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 pre-transaction condition and performance.
12. The effect of transactions on ratios Aa Aa You've been asked to tutor Alex, 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 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 Edinburgh Exports Inc. 's Pretransaction Statement of Financial Condition Edinburgh Exports Inc. 's Pretransaction Statement of Financial Performance Sales Less: Cost of goods sold1 Gross profit Less: Operating expenses Operating profit (EBIT) Less: Interest expense2 Earnings before taxes (EBT) Less: Tax expense3 Net income $5,000,000 2,000,000 3,000,000 600,000 2,400,000 33,000 2,367,000 828,450 $1,538,550 Cash Marketable securities Accounts receivable Inventory 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 $2,000,000 10,000 Wages payable 470,000 Taxes payable 500,000 Notes payable 5,000 Total current liabilities Total current assets 1,000,000 Long-term debt Total liabilities 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 Total equity Total debt and equity Cost of goods sold equals 40% of sales 2 Interest expense equals 6% of the combined notes payable and long-term debt balances 3The average federal and state tax rate is 35% Total assets $2,000,000 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.)
