Question

Gerrard Construction Co. is an excavation contractor. The following summarized data (in thousands) are taken from the December 31, 2019, financial statements:

For the Year Ended December 31, 2019:
Net revenues	$	96,600
Cost of services provided		34,200
Depreciation expense		19,500
Operating income	$	42,900
Interest expense		11,400
Income tax expense		9,600
Net income	$	21,900
At December 31, 2019:
Assets
Cash and short-term investments	$	8,400
Accounts receivable, net		29,400
Property, plant, and equipment, net		232,200
Total assets	$	270,000
Liabilities and Stockholders’ Equity
Accounts payable	$	4,500
Income taxes payable		4,800
Notes payable (long term)		142,500
Paid-in capital		30,000
Retained earnings		88,200
Total liabilities and stockholders’ equity	$	270,000

At December 31, 2018, total assets were $246,000 and total stockholders’ equity was $97,800. There were no changes in notes payable or paid-in capital during 2019.

Required:

1. The cost of services provided amount includes all operating expenses (selling, general, and administrative expenses) except depreciation expense. What do you suppose the primary reason was for management to separate depreciation from other operating expenses? From a conceptual point of view, should depreciation be considered a “cost” of providing services?
2. Why do you suppose the amounts of depreciation expense and interest expense are so high for Gerrard Construction Co.? To which specific balance sheet accounts should a financial analyst relate these expenses?
3. Calculate the company’s average income tax rate. (Hint: You must first determine the earnings before taxes.)

5. Calculate the amount of total current assets.
6. Why doesn’t the company have a Merchandise Inventory account?
7. Calculate the amount of working capital and the current ratio at December 31, 2019. Assess the company’s overall liquidity.
8. Calculate ROI (including margin and turnover) and ROE for the year ended December 31, 2019.
9. Calculate the amount of dividends declared and paid during the year ended December 31, 2019. (Hint: Do a T-account analysis of retained earnings.)

ANSWER QUESTIONS A-J

A.The cost of services provided amount includes all operating expenses (selling, general, and administrative expenses) except depreciation expense. What do you suppose the primary reason was for management to separate depreciation from other operating expenses?

the owners of the firm would be interested in knowing what the approximate "economic" cost of fixed asset utilization is, because a substantial portion of the firm’s profits will need to be invested in replacement machinery and equipment. The depreciation expenditure does not affect the financial position of Gerrard Construction Co

B.From a conceptual point of view, should depreciation be considered a “cost” of providing services?

Yes or No

C.Why do you suppose the amounts of depreciation expense and interest expense are so high for Gerrard Construction Co.? (Select all that apply.)

	Depreciation expense is high because Gerrard Construction Co. is a highly capital-intensive firm. Depreciation expense is high because the firm has a large amount of long-term debt. Interest expense is high because the firm has a large amount of long-term debt Interest expense is high because Gerrard Construction Co. is a highly capital-intensive firm.

D.To which specific balance sheet accounts should a financial analyst relate these expenses?

	Depreciation should be related to property, plant, and equipment, and interest should be related to notes payable. Interest should be related to property, plant, and equipment, and depreciation should be related to notes payable.

E.Calculate the company’s average income tax rate. (Hint: You must first determine the earnings before taxes.) (Round your answer to 1 decimal place. (e.g., 32.1))

Average income tax rate ______%

F.Calculate the amount of total current assets. (Enter your answer in whole dollars (Example - enter 20,000,000 and not 20,000)

Cash and short term investments _________

Accounts receivable,net _________

Total current assets $_____

G.Why doesn’t the company have a Merchandise Inventory account?

G(A). As an excavation contractor, the firm sell goods to its customers, but does not provide services.

G(B). An excavation contractor, the firm provides services to its customers, but does not sell goods.

H.Calculate the amount of working capital and the current ratio at December 31, 2019. Assess the company’s overall liquidity. (Enter your answers in whole dollars (Example - enter 20,000,000 and not 20,000). Round your ratio answer to 2 decimal places. (e.g., 32.16))

Working capital __________

current ratio__________

the companys overall liquidity is _______________

I.Calculate ROI (including margin and turnover) and ROE for the year ended December 31, 2019. (Round "Turnover" answer to 2 decimal places and other answer to 1 decimal place.)

ROI _______%

margin_______%

turnover________

ROE_________%

J.Calculate the amount of dividends declared and paid during the year ended December 31, 2019. (Hint: Do a T-account analysis of retained earnings.) (Enter your answers in whole dollars (Example - enter 20,000,000 and not 20,000).)

dividends declared and paid________________

Answer 1

Please refer the following image for the solution:  

Answer B Depreciation represents the periodic conversion of a fixed asset into an expense. As the asset is used during normal business operations depreciation is considered an operating expense. Depreciation is a non-cash component of operating expenses as there is no cash outflow inis expended. So, Depreciation should not be considered as cost of providing service. Answer C Depreciation expenses is high because Gerrard Construction Co. is a highly capital intensive firm. Interest Expenses is high because the firm has large amount of Long - term debt. As the amount of investment in Plant Property Equipment is increased, the amount of depreciation will aslo increase gradually. When firm takes large amount of loan, interest expense will also increase gradually. Answer D Depreciation should be related to Plant, Property and Equipmentt and interest should be related to Notes payable. Depreciation is charged on Assets so it is related to Plant, Property and Equipment. Interest is charged on amount of loan taken so it is related to Notes Payable. Answer E Company's avg income tax rate 30.48% Operating income Less: Interest Expense Income before taxes (1) Income Tax expense (2) avg income tax rate (1/2) $ 42,900 $ 11,400 $ 31,500 $ 9,600 30.48% Answer F Total current assets $ 37,800 Cash and short-term investments Accounts receivable, net $ 8,400 $ 29,400 $ 37,800 Answer G The firm being an excavation contractor, provides services to its customers and not a manufacturer who sells goods hence does not have any merchandise inventory. Answer H Working Capital Current Ratio Company's overall Liquidity is good as current ratio is more than 1 $ 28,500 4.06 Working Capital = Current Assets - current liabilities $37,800 - $9300 $ 28,500 Current assets Cash and short-term investments $ 8,400 Accounts receivable, net $ 29,400 $ 37,800 Current Liabilities Accounts payable Income taxes payable $4,500 $4,800 $9,300 Current Ratio = Current Assets / Current Liabilities $37,800 / $9,300 4.06 Answer! ROI Margin Turnover ROE 8.49% 22.67% 0.37 20.28% ROI Net Income / Average Total assets $21,900 / $258,000 8.49% Average Total assets (Opening balance + Closing balance)/2 ($246,000 + $ 270,000)/2 $ 258,000 Margin Net Income / Net Revenue $21,900 / $96,600 22.67% Turnover Net Revenue / Average Total assets $96,600 / $258,000 0.37 Average Total assets (Opening balance + Closing balance)/2 ($246,000 + $ 270,000)/2 $ 258,000 ROE Net Income / Average Stockholders' Equity $21,900 / $108,000 20.28% Average Stockholders' equity (Opening balance + Closing balance)/2 ($97,800 +($30,000 + $88,200))/2 $ 108,000 Answer) Dividend declared and paid $ 1,500 Beginning balance of stockholders' equity Less :Paid in capital Beginning balance of Retained earnings Add: Net Income Less : Ending balance of Retained earnings Dividend declared and paid $ 97,800 $ 30,000 $ 67,800 $ 21,900 $ 88,200 $ 1,500