11. The effect of transactions on ratios You've been asked to tutor Ethan, a finance student who doesn't feel comfortable about his understanding of the relationship between a company's business activities, its financial accounts, and the company's financial ratios. To better appreciate these relationships, you've created the following exercises for Ethan to complete. The purpose of these exercises is to help Ethan (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. Universal Computer Corp.'s Pretransaction Statement of Financial Condition Universal Computer Corp.'s Statement of Financial Performance Cash Marketable securities Accounts receivable 15,000 Accounts payable 10,000 Wages payable 70,000 Taxes payable 500,000 Notes payable 5,000,000 2,000,000 3,000,000 600,000 2,400,000 33,000 2,367,000 828,450 $1,538,550 20,000 10,000 50,000 100,000 Less: Cost of goods sold Gross profit Less: Operating expenses Prepaid expenses 5,000 Total current liabilities Total current assets 1,000,000 Long-term debt 00,000Operating profit (EBI) Less: Interest expense Earnings before taxes (EBT Less: Tax expense Net income Total liabilities 600,000 Gross plant and equipment 1,500,000 Common stock 500,000 Capital paid in excess of par 350,000 900,000 1,400,000 $2,000,000 Net plant and equipment 1,000,000 Retained earnings Total equity Total debt and equity Total assets $2,000,000 cost of goods sold equals 40% of sales. interest expense equals 6% of the combined notes payable and long-term debt balances The average federal and state tax rate is 35%. Indicate if any of the listed financial statement accounts is affected by the following business transactions and whether the listed ratios will increase decrease, or remain unchanged as a result of the transaction. (Hint: Assume that the business transaction occurs exactly as stated without interpreting it further. Do not consider any related transactions that may occur before or after the specified transaction.) Business Transaction 1 Universal Computer Corp. (UCC) sells 25,000 shares of new common stock ($1 per share par value) to new and existing shareholders for $20 per share Check if the Account Is Affected by the Specified Transaction Financial Ratio Ratio's Behavior Financial Account Operating income Retained eanings Capital paid-in excess of Debt ratio Current ratio Basic earnings power Operating profit margin Fixed assets turnover Common stock Long-term debt Business Transaction 2 Universal Computer Corp. (UCC) pays $10,000 of its federal and state taxes payable Check if the Account Is Affected by the Financial Ratio Ratio's Behavior Financial Account Long-term debt Net income Debt ratio Quick ratio Return on assets Operating profit margin Times interest earned Average collection period Prepaid expenses Taxes payable