Estimate as best you can the journal entries that Harley ...



BA 270 - Final Exam

Fall, 2003

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Part Topic Points

I. Receivables, etc. 24

II. Valuation 21

III. Manufacturing 38

IV. Intercompany Investments 18

101

SHOW YOUR WORK FOR PARTIAL CREDIT. If you feel that you need to make an assumption on a problem, please state it. If you are really confused by a question, I will be in the hall to answer questions. All numbers are in $ thousands. Please round to the nearest thousand. WATCH THE TIME—IF YOU GET STUCK ON A QUESTION, MOVE ON AND COME BACK TO IT.

The Steinway Music Company, through its wholly-owned subsidiaries, The Steinway Piano Company and Conn-Selmer, Inc., is engaged in the design, manufacture, marketing and distribution of high quality musical instruments. They are organized into two segments—pianos and band and orchestra instruments. Their piano division concentrates on the high-end grand piano market, handcrafting Steinway pianos in New York and Germany. They also offer upright pianos as well as two mid-priced lines of pianos under the Boston and Essex brand names. They are also the largest domestic producer of band and orchestral instruments and offer a complete line of brasswind, woodwind, percussion and stringed instruments and related accessories with well known brand names such as Bach, C.G. Conn, King and Ludwig. All questions pertain to 2002 unless noted otherwise; 2002 results are noted in bold in the financial statements.

I. Receivables, etc. (24 points)

1. What journal entries did Steinway record that explain the change in gross accounts receivable and the allowance for bad debts in 2002? Assume all sales were on credit. (15 points)

Bad Debt Expense 2,590

Allowance for Bad Debts 2,590

Allowance for Bad Debts 2,353

Accounts Receivable 2,353

Accounts Receivable 243

Allowance for Bad Debts 243

Accounts Receivable 332,297

Sales Revenue 332,297

Cash 334,474

Accounts Receivable 334,474

Accounts Receivable Allowance for Bad Debts

BB=93,097 BB=10,909

Cr. Sales Writeoffs Writeoffs Bad Debt

332,297 2,353 2,353 Expense

Recoveries Collections 2,590

243 (plug) Recoveries

334,474 243

EB=88,810 EB=11,389

Defining accounts receivable turnover as collections/average net accounts receivable, estimate how many days receivables were outstanding on average in 2002. (3 points)

334,474/((82,188+77,421)/2) = 4.19; 365/4.19 = 87.0 days

2. Steinway offers warrantees with its product. Assume that Steinway satisfies all warrantee claims in cash (e.g., by paying workers to fix the instruments). What journal entries did Steinway record with respect to its warrantees in 2002? (6 points)

Warrantee Expense 950

Warrantee Liability 950

Warrantee Liability 814

Cash 814

STEINWAY FINAL SOLUTIONS

II. Valuation and Evaluation (21 points)

1. Assume that you believe that Steinway’s balance sheet is fairly recorded except as follows. The internally-developed Steinway brands are worth $40,000, their property plant and equipment is worth $124,011 and the reserve which was established for environmental liabilities discussed in the footnotes should be $10,610.

Estimate a fair stock price per share for Fleetwood (they have 8.9 million shares outstanding). (6 points)

Fair value of equity = Book value of equity + fair value of intangible assets not on the balance sheet because internally developed + (fair value of PP&E – book value) – (fair value of liabilities – book value)

$135,806 + $40,000 + ($124,011 – 102,567) – ($10,610 - $610) = $187,250

$187,250/8,900 = $21.04

2. You estimate that Steinway will have net income of $9,345 and $12,905 in 2003 and 2004, respectively. Also, noncash working capital (operating current assets minus operating current liabilities) will increase by $1,610 in 2003 (relative to 2002) and decrease by $511 in 2004 (relative to 2003). Capital expenditures and interest expense (all paid in cash) and depreciation and amortization in both 2003 and 2004 will be the same as in 2002. Existing interest bearing debt is $202,469. Steinway faces a tax rate of 35%. Assume a discount rate of 10% and that the sum of all years’ adjusted cash flows 2005 and beyond total $332,000 when present valued to December 31, 2002.

Estimate the fair value of a share of Steinway’s stock as of December 31, 2002 using a discounted cash flow approach (they have 8.9 million shares outstanding). (8 points)

Net Income 9,345 12,905

+ Depreciation + 11,037 + 11,037

- Δ Working Capital - 1,610 + 511

- Capital Expenditures - 5,604 - 5,604

+ After-tax interest

(.65 x 15,171) + 9,861 + 9,861

23,029 28,720

Value = 23,029/1.1 + 28,720/1.21 + 332,000 – 202,469 = $174,202

$174,202/8,900 = $19.57

3. Steinway has two major segments—pianos, and band and orchestral. Suppose you were evaluating each division (in doing so, just focus on the “Total” amount for each division) from the perspective of Economic Value Added on their assets. Compute the EVAAssets for both divisions for 2002 using operating profit (which is before interest). Assume a cost of capital of 10%. Taken at face value, what do these EVA numbers tell you about whether the divisions should be closed down or retained? (7 points)

Piano EVA: 21,336 – 10% x (203,620 + 213,478)/2 = $481

Band EVA: 11,988 – 10% x (396,575 + 403,031)/2 = -$27,992

The band division clearly does not cover cost of capital and should therefore be closed down. The piano division does (barely) cover cost of capital and should be retained. (Of course, in reality other factors would have to be considered like Steinway’s moral obligation to abet the persecution of children by providing the instruments of their torture).

III. Manufacturing and Absorption Costing (38 points)

1. What journal entries did Steinway record for inventory obsolescence in 2002? Assume that the allowance for obsolescence pertains to finished goods inventory; there are no proceeds on obsolete inventory disposed of (i.e., they destroy it) and obsolescence expense is included in other operating expenses on the income statement. (6 points)

Other Expenses 1,644

Allowance for Obsolescence 1,644

Allowance for Obsolescence 892

Finished Goods Inventory 892

2. Assume that Steinway’s production process involves 40% raw materials, 40% labor and 20% overhead (i.e., those are the proportions of costs which go into work in process). Assume all purchases are on credit (accounts payable), salaries are paid in cash and all overhead is depreciation. What were all of the journal entries (other than the obsolescence journal entry above) that explain the change in each of the inventory accounts (your entries along, with those in question 1., should explain the changes in raw materials, work-in-process and finished goods accounts). Note that you will need to use the answer to question 1. to solve the problem. (19 points)

Cost of Goods Sold 235,146

Finished Goods Inventory 235,146

Finished Goods Inventory 234,332

Work In Process 234,332

Work In Process 94,954

Cash 94,954

Work In Process 47,477

Accumulated Depreciation 47,477

Work In Process 94,954

Raw Material Inventory 94,954

Raw Materials Inventory 95,574

Accounts Payable 95,574

Raw Materials Inv. Work-In-Process Inv. Fin. Goods Inv.

BB=20,948 BB=52,967 BB=87,209

Purchases Transfers Transfers Transfers Transfers CGS

95,574 to WIP from RM to FG from WIP 235,146

94,954 94,954 234,332 234,332 Obs

Salaries 892

94,954

Depr.

47,477

EB=21,568 EB=56,019 EB=85,503

3. Recall that the turnover in an account can be computed based on amounts coming out of that account divided by its average balance. How long on average do raw materials remain in the warehouse before being moved to the production floor? (3 points)

94,954/((20,948+21,568)/2) = 4.47; 365/4.47 = 81.7 days

Estimate how long on average product remains in process on the production plant floor. (2 points)

234,332/((52967+56019)/2) = 4.30; 365/4.30 = 84.9 days

Estimate how long on average inventory remains in finished goods inventory before it is sold or disposed of (i.e., base your answer on gross finished goods inventory and include all of the inventory leaving finished goods inventory including obsolete inventory disposed of). (2 points).

(235,146+892)/((85,503+87,209)/2) = 2.73; 365/2.73 = 133.5

Estimate how long on average elapses between when Steinway purchases raw materials and when it sells or disposes of the final product. (2 points)

81.7 + 84.9 + 133.5 = 300.1 days

Based on the preceding including the analysis of accounts receivable in Part I. above, and assuming that Steinway takes 35 days on average to pay its accounts payable, how long does it take from when Steinway pays cash to purchase raw materials and when they collect cash from customers? (2 points)

300.1 + 87.0 – 35.0 = 352.1 days

Assume that an instrument ties up $1,000 on average over the time between when cash is paid to suppliers and when it is collected from customers and that Steinway’s cost of capital is 10%. Estimate the cost to Steinway of the capital tied up in the average instrument. (2 points)

352.1/365 x 10% x $1,000 = $96.5

IV. Intercompany Investment (18 points)

1. In 2000, Steinway acquired 100% of UMI for $84,227 cash. Prior to acquisition, UMI had inventories of $30,041, receivables of $41,734, property, plant and equipment of $17,510 and accounts payable of $18,622 on its books. Steinway estimated that all of the assets and liabilities were on UMI’s books at fair value except for inventory which was worth $10,000 more than book value. Assuming purchase accounting treatment (not a merger of equals), what journal entry would Steinway have recorded for the transaction? (6 points)

Inventories 40,041

Accounts Receivable 41,734

Property, Plant and Equipment 17,510

Goodwill 3,564

Accounts Payable 18,622

Cash 84,227

What would the journal entry have been if Steinway had only bought 80% of UMI and paid $67,382? (3 points)

Inventories 40,041

Accounts Receivable 41,734

Property, Plant and Equipment 17,510

Goodwill 3,564

Accounts Payable 18,622

Cash 67,382

Minority Interest 16,845

2. On December 31, 2002 Steinway had available-for-sale marketable securities with a cost of $1,080, fair value of $1,299 and unrealized gains of $219.

What was the carrying amount of the securities on Steinway’s books? (1 point)

$1,299

What would the carrying amount have been had the securities been trading securities? (1 point)

$1,299

What would the carrying amount have been if the securities had been debt held to maturity? (1 point)

$1,080

3. Suppose Steinway holds the same marketable securities through the end of 2003 and that they increased in value to $1,312 by the end of 2003.

What effect (direction and amount) would the securities have had on Steinway’s 2003 pretax income if they were securities available for sale? (1 point)

None

What effect (direction and amount) would the securities have had on Steinway’s 2003 pretax income if they were trading securities? (1 point)

Increase by $13.

4. Instead of holding them on December 31, 2003, suppose Steinway sold the securities on December 31, 2003 for $1,312.

What effect (direction and amount) would the securities have had on Steinway’s 2003 pretax income if they were securities available for sale? (2 point)

Increase by $1,312 - $1,080 = $232

What effect (direction and amount) would the securities have had on Steinway’s 2003 pretax income if they were trading securities? (2 point)

Increase by $13.

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