Chapter 15, Problem 56P

The following selected information is taken from the financial statements of Arnn Company for its most recent year of operations:

During the year, Arnn had net sales of $2.45 million. The cost of goods sold was $1.3 million.

Required:

Note: Round all answers to two decimal places.

1. 1. Compute the current ratio.
2. 2. Compute the quick or acid-test ratio.
3. 3. Compute the accounts receivable turnover ratio.
4. 4. Compute the accounts receivable turnover in days.
5. 5. Compute the inventory turnover ratio.
6. 6. Compute the inventory turnover in days.

To determine

Calculate current ratio

Answer to Problem 56P

Current ratio is 2.5.

Explanation of Solution

Liquidity ratio

Liquidity ratios evaluate a firm’s ability to fulfil its present obligations. Some of the ratios calculated are current ratio, acid-test ratio and inventory turnover ratio.

Use the following formula to compute current ratio:

$\text{Current ratio}=\frac{\text{Current}\text{Assets}}{\text{Current}\text{Liabilities}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Current ratio}=\frac{1,000,000}{400,000}\\ =2.5\end{array}$

Therefore, current ratiois 2.5.

Working notes

1. Calculation of current assets:

$\begin{array}{c}\text{Current}\text{assets}=\text{Inventory}+\text{Accounts}\text{receivables}+\text{Cash}+\\ \text{Marketable}\text{securities}+\text{Prepaid}\text{expenses}\\ =250,000+400,000+100,000+200,000+50,000\\ =\$1,000,000\end{array}$

2. Calculation of current liabilities:

$\begin{array}{c}\text{Current}\text{liabilities}=\text{Accounts}\text{payables}+\text{Taxes}\text{payable}+\text{Wages}\text{payable}\\ \text{Short}\text{term}\text{loans}\text{payable}\\ =175,000+85,000+90,000+50,000\\ =\$400,000\end{array}$

To determine

Calculate quick ratio.

Answer to Problem 56P

Quick ratio is 1.75

Explanation of Solution

Use the following formula to compute quick ratio:

$\text{Quick ratio}=\frac{\text{Quick}\text{assets}}{\text{Current}\text{laibilities}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Quick ratio}=\frac{700,000}{400,000}\\ =1.75\end{array}$

Therefore, quick ratio is 1.75

Working notes

1. Calculation of quick assets:

$\begin{array}{c}\text{Quick}\text{assets}=\text{Current}\text{Assets}-\text{Inventory}-\text{Prepaid}\text{expenses}\\ =1,000,000-250,000-50,000\\ =\$700,000\end{array}$

To determine

Calculate accounts receivable turnover ratio.

Answer to Problem 56P

Accounts receivable turnover ratio is 7 times.

Explanation of Solution

Use the following formula to compute accounts receivable turnover ratio:

$\text{Accounts receivable turnover ratio}=\frac{\text{Net}\text{sales}}{\text{Average}\text{accounts}\text{receivable}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Accounts receivable turnover ratio}=\frac{2,450,000}{350,000}\\ =7\text{times}\end{array}$

Therefore, accounts receivable turnover ratio is 7 times.

Working notes

1. Calculation of average accounts receivables:

$\begin{array}{c}\text{Average}\text{accounts}\text{receivable}=\frac{\begin{array}{l}\text{Beginning}\text{accounts}\text{receivable}+\\ \text{Ending}\text{accounts}\text{receivable}\end{array}}{2}\\ =\frac{300,000+400,000}{2}\\ =\$350,000\end{array}$

To determine

Calculate accounts receivable turnover in days.

Answer to Problem 56P

Accounts receivable turnover in days is 52.14 days.

Explanation of Solution

Use the following formula to compute accounts receivable turnover in days:

$\text{Accounts receivable turnover in}\text{days}=\frac{\text{365}}{\text{Accounts receivable turnover}\text{ratio}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Accounts receivable turnover in}\text{days}=\frac{365}{7}\\ =52.14\text{days}\end{array}$

Therefore, accounts receivable turnover in days is 52.14 days.

To determine

Calculate inventory turnover ratio.

Answer to Problem 56P

Inventory turnover ratio is 5.78 times.

Explanation of Solution

Use the following formula to compute inventory turnover ratio:

$\text{Inventory turnover ratio}=\frac{\text{Cost}\text{of}\text{goods}\text{sold}}{\text{Average}\text{inventory}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Inventory turnover ratio}=\frac{1,300,000}{225,000}\\ =5.78\text{times}\end{array}$

Therefore, $\text{Inventory turnover ratio}$ is 5.78 times.

Working notes

1. Calculation of average inventory:

$\begin{array}{c}\text{Average}\text{inventory}=\frac{\begin{array}{l}\text{Beginning}\text{inventory}+\\ \text{Ending}\text{inventory}\end{array}}{2}\\ =\frac{200,000+250,000}{2}\\ =\$225,000\end{array}$

To determine

Calculate inventory turnover in days.

Answer to Problem 56P

Inventory turnover in days is 63.15 days.

Explanation of Solution

Use the following formula to compute inventory turnover in days:

$\text{Inventory turnover in}\text{days}=\frac{\text{365}}{\text{Inventory turnover}\text{ratio}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Inventory}\text{turnover in}\text{days}=\frac{365}{5.78}\\ =63.15\text{days}\end{array}$

Therefore, inventory turnover in days is 63.15 days.