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 StatementSales $50,000,000All Cost (incl. Interest & Taxes) $40,000,000Net Income $10,000,000Summarized Balance SheetThis Year Last YearAssets:All Current Assets combined $50,000,000 $40,000,000All Long-Term Assets combined $50,000,000 $40,000,000Total Assets : $100,000,000 $80,000,000This Year Last YearLiablities & Stoickholders EquityAll Current Liabilties combined $30,000,000 $25,000,000All Long-Term Liabilities combined $25,000,000 $20,000,000Stockholders Equity $45,000,000 $35,000,000Total Liabilties & Equity $100,000,000 $80,000,0001) What is the impact of this omission on the company's current ratio?2) What is the impact of this omission on the company's ROI?3) What is the impact of this omission on the company's ROE?

Answer 1

The adjustment depletes our Net income by $5,000,000, thus all basic key ratios will drop as shown below:

Step-by-step explanation:

Company X

Adjustment Entry

Dr. Income Statement with $5,000,000

Cr. Accrued Liability with $5,000,000

(Being accrued Warranty liability and Vendors invoices for the year)

1.

Current ratio

Before the adjustment:

= Current Asset divided by Current Liability

This year = $50,000,000/$30,000000 = 1.67

Last Year = $40,000,000/$25,000,000 = 1.6

After the adjustment:

= Current Asset divided by Current Liability

This year = $50,000,000/$35,000000 = 1.43

Last Year = $40,000,000/$25,000,000 = 1.6

2.

Return on Investment

Before the adjustment:

= Net Income/(Shareholders Equity + Long term liability)

This year = $10,000,000/($45,000000+$25,000,000) = 14.29%

After the adjustment:

= Net Income/(Shareholders Equity + Long term liability)

Net Income depletes by the Accrued Warranty Liability of $5,000,000

This year = $5,000,000/($35,000000+$20,000,000) = 9.1%

3.

Return on Equity

Before the adjustment:

= Net Income/Shareholder's equity

This year = $10,000,000/$45,000000 = 22.22%

After the adjustment:

= Net Income/Shareholder's equity

Net Income depletes by the Accrued Warranty Liability of $5,000,000

This year = $5,000,000/$35,000000 = 14.29%