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Part 3
BUSINESS SOLUTIONS
Trial Balance
November 30
Debit Credit
Cash............................................................... $38,264
Accounts
receivable....................................... 12,618
Computer
supplies......................................... 2,545
Prepaid
insurance.......................................... 2,220
Prepaid
rent................................................... 3,300
Office
equipment............................................ 8,000
Computer
equipment..................................... 20,000
Accounts
payable........................................... $ 0
Common
stock............................................... 73,000
Dividends....................................................... 5,600
Computer
services revenue........................... 25,659
Wages
expense.............................................. 2,625
Advertising
expense....................................... 1,728
Mileage
expense............................................. 704
Miscellaneous
expense.................................. 250
Repairs
expense—Computer..........................
805
Totals............................................................. $98,659
$98,659
Reporting in Action — BTN
2-1
1. Research In Motion reports ($ millions):
$2,227 in liabilities for the fiscal year ended February 28, 2009, and $2,602
for fiscal year ended February 27, 2010.
2. Research
In Motion reports ($ millions): $8,101 in
assets for fiscal year
ended February 28, 2009, and $10,204 for fiscal year ended February 27, 2010.
3. Year ended February 28, 2009 Debt Ratio = $2,227 / $8,101 = 27.5%
Year ended February 27, 2010 Debt Ratio = $2,602 /
$10,204 = 25.5%
4. Research In
Motion employed slightly less financial leverage in the year ended February 27,
2010. In the year ended February 28,
2009, 27.5% of its assets were financed by debt. In 2010, only 25.5% of its assets were
financed by debt. Consequently, its
financing structure was a bit more risky for 2009 in comparison to 2010.
5.
Solution depends on the financial statements accessed.
Comparative Analysis — BTN
2-2
1. Research In Motion ($
millions)
Current year debt ratio: $2,602 / $10,204 = 25.5%
Prior year debt ratio: $2,227 /
$8,101 = 27.5%
2. Apple ($ millions)
Current
year debt ratio: $15,861 / $47,501 =
33.4%
Prior
year debt ratio: $13,874 / $36,171 =
38.4%
3. Apple has the higher degree of financial
leverage. Apple’s debt ratio is markedly
higher (33.4% vs. 25.5% for the current year) than that of Research In Motion.
This indicates that Apple carries more debt financing than Research In Motion.
This also implies that Apple is attempting to use nonowner financing to make
more money for its owners. This is fine provided Apple’s return does not
decline below that of what it pays nonowners for use of that money— this is the
main source of financing risk.
Ethics Challenge — BTN 2-3
This case involves a conflict between the
need for efficiency and the need for control.
While it makes sense to take and process lunch orders quickly, this
efficiency is being accomplished by a shortcut that greatly weakens control
over cash receipts. Cash could be
received and lost or stolen because there would be no initial record of how
much was received.
The assistant manager’s explanation about the
head manager not arriving until 3 o’clock suggests that the head manager
doesn’t know about the proposed shortcut.
Thus, the new employee is faced with the dilemma of deciding whether to
accept the assistant manager’s instructions, suggest to the assistant manager
that the shortcut seems wrong, or to ask the head manager to confirm the
instructions. Each of these alternatives
involves personal risk.
It is possible that the assistant manager
does not understand the potential for fraud and abuse if this shortcut is
used. If the relationship between you
and the assistant manager is such that you feel you can do so, you should
explain your understanding of how the shortcut could lead to the problems of
inaccurate records for tax purposes, gathering inaccurate marketing
information, and abuse by other
employees who might not be as honest as you and the assistant manager.
If the assistant manager insists, you may
want to work as instructed to get an idea of whether the shortcut is being
abused by the assistant manager and perhaps to find out discreetly whether the
head manager knows about it. (Although,
this behavior does involve personal risk of perceived collusion with the
assistant manager.) If you conclude that
the assistant manager is committing fraud, you should report the situation to
the head manager as quickly as possible.
Communicating in Practice — BTN
2-4
MEMORANDUM
To: Mora
Stanley
From:
Subject: Financial
statements explanation
Date:
The four major financial statements and their
purposes are:
·
Income statement describes a
company’s revenues and expenses along with the resulting net income or loss
over a period of time. It helps explain how equity changes during a period due
to earnings activities.
·
Statement of retained
earnings explains
changes in retained earnings due to net income (or net loss) and any dividends
over a period of time.
·
Statement of cash
flows
identifies cash inflows (receipts) and outflows (payments) over a period of
time. It also explains how the cash balance on the balance sheet changed from
the beginning to the end of a period.
·
Balance sheet describes a company’s
financial position (assets, liabilities, and equity) at a point in time.
These financial statements are linked to each
other across time. Specifically, a
balance sheet reports an organization’s financial position at a point in time. The income statement,
statement of retained earnings, and statement of cash flows report on
performance over a period of time.
These three statements link balance sheets from the beginning to the end of a
reporting period. That is, they explain how the financial position of an
organization changes from one point to another.
Taking It to the Net — BTN
2-5
1. The prior three years’ net income or (loss)
for Amazon are ($ millions):
2009 = $902 2008
= $645 2007 = $476
2.
The three years net cash provided by operations follows ($ millions):
2009 = $3,293 2008
= $1,697 2007 =
$1,405
3.
In 2009,
Amazon had net income of $902 million and operating cash flows of $3,293
million; and, in that same year, cash increased by only $675 million (see its
statement of cash flows).
The reason
its cash balance only increased by $675 million in 2009 was because of cash
outflows of $2,337 million for its investing activities and $280 million for
its financing activities (along with a foreign currency effect). Those uses of
cash absorbed much of the cash generated by its operating activities. A large part of those cash outflows was tied
to its investments in securities and its other purchases and acquisitions.
Teamwork in Action — BTN
2-6
<Instructor note: There
is no specific solution to this activity.>
The following sample
solution gives a summary outline of what a minimum report needs to
include. Assume a team member selects
assets:
Category:
Assets
a.
Increases
(decreases) in assets are debits (credits) to asset accounts. Debit means left
side, credit means right side. The normal side of an account refers to the side
where increases are recorded. For assets, this is the debit, or left, side.
b.
Owner
investment of $10,000 cash in business.
c.
Assets = Liabilities + Common Stock – Dividends + Revenues – Expenses
+ $10,000 =
$0 + $10,000 – $0
+ $0 –
$0
Owner investments have no effect on the
income statement, but they do increase the cash flows from financing by $10,000
on the statement of cash flows (this increases its net cash flow).
d.
Paid
rent expense with $2,000 cash.
e.
Assets = Liabilities + Common Stock – Dividends +
Revenues – Expenses
- $2,000 =
$0 +
$0 –
$0 + $0
– $2,000
An expense paid in
cash will decrease net income on the income statement and decrease operating
cash flows on the statement of cash flows.
Entrepreneurial
Decision — BTN
2-7
There
are several issues that Susie and Katie should consider. Those considerations include the following
three issues (among others):
·
If they choose to contribute their own funds
for the expansion, they will be risking their own savings, but they will not
have the expense of interest payments, nor will they have the risk of the
inability to repay a loan.
·
If they choose to borrow, they will have
interest and loan payments to make, and they will have more risk (as reflected
in their company’s debt ratio).
·
If they can pay the interest and loan
payments, it can be to their advantage to borrow, as long as their return on
assets is high enough (that is, higher than the rate of interest on the
borrowings).
Entrepreneurial
Decision — BTN
2-8
1.
Langely Music
Services
Balance Sheet
December 31, 2011
Assets Liabilities
Cash.................................. $ 1,800 Accounts payable................... $ 1,100
Accounts receivable
......... 4,800 Unearned lesson
fees ............ 7,800
Prepaid insurance............. 750 Total
liabilities....................... 8,900
Prepaid rent....................... 4,700
Store supplies................... 3,300 Equity
Equipment ........................ 25,000 Total
equity............................
31,450
Total assets....................... $40,350 Total liabilities and equity...... $40,350
2.
Debt ratio
= Total liabilities / Total
assets =
$8,900 / $40,350 = 0.22
Return on assets = Net income/Average
assets = $20,000/$40,350*
= 0.50
(rounded)
*Ending balance is used per instructions.
3.
The prospects of a bank loan are likely
to be good. (i) The debt ratio indicates
that 78% of the company’s funding is from equity. Also, there are no debt
obligations requiring periodic payments. This implies low risk. (ii) The level of return on assets is very
high. This implies good return.
Overall, given the information and the
assumption that current performance will continue into the future, the
prospects of a bank loan are good.
[Note, the loan does carry some risk—fueling this risk are (i) poor
recordkeeping, (ii) lack of information on growth potential, and (iii) a much
higher pro forma debt ratio—that is, if the loan is granted, the debt ratio
will jump to 0.43, computed as ($8,900 + $15,000) divided by ($40,350 +
$15,000).]
Hitting the Road — BTN
2-9
Findings will vary. It is advisable that the instructor obtain a
few classified sections from newspapers that were published over the period of
the assignment. If student reports lack
responses for question 2, it is informative and motivating to bring these
(accounting-related job opportunities) sections to class when discussing or
returning student reports as many students are not accounting majors.
Global
Decision — BTN
2-10
1. An
analysis of return on assets suggests that Research In Motion (26.8%), followed
by Apple (19.7%), yields the greatest return on assets, while Nokia (0.7%)
yields the lowest return.
2. An
analysis of the debt ratio suggests that Nokia (58.7%) presents the greatest
risk, while Research In Motion (25.5%) presents the least risk. Apple’s debt
ratio (33.4%) is higher than Research In Motion’s but lower than Nokia’s debt
ratios. Therefore, Apple’s financing
risk is higher than Research In Motion but lower than Nokia.
3. In this case, Research In Motion would appear
to warrant some consideration for additional investment. Research In Motion has
the highest profitability for the current year, and it has the lowest financing
risk level of the three. Apple is not
far behind on both dimensions, while Nokia’s return is substantially lower and
its financing risk level is substantially higher for the current year compared
to Research In Motion’s.
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