Question

The Company failed to record (accrue) $9,000,000 of cost related to vendor invoices and warranty liability at year-end. With this omission, the company's summary financial statements were stated as follows:

Summarized Income Statement

Sales                                                                     $97,000,000

All Cost (incl. Interest & Taxes) $83,000,000

Net Income   $14,000,000

Summarized Balance Sheet                          This Year                              Last Year

All Current Assets combined                      $74,000,000                      $68,000,000

All Long-Term Assets combined                 $61,000,000                      $59,000,000

Total Assets: $135,000,000                   $127,000,000

Liabilities & Stockholder’s Equity

All Current Liabilities combined                $61,000,000                       $57,000,000

All Long-Term Liabilities combined           $35,000,000                       $45,000,000

Stockholders’ Equity                                 $39,000,000                       $25,000,000

Total Liabilities & Equity                          $135,000,000                     $127,000,000

Answer the following questions:

1. Current Ratio per Company Statements?
2. Current Ratio if Statements Fixed This Error?
3. Would the Current Ratio Be Better or Worse?
4. ROI per Company Statements?
5. ROI if Statements Fixed This Error?
6. Would the ROI be Better or Worse?
7. ROE per Company Statements?
8. ROE if Statements Fixed This Error?
9. Would the ROE be Better or Worse?

Display current ratio in the following format only X.XX (go two decimal places)

Display ROI and ROE in the following format only X.X% (go one decimal point)

Answer 1

Answer- 1. Calculation of Current Ratio as per Company Statements :

Current Ratio = Current Assets ÷ Current Liabilities = $74,000,000 ÷ $61,000,000

Current Ratio = 1.2

2. Calculation of Current Ratio if Statements are corrected :

Current Ratio = (Current Assets given + omission of purchases) ÷ Total (Current Liabilities + omitted liability)

= ($74,000,000 + 9,000,000) ÷ (61,000,000 + 9,000,000)

= 1.18

3. Is the Current Ratio better or worse after adjustment of error?

Well, itsi neutral, since the omitted entry increased the current assets and current liabilities in the same amount. So, there's not much difference in the ratio previously calculated and after adjustment.

4. Calculation of ROI as per Company Statements :

ROI = (Net Income ÷ Cost of Investment) × 100

= ($14,000,000 ÷ $83,000,000) × 100

= 16.87% (approximately).

5. Calculation of ROI if statements are corrected :

ROI = {(Sales - Total Purchases) ÷ Total Cost of Investment} × 100

= {($97,000,000) - ($83,000,000 + $9,000,000)} ÷ ($83,000,000 + $9,000,000) × 100

= ($7,000,000 ÷ $92,000,000) × 100

= 7.61% (approximately).

6. Calculation of ROE as per Company Statements :

ROE = (Net Income ÷ Shareholders Equity) × 100

= ($14,000,000 ÷ $39,000,000) × 100

= 35.9% (approximately).

7. Calculation of ROE if error gets corrected :

ROE = (Revised Net Income ÷ Shareholders Equity) × 100

= ($7,000,000 ÷ $39,000,000) × 100

= 17.94% (approximately).

8. Would the ROE be better or worse?

Well, comparing the earlier ROE with the revised ROE calculated after adjusting the error, it lessens the income, which in turn lessens the return on equity. Therefore, ROE after adjustment of error gets worse.