Chapter 4, Problem 3CP

1.

To determine

Indicate the amount of advertising expense for each company for the most recent year, and identify the source of this information.

Explanation of Solution

The amount of advertising expense for AE Outfitters for the fiscal year 2017 is $129,800. This information is found in Note 2 “Advertising costs” of the financial statements of AE Outfitters.

The amount of advertising expense Incorporation E for the fiscal year 2017 is $112,800. This information is found Note 2 “Advertising costs” of the financial statements of Incorporation E.

2.

To determine

Ascertain the percentage of advertising expense to net sales ratio for the three years for both companies, indicate the company with the higher percentage, and provide the comments on the use of the advertising expense. 

Explanation of Solution

Compute the percentage of advertising expense to net sales ratio for AE Outfitters for 2017.

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales revenue}}\times 100\\ =\frac{\$129,800}{\$3,795,549}\times 100\\ =3.42\%\end{array}$

Compute the percentage of advertising expense to net sales ratio for AE Outfitters for 2016.

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$124,500}{\$3,609,865}\times 100\\ =3.45\%\end{array}$

Compute the percentage of advertising expense to net sales ratio for AE Outfitters for 2015.

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$104,100}{\$3,521,848}\times 100\\ =2.96\%\end{array}$

Compute the percentage of advertising expense to net sales ratio for Incorporation E for 2017.

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$112,800}{\$2,138,030}\times 100\\ =5.28\%\end{array}$

Compute the percentage of advertising expense to net sales ratio for Incorporation E for 2016.

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$113,200}{\$2,192,547}\times 100\\ =5.16\%\end{array}$

Compute the percentage of advertising expense to net sales ratio for Incorporation E for 2015.

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$110,500}{\$2,350,129}\times 100\\ =4.70\%\end{array}$

Comments: Incorporation E has incurred the higher percentage in all three years. The ratio has increased and decreased for AE Outfitters over the three year period, and the ratio has increased for Incorporation E over the three-year period. Both the companies increase also increased the advertising expense as a percentage of sales each year to increase sales revenue.

3.

To determine

Explain the accounting policy for advertising for both the companies which includes note to the financial statements.

Explanation of Solution

The accounting policies of both the companies are similar in expensing the advertising costs when the marketing campaigns become publicly available. AE Outfitters reports the expenses associated with in-store photographs, mail, promotional costs as prepaid expenses and expenses these costs when the campaign starts over. Incorporation E records the advertising expenses as selling, general, and administration expenses on its income statement.

4-a.

To determine

Ascertain the total asset turnover ratio for both the companies for the three years reported and provide the inferences about each company over the three year period in comparison to each other.

Explanation of Solution

Calculate total asset turnover for AE Outfitters for the year 2017.

$\begin{array}{c}\text{Total asset turnover = }\frac{\text{Sales}}{\text{ Average total assets}}\\ =\frac{\$3,795,549}{\$1,799,486.5}\\ =2.11\end{array}$

Calculate total asset turnover for AE Outfitters for the year 2016.

$\begin{array}{c}\text{Total asset turnover = }\frac{\text{Sales}}{\text{ Average total assets}}\\ =\frac{\$3,609,865}{\$1,697,453}\\ =2.13\end{array}$

Calculate total asset turnover for AE Outfitters for the year 2015.

$\begin{array}{c}\text{Total asset turnover = }\frac{\text{Sales}}{\text{ Average total assets}}\\ =\frac{\$3,521,848}{\$1,654,577}\\ =2.13\end{array}$

Calculate total asset turnover for Incorporation E for the year 2017.

$\begin{array}{c}\text{Total asset turnover = }\frac{\text{Sales}}{\text{ Average total assets}}\\ =\frac{\$2,138,030}{\$1,186,398}\\ =1.80\end{array}$

Calculate total asset turnover for Incorporation E for the year 2016.

$\begin{array}{c}\text{Total asset turnover = }\frac{\text{Sales}}{\text{ Average total assets}}\\ =\frac{\$2,192,547}{\$1,181,916.5}\\ =1.86\end{array}$

Calculate total asset turnover for Incorporation E for the year 2015.

$\begin{array}{c}\text{Total asset turnover = }\frac{\text{Sales}}{\text{ Average total assets}}\\ =\frac{\$2,350,129}{\$1,228,397}\\ =1.91\end{array}$

AE Outfitters and Incorporation E have decreased their total asset turnover ratios over the three year period from 2015 to 2017. This suggests that both the companies were less efficient in managing the assets to generate revenues. In each year, AE Outfitters has a higher turnover ratio than Incorporation E which suggests that AE Outfitters is more efficient in utilizing its assets compared to its competitor.

4-b.

To determine

Compare the total asset turnover ratio for the most recent year of both the companies to the industry average and explain whether these two companies were performing better or worse than their average company in the industry.

Explanation of Solution

Comparison:

	Industry average	AE Outfitters	Incorporation E
Total asset turnover ratio (for fiscal year ended 2017)	1.93	2.11	1.80

Table (2)

Analysis: AE Outfitters has higher and Incorporation E has lower total asset turnover ratio compared to the industry average for the fiscal year 2017.  This indicates that AE Outfitters is more effective and Incorporation E is less effective in managing total assets to generate revenue.