Ch 5 solution

Chapter 05 - Income Measurement and Profitability Analysis

5-1

Chapter 5 Income Measurement and Profitability

Analysis

Brief Exercise 5-1

2011 gross profit = $3,000,000 – 1,200,000 = $1,800,000

2012 gross profit = 0

Brief Exercise 5-2

2011 Cost recovery % = Cost Sales:

$1,200,000

= 40% (implying a gross profit % = 60%)

$3,000,000

2011 gross profit = 2011 cash collection of $150,000 x 60% = $90,000

2012 gross profit = 2012 cash collection of $150,000 x 60% = $90,000

Brief Exercise 5-3

No gross profit will be recognized in either 2011 or 2012. Gross profit will not

be recognized until the entire $1,200,000 cost of the land is recovered. In this case, it

will take 8 payments to recover the cost of the land ($1,200,000 $150,000 = 8), so

gross profit recognition will equal 100% of the cash collected beginning with the

ninth installment payment.

Brief Exercise 5-4

Initial deferred gross profit ($3,000,000 – 1,200,000) $1,800,000

Less gross profit recognized in 2011 ($150,000 x 60%) (90,000)

Less gross profit recognized in 2012 ($150,000 x 60%) (90,000)

Deferred gross profit at the end of 2012 $1,620,000


5-2

Brief Exercise 5-5 The seller must meet certain criteria before revenue can be recognized in

situations when the right of return exists. The most critical of these criteria is that the

seller must be able to make reliable estimates of future returns. If Meyer’s

management can make reliable estimates of the furniture that will be returned,

revenue can be recognized when the product is delivered, assuming the company has

no additional obligations to the buyer. If reliable estimates cannot be made because

of significant uncertainty, revenue and related cost recognition is delayed until the

uncertainty is resolved.

Brief Exercise 5-6

Total estimated cost to complete = $6 million + $9 million = $15 million

% of completion = $6 million $15 million = 40%

Total estimated gross profit ($20 million – 15 million) = $5,000,000

multiplied by the % of completion 40%

Gross profit recognized the first year $2,000,000

First year revenue = $20,000,000 x 40% = $8,000,000

Brief Exercise 5-7

Assets:

Accounts receivable ($7 million – 5 million) $2,000,000

Cost plus profit ($6 million + $2 million*)

in excess of billings ($7 million) 1,000,000

* Total estimated gross profit ($20 million – 15 million) = $5,000,000

multiplied by the % of completion 40%

Gross profit recognized in the first year $2,000,000


5-3

Brief Exercise 5-8

Year 1 = 0

Year 2 = $4 million

Revenue $20,000,000

Less: Costs in year 1 (6,000,000)

Costs in year 2 (10,000,000)

Actual profit $ 4,000,000

Brief Exercise 5-9

Year 1:

Revenue: $6 million

Cost: $6 million

Gross profit: $0

Year 2:

Revenue: $14 million ($20 million total – $6 million in year 1)

Cost: $10 million

Gross profit: $ 4 million

Brief Exercise 5-10 The anticipated loss of $3 million ($30 million contract price less total estimated

costs of $33 million) must be recognized in the first year applying either method.


5-4

Brief Exercise 5-11 Orange has separate sales prices for the two parts of LearnIt-Plus, so that vendor-

specific objective evidence (VSOE) allows them to allocate revenue to those parts

according to their relative selling prices. LearnIt will be allocated $200 x [$150 ÷

($150 + $100)] = $120, and that revenue will be recognized upon delivery of the

LearnIt software. LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 +

$100)] = $80, and that revenue will be deferred and recognized over the life of the

one-year period in which the Office Hours are delivered.

If LearnIt were not sold separately, Orange would not have VSOE for all of the

parts of the contract. In that case, revenue would be delayed until the later part was

delivered. In this case, the $200 would be deferred and recognized over the life of the

one-year period in which the Office Hours are delivered.

Brief Exercise 5-12 Orange has separate sales prices for the two parts of LearnIt-Plus, so the

company can base its estimates of the fair value of those parts according to their

relative selling prices. LearnIt will be allocated $200 x [$150 ÷ ($150 + $100)] =

$120, and that revenue will be recognized upon delivery of the LearnIt software.

LearnIt Office Hours will be allocated $200 x [$100 ÷ ($150 + $100)] = $80, and that

revenue will be deferred and recognized over the life of the one-year period in which

the Office Hours are delivered.

If LearnIt were not sold separately, the accounting would be the same. Orange

would estimate the fair value of LearnIt Office Hours to be $100 and allocate revenue

in the same fashion as it did when that product was sold separately. (VSOE is not

required under IFRS).

Brief Exercise 5-13 Specific conditions for revenue recognition of the initial franchise fee are

provided by FASB ASC 952-605–25–1. A key to these conditions is the concept of

substantial performance. It requires that substantially all of the initial services of the

franchisor required by the franchise agreement be performed before the initial

franchise fee can be recognized as revenue. The term “substantial” requires

professional judgment on the part of the accountant. Often, substantial performance

is considered to have occurred when the franchise opens for business.

Continuing franchise fees are recognized over time as the services are performed.


5-5

Exercise 5-1

Requirement 1

Alpine West should recognize revenue over the ski season on an anticipated

usage basis, in this case equally throughout the season. The fact that the $450 price is

nonrefundable is not relevant to the revenue recognition decision. Revenue should be

recognized as it is earned, in this case as the services are provided during the ski

season.

Requirement 2

November 6, 2011 To record the cash collection

Cash ................................................................................ 450

Unearned revenue ....................................................... 450

December 31, 2011 To recognize revenue earned in December (no

revenue earned in November, as season starts on December 1).

Unearned revenue ($450 x 1/5) ....................................... 90

Revenue ...................................................................... 90

Requirement 3

$90 is included in revenue in the 2011 income statement. The $360 remaining

balance in unearned revenue is included in the current liability section of the 2011

balance sheet.

EXERCISES


5-6

Exercise 5-2

Requirement 1

2011 Cost recovery %:

$234,000

= 65% (gross profit % = 35%)

$360,000

2012 Cost recovery %:

$245,000

= 70% (gross profit % = 30%)

$350,000

2011 gross profit:

Cash collection from 2011 sales of $150,000 x 35% = $52,500

2012 gross profit:

Cash collection from 2011 sales of $100,000 x 35% = $ 35,000

+ Cash collection from 2012 sales of $120,000 x 30% = 36,000

Total 2012 gross profit $71,000

Requirement 2

2011 deferred gross profit balance:

2011 initial gross profit ($360,000 – 234,000) $126,000

Less: Gross profit recognized in 2011 (52,500)

Balance in deferred gross profit account $73,500

2012 deferred gross profit balance:

2011 initial gross profit ($360,000 – 234,000) $ 126,000


Gross profit recognized in 2012 (35,000)

2012 initial gross profit ($350,000 – 245,000) 105,000


Balance in deferred gross profit account $107,500


5-7

Exercise 5-3

2011 To record installment sales

Installment receivables ................................................... 360,000

Inventory ..................................................................... 234,000

Deferred gross profit .................................................. 126,000

2011 To record cash collections from installment sales

Cash ................................................................................ 150,000

Installment receivables ............................................... 150,000

2011 To recognize gross profit from installment sales

Deferred gross profit ...................................................... 52,500

Realized gross profit................................................... 52,500

2012 To record installment sales


Inventory ..................................................................... 245,000


2012 To record cash collections from installment sales

Cash ................................................................................ 220,000


2012 To recognize gross profit from installment sales




5-8

Exercise 5-4

Requirement 1

Year Income recognized

2011 $180,000 ($300,000 – 120,000)

2012 - 0 -

2013 - 0 -

2014 - 0 -

Total $180,000

Requirement 2

Cost recovery %:

$120,000

------------- = 40% (gross profit % = 60%)

$300,000

Year Cash Collected Cost Recovery(40%) Gross Profit(60%)

2011 $ 75,000 $ 30,000 $ 45,000

2012 75,000 30,000 45,000

2013 75,000 30,000 45,000

2014 75,000 30,000 45,000

Totals $300,000 $120,000 $180,000

Requirement 3

Year Cash Collected Cost Recovery Gross Profit

2011 $ 75,000 $ 75,000 - 0 -

2012 75,000 45,000 $ 30,000

2013 75,000 - 0 - 75,000

2014 75,000 - 0 - 75,000

Totals $300,000 $120,000 $180,000


5-9

Exercise 5-5

Requirement 1

July 1, 2011 To record installment sale


Sales revenue .............................................................. 300,000

Cost of goods sold .......................................................... 120,000

Inventory ..................................................................... 120,000

To record cash collection from installment sale

Cash ................................................................................ 75,000


July 1, 2012 To record cash collection from installment sale

Cash ................................................................................ 75,000



5-10

Exercise 5-5 (continued)

Requirement 2



Inventory ..................................................................... 120,000



Cash ................................................................................ 75,000


To recognize gross profit from installment sale




Cash ................................................................................ 75,000






5-11

Exercise 5-5 (concluded)

Requirement 3



Inventory ..................................................................... 120,000



Cash ................................................................................ 75,000



Cash ................................................................................ 75,000





Exercise 5-6

Requirement 1

Cost of goods sold ($1,000,000 – 600,000) $400,000

Add: Gross profit if using cost recovery method 100,000

Cash collected $500,000

Requirement 2

$ 600,000

Gross profit percentage = = 60%

$1,000,000

Cash collected x Gross profit percentage = Gross profit recognized

$500,000 x 60% = $300,000 gross profit


5-12

Exercise 5-7

October 1, 2011

To record the installment sale

Installment receivable .................................................... 4,000,000

Inventory ..................................................................... 1,800,000

Deferred gross profit .................................................. 2,200,000

To record the cash down payment from installment sale

Cash ................................................................................ 800,000

Installment receivable ................................................ 800,000


Deferred gross profit ($800,000 x 55%*) ...................... 440,000


October 1, 2012

To record the default and repossession

Repossessed inventory (fair value) ............................... 1,300,000

Deferred gross profit (balance) ...................................... 1,760,000

Loss on repossession (difference) ................................. 140,000

Installment receivable (balance) ................................ 3,200,000

*$2,200,000 $4,000,000 = 55% gross profit percentage


5-13

Exercise 5-8

Requirement 1

April 1, 2011 To record installment sale

Installment receivables ................................................... 2,400,000

Land ............................................................................ 480,000

Gain on sale of land .................................................... 1,920,000

April 1, 2011 To record cash collection from installment sale

Cash ................................................................................ 120,000



Cash ................................................................................ 120,000


Requirement 2

April 1, 2011 To record installment sale

Installment receivables ................................................... 2,400,000

Land ............................................................................ 480,000

Deferred gain .............................................................. 1,920,000


5-14


When payments are received, gain on sale of land is recognized, calculated by

applying the gross profit percentage ($1,920,000 ÷ $2,400,000 = 80%) to the cash

collected (80% x $120,000).


Cash ................................................................................ 120,000


To recognize profit from installment sale

Deferred gain .................................................................. 96,000

Gain on sale of land (80% x $120,000) .......................... 96,000


Cash ................................................................................ 120,000


To recognize profit from installment sale

Deferred gain .................................................................. 96,000

Gain on sale of land (80% x $120,000) .......................... 96,000


5-15

Exercise 5-10

Requirement 1

($ in millions) 2011 2012 2013

Contract price $220 $220 $220

Actual costs to date 40 120 170

Estimated costs to complete 120 60 - 0 -

Total estimated costs 160 180 170

Estimated gross profit (actual in 2013) $ 60 $ 40 $ 50

Gross profit (loss) recognition:

2011: $40

= 25% x $60 = $15

$160

2012: $120

= 66.67% x $40 = $26.67 – $15 = $11.67

$180

2013: $220 – 170 = $50 – ($15 + 11.67) = $23.33

Requirement 2

2011: $220 x 25% = $55

2012: $220 x 66.67% = $146.67 – 55 = $91.67

2013: $220 – 146.67 = $73.33

Requirement 3

Year Gross profit (loss) recognized

2011 - 0 -

2012 - 0 -

2013 50

Total project income $50


5-16


Requirement 4

2011:

Revenue: $40

Cost: $40

Gross profit: $ 0

2012:

Revenue: $80

Cost: $80

Gross profit: $ 0

2013:

Revenue: $100 ($220 contract price – $40 – $80)

Cost: $ 50

Gross profit: $ 50

Requirement 5

2012: $120

= 60% x $20* = $12 – 15 = $(3) loss

$200

*$220 – ($40 + 80 + 80) = $20


5-17

Exercise 5-11

Requirement 1

2011 2012 2013

Contract price $8,000,000 $8,000,000 $8,000,000

Actual costs to date 2,000,000 4,500,000 8,300,000

Estimated costs to complete 4,000,000 3,600,000 - 0 -

Total estimated costs 6,000,000 8,100,000 8,300,000

Estimated gross profit (loss)

(actual in 2013) $2,000,000 $ (100,000) $ (300,000)

Gross profit (loss) recognition:

2011: $2,000,000

= 33.3333% x $2,000,000 = $666,667

$6,000,000

2012: $(100,000) – 666,667 = $(766,667)

2013: $(300,000) – (100,000) = $(200,000)


5-18


Requirement 2

2011 2012

Construction in progress 2,000,000 2,500,000

Various accounts 2,000,000 2,500,000

To record construction costs.

Accounts receivable 2,500,000 2,750,000

Billings on construction contract 2,500,000 2,750,000

To record progress billings.

Cash 2,250,000 2,475,000


To record cash collections.

Construction in progress (gross profit)

666,667

Cost of construction 2,000,000

Revenue from long-term contracts (33.3333% x $8,000,000)

2,666,667

To record gross profit.

Cost of construction (2) 2,544,000

Revenue from long-term contracts (1) 1,777,333

Construction in progress (loss) 766,667

To record expected loss.

(1) and (2):

Percent complete = $4,500,000 ÷ $8,100,000 = 55.55%

Revenue recognized to date:

55.55% x $8,000,000 = $4,444,000

Less: Revenue recognized in 2011 (above) (2,666,667)

Revenue recognized in 2012 1,777,333 (1)

Plus: Loss recognized in 2012 (above) 766,667

Cost of construction, 2012 $2,544,000 (2)


5-19


Requirement 3

Balance Sheet 2011 2012

Current assets:

Accounts receivable $250,000 $525,000

Costs and profit ($2,666,667*) in

excess of billings ($2,500,000)

166,667

Current liabilities:

Billings ($5,250,000) in excess

of costs less loss ($4,400,000**)

$850,000

* Costs ($2,000,000) + profit ($666,667)

** Costs ($2,000,000 + $2,500,000) – loss ($100,000 = $766,667 – $666,667)


5-20

Exercise 5-12

Requirement 1


2011 - 0 -

2012 $(100,000)

2013 (200,000)

Total project loss $(300,000)

Requirement 2

2011 2012

Construction in progress 2,000,000 2,500,000

Various accounts 2,000,000 2,500,000

To record construction costs.


Billings on construction contract 2,500,000 2,750,000

To record progress billings.

Cash 2,250,000 2,475,000


To record cash collections.

Loss on long-term contract 100,000

Construction in progress 100,000

To record an expected loss.


5-21


Requirement 3

Balance Sheet 2011 2012

Current assets:

Accounts receivable $250,000 $525,000

Current liabilities:

Billings ($2,500,000) in excess of costs ($2,000,000)

$500,000

Billings ($5,250,000) in excess of costs less

loss ($4,400,000*)

$850,000

* Costs ($2,000,000 + $2,500,000) – loss ($100,000)


5-22

Exercise 5-13 Situation 1 - Percentage-of-Completion

2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000


Estimated costs to complete 3,000,000 900,000 - 0 -


Estimated gross profit

(actual in 2013) $ 500,000 $ 500,000 $ 500,000

Gross profit (loss) recognized:

2011: $1,500,000

= 33.3333% x $500,000 = $166,667

$4,500,000

2012: $3,600,000

= 80.0% x $500,000 = $400,000 – 166,667 = $233,333

$4,500,000

2013: $500,000 – 400,000 = $100,000

Situation 1 - Completed Contract

Year Gross profit recognized

2011 - 0 -

2012 - 0 -

2013 $500,000

Total gross profit $500,000


5-23


Situation 2 - Percentage-of-Completion

2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000





(actual in 2013) $ 500,000 $ 200,000 $ 200,000


2011: $1,500,000

= 33.3333% x $500,000 = $166,667

$4,500,000

2012: $2,400,000

= 50.0% x $200,000 = $100,000 – 166,667 = $(66,667)

$4,800,000

2013: $200,000 – 100,000 = $100,000



2011 - 0 -

2012 - 0 -

2013 $200,000



5-24



2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000





(actual in 2013) $ 500,000 $ (100,000) $ (200,000)


2011: $1,500,000

= 33.3333% x $500,000 = $166,667

$4,500,000

2012: $(100,000) – 166,667 = $(266,667)

2013: $(200,000) – (100,000) = $(100,000)



2011 - 0 -

2012 $(100,000)

2013 (100,000)



5-25



2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000

Actual costs to date 500,000 3,500,000 4,500,000

Estimated costs to complete 3,500,000 875,000 - 0 -



(actual in 2013) $1,000,000 $ 625,000 $ 500,000


2011: $ 500,000

= 12.5% x $1,000,000 = $125,000

$4,000,000

2012: $3,500,000

= 80.0% x $625,000 = $500,000 – 125,000 = $375,000

$4,375,000

2013: $500,000 – 500,000 = $ - 0 -



2011 - 0 -

2012 - 0 -

2013 $500,000



5-26



2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000





(actual in 2013) $1,000,000 $ - 0 - $ 200,000


2011: $ 500,000

= 12.5% x $1,000,000 = $125,000

$4,000,000

2012: $ 0 – 125,000 = $(125,000)

2013: $200,000 – 0 = $200,000



2011 - 0 -

2012 - 0 -

2013 $200,000



5-27



2011 2012 2013

Contract price $5,000,000 $5,000,000 $5,000,000





(actual in 2013) $ (100,000) $ (200,000) $ (300,000)


2011: $(100,000)

2012: $(200,000) – (100,000) = $(100,000)

2013: $(300,000) – (200,000) = $(100,000)



2011 $(100,000)

2012 (100,000)

2013 (100,000)



5-28

Exercise 5-14

Requirement 1

Construction in progress = Costs incurred + Profit recognized

$100,000 = ? + $20,000

Actual costs incurred in 2011 = $80,000

Requirement 2

Billings = Cash collections + Accounts Receivable

$94,000 = ? + $30,000

Cash collections in 2011 = $64,000

Requirement 3

Let A = Actual cost incurred + Estimated cost to complete

Actual cost incurred

x (Contract price – A) = Profit recognized

A

$80,000

($1,600,000 – A) = $20,000

A

$128,000,000,000 – 80,000A = $20,000A

$100,000A = $128,000,000,000

A = $1,280,000

Estimated cost to complete = $1,280,000 – 80,000 = $1,200,000

Requirement 4

$80,000

= 6.25%

$1,280,000


5-29

Exercise 5-15

Requirement 1

Revenue should be recognized as follows:

Software - date of shipment, July 1, 2011

Technical support - evenly over the 12 months of the agreement

Upgrade - date of shipment, January 1, 2012

The amounts are determined by an allocation of total contract price in

proportion to the individual fair values of the components if sold separately:

Software $210,000 ÷ $270,000 x $243,000 = $189,000

Technical support $30,000 ÷ $270,000 x $243,000 = 27,000

Upgrade $30,000 ÷ $270,000 x $243,000 = 27,000

Total $243,000

Requirement 2

July 1, 2011 To record sale of software Cash ................................................................................ 243,000

Revenue ...................................................................... 189,000

Unearned revenue ($27,000 + 27,000) ........................... 54,000


5-30

Exercise 5-16

Requirement 1

Conveyer ($20,000 ÷ $50,000) x $45,000 = $18,000

Labeler ($10,000 ÷ $50,000) x $45,000 = 9,000

Filler ($15,000 ÷ $50,000) x $45,000 = 13,500

Capper ($5,000 ÷ $50,000) x $45,000 = 4,500

total $45,000

Requirement 2

All $45,000 of revenue is delayed until installation of the conveyer,

because the usefulness of the other elements of the multi-part arrangement

is contingent on its delivery.


5-31

Exercise 5-17

Requirement 1

Conveyer ($20,000 ÷ $50,000) x $45,000 = $18,000

Labeler ($10,000 ÷ $50,000) x $45,000 = 9,000

Filler ($15,000 ÷ $50,000) x $45,000 = 13,500

Capper ($5,000 ÷ $50,000) x $45,000 = 4,500

total $45,000

Requirement 2

Under IFRS, it is likely that Richardson would recognize revenue the same

as in Requirement 1, because (a) revenue for each part can be estimated

reliably and (b) the receipt of economic benefits is probable.


5-32

Exercise 5-18

October 1, 2011 To record franchise agreement and down payment

Cash (10% x $300,000) ...................................................... 30,000

Note receivable ............................................................... 270,000

Unearned franchise fee revenue ................................. 300,000

January 15, 2012 To recognize franchise fee revenue

Unearned franchise fee revenue ..................................... 300,000

Franchise fee revenue ................................................. 300,000

Exercise 5-19

List A List B

h 1. Inventory turnover a. Net income divided by net sales.

d 2. Return on assets b. Defers recognition until cash collected equals

cost.

g 3. Return on shareholders' equity c. Defers recognition until project is complete.

a 4. Profit margin on sales d. Net income divided by assets.

b 5. Cost recovery method e. Risks and rewards of ownership retained

by seller.

i 6. Percentage-of-completion method f. Contra account to construction in progress.

c 7. Completed contract method g. Net income divided by shareholders' equity.

k 8. Asset turnover h. Cost of goods sold divided by inventory.

l 9. Receivables turnover i. Recognition is in proportion to work completed.

m 10. Right of return j. Recognition is in proportion to cash received.

f 11. Billings on construction contract k. Net sales divided by assets.

j 12. Installment sales method l. Net sales divided by accounts receivable.

e 13. Consignment sales m. Could cause the deferral of revenue recognition

beyond delivery point.


5-33

Exercise 5-20

Requirement 1

Requirement 2

By itself, this one ratio provides very little information. In general, the higher

the inventory turnover, the lower the investment must be for a given level of sales. It

indicates how well inventory levels are managed and the quality of inventory,

including the existence of obsolete or overpriced inventory.

However, to evaluate the adequacy of this ratio it should be compared with some

norm such as the industry average. That indicates whether inventory management

practices are in line with the competition.

It’s just one piece in the puzzle, though. Other points of reference should be

considered. For instance, a high turnover can be achieved by maintaining too low

inventory levels and restocking only when absolutely necessary. This can be costly in

terms of stockout costs.

The ratio also can be useful when assessing the current ratio. The more liquid

inventory is, the lower the norm should be against which the current ratio should be

compared.

Inventory turnover ratio = Cost of goods sold

Average inventory

= $1,840,000 [$690,000 + 630,000] ÷ 2

= 2.79 times


5-34

Exercise 5-21

Turnover ratios for Anderson Medical Supply Company for 2011:

The company turns its inventory over 6 times per year compared to the industry

average of 5 times per year. The asset turnover ratio also is slightly better than the

industry average (2 times per year versus 1.8 times). These ratios indicate that

Anderson is able to generate more sales per dollar invested in inventory and in total

assets than the industry averages. However, Anderson takes slightly longer to collect

its accounts receivable (27.4 days compared to the industry average of 25 days).

Inventory turnover ratio = $4,800,000

[$900,000 + 700,000] ÷ 2

= 6 times

Receivables turnover ratio = $8,000,000

[$700,000 + 500,000] ÷ 2

= 13.33 times

Average collection period = 365

13.33

= 27.4 days

Asset turnover ratio = $8,000,000

[$4,300,000 + 3,700,000] ÷ 2

= 2 times


5-35

Exercise 5-22

Requirement 1

a. Profit margin on sales $180 ÷ $5,200 = 3.5%

b. Return on assets $180 ÷ [($1,900 + 1,700) ÷ 2] = 10%

c. Return on shareholders’ equity $180 ÷ [($550 + 500) ÷ 2] = 34.3%

Requirement 2

Retained earnings beginning of period $100,000

Add: Net income 180,000

280,000

Less: Retained earnings end of period 150,000

Dividends paid $130,000

Exercise 5-23

Requirement 1

a. Profit margin on sales $180 ÷ $5,200 = 3.5%

b. Asset turnover $5,200 ÷ [($1,900 + 1,700) ÷ 2] = 2.89

c. Equity multiplier [($1,900 + 1,700) ÷ 2] ÷ [($550 + 500) ÷ 2] = 3.43

d. Return on shareholders’ equity $180 ÷ [($550 + 500) ÷ 2] = 34.3%

Requirement 2

Profit margin x Asset turnover x Equity multiplier = ROE

3.5% x 2.89 x 3.43 = 34.7% ~ 34.3% (difference due

to rounding)

Exercise 5-24 Quarter

First Second Third

Cumulative income before taxes $50,000 $90,000 $190,000

Estimated annual effective tax rate 34% 30% 36%

17,000 27,000 68,400

Less: Income tax reported earlier 0 17,000 27,000

Tax expense to be reported $17,000 $10,000 $ 41,400


5-36

Exercise 5-25 Incentive compensation $300 million ÷ 4 = $ 75 million

Depreciation expense $60 million ÷ 4 = 15 million

Gain on sale 23 million

Exercise 5-26 1st 2nd 3rd 4th

Advertising $200,000 $200,000 $200,000 $200,000

Property tax 87,500 87,500 87,500 87,500

Equipment repairs 65,000 65,000 65,000 65,000

Extraordinary casualty loss 0 185,000 0 0

Research and development 0 32,000 32,000 32,000

Ch 5 solution

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Transcript of Ch 5 solution