Problem 2.

11

Arrange the following Income Statement items so they are in the proper order of an income statement:

Taxes Earnings after taxes

Shares outstanding Earnings available to common shareholders
Gross profit Cost of goods sold
Interest expense Earnings per share
Amortization expense Earnings before taxes
Preferred stock dividends Selling and administrative expense
Sales Operating profit

Instructions:

Use the data below to arrange the following Income Statement items so that they are in the proper
order of an income statement:

Taxes
Shares outstanding
Gross profit
Interest expense
Amortization expense
Preferred stock dividends
Sales
Earnings after taxes
Earnings available to common shareholders
Cost of goods sold
Earnings per share
Earnings before taxes
Selling and administrative expense
Operating profit

Income Statement
For the Year Ended December 31, 20XX

Sales correct
Cost of goods sold correct
Gross profit correct
Selling and administrative expense correct
Amortization expense correct
Operating profit correct
Interest expense correct
Earnings before taxes correct
Taxes correct
Earnings after taxes correct
Preferred stock dividends correct
Earnings available to common shareholders correct
Shares outstanding correct
Earnings per share correct
Problem 2.9

The Ahmed Book Company sold 1,400 finance textbooks to High Tuition College for $92 each in 20XX.
These books cost $68 to produce. In addition, Aztec Book spent $2,000 (selling expense) to persuade the
college to buy its books. Ahmed Books borrowed $50,000 on January 1, 20XX, on which it paid 10 percent
interest. Both interest and principal of the loan were paid on December 31, 20XX. Ahmed Book's tax
rate is 20 percent. Amortization expense for the year was $5,000.

Did Ahmed Books make a profit in 20XX? Please verify with an income statement presented
in good form.

Solution

Data provided

Units sold 1,400

Selling price $92 per unit
Cost to produce $68 per unit
Selling expense $2,000
Amortization expense $5,000
Tax rate 20%
Loan $50,000
Interest rate 10%

Ahmed Book Company

Income Statement
For the Year Ended December 31, 20XX
Sales $128,800 correct correct
Cost of goods sold $95,200 correct correct
Gross profit $33,600 correct correct
Selling expense $2,000 correct correct
Amortization expense $5,000 correct correct
Operating profit $26,600 correct correct
Interest expense $5,000 correct correct
Earnings before taxes $21,600 correct correct
Taxes $4,320 correct correct
Earnings after taxes $17,280 correct correct
Problem 2.10

Carr Auto Wholesalers had sales of $900,000 in 20XX, and cost of goods sold represented 65 percent
of sales. Selling and administrative expenses were 9 percent of sales. Amortization expense was
$10,000, and interest expense for the year was $8,000. The firm's tax rate is 30 percent. Compute
the earnings after taxes.

Assume the firm hires Ms. Hood, an efficiency expert, as a consultant. She suggests that by increasing
selling and administrative expenses to 12 percent of sales, sales can be increased to $1,000,000. The
extra sales effort will also reduce cost of goods sold to 60 percent of sales (there will be a larger mark-up in
prices as a result of more aggressive selling). Amortization expense will remain at $10,000. However, more
automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to
$15,000. The firm's tax rate will remain at 30 percent. Compute revised earnings after taxes based on
Ms. Hood's suggestions for Carr Auto Wholesalers. How much will her ideas increase or decrease profitability?

Solution

Data provided for part a.

Sales $900,000
Cost of goods sold 65% of sales
Selling and administrative expenses 9% of sales
Amortization expense $10,000
Interest expense $8,000
Tax rate 30%

Carr Auto Wholesalers

Income Statement
For the Year Ended December 31, 20XX
Sales $900,000 correct correct
Cost of goods sold $585,000 correct correct
Gross profit $315,000 correct correct
Selling and administrative expenses $81,000 correct correct
Amortization expense $10,000 correct correct
Operating profit $224,000 correct correct
Interest expense $8,000 correct correct
Earnings before taxes $216,000 correct correct
Taxes $64,800 correct correct
Earnings after taxes $151,200 correct correct

Data provided for part b.

Sales $1,000,000
Cost of goods sold 60% of sales
Selling and administrative expenses 12% of sales
Amortization expense $10,000
Interest expense $15,000
Tax rate 30%

Carr Auto Wholesalers

Income Statement
For the Year Ended December 31, 20XX
Sales $1,000,000 correct correct
Cost of goods sold $600,000 correct correct
Gross profit $400,000 correct correct
Selling and administrative expenses $120,000 correct correct
Amortization expense $10,000 correct correct
Operating profit $270,000 correct correct
Interest expense $15,000 correct correct
Earnings before taxes $255,000 correct correct
Taxes $76,500 correct correct
Earnings after taxes $178,500 correct correct

The changes would result in a/an increase in profit of $27,300 correct correct
Problem 2.17

Arrange the following items in proper balance sheet presentation.

Accumulated amortization $300,000

Retained earnings 96,000
Cash 10,000
Bonds payable 136,000
Accounts receivable 48,000
Plant and equipment - original cost 680,000
Accounts payable 35,000
Allowance for bad debts 6,000
Common stock, 100,000 shares outstanding 188,000
Inventory 66,000
Preferred stock, 1,000 shares outstanding 50,000
Marketable securities 20,000
Investments 20,000
Notes payable 33,000

Solution
Balance Sheet
As At December 31, 20XX
Assets
Current Assets
Cash 10,000 correct
Marketable securities 20,000 correct
Accounts receivable 48,000 correct correct
Allowance for bad debts 6,000 42,000 correct correct correct
Inventory 66,000 correct
Total Current Assets 138,000 correct
Other Assets
Investments 20,000 correct
Capital Assets
Plant and equipment - original cost 680,000 correct correct
Accumulated amortization 300,000 correct correct
Net plant and equipment 380,000 correct
Total Assets 538,000 correct

Liabilities and Shareholders' Equity

Current Liabilities
Accounts payable 35,000 correct
Notes payable 33,000 correct
Total Current Liabilities 68,000 correct
Long-term Liabilities
Bonds payable 136,000 correct
Total Liabilities 204,000 correct
Shareholders' Equity
Preferred stock, 1,000 shares outstanding 50,000 correct correct
Common stock, 100,000 shares outstanding 188,000 correct correct
Retained earnings 96,000 correct correct
Total Shareholders' Equity 334,000 correct
Total Liabilities and Shareholders' Equity 538,000 correct
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Problem 2.23

Identify whether each of the following items increases or decreases cash flow:

Increase in inventory
Decrease in prepaid expenses
Decrease in accounts receivable
Decrease in inventory
Dividend payment
Increase in short-term notes payable
Amortization expense
Decrease in accounts payable
Increase in long-term investments

Solution
Increase/Decrease Reason
Increase in inventory Decrease Use of Cash correct
Decrease in prepaid expenses Increase Source of Cash correct
Decrease in accounts receivable Increase Source of Cash correct
Decrease in inventory Increase Source of Cash correct
Dividend payment Decrease Use of Cash correct
Increase in short-term notes payable Increase Source of Cash correct
Amortization expense No effect Non-Cash Item correct
Decrease in accounts payable Decrease Use of Cash correct
Increase in long-term investments Decrease Use of Cash correct
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Problem 2.26

The following information is provided for Waif Corporation.

December 31, 20XX December 21, 20XW

Assets
Cash $54,500 $17,400
Accounts receivable 64,800 52,200
Inventory 142,200 149,300
Land 60,000 87,000
Plant and equipment 206,000 158,000
Less: Accum amortization 55,000 33,000
Net plant and equipment 151,000 125,000
Total assets $472,500 $430,900

Liabilities and Equity

Accounts payable $27,000 $37,000
Bonds payable 118,000 158,000
Common stock 170,000 130,000
Retained earnings 157,500 105,900
Total liabilities and shareholders' equity $472,500 $430,900

During 20XX, the following occurred:

1. Net income was $91,000.

2. Bonds were retired by issuing new common stock.
3. No equipment was sold.
4. Cash dividends were paid.

Prepare the statement of cash flows for the Waif Corporation.

Waif Corporation
Statement of Cash Flows
For the Year Ended December 31, 20XX

Operating Activities:
Net Income (earnings after taxes) $91,000
Add: Items not requiring an outlay of cash
Amortization 22,000 22,000
Cash flow from operations 113,000
Changes in non-cash working capital
Increase in accounts receivable -12,600
Decrease in inventory 7,100
Decrease in accounts payable -10,000
Net change in non-cash working capital -15,500
Cash provided by operating activities 97,500
Investing Activities:
Increase in plant and equipment -48,000
Sale of land 27,000
Cash used in investing activities -21,000
Financing Activities:
Retirement of bonds payable -40,000
Issue of common stock 40,000
Common stock dividends paid -39,400
Cash used in financing activities -39,400
Net increase in cash (equivalents) during the year 37,100
Cash, beginning of year 17,400
Cash, end of year $54,500
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Problem 2.27

Prepare a statement of cash flows for the Maris Corporation.

Maris Corporation
Income Statement
For the Year Ended December 31, 20XX
Sales $3,300,000
Cost of goods sold 1,950,000
Gross profit $1,350,000
Selling and administrative expense 650,000
Amortization expense 230,000
Operating income $470,000
Interest expense 80,000
Earnings before taxes $390,000
Taxes 140,000
Earnings after taxes $250,000
Preferred stock dividends 10,000
Earnings available to common shareholders $240,000
Shares outstanding 150,000
Earnings per share $1.60

Statement of Retained Earnings

For the Year Ended December 31, 20XX
Retained earnings, balance, January 1, 20XX $800,000
Add: Earnings available to common shareholders, 20XX $240,000
Deduct: Cash dividends declared and paid in 20XX 140,000
Retained earnings, balance, December 31, 20XX $900,000

Comparative Balance Sheets

December 31, 20XX December 21, 20XW

Assets
Current assets:
Cash $120,000 $100,000
Accounts receivable (net) 510,000 500,000
Inventory 640,000 610,000
Prepaid expenses 30,000 60,000
Total current assets 1,300,000 1,270,000
Investments (long-term securities) 80,000 90,000
Plant and equipment 2,600,000 2,000,000
Less: Accum amortization 1,230,000 1,000,000
Net plant and equipment 1,370,000 1,000,000
Total assets $2,750,000 $2,360,000

Liabilities and Equity

Current liabilities:
Accounts payable $550,000 $300,000
Notes payable $500,000 $500,000
Accrued expenses $50,000 $70,000
Total current liabilities $1,100,000 $870,000
Long-term liabilities:
Bonds payable, 2021 160,000 100,000
Total liabilities 1,260,000 970,000
Shareholders' equity:
Preferred stock 90,000 90,000
Common stock 500,000 500,000
Retained earnings 900,000 800,000
Total shareholders' equity 1,490,000 1,390,000
Total liabilities and shareholders' equity $2,750,000 $2,360,000

Prepare the statement of cash flows for the Maris Corporation.

Maris Corporation
Statement of Cash Flows
For the Year Ended December 31, 20XX

Operating Activities:
Net Income (earnings after taxes) $250,000
Add: Items not requiring an outlay of cash
Amortization 230,000 230,000
Cash flow from operations 480,000
Changes in non-cash working capital
Increase in accounts receivable -10,000
Increase in inventory -30,000
Decrease in prepaid expenses 30,000
Increase in accounts payable 250,000
Decrease in accrued expenses -20,000
Net change in non-cash working capital 220,000
Cash provided by operating activities 700,000
Investing Activities:
Decrease in investments 10,000
Increase in plant and equipment -600,000
Cash used in investing activities -590,000
Financing Activities:
Increase in bonds payable 60,000
Preferred stock dividends paid -10,000
Common stock dividends paid -140,000
Cash used in financing activities -90,000
Net increase in cash (equivalents) during the year 20,000
Cash, beginning of year 100,000
Cash, end of year $120,000
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Problem 2.35

Continental Pipeline Corp. anticipates cash flows from operating activities of $4 million in 20XX. It will
need to spend $1.5 million on capital investments in order to remain competitive within the industry.
Common share dividends are projected at $0.6 million and preferred dividends at $0.25 million.

a. What is the firm’s projected free cash flow for the year 20XX?

Solution

Data provided

Cash flow from operating activities $4,000,000

Capital investments 1,500,000
Common share dividends 600,000
Preferred share dividends 250,000

Projected Free Cash Flow $1,650,000 correct