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Chapter 1 Case：Assume that Ada has recently become a certified public accountant, (CPA) and opens his own accounting practice. Because this business has a single owner, it is called a proprietorship.We now consider 5 events and analyze each in terms of its effect on the accounting equation of Adas accounting practice. Transaction analysis is the essence of accounting.Transaction 1 Ada invests $50,000 of his money to begin the business. Specifically, he deposits $50, 000 in a bank account. The effect of this transaction on the accounting equation is:Assets = Liabilities + Owners Equity Cash = + Adas Capital 1. +$50,000 = + $50,000 The amount on the left side of the equation must equal the amount on the right side for every transaction. The first transaction increases both the assets (in the ease, cash) and the owners equity of the business (Ada, capital). The transaction involves no liabilities of the business because it creates no obligation for Ada to pay an outside party. To the right of the transaction we write “owner investment” to keep track of the reason for the effect on owners equity.Transaction 2 Ada purchases land for a future office location, paying cash of $40, 000. The effect of this transaction on the accounting equation is:Assets = Liabilities + Owners Equity Cash + Land = + Adas Capital $50,000 $50,000 -$40,000 +$40,000 2. $10,000 $40,000 $50,000The cash purchase of land increases one asset, land, and decreases another asset, cash, by the same amount. After the transaction is completed, Adas business has cash of $10,000, land of $40,000, no liabilities, and owners equity of $50,000. Note that the sums of the balances on both sides of the equation are equal. This equality must always exit.Transaction 3 Ada buys stationary and other office supplies, agreeing to pay $500 within 30 days. This transaction increases both the assets and the liabilities of the business. Its effect on accounting equation is:Assets = Liabilities + Owners Equity Cash + Supplies + Land = Payable + Adas Capital $10,000 $40,000 $50,000 +$500 +$500 3. $10,000 $500 $40,000 $500 $50,000The asset affected is office supplies, and the liability is called an account payable. The term payable signifies a liability. Because Ada is obligated to pay $500 in the future but signs no formal promissory note, we record the liability as an account payable, not as a note payable.Transition 4 Ada earns service revenue by providing professional accounting services for his clients. Assume he earns $5, 500 and collects this amount in cash. The effect on the accounting equation is an increase in the asset cash and an increase in Ada, capital, as follows:Assets = Liabilities + Owners Equity Cash + Supplies + Land = Payable + Adas Capital $10,000 $500 $40,000 $500 $50,000 +$5,500 +$5,5004. $15,000 $500 $40,000 $500 $55,000This revenue transaction causes d the business to grow, as shown by the increase in total assets and in total liabilities plus owners equity. A company that sells goods to customers is a merchandising business. Its revenue is called sales revenue. By contrast, Ada performs services for clients, such revenue is called service revenueTransaction 5 Ada performs service for a client who does not pay immediately. In return for his accounting service, Ada receives the clients promise to pay the $3, 000 amounts within one month. This promise is an asset to Ada, an account receivable because he expects to collect the cash in the future. In accounting, we say that Ada performed this service on account. When the business performs service for a client or customer, the business earns revenues regardless of whether it receives cash immediately or expects to collect cash later. Ada records an increase in the assets accounts receivable and an increase in owners equity as follow:Assets = Liabilities + Owners Equity Cash + Receivables +supplies +lands = Payable + Adas Capital $15,000 $500 $40,000 $500 $55,500 +$3,000 + $3,0005. $15,500 $3,000 $500 $40,000 $500 $58 ,500Chapter 10 Case:This case will compare the calculating variable and absorption costing profits, and will highlight the differences between the two techniques.X Company manufactures a single product, details of which are as follows:Per unit $Selling price 180.00Direct materials 40.00Direct labor 16.00Variable overheads 10.00Annual fixed production overheads are budgeted to be $1.6 million and Big Woof expects to produce 1,280,000 units of the Bark each year. Overheads are absorbed on a per unit basis. Actual overheads are $1.6 million for the year. Budgeted fixed selling costs are $320,000 per quarter. Actual sales and production units for the first quarter of 20XX are given below:January-March Sales 240,000Production 280,000 There is no opening inventory at the beginning of January. Prepare statements of profit or loss for the quarter, using: variable costing and absorption costingSolution: Calculate the overhead absorption rate per unitRemember that the overhead absorption rate is based only on budgeted figures.Budgeted fixed overheadOverhead absorption rate =Budgeted units Budgeted overheads (quarterly) $1.6 million4= $400,000Also be careful with your calculations. You are dealing with a three month period but the figures in the question are for a whole year. You will have to convert these to quarterly figures.Budgeted production (quarterly) 1,280,0004= 320,000unitsOverhead absorption rate per unit $400,000320,000= $1.25 per unitCalculate total cost per unitTotal cost per unit (absorption costing) = Variable cost + fixed production cost = (40 + 16 + 10) + 1.25 = $67.25Total cost per unit (variable costing) = Variable cost per unit = $66Calculate closing inventory in unitsClosing inventory = Opening inventory + production salesClosing inventory = 0 + 280,000 240,000 = 40,000 unitsCalculate under/over absorption of overheadsThis is based on the difference between actual production and budgeted production.Actual production = 280,000 unitsBudgeted production = 320,000 units Under-production = 40,000 unitsAs X Company produced 40,000 fewer units than expected, there will be an under absorption of overheads of 40,000 $1.25 = $50,000. This will be added to production costs in the statement of profit or loss.Chapter 11 Case:ABC Company is a company that produces different models of decorative lamps for households. Estimated fixed costs for the year 20X7 are $120 000. Variable costs of new model of lamps are total $10 per unit. The proposed price for the sale of a unit is $30. The companys relevant range is between 2 000 units and 10 000 units.Required:Calculate the Degree of operating leverage when units sold were 2 000, 4 000, 6 000,8 000 and 10 000.Key:Calculation the Degree of Operating Leverage for Marry ABC Company Units Sold 2 0004 000 6 0008 00010 000Sales revenue ($30 per unit)$60 000$120 000$180 000$240 000 $300 000Less: Variable costs ($10 per unit)20 00040 00060 000 80 000100 000Contribution margin 40 00080 000 120 000160 000200 000Less: Fixed cost120 000120 000120 000120 000120 000Net income($80 000) ($40 000)0$40 000$80 000Degree of operating leverage-0.5-2042.5When sales increase form 8 000 to 10 000, there is a 25% increase in sales volume (10 000 - 80 000)/8 000. The 25% increase in sales produces a 100% increase in net income 25%*4 (the degree of operating leverage) = 100%. You can also note that the corresponding increase in net income (80 000 - 40 000)/40 000 represents 100%. The next increase of 25% in sales volume produces a 62.5% increase in net income 25%*2.5 (the degree of operating leverage) = 100%.Chapter 12 Case:LCH manufactures product X which it sells for $5 per unit. Variable costs of production are currently $3 per unit, and fixed costs 50c per unit. A new machine is available which would cost $90,000 but which could be used to make product X for a variable cost of only $2.50 per unit. Fixed costs, however, would increase by $7,500 per annum as a direct result of purchasing the machine. The machine would have an expected life of four years and a resale value after that time of $10,000. Sales of product X are estimated to be 75,000 units per annum. LCH expects to earn at least 12% per annum from its investments. Ignore taxation. You are required to decide whether LCH should purchase the machine.Solution:Savings are 75,000 * ($3 $2.50) = $37,500 per annum.Additional costs are $7,500 per annum.Net cash savings are therefore $30,000 per annum. (Remember, depreciation is not a cash flow and must be ignored as a “cost”.)The first step in calculating an NPV is to establish the relevant costs year by year. All future cash flows arising as a direct consequence of the decision should be taken into account. It is assumed that the machine will be sold for $10,000 at the end of year 4.Year Cash flow PV factor 12% PV of cash flow$ $0 (90,000) 1.000 (90,000)1 30,000 0.893 26,7902 30,000 0.797 23,9103 30,000 0.712 21,3604 40,000 0.636 25,440NPV = +7,500The NPV is positive and so the project is expected to earn more than 12% per annum and is therefore acceptable.Chapter 13 Risk and ReturnCase:Karen Kay, a portfolio manager at Collins Asset Manager, is using the capital asset pricing model for making recommendations to her clients. Her research department has developed the information shown in the following exhibit.Forecast Return, Standard Deviations, and BetasForecast ReturnStandard DeviationBetaStock X14.0%36%0.8Stock Y17.0251.5Market index14.0151.0Risk-free rate 5.0a. Calculate expected return and alpha for each stock.Expected ReturnAlphaStock X5% + 0.8 (14% - 5%) = 12.2%14.0% - 12.2% = 1.8%Stock Y5% + 1.5 (14% - 5%) = 18.5%17.0% - 18.5% = -1.5%b. Identify and justify which stock would be more appropriate for an investor who wants to i. add this stock to a well-diversified equity portfolio. ii. Hold this stock as a single-stock portfolio.i. Kay should recommend Stock X because of its positive alpha, compared to Stock Y, which has a negative alpha. In graphical terms, the expected return/risk profile for Stock X plots above the security market line (SML), while the profile for Stock Y plots below the SML. Also, depending on the individual risk preferences of Kays clients, the lower beta for Stock X may have a beneficial effect on overall portfolio risk.ii. Kay should recommend Stock Y because it has higher forecasted return and lower standard deviation than Stock X. The respective Sharpe ratios for Stocks X and Y and the market index are:a. Stock X:(14% - 5%)/36% = 0.25b. Stock Y:(17% - 5%)/25% = 0.48c. Market index:(14% - 5%)/15% = 0.60d. The market index has an even more attractive Sharpe ratio than either of the individual stocks, but, given the choice between Stock X and Stock Y, Stock Y is the superior alternative.e. When a stock is held as a single stock portfolio, standard deviation is the relevant risk measure. For such a portfolio, beta as a risk measure is irrelevant. Although holding a single asset is not a typically recommended investment strategy, some investors may hold what is essentially a single-asset portfolio when they hold the stock of their employer company. For such investors, the relevance of standard deviation versus beta is an important issue.Chapter 14 Case:ABC, Inc., has equity with a market value of $20 million and debt with a market value of $10 million. The cost of the debt is 14 percent per year. Treasury bills that mature in one year yield 8 percent per year, and the expected return on the market portfolio over the next year is 18 percent. The beta of ABCs equity is .90. The firm pays no taxes. a. What is ABCs debt-equity ratio? b. What is the firms weighted average cost of capital? c. What is the cost of capital for an otherwise identical all-equity firm?Answer：a. A firms debt-equity ratio is the market value of the firms debt divided by the market value of a firms equity. So, the debt-equity ratio of the company is: Debt-equity ratio = MV of debt / MV of equity Debt-equity ratio = 10,000,000 / 20,000,000Debt-equity ratio =0.50 b. We first need to calculate the cost of equity. To do this, we can use the CAPM, which gives us: RS = RF + bE(RM) RF RS = 0.08 +0 .90(0.18 0.08) RS = 0.17 or 17% In the absence of taxes, a firms weighted average cost of capital is equal to: RWACC = B / (B + S)RB + S / (B + S)RS RWACC = (10,000,000/30,000,000)(0.14) + (20,000,000/30,000,000)(0.17) RWACC = 0.16 or 16% c. According to Modigliani-Miller Proposition II with no taxes: RS = R0 + (B/S)(R0 RB) 0.17 = R0 + (0.50)(R0 0.14) R0 =0 .16 or 16.% This is consistent with Modigliani-Millers proposition that, in the absence of taxes, the cost of capital for an all-equity firm is equal to the weighted average cost of capital of an otherwise identical levered firm.Chapter 15 Case: Ray, the owner of a small company asked Harris, CPA, to conduct an audit of the companys records. Ray told Harris that an audit was to be completed in time to submit audited financial statements to a bank as part of a loan application. Harris immediately accepted the engagement and agreed to provide an auditors report within three weeks. Ray agreed to pay Harris a fixed fee plus a bonus if the loan was granted.Harris hired two accounting students to conduct the audit and spent several hours telling them exactly what to do. Harris told the students not to spend time reviewing the controls but instead to concentrate on proving the mathematical accuracy of the ledger accounts, and summarizing the data in the accounting records that support Rays financial statement. The students followed Harris instructions and after two weeks gave Harris the financial statements, which did not include footnotes. Harris reviewed the statements and prepared an unqualified auditors report. The report did not refer to accounting standards nor to the year-to-year application of such priciples.Required: Briefly describe each of the Auditing standards and indicate how the action (s) of Harris resulted in a failure to comply with each standard.Solution:(1) General GAAS StandardsThe three general standards of GAAS relate to the personal integrity and professional qualifications of auditors. Three of the five concepts of auditing theory providing the primary framework for the general standards are ethical conduct, independence, and due audit care. The other two evidence and fair presentation are related to other standards.The postulates most closely related to the three general standards are potential conflicts of interest (the social environment dictates this postulated a potential conflict of interest always exists between the auditor and the management of the enterprise under audit); exclusively an auditor (when examining financial data for the purpose of expressing an independent opinion thereon, the auditor acts exclusively in the capacity of an auditor); and professional obligations (the professional status of the independent auditor imposes commensurate professional obligations, one important facet of this idea is that auditors have responsibilities both to the clients who hire them and to outsiders who use the financial statements and the audit report).(2) GAAS Field Work StandardsThe concept of due audit care is particularly evident in the first of the field standards. Adequate planning and proper supervision are indications of care, and their absence is an indication of careless work.The fourth of the auditing concepts is evidence. Evidence was defined earlier as consisting of “all those in