The financial statements of XYZ Corporation - Essay Example

The financial statements of XYZ Corporation REQUIREMENT 1 The defined contribution plan is a type of pension plan whereby the employer and the employee both contribute to the fund in a defined manner. Basically, employers are the one who establish the plan and are responsible to make their contributions (Retirement Plan Basics, n.d. retrieved 08.09.06). The contribution on the part of employers happens to be a defined amount and may differ with the salary of the employees. The employees’ contribution to the plan comprises fixed deductions from their salary (Building Your Retirement Funds, 2006). The contribution that can be deductible by the employer must not exceed 25% of employee’s total compensation (Green, n.d., retrieved 07.09.06). The employer receives a tax deduction equaling his contribution in the employee’s defined contribution plan. The employees benefit from deduction of contribution from pre-tax salary, which enables them to save taxes and fund the retirement plan with the gross amount. The tax continues to be deferred until the plan is distributed and therefore there remain opportunities for fast investment growth (Building Your Retirement Funds, 2006). The advantages for defined contribution plan are that this plan allows the employees to save the tax payments until the plan is withdrawn, employees also benefit from employer contribution into the fund, the employees will have the opportunity after the retirement to either receive the entire amount or a series of payment over their entire life etc. The major advantage for employer underlying this plan is that it enables him to evade the risk on investment and also the burden of plan contribution is shared between the employer and the employees. Its major disadvantage is the complexity and strictness of the rules concerning the plan administration (Employer-Sponsored Retirement Plans, 2005). Being the one who establishes the pension plan, an employer is expected to administer it and meet its requirements. The employer will monitor and supervise the investment poured into the plan and review the growth of funds. Moreover, he is also required to provide periodical information to the employees concerning the operation and status of the invested funds (Retirement Plan Basics, n.d. retrieved 08.09.06) The contribution on the part of employer is limited to a maximum of $40,000 or 25% of the employees’ compensation whereas, for the year 2006, the contribution by employees has been defined as limited to 100% of his compensation up to the maximum of $15,000 (Green, n.d., retrieved 07.09.06). The distribution from a defined contributed plan is not allowed whilst the employee is still working. However, when this distribution takes place, it is taxed as an ordinary income. The Internal Revenue Service states the minimum age limit for pension plan distribution as 70-1/2 years, from which the employees should start withdrawing the funds. The distribution is not allowed before the employees reach the age of 59-1/2. If it is done, the investment would be subjected to an early-withdrawal penalty of 10% (Retirement Planning, 2006). The financial statements of XYZ Corporation should include a statement of net assets available for benefits at the end of the plan year. Moreover, the company also needs to present a statement of changes in net assets available for the benefits at the same time. Also, the GAAP requires the financial statements to be prepared under the accrual basis so as to ease the evaluation of plan assets composition (Defined Contribution Pension Plans, 2005). REQUIREMENT 2 Type Of Tax-Book Difference The discrepancies in the rules and principles set down for financial reporting and tax accounting lead to significant differences in the tax amounts shown in financial statements and the tax returns. These differences are known as the book-tax differences, which are further classified as either temporary or permanent tax differences (Michel, 2005). Permanent tax difference originates when an income or expense amount needs to be recognized by any of the two methods but not by both of them simultaneously. An example of these income and expense figures includes stock option compensation and tax-free municipal bonds interests. The tax accounting rules require the stock option compensation to be recorded as an expense in the tax returns, whereas there is no such financial reporting requirement under the US GAAP. Similarly, the tax-free municipal bonds interest is recognized in the company’s income under GAAP, but not in the pre-tax income shown in the tax returns (Michel, 2005). Temporary tax differences appear when an income or expense needs to be recognized under the tax and financial reporting systems altogether. The most significant example for this type of difference is the use of different methods of depreciation for financial reporting and tax purposes. The tax rules allow the companies to utilize the accelerated depreciation method for tax benefits, whereas GAAP does not require the companies to use this method. Under both the methods, the amount of annual depreciation differs that leads to temporary tax differences, however the total depreciation expense remains the same (Michel, 2005). The difference in the tax and book depreciation of XYZ Corporation has arisen because of the discrepancies in depreciation expense for financial reporting and tax purposes. Hence, this type of tax-book difference happens to be temporary. Journal Entry The journal entry for the tax difference along with the necessary computations is shown below: Account Debit Credit Income Tax Expense $10,050 Deferred Tax Liability $350 Taxes Payable $11,400 Computation: Book Tax Net Loss ($50,000) ($50,000) Depreciation Expense 17,000 26,000 Taxable Income (Loss) (67,000) (76,000) Tax- 15% 10,050 11,400 Impact On XYZ Corporation’s Financial Statements Income Statement Balance Sheet Current Liabilities Taxes Payable $11,400 Non-Current Liability Deferred Tax Liability (350) Expenses Assets-Liabilities (10,050) Income Tax Expense $10,050 Equity Net Profit (Loss) (10,050) Retained Earnings (10,050) The above entry for recording of tax difference has affected the company’s income statement as well as the balance sheet considerably. The increase in tax expense by $10,050 has led to a net loss by the same amount in the company’s income statement. The two portions of balance sheet i.e., the current and non-current liabilities have also been affected by this entry. The current year’s tax payable has caused an increase in the company’s current liabilities whereas the reduction in deferred tax liability due to excess of tax depreciation over the book depreciation has led to a decline in the company’s deferred tax liability. The retained earnings section is also showing a decline owing to the net loss of $10,050. REQUIREMENT 3 Ratio calculations on excel spreadsheet Financial Analysis Of XYZ Corporation An analysis of the income statements of XYZ Corporation for two years shows that there has been a hike in the company’s net sales by about 10% in the current year. The cost of sales has also declined showing a positive impact on the gross profit, which increased by 27%. The selling and administrative expenses have risen by about 9% as compared to the previous year. Consequently, the corporation’s income statements show a drastic increase in the net income by about 272%. Hence, all in all, it can be said that the company has shown a significant improvement in its financial performance in the current year as compared to the prior year. The following ratio analysis will further gauge and depict the company’s financial position and performance with respect to its various stakeholders. Ratios Current Year Previous Year Current Ratio 3.51 3.39 Acid-test Ratio 2.12 2.05 Cash to debt ratio 0.10 0.11 Times interest earned 3.73 1.67 Cash to debt coverage 0.10 0.06 Book value per share 1 1 Receivable turnover 3.49 3.37 Inventory turnover 1.73 1.93 Asset turnover 0.71 0.73 Profit margin on sales (Gross) 52.63% 45.51% Rate of return on assets 7.71% 2.33% Earnings per share (EPS) 16.4 4.4 Payout ratio 7.32% 13.64% Profit margin on sales (Net) 10.79% 3.19% Rate of return on common equity 16.4 4.4 Price to earnings (P/E) ratio 0.91 1.82 The above table shows the XYZ Corporation’s profitability ratios evaluating the financial performance and position of the company over the last two years. The profitability analysis is crucial for various users of financial statements including the investors, creditors, management, and employees etc. The current ratio reveals that the company is able to pay every $1 of its short-term liabilities out of $3.51 worth of its assets. This company’s current ratio has risen slightly as compared to the previous year owing to an increase in its current assets. The quick ratio illuminates the company’s liquidity position by showing that the company is left with $2.21 of quick assets after keeping aside stock from its current assets. Although, this ratio indicates that the company does not risk bankruptcy in the short-run but it also reflects that much of the company’s funds are lying idle or tied up in inventories and receivables etc. The Cash to debt ratio indicates that the company does not have enough cash to pay off its various debts. Times interest earned shows that company’s income was able enough to meet its interest expenses for about 4 times. The cash to debt coverage ratio reveals that albeit the company’s cash flow from operations is rising but is not enough to pay off its entire liabilities (Analyzing Your Financial Ratios, n.d., retrieved 08.09.06). The receivables turnover reveals that receivables were turned over 3 times in the year. Inventory turnover indicates the efficiency of company’s management in consistently converting its inventory into sales for about 2 times in a year. Both of these ratios do not indicate a sound position because of the long time required to turn the assets into cash. The company’s rate of return on assets ratio suggests that the company has been able to utilize its assets efficiently so as to obtain increasing profits, which improved by about 8% in the current year. XYZ Corporation’s rate of return on common equity ratio shows that the company has earned $16.4 for every single dollar invested by common shareholders. Hence, the management employed the funds invested by shareholders in an efficient manner (Analyzing Your Financial Ratios, n.d., retrieved 08.09.06). The Profit Margin on Sales (Gross) evaluates the percentage of profit earned by a company on sales after the production and distribution activities (Mcmenamin, 1999). This ratio has also increased in the current year. The net profit margin on sales has also increased significantly from the last year. XYZ Corporation’s analysis of Earnings per share shows an increase as compared to the last year. The dividend per share has also increased by about 100% but dividend payout ratio has declined, which reflects that although the company has been paying dividends to its shareholders at an increasing rate, yet it does not comply with the real worth of their investment (Financial Ratios, n.d., retrieved 08.09.06). REQUIREMENT 4 Company’s Fair Selling Price = Net Sales x 2 = 760,000 x 2 = 1,520,000 The above fair selling price of the company is based upon the rule of thumb method, which is derived at two times the value of net sales. Net Worth Total Assets = 1,064,000 Less: total liabilities = (512,000) Net worth $552,000_ The net worth of the company i.e., total assets less total liabilities is 552,000, which shows that about half the company’s assets are tied up in liabilities or are financed by borrowed funds. This is the value of total assets in the company that should be received at the minimum if XYZ Corporation plans to sell its business. % Change Sales = 10.14% Cost Of Goods Sold = (4.25)% Gross Profit = 27.38% Net Income = 272% The above chart depicts the financial performance of the company in terms of the changes that have taken place as compared to the previous year. The company’s sales show a rising trend by about 10% in the current year. Also the company managed to push down the cost of sales by about 4% further enhancing its gross margin, which increased by 27% as compared to the prior year. Finally the company’s net income showed a spectacular growth in the earnings by 272% after accounting for all the costs from production to distribution, SG&A and interests etc. The dividend paid by the company to its common stockholders has also grown remarkably. This not only shows the company’s performance for investors, management and other stakeholders, but also highlights the sheer growth chances in the company with respect to its future performance. Based on the above calculations and analysis, the minimum and maximum selling price of the XYZ Corporation can be determined as: $552,000-$1,520,000 The minimum price range, being the net worth of XYZ Corporation, is the amount that should necessarily be received by the company if Aggressive Venture Capital Company decides to purchase it. The maximum price reflects the horizon or a value of the company with respect to the industry trend. It also reflects the company’s current potential to earn money. The company’s staunch financial performance as reflected in the above ratios and trend analysis indicates strong future prospects. Hence, the above threshold connotes the lowest and highest amounts that could lead to a selling price acceptable to both the buyer and the seller, obviously in the context of the company’s performance and position. Reference List Analyzing Your Financial Ratios, n.d., retrieved September 8, 2006 from http://www.va-interactive.com/inbusiness/editorial/finance/ibt/ratio_analysis.html Building Your Retirement Funds, 2006, Bank Of America, retrieved September 8, 2006 from: http://www.bankofamerica.com/financialtools/index.cfm?view=DETAIL&tools=retirement&product=RETFUNDS Defined Contribution Pension Plans, 2005, Employee Benefit Plan Audit Quality Center, AICPA, retrieved September 7, 2006 from: http://ebpaqc.aicpa.org/Resources/Accounting+and+Auditing/Accounting+and+Reporting+by+Plans/Defined+Contribution+Plans.htm Employer-Sponsored Retirement Plans, 2005, HSBC North America Military Financial Education Center, retrieved September 7, 2006 from: http://militaryfinance.umuc.edu/retirement/retire_employer.html Financial Ratios, n.d., Net MBA, retrieved September 8, 2006 from http://www.netmba.com/finance/financial/ratios/ Green, Paul (n.d.), Dealing with Pension Contribution Limitations: Outline of Contribution Limitations, Mooney, Green, Baker & Saindon, P.C., retrieved September 7, 2006 from: http://www.mooneygreen.com/PensionContributionLimitations.html Mcmenamin, Jim (1999), “Financial Management: An Introduction”, Routledge, London Michel, Nobert (2005), Did The Bush Tax Cuts Substantially Reduce Tax Payments By Corporations? A Critique Of The Citizens For Tax Justice Report, The Heritage Foundation, retrieved September 8, 2006 from: http://www.heritage.org/Research/Taxes/cda05-01.cfm Retirement Plan Basics, n.d., retrieved September 8, 2006 from: http://www.pensionconsultant.com/basics.htm Retirement Planning: Defined-Contribution Plans, 2006, AOL Money & Finance, retrieved September 7, 2006 from: http://money.aol.com/basics/3canvas/_a/retirement-planning-defined-contribution/20050225134209990018 Read More