Chapter 10, Problem 9PEA

a.

To determine

Determine the fixed asset Turnover Ratio of Company D for Year 1 ad Year 2.

Explanation of Solution

Fixed Asset turnover: It is a ratio that measures the productive capacity of the fixed assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total fixed assets. The following is the formula to calculate the ratio:

$\text{Fixed}\text{Asset turnover }=\frac{\text{Sales}}{\text{Average total}\text{fixed assets}}$

Calculate the fixed asset turnover ratio:

For Year 1

Sales= $4,880,000

Total average fixed assets= $1,525,000 (1)

$\begin{array}{c}\text{Fixed}\text{Assets Turnover}=\frac{\text{Sales}}{\text{Average Fixed}\text{Assets}}\\ =\frac{\$4,880,000}{\$1,525,000}\\ =3.2\text{times}\end{array}$

Working note 1: Calculate the average total fixed assets.

Beginning total fixed assets     = $1,450,000

Ending total fixed assets      = $1,600,000

$\begin{array}{c}\text{Average total assets}=\frac{\text{Total Beginning Fixed}\text{Assets}+\text{Total Ending}\text{Fixed Assets}}{2}\\ =\frac{\$1,450,000+\$1,600,000}{2}\\ =\$1,525,000\end{array}$

For Year 2

Sales= $5,510,000

Total average fixed assets= $1,900,000 (2)

$\begin{array}{c}\text{Fixed}\text{Assets Turnover}=\frac{\text{Sales}}{\text{Average Fixed}\text{Assets}}\\ =\frac{\$5,510,000}{\$1,900,000}\\ =2.9\text{times}\end{array}$

Working note 2: Calculate the average total fixed assets.

Beginning total fixed assets     = $1,600,000

Ending total fixed assets      = $2,200,000

$\begin{array}{c}\text{Average total assets}=\frac{\text{Total Beginning Fixed}\text{Assets}+\text{Total Ending}\text{Fixed Assets}}{2}\\ =\frac{\$1,600,000+\$2,200,000}{2}\\ =\$1,900,000\end{array}$

Conclusion

Hence, the fixed asset turnover ratio for Year 1 is 3.2 times and for Year 2 is 2.9 times.

b.

To determine

Explain whether the change in the fixed asset turnover ratio from Year 1 to Year 2 indicates a favorable or unfavorable change.

Explanation of Solution

The change in the fixed asset turnover ratio from Year 1 to Year 2 indicates an unfavorable change as the ratio decreased from 3.2 to 2.9 times. This is because, the company has inefficienctly utilized the fixed assets that resulted in a lower revenue generation.