anshultongia

What does the LIFO reserve measure?

A) The accumulated difference between the reported inventory balance and the cost of that inventory if first in, first out (FIFO) had been used.

B) The results of older inventory flowing to cost of goods sold (COGS).

C) The overstatement relative to the current cost of inventory.

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The LIFO reserve measures the accumulated difference between the reported inventory balance and the cost of that inventory if FIFO had been used

anshultongia

A firm has booked as a sale, the transfer of $100 million in short-term accounts receivable to Public Finance Co., subject to recourse. The notes to the financial statements disclose that as of the end of the fiscal year, $80 million remained uncollected. In order to reflect this on the balance sheet, which of the following adjustments must be made?

A) Decrease cash and increase accounts receivable.

B) Increase accounts receivable and increase current liabilities.

C) Decrease retained earnings and increase accounts receivable.

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Since the accounts receivable were sold with recourse, the risk on uncollected accounts remains with the company

anshultongia

Adjustments for off-balance-sheet items include all but which of the following?

A) Capitalizing operating leases, including this amount as an asset and a liability.

B) Using the equity method in place of the proportionate consolidation to reflect the investment in affiliates.

C) Estimating the probable obligation for contingent liabilities.

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The correct statement is that proportionate consolidation should be used in place of the equity method.

anshultongia

Northern Bottling (NB) currently shows minimum expected operating leases over the next 5 years of $3 million, $2.5 million, $2 million, $2 million, and $1.5 million. The firm’s current financing rate is 6.75% and the rate implicit in the lease contract is 7%. What adjustments would an analyst make to modify the balance sheet of NB to include this off-balance sheet financing? Increase long-term:

A) assets and long-term liabilities by $9.22 million.

B) assets and long-term liabilities by $9.27 million.

C) liabilities by $9.27 million and decrease equity by $9.27 million.

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Recall that the interest rate in this present value computation is the lower of the firm’s financing rate or the interest rate that is implicit in the lease.  Therefore, the PV (operating leases) is:

= 3 / (1 + 0.0675) + 2.5 / (1 + 0.0675)2 + 2 / (1+ 0.0675)3 + 2 / (1 + 0.0675)4 + 1.5 / (1 + 0.0675)5

= 9.27 million

The proper adjustment is to increase both long-term assets and liabilities by the same amount.

anshultongia

Northern Bottling (NB) currently shows minimum expected operating leases over the next 5 years of $3 million, $2.5 million, $2 million, $2 million, and $1.5 million. The firm’s current financing rate is 6.75% and the rate implicit in the lease contract is 7%. What adjustments would an analyst make to modify the balance sheet of NB to include this off-balance sheet financing? Increase long-term:

A) assets and long-term liabilities by $9.22 million.

B) assets and long-term liabilities by $9.27 million.

C) liabilities by $9.27 million and decrease equity by $9.27 million.

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Recall that the interest rate in this present value computation is the lower of the firm’s financing rate or the interest rate that is implicit in the lease.  Therefore, the PV (operating leases) is:

= 3 / (1 + 0.0675) + 2.5 / (1 + 0.0675)2 + 2 / (1+ 0.0675)3 + 2 / (1 + 0.0675)4 + 1.5 / (1 + 0.0675)5

= 9.27 million

The proper adjustment is to increase both long-term assets and liabilities by the same amount.

anshultongia

Northern Bottling (NB) currently shows minimum expected operating leases over the next 5 years of $3 million, $2.5 million, $2 million, $2 million, and $1.5 million. The firm’s current financing rate is 6.75% and the rate implicit in the lease contract is 7%. What adjustments would an analyst make to modify the balance sheet of NB to include this off-balance sheet financing? Increase long-term:

A) assets and long-term liabilities by $9.22 million.

B) assets and long-term liabilities by $9.27 million.

C) liabilities by $9.27 million and decrease equity by $9.27 million.

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Recall that the interest rate in this present value computation is the lower of the firm’s financing rate or the interest rate that is implicit in the lease.  Therefore, the PV (operating leases) is:

= 3 / (1 + 0.0675) + 2.5 / (1 + 0.0675)2 + 2 / (1+ 0.0675)3 + 2 / (1 + 0.0675)4 + 1.5 / (1 + 0.0675)5

= 9.27 million

The proper adjustment is to increase both long-term assets and liabilities by the same amount.

anshultongia

Millennium Airlines Corp. (MAC) reported the following year-end data:

Rent expense	$23 million
Depreciation expense	$17 million
EBIT	$88 million
Interest expense	$22 million
Total assets	$500 million
Long-term debt	$150 million
Capital lease obligations	$100 million
Total equity	$250 million

MAC also reported that the present value of its operating leases at the beginning of the year was $240 million. The term on the leases was 8 years. What are the effects on the leverage (liabilities / total capital) and times interest earned if an analyst chooses to capitalize the leases at a rate of 10% using a straight-line depreciation assumption? Leverage measures:

A) increase to 65% from 50% and times interest earned decreases to 1.33 times from 4 times.

B) increase to 65% from 50% and times interest earned decreases to 1.76 times from 4 times.

C) remain unchanged and times interest earned decreases to 1.23 times from 4 times.

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Using the reported data the leverage measure is 0.50 ((150 + 100) / (150 + 100 + 250)) and times interest earned is 4 times (88 / 22). Following the capitalization of the operating leases the balance sheet values are:

Total assets	$710 million	(500 assets + 240 leases - 30 depreciation on leases)
Value of operating leases	$210 million	(increase in financing liabilities)
Long-term debt	$150 million	unchanged
Capital lease obligations	$100 million	unchanged
Total equity	$250 million	unchanged

Therefore, the leverage measure is 0.65 ((210 + 150 + 100) / (210 + 150 + 100 +250)).
The income statement is affected in the following way:

reported EBIT	88
+ rent expense	23
= EBIT excluding cost of operating leases	111
- depreciation of operating leases	30	($240 million/8 years)
= adjusted EBIT	81

Interest expense will increase by $24 million ($240 million × 0.10) to $46 million. Therefore times interest earned decreases to 1.76 times (81 / 46). Recall that when capitalizing operating leases interest expense is calculated as the present value of the lease obligations multiplied by implied interest rate.

anshultongia

Millennium Airlines Corp. (MAC) reported the following year-end data:

Rent expense	$23 million
Depreciation expense	$17 million
EBIT	$88 million
Interest expense	$22 million
Total assets	$500 million
Long-term debt	$150 million
Capital lease obligations	$100 million
Total equity	$250 million

MAC also reported that the present value of its operating leases at the beginning of the year was $240 million. The term on the leases was 8 years. What are the effects on the leverage (liabilities / total capital) and times interest earned if an analyst chooses to capitalize the leases at a rate of 10% using a straight-line depreciation assumption? Leverage measures:

A) increase to 65% from 50% and times interest earned decreases to 1.33 times from 4 times.

B) increase to 65% from 50% and times interest earned decreases to 1.76 times from 4 times.

C) remain unchanged and times interest earned decreases to 1.23 times from 4 times.

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Using the reported data the leverage measure is 0.50 ((150 + 100) / (150 + 100 + 250)) and times interest earned is 4 times (88 / 22). Following the capitalization of the operating leases the balance sheet values are:

Total assets	$710 million	(500 assets + 240 leases - 30 depreciation on leases)
Value of operating leases	$210 million	(increase in financing liabilities)
Long-term debt	$150 million	unchanged
Capital lease obligations	$100 million	unchanged
Total equity	$250 million	unchanged

Therefore, the leverage measure is 0.65 ((210 + 150 + 100) / (210 + 150 + 100 +250)).
The income statement is affected in the following way:

reported EBIT	88
+ rent expense	23
= EBIT excluding cost of operating leases	111
- depreciation of operating leases	30	($240 million/8 years)
= adjusted EBIT	81

Interest expense will increase by $24 million ($240 million × 0.10) to $46 million. Therefore times interest earned decreases to 1.76 times (81 / 46). Recall that when capitalizing operating leases interest expense is calculated as the present value of the lease obligations multiplied by implied interest rate.

anshultongia

A firm seeking to lower current tax liability may elect to use which method of inventory valuation during an inflationary period?

A) FIFO.

B) LIFO.

C) Average cost.

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During a inflationary period, using LIFO would increase COGS, since the most recent (highest cost) inventory would be sold. Therefore, earnings and taxes would be lowest under LIFO.

anshultongia

Express Delivery Inc. (EDI) reported the following year-end data:

Depreciation expense	$30 million
Net income	$30 million
Total assets	$535 million
Shareholder’s equity	$150 million
Effective tax rate	35 percent

Last year EDI purchased a fleet of delivery vehicles for $140 million. For the first year, straight-line depreciation was used assuming a depreciable life of 7 years with no salvage value. However, at year-end EDI’s management determined that assumptions of a useful life of 5 years with a salvage value of 10 percent of the original value were more appropriate. How would the return on assets (ROA) and return on equity (ROE) for last year change due to the change in depreciation assumptions? ROA and ROE would be closest to:

A) ROA 5.0% and ROE 18.2%.

B) ROA 5.7% and ROE 19.5%.

C) ROA 5.3% and ROE 20.5%.

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The reported ROA and ROE are 5.6% (30/535) and 20.0% (30/150) respectively. Under the new depreciation assumptions, depreciation expense would be (140-14)/5 = 25.2 million. Under the original assumptions depreciation of the fleet was 20 million. Therefore depreciation increases by 5.2 million. With the change in depreciation methods EDI would have reported:

Depreciation expense	$35.20 million	(30 + 5.2)
Net income	$26.62 million	(30 − (5.2 × (1-0.35)))
Total assets	$529.80 million	(535 − 5.2 )
Shareholder’s equity	$146.62 million	(150 − 3.38)

Note that assets would have been lower by $5.2 million due to the new depreciation assumptions and shareholder’s equity by $3.38 million (5.2 × (1 − 0.35)) due to lower retained earnings. Tax liabilities would have fallen by $1.82 million to balance the $5.2 million reduction in assets. Therefore, ROA would have been 5.0% (26.62 / 529.80) and ROE would have been 18.16% (26.62 / 146.62).