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					AMERICAN UNIVERSITY IN BULGARIA BUS 251: Principles of Accounting The Third Exam: FIVE Questions about Chapters 10 - 13 December 11, 2001 Score First Name Last Name KEY !

Question 1 (15 Points) – The Cosmic Software Company has 15,000 shares authorized and 3,000 shares issued and outstanding of its $3 par value common stock. The stock is currently selling for $32 per share. Give the journal entry or appropriate memorandum entry for each of these INDEPENDENT events: a. b. c. The Cosmic Software Company declared and issued a three-for-one stock split by issuing new $1 par value shares for the old shares. The Cosmic Software Company declared and issued a 10% stock dividend. The Cosmic Software Company declared and issued a 50% stock dividend. General Journal Account a. No Jounral Entry [memo that 9,000 $1 shares are now outstanding] Note: Other options described in the text for stock splits do not apply to the split specified here – the par value has been reduced! b. Retained Earnings Common Stock Additional Paid-In Capital c. Retained Earnings Common Stock 9,600 900 8,700 4,500 4,500 Debit Credit

Question 2 (15 Points) – On January 1, 2000, Green Country Petroleum acquired 30% of the outstanding shares of Jones Textiles, Inc. for $24 per share. Jones Textiles had 5,000 shares outstanding. During 2000, Jones Textiles had net income of $2,500 and declared and paid dividends of $1,200. The price per share at December 31, 2000 is $26.53 per share. Prepare the journal entries to record the appropriate transactions throughout the year. General Journal Account 1 - 1 - 00 Investment in Jones Textile, Inc. Cash 12 – 31 – 00 Investment in Jones Textile, Inc. Investment Revenue 12 – 31 – 00 Cash Investment in Jones Textile, Inc. 12 – 31 – 00 No entry related to price per share because the investment is long-term Note that the question cannot be reasonably interpreted to call for Jones’ entries; Green acquired Jones’ OUTSTANDING shares! Debit 36,000 36,000 750 750 360 360 Credit

Question 3 (15 Points) – On March 1, Steven's Jewelry purchased marketable securities consisting of common stocks. The portfolio consists of 115 shares of Alpha Co. (at $37 per share, purchased because Steven thought that the price is low and he can make a quick profit) and 305 shares of Beta Co. which Steven’s does not intend to sell in the near future to (purchased at $29 per share). On March 15, Beta gave a cash dividend of $3.00 per share to shareholders of record on March 5. The market value of the securities on a per share basis on March 31 were $36 per share for Alpha and $27 for Beta and the earnings per share were reported by Alpha at $0.25 per share during March and by Beta at $ 0.17 per share. Prepare the journal entries which will need to be made on: a. March 1 b. March 15 c. March 31 General Journal Account a. Trading securities – Alpha Co. Available-for-sale-securities – Beta Co. Cash Cash Dividend revenue – Beta Co. Unrealized loss – Alpha Co. Valuation allowance – Beta Co Trading securities – Alpha Co.. Available-for-sale-securities – Beta Co. or, because Beta’s dividend would have been declared by March 1, these entries could arguably be made as an acceptable alternative: Dividend receivable – Beta Co. Trading securities – Alpha Co. Available-for-sale-securities – Beta Co. Cash Cash Dividend receivable – Beta Co. Unrealized loss – Alpha Co. Available-for-sale-securities – Beta Co. Valuation allowance – Beta Co Trading securities – Alpha Co.. Debit 4,255 8,845 13,100 915 915 115 610 115 610 Credit




915 4,255 7,930 13,100 915 915 115 305 115 305



Question 4 (35 Points) – Here is some fascinating information about the Seattle Company: The Seattle Company Balance Sheet -- At December 31, 2000 and 1999 12/31/2000 Current Assets: Cash Accounts Receivable Supplies Inventory Prepaid Insurance Total Current Assets Long-term Assets: Fixed Assets Accumulated Depreciation Patent Total Long-term Assets Total Assets Current Liabilities: Accounts Payable Wages Payable Interest Payable Taxes Payable Total Current Liabilities Long-term Liabilities: Bonds Payable Total Liabilities Stockholders' Equity: Common Stock Retained Income Total Stockholders' Equity Total Liabilities and Stockholders' Equity $ 7,600 11,500 1,200 12,500 1,400 $34,200 $76,000 (30,400) 6,000 $51,600 $85,800 $ 6,100 1,200 800 2,300 $10,400 21,300 $31,700 $27,700 26,400 $54,100 $85,800 12/31/1999 $ 3,100 7,900 2,100 18,600 1,000 $32,700 $58,000 (26,500) 7,000 $38,500 $71,200 $ 4,900 2,600 1,000 1,600 $10,100 19,000 $29,100 $25,000 17,100 $42,100 $71,200

The Seattle Company Income Statement -- For the Year Ended December 31, 2000 Sales Cost of Goods Sold Gross Profit Less Operating Expenses: Wage Expense Supply Expense Insurance Expense Depreciation Expense Amortization Expense Rent Expense Operating Income Interest Expense Income before Taxes Income Tax Expense Net Income $157,500 (63,800) $ 93,700 $ 50,200 3,600 3,000 3,900 1,000 5,400

$ 67,100 $ 26,600 (2,600) $ 24,000 (10,800) $ 13,200

On the next page, prepare in good form the complete cash flow statement of the Seattle Company for 2000. Use the indirect method in your Statement and include a reconciliation of Net Income to Net Cash Provided by Operating Activities.

The Seattle Company Statement of Cash Flows -- For the Year Ended December 31, 2000 Cash from Operating Activities: Cash from customers Cash to suppliers Cash to employees Cash for supplies Cash for insurance Cash for rent Cash for lenders Cash for taxes Cash from Operating Activities Cash from Investing Activities: Bought fixed assets Cash for Investing Activities Cash from Financing Activities: Issued bonds payable Issued common stock Paid dividends Cash for Financing Activities Change in Cash Beginning Cash Balance Ending Cash Balance

$ 153,900 -56,500 -51,600 -2,700 -3,400 -5,400 -2,800 -10,100 $ 21,400

$ -18,000 -18,000


2,300 2,700 -3,900 $ $ 1,100 4,500 3,100 7,600

Reconciliation of Net Income to Cash from Operating Activities: Net Income $ 13,200 Add: Depreciation Expense 3,900 Amortization Expense 1,000 Changes in relevant accounts: Accounts Receivable -3,600 Supplies 900 Inventory 6,100 Prepaid Insurance -400 Accounts Payable 1,200 Wages Payable -1,400 Interest Payable -200 Taxes Payable 700 Cash from Operating Activities $ 21,400

Question 5 (20 Points) – Using the information about Seattle Company presented in Question 4, above, calculate these twelve ratios for Seattle Company as of, or for the year ended, December 31, 2000. Show your answer in three significant digits and, if you care to receive partial credit, show your computations! Current ratio 3.29 34.2 / 10.4

22.5 days 365 / [157.5 / {(11.5 + 7.9) / 2}] Note this solution focuses on the fact that average days are computed by dividing 365 days per year by the related turnover rate – an idea easier to recall than the formula in the text. Return on stockholders’ equity (ROE) 27.4 % 13.2 / [(54.1 + 42.1) / 2] 59.5 93.7 / 157.5 .586 31.7 / 54.1 10.2 26.6 / 2.6 8.38 13.2 / 157.4 times %

Average collection period in days

Gross profit rate

Total debt to equity

Interest coverage

Return on sales (ROS)


Total debt to assets

.369 31.7 / 85.8 Note that “debt to assets” is thoroughly redundant to “debt to equity,” computed above: If debt = .586 and equity = 1.000, which is what the “debt to equity” ratio indicates, then assets must = 1.586. .586 / 1.586 = .369!! The point here is that only of of the ratios in this family of ratios are ever reported in any one analysis – to do more than one of those ratios tells the world the analyst does not know what he or she is doing!! Practical hint: either “debt to assets” or “equity to assets” is better than versions of the ratio that place equity or debt in the denominator – if a firm’s value for that denominator is very small, the ratio blasts into infinity, reducing its usefulness for comparative purposes. Quick ratio 1.84 [7.6 + 11.5 ] / 10.4 2.01 157.5 / 85.8 times

Asset turnover

Two notes on averaging: First, the ratios for which averaging makes some sense are those that juxtapose balance sheet with income statement measures. That is why, for example, current and quick ratios are not averaged [both exclusively focusing on the balance sheet] and why, for example, gross profit rate and interest coverage [both exclusively focusing on the income statement]. But ratios like the turnover rates or the returns on some balance sheet measure juxtapose measurements from the two statements, giving rise to the question about the value of using averaged balance sheet measurements rather than year-end measures. Second, should averages be used at all – even for those ratios that do juxtapose balance sheet and income statement measures? The key conceptual reason for averaging is to reflect the effect of significant changes during the year; if, during the year, a firm issues new equity that hugely increases assets, the averaging tries to reflect that event in the ratios.

The key practical reason for averaging is because many analysts do it & AUBG students should know that method. Meanwhile, the key reasons for NOT averaging are that – 1) the average may not differ from the year-end value, so averaging does not change the analysis. 2) if the average value is different from the year-end value, the more interesting number remains the more recent value rather than the year-old value. 3) a simple average fails to do an effective job of responding to the conceptual reason for averaging – to do it right, we should average the values of say, 12 months’ observations, not just beginning & ending. 4) averaging costs you one set of observations in your data – those data are better used to add an extra year’s observations than to compute a crude average for a single year. In this course, averages were used with consistency to ensure AUBG students are familiar with the technique commonly used. Finally, some rules on rounding computations & answers. Accounting is the art and science of communicating business information to decision-makers; there are some general rules that help the preparer communicate effectively. Here are some of those rules: Rule No. 1 – the more digits you tell me, the more likely I am to forget the number itself & even its scale! This stems from the way humans innately process information; this you cannot change. Therefore, you need to consider that barrier in communicating effectively. Which is more potent to you? “You could win $987,654.32!” or “You could win One Million Dollars!” Reducing the detail increases the power and clarity of your message. That is why carrying an answer out to nine digits just looks silly, rather than precise, most of the time. Rule No. 2 – there is a limit to detail reduction. It is OK to round 567,890 to 567,900; 568,000; and even 570,000. It is not ok to round the number to 1,000,000! What is safe? A good guess – maybe working 99% of the time – is showing three significant digits. [That is not the same as showing three decimals!] So, 567,890 is slightly changed but still quite specific at 568,000 and two of the five significant digits so hard for humans to recall [see Rule No. 1] are removed. Likewise, .00056789 may not be rounded to .001 – do .000568. Rule No. 3 – whatever digits you show tells the reader how precise the underlying computations are. Say you have a machine that cost $9,700 and you expect it to make 250,000 units of output before giving it away for free; say also the machine is used to make 123,456 units this year. The correct depreciation expense using the method implied here is 123,456 / 250,000 * $9,700 = $4,790.09 or $4,790. But it is common to compute a depreciation rate per kilometer and multiply that rate by 123,456 – there is the source for a serious error: $9,700 / 250,000 = $.0388. If you round that $.0388 to $.04 and multiply $.04 by 123,456, your answer will be $4,938.24. One issue is that you created needlessly a 3.1% by replacing the .0388 that was in your calculator with the crude .04 that you punched in on your own and with a whole new chance for math errors – that is not too clever. But the other issue is bigger – when you rounded .0388 to .04, you compressed three significant digits into a single one. To use .04 to get an answer you report as $4,938.24 is false precision. It is a thorough and serious flaw in the proper processing of any data. It is sloppy -- a clear indication that an amateur has been at work. If that means nothing to you, try this: IT WILL CONSISTENTLY COST YOU POINTS ON AUBG ACCOUNTING EXAMS! Rule No. 4 – truncation is not the same as rounding. 8.9 does not round to 8! 8.8 does not round to 8! 8.7 does not round to 8! And 8.6 does not round to 8! On the other side, a few need to know that 8.4 does not round to 9, but that problem is not so frequent! AUBG assumes rounding is a skill you have already acquired and will use on exams; if you need a refresher review of the rules of rounding, ask for an appointment with your accounting professor. Thoughtless rounding is sloppy – a clear indication that an amateur has been at work. If that means nothing to you, try this: IT WILL CONSISTENTLY COST YOU POINTS ON AUBG ACCOUNTING EXAMS!

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