Chapter 13, Problem 13.6P

Computing Comparative Financial Statements and DuPont Ratios (AP13-6)

Use the data given in P13-5 for Prince Company.

Required:

1. 1. Compute component percentages for Year 2.
2. 2. Compute the ratios in the DuPont model for Year 2.

To determine

Compute the Component percentage for the year 2.

Explanation of Solution

Component percentage analysis:

Component percentage analysis is prepared to analyse the relationship among various items of the financial statements with a particular base amount. This analysis is also called as common-size statement.

Compute the component percentage for the Year 2.

Corporation P
Income Statement
For the year ended Year 2
Particulars	Year 2
	Amount	Percent
	( $)	(%)
Sales revenues	190,000	100
Cost of goods sold	112,000	58.95
Gross profit on sales	78,000	41.05
Operating  expenses	56,000	29.47
Pre-tax income	22,000	11.58
Income tax expense	8,000	4.21
Net income	14,000	7.37

Table (1)

Corporation P
Balance Sheet
As on date of Year 2 end
Particulars	2013
	Amount ( $)	Percent (%)
Cash	4,000	3.88
Accounts receivable	14,000	13.59
Inventory	40,000	38.83
Property and equipment	45,000	43.69
Total assets	103,000	100.00
Current liabilities	16,000	15.53
Long-term liabilities	45,000	43.69
Common stock ($5 par value)	30,000	29.13
Retained earnings	12,000	11.65
Total liabilities and owners’ equity	103,000	100.00

Table (2)

In the income statement, base amount is sales revenue. In the balance sheet, base amount is total assets.

To determine

Compute the ratios in the DuPont model for Year 2.

Explanation of Solution

DuPont model:

It is a model which allows the analyst to analyse a company’s performance using ratios. This model uses the ratios which indicates the company performance. DuPont model equiation is as follows:

$\begin{array}{l}\text{ROE}\text{=}\text{Net profit margin}\text{×}\text{Total assets turnover}\text{×}\text{Financial leverage}\\ \frac{\text{Net Income}}{\text{Average}\text{TotalStockholders'}\text{equity}}\text{=}\{\begin{array}{l}\frac{\text{Net}\text{Income}}{\text{Net}\text{Sales}\text{Revenue}}\text{×}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{Total}\text{Assets}}\\ \text{×}\frac{\text{Average}\text{Total}\text{Assets}}{\text{Average}\text{TotalStockholders'}\text{equity}}\end{array}\end{array}$

Calculate the ratios in the DuPont model for Year 2.

	Ratio	Formula	Calculation		Result
1	Return on Equity (ROE)	$\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}$		$\frac{\$14,000}{\$38,500\left(1\right)}$	36.36%
2	Return on Assets (ROA)	$\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Assets}}$		$\frac{\$14,000}{\left(\$103,000+\$97,000\right)÷2}$	14.00%
3	Total asset turnover	$\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{Total}\text{Assets}}$		$\frac{\$190,000}{\left(\$103,000+\$97,000\right)÷2}$	1.90
4	Net profit margin	$\frac{\text{Net}\text{Income}}{\text{Net Sales Revenue}}$		$\frac{\$14,000}{\$190,000}$	7.37%
5	Financial leverage	$\frac{\text{Average Total Assets}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}$		$\frac{\left(\$103,000+\$97,000\right)÷2}{\$38,500(1)}$	2.60

Table (3)

Working notes:

Calculate the average total stockholders’ equity

Average common stock for the year 2

$\begin{array}{c}\text{Average common stock}\text{=}\frac{\text{Beginning}\text{Stock}\text{+}\text{Ending}\text{Stock}}{\text{2}}\\ =\frac{\$30,000+\$30,000}{2}\\ =\frac{\$60,000}{2}\\ =\$30,000\end{array}$

Average retained earnings for theYear 2:

$\begin{array}{c}\text{Average Retained Earnings}\text{=}\frac{\left(\begin{array}{l}\text{Beginning Retained}\\ \text{ Earnings}\end{array}\right)\text{+}\left(\begin{array}{l}\text{Ending}\text{Stock Retained}\\ \text{ Earnings}\end{array}\right)}{\text{2}}\\ =\frac{\$12,000+\$5,000}{2}\\ =\frac{\$17,000}{2}\\ =\$8,500\end{array}$

Average total stockholders’ equity for the Year 2:

$\begin{array}{c}\text{Average Total Stockholders' Equity}\text{=}\{\begin{array}{l}\text{Average Common Stock}\text{+}\\ \text{Average Reatined Earnings}\end{array}\\ \text{=}\text{\$30,000}\text{+}\text{\$8,500}\\ \text{=}\text{\$38,500}\end{array}$ (1)