Q1AAP. - Intermediate Accounting (Kieso)

Question

Early in January 2018, Hopkins Company is preparing for a meeting with its bankers to discuss a loan request. Its bookkeeper provided the following accounts and balances at December 31, 2017.

	Debit \(	Credit \)
Cash	\(75,000
Accounts receivable (net)	38,500
Inventory (net)	65,300
Equipment (net)	84,000
Patent	15,000
Notes and Accounts payable		\)52,000
Note payable (due 2019)		75,000
Common stock		100,000
Retained earnings		50,800
	\(277,800	\)277,800

 

Except for the following items, Hopkins has recorded all adjustments in its accounts.

1. Cash includes \(500 petty cash and \)15,000 in a bond sinking fund. 

2. Net accounts receivable is comprised of \(52,000 in accounts receivable and \)13,500 in allowance for doubtful accounts. 

3. Equipment had a cost of \(112,000 and accumulated depreciation of \)28,000. 

4. On January 8, 2018, one of Hopkins’ customers declared bankruptcy. At December 31, 2017, this customer owed Hopkins \(9,000.

Accounting 

Prepare a corrected December 31, 2017, balance sheet for Hopkins Company.

Analysis 

Hopkins’ bank is considering granting an additional loan in the amount of \)45,000, which will be due December 31, 2018. How can the information in the balance sheet provide useful information to the bank about Hopkins’ ability to repay the loan?

Principles 

In the upcoming meeting with the bank, Hopkins plans to provide additional information about the fair value of its equipment and some internally generated intangible assets related to its customer lists. This information indicates that Hopkins has significant unrealized gains on these assets, which are not reflected on the balance sheet. What objections is the bank likely to raise about the usefulness of this information in evaluating Hopkins for the loan renewal?

Step-by-Step Solution

Answer

The balance sheet of the company totals $277,800.

Definition of Financial Analysis

The process of evaluating a business entity or any project from the perspective of finance is known as financial analysis. It uses various figures from the financial statement to determine liquidity, solvency, stability, and profitability.

Balance Sheet

Particular	Amount $	Amount $
Assets:
Current assets
Cash		$58,500
Petty cash		1,500
Accounts receivables	$52,000
Less: Allowance for doubtful account	(13,500)	38,500
Inventory		65,300
Total current assets		163,800
Long-term investment
Bonds sinking fund		15,000
Property, Plant and Equipment
Equipment	112,000
Less: Accumulated depreciation	(28,000)	84,000
Intangible assets
Patent		15,000
Total Assets		$277,800
Liabilities and shareholder’s equity
Current liabilities
Note and Accounts payable		52,000
Non-Current liabilities
Note payable (due 2019)		75,000
Total liabilities		127,000
Shareholders’ equity
Common stock		100,000
Retained earnings		50,800
Total liabilities and shareholder’s equity		$277,800

Analysis

The loan will become due within one year; therefore, the liquidity of the business entity will be used to assess the capacity to make repayment. Thus, the current ratio will be calculated:

$\begin{array}{rcl}\mathbf{Current}\mathbf{ }\mathbf{ratio}& \mathbf{=}& \frac{\mathbf{Current}\mathbf{ }\mathbf{assets}}{\mathbf{Current}\mathbf{ }\mathbf{liabilities}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{163}\mathbf{,}\mathbf{800}}{\mathbf{\$}\mathbf{52}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{3}\mathbf{.}\mathbf{15}\mathbf{ }\mathbf{times}\end{array}$

The current ratio is more than the ideal current ratio two times. Therefore, it can be said that a business entity can repay the loan.

Principles

The business entity has not followed the entire disclosure principle because information relating to unrealized gain is not reported in the company’s financial statement. However, the bank will not object to the usefulness of the information because the bank does not provide loans considering the unrealized gains. Bank evaluates the liquidity and solvency, which is determined using the current and non-current assets and liabilities.