Question

Part I: You, the accountant, are analyzing Nolans Corporation. Nolans corp. has expanded its production facilities by 200% since 2016. The income statements for the last three year are below:

Nolan Security Corporation
Statement of Financial Position
At December 31, 2020
Assets		Liabilities
Current		Current
Cash	$100	Accounts Payable	$300
Accounts Receivable	200	Wages Payable	50
Merchandise Inventory	500	Dividends Payable	50
Prepared Expenses	50		400
	850
Non-current		Non-current
Property, plant & equipment (net)	1,000	Loan Payable	800
			1,200
		Shareholders’ Equity
		Common Shares	500
		Retained Earnings	150
		Total Shareholder’s Equity	650
Total Assets	$1,850	Total Liability and Equity	$1,850

Requirements: Show all work.

1. Calculate current ratio, acid-test ratio, and debt to shareholder’s equity ratio.

2. Discuss the meaning of each ratio result. (What do these ratios mean for Nolans Security?)

Part III: The following balance sheet (statement of financial position) is presented for LevelUp Corporation.

LevelUp Corporation
Statement of Financial Position
At December 31, 2020
Assets		Liabilities
Current		Current
Cash	$60	Accounts Payable	$100
Accounts Receivable	140	Loan Payable	20
Merchandise Inventory	250	Notes Payable	60
Prepared Expenses	10		180
	460
Non-current		Non-current
Property, plant & equipment (net)	330	Loan Payable	140
			320
		Shareholders’ Equity
		Preferred shares, 10% (8 shares)	120
		Common shares (50 shares)	250
		Retained earnings	100
			470
Total Assets	$790	Total Liability and Equity	$790

LevelUp Corporation
Income Statement
For the Year Ending December 31, 2020
Net Sales (all on credit)	$800
Cost of Goods Sold	600
Gross Profit	200
Selling and Administration Expenses	100
Income from Operations	100
Interest Expense	20
Income before Income Taxes	80
Income Taxes	30
Net Income	$50

Additional information from December 31, 2019 statement of financial position:

Accounts receivable                            $180

Merchandise inventory                        200

Property, Plant and Equipment (net) 250

Retained earnings                                   80

Preferred shares                                  120

Common Shares                                  250   

Requirements:

1. Compute the following ratios, showing all work.

Current ratio

Acid-test ratio

Accounts receivable collection period

Number of days of sales in inventory

Debt to shareholders’ equity ratio

Return on shareholder’s equity

2. What do these ratios tell you about the LevelUp Corporation?

Answer 1

Part-1

Current ratio=current asset/current liabilities

Current asset=Cash+account receivable+merchandise inventory+prepaid expenses

=100+200+500+50=$850

Current liabilities= Account payable+ wages payable+ dividend payable

=300+50+50=$400

Therefore,

Current ratio= $850/$400=2.125:1

Acid test ratio= (current asset-inventory-prepaid expenses)/current liabilities

=($850-$500-$50)/400= 0.75:1

Debt to shareholders equity ratio= Debt/shareholders equity

= Loan payable/shareholders equity

= 800/650=1.23:1

Current ratio is adequate in this case as ideal current ratio is 2:1

Acid test ratio is not adequate as ideal ratio is 1:1, asset are less than liabilities

Debt equity ratio is adequate as ideal ratio lies between 1 to 1.5.

Part-III

Current ratio=current asset/current liabilities

Current asset=Cash+account receivable+merchandise inventory+prepaid expenses

=60+140+250+10=$460

Current liabilities= Account payable+ Loan payable + notes payable

=100+20+60=$180

Therefore,

Current ratio= $460/$180=2.55:1

Acid test ratio= (current asset-inventory-prepaid expenses)/current liabilities

=($460-$250-$10)/180= 1.11:1

Account receivable collection period= (Account receivable/sales)*365

= ($140/$800)*365= 63.875 days or 64 days(rounded off)

Number of days of sales in inventory= ( inventory/COGS)*365

=($250/$600)*365= 152 days approx.

Debt to shareholders equity= Debt/shareholders equity

=$140/$470= 0.30:1

Return on shareholders equity= net income/ shareholders equity*100

= ($50/$470)*100=10.64%

Current ratio adequate as it is above ideal ratio of 2:1

Acid test ratio is adequate as it is above ideal ratio of 1:1

Account receivable collection period is adequate as ideal period is of 45 days

Debt to shareholders equity is not appropriate as it is below ideal ratio.

No. Of days of sale in inventory is 152 days which shows that this much time company takes to convert inventory into cash.

Return on equity is not adequate as ideal percentage should be in between 15%-20%.