TUTORIAL 4

1. Exercise 6-6 Analyzing effects on current ratio (LO6-5)

Gil Corporation has current assets of $90,000 and current liabilities of $180,000.

Required:
Compute the effect of each of the following independent transactions on Gil’s current ratio:

1. Refinancing a $30,000 long-term mortgage with a short-term note.

2. Purchasing $50,000 of merchandise inventory with short-term accounts payable.
3. Paying $20,000 of short-term accounts payable.
4. Collecting $10,000 of short-term accounts receivable.

Current Current Current

Assets Liabilities Ratio
Prior to transaction $ 90,000 $ 180,000 0.50
Transaction effect 30,000
With transaction $ 90,000 $ 210,000 0.43

Current Current Current

Assets Liabilities Ratio
Prior to transaction $ 90,000 $ 180,000 0.50
Transaction effect 50,000 50,000
With transaction $ 140,000 $ 230,000 0.61

Current Current Current

Assets Liabilities Ratio
Prior to transaction $ 90,000 $ 180,000 0.50
Transaction effect (20,000) (20,000)
With transaction $ 70,000 $ 160,000 0.44

Current Current Current

Assets Liabilities Ratio
Prior to transaction $ 90,000 $ 180,000 0.50
Transaction effect 0
With transaction $ 90,000 $ 180,000 0.50
2. Exercise 6-2 Determining inventory turnover (LO6-3)
On January 1, 20X1, River Company’s inventory was $400,000. During 20X1, the company
purchased $1,900,000 of additional inventory, and on December 31, 20X1, its inventory was
$500,000.

Required:
What was the inventory turnover for 20X1?

Beginning inventory $ 400,000 (given)

Purchases 1,900,000 (given)
Cost of goods sold (1,800,000) (infer from other items)
Ending inventory $ 500,000 (given)

Cost of goods sold $1,800,000 (from above)

Divide by average inventory:
Beginning inventory 400,000
Ending inventory 500,000
(Beginning + Ending)/2 450,000
Inventory turnover 4.00 times

3. Exercise 6-3 Determining receivable turnover (LO6-3)

Utica Company’s net accounts receivable was $250,000 at December 31, 20X0, and $300,000 at
December 31, 20X1. Net cash sales for 20X1 were $100,000. The accounts receivable turnover
for 20X1 was 5.0, which was computed from net credit sales for the year.

Required:
What was Utica’s total net sales for 20X1?

Average receivables:
Beginning receivables $ 250,000
Ending receivables 300,000
(Beginning + Ending)/2 275,000
× Accounts receivable turnover 5
Total credit sales 1,375,000
Cash sales 100,000
Total net sales $ 1,475,000
4. Exercise 6-7 Calculating interest coverage (LO6-5)
The following data were taken from the financial records of Glum Corporation for 20X1:

Sales $ 3,600,000
Bond interest expense 120,000
Income taxes 350,000
Net income 1,050,000

Required:
How many times was bond interest earned in 20X1? (Round your answer to 2 decimal places.)

Net income $ 1,050,000

Income taxes 350,000
Pretax income 1,400,000
Interest expense 120,000
Earnings before interest and taxes 1,520,000
Divided by Interest expense 120,000
Interest coverage 12.67 times
5. Exercise 6-9 Calculating days sales outstanding (LO6-3)
Selected information taken from the accounting records of Vigor Company follows:

Net accounts receivable at December 31, 20X0 $ 900,000

Net accounts receivable at December 31, 20X1 $ 1,000,000
Accounts receivable turnover 5 to 1
Inventories at December 31, 20X0 $ 1,100,000
Inventories at December 31, 20X1 $ 1,200,000
Inventory turnover 4 to 1

Required:

1. What was Vigor’s gross profit for 20X1?

2. Suppose that there are 360 business days in the year. What were the number of days
sales outstanding in average receivables and the number of days sales outstanding in
average inventories, respectively, for 20X1?

Beginning receivables $ 900,000

Ending receivables 1,000,000
Average receivables = (Beg + End)/2 $ 950,000
× Receivable turnover 5
Sales 4,750,000
Beginning inventory 1,100,000
Ending inventory 1,200,000
Average inventory = (Beg + End)/2 1,150,000
× Inventory turnover 4
Cost of goods sold 4,600,000
Gross profit $ 150,000

Days sales in receivables = 360/Receivable turnover = 360/5 = 72 days

Days cost of goods sold in inventory = 360/Inventory turnover = 360/4 = 90 days

6, Panera Bread Company is a national bakery-cafe concept with 1,380 Company-owned and
franchise-operated bakery-cafe locations in 40 states and in Ontario, Canada. The company has
grown from serving approximately 60 customers a day at its first bakery-cafe to currently serving
nearly six million customers a week system-wide, becoming one of the largest food service
companies in the United States. Sara Lee Corporation is a global manufacturer and marketer of
high-quality, brand-name products for consumers throughout the world focused primarily on the
meats, bakery and beverage categories. Selected financial information about each company
follows:

Sara Lee Panera Bread

Sales $ 10,793 million $ 1,353.5 million
Net Income $ 527 million $ 86.8 million
Return on Assets (ROA) 8.32% 11.55%
Profit margin 7.05% 6.45%
Asset turnover 1.18 1.79

Required:
a. Why is Sara Lee less profitable than Panera Bread?

Return on assets, the measure of profitability in this case, is a function of both profit margin
and asset turnover. While Sara Lee has a slightly higher profit margin than Panera Bread
(7.05% vs. 6.45%), its asset turnover is much lower than Panera Bread’s which explains
the lower return on assets.

b. Return on assets and return on sales in the bakery industry are 4.85% and 8.16%,
respectively. How do these two companies compare to their industry and what might
explain any noted differences?
Neither beats the industry return on sales (4.89% AND 6.41%), but both are quite a bit
better with respect to ROA; both must have net income that are significantly higher than
the industry average.
7. Exercise 6-12 Cause-of-change analysis (LO6-1)
Following are income statements for Hossa Corporation for 20X1 and 20X2. Percentage of sales
amounts are also shown for each operating expense item. Hossa’s income tax rate was 22% in
20X1 and 24% in 20X2.
20X1 20X2
($ in millions) $ in millions % of sales $ in millions % of sales
Sales $ 5,500.0 $ 6,500.0
Cost of sales (2,475.0) 45% (3,055.0) 47%
Other operating expenses (825.0) 15% (1,040.0) 16%
Operating income 2,200.0 2,405.0
Provision for income taxes (484.0) (577.2)
Net income $ 1,716.0 $ 1,827.8
Income tax rate 22% 24%

Hossa’s management was pleased that 20X2 net income was up 6.5% from the prior year.
Although you are also happy with the increase in net income, you are not so sure the news is all
positive. You have modeled Hossa’s income as follows:

NET INCOME = SALES × (1 − COGS% − OPEX%) × (1 − TAX RATE)

Using this model, net income in 20X1 is computed as $5,500 × (1 − 45% − 15%) × (1 − 22%) =
$1,716.0. Net income in 20X2 is computed as $6,500 × (1 − 47% − 16%) × (1 − 24%) = $1,827.8.

Required:

• Prepare a cause-of-change analysis to show the extent to which each of the following
items contributed to the $111.8 million increase in Hossa’s net income from 20X1 to
20X2Increase in sales (SALES)
• Increase in cost of sales as a percent of sales (COGS%)
• Increase in other operating expenses as a percent of sales (OPEX%)
• Increase in income tax rate (TAX RAT

($ in millions)
Net income 20X1 $1,716.0
Effect of increase in sales:
Increase in sales ($6,500 − $5,500) 1,000
× (1 − COGS% − OPEX%) in 20X1 0.40
× (1 − TAX RATE) in 20X1 0.78 312.0
Effect of increase in COGS%:
Sales in 20X2 6,500
× Increase in COGS% 0.02
× (1 − TAX RATE in 20X1) 0.78 (101.4)
Effect of increase in OPEX%:
Sales in 20X2 6,500
× Increase in OPEX% 0.01
× (1 − TAX RATE in 20X1) 0.78 (50.7)
Effect of increase in tax rate:
Operating income in 20X2 2,405
× Increase in tax rate 0.02 (48.1)
Total change in Net income 111.8
Net income in 20X2 $1,827.8