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Unformatted text preview: Suggested solutions to homework questions – Week 11 Problem 14.27 Ratio Which company will report the higher ratio? 1 Current ratio (CA/CL) ‐ Depreciation method will have no impact on the current ratio. ‐ Inventory policy will have an impact on inventory valuation on the Balance Sheet. JFA uses FIFO and therefore will have inventory at current prices on the Balance sheet. JRU uses LIFO and therefore will have inventory at historic prices on the Balance sheet. Assuming inflation, JFA will have higher asset values and therefore a higher Current ratio. 2 Inventory turnover ‐ Depreciation method will have no impact (COGS/Avg. Inventory) on the inventory turnover ratio. ‐ Inventory policy will have an effect on both COGS and Inventory balances. JFA uses FIFO and therefore will have inventory at current prices on the Balances sheet and historic prices in COGS. JRU uses LIFO and therefore will have inventory at historic prices on the Balance sheet and current prices in COGS. JRU will have a higher COGS figure and a lower average inventory figure; therefore, will report a higher inventory turnover. 3 Profit margin Inventory method and depreciation (NPAT/Sales) method will both have an impact on NPAT. Neither method will have an impact on sales. JFA will report a higher profit (lower COGS and lower depreciation using straight line method) than JRU. JFA will therefore report a higher profit margin ratio. Assumptions Rising prices (inflation) Assuming COGS > Average Inventory (inventory at year end generally would be higher than the total amount sold during the year). Assuming increasing prices (inflation). Assumes that the depreciable assets are in the first half of their useful lives. Inflation is also assumed. *Note: For Problem 14.27, as noted in the lecture note, assume (i) the depreciable assets are in the first half of their useful life and (ii) inflation. Problem 15.16 *Note: For Problem 15.16, as noted in the lecture note, calculate net profit and net assets (instead of total assets). 3 a. Net Profit: The increased 2008 receivables would produce a reduction in 2009 profit because revenue formerly recognised in 2009 would now be pushed back to 2008. The increased 2009 receivables would produce an increase in 2009 profit because revenue formerly recognised in 2010 would be brought back to 2009 Income tax of 30% would reduce the 2009 profit effect, so the effect on 2009 net profit would be 70% of the gross effect. Net change in 2009 profit = (– $12 000 + $23 000)(1 – .30) = $11 000 (.70) = $7700 increase Net assets: The increased 2008 receivables ($12000) would produce a reduction in 2009 receivables because receivables formerly recognised in 2009 would now be pushed back to 2008. The increased 2009 receivables ($23000) would produce an increase in 2009 receivables. There were increases in income tax expenses (see above) and, in turn, there would be increases in income tax payables* by the same amount ($11000 X .30). Change in 2009 net assets = – $12 000 + $23 000 – ($11000 X .30) = $7700 increase * I have assumed that the income tax effect would increase income tax liability rather than decreasing an income tax receivable (as this is unlikely). b Net Profit: The increased 2008 inventories would produce a reduction in 2009 profit because expenses formerly included in 2008 COGS would now be held on the 2008 balance sheet and so form part of the calculation of 2009 COGS (part of the ‘beginning inventory’ amount in the calculation COGS = beginning inventory + purchases – ending inventory). The increased 2009 inventories would produce an increase in 2009 profit because expenses formerly included in 2009 COGS would now be held on the 2009 balance sheet and so form part of the calculation of 2010 COGS. Income tax of 30% would again reduce the 2009 profit effect. Net change in 2009 profit = (– $4000 + $1000)(1 – .30) = – $3000 (.70) = $2100 decrease Net assets: The increased 2008 inventories ($4000) would produce a reduction in 2009 inventories because inventories formerly recognised in 2009 would now be pushed back to 2008. The increased 2009 inventories ($1000) would produce an increase in 2009 inventories. There was a decrease in income tax expenses (see above) and, in turn, there would be decreases in income tax payables by the same amount ($3000 X .30). Change in 2009 net assets = – $4000 + $1000 + ($3000 X .30) = $2100 decrease d In order to answer this, an assumption is needed about whether the capitalised expenses are also amortised in the year they are capitalised. The calculations below assume that they are (if not, the amortisation figures would be lower but the general direction of the effects would be similar). Net Profit: This policy would have the following specific effects: • 2008 development expenses reduced by $4000; • 2008 amortisation expenses increased by $800 (amortising the $4000 straight‐line over five years); • 2008 year‐end assets increased by $3200 ($4000 capitalised less $800 amortised); • 2009 development expenses reduced by $6000; • 2009 amortisation expenses increased by $2000 ($800 amortisation of the 2008 capitalisation, $1200 amortisation of the 2009 capitalisation); • 2009 year‐end assets increased by $7200 ($4000 capitalised in 2008 less two years’ amortisation of $800 each, plus $6000 capitalised in 2009 less one year’s amortisation of $1200). The gross effect on 2009 profit would therefore be an increase of $6000 due to expenses capitalised, minus $2000 amortisation expenses, or $4000. After 30% income tax, this would result in an increase in 2009 net profit of $2800. Net assets: $6000 was capitalised in 2009 and, therefore, there was increases in assets by that amount. As noted above, there was an increase in amortisation expenses by $2000, and, therefore, there was also increase in accumulated amortisation by the same amount. Also, there was an increase in income tax by $1200 (i.e. $4000X.30). This indicates that there was an increase in income tax payables by the same amount. Change in 2009 net assets = $6000 ‐ $2000 ‐ $1200 = $2800 (increase) ...
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This note was uploaded on 09/22/2011 for the course ACCT 1511 taught by Professor Kim during the One '10 term at University of New South Wales.
 One '10
 kim
 Depreciation

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