Chapter 4, Problem 4.14P

Creating a balance sheet from ratios; Chapters 3 and 4

• LO4–10

Cadux Candy Company’s income statement for the year ended December 31, 2018, reported interest expense of $2 million and income tax expense of $12 million. Current assets listed in its balance sheet include cash, accounts receivable, and inventories. Property, plant, and equipment is the company’s only noncurrent asset. Financial ratios for 2018 are listed below. Profitability and turnover ratios with balance sheet items in the denominator were calculated using year-end balances rather than averages.

Debt to equity ratio	1.0
Current ratio	2.0
Acid-test ratio	1.0
Times interest earned ratio	17 times
Return on assets	10%
Return on shareholders’ equity	20%
Profit margin on sales	5%
Gross profit margin (gross profit divided by net sales)	40%
Inventory turnover	8 times
Receivables turnover	20 times

Required:

Prepare a December 31, 2018, balance sheet for the Cadux Candy Company.

To determine

Ratio analysis

Ratio analysis is a tool to analyze the financial statements of a company which helps to express a mathematical relationship among the items of financial statements.

Balance sheet

This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

To prepare: The balance sheet of Company CC for the year ended December, 31 2018.

Explanation of Solution

Prepare the balance sheet of Company CC for the year ended December, 31 2018.

Corporation CC
Balance Sheet
For the year ended December 31, 2018
Assets	Amount ($ in millions)	Amount ($ in millions)
Current assets:
Cash (3)	10
Accounts receivables (2)	20
Inventories (1)	30
Total current assets		60
Net property, plant, and equipment (5)		140
Total assets		200
Liabilities and Shareholders' Equity	Amount ($ in millions)	Amount ($ in millions)
Current liabilities (4)		30
Long-term liabilities (7)		70
Shareholders’ equity (6)		100
Total liabilities and shareholders’ equity		200

Table (1)

Working notes:

1)

To determine: The amount of net income.

Solution:

Given, Interest expense is $2 and Income tax expense $12

$\begin{array}{c}\text{Times interest earned ratio = }\frac{\text{Net income}+\text{Interest expense}+\text{Income tax expense}}{\text{Interest expense}}\\ 17\text{ = }\frac{\text{Net income}+\$2+\$12}{\$2}\\ 34=\text{ Net income}+\$14\\ \text{Net income = }\$34-\$14\\ \text{Net income = }\$20\end{array}$

2)

To determine: The average total assets using return on assets ratio.

Solution:

$\begin{array}{c}\text{Return on Assets = }\frac{\text{Net income}}{\text{Average total assets}}\\ \text{10\% = }\frac{\$20}{\text{Average total assets}}\\ \text{Average total assets = }\frac{\$20}{\text{10}}\times 100\\ \text{Average total assets = }\$200\end{array}$

3)

To determine: The amount of net sales.

Solution:

$\begin{array}{c}\text{Profit margin on sales = }\frac{\text{Net income}}{\text{Net sales}}\\ \text{5\% = }\frac{\$20}{\text{Net sales }}\\ \text{Net sales = }\frac{\$20}{5}\times 100\\ \text{Net sales = }\$400\end{array}$

4)

To determine: The gross profit and cost of goods sold.

Solution:

$\begin{array}{c}\text{Gross profit margin= }\frac{\text{Gross profit}}{\text{Net sales}}\\ \text{40\% = }\frac{\text{Gross profit}}{\text{400 }}\\ \text{Gross profit = \$4}00\times \frac{40}{100}\\ \text{Gross profit = }\$160\end{array}$

$\begin{array}{c}\text{Cost of goods sold = Net sales}-\text{ Gross profit}\\ \text{= \$400}-\$160\\ =\$240\end{array}$

5)

To determine: The amount of average inventory.

Solution:

$\begin{array}{c}\text{Inventory turnover ratio = }\frac{\text{Cost of goods sold}}{\text{Average inventories}}\\ 8\text{ = }\frac{\$240}{\text{Average inventories}}\\ \text{Average inventories}=\frac{\$240}{8}\\ \text{Average inventories}=\text{ \$30}\end{array}$ (1)

6)

To determine: The amount of average receivables.

Solution:

$\begin{array}{c}\text{Receivables turnover ratio = }\frac{\text{Net sales }}{\text{Average receivables}}\\ \text{20 = }\frac{\$400}{\text{Average receivables}}\\ \text{Average receivables}=\frac{\$400}{20}\\ \text{Average receivables}=\text{ \$20}\end{array}$ (2)

7)

To determine: The cash balance.

Solution:

$\begin{array}{c}\text{Current ratio }=\frac{\text{Current assets}}{\text{Current liablities}}\\ \frac{2}{1}=\frac{\text{Current assets}}{\text{Current liabilities}}\\ \text{Current assets}=2\text{ Current liabilities}\end{array}$ (a)

$\begin{array}{c}\text{Acid-test ratio =}\frac{\text{Quick assets}}{\text{Current liabilities}}\\ 1=\frac{\text{Quick assets}}{\text{Current liabilities}}\\ \frac{1}{1}=\frac{\text{Quick assets}}{\text{Current liabilities}}\\ \text{Current liabilities}=\text{Quick assets}\end{array}$ (b)

By using the above equation, determine amount of cash.

$\begin{array}{c}\text{Current assets }=2\text{ Quick assets}\\ \text{Cash}+\text{Receivables}+\text{Inventories }=\text{ 2}\times \left(\text{Cash}+\text{Receivables}\right)\\ \text{Cash}+\text{Receivables}+\text{Inventories }=2\text{Cash}+2\text{Receivables}\\ \text{Inventories }=2\text{Cash}+2\text{Receivables}-\text{Cash}-\text{Receivables}\end{array}$

$\begin{array}{c}\text{Inventories }=\text{ Cash }+\text{ Receivables}\\ \text{Cash }=\text{Inventories }-\text{Receivables}\\ \text{Cash }=\$30-\$20\\ \text{Cash }=\$10\end{array}$ (3)

8)

To determine: The amount of current liabilities.

Solution:

$\begin{array}{c}\text{Acid-test ratio =}\frac{\text{Quick assets}}{\text{Current liabilities}}\\ \frac{1}{1}=\frac{\left(\text{Cash}+\text{Receivables}\right)}{\text{Current liabilities}}\\ 1=\frac{\left(\$10+\$20\right)}{\text{Current liabilities}}\\ 1=\frac{\$30}{\text{Current liabilities}}\end{array}$

$\text{Current liabilities = }\$30$ (4)

9)

To determine: The amount of non-current assets.

Solution:

$\begin{array}{c}\text{Non-current assets = Total assets}-\text{ Current assets}\\ \text{Non-current assets = \$200}-\left(\text{Cash}+\text{Receivables}+\text{Inventories}\right)\\ \text{Non-current assets = \$200}-\left(\$10+\$20+\$30\right)\\ \text{Non-current assets = \$200}-\text{ \$60}\end{array}$

$\text{Non-current assets = \$140}$ (5)

10)

To determine: The amount of average shareholders’ equity.

Solution:

$\begin{array}{c}\text{Return on shareholders' equity = }\frac{\text{Net income}}{\text{Average shareholders' equity}}\\ \text{20\% = }\frac{\$20}{\text{Average shareholders' equity }}\\ \text{Average shareholders' equity = }\frac{\$20}{20}\times 100\\ \text{Average shareholders' equity = }\$100\end{array}$ (6)

11)

To determine: The amount of long-term liabilities

Solution:

$\begin{array}{c}\text{Debt equtiy ratio =}\frac{\text{Total liabilities}}{\text{Total shareholders' equity}}\\ 1=\frac{\text{Total liabilities}}{\$100}\\ \text{Total liabilities}=\$100\end{array}$

$\begin{array}{c}\text{Long term liabilities = Total liabilities}-\text{Current liabilities}\\ \text{= \$100}-\$30\\ =\$70\end{array}$ (7)