Question
Youve been asked to teach Caleb, a finance student who doesnt feel comfortable about his understanding of the relationship between a companys business activities, its
Youve been asked to teach Caleb, a finance student who doesnt feel comfortable about his understanding of the relationship between a companys business activities, its financial accounts, and the companys financial ratios. To better appreciate these relationships, youve created the following exercises for Caleb to complete. The purpose of these exercises is to help Caleb (1) understand the effect of business transactions on the financial statementssuch as balance sheet and income statementaccounts and (2) how these changes in the numerators and denominators of financial ratios affect the ratios values. However, before using these exercises in your teaching session later today, youll 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 companys financial statements and ratios, assume that the following balance sheet and income statement reflect the companys pretransaction condition and performance.
Fresno Furniture Manufacturing Inc.s Pre transaction Statement of Financial Condition
Cash | $15,000 | Accounts payable | $20,000 |
Marketable securities | 10,000 | Wages payable | 20,000 |
Accounts receivable | 470,000 | Taxes payable | 10,000 |
Inventory | 500,000 | Notes payable | 50,000 |
Prepaid expenses | 5,000 | Total current liabilities | 100,000 |
Total current assets | $1,000,000 | Long-term debt | 500,000 |
Total liabilities | $600,000 | ||
Gross plant and equipment | $1,500,000 | Common stock | $150,000 |
Accumulated depreciation | 500,000 | Capital paid in excess of par | 350,000 |
Net plant and equipment | $1,000,000 | Retained earnings | 900,000 |
Total equity | $1,400,000 | ||
Total assets | $2,000,000 | Total debt and equity | $2,000,000 |
Fresno Furniture Manufacturing Inc.s Pretransaction Statement of Financial Performance
Sales | $5,000,000 |
Less: Cost of goods sold1Cost of goods sold1 | 2,000,000 |
Gross profit | $3,000,000 |
Less: Operating expenses | 600,000 |
Operating profit (EBIT) | $2,400,000 |
Less: Interest expense2Interest expense2 | 33,000 |
Earnings before taxes (EBT) | $2,367,000 |
Less: Tax expense3Tax expense3 | 828,450 |
Net income | $1,538,550 |
11Cost of goods sold equals 40% of sales.
22Interest expense equals 6% of the combined notes payable and long-term debt balances.
33The average federal and state tax rate is 35%.
Indicate if any of the listed financial statement accounts are 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
Fresno Furniture Manufacturing Inc. (FFM) sells $165,000 of merchandise on credit.
Financial Account | Check if the Account Is Affected by the Specified Transaction | |
---|---|---|
Inventory |
| |
Accounts receivable |
| |
Taxes payable |
| |
Retained earnings |
| |
Sales |
| |
Accounts payable |
|
Financial Ratio | Ratios Behavior |
---|---|
Times-interest-earned | |
Quick ratio | |
market-to-book ratio | |
Price-to-earnings ratio | |
Inventory turnover ratio |
Business Transaction 2
A $500,000 10-year bank loan is initiated, and the funds are placed in Fresno Furniture Manufacturing Inc. (FFM)s checking account.
Financial Account | Check if the Account Is Affected by the Specified Transaction | |
---|---|---|
Long-term debt |
| |
Marketable securities |
| |
Cash |
| |
Common stock |
| |
Gross plant and equipment |
|
Financial Ratio | Ratios Behavior |
---|---|
Operating profit margin | |
Debt ratio | |
Current ratio | |
Return on assets | |
Gross profit margin |
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started