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# Accounting Financial Ratios and Analysis

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Problem One:
Mason Company has a product that sells for \$20 per unit. The variable expenses are \$12 per unit, and fixed expenses total \$30,000 per year.
Required:
(a). What is the total contribution margin at the break-even point?
(b). What is the contribution margin ratio for the product?
(c). If total sales increase by \$20,000 and fixed expenses remain unchanged, by how much would net operating income be expected to increase?
(d). The marketing manager wants to increase advertising by \$6,000 per year. How many additional units would have to be sold to increase overall net operating income by \$2,000?

Problem Two:
Zoran Company offers two products. At present, the following represents the usual results of a month's operations:

Product K Product L
Amount Per Unit Amount Per Unit Combined Amount
Sales revenue..................... \$120,000 \$1.20 \$80,000 \$0.80 \$200,000
Variable expenses............... 60,000 0.60 60,000 0.60 120,000
Contribution margin.............. \$ 60,000 \$0.60 \$20,000 \$0.20 \$80,000
Fixed expenses................... 50,000
Net operating income............ \$30,000

Required:
(a). Find the break-even point in terms of dollars.
(b). Find the margin of safety in terms of dollars.
(c). The company is considering decreasing product K's unit sales to 80,000 and increasing product L's unit sales to 180,000, leaving unchanged the selling price per unit, variable expense per unit, and total fixed expenses. Would you advise adopting this plan?
(d). Refer to (c) above. Under the new plan, find the break-even point in terms of dollars.
(e). Under the new plan in (c) above, find the margin of safety in terms of dollars.

Problem Three:

Parkins Company produces a single product. Operating date for the company and its absorption costing income statements for the last two years are presented below:

Year 1 Year 2
Units in beginning inventory.................................... 0 1,000
Units produced.................................................... 9,000 9,000
Units sold........................................................... 8,000 10,000

Year 1 Year 2
Sales.................................................................. \$80,000 \$100,000
Less cost of goods sold:
Beginning inventory......................................... 0 6,000
Add cost of goods manufactured......................... 54,000 54,000
Goods available for sale.................................... 54,000 60,000
Less ending inventory....................................... 6,000 0
Cost of goods sold................................................. 48,000 60,000
Gross margin....................................................... 32,000 40,000
Less selling & administrative expenses....................... 28,000 30,000
Net operating income............................................. \$ 4,000 \$ 10,000

Variable manufacturing costs are \$4 per unit. Fixed factory overhead totals \$18,000 in each year. This overhead was applied at a rate of \$2 per unit. Variable selling and administrative expenses were \$1 per unit sold.
(a). What was the unit product cost in each year under variable costing?
(b). Prepare new income statement for each year using variable costing.
(c). Reconcile the absorption costing and variable costing net operating income for each year.

#### Solution Summary

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## Accounting: Ratio analysis for XYZ ltd.

XYZ Ltd is a group of doctors, dentists, professional sports players and celebrities with excess funds who wish to find small companies with great innovative ideas and invest in them. Several of the small companies present their idea to XYZ under a televised show broadcasted on national TV.

The following information has been derived from the past three years' financial statements of ABC Ltd, one of the small companies looking for investment from XYZ.

Balance sheets, December 31

2012 2011 2010
Current assets
Cash 50,000 45,000 94,000
Account receivable, net 130,000 120,000 110,000
Merchandise inventories 250,000 230,000 195,000
Other current assets 45,000 53,000 42,000
Total current assets 475,000 448,000 441,000
Property plant and equipment, net 196,000 191,000 175,000

Total assets 671,000 639,000 616,000

Current liabilities
Accounts payable 175,000 195,000 185,000
Accrued liabilities 1,000 6,500 21,000
Total current liabilities 176,000 201,500 206,000

Long-term liabilities 230,000 250,000 295,000
Total liabilities 406,000 451,500 501,000

Shareholders' equity
Common shares 110,000 95,000 65,000
Preferred shares, note 5 25,000 25,000 25,000
Retained earnings 130,000 67,500 25,000
Total shareholders' equity 265,000 187,500 115,000
Total liabilities and shareholders' equity 671,000 639,000 616,000

Income statements 2012 2011

Net sales £723,700 £694,000
Cost of goods sold 347,350 344,500
Gross margin 376,350 349,500

Operating expenses 183,500 179,750

Income from operations 192,850 169,750
Interest expense 37,525 39,450
Income before income tax 155,325 130,300
Income tax expense 38,831 32,575

Net income £116,494 £97,725

1. The common shares are traded on the stock exchange. At the end of 2012, the value of the share was £15.00, and at the end of 2011, the value per share was £14.00.
2. The number of shares outstanding on the market is as follows:
i. 2012: 25,000
ii. 2011: 15,000
iii. 2010: 10,000
3. All sales are made on credit.
4. The company's income tax rate is 25%.
5. The preferred shares are cumulative; no par value, £2.50; 10,000 Shares authorized; 2,000 shares issued and outstanding.

Complete the following:
You, the consultant, have been hired by XYZ to assist in the analysis of the financial statements and provide a recommendation as to whether XYZ should invest or not invest in this company. You should justify your recommendation based on the calculation of the following financial ratios:
• Current ratio (Liquidity)
• Operating profit margin (Profitability)
• Return on Ordinary Shareholders' Funds (ROSF) (Profitability)
• Average settlement period for trade receivables (Efficiency)
• Earnings per share (Investment)

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