Name : Jaimin Pandya Student ID:2292119

Q2-3. GAAP is based on the concept of accrual accounting. Define and describe accrual
accounting.
Answer:
Accrual accounting is a method of accounting that records revenues and expenses when they are
incurred, regardless of when cash is received or paid. It is based on the principle of matching revenues
with expenses, providing a more accurate picture of a company's financial performance and position
compared to cash-basis accounting.

Here are the key characteristics and principles of accrual accounting:

1. Recognition of Revenue: Under accrual accounting, revenue is recognized when it is earned,

which typically occurs when goods or services are delivered to customers, and there is a
reasonable expectation of payment. This is in contrast to cash accounting, where revenue is
recognized only when cash is received.

2. Recognition of Expenses: Expenses are recognized when they are incurred, meaning when
goods or services are consumed or utilized in the revenue-generating process, regardless of
when payment is made. This includes expenses like salaries, rent, and utilities.

3. Matching Principle: The core concept of accrual accounting is the matching principle, which
aims to align expenses with the revenue they help generate. This means that expenses are
matched with the revenues they contribute to in the same accounting period, even if the actual
cash flows occur at different times.

4. Accruals and Deferrals: To achieve this matching, accrual accounting uses accruals and deferrals.
Accruals involve recognizing revenues or expenses before cash is exchanged, while deferrals
involve recognizing them after cash changes hands. For example, an accrued revenue might
represent services provided but not yet billed, while a deferred expense might involve prepaid
rent.

5. Financial Statements: Accrual accounting generates financial statements, including the income
statement and balance sheet, that provide a more comprehensive and accurate overview of a
company's financial performance and financial position compared to cash accounting.

6. Accrual Basis vs. Cash Basis: The key distinction between accrual accounting and cash
accounting is the timing of recognition. While accrual accounting focuses on the economic
reality of transactions, cash accounting records transactions only when cash is received or paid.

Overall, accrual accounting is a more accurate and informative method of accounting than cash-basis
accounting. It is required by GAAP and is used by most businesses. However, it can be more complex and
difficult to track than cash-basis accounting.
Q2-4. Analysts attempt to identify transitory items in an income statement. Define transitory
items. What is the purpose of identifying transitory items?
Answer:
Transitory items are financial elements or events that appear in a company's income statement but are
not expected to recur in the future, at least not on a regular basis. They can be either positive or
negative, and they can have a significant impact on a company's financial performance in a particular
period. These items are typically considered unusual or non-operating in nature and are not part of a
company's core, ongoing operations. They can significantly affect a company's reported earnings for a
particular period but are not representative of its typical financial performance. Some examples of
transitory items include: Gains or losses on the sale of assets, Restructuring charges, Litigation
settlements, foreign exchange gains or losses.

The purpose of identifying transitory items in an income statement is to provide stakeholders, such as
investors, analysts, and management, with a clearer and more accurate understanding of a company's
underlying, ongoing financial performance. Here are some key reasons for identifying and analyzing
transitory items:

1. Earnings Quality Assessment: By isolating and categorizing transitory items, analysts can assess
the quality of a company's earnings. High levels of transitory items can indicate that a company's
reported earnings are less reliable for predicting future performance.

2. Projection and Forecasting: Identifying transitory items helps analysts make more accurate
projections and forecasts for a company's future financial performance. By excluding non-
recurring items, they can better estimate the company's sustainable or core earnings.

3. Investor Decision-Making: Investors rely on income statements to make investment decisions.

Recognizing transitory items allows investors to filter out non-recurring events and focus on the
company's ongoing profitability, which is essential for making informed investment choices.

4. Comparability: When comparing the financial performance of multiple companies or analyzing a

company's performance over several periods, it's crucial to remove the impact of transitory
items to ensure a meaningful and fair comparison.

5. Valuation: Analysts often use earnings multiples (e.g., price-to-earnings ratio) to value
companies. Removing transitory items provides a more accurate earnings figure for these
calculations, leading to more reliable valuations.

Hence, identifying transitory items is also important for investors. Investors are interested in investing in
companies that have the potential to generate sustainable profits over the long term. By excluding
transitory items from a company's earnings, investors can get a better understanding of the company's
true earnings power.
Q2-16 Define net working capital. Explain how increasing the amount of trade credit can reduce
the net working capital for a company.
Answer:
Net working capital is a measure of a company's liquidity, or its ability to meet its short-term financial
obligations. It is calculated as the difference between a company's current assets and current liabilities.

The formula for calculating net working capital is:

Net Working Capital=CurrentAssets−CurrentLiabilities

 Current Assets include items like cash, accounts receivable (money owed to the company by
customers), inventory, and other assets that are expected to be converted into cash or used up
within one year or one operating cycle, whichever is longer.

 Current Liabilities encompass obligations that are expected to be settled within one year or one
operating cycle, such as accounts payable (money owed to suppliers), short-term debt, and other
current liabilities.

Trade credit is a type of credit that a company receives from its suppliers. It allows the company to
purchase goods or services on credit, and pay for them at a later date. Increasing the amount of trade
credit can reduce a company's NWC. When a company receives favorable trade credit terms, it
essentially means it can delay the cash outflows associated with paying its suppliers, thereby affecting its
net working capital in the following way:

1. Increase in Current Liabilities: When a company is granted extended payment terms by its
suppliers, its accounts payable balance increases. Accounts payable represent the amount of
money the company owes to its suppliers for goods or services received but not yet paid for. As
a result, there is an increase in the current liabilities component of the net working capital
formula.

2. No Immediate Impact on Current Assets: In the short term, this extension of trade credit
typically does not affect the company's current assets (e.g., cash, accounts receivable, inventory)
since these assets are not directly related to the company's trade credit terms with suppliers.

3. Reduction in Net Working Capital: Since the increase in current liabilities exceeds any
immediate change in current assets, the net working capital decreases. This reduction in net
working capital reflects the fact that the company has more short-term obligations to pay than it
has readily available short-term assets to cover those obligations.

The overall impact of increasing trade credit on NWC will depend on the relative increase in
current assets and current liabilities. If the increase in current assets is greater than the
increase in current liabilities, then NWC will increase. However, if the increase in current
liabilities is greater than the increase in current assets, then NWC will decrease.
A) Beginning Balance + Purchases - Supplies Expense = Ending Balance

Given that the ending balance of supplies on January 31st is $900, and $620 worth of supplies were
purchased during January, and the supplies expense is $960, we can rearrange the formula to solve for
the beginning balance:

Beginning Balance + $620 - $960 = $900

Beginning Balance - $340 = $900

Beginning Balance = $900 + $340 = $1,240

So, the beginning balance of supplies on January 1st was $1,240.

B)

Amount of the insurance premium= Monthly insurance expense * 12 months

= $82*12

=$984
Prepaid insurance Balance = $574

Insurance expense booked for the year, till Jan month end:

$984 – $574 = 410 (equivalent to 5 months of insurance expense)

Thus, annual insurance premium was paid 5 months back (including Jan month), i.e. September in the
previous year. Thus, policy start date is 1st Sept in previous month.

C)

Wages Payable=Beginning balance + Wages Expenses - Cash Paid for wages

Cash Paid for wages=Wages expenses- Wages Payable ( as (begin balance=0))

=$3200-$700

=$2500

D)

Assuming the original cost of the truck was $8,700 and there is no salvage value mentioned, we can
calculate the monthly depreciation expense using the straight-line method:

Depreciation Expense per Month = (Original Cost - Salvage Value) / Useful Life in Months

Depreciation Expense per Month = ($8,700 - $0) / 60 months = $8,700 / 60 months = $145 per month

Accumulated depreciation=Depreciation Expense per Month*Number of months owned by truck

Number of months owned by truck= $2610/$145

=18months
A)

Income Statement for year End December 31:

$ $

Revenue 75,000

Service fees earned 75,000

COGS 0

Gross Income 75,000

Total Operating Expenses 62,100

Rent 18,000

Salaries 37,100

Depreciation 7,000

Net Operating income 12,900

Dividends 8000

Net Income 4,900

Statement of Stockholders' Equity for Year-End December 31:

Shareholder's Equity
Account $

Common Stock 43,000

Retained Earnings 20,600

Net Operating Income 12,900

Dividends -8,000

Equity at the end of the year 68,500

Balance Sheet as of December 31:

Assets Liabilities

14,50
Current Assets 0 Current Liabilities 10,000

Cash 8,000 Notes Payable 10,000

Accounts Receivable 6,500

64,00
Long term Assets 0 Long Term Liabilities 0

Equipment 78,000

less Accumulated
Dep. -14,000

Total Liabilities 10,000

Shareholder’s Equity 68,500

Common Stock 43,000

Retained Earnings 25,500

 78,50
Total Assets 0 Total Liabilities + Equity 78,500
B) To close Beinish Corporation's temporary accounts (revenue, expenses, and dividends), we'll make the
following journal entries:

1. Close Service Fees Earned:

 Debit Service Fees Earned (75000)

 Credit Income Summary (75000)

2. Close Rent Expense:

 Debit Income Summary (18000)

 Credit Rent Expense (18000)

3. Close Salaries Expense:

 Debit Income Summary (37100)

 Credit Salaries Expense (37100)

4. Close Depreciation Expense:

 Debit Income Summary (7000)

 Credit Depreciation Expense (7000)

5. Close Dividends:

 Debit Retained Earnings (8000)

 Credit Dividends (8000)

C)

Retained Earnings

Rent expense 18000 20600 Beginning Balance

Salaries expense 37100 75000 Service fees earned

Depreciation expense 7000

Dividends 8000

Service fees earned

Retained Earnings 75000 75000 Beginning Balance

Rent expense

Beginning Balance 18000 18000 Retained Earnings

Salaries expense

Beginning Balance 37100 37100 Retained Earnings

Depreciation expense

Beginning Balance 7000 7000 Retained Earnings

Dividends

Beginning Balance 8000 8000 Retained Earnings

Answer:

A) Express each income statement amount as a percentage of sales:

Pfizer:

 Gross Profit as a percentage of Sales: (42,399 / 53,647) * 100% ≈ 79.2%

 Total Expenses as a percentage of Sales: (31,211 / 53,647) * 100% ≈ 58.1%

 Net Income as a percentage of Sales: (11,188 / 53,647) * 100% ≈ 20.9%

Dr. Reddy's:

 Gross Profit as a percentage of Sales: (1,172 / 2,181) * 100% ≈ 53.7%

 Total Expenses as a percentage of Sales: (1,021 / 2,181) * 100% ≈ 46.8%

 Net Income as a percentage of Sales: (151 / 2,181) * 100% ≈ 6.9%

 Pfizer Dr. Reddy's

$ Million % Sales $ Million % Sales

Sales 53,647 100% 2181 100%

COGS 11,248 21% 1009 46%

Gross Profit 42,399 79% 1172 54%

Total Expenses 31,211 58% 1021 47%

Net Income 11,188 21% 151 7%

Comment:

1) Pfizer's gross profit as a percentage of sales is significantly higher than Dr. Reddy's, indicating
that Pfizer is more efficient at generating gross profit from its sales. This suggests that Pfizer may
have a stronger brand with wider range of products, higher pricing power, or better cost
management.
2) Pfizer's total expenses as a percentage of sales are also higher than Dr. Reddy's, which means
Pfizer has higher operating expenses in relation to its sales. This might be due to Pfizer's larger
scale and global operations.
3) Pfizer's net income as a percentage of sales is substantially higher than Dr. Reddy's, indicating
that Pfizer is more profitable after considering all expenses. This suggests that Pfizer's business
model is more profitable overall.

One aspect driving Pfizer's profitability could be its ability to command higher prices for its
pharmaceutical products due to its brand reputation and the nature of its products (possibly
patented drugs).

B)

Pfizer:

 Current Assets as a percentage of Total Assets: (49,926 / 159,422) * 100% ≈ 31.4%

 Long-Term Assets as a percentage of Total Assets: (109,496 / 159,422) * 100% ≈ 68.6%

 Current Liabilities as a percentage of Total Assets: (31,858 / 159,422) * 100% ≈ 20%

 Long-Term Liabilities as a percentage of Total Assets: (63,806 / 159,422) * 100% ≈ 40%

 Stockholders' Equity as a percentage of Total Assets: (63,758 / 159,422) * 100% ≈ 40%

Dr. Reddy's:

 Current Assets as a percentage of Total Assets: (1,684 / 3,465) * 100% ≈ 48.6%

 Long-Term Assets as a percentage of Total Assets: (1,781 / 3,465) * 100% ≈ 51.4%

 Current Liabilities as a percentage of Total Assets: (1,070 / 3,465) * 100% ≈ 30.9%

 Long-Term Liabilities as a percentage of Total Assets: (453 / 3,465) * 100% ≈ 13.1%

 Stockholders' Equity as a percentage of Total Assets: (1,942 / 3,465) * 100% ≈ 56%

Pfizer Dr. Reddy's

$
Millions % Assets $ Millions % Assets

Current assets 49,926 31% 1,684 49%

Long-term assets 1,09,496 69% 1,781 51%

Total assets 1,59,422 100% 3,465 100%

Current liabilities 31,858 20% 1,070 31%

Long-term liabilities. 63,806 40% 453 13%

Total liabilities 95,664 60% 1,523 44%

Stockholders' equity 63,758 40% 1,942 56%

Total liabilities and equity 1,59,422 100% 3,465 100%

Comment:

1. Pfizer has a higher proportion of long-term assets compared to Dr. Reddy's, indicating that Pfizer
has made significant investments in its long-term assets, which might be related to research and
development or acquisitions. Dr. Reddy's, on the other hand, has more of its assets invested in
current assets, such as cash and accounts receivable.

2. Pfizer has a higher proportion of long-term liabilities compared to Dr. Reddy's, indicating a higher
degree of leverage or debt in its capital structure. This is because Pfizer is more reliant on debt
to finance its operations. If Pfizer is unable to repay its debt, it could face financial difficulties.
3. Pfizer has a lower proportion of equity (stockholders' equity) compared to Dr. Reddy's. This
means that Pfizer has financed a larger portion of its assets with debt than Dr. Reddy's.

Overall, the financial statements of Pfizer and Dr. Reddy's show that with Pfizer having more debt
and Dr. Reddy's having more equity, can affect the relative riskiness of the two companies. Pfizer's
higher debt levels may make it more sensitive to changes in interest rates and economic conditions.
Dr. Reddy's, with a higher equity proportion, may have a more conservative financial structure but
potentially lower returns on equity due to reduced leverage. The choice between higher debt or
equity depends on the company's risk tolerance and growth strategy.