CH. 3 HOMEWORK DISCUSSION QUESTION 3, 4 & 5
3.) Bill Simon says, “We should get rid of the FASB and SEC since free market forces will make sure that companies report reliable information.” Do you agree? Why or why not?
I disagree for several reasons. One, investors view profits a measure of managers’ performance, therefore giving managers an incentive to use their accounting discretion to distort reported profits by making biased assumptions. Many top managers receive bonus compensation if they exceed certain pre-specified profit targets. Furthermore, stock option awards can also entice a manager to manage earnings in their favor. Regulation and generally accepted accounting standards help deter managers’ from taking this too far.
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Each company’s customer pays 30 days after receiving shipment. Using accounting ratios, how can you distinguish these companies? In regards to the income statements, there are no differences between the two companies because both companies have the same amount of expenses and revenues. In regards to their balance sheets however, the companies are different. The company that ships all of its products in the last two weeks of the quarter will have a higher account receivable balance and lower cash than the company that ships its product evenly throughout the quarter.
Accounts Receivable Turnover [= Sales / Accounts Receivable]
The company who ships its product in the last two weeks of the quarter will have a lower accounts receivable turnover ratio compared to the company which ships its product evenly throughout the quarter.
Cash Ratio [= Cash + Short-Term Investments / Current Liabilities]
The company who ships its product in the last two weeks of the quarter will have a lower cash ratio than the company, which ships its product evenly throughout the quarter.
Day Receivable [= Accounts Receivable / Average Sales Per Day]
The company who ships its product in the last two weeks of the quarter will display a higher days’ receivable ratio than the company, which ships its product evenly throughout the quarter.
5.) a. If management reports truthfully, what economic events are likely to prompt the following accounting changes?
Increase in the estimated life of
Presence of Board of Directors, Audit committee, Board’s compliance with the SEC’s Blue ribbon committee, independent and experienced board members, management’s oversight and audit committee’s annual review’s leaves very less room for opportunity for employee’s to commit any type of fraud and present misstated financial information.
1. A company’s ending accounts receivable balance and the period’s advertising expense would be found on which financial statements, respectively
The number of days receivables equals 47 which represents the number of days in receivables. The older an account receivable remains the more difficult it will be to collect.
Answer: Aging schedules definitely help a company keep track of which of its customers are paying on time, and are useful in figuring cash flow. In this case, it is apparent that the majority of accounts receivable by the end of March are less than 30 days old (80.8%). By the end of June, that percentage goes down to 63.7%. By the end of March, 19.2% of accounts receivable are between 30-60 days old, and by the end of June, there is 36.3%. 0% of accounts receivable get to be over 60 days old, which indicates payment.
A vertical and horizontal analysis of each company's balance sheet and income statement in this particular case will be enlightening. A vertical analysis will for instance shed some light on how revenue is being used. In this case, each component of the companies' financial statements will be converted into a percentage of a key component of either the balance sheet or the income statement. A special common size balance sheet and income statement will be utilized to ease comparison. The
Accounts receivable are amounts owed by customers on account. They result from the sale of goods and services on credit. These receivables are generally expected to be collected within 30 to 60 days. They are typically the most significant type of claim held by a company. Accounts receivable and notes receivable resulting from sales are also known as trade receivables. Accounts receivable resulting from sales are referred to as trade receivables in Alcatel's financial statements.
J reflects department store chain. This industry is a retail business; therefore, there is a large amount of inventories. This industry also has high accounts receivable because usually customers pay with credit cards which are billed at the end of the month. However, sometimes, customers forget to pay their bills on time, and the bills are brought to next month. Therefore, the collection period is approximately 2 months.
In this case, a summary sheet which contains 14 sets of financial data from 14 different industries is provided. The task is to match 14 different firms with 14 industries by distinguishing the differences (e.g. sources of financing, profitability, the inventory turnover and the accounts receivable collection period) in the financial structures.
With this company the inventory management ratios further indicate that there may be an issue with inventory and inventory controls. The inventory turnover ratio is lower than the industry average and the days’ sales in inventory are high. A company wants to turn inventory quickly to reduce storage costs, and
11. Accounts receivable turnover and days sales in accounts receivable for the last three years:
Receivables Turnover: This shows the degree of realization in accounts receivables. Company N has a lower turnover rate, a lower rate implies that receivables are being held longer and the less likely they are to be collected. Also there is an opportunity cost of tying up funds in receivables for a long period of time. Company M is 29 times higher than company N.
This is due to the fact that inventory and accounts receivable are left out of the equation. Based on the cash ratio, this company carries a low cash balance. This may be an indication that they are aggressively investing in assets that will provide higher returns. We need to make sure that we have enough cash to meet our obligations, but too much cash reduces the return earned by the company.
Accounts receivable turnover is the second method by which a company’s trade receivables’ liquidity can be evaluated (Gibson, 2011). Žager et al. (2012) noted turnover ratios should be as high as possible as this indicates a firm’s ability to convert its assets more often. 3M’s accounts receivable turnover for years 2007 and 2008 is shown in Exhibit 2. In 2007, 3M turned its accounts receivable over 7.12 times and 7.70 times in 2008. This calculates into a turnover of its accounts receivable every 51.28 days in 2007 and 47.38 days in 2008. The increase in accounts receivable turnover times per year (decrease in number of days to turnover accounts receivables) from 2007 to 2008 is a positive trend for 3M. It suggests, along with the prior calculation, the management of receivables is likely to be improving in efficiency.
Days inventory are the same in both companies: on average they turn over their inventories in two months. Analysis shows that both companies have a positive Cash Conversion Cycle (CCC), which means that they require external sources of financing for their working capital needs. In both cases, this gap is covered with debt (100% short term debt in the case of WM, and both short term and long term debt in the case of SRC).
Note that the company carries fewer days’ supply (25.3 days) in its finished goods inventory.