Sunteți pe pagina 1din 6

PMBA 8020

Module 7 Solutions
M7-9
a. Accounts Payable, $110,000 (current liability).
b. Not recorded as a liability; an accounting transaction has not yet occurred because Heller did
not receive the drill press before year-end.
c. Liability for Product Warranty, $2,200 (current liability).
d. Bonuses Payable, $30,000 (current liability)computed as $600,000 5%. This liability must
be reported because the bonus relates to operating results of 2014.
M7-12
a. The information indicates that Bristol-Myers Squibb has debt maturing in 2013 and 2014,
$648 million and $27 million respectively. The company has no debt scheduled to mature in
2015. Bristol-Myers Squibb will either make these payments in 20113 and 2014 with
operating cash flows or it will have to issue more debt (refinance), or sell stock to pay the
debt in full.
b. Bristol-Myers Squibbs debt maturity schedule indicates near-term maturities that will require
cash payments. This information is important to analysts as they determine the companys
liquidity and solvency. Analysts may review the companys recent operating cash-flows to
determine how much of its operating cash flow would be required to pay-off the debt if
Bristol-Myers Squibb cannot refinance the debt. Repayment out of operating cash flows may
divert cash needed for operating activities or alternative investment opportunities. With this
information, analysts can better determine whether or not there is a concern about the
companys liquidity and solvency.

E7-23
a. Total expected failures from units sold (70,000 0.02)...........................................
Average cost per failure ..........................................................................................
Total warranty expense for the current period.........................................................

1,400
$125
$175,000

b. Total expected failures from units sold (70,000 0.02)...........................................


Units repaired during the period ..............................................................................
Expected units left to be repaired............................................................................
Average cost per failure ..........................................................................................
Total warranty liability at end of current period ........................................................

1,400
1,000
400
$125
$ 50,000

At the end of the current period, Waymire will have a product warranty liability of $50,000
related to current period sales. This amount will cover the expected $125 repair costs of the
additional 400 units expected to fail in the next period.
c. The warranty liability should be equal, at all times, to the expected dollar cost of future
repairs. A key analysis issue is whether the warranty liability exists and, if so, is it at the
correct amount. Computing the warranty-expense-to-sales ratio (common-size warranty
expense) will enable a comparative analysis over several periods. We must recognize that
understating (overstating) the accrual overstates (understates) current-period income at the
expense (benefit) of future income. This provides managers the opportunity to set up a
cookie jar reserve for warranties.

E7-24
1. Neither record nor disclose (the loss is not probable, nor reasonably possible).
2. Record a current liability for the note. At the financial statement date, record a liability for any
interest that has been incurred since the note was signed.
3. Disclose in a footnote (the loss is reasonably possible but the amount cannot be estimated).
4. Record warranty liability on the balance sheet and recognize an expense in the income
statement (costs are probable and reasonably estimable).

E7-29
a. Credit rating companies such as the four NRSROs listed, typically utilize financial ratios that
measure liquidity and solvency (and sometimes profitability). Liquidity is measured with
ratios like the current ratio, quick ratio, that we discuss in Module 4, and various operatingcash-flow-to-liabilities ratios. Solvency is measured using financial leverage, debt to equity,
times interest earned, and various cash-flow-to-financial-payment ratios.
b. When credit rating agencies increase a companys rating, it implies they view the company
as less risky with respect to the probability of default and bankruptcy. As a result, lenders
may accept a lower rate of interest to reflect the reduced risk. Ford reports that its debt fell
below investment grade in 2005 and 2006, meaning that institutional investors were
precluded from investing in debt issued by that company. In its 2010 10-K, Ford reports that
Ford Credit's higher credit ratings have provided it more economical access to the
unsecured debt markets. Although the company as a whole remains below investment
grade as of the date of its 2010 year-end, the companys financial picture is improving and,
consequently, its access to credit is increasing and the cost of that credit is declining.
c. To improve its credit ratings, Ford must improve its liquidity and solvency and/or reduce its
debt payments (by reducing its debt level). All of these actions, while serving to improve its
credit ratings, entail certain costs that Ford must seriously consider. For example, increasing
liquidity by reducing inventories or foregoing capital expenditures can impact Fords sales
and competitive position. Likewise, reducing debt by issuing equity is costly because equity
capital is usually more expensive (due to the subordinated position of equity investors vis-vis creditors and also the non-deductibility of dividends for tax purposes). In sum, Ford must
carefully weigh the costs and benefits of various actions it can undertake to increase its
credit ratings.

P7-39
a. The total face amount of the long-term debt reported on Dells February 1, 2013 balance
sheet is $5,242 million.
From the last paragraph of the footnote, we see that the scheduled maturities of this
indebtedness are: $1,617 million in 2014, $1,465 million in 2015, $790 million in 2016, $400
million in 2017, $0 million in 2018, and $2.5 billion, thereafter.
Analysts monitor these scheduled maturities amounts coming due over the next few years.
Excessive payments required in any one year might present a cash flow problem if the debt
cannot be refinanced. Such information can also be useful in forecasting cash flows.
b. It is rarely the case that companies interest expense and interest payments are the same.
The difference arises from the amortization of any discounts or premiums on the debt
recall, interest expense is equal to cash paid plus discount amortization (or less premium
amortization). As second explanation is that Dell might have capitalized (added to the
balance sheet as a long-term asset) some of the interest incurred during the year.
c. Credit rating agencies assess companies default risk by gauging the level of debt in relation
to the companies operating cash flow and total assets. This is because cash flow is the
primary source of repayment of the bonds and because assets serve as a secondary source
(collateral) in the event of default. Credit rating agencies also look at profitability ratios and
the ratios for long-term creditworthiness (see the Appendix to Module 4). This credit
analysis would also focus on the market conditions for Dells product and services and
compare all metrics to close competitors.

d. The market value of these notes is $300 million 0.695 = $208.5 million.
The difference between the current trading price of $208.5 million and its face amount of
$300 million is $91.5 million. We know that notes are reported at historical cost (face value
less unamortized discount, or plus unamortized premium). The current market value of the
notes is, therefore, not reflected in the balance sheet.
If Dell were to repurchase these notes, the $91.5 million difference would be reported as a
pre-tax gain in the current income statement. This is because Dell would pay market value
to repurchase the notes, which is less than the notes carrying value on Dells balance
sheet.
Since these notes have declined in value subsequent to their issuance, market interest rates
must have increased. Another possibility is that Dells credit rating has deteriorated while the
interest rates have remained unchanged (or a combination of these two factors).

e. The table generally reveals the following relation: the longer the time to maturity, the higher
the yield. Typically, there is an increasing relation between the term period of the debt and
its yield. This is a general relation that exists in the market. The higher yields compensate
investors for having their money tied up for longer periods of time, resulting in increased
collection (credit quality) risk and increased inflation (loss of purchasing power) risk.

MA7-51
Failure to abide by bond covenants can result in serious consequences. Ensuring that the
company has complied with such restrictions is an important area of corporate governance.
Companies can utilize internal and external auditing to monitor compliance. The board of
directors must also be aware of the possibility of earnings management in order to avoid default
on bond covenants. As the possibility of default increases, so does managements desire to
avoid default by whatever means it can, including earnings management.

S-ar putea să vă placă și