1. New River Equestrian Products, Inc. began operations on April 1, 2017. The CEO of the company would like to obtain a loan from the local community bank. She knows you are very knowledgeable about accounting because you are about to graduate with an MBA and she has asked you to prepare the income statement and balance sheet for the quarter ended June 30, 2017. The bank requires that the financial statements be prepared on an accrual basis. New River Equestrian Products, Inc. entered into the following transactions during the quarter ended June 30.
a. New River Equestrian Products (NREP) began operations on April 1 with cash and common stock of $500,000.
b. NREP borrowed $150,000 on April 2 by issuing a note. Principal and interest of 6% are due in one year.
c. The company purchased furniture and equipment on April 3 for $100,000 in cash. The furniture and equipment has a 10-year life and no salvage value. Straight-line depreciation is used.
d. The company purchased $180,000 in inventory on account. The company paid half of its accounts payable by the end of the quarter.
e. The company paid $4,500 in cash to cover insurance for the period from April 1 to September 30.
f. The company operates in a rented facility. It signed a one-year lease for the facility and paid $24,000 in cash for 12 months of rent.
g. The company sold inventory on account for $120,000. The cost of the inventory was $90,000.
h. The company collected half of its accounts receivable from customers by the end of the quarter.
i. The company's employees earn wages of $4,000 per month. Two thousand in wages is owed to employees at the end of the quarter.
j. The company incurred other operating expenses of $8,600 for the quarter ended June 30. The company has paid $4,000 in cash for these expenses.
k. The company purchased short-term investments in equity securities for $2,000 in cash. At the end of the quarter the equity securities have a market value of $2,500.
l. Assume the tax rate is 30%. The taxes for the quarter have not been paid.
2. Companies are aware that analysts focus on profitability in evaluating financial performance. Managers have historically utilized a number of methods to improve reported profitability that are cosmetic in nature and do not affect "real" operating performance. These are typically subsumed under the general heading of "earnings management." Justification for such actions typically includes the following arguments:
- Increasing stock price by managing earnings benefits shareholders; thus, no one is hurt by these actions.
- Earnings management is a temporary fix; such actions will be curtailed once "real" profitability improves, as managers expect.
Required:
a. Identify the affected parties in any scheme to manage profits to prop up stock price.
b. Do the ends (of earnings management) justify the means? Explain.
c. To what extent are the objectives of managers different from those of shareholders?
d. What governance structure can you envision that might prohibit earnings management?
3. Increasing net operating asset turnover (sales/average net operating assets) requires some combination of increasing sales and/or decreasing net operating assets. For the latter, many companies consider ways to reduce their investment in working capital (current assets less current liabilities). This can be accomplished by reducing the level of accounts receivable and inventories, or by increasing the level of accounts payable.
Required:
a. Develop a list of suggested actions that a manager could take to achieve all three of these objectives.
b. Examine the implications of each. That is, describe the marketing implications of reducing receivables and inventories, and the supplier implications of delaying payments. How can a company achieve working capital reduction without negatively impacting its performance?