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E6-1

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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E6-1

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  1. 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. • Investment. Certificates of deposit contain penalties for early withdrawal. Since the certificates mature outside the time frame of current assets, this source of cash is not readily available and should not be classified as Cash.

  2. E6-1 • Cash. Because banks have the right to demand notice prior to a withdrawal from a savings account, the cash in savings accounts is technically not readily available. However, since banks rarely exercise this right, savings accounts are considered cash. • Cash. Petty cash is always considered cash. • Restricted cash. Because the company does not have ready access to these funds, the $50,000 should not be reported as cash. The portion of the $50,000 corresponding to short-term loans (i.e., $15,000) should be classified in current assets as restricted cash, and the remaining $35,000 should be classified as a long-term investment or as an other asset. • Cash

  3. E6-7 • Bad Debt Expense 3 Allowance for Bad Debts 3 Recognized bad debt charge. • Allow. For Bad Debts 4 Accounts Receivable 4 Accounts receivable 1 Allowance for Bad Debts 1 Record write-off • Ending Allowance Balance = Beginning Allowance Balance + Bad Debt Charge – Write-Offs + Recoveries Allowance for Bad Debts Write off 4 Beg. Bal . 14 Bad debts 3 1 4 18 End. balance 14

  4. ID6-6 “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.

  5. ID6-6 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.

  6. Question box p. 260 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.

  7. ID 6-11 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.

  8. ID 6-11 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.

  9. ID 6-11 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.

  10. Question box p. 295 • If Pier 1 Imports had incorrectly counted ending inventory at $300 million, the resultant overstatement in inventory of $31 million ($300 million inventory versus the actual of $269 million), would in turn have understated cost of goods sold, and overstated gross margin and net income by a like amount. 2000 net income would have been erroneously reported at $106 million.

  11. Question box p. 299 • Inventories valued using the LIFO cost flow assumption reflect older costs, compared to FIFO which assigns the most recent costs to inventory. In a period of rising prices, use of FIFO would therefore produce a higher ending inventory than through the use of LIFO. So long as Goodyear maintains a certain base quantity of inventory, it will always be valued at the older, lower costs under LIFO. Over a long enough period of rising prices, the difference between those older costs and the recent costs used under FIFO can become quite large. The case would be just the opposite in a period of declining prices.

  12. Question box p. 300 • Goodyear reported a $300 million lower inventory balance under LIFO than it would have been under FIFO; this difference correspondingly resulted in a higher cost of goods sold, and accordingly a lower pretax income. At a 30 percent tax rate, the $300 million difference would have saved Goodyear $90 million in income taxes.

  13. E7-8 FIFO cost flow assumption: CGS = (75 units @ $450) + (50 units @ $500) + (5 units @ $600) = $61,750 Gross Profit = Sales - Cost of Goods Sold = (130 units @ $1,000) - $61,750 = $68,250 Ending Inventory = (60 units @ $600) = $36,000

  14. E7-8 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) = $66,881.10 Gross Profit = Sales - Cost of Goods Sold = (130 units @ $1,000) - $66,881.10 = $63,118.90 Ending Inventory = 60 units ´ $514.47 = $30,868.20

  15. E7-8 LIFO cost flow assumption: Cost of Goods Sold = (65 units @ $600) + (50 units @ $500) + (15 units @ $450) = $39,000 + $25,000 + $6,750 = $70,750 Gross Profit = Sales - Cost of Goods Sold = (130 units ´ $1,000) - $70,750 = $59,250 Ending Inventory = (60 units @ $450) = $27,000

  16. Question box p. 331 • Unrealized gains (or losses) on available-for-sale securities are considered permanent accounts and are carried in the stockholders’ equity section of the balance sheet.(Comprehensive income) If the investments were considered trading securities, these gains or losses are considered temporary accounts, appear on the income statement, and are reflected in retained earnings.

  17. Question box p. 332 • An analyst would be interested in the amount of comprehensive income because it provides an estimate of the overall change in a company's wealth during a period from other than investments by owners or distributions to them. The wide variety of options for disclosure of comprehensive income would not be of great concern, because the standard for determination of the amount of comprehensive income is the same for all companies, and the statement of comprehensive income must be prominently displayed. • Do E8-1

  18. E8-1 • (1) Trading Securities (+A) 50,000 Cash (-A) 50,000 Invested in IBM. (2) Trading Securities (+A) 40,000 Cash (-A) 40,000 Invested in GM. (3) Cash (+A) 45,000 Trading Securities (-A) 37,500 Realized Price Increase on Sale of Trading Securities (Ga, +SE) 7,500 Sold IBM stock.

  19. E8-1 (4) Cash (+A) 750 Dividend Receivable 750 Received dividend. (5) Trading Securities (+A) 8,000 Cash (-A) 8,000 Invested in Xerox. (6) Cash (+A) 7,500 Realized Price Decrease on Sale of Trading Securities (Lo, -SE) 5,000 Trading Securities (-A) 12,500 Sold IBM stock.

  20. E8-1 (7) Cash (+A) 11,600 Trading 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) 10,000 Trading Securities (-A) 40,000 Sold GM stock.

  21. E8-1 • The transactions that affected the income statement for Monroe Auto Supplies are the gains and losses Monroe Auto Supplies realized from selling marketable securities for amounts different from their purchase prices. Monroe Auto Supplies realized gains of $7,500 and $3,600, respectively, on the first sales of IBM and Xerox stock and realized losses of $5,000 and $10,000, respectively, on the second sale of IBM stock and on GM stock. Thus, the net effect of the dividends, gains, and losses on net income was to decrease net income by $3,900. The dividends received from the General Motors stock were recognized as income in the previous period.

  22. Question box p. 337 • The total cash in the form of dividends received by Exxon Mobil from its affiliates in 1999 would be the amount of reported equity income of $3 billion, plus the dividends in excess of that amount of $146 million, for a total of $3.146 billion. • Let’s do the review problem on page 349

  23. ID 8-10 • Home Depot carries a small amount ($26 million, out of total assets of $34,437 million) of investments. The first footnote indicates that the investments are designated available-for-sale securities. • Home Depot labels its goodwill “Cost in Excess of the Fair Value of Net Assets Acquired”. Goodwill was $833 million and $575 million in 2003 and 2002, respectively. The growth in good will indicates that Home Depot is growing through acquisitions. The Statement of Cash Flow, in the Investing section, indicates that the company used $215 million of cash to acquire other businesses during 2003. • Footnote #9 indicates that the aggregate purchase price of 2003 acquisitions by Home Depot was $248 million, with $231 million being allocated to goodwill and the remainder to the fair value of the assets purchased.

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