Solutions Guide: Please do not present as your own



Solutions Guide:   Please do not present as your own.  I sometimes post solutions that are totally mine, from the book’s solutions manual, or a mix of my work and the books solutions manual. But this is only meant as a solutions guide for you to answer the problem on your own. I recommend doing this with any content you buy online whether from me or from someone else.

E24-2 (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 federal tax case at a cost considerably in excess of the amount expected at year-end. ______ 2. Introduction of a new product line. ______ 3. Loss of assembly plant due to fire. ______ 4. Sale of a significant portion of the company’s assets. ______ 5. Retirement of the company president. ______ 6. Prolonged employee strike. ______ 7. Loss of a significant customer. ______ 8. Issuance of a significant number of shares of common stock. ______ 9. Material loss on a year-end receivable because of a customer’s bankruptcy. ______ 10. Hiring of a new president. ______ 11. Settlement of prior year’s litigation against the company. ______ 12. Merger with another company of comparable size.

|1. |(a) |4. |(b) |7. |(c) |10. |(c) |

|2. |(c) |5. |(c) |8. |(b) |11. |(a) |

|3. |(b) |6. |(c) |9. |(a) |12. |(b) |

*E24-4 (Ratio Computation and Analysis; Liquidity) As loan analyst for Utrillo Bank, you have been presented the following information. Toulouse Co. Lautrec Co. Assets Cash $ 120,000 $320,000 Receivables 220,000 302,000 Inventories 570,000 518,000 Total current assets 910,000 1,140,000 Other assets 500,000 612,000 Total assets $1,410,000 $1,752,000 Liabilities and Stockholders’ Equity Current liabilities $ 305,000 $ 350,000 Long-term liabilities 400,000 500,000 Capital stock and retained earnings 705,000 902,000 Total liabilities and stockholders’ equity $1,410,000 $1,752,000 Annual sales $ 930,000 $1,500,000 Rate of gross profit on sales 30% 40% Each of these companies has requested a loan of $50,000 for 6 months with no collateral offered. In as much 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 thebetter risk and why? Assume that the ending account balances are representative of the entire year.

Computations are given below which furnish some basis of comparison of the two companies:

| |Toulouse Co. | |Lautrec Co. |

|Composition of current assets | | | |

| Cash |13% | |28% |

| Receivables |24% | |27% |

| Inventories | 63% | | 45% |

| |100% | |100% |

| | | | |

|Computation of various ratios | | | |

| Current ratio ($910 ÷ $305) |2.98 to 1 |($1,140 ÷ $350) |3.26 to 1 |

| Acid-test ratio ($120 + $220) ÷ $305 |1.11 to 1 |($320 + $302) ÷ $350 |1.78 to 1 |

| Accounts receivable turnover ($930 ÷ $220) |4.23 times |$1,500 ÷ $302 |4.97 times |

| Inventory turnover |1.14a times | |1.74b times |

| Cash to current liabilities ($120 ÷ $305) |.39 to 1 |($320 ÷ $350) |.91 to 1 |

| | | | |

|a($930 X .70) ÷ $570 b($1,500 X .60) ÷ $518 | | | |

Lautrec Co. appears to be a better short-term credit risk than Toulouse Co. Analysis of various liquidity ratios demonstrates that Lautrec Co. is stronger financially, all other factors being equal, in the short-term. Comparative risk could be judged better if additional information were available relating to such items as net income, purpose of the loan, due date of current and long-term liabilities, future prospects, etc.

CA24-2 (Disclosures Required in Various Situations) Rem Inc. produces electronic components for sale to manufacturers of radios, television sets, and digital sound systems. In connection with her examination of Rem’s financial statements for the year ended December 31, 2007, Maggie Zeen, CPA, completed field work 2 weeks ago. Ms. Zeen now is evaluating the significance of the following items prior to preparing her auditor’s report. Except as noted, none of these items have been disclosed in the financial statements or notes. Item 1 A 10-year loan agreement, which the company entered into 3 years ago, provides that dividend payments may not exceed net income earned after taxes subsequent to the date of the agreement. The balance of retained earnings at the date of the loan agreement was $420,000. From that date through December 31, 2007, net income after taxes has totaled $570,000 and cash dividends have totaled $320,000. On the basis of these data, the staff auditor assigned to this review concluded that there was no retained earnings restriction at December 31, 2007. Item 2 Recently Rem interrupted its policy of paying cash dividends quarterly to its stockholders. Dividends were paid regularly through 2006, discontinued for all of 2007 to finance purchase of equipment for the company’s new plant, and resumed in the first quarter of 2008. In the annual report dividend policy is to be discussed in the president’s letter to stockholders. Item 3 A major electronics firm has introduced a line of products that will compete directly with Rem’s primary line, now being produced in the specially designed new plant. Because of manufacturing innovations, the competitor’s line will be of comparable quality but priced 50% below Rem’s line. The competitor announced its new line during the week following completion of field work. Ms. Zeen read the announcement in the newspaper and discussed the situation by telephone with Rem executives. Rem will meet the lower prices that are high enough to cover variable manufacturing and selling expenses but willpermit recovery of only a portion of fixed costs. Item 4 The company’s new manufacturing plant building, which cost $2,400,000 and has an estimated life of 25 years, is leased from Ancient National Bank at an annual rental of $600,000. The company is obligated to pay property taxes, insurance, and maintenance. At the conclusion of its 10-year noncancellable lease, the company has the option of purchasing the property for $1. In Rem’s income statement the rental payment is reported on a separate line. Instructions For each of the items above discuss any additional disclosures in the financial statements and notes that the auditor should recommend to her client.

Item 1

The staff auditor reviewing the loan agreement misinterpreted its requirements. Retained earnings are restricted in the amount of $420,000, which was the balance of retained earnings at the date of the agreement. The nature and amount of the restriction should be disclosed in the balance sheet or a note to the financial statements.

Item 2

Unless cumulative preferred dividends are involved, no recommendation by the CPA is required. Common stock dividend policy is understood by readers of financial statements to be discretionary on the part of the board of directors. The company need not commit itself to a prospective common stock dividend policy or explain its historical policy in the financial statements, particularly since dividend policy is to be discussed in the president’s letter. If cumulative preferred dividends are omitted, this should be disclosed in the financial statements or a note.

Note that the SEC encourages companies to disclose their dividend policy in their annual report. Those that: (1) have earnings but fail to pay dividends or (2) do not expect to pay dividends in the foreseeable future are encouraged to report this information. In addition, companies that show a consistent pattern of paying dividends are encouraged to indicate whether they intend to continue this practice in the

future.

Item 3

A competitive development of this nature normally is considered to be the type of subsequent event that provides evidence with respect to a condition that did not exist at the date of the balance sheet. In some circumstances the auditor might conclude that Rem’s poor competitive situation was evident at year-end. In any event, the development should be disclosed to users of the financial statements because the economic recoverability of the new plant and inventory are in doubt and Rem may incur substantial expenditures to modify its facilities. Because the economic effects probably cannot be determined, the usual disclosure will be in a note to the financial statements. If the present recoverable value of the plant can be determined, Rem should consider disclosure of the company’s revised financial position in a pro-forma balance sheet, assuming that this event is concluded to be evidence of a condition that did not exist at year-end. (Only if circumstances were such that it was concluded that this condition did exist at year-end should the financial statements for the year ended December 31, 2007, be adjusted for the ascertainable economic effects of this development.)

Item 4

The lease agreement with Ancient National Bank meets the criteria for a capital lease because it contains a bargain purchase option (a 25-year-life building can be purchased at the end of 10 years for $1). Additionally, unless the fair value of the building is considerably greater than its $2,400,000 cost, the present value of the lease payments probably exceeds 90% of the fair value of the building. The lessee, therefore, must capitalize the leased asset and the related obligation in the balance sheet at the appropriate discounted amount of the future rental payments under the lease agreement. Via note, the lessee must disclose: (1) the gross amount of the leased asset and the accumulated depreciation thereon,

(2) the future minimum lease payments as of the latest balance sheet date, in the aggregate and for each five succeeding fiscal years and for the amount of imputed interest necessary to reduce the lease payments to present value, (3) a general description of the lease arrangement, and (4) the existence of the terms of the purchase option. The income statement should contain a charge for depreciation of the leased asset plus an interest charge.

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