Question

Your accounting department has given you the following summary financial statement for the year:

Accounts	Last Year	This Year
Inventory	250,000	300,000
Other Assets	500,000	550,000
Total Assets	750,000	850,000
Liabilities	150,000	150,000
Equity	600,000	700,000
Total Liabilities & Equity	750,000	850,000
Sales		1,000,000
Cost of Goods Sold		400,000
Other Expenses		250,000
Net Income		350,000

1 Calculate your Inventory Turnover ratio and Return on Equity from these numbers.
2 Now you discover that $25,000 worth of inventory is unsalable. Since it is no longer a resource that is expected to provide a future economic benefit, it no longer qualifies as an asset and should be written off. Calculate your Inventory Turnover ratio and Return on Equity after writing off the inventory.

Answer 1

1.a. Inventory turnover ratio = cost of goods sold /average inventory

Avearge inventory = (Opening inventory i,e previous year +closing inventory)/2

So avearge inventory =( 250000+300000)/2=275000

Inventory turnover ratio =400000/275000 = 1.45 times

b. Return on Equity ratio = Net income/equity = 350000/700000=0.5

2. If the inventory is written off then it will have impact on average inventory and net income of the year.

Inventory closing balance for currrent year after written off =300000-25000=275000

Because of written off of Inventory (asset)  other expenses increases and net income decreases by 25000 so net income will be 350000-25000=325000

So avearge inventory =( 250000+275000)/2=262500

a. Inventory turnover ratio = cost of goods sold /average inventory

Avearge inventory = (Opening inventory i,e previous year +closing inventory)/2

Inventory turnover ratio =400000/262500 = 1.52 times

b. Return on Equity ratio = Net income/equity = 325000/700000=0.46