1. Rite Aid has considerable debt a portion of which is convertible debt. What w

Question

1. Rite Aid has considerable debt a portion of which is convertible debt. What would be the impact of the conversion of this debt on the company's balance sheet? individual shareholder?

3.what is the effect of using LIFO vs FIFO on: The inventory carrying value and New Income. How does the use of LIFO contribute to earnings management.

4. How does financial leverage increase non systemic risk and affect long and short term solvency?

5. Estimating bad debts can be done by the percentage of sales method and the aging of accounts receivable method. each method has its drawbacks and advantages. If the company you were reviewing used the percentage of sales method and you noted that the allowance shown on the balance sheet was growing disproportionately to the accounts receivable give possible reasons for the disproportionate growth and suggest a means to adjust this situation if necessary. See example below.

Year                                    Accounts Receivable Allowance     Percent of A/R

2014                                         4,500,000                                            450,000     10.0%

2015                                         5,200,000                                            600,000    11.5%

2016 7,500,000 950,000    12.7%

Explanation / Answer

1. Convertible debt is debt which has the option to convert into common stock of the company at the end of specified time period. if this option is exercised, the total debt of the company will reduce and it will become equity share capital of the company by same amount. As a result, there will be following impacts on the balance sheet:

a. Total Debt obligation on the liability side will reduce with the increase of same amount in the equity share capital of the company.

b. Total outstanding shares of the company will increase.

c. Net income per share will reduce. This means that Earnings Per share as total outstanding shares have increased will reduce.

d. Company is not required to pay interest on converted bonds and therefore, income available for shareholders will increase.

2. Under LIFO method, it is assumed that sales is made of the inventory which is latest purchased by the company and inventory is calculated on the basis of the items purchased or held oldest. This type of method of inventory valuation will lead to undervaluation of the closing inventory as the old purchases are usually bought on low prices than the latest one and therefore, valuation is made on the basis of low cost. Moreover, Due to low cost of closing inventory, net income of the company is more than the FIFO method. This method helps the management in shhowing more net income during the period and higher earnings management. As per IFRS, LIFO method cannot be used by the company.

On the other hand in FIFO, first purchases are assumend to be sold first and therefore, closing inventory valuation is made on the basis of latest purchase cost to the company. This method, as result, shows higher cost of inventory valuatioon than the LIFO method as prices are latest and therefore low net income of the company compared to LIFO.

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