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? Current Ratio if Statements Fixed This Error? Would the Current Ratio Be Better or Worse? ROI per Company Statements? ROI if Statements Fixed This Error? Would the ROI be Better or Worse? ROE per Company Statements? ROE if Statements Fixed This Error? Would the ROE be Better or Worse?

Answer 1

Current Ratio as per the given financial statements: Total Current Assets/Total Current Liabilities

= $50,000,0000/$30,000,000

= 1.67

Therefore, current ratio as per the given financial statements is 1.67.

If the Company records the accrue of $5,000,000 of vendor invoices as warranty expenses and warranty liability then expenses will increase, thus, net income will decrease from $10,000,000 to $5,000,000 [$50,000,000 - ($40,000,000 + $5,000,000)]. And Warranty liabilities will increase the total current liabilities from $30,000,000 to $35,000,000 ($30,000,000 + $5,000,000).

Current ratio after recording accrue of Warranty expenses and warranty liabilities = Total Current Assets/Total Current Liabilities

= $50,000,000/$35,000,000

= 1.43 times

Therefore, current ratio after recording the accrue expense is $1.43 times

The current ratio is further decreased from 1.67 to 1.43 times due to increase in current liabilities.

Return on Investment (ROI) before = Net Income/Total Investment*100

Note: Total assets do not contain the investments, hence, ROI can't be calculated.

Return on Equity before = Net Income/Average Stockholders' Equity

= $10,000,000/$40,000,000

= 0.25 or 25%

Therefore, return on equity before recording is 0.25 or 25%.

Working Note:

Average Stockholders' Equity = ($45,000,000 + $35,000,000)/2

= $40,000,000

Return on Equity after recording = Net Income/Average Stockholders' Equity

= $5,000,000/$40,000,000

= 0.125 or 12.5%

Therefore, return on equity before recording is 0.125 or 12.5%.

The Return on Equity is further decreased from 25% to 12.5% due to decrease in Net Income from $10,000,000 to $5,000,000.