340_Answers_to_Assignment_3_Fall_2023

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Lansing Community College *

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Apr 3, 2024

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1 Accounting 340: Howard Bunsis Answers to Assignment 3: Fall 2023 10-7 Fair value given 11,000,000 Less Fair value of assets - Liab (11.7-1.7) 10,000,000 Goodwill 1,000,000 Db. AR 1,100,000 Db. Land 1,500,000 Db. PPE 7,900,000 Db. Patent 1,200,000 Db. Goodwill 1,000,000 Cr. AP 1,700,000 Cr. Cash 11,000,000 Assets 1,700,000 Liabilities 1,700,000 Equity 0 Revenues 0 Expenses 0 Net Income 0 10-9 Period Int Expense Liability 0 $18,782.87 1 $1,878.29 $20,661.16 2 $2,066.12 $22,727.27 3 $2,272.73 $25,000.00 Db. PPE (18783 + 5000) 23,783 Cr. Note Payable 18,783 Cr. Cash 5,000 Assets 18,783 Liabilities 18,783 Equity 0 Revenues 0 Expenses 0 Net Income 0

2 10-14 Db. PPE - New 260,000 Db. Accum Depre. 220,000 Cr. PPE - Old 400,000 Cr. Cash 60,000 Cr. Gain 20,000 10-15 Db. PPE - New 230,000 Db. Accum Depre. 220,000 Db. Loss 10,000 Cr. PPE - Old 400,000 Cr. Cash 60,000 10-14 10-15 Assets 20,000 (10,000) Liabilities 0 0 Equity 20,000 (10,000) Revenues 20,000 0 Expenses 0 10,000 Net Income 20,000 (10,000)

3 10-18 Fair value of old land 72,000 Cash given 14,000 RQ 1: FV Old + cash given 86,000 RQ 2 (yes, commercial substance): Db. Land - New (FV given + cash paid) 86,000 Cr. Land - old 30,000 Cr. Cash 14,000 Cr. Gain 42,000 Get: 86,000 Give 44,000 Gain 42,000 RQ 3 (lacks commercial substance): Db. Land - new (BV old + cash given) 44,000 Cr. Land - old 30,000 Cr. Cash 14,000 RQ 4 (lacks commercial substance): Db. Land - New (BV old - cash + gain) 26,250 Db. Cash 9,000 Cr. Land Old 30,000 Cr. Gain 5,250 Gain: (FV given - BV given( * (cash received / Total FV) (72,000 - 30,000) * (9,000/72,000) A portion of the 42,000 is the gain (42000/8) RQ 2 RQ 3 RQ 4 Assets 42,000 0 5,250 Liabilities 0 0 0 Equity 42,000 0 5,250 Revenues 42,000 0 5,250 Expenses 0 0 0 Net Income 42,000 0 5,250

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4 10-24 1/1/24 600,000 100.0% 600,000 3/31/24 1,200,000 75.0% 900,000 6/30/24 800,000 50.0% 400,000 /9/30/24 600,000 25.0% 150,000 12/31/24 400,000 0.0% 0 Total WAE 2,050,000 Construction loan interest capped 1,500,000 8.00% 120,000 WAE - construcditon loan (2,050,000 - 1.5M) 550,000 10.50% 57,750 Total interest capitalized 177,750 Since 177,750 is much less than total interest (840,000 + 120,000), we cap 177,750 Other debt: Debt issue 1 5,000,000 12.0% 600,000 Debt issue 2 3,000,000 8.0% 240,000 Totals 8,000,000 840,000 Average rate (840,000 / 8,000,000) 10.50% 11-1 Straight Line Cost 33,000 Salvage Value 3,000 Depreciable Base 30,000 Number of years 5 Annual depreciation expense 6,000 11-11 Year Book Value at Beginning of Year Depreciation Rate per Year Depreciation Expense Accumulated Depreciation Book Value at End of Year 1 33,000 0.40 13,200 13,200 19,800 2 19,800 0.40 7,920 21,120 11,880 3 11,880 0.40 4,752 25,872 7,128 4 7,128 0.40 2,851 28,723 4,277 5 4,277 1,277 30,000 3,000 Total 30,000 1277 = 30,000 - 13,200 - 7920 - 4752 - 2851

5 11-11 Year of sale depreciation: Base 126,000 Salvage value 30,000 Depreciable Base 96,000 Number of years 8 Annual depreciation expense 12,000 Partial year (2/12 for March 1) 2,000 Db. Depreciation Expense 2,000 Cr. A/D 2,000 Accumulated Depreciation: Year 1 (6 months) 6,000 Year 2 12,000 Year 3 12,000 Year 4 12,000 Year 5 12,000 Partial year of sale 2,000 Total A/D 56,000 Original Cost 126,000 Total A/D 56,000 Book Value at sale 70,000 RQ 2 cash received 58,000 BV Given 70,000 Loss for RQ 2 (12,000) RQ 3 cash received 80,000 BV Given 70,000 Gain for RQ 3 10,000 RQ 2 entry Db. Cash 58,000 Db. A/D 56,000 Db. Loss 12,000 Cr. PPE 126,000 RQ 3 entry Db. Cash 80,000 Db. A/D 56,000 Cr. PPE 126,000 Cr. Gain 10,000 Dep Exp RQ 2 RQ 3 Assets (2,000) (12,000) 10,000 Liabilities 0 0 0 Equity (2,000) (12,000) 10,000 Revenues 0 0 10,000 Expenses 2,000 12,000 0 Net Income (2,000) (12,000) 10,000

6 3a Southwest 2022 2021 2020 Profit Margin 2.3% 6.2% -34.0% Asset Turnover 0.66 0.45 0.30 Return on Assets 1.50% 2.76% -10.16% Sales 23,814 15,790 9,048 Average Total Assets 35,845 35,454 30,242 Asset Turnover 0.664 0.445 0.299 Net Income 539 977 (3,074) Average Total Assets 35,845 35,454 30,242 Return on Assets 1.50% 2.76% -10.16% Total assets 2022 35,369 Total assets 2021 36,320 Total Assets 2020 34,588 Total Assets 2019 25,895

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7 Step 1: • Profit margin of 2.3% was lower than 6.2% of 2021, but much higher than -34.0% of 2020. • Average profit margin for the industry was -1.7%, so LUV was ahead of that in 2022 • Profit margin of 2.3% is lower than the overall profit margin for all firms of 11.4% Step 2: Why did profit margin decrease from +6.2% in 2021 to +2.3% in 2022? • The big reason that profit margin declined was due to Payroll support, which was an income item of 18.7% of sales in 2021 to 0.0% of sales in 2022. This hurt profit margin • Fuel went from 21.0% of sales in 2021 up to 25.1% of sales in 2022, hurting profit margin. • Items that made profit margin go up: o Salaries went from 49.0% of sales in 2021 to 39.4% of sales in 2022, making profit go up o Fuel increased from 21.0% of sales in 2021 to 25.1% of sales in 2022 o Maintenance went from 5.4% of sales in 2021 to 3.6% of sales in 2022 o Landing fees went from 9.2% of sales in 2021 to 6.3% of sales in 2022 Step 2: Why did profit margin change from -34.0% in 2020 to +6.2% in 2021? • Salary expense went from 75.3% of sales in 2020 to 49.0% of sales in 2021. • Payroll support increased from 10.7% of sales in 2020 to 18.7% of sales in 2021. • Landing fees went from 13.7% of sales in 2020 to 9.2% of sales in 2021 Step 2: Why did profit margin change from +10.3% in 2019 to -34.0% in 2021? • Salary expense went from 37.0% of sales in 2019 to 75.3% of sales in 2020. This was a huge change that reduced profit margin • Payroll support went from 0.0% of sales in 2019 to 10.7% of sales in 2020. This helped profit margin. Another way to look at payroll support: Notice that in 2020 and 2021, net salary expense was much lower as a percent of sales. Step 3: You had to use the note from the MD&A, page 64, which revealed why sales changed: • Easing of negative impacts of covid led to increases in leisure travel • Increase in revenue per available seat mile • Increase in load factor Southwest Common Size Amounts in Millions 2022 2021 2020 2019 2022 2021 2020 2019 Total revenues 23,814 15,790 9,048 22,428 100.0% 100.0% 100.0% 100.0% Salaries 9,376 7,743 6,811 8,293 39.4% 49.0% 75.3% 37.0% Payroll support 0 (2,960) (967) 0 0.0% -18.7% -10.7% 0.0% Fuel 5,975 3,310 1,849 4,347 25.1% 21.0% 20.4% 19.4% Maintenance 852 854 750 1,223 3.6% 5.4% 8.3% 5.5% Landing fees 1,508 1,456 1,240 1,363 6.3% 9.2% 13.7% 6.1% Depreciation 1,351 1,272 1,255 1,219 5.7% 8.1% 13.9% 5.4% Other operating expen 3,735 2,394 1,926 3,026 15.7% 15.2% 21.3% 13.5% Total operating expens 22,797 14,069 12,864 19,471 95.7% 89.1% 142.2% 86.8% Operating income 1,017 1,721 (3,816) 2,957 4.3% 10.9% -42.2% 13.2% Other expenses 289 396 440 0 1.2% 2.5% 4.9% 0.0% Income before taxes 728 1,325 (4,256) 2,957 3.1% 8.4% -47.0% 13.2% Income tax (benefit) e 189 348 (1,182) 657 0.8% 2.2% -13.1% 2.9% Net Income 539 977 (3,074) 2,300 2.3% 6.2% -34.0% 10.3% % Change in sales 50.8% 74.5% -59.7% 2022 2021 2020 2019 2022 2021 2020 2019 Salary expense 9,376 7,743 6,811 8,293 Payroll support 0 (2,960) (967) 0 Net Salary expense 9,376 4,783 5,844 8,293 39.4% 30.3% 64.6% 37.0%

8 • Notice how the profit margin would have been much worse without the payroll support in 2021 and 2020 • The profit margin would not have changed for 2022 and 2019 The percentage changes are not relevant here; all that matters is that the level of 2022 sales were higher than in 2019, so it took from 2019 to 2022 to recover from the pandemic in terms of total revenues. • For the first table, the assets are not too old, as less than 50% is used up. • From the 2 nd table, they had backlogs of purchases that appeared in 2022. For f(i), sales went down and up much more than the changes in load factor For f(ii), in 2022, the price increase was much more than inflation, after being less than inflation in 2021 and 2020 For f(iii), the changes in fuel prices were huge; the changes per the common size statement were very small, suggesting Southwest was able to use derivatives to smooth out the price to them. 3c 2022 2021 2020 2019 Profit margin without support 2.3% -12.6% -44.7% 10.3% Profit margin with support 2.3% 6.2% -34.0% 10.3% 3d. 2022 2021 2020 2019 Levels 23,814 15,790 9,048 22,428 3e. 2022 2021 PPE at Cost 30,984 27,574 Accumulated depreciation 13,642 12,732 PPE, Net 17,342 14,842 % used up (Acc Dep/PPE at Cost) 44.0% 46.2% 2022 2021 2020 Capital Expenditures 3,924 505 515 Depreciation and Amortization 1,351 1,272 1,255 Cap Exp / Dep + Amort 2.90 0.40 0.41 3f.i Load factor is the % of seats filled 2022 2021 2020 2019 Load Factor 83.4% 78.5% 52.4% 83.5% Change in load factor 4.9% 26.1% -31.1% % change in sales 50.8% 74.5% -59.7% 3fii 2022 2021 2020 2019 Passenger fares 169.12 141.92 141.72 154.98 % Change 19.2% 0.1% -8.6% Inflation 6.5% 7.0% 1.4% 2.3% 3fiii 2022 2021 2020 2019 Fuel cost per gallon: 3.10 1.98 1.45 2.09 % Change 56.6% 36.6% -30.6% Fuel per common size 25.1% 21.0% 20.4% 19.4% Very small changes per the common size, but huge per operating stats This is because Southwest uses hedges to lock in the price of fuel

9 You had to mention the yearly profit margins and sales % changes for Southwest: It is puzzling why LUV did so poorly vs. the S&P in 2021. -80.0% -60.0% -40.0% -20.0% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0% 2022 2021 2020 % change in sales Change in load factor 3g. Delta American Southwest S&P 500 Stock Price end of 2019 57.80 28.57 52.46 3,230.78 Stock Price end of 2020 40.01 15.77 45.62 3,756.07 Stock Price end of 2021 38.89 17.96 41.93 4,766.18 Stock Price 12/31/2022 32.70 12.72 32.95 3,839.50 Stock Price 9/27/2023 36.56 12.61 26.81 4,274.51 2020 % Return -30.8% -44.8% -13.0% 16.3% 2021 % Return -2.8% 13.9% -8.1% 26.9% 2022 % Return -15.9% -29.2% -21.4% -19.4% 2023 % return 11.8% -0.9% -18.6% 11.3% 2020 net of S&P -47.0% -61.1% -29.3% 2021 net of S&P -29.7% -13.0% -35.0% 2022 net of S&P 3.5% -9.7% -2.0% 2023 net of S&P 0.5% -12.2% -30.0% Profit Margin % Change in Sales 2020 -34.0% -59.7% 2021 6.2% 74.5% 2022 2.3% 50.8% 6 months 2023 4.1% 11.6% Bonus Southwest American Delta 2022 Operating Rev per ASM 16.04 18.82 21.69 Operating Exp per ASM 15.36 18.20 20.12 Difference 0.68 0.62 1.57 Difference as % of Rev 4.2% 3.3% 7.2% 2021 Operating Rev per ASM 11.96 16.05 17.07 Operating Exp per ASM 10.66 14.98 14.40 Difference 1.30 1.07 2.67 Difference as % of Rev 10.9% 6.7% 15.6% It appears as if LUV has an edge in 2021 but not 2022

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