Chapter 3, Problem 3CP

1.

To determine

Identify the manner in which the company has named its income statement and explain the term consolidated.

Explanation of Solution

Income statement:

The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

• Incorporation AEO titled its income statement as “Consolidated statement of operations”.
• Incorporation UO titled its income statement as “Consolidated statements of income”.
• The term consolidated represents statements of two or more companies that are combined into a single statement for the purpose of presentation.

2.

To determine

Identify the company which had higher net income for the year.

Explanation of Solution

Net income:

Net income is the excess amount of revenue which arises after deducting all the expenses of a company. In simple terms, it is the difference between total revenue and total expenses of the company.

• Incorporation UO had the higher net income for 31^st January 2012 amounts to $185,251 While Incorporation AEO had only $151,705 for the same year.

3.

To determine

Compute the net profit margin ratios for both the companies and identify the company which is managing its revenues and expenses more effectively than the other company.

Explanation of Solution

Net profit margin ratio:

Net profit is the financial ratio that shows the relationship between the net profit and net sales (Operating revenue). Net profit is the difference between total operating revenue and total operating expenses. It can be calculated by dividing net profit and net sales revenue.

Compute the net profit margin ratio for Incorporation AEO:

$\begin{array}{c}\text{Net profit margin ratio}=\frac{\text{Net income}}{\text{Net sales}}\\ =\frac{\$151,705}{\$3,159,818}\\ =0.048\end{array}$

Hence, the net profit margin ratio for Incorporation AEO is 0.048.

Compute the net profit margin ratio for Incorporation UO:

$\begin{array}{c}\text{Net profit margin ratio}=\frac{\text{Net income}}{\text{Net sales}}\\ =\frac{\$185,251}{\$2,473,801}\\ =0.075\end{array}$

Hence, the net profit margin ratio for Incorporation UO is 0.075.

• By computing the net profit margin ratio, it is identified that Incorporation UO is having higher margin ratio of 0.075.
• This indicates that Incorporation UO is effective in generating more revenues and controlling its expenses for every dollar of sales.

4.

To determine

Compare the net profit margin ratio of both the companies and explain whether both the companies managing its sales and expenses better or worse than their competitors.

Explanation of Solution

Net profit margin ratio:

Net profit is the financial ratio that shows the relationship between the net profit and net sales (Operating revenue). Net profit is the difference between total operating revenue and total operating expenses. It can be calculated by dividing net profit and net sales revenue.

Given:

Industry average net profit margin ratio is 0.054.

Compute the net profit margin ratio for Incorporation AEO:

$\begin{array}{c}\text{Net profit margin ratio}=\frac{\text{Net income}}{\text{Net sales}}\\ =\frac{\$151,705}{\$3,159,818}\\ =0.048\end{array}$

Hence, the net profit margin ratio for Incorporation AEO is 0.048.

Compute the net profit margin ratio for Incorporation UO:

$\begin{array}{c}\text{Net profit margin ratio}=\frac{\text{Net income}}{\text{Net sales}}\\ =\frac{\$185,251}{\$2,473,801}\\ =0.075\end{array}$

Hence, the net profit margin ratio for Incorporation UO is 0.075.

• By comparing the net profit margin ratio of both the companies with the industry average, it is identified that the Incorporation UO (0.075) is more effective in generating the revenues and controlling the expenses.
• The net profit margin ratio of Incorporation AEO (0.048) suggests that it is very less effective in generating the revenues and controlling the expenses.

5.

To determine

Compute the percentage of change in operating cash flows.

Explanation of Solution

Compute the percentage of change in operating cash flows for Incorporation AEO for the year 2012:

$\begin{array}{c}\text{Percentage change in operating cash flows}=\left[\frac{\text{Amount in 2012}-\text{Amount in 2011}}{\text{Amount in 2011}}\times 100\right]\\ =\left[\frac{\$239,256-\$402,594}{\$402,594}\times 100\right]\\ =\left[\frac{\left(\$166,338\right)}{\$402,594}\times 100\right]\\ =\left(40.57\%\right)\end{array}$

Hence, the percentage of change in operating cash flows for Incorporation AEO is (40.57%)

Compute the percentage of change in operating cash flows for Incorporation AEO for the year 2011:

$\begin{array}{c}\text{Percentage change in operating cash flows}=\left[\frac{\text{Amount in 2011}-\text{Amount in 2010}}{\text{Amount in 2010}}\times 100\right]\\ =\left[\frac{\$402,594-\$400,326}{\$400,326}\times 100\right]\\ =\left[\frac{\$2,268}{\$400,356}\times 100\right]\\ =0.57\%\end{array}$

Hence, the percentage of change in operating cash flows for Incorporation AEO is 0.57%

Compute the percentage of change in operating cash flows for Incorporation UO for the year 2012:

$\begin{array}{c}\text{Percentage change in operating cash flows}=\left[\frac{\text{Amount in 2012}-\text{Amount in 2011}}{\text{Amount in 2011}}\times 100\right]\\ =\left[\frac{\$282,702-\$385,113}{\$385,113}\times 100\right]\\ =\left[\frac{\left(\$102,411\right)}{\$385,113}\times 100\right]\\ =\left(26.59\%\right)\end{array}$

Hence, the percentage of change in operating cash flows for Incorporation UO for the year 2012 is (26.59%).

Compute the percentage of change in operating cash flows for Incorporation UO for the year 2011:

$\begin{array}{c}\text{Percentage change in operating cash flows}=\left[\frac{\text{Amount in 2011}-\text{Amount in 2010}}{\text{Amount in 2010}}\times 100\right]\\ =\left[\frac{\$385,113-\$325,394}{\$325,394}\times 100\right]\\ =\left[\frac{\$59,719}{\$325,394}\times 100\right]\\ =18.35\%\end{array}$

Hence, the percentage of change in operating cash flows for Incorporation UO is 18.35%.