ACC E113 Lecture Notes - Lecture 9: Intangible Asset, Accounts Receivable, Canadian Tire

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30 Jul 2020

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Constraints of accounting measurement: accurate interpretation of financial statements requires that the statement"s reader to be aware of important constraints. Companies produce and disseminate accounting information to users with the expectation that the benefits to users of such information exceed the cost of producing it. The cost constraint suggests that information should be produced only if the perceived benefits of increased decision usefulness exceed the expected costs of providing that information. Prudence requires that special care be taken to avoid (1) overstating assets and revenues and (2) understating liabilities and expenses. The separate-entity assumption states that the activities of each business must be accounted for separately from the activities of its owners, all other persons and other entities. Ex: a building purchased by the owner of a real estate company for. The use of a specific unit of measure allows for meaningful aggregation of.

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This term you have learned to understand a companyâs financial story using the language of accounting. The recording and reporting of information is essential to decision makers and other users of financial information; numbers on the various financial statements are used to help further understand the financial condition of the business. This process is known as financial ratio analysis and allows us to analyze the companyâs financial position in relation to other organizations in the industry. In this final assignment, you will apply the concepts you have learned throughout the term to perform financial statement analysis and to offer some recommendations.

Assume that you are a health care consultant hired by the Dependable DME Company. DME is Durable Medical Equipment and includes all equipment that benefits patients who have certain medical conditions. The owner of the company, David Smith, is interested in applying for a loan to expand his business; he desires to open a second location in another city. He is preparing to apply to a local bank for a loan.

The bank will base its decision on the following averages for the DME industry:

Ratio	Industry Average
Current ratio	1.50
Quick ratio	0.80
Receivables turnover ratio	18.0
Inventory turnover ratio	20.0
Debt to assets ratio	0.56
Profit margin	10.25%

The balance sheet data for Dependable DME Company follows:

	December 31, 2017	December 31, 2016
Cash	$75,000	$60,000
Accounts receivable	40,000	20,000
Inventory	30,000	20,000
Prepaid insurance	5,000	5,000
Total current assets	140,000	105,000
Property and equipment	600,000	550,000
Accumulated depreciation	140,000	110,000
Total property and equipment	460,000	440,000
Total assets	$600,000	$545,000
Accounts payable	$60,000	$60,000
Other current liabilities	40,000	45,000
Total current liabilities	100,000	105,000
Bonds payable	150,000	150,000
Total liabilities	250,000	255,000
Common stock	250,000	250,000
Retained earnings	100,000	40,000
Total stockholdersâ equity	350,000	290,000
Total liabilities and stockholdersâ equity	$600,000	$545,000

The income statement data for Dependable DME Company follows:

Sales	$600,000
Cost of goods sold	350,000
Gross profit	$250,000
Operating expenses	100,000
Operating income	$150,000
Interest expense	25,000
Income before taxes	$125,000
Income tax expense	65,000
Net income	$60,000

Required:

Calculate the following six (6) ratios: Current Ratio, Quick Ratio, Receivables Turnover Ratio, Inventory Turnover Ratio, Profit Margin Ratio and Debt to Assets Ratio. Be sure to show the actual calculation as well as your final answer.

You are only required to calculate the ratios for 2017; however, for two of the ratios (Receivables Turnover Ratio and Inventory Turnover Ratio), you will need data from 2016 for the formula. When calculating the Quick Ratio, please note that Short-Term Investments are $0 in this scenario. (24 points; 4 points for each ratio calculation)

Below each ratio, comment on the interpretation of the ratio. In other words, what does the result tell you, specifically? (8 points)

Based upon the industry averages upon which the bank relies, should they approve the loan to Mr. Smith? Why or why not? (7 points)

In one-half page, comment on what financial aspect of Dependable DME Company looks good and where can Mr. Smith make some improvements. Specifically identify at least two recommendations to Mr. Smith that can be made to improve the financial position of his business. (8 points)

ACC E113 Lecture Notes - Lecture 9: Intangible Asset, Accounts Receivable, Canadian Tire

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