ACCT101 FINANCIAL ACCOUNTING

INSTRUCTIONS TO CANDIDATES

1 The time allowed for this examination paper is 3 hours.

2 This examination paper contains Ten (10) multiple-choice questions in Part A and
Seven (7) problem-solving questions in Part B, and comprises Fourteen (14)
pages including this instruction sheet.

3 You are required to answer ALL questions.

4 You are required to provide the answers for Part A and the answers and the
workings for Part B in the Answer Script. Please write your answers to Part A
on the FIRST page of your answer script. No penalty for incorrect answers in
Part A.

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 PART A

(1 mark each and 10 marks in total. Please choose ONE as your best choice.)

Provide the answers (in CAPITAL letter) on the first page of the Answer Script.

1. Which of the following is NOT true of stock dividends?

A. Stock dividends have no effect on assets or liabilities.

B. Stock dividends affect only stockholder's equity accounts.
C. Stock dividends have no effect on total stockholders' equity.
D. Stock dividends increase dividends payable and reduce cash.

2. Which of the following accounting principles is consistent with the amortization of

bonds premium?

A. The revenue concept

B. The matching concept
C. Reliability concept
D. Entity concept

3. Which of the following entries would be made as the result of the matching principle?

A. Dr Cash $1,000
Cr Service Revenue $1,000
B. Dr Salary Expense $1,000
Cr Accounts Payable $1,000
C. Accounts Receivable $1,000
Cr Service Revenue $1,000
D. Both B and C

4. A corporation issues $400,000 of 10%, 5-year bonds at 103. What will be the total
interest expense over the life of the bonds?

A. $212,000
B. $200,000
C. $40,000
D. $188,000

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5. A company makes two errors in the physical count of inventory. Beginning inventory
was understated by $28,000 and ending inventory is understated by $43,000. Which of
the following will be the net effect of the two errors?

A. Net income for the current year is understated by $15,000.

B. Net income for the current year is overstated by $15,000.
C. Net income for the current year is understated by $43,000.
D. Net income for the current year is overstated by $71,000.

6. Which of the following is the amount capitalized as goodwill?

A. The excess of the cost of an acquired company over the sum of the market value
of its net assets
B. The excess of the cost of an acquired company over the sum of the book value of
its assets
C. The excess of the cost of an acquired company over the sum of the book value of
its net assets
D. The excess of the cost of an acquired company over the sum of the market value
of its assets

7. A company purchases land using its common stock. Where would this transaction
appear if the company prepares the statement of cash flows using the indirect method or
the direct method?

A. The purchase of land would be presented in the financing activities section as a

cash payment under both methods.
B. The purchase of land would be presented in the investing activities section as a
cash payment under both methods.
C. The purchase of land would be presented in the non-cash investing and financing
activities section under both methods.
D. The purchase of land would be presented in the operating activities section as a
reduction in net income under the indirect method and as a cash payment under
the direct method.

8. A company uses the direct method to prepare the statement of cash flows. How will the
amount of cash payments to suppliers be computed?

A. The amount of cash payments to suppliers is computed as interest expense minus

the decrease in accounts payable.
B. The amount of cash payments to suppliers is computed as purchases minus the
increase in accounts payable.
C. The amount of cash payments to suppliers is computed as interest expense minus
the decrease in merchandise inventory.
D. The amount of cash payments to suppliers is computed as interest expense minus
the increase in merchandise inventory.

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9. The Supplies account for Vulcan Detail Company had a balance of $3,200 at the
beginning of the year. Additional supplies of $13,400 were purchased during the year. A
physical count of the ending inventory of supplies revealed that $5,900 of supplies was
still on hand. What was total supplies expense for the year?

A. $16,400
B. $9,100
C. $10,700
D. $4,300

10. A company that uses the periodic inventory method purchases inventory of $1,000 on
account with terms of 2/10 net/30. Defective inventory of $200 is returned 2 days later.
Which of the following entries would be made to record the payment for the inventory if
the payment is made within 10 days?

A. The accounting entry would be an $800 debit to Accounts Payable, a $16 credit to
Purchase Discounts and a $784 credit to Cash.
B. The accounting entry would be a $16 debit to Purchase Discounts, an $800 debit
to Accounts Payable and an $816 credit to Cash.
C. The accounting entry would be a $784 debit to Accounts Payable, a $16 debit to
Purchase Discounts and a $800 credit to Cash.
D. The accounting entry would be an $800 debit to Accounts Payable and an $800
credit to Cash.

4
 PART B

Question 1 (18 marks)

Hong Leong Electronic Pte Ltd, with a fully paid-up capital of 100,000 no-par ordinary
shares and 50,000 5% no-par preference shares, was incorporated in SingLand on 1
January 2008. The trial balance below has been extracted from the general ledger of
Hong Leong Electronic Pte Ltd as at December 31, 2008.

Trial Balance of Hong Leong Electronic Pte Ltd

as at December 31, 2008
Dr Cr
Accounts Receivable 407,700
Inventory (31December 2008) 115,000
Cash 30,000
Prepaid Rent 16,000
Office Equipment 50,000
Sales Demonstration Equipment 46,000
Accounts Payable 116,200
Note Payable 50,000
Allowance for Uncollectible Accounts 8,800
Estimated Warranty Payable 2,100
Sales Revenue 1,055,800
Ordinary Share Capital 100,000
Preferred Share Capital 50,000
Cost of Goods Sold 493,000
Salary Expense 130,600
Advertising Expense 81,800
General Office Expense 12,800
Total 1,382,900 1,382,900

The following facts came to light after completion of the trial balance:

a. Inventory physical stocktaking on 31 December amounts to $100,000.

b. The last day of the period, 31 December 2008, was a Wednesday. The staff is paid
on Friday for their five-day working week ending on Friday. Staff salaries are
$2,510 per week.
c. Hong Leong purchased the office equipment on 1 January 2008 for $50,000 FOB
shipping point. Transportation costs and installation costs amounted to $1,500 and
$4,500, respectively. Hong Leong recorded the office equipment at $50,000 and
recorded the transportation and installation costs under the General Office
Expense. The useful life of the office equipment is expected to be 10 years with
residual value of $2,000. The company decides to depreciate the office equipment
using straight-line method.

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 d. The sales demonstration equipment was purchased on 1 April 2008. The useful
life of the equipment is 5 years with $6,000 residual value. Hong Leong
depreciates the sales demonstration equipment by double-declining method.
e. Hong Leong issued a 12% three-month note payable on 1 December 2008.
f. Hong Leong estimates that the total cost of warranty claim for the electronic
products sold will be 1% of sales revenue in the year of sale.
g. The year-end audit revealed that cash payment of $5,000 to the supplier was
erroneously recorded as a debit to Cash account and a credit to Accounts Payable
account.
h. On April 1, 2008, Hong Leong paid office rental in advance. The amount paid
was for a two-year period.
i. $7,700 of Accounts Receivable is to be written off as uncollectible. Hong Leong
then record the uncollectible-account expense based on the aging of receivables,
as follows:

Age of Accounts
Accounts 130 3160 6190 Over
Receivable Days Days Days 90 Days
$400,000 $100,000 $150,000 $100,000 $50,000
Estimated percent 0.5% 1.0% 4% 10%
uncollectible

j. Hong Leong declared a dividend of 10 cents per share for the common
stockholders and regular dividends for the preferred stockholders. The declaration
has not been recorded by Hong Leong.

Provide the necessary adjusting journal entries for the above. No explanations are
required for the adjusting journal entries.
(18 marks)

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Question 2 (12 marks)

HDC issued $2,000,000, 8-pecent bonds on 1 January, Year 1 when the annual market
rate of interest was 10%. The bonds required HDC to make semiannual payments of 4%
of face value, on June 30 and December 31 of each year. The bonds mature on December
31, Year 5. HDC amortizes bond premium/discount by the effective-interest method.

Periods Present Value of $1 Present Value of

Ordinary Annuity of $1
4% 5% 8% 10% 4% 5% 8% 10%
5 0.822 0.784 0.681 0.621 4.452 4.329 3.993 3.791
10 0.676 0.614 0.463 0.386 8.111 7.722 6.710 6.145

Required (all computations are rounded to the nearest dollar)

1) Provide the journal entry when HDC issued the bonds on January 1, Year 1.
(3 marks)

2) Provide the journal entry for recognizing interest expense and interest paid on
June 30 and December 31,Year 1.
(4 marks)

3) Show how HDC would report the bonds on its balance sheet on December 31,
Year 1.
(2 marks)

4) On January 1, Year 2, these bonds are traded at 110 in the market. On this date,
HDC repurchased 20% of these bonds on the open market and retired them.
Provide the journal entry to record the repurchase.
(3 marks)

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Question 3 (10 marks)

Part A:
The Hill Company purchased some equipment at July 1, 2008, for $16,000. Hill also paid
freight costs $1,500 and sales tax $500 in addition. Hills fiscal year starts from January 1.
Upon receipt, the following expenditures were incurred in 2008:

Major repair prior to use $1,000

Installation 600
Testing prior to use 400
Operating costs after start of production 1,500
Minor repair and maintenance after start of production 500

The company adopted a straight-line depreciation method and estimated that the useful
life of the equipment to be ten years from July 1, 2008. Hill expects that the residual
value of the equipment will be $2,000 at the end of the useful life.

Required:

1) Determine the total depreciable value of the equipment. (2 marks)

2) Determine the book value of the equipment at December 31, 2008. (2 marks)

3) Hill received an offer to sell the equipment at January 1, 2009. If Hill sold the
equipment for $23,000 in cash, what journal entry would they record for the sale of
the equipment? No entry explanation is required. (2 marks)

Part B:
Assume that the book value of the equipment above at December 31, 2008 is $22,000 and
Hill decided not to sell the equipment. In early 2009, a major improvement to the
equipment took place, costing $900. As a result, the annual capacity was expanded, but
its estimated life and residual value remained unchanged. In early 2010, due to signs of
severe wear, Hill revised its estimated useful life to be only five remaining years from
January 1, 2010 and its residual value to be $1,000.

Required:

1) Determine the amount of depreciation expense for the equipment in 2009. (2 marks)

2) Determine the amount of depreciation expense for the equipment in 2010. (2 marks)

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Question 4 (10 marks)
The July cash records of SMU Foods follow.
Cash Receipts (CR) Cash Payments (CP)
Date Cash Debit Check No. Cash Credit
July 4 $2,855 1416 $ 10
9 662 1417 862
14 991 1418 92
17 374 1419 410
31 2,185 1420 850
1421 2,500
1422 2,366

SMU Foods Cash account shows a balance of $4,022 on July 31. On July 31, SMU
Foods received the following bank statement.
Bank Statement for July

Beginning Balance $4,045

Deposits and other credits

July 1 EFT $ 725

5 2,855

10 662

15 991

18 374

31 BC 1,200 6,807

Checks and other Debits

July 8 NSF 445

11 (check no. 1416) 10

19 EFT 275

22 (check no. 1417) 862

29 (check no. 1418) 92

31 (check no. 1419) 140

31 SC 28 (1,852)

Ending Balance $9,000

Explanations: BC-bank collections; ETF-electronic funds transfer; NSF-nonsufficient funds checks;
SC-service charge.

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Additional data for the bank reconciliation:

a. The EFT deposit was a receipt of rent revenue. The EFT debit was payment
of insurance expense.

b. The NSF check was received from XYZ Company.

c. The $1,200 bank collection was for dividend revenue.

d. The correct amount of check 1419 (paid to Bill Company on account) is

$140. SMU Foods mistakenly recorded the check for $410.

Required:

Prepare the bank reconciliation of SMU Foods at July 31, 2008, and record entries called
for by the reconciliation. No entry explanation is required. (10 marks)

10
Question 5 (8 marks)

A statement of cash flows for the Elf Company is presented below:

Elf Company
Statement of Cash Flows
Year Ended December 31, 2008
Cash Flows from Operating Activities:
Net income $ 24,000
Adjustments:
Depreciation Expense 2,800
Changes in Working Capital Accounts (10,000)
Net cash provided by operating activities 16,800

Cash Flows from Investing Activities:

Purchase of Equipment (8,800)

Cash Flows from Financing Activities:

Issuance of common stock 6,000
Net increase in cash 14,000
Cash, January 1, 2008 2,800
Cash, December 31, 2008 $ 16,800

After preparing this condensed statement of cash flows for 2008, Elf receives an offer to
sell a building on the last day of the year. The building originally cost $100,000 and had
accumulated depreciation of $90,000 (including 2008 depreciation $1,600) at the time of
the offer. The chief accountant of Elf is wondering how the sale of the building would
affect its statement of cash flows.

Required:

1) Recast the statement of cash flows above assuming that Elf sold the building for cash
$15,000 at December 31, 2008 (ignore income taxes). (4 marks)

2) Recast the statement of cash flows above assuming that Elf sold the building for cash
$7,000 at December 31, 2008 (ignore income taxes). (4 marks)

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Question 6 (11 marks)

BB Co. is a food wholesaler that uses a perpetual inventory system for all of its food
products. The first-in, first-out (FIFO) method of inventory valuation is used.
Transactions and other related information on coffee carried out by BB Co. are given
below for October 2008:

Standard unit of packaging: Case containing 24, one-pound jars

Inventory 1 Oct 2008: 1,000 cases @ $60.20 per case
Purchases: (1) 10 Oct 1,600 cases @$62.10 per case plus freight of
$480 (freight is paid on same date)
(2) 20 Oct 2,400 cases @$64.00 per case plus freight of
$480 (freight is paid on same date)

October sales: (1) 17 Oct 1,500 cases @ $75 sale price per case
(2) 27 Oct 1,200 cases @ $76 sale price per case

Returns and allowances: On 28 Oct, a customer returned 50 cases sold on 27 Oct

that had been damaged in transit. The customers account
was credited for $3,800

Required:

1) Assuming no shrinkages, calculate the number of cases in ending inventory as of 31

Oct, the ending inventory cost as of 31 Oct and the cost of goods sold in October.
(4 marks)

2) Calculate the ending inventory cost if the LIFO method were applied instead.
(4 marks)

3) Record the journals for the purchases made on 10 Oct. (1 mark)

4) Record the journal for the sales returns and allowances on 28 Oct. (1 mark)

5) Assume that inventory net realizable value at 31 Oct 2008 is $56 per case.
Record the journal to apply the lower of cost or net realizable value rule. (1 mark)

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Question 7 (21 marks)
The financial statements of CW Co. for the years ended December 31 are provided below:
CW Co.
Income Statements
For the Year Ended December 31 (in $ thousands)
2007 2006
Net sales 534,000 326,000
Cost of goods sold (477,000) (296,000)
Gross Profit 57,000 30,000
Selling and distribution expenses (3,000) (1,000)
General and administrative expenses (37,000) (18,000)
Other income 18,000 20,000
Interest income 5,000 1,000
Interest expense (4,000) (2,000)
Profit before tax 36,000 30,000
Tax expense (3,600) (6,000)
Net Profit After tax 32,400 24,000
Earnings per share $6.65 $5.90

CW Co.
Balance Sheets
As at December 31 (in $ thousands)
2007 2006
Assets
Current assets
Cash and cash equivalents 51,000 41,000
Accounts receivable-net 130,000 83,000
Inventories 1,000 2,000
Other current assets (less liquid than inventories) 1,000 0
Non-current assets
Property plant and equipment 220,000 85,000
Intangible assets 28,000 29.000
Long term investments 24,000 21,000
Financial assets 32,000 41,000
Non-current receivables 4,000 2,400
Other non-current assets 1,000 1,000
Total assets 492,000 305,400

Liabilities and Shareholders' Equity

Current liabilities
Accounts payable 105,000 67,000
Financial liabilities 37,000 6,000
Tax payable 7,000 16,000
Other payables and accruals 8,000 8,000
Long term liabilities
Financial liabilities 97,000 32,400
Other long term liabilities 36,000 39,000
Total liabilities 288,000 168,400
Common Share capital 149,000 65,000
Retained earnings/Reserves 55,000 72,000
Total equity 204,000 137,000
Total liabilities and Shareholders' equity 492,000 305,400

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The answer to each question is independent and should not affect the answers to the
next questions. Calculate all ratios up to four decimal places.

Required:

1) Has CW Co.s ability to meet the short term and long term liabilities improved or
worsened between the years 2007 and 2006? Use four appropriate financial ratios to
support your answers. Explain the asset or liability items that contribute to the change
in financial ratios. (6 marks)

2) If the accounts receivable for 2007 is to include additional write-offs of $500k and
additional allowance of $600k, recalculate the ratios in part (1) for 2007 that are
impacted. (2 marks)

3) One single large customer TQ accounts for 60% of the sales in both years 2007 and
2006. The gross profit margin of sales to TQ is 15%.

What is the gross profit margin of sales to the remaining customers for 2007
(excluding TQ)? Discuss the implication to CW Co.s profitability if TQ were to stop
dealing with CW Co.
(2 marks)

4) Use vertical analysis of income statements for the years 2006 and 2007 and explain
the items that contribute to the change in profitability from 2006 to 2007. (4 marks)

5) How well is CW able to generate returns from its assets and shareholders equity in
the year 2007? Calculate two appropriate financial ratios.

Is the return to shareholders higher or lower than the return to creditors? (2 marks)

6) Name two financial ratios that are likely to be impacted if higher sales discounts are
given to CW customers. Explain the reasons. (2 marks)

7) CW shows contingent liabilities of $8m due to lawsuit in the notes to accounts of

2007. The lawsuit has a probable chance of settlement in the first quarter of 2008.
The external auditor disagrees with the accounting treatment and asks that CW
accrues the liabilities in the balance sheet.

Calculate three profitability ratios and three ratios on ability to pay debt (i.e. six ratios
in total) for 2007 that will be impacted if CW carries out the auditors instructions.
Assume no tax impact.
(3 marks)

The End

14
 Solutions:

MCQ

1. D
2. B
3. B
4. D
5. A
6. A
7. C
8. B
9. C
10. A

15
Question 1 (18 marks)

Dr Cr
a) Inventory Loss/ Cost of goods sold 15,000
Inventory 15,000

b) Salary Expense 1,506*

Salary Payable 1,506

* 2510 x 3/5 = 1506

c) Office Equipment 6,000

General office expense 6,000

Depreciation expense 5,400*

Accumulated depreciation for Office 5,400
equipment

* (56,000 2,000)/10 = 5400

d) Depreciation expense 13,800*

Accumulated Depreciation for Demonstration 13,800
Equipment

* 46,000 x 2/5 x 9/12 = 13,800

e) Interest expense 500*

Interest payable 500

* 50,000 x 12% x 1/12 = 500

f) Warranty expense 10,558

Estimated warranty payable 10,558

g) Accounts payable 10,000

Cash 10,000

h) Rent expense 6,000*

Prepaid rent 6,000

*(16,000 /2) x 9/12 = 6,000

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i) Allowance for uncollectible accounts 7,700
Accounts receivable 7,700

Uncollectible account expense 9,900*

Allowance for uncollectible accounts 9,900

*Desired ending balance in Allowance a/c = $100,000 x 0.5% + 150,000 x 1%

+ 100,000 x 4% + 50,000 x 10% = $11,000
Uncollectible expense = $11,000 + 7700 8800 = $9900

j. Retained earnings 12,500

Ordinary Share Dividend payable 10,000*
Preference Share Dividend payable 2,500**
*100,000 x 0.1 **5% x 50,000 = $12500

Each journal entry 2 marks, total = 12 x 1.5 = 18 marks

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Question 2 (12 marks)

1)

Cash 1,845,760
Discount on Bonds Payable 154,240
Bonds Payable 2,000,000

$2,000,000 x 0.614 (n=10, i=5%) 1,228,000

$80,000 x 7.722 (n=10, i=5%) 617,760
Issue price 1,845,760

(3m)

2) June 30, Year 1

Interest expense ($1,845,760 x 0.05) 92,288

Cash ($2,000,000 x 0.04) 80,000
Discount on Bonds Payable 12,288

Dec 31, Year 1

Interest expense (($1,845,760 + 12,288) x 0.05) 92,902

Cash ($2,000,000 x 0.04) 80,000
Discount on Bonds Payable 12,902

(4m)
3) Long term liabilities

Bonds Payable $2,000,000

Less Discount on Bonds Payable* 129,050
$1,870,950

*154240 12288 12902 = 129,050

(2m)
4) Purchase price for the retired bonds = $2000000 x 1.1 x 0.2 = $440,000

Bonds Payable (20% x $2000,000) $400,000

Loss on Repurchase of Bonds 65,810
Discounts on Bonds Payable (129,050 x 0.2) 25,810
Cash 440,000
(3m)

18
Question 3 (10 marks)

PART A:

1) ($16,000+1,500+500+1,000+600+400) - $2,000 = $18,000

2) Dep. Exp. for 2008 = $18,000 / 10yrs * = $900

Book value as at Dec. 31, 2008 = ($20,000 $900) = $19,100

3) DR Cash 23,000
DR Acc Depn 900
CR Equipment 20,000
CR Gain on Sale 3,900

PART B:

1) Dep. Exp. for 2009 = ($22,000+900-2,000) / 9.5yrs = $2,200

2) Dep. Exp. for 2010 = {($22,000+900-2,200)-$1,000} / 5yrs = $3,940

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Question 4 (10 marks)

SMU Foods
Bank Reconciliation
July 31, 2008
BANK:
Balance, July 31 $ 9,000
Add: Deposit in transit 2,185
11,185
Less: Outstanding checks:
Check No.
1420 $ 850
1421 2,500
1422 2,366 (5,716)
Adjusted bank balance, July 31 $ 5,469

BOOKS:
Balance, July 31 $ 4,022
Add: EFT collection of rent $ 725
Bank collection of dividend revenue 1,200
Book error$140 check
recorded as $410 270 2,195
6,217
Less: NSF check $ 445
EFT payment of insurance 275
Service charge 28 (748)
Adjusted book balance, July 31 $ 5,469

POST.
DATE ACCOUNTS AND EXPLANATIONS REF. DEBIT CREDIT
May 31 Cash 725
Rent Revenue 725
Rent Revenue by EFT deposit

31 Cash $1200
Dividend Revenue $1200
Dividend revenue collected by bank.

31 Cash 270
Accounts Payable Bill Company 270
Correction of check 1419

31 Accounts Receivable XYZ Company 445

Cash 445
NSF checks.

31 Insurance Expense 275

20
 Cash 275
EFT payment of insurance expense.

31 Miscellaneous Expense 28
Cash 28
Bank service charge.

21
Question 5 (8 marks)

Elf Company
Statement of Cash Flows
Year Ended December 31, 2008
Cash Flows from Operating Activities: 1) 2)
Net income * $ 29,000 $ 21,000
Adjustments:
Depreciation Expense 2,800 2,800
(Gain) Loss on Sale of Building (5,000) 3,000
Changes in Working Capital Accounts (10,000) (10,000)
Net cash provided by operating 16,800 16,800

Cash Flows from Investing Activities:

Purchase of Equipment (8,800) (8,800)
Sale of Building 15,000 7,000
Net cash provided by investing 6,200 (1,800)

Cash Flows from Financing Activities:

Issuance of common stock 6,000 6,000
Net increase in cash 29,000 21,000
Cash, January 1, 2008 2,800 2,800
Cash, December 31, 2008 $ 31,800 $ 23,800

* Includes $5,000 gain in 1) and $3,000 loss in 2).

22
Question 6 (11 marks)

1. Number of cases in ending inventory = 1000 + 1600 + 2400 1500 1200 + 50 =

2350
Cost of goods sold = 1000*$60.20 + 500*$62.40 + 1100*$62.40 + 50*$64.20 =
$163,250

Ending inventory cost as of 31 Oct = 2350*$64.20 = $150,870

2. Ending inventory cost = 1000@ $60.20 + 100@ $62.40 + 1250@ $64.20 = $146,690
(4 marks)

3. Journals (1 mark)
10 Oct Dr Inventory(1600*$62.1)$99360
Cr Accounts payable $99360

Dr Inventory $480
Cr Cash $480

4. Journal (1 mark)
28 Oct Dr Sales return (50*$76) $3800
Cr Accounts receivable $3800

Dr Inventory (50*$64.20) $3210

Cr Cost of goods sold $3210

5. (1 mark)
Ending inventory unit cost = $64.20
Net realizable value = $56
Amount to mark down = (64.20-56)*2350 = $19270

Journal:
Dr Inventory write-down expense/COGS $19270
Cr Inventory $19270

23
Question 7 (21 marks)

1) 2007:
Current ratio = (51,000+130,000+1,000+1,000)/(105,000+37,000+7,000+8,000) =
1.1656
Acid test ratio = (51,000+130,000)/(105,000+37,000+7,000+8,000) = 1.1529
(1 mark)

Debt ratio = 288,000/492,000 = 58.54%

Times interest earned = (57,000 37,000-3,000)/(4,000) = 4.25
(1 mark)

2006:
Current ratio = (41,000+83,000+2,000)/(67,000+6,000+16,000+8,000) = 1.2990
Acid test ratio = (41,000+83,000)/(67,000+6,000+16,000+8,000) = 1.2784
(1 mark)

Debt ratio = 168,400/305,400 = 55.14%

Times interest earned = (30,000-1,000-18,000)/2,000 = 5.5
(1 mark)

The ability to pay short term debt has worsened from 2006 to 2007. This is shown from
the drop in current ratios and acid test ratios. The accounts payable and financial
liabilities have increased at a higher rate than that of the accounts receivable and cash. (1
mark)

The ability to pay long term debt has worsened from 2006 to 2007. The debt ratio has
increased while the times interest earned ratio have dropped.
The increase in accounts payable and financial liabilities (both short and long term)
resulted in a higher debt ratio. The interest expense has doubled but not the income from
operations. This caused the drop in times interest earned. (1 mark)

2) Write-off debits allowance, credit accounts receivable. No impact to net account

receivable. No impact to the 4 ratios.

Additional allowance reduces net accounts receivable to $129,400k for 2007.

Revised ratios for 2007:
Current ratio = (51,000+129,400+1,000+1,000)/(105,000+37,000+7,000+8,000) =
1.1618
Acid test ratio = (51,000+129,400)/(105,000+37,000+7,000+8,000) = 1.1490

Debt ratio = 288000/491400 = 0.5861

Times interest earned = (57,000 37,000-3,000- 600)/(4,000) = 4.1

3) 2007:
Sales to TQ = $534000 * 60% = $320,400

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COGS to TQ = (1-0.15) * 320,400 = $272,340

Sales to remaining customers = $213,600

COGS to remaining customers = $477,000 - $272,340 = $204,660
Gross profit to remaining customers = $8940
Gross profit margin to remaining customers = 8940/213600 = 4.1854%

If TQ were to stop dealing with CW, the gross margin drops drastically to $8940 and net
profit turns into a net loss. This is because the gross profit margin to other customers is
only 4.1854%..

4)
As % net sales:
COGS: 2007 (477/534 = 89.33%); 2006 (296/326 = 90.8%)
Gross profit margin: 2007 (57/534 = 10.67%); 2006 (30/326 = 9.20%)
General & admin expense: 2007 (37/534 = 6.93%); 2006 (18/326 = 5.52%)
Other income: 2007 (18/534 = 3.37%); 2006 (20/326 = 6.14%)
Net profit after tax: 2007 (32.4/534 = 6.07%); 2006 (24/326 = 7.36%)

The net profit margin declines from 7.36% in 2006 to 6.07% in 2007 largely due to the
increase in the proportion of general and admin expenses (from 5.52% in 2006 to 6.93%
in 2007) as well as the drop in other income from 6.14% in 2006 to 3.37% in 2007, partly
mitigated by the increase in gross profit margin from 9.2% in 2006 to 10.67% in 2007
(the latter from the drop in COGS from 90.8% of net sales in 2006 to 89.33% in 2007).

5)
Return to shareholder: 2007 (32.4/(204+137)/2 = 19.00%; 2006 (24/137 = 17.52%)
ROA: 2007 (32.4+4)/(492+305.4)/2 = 9.13%; 2006 (24+2)/305.4 = 8.51%

CW is able to generate 18 or 19 cents return to every dollar of shareholder investment

relatively good return. CW is able to generate 8 cents return to every dollar of asset
utilized relatively good return.

Where return to shareholder > return to total assets, return to shareholder is higher than
return to creditors.

6) Account receivable turnover is likely to be positively impacted because of the drop in

collection period. Net profit and gross profit margins are likely to be impacted. The net
effect (positive or negative) depends on whether the resulting higher sales revenue (from
higher volume) offset the higher sales discount.

7) Any 3 of the ability to pay debt ratios impacted:

Current ratio: (51,000+130,000+1,000+1,000)/(105,000+37,000+7,000+8,000+8000) =
1.1091
Acid test ratio: (51,000+130,000)/(105,000+37,000+7,000+8,000+8000) = 1.0970
Debt ratio = (288 + 8)/492 = 60.16%

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Times interest earned ratio = (57,000 37,000-3,000+18,000+5,000-8000)/(4,000) = 8

Any 3 of profitability ratios:

Net profit margin = (32.4 -8)/534 = 4.57%
Return on shareholders equity = (32.4-8)/(204+137-8)/2 = 14.65%
Return on total assets = (24.4+4)/(492+305.4)/2 = 7.12%
Return on sales = 24.4/534 = 4.57%
Earnings per share = 24400k/(32400k/6.65) = $5.0080

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