Problem 4 - Accounting

Question

Balance sheet data for Santa Fe Tile Company on December 31 , the end of the fiscal year, are as follows: \begin{tabular}{lrr} & \multicolumn{1}{c}{2006} & \multicolumn{1}{c}{2005} \\ \hline Current assets & \(\$ 260,000\) & \(\$ 200,000\) \\ Property, plant, and equipment & 500,000 & 450,000 \\ Intangible assets & 40,000 & 50,000 \\ Current liabilities & 170,000 & 150,000 \\ Long-term liabilities & 210,000 & 200,000 \\ Common stock & 50,000 & 50,000 \\ Retained earnings & 370,000 & 300,000 \end{tabular} Prepare a comparative balance sheet for 2006 and 2005 , stating each asset as a percent of total assets and each liability and stockholders' equity item as a percent of the total liabilities and stockholders' equity. Round to two digits after the decimal place.

Step-by-Step Solution

Answer

Current assets increased as a percentage of total assets from 2005 to 2006, while intangible assets decreased.

Step 1: Calculate Total Assets for Each Year

First, we need to find the total assets for both 2006 and 2005. This is the sum of current assets, property, plant, and equipment, and intangible assets.For 2005:\[ \text{Total Assets} = \text{Current Assets} + \text{Property, Plant, and Equipment} + \text{Intangible Assets} = 200,000 + 450,000 + 50,000 = 700,000 \]For 2006:\[ \text{Total Assets} = \text{Current Assets} + \text{Property, Plant, and Equipment} + \text{Intangible Assets} = 260,000 + 500,000 + 40,000 = 800,000 \]

Step 2: Calculate Total Liabilities and Stockholders' Equity

Next, calculate the total liabilities and stockholders' equity for each year. This includes current liabilities, long-term liabilities, common stock, and retained earnings.For 2005:\[ \text{Total Liabilities and Stockholders' Equity} = 150,000 + 200,000 + 50,000 + 300,000 = 700,000 \]For 2006:\[ \text{Total Liabilities and Stockholders' Equity} = 170,000 + 210,000 + 50,000 + 370,000 = 800,000 \]

Step 3: Compute Each Item as a Percentage of Total Assets for 2005

Use the total assets of 2005 to find each asset as a percentage of total assets, and each liability and equity item as a percentage of total liabilities and equity. Round each percentage to two decimal places.\[ \text{Current Assets} = \left(\frac{200,000}{700,000}\right) \times 100 \approx 28.57\% \]\[ \text{Property, Plant, and Equipment} = \left(\frac{450,000}{700,000}\right) \times 100 \approx 64.29\% \]\[ \text{Intangible Assets} = \left(\frac{50,000}{700,000}\right) \times 100 \approx 7.14\% \]\[ \text{Current Liabilities} = \left(\frac{150,000}{700,000}\right) \times 100 \approx 21.43\% \]\[ \text{Long-term Liabilities} = \left(\frac{200,000}{700,000}\right) \times 100 \approx 28.57\% \]\[ \text{Common Stock} = \left(\frac{50,000}{700,000}\right) \times 100 \approx 7.14\% \]\[ \text{Retained Earnings} = \left(\frac{300,000}{700,000}\right) \times 100 \approx 42.86\% \]

Step 4: Compute Each Item as a Percentage of Total Assets for 2006

Repeat the percentage calculation for 2006 using its total assets.\[ \text{Current Assets} = \left(\frac{260,000}{800,000}\right) \times 100 = 32.50\% \]\[ \text{Property, Plant, and Equipment} = \left(\frac{500,000}{800,000}\right) \times 100 = 62.50\% \]\[ \text{Intangible Assets} = \left(\frac{40,000}{800,000}\right) \times 100 = 5.00\% \]\[ \text{Current Liabilities} = \left(\frac{170,000}{800,000}\right) \times 100 = 21.25\% \]\[ \text{Long-term Liabilities} = \left(\frac{210,000}{800,000}\right) \times 100 = 26.25\% \]\[ \text{Common Stock} = \left(\frac{50,000}{800,000}\right) \times 100 = 6.25\% \]\[ \text{Retained Earnings} = \left(\frac{370,000}{800,000}\right) \times 100 = 46.25\% \]

Step 5: Summarize the Comparative Balance Sheet

Now summarize the results in a comparative balance sheet format. Use the previously calculated percentages to display each item relative to total assets, total liabilities, and stockholders' equity for both 2005 and 2006.\[\begin{array}{|c|c|c|}\hline& \text{2006} & \text{2005} \\hline\text{Current Assets} & 32.50\% & 28.57\% \\text{Property, Plant, and Equipment} & 62.50\% & 64.29\% \\text{Intangible Assets} & 5.00\% & 7.14\% \\hline\text{Current Liabilities} & 21.25\% & 21.43\% \\text{Long-term Liabilities} & 26.25\% & 28.57\% \\text{Common Stock} & 6.25\% & 7.14\% \\text{Retained Earnings} & 46.25\% & 42.86\% \\hline\end{array}\]

Key Concepts

Balance Sheet Analysis

Balance sheet analysis is a crucial part of understanding a company's financial health. It involves evaluating the components of the balance sheet to determine the business's financial position at a specific point in time. By examining the balance sheet, we can assess a company's liquidity, leverage, and financial flexibility.

One of the primary ways to analyze a balance sheet is through ratio analysis. This involves calculating various financial ratios that reveal different aspects of the company's performance. For instance, the current ratio (current assets divided by current liabilities) indicates liquidity. It shows if the company can meet its short-term obligations.

Another important metric to consider is the debt-to-equity ratio. This measures a company's financial leverage and indicates the balance between debt and equity in financing the company’s assets. An extremely high ratio might suggest that the company is at risk of being over-leveraged, but it can also indicate aggressive growth strategies.

Analyzing trends in these ratios over time can provide valuable insights into a company’s stability and growth conditions.

Financial Statement Preparation

Preparing financial statements like the balance sheet involves several systematic steps to ensure accuracy and compliance with accounting standards. These statements provide a snapshot of the company’s financial condition at the end of a given period.

The process begins with gathering and organizing financial data. This includes transactions, adjustments, and other financial events from the fiscal period. All this information is recorded in journals and ledgers, which are then used to create trial balances.

Once all entries are accurately documented, accountants adjust entries for any accrued or prepaid items. These adjustments are essential for matching revenue with expenses in the period they occur. This process ensures compliance with the accrual basis of accounting.

After adjusting entries are completed, the final trial balance is prepared. From this, the income statement is drawn up to reflect profitability, and then the balance sheet is created. The balance sheet's task is to outline the financial position by showing the assets, liabilities, and shareholders' equity.

Assets and Liabilities Accounting

Understanding assets and liabilities is fundamental to mastering balance sheets. Assets are resources owned by a company that have economic value and can be converted into cash. Liabilities, on the other hand, represent obligations that the company must fulfill in the future.

Assets are typically categorized into current and non-current types. Current assets include cash, inventories, and accounts receivable, which can be turned into cash within a year. Non-current assets are long-term resources like property, equipment, and intangible items such as patents. Each asset type plays a different role in generating revenue and supporting operations.

Liabilities are also classified into current and non-current categories. Current liabilities, such as accounts payable, are due within a short period, often a year. Non-current liabilities include longer-term commitments like bonds payable or mortgage obligations. Managing these appropriately is crucial for ensuring long-term financial stability.

Proper accounting treatment of assets and liabilities affects the accuracy of financial statements. This accounting ensures that a company's financial position is fairly represented, which aids investors and managers in making informed decisions.