Attempts: Do No Harm: 123 11. The effect of transactions on ratios Aa Aa You\'ve

ID: 2813767 • Letter: A

Question

Attempts: Do No Harm: 123 11. The effect of transactions on ratios Aa Aa You've been asked to tutor Alex, a finance student who doesnt feel comfortable about his understanding of the relationship between a business activities, its financial accounts, and the company's financial ratios. To better appreciate these relationships, you've created the following exercises for Alex to complete. The purpose of these exercises is to help Alex (1) understand the effect of business transactions on financial statement-such as balance sheet and income statement-accounts and (2) how these changes in the numerators and denominators of financial ratios affect the ratios' values. However, before using these exercises in your tutoring session later today, you'll want to run the calculations on the following two business transactions, to verify the accuracy of your answers To provide a consistent frame of reference for the company's financial statements and ratios, assume that the following balance sheet and income statement reflect the company's pretransaction condition and performance. Wellington Industries's Pretransaction Statement of Financial Condition Wellington Industries's Pretransaction Statement of Financial Performance Cash Marketable securities Accounts receivable Inventony Prepaid expenses $15,000 Accounts payable $20,000 20,000 10,000 50,000 100,000 500,000 600,000 150,000 350,000 900,000 1,400,000 Sales Less: Cost of goods sold Gross profit Less: Operating expenses Operating profit (EBIT) Less: Interest expense $5,000,000 2,000,000 3,000,000 600,000 2,400,000 33,000 10,000 Wages payable 470,000 Taxes payable 00,000 Notes payable 5,000 1,000,000 Long-term debt Total current liabilities Total current assets Total liabilities Earnings before taxes (EBT)2,367,000 Gross plant and equipment Accumulated depreciation Net plant and equipment 1,500,000 500,000 1,000,000 Common stock Capital paid in excess of par Retained earnings Less: Tax expense Net income 828,450 $1,538,550 Total equity Cost of goods sold equals 40% of sales.

Explanation / Answer

Business Transaction 1:

Financial Account

Affected by transaction

Explanation

Cost of goods sold

This transaction not affect on inventory.

Cash

Yes

It has used cash of $5,000

Gross plant and equipment

Yes

It is an addition of equipment.

Notes payable

Yes

It has used Notes Payable of $45,000

Accounts payable

It is not affecting any inventory purchase.

Retained earnings

Retained earnings are dependent on income and dividends.

Financial ratio

Ratio Behavior

Average collection period

No change, it is in no way affecting debtors and sales.

Times interest earned

Decrease, as interest would increase but income is the same.

Quick ratio

Decrease, as there will be a decrease in cash.

Return on common equity

No change, neither income is changed nor equity.

Debt ratio

Increase, as there is an increase in debt due to notes payable.

Fixed asset turnover

Decrease, as for the same sales and assets has increased.