E6-1. Cash. Money held in checking accounts is defined as cash, and there are no restrictions on the account. Cash. Checks are considered cash unless the checks cannot be cashed until a later date (i.e., postdated). In this case, the check date has passed, so the checks are considered cash.
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Accounts receivable 1Allowance for Bad Debts 1
Allowance for Bad Debts
Write off 4 Beg. Bal . 14
Bad debts 3
1 4 18
End. balance 14
“Booking bogus sales to faked companies” would increase sales and increase the gross profit percentage of the company. This has double impact on the income statement. Since the cost of goods sold would not increase for these fake sales, the company’s gross profit would increase by every dollar of fake sales that were booked. After booking these fake sales over a few years the impact on the balance sheet would be that accounts receivable would be overstated. These fake sales to fake companies would not be paid by anybody so the company would have an inflated accounts receivable.
The impact of a receivables writeoff is a debit to the allowance for doubtful accountsand a credit to accounts receivable. The Company probably would not have an allowance account large enough to offset the write-off so that the Company would have to take a hit to its income statement. The Company's stock price will take a significant decrease as a result of a large write-off. There are two primary reasons why the Company's stock will go down. First, the Company had been falsely overstating sales and net income which are some of the primary numbers that investors use to value a stock. The second reason is that investors will have lost confidence in the integrity of management to report actual results in the future. This loss of confidence in management will take a very long time for investors to overcome and the Company's stock will suffer through this time.
Receivables may have increased because sales grew, collections slowed, or because of acquisitions of other companies, or a combination of those factors. An investor's interpretation of the company's current ratio and cash flow statement should include an evaluation of the factors underlying the increase to help determine whether the receivables are in fact realizable. A favorable current ratio does not mean much unless the receivables are in fact collectible. Cash flow measures should be used together with the current ratio. A large difference between net income and net cash from operations because of an increase in receivables could be a problem, but not necessarily. If the increase in receivables is commensurate with an increase in sales, it may not be.
a. Home Depot’s current ratio in 2004 was 1.40 ($13,328/$9,554), down from the 2003 level of 1.48. Home Depot’s working capital in 2004 was $3,774, which changed from 2003’s working capital of $3,882. The accounts that had the biggest impact on these numbers were Merchandise Inventories, Accounts Payable, and current installments of long-term debt. Most other accounts were either up or down by a relatively small amount.
b.Cash and cash equivalents. Cash equivalents refer to any short-term investments that have an original maturity of less than 90 days and that carry virtually no credit risk. Examples of these would be investments like US Government t-bills that are maturing in less than 90 days.
c.Home Depot’s accounts receivable are relatively small compared to current assets and total assets. In 2004 receivables as a percentage of current assets was 8.2% and in 2003 this percentage was 9.0%. In 2003 receivables as a percentage of total assets was 3.2% and in 2002 3.6%.
Receivables management is not a critical element to Home Depot’s operations. Receivables are not a large asset for Home Depot because of the nature of the sales of the company. Most sales are paid for in cash or credit cards. The credit card sales are immediately factored to banks for cash payment. Footnote #1 indicates that the company’s reserve for accounts receivable was “not material” as of 2/1/2004.
d.Expanding operations to China will put Home Depot in the position of selling goods in Chinese currency and ultimately having to convert those sales to U.S. dollars. If exchange rates move unfavorably against the U.S. dollar, Home Depot will face currency losses. To offset this risk against the Chinese currency, Home Depot should enter into hedging agreements to minimize currency risk. As noted in the first footnote, the company currently deals with some foreign currency risk; adding China stores to its operations will require the company to hedge its currency position to minimize risk for shareholders.
FIFO cost flow assumption:
CGS =(75 units @ $450) + (50 units @ $500) + (5 units @ $600)
Gross Profit=Sales - Cost of Goods Sold
=(130 units @ $1,000) - $61,750
Ending Inventory=(60 units @ $600)
Averaging cost flow assumption:
Cost per Unit=[(75 units ´@ $450) + (50 units @ $500) + (65 units @ $600)] ÷ (75 units + 50 units + 65 units)
=$514.47 per unit (rounded)
CGS=(130 units @ $514.47)
Gross Profit=Sales - Cost of Goods Sold
=(130 units @ $1,000) - $66,881.10
Ending Inventory=60 units ´ $514.47
LIFO cost flow assumption:
Cost of Goods Sold =(65 units @ $600) + (50 units @ $500) + (15 units @ $450)
=$39,000 + $25,000 + $6,750
Gross Profit =Sales - Cost of Goods Sold
=(130 units ´ $1,000) - $70,750
Ending Inventory =(60 units @ $450)
(2)Trading Securities (+A)40,000Cash (-A)40,000Invested in GM.
(3)Cash (+A)45,000Trading Securities (-A)37,500Realized Price Increase on Sale of Trading Securities (Ga, +SE) 7,500Sold IBM stock.
(4) Cash (+A) 750Dividend Receivable 750Received dividend.
(5) Trading Securities (+A)8,000Cash (-A)8,000 Invested in Xerox.
(6) Cash (+A)7,500Realized Price Decrease on Sale of Trading Securities (Lo, -SE)5,000Trading Securities (-A)12,500 Sold IBM stock.
(7) Cash (+A)11,600Trading Securities (-A) 8,000 Realized Gain on Sale of Marketable Securities (Ga, +SE) 3,600 Sold Xerox stock.
(8) Cash (+A)30,000 Realized Loss on Sale of Trading Securities (Lo, -SE)10,000Trading Securities (-A)40,000Sold GM stock.