Analyzing capital leases, notes payable, preferred stock | Online Assignment Help: +1 (857)-330-4622

Analyzing capital leases, notes payable, preferred stock

Analyzing capital leases, notes payable, preferred stock For this case study, you will type a one- to two-page double-spaced document completing therequirements a through e at the end of the case. Capstone analytical review of Chapters 6–8. Analyzing capital leases, notes payable, preferred stock,and common stock (Note: Please refer to Case 4.30 on pages 145–146 for the financial statement dataneeded for the analysis of this case. You should also review the solution to Case 4.30, provided by yourinstructor, before attempting to complete this case.) Your conversation with Mr. Gerrard, which tookplace in February 2014 (see Case 6.35), continued as follows: Mr. Gerrard: I’ve been talking with my accountant about our capital expansion needs,which will be considerable during the next couple of years. To stay in a strongcompetitive position, we’re constantly buying new pieces of earthmoving equipmentand replacing machinery that has become obsolete. What it all comes down to isfinancing, and it’s not easy to raise $10 million to $20 million all at once. There are anumber of options, including dealer financing, but the interest rates offered by banks areusually lower. Your reply: From reviewing your balance sheet, I can see that you’ve got a lot of notespayable already. How is your relationship with your bank? Mr. Gerrard: Actually we use several banks and we have an excellent credit history, sogetting the money is not a major problem. The problem is that we already owe morethan $40 million on all of those notes and I don’t want to get overextended. Your reply: Have you considered long-term leases? Mr. Gerrard: Yes. This is essentially how dealer financing works. Usually it is arranged asa lease with an option to buy the equipment after a number of years. We’ve beenactively looking into this with our Cat dealer for a couple of scrapers that we need to puton a big job immediately. I can show you one of the contracts involved. Your reply: OK, I’ll have a look at the contract, but this sounds like a long-term capitallease. Mr. Gerrard: Yes, I think that’s what my accountant called it. What matters most to me isthat we get the equipment in place ASAP; but if you could explain what the accountingimplications would be of entering into these types of arrangements, that might put meat ease about it. Your reply: No problem; will do. It would impact both your balance sheet and incomestatement, but in most respects a long-term capital lease is treated very much like along-term note payable with a bank. I’ll give you a memo about it. But what aboutlooking into other sources of equity financing? Have you considered any of theseoptions? Mr. Gerrard: We’re a family business and want to keep it that way. Our shares arepublicly traded, but we’re owned mostly by family members and employees. We’ve got alot of retained earnings, but that’s not the same thing as cash, you know. Should we beissuing bonds? Your reply: Issuing bonds is possible, but I was thinking more on the lines of preferredstock. Are you familiar with this option? Mr. Gerrard: Oh sure. That’s the cologne I wear! But other than that, I don’t know muchabout it. Isn’t preferred stock a lot like bonds payable? Your reply: Maybe this is something else I should include in my memo: an explanation ofthe differences between common stock, preferred stock, and bonds payable. Mr. Gerrard: Yes, please do. Required:1. a. When discussing capital leases with Mr. Gerrard, you commented, “It wouldimpact both your balance sheet and income statement, but in most respects along-term capital lease is treated very much like a long-term note payable with abank.” Explain the accounting treatment of capital leases as compared to theaccounting treatment of notes payable in terms that a nonaccountant couldeasily understand. Include in your answer both the balance sheet and incomestatement effects of capital leases. (Note: You do not need to make reference tothe four criteria for capitalizing a lease.)2.3. b. Assume you have reviewed the contract Mr. Gerrard provided concerning thedealer financing agreement for the purchase of two new scrapers. You havedetermined that the lease agreement would qualify as a capital lease. Thepresent value of the lease payments would be $2 million. Use the horizontalmodel, or write the journal entry, to show Mr. Gerrard how this lease wouldaffect the financial statements of Gerrard Construction Co.4.5. c. Explain what Mr. Gerrard meant by his statement “We’ve got a lot of retainedearnings, but that’s not the same thing as cash, you know.” Review the balancesheet at December 31, 2013, provided in Case 4.30. In which assets are most ofthe company’s retained earnings invested6.7. d. Explain to Mr. Gerrard what the similarities and differences are betweenbonds payable, preferred stock, and common stock.8.e. Why would you recommend to Mr. Gerrard that his company consider issuing$10 million to $20 million of preferred stock rather than bonds payable? (Hint:Review the company’s balance sheet provided in Case 4.30 in the context of yourpresent conversation with Mr. Gerrard.)