LO2 EXERCISE 2.4 Accounting Principles and Asset Valuation a. The following cases relate to the valuation of assets. Consider each case independently. World-Wide Travel Agency has office supplies costing $1,700 on hand at the balance sheet date. These supplies were purchased from a supplier that does not give cash refunds. World- Wide's management believes that the company could sell these supplies for no more than $500 if it were to advertise them for sale. However, the company expects to use these supplies and to purchase more when they are gone. In its balance sheet, the supplies were presented at 5500, b. Perez Corporation purchased land in 1957 for $20,000. In 2011, it purchased a similar parcel of land for $300,000. In its 2011 balance sheet, the company presented these two parcels of land at a combined amount of $320,000 At December 30, 2011, Lenier, Inc., purchased a computer system from a mail-order sup plier for $14,000. The retail value of the system-according to the mail-order supplier-was $20,000. On January 7, however, the system was stolen during a burglary. In its December 31. 2011, balance sheet, Lenier showed this computer system at $14,000 and made no reference to its retail value or to the burglary. The December balance sheet was issued in February 2012. In cach case, indicate the appropriate balance sheet amount of the asset under generally accepted accounting principles. If the amount assigned by the company is incorrect, briefly explain the accounting principles that have been violated. If the amount is correct, identify the accounting principles that justify this amount. c. M 2.9A a Balance cussion of Principles Helen Berkeley is the founder and manager of Berkeley Playhouse. The business needs to obtain a bank loan to finance the production of its next play. As part of the loan application, Berkeley was asked to prepare a balance sheet for the business. She prepared the following balance sheet, which is arranged correctly but which contains several errors with respect to such concepts as the busi- ness entity and the valuation of assets, liabilities, and owner's equity. BERKELEY PLAYHOUSE BALANCE SHEET SEPTEMBER 30, 2011 Assets Liabilities & Owner's Equity Cash..... $ 21,900 Liabilities: Accounts Receivable 132,200 Accounts Payable......... $ 6,000 Props and Costumes 3,000 Salaries Payable 29,200 Theater Building 27,000 Total liabilities $ 35,200 Lighting Equipment 9,400 Owner's equity: Automobile. 15,000 Helen Berkeley, Capital.. 173,300 Total. $208,500 Total.. $208,500 ... 73 In discussions with Berkeley and by reviewing the accounting records of Berkeley Playhouse, you discover the following facts: 1. The amount of cash, $21,900, includes $15,000 in the company's bank account, $1.900 on hand in the company's safe, and $5,000 in Berkeley's personal savings account. 2. The accounts receivable, listed as $132,200, include $7.200 owed to the business by Artistic Tours. The remaining S125,000 is Berkeley's estimate of future ticket sales from September 30 through the end of the year (December 31). 3. Berkeley explains to you that the props and costumes were purchased several days ago for $18,000. The business paid $3,000 of this amount in cash and issued a note payable to Actors' Supply Co. for the remainder of the purchase price ($15.000). As this note is not due until January of next year, it was not included among the company's liabilities. 4. Berkeley Playhouse rents the theater building from Kievits International at a rate of $3,000 a month. The $27,000 shown in the balance sheet represents the rent paid through September 30 of the current year. Kievits International acquired the building seven years ago at a cost of $135,000. 5. The lighting equipment was purchased on September 26 at a cost of $9,400, but the stage manager says that it isn't worth a dime. 6. The automobile is Berkeley's classic 1978 Jaguar, which she purchased two years ago for $9,000. She recently saw a similar car advertised for sale at $15.000. She does not use the car in the business, but it has a personalized license plate that reads "PLAHOUS." 7. The accounts payable include business debts of $3,900 and the $2,100 balance of Berkeley's personal Visa card. 8. Salaries payable include $25,000 offered to Mario Dane to play the lead role in a new play opening next December and $4.200 still owed to stagehands for work done through September 30. 9. When Berkeley founded Berkeley Playhouse several years ago, she invested $20,000 in the business. However, Live Theatre, Inc., recently offered to buy her business for $173,300. Therefore, she listed this amount as her equity in the above balance sheet. Instructions a. Prepare a corrected balance sheet for Berkeley Playhouse at September 30, 2011. b. For each of the nine numbered items above, explain your reasoning in deciding whether or not to include the items in the balance sheet and in determining the proper dollar valuation. CASE 2.3 Using a Balance Sheet Moon Corporation and Star Corporation are in the same line of business and both were recently organized, so it may be assumed that the recorded costs for assets are close to current market val- ues. The balance sheets for the two companies are as follows at July 31, 2011: MOON CORPORATION BALANCE SHEET JULY 31, 2011 Assets Liabilities & Owners' Equity Cash.. $ 18,000 Liabilities: Accounts Receivable 26.000 Notes Payable Land 37,200 (due in 60 days). $ 12,400 Building 38,000 Accounts Payable 9.600 Office Equipment 1,200 Total liabilities $ 22,000 Stockholders' equity: Capital Stock $60,000 Retained Earnings. 38.400 98,400 Total $120,400 Total $120.400 Assets Cash Accounts Receivable Land. Building Office Equipment STAR CORPORATION BALANCE SHEET JULY 31, 2011 Liabilities & Owners' Equity 4,800 Liabilities: 9,600 Notes Payable 96,000 (due in 60 days) 60,000 Accounts Payable 12,000 Total liabilities Stockholders' equity Capital Stock $72,000 Retained Earnings.... 44,800 $182.400 $ 22,400 43,200 $ 65,600 116,800 $182,400 Total Total ... a. Instructions Assume that you are a banker and that each company has applied to you for a 90-day loan of $12,000. Which would you consider to be the more favorable prospect? Explain your answer fully. b. Assume that you are an investor considering purchasing all the capital stock of one or both of the companies. For which business would you be willing to pay the higher price? Do you see any indication of a financial crisis that you might face shortly after buying either company? Explain your answer fully. (For either decision, additional information would be useful, but you are to reach your decision on the basis of the information available.) John Marshall is employed as a bank loan officer for First State Bank. He is comparing two companies that have applied for loans, and he wants your help in evaluating those companies. The two companies--Morris, Inc., and Walker Company--are approximately the same size and had approximately the same cash balance at the beginning of 2009. Because the total cash flows for the three-year period are virtually the same, John is inclined to evaluate the two companies as equal in terms of their desirability as loan candidates. Abbreviated information (in thousands of dollars) from Morris, Inc., and Walker Company is as follows: LOG CASE 2.4 Using Statements of Cash Flows Morris, Inc. 2010 Walker Company 2009 2010 2011 2009 2011 Cash flows from: Operating activities Investing activities Financing activities Net from all activities $10 (5) 8 $13 $13 (8) (3) $ 2 $15 (10) 1 $ 6 $ 8 (7) 12 $13 $3 (5) 4 $2 $(2) 8 -O- $6 Instructions Do you agree with John's preliminary assessment that the two companies are approximately equal in terms of their strength as loan candidates? Why or why not? b. What might account for the fact that Walker Company's cash flow from financing activities is zero in 2011? Generally, what would you advise John with regard to using statements of cash flows in evalu- ating loan candidates? C