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Homework answers / question archive / Q13) II) Inventory business analysis (10 points) The inventory footnote to the annual report of Ballistic Brothers & Co

Q13) II) Inventory business analysis (10 points) The inventory footnote to the annual report of Ballistic Brothers & Co

Business

Q13) II) Inventory business analysis (10 points)

The inventory footnote to the annual report of Ballistic Brothers & Co. reads in part as follows:

Because of continuing high demand throughout the year, inventories were unavoidably reduced and could not be replaced. Under the LIFO system of accounting, used for many years by Ballistic Brothers & Co., the net effect of all the inventory changes was to increase pretax income by $900,000 over what it would have been had inventories been maintained at their physical levels at the start of the year.

The price of Ballistic Brothers & Co.'s merchandise purchases was $26 per unit during the year, after having risen erratically over past years. Ballistic Brothers & Co.'s inventory positions at the beginning and the end of the year appear below:

Date Physical Count of Inventory LIFO Cost of Inventory January 1st 200,000 units ?December 31st 150,000 units $600,000

Answer the following questions:

11. What was the average cost per unit of the 50,000 units removed from the January st inventory? (5 points)

 

2. What was the January 1st LIFO cost of inventory? (5 points)

 

III. Accounting for bonds (25 points)

On January 1, 1985, First National Bank (FNB) acquired $10 million of face value bonds issued on that date by Metro Area Inc. The bonds carried 12 percent annual coupons and were to mature 20 years from the issue date. Metro Area Inc. issued the bonds at par.

By 1990, Metro Area Inc. was in severe financial difficulty and threatened to default on the bonds. After much negotiation with FNB (and other creditors), it agreed to repay the bond issue but only on less burdensome terms. Metro Area Inc. agreed to pay 5 percent per year, i.e., annually, for 25 years and to repay the principal on January 1, 2015, or 25 years after the negotiation. FNB will receive $500,000 every year starting January 1, 1991, and $10 million on January 1, 2015.

By January 1, 1990, Metro Area Inc. was being charged 20 percent per year, compounded annually, for its new long-term borrowings.

Remember that the theoretical present value factor of an ordinary annuity is: (PV annuity, n years, i%) = 1-(1+i)-n i and answer the following questions:

1. At what value is Metro Area's bond recorded on FNB's balance sheet before the renegotiations? (Hint: FNB holds the bond as an investment and values the investment at present value. The accounting treatment of this investment in Metro Area's bond mirrors the treatment of the bond in Metro Area's balance sheet.) (5 points)

 

2. Determine the value of the bonds that FNB holds at the time of renegotiations using the market interest rate at the time of initial issue, 12 percent, compounded annually. In other words, what is the present value of the newly promised cash payments discounted at Metro Area's historical borrowing rate? (5 points)

 

3. Consider two accounting treatments for this negotiation (called a "troubled debt restructuring" by the FASB in its Statement of Financial Accounting Standards No. 114). (10 points)

Scenario a: Write down the bonds to the value computed in part 2, and base future interest revenue computations on that new book value and the historical interest rate of 12 percent per year, compounded annually.

 

 

 

 

Scenario b: Make no entry to record the negotiation, and record interest revenue as the amount of cash, $500,000, that FNB receives annually.

 

 

4. Which of the two methods listed in 3 best reflects the economic events that take place during and after the debt restructuring? Can you think of a third method to record the effect of the renegotiations? (5 points)

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