CASE 1&2.docx - Case 1 A This question involves whether...

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Case 1 A) This question involves whether the costs incurred in the aging process (oak barrels and warehousing costs) are period costs (and written off) or product costs (and capitalized as part of the inventory value). The table below shows the effect on income of capitalizing all the warehousing costs and then writing them off when the whiskey is sold. Base Year Year 1 Year 2 Year 3 Revenues $6,000,0 00 $6,000,0 00 $6,000,0 00 $6,000,0 00 less: Cost of Goods Sold: bbls distilled @ $100/bbl $1,000,0 00 $1,000,0 00 $1,000,0 00 $1,000,0 00 Oak barrels 750,000 750,000 750,000 750,000 Warehouse rental 1,000,00 0 1,000,00 0 1,000,00 0 1,000,00 0 Warehouse direct costs 2,500,00 0 2,500,00 0 2,500,00 0 2,500,00 0 Net Income before taxes $ 750,000 $ 750,000 $ 750,000 $ 750,000 Income taxes (30%) 225,000 225,000 225,000 225,000 Net Income after taxes $ 525,000 $ 525,000 $ 525,000 $ 525,000 Increase in income from capitalizing aging costs $000 $203,00 0 $504,00 0 $903,00 0
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Since all the additional expansion cost now being capitalized into inventory, profits are higher by the amount of capitalized costs less the increase in tax. B) The present financial statements based on treating aging cost as period costs show an operating loss. This loss more closely represents the operating cash flows of the firm. Unless the bank is dumb, the bank will want to see a statement of cash flows in addition to the income statement. If the firm computes net income with the aging costs treated as product costs, net income is higher. But is the banker really fooled? If the firm is able to sell the additional production as it emerges from the aging process, then the following income statements will result for years 3 to 10: Warehouse direct costs 4,900,000 5,000,000 5,000,000 Net Income before taxes (360,000) 500,000 1,500,000 Income taxes (30%) 108,000 (150,000) (450,000) Net Income after taxes ($ 252,000) $ 350,000 $1,050,000 Year 3 Year 4 Year 5 Year 6 Year 7 Revenues $6,000,0 00 $6,000,0 00 $6,000,00 0 $7,200,00 0 $8,400,0 00 less: Cost of Goods Sold: (gallons sold x $2.50) 1,000,00 0 1,000,00 0 1,000,000 1,200,000 1,400,00 0 Oak barrels 1,200,00 0 1,350,00 0 1,500,000 1,500,000 1,500,00 0 Warehouse rental 1,240,00 0 1,400,00 0 1,600,000 1,760,000 1,880,00 0 Warehouse direct costs 3,100,00 0 3,500,00 0 4,000,000 4,400,000 4,700,00 0 Net Income before taxes (540,000 ) (1,250,0 00) (2,100,00 0) (1,660,00 0) (1,080,0 00)
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