Return on Equity ROE Problem

Solve the following accounting problem related to return on equity:

A manufacturing company has a profit margin of 3% and an equity multiple of 2.0.

For the current year, the manufacturing company has sales of $100 million and it has total assets of $50 Million. What is the company's Return on Equity (ROE)? Use the following accounting information and accounting ratios to solve the problem. 

Answer to Accounting ROE Problem:

Formula for Return on Equity (ROE) is : Return on Equity   = Net Income / Shareholder’s Equity

Total Assets  =  $50 million

Net Profit After Tax = Missing

Total Shareholders’ Equity- Missing

To compute return on equity for this company, it is essential to find out shareholder’s equity and total net profit:

Profit Margin Equation =  Net Income/ Sales   =   Net income / Sales

                                    .03       =          Net Income / 100 Million

Net Income                             =          .03 X 100 Million       = $3 Million

Furthermore, the company has an Equity Multiplier of 2 which means it has $2 of dollar aginst every $1 of equity in common stock.

Calculate Equity Ratio for the Company:

Equity Ratio   = 1 / Equity Multiplier                      =          1 / 2     = 0.50  =          50%

Calculate Stockholder equity      =          $50 Million X 0.50     =          $25 Million

Calculate Return on Equity (ROE)                    =          Net Income / Shareholder’s Equity

                                                =          $3 Million / $25 Million

                                                =          0.12     =          12%

Calculate Price to Earnings Ratio

A company has Earnings per Share (EPS) of $1.50, a cash flow per share (CPS) of $3.00, and a price /cash flow ratio of 8.0.What is its price to earnings (P/E) ratio?

Accounting Answer:

First, when approaching the type of problem, it is useful to list all the information that will be required to calculate the price to earnings (P/E) ratio.

EPS  =  $1.5

Cash Flow Per share =  $3

Price/Cash Flow Ratio = 8.0

P/E Ratio Formula =  Market Value Per Share/ EPS

Second, the next step will be to use the available information to calculate earnings per share. 

Price / Cash Flow Ratio of 8 =    Price Per Share / $3

Price Per Share            =          8 X $3 = $24

Use the Price to Earnings Equation for the final computation:

P/E Ratio =   Market Value Per Share/ EPS =  $24/$1.5 = 16

Calculate Bank Account Interest

If an investor deposits $10,000 in a bank account that pays 10% interest annually, How much will be in your account after 5 years with calculating with interest earned?

Amount of Interest Earned Answer:

Initial  Deposit = $10,000
Interest Rate = 10% Years

Future Value of Account = $10,000 X (1 + 0.10)5 = $10,000 X (1.10)5
= $10,000 X (1.611) = $16,110

DSO (Daily Sales Outstanding)

A company has Daily Sales Outstanding (DSO) of 20 days. The company’s average daily sales are $20,000. What is the level of its accounts receivables? Assume there are 365 days in a year.


Accounting Answer and DSO equation:

Formula for daily sales outstanding = Account Receivables / Average Sales Per Day

DSO (Daily Sales Outstanding) =  20 days
Average Daily Sales = $20,000
Account Receivables =    ?


 DSO 20 days = AR/$20,000

 Level of Accounts Receivable = 20 X $20,000 = $400,000

Inventory Turnover Accounting Problem

Use the following information to solve this inventory turnover accounting problem:

A golf ball manufacturer reported sales of $10 million and an inventory turnover ratio of 2 during its last accounting period.  The manufacturing company is now adopting a new inventory system to increase efficiency.

The goal of the new inventory system is to reduce the firm’s inventory level and increase the firm’s inventory turnover ratio to 5. At the same time, the company hopes to maintain the same level of sales. Answer how much cash will be freed up by doing this?  

Solution to Accounting Problem:


Yearly Sales                                                    $10,000,000
Inventory Turnover ratio (old)                                   2
Inventory Turnover ratio (new)                                 5



Calculate the level of inventory:

Inventory Equation       =   (Sales/Inventory Turnover)

Calculating Value of old inventory 

Old Inventory                      =       $10,000,000/2 =$5,000,000

Calculating Value of New inventory 

Inventory New            =     $10,000,000/5 = $2,000,000

Amount of Freed up cash by the transition= (Old Inventory – New Inventory)                                                        

=$5,000,000 - $2,000,000= $3,000,000

Correct Accounting Answer = $3,000,000

Purpose of Fixed Asset Register

What is the main accounting purpose of a fixed asset register?

it may be hard, but it is very important for an account to maintain a register of all assets that the company owns.  By properly maintaining a proper fixed asset register, it helps the company to keep track of details of each fixed asset. This ensures proper control and prevents misappropriation of a company's assets

The fixed asset register also keeps track of the correct value of assets, which allows for computation of depreciation and for tax purposes. This also might be necessary to comply with legislation governing corporations, companies, etc.

A Fixed asset register should contain  the following information to help a decision maker identify and track an asset. Look at the following examples of information to include in the asset register:

• unique identification of asset number /tag number 
• date of acquisition of fixed asset  
• cost of fixed asset 
• description and purpose for company 
• serial number 
• location 
• name of manager

Inaccurate Sales Forecast

What are some things that might cause a sales forecast to be inaccurate? 

If a company fails to understand current market position, trends, competition, worldwide economic conditions and other factors impacting their business, there may be big consequences for different pro cuts.

Inaccurate sales forecasts can be either due to inexperience of sales department or sudden changes in other factors discussed above. Most importantly, competition, changes in economic conditions, change in buying behavior and other types should be watched.  

Accurate Sales Forecast Profitability

Why is an accurate sales forecast critical to profitability?

Forecasting sales accurately is critical to profitability of company as its whole structure is knitted against the product or service as company may need to take important steps for required raw material, special arrangement to for production facilities to meet the demand, item stock levels, financial requirements and many others. If sales forecast is poorly conducted by the accountants and managers, that can really effect the financial health of the company for future years.

For example, if the company forecasts ten million units sales in year 2012 and company purchased materials, production facilities expansion to meet produce unit, arranged for financial loans, maintained high levels of stock for both finished goods and raw materials, however, the  company is only able to sell 50% of forecast. There will be big problems that trickle down through the company that could have very drastic effects.

Every department of the company will be affected by missing the sales forecast, and company may need downsizing, or at worst may be unable to pay the debts or dividends.

Calculate Recharge Rate

What are Recharges?

In accounting terms, recharges are a type of charge to specific departments for goods and services that they provide the company internally. These recharges are treated like income by the department providing the good or service.

However, recharges are not for profit. The internal rates equal the recovery of costs incurred in providing the good or service to the other department.

Recharge Rate= Original Cost + expense to provide good/service

When recharges and expenses are totaled across, the net effect is the original cost.  This avoids double recording of cost: once when purchased and again when sold internally. Thus, the recharge rate is very important to proper accounting within a company.

Notes Receivables Journal Entries

What are Notes Receivables?

Notes Receivable arise on a company's balance sheet when the seller asks for a promissory note to replace an Accounts Receivable that is due. This generally occurs when the customer requests additional time to pay a past-due account that is owed to the company.

A promissory note is then a written promise to pay a specific amount of money, usually including interest, at a future date. The journal entries required are:

• Converting an accounts receivable to a note receivable.
• Recording an adjusting entry for interest receivable at the end of the accounting period.
• Recording receipt of note payment and interest when due.
• Recording a dishonored note  

CVP Analysis Multiple Products

How to conduct a CVP Analysis with Multiple Products in Same Company

Multiple products require weighting a sale mix: A majority of companies sell more than one product and they will require a CVP equation in order to properly use the CVP analysis formula.

When conducting a CVP analysis, the sales mix is the number of units sold of a given product relative to the total units sold by the entire company. The same basic equations are used when there are multiple products with one important exception.  This exception is that the contribution margin must be weighted by the sales mix.

Accounting Multiple Product CVP Example: 

Company sells 16,000 units of product A
Company sells 4,000 units of product B
The sales mix is 80% A and 20% B.

A weighted-average unit contribution margin is calculated by:

Product’s contribution margin (CM) multiplied by sales mix percentage, and then summing the results together for individual products.  The result is then divided into fixed expenses to arrive at the break-even point in units.

Final Step toward Multiple Product CVP Analysis:  The sale-mix percentage is multiplied by the number of "units" to calculate the individual product sales to break even point. A change in a firm’s sales mix, no matter how big or small, will alter the company’s break-even point.

Additional Related Accounting Examples:

Calculate Break-Even Analysis 

Margin of Safety Accounting Equation

Absorption Costing and CVP Analysis

Fixed Costs and Variable Costs Examples

Explicit or Implicit Cost Example

Example to distinguish an explicit or implicit cost.

A company pays its lawyers an annual retainer of $100,000.  Is this considered an explicit or implicit cost?

Explicit costs are actual outlays of cash by a company.  These costs generally include all costs that involve a financial transaction between two different parties.

On the other hand,  an implicit cost is an economic cost that does not necessarily involve a financial transaction, but still involves the use of company's limited resources. .

To reference the previous question, when a company pays an annual retainer of $100,000, there is a financial transaction between two parties because the lawyer is trading their time for money.

Therefore, an annual retainer for a lawyer in is an explicit accounting cost.

Purchase of Intangible Assets Journal Entry

Use the following chart to help create journal entries for the purchase of intangible assets:

Transaction for journal entry	Account Title	Debit	Credit
Recording purchase of patent	Patent Cash	XXX	XXX
Recording Purchase of Copyright	Copyright Cash	XXX	XXX
Recording Purchase of Franchise	Franchise Cash	XXX	XXX
Recording Purchase of Trademark	Trademark Cash	XXX	XXX

These journal entries will make sure that the accounting ledger is up to date when intangible assets are purchased by a company.

Simple Interest Example Problem

On September 9, Enrique went to a Texas bank to borrow $3,200 at 11 2/3% interest. Enrique plans to repay the loan on January 7. Assume the loan is on ordinary interest (Generally, ordinary interest uses 360 days a year to calculate interest).

1. Calculate Simple Interest that Enrique will owe on January 7
2. Calculate the total amount Enrique must repay at maturity.




Accounting Answer:

1.
Simple Interest = Principal Amount * Period Interest Rate * Number of periods
I=3200*(35/3)%/100%)*(118/360)=$122.37.  

2. Pt = 3200 + 122.37 = $332237.


See also: How to Calculate Simple Interest

Hobby Loss vs. Business Deduction Factors

What factors differentiate a hobby from an active business for tax purposes? 

§ 183 of the internal revenue codes says that to be deductible, activities must be motivated by profit. There are many important factors that differentiate a hobby from a business include: 

• Look at the manner in which the taxpayer carried out the activity. Are they seriously and regularly trying to make a profit?
• What is the expertise of the taxpayer and the advisors? Is there expertise in doing the activity? Previous experience in doing the activity.
• Time and Effort the taxpayer has put into the activity.
• Any expectation that the assets used in the activity might appreciate in value.
• The success of the taxpayer carrying out similar activities in the past.
• The taxpayer’s history of income and loss in regards to the activity. This is a backward looking factor to examine how good they were in the past. You do not need to show a profit every year. It is helpful to show improvement over several years to indicate that they are trying. TRAJECTORY 
• The amount of profit in the current year. Current state of the business.
• Financial Status of the taxpayer. Is the taxpayer financially dependent on this particular activity?
• Any elements of personal pleasure or recreation. They will have harder time showing that something fun is an activity engaged in for profit. 

If a taxpayer is merely engaged in a hobby, they will not be able to deduct any hobby losses on their tax returns. 

Journal Entry Plant Assets

Use this chart to help record the sale of long term plant assets:

Type of Transaction	Journal Entry Account Name	Debit	Credit
Adjusting Entry bringing accumulated depreciation up to date	Depreciation Expense Accumulated Depreciation- Asset	XXX	XXX
Journal Entry for recording the sale of asset with a gain	Accumulated Depreciation – Asset Cash Asset Gain on Disposal	XXX XXX	XXX XXX
Journal Entry for recording the sale of an asset with loss	Accumulated Depreciation Cash Loss on Disposal Asset	XXX XXX XXX	XXX
Record the retirement of an asset that is fully depreciated	Accumulated Depreciation – Asset Asset	XXX	XXX
Record the retirement of an asset that has not been fully depreciated	Accumulated Depreciation – Asset Loss on Disposal Asset	XXX XXX	XXX

 Remember to update all the accounts when selling long term plant assets!