Case study 65: Home Heaters: The Effects of Accounting Estimates 2 For this case, we are analyzing two separate companies and their accounting processes. To this, I first recreated the journal entries corresponding with the transactions listed in the case. I then used these journal entries to a chart of accounts, a trial balance, and, using the information from Part B, financial statements including an income statement, a statement of stockholders' equity, a classified balance sheet, and a statement of cash flows. Using Excel as a medium to create the statements, I then compared the two companies and evaluated which of the companies that I would prefer to invest in, lend money to, or do business with. I also used these statements to analyze the methods of estimation and adjusting used by each company and how each method affects things like total assets, net income, and retained earnings. Home Heaters Trial Balance - Part A Debits Credits Cash $47,340 Accounts Receivable 99,400 Inventory 239,800 Land 70,000 Building 350,000 Equipment 80,000 Accounts Payable $26,440 Note Payable 380,000 Interest Payable 6,650 Common stock 160,000 Dividends 23,200 Sales 398,500 Other Operating Expenses 34,200 Interest Expense 27,650 Total $971,590 $971,590 3 The two companies, Glenwood Heating and Eads Heaters, have identical transactions throughout the year and differ only in their estimation methods and adjusting entries. These estimation methods are integral to the differences in the companies but are not implemented until year end. The two companies' identical transactions during the year are reflected in the following trial balance. As seen in this trial balance, both Glenwood and Eads have the same amount of debits and credits at December 31. On this date, however, the two companies begin to differentiate on several things, including their adjusting entries and the estimations used in the entries. The adjustments are done differently by each company, and therefore affect net income for each company differently. These adjustments and their effects are best reflected in the income statements for the two companies. The adjustments deal with bad debts, cost of goods sold, depreciation expense, a lease agreement, and income tax expense. As shown below in the income statements, the cost of goods sold directly affects net income, as do bad debt expense and depreciation expense. Rent expense also directly affects net income, and is only present on Glenwood's income statement because Eads capitalized the lease as an asset. 4 Eads Company Multistep Income Statement For year ended December 31, 20X1 Sales $398,500 Cost of Goods Sold (188,800) Gross Profit $209,700 Operating Expenses Bad Debt Expense 4,970 Depreciation Expense 41,500 Other Operating Expenses 34,200 Total operating expenses 80,670 Operating Income $129,030 Other expenses Interest Expense 35,010 Income before taxes $94,020 Income tax expense 23,505 Net Income $70,515 Glenwood Company Multistep Income Statement For year ended December 31, 20X1 Sales $398,500 Cost of Goods Sold (177,000) Gross Profit $221,500 Operating Expenses Bad Debt Expense 994 Depreciation Expense 19,000 Other Operating Expenses 34,200 Total operating expenses $54,194 Operating Income $167,306 Other expenses Rent Expense 16,000 Interest Expense 27,650 Total other expenses $43,650 Income before taxes $123,656 Income tax expense 30,914 Net income $92,742 5 The first adjustment deals with bad debts. Glenwood estimates that one percent of accounts receivable will be uncollectable, while Eads estimates that five percent of accounts receivable will be uncollectable. This method is the same for both companies, but they have different percentage estimations based on their customers. Glenwood recorded $994.00 in bad debt expense; Eads calculated $4,970.00 to be uncollectable. This estimation decreases both assets (accounts receivable) and net income (bad debt expense). The second adjustment is the estimation of cost of goods sold. Glenwood uses a periodic first in, first out inventory system; cost of goods sold expense is based on the historical cost of the units when they were purchased possibly several months ago. This method often uses outdated costs that are not current and therefore does not align well with the matching principle. Glenwood's cost of goods sold is calculated to be $177,000, while Eads' cost of goods sold is $188,800. Eads uses a periodic last in, first out inventory, which uses current costs instead of old costs to calculate cost of goods sold. Third is the adjustment to account for depreciation. The two companies both use the straight line method for depreciation on their building, which is estimated to be $10,000 per year each. Glenwood also uses the straight line method for depreciation on their equipment, bringing their total depreciation to $19,000. Eads uses the doubledeclining balance method for their equipment's depreciation, totaled at $20,000. Eads also must depreciate the leased equipment in the fourth adjustment; they use the straight line method to calculate this at $11,500. Eads' total depreciation expense including building, equipment, and leased equipment is $41,500. 6 The fourth adjustment is the payment of a lease agreement for equipment used by the companies. Glenwood simply rents the equipment for one year at a time, payable on December 31 of each year. The adjustment for this lease is a debit to rent expense and a credit to cash. Eads capitalizes the lease as an asset because they agree to lease the equipment for eight years, paying $16,000 at the end of each year to cover both the rent expense and the interest expense. The last adjustment deals with income tax provisions. The stated rate for income tax is 25 percent; thus, each company sets aside 25 percent of their income before taxes to pay to the IRS for income tax. Glenwood has a higher income, so their income tax expense is more than Eads'. These adjustments affect net income, an important aspect to examine before lending to or investing in a company. Net income, however, is not the only important aspect to consider. Other aspects to consider include cash flows, which show that the company is a going concern throughout the fiscal year; current assets, which show liquidity; and property, plant, and equipment, which show possible collateral against a loan. These are shown on the statement of cash flows and the balance sheet, respectively, which are included below for both Glenwood and Eads. These statements of cash flow below provide insight on the company as an operation as well as in its peripheral transactions. Glenwood has overall greater cash flow, but Eads' net cash from operating activities is a greater amount. Part of this is due to Eads' capitalization of the lease agreement, compared to Glenwood's payment at the end of the year. This one adjustment method can impact the decisions of many investors and lenders

31. _____ and government _____ are examples of _____.

32. Debt _____ buy and sell ___________, and equity markets buy and sell _________.

33. A primary _____ that has led to the _____ of financial firms is the desire _____.

34. The Money for You Bank recently _____with the Keeping You Safe Insurance Company. The ______is an example of __________ in the finance industry.

35. Falling _____ rates typically cause _____.

36. When an emerging _____ suffers an economic____, foreign investors usually _____.

37. Which of the following has _____ the globalization of financial_____:

38. April is a college student who wants to open a bank account for the first time. She has $500 cash to deposit in the _______ account initially. The bank she chooses is not ______ near her dorm, and it's difficult for her to get there. She has a part-time job and receives a bi-weekly paycheck that will be directly deposited into her account. Which of the following types ______ should she ask for at the bank:

39. Which of the following is not a ____ financial statement:

40. What does an _____ statement show about a _____ over a period of time?