Chapter 4, Problem 13P

1.

To determine

Prepare the balance sheet of Company W for December 31, 2016.

Explanation of Solution

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

The balance sheet of company W is prepared as follows:

Company W
Balance Sheet
December 31,2016
Current Assets:	Amount ($)	Amount ($)	Amount ($)
Cash		$11,600
Short-term investments in marketable securities [Refer to subpart 2 (note 1)]		$19,100
Accounts receivable	$32,300
Less: Allowance for doubtful accounts	($1,500)	$30,800
Inventories [Refer to subpart 2 (Notes 1 and 2) ]		$98,500
Total current assets			$160,000
Long-Term Investments:
Investment in bonds [Refer to subpart 2 (note 1)]		$25,000
Land held for building site		$19,500
Cash surrender value of life insurance		$8,900
Total long-term investments			$53,400
Property, plant, and equipment [Refer to subpart 2 (Notes 1 and 3) ]			$229,300
Intangible Assets:
Patents (net) [Refer to subpart 2 (Notes 1 and 2) ]			$18,200
Total Assets			$460,900
Liabilities
Current Liabilities:
Accounts payable		$58,000
Income taxes payable		$24,700
Miscellaneous current payables		$6,200
Estimated liability for product warranties		$7,300
Total current liabilities			$96,200
Long-Term Liabilities:
Bonds payable (mature on 12/31/2024)		$80,000
Premium on bonds payable		$4,800
Total long-term liabilities			$84,800
Total Liabilities			$181,000
Shareholders’ Equity
Contributed Capital:
Preferred stock, $100 par, 1,000 shares authorized, 400 shares issued		$40,000
Common stock, $10 par, 12,000 shares authorized, 6,280 shares issued		$62,800
Additional paid-in capital on:
Preferred stock		$23,400
Common stock		$30,300
Total contributed capital			$156,500
Retained earnings			$123,400
Total Shareholders’ Equity			$279,900
Total Liabilities and Shareholders’ Equity			$460,900

Table (1)

Therefore, the amount of total assets and total liabilities and stockholders’ equity equals $460,900.

2.

To determine

Prepare notes to accompany the balance sheet that itemize company accounting policies, inventories, and property, plant and equipment.

Explanation of Solution

Accompanying Notes to the balance sheet:

Note (1):

Summary of important accounting policies:

• “Inventories are valued at the lower of average cost or market.”.
• “Property, plant, and equipment are recorded at cost less accumulated depreciation. The straight-line method is used to depreciate all property, plant, and equipment, except land”.
• “Patents are amortized on a straight-line basis directly to the Patent account”.
• “Temporary investments in marketable securities are stated at their market value”.
• “Investment in bonds is carried at original cost (face value) and is being held to maturity”.

Note (2):

Composition of inventories:

The inventories of the company as of December 31, 2016, are composed of the following components:

Particulars	Amount
Raw materials	$22,200
Work in process	$34,700
Finished goods	$41,600
Total	$98,500

Table (2)

Note (3)

Composition of property, plant, and equipment:

The property, plant, and equipment of the company as of December 31, 2016, comprise the following:

Item	Cost	Accumulated Depreciation	Book value
Land	$32,000		$32,000
Buildings	$182,400	$62,200	$120,000
Machinery	$63,900	$18,600	$45,300
Equipment	$53,000	$21,200	$31,800
Total	$331,300	$102,000	$229,300

Table (3)

3.

To determine

Compute the current ratio and the quick ratio, state the way in which the two ratios provide different information about the liquidity of the company and explain the way in which these ratios are useful.

Explanation of Solution

Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Quick ratio: The financial ratio which evaluates the ability of a company to pay off the instant debt obligations is referred to as quick ratio. Quick assets are cash, marketable securities, and accounts receivables. This ratio assesses the short-term liquidity of a company from its most liquid (quick) assets.

Calculate the current ratio:

$\begin{array}{c}\text{Current}\text{ratio=}\frac{\text{Current}\text{assets}}{\text{Current}\text{liabilities}}\\ \text{=}\frac{\text{\$1,60,000}}{\text{\$96,200}}\\ \text{=}1.66:1\end{array}$

Therefore, the current ratio is 1.66:4.

Compute quick ratio:

$\begin{array}{c}\text{Quick ratio}\text{=}\frac{\left(\begin{array}{l}\text{Cash and cash equivalents +Short-term investments}\\ \text{+Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ \text{=}\frac{\text{\$11,600+\$19,100}\text{+}\text{\$30,800}}{\text{\$61,500}}\\ \text{=0}\text{.64:1}\end{array}$

Therefore, the quick ratio is 0.64:1.

• Current ratio evaluates the liquidity
• Quick ratio analyzes a company’s potential working capital.
• Comparison of these two ratios states the amount of liquidity that comes from the inventory, which is not as liquid as the quick assets.