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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883

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BuyFindarrow_forward

Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883
Textbook Problem

Ratio of liabilities to stockholders' equity and times interest earned
The following data were taken from the financial statements of Starr Construction Inc. for December 31, 20Y6 and 20Y5:


The income before income tax was $2,816,000 and $2,640,000 for the years 20Y6 and 20Y5, respectively.

a.Determine the ratio of liabilities to stockholders' equity at the end of each year.
b. Determine the times (bond) interest earned during the year for both years.
c. What conclusions can be drawn from these data as to the company's ability to meet its currently maturing debts?

To determine

(a)

Introduction:

Accounting ratios are used to evaluate the financial performance of the business organisation.

Debt to equity ratio:

It is used to evaluate company's financial leverage. It reflects the ability of shareholders equity to cover all outstanding debts.

To calculate:

Debt to equity ratio at the end of each year.

Explanation

Debt-equity ratio can be calculated as follows.

Debt-equity ratio = Total liabilitiesTotal Equity

    ParticularsDec 31, 20Y6Dec 31, 20Y5
    Accounts Payable and other liabilities$1,700,000$2,325,000
    Current Maturities of Bonds Payable$500,000$500,000
    Serial bonds payable, 8% issued 2008, due in 5 years$5,000,000$5,500,000
    Total Liabilities$7,200,000$8,325,000
    Common Stock, $5 par value$250,000$250,000
To determine

(b)

Concept Introduction:

Time interest earned:

It is used to measure a company's ability to meet interest obligations on its debt. It can be calculated using following formula.

  Time interest earned=Earning before interest and taxes  Total Interest payable

To Calculate:

Times interest earned for both the years.

To determine

(c)

Current Liabilities:

Liabilities that have a maturity period of less than a year are regarded as current liabilities. Also, the part of long liability that is expected to mature in current year are referred to as current maturities.

To conclude:

The ability of the firm to pay off its current maturities.

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