
Concept explainers
Times Interest Earned:
The ratio which measures a company’s ability to pay its obligation is called a times interest earned. It is computed by dividing the net income before interest and taxes by the interest expense of the company.
To determine:
1. Prepare an Income statement showing current operations, European and total when the sales at European location are $250,000.
2. Compute the times interest earned for expansion assumptions.
3. Prepare an Income statement showing current operations, European and total when the sales at European location are $400,000 and compute times interest earned.
4. Prepare an Income statement showing current operations, European and total when the sales at European location are $100,000 and compute times interest earned.
5. Comment on the results obtained in part 1 through 4.

Answer to Problem 7BTN
Solution:
1.
UNCHARTED PLAY Income Statement | |||
Current Operations | European | Total | |
Sales | $1,000,000 | $250,000 | $1,250,000 |
Operating Expenses (55%) | 550,000 | 137,500 | 687,500 |
Income before interest and tax | 450,000 | 112,500 | 562,500 |
Interest Expense | 21,000 | 21,000 | |
Net Income | $450,000 | $91,500 | $541,500 |
2.
When sales at European location are $250,000, the times interest earned is 26.79.
3.
UNCHARTED PLAY Income Statement | |||
Current Operations | European | Total | |
Sales | $1,000,000 | $400,000 | $1,400,000 |
Operating Expenses (55%) | 550,000 | 220,000 | 770,000 |
Income before interest and tax | 450,000 | 180,000 | 630,000 |
Interest Expense | 21,000 | 21,000 | |
Net Income | $450,000 | $159,000 | $609,000 |
When sales at European location are $400,000, the times interest earned is 30.
4.
UNCHARTED PLAY Income Statement | |||
Current Operations | European | Total | |
Sales | $1,000,000 | $100,000 | $1,100,000 |
Operating Expenses (55%) | 550,000 | 55,000 | 605,000 |
Income before interest and tax | 450,000 | 45,000 | 495,000 |
Interest Expense | 21,000 | 21,000 | |
Net Income | $450,000 | $24,000 | $474,000 |
When sales at European location are $100,000, the times interest earned is 23.57.
5. The times interest earned has direct relationship with the net income of the company. With Operating expense being constant, when the net income increases due to increase in sales, the times interest earned rises and when the net income decreases due to decrease in sales, the time interest earned also falls.
Explanation of Solution
Explanation:
1.
Current Operations | European | Total | |
Sales | $1,000,000 | $250,000 | $1,250,000 |
55% of sale is operating expense | 55% | 55% | 55% |
Operating Expense | $550,000 | $137,500 | $687,500 |
Computation of interest expense
2. When the sales are 250,000
3. When the sales are $400,000
4. When the sales are $100,000
Conclusion:
It is concluded that the times interest earned ratio depends upon the increase and decrease of net income and interest expense of a company.
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