FIN 350 P3-3 to P3-21 P3-3 P3-6 P3-10 P3-16 P3-18 P3-20 P3-21

P-3 Income statement preparation On December 31, 2015, Cathy Chen, a self-employed redefining certified public accountant (CPA), completed her first full year in business. During the year, she billed $360,000 for her accounting services. She had two employees, a bookkeeper and a clerical assistant. In addition to her monthly salary of $8,000, Ms. Chen paid annual salaries of $48,000 and $36,000 to the bookkeeper and the clerical assistant, respectively. Employment taxes and benefit costs for Ms. Chen and her employees totaled $34,600 for the year. Expenses for office supplies, including postage, totaled $10,400 for the year. In addition, Ms. Chen spent $17,000 during the year on tax-deductible travel and entertainment associated with client visits and new business development. Lease payments for the office space rented (a tax deductible expense) were $2,700 per month. Depreciation expense on the office furniture and fixtures was $15,600 for the year. During the year, Ms. Chen paid interest of $15,000 on the $120,000 borrowed to start the business. She paid an average tax rate of 30% during 2015.

a. Prepare an income statement for Cathy Chen, CPA, for the year ended December 31, 2015.

b. Evaluate her 2015 financial performance.

P3-6 Balance sheet preparation Use the appropriate items from the following list to prepare in good form Mellark’s Baked Goods balance sheet at December 31, 2015. 

Item Value at ($000) December 31, 2015  Item Value ($000) at December 31, 2015

Accounts payable $ 220

Inventories $375

Accounts receivable 450

Land 100

Accruals 55

Long-term debts 420

Accumulated depreciation 265

Machinery 420

Buildings 225

Marketable securities 75

Cash 215

Notes payable 475

Common stock (at par) 90

Paid in capital in excess Cost of goods sold 2,500

of par 360

Depreciation expense 45

Preferred Stock 100

Equipment 140

Retained Earnings 210

Furniture and fixtures 170

Sales Revenue 3,600

General expense 320

Vehicles 25

P3-10 Statement of retained earnings Hayes Enterprises began 2015 with a retained earnings balance of $928,000. During 2015, the firm earned $377,000 after taxes. From this amount, preferred stockholders were paid $47,000 in dividends. At year-end 2015, the firm’s retained earnings totaled $1,048,000. The firm had 140,000 shares of common stock outstanding during 2015.

a. Prepare a statement of retained earnings for the year ended December 31, 2015, for Hayes Enterprises. (Note: Be sure to calculate and include the amount of cash dividends paid in 2015.)

Month of origin       Accounts receivable

July                                   $ 3,875
August                                 2,000
September                         34,025
October                              15,100
November                           52,000
December                         193,000
Year-end accounts receivable $300,000

a. Use the year-end total to evaluate the firm’s collection system.

b. If 70% of the firm’s sales occur between July and December, would this information affect the validity of your conclusion in part a? Explain.

P3-18 Debt analysis Springfield Bank is evaluating Creek Enterprises, which has requested a $4,000,000 loan, to assess the firm’s financial leverage and financial risk. On the basis of the debt ratios for Creek, along with the industry averages (see the top of the next page) and Creek’s recent financial statements (following), evaluate and recommend appropriate action on the loan request

Creek Enterprises Income Statement for the Year Ended December 31, 2015

Sales revenue                                                                              $30,000,000

Less: Cost of goods sold                                                                21,000,000

Gross profits                                                                                $ 9,000,000

Less: Operating expenses

          Selling expense                                                                   $3,000,000

          General and administrative expenses                                      1,800,000

          Lease expense                                                                         200,000 

Depreciation expense                                                                       1,000,000

    Total operating expense                             $ 6,000,000 

       Operating profits                                           $ 3,000,000

Less: Interest expense                                                1,000,000

       Net profits before taxes                                                          $ 2,000,000

Less: Taxes (rate 5 40%)                                                                    800,000

       Net profits after taxes                                                             $ 1,200,000

Less: Preferred stock dividends                                                           100,000

       Earnings available for common stockholders                           $ 1,100,000

P3-20 Common-size statement analysis A common-size income statement for Creek Enterprises’ 2014 operations follows. Using the firm’s 2015 income statement presented in Problem 3–18, develop the 2015 common-size income statement and compare it with the 2014 statement. Which areas require further analysis and investigation?

Creek Enterprises Common-Size Income Statement

for the Year Ended December 31, 2014

Sales revenue ($35,000,000)                                                   100.0%

Less: Cost of goods sold                                                             65.9

        Gross profits                                                                     34.1%

Less: Operating expenses

        Selling expense                                                                            12.7%

        General and administrative expenses                                               6.3

        Lease expense                                                                     0.6

        Depreciation expense                                                          3.6

Total operating expense                                                             23.2

Operating profits                                                                      10.9%

Less: Interest expense                                                                 1.5

Net profits before taxes                                                               9.4%

Less: Taxes (rate 5 40%)                                                             3.8

Net profits after taxes                                                                 5.6%

Less: Preferred stock dividends                                                    0.1

Earnings available for common stockholders                               5.5% 

P3-21 The relationship between financial leverage and profitability Pelican Paper, Inc., and Timberland Forest, Inc., are rivals in the manufacture of craft papers. Some financial statement values for each company follow. Use them in a ratio analysis that compares the firms’ financial leverage and profitability.

Item                                                       Pelican Paper, Inc.                      Timberland Forest, Inc.

Total assets                                            $10,000,000                                     $10,000,000

Total equity (all common)                          9,000,000                                         5,000,000

Total debt                                                  1,000,000                                         5,000,000

Annual interest                                             100,000                                            500,000

Total sales                                               25,000,000                                       25,000,000

EBIT                                                          6,250,000                                         6,250,000

Earnings available for

   common stockholders                            3,690,000                                        3,450,000

a. Calculate the following debt and coverage ratios for the two companies. Discuss their financial risk and ability to cover the costs in relation to each other.

1. Debt ratio

2. Times interest earned ratio

b. Calculate the following profitability ratios for the two companies. Discuss their profitability relative to one another.

1. Operating profit margin
2. Net profit margin
3. Return on total assets
4. Return on common equity

c. In what way has the larger debt of Timberland Forest made it more profitable than Pelican Paper? What are the risks that Timberland’s investors undertake when they choose to purchase its stock instead of Pelican’s?