Chapter 14:
Exercise 14.1 Wofford Company had net sales of $150,000 in its first year and $187,500 in its second year. Calculate the amount of change in terms of both dollar and percentage.
The amount of change in percentage is calculated by taking the change in dollars divided by the first year sales.
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| Year 2 | Year 1 | Increase amount | Increase percentage | |
| Net sales | $187,500 | $150,000 | $37,500 | 37,500/150,000 * 100 = 25% |
Percentage change from base year is 25%.
Exercise 14.2: White, Inc., had depreciation expenses on its plant assets as follows for 2005, 2006, and 2007 respectively: $267,000, $289,000, and $357,000. Compute the trend percentages for these years assuming 2005 is the base year.
The depreciation of every year is calculated by dividing each year by the base year.
Assuming 2005 is the base year:
| 2007 | 2006 | 2005 | |
| Depreciation expenses | $357,000 | $289,000 | $267,000 |
| Trend percentage calculation | |||
| Trend percentage | 133.71% | 108.24% | 100% |
Exercise 14.6 A. Given the selected data from the financial statements of Rentsch, Inc., a retail furniture store.
a. Explain how the interest expense shown in the income statement could be $84,000, when the interest payment appearing in the statement of cash flows is only $79,000.
Amounts in the statement of cash flows are reported on a cash basis while in the income statement they are reported on an accrual basis. The $5,000 at the interest expense had not been paid at the year-end. This amount should be included at the accrued expenses and appears as a current liability at the company’s balance sheet.
b. Compute the following (round to one decimal place)
| (1) Current ratio | |
| Current assets: | |
| Cash | $ 30,000 |
| Accounts receivables | $ 150,000 |
| Inventory | $ 200,000 |
| Total current assets | $ 380,000 |
| Current liabilities | $ 150,000 |
| Current ratio(380,000/150,000) |
2.5 |
| (2) Quick ratio | |
| Quick assets: | |
| Cash |
30,000 |
| Accounts receivable |
150,000 |
| Total quick assets |
180,000 |
| Current liabilities |
150,000 |
| Quick ratio (180,000/150,000) |
1.2 |
| (3) Working capital: | |
| Current assets |
$380,000 |
| Less: Current liabilities |
($150,000) |
| Working capital |
$230,000 |
| (4) Debt ratio | |
| Total liabilities | |
| Total assets | $ 1,000,000 |
| Less Total stockholders' equity | $ 300,000 |
| Total liabilities | $ 700,000 |
| Total assets | $ 1,000,000 |
| Debt ratio (700,000/1,000,000*100) |
70% |
c. Comment on these measurements and evaluate Rentsch, Inc.’s short-term debt-paying ability.
The current ratio of 2.5 and quick ratio of 1.2 are adequate based on industry standards. Additionally, the company generates positive cash flow from its operating activities, this is twice the amount of its dividend payment to stockholders. If the extract was from a typical year, the company appears to be liquid and can pay its short-term debts.
d. Compute the following ratios (assume that the year-end amounts of total assets and total stockholders’ equity also represent the average amounts throughout the year).
| (1) Return on assets | |
| Operating income: | |
| Net sales | $ 1,500,000 |
| Less: Cost of goods sold | $ (1,080,000) |
| Operating expenses | $ (315,000) |
| Operating income | $ 105,000 |
| Total assets (at year-end) | $ 1,000,000 |
| Return on assets (105,000/1,000,000*100) |
10.5% |
| (2) Return on equity | |
| Net income | $ 15,000 |
| Total stockholders' equity (at year-end) | $ 300,000 |
| Return on equity (15,000/300,000*100) |
5% |
e. Comment on the company’s performance on these measurements. Explain why the return on asset and return on equity are so different.
The return on assets of 10.5% is adequate by industry standards but the 5% return on equity is quite low. There is a large expense of $84,000 that causes the problem.
f. Discuss (1) the apparent safety of long-term creditors’ claims and (2) the prospect of Rentsch, Inc., continuing its dividend payments at the present level.
Long-term creditors do not seem to have a high safety margin. The debt ratio of the firm is currently at 70% which is quite high. During that year, the company borrowed $50,000 but repaid only $14,000 of the liabilities. The interest payments for that year alone amounted to twice the net cash flow from its operating activities.
At the present level, if the given extract is that of a typical year, then it is highly doubtful that Rentsch, Inc. can continue paying its annual dividend of $20,000. Investing activities consumed more than the net cash flow from operating activities in the current year. It is apparent that the company is borrowing the money it pays as dividends instead of earning it.
