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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Measures of liquidity, solvency and profitability

The comparative financial statements of Stargel Inc. are as follows. The market price of common stock was $119.70 on December 31, 20Y2.

Stargel Inc.

Comparative Retained Earnings Statement

For the Years Ended December 31, 20Y2 and 20Y1

  20Y2 20Y1
Retained earnings, January 1............. $5,375,000 $4,545,000
Net income............................. 900,000 925.000
Total................................ $6,275,000 $5,470,000
Dividends:    
Preferred stock dividends............. $ 45,000 $ 45,000
Common stock dividends............. 50,000 50,000
Total dividends.................... $ 95,000 $ 95,000
Retained earnings, December 31......... $6,180,000 $5,375,000

Stargel Inc.

Comparative Income Statement

For the Years Ended December 31, 20Y2 and 20Y1

  20Y2 20Y1
Sales..................... $10,000,000 $9,400,000
Cost of goods sold......... 5,350,000 4,950,000
Gross profit............... $ 4,650,000 $4,450,000
Selling expenses.......... $ 2,000,000 $1,880,000
Administrative expenses....... 1,500,000 1,410,000
Total operating expenses…… $ 3,500,000 $3,290,000
Income from operations……. $ 1,150.000 $1,160,000
Other revenue............ 150,000 140,000
  $ 1,300,000 $1,300,000
Other expense (interest)….. 170,000 150,000
Income before income tax….. $ 1,130,000 $1,150,000
Income tax expense....... 230,000 225,000
Net income............... $ 900,000 $ 925,000

Stargel Inc.

Comparative Balance Sheet

December 31,20Y2 and 20Y1

  20Y2 20Y1
Assets    
Current assets:    
Cash.......................................................... $ 500,000 $ 400,000
Marketable securities........................................... 1,010,000 1,000,000
Accounts receivable (net)....................................... 740,000 510,000
Inventories.................................................... 1,190,000 950,000
Prepaid expenses.............................................. 250,000 229,000
Total current assets.......................................... $3,690,000 $3,089,000
Long term investments............................................ 2,350,000 2,300,000
Property, plant, and equipment (net)............................... 3,740,000 3,366,000
Total assets....................................................... $9,780.000 $8,755,000
Liabilities    
Current liabilities.................................................. $ 900,000 $ 880,000
Long term liabilities:    
Mortgage note payable, 10%.................................... $ 200,000 $ 0
Bonds payable, 10%............................................ 1,500,000 1,500,000
Total long term liabilities.................................... $ 1,700,000 $1,500,000
Total liabilities.................................................... $2,600,000 $2,380,000
Stockholders' Equity    
Preferred $0, 90 stock. $ 10 par...................................... $ 500,000 $ 500,000
Common stock, $5 par............................................. 500,000 500,000
Retained earnings................................................. 6,180,000 5,375,000
Total stockholders' equity.......................................... $7,180,000 $6,375,000
Total liabilities and stockholders' equity............................. $9,780,000 $8,755,000

Instructions

Determine the following measures for 20Y2, rounding to one decimal place including percentages, except for per-share amounts:

1. Working capital

2. Current ratio

3. Quick ratio

4. Accounts receivable turnover

5. Number of days’ sales in receivables

6. Inventory turnover

7. Number of days’ sales in inventory

8. Ratio of fixed assets to long-term liabilities

9. Ratio of liabilities to stockholders’ equity

10. Times interest earned

11. Asset turnover

12. Return on total assets

13. Return on stockholders’ equity-

14. Return on common stockholders’ equity

15. Earnings per share on common stock

16. Price-earnings ratio

17. Dividends per share of common stock

18. Dividend yield

To determine

Financial Ratios: Financial ratios are the metrics used to evaluate the capabilities, profitability, and overall performance of a company.

To determine:  The following ratios measures for 20Y2.

  1. 1. Working capital
  2. 2. Current ratio
  3. 3. Quick ratio
  4. 4. Accounts receivable turnover
  5. 5. Number of days' sales in receivables
  6. 6. Inventory turnover ratio
  7. 7. Number of days' sales in inventory
  8. 8. Ratio of fixed assets to long-term liabilities
  9. 9. Ratio of liabilities to stockholders’ equity
  10. 10. Times interest earned ratio
  11. 11. Asset turnover ratio
  12. 12. Return on total assets
  13. 13. Return on stockholders' equity
  14. 14. Return on common stockholders' equity
  15. 15. Earnings per share on common stock
  16. 16. Price earnings ratio
  17. 17. Dividends per share of common stock
  18. 18. Dividend yield
Explanation

1. Working capital

Working capital  = Current assets – Current liabilities = $3,690,000 – $900,000= $2,790,000

Explanation:

Working capital is determined as the difference between current assets and current liabilities.

Formula:

Working capital = Current assets – Current liabilities 

2. Current ratio

Current ratio=Current assetsCurrentliabilities=$3,690,000$900,000=4.1

Current ratio is used to determine the relationship between current assets and current liabilities. The ideal current ratio is 2:1.  Current assets include cash and cash equivalents, short-term investments, net, accounts and notes receivables, net, inventories, and prepaid expenses and other current assets. Current liabilities include short-term obligations and accounts payable.

Formula:

Current ratio=Current assetsCurrentliabilities

3. Quick ratio

Quick ratio =Quick assets Currentliabilities=$2,250,000$900,000=2.5

Acid-Test Ratio is the ratio denotes that this ratio is a more rigorous test of solvency than the current ratio. It is determined by dividing quick assets and current liabilities. The acceptable acid-test ratio is 0.90 to 1.00. It is referred as quick ratio. Use the following formula to determine the acid-test ratio:

Acid Ratio=Quick assetsCurrentliabilities

4. Accounts receivable turnover

Accounts receivables turnover ratio}=Net credit salesAverage accounts receivables=$10,000,000$625,000=16.0

Accounts receivables turnover ratio is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. Main purpose of accounts receivable turnover ratio is to manage the working capital of the company. This ratio is determined by dividing credit sales and sales return.

Formula:

Accounts receivables turnover ratio}=Net credit salesAverage accounts receivables

Average accounts receivable is determined as follows:

Average accounts receivables }(Opening accounts receivables + Closing accounts receivables )2=$740,000+$510,0002=$625,000

5. Number of days’ sales in receivables

 Number of days’ sales in receivable }=Average accounts receivable Average daily sales=$625,00027,397.26=22.8days

Number of days’ sales in receivables is used to determine the number of days a particular company takes to collect accounts receivables.

Formula:

 Number of days’ sales in receivable=Average accounts receivable Average daily sales

Average daily sales are determined by dividing sales by 365 days.

Average daily sales = Sales365days=$10,000,000365days=$27,397.26

6. Inventory turnover ratio

Inventory turnover ratio =Cost of goods soldAverage inventory=$5,350,000$1,070,000=2.2times

Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.

Formula:

Inventory turnover=Cost of goods soldAverage inventory

Average inventory is determined as below:

Average inventory = (Opening inventory + Closing inventory )2=$1,190,000+$950,0002=$1,070,000

7.  Number of days sales in inventory ratio

 Number of days’ sales in inventory }=Average inventory Average daily cost of goods sold=$1,070,000$14,657.53=73.0days

Number of days’ sales in inventory is determined as the number of days a particular company takes to make sales of the inventory available with them.

Formula:

 Number of days’ sales in invenotry=Average inventory Average daily cost of goods sold

Average daily cost of goods sold are determined by dividing cost of goods sold by 365 days. Thus, average daily cost of goods sold are determined as follows:

Average daily cost of goods sold= Cost of goods sold365days=$5,350,000365days=$14,657.53

8. Ratio of fixed assets to long-term liabilities

Ratio of fixed assets to long-term liabilities=Fixed assets Long-term liabilities =$3,740,000$1,700,000=2.2

Ratio of fixed assets to long-term liabilities is determined by dividing fixed assets and long-term liabilities.

Formula:

Ratio of fixed assets to long-term liabilities=Fixed assets Long-term liabilities 

9.Ratio of liabilities to stockholders’ equity

 Ratio of liabilities to stockholders' equity }=Total liabilitiesStockholders' equity=$2,600,000$7,180,000=0.4

Explanation:

Ratio of liabilities to stockholders’ equity is determined by dividing liabilities and stockholders’ equity.

Formula:

 Ratio of liabilities to stockholders' equity=Total liabilitiesStockholders' equity

10.Times interest earned ratio

Times-interest-earned ratio }=Income before income tax+Interest expenseInterest expense=$1,130,000+$170,000$170,000=7

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