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Chapter 6.2, FAR617527, FAR617529, FAR617590, FAR617856, FAR617861,…
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FAR617529
If there is a huge difference between a company's gross margin and its operating profit margin, then it would suggest that:
Operating profit is calculated by further deducting indirect expenses from the gross profit. If these indirect expenses, like training, administration, research or other day-to-day business costs are too high then there will be a huge difference between a company’s gross margin and operating profit margin. Thus, it can be said that if there is a huge difference between a company's gross margin and its operating profit margin the company is less efficient in managing its indirect expenses.
FAR617590
Pricewater’s sales in the year ended December 31, Y2 were $400,000. Gross profit percentage was 25%. If average inventory for the year was $55,000, what would be inventory days if purchases for the year amounted to $270,000 (number of days in a year to be taken as 360 and the company uses closing stock instead of average stock in the calculation of the ratios)?
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Gross profit = Net sales x Gross profit margin = $400,000 x 25% = $100,000.
Cost of goods sold (COGS) = Sales – Gross profit = $400,000 - $100,000 = $300,000.
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Opening stock + $270,000 – Closing stock = $300,000.
Opening stock – Closing stock = $30,000.
Or Opening stock = $30,000 + Closing stock.
Average inventory or (Opening stock + Closing stock) / 2 = $55,000.
($30,000 + Closing stock + Closing stock) / 2 = $55,000.
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Opening stock = Closing stock + $30,000 = $70,000.
Inventory days, or number of days supply in average inventory = 360 / Inventory turnover ratio
Or (Average ending inventory / COGS) x 360 = $40,000 / $300,000 x 360= 48 days.
FAR617856
When a company follows straight line depreciation method instead of double-declining depreciation, it will most likely result during the initial years in
Return on equity (ROE) = Net income / Equity].
Under straight line depreciation, the depreciation expense will be lower and the net income will be higher. The retained earnings will be higher along with the asset value. Thus, as both increase, the ROE will be indeterminate.
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FAR617852
A company's debt-to-equity ratio is 1.5. All else being equal which of the following will most likely result in an increase in financial leverage?
In the initial years when an asset is depreciated using the straight-line method the book value will be higher compared to assets depreciated using the double declining balance method. Under double declining balance depreciation, the asset value has decreased and consequently, equity (retained earnings) is decreased. The numerator (debt) remains unchanged and the denominator (equity) will decrease and the financial leverage (debt / equity) will increase.