Question

Company X failed to record (accrue) $5,000,000 of 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 $50,000,000

All Cost (incl. Interest & Taxes)   $40,000,000

Net Income    $10,000,000

Summarized Balance Sheet

This Year Last Year

Assets:

All Current Assets combined $50,000,000 $40,000,000

All Long-Term Assets combined   $50,000,000     $40,000,000

Total Assets: $100,000,000 $80,000,000

Liabilities & Stockholders Equity

All Current Liabilities combined $30,000,000 $25,000,000

All Long-Term Liabilities combined $25,000,000 $20,000,000

Stockholders Equity   $45,000,000 $35,000,000

Total Liabilities & Equity $100,000,000 $80,000,000

Answer the following questions:

Current Ratio per Company Statements? 1.67

Current Ratio if Statements Fixed This Error? 1.43

Would the Current Ratio Be Better or Worse once this error is corrected? Worse

ROI per Company Statements?

ROI if Statements Fixed This Error?

Would the ROI be Better or Worse once this error is corrected? Worse

ROE per Company Statements?

ROE if Statements Fixed This Error?

Would the ROE be Better or Worse once this error is corrected? Worse

Answer 1

Solution

BALANCE SHEET (INCORRECT)

PARTICULARS	THIS YEAR	LAST YEAR
ASSETS
All current assets	$50,000,000	$40,000,000
All long term assest	$50,000,000	$40,000,000
Total Assets	$100,000,000	$80,000,000
LIABILITIES & STOCKHOLDER'S EQUITY
All current liabilities	$30,000,000	$25,000,000
All long term liabilities	$25,000,000	$20,000,000
Stockholder's equity	$45,000,000	$35,000,000
Total liabilities & stockholder's equity	$100,000,000	$80,000,000
BALANCE SHEET (CORRECT)
PARTICULARS	THIS YEAR	LAST YEAR
ASSETS
All current assets	$50,000,000	$40,000,000
All long term asset	$50,000,000	$40,000,000
Total Assets	$100,000,000	$80,000,000
LIABILITIES & STOCKHOLDER'S EQUITY
All current liabilities ($30,000,000 + $5,000,000)	$35,000,000	$25,000,000
All long term liabilities	$25,000,000	$20,000,000

Stockholder's equity ($45,000,000- $5000,000)	$40,000,000	$35,000,000
Total liabilities & stockholder's equity	$100,000,000	$80,000,000

Due to omission of vendor invoices and warranty liability the year end balance of all cureent liabilities will increase by $5,000,000 and the net income will decrease by $5,000,000. the net income after correctiion is $5,000,000

Formula This year Last year

1) Current Ratio Current assets 1.667 1.60

Current liabilities

2) Correct statement Current Assets   1.43 1.60

Current liabilites

3) Current Ratio will be worse

4) ROI Formula This year

Company statements Net income x100 $ 10,000,000 x 100 = 11.11%

Total Average Assets    ($100,000,000+$80,000,000)/2

5) Correct statements    Net income x100 $ 5,000,000 x 100 = 5.56%

Total Average Assets ($100,000,000+$80,000,000)/2

6) ROI will be worse as it has reduced from 11.11% to 5.56% due to decrease in net income

7) ROE Formula This year

Company statements Net income x100   $ 10,000,000 x 100 = 25%

Average Total Stock holder equity ( $45,000,000+$35,000,000)/2

8) Correct statements    Net income x100 $ 5,000,000 x 100 = 13.33%

Average Total Stock holder equity ($45,000,000-$5,000,000+$35,000,000)/2

9) ROE will be worse as it has reduced from 25% to 13.33% due to decrease in net income