Microline Insurance Company Case Study Essay

1. Is there any evidence that management’s bonuses caused it to enter into any transactions, especially at year-end, that may not have been in the shareholder’s interest? I first need to understand the way managements bonuses are calculated. Per the notes, at the end of the year, Microline’s executives share equally in a bonus, which is equal to 25% of the dollar amount by which the corporation’s net income exceeds 10% of the shareholder’s equity dollar amount at the beginning of the year. To determine if the bonuses cause any conflicts, I must calculate what those bonuses were and to do that I will look to the balance sheet.

The shareholder’s equity for 2013 is $22,500 and I arrived at that figure by adding retained earnings and paid in capital of $12,500 and $10,000 respectively. The net income for 2014 is $3,250. As per their bonus structure, 10% of the shareholder’s equity would be $2,250 and net income exceeds that amount by $1,000 so their bonus would be $1,000*25% or $250. One transaction that Microline had entered at the end of 2014 was the sale of land and the realization of a $1,500 gross profit. Adjusted for their effective tax rate that would be a net gain of around $990.

This amount boosted the net income for the year. Had they not sold this land their bonus structure would have looked like this; the net income for 2014 would have been $2,260. As per their bonus structure, 10% of the shareholder’s equity would be $2,250 and net income exceeds that amount by $10 so their bonus would be $10*25% or $2. 5. So, we can see that transaction greatly affected the way their bonus was calculate and because of that, retained earnings are $247. 50 lower that they would be otherwise and this directly affects the shareholders interest.

The shareholders would have had almost 25% more in retained earnings from 2013 to 2014 had that land not been sold when it had been. 2. Has the debt covenant imposed any restrictions that may have influenced any of management’s reporting choices? As per the notes we know that on November 12, 2014 Microline signed a 90 day note payable in the amount of $4,000. On December 31st 2014 the note was classified as long term because they intend to refinance it indefinitely. Microline also signed a long term note in the amount of $3,000.

This is a 10 year note with an interest rate of 8% and requires the company to maintain a current ratio of greater than 1. 0 over the 10-year life. To determine if management was influenced, I will first calculate the current ratio for both 2013 and 2014. The following equations are for both years Total current assets for 2014 were $16,500 Total current liabilities were $13,000. 2014 current ratio is 1. 27 Total current assets for 2013 were $11,750 Total current liabilities were 12,500 2013 current ratio was .

4 If Microline would have been unable to enter that loan agreement in 2013, because their current ratio would have been too low. Because the current ratio has two components; total current assets and total current liabilities, I will look at the balance sheet and the notes to see what transactions would have affected either of those numbers. In the notes, Microline indicates that the 90 day note payable that was entered on Nov 12, 2014 was converted into a long-term note. By doing this the company lowered their current liability number and would able to keep their current ratio above 1. to comply with the terms of the 10-year loan. Having to maintain a current ratio above 1 influenced management decision to restructure a debt obligation from short-term to long-term.

3. What was the acquisition price of Littleton when it was purchased by Microline? Microline acquired Littleton and has goodwill of $5,250 for both 2013 and 2014 year’s end. This would mean that the goodwill amount of $5,250 was the excess that Microline paid above the $7,500, the net fair-market-value of Littleton’s assets and liabilities at the time, and would mean that the total purchase price is $12,750. . Is Microline’s bad debt allowance sufficient? To determine if Microline’s bad debt allowance is sufficient I will examine the income statement and the attached notes. The notes indicate that bad debt allowance is calculated as a percentage of sales and all sales are made on credit. The company’s bad debt allowance was $400 for Dec 31st 2014 and $350 for Dec 31st 2013. We can see that 2013 sales were $52,500, so the bad debt allowance of $350 was . 7%. Sales for 2014 sales were $60,000 so bad debt allowance of $400 was the same as 2013 at . 7%.

From the income statement, we can see that bad debt expenses were $350 and $250 for 2013 and 2014 respectively. Microline’s bad debt allowance is sufficient, but they do have a substantial increase in accounts receivables from 2013 to 2014, so the need to maintain vigilance over that bad debt amount. They might even be carrying some bad debt in the Account Receivables numbers, but there is no way to be sure unless we had access to their journal reports. 5. How much cash was received by Ellery Inc during 2014, and what percentage of Ellery’s total income was paid out in the form of dividends?

To solve this problem, we must understand the equity method of accounting for this investment. Since Microline has a 40% stake in Ellery, they can claim 40% of Ellery’s reported income, but because of the rules of equity accounting for an investment, they must also allocate back any dividend received from Ellery from the investment book value at the end of the year. We know that in 2013 Ellery reported $1,000 in income and paid $400 in dividends. Microline could report 40% of the $1,000 or $400, but must account for their $40% or $160 in dividends received.

The difference in the two numbers is $240 and would be included in the 2013 year-end book value of the investment. This would indicate that they paid $4,760 in the beginning of 2013 for Ellery and the addition of the income (minus dividends) that occurred during 2013 would total the $5,000 listed on the balance sheet for 2013. For the year 2014 we see the amount of $1,250 listed on the Other Gaines(Losses) chart under the heading Income from Affiliate. We already know that the carry over amount for the end of 2014 is $6,000 and the difference from that and 2013 is $1,000.

Because Microline received $1,250, or 40% of Ellery’s income as listed on the other gains and losses sheet as income from affiliate, at first appearance this would means that Ellery must have received $3,125 in cash in 2014. However, there is a notation of an unrealized revaluation of equity investment listed on the statement of cashflows and accounted for in total for net cash from operating activities of $250. It hasn’t been accounted for in the 2014 ending book value of investment in affiliate, but it has been notated as part of the shareholders’ equity.

Microline must had revaluated the investment and determined that Ellery’s income was higher As of now the undistributed affiliate income on the cash flow statement for 2014 is $1,000 so that amount would include the subtracted dividend amount of the difference between the $1,250 listed as income and the $1,000 listed as undistributed making the dividend $250. The total cash received by Ellery(without accounting for the unrealized amount) by equation $1,2507. 4 or $3,125. Having this information, I can now calculate the total dividends paid out of $250/. or $625. The percentage of total income paid out in the form of dividend is $625/$3,125 or 20% However, if that unrealized revaluation of $250 becomes realized that would then change the equation to $1,500/. 4 and would mean that Ellery earned $3,750 and the total dividends paid out of $250/. 4 or $625 would be the same but, the percentage of total income paid out in the form of dividend is $625/$3,750 or 16. 7% 6. How much cash was collected from customers during 2014?

To calculate this I must take the sales 2014 $60,000 and identify the Accounts receivables(net) for both years and adjust for any bad debt in 2014. Total account receivables were $5,700 and $3,650 for 2014 and 2013 respectively. I will then find the difference from the two $5,700- $3,650 to get $2,050. I also see that there was a notation for bad debt in the amount of $250. I now need to subtract this increase in accounts receivables from total sales to get $60,000-$2,050 = $57,950 and then subtract the bad debt amount $57,950-$250 to get $57,700. The total cash collected from customers in 2014 was $57,700.