Question: As you have seen, companies sometimes have choices in financial accounting

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Question:

As you have seen, companies sometimes have choices in financial accounting. You have learned of three widely used depreciation methods that can be used. Discuss why these choices exist. Would it be possible to force all companies to use one depreciation method? Why or why not? 

 George Stamper, a credit analyst with Micro-Encapsulators Corp. (MEC), needed to respond to an urgent e-mail request from the southeast sales office. The local sales manager reported that she had an opportunity to clinch an order from Miami Spice (MS) for 50 encapsulators at $10,000 each. She added that she was particularly keen to secure this order since MS was likely to have a continuing need for 50 encapsulators a year and could therefore prove a very valuable customer. However, orders of this size to a new customer generally required head office agreement, and it was therefore George's responsibility to make a rapid assessment of MS's creditworthiness and to approve or disapprove the sale.

Mr. Stamper knew that MS was a medium-sized company with a patchy earnings record. After growing rapidly in the 1980s, MS had encountered strong competition in its principal markets and earnings had fallen sharply. Mr. Stamper was not sure exactly to what extent this was a bad omen. New management had been brought in to cut costs, and there were some indications that the worst was over for the company. Investors appeared to agree with this assessment, for the stock price had risen to $5.80 from its low of $4.25 the previous year. Mr. Stamper had in front of him MS's latest financial statements, which are summarized in Table 20.4. He rapidly calculated a few key financial ratios and the company's Z score. 

Table 20.4 shows in the attached files as pictures.

Mr. Stamper also made a number of other checks on MS. The company had a small issue of bonds outstanding, which were rated B by Moody's. Inquiries through MEC's bank indicated that MS had unused lines of credit totaling $5 million but had entered into discussions with its bank for a renewal of a $15 million bank loan that was due to be repaid at the end of the year. Telephone calls to MS's other suppliers suggested that the company had recently been 30 days late in paying its bills.

Mr. Stamper also needed to take into account the profit that the company could make on MS's order. Encapsulators were sold on standard terms of 2/30, net 60. So if MS paid promptly, MEC would receive additional revenues of 50 × $9,800 = $490,000. However, given MS's cash position, it was more than likely that it would forgo the cash discount and would not pay until sometime after the 60 days. Since interest rates were about 8%, any such delays in payment could reduce the present value to MEC of the revenues. Mr. Stamper also recognized that there were production and transportation costs in filling MS's order. These worked out at $475,000, or $9,500 a unit. Corporate profits were taxed at 35%.

QUESTIONS

1.
What can you say about Miami Spice's creditworthiness?

2.
What is the break-even probability of default? How is it affected by the delay before MS pays its bills?

3.
How should George Stamper's decision be affected by the possibility of repeat orders?

P5–3 (Balance Sheet Adjustment and Preparation) The adjusted trial balance of Side Kicks Company and other related information for the year 2007 are presented on the next page SIDE KICKS COMPANY ADJUSTED TRIAL BALANCE DECEMBER 31, 2007 Debits Credits Cash $ 41,000 Accounts Receivable 1 63,500 Allowance for Doubtful Accounts $ 8,700 Prepaid Insurance 5,900 Inventory 308,500 Long-term Investments 339,000 Land 85,000 Construction Work in Progress 124,000 Patents 36,000 Equipment 400,000 Accumulated Depreciation of Equipment 140,000 Unamortized Discount on Bonds Payable 20,000 Accounts Payable 148,000 Accrued Expenses 49,200 Notes Payable 94,000 Bonds Payable 400,000 Common Stock 500,000 Premium on Common Stock 45,000 Retained Earnings 138,000 $1,522,900 $1,522,900 Additional information: 1. The LIFO method of inventory value is used. 2. The cost and fair value of the long-term investments that consist of stocks and bonds is the same. 3. The amount of the Construction Work in Progress account represents the costs expended to date on a building in the process of construction. (The company rents factory space at the present time.) The land on which the building is being constructed cost $85,000, as shown in the trial balance. 4. The patents were purchased by the company at a cost of $40,000 and are being amortized on a straight-line basis. 5. Of the unamortized discount on bonds payable, $2,000 will be amortized in 2008. 6. The notes payable represent bank loans that are secured by long-term investments carried at $120,000. These bank loans are due in 2008. 7. The bonds payable bear interest at 8% payable every December 31, and are due January 1, 2018. 8. 600,000 shares of common stock of a par value of $1 were authorized, of which 500,000 shares were issued and outstanding. Instructions Prepare a balance sheet as of December 31, 2007, so that all important information is fully disclosed.

1. Who explored enough of South America to deem it a new continent?
A. Pedro Alvarez Cabral
B. Ferdinand Magellan
C. John Cabot
D. Amerigo Vespucci

2. Which factor made the most difference in how agriculture affected the economies of the colonies?
A. workforce
B. choice of crops
C. climate
D. access to ports

3. Why did Spain colonize Florida and the Rio Grande valley?
A. Spain wanted to protect its colony in Mexico from other Europeans.
B. Native Americans in that region wanted to trade with the Spanish.
C. Missionaries insisted on spreading Christianity across the continent.
D. The Spanish found silver and gold mines there.
1. The French came to the Americas primarily to:
A. look for gold and riches.
B. convert the Indians to Christianity.
C. challenge Spanish domination.
D. profit from the fur trade.
 
2. Robert de La Salle is noted for:
A. leading a Jesuit mission in New France.
B. finding the Northwest Passage.
C. exploring the St. Lawrence River.
D. claiming for France the land around the Mississippi River.
 
3. Which of the following was a push factor that encouraged people to leave England?
A. the desire for gold
B. religious persecution
C. the attraction of fertile land
D. a thriving economy