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Critical Thinking: Analyzing the Effects of
As an aspiring financial analyst, you have applied to a major Wall Street firm for a summer job. To screen potential applicants, the firm provides you a short case study and asks you to evaluate the financial success of two hypothetical companies that started operations last year on January 1. Both companies operate in the same industry, use very similar assets, and have very similar customer bases. Among the additional information provided about the companies are the following comparative income statements.
Required:
Prepare an analysis of the two companies with the goal of determining which company is better managed. If you could request two additional pieces of information from these companies’ financial statements, describe specifically what they would be and explain how they would help you to make a decision.
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FUNDAMENTALS OF FINANCIAL ACCOUNTING
- Suppose that you have been given a summer job as an intern at Issac Aircams, a company that man- ufactures sophisticated spy cameras for remote-controlled military reconnaissance aircraft. The company, which is privately owned, has approached a bank for a loan to help it finance its growth. The bank requires financial statements before approving such a loan. You have been asked to help prepare the financial statements and were given the following list of costs: Depreciation on salespersons’ cars. Rent on equipment used in the factory. Lubricants used for machine maintenance. Salaries of personnel who work in the finished goods warehouse. Soap and paper towels used by factory workers at the end of a shift. Factory supervisors’ salaries. Heat, water, and power consumed in the factory. Materials used for boxing products for shipment overseas. (Units are not normally boxed.) Advertising costs. Workers’ compensation insurance for factory employees. Depreciation on…arrow_forwardDepreciation of Lon-Term Assets You are a new staff accountant at a large construction company. After a rough year, management is seeking ways to minimize expenses or increase revenues before year-end to help increase the company’s earnings per share. Your boss has asked staff to think “outside the box” and has asked to you look through the list of long-term assets to find ones that have been fully depreciated in value but may still have market value. Why would your manager be looking for these specific assets? How significantly might these items impact your company’s overall performance? What ethical issues might come into play in the task you have been assigned?arrow_forwardChoosing Appropriate Depreciation Method You are part of a team reviewing the financial statements of a new computer company. Looking over the fixed assets accounts, one long-term tangible asset sticks out. It is labeled “USB” and valued at $10,000. You ask the company’s accountant for more detail, and he explains that the asset is a USB drive that holds the original coding for a game the company developed during the year. The company expects the game to be fairly popular for the next few years, and then sales are expected to trail off. Because of this, they are planning on depreciating this asset over the next five years using the double-declining method. Does this recording seem appropriate, or is there a better way to categorize the asset? How should this asset be expensed over time?arrow_forward
- Suppose that Demont has been given a summer job as an intern at Isaac Aircams, a company that manufactures sophisticated spy cameras for remote-controlled military reconnaissance aircraft. The company, which is privately owned, has approached a bank for a loan to help it finance its growth. The bank requires financial statements before approving such a loan. Classify each cost listed below as either product costs or period costs for the purpose of preparing the financial statements for the bank. Costs Product Cost/Period Cost 1. Depreciated on salesperson's cars 2. Rent on equipment used in the factory 3. Lubricants used for machine maintenance 4. Salaries of personnel who work in the finished goods warehouse 5. Soap and paper towels used by factory workers at the end of a shiftarrow_forwardIdentify whether the statement is True or False. Replacement value is an estimate of the cost of reproducing, creating, developing, or manufacturing a similar asset. * The replacement value method is superior to book value as it gives an indication of the true value of the firm as of the valuation date. * Borrowings that are contracted to be paid after 24 months are classified as current liabilities. * Brownfield investment is the term used to describe businesses that are starting from scratch. * Replacement cost is the cost of similar assets that have the nearest equivalent value as of the valuation date. * An asset has been defined by the industry as transactions that would yield future economic benefits as a result of past transactions. * Equipment is classified as non-current assets. *arrow_forwardAssume that you are the accountant for Computer Consultants. Prior to this year, Computer Consultants operated out of a leased office. However, the company purchased its own office building this year. The building is in an area where real estate values have been increasing an average of 6 percent per year. The owner of Computer Consultants has asked why you recorded depreciation on the building if real estate values are appreciating. Write a response to the owner explaining why depreciation must be recorded on the company’s accounting records.arrow_forward
- During the previous year, Computron had doubled its plant capacity, opened new sales offices outside its home territory, and launched an expensive advertising campaign. Cochran was assigned to evaluate the impact of the changes. She began by gathering financial statements and other data. Assume that you are Cochran’s assistant and that you must help her answer the following questions: What effect did the expansion have on sales and net income? What effect did the expansion have on the asset side of the balance sheet? What effect did it have on liabilities and equity? What do you conclude from the statement of cash flows?arrow_forwardYou are an accountant at a large research university. The controller is considering switching its accounting policy so that it is in line with other universities. The current policy requires all assets be depreciated on a straight-line basis with no salvage value and a full year of depreciation taken in the year of acquisition regardless of the acquisition date. The proposed policy would require all asset depreciated on a straight-line basis with no salvage value and depreciation taken based on the nearest full month from the acquisition date. The data provided shows all assets that are in use even though some assets have already been fully depreciated. The controller has provided a dashboard visualization that shows the differences between the two depreciation policies for the period ending December 31, 2018 and asks you to answer the questions below. Click here to view the data in Tableau, and here to view it in Power BI. (The Tableau and Power BI files contain the same data; you can…arrow_forwardWrite a report to management by carefully analyzing the following comments made by the Finance Manager of Combo Company Limited, a listed company with a total net worth of GH¢ 25,000,000.00. Your position should be supported by the relevant accounting standard, convention, and concept.i. “The depreciation of a motor vehicle is charged on a straight-line basis but after some years of the asset usage, I notice that the efficiency of the asset has reduced, but the same amount of depreciation amount is charged and that reduces profit level. So, let us change from straight line to reducing balance method which to him is fair”ii. The company bought two needles at the cost of GH¢1.00 each. The Finance Manager said “this is an acquisition of non-current asset (equipment) which should be recorded in the asset register and depreciated in line with equipment depreciation policy”iii. “Our customers have proved to be trustworthy for the years the company has dealt with them, so to me, making…arrow_forward
- Malone Industries has been in business for five years and has been very successful. In the past year, it expanded operations by buying Hot Metal Manufacturing for a price greater than the value of the net assets purchased. In the past year, the customer base has expanded much more than expected, and the companys owners want to increase the goodwill account. Your CPA firm has been hired to help Malone prepare year-end financial statements, and your boss has asked you to talk to Malones managers about goodwill and whether an adjustment can be made to the goodwill account. How do you respond to the owners and managers?arrow_forwardEthics and professional conduct in business Erin Haywood was recently hired as a cost analyst by Wind River Medical Supplies Inc. Oneof Erin’s first assignments was to perform a net present value analysis for a new warehouse.Et-in performed the analysis and calculated a present value index of 0.8. The plant manager.ZuhairBarbat, is very intent on purchasing the warehouse because he believes that more storage space is needed. Zuhair asks Erín into his office and the following conversation takes place: ZubairErín, you’re new here, aren’t you? EHii: Yes, sir. Zubair: V.dl, Erin, let me tell you something. ¡m not at all pleased with the capital investment analysis that you performed on this new warehouse. T need that warehouse for my production. If I dont get it, where am I going to place our output? Erín: Hopefully with the customer, sir. Zithair: Now don’t get smart with me. Erín: No, really. I was being serious. My analysis does not support constructing a new ware- house. The numbers don’t lie: the warehouse does not meet our investment return targets. In fact, it seems to me that purchasing a warehouse dots not add much value to the business. We need to be producing product to satisfy customer orders, not to fill a warehouse. Zubair Listen, you need to understand sonwthing. The headquarters people will not allow mv to build the warehouse if the numbers dont add up. You know as well as I that many assump tions go into your net present value analysis. Why don’t you relax some of your assumptions so that the f́nancial savings will offset the cost? Erín: I’m willing to discuss my assumptions with you. Maybe I overlooked something. Zubafr Good. Here’s what I want you to do. 1 see in your analysis tha you don’t project greater sales as a result of the warehouse. It seems to me, if we can store more goxLs, then will have more to sell. Thus, logically, a larger warehouse translates into more sales. If you incorporate this into your analysis, I think you’ll see that the numbers will work out. Why don’t you work it through and come back with a new analysis? I’m really counting on you on this one. Let’s get off to a good start together and see if we can get this project accepted. What is your advice to Erin?arrow_forwardDuring the last few years, Jana Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Jana’s cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task: The firm’s tax rate is 40%. The current price of Jana’s 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Jana does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firm’s 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Jana would incur flotation costs equal to 5% of the proceeds on a new issue. Jana’s common stock is currently selling at $50 per share. Its last dividend (D0) was $3.12, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Jana’s beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is estimated to be 6%. For the own-bond-yield-plus-judgmental-risk-premium approach, the firm uses a 3.2% risk premium. Jana’s target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. To help you structure the task, Leigh Jones has asked you to answer the following questions: (1) What sources of capital should be included when you estimate Jana’s weighted average cost of capital? (2) Should the component costs be figured on a before-tax or an after-tax basis? (3) Should the costs be historical (embedded) costs or new (marginal) costs?arrow_forward
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