Universitas Pelita Harapan (UPH)
Medan Campus Financial Statement Analysis (FSA)
SUPPLEMENT MATERIAL
FOR
CHAPTER 4 – ANALYZING INVESTING ACTIVITIES
Problem 1 (Restating Inventory from LIFO to FIFO)
Big Bad Wolf uses LIFO inventory accounting. Notes to Big Bad Wolf’s Year 9 financial statements disclose the
following (it has a marginal tax rate of 35%):
Inventories Year 8 Year 9
Raw materials $392,675 $369,725
Finished products 401,342 377,104
794,017 746,829
Less LIFO reserve (46,000) (50,000)
$748,017 $696,829
Required:
a. Determine the amount by which Year 9 retained earnings of Big Bad Wolf changes if FIFO is used.
b. Determine the amount by which Year 9 net income of Big Bad Wolf changes if FIFO is used for both Years 8
and 9.
c. Discuss the usefulness of LIFO to FIFO restatements in an analysis of Big Bad Wolf
Problem 2 (Financial Statement Consequences of FIFO and LIFO)
Wisely Co. purchases its merchandise at current market costs and resells the product at a price 20 cents higher. Its
inventory costs are constant throughout the current year. Data on the number of units in inventory at the beginning of
the year, unit purchases, and unit sales are shown here:
Number of units in inventory—beginning of year (@ $1 per unit cost) 1,000 units
Number of units purchased during year @ $1.50 per unit cost 1,000 units
Number of units sold during year @ $1.70 per unit selling price 1,000 units
The beginning-of-year balance sheet for Wisely Co. reports the following:
Inventory (1,000 units @ $1) $1,000
Total equity $1,000
Required:
a. Compute the after-tax profit of Wisely Co. separately for both the (1) FIFO and (2) LIFO methods of inventory
valuation assuming the company has no expenses other than cost of goods sold and its income tax rate is
50%. Taxes are accrued currently and paid the following year.
b. If all sales and purchases are for cash, construct the balance sheet at the end of this year separately for both
the (1) FIFO and (2) LIFO methods of inventory valuation.
From the desk of Ciptawan 1
Universitas Pelita Harapan (UPH)
Medan Campus Financial Statement Analysis (FSA)
Problem 3 (Financing Statement Effects of Alternative Investing Methods)
Dragon Co. is a retailer dealing in a single product. Beginning inventory at January 1 of this year is zero, operating
expenses for this same year are $5,000, and there are 2,000 common shares outstanding. The following purchases
are made this year:
Units Per Unit Cost
January 100 $10 $ 1,000
March 300 11 3,300
June 600 12 7,200
October 300 14 4,200
December 500 15 7,500
1,800 $23,200
Ending inventory at December 31 is 800 units. End-of-year assets, excluding inventories, amount to $75,000, of which
$50,000 of the $75,000 are current. Current liabilities amount to $25,000, and long-term liabilities equal $10,000.
Required:
a. Determine net income for this year under each of the following inventory methods. Assume a sales price of
$25 per unit and ignore income taxes.
(1) FIFO
(2) LIFO
(3) Average cost
b. Compute the following ratios under each of the inventory methods of FIFO, LIFO, and average cost.
(1) Current ratio
(2) Debt-to-equity ratio
(3) Inventory turnover
(4) Return on total assets
(5) Gross margin as a percent of sales
(6) Net profit as a percent of sales
From the desk of Ciptawan 2
Universitas Pelita Harapan (UPH)
Medan Campus Financial Statement Analysis (FSA)
Problem 4 (Capitalizing versus Expensing Costs)
The Bernard Solutions develops software to support e-commerce. The Bernard incurs substantial computer software
development costs as well as substantial research and development (R&D) costs related to other aspects of its product
line. Under GAAP, if certain conditions are met, The Bernard capitalizes software development costs but expenses the
other R&D costs. The following information is taken from The Bernard’s annual reports ($ in thousands):
1999 2000 2001 2002 2003 2004 2005 2006
R&D costs $ 400 $ 491 $ 216 $ 212 $ 355 $ 419 $ 401 $ 455
Net income 312 367 388 206 55 81 167 179
Total assets (at year- 3,368 3,455 3,901 4,012 4,045 4,077 4,335 4,650
end
Equity (at year-end) 2,212 2,460 2,612 2,809 2,889 2,915 3,146 3,312
Capitalized software
costs:
Unamortized balance 20 31 27 22 31 42 43 36
(at year-end)
Amortization Expense 4 7 9 12 13 15 15 14
Required:
(a) Compute the total expenditures for software development costs for each year.
(b) R&D costs are expensed as incurred. Compare and contrast computer software development costs with the
R&D costs and discuss the rationale for expensing R&D costs but capitalizing some software development
costs.
(c) Based on the information provided, when do successful research efforts appear to produce income for The
Bernard?
(d) Discuss how income and equity are affected if The Bernard invests more in software development versus
R&D projects (focus your response on the accounting, and not economic, implications).
(e) Compute net income, return on assets, and return on equity for year 2006 while separately assuming
a. software development costs are expensed as incurred and
b. R&D costs are capitalized and amortized using straight line over the following four years.
(f) Discuss how the two accounting alternatives in € would affect cash flow from operations for The Bernard.
From the desk of Ciptawan 3
