Chapter 24, Problem 2CE

(a)

To determine

Compute accounts receivable turnover and average collection period.

Explanation of Solution

Accounts receivable turnover:

Accounts receivable turnover is a liquidity measure of accounts receivable in times, which is computed by dividing “the net credit sales by the average amount of net accounts receivables”. In other words, it indicates the number of times the average amount of net accounts receivables collected during a particular period. The formula to calculate the accounts receivable turnover ratio is as follows:

Average collection period:

Average collection period indicates the number of days taken by a business to collect its outstanding amount of accounts receivable on an average.

Calculate accounts receivable turnover ratio:

$\begin{array}{c}\begin{array}{l}\text{Accounts}\text{receivable}\\ \text{turnover}\text{ratio}\end{array}\}\text{=}\frac{\text{Net}\text{sales}\text{on}\text{account}}{\text{Average}\text{accounts}\text{receivable}\left(\text{net}\right)}\\ \text{=}\frac{\text{\$900,000}}{\text{\$175,000}(1)}\\ \text{=}\text{5}\text{.14}\end{array}$

Therefore, the accounts receivable turnover ratio is 5.14.

Working note:

(1) Calculate the average accounts receivables:

$\begin{array}{c}\begin{array}{l}\text{Average}\text{accounts}\\ \text{receivables}\end{array}\}\text{=}\frac{\left(\begin{array}{l}\text{Average}\text{accounts}\text{receivable}\text{at}\text{the}\text{end+}\\ \text{Average}\text{accounts}\text{receivable}\text{at}\text{the}\text{beginning}\end{array}\right)}{\text{2}}\\ \text{=}\frac{\text{\$160,000+\$190,000}}{\text{2}}\\ \text{=}\text{175,000}\end{array}$

Calculate average collection period:

$\begin{array}{c}\begin{array}{l}\text{Average}\text{collection}\\ \text{period}\end{array}\}\text{=}\frac{\text{365}\text{days}}{\text{Accounts}\text{receivable}\text{turnover}\text{ratio}}\\ \text{=}\frac{\text{365}\text{days}}{\text{5}\text{.14}}\\ \text{=}\text{71}\text{.01}\text{days}\end{array}$

Therefore, average collection period is 71.01 days.

(b)

To determine

Compute merchandise inventory turnover ratio and average number of days to sell inventory.

Explanation of Solution

Merchandise Inventory turnover ratio:

Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period. The formula to calculate the merchandise inventory turnover ratio is as follows:

Days’ sales in inventory:

Days’ sales in inventory are used to determine number of days a particular company takes to make sales of the inventory available with them.

Calculate merchandise inventory ratio:

$\begin{array}{c}\begin{array}{l}\text{Merchandise}\text{Inventory}\\ \text{ turnover}\end{array}\}\text{=}\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ \text{=}\frac{\text{\$600,000}}{\text{\$190,000}(2)}\\ \text{=}\text{3}\text{.16}\end{array}$

Therefore, merchandise inventory ratio is 3.16.

Working note:

(2) Calculate average inventory:

$\begin{array}{c}\text{Average}\text{inventory}\text{=}\frac{\text{Beginning}\text{inventory}\text{+}\text{Ending}\text{inventory}}{\text{2}}\\ \text{=}\frac{\text{\$200,000}\text{+}\text{\$180,000}}{\text{2}}\\ \text{=\$190,000}\end{array}$

Calculate average number of days to sell inventory:

$\begin{array}{c}\begin{array}{l}\text{Average}\text{number}\text{of}\\ \text{days}\text{to}\text{sell}\text{inventory}\end{array}\}\text{=}\frac{\text{365}\text{days}}{\text{Merchandise}\text{inventory}\text{turnover}\text{ratio}}\\ \text{=}\frac{\text{365}\text{days}}{\text{3}\text{.16}}\\ \text{=}\text{115}\text{.51}\text{days}\end{array}$

Therefore, average number of days to sell inventory is 115.51 days.

(c)

To determine

Calculate asset turnover ratio.

Explanation of Solution

Asset turnover ratio:

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

Calculate asset turnover ratio:

$\begin{array}{c}\text{Asset}\text{turnover}\text{=}\frac{\text{Net}\text{sales}}{\text{Average}\text{assets}}\\ \text{=}\frac{\text{\$900,000}}{\text{\$670,000}\text{(3)}}\\ \text{=}\text{1}\text{.34:1}\end{array}$

Therefore, asset turnover ratio is 1.34:1.

Working note:

(3) Calculate average assets:

$\begin{array}{c}\text{Average}\text{assets}\text{=}\frac{\text{Total}\text{assets}\text{(beginning)}\text{+Total}\text{assets}\text{(ending)}}{\text{2}}\\ \text{=}\frac{\text{\$630,000}\text{+}\text{\$710,000}}{\text{2}}\\ \text{=}\text{\$670,000}\end{array}$