Transactions - William's Merchandize Distribution Answers

GUIDELINES 1. This exam contains 8 pages, in two parts. Please make sure your copy is not missing any pages. 2. The exam must be completed within 80 minutes. 3. The total number of points in this exam is also 80, so budget about 1 minute / point. Avoiding spending too much time on any one question. Question I II Topic Recording the effects of transactions: William’s Merchandize Distribution Accounts receivable, inventories, and cash flow: Abercrombie & Fitch Points 30 50 4. Please work the problems in a clear, readable manner and show all computations. We will not grade what we cannot read. 5. If you feel that assumptions are necessary to solve a problem, please state your assumption and why it was necessary. 6. Calculators may be used for computations on this exam. QUESTION I: TRANSACTIONS: WILLIAM’S MERCHANDIZE DISTRIBUTION (30 POINTS) William’s Merchandize Distribution (WMD) is a wholesale grocery distributor. Using the Balance Sheet Equation worksheet provided below, record the effects of the transactions shown on page 6 (2 points each). Calculate the ending balances of each account when you are done recording the transactions (2 points). Compute net income for the year ended December 31, 2002 (2 points). Cash 1/1/2002 Balances 150,000 Receivables Inventories 95,000 896,000 1. Prepaid Rent 51,000 Property, at Current Cost, Less Liabilities Accum. Depr. 1,372,000 6,320,000 2. 988,000 Noncurrent Liabilities Contributed Capital 579,000 240,000 Retained Earnings R/E Explanation 757,000 6,320,000 7,900,000 7,900,000 Revenue 3. -108,000 108,000 4. -6,305,000 5. none 6. 7,820,000 7. -67,000 -67,000 Interest exp. 8. -42,000 -42,000 Dividends -6,305,000 -7,820,000 9. 10. -6,287,000 -1,230,000 11. 4,000 12. -105,000 13. 12/31/2002 Balances -70,000 218,000 175,000 929,000 54,000 1,302,000 1007,000 579,000 Net Income for the period ended December 31, 2002: 137,000 240,000 -6,287,000 COGS -1,230,000 Wages expense -4,000 Wages expense -105,000 Rent expense -70,000 Depr. expense 852,000 QUESTION II: ABERCROMBIE & FITCH (50 POINTS) Abercrombie & Fitch (A&F) is a large and growing retail chain of 597 stores in the U.S (adding 112 stores in the last year). The last two pages of this exam contain the balance sheets and income statements from A&F’s February 1, 2003 annual report to shareholders (with minor modifications). ACCOUNTS RECEIVABLE AND REVENUE RECOGNITION (15 POINTS) 1. As a retailer, A&F has only a minimal amount of accounts receivable, as shown on the balance sheets. Nevertheless, assume that the company wrote off $1,160k in uncollectible receivables in the year ended February 1, 2003. Reconstruct plausible transactions to record these write-offs and the recognition of bad debt expense in the Balance Sheet Equation for the year ended February 1, 2003. (6 points) Cash Beg. Bal BDE Collections Write-off End. Bal Accts Receivable –ADA 21,756 1,300 +760 Not needed to answer question –1,160 –1,160 11,362 900 Retained Earnings -760 Bad debt expense 2. A&F has a policy that allows customers to return merchandise within 14 days for a full refund. Assume the company estimated that at the fiscal years ended February 1, 2003 and February 2, 2002, expected returns to be $3,500k and $2,900k, respectively. These amounts (allowances for returns) have been included in “Accrued Expenses” on the balance sheets. If A&F had not recorded these allowances for returns, estimate the following items: (ig6nore the effect of income taxes) a) Retained earnings on February 1, 2003 (3 points) Retained earnings, as reported Add: expected returns Retained earnings if no allowance for returns $714,475 3,500 $717,975 b) Net income for the year ended February 1, 2003 (3 points) Net income, as reported Add: increase in expected returns Net income if no allowance for returns $194,935 600 $195,535 c) Cash on February 1, 2003 (3 points) Cash is not affected. Cash, as reported $391,035 INVENTORIES (15 POINTS) 3. Compute the value of inventory purchased in the year ended February 1, 2003. (3 points) BInv + Purchases = EInv + COGS Purchases = EInv + COGS – Binv = 144,218 + 939,708 – 108,876 = 975,050 4. a) Compute the inventory turnover ratio (COGS / average inventory) for the fiscal year ended February 1, 2003. (1 points) Inventory Turnover = 939,708 = 7.43 times (144,218 + 108,876) / 2 b) The notes to A&F’s financial statements indicate that the company uses the FIFO cost flow assumption. Given this information, what adjustments, if any, would you make to the turnover ratio you calculated in part (a) in order for the ratio to be a good estimate of physical turnover. (A qualitative response is all that is expected here. 3 points) A slightly better measure would adjust either the numerator or denominator so that all numbers approximate current cost. However, in this case, no adjustments are necessary because: - denominator: inventory approximates current cost under FIFO - numerator: given rapid turnover, COGS approximates current cost (i.e., COGS contains no more than 2 months of costs (1/7.43 yr) from beginning inventory) 5. a) Suppose that A&F had used the LIFO method instead. Assume that the LIFO inventory values would have been $89,000k and $57,000k on February 1, 2003 and February 2, 2002, respectively. Compute the cost of goods sold that A&F would have reported had it used LIFO instead of FIFO. (5 points) Method 1: COGSLIFO = BInvLIFO + Purchases – EinvLIFO = 57,000 + 975,050 – 89,000 = 943,050 Method 2: LIFO Reserve2003 = 144,218 – 89,000 = 55,218 LIFO Reserve2002 = 108,876 – 57,000 = 51,876 COGSLIFO = COGSFIFO + ∆LIFO Reserve = 939,708 + (55,218 – 51,876) = 939,708 + 3,342 = 943,050 b) Compute the cumulative amount of taxes that A&F would have saved by using the LIFO method. Assume a tax rate of 35%. (3 points) Tax saved = LIFO Reserve × Tax Rate = 55,218 × 35% = 19,326.3 CASH FLOWS (20 POINTS) 6. Shown below is the first portion of A&F’s Statement of Cash Flows (indirect method) for the year ended February 1, 2003. Provide four other adjustments in the Operating Activities section of the statement. Be sure to indicate the direction of the adjustment (add or substract). (Note: Marketable securities are not an operating asset.) (8 points) 000’s Net income $194,935 Add: depreciation $56,925 Add: Subtract: Subtract: Add: Add: Add: Add: ↓ Accounts receivable ↑ Inventory ↑ Supplies and Other ↑ Accounts payable ↑ Accrued expenses ↑ Tax payable ↑ Deferred tax 9,994 (35,342) (8,462) 18,256 10,852 18,783 19,616 7. For the year ended February 1, 2003, A&F reported Investing Cash Flow of –$26,802k and Financing Cash Flow of –$42,973k. Using this information and the balance sheets, compute Operating Cash Flow for the year ended February 1, 2003. (3 points) ∆Cash = Operating CF + Investing CF + Financing CF Op. CF = ∆Cash – Investing CF – Financing CF = 223,371 – -26,802 – -42,973 = 293,146 8. Provide your qualitative assessment of A&F’s ability to generate cash flows. (3 points) A variety of responses could be made here. The most reasonable inference is that the company is able to generate a considerable amount of cash from its operations, even while growing its business rapidly., The operating cash flow far exceeds the amounts used for investing and financing activities. 9. Assume that “Accounts Payable” relates entirely to inventory purchases. Estimate the amount of cash A&F paid for inventory purchases in the year ended February 1, 2003. (6 points) Cash Beg. Bal Purchases COGS Payments End. Bal Inventory 108,876 975,050 –939,708 –956,794 144,218 Accts Payable 31,897 975,050 Retained Earnings –939,708 COGS –956,794 50,153 An alternative way to come to the same answer is as follows: Payments of inventory = COGS + ∆Inventory – Accts Payable = 939,708 + 35,342 – 18256 = 956,794 TRANSACTIONS FOR QUESTION I 1. During 2002, the company purchased $6,320,000 of groceries on account. 2. The company made $7,900,000 of credit sales to grocery retailers during 2002. 3. On June 30, 2002, the company prepaid $108,000 for one year of store rental. 4. The company had beginning accounts payable of $430,000 on January 1, 2002 and accounts payable of 445,000 on December 31, 2002. Record the cash payments, noting that accounts payables were increased by transaction 1. 5. On December 15, 2002, a consulting firm issued a report stating that the "WMD" brand name has declined in value by $500,000 because of negative associations with “Weapons of Mass Destruction.” WMD had no brand name asset recorded on its December 31, 2001 balance sheet. 6. WMD collected $7,820,000 from customers during 2002. 7. During 2002, the company paid debt holders $67,000 for interest incurred in the year. 8. The company declared and paid $42,000 of dividends. 9. WMD employees took a physical count of inventory on December 31, 2002. The cost of goods in the company's possession on that date was $929,000. The cost of goods in the company's possession on January 1, 2002 was $896,000. 10. During 2002, the company paid its employees $1,230,000 in wages and benefits for work performed in 2002. 11. The last payday for the company was December 30, 2002. Employees had earned, but the company had not yet recorded, $4,000 of wages for work done on December 31, 2002. 12. Adjust for the unused rent at December 31, 2002. Note that Prepaid Rent on January 1, 2002 was 51,000 and that Food Lion never prepays rent for more than one year. 13. WMD calculates that $70,000 should be recorded as depreciation on its warehouses and machinery. Abercrombie & Fitch BALANCE SHEETS (Thousands) February 1 2003 February 2 2002 $391,035 10,000 $167,664 71,220 10,462 20,456 144,218 45,441 601,156 392,941 725 $994,822 108,876 36,979 405,195 365,112 239 $770,546 $ 50,153 120,438 40,879 211,470 20,781 13,044 $ 31,897 109,586 22,096 163,579 1,165 10,368 1,033 142,577 714,475 858,085 (108,558) 749,527 $994,822 1,033 141,394 519,540 661,967 (66,533) 595,434 $770,546 Assets Current Assets Cash and Equivalents Marketable Securities Receivables, net of allowance for doubtful accounts of $900 and $1,300, respectively Inventories Store Supplies and Other Total Current Assets Property and Equipment, Net Other Assets Total Assets Liabilities and Shareholders’ Equity Current Liabilities Accounts Payable Accrued Expenses Income Taxes Payable Total Current Liabilities Deferred Income Taxes Other Long-Term Liabilities Shareholders’ Equity Common Stock – $.01 par value: 150,000,000 shares authorized, 97,268,877 and 98,871,478 shares outstanding at February 1, 2003 and February 2, 2002, respectively Paid-In Capital Retained Earnings Less: Treasury Stock, at Average Cost Total Shareholders’ Equity Total Liabilities and Shareholders’ Equity Courtesy of U.S. Securities and Exchange Commission. Used with permission. Abercrombie & Fitch STATEMENTS OF INCOME For years ended (Thousands) Net Sales Cost of Goods Sold Gross Income General, Administrative and Store Operating Expenses Operating Income Interest Income, Net Income Before Income Taxes Provision for Income Taxes Net Income February 1, 2003 $1,595,757 939,708 656,049 343,432 312,617 (3,768) 316,385 121,450 $ 194,935 February 2, 2002 $1,364,853 806,819 558,034 286,576 271,458 (5,064) 276,522 107,850 $ 168,672 February 3, 2001 $1,237,604 728,229 509,375 255,723 253,652 (7,801) 261,453 103,320 $ 158,133 Courtesy of U.S. Securities and Exchange Commission. Used with permission.