Individual Exercise Block 1

November 7th 2011

Please, answer questions a) to g). You have three hours to do so. This exercise can be done,
under normal circumstances, in 90 minutes (half the time) so, no need to hurry/worry
Company ABC was founded in October 2009 to buy and sell high quality widgets. Until
January 2010 it did not started its operations, although in 2009 it was incorporated, it obtained
a loan, it invested in a new building, it incurred in some start up costs and it also purchased
merchandise from one vendor. Its operations are very simple: It buys merchandise on credit,
and it sells it, part on cash, part on credit.
The company does not pay dividends. The accountant has the balance sheets as of December
31st 2009 and December 31st 2010 and the cash account entries. Taxes are 40% of the pre-tax
profit and as of December 31st they were not paid yet.
Please, compute the following items from the P&L:
a)
Revenue from credit sales
b)
Cost of inventory purchased
c)
Cost of goods sold
d)
Depreciation expense
e)
Salaries and other operating expenses
f)
Profit before taxes
g)
Tax expense

Balance Sheet (000 euros)

Cash
Accounts receivable (A/R)
Inventory
Organizational expenses
Equipment, net of depreciation

Accounts payable (A/P)

Salaries and other operating costs payable
Taxes payable
Loan
Capital
Retained earnings

Information from the cash account

Cash Sales
Collection from customers (from sales on credit)
Payment to suppliers
Cash purchases of equipment
Salaries and other operating payments
Repayment of loan

31-12-09
19
10
55
5
25
114

31-12-10
25
15
57
27
124

31-12-09
14
20
80
114

31-12-10
19
5
4
10
80
6
124

2010
81
65
-70
-7
-53
-10

Proposed Solution

November 7th 2011

a) Revenue from credit sales

Accounts receivable have gone from 10 to 15, that is, we have paid less than we should
have. Since we have paid 65 (collected from customers) then it must be that Sales on credit
were 65 + 5 = 70.
More formally: Sales credit = EB - BB + collections = 15 10 + 65 = 70
Please, note that there is an inconsistency (it does not affect the result, however): since
if the company started its operations in January, it should not have any A/R by Dec 2009.
b) Cost of inventory purchased
Lets focus now on A/P, or the account where you keep track of purchase of inventory
and payment to suppliers.
A/P has gone from 14 to 19, an increase of 5. That means that we owe more money than
before, or that we have paid 5 less than we have purchased. Alternatively, we have purchased
more than we have paid. Since we paid 70, we must have purchased 75
c) Cost of goods sold
We need to analyze the inventory account. It went from 55 to 57. So the warehouse
increased by 2. Since we purchased (see previous point) 75, we only sold 73 (the other 2 were
left in the warehouse)
d) Depreciation expense
The net equipment went from 25 to 27. We purchased 7. Since in the net account both
the gross amount and the accumulated depreciation are together, then has to be:
BB (beginning balance) + purchases depreciation = EB (ending balance)
25 + 7 Depreciation = 27 Depreciation = 5
e) Salaries and other expenses
There is an account, Salaries & other Payable which went from 0 to 5. That means
that we owe the workers and others 5. If we owe them 5 is because we paid them less than we
should have. We paid them 53 and, what we should have paid was the expense or 53 + 5 = 58
f) Profit before taxes
There are two ways to compute that. One is to subtract expenses from revenues:
Revenues: Cash sales (81) + Credit sales (70) = 151
Expenses: COGS (73) + Salaries and other (58) + Depreciation (5) + Organizational
expenses (5) = 141
Profit before taxes = Revenues Expenses = 151 141 = 10
(We have expensed all the organizational expenses)
Another way is to work backwards. Since there are no dividends, the difference in retained
Earning, must be the profit after taxes. Retained earnings went from 0 to 6, therefore 6 is the
profit after taxes. For a tax rate of 40%, the profit before taxes must be 10
g) Tax expense
If Profit before taxes is 10, and profit after taxes is 6 then taxes must be 4. Since taxes
were not paid, this result can also be obtained by simply checking the difference in the Tax
Payable account, 4.