Financial & Managerial Accounting
Financial & Managerial Accounting
18th Edition
ISBN: 9781260006520
Author: williams
Publisher: MCG
Question
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Chapter 14, Problem 9BP

a.

To determine

Compute the ratios for each of the companies.

1. Working capital.

2. Current ratio.

3. Quick ratio.

4. Number of times inventory turned over during the year and the average number of days required to turn over inventory.

5. Number of times accounts receivable turned over during the year and the average number of days required to collect accounts receivable.

6. Operating cycle.

a.

Expert Solution
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Answer to Problem 9BP

Computation of ratios for each of the companies is as follows:

RatiosIncorporation TISIncorporation TAS
1. Working capital
Cash $95,000$47,000
Accounts receivable (net)$100,000  $90,000
Inventory $50,000$160,000
Current Assets (A) (1)$245,000$297,000
  
Current Liabilities (B)$120,000$110,000
   
Working capital (A)(B)$125,000$187,000
 
2. Current ratio
Current Assets (A) (1)$245,000$297,000
Current Liabilities (B)$120,000$110,000
   
Current ratio (A)÷(B)2.04:12.7:1
 
3. Quick ratio
Cash $95,000$47,000
Accounts receivable (net)$100,000  $90,000
Quick Assets (A)$195,000$137,000
   
Current Liabilities (B)$120,000$110,000
   
Quick ratio (A)÷(B)1.63:11.25:1
 
4. Number of times inventory turned over and average number of days to sell
Cost of goods sold (A)$700,000$640,000
Average inventory  (B)$50,000$160,000
   
Number of times inventory turned over (A)÷(B) (2)14.0 Times4.0 Times
   
Number of times inventory turned over (C) (2)14.0 Times4.0 Times
Days in a year (D)365 days365 days
   
Average number of days to sell (D)÷(C) (3)26 days91 days
 
5. Number of times accounts receivable turned over and average number of days to collect receivable
Sales (A)$900,000$840,000
Average accounts receivable  (B)$100,000  $90,000
   
Number of times accounts receivable turned over (A)÷(B)(4)9.0 Times9.33 Times
   
Number of times accounts receivable turned over (C) (4)9.0 Times9.33 Times
Days in a year (D)365 days365 days
   
Average number of days required to collect receivable (D)÷(C) (5)41 days39 days
 
6. Operating cycle
Number of days to sell inventory (A) (3)26 days91 days
Number of days to collect receivable (B) (5)41 days39 days
Operating cycle (A)+(B)67 days130 days

Table (1)

Explanation of Solution

  1. 1) Working capital: Working capital refers to the excess amount of current assets over its current liabilities of a business. It measures the excess funds that are required for the companies to carry out their day to day operations, excluding any new funds that have been invested during the year. Working capital is calculated by using the formula:

Working Capital=Current AssetsCurrent Liabilities

  1. 2) Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company. Current ratio is calculated by using the formula:

Current ratio=Current AssetsCurrent Liabilities

  1. 3) Quick ratio: The financial ratio which evaluates the ability of a company to pay off the instant debt obligations is referred to as quick ratio. Quick assets are cash, marketable securities, and accounts receivables. Quick ratio is calculated by using the formula:

Quick ratio=Quick AssetsCurrent Liabilities

  1. 4) Number of times inventory turned over: This is a financial measure that is used to evaluate as to how many times a company sells or uses its inventory during an accounting period. It is calculated by using the following formula:

Number of times inventory turned over} = Cost of goods soldAverage inventory

Average number of days to sell: This ratio is determined as the number of days a particular company takes to make sales of the inventory available with them. It is calculated by using the formula:

Numbers of days to sell inventory}=365Inventory turnover

  1. 5) Number of times accounts receivable turned over: Number of times accounts receivable turned over is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. This ratio is determined by dividing credit sales and average accounts receivable.

Number of times accounts receivable turned over}=Net credit salesAverage accounts receivables

Average number of days to collect receivable: This ratio is used to determine the number of days a particular company takes to collect accounts receivables. It is calculated by using the formula:

Average days to collect accounts receivable}=365Receivables turnover

  1. 6) Operating cycle: This ratio is used to determine the number of days a particular company takes to convert its invested cash into inventory and then converts the inventory back to cash. This ratio is calculated by using the formula:

Operating cycle=(Number of days to sell inventory)+(Number of days to collect receivable)

Conclusion

As per table (1), the ratios of each company are as follows:

ParticularsIncorporation TISIncorporation TAS
1. Working capital.$125,000$187,000
2. Current ratio.2.04:12.70:1
3. Quick ratio.1.63:11.25:1
4. Number of times inventory turned over.14.0 Times4.0 Times
Average number of days to sell inventory.26 days91 days
5. Number of times accounts receivable turned over.9.0 Times9.33 Times
Average number of days to collect receivable.41 days39 days
6. Operating cycle67 days130 days

Table (2)

b.

To determine

Comment on the quality of each company’s working capital from the viewpoint of a short term creditor and identify the company that would be preferred for the sale of $50,000 in merchandise on a 30-day open account.

b.

Expert Solution
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Explanation of Solution

From the viewpoint of creditors, the following points must be considered:

  • As per table (2), the current ratio and working capital of Incorporation TAS is higher than the working capital of Incorporation TIS.
  • The quick ratio of Incorporation TAS is lower than the quick ratio of Incorporation TIS because the major portion of current assets of Incorporation TAS consists of inventories that have blocked the cash inflow.
  • The number of times inventory turned over of Incorporation TIS is higher than the turnover ratio Incorporation TAS, whereas the number of times accounts receivable turned over of Incorporation TIS is lower than the turnover ratio of Incorporation TAS.
  • Similarly, Incorporation TIS’s average number of days to sell inventory is lower than Incorporation TAS that indicates Incorporation TIS has been managing its inventory level efficiently.
  • The number of days to collect receivable of Incorporation TAS is lower than Incorporation TIS that indicates Incorporation TAS has been managing its collections efficiently. Although, the operating cycle of Incorporation TAS is higher than the operating cycle of Incorporation TIS.

Incorporation TIS would be preferred to sell merchandise worth of $50,000 because Incorporation TIS has a greater potential for paying off the obligations when it becomes due.

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Chapter 14 Solutions

Financial & Managerial Accounting

Ch. 14 - Prob. 4DQCh. 14 - Prob. 5DQCh. 14 - Prob. 6DQCh. 14 - 7. What is the characteristic common to all...Ch. 14 - Prob. 8DQCh. 14 - Prob. 9DQCh. 14 - Prob. 10DQCh. 14 - Prob. 11DQCh. 14 - Prob. 12DQCh. 14 - Prob. 13DQCh. 14 - Prob. 14DQCh. 14 - Prob. 15DQCh. 14 - BRIEF EXERCISE 14.1 Dollar and Percentage...Ch. 14 - BRIEF EXERCISE 14.2 Trend Percentages Star, Inc.,...Ch. 14 - Prob. 3BECh. 14 - BRIEF EXERCISE 14.4 Working Capital and Current...Ch. 14 - BRIEF EXERCISE 14.5 Current and Quick Ratio Foster...Ch. 14 - BRIEF EXERCISE 14.6 Debt Ratio Jarman Company had...Ch. 14 - Prob. 7BECh. 14 - BRIEF EXERCISE 14.8 Earnings per Share Multi-Star,...Ch. 14 - Prob. 9BECh. 14 - BRIEF EXERCISE 14.10 Return on Equity Prince...Ch. 14 - Prob. 1ECh. 14 - EXERCISE 14.2 Trend Percentages Compute trend...Ch. 14 - Prob. 3ECh. 14 - EXERCISE 14.4 Measures of Liquidity Roy’s Toys is...Ch. 14 - Prob. 5ECh. 14 - Prob. 6ECh. 14 - Prob. 7ECh. 14 - Prob. 9ECh. 14 - Prob. 10ECh. 14 - Prob. 11ECh. 14 - Prob. 12ECh. 14 - Prob. 13ECh. 14 - Prob. 14ECh. 14 - Prob. 15ECh. 14 - Prob. 1APCh. 14 - Prob. 2APCh. 14 - Prob. 3APCh. 14 - Prob. 4APCh. 14 - Prob. 5APCh. 14 - Prob. 6APCh. 14 - Prob. 7APCh. 14 - Prob. 8APCh. 14 - Prob. 9APCh. 14 - Prob. 1BPCh. 14 - Prob. 2BPCh. 14 - Prob. 3BPCh. 14 - Prob. 4BPCh. 14 - PROBLEM 14.5B Balance Sheet Measures of Liquidity...Ch. 14 - Prob. 6BPCh. 14 - Prob. 7BPCh. 14 - Prob. 8BPCh. 14 - Prob. 9BPCh. 14 - Prob. 1CTCCh. 14 - Prob. 2CTCCh. 14 - Prob. 3CTCCh. 14 - Prob. 5CTCCh. 14 - Prob. 4CP
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