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?
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