19.Vista Corporation, producer of computer software packages, began operations on January 1. It acquired financing from the issuance of common stock for $60,000,000 and long-term debt for $80,000,000. At the beginning of business operations, Vista produced the following projected income statement and balance sheet for the first year. All amounts are in thousands.
Vista Corporation
|
Projected Income Statement
|
First Year of Operations
|
Sales
|
|
$100,000
|
Expenses:
|
|
|
Warranty
|
$10,000
|
|
Depreciation
|
40,000
|
|
Research
|
20,000
|
70,000
|
Operating income before bonus
|
|
$ 30,000
|
Bonus
|
|
3,000
|
Operating income
|
|
$ 27,000
|
Interest expense
|
|
7,000
|
Income before taxes
|
|
$ 20,000
|
Income taxes (40%)
|
|
8,000
|
Net income
|
|
$ 12,000
|
|
|
|
Vista Corporation
|
Projected Balance Sheet
|
December 31 of First Year
|
Assets:
|
|
Cash
|
$ 30,000
|
Accounts receivable
|
24,000
|
Net computers
|
158,000
|
Total assets
|
$212,000
|
Liabilities &Shareholders' Equity:
|
|
Accounts payable
|
$ 50,000
|
Warranty payable
|
10,000
|
Long-term debt
|
80,000
|
Common stock
|
60,000
|
Retained earnings
|
12,000
|
Total liabilities and shareholders' equity
|
$212,000
|
|
|
The new president is rather disappointed with these projected results having just quit a job of which his compensation package was $4,000,000. After examining the forecasts of a bonus of only $3,000,000, the president decides to use his knowledge of financial statements to modify his bonus. He meets with the company's CFO the next day to see what could be done. He suggested the following possibilities that would boost the first year's income:
1.Slash research and development expenditures, which are paid in cash, from $20 million to $10 million.
2.Double the estimated life of the computers, which will decrease depreciation expense from $40 million to $20 million. Because identical accounting procedures are used for taxes, no deferred taxes will be generated. Taxes require immediate payment.
3.Reduce estimated warranty expense from 10% of sales to 7% of sales.
4.Any resultant change in the bonus of 10% of operating income before the bonus will be paid to the president in cash.
A.Adjacent to the income statement for Year 1, create a new statement using the alternative accounting procedures and operating decisions.
B.Compare the president’s compensation if the changes in part A are enacted with his current compensation. What are the ramifications of these changes on the future?
20.On December 31, 2010, Cocoa Incorporated had total liabilities of $80,000 and total shareholders' equity of $100,000, resulting in a debt/equity ratio of 0.80 before executive bonus expense is recognized. During 2010, Cocoa’s CEO earned a 5% bonus on net income before bonus of $100,000. If Cocoa pays the bonus due its CEO on December 31, 2010, what is Cocoa’s debt/equity ratio after the bonus expense and what related liability is recognized?