Goal: to practice recording contingent liabilities and reporting them in the financial statements. (See TopicGuides LE 6, 7, 8).
Information:
At the beginning of 2020, Terry was informed that a new city ordinance would require them to restore the woods behind their main factory if they intend to keep using it. The estimated cost of the restoration will be approximately $2,280,000 and must be done within the next 7 years or the factory will be shut down. At the time, Terrys board decided to wait until the beginning of Year 8 to start the restoration.
Although the notice was received and the boards decision made at the beginning of the year, no journal entries have yet been made for this obligation. The factory was built 5 years ago when Terry was still a privately held company and is being depreciated using SL depreciation using the original estimate of a 15-year useful life. The depreciation for the building has already been recorded for 2020. The restoration will not change the factorys salvage value.
Terrys management would like to know the effect of the sale on the following ratios:
-Current Ratio
-ROA
Ratio Analysis Before the Change
Current Ratio: Current Assets$14,396,715/Current Liabilities$6,301,132=2.285
ROA: Net Income$10,860,207/Average Total Assets$46,626,044=0.233
Assignment- Calculations
1.Calculate each of the two (2) ratio before you make any adjustments
2.Make the appropriate journal entries, if any, to account for the new liability (including any necessary changes to income tax expense). In making your entries, assume that TerrysInternal Rate of Return is 5%
3. Make any necessary changes to the financial statements.
4.Calculate the two (2) ratios after you make any adjustments
Critical Thinking
5.What do you think investors reaction will be to this new obligation? In other words, based on your changes to the financial statements and the change in the ratios, do you think investors will be happy with this new requirement? Why or why not?
6.Terrys CEO argued that they should wait until they had to actually satisfy the obligation to record it, after all, they werent going to have to actually pay anything until then. What are the possible consequences of these decisions and who is likely to be affected?
Hints:
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An obligation that will be paid more than 1 year out should be recorded at its present value, not its face value.
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You will need to make two journal entries in addition to the initial recognition of the obligation (not including taxes). When you make the estimates for these adjusting entries, you only need to use the information from the initial recognition of this obligation. You wont need to redo any other estimates or other adjusting entries from earlier Terry problems.
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When working on the Statement of Cash Flows, pay close attention to the actual cash amounts in your journal entries. The total change in cash should change by that amount. Any non-cash changes to NI will need to be removed from the CFO section to correctly make your statement to balance (just like we remove Depreciation because it doesn't have a real cash effect). When making those adjustments, the common line title when adjusting for interest on an ARO is Accretion Expense.
Terry Co. Multi-Step Income Statement For Year Ended December 31, 2020 Sales Revenue Sales Revenue Less: Sales Discounts $901.200 Sales Returns $3,567 250 Net Sales Revenue $75,100,000 $4,468.450 $70,631,550 Cost of Goods Sold Cost of Goods Sold Gross Profit $41,775,993 $28,855,557 $1,408,125 $232,810 $366,113 $1,032,625 $3,755,000 $614,881 $7,409,554 Operating Activities Selling Expenses Advertising Expense Bad Debt Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense Total Selling Expenses Administrative Expenses Executive Salaries Expense Depreciation & Amortization Expense Insurance Expense Miscellaneous Admin Expenses Office Supplies Expense R&D Expense Utilities Expense Total Administrative Expenses Income from Operations $3,285,625 $3,772,667 $647,738 $37,081 $291,013 $46,938 $563,250 $8.644,312 $16,053,866 $12,801,691 Other Gains and Losses Rent Revenue Income from Investment in ZHT, Inc. Gain on Sale of AR Interest Expense Gain on sale Income from Continuing Operations before Taxes Income Tax Expense Net Income $234.688 $2.826,000 $104,089 ($478.783) $26.876 $2.712.890 $15,514 581 ($4.654,375) $10.880.207 EPS $1.26 Terry Co. Balance Sheet As of 12/31/2020 2020 2019 $2.741,368 $1,554,570 ($139,911) $104,089 $8,289,600 $908,250 $938,750 $14,396,715 $3,755,000 $6,383,500 ($1,877,500) $0 $10,514,000 $1,126,500 $751,000 $20,652,500 Current Assets Cash AR Allowance for Bad Debts Due from First National Bank Inventory Prepaid Insurance Prepaid Utilities Total Current Assets Long-term Investments Loans to other businesses Investment in ZHT, Inc. Expansion Fund Total Long-term Investments PPE Land Building Equipment Accumulated Depreciation Total PPE Intangible Assets Patents, net Total Assets $3,004,000 $3,380,840 $2,253,000 $8,637,840 $3,004,000 $0 $2,253,000 $5,257,000 $8,261,000 $6,840,150 $23,347,850 (59.911,967) $28,537,033 $5,257.000 $6,008,000 $9,763,000 (57.510,000) $13,518,000 $1,126,500 $52,698,088 $1,126,500 $40.554,000 Liabilities and Stockholders' Equity Current Liabilities Accounts Payable $946,740 $4,506,000 Income Tax Payable $2,200,192 $751,000 Unearned Revenue $1,877,500 $1,126,500 Wages Payable $901,200 $938.750 Current Portion of Loan Payable $375,500 $375,500 Total Current Liabilities $6,301,132 $7,697.750 Long-term Debt Loan Payable $1,877,500 $2,253,000 Notes Payable $10,514,000 $6,008,000 Total Long-term Debt $12.391.500 $8.261,000 Total Liabilities $18,692,632 $15.958,750 Stockholders' Equity Common stock $8,600,000 $8,600,000 (51 par, 517,200,000.00 authorized, 88,600,000 outstanding Additional Paid In capital $2,253,000 $2,253,000 Retained Earnings $23,152.457 $13,742,250 Accumulated OCI so $0 Total Stockholders' Equity $34.005.457 $24.595 250 Total Liabilities and Stockholder's Equity $52,698.088 $40.554.000 + Terry Co. Statement of Cash Flows For Year Ended December 31, 2020 Cash Flow from Operations Net Income $10,860,207 Adjustments: Change in A/R ($1,644,690) Change in Inventory $2,224,400 Change in Prepaid Insurance $218,250 Change in Prepaid Utilities ($187.750) Depreciation $3,772,667 Gain on Sale of A/R ($104,089) Equity Method Investments ($2,317,500) Change in AP ($3,559,260) Change in Income Tax Payable $1,449,192 Change in Interest Accrued $751,000 Change in Unearned Revenue ($37,550) Gain on sale ($26,876) $537,793 Net Cash Flow from Operations $11,398,000 Cash Flow from Investments Sale of A/R Sale of Equipment Purchase of Equity Investment Purchase of Land Purchase of Building Purchase of Equipment Net Cash Flow from Investments $4,736,031 $179,176 ($1,063,340) ($3,004,000) ($832,150) ($15, 107,850) ($15,092,132) Cash Flow from Financing Repayment of Loans Issuance of Notes Payable Payments of Dividends Net Cash Flow from Financing ($375,500) $4,506,000 ($1.450,000) $2,680,500 Net Increase (Decrease) in Cash Cash, January 1, 2019 Cash, December 31, 2019 ($1,013,632) $3,755,000 $2,741,368 Terry Co. Multi-Step Income Statement For Year Ended December 31, 2020 Sales Revenue Sales Revenue Less: Sales Discounts $901.200 Sales Returns $3,567 250 Net Sales Revenue $75,100,000 $4,468.450 $70,631,550 Cost of Goods Sold Cost of Goods Sold Gross Profit $41,775,993 $28,855,557 $1,408,125 $232,810 $366,113 $1,032,625 $3,755,000 $614,881 $7,409,554 Operating Activities Selling Expenses Advertising Expense Bad Debt Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense Total Selling Expenses Administrative Expenses Executive Salaries Expense Depreciation & Amortization Expense Insurance Expense Miscellaneous Admin Expenses Office Supplies Expense R&D Expense Utilities Expense Total Administrative Expenses Income from Operations $3,285,625 $3,772,667 $647,738 $37,081 $291,013 $46,938 $563,250 $8.644,312 $16,053,866 $12,801,691 Other Gains and Losses Rent Revenue Income from Investment in ZHT, Inc. Gain on Sale of AR Interest Expense Gain on sale Income from Continuing Operations before Taxes Income Tax Expense Net Income $234.688 $2.826,000 $104,089 ($478.783) $26.876 $2.712.890 $15,514 581 ($4.654,375) $10.880.207 EPS $1.26 Terry Co. Balance Sheet As of 12/31/2020 2020 2019 $2.741,368 $1,554,570 ($139,911) $104,089 $8,289,600 $908,250 $938,750 $14,396,715 $3,755,000 $6,383,500 ($1,877,500) $0 $10,514,000 $1,126,500 $751,000 $20,652,500 Current Assets Cash AR Allowance for Bad Debts Due from First National Bank Inventory Prepaid Insurance Prepaid Utilities Total Current Assets Long-term Investments Loans to other businesses Investment in ZHT, Inc. Expansion Fund Total Long-term Investments PPE Land Building Equipment Accumulated Depreciation Total PPE Intangible Assets Patents, net Total Assets $3,004,000 $3,380,840 $2,253,000 $8,637,840 $3,004,000 $0 $2,253,000 $5,257,000 $8,261,000 $6,840,150 $23,347,850 (59.911,967) $28,537,033 $5,257.000 $6,008,000 $9,763,000 (57.510,000) $13,518,000 $1,126,500 $52,698,088 $1,126,500 $40.554,000 Liabilities and Stockholders' Equity Current Liabilities Accounts Payable $946,740 $4,506,000 Income Tax Payable $2,200,192 $751,000 Unearned Revenue $1,877,500 $1,126,500 Wages Payable $901,200 $938.750 Current Portion of Loan Payable $375,500 $375,500 Total Current Liabilities $6,301,132 $7,697.750 Long-term Debt Loan Payable $1,877,500 $2,253,000 Notes Payable $10,514,000 $6,008,000 Total Long-term Debt $12.391.500 $8.261,000 Total Liabilities $18,692,632 $15.958,750 Stockholders' Equity Common stock $8,600,000 $8,600,000 (51 par, 517,200,000.00 authorized, 88,600,000 outstanding Additional Paid In capital $2,253,000 $2,253,000 Retained Earnings $23,152.457 $13,742,250 Accumulated OCI so $0 Total Stockholders' Equity $34.005.457 $24.595 250 Total Liabilities and Stockholder's Equity $52,698.088 $40.554.000 + Terry Co. Statement of Cash Flows For Year Ended December 31, 2020 Cash Flow from Operations Net Income $10,860,207 Adjustments: Change in A/R ($1,644,690) Change in Inventory $2,224,400 Change in Prepaid Insurance $218,250 Change in Prepaid Utilities ($187.750) Depreciation $3,772,667 Gain on Sale of A/R ($104,089) Equity Method Investments ($2,317,500) Change in AP ($3,559,260) Change in Income Tax Payable $1,449,192 Change in Interest Accrued $751,000 Change in Unearned Revenue ($37,550) Gain on sale ($26,876) $537,793 Net Cash Flow from Operations $11,398,000 Cash Flow from Investments Sale of A/R Sale of Equipment Purchase of Equity Investment Purchase of Land Purchase of Building Purchase of Equipment Net Cash Flow from Investments $4,736,031 $179,176 ($1,063,340) ($3,004,000) ($832,150) ($15, 107,850) ($15,092,132) Cash Flow from Financing Repayment of Loans Issuance of Notes Payable Payments of Dividends Net Cash Flow from Financing ($375,500) $4,506,000 ($1.450,000) $2,680,500 Net Increase (Decrease) in Cash Cash, January 1, 2019 Cash, December 31, 2019 ($1,013,632) $3,755,000 $2,741,368
