C11.12. ?

a.?Note to Instructor:  Students find this problem challenging, and generally prefer not to be provided any “hints” if it is assigned as an individual take-home problem.  If it is used as an in-class group-learning problem, you should be careful to monitor the progress of each group to make sure that the “whiz kids” don’t do all of the work — otherwise, the problem may lose its effectiveness for many students.  After about 10-15 minutes, walk them through the solution to part a up to a certain point, or provide some hints based on their questions, and then allow additional time for them to complete part a.Part b can be assigned as take-home work if time runs short.  It may also be interesting to have each group explain the sequence of steps they used in solving the problem, and to then compare the different approaches taken.

	WHITTAKER, INC. Income Statement For the Year Ended December 31, 2011
	Sales Cost of goods sold Gross profit Operating expenses Income from operations Interest expense Income before taxes Income taxes (20%) Net income	$340,000 (204,000) $136,000 (91,500) $ 44,500 (10,000) $ 34,500 (6,900) $ 27,600

	WHITTAKER, INC. Balance Sheet December 31, 2011
	Current assets:   Cash   Accounts receivable, net   Inventory      Total current assets Property, plant, and equipment, net Total assets   Current liabilities Bonds payable, 15%   Total liabilities Owners’ equity:   Common stock, $2 par value   Additional paid-in capital   Retained earnings      Total owners’ equity Total liabilities and owners’ equity	$   74,000 43,000    54,000 $ 171,000    69,000 $ 240,000   $   90,000 70,000 $ 160,000   $   10,000 15,000 55,000 $   80,000 $ 240,000

Solution approach: Complete the balance sheet first.  There are a variety of ways of working through the problem, but the balance sheet can be completed rather easily (except that it takes some effort to separate cash from accounts receivable).  Enough information is given so that the solution can be approached from many different angles and it is not necessary to follow a lock-step pattern to get the correct results. 

One possible sequence of steps:

?1.  Current ratio = 1.9 to 1, so current assets of $171,000 / 1.9 = $90,000 current  liabilities.

?2.  Current liabilities + Bonds payable = $90,000 + $70,000 = $160,000 total liabilities.

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?3.  Inventory accounts for the difference between the current ratio of 1.9 and the acid-test ratio of 1.3, so Inventory = (0.6 * current liabilities) = 0.6 * $90,000 = $54,000. 

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?4.  Debt/equity ratio = 2.0 to 1, so total liabilities of $160,000 / 2 = $80,000 total  owners’ equity.

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?5.  Total liabilities + total owners’ equity = $160,000 + $80,000 = $240,000 total liabilities and owners’ equity.  Thus, total assets = $240,000.

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?6.  Retained earnings can now be determined by subtraction = $80,000 - $10,000 - $15,000 = $55,000.

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?7.  Property, plant, and equipment, netcan be determined in a similar manner = $240,000 - $171,000 = $69,000.

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?8.  Total current assets = $171,000 - $54,000 of inventory = $117,000, which represents the sum of Cash + Accounts receivable. Using the accounts receivable information, the beginning balance of $57,000 minus cash collections in excess of credit sales during the year of $14,000 = $43,000 ending balance.

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?9.  Thus,Cash = $117,000 - $43,000 =$74,000.

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?10.  Average accounts receivable = ($57,000 + $43,000) / 2 = $50,000, so Sales = $50,000 * 6.8 accounts receivable turnover = $340,000.

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?11.  Average inventory = ($48,000 + $54,000) / 2 = $51,000, so Cost of goods sold = $51,000 * 4.0 inventory turnover = $204,000.  Alternatively, cost of goods sold = Sales * (1 - 40% gross profit ratio) = $340,000 * 60% = $204,000.

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?12.  Gross profit = Sales * 40% = $340,000 * 40% = $136,000. Alternatively, gross profit = Sales - Cost of goods sold = $340,000 - $204,000 = $136,000.

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?13.  Interest expense can be calculated as follows: ($10,000 face amount * 15% * 8/12 = $1,000 interest expense) + ($60,000 face amount * 15% = $9,000 interest expense).  Thus, total Interest expense = $1,000 + $9,000 = $10,000.

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?14.  Times interest earned = 4.45 * $10,000 = $44,500 income from operations.

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?15.  Operating expenses can now be determined by subtraction = $136,000 gross profit - $44,500 income from operations = $91,500.

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?16. Income before taxescan be determined in a similar manner = $44,500 income from operations - $10,000 interest expense = $34,500.

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?17.  Income taxes = $34,500 income before taxes * 20% = $6,900.

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?18.  Net income = $34,500 income before taxes - $6,900 income taxes = $27,600.