $668

6. ($361 + 503)/2 = $432

7. ($2,112 + 2,486)/2 = $2,299

8. ($1,417 + 2,112)/2 = $1,764.50

9. ($2,112 + 2,486)/2 = $2,299

10. ($1,417 + 2,112)/2 = $1,764.50

11. ($1,195 + 1,231)/2 = $1,213

12. ($1,048 + 1,195)/2 = $1,121.50