BACKGROUND
Kennedy Power Solutions Ltd. (KPS) was incorporated in January, 2001 in Sudbury, Ontario. KPS is a private company, involved in the manufacture and sales of electrical enclosures, power bars and transformers.
Kennedy Manufacturing was originally founded in 1957 and had, over the years, manufactured a vast array of electronic and electrical products. In 2001, the company split into two separate independent entities: Kennedy Power Solutions Ltd. and Kennedy Radios and Transmitters Group Ltd.
Michel Dulac holds the position of CEO with Kennedy Power Solutions. Dulac graduated from McGill University in Montreal in 1994 with degrees in both engineering and business. He moved to Sudbury, Ontario in 2003 to accept the position of Vice President of Manufacturing with KPS. In 2005, Dulac was married to Melinda Kennedy, the CFO, and the daughter of the owner. Shortly after the wedding, William Kennedy, Melinda's father was killed while flying his plane to a fishing resort. Dulac was offered the CEO's position on an interim basis. In 2007, after a significant effort on the part of Dulac, the company experienced a substantial growth in sales and the board confirmed his position as CEO.
Despite the recession that had a huge impact on construction and manufacturing, sales continued to grow at KPS and the new VP of Manufacturing, Linda Kouri, recommended that KPS expand the manufacturing plant to meet the increasing demand. Dulac has a reputation of being willing to take risks and agreed to the expansion in spite of the economic outlook. In the spring of 2010, the company purchased a plot of land next to the current plant and construction on the expansion began. As part of the implementation of the development plan, new shares were issued to a venture capital company, Accel Ventures Inc. in 2010 and again in 2012.
CAPITALIZATION
KPS's authorized capital consists of an unlimited number of common shares, no par value, together with 1,000,000 preferred shares with a stated value of $100.00 each. There are
KPS OPERATIONS
Since 2009 there have been approximately 100 full time employees with the company. In the spring of 2012, when the expanded plant began full operations, another 30 employees were hired and the facility is now functioning at about 75% of its full capacity. The financial statements for the fiscal year ended March 31, 2013 are the first year that will reflect full operations for the expanded plant. Although the Canadian economy was relatively stable during this period and the company's sales have grown, costs have been continuing to rise and the board is concerned over the drop in cash from the previous year's financial statements.
In addition to the products that the company has been famous for over its long history, Dulac has been working with the Innovation Department and in late 2011, the company also introduced two new products to its line. The board is wondering if the new products are successful or whether the company is expanding and diversifying too quickly. They are aware that if the company continues to grow, the direction taken will need to be carefully considered. As a result, they believe that an examination of the existing business would be beneficial.
FINANCIAL INFORMATION
KPS makes an effort to maintain good working relationships with both its customers and suppliers. Sales are made on account to its customers with terms of Net 30 and suppliers provide terms of 2/10, Net 30. These are considered reasonable within the industry.
Since 2008, KPS has obtained financing from the Royal Bank. The company has a line of credit secured by both its accounts receivable and its inventory. To date, the Royal Bank has only been willing to lend 50% of the value of the accounts receivable. As KPS' inventory includes technical products with a risk of obsolescence, the Royal Bank will only lend up to 30% of the inventory value. KPS also has a long-term loan with the Royal Bank secured by its capital assets and the personal guarantee of Mrs. Kennedy.
The CEO and the CFO meet twice a year with the bank loan officer, at which time the results of company's operations are reviewed to ensure that it is complying with the loan conditions. The Royal Bank requires that the company maintain a current ratio of at least 1.5, a debt to total assets ratio of no more than 30% and an EBIT interest coverage of at least 8 times. In addition, salaries and bonuses paid to the CEO and CFO may not exceed a total of $400,000 per year and any proposed change to the company's capital assets must first be approved by the bank.
KPS utilizes a perpetual inventory system for its all of its inventories. At fiscal year end, the goods physically counted and the results are compared to the company's records.
The current year's partially adjusted trial balance for KPS is shown in Exhibit 1 and the statements of financial position and the income statements for the prior two fiscal years for are shown in Exhibit 2. The trial balance shown in Exhibit 1 is considered to be partially adjusted because the majority of the adjusting journal entries have already been entered for the fiscal year ended March 31, 2013. However, some adjustments may still be necessary.
1) Office and manufacturing equipment are each depreciated on the single declining balance basis at the rate of 20%. The building itself is depreciated on the single declining balance basis at the rate of 10%. No assets were purchased or sold during the year ended March 31, 2013 and no depreciation has been recorded for the fiscal year.
2) A physical count of the inventory at March 31, 2013 has determined that:
a. The perpetual inventory records of the company were accurate in terms of quantity; and
b. due to technological advances, approximately 12% of the inventory is considered obsolete.
3) The income tax rate for the company is 20%
4) The accounts receivable have been reviewed and the bad debts are estimated to be 8% of the balance.
5) The shareholders as of March 31, 2013 are expecting a 10% dividend based on their common share holdings to be paid soon after year end. The Board of Directors has approved the dividend as this is consistent with prior years.
REQUIRED
1. Prepare any outstanding adjusting journal entries for the year ended March 31, 2013 and post them to the trial balance.
2. Prepare all financial statements in good form for the year ended March 31, 2013 (excluding only the Statement of Cash Flows).
3. Based on the financial statements, provide a ratio analysis for the three years up to and including the year ended March 31, 2013 that includes sufficient information to analyze the liquidity, solvency and profitability of KPS. Indicate for each ratio whether the results of your analysis are either favorable or not favorable for KPS and explain why.
4. What financial problems is KPS facing in the areas of liquidity, solvency and profitability? What are their causes? Provide suggestions as to what actions KPS should consider.
Should KPS be concerned about the possibility of bankruptcy?