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11.

1:
Entries for the Warren Clinic 2008 income statement are listed below in
alphabetical order. Reorder the data in the proper format.

INCOME STATEMENT FOR YEAR 2008:

Particulars Amount
REVENUE:
Patient service revenue $440,000
Bad debt expense - ($40,000)
Net Revenue: $400,000
Other revenue: $10,000
Total revenues: $410,000

EXPENSES:
Salaries and benefits: $150,000
Depreciation expense: $90,000
Interest expense $20,000
General/administrative expenses: $70,000
Purchased clinic services: $90,000
Total expenses: $460,000

Operating loss: - ($10,00)


Interest income nonoperating $40,000
income:
Net Income: $30,000

The operating loss at Warren Clinic in 2008 is $10,000 because total net
income is $30,000 and we know that interest income is $40,000 so we can
calculate the operating loss to be the difference which is $10,000.

11.2: Consider the following income statement:


a. How does this income statement differ from the one presented in
Table 11.1?

BestCare HMO Warren Clinic


Operating Operating income = Net OI = $30,000 - $40,000
Income: income non-operating OI = - ($10,000)
income
OI = $1,218,000 - Warren clinic, however, does
$242,000 not have an operating income
OI = $976,000 but rather an operating loss of
$10,000 meaning that the
BCHMO has an operating operating expenses are more
income at $976,000 so than the operating revenues.
operating revenues are
more than the operating
expenses.
Provision for % of provision for bad % of provision for bad debts =
bad debts: debts = (Provision of (Provision of bad debts/total
bad debts/total operating revenues) x 100
operating revenues) x %X =
100 ($40,000/$440,000)x100
%X = %X = 9.09%
($19,000/$28,371,000)x
100 The provision for bad debts
%X = 0.067% percentage for Warren Clinic is
9.09% of the total revenues
Total Revenue was which is a high percentage
calculated by adding relatively, and implies that
$26,682,000 (premiums Warren Clinic wont be able to
earned) + $1,689,000 recover as much of its
(coinsurance) revenues from its patients as
BestCare HMO.
The provision for bad
debts is much lower at
BestCare HMO (0.067%
of the total revenues)
than Warren Clinic which
means that BestCare
HMO can anticipate the
maximum recovery of
revenues from its
patients.
Total profit Total Profit Margin = Total Profit Margin = (Net
margin: (Net Income/Total Income/Total Revenues) X 100
Revenues) X 100 Total Profit Margin= ($30,000/
Total Profit Margin= $450,000) X 100
($1,218,00/ $2,859,400) Total Profit Margin= 6.67%
X 100
Total Profit Margin= Note: Total revenues was
4.26% calculated by adding net
operating revenues
Note: Total revenues was ($440,000-$40,000+$10,000)
calculated by with non operating revenues
subtracting net ($40,000)
operating revenues
($28,613,000) from Total profit margin is 6.67%
provision for bad debts which means that each dollar
($19,000). of revenues produces about 7
cents of total profit or net
Total profit margin is income. Another way to look
4.26% which suggests about it is that the production
that each dollar of of each dollar of revenues
revenue produces 4.26 required 93 cents of expenses.
cents of total profit. The
production of each dollar
of revenue requires 96
cents of expenses.

b. Did BestCare spend $367,000 on new fixed assets during fiscal


year 2008? If not,
what is the economic rationale behind its reported depreciation
expense?
BestCare did not spend $367,000 on new fixed assets during 2008. The
economic rationale behind the depreciation expense entry is that it takes
into factor the loss of value due to regular use that the companys fixed
assets experience during the year. However, since this is somewhat
subjective, the amount that is listed doesnt always accurately represent the
market price of those assets.

c. Explain the provision for bad debts entry.


The provisions for bad debts is basically uncollectable revenues. This
means that the company gets a certain amount as revenue from employers
and individuals. For example, the amount of revenues projected for 2007 for
BestCare HMO is $440,000 however all those revenues may not be
collected. The provision for bad debts is the value the company predicts
wont be collected.

d. What is BestCares total margin? How can it be interpreted?


BestCares total margin is 4.3%. This is calculated by: Total (profit)
margin = net income / total revenues. For BestCare: $1,218 / $28,613 = .043
= 4.3%. The interpretation of this is that for each dollar of revenue, BestCare
will produce 4.3 cents of earnings. Ultimately, the organization will want to
have a high total profit margin because it will indicate greater revenues that
are contributing to net come.

11.3:

a. How does this income statement differ from the ones presented
in Table 11.1 and Problem 11.2?
The main difference between the income statement of GreenValley
Nursing Home from the income statements at BestCare and Warren Clinic is
that this nursing home has operating (taxable) income as well as provision
for income taxes entries while the other income statements didnt contain
these entries. The fact that this nursing home has both operating income and
provision for income taxes indicates that this is an investor owned company
because there are tax payments on this sheet. The implied tax rate for Green
valley would be 35% calculated by: (($31,167/$89,048)x100)).

b. Why does Green Valley show a provision for income taxes while
the other two income statements did not?
This is because Green Valley is an investor-owned firms and as a result
will have taxable income.

c. What is Green valleys total (profit) margin? How does this value
compare with the values for Park Ridge Homecare Clinic and
BestCare?
Green Valleys total profit margin is 1.8%. This was calculated by
dividing the net income ($57,881) by the total revenues ($3,269,404) and
multiplying by 100 to get the percentage. This total profit margin is a lot
lower than the profit margins of Warren Clinic (6.67%) and Best Care
(4.26%). This may be because this is a for-profit, investor-owned company
and because there are taxes, it can have a lower profit margin than not-for-
profit businesses if other variables are kept constant.

d. The before-tax profit margin for Green Valley is operating income


divided by total revenues. Calculate Green Valleys before-tax profit
margin. Why may this be a better measure of expense control when
comparing an investor-owned business with a not-for-profit
business?
Green Valleys before-tax profit margin is 2.7%. This is done by dividing
operating income ($89,048) by the total revenue ($3,269,404) x 100 = 2.7%.
This percentage is a higher percentage than Green Valleys total profit
margin percentage and this may be a better measure of expense control
because it removes the variable of taxes so its a better percentage to
compare with not-for-profit businesses that dont have taxes as a variable
either.

11.4: Great Forks Hospital reported net income for 2008 of $2.4 million on
total revenues of $30 million. Depreciation expense totaled $1 million.
a. What were total expenses for 2008?
The total expenses for 2008 will be the total revenue of $30 million
minus the net income of $2.4 million which results in $27.6 million as the
total expenses.

b. What were total cash expenses for 2008? (Hint: Assume that all
expenses, except depreciation, were cash expenses.)
Since depreciation was $1 million, total cash expenses will be adjusted
to be $26.6 million (Answer form part a with $1 million subtracted).

c. What was the hospitals 2008 cash flow? It was approximately


$3.4 million
Cash flow =
Net Income + Noncash expenses = Net income + Depreciation
$2.4 million + $1 million = $3.4 million

11.5: Brandywine Clinic, a not-for-profit business, had revenues of $12


million in 2008. Expenses other than depreciation totaled 75 percent of
revenues, and depreciation expense was $1.5 million. All revenues were
collected in cash during the year and all expenses other than depreciation
were paid in cash.
a. Construct Brandywines 2008 income statement.
Revenue $12,000,000
Expenses: $9,000,000
Depreciation charged $1,500,000
Total Expenses $10,500,000
Net Income $1,500,000

b. What were Brandywines net income, total profit margin, and cash flow?
Net Income: $1,500,000 ($12,000,000 - $10,500,000)
Total profit margin: 12.5 %
TPM = Net Income / Revenues
X = $1,500,000 / $12,000,000 = 12.5%
Cash Flow: $3,000,000
Cash Flow = $1,500,000 + $1,500,000 = $3,000,000
c. Now, suppose the company changed its depreciation calculation
procedures (still within GAAP) such that its depreciation expense
doubled. How would this change affect Brandywines net income, total
profit margin, and cash flow?
The new depreciation expense would be $3 million instead of $1.5
million so calculations would be changed:
Net Income: $0 ($12,000,000 - $12,000,000)
Total profit margin: 0%
TPM = Net Income / Revenues
X = 0 / $12,000,000 = 0%
Cash Flow: $3,000,000
Cash Flow = $0 + $3,00,000 = $3,000,000

d. Suppose the change had halved, rather than doubled, the firms
depreciation expense. Now, what would be the impact on net income, total
profit margin, and cash flow?
The new depreciation expense would be $.75 million or $750,000 so
the calculations would come out to as follows:
Net Income: $2.25 million ($12 - $9 - $.75)
Total profit margin: 18.8% (($2.25/$12)x100)
Cash Flow: $3,000,000 ($2.25 million + .75 million)

For all three examples, depreciation did not affect cash flow.

11.6: Assume that Mainline Healthcare, a for-profit corporation, had


exactly the same situation as reported in Problem 11.5. However,
Mainline must pay taxes at a rate of 40 percent of pretax income.
Assuming that the same revenues and expenses reported for
financial accounting purposes would be reported for tax purposes,
redo Problem 11.5 for Mainline.
a)
Revenue $12,000,000
Expenses: $9,000,000
Depreciation charged $1,500,000
Total Expenses ($10,500,000)
Operating income $1,500,000
Taxes ($600,000)
Net Income $900,000

b)
Net income = $12,000,000 - $9,000,000 - $1,500,000 = $10,500,000
$12,000,000 - $10,500,00 = $1,500,000 -> Operating income
$1,500,000 x .4 = $600,000 -> Taxes
$1,500,000 - $600,000 = $900,000
Total profit margin: 7.5% -> net income / total revenues = $900,000 /
$12,000,000 = .075 x100 = 7.5%
Cash flow: $2.4 million -> net income / depreciation expenses =
$900,000 / $1,500,000 = $2,400,000

c) If depreciation were doubled:


Net income = $0 ($12-$9-$3)= 0 taxes and operating income will also be
0)
Total profit margin: 0% because since net income is 0, you will be dividing
by 0
Cash flow: $3 million (0 + $3 million)

d) If depreciation were halved:


Net income = $1.35 million
($12-$9-$.75) (($12-$9-$.75)x.4) = $1.35 million
Total profit margin: 11.2% ($1,350,000/$12,000,000)
Cash flow: $2.1 million ($1,350,000 + $750,000)

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