2-8 These financial statement items are for Barone Corporation at year-end, July

Question

2-8 These financial statement items are for Barone Corporation at year-end, July 31, 2010.
Salaries Payable 2,080
Salaries Expense 51,700
Utilities expense 22,600
Equipment 18,500
Accounts Payable 4,000
Commission revenue 66,100
Rent revenue 8,500
Long-term note payable 1,800
Common Stock 16,000
Cash 29,200
Accounts Receivable 9,780
Accumulated depreciation 6,000
Dividends 4,000
Depreciation expense 4,000
Retained earnings 35,200

Suppose that you are the president of Allied Equipment. Your sales manager has approached you with a proposal to sell $20,000 of equipment to Barone. He would like to provide a loan to Barone in the form of 10%, 5-year note payable. Evaluate how this loan would change Barrone's current ratio and debt to total assets ratio and discuss whether you would make the sale.

Explanation / Answer

Whitnall Corporation Balance sheet as on July 32,2012 Assets Current Assets: Cash 29,200 Accounts receivable 9,780 Total current assets 38,980 Property, Plant and Equipment 18,500 Less: Accumulated depreciation -Equipment 6,000 12,500 Total assets 51,480 Liabilities Current liabilities: Accounts payable 4,100 Salaries and wages payable 2,080 Total current liabilities 6,180 Long term liabilities Notes payable 1,800 Stock holders equity Common stock 16,000 Retained earnings 27,500 Total stockholders equity 43,500 Total liabilities and stockholders equity 54,180 c. Current ratio=Current Assets/Current liabilities Current assets 38,980 Current liabilities 6,180 Current ratio= 38980/6180 6.30:1 Debt to total assets ratio Total Debt 7,980 Total Assets 51,480 Debt to total assets ratio=7980/51,480 15.50% d. The sale of Equipment to Whitnall by providing a loan to Whitnall in the form of a 10% 5 year note payable, this will not give any change to current ratio, as the loan here is a Long term liability, and there will be an increase in fixed assets .There is no change in neither in current assets or in current liabilities. Regarding the debt to total assets, the same old ratio will be maintained as the total debt is increased by 20,000 and at the same time the total assets are also increased by 20,000. Therefore there is no change in debt to total assets ratio

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