Question

Balance sheet

The balance sheet provides a snapshot of the financial condition of a company. Investors and analysts use the information given on the balance sheet and other financial statements to make several interpretations regarding the company’s financial condition and performance.

Fuzzy Button Clothing Company is a hypothetical company. Suppose it has the following balance sheet items reported at the end of its first year of operation. For the second year, some parts are still incomplete. Use the information given to complete the balance sheets for Fuzzy Button Clothing Company for the years ending December 31, Year 2 and 1, respectively.

Fuzzy Button Clothing Company
Balance Sheet
For the Year ended December 31
	Year 2	Year 1		Year 2	Year 1
Assets			Liabilities and equity
Current assets:			Current liabilities:
Cash and equivalents		$110,700	Accounts payable	$0	$0
Accounts receivable	$50,625	$40,500	Accruals	$7,031	$0
Inventories	$148,500	$118,800	Notes payable	$39,844	$37,500
Total current assets	$337,500	$270,000	Total current liabilities		$37,500
Net fixed assets:			Long-term debt	$140,625	$112,500
Net plant and equipment		$330,000	Total debt	$187,500	$150,000
			Common equity:
			Common stock	$365,625	$292,500
			Retained earnings		$157,500
			Total common equity	$562,500	$450,000
Total assets	$750,000	$600,000	Total liabilities and equity	$750,000	$600,000

Given the information in the preceding balance sheet—and assuming that Fuzzy Button Clothing Company has 50 million shares of common stock outstanding—read each of the following statements, then identify the selection that best interprets the information conveyed by the balance sheet.

Statement #1: Fuzzy Button’s pool of relatively liquid assets, which are available to support the company’s current and future sales, decreased from Year 1 to Year 2.

This statement is   , because:

Fuzzy Button’s total current liabilities balance decreased by $67,500 between Year 1 and Year 2.

Fuzzy Button’s total current liabilities balance increased from $40,500 to $50,625 between Year 1 and Year 2.

Fuzzy Button’s total current asset balance decreased from $337,500 to $270,000 between Year 1 and Year 2.

Fuzzy Button’s total current asset balance actually increased from $270,000 to $337,500 between Year 1 and Year 2.

Statement #2: Over the past two years, Fuzzy Button Clothing Company has relied more on the use of short-term debt than on long-term debt financing.

This statement is   , because:

Fuzzy Button’s total current liabilities increased by $9,375, while its use of long-term debt increased by $28,125.

Fuzzy Button’s total current liabilities decreased by $9,375, while its long-term debt account decreased by $28,125.

Fuzzy Button’s total notes payable increased by $2,344, while its common stock account increased by $73,125.

Statement #3: The book value per share of Fuzzy Button’s stock in Year 2 was $11,250.

This statement is   , because:

The per-share book value is calculated by dividing the company’s total assets by the number of outstanding shares of common stock.

The per-share book value is calculated by dividing the company’s total common equity by the number of outstanding shares of common stock.

The per-share book value is calculated by dividing the company’s total debt by the number of outstanding shares of common stock.

Based on your understanding of the different items reported on the balance sheet and the information they provide, if everything else remains the same, then the cash and equivalents item on the current balance sheet is likely to   if the firm buys a new plant and equipment at a cost of $1 million with liquid capital.

Based on your understanding of the different items reported in the balance sheet and the information they provide, which statement regarding Fuzzy Button Clothing Company’s balance sheet is consistent with U.S. Generally Accepted Accounting Principles (GAAP)?

The company’s assets should be listed from those carrying the largest balance to those with the smallest balance.

The company’s assets should be listed in the order in which they are to be converted into cash.

The company’s assets should be listed in alphabetical order.

Answer 1

Statement # 1 :Fuzzy Button’s pool of relatively liquid assets, which are available to support the company’s current and future sales, decreased from Year 1 to Year 2.

This statement is false, because:

Fuzzy Button’s total current asset balance actually increased from $270,000 to $337,500 between Year 1 and Year 2.

Statement # 2: Over the past two years, Fuzzy Button Clothing Company has relied more on the use of short-term debt than on long-term debt financing.

This statement is false, because:

Fuzzy Button’s total current liabilities increased by $9,375, while its use of long-term debt increased by $28,125.

Statement # 3: The book value per share of Fuzzy Button’s stock in Year 2 was $11,250.

This statement is false, because:

The per-share book value is calculated by dividing the company’s total common equity by the number of outstanding shares of common stock.

Based on your understanding of the different items reported in the balance sheet and the information they provide, which statement regarding Fuzzy Button Clothing Company’s balance sheet is consistent with U.S. Generally Accepted Accounting Principles (GAAP)?

The company’s assets should be listed in the order in which they are to be converted into cash.