Financial Accounting Fundamentals
Financial Accounting Fundamentals
6th Edition
ISBN: 9781259726910
Author: John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting Principles
Publisher: McGraw-Hill Education
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Chapter 13, Problem 4AP
To determine

Compute the following ratios for Corporation C: (1) current ratio, (2) acid-test ratio, (3) days’ sales uncollected, (4) inventory turnover,(5) days’ sales in inventory, (6) debt-to-equity ratio, (7) times interest earned, (8) profit margin ratio, (9) total asset turnover, (10) return on total assets, and (11) return on common stockholders’ equity.

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Explanation of Solution

  1. 1) Current ratio: Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets. Current ratio is calculated by using the formula:

Current ratio=Current AssetsCurrent Liabilities

Determine the current ratio.

RatioResult
Cash$10,000
Short term investments$8,400
Accounts receivables, net$29,200
Current notes receivable (trade)$4,500
Merchandise inventory$32,150
Prepaid expenses$2,650
Current assets (A)$86,900
  
Accounts payable$17,500
Accrued wages payable$3,200
Income taxes payable$3,300
Current liabilities (B)$24,000
Current ratio  (A)÷(B)3.62:1

Table (1)

Hence, the current ratio is 3.62:1.

  1. 2) Acid-test ratio: It is a ratio used to determine a company’s ability to pay back its current liabilities by liquid assets that are current assets except inventory and prepaid expenses.

Acid-test ratio=Quick AssetsCurrent Liabilities

Determine the acid-test ratio.

RatioResult
Cash$10,000
Short term investments$8,400
Accounts receivables, net$29,200
Current notes receivable (trade)$4,500
Quick assets (A)$52,100
  
Accounts payable$17,500
Accrued wages payable$3,200
Income taxes payable$3,300
Current liabilities (B)$24,000
Acid-test ratio  (A)÷(B)2.2:1

Table (2)

Hence, the acid-test ratio is 2.2:1.

  1. 3) Days’ sales uncollected: This ratio is used to determine the number of days a particular company takes to collect accounts receivables.

Days’ sales uncollected=Ending accounts receivable Sales×365days

Determine the days’ sales uncollected.

RatioResult
Accounts receivables, net$29,200
Current notes receivable (trade)$4,500
Ending  net accounts (including notes) receivables (A)$33,700
  
Net credit sales (B)$448,600
  
Days’ sales uncollected  [(A)÷(B)]×36527.4 days

Table (3)

Hence, the days’ sales uncollected are 27.4 days.

  1. 4) Inventory Turnover Ratio: This ratio is a financial metric used by a company to quantify the number of times inventory is used or sold during the accounting period. It is calculated by using the formula:

    Inventory turnover=Cost of goods soldAverage inventory

Determine the inventory turnover ratio.

RatioResult
Ending inventory (A)$32,150
Beginning inventory (B)$48,900
Total inventory  (C)  (A)+(B)$81,050
  
Average inventory (D) (C)÷2$40,525
  
Cost of goods sold (E)$297,250
  
Inventory turnover ratio (E)÷(D)7.3 times

Table (4)

Hence, the inventory turnover ratio is 7.3 times.

  1. 5) Days’ sales in inventory: Days’ in inventory is determined as the number of days a particular company takes to make sales of the inventory available with them.

Days’ in inventory=EndingInventoryCost of goods sold×365days

Determine the days’ sales in inventory.

RatioResult
Ending inventory (A)$32,150
Cost of goods sold (B)$297,250
  
Days’ sales in inventory[(A)÷(B)]×36539.5 days

Table (5)

Hence, the days’ sales in inventory are 39.5 days.

  1. 6) Debt–to-equity ratio or Debt equity ratio: The debt-to-equity ratio indicates that the company’s debt as a proportion of its stockholders’ equity. The debt-to-equity ratio is calculated using the formula:

Debt-to-equity ratio=Total liabilitiesTotal stockholders' equity

Determine debt-to-equity ratio.

RatioResult
Accounts payable$17,500
Accrued wages payable$3,200
Income taxes payable$3,300
Long term note payable$63,400
Total liabilities (A)$87,400
  
Common stock$90,000
Retained earnings$62,800
Total stockholders’ equity (B)$152,800
  
Debt-to-Equity ratio  (A)÷(B)0.57:1

Table (6)

Hence, the debt to equity ratio is 0.57:1.

  1. 7) Times interest earned ratio: The times interest earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense.

Times interestearned ratio}=Earnings before interest and taxes expenseInterest expense

Determine times interest earned ratio.

RatioResult
Net income$29,052
Interest expense$4,100
Income taxes$19,598
Income before interest expense and income taxes (A)$52,750
  
Interest expense (B)$4,100
  
Times interest earned ratio (A)÷(B)12.9 times

Table (7)

Hence, the times interest earned ratio is 12.9 times.

  1. 8) Profit margin: It is one of the profitability ratios. Profit margin ratio is used to measure the percentage of net income that is being generated per dollar of revenue or sales.

Profit margin=Net incomeNet sales

Determine profit margin ratio.

RatioResult
Net income (A)$29,052
Net sales (B)$448,600
  
Profit margin ratio (A)÷(B)6.5%

Table (8)

Hence, the profit margin ratio is 6.5%.

  1. 9) Total asset turnover: Total asset turnover is a ratio that measures the productive capacity of the total assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total assets. Turnover of assets is calculated as follows:

    Turnover of assets=Net sales Average total assets

Determine total asset turnover ratio.

RatioResult
Ending total assets (A)$240,200
Beginning total assets  (B)$189,400
  
Average total assets (C) [(A)+(B)]÷2$214,800
  
Net sales (D)$448,600
  
Total asset turnover ratio (D)÷(C)2.1 times

Table (9)

Hence, the total asset turnover ratio is 2.1 times.

  1. 10) Return on total assets: Return on total assets is the financial ratio that determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets. Return on investment is calculated as follows:

Return on total assets=Net income Average total assets

Determine return on asset ratio.

RatioResult
Ending total assets (A)$240,200
Beginning total assets  (B)$189,400
  
Average total assets (C) [(A)+(B)]÷2$214,800
  
Net income (D)$29,052
  
Return on asset ratio (D)÷(C)13.5%

Table (10)

Hence, the return on asset ratio is 13.5%.

Return on common stockholders’ equity ratio: It is a profitability ratio that measures the profit generating ability of the company from the invested money of the shareholders. The formula to calculate the return on equity is as follows:

Return on equity= Net incomeAverage stockholders' equity×100

Determine return on common stockholders’ equity ratio.

RatioResult
Common stock$90,000
Retained earnings$62,800
Ending total stockholders’ equity (A)$152,800
  
Common stock$90,000
Retained earnings$22,748
Beginning total stockholders’ equity (B)$112,748
  
Average common stockholders’ equity (C) [(A)+(B)]÷2$132,774
  
Net income (D)$29,052
  
Return on common stockholders’ equity ratio (D)÷(C)21.9%

Table (11)

Hence, the return on common stockholders’ equity ratio is 21.9%.

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