P3-3 Income Statement Preparation

On December 31, 2012, Cathy Chen, a self-employed certified public accountant (CPA)
completed her first full year in business. During the year, she billed $360,000 for her
accounting services. She had two employees, a bookkeeper and a clerical assistant. In
addition to her monthly salary of $8,000, Ms. Chen paid annual salaries of $48,000
and$36,000 to the bookkeeper and the clerical assistant, respectively. Employment taxes and
benefit costs for Ms. Chen and her employees totaled $34,600 for the year. Expenses for
office supplies, including postage, totaled $10,400 for the year. In addition, Ms. Chen spent
$17,000 during the year on tax-deductible travel and entertainment associated with client
visits and new business development. Lease payments for the office space rented (a tax-
deductible expense) were $2,700 per month. Depreciation expense on the office furniture and
fixtures was $15,600 for the year. During the year, Ms. Chen paid interest of $15,000 on the
$120,000 borrowed to start the business. She paid an average tax rate of 30% during 2012.

a. Prepare an income statement for Cathy Chen, CPA, for the year ended December 31, 2012.

b. Evaluate her 2012 financial performance.

P3-7 Balance Sheet Preparation

Adam and Arin Adams have collected their personal income and expense information and
have asked you to put together an income and expense statement for the year ended
December 31, 2012. The following information is received from the Adams family.

Cash $ 300 Retirement funds, IRA

$2,000
Checking 3,000
2011 Sebring
Savings 1,200
15,000
IBM stocks 2,000
2010 Jeep
Auto loan 8,000 8,000

Mortgage 100,000 Money market funds 1,200

Medical bills payable 250 Jewelry and artwork

Utility bills payable 150 3,000

Real estate 150,000 Net worth

76,500

Household furnishings 4,200

a. Create
Credit card balance 2,000 a

Personal loan 3,000

personal balance sheet as of December 31, 2012. It should be similar to a corporate

balance sheet.
b. What must the total assets of the Adams family be equal to December 31, 2012?
c. What was their net working capital (NWC) for the year? (NWC is the difference
between total liquid assets and total current liabilities.)
P3-8 Impact of Net Income on a firm’s Balance Sheet

Conrad Air Inc. reported net income of $1, 365,000 for the year ended December 31,
2013. Show how Conrad’s balance sheet would change from 2012 to 2013 depending on
how Conrad “spend” those earnings as described in the scenarios appear below.

Conrad Air Inc. Balance Sheet as of December 31, 2006.

Assets Liabilities and Stockholders’ Equity

Cash $ 120,000 Accounts payable $ 70,000

Marketable securities 35,000 Short-term notes 55,000

Accounts receivable 45,000 Current liabilities 125, 000

Inventories 130,000 Long term debt 2,700,000

Current Assets 330,000 Total liabilities 2,825,000

Equipment 2,970,000 Common stock 500,000

Buildings 1,600,000 Retained earnings 1,575,000

Fixed assets 4,570,000 Stockholders equity 2,075,000

Total Assets 4,900,000 Total liability and equity 4,900,000

a. Conrad paid no dividends during the year and invested the funds in marketable
securities.
b. Conrad paid dividends totaling $500,000 and used the balance of the net income to
retire (payoff) long term debt.
c. Conrad paid dividends totaling $500,000 and invested the balance of the net income
in building a new hangar.
d. Conrad paid out all $1,365,000 as dividends to its stockholders.
Analyze the overall financial position from both a cross-sectional and a time-series
viewpoint. Break your analysis into evaluations of the firm’s liquidity, activity, debt,
profitability, and market.

Historical and Industry Average Ratios for Sterling Company

Current ratio 1.40 1.55 1.85

Quick ratio 1.00 0.92 1.05
Inventory turnover 9.52 9.21 8.60
Average collection period 45.6 days 36.9 days 35.5 days
Average payment period 59.3 days 61.6 days 46.4 days
Total asset turnover 0.74 0.80 0.74
Debt ratio 0.20 0.20 0.30
Time interest earned ratio 8.2 7.3 8.0
Fixed payment coverage ratio 4.5 4.2 4.2
Gross profit margin 0.30 0.27 0.25
Operating profit margin 0.12 0.12 0.10
Net profit margin 0.062 0.062 0.053
Return on asset (ROA) 0.045 0.050 0.040
Return on common equity 0.061 0.067 0.066
Earnings per share (EPS) $1.75 $2.20 $1.50
Price/earnings (P/E) ratio 12.0 10.5 11.2
Market/book (M/B) ratio 1.20 1.05 1.10
DuPont system of analysis

use the following ratio information form Johnson international and the industry average for
Johnson’s line of business to:

a. Construct the DuPont system of analysis for both Johnson and the industry.
b. Evaluate Johnson (and the industry) over 3 years period.
c. Indicate in which areas Johnson require further analysis. Why?

Johnson 2010 2011 2012

Financial leverage multiplier 1.75 1.75 1.85

Net profit margin 0.059 0.058 0.049

Total asset turnover 2.11 2.18 2.34

Industry average Financial

leverage multiplier
1.67 1.69 1.64
Net profit margin
0.054 0.047 0.041
Total asset turnover
2.05 2.13 2.15