Module 3 Sample Exam - Annotated Solutions

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Warning: do not assume your actual Module 3 Exam for ACCTG 211 will be exactly like what you see below. The sample exam below is based on information that we feel is important to reinforce via practice problems. Refer to your notes from class and all other sources for this semester to determine the complete set of topics that will be covered on the exam. So what is the value of this sample exam? It is simply offered as a means to help you study the basic concepts we have addressed in class and provide a look at how the concepts might be applied on a sample exam. Refer all questions to members of the instructional team (instructors and/or TAs). ACCTG 211 SAMPLE EXAM #3 Rev: 08/18/21 (Originally Rev: 04/30/20 ) The last page of this document is a list of the exact Ratios and Formulas that will be provided on the Exam. 1. Cracker Company Balance Sheet December 31, 2013 Assets Liabilities Current Assets: Current Liabilities: Cash $ 100 Accounts Payable $ 500 Accounts Receivable $ 500 Wages Payable $ 150 Inventory $1,000 Warranty Payable $ 150 Total Current Assets $1,600 Total Current Liabilities $ 800 Operating Assets $1,000 Longterm Liabilities $ 300 Total Liabilities $1100 Other Assets $ 400 Stockholders' Equity: Total Assets $3,000 Common Stock 1,000 shares issued and outstanding Additional Paid In Capital Common Stock $ 900 Total SE $1,900 Liabilities and Total SE $3,000 The Book Value per share of common stock would be: a. $3.00 b. $1.90 c. $1.60 d. $1.10 Book Value per Share of Common Stock = Common Stockholders’ Equity / Number of Common Shares Outstanding Remember: Common Stockholders’ Equity = Stockholders’ Equity – Preferred Stock Since there is no Preferred Stock, Common Stockholders’ Equity would be the same as Total Shareholders’ Equity Book Value per Share = $1,900 Common Stockholders’ Equity / 1,000 Shares of Common Stock Outstanding

The following information pertaining to Shorty's Shirt Factory for the year 2013 is to be used for Questions 2-5. Net Sales (all on credit) $250,000 Cost of goods sold 110,000 Gross margin 140,000 Operating expenses 96,000 Interest expense 14,000 Income taxes expense 12,000 Net income 18,000 01/01/13 12/31/13 Cash $ 10,000 $ 12,000 Accounts receivable 7,400 10,600 Inventory 11,300 12,700 Long-Term operating assets (net of accum. depreciation) 70,300 85,700 Total assets 99,000 121,000 Accounts payable 5,000 17,000 Income taxes payable 3,000 5,000 Notes payable (long-term) 28,000 28,000 Common stock ($10 par) 50,000 50,000 Retained earnings 13,000 21,000 2. Shorty's gross margin ratio for 2013 is: a. 6.11% b. 7.78% c. 17.60% d. 56.00% e. 60.00% Gross Margin = (Net Sales – COGS) / Net Sales  ($250,000 – 110,000) / $250,000 = 0.56 (56%) 3. Shorty's return on equity ratio for 2013 is: a. 65.67% b. 44.78% c. 39.40% d. 35.22% e. 26.87% Return on Equity = (Net Income) / Average Stockholders’ Equity  $18,000 / [($63,000 + $71,000) / 2] = .02687 4. Shorty's current ratio at 12/31/13 is: a. 1.60 b. 2.08 c. .62 d. 1.03 e. .58 Current Ratio = Current Assets / Current Liabilities  ($12,000 + $10,600 + $12,700) / ($17,000 + $5,000) = 1.6 *Remember: Current Assets = Cash or other Assets that are expected to be converted into cash within a year and Current Liabilities are obligation that are expected to be met/satisfied (paid) within one year.

5. Shorty's earnings per share ratio for 2013 is: a. $ 0.36 b. $ 3.6 c. $ 5.0 d. $ 8.8 e. $ 0.60 Earnings per Share = (Net Income – Preferred Dividends) / Average Number of Common Shares Outstanding ($18,000 – $0) / 5,000 Shares of Common Stock = 3.6 *There is NO Preferred Stock Outstanding, so there can’t be any Preferred Dividends and Common Shares Outstanding does not change throughout the year (Remember: the balance in the Common Stock Account = Shares Outstanding / Par Value of Common Stock) 6. Spilled, Inc. wants to increase its earnings per share. Which of the following actions will cause an increase? a. reduce the amount of dividends on common stock. b. sell more shares of common stock. c. sell more shares of preferred stock. d. acquire shares of common stock and hold them as treasury shares. e. increase interest expense. *Earnings per Share = (Net Income – Preferred Dividends) / Average Number of Common Shares Outstanding Therefore, we are looking for anything that would change Net Income, Preferred Dividends, or CS Outstanding a). Dividends paid to Common Shareholders ARE NOT on the Income Statement, so they DO NOT affect Net Income b). Selling more Shares of Common Stock would INCREASE Average Common Shares Outstanding; therefore, it would DECREASE Earnings per Share (by increasing the denominator of the equation, EPS would decrease ) c). Selling shares of Preferred Stock WOULD NOT change Average Number of Common Shares outstanding d). When a company repurchases shares of Common Stock (as Treasury Shares), the number of Common Shares Issued would not change, but the Number of Common Shares Outstanding WOULD decrease. This would DECREASE Average Number of Common Shares Outstanding; therefore, it would INCREASE Earnings per Share (by decreasing the denominator of the equation, EPS would increase) d). Increasing Interest Expense would DECREASE Net Income which would DECREASE Earnings per Share 7. Which of the following transactions will cause the current ratio to increase? a. The cash payment of a long-term debt b. The sale of common stock for cash c. Purchase of a factory building for exchange of common stock not previously issued d. Borrowing money from a bank which is to be repaid in 10 years e. Both (b) and (d) are correct *Current Ratio = Current Assets / Current Liabilities Therefore, we are looking for anything that would Increase Current Assets with respect to Current Liabilities This can be done in a Number of ways: 1). Increase in Current Assets, No change in Current Liabilities 2). No Change in Current Assets, Decrease in Current Liabilities 3). Both Current Assets & Current Liabilities Decrease, but Current Liabilities Decrease MORE THAN Current Assets Decrease 3). Both Current Assets & Current Liabilities Increase, but Current Assets Increase MORE THAN Current Assets Decrease a). Cash Payment of a Long-Term Debt would DECREASE Cash (a Current Asset) and have NO EFFECT on Current Liabilities (Long-Term Debt is not considered to be “Current”), which as a result would DECREASE the current Ratio b). The sale of Common Stock for Cash would INCREASE Cash (a Current Asset), and have NO EFFECT on Current Liabilities, which as a result would INCREASE the Current Ratio c). The Purchase of a factory building for an exchange of common stock not previously issued would have NO EFFECT on Current Assets OR Current Liabilities d). Borrowing Money from a bank that is to be repaid in 10 years would INCREASE Cash (a Current Asset), and have NO EFFECT on Current Liabilities (it would end up INCREASING Long-Term Liabilities)

Use the following information to answer Questions 8 and 9: Income Statement 9For Year Ended 12/31/13 Net sales $750,000 Cost of goods sold 400,000 Cash operating expenses 200,000 Depreciation and amortization expense 50,000 Gain on sale of equipment 30,000 Net income $130,000 ADDITIONAL INFORMATION: 1. Increase in accounts receivable during 2013 $ 20,000 2. Decrease in inventory during 2013 15,000 3. Increase in accounts payable during 2013 22,000 8. What amount of cash was collected from customers during 2013? a. $730,000 b. $760,000 c $770,000 d. $780,000 When a company makes a sale, they recognize revenue in the amount of the sale, but they do not necessarily collect the cash from the sale (they would either book cash or accounts receivable). In the event cash is not collected in the full amount, the outstanding balance would increase Accounts Receivable until the balance is paid off. When calculating cash collections from customers, we must take a look at the amount of money that was owed to the company from customers at the beginning of the year (Beginning Accounts Receivable Balance) and compare to the amount of money owed to the company from the customers at the end of the year (Ending Accounts Receivable Balance). Here, there are three scenarios: 1). Accounts Receivable Balance doesn’t change  Cash Collections from Customers would equal Net Sales during the period since you are owed no more nor any less money at the end of the year than you were owed at the beginning of the year 2). If a company’s Accounts Receivable balance increases  you would be owed more money at the end of the year than customers owed you at the beginning of the year, which would suggest that you were not able to collect the same amount of cash as you made in sales during the year 3). If a company’s Accounts Receivable balance decreases  you would be owed less money at the end of the year than customers owed you at the beginning of the year, which would suggest that you were able to collect more cash owed/outstanding from customers than sales made during the year For example, if the Beginning AR in the problem above was $78,000 and the Ending AR was $98,000 (Consistent with the Increase in AR of $20,000) This idea can be represented by the following Roll Forward: Beginning Accounts Receivable . . . . . . . . . . . $ 78,000 + Net Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 750,000 – Cash Collected from Customers . . . . . . . . . $ _____ = Ending Accounts Receivable . . . . . . . . . . . . $ 98,000 9. What amount of cash was paid to suppliers during 2013? a. $437,000 b. $407,000 c. $393,000 d. $363,000 This Roll Forward shows us that Cash Collected from Customers must be $20,000 less than Net Sales during the period in order to increase the Accounts Receivable Balance by $20,000.

In order to find the Cash Paid to Suppliers, you must first find how much inventory was purchased from the suppliers during the period. Since COGS represents the reduction of inventory as a result of sales throughout the period, Inventory purchases from the supplier can be determined by looking at the change in the Inventory account from the beginning of the period to the end. The question tells us the Inventory Balance Decreased during the year by $15,000. We can see the effect of this in the roll forward by making up numbers to plug into the equation that represent the decrease in Inventory over the course of the year: Beginning Inventory (as of 1/1/13) . . . . . . . . . $60,000 + Purchases of Inventory . . . . . . . . . . . . . . . .+ $ _____ – Cost of Goods Sold . . . . . . . . . . . . . . . . . . . – $400,000 = Ending Inventory (as of 12/31/13) . . . . . . . = $45,000 Once Inventory purchases from the supplier is determined, we can find cash paid to suppliers by comparing Inventory purchases over the year with the change in the Accounts Payable from the beginning of the year to the end of the year to the balance at the end of the year: • An increase in Accounts Payable = Company owes more money to its suppliers at the end of this year than they did at the beginning of the year o i.e. they did not pay for all inventory purchased from suppliers with cash o THEREFORE, you would SUBTRACT an increase in AP from purchases  This represents the amount of Inventory that was purchased this year on account (using Accounts Payable instead of cash) that is still outstanding as an Account Payable at the end of the year  i.e. They still owe the money! • A decrease in Accounts Payable = Company owes less money to its suppliers at the end of this year than they did at the beginning of the year o i.e. they paid outstanding Accounts Payable balances from previous periods o THEREFORE, you would ADD a decrease in AP from Inventory Purchases form Suppliers  At the beginning of the year, the company still owed suppliers from previous purchases. In this situation, the company would have paid cash to suppliers in an amount greater than purchases of Inventory in the current year in order to reduce its total liability/amount owed to the supplier • Just like we did above for the Beginning and Ending Inventory Balances, we can see the effect of the $22,000 Increase in Accounts Payable over the year by making up numbers to plug in, ensuring that the numbers reflect an increase of $22,000 from the Beginning of the year to the End of the Year. This can be represented by the following roll forward: Beginning Accounts Payable (as of 1/1/13) . . . . . . . . . . . $ 48,000 + Purchases of Inventory . . . . . . . . . . . . . . . . . . . . . . . + $ 385,000 – Cash Payments to Suppliers. . . . . . . . . . . . . . . . . . . . . – $ = Ending Accounts Payable (as of 12/31/13) . . . . . . . . = $70,000 This can also be represented using the following linear formula: Beginning AP + Purchases of Inventory – Ending AP = Cash Paid to Suppliers for Inventory The $60,000 plug for Beginning Inventory and the $45,000 plug for ending Inventory demonstrate the decrease in inventory over time and the effect COGS has on ending Inventory The $48,000 plug for Beginning AP and the $70,000 plug for Ending AP demonstrate the increase in AP the year and the implications that has on Cash Payments to Suppliers for Inv.

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