91Ó°ÊÓ

Pratsky, Inc., had the following account balances:During 2000 , the corporation had the following transactions: 1\. Issued common stock for \(\$ 40,000\) cash. 2\. Purchased inventory on account; 200 units \(@ \$ 38\), then 150 units \(@ \$ 39\) Note: Beginning inventory was comprised of 500 units @ \$35. 3\. Purchased 200 shares of IBM for \(\$ 45 /\) share and purchased 100 shares of \(\mathrm{Mi}\) crosoft for \(\$ 90 /\) share 4\. Sales at retail during 2000 were \(\$ 75,000\) (half received in cash, and the balance on account 5\. Write-offs of uncollectible accounts totaled \(\$ 2,600\). 6\. Received 38,000 dollars from receivable customers. 7\. Paid creditors on account, \(\$ 18,000\). Paid operating expenses for the current period of 51,000 dollars 8. At year-end, a physical inventory equaled 225 units.The company uses the LIFO inventory costing method. 9\. Assume that marketable securities are "available-for-sale," and the market price at December \(31,2000,\) for \(\mathrm{IBM}\) is \(\$ 42 / \mathrm{share},\) and for Microsoft 102 dollars share 10. Based on the accounts receivable aging, management feels that the allowance for uncollectible accounts should have a balance of \(\$ 5,700\) at year end.a. Set up the beginning balances in the balance sheet equation. Leave enough room to add new columns as necessary. b. Record transactions 1 through 10 using the balance sheet equation. c. Calculate the following ratios for 1999 and 2000 and evaluate the company's management of its accounts receivable:Accounts receivable/sales (assume that sales in 1999 were \(\$ 125,786\) ) Sales/day Collection period Allowance as a percentage of accounts receivable.

Step by step solution

01

Set up the beginning balances

Let's start by setting up the beginning balances in the balance sheet equation: Assets = Liabilities + Owner's Equity

02

Record transactions

Record the given transactions 1 through 10 using the balance sheet equation. Firstly, add \$40,000 to the Owner's Equity section for the issuance of common shares. Then, add the cost of purchased inventory (200 units @ \$38 & 150 units @ \$39) and decrease by the cost of sold inventory using LIFO method. Next, we'll add the cost of IBM and Microsoft shares to the Assets section. Record the sales amount of \$75,000 and divide it equally into Cash and Accounts Receivable. Subtract \$2,600 from Allowance for bad debts and increase the Accounts Receivable by \$38,000 representing payments from customers. Paid amounts to creditors and for running expenses are subtracted from the asset section. Adjust the inventory and marketable securities value, and finally, adjust the Allowance for bad debts to \$5,700 at year end.

03

Calculate financial ratios for 1999 and 2000

Calculate the accounts receivable to sales ratio, sales per day, collection period and allowance as a percentage of accounts receivable using the provided formulae and final balance sheet figures.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Balance Sheet Equation

The Balance Sheet Equation forms the backbone of financial accounting. It's simply expressed as: \( \text{Assets} = \text{Liabilities} + \text{Owner's Equity} \). This equation must always balance, reflecting that a company's resources (assets) are financed by debts and equity. Understanding it is crucial for analyzing a company’s financial health.

Imagine starting a business. The money you inject is equity, and if you take a loan, it becomes a liability. Together, they fund your assets, like office equipment or inventory. This perpetual balance is maintained by recording every transaction twice. For example, issuing stock increases both cash (an asset) and equity.

• Adding cash from stock issues boosts both assets and equity.
• Buying inventory on credit increases both assets (inventory) and liabilities (accounts payable).
• Selling goods increases assets (cash/accounts receivable) and decreases inventory within assets.

Keeping these principles in mind can help you record financial transactions accurately, maintaining the balance.

LIFO Inventory Method

The Last In, First Out (LIFO) inventory method assumes the last items purchased are the first to be used or sold. Companies use this method to match recent costs against current revenues, especially in times of rising prices.

Let's say Pratsky, Inc., bought inventory at different prices over the year. With LIFO, when they sell 600 units, they'll count the most recent ones first (150 units @ $39, then 200 units @ $38). By applying LIFO, they might show lower profits on financial statements because newer inventory is more expensive.

• Useful in inflationary times to save on taxes by showing lower profits.
• Can result in outdated inventory costs on the balance sheet.
• Requires meticulous tracking of inventory layers.

While LIFO affects reported profits and tax liabilities, businesses must consider financial visibility and tax strategies when choosing it.

Accounts Receivable Management

Effectively managing accounts receivable is essential to ensure steady cash flow in any business. Accounts receivable represent money owed to the company by its customers for sales made on credit.

At Pratsky, Inc., managing receivables involved decisions about write-offs and adjustments for uncollectible accounts. They received payments worth \( \\(38,000 \) and decided on a \( \\)5,700 \) allowance for doubtful accounts. This strategic management helps maintain liquidity and reduce bad debts risks.

• Monitor customer creditworthiness to avoid defaults.
• Set realistic credit terms and payment periods.
• Regularly assess and adjust the allowance for uncollectibles.

Good receivables management ensures that the company can pay its bills and invest in growth without straining cash reserves.

Financial Ratios Calculation

Financial ratios are vital tools for assessing a company’s financial performance and health. They provide insights into aspects like liquidity, profitability, and solvency.

For Pratsky, Inc., ratios might include the accounts receivable to sales ratio, which indicates how effectively they're collecting cash from sales. The collection period tells how long it takes to collect cash after a sale, highlighting the efficiency of accounts receivable management.

• Accounts receivable to sales ratio = (Accounts Receivable / Sales) x 100.
• Average collection period = (365 / (Sales / Accounts Receivable)).
• Allowance as a percentage of accounts receivable = (Allowance for Doubtful Accounts / Total Receivables) x 100.

By leveraging these ratios, companies can hone their financial strategies, ensuring sustainable growth and solvency.