Question

The accounting department of your company has just delivered a draft of the current year's financial statements to you. The summary is as follows: Total Assets Total Liabilities Total Equity Net Income for the Year Common Shares Outstanding Beginning of the Year $550,000 210,000 340,000 End of the Year $609,000 213,000 396,000 91,800 21,000 21,000 You discovered that they have not adjusted for estimated bad debt expenses of $7,800. For each of the following ratios, calculate: 1. The ratio that would have resulted had the error not been discovered (i.e. the incorrect ratio). 2. The correct ratio. A в Incorrect: с Correct: т р F | 2 ROA 3 ROE 4 Debt Ratio 5 EPS 9 10

Answer 1

(1) the incorrect ratio

(a)

ROA = net income/average total assets

= $91800/{($550000 + $609000)/2}

= $91800/$579500

= 15.84%

(b)

ROE = net income/average total equity

= $91800/{($340000 + $396000)/2}

= $91800/$368000

= 24.95%

(c)

Debt ratio = total liabilities/total assets

= $213000/$609000

= 34.98%

(d)

EPS = (net income - preference dividend)/average common shares outstanding

= ($91800 - 0)/{(21000 + 21000)/2}

= $91800/21000

= $4.37

(1) the correct ratio:

correct net income for the year = $91800 - $7800 = $84000

correct total equity at the end of the year = $396000 - $7800 = $388200

(a)

ROA = net income/average total assets

= $84000/{($550000 + $609000)/2}

= $84000/$579500

= 14.50%

(b)

ROE = net income/average total equity

= $84000/{($340000 + $388200)/2}

= $84000/$364100

= 23.07%

(c)

Debt ratio = total liabilities/total assets

= $213000/$609000

= 34.98%

(d)

EPS = (net income - preference dividend)/average common shares outstanding

= ($840000 - 0)/{(21000 + 21000)/2}

= $84000/21000

= $4