11. The effect of transactions on ratios You've been asked to tutor Logan, a finance student who doesn't feel comfortabl

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11 The Effect Of Transactions On Ratios You Ve Been Asked To Tutor Logan A Finance Student Who Doesn T Feel Comfortabl 1 (62.22 KiB) Viewed 28 times

11. The effect of transactions on ratios You've been asked to tutor Logan, a finance student who doesn't feel comfortable about his understanding of the relationship between a company's business activities, its financial accounts, and the company's financial ratios. To better appreciate these relationships, you've created the following exercises for Logan to complete. The purpose of these exercises is to help Logan (1) understand the effect of business transactions on financial statement-such as balance sheet and income statement-accounts and (2) how these changes in the numerators and denominators of financial ratios affect the ratios' values. However, before using these exercises in your tutoring session later today, you'll want to run the calculations on the following two business transactions, to verify the accuracy of your answers. To provide a consistent frame of reference for the company's financial statements and ratios, assume that the following balance sheet and income statement reflect the company's pretransaction condition and performance. Fresno Furniture Manufacturing Inc.'s Pretransaction Statement of Financial Condition Cash $15,000 Accounts payable $20,000 Marketable securities 10,000 Wages payable 20,000 Accounts receivable 470,000 Taxes payable 10,000 Inventory 500,000 Notes payable 50,000 Prepaid expenses 5,000 Total current liabilities 100,000 Total current assets 1,000,000 Long-term debt 500,000 Total liabilities 600,000 Gross plant and equipment 1,500,000 Common stock 150,000 Accumulated depreciation 350,000 500,000 1,000,000 Capital paid in excess of par Retained earnings Net plant and equipment 900,000 Total equity 1,400,000 $2,000,000 Total assets $2,000,000 Total debt and equity
Fresno Furniture Manufacturing Inc.'s Pretransaction Statement of Financial Performance Sales $5,000,000 2,000,000 Less: Cost of goods soldi Gross profit 3,000,000 Less: Operating expenses Operating profit (EBIT) Less: Interest expense 2 Earnings before taxes (EBT) Less: Tax expense 3 600,000 2,400,000 33,000 2,367,000 828,450 Net income $1,538,550 Cost of goods sold equals 40% of sales. 2Interest expense equals 6% of the combined notes payable and long-term debt balances. 3 The average federal and state tax rate is 35%. Indicate if any of the listed financial statement accounts is affected by the following business transactions and whether the listed ratios will increase, decrease, or remain unchanged as a result of the transaction. (Hint: Assume that the business transaction occurs exactly as stated without interpreting it further. Do not consider any related transactions that may occur before or after the specified transaction. Assume there are 365 days in a year.)
Business Transaction 1 Fresno Furniture Manufacturing Inc. (FFM) sells 25,000 shares of new common stock ($1 per share par value) to new and existing shareholders for $20 per share. Financial Account Check if the Account Is Affected by the Specified Transaction Cash Operating income Long-term debt 0 0 0 0 0 Common stock Capital paid-in excess of par Financial Ratio Ratio's Behavior Inventory turnover Debt ratio No change Times interest earned Operating profit margin Increases Basic earnings power Decreases Current ratio
Business Transaction 2 Fresno Furniture Manufacturing Inc. (FFM) switches from holding an available inventory to a just-in-time inventory system, thereby reducing its inventory by 80.00%. Financial Account Check if the Account Is Affected by the Specified Transaction Inventory Accounts payable 0 0 Prepaid expenses Total assets U Common stock Financial Ratio Ratio's Behavior Average collection period Inventory turnover Increases Fixed assets turnover Quick ratio No change Return on assets Decreases Debt ratio