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Comprehensive Problem (Continued)
Part 3
2013
(a)
Miscellaneous Expenses ............................................
15
Accounts Payable ........................................................
1,287
Interest Revenue ....................................................
52
Cash ........................................................................
1,250
Adjust cash account. (Separate entries are acceptable.)
(b1)
Allowance for Doubtful Accounts ...............................
679
Accounts Receivable .............................................
679
Wrote off uncollectible accounts.
(b2)
Bad Debts Expense ......................................................
551
Allowance for Doubtful Accounts .........................
551
Recognize bad debts expense.
(c)
Depreciation Expense—Trucks ...................................
6,000
Accumulated Depreciation—Trucks .....................
6,000
Depreciation on truck.
(d)
Depreciation Expense—Equipment ............................
6,100
Accumulated Depreciation—Equipment ..............
6,100
Depreciation on equipment.
(e)
Extermination Services Revenue ................................
2,240
Unearned Services Revenue ................................
2,240
Adjust for unearned revenues.
(f)
Warranty Expense ........................................................
1,444
Estimated Warranty Liability ................................
1,444
Estimate warranty expense.
(g)
No interest accrual required for 2013
Comprehensive Problem (Continued)
Part 4
BUG-OFF EXTERMINATORS
Income Statement
For Year Ended December 31, 2013
Revenues
Extermination services revenue ...............
$57,760
Sales ............................................................
71,026
Interest revenue .........................................
924
Total revenues............................................
$129,710
Expenses
Cost of goods sold ....................................
46,300
Depreciation expense—Trucks ................
6,000
Depreciation expense—Equipment .........
6,100
Wages expense ..........................................
35,000
Interest expense.........................................
0
Rent expense..............................................
9,000
Bad debts expense ....................................
551
Miscellaneous expenses ...........................
1,241
Repairs expense ........................................
8,000
Utilities expense.........................................
6,800
Warranty expense ......................................
1,444
Total expenses ...........................................
120,436
Net income ...................................................
$ 9,274
BUG-OFF EXTERMINATORS
Statement of Owner’s Equity
For Year Ended December 31, 2013
D. Buggs, Capital, December 31, 2012 .........................
$ 59,700
Add: Investments by owner ........................................
0
Net income ...........................................................
9,274
68,974
Less: Withdrawals by owner ........................................
(10,000)
D. Buggs, Capital, December 31, 2013 ........................
$ 58,974
Comprehensive Problem
Part 4 (concluded)
BUG-OFF EXTERMINATORS
Balance Sheet
December 31, 2013
Assets
Current assets
Cash ................................................................
$15,750
Accounts receivable ......................................
$ 3,321
Allowance for doubtful accounts .................
(700)
2,621
Merchandise inventory ................................
11,700
Total current assets ......................................
30,071
Plant assets
Trucks .............................................................
32,000
Accumulated depreciation—Trucks ............
(6,000)
26,000
Equipment ......................................................
45,000
Accumulated depreciation—Equipment .....
(18,300)
26,700
Total plant assets ..........................................
52,700
Total assets ......................................................
$82,771
Liabilities
Current liabilities
Accounts payable ..........................................
$ 3,713
Estimated warranty liability ..........................
2,844
Unearned services revenue ..........................
2,240
Total current liabilities ................................
$ 8,797
Long-term liabilities
Long-term notes payable ..............................
15,000
Total liabilities ..................................................
23,797
Equity
D. Buggs, Capital .............................................
58,974
Total liabilities and equity ...............................
$82,771
Reporting in Action — BTN 11-1
1. Times interest earned
($ thousands)
2011
2010
2009
Net income ..................................................
$227,575
$147,138
$101,017
Add income taxes ................................
119,051
71,403
50,157
Add interest expense ................................
3,987
2,680
4,111
Income before taxes and interest .............
$350,613
$221,221
$155,285
Times interest earned ratio ...................
87.9a
82.5b
37.8c
a$350,613/$3,987
b$221,221/$2,680
c$155,285/$4,111
Analysis comment: For each of these fiscal years, it is obvious that
2. Loyalty reward liabilities arise when a customer makes a purchase
under a frequent purchase program. It is an estimated liability as the
3. Yes. Polaris has both commitments and contingencies (see its Note
4. The solution depends on the financial statement information accessed.
Comparative Analysis — BTN 11-2
1. Polaris—Times interest earned
($ thousands)
Current
Year
One Year
Prior
Two Years
Prior
Net income ..................................................
$227,575
$147,138
$101,017
Add income taxes ................................
119,051
71,403
50,157
Add interest expense ................................
3,987
2,680
4,111
Income before taxes and interest .............
$350,613
$221,221
$155,285
Times interest earned ratio ...................
87.9a
82.5b
37.8c
a$350,613/$3,987
b$221,221/$2,680
c$155,285/$4,111
Arctic Cat—Times interest earned
($ thousands)
Current
Year
One Year
Prior
Two Years
Prior
Net income (loss) ................................
$ 13,007
$1,875
$ (9,508)
Add income taxes (benefit) .......................
5,224
(777)
(6,247)
Add interest expense ................................
11
250
1,015
Income before taxes and interest .............
$ 18,242
$1,348
$(14,740)
Times interest earned ratio ...................
1,658.4a
5.4b
(14.5)c
a$18,242/$11
b$ 1,348/$250
2. Polaris and Arctic Cat both are in very strong positions in their ability to
make any interest payments should their income decline based on the
Ethics Challenge — BTN 11-3
1. It is in Bly’s self-interest to maximize the amount of revenues less
warranty expenses so as to maximize his personal bonus. Since Bly
2. Although Bly might be able to affect the amount of revenues less
warranty expenses via the warranty expense accrual in the short run,
over several years the amounts should even out. The dealership
Communicating in Practice — BTN 11-4
MEMORANDUM
To:
Tom Pretti, General Manager
From:
Dusty Johnson, Manager⎯Accounting and Finance
Date:
Subject:
Reporting warranties in financial statements
This memorandum is in response to your comment on my proposal for the
treatment of a contingency in our financial statements. You specifically
object to the proposed recognition of an expense and liability for
warranties. The purpose of this memorandum is to respond to your
objection.
Both the conservatism and matching principles apply to accounting for
warranties. Conservatism requires us to include an expense in this year’s
financial statements for costs that we may or may not pay in the future.
income measure would be incomplete if it did not match the cost of
fulfilling the warranty against revenues generated by offering the warranty.
This treatment would be in compliance with the matching principle.
Your comment also raised the objection that we don’t know what costs
reasonableness of repair costs. If the product is different from others, we
may have a basis for going with only a note disclosure. However, financial
statement recognition is a more effective way to get the information into
users’ hands. As a result, it is usually preferred, even if we are uncertain
about the amount.
Taking It to the Net — BTN 11-5
1. McDonald’s 2011 current liabilities include the following:
• Accounts payable
• Income taxes
• Current maturities of long-term debt
2. The portion of long-term debt maturing in the next 12 months ($
millions) is:
3. Times interest earned for McDonald’s as of 12/31/2011
($ millions)
12/31/2011
Net Income ...............................................................
$ 5,503.1
Plus income taxes ...................................................
2,509.1
Plus interest expense ..............................................
492.8
Income before interest and taxes ..........................
$ 8,505.0
Times interest earned .............................................
17.26
times
Teamwork in Action — BTN 11-6
1. Option A: Interest Expense = $6,000 x 10% x 90/360 = $150
The interest expense in option B does exceed option A. If interest cost
is the only consideration, then Option A is the preferred loan. However,
2. Entries:
2a. Issue date, Option A
June 1
Cash ..........................................................................
6,000
Notes Payable ....................................................
6,000
Borrowed cash by issuing an
interest-bearing note.
Teamwork in Action (Concluded)
4. Entries:
4a. Adjusting entry, Option A (Dec. 31)
Dec. 31
Interest Expense ......................................................
50
Interest Payable .................................................
50
Accrue interest on note
payable [$6,000 x 10% x 30/360].
4b. Adjusting entry, Option B (Dec. 31)
Dec. 31
Interest Expense ......................................................
40
Interest Payable .................................................
40
Accrue interest on note payable
[$6,000 x 8% x 30/360].
4c. Maturity date entry, Option A
March 1
Interest Expense ......................................................
100
Interest Payable .......................................................
50
Notes Payable ..........................................................
6,000
Cash ................................................................
6,150
Repaid note plus interest.
4d. Maturity date entry, Option B
March 31
Interest Expense ......................................................
120
Interest Payable .......................................................
40
Notes Payable ..........................................................
6,000
Cash ................................................................
6,160
Repaid note plus interest.
Entrepreneurial Decision — BTN 11-7
1.
SmartIT Staffing
Income Statement (Prospective)
Current
Operations
European
Total
Sales .............................................
$1,000,000
$ 250,000
$1,250,000
Operating expenses (55%) .........
550,000
137,500
687,500
Income before interest ...............
450,000
112,500
562,500
Interest expense..........................
0
21,000
21,000
Net income ...................................
$ 450,000
$ 91,500
$ 541,500
2. Times interest earned = $562,500 / $21,000 = 26.8 times
3.
SmartIT Staffing
Income Statement (Prospective)
Current
Operations
European
Total
Sales .............................................
$1,000,000
$ 400,000
$1,400,000
Operating expenses (55%) .........
550,000
220,000
770,000
Income before interest ...............
450,000
180,000
630,000
Interest expense..........................
0
21,000
21,000
Net income ...................................
$ 450,000
$ 159,000
$ 609,000
Times interest earned = $630,000 / $21,000 = 30.0 times
Entrepreneurial Decision (concluded)
4.
SmartIT Staffing
Income Statement (Prospective)
Current
Operations
European
Total
Sales .............................................
$1,000,000
$ 100,000
$1,100,000
Operating expenses (55%) .........
550,000
55,000
605,000
Income before interest ...............
450,000
45,000
495,000
Interest expense..........................
0
21,000
21,000
Net income ...................................
$ 450,000
$ 24,000
$ 474,000
Times interest earned = $495,000 / $21,000 = 23.6 times
5. In each of these cases, the company’s times interest earned is at least
Hitting the Road — BTN 11-8
There is no formal solution to this problem. A discussion of the
Global Decision — BTN 11-9
1. KTM— Times interest earned
(Euro in thousands)
Current Year
One Year Prior
Net income .................................................
€ 20,818
€ 2,660
Add income taxes ......................................
1,709*
(229)
Income before income taxes ....................
19,109
2,889
Add interest expense ................................
9,693
4,256
Income before taxes and interest ............
€ 28,802
€ 7,145
Times interest earned ratio .......................
3.0a
1,7b
* Income tax is added for the current year, which is not normal. This is because of a tax loss
carryforward in Austria (which is explained in advanced courses).
a 28,802/ 9,693
b 7,145/ 4,256
2. Of these three companies, Polaris and Arctic Cat both have superior
coverage of interest expense for the current year. Specifically,
Polaris’s times interest earned of 87.9 for the current year and Arctic
