(1)
Condensed financial statement:
Condensed financial statements are statements which are prepared in addition to the traditional financial statement. It is viewed by the auditing team at the time of audit the condensed financial statements along with full financial statements for a full picture of the company’s financial status.
To Compare: The two firms greater earnings relative to resources available.
(1)
Explanation of Solution
Determine the
Rate of return on assets indicates the company’s overall profitability by excluding specific sources of finance.
Hence, Company M profitability exceeds the profitability of the Company R.
(2)
The two companies have achieved their respective rates of return on assets with similar combinations of profit margin and turnover.
(2)
Explanation of Solution
Profitability is achieved through a high profit margin or a high turnover or a combination of both.
Determine the rate of return on assets with combinations of profit margin and turnover:
Hence, Company R profit margin is less than that of Company M.
(3)
To Calculate: The rate of return on shareholders’ equity of two firms.
(3)
Explanation of Solution
Determine the rate of return on shareholders’ equity of two firms:
Rate of return on shareholders’ equity reveals the profit of the company generates with the money shareholders’ have invested.
Hence, Company R provides greater return to common shareholders than Company M.
(4)
To Calculate: The financial leverage (or) Equity multiplier of two firms.
(4)
Explanation of Solution
When the return on shareholders’ equity is greater than the return on assets, management is using debt funds to enhance the earnings for stockholders. Both firms do this. Company R has higher leverage than Company M which is used to provide a higher return to shareholders, even though its return on assets is less.
Determine the Equity multiplier of two firms:
Company R increased its return to shareholders 4.07 times (43.6% ÷ 10.7%) the return on assets. Company M increased its return to shareholders 2.34 times (34.6% ÷ 14.8%) the return on assets.
(5)
To identify: Of the two companies, which company appears riskier in terms of its ability to pay short-term obligations
(5)
Explanation of Solution
Determine the short term obligations of the two firms:
The current ratios of the two firms are comparable and within the range of the rule-of-thumb standard of 1 to 1. Acid-test ratio reveals that Company M is more liquid than Company R.
(6)
To identify: The efficient management of current assets.
(6)
Explanation of Solution
Receivables turnover ratio indicates how quickly a company is able to collect its accounts receivable.
Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.
Determine the management of current assets through receivables turnover and inventory turnover of both the firms.
Company R receivables turnover is more rapid than Company M. Hence, its relative liquidity is not as bad as its acid-test ratio indicated.
(7)
To Identify: The creditor point of view, which company offers the most suitable margin of safety in terms of its ability to pay fixed interest charges?
(7)
Explanation of Solution
Times interest earned ratio quantifies the number of times the earnings before interest and taxes the business pay for the interest expense.
Determine the times interest earned ratio of both the firm:
Hence, Company M and Company R provides an adequate margin of safety in terms of its ability to pay fixed interest charges.
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Chapter 4 Solutions
Intermediate Accounting
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