Class Exercise Solution

EXERCISE 13-25 (20-25 minutes) (a) 1. | Current ratio = | $773,000 | = 3.22 times | | | $240,000 | | 2. | Acid-test ratio = | $52,000 + $198,000 + $80,000 | = 1.38 times | | | $240,000 | | 3. Accounts receivable turnover = $1,640,000 | $80,000 + $198,000 | = 11.8 times | | 2 | | (or approximately every 31 days) | 4. Inventory turnover = $800,000 | $360,000 + $440,000 | = 2 times | | 2 | | (or approximately every 183 days) | 5. Days payables outstanding = $145,000 + $220,000 | | $800,000 | = 83 days | 2 | | 365 | | 6. Rate of return on assets = $360,000 | $1,400,000 + $1,630,000 | = 23.76% | | 2 | | 7. Profit margin on sales = $360,000 $1,640,000 = 21.95% EXERCISE 13-25 (Continued) (b) Financial ratios should be evaluated in terms of industry peculiarities and prevailing business conditions. Although industry and general business conditions are unknown in this case, the company appears to have a relatively strong current position. The main concern from a short-term perspective is the apparently low inventory turnover and the high days payables outstanding. The two ratios may be linked where extended credit terms are provided by suppliers if the inventory is slow-moving. The rate of return on assets and profit margin on sales are extremely good and indicate that the company is employing its assets advantageously. (c) Unearned revenue is a liability that arises from current sales but for which some future services or products are owed to customers in the future. At the time of sale, customers pay not only for the delivered product, but they also pay for future products or services. In this case, the company recognizes revenue from the current product and part of the sale proceeds is recorded as a liability (unearned revenue) for the value of future products or services that are “owed” to customers. An increase in the