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:

$$ \begin{array}{|l|l|l|} \hline & \text { Beginning of the Year } & \text { End of the Year } \\ \hline \text { Total Assets } & \$ 550,000 & \$ 587,000 \\ \hline \text { Total Liabilities } & 210,000 & 218,000 \\ \hline \text { Total Equity } & 340,000 & 369,000 \\ \hline \text { Net Income for the Year } & & 91,300 \\ \hline \text { Common Shares Outstanding } & 21,000 & 21,000 \\ \hline \end{array} $$

You discovered that they have not adjusted for estimated bad debt expenses of \(\$ 9,900 .\) For each of the following ratios, calculate.

1. The ratio that would have resulted had the error not been discovered (Le. the incorrect ratio).

2. The correct ratio.

Answer 1

ROA = Net Income / Avg.Total Assets

Incorrect = 91300 / ( 550000 + 587000 ) / 2 = 91300 / 568500 = 16.06%

Correct = ( 91300 - 9900 ) / ( 550000 + 587000 - 9900 ) / 2 = 81400 / 563550 = 14.44%

ROE = Net Income / Avg.Total Equity

Incorrect = 91300 / ( 340000 + 369000 ) / 2 = 91300 / 354500 = 25.75%

Correct = ( 91300 - 9900 ) / ( 340000 + 369000 - 9900 ) / 2 = 81400 / 349550 = 23.29%

Debt Ratio = Total Liabilities / Total Assets

Incorrect = 218000 / 587000 = 0.3714 ~ 37.14%

Correct = 218000 / (587000 - 9900 ) = 218000 / 577100 = 0.3778 ~ 37.78%

EPS = Net Income / Common Shares Outstanding

Correct = 91300 / 21000 = $4.35 per share

Correct = ( 91300 - 9900 ) / 21000 = 81400 / 21000 = $3.88 per share