Financial Accounting, 8th Edition
Financial Accounting, 8th Edition
8th Edition
ISBN: 9780078025556
Author: Robert Libby, Patricia Libby, Daniel Short
Publisher: McGraw-Hill Education
Question
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Chapter 5, Problem 3CP

1.

To determine

Compute the return on assets for the most recent year and to state the company that provided the highest return on invested capital during the current year.

1.

Expert Solution
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Explanation of Solution

Return on assets: Return on assets is the financial ratio which determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets.

The return on asset ratios of Incorporation AE and Incorporation UO for the most recent years is given below:

ParticularsIncorporation AEIncorporation UO
Return on assets=Net incomeAverage total assets=Net incomeAverage total assets=$151,705 (Given)$1,915,400(1)=0.079 =Net incomeAverage total assets=$185,251(Given)$1,639,015(2)=0.1131

Table (1)

Working Note:

Determine the average total assets of Incorporation AE.

Average total assets=(Beginning total assets)+(Ending total assets)2=$1,879,998 +$1,950,8022=$3,830,8002=$1,915,400 (1)

Determine the average total assets of Incorporation UO.

Average total assets=(Beginning total assets)+(Ending total assets)2=$1,794,321 +$1,483,7082=$3,278,0292=$1,639,015 (2)

Comparing the return on assets of the two companies from Table (1), Incorporation UO is having higher return on assets ratio of 0.1131% during the current year.

2.

To determine

Ascertain the cause(s) of any differences using ROA profit driver analysis and to explain the ownership versus the rental of property, plant, and equipment affect the total asset turnover ratio.

2.

Expert Solution
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Explanation of Solution

Return on assets (ROA) profit driver analysis: Return on assets (ROA) profit driver analysis categorizes the ROA into two factors that are Net profit margin and Total asset turnover, which helps the management to improvise ROA. The ROA profit driver analysis can be computed by using the following formula:

Return on assets (ROA)=Net profit margin ×Total asset turnover Net incomeAverage Total assets=Net salesAverage Total assets×Net incomeNet sales

Net profit margin ratio: Net profit is the financial ratio that shows the relationship between the net profit and net sales (Operating revenue). Net profit is the difference between total operating revenue and total operating expenses. It can be calculated by dividing net profit and operating revenue. Net profit margin ratio can be calculated by using the following formula:

Net profit margin =Net incomeNet sales

Total asset turnover ratio: Total asset turnover ratio shows the relationship between the net income and total assets. Total asset turnover ratio is used to determine how much the sales revenue is generated with the efficient utilization of total assets. Total asset turnover ratio can be calculated by using the following formula:

Total asset turnover =Net SalesAverage Total assets

Prepare a table showing the changes in ROA using ROA profit driver analysis as given below:

Determine the return on asset ratio for the current year and prior year.

ROA AnalysisIncorporation AEIncorporation UO

Net profit margin =Net incomeNet sales

=$151,705$3,159,818=0.048  =$185,251$2,473,801  = 0.075
Total asset turnover =Net SalesAverage Total assets=$3,159,818 $1,915,400(1) = 1.65 =$2,473,801$1,639,015(2)      = 1.509 
  Return on Assets0.0790.1131

Table (2)

Comparing the return on assets of the two companies from Table (2) Incorporation UO has a higher ROA than Incorporation AE because it has a greater profit margin of 0.079 that compensates for having lower total asset turnover ratio of 1.65.

Title of property, plant, and equipment would decrease the total asset turnover ratio comparative to rentals. The possessed assets would be included while determining the “average total assets” whereas the rented assets would not be included and hence, the asset turnover would be lesser at the same level of sales volume.

3.

To determine

Compare the ROA profit driver analysis for Incorporation AE and Incorporation UO to the ROA profit driver analysis for their industry and to comment whether Incorporation AE and Incorporation UO outperform or underperform the industry

3.

Expert Solution
Check Mark

Explanation of Solution

Return on assets (ROA) profit driver analysis: Return on assets (ROA) profit driver analysis categorizes the ROA into two factors that are Net profit margin and Total asset turnover, which helps the management to improvise ROA. The ROA profit driver analysis can be computed by using the following formula:

Return on assets (ROA)=Net profit margin ×Total asset turnover Net incomeAverage Total assets=Net salesAverage Total assets×Net incomeNet sales

Prepare a table showing the comparison of industry average ratio with Incorporation AE and Incorporation UO:

ROA AnalysisIndustry
Average
Incorporation AEIncorporation UO
 Net Profit Margin (Refer Table (2))0.054 (Given)0.0480.075
 Total Asset Turnover (Refer Table (2))1.75 (Given)1.651.509
  Return on Assets (Refer Table (1))0.0910.0790.1131

Table (3)

From Table (3), Incorporation UO has a greater ROA and Incorporation AE has a lesser ROA than the industry average. This is due to the greater net profit margins maintained by Incorporation UO.  This is expected, given that the Incorporation UO competes by product differentiation rather than price differentiation.

Incorporation AE and Incorporation UO are having lower total asset turnover ratios compared with the industry average.

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Chapter 5 Solutions

Financial Accounting, 8th Edition

Ch. 5 - Briefly explain the major classifications of...Ch. 5 - Prob. 12QCh. 5 - Prob. 13QCh. 5 - Prob. 14QCh. 5 - If average total assets increase, but net income,...Ch. 5 - Prob. 2MCQCh. 5 - Prob. 3MCQCh. 5 - Prob. 4MCQCh. 5 - Prob. 5MCQCh. 5 - Prob. 6MCQCh. 5 - Prob. 7MCQCh. 5 - Prob. 8MCQCh. 5 - Prob. 9MCQCh. 5 - Prob. 10MCQCh. 5 - Prob. 1MECh. 5 - Prob. 2MECh. 5 - Prob. 3MECh. 5 - Prob. 4MECh. 5 - Determining Financial Statement Effects of Sales...Ch. 5 - Prob. 6MECh. 5 - Prob. 7MECh. 5 - Matching Players in the Accounting Communication...Ch. 5 - Prob. 2ECh. 5 - Finding Financial Information: Matching...Ch. 5 - Prob. 4ECh. 5 - Preparing a Classified Balance Sheet Campbell Soup...Ch. 5 - Prob. 6ECh. 5 - Prob. 7ECh. 5 - Prob. 8ECh. 5 - Prob. 9ECh. 5 - Prob. 10ECh. 5 - Prob. 11ECh. 5 - Stock Issuances and the Statement of Stockholders...Ch. 5 - Prob. 13ECh. 5 - Prob. 14ECh. 5 - Prob. 15ECh. 5 - Prob. 16ECh. 5 - Prob. 17ECh. 5 - Prob. 18ECh. 5 - Prob. 19ECh. 5 - Prob. 1PCh. 5 - Matching Definitions with Balance Sheet-Related...Ch. 5 - Prob. 3PCh. 5 - Prob. 4PCh. 5 - Preparing a Classified (Multiple-Step) Income...Ch. 5 - Prob. 6PCh. 5 - Determining and Interpreting the Effects of...Ch. 5 - Determining the Effects of Transactions on Ratios...Ch. 5 - Prob. 9PCh. 5 - Prob. 1APCh. 5 - Prob. 2APCh. 5 - Prob. 3APCh. 5 - Prob. 4APCh. 5 - Prob. 1CPCh. 5 - Prob. 2CPCh. 5 - Prob. 3CPCh. 5 - Prob. 4CPCh. 5 - Prob. 5CPCh. 5 - Prob. 6CPCh. 5 - Prob. 7CPCh. 5 - Evaluating the Impact of Transactions on Statement...Ch. 5 - Prob. 2CC
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