Financial Accounting
Financial Accounting
5th Edition
ISBN: 9781259914898
Author: SPICELAND
Publisher: MCG
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Chapter 12, Problem 6E

1.

To determine

Compute the profitability ratios of Company AE.

1.

Expert Solution
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Answer to Problem 6E

Financial Ratios: Financial ratios are the metrics used to evaluate the liquidity, capabilities, profitability, and overall performance of a company. The profitability ratios are:

  • Gross profit ratio: 36.56%
  • Return on assets: 20%
  • Profit margin: 8.80%
  • Asset Turnover: 2.27 times
  • Return on equity: 40.38%

Explanation of Solution

Gross profit ratio: Gross profit is the financial ratio that shows the relationship between the gross profit and net sales. It represents gross profit as a percentage of net sales. Gross Profit is the difference between the net sales revenue, and the cost of goods sold. It can be calculated by dividing gross profit and net sales.

Formula:

Gross profit ratio=Gross profit Net sales×100

Determine gross profit ratio.

Given: Company AE reports sales of $19,310,000.

Gross profit ratio=Gross profit Net sales×100=$7,060,000(1) $19,310,000 ×100=36.56%

Working Note:

Determine the amount of gross profit.

Gross profit=Net salesCost of goods sold=$19,310,000$12,250,000=$7,060,000 (1)

Return on assets: Return on assets determines the particular company’s overall earning power. It is determined by dividing sum of net income and average total assets.

Formula:

Return on assets=Netincome Average total assets×100

Determine return on assets ratio.

Return on assets=Netincome Average total assets×100=$1,700,000$8,500,000 (2)=20%

Working Note:

Determine the amount of average total assets.

Average total assets=Opening total assets +Closing total assets 2=$7,800,000+$9,200,0002=$17,000,0002=$8,500,000 (2)

Profit margin: This ratio gauges the operating profitability by quantifying the amount of income earned from business operations from the sales generated.

Formula:

Profit margin=Netincome Net sales×100

Determine profit margin ratio.

Given: Company AE reports sales of $19,310,000 and net income of $1,700,000.

Profit margin=Netincome Net sales×100=$1,700,000$19,310,000×100=8.80%

Asset Turnover: Asset turnover refers to the ratio calculated which determines the amount of sales revenue generated by the business with the use of the total assets owned by it.

Formula:

Asset turnover=Netsales Average total assets×100

Determine asset turnover ratio.

Given: Company AE reports sales of $19,310,000, opening and closing balance of total assets amounts to $7,800,000 and $9,200,000 respectively.

Asset turnover=Netsales Average total assets×100=$19,310,000$8,500,000 (3)=2.27 times

Working Note:

Determine the amount of average total assets.

Average total assets=Opening total assets +Closing total assets 2=$7,800,000+$9,200,0002=$17,000,0002=$8,500,000 (3)

Return on equity: Return on equity is used to determine the relationship between the net income and the average common equity that are invested in the company.

Formula:

 Return on stockholders' equity = Net incomeAverage stockholder’s equity

Determine return on stockholders’ equity ratio.

Given: Company AE reports net income of $1,700,000.

Return on assets=Netincome Average stockholders' equity×100=$1,700,000$4,210,000 (6)=40.38%

Working Note:

Determine the amount of average stockholders’ equity.

Average stockholder’s equity=(Opening stockholder’s equity)+(Closing stockholder’s equity)2=$3,540,000+$4,880,0002=$8,420,0002=$4,210,000 (6)

Compute the amount of opening and closing stockholders’ equity.

Opening stockholders' equity=Common stock+Retained earnnings=$1,900,000+$1,640,000=$3,540,000 (4)

Closing stockholders' equity=Common stock+Retained earnnings=$1,900,000+$2,980,000=$4,880,000 (5)

2.

To determine

Explain whether the company is more profitable or less profitable based on the given industry average.

2.

Expert Solution
Check Mark

Explanation of Solution

Comparison between industry average and company’s performance:

RatiosIndustry averageCompany AE’s Performance
Gross profit ratio45%36.56%
Return on assets25%20%
Profit margin15%8.80%
Asset Turnover2.5 times2.27 times
Return on equity35%40.38%

Table (1)

Company AE is less profitable as its profitability is lower than the industry average in every aspect, except in return on equity, where the ratio is better than the industry average.

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Chapter 12 Solutions

Financial Accounting

Ch. 12 - Prob. 11SSQCh. 12 - Prob. 12SSQCh. 12 - Prob. 13SSQCh. 12 - Prob. 14SSQCh. 12 - Prob. 15SSQCh. 12 - Prob. 1AECh. 12 - Prob. 2AECh. 12 - Prob. 1RQCh. 12 - Prob. 2RQCh. 12 - Prob. 3RQCh. 12 - Prob. 4RQCh. 12 - Prob. 5RQCh. 12 - Prob. 6RQCh. 12 - Prob. 7RQCh. 12 - Prob. 8RQCh. 12 - Prob. 9RQCh. 12 - Prob. 10RQCh. 12 - Prob. 11RQCh. 12 - Prob. 12RQCh. 12 - Prob. 13RQCh. 12 - Prob. 14RQCh. 12 - Prob. 15RQCh. 12 - Prob. 16RQCh. 12 - Prob. 17RQCh. 12 - Prob. 18RQCh. 12 - Prob. 19RQCh. 12 - Prob. 20RQCh. 12 - Prob. 1BECh. 12 - Prepare horizontal analysis (LO12-2) BE12-2 Using...Ch. 12 - Prob. 3BECh. 12 - Prob. 4BECh. 12 - Prob. 5BECh. 12 - Prob. 6BECh. 12 - Prob. 7BECh. 12 - Prob. 8BECh. 12 - Prob. 9BECh. 12 - Prob. 10BECh. 12 - Prob. 11BECh. 12 - Prob. 12BECh. 12 - Prob. 13BECh. 12 - Prob. 14BECh. 12 - Prob. 15BECh. 12 - Prob. 1ECh. 12 - Prob. 2ECh. 12 - Prob. 3ECh. 12 - Prob. 4ECh. 12 - Prob. 5ECh. 12 - Prob. 6ECh. 12 - Prob. 7ECh. 12 - Prob. 8ECh. 12 - Prob. 9ECh. 12 - Prob. 10ECh. 12 - Prob. 11ECh. 12 - E12-12 LeBron’s Bookstores has two divisions:...Ch. 12 - Prob. 13ECh. 12 - Prob. 14ECh. 12 - Prob. 15ECh. 12 - Prob. 1PACh. 12 - Prob. 2PACh. 12 - P12-3A The balance sheets for Sports Unlimited for...Ch. 12 - Prob. 4PACh. 12 - Prob. 5PACh. 12 - Prob. 6PACh. 12 - Prob. 1PBCh. 12 - Prob. 2PBCh. 12 - Prob. 3PBCh. 12 - Prob. 4PBCh. 12 - P12-5B Data for The Athletic Attic are provided in...Ch. 12 - Prob. 6PBCh. 12 - Prob. 1APCh. 12 - Prob. 2APCh. 12 - Prob. 3APCh. 12 - Prob. 4APCh. 12 - Ethics AP12-5 After years of steady growth in net...Ch. 12 - Prob. 7APCh. 12 - Prob. 8AP
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