Question

Determining the effects of business transactions on selected ratios Financial statement data of Style Traveler Magazine include the following items:

Cash	\( 23,000
Accounts Receivable, Net	81,000
Merchandise Inventory	185,000
Total Assets	635,000
Accounts Payable	99,000
Accrued Liabilities	37,000
Short-term Notes Payable	51,000
Long-term Liabilities	224,000
Net Income	68,000
Common Shares Outstanding	20,000 shares

Requirements

1. Compute Style Traveler’s current ratio, debt ratio, and earnings per share. Round all ratios to two decimal places, and use the following format for your answer:

Current Ratio Debt Ratio Earnings per Share

2.Compute the three ratios after evaluating the effect of each transaction that follows. Consider each transaction separately

1. Purchased merchandise inventory of \)49,000 on the account.
2. Borrowed \(127,000 on a long-term note payable.
3. Issued 2,000 shares of common stock, receiving cash of \)107,000.
4. Received cash on account, $5,000.

Short answer

S. no.	Current Ratio	Debt ratio	Earnings per share
1	1.54	.64	$3.40
2a	1.43	.67	$3.40
2b	2.22	.70	$3.40
2c	2.12	.55	$3.09
2d	1.55	.65	$3.40

Step-by-step solution

Meaning of Current Ratio

The current ratio is the ratio that determines the efficiency of a business. The current ratio is one of the most helpful liquidity ratios in the financial analysis since it allows for assessing a company's liquidity situation.

(1) Computing various ratios

Preparing extract of Balance sheet

Company ST
Extract of balance sheet
Assets	Amount ($)	Liabilities	Amount ($)
Current asset:		Current liabilities:
Cash	23,000	Accounts payable	99,000
Account receivable	81,000	Accrued liabilities	37,000
Merchandise inventory	185,000	Short term payable	51,000
Total current asset	289,000	Total current liabilities	187,000
		Long term liabilities	224,000
		Total liabilities	411,000

Compute the current ratio for Company ST

$\begin{array}{c}\mathrm{Current}\mathrm{ratio}=\frac{\text{Current\hspace{0.17em}asset}}{\text{Current\hspace{0.17em}liabilities}}\\ =\frac{\mathrm{\$}289,000}{\mathrm{\$}187,000}\\ =1.54\end{array}$

Compute the debt ratio for Company ST

$\begin{array}{c}\text{Debt\hspace{0.17em}ratio}=\frac{\text{Total\hspace{0.17em}liabilities}}{\text{Total\hspace{0.17em}assets}}\\ =\frac{\mathrm{\$}411,000}{\mathrm{\$}635,000}\\ =0.64\end{array}$

Compute the earnings per share for Company ST

$\begin{array}{c}\text{Earning\hspace{0.17em}per\hspace{0.17em}share}=\frac{\text{Net\hspace{0.17em}income}-\text{Preferred\hspace{0.17em}share}}{\text{Weighted\hspace{0.17em}average\hspace{0.17em}number\hspace{0.17em}of\hspace{0.17em}shares\hspace{0.17em}outstanding}}\\ =\frac{\mathrm{\$}68,000-\mathrm{\$}0}{20,000}\\ =\mathrm{\$}3.40\text{\hspace{0.17em}per\hspace{0.17em}share}\end{array}$

(2) Computing three ratios considering the effect in each transaction

a. Purchased merchandise inventory of $49,000 on the account.

Compute the current ratio of the or Company ST

Compute the debt ratio for Company ST

Compute the earning per ratio for Company ST

b. Borrowed $127,000 on a long-term note payable

Compute the current ratio of the or Company ST

Compute the debt ratio for Company ST

Compute the earning per ratio for Company ST

c. Issued 2,000 shares of common stock, receiving cash of $107,000

Compute the current ratio of the or Company ST

Compute the debt ratio for Company ST

Compute the earning per ratio for Company ST

$\begin{array}{c}\text{Earning\hspace{0.17em}per\hspace{0.17em}share}=\frac{\text{Net\hspace{0.17em}income}-\text{Preferred\hspace{0.17em}share}}{\text{Weighted\hspace{0.17em}average\hspace{0.17em}number\hspace{0.17em}of\hspace{0.17em}shares\hspace{0.17em}outstanding}}\\ =\frac{\mathrm{\$}68,000-\mathrm{\$}0}{20,000+2,000}\\ =\mathrm{\$}3.09\text{\hspace{0.17em}per\hspace{0.17em}share}\end{array}$

d. Received cash on account, $5,000

Compute the current ratio of the or Company ST

$\begin{array}{c}\mathrm{Current}\mathrm{ratio}=\frac{\text{Current\hspace{0.17em}asset}}{\text{Current\hspace{0.17em}liabilities}}\\ =\frac{\mathrm{\$}289,000}{\mathrm{\$}187,000}\\ =1.54\end{array}$

Note: Received $5,000 cash on account increases the cash balance and decreases the accounts receivable by $5000. Cash and accounts receivable are current assets, so this transaction's effect is NIL on current assets.

Compute the debt ratio for Company ST

$\begin{array}{c}\text{Debt\hspace{0.17em}ratio}=\frac{\text{Total\hspace{0.17em}liabilities}}{\text{Total\hspace{0.17em}assets}}\\ =\frac{\mathrm{\$}411,000}{\mathrm{\$}635,000}\\ =0.65\end{array}$

Compute the earning per ratio for Company ST

$\begin{array}{c}\text{Earning\hspace{0.17em}per\hspace{0.17em}share}=\frac{\text{Net\hspace{0.17em}income}-\text{Preferred\hspace{0.17em}share}}{\text{Weighted\hspace{0.17em}average\hspace{0.17em}number\hspace{0.17em}of\hspace{0.17em}shares\hspace{0.17em}outstanding}}\\ =\frac{\mathrm{\$}68,000-\mathrm{\$}0}{20,000}\\ =\mathrm{\$}3.40\text{\hspace{0.17em}per\hspace{0.17em}share}\end{array}$