P3–3 Income statement preparation On December 31, 2015, Cathy Chen, a self-employed
certified public accountant (CPA), completed her first full year in business. During
the year, she billed $360,000 for her accounting services. She had two employees, a
bookkeeper and a clerical assistant. In addition to her monthly salary of $8,000,
Ms. Chen paid annual salaries of $48,000 and $36,000 to the bookkeeper and the
clerical assistant, respectively. Employment taxes and benefit costs for Ms. Chen and
her employees totaled $34,600 for the year. Expenses for office supplies, including
postage, totaled $10,400 for the year. In addition, Ms. Chen spent $17,000 during
the year on tax-deductible travel and entertainment associated with client visits
and new business development. Lease payments for the office space rented (a taxdeductible
expense) were $2,700 per month. Depreciation expense on the office
furniture and fixtures was $15,600 for the year. During the year, Ms. Chen paid
interest of $15,000 on the $120,000 borrowed to start the business. She paid an
average tax rate of 30% during 2015.
a. Prepare an income statement for Cathy Chen, CPA, for the year ended December
b. Evaluate her 2015 financial performance.
P3–6 Balance sheet preparation Use the appropriate items from the following list to prepare
in good form Mellark’s Baked Goods balance sheet at December 31, 2015.
Value ($000) at Value ($000) at
Item December 31, 2015 Item December 31, 2015
Accounts payable $ 220 Inventories $ 375
Accounts receivable 450 Land 100
Accruals 55 Long-term debts 420
Accumulated depreciation 265 Machinery 420
Buildings 225 Marketable securities 75
Cash 215 Notes payable 475
Common stock (at par) 90 Paid-in capital in excess
Cost of goods sold 2,500 of par 360
Depreciation expense 45 preferred stock 100
Equipment 140 Retaining ed earnings 210
Furniture and fixtures 170 Sales revenue 3,600
General expense 320 Vehicles 25
P3–10 Statement of retained earnings Hayes Enterprises began 2015 with a retained earnings
balance of $928,000. During 2015, the firm earned $377,000 after taxes. From
this amount, preferred stockholders were paid $47,000 in dividends. At year-end
2015, the firm’s retained earnings totaled $1,048,000. The firm had 140,000 shares
of common stock outstanding during 2015.
a. Prepare a statement of retained earnings for the year ended December 31, 2015,
for Hayes Enterprises. (Note: Be sure to calculate and include the amount of cash
dividends paid in 2015.)
b. Calculate the firm’s 2015 earnings per share (EPS).
c. How large a per-share cash dividend did the firm pay on common stock during
P3–16 Accounts receivable management An evaluation of the books of Blair Supply, which
follows, gives the end-of-year accounts receivable balance, which is believed to consist
of amounts originating in the months indicated. The company had annual sales
of $2.4 million. The firm extends 30-day credit terms.
Month of origin Accounts receivable
July $ 3,875
Year-end accounts receivable $300,000
a. Use the year-end total to evaluate the firm’s collection system.
b. If 70% of the firm’s sales occur between July and December, would this information
affect the validity of your conclusion in part a? Explain.
P3–18 Debt analysis Springfield Bank is evaluating Creek Enterprises, which has requested
a $4,000,000 loan, to assess the firm’s financial leverage and financial risk. On the
basis of the debt ratios for Creek, along with the industry averages (see the top of
the next page) and Creek’s recent financial statements (following), evaluate and
recommend appropriate action on the loan request.
Creek Enterprises Income Statement for the Year Ended December 31, 2015
Sales revenue $30,000,000
Less: Cost of goods sold 21,000,000
Gross profits $ 9,000,000
Less: Operating expenses
Selling expense $ 3,000,000
General and administrative expenses 1,800,000
Lease expense 200,000
Depreciation expense 1,000,000
Total operating expense $ 6,000,000
Operating profits $ 3,000,000
Less: Interest expense 1,000,000
Net profits before taxes $ 2,000,000
Less: Taxes (rate 5 40%) 800,000
Net profits after taxes $ 1,200,000
Less: Preferred stock dividends 100,0000
Earnings available for common stockholders $ 1,100,000
P3–20 Common-size statement analysis A common-size income statement for Creek Enterprises’
2014 operations follows. Using the firm’s 2015 income statement presented in
Problem 3–18, develop the 2015 common-size income statement and compare it with
the 2014 statement. Which areas require further analysis and investigation?
Creek Enterprises Common-Size Income Statement
for the Year Ended December 31, 2014
Sales revenue ($35,000,000) 100.0%
Less: Cost of goods sold 65.9
Gross profits 34.1%
Less: Operating expenses
Selling expense 12.7%
General and administrative expenses 6.3
Lease expense 0.6
Depreciation expense 3.6
Total operating expense 23.2
Operating profits 10.9%
Less: Interest expense 1.5
Net profits before taxes 9.4%
Less: Taxes (rate 5 40%) 3.8
Net profits after taxes 5.6%
Less: Preferred stock dividends 0.1
Earnings available for common stockholders 5.5%
P3–21 The relationship between financial leverage and profitability Pelican Paper, Inc.,
and Timberland Forest, Inc., are rivals in the manufacture of craft papers. Some financial
statement values for each company follow. Use them in a ratio analysis that
compares the firms’ financial leverage and profitability.
Item Pelican Paper, Inc. Timberland Forest, Inc.
Total assets $10,000,000 $10,000,000
Total equity (all common) 9,000,000 5,000,000
Total debt 1,000,000 5,000,000
Annual interest 100,000 500,000
Total sales 25,000,000 25,000,000
EBIT 6,250,000 6,250,000
Earnings available for 3,690,000 3,450,000
a. Calculate the following debt and coverage ratios for the two companies. Discuss
their financial risk and ability to cover the costs in relation to each other.
1. Debt ratio
2. Times interest earned ratio
b. Calculate the following profitability ratios for the two companies. Discuss their
profitability relative to one another.
1. Operating profit margin
2. Net profit margin
3. Return on total assets
4. Return on common equity
c. In what way has the larger debt of Timberland Forest made it more profitable
than Pelican Paper? What are the risks that Timberland’s investors undertake
when they choose to purchase its stock instead of Pelican’s?