Question

To provide a consistent frame of reference for the company’s financial statements and ratios, assume that the following balance sheet and income statement reflect the company’s pre-transaction condition and performance.

Phoenix Golf Club Co.’s Pre transaction Statement of Financial Condition

Cash	$15,000	Accounts payable	$20,000
Marketable securities	10,000	Wages payable	20,000
Accounts receivable	470,000	Taxes payable	10,000
Inventory	500,000	Notes payable	50,000
Prepaid expenses	5,000	Total current liabilities	100,000
Total current assets	1,000,000	Long-term debt	500,000
		Total liabilities	600,000
Gross plant and equipment	1,500,000	Common stock	150,000
Accumulated depreciation	500,000	Capital paid in excess of par	350,000
Net plant and equipment	1,000,000	Retained earnings	900,000
		Total equity	1,400,000
Total assets	$2,000,000	Total debt and equity	$2,000,000

Phoenix Golf Club Co.’s Pre transaction Statement of Financial Performance
Sales	$5,000,000
Less: Cost of goods sold¹	2,000,000
Gross profit	3,000,000
Less: Operating expenses	600,000
Operating profit (EBIT)	2,400,000
Less: Interest expense²	33,000
Earnings before taxes (EBT)	2,367,000
Less: Tax expense³	828,450
Net income	$1,538,550

¹Cost of goods sold equals 40% of sales.

²Interest expense equals 6% of the combined notes payable and long-term debt balances.

³The average federal and state tax rate is 35%.

Indicate if any of the listed financial statement accounts is affected by the following business transactions and whether the listed ratios will increase, decrease, or remain unchanged as a result of the transaction. (Hint: Assume that the business transaction occurs exactly as stated without interpreting it further. Do not consider any related transactions that may occur before or after the specified transaction. Assume there are 365 days in a year.)

Business Transaction 1

Phoenix Golf Club Co. (PGC) sells 25,000 shares of new common stock ($1 per share par value) to new and existing shareholders for $20 per share.

Financial Account	Check if the Account Is Affected by the Specified Transaction
Cash
Operating income
Long-term debt
Common stock
Capital paid-in excess of par

Financial Ratio	Ratio’s Behavior
Inventory turnover
Debt ratio
Times interest earned
Operating profit margin
Basic earnings power
Current ratio

Business Transaction 2

Phoenix Golf Club Co. (PGC) switches from holding an available inventory to a just-in-time inventory system, thereby reducing its inventory by 80.00%.

Financial Account	Check if the Account Is Affected by the Specified Transaction
Inventory
Accounts payable
Prepaid expenses
Total assets
Common stock

Financial Ratio	Ratio’s Behavior
Average collection period
Inventory turnover
Fixed assets turnover
Quick ratio
Return on assets
Debt ratio

Answer 1

Business Transaction 1
Financial account	Account is affected or not
Cash	Yes, it will increase by $ 500,000
Operating income	No, it will not be affected
Long term debt	No, it will not be affected
Common stock	Yes, it will increase by $ 25,000
Capital paid-in excess of par	Yes, it will increase by $ 475,000
Financial Ratio	Ratio’s Behavior
Inventory turnover	Not affected
Debt ratio	Yes, it will decreased
Times interest earned	Not affected
Operating profit margin	Not affected
Basic earnings power	Affected, it will decrease
Current ratio	Not affected

Business Transaction 2
Financial account	Account is affected or not
Inventory	Yes, it will decrease
Accounts payable	Not affected
Prepaid expenses	Not affected
Total assets	Yes, it will decrease
Common stock	Not affected
Financial Ratio	Ratio’s Behavior
Average collection period	Not affected
Inventory turnover	Yes, it will increase
Fixed assets turnover	Not affected
Quick ratio	Not affected
Return on assets	affected, it will increase since funds will be less block in working capital
Debt ratio	Not affected