1

JRE300: Fundamentals of Accounting and Finance

MIDTERM EXAMINATION (30% of Final Grade): Winter 2015

Time Allowed: 2 Hours

LAST NAME ________________________________________ STUDENT NUMBER:__________________________________

PLEASE INDICATE YOUR INSTRUCTOR:

S. Douglas___________ M. Stapleton____________ F. Tolias___________

Instructions:

• Write all of your answers on the examination paper. If you need additional space, use the back of the page facing the question and clearly identify the question being answered.

• This is a closed book exam. One double-sided 8.5'x11' hand-written or typed aid sheet containing formulas/notes is permitted. Non-programmable calculators are permitted.

• Pencil or pen may be used. However, papers written in pencil or papers with white outs will not be re-marked.

Question Marks Marks Awarded

1 20

2 10

3 14

4 10

5 16

6 10

7 20

Total 100

There are 19 pages.

2

QUESTION 1 – Total of 20 Marks

Taylor Retail Company Inc. (“Taylor”) had the following balances in its T-accounts for the 11 months ended November 30, 2014:

Taylor has a December 31st fiscal year end and Taylor uses specific identification for its inventory. The following transactions occurred in December:

• December 1 – Paid rent of $1,400 • December 15– Purchased merchandise inventory from Neddy Corp. for $16,000. Paid

50% of the purchase price in the month of purchase, and the other 50% in the following month.

• December 17 - Sold merchandise on credit to Kerry Ltd. The cost of the inventory was $14,000 and it was sold for $23,000.

• December 18 – $20,000 worth of computers, desks, telephones and other equipment purchased with 50% down payment and the remaining 50% due in 60 days.

• December 18 – Hired a part-time employee for the busy holiday season. • December 19 – Delivered goods to Stapleton Industries. Stapleton made a deposit on

November 19 of $6,200 and paid the balance owing of $3,800 on delivery (December 27th). The cost of the inventory sold was $5,800.

• December 22 – Various office supplies purchased for $2,100; paid cash • December 31 – Paid $9,500 for annual insurance premium for coverage that starts in

2015. Assume that the prepaid insurance in the T-accounts above relates to 2014 coverage only.

• Dec 31 - Paid $2,900 to full and part-time employees. • Dec 31 - Shipped goods f.o.b. destination. The goods were originally purchased for

$22,000 and sold for $30,000. • Depreciation expense for the year was $12,000.

Accounts Receivable 125,000 Loan Payable 166,000 Common Shares 25,000 Inventory 55,000 Cash 35,000 Prepaid Insurance 9,300 Trucks and Equipment 204,500 Accumulated Depreciation: Trucks 33,600 Retained Earnings 172,000 Rent Expense 14,000 Sales 101,400 Unearned Revenue - Deposits 6,200 Salaries Expense 27,800 Utilities Expense 8,200 Cost of Goods Sold 25,400

3

PART A (10 marks)

Journalize the transactions above using the correct account names. Be sure to include any year-end adjusting entries. Also, if an entry is not required for a transaction, please explain.

Dec 1 Rent expense ............................................................................. 1,400 Cash ..................................................................................... 1,400 15 Inventory ................................................................................... 16,000 Cash ..................................................................................... 8,000 Accounts Payable ................................................................. 8,000 17 Accounts Receivable .................................................................. 23,000 Revenue .............................................................................. 23,000 17 Cost of Goods Sold ..................................................................... 14,000 Inventory .............................................................................. 14,000 18 Equipment ................................................................................. 20,000 Cash ..................................................................................... 10,000 Accounts Payable ................................................................. 10,000 18 NO ENTRY – not an economic event 19 Unearned Revenue .................................................................... 6,200 Cash ........................................................................................... 3,800 Sales Revenue ...................................................................... 10,000 19 Cost of Goods Sold ..................................................................... 5,800 Inventory .............................................................................. 5,800 22 Office Supplies ........................................................................... 2,100 Cash ..................................................................................... 2,100 31 Prepaid Insurance ...................................................................... 9,500 Cash 9,500

31 Insurance Expense ..................................................................... 9,300 Prepaid Insurance ................................................................ 9,300 31 Salary Expense ........................................................................... 2,900 Cash ..................................................................................... 2,900 31 NO ENTRY – f.o.b destination – sale not recorded until delivery to customer 31 Depreciation Expense ................................................................. 12,000 Accumulated Depreciation .................................................... 12,000

4

PART B (10 marks)

Prepare an income statement and balance sheet for Taylor for the year ended December 31, 2014.

Statement of Earnings, year ended Dec 31, 2014 Sales revenue $ 134,400 Cost of Goods Sold 45,200 Gross Margin $ 89,200 Expenses Salaries expense $30,700 Utilities 8,200 Insurance Expense 9,300

Depreciation Expense 12,000 Rent expense 15,400 75,600 Net earnings $ 13,600

Balance Sheet, as at Dec 31, 2014

Current assets Cash $ 4,900 Accounts receivable $ 148,000 Prepaid Insurance $ 9,500 Supplies $ 2,100 Inventory $ 51,200 $215,700 Property, plant, and equipment Trucks and Equipment $224,500 Accumulated Depreciation (45,600) 178,900 Total Assets $ 394,600 Liabilities Accounts payable $ 18,000 Loan payable $166,000 Shareholder’s equity Common shares $25,000 Retained earnings 185,600 210,600 Total liabilities and shareholder’s equity $ 394,600

5

QUESTION 2 - Total of 10 Marks

Atlantic Transport collects 75 percent of its monthly sales immediately and the rest at the end of the month; has production costs that are 50 percent of sales, pays 50 percent of its bill immediately and the rest at the end of the month; and has four months of sales in inventory.

Part A (5 marks)

Calculate the break-even sales growth rate.

With the data α = 0.75; b = 0.5; β = 0.5 and γ = 4.0.

( )

%33.33333.00.75-4)(0.5*0.5

0.5-1g

)1g

or

bb

=+

=

-+-

=αgb

Part B (5 marks)

Suppose Atlantic adopts a more efficient inventory policy that reduces the size of its inventory to three months of sales. Atlantic Transport also reduces its production costs to 40 percent of sales. What is the new break-even sales growth rate?

With the new policy, γ = 3 and b = 0.4, so the growth rate increases to:

( )

%31.92or9231.00.75-3)(0.4*0.4

0.4-1g

)1g

=+

=

-+-

=αgbb

b

** note: some students interpreted that 100% of sales were received in the same month and 100% of production costs were charged in the same month** no marks were deducted

6

QUESTION 3 – Total of 14 marks

Appendix 1 contains excerpt financial statements for Leon’s Furniture Limited (“Leon’s”). Use those financial statements to answer the questions below.

PART A (10 marks): Fill out the table below. For each required ratio show the calculation (i.e. which numbers you used in arriving to the final figure), and the result for fiscal years 2013 and 2012. No need to use the 'average' for your calculations, use the appropriate number for 2013 and 2012.

Ratio/Value General Formula 2013 calculation and answer

2012 calculation and answer

Working Capital

Current Assets –Current Liabilities

$427,765 - $444,027 = ($16,262)

$341,934-115,726 = $226,208

Current Ratio

Current Assets/Current Liabilities

$427,765/444,027 = .9633 $341,934/115,726 = 2.95

Inventory Turnover

Cost of Sales/Inventory

959,307/277,656=3.45x

398,704/86,057=4.63x

Days in Inventory

365 days/Inventory Turnover

365 days/3.45x=105.79 days

365 days/4.63x=78.83 days

Receivables Turnover

Credit Sales/Accounts Receivable

1,694,643/104,275=16.25 x

682,163/27,961=24.39 x

Average Collection Period

365 days/Receivables Turnover

365 days/1.63x=22.46 days

365 days/24.39x = 14.96 days

PART B (4 marks)

a) Comment on Leon’s liquidity in 2013 relative to 2012. Make sure you reference the relevant ratios you calculated in Part I (above) as well as any other relevant information from Appendix 1. (4 marks)

7

Liquidity has suffered significantly year over year Current ratio 3+ times in 2012 but fell to under 1 in 2013 Working capital is negative in 2013 inventory turnover significantly decreased and receivables turnover decreased days in inventory increased significantly (possibility of inventory

obsolescence/spoilage) and average collection period went up dramatically Other

QUESTION 4 – Total of 10 marks

Jory Inc. purchases all merchandise inventory on credit and uses a perpetual inventory system. The accounts payable account shown here is used only for recording merchandise inventory purchases. You have been given the following information for fiscal years 2012 to 2014.

Calculate the missing amounts for items (1) to (10). Show all your work.

2014 2013 2012

Statement of Earnings:

Net Sales $87,000 (5) $96,000

Cost of Goods Sold 26,500 27,000 (9)

Gross Profit (1) 61,500 69,300

Operating Expenses 45,100 (6) 53,000

Net earnings (2) $14,500 (10)

Selected Balance Sheet Data:

Inventory (3) $14,700 $11,000

Accounts Payable (4) 4,600 6,500

Additional Information:

Purchase of inventory on account

$22,000 (7) $25,900

Cash Payments to suppliers

$24,000 (8) $25,000

8

(1) Gross profit = Net sales – Cost of goods sold

= $87,000 - $26,500 = $60,500

(2) Net earnings = Gross profit – Operating expenses

= $60,500 – $45,100 = $15,400

(3) Merchandise inventory = Inventory 2008 + Purchases – CGS

= $14,700 + $22,000 – $26,500 = $10,200

(4) Accounts payable = Accounts payable 2008 + Purchases –

Cash payments to suppliers

= $4,600 + $22,000 – $24,000 = $2,600

(5) Net sales = Cost of goods sold + Gross profit

= $27,000 + $61,500 = $88,500

(6) Operating expenses = Gross profit - Net earnings

= $61,500 - $14,500 = $47,000

(7) Purchase of merchandise inventory

= Ending Inventory 2008 + Cost of goods sold 2008

- Ending Inventory 2007 = $14,700 + $27,000 - $11,000 = $30,700

(8) Cash payments to suppliers

= Accounts payable 2007 + Purchases – Accounts

payable 2008 = $6,500 + (7) $30,700 – $4,600 = $32,600

(9) Cost of goods sold = Net sales – Gross profit

= $96,000 - $69,300 = $27,600

(10) Net earnings = Gross profit – Operating expenses

= $ 69,300 – $53,000 = $16,300

9

QUESTION 5 – Total of 16 marks

You and your friends decided to start an investment club. In preparation for the first meeting, you decided to review METRO Inc. ( a food retailer, similar to Loblaw Companies). METRO's shares are listed on the TSX, ticker: MRU.

a) For each of the items relating to METRO and listed below, identify which of the following conceptual framework components: i) economic entity, ii) matching principal, iii) comparability, iv) going concern, v) full disclosure, vi) historical cost, vii) timeliness, or viii) revenue recognition that is most applicable. Make sure you identify only one that is most applicable, and explain your choice.

METRO INC Information Conceptual framework assumption

Explanation

METRO INC reports depreciation expense on the consolidated statements of income. What is purpose of this expense item?

Matching principle To assist in assessing performance for a given period, all expenses should be “matched” (same period) to the revenue they helped to generate

METRO INC. consolidated statement of income includes fiscal years 2014 and 2013. Consolidated statements of financial position include balances as of fiscal years ending 2014, 2013, and 2012.

Comparability For Metro’s financial statements to be useful in assessing performance, they must be compared (year-over-year) with the results of other recent years

METRO INC. assets are reported on the consolidated statements of financial positing are NOT measured at liquidation value - why not? and what is the value reported?

Going concern/historical cost Metro is expected to be a going concern for the foreseeable future, and so liquidation value of assets is not relevant at this time.

METRO INC. financial statements include over 20 pages of MD&A and over 50 pages of “notes to consolidated financial statements”.

Full disclosure

Any information that is relevant (i.e. would make a difference in the minds of the user) must be disclosed in the body of the financial statements and/or in the notes to the financial statements

10

QUESTION 6 – Total of 10 marks

Jonah Ltd., a wholesale supply company, uses independent sales agents to market the company’s products. These agents currently receive a commission of 20% of sales. Cost of sales is a variable cost. The budgeted income statement appears below:

11

Sales (100,000 units) $ 10,000,000 Cost of sales 6,000,000 Gross margin 4,000,000 Selling and administrative expenses:

Commissions $ 2,000,000 All other expenses (fixed) 100,000 2,100,000

Operating income $ 1,900,000 Jonah is considering the possibility of employing its own sales agents. Three individuals would be required at a salary of $70,000 each, plus commissions of 5% of sales. In addition, a sales manager would be employed at a fixed annual salary of $160,000. a. Compute Jonah’s breakeven point in units based upon the company’s budgeted income

statement, assuming that the company continues to use independent sales agents. (3 marks)

BEP (units) = $100,000/(10,000,000-6,000,000-2,000,000)/100,000 = 5,000 units

b. Compute Jonah’s breakeven point in sales dollars, assuming that the company employs its own sales agents? (4 marks)

New fixed costs = $100,000 + 3(70,000) + $160,000 = $470,000 New CM Ratio = 1 – (60% + 5%) = 35% BEP (sales $) = $470,000/.35 = $1,342,857

c. What is the minimum sales volume (in units) that Johan must achieve before it starts to realize the monetary benefits of employing its own sales agents? (3 marks)

$100,000 + 80X = $470,000 + 65X X = 24,667 (rounded)

12

QUESTION 7 – Total of 20 Marks

Frank James, the CEO of Makin’ Money In. (“Money”), is considering an investment in a Lynch Corporation (“Lynch”). Frank is somewhat “risk averse”, and he only invests in companies that have high quality earnings with regular dividend payments. As such, Frank wants to carefully examine the cash situation very carefully before investing. On February 23th, 2015 (today!), Lynch Corporation released its comparative balance sheets for the period ending December 31, 2014.

Lynch Corporation Comparative Balance Sheet

As of December 31, 2013 and 2014 (Canadian dollars, in thousands)

December 31,

2013

2014 Assets Current Assets

Cash $ 10,000 $60,000 Accounts receivable 25,000 20,000 Inventories 40,000 30,000 Total Current Assets 75,000 110,000

Non-Current Assets Long Term Investment 20,000 0 Land 120,000 160,000 Building and Equipment 100,000 150,000 Accumulated Depreciation (15,000) (30,000) Total Non-Current Assets 225,000 280,000

Total Assets $300,000 $390,000 Liabilities and Shareholders' Equity Current Liabilities

Accounts Payable $ 35,000 $ 50,000 Total Current Liabilities 35,000 50,000

Non-Current Liabilities Bonds Payable 100,000 130,000 Total Non-Current Liabilities 100,000 130,000

Shareholders' Equity Common Stock 125,000 165,000 Retained Earnings 40,000 45,000 Total Shareholders' Equity 165,000 210,000

Total Liabilities and Shareholders' Equity $300,000 $390,000 Additional information during the year of 2014 is presented below:

• Dividends of $10,000 were declared and paid. • There were no disposals of any property, plant and equipment. • Lynch acquired a piece of land for a future factory site in exchange for 1,000 shares of

common stock. There were no other transactions involving common stock during the year.

13

• Lynch acquired a piece of equipment at $50,000. Lynch paid $10,000 upfront, and issued bonds for the remainder of the purchase price.

• Long-term investment with a book value of $20,000 (as of January 1, 2014) was sold at a market price of $30,000, and a gain of $10,000 was recognized.

Assume Net Income of Lynch for the year ended December 31, 2014 is $15,000.

a) What was net cash inflow or outflow from operating activities? Show all calculations. (10

marks)

Net Income (above) $15,000

Add: Depreciation Expense $15,000

Deduct: Accounting Gain ($10,000)

Add/Deduct Non-Cash Changes to Working Capital:

Accounts Receivable (decrease) $5,000

Inventory (decrease) $10,000

Accounts Payable (increase) $15,000

Net Cash Inflow from Operations $50,000

b) What is the net cash inflow or out flow from investing activities? Show all calculations. (4 marks)

Cash outflow re acquisition of equipment ($10,000)

Cash inflow from sale of temporary investments $30,000

Net Cash Inflow from Investing Activities $20,000

c) What is the net cash inflow or outflow from financing activities? Show all calculations. (4 marks)

Cash outflow re payment of dividends ($10,000)

Cash outflow re: reduction of bonds payable ($10,000)

14

Net Cash Outflow from Financing Activities ($20,000)

Alternatively:

Total change in cash – operating cash flows – investing cash flows = cash from financing activities

$50,000 – 50,000 – 20,000 = ($20,000)

d) Is Lynch a suitable investment for Money? Explain. (2 marks)

Yes

Payout Ratio = $10,000/$15,000 = 66%

Cash flow operations > net income operations (apparent high quality of earnings)

Other acceptable answer

15

APPENDIX 1 LEONS FURNITURE LTD - FINANCIAL STATEMENTS

16

APPENDIX 1 LEONS FURNITURE LTD - FINANCIAL STATEMENTS