CHAPTER 24
SOLUTIONS TO B EXERCISES
E24-1B (10–15 minutes)
(a) The purchase of common stock is an example of a subsequent event
which provides evidence about conditions that did not exist at the
(b) The changed estimate of the litigation accrual is an example of a sub–
sequent event which provides additional evidence about conditions that
existed at the balance sheet date. The litigation accrual existed at
E24-2B (15–20 minutes)
1.
(a)
4.
(b)
7.
(b)
10.
(b)
3.
(c)
6.
(c)
9.
(c)
E24-3B (5–10 minutes)
(a) Revenue test: 10% X $398,000 = $39,800
Segments A ($140,000), B ($40,000) and D ($190,000) meet this test.
*E24-4B (20–30 minutes)
Computations are given below which furnish some basis of comparison of the
two companies:
Era Co.
McCoy Co.
Composition of current assets
Cash
26%
19%
Receivables
13%
31%
Inventories
Computation of various ratios
Current ratio ($833 ÷ $241)
3.46 to 1
($781 ÷ $401)
1.95 to 1
Acid-test ratio ($220 + $108) ÷ $241
1.36 to 1
($150 + $241) ÷ $401
0.97 to 1
Accounts receivable turnover $1,300 ÷ $108
$2,300 ÷ $241
9.54 times
Inventory turnover ($1,300 X .65) ÷ $505
($2,300 X .75) ÷ $390
4.42 times
Cash to current liabilities ($220 ÷ $241)
0.91 to 1
($150 ÷ $401)
0.37 to 1
Era Co. appears to be a better short-term credit risk than McCoy Co. Analysis of
various liquidity ratios demonstrates that Era Co. is stronger financially, all
*E24-5B (20–30 minutes)
(a) The acid-test ratio is the current ratio with the subtraction of inventory
and prepaid expenses (generally insignificant relative to inventory) from
current assets. Any divergence in trend between these two ratios would
(b) Financial leverage has changed during the 3-year period. This is shown by
the steady drop in the total debt-to-total-assets ratio, and the constant
(c) The company’s net investment in plant and equipment has decreased
during the 3-year period. This conclusion is reached by using the sales–
*E24-6B (30–40 minutes)
(a) The current ratio measures overall short-term liquidity and is an indicator of
the short-term debt-paying ability of the firm.
The quick ratio also is a measure of short-term liquidity. However, it is a
inventories in its current assets when compared to the current ratio.
Inventory turnover is an indicator of the number of times a firm sells its
average inventory level during the year. A low inventory turnover may
indicate excessive inventory accumulation or obsolete inventory.
Total liabilities to stockholders’ equity compares the amount of resources
provided by creditors to the resources provided by stockholders. Thus, it
measures the extent of leverage in the company’s financial structure and
is used to evaluate or judge the degree of financial risk.
(b) The two ratios that each of the four entities would specifically use to
examine Voda Link Corp. are as follows:
*E24-6B (Continued)
(c) Voda Link Corp. appears to have an uncertain current/liquidity position
as evidenced by the current and quick ratios. The current ratio has been
declining and is less than the industry average. The quick ratio is
The total liabilities to equity ratio has increased over the 3-year period
and exceeds the industry average, indicating a heavy reliance on debt.
This high leverage position could be dangerous if sales volume, sales
margin, or income falls because interest expense is a fixed cash outlay.