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P3–3 Income statement preparation On December 31, 2015, Cathy Chen, a self-employed | Rated A+
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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

31, 2015.

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
                                 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
               August                                 2,000
             September                          34,025
             October                               15,100
            November                             52,000
           December                            193,000
    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
common stockholders

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?

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