Chapter 15, Problem 21P

To determine

Concept Introduction:

Basic Earnings per share:

The Basic Earnings per share is the amount of net income earned by each common share outstanding. The Earnings per share calculated by with help of following formula:

  $\text{Basic Earnings per share=}\frac{\text{Net Income - Preferred Dividend}}{\text{Weighted Average Common Shares Outstanding}}$

  $\begin{array}{l} \hfill \\ NetIncomeavailabletocommonstockholder=Netincome–PreferredDividend\hfill \end{array}$

Debt to Equity Ratio:

Debt to equity ratio is calculated to determine the leverage position of the company. It compares the total liabilities of the company with it total shareholders’ equity. The debt to equity ratio is calculated by dividing the Total Liabilities by Total Stockholder’s Equity. The formula to calculate Debt to equity ratio is as follows:

  $\text{Debt to equity ratio = }\frac{\text{Total liabilities}}{\text{Total Stockholder’s Equity}}$

Current Ratio:

Current Ratio is measure of the company’s ability to pay off its current liabilities using its current assets. It is calculated by dividing the total current assets by total current liabilities. The formula of the current ratio is as follows:

  $CurrentRatio=\frac{Currentassets}{Currentliabilities}$

Acid test ratio:

Acid test ration is also called Quick ratio. This ratio is calculated by dividing the quick assets (Cash, Cash equivalents, Short term investments and current receivables) by total current liabilities for the year. The formula for Acid test ratio is as follows:

  $Acidtestratio=\frac{\left(Cash+Cashequivalents+Shortterminvestments+Accountsreceivables\right)}{CurrentLiabilities}$

Accounts receivable turnover ratio:

This is an efficiency ratio that indicates the conversion of accounts receivable into cash. This ratio is calculated by dividing the Net credit Sales by the Average accounts receivable. The formula to calculate this ratio is as follows:

  $Accountsreceivableturnoverratio= \frac{NetcreditSales}{Averageaccountsreceivable}$

Inventory Turnover Ratio: Inventory Turnover Ratio measures the efficiency of the company in converting its inventory into sales. It is calculated by dividing the Cost of goods sold by Average inventory. The formula of the Inventory Turnover Ratio is as follows:

  $InventoryTurnoverRatio=\frac{Costofgoodssold}{Averageinventory}$

Note: Average inventory is calculated with the help of following formula:

  $Averageinventory=\frac{(Beginninginventory+Endinginventory)}{2}$

Times interest earned Ratio:

A company pays its interest expenses from the Net operating Income available. To find the company’s ability to pay the interest expenses, the ratio of Net operating income to Interest expense should be calculated. Times Interest earned ratio shows the number of times interest expenses are covered by the net operating income. It is calculated by dividing the Net operating Income by Interest Expense. The formula is as under:

Times interest earned Ratio = Net Operating Income / Interest Expense

(Note: The numerator of the formula .Net operating income. is equal to the Income before deduction of Interest and taxes)

Return on total Assets: The Return on total assets is profitability ratio that measures the percentage of profit earned on average assets invested in the business. Return on asset is calculated by dividing the net income by average total assets. The formula to calculate Return on assets is as follows:

  $Returnonassets=\frac{Netincome}{AverageTotalAssets}$

Note: Average total assets are calculated as an average of beginning and ending total assets. The formula to calculate the average total assets is as follows:

  $AveragetotalAssets=\frac{\left(Beginningtotalassets+Endingtotalassets\right)}{2}$

To calculate:The missing amounts for balance sheet and income statement

Answer to Problem 21P

Solution: The Complete balance sheet and income statement are as follows:

Pepper Industries
Balance Sheet
Mar. 31
Current Assets:
Cash	$ 70,000
Accounts Receivables, Net	$ 330,000
Inventory	$ 480,000
Total Current Assets	$ 880,000
Plant and Equipment, net	$ 908,889
Total Assets	$ 1,788,889
Liabilities:
Current Liabilities:	$ 320,000
Bonds Payable, 10%	$ 514,815
Total Liabilities	$ 834,815
Stockholder's Equity:
Common Stock, $5 par value	$ 700,000
Retained earnings	$ 254,074
Total Stockholder's Equity	$ 954,074
Total Liabilities and Stockholder's Equity	$ 1,788,889

Pepper Industries
Income Statement
For the year ended Mar. 31
Sales	$ 4,200,000
Cost of Goods Sold	$ 2,730,000
Gross Margin	$ 1,470,000
Selling and administrative expenses	$ 930,000
Net operating income	$ 540,000
Interest Expense	$ 80,000
Net Income before taxes	$ 460,000
Income taxes (30%)	$ 138,000
Net Income	$ 322,000

Explanation of Solution

The missing amounts for balance sheet and income statement are calculated as follows:

Pepper Industries
Balance Sheet
Mar. 31
	Calculations
Current Assets:
Cash	Total Current Assets -Accounts Receivable -Inventory = 880000-330000-480000 =	$ 70,000
Accounts Receivables, Net	(Credit Sales /Accounts Receivable turnover)*2-Beginning Accounts receivable =(4200000/14)*2- 270000=	$ 330,000
Inventory	Total Current Assets - (Current Liabilities * Acid Test Ratio) = 880000-(320000*1.25) =	$ 480,000
Total Current Assets	Current Liabilities * Current Ratio = 320000*2.75 =	$ 880,000
Plant and Equipment, net	Total Assets - Total Current Assets = 1788889-880000=	$ 908,889
Total Assets	Net Income / Return on Total Assets = 322000/18% =	$ 1,788,889
Liabilities:
Current Liabilities:		$ 320,000
Bonds Payable, 10%	Total Liabilities - Current Liabilities = 834815-320000=	$ 514,815
Total Liabilities	Total Assets * Debt to equity ratio / (1+Debt to equity ratio) = 1788889*0.875/1.875 =	$ 834,815
Stockholder's Equity:
Common Stock, $5 par value	(Net Income / Earnings per share )*Par value = (322000/2.3)*5 =	$ 700,000
Retained earnings	Total Stockholder's Equity - Common Stock = 954074-700000=	$ 254,074
Total Stockholder's Equity	Total Assets - Total Liabilities = 1788889-834815 =	$ 954,074
Total Liabilities and Stockholder's Equity	Total Liabilities and Stockholder's Equity = Total Assets =	$ 1,788,889

Pepper Industries
Income Statement
For the year ended Mar. 31
Sales		$ 4,200,000
Cost of Goods Sold	Average Inventory * Inventory Turnover = ((360000+480000)/2))*6.5=	$ 2,730,000
Gross Margin	Sales - Cost of Goods Sold = 4200000-3900000=	$ 1,470,000
Selling and administrative expenses	Gross Margin -Net operating income = 1470000-540000=	$ 930,000
Net operating income	Interest expense * Times interest earned ratio = 80000*6.75 =	$ 540,000
Interest Expense		$ 80,000
Net Income before taxes	Net operating income - Interest Expense = 540000-80000=	$ 460,000
Income taxes (30%)	Net Income before taxes * 30% = 460000*30% =	$ 138,000
Net Income	Net Income before taxes - Income tax = 460000-138000=	$ 322,000