Managerial Accounting

Midterm Examinations
SY 2018-2019

Answer the following completely and comprehensively using a SLC Official Examination Booklet
(Bluebook)
You will be graded in each of the questions using the following criteria:
Application of Concepts 5
Correctness of Interpretation of Concepts
to support opinions/allegations 3
Cohesiveness of ideas and essay 2
10

A. .Lenovo has the following financial ratios at the end 2016, 2017 and 2018 vis-à-vis Industry ratios:
Lenovo Industry Lenovo Industry
A. Liquidity Ratios D. Activity Ratios
Current Ratio Average Collection in Days
2018 2.39 2.15 2018 65.0 65.7
2017 2.26 2.09 2017 71.1 66.3
2016 1.91 2.01 2016 83.6 69.2
Acid Test Ratio Payable Turnover in Days
2018 1.00 1.25 2018 22.1 46.7
2017 1.04 1.23 2017 25.4 51.1
2016 1.14 1.25 2016 43.5 48.5
B. Financial Leverage Ratios Inventory Turnover
Debt to Equity Ratio 2018 2.30 3.45
2018 .90 .90 2017 2.44 3.76
2017 .88 .90 2016 2.64 3.69
2016 .81 .89 E. Profitability Ratios
Debt to Total Asset Ratio Gross Profit Margin
2018 .47 .47 2018 27.7 31.1
2017 .47 .47 2017 28.7 30.8
2016 .45 .47 2016 31.3 27.6
C. Coverage Ratios Net Profit Margin
Interest Coverage Ratio 2018 4.1 8.2
2018 3.56 5.19 2017 4.9 8.1
2017 4.35 5.02 2016 9.0 7.6
2016 10.30 4.66 Return on Investment
2018 4.2 9.8
2017 5.0 9.1
2016 9.1 10.8

1. Interpret the ratios vis a vis Industry ratios as to the financial health of Lenovo using
a. Individual ratios(10 pts)
1. Current Ratio
Current Assets are the assets that the firm expects to convert into
cash in the coming year and Current Liabilities represent the
 liabilities which have to be paid in cash in the coming year. The
Company has 1.91, 2.26 and 2.39 current assets to pay for a peso
of current liability for the years 2016, 2017 and 2018 respectively.
The company is highly liquid in years 2017 and 2018 compared to
the industry.

2. Acid Test Ratio

It recognizes that, for many firms, Inventories can be rather
illiquid. If these Inventories had to be sold off in a hurry to meet an
obligation the firm might have difficulty in finding a buyer and the
inventory items would likely have to be sold at a substantial
discount from their fair market value. The quick ratio is a better
indicator of the company's ability to cover its current liabilities
since we're only considering that part of the current assets that is
in cash, or will be converted to cash within the next 90 days.
Company yields us a quick ratio of 1.14,1.04 and 1.00 for years
2016,2017 and 2018, suggesting that Lenovo cannot easily pay off
its current liabilities when compared to Industry’s ratio, trend also
shows the decreasing capability of the firm’s ability to meet its
obligations relying solely on its more liquid Current Asset accounts
such as Cash and Accounts Receivable.

3. Debt to Equity Ratio

This ratio compares the Total Liabilities to the Total Equity of the company. It
paints a useful picture of the company's liability position and is frequently used.
The debt ratio of the company is .90, .88, and 0.81 for the past three years
compared to the industry’s ratio of .90, it indicates that creditors do not overpower
the investments of shareholders in the company . There is still possibility of
incurring future loans of the company to generate additional funds.

4. Debt to Total Asset Ratio

It is a quick indicator of a company's level of indebtedness. The trend means that
during the year, 45-47% of the company’s assets were provided by the creditor.
The company is fairly leveraged compared to the industry. These are liabilities
used to fund the day-to-day working of the company and not traditional debts from
a leverage perspective.

5. Interest Coverage Ratio

Staying above water with interest payments is a critical and ongoing concern for any
company. As soon as a company struggles with the ratio of 3.56, 4.35 and 10.30, it may
have to borrow further or dip into its cash reserve, which is much better used to invest in
capital assets or for emergencies.
 The lower a company’s interest coverage ratio is compared to the industry, the more its
debt expenses burden the company. It is generally considered to be a bare minimum
acceptable ratio for a company and the tipping point below which lenders will likely refuse
to lend the company more money, as the company’s risk for default may be perceived as
too high.
.
6. Average Collection in Days
In general, the higher the Receivables Turnover Ratio the better since this implies
that the firm is collecting on its accounts receivables sooner. Company can expect
to collect its receivables in an average of 65.0, 71.1 and 83.6 days in years 2018,
2017 and 2016 respectively. In comparison to the industry, this means the firm's
management of its Accounts Receivables and, thus, its credit policy is good and
efficient. They have effective discount/ promotions for early payment and credit
terms.

7. Payable Turnover in Days

Payment requirements will usually vary from supplier to supplier, depending on its
size and financial capabilities. A low ratio of 22.1, 25.4 and 43.5 compared to the
industry means there is a relatively long time between purchase of goods and
services and payment for them. A lower accounts payable turnover ratio usually
signifies that a company is slow in paying its suppliers. However, many companies
extend the period of credit turnover

8. Inventory Turnover
The company replaces its inventory 2.30, 2.44 and 2.64 times during the year’s
2018, 2017 and 2016 respectively. This means that the company is unable to move
out its stock speedily. They bought more stocks than what is required for the sales
volume of the company compared to the industry. However, yearly changes in ratio
is indicative of better performance since this indicates that the firm's inventories
are being sold more quickly compared to previous years.

9. Gross Profit Margin

Gross margin is the gross income(or profit) expressed as a percentage of sales (or
revenue). Gross margin of 27.7, 28.7 and 31.3 in three year’s analysis show the
profit margin after direct costs (cost of goods sold) have been taken out of the
sales. The downward trends in the gross margin over time could indicate things
like increasing competition, rising inventory costs, poor pricing,etc.

10. Net Profit Margin

Net Profit margin of the company such as 4.1, 4.9 and 9.0 in the past three years
shows the operating income (or profit) expressed as a percentage of sales (or
revenue). The downward trend of operating margin that cannot be explained by the
gross margin getting worse means that operating expenses have increased over
time without a proportional increase in sales. The next step under such conditions
would be to examine which operating expenses increased and if this increase was
justified, considering the alarming comparison on the industry’s ratio.
11. Return on Investment
ROI of 4.2, 5.0 and 9.1 for years 2018, 2017 and 2016 indicates how much the
shareholders earned on their investment in the company. Compared to the industry, the
low percentage is not a good indicator. The increase in the company’s debt will reduce
its equity base and increase its ROE. The bump in the ROE comes at a price — higher
debt. The Return on Equity Ratio indicates the peso of income earned by the firm on its
shareholders' equity.

b. Combination of ratio within the category (eg. Liquidity ratios) (10 pts)

A. Liquidity Ratios
The Short-term Solvency Ratios of the company compared to industry attempt to
measure the ability of a firm to meet its short-term financial obligations. These
ratios determine that the firm has ability to avoid financial distress in the short-
run.

B. Financial Leverage Ratios

These are also known as debt ratios, the ratio compare the company's debt load to
its net worth. Compared to the industry, the company’s debts are in relation to net
worth, indicated it is fairly leveraged. Leverage, or debt load, also helps us
determine if a company can assume more liability. This also means that company’s
assets are mostly from its investors/ company assets.

C. Coverage Ratios
Coverage ratios are a useful way to help gauge such risks. These relatively below
industry’s ratio determine the company’s ability to service its existing debt,
potentially sparing the investor from heartache down the road.

D. Activity Ratios
Compared to the industry, the company effectively the firm uses/ collects its
accounts receivable. On the other hand, it needs some improvement in using its
inventories, and payment of payables. The activity ratio analysis is being applied
for the measurement of the company’s working capital usage efficiency. Activity
ratios indicate if a firm manages its inventories, cash, receivables and payables
and other assets well.

E. Profitability Ratios
The company’s trend compared the industry reflects decreasing firm's success in
generating income. These ratios reflect the combined effects of the firm's asset
and debt management.

c. Trend Analysis (over time) (10 pts.)

 A. Liquidity Ratios D. Activity Ratios
Current Ratio Average Collection in Days
2018 2.39 0.13 2018 65 -6.1
2017 2.26 0.35 2017 71.1 -12.5
2016 1.91 0 2016 83.6 0
Acid Test Ratio Payable Turnover in Days
2018 1 -0.04 2018 22.1 -3.3
2017 1.04 -0.1 2017 25.4 -18.1
2016 1.14 0 2016 43.5 0
B. Financial Leverage Ratios Inventory Turnover
Debt to Equity Ratio 2018 2.3 -0.14
2018 0.9 0.02 2017 2.44 -0.2
2017 0.88 0.07 2016 2.64 0
2016 0.81 0 E. Profitability Ratios
Debt to Total Asset Ratio Gross Profit Margin
2018 0.47 0 2018 27.7 -1
2017 0.47 0.02 2017 28.7 -2.6
2016 0.45 0 2016 31.3 0
C. Coverage Ratios Net Profit Margin
Interest Coverage Ratio 2018 4.1 -0.8
2018 3.56 -0.79 2017 4.9 -4.1
2017 4.35 -5.95 2016 9 0
2016 10.3 0 Return on Investment
2018 4.2 -0.8
2017 5 -4.1
2016 9.1 0

As can be from the Trend analysis above, it clearly evaluates an organization’s financial
information over a period of time. The increasing amount of current assets signifies the
building up of working capital. The decrease in Accounts receivable collection and
inventories must be tested for quality use. It can be viewed in ratio analysis for their
turnovers. Current assets less current liabilities pertain to working capital. The company
has sufficient working capital for the business to operate smoothly.

In Income statement, the decrease in profitability rations is worth noting. It cautions the
company to go over the cost of its merchandise and ensure that it is controlled as it is
much higher than the increase in its selling price. Expenses have also gone higher hence
decrease in net profit margin. Change in net income and ROI has drastically become
lower. The reason might be the increase in competitors and cheaper substitutes of
products.
 2. Make an action plan for Lenovo to maintain or improve its financial status (10 pts).
The economy is relatively healthy, but history has taught us that growth cycles don’t last
forever. It’s not if there will be an economic downturn — it’s when.

Here are five action items that are critical to middle-market companies for maximizing growth,
profitability, and value — in any economy:

1. Develop a strategic plan, especially thinking to incur additional debts or investments to

increase capital; 2. Grow your customer base to increase sales 3. Make better decisions
through data analytics, as can be observe, recomputed proper pricing as to expenses and
consider new promotion strategies 4. Maximize value when selling inventories. Thus, trying to
improve sales by changing prices and sales promotion, focus on better order management for
purchase of inventory, reduce safety stock and old inventory or reduce purchase quantity.

B. Rodgers Industries Inc. has completed its fiscal year on December 31, 2018. The auditor, Josh
McCoy, has approached the CFO, Aaron Mathews, regarding the year-end receivables and
inventory levels of Rodgers Industries. The following conversation takes place.

Josh: We are beginning our audit of Rodgers Industries and have prepared ratio analyses to determine if
there have been significant changes in operations or financial position. This helps us guide the audit
process. This analysis indicates that the inventory turnover has decreased from 5.1 to 2.7 while the
accounts receivable turnover has decreased from 11 to 7.1. I was wondering if you could explain this
change in operations.

Aaron: There is a little need for concern. The inventory represents computers that we were unable to sell
during the holiday buying season. We are confident however that we will be able to sell these
computers as we move into the next fiscal year.

Josh: What gives you this confidence?

Aaron: We will increase our advertising and provide some very attractive price concessions to move
these machines. We have no choice. Newer technology is already out there and we have to unload the
inventory.

Josh: . . . and the receivables?

Aaron: As you may be aware, the company is under tremendous pressure to expand sales and profits.
As a result, we lowered our credit standards to our commercial customers so that we would be able to
sell products to a broader customer base. As a result of this policy, we have been able to expand sales by
35%.

Josh: Your responses have not been reassuring to me.

Aaron: I’m a little confused. Assets are good, right? Why don’t you look at current ration? It has
improved, hasn’t it? I would think that you would view that very favorably.

1. Why is Josh concerned about the inventory and accounts receivable turnover ratios and Asron’s
responses to them? (10 pts)
Josh is concerned because of the Impact of Decreased Receivable Turnover Ratio . Josh Analysis
indicates that the Accounts Receivable Ratio has decreased from 5.1 to 2.7. This means that
Company now collects his receivables about 2.7 times a year or once every 135 days as
compared to previous data 5.1 times a year or once every 72 days. The receivables turnover
ratio measures a business' ability to efficiently collect its receivables, it only makes sense that a
higher ratio would be more favorable. Higher ratios mean that companies are collecting their
receivables more frequently throughout the year. If a company can collect cash from customers
sooner, it will be able to use that cash to pay bills and other obligations sooner. Higher Ratio is
also important since accounts receivable are often posted as collateral for loans, quality of
receivables is important.

2. What action may Josh need to take? (10 pts)

Actions to be taken by Josh to improve Receivable Turnover Ratio
 Defined Credit Policies: Design and document clear credit policies and encourage
adherence of the same to reduced instances of delays in collection. A frequent revisit
and modification of the policies will help adjust to the new environment.
 Collection Efficiency: Increase efficiency of the collections from debtors; some of it can
be done by a dedicated team force. Insisting for a post-dated cheque, timely reminders
etc. can help in aiding faster collection.
 Offer Discounts For Early Payments: Designing discount structure for debtors who pay
earlier than the credit period sanctioned will motivate some

3. How would you respond to Aaron’s last comment? (10 pts)

Not at all times, It recognizes that, for many firms, Accounts Receivable and
Inventories can be rather illiquid. Cash is not readily available because it
is invested in inventories or it is still uncollected in the form of
receivables.It will always be still subjected to further analysis ,
C. The condensed income statement through income from operations for Dell Inc and Apple Inc.
are reproduced below for recent fiscal years (numbers in millions of dollars)
Dell, Inc. Apple, Inc

Sales (net) 61,494 65,225

Cost of Sales 50,098 39,541
Gross Profit 11,396 25,684
Selling, general and administrative expenses 7,302 5,517
Research and development 661 1,782
Operating expenses 7,963 7,299
Income from operations 3,433 18,385
===== ======

Prepare comparative common sized statements, rounding percentages to one decimal place. (10
pts) Interpret the analyses.(10 pts)