Accounting Chapter 11 Homework Magi records sales revenue when it receives an installment sale contract and a cash down payment from a customer

Challenge Exercises and Problem

(20 min.) P 11-62

Req. 1

Transaction

Operating

Income

before

Tax

Net

Income

Earnings

per

Share

Beg. Bal.

$655,000

$680,000

$510,000

a.*

NE

b.

+ $70,000

+ $52,500

+

c.

NE

e.

NE

h.

NE

*Assuming the company uses the perpetual inventory method, the

omitted entry only affects balance sheet accounts (Inventory and

Accounts Payable).

Req. 2

Operating

Income

before

Tax

Net

income

Earnings

per

Share

Totals

$722,000

$725,600

$544,200

$14.16*

Decision Cases

(15-20 min.) Decision Case 1

EPS to use for predicting future profits:

Unaudited EPS …………………………………………………………………. $1.19

Include:

Gain on sale of building ……………………………………………….. .05

Restructuring expenses ……………………………………………….. (.29)

Loss on lawsuit settlement …………………………………………… (.12)

Lost income due to employee labor strike …………………….. (.24)

EPS to use for prediction ………………………………………………….. $0.59

Include all the preceding items for your prediction because all are

labeled by GAAP as normal business occurrences and are thus part of

income from continuing operations. None is part of discontinued

operations.

Exclude the following items:

• unrealized loss on investments in AFSS because this is not even part

of net income (it is included in comprehensive income).

(15-20 min.) Decision Case 2

Magid’s earnings are of higher quality than those of Bay Area. Magid

follows more conservative (and more realistic) accounting policies than

Bay Area. Here are some examples:

SALES REVENUE

Magid records sales revenue when it receives an installment sale

contract and a cash down payment from a customer. In contrast, Bay

INSURANCE REVENUE

Magid records insurance revenue over the life of the policy, while Bay

Area records insurance revenue up front when the customer signs the

Overall, Bay Area’s policies for recording revenue suggest that the

company may be overstating its revenue. Magid’s accounting policies

make Magid appear to be the safer investment. The accounts that will

Ethical Issue

Req. 1

The ethical issue: Does it matter how a company reports its operating

results as long as the totals are accurate? May all items of income and

Req. 2 and Req. 3

The stakeholders in this case include the bank, its officers and directors,

shareholders, prospective shareholders, its creditors, and stock

analysts.

Economic analysis: Prospective investors want to predict the level of

net income and cash flows that a company will generate from year to

year. Continuing operations are more predictable than discontinued

operations. This is why discontinued operations are highlighted on the

income statement — to alert investors and creditors of their special,

(continued) Ethical Issue

to Royal Bank and stockholders who buy the company’s stock based on

the second income statement can be hurt. They may lend to the

company on too-favorable terms, or they may pay too high a price for its

stock. When the truth comes out — in terms of actual results — Royal

Bank may be unable to pay its loans. Or the company’s stock price may

fall, leaving the new stockholders with stock worth less than they paid

for it.

Req. 4

The bank should report their results of operations in a way that

separates the recurring from the non-recurring items. This course of

action is not only the legal and ethical thing to do, but in the long run it

Focus on Financials: Apple Inc.

(30-45 min.)

Req. 1

Apple Inc.’s income statement does not mention income from continuing

operations because there are no special items of income, such as

discontinued operations. All of Apple, Inc.’s net income results from

continuing operations. To evaluate quality of earnings, we reviewed

Apple’s revenue and expense recognition principles. According to the

Measures

of Quality

of Earnings

2014

2013

2012

Cost of

goods sold

to sales

ratio

$112,258/$182,795

= 0.61

$106,606/$170,910

= 0.62

$87,846/$156,508

= 0.56

Operating

expenses

to sales

ratio

$18,034/$182,795

= 0.10

$15,305/$170,910

= 0.09

$13,421/$156,508

= 0.09

From this analysis, we see the following trends:

(1) the cost of goods sold to sales ratio increased 6% in 2013 and

declined slightly (1%) in 2014, (2) the gross margin to sales ratio

decreased 6% in 2013 and increased slightly (1%) in 2014, (3) the

operating expenses to sales ratio held steady in 2013 and increased 1%

in 2014, (4) the operating income to sales ratio decreased in 2013 and

held steady in 2014.

(continued) Apple Inc.

Req. 2

Net Income per outstanding share: $39,510,000,000 / 6,085,572 = $6.49.

Investment Capitalization Rates

5%

6%

7%

Req. 3

Student answers will vary depending on when this problem is assigned.

If a student used a price of $112, the approximate cost on October 12,

Focus on Analysis: Under Armour, Inc.

(30 min.)

Req. 1

Measures

of Quality

of Earnings

2014

2013

2012

Cost of

goods sold

to revenues

$1,572/$3,084

= 0.51

$1,195/$2,332

= 0.51

$956/$1,835

= 0.52

Operating

expenses

to revenues

ratio

$1,158/$3,084

= 0.38

$872/$2,332

= 0.37

$671/$1,835

= 0.37

This table examines four ratios that investigate earnings quality. Cost of

goods sold to revenues have been stable over 2013 and 2014, which is a

favorable sign. The same comment applies to gross margin to revenues

and operating income to revenues ratio. The only unfavorable measure

(continued) Under Armour, Inc.

The notes about revenue and expense recognition are also in line with

generally accepted accounting principles, which is favorable for quality

of earnings. The Company presents sales net of sales-related

taxes. We recognize initial fees received from a franchisee or licensee

Req. 2

They define their segments by geographic region either North America

or Foreign. The financial information they provide by segments is for

revenues and operating income. North American segments generate the

majority (90%) of revenues for this company, so this company relies

Req. 3

Investment Capitalization Rate

4%

6%

8%

10%

Estimated

value

of a share of

Under Armour,

stock

=

$0.98

= $24.50

$0.98

= $16.33

$0.98

= $12.25

$0.98

= $9.80

.04

.06

.08

.10

(continued) Under Armour, Inc.

Req. 4

Student answers will vary depending on when this problem is assigned.

If a student used the price of $103 on October 12, 2015, this would be

Group Project

1-2 hours

Student responses on this problem will vary.