Question

Indicate below the net effects that each of the ten independent transactions will have on the following three ratios. Use the expressions: increase, decrease, or no effect. 1. Earnings per share ([Net income - Preferred dividends] / Average number of outstanding shares) 2. Current ratio (Current assets/Current liabilities) 3. Debt to equity ratio (Total liabilities/Total equities = liabilities plus shareholders equity) You should record your response on the schedule provided below. State any assumptions you feel are necessary. You are to assume that these are the respective ratios for this firm prior to each transaction: 1. EPS = $2 per share 2. CR = 3 to 1 3. D to E -25% Transaction JEPS D to E 1. Sold a service for cash [Select] Select) [Select] 2. Received cash payments from customers on previously recorded sales. [Select] [Select) [Select] 3. Sold a service on account. [Select] [Select) [Select]

Answer 1

Solution:

	Transaction	EPS	CR	D to E
1	Sold a service for cash	Increase	Increase	Decrease
	Revenue will increase, Net income will increase, Cash will increase current asset, Retained earnings will increase equity	(Net income - preferred dividends )↑/ (Average number of outstanding shares)	(Current assets) ↑/ (Current liabilities)	(Total liabilities) / (Total equities)↑
2	Received cash payments from customers on previously recorded sales.	No effect	No effect	No effect
	Cash will increase, Account Receivables will decrease, net current assets will remain same	No net change	No net change	No net change
3	Sold a service on account	Increase	Increase	Decrease
	Revenue will increase, Net income will increase, Accounts receivables will increase current asset, Retained earnings will increase equity	(Net income - preferred dividends )↑/ (Average number of outstanding shares)	(Current assets) ↑/ (Current liabilities)	(Total liabilities) / (Total equities)↑
4	Purchased inventory on an account	No effect	Decrease	Increase
	Inventory will increase current assets, account payables will increase current liabilities, account payables will increase total liabilities	No net change	(Current assets) ↑/ (Current liabilities)↑↑     Both current asset and current liabilities will increase. As CR was equal to 3 so current assets were more than current liabilities so the same increase in both will decrease the ratio	(Total liabilities)↑ / (Total equities)
5	Purchased equipment for cash	Decrease	Decrease	Increase
	Decrease in cash will reduce current asset, Depriciation expense will decrease Net Income and equity	(Net income - preferred dividends )↓/ (Average number of outstanding shares)	(Current assets) ↓/ (Current liabilities)	(Total liabilities) / (Total equities)↓
6	Paid cash to reduce the wages payable account	No effect	Increase	Decrease
	Decrease in cash will reduce current asset, Decrease in payable account will decrease current liabilities, Total liabilities will decrease	No change	(Current assets) ↓/ (Current liabilities)↓↓     Both current asset and current liabilities will decrease. As CR was equal to 3 so current assets were more than current liabilities so the same decrease in both will increase the ratio	(Total liabilities)↓ / (Total equities)
7	Issued common stock for cash	Decrease	Increase	Decrease
	Cash will increase current asset, equity will be increased and average number of shares outstanding will increase	(Net income - preferred dividends )/ (Average number of outstanding shares)↑	(Current assets) ↑/ (Current liabilities)	(Total liabilities) / (Total equities)↑
8	Sold land for an amount greater than its cost	Increase	Increase	Decrease
	Cash will increase current asset, Net income will increase, retained earning will increase equity	(Net income - preferred dividends )↑/ (Average number of outstanding shares)	(Current assets) ↑/ (Current liabilities)	(Total liabilities) / (Total equities)↑
9	Made a cash interest payment (debit interest, credit cash)	Decrease	Decrease	Increase
	Interest expense will decrease net income, equity will be decreased, cash will reduce current asset	(Net income - preferred dividends )↓/ (Average number of outstanding shares)	(Current assets) ↓/ (Current liabilities)	(Total liabilities) / (Total equities)↓
10	Paid off a long-term loan	No effect	Decrease	Decrease
	Cash will reduce current asset, liability will decrease	No Change	(Current assets) ↓/ (Current liabilities)	(Total liabilities)↓ / (Total equities)