PAGE 1 ROSS SCHOOL OF BUSINESS UNIVERSITY OF MICHIGAN ACCOUNTING 501 PRACTICE QUIZ 2 WINTER 2006 Name: (Print) Please print your name and section number above. The exam is closed-book, closed-notes. You may use a calculator. You will have 90 minutes to complete the quiz. Do your own work. Read each question carefully. If you feel an assumption must be made in a problem, state your assumption in your solution, and it will be considered in grading the quiz. For your convenience, a list of ratios and formulas is provided at page 12. Note: You must show all of your work in Problem II to receive full credit. Point Distribution Problem Points Possible Points Earned I. Multiple Choice 30 _____ II. Short Answer Questions and Account Analysis 70 _____ 100 ______ At the conclusion of the 90-minute quiz period, please read and sign the statement of compliance with the Business School Honor Policy. Business School Honor Policy: We, the members of the Business School community --- students, faculty, and staff --- commit ourselves to do our work and perform our duties honestly. We understand that in striving for excellence in performance, our personal and institutional integrity is our most precious asset; and accordingly, we will not knowingly act in ways that erode our integrity. Because we are an academic community, honesty in our academic work is vital. Therefore, we pledge neither to cheat nor to tolerate cheating. I acknowledge that I have been directed to work individually on this quiz. I certify that I have neither given nor received prohibited aid on this quiz. Signed _______________________________________________ Problem I: Multiple Choice (30 Points) For each question, choose the most correct answer. 1. A firm had beginning balances in Accounts Receivable of $115,600 and Allowance for Uncollectible Accounts of $7,500. The ending balance in Accounts Receivable is $132,800, and an aging analysis estimates that $8,900 of that amount will not be collected. Bad Debt Expense for the year was $19,700. Revenue from credit sales for the year was $1,117,800. What was the total of the uncollectible accounts written off during the year? $21,100 $19,700 $18,300 $ 8,900 None of the above. 2. The credit manager of Preston Company recently analyzed the company?s financial statements for the year ending 12/31/05. The company?s beginning balance of accounts receivable was $230,000; the balance of accounts receivable at 12/31/05 was $190,000. Net sales for the year were $850,000. The average collection period was: a. 120 days. b. 99 days. c. 95 days. d. 90 days. e. 82 days. 3. In January 2006, two inventory errors were discovered: ending inventory at December 31, 2004 was overstated by $55,000, and ending inventory at December 31, 2005 was understated by $19,250. What effect did these errors have on the 2005 financial statements? (Ignore any effects on income taxes.) a. Cost of Goods Sold understated by $19,250; Stockholders? Equity overstated by $19,250. b. Cost of Goods Sold understated by $55,000; Stockholders? Equity overstated $74,250. c. Cost of Goods Sold overstated by $74,250; Stockholders? Equity understated by $19,250. d. Cost of Goods Sold understated by $19,250; Stockholders? Equity understated by $19,250. e. None of the above. 4. A company had the following purchases and sales of inventory during 2005: 1/1 Beginning inventory 140 units at $79 per unit 3/2 Purchases 217 units at $81 per unit 8/17 Purchases 95 units at $82 per unit 10/25 Purchases 210 units at $84 per unit 11/21 Purchases 248 units at $87 per unit 12/31 Ending inventory 229 units During the year, the company sold 681 units at $130 per unit. Calculate the gross profit for the company using the periodic LIFO costing method: a. $32,810 b. $31,921 c. $31,156 d. $12,887 e. None of the above. 5. Photon Corp. acquired a metal-cutting machine on January 1, 1990, at a cost of $18,000. It was expected to have a 12-year life and a $2,400 salvage value. Photon uses the straight-line method to record depreciation. The machine was sold on July 1, 1997 for $8,900. The entry to record the sale would reflect a gain of $2,150. a gain of $650. a loss of $2,150. a loss of $650. neither a gain nor a loss since the machine was sold at its book value. 6. At January 1, 2002, Diamond Corp. purchased and placed in service a machine costing $264,600. Depreciation is recognized using the straight-line method. The machine was expected to have a useful life of 8 years and an estimated salvage value of $9,000. On January 1, 2005, Diamond determined that the machine would last an additional 9 years from that date, with the salvage value remaining unchanged. What is the depreciation expense to be recognized for 2005? a. $17,750 b. $18,125 c. $18,375 d. $18,750 e. None of the above. 7. On January 1, 2000, a corporation acquired an asset for $120,000 that had a salvage value of $15,000 and a 5-year life. The asset is being depreciated using the double-declining-balance method. Company management wonders what effect this depreciation method had on net income for 2002 compared to the straight-line method. By how much would net income before taxes in 2002 be different if the straight-line method had been used for the entire time? Net income before taxes would be $1,680 lower using straight-line depreciation. Net income before taxes would be $1,680 higher using straight-line depreciation. Net income before taxes would be $6,720 lower using straight-line depreciation. Net income before taxes would be $3,720 higher using straight-line depreciation. None of the above. 8. Information relating to Lally Company at December 31, 2001 and December 31, 2002 is as follows: 2001 2002 Income Before Taxes $5,000,000 $4,000,000 Income before taxes in 2001 included rent revenue of $80,000 that was not subject to income tax until its receipt in 2002. This is the only temporary difference affecting Lally either year. Lally was subject to an effective income tax rate of 40% in 2001 and 2002. There was no deferred tax asset or liability at the beginning of 2001. The amount of current income tax liability that would have been reported by Lally Company for the year ended December 31, 2001 is: $1,928,000 $1,968,000 $1,992,000 $2,000,000 None of the above. 9. Mead Co. reported the following information related to bonds payable: 12/31/98 12/31/97 Bonds Payable $300,000 $100,000 Discount on Bonds Payable ( 2,526) ( 3,221) Premium on Bonds Payable 12,464 -0- Total Book Value $309,938 $ 96,779 The bonds outstanding at December 31, 1997, had a coupon rate of 9% and had been sold to yield 10%. The new bonds were all issued on December 31, 1998, with a coupon rate of 11% and had been sold to yield 10%. All bonds pay interest semiannually. For the year ended December 31, 1998, what is Mead?s interest expense related to these bonds? a. $ 8,305 b. $ 9,695 c. $10,246 d. $12,221 e. None of the above. 10. Jacobs Corp. sold 10-year bonds at a discount of $10,000 on January 1, 1995. During the period January 1, 1995 to December 31, 1997, Jacobs amortized $2,000 of the discount. On January 1, 1998, Jacobs retired the bonds by paying $5,000 more than face value. What amount of gain or loss should Jacobs report on the retirement of these bonds? $ 2,000 gain $ 5,000 loss $10,000 gain $13,000 loss None of the above. Problem II: Short Answer and Account Analysis (70 Points) 1. Accounts Receivable Following is the current asset section (in millions) from Colgate?s 2003 balance sheet. Consolidated Balance Sheets As of December 31, (Dollars in Millions Except Per Share Amounts) Assets 2003 2002 Current Assets Cash and cash equivalents $265.3 167.9 Receivables (less allowances of $43.6 and $45.9, respectively) 1,222.4 1,145.5 Inventories 718.3 671.7 Other current assets 290.5 243.0 Total Current Assets 2496.5 2228.1 During 2003, Colgate recorded $6.60 million in Bad Debt Expense and wrote off $8.90 million of uncollectible accounts. Also, Colgate reported sales $9,903.40 for 2003 and $9,294.30 for 2002. Required: What is Colgate?s gross amount of receivables at the end of (i) 2003 and (ii) 2002? For 2003 and 2002, compute the ratio of (i) the allowance for uncollectible accounts to gross accounts receivable and (ii) gross accounts receivable to sales. Discuss any shift in these percentages. Compute (i) accounts receivable turnover and (ii) the average collection period for 2003. (iii) Does the collection period seem reasonable for Colgate?s industry? Explain. 2. Inventory Walgreen Co. reports the following current assets: Assets 2003 2002 Cash and cash equivalents 1017.1 449.9 Accounts receivable, net 1017.8 954.8 Inventories 4202.7 3645.2 Other current assets 120.5 116.6 Total Current Assets 6358.1 5166.5 The following is excerpted from the Walgreen Co. Income Statement: 2003 2002 Net Sales 32,505.4 28,681.1 Cost of Sales 30,657.1 27,056.9 Gross Profit 1,848.3 1,624.2 The inventory footnote reads as follows: Inventories are valued on a lower of last-in, first-out (LIFO) cost or market basis. At August 31, 2003 and 2002, inventories would have been greater by $729.7 million and $693.5 million, respectively, if they had been valued on a lower of first-in, first-out (FIFO) cost or market basis. Required: Calculate the Company?s inventory to current assets ratio for 2003 and 2002. Does this percentage make sense in Walgreen?s industry? What does the change suggest about Walgreen? Recalculate the above ratios under the FIFO method. Explain why this answer differs from that in a). Compute the inventory turnover ratio for 2003 and 2002 (ending inventory in 2001 is $3,482.4). What does this say about the Company? 3. Plant Assets Following is the assets section of the balance sheet of Mattel, Inc. and Subsidiaries and footnote disclosure taken from its 2003 annual report. Property, Plant and Equipment Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over estimated useful lives of 10 to 40 years for buildings, 3 to 10 years for machinery and equipment, and 10 to 20 years, not to exceed the lease term, for leasehold improvements. Tools, dies and molds are amortized using the straight-line method over 3 years. Estimated useful lives are periodically reviewed and, where appropriate, changes are made prospectively. The carrying value of fixed assets is reviewed when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Any impairment identified is assessed by evaluating the operating performance and future undiscounted cash flows of the underlying assets. When property is sold or retired, the cost of the property and the related accumulated depreciation are removed from the consolidated balance sheet and any gain or loss on the transaction is included in the results of operations. Additional Information: Sales totaled $4,960,100 and $4,885,340 for 2003 and 2002, respectively. Required: Compute Property, Plant, and Equipment Turnover (disregard ?Other Noncurrent Assets?) for 2003 and 2002. (Property Plant and equipment, net for 2001 was $626,722.) Is there any significant change? Does the level of plant asset turnover suggest that Mattel is capital intensive? Explain. What assets may not be reflected on Mattel?s balance sheet? Mattel reported depreciation expense of $109,444 for 2003. Using the reported method of depreciation, estimate the useful life, on average, for its depreciable plant assets. By what percentage are Mattel?s assets ?used up? at year-end 2003? What implications does this computation have for prospective cash flows? 4. Long-Term Debt Reproduced below is the long-term debt footnote from the 2003 annual report of Progressive (an insurance company). EMBED Word.Document.8 \s Required: Consider the 7.30% Notes due 2006. Without completing any calculations, can you tell if market interest rates are higher or lower than they were when these notes were issued in 1996? Why is there a difference between the market price and the cost of the notes? At what amount does Progressive report the debt on its balance sheet? Cost or market? If Progressive were to repurchase its bonds, how would the difference the difference between the market price and the cost be reflected in the income statement? Ratio Numerator Denominator Current Ratio Current Assets Current Liabilities Accounts Receivable Average Accounts Receivable Turnover Ratio Credit Sales during the Period Inventory Turnover Ratio Cost of Goods Sold Average Inventory during the Period Average Collection Accounts Receivable Average Daily Sales Period Gross Profit Percentage Gross Profit Sales Return on Sales Net Income Sales Property, Plant, and Equipment Sales Average PPE Assets Turnover Ratio during the Period PAGE PAGE 11
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