You work in the finance and investment department of Mega Industries, which recently purchased several small high-tech companies. An additional company, Microline Corporation, is presently under consideration. You have been asked to serve on a project team that is preparing a recommendation to the chief financial officer about whether Mega should attempt to acquire Microline. Your duty on this team is to review the company’s financial statements and write a memo to the team leader, Sharon Sonneborn. The memo should analyze Microline’s solvency position, earning power potential, and the extent to which the reported financial statements reflect the company’s “true” financial position and performance. After a brief review of Microline, Sharon believes that you should also address in your report the following important questions:

1. Is there any evidence that management’s bonus caused it to enter into any transactions, especially at year-end, that may not have been in the shareholders’ interest?

2. Has the debt covenant imposed any restrictions that may have influenced any of management’s reporting choices?

3. What was the acquisition price of Littleton when it was purchased by Microline?

4. Is Microline’s bad debt allowance sufficient?

5. How much cash was received by Ellery Inc. during 2014, and what percentage of Ellery’s total income was paid out in the form of dividends?

6. How much cash was collected from customers during 2014?

Microline’s most recent financial statements are as follows (dollars in thousands):

Exchange Gain On December 3, 2014, Microline sold goods to a customer in Canada and agreed to accept 4,000 Canadian dollars in payment. The receivable was still outstanding as of December 31, 2014, at which time the exchange rate of Canadian to U.S. dollars was 1.6/1. No other transactions were conducted outside U.S. borders during 2013 or 2014.

Short- and Long-Term Debt On November 15, 2014, Microline signed a 90-day note payable in the amount of $4,000. As of December 31, 2014, this note was classified as long term because Microline intends to refinance it indefinitely. Microline also signed a long-term note in the amount of $3,000. This ten-year note includes an interest rate of 8 percent and requires that Microline maintain a current ratio of greater than 1.0 over the ten-year life.

Income Taxes Microline’s effective income tax rate is 34 percent.

Executive Compensation At the end of each year, Microline’s executives share equally in a bonus, which is equal to 25 percent of the dollar amount by which the corporation’s net income exceeds 10 percent of the shareholders’ equity dollar amount at the beginning of the year.

Revenue Recognition All sales made by Microline are on credit, and Microline recognizes revenue when goods are shipped.