A Construction Company Entered Into a Fixed

A construction company entered into a fixed-price contract to build an office building for $23.0 million. Construction costs incurred during the first year were $7.1 million and estimated costs to complete at the end of the year were $9 million. The building was completed during the second year. Construction costs incurred during the second year were $10.4 million.

How much gross profit will the company recognize in the first year and in the second year applying the completed contract method? (Leave no cells blank - be certain to enter "0" wherever required. Enter your answers in dollars not in millions. Omit the "$" sign in your response.)

Year 1 Year 2 Gross profit $ $

Explanation:

Revenue $ 23,000,000

Less : Costs in year 1 (7,100,000)

Costs in year 2 (10,400,000)

Actual profit $ 5,500,000

Charter Corporation, which began business in 2011, appropriately uses the installment sales method of accounting for its installment sales. The following data were obtained for sales made during 2011 and 2012:

2011 2012

Installment sales $ 364,000 $347,000

Cost of installment sales 231,000 245,000

Cash collections on installment sales during:

2011 152,000 104,000

2012 — 121,000

Required:(1)How much gross profit should Charter recognize in 2011 and 2012 from installment sales? (Round Gross Profit

percentages to the nearest whole percentage. Omit the "$" sign in your response.)

Gross Profit 2011 $ 2012 $

0 5,500,000

56,240

73,570

(2)What should be the balance in the deferred gross profit account at the end of 2011 and 2012? (Round Gross Profit percentages to the nearest whole percentage. Omit the "$" sign in your response.)

2011 2012 Balance in deferred gross profit account $ $

Explanation:(1)

2011 Cost recovery %:

$231,000 = 63% (gross profit % = 37%)

$364,000


$245,000 = 71% (gross profit % = 29%)

$347,000

2011 gross profit:

Cash collection from 2011 sales of $152,000 × 37% = $56,240

2012 gross profit:

Cash collection from 2011 sales of $104,000 × 37%

= $ 38,480

Cash collection from 2012 sales of $121,000 × 29%

= 35,090

Total 2012 gross profit $73,570

(2)

76,760 105,190

2011 deferred gross profit balance: 2011 initial gross profit ($364,000 – 231,000) $ 133,000 Less: Gross profit recognized in 2011 (56,240)

Balance in deferred gross profit account $ 76,760

2012 deferred gross profit balance: 2011 initial gross profit ($364,000 – 231,000) $ 133,000 Less: Gross profit recognized in 2011 (56,240) Gross profit recognized in 2012 (38,480) 2012 initial gross profit ($347,000 – 245,000) 102,000 Less: Gross profit recognized in 2012 (35,090)

Balance in deferred gross profit account $ 105,190 On July 1, 2011, the Foster Company sold inventory to the Slate Corporation for $300,000. Terms of the sale called for a down payment of $75,000 and three annual installments of $75,000 due on each July 1, beginning July 1, 2012. Each installment also will include interest on the unpaid balance applying an appropriate interest rate. The inventory cost Foster $120,000. The company uses the perpetual inventory system.

Required:(1) Prepare the necessary journal entries for 2011 and 2012 using point of delivery revenue recognition. Ignore

interest charges. (Omit the "$" sign in your response.)

Date General Journal Debit Credit July 1, 2011 To record installment sale Installment receivables

Sales revenue Cost of goods sold

Inventory To record cash collection from installment sale Cash

Installment receivables July 1, 2012 To record cash collection from installment sale

Cash

Installment receivables

(2) Prepare the necessary journal entries for 2011 and 2012, applying the installment sales method. (Omit the "$" sign in your response.)

Date General Journal Debit Credit July 1, 2011 To record installment sale

300,000

300,000

120,000

120,000

75,000

75,000

75,000

75,000


Inventory

Deferred gross profit

To record cash collection from installment sale Cash

Installment receivables To recognize gross profit from installment sale Deferred gross profit

Realized gross profit July 1, 2012 To record cash collection from installment sale

Cash

Installment receivables To recognize gross profit from installment sale Deferred gross profit

Realized gross profit

(3) Prepare the necessary journal entries for 2011 and 2012, applying the cost recovery method. (Omit the "$" sign in your response.)

Date General Journal Debit Credit July 1, 2011 To record installment sale


Inventory


To record cash collection from installment sale

Cash


July 1, 2012 To record cash collection from installment sale

300,000

120,000

2

180,000

2

75,000

75,000

45,000

45,000

75,000

75,000

45,000

45,000

300,000

120,000

2

180,000

2

75,000

75,000

Cash

Installment receivables To recognize gross profit from installment sale


Realized gross profit Assume Nortel Networks contracted to provide a customer with Internet infrastructure for $2,000,000. The project began in 2011 and was completed in 2012. Data relating to the contract are summarized below:

2011 2012 Costs incurred during the year $ 300,000 $1,575,000 Estimated costs to complete as of 12/31 1,200,000 0 Billings during the year 380,000 1,620,000 Cash collections during the year 250,000 1,750,000

Required:(1) Compute the amount of gross profit or loss to be recognized in 2011 and 2012 using the percentage-of-

completion method. (Omit the "$" sign in your response.)

Gross Profit (Loss) 2011 $ 2012 $

(2) Compute the amount of gross profit or loss to be recognized in 2011 and 2012 using the completed contract method. (Leave no cells blank - be certain to enter "0" wherever required. Omit the "$" sign in your response.)

Gross Profit (Loss) 2011 $ 2012 $

(3) Prepare a partial balance sheet to show how the information related to this contract would be presented at the end of 2011 using the percentage-of-completion method. (Enter assets in the order of their liquidity. Omit the "$" sign in your response.)

Balance SheetAt December 31, 2011

Current Assets: Accounts receivable $

75,000

75,000

30,000

30,000

100,000

25,000

0

125,000

130,000

Costs and profit in excess of billings $

(4) Prepare a partial balance sheet to show how the information related to this contract would be presented at the end of 2011 using the completed contract method. (Omit the "$" sign in your response.)

Balance SheetAt December 31, 2011

Current Assets: Accounts receivable $ Current liabilities: Billing in excess of costs $

Explanation:(1)

2011 2012 Contract price

$ 2,000,000 $ 2,000,000

Actual costs to date

300,000 1,875,000

Estimated costs to complete

1,200,000 0

Total estimated costs

1,500,000 1,875,000

Gross profit (estimated in 2011)

500,000 125,000

20,000

130,000

80,000

2011:$300,000

= 20% × $500,000 = $100,000$1,500,000

2012: $125,000 – $100,000 = $25,000

(3)

Costs and profit ($400,000*) in excess of billings ($380,000) = $20,000* Costs ($300,000) + profit ($100,000)

(4)

Billings ($380,000) in excess of costs ($300,000) = $80,000On June 15, 2011, Sanderson Construction entered into a long-term construction contract to build a baseball stadium in Washington D.C. for $218 million. The expected completion date is April 1 of 2013, just in time for the 2013 baseball season. Costs incurred and estimated costs to complete at year-end for the life of the contract are as follows ($ in millions):

2011 2012 2013

Costs incurred during the year $ 40 $ 80 $ 5

0

Estimated costs to complete as of 12/31 120 60 —

Required:(1) Determine the amount of gross profit or loss to be recognized in each of the three years using the percentage-of-

completion method. (Enter your answers in millions. Do not round intermediate calculations. Round final answers to 2 decimal places. Loss amounts should be indicated with a minus sign. Omit the "$" sign in your response.)

Year Gross Profit (Loss) ($ in millions)

2011 $ 2012 $ 2013 $

(2) How much revenue will Sanderson report in its 2011 and 2012 income statements related to this contract using the percentage-of-completion method? (Enter your answers in millions. Do not round intermediate calculations. Round final answers to 2 decimal places. Omit the "$" sign in your response.)

Year Revenue ($ in millions)

2011 $ 2012 $

14.50 ± .05

10.83 ± .05

22.67 ± .05

54.50 ± .05

90.83 ± .05

2013 $

(3) Determine the amount of gross profit or loss to be recognized in each of the three years using the completed contract method. (Enter your answers in millions. Leave no cells blank - be certain to enter "0" wherever required. Loss amounts should be indicated with a minus sign. Omit the "$" sign in your response.)

Year Gross Profit (Loss)2011 2012 2013

Total project income $

(4) Determine the amount of revenue, cost, and gross profit or loss to be recognized in each of the three years using the cost recovery method that is required by IFRS. (Enter your answers in millions. Leave no cells blank - be certain to enter "0" wherever required. Input all amounts as positive number except "Loss", loss amounts should be indicated with a minus sign. Omit the "$" sign in your response.)

2011 2012 2013 Revenue $ $ $ Cost

Gross profit (loss) $ $ $

(5) Suppose the estimated costs to complete at the end of 2012 are $80 million instead of $60 million. Determine the amount of gross profit or loss to be recognized in 2012 using the percentage-of-completion method. (Enter your answer in millions. Loss amount should be indicated with a minus sign. Do not round intermediate calculations. Round final answers to 2 decimal places. Omit the "$" sign in your response.)

2012 Gross profit (loss) $

Explanation:(1)

72.67 ± .05

0

0

48

48

40 80 98

40 80 50

0 0 48

-3.70 ± .05

($ in millions)

2011 2012 2013

Contract price

$ 218 $ 218 $ 218


40 120 170


120 60 0


160 180 170

Estimated gross profit (actual in 2013)

$ 58 $ 38 $ 48

Gross profit (loss) recognition:

2011:$40

= 25% × $58 = $14.50

$160

2012:$120

= 66.67% × $38 = $25.33 – $14.50 = $10.83

$180

2013: $218 – 170 = $48 – ($14.50 + 10.83) = $22.67

(2)

2011: $218 × 25% = $54.502012: $218 × 66.67% = $145.33 – 54.50 = $90.832013: $218 – 145.33 = $72.67

(4)

2013:Revenue: $98 ($218 contract price – $40 – $80)

(5)

2012:$120

= 60% × $18* = $10.80 – 14.50 = $(3.70) loss

$200*$218 – ($40 + 80 + 80) = $18

On October 1, 2011, the Submarine Sandwich Company entered into a franchise agreement with an individual. In exchange for an initial franchise fee of $300,000, Submarine will provide initial services to the franchisee to include assistance in design and construction of the building, help in training employees, and help in obtaining financing. 10% of the initial franchise fee is payable on October 1, 2011, with the remaining $270,000 payable in nine equal annual installments beginning on October 1, 2012. These installments will include interest at an appropriate rate. The franchise opened for business on January 15, 2012.

Required:Assume that the initial services to be performed by Submarine Sandwich subsequent to October 1, 2011, are substantial and that collectibility of the installment receivable is reasonably certain. Substantial performance of the initial services is deemed to have occurred when the franchise opened. Prepare the necessary journal entries for the following dates (ignoring interest charges) (Omit the "$" sign in your response):

Date General Journal Debit Credit Oct. 1, 2011 To record franchise agreement and down payment

Cash

Note receivable

Unearned franchise fee revenue

Jan. 15, 2012 To recognize franchise fee revenue Unearned franchise fee revenue

Franchise fee revenue

Explanation:Cash (10% × $300,000) = 30,000

30,000

2

270,000

2

300,000

300,000

300,000

Ajax Company appropriately accounts for certain sales using the installment sales method. The perpetual inventory system is used. Information related to installment sales for 2011 and 2012 is as follows:

2011 2012 Sales $250,000 $350,000 Cost of sales 150,000 280,000 Customer collections on: 2011 sales 120,000 100,000 2012 sales 150,000

Required:(1) Calculate the amount of gross profit that would be recognized each year from installment sales. (Omit the "$"

sign in your response.)

2011 2012 Gross profit $ $

(2) Prepare all necessary journal entries for each year. (Omit the "$" sign in your response.)

Date General Journal Debit Credit2011 To record installment sales


Inventory


To record cash collections from installment sales Cash

Installment receivables To recognize gross profit from installment sales Deferred gross profit


2012 To record installment sales Installment receivables

Inventory


48,000 70,000

250,000

150,000

2

100,000

2

120,000

120,000

48,000

48,000

350,000

280,000

2

70,000

2




(3-a) Compute the following table, assuming that Ajax uses the cost recovery method to account for its installment sales. (Leave no cells blank - be certain to enter "0" wherever required. Omit the "$" sign in your response.)

Date Cash Collected Cost Recovery Gross Profit 2011 2011 sales $ $ $

2012 2011 sales $ $ $ 2012 sales

2012 totals $ $ $

(3-b) Prepare all necessary journal entries for each year. (Omit the "$" sign in your response.)

Date General Journal Debit Credit2011 To record installment sales


Inventory


To record cash collections from installment sales

2

250,000

250,000

70,000

70,000

120,000 120,000 0

100,000 30,000 70,000

150,000 150,000 0

250,000 180,000 70,000

250,000

150,000

2

100,000

2

Cash


2012 To record installment sales Installment receivables

Inventory





Explanation:(1)


$150,000 = 60% (gross profit % = 40%)

$250,000


$280,000 = 80% (gross profit % = 20%)

$350,000

2011 gross profit:

Cash collection from 2011 sales = $120,000 × 40% = $48,000

2012 gross profit:

120,000

120,000

350,000

280,000

2

70,000

2

250,000

250,000

70,000

70,000

Cash collection from 2011 sales = $100,000 × 40%

$ 40,000

Cash collection from 2012 sales = $150,000 × 20%

30,000

Total 2012 gross profit $ 70,000

In 2011, the Westgate Construction Company entered into a contract to construct a road for Santa Clara County for $8,750,000. The road was completed in 2013. Information related to the contract is as follows:

2011 2012 2013 Cost incurred during the year $2,100,000 $3,150,000 $1,875,000 Estimated costs to complete as of year-end 4,900,000 1,750,000 0 Billings during the year 1,750,000 3,500,000 3,500,000 Cash collections during the year 1,575,000 3,150,000 4,025,000

Westgate uses the percentage-of-completion method of accounting for long-term construction contracts.

Required:(1) Calculate the amount of gross profit to be recognized in each of the three years. (Do not round intermediate

calculations. Omit the "$" sign in your response.)

2011 2012 2013 Gross profit $ $ $

(2) In the journal below, complete the necessary journal entries for each of the years (credit various accounts for construction costs incurred). (Do not round intermediate calculations. Omit the "$" sign in your response.)

2011 2012 General Journal Debit Credit Debit Credit

To record construction costs. Construction in progress

Various accounts To record progress billings. Accounts receivable

Billings on construction contract

525,000 787,500 312,500

2,100,000 3,150,000

2,100,000 3,150,000

1,750,000 3,500,000

1,750,000 3,500,000

To record cash collections. Cash

Accounts receivable To record gross profit. Construction in progress

Cost of construction

Revenue from long-term contracts

(3) Complete the information required below to prepare a partial balance sheet for 2011 and 2012 showing any items related to the contract. (Do not round intermediate calculations. Amounts to be deducted should be indicated with minus sign. Omit the "$" sign in your response.)

Balance sheet 2011 2012 Current assets: Accounts receivable $ $ Construction in progress $ $ Less: Billings

Costs and profit in excess of billings

(4) Calculate the amount of gross profit to be recognized in each of the three years, assuming the following costs incurred and costs to complete information. (Do not round intermediate calculations. Round your answers to the nearest dollar amount. Loss amounts should be indicated with a minus sign. Omit the "$" sign in your response.)

2011 2012 2013 Costs incurred during the year $2,100,000 $3,350,000 $2,875,000 Estimated costs to complete as of year-end 4,900,000 2,850,000 0

2011 2012 2013 Gross profit (loss) $ $ $

(5) Calculate the amount of gross profit to be recognized in each of the three years, assuming the following costs incurred and costs to complete information. (Do not round intermediate calculations. Loss amounts should be indicated with a minus sign. Omit the "$" sign in your response.)

1,575,000 3,150,000

1,575,000 3,150,000

525,000 787,500

2,100,000 3,150,000

2,625,000 3,937,500

175,000 525,000

2,625,000 6,562,500

-1,750,000 -5,250,000

875,000 1,312,500

525,000 -229,518 129,518



Explanation:(1)

2011 2012 2013 Contract price

$ 8,750,000 $ 8,750,00

0 $ 8,750,000


2,100,000 5,250,00

0 7,125,000


4,900,000 1,750,00

0 0


7,000,000 7,000,00

0 7,125,000

Estimated gross profit (loss) (actual in 2013) $

1,750,000 $

1,750,000 $

1,625,000


2011: $2,100,000 = 30.00% × $1,750,000 = $525,000

525,000 -1,075,000 275,000

$7,000,000

2012:$5,250,000

= 75.00% × $1,750,000 = $1,312,500 – 525,000 = $787,500$7,000,000

2013: $1,625,000 – 1,312,500 = $312,500

(2)

2011 2012 2013 Revenue from long-term contracts (1) 2,625,000 3,937,500 2,187,500

(1) Revenue recognized:

2011: 30.00% × $8,750,000

$ 2,625,000

2012: 75.00% × $8,750,000

$ 6,562,500

Less: Revenue recognized in 2011

(2,625,000)

Revenue recognized in 2012

$ 3,937,500

2013: 100% × $8,750,000

$ 8,750,000

Less: Revenue recognized in 2011 & 2012

(6,562,500)

Revenue recognized in 2013

$ 2,187,500

(4)


$ 8,750,000 $ 8,750,00

0 $ 8,750,000


2,100,000 5,450,00

0 8,325,000


4,900,000 2,850,00

0 0


7,000,000 8,300,00

0 8,325,000


1,750,000 $ 450,000 $ 425,000


2011: $2,100,000 = 30.00% × $1,750,000 = $525,000

$7,000,000

2012:$5,450,000

= 65.6627% × $450,000 = $295,482 – 525,000 = $(229,518)$8,300,000

2013: $425,000 – 295,482 = $ 129,518

(5)


$ 8,750,000 $ 8,750,00

0 $ 8,750,000


2,100,000 5,450,00

0 9,025,000


4,900,000 3,850,00

0 0


7,000,000 9,300,00

0 9,025,000


1,750,000 $ (550,000) $

( 275,000)


2011: $2,100,000 = 30.00% × $1,750,000 = $525,000

$7,000,000

2012: $(550,000) – 525,000 = $(1,075,000)

2013: ( 275,000) – (550,000) = $275,000


2011 2012 2013

Cost incurred during the year $ 2,400,000 $ 3,600,00

0 $ 2,100,000

Estimated costs to complete as of year-end 5,600,000 2,000,00

0 0

Billings during the year 2,000,000 4,000,00

0 4,000,000

Cash collections during the year 1,800,000 3,600,00

0 4,600,000

Westgate uses the completed contract method of accounting for long-term construction contracts.

Required:(1) Calculate the amount of gross profit to be recognized in each of the three years. (Leave no cells blank - be

certain to enter "0" wherever required. Omit the "$" sign in your response.)

2011 2012 2013 Gross Profit $ n/r $ n/r $ n/r

(2) In the journal below, complete the necessary journal entries for each of the years (credit various accounts for construction costs incurred). (Leave no cells blank - be certain to enter "0" wherever required. Omit the "$" sign in your response.)

2011 2012General Journal Debit Credit Debit Credit

To record construction costs. n/r n/r n/r n/r n/r n/r To record progress billings. n/r n/r n/r n/r n/r n/r

-2-2 http://ezto.mhhm.

To record cash collections. n/r n/r n/r n/r n/r n/r To record gross profit. n/r n/r n/r n/r n/r n/r n/r n/r n/r

(3) Complete the information required below to prepare a partial balance sheet for 2011 and 2012 showing any items related to the contract. (Leave no cells blank - be certain to enter "0" wherever required. Amounts to be deducted should be indicated with minus sign. Omit the "$" sign in your response.)

Balance sheet 2011 2012 Current assets: n/r $ n/r n/r $ n/r $ n/r Less: n/r n/r n/r n/r n/r

(4) Calculate the amount of gross profit to be recognized in each of the three years assuming the following costs incurred and costs to complete information. (Leave no cells blank - be certain to enter "0" wherever required. Loss amounts should be indicated with a minus sign. Omit the "$" sign in your response.)


2011 2012 2013 Gross profit (loss) $ n/r $ n/r $ n/r



2011 2012 2013

Gross profit (loss) $ n/r $ n/r $ n/r

eBook Link

Worksheet

Learning Objective: 05-04 Identify situations that call for the recognition of revenue over time and distinguish between the percentage-of-completion and completed contract methods of recognizing revenue for long-term contracts.


2011 2012 2013

Cost incurred during the year $ 2,400,000 $ 3,600,00

0 $ 2,100,000

Estimated costs to complete as of year-end 5,600,000 2,000,00

0 0

Billings during the year 2,000,000 4,000,00

0 4,000,000

Cash collections during the year 1,800,000 3,600,00

0 4,600,000

Westgate uses the completed contract method of accounting for long-term construction contracts.

Required:(1) Calculate the amount of gross profit to be recognized in each of the three years. (Leave no cells blank - be

certain to enter "0" wherever required. Omit the "$" sign in your response.)

2011 2012 2013 Gross Profit $ $ $

(2) In the journal below, complete the necessary journal entries for each of the years (credit various accounts for construction costs incurred). (Leave no cells blank - be certain to enter "0" wherever required. Omit the "$" sign in your response.)

2011 2012General Journal Debit Credit Debit Credit

To record construction costs.

-2-2

0 0 1,900,000

Construction in progress Various accounts To record progress billings. Accounts receivable

Billings on construction contract To record cash collections. Cash

Accounts receivable To record gross profit. Construction in progress

Cost of construction

Revenue from long-term contracts

(3) Complete the information required below to prepare a partial balance sheet for 2011 and 2012 showing any items related to the contract. (Leave no cells blank - be certain to enter "0" wherever required. Amounts to be deducted should be indicated with minus sign. Omit the "$" sign in your response.)

Balance sheet 2011 2012 Current assets: Accounts receivable $

Construction in progress $ $ Less: Billings

Costs in excess of billings




2,400,000 3,600,000

2,400,000 3,600,000

2,000,000 4,000,000

2,000,000 4,000,000

1,800,000 3,600,000

1,800,000 3,600,000

0 0

0 0

0 0

200,000

2,400,000 6,000,000

-2,000,000 -6,000,000

400,000

0 700,000 700,000




Explanation:(1)

Year Gross profit recognized2011 0

2012 0

2013 $ 1,900,000

Total

gross

profit

$ 1,900,000

(4)

Year Gross profit recognized2011 0

2012 0

2013 $ 700,000

Total

gross

profi

$ 700,000

0 -300,000 300,000

t

(5)

Year Gross profit (loss) recognized2011 0 2012 $ (300,000)2013 300,000

Total project loss

$ 0

Presented below are condensed financial statements adapted from those of two actual companies competing in the pharmaceutical industry—Johnson and Johnson (J&J) and Pfizer, Inc. ($ in millions, except per share amounts). Note: Because two-year comparative statements are not provided, you should use year-end balances in place of average balances as appropriate.

Balance Sheets($ in millions, except per share data)

J&J Pfizer Assets Cash $ 5,377 $ 1,520 Short-term investments

4,146 10,432

Accounts receivable (net)

6,574 8,775

Inventories 3,588 5,837

Other current assets

3,310 3,177

Current assets 22,995 29,741

Property, plant, and equipment (net)

9,846 18,287

Intangibles and other assets

15,422 68,747

Total assets $ 48,263 $ 116,775

-2-2 http://ezto.mhhm.

Liabilities and Shareholders' Equity

Accounts payable $ 4,966 $ 2,601

Short-term notes 1,139 8,818

Other current liabilities

7,343 12,238

Current liabilities

13,448 23,657

Long-term debt 2,955 5,755

Other long-term liabilities

4,991 21,986

Total liabilities 21,394 51,398

Common stock (par and additional paid-in capital)

3,120 67,050

Retained earnings 30,503 29,382

Accumulated other comprehensive income (loss)

(590) 195

Less: treasury stock and other equity adjustments

(6,164) (31,250)

Total shareholders' equity

26,869 65,377

To $ 48,263 $ 116,775

tal liabilities and shareholders' equity

Income Statements Net sales $ 41,862 $ 45,188 Cost of goods sold 12,176 9,832

Gross profit 29,686 35,356

Operating expenses 19,763 28,486

Other (income) expense—net

(385) 3,610

Income before taxes

10,308 3,260

Tax expense 3,111 1,621

Net income $ 7,197 $ 1,639*

Basic net income per share

$ 2.42 $ 0.22

*This is before income from discontinued operations. There were no other separately reported items for either company. Evaluate and compare the two companies by responding to the following questions.

Required:(1-a) Compute the receivables turnover for both the companies. (Round your answers to 2 decimal places.)

Receivables Turnover J&J n/r times Pfizer n/r times

(1-b) Compute the average collection for both the companies. (Consider 365 days a year. Round your answers to the nearest whole days.)

Average CollectionPeriod

J&J n/r days Pfizer n/r days

(1-c) Which of the two companies appears more efficient in collecting its accounts receivable?

n/r

(1-d) Compute the inventory turnover for both the companies. (Round your answers to 2 decimal places.)

Inventory Turnover J&J n/r times Pfizer n/r times

(1-e) Compute the average days in inventory for both the companies. (Consider 365 days a year. Round your answers to the nearest whole number.)

Average Days in Inventory J&J n/r days Pfizer n/r days

(1-f) Which of the two companies appears more efficient in managing its inventory?

n/r

(2-a) Compute the rate of return on assets for both the companies. (Round your answers to 1 decimal place. Omit the "%" sign in your response.)

Rate of Return on Assets J&J n/r % Pfizer n/r %

(2-b) Which of the two firms had greater earnings relative to resources available?

n/r

(3-a) Compute the profit margin, asset turnover and return on assets.(Round your answers to 2 decimal places.Omit the "%" sign in your response.)

Profit Margin Asset Turnover Return on Assets J&J n/r % n/r times n/r % Pfizer n/r % n/r times n/r %

(3-b) Have the two companies achieved their respective rates of return on assets with similar combinations of profit margin and turnover?

n/r

(4-a) Compute the rate of return on shareholders’ equity for both the companies. (Round your answers to 1 decimal place. Omit the "%" sign in your response.)

Shareholders’ Equity J&J n/r % Pfizer n/r %

(4-b) From the perspective of a common shareholder, which of the two firms provided a greater rate of return?

n/r

(5) Compute the equity multiplier shareholders’ equity for both the companies. (Round your answers to 2 decimal places.)

Equity multiplier J&J n/r Pfizer n/r

eBook Link

WorksheetLearning Objective: 05-06 Identify and calculate the common ratios used to assess profitability.

Presented below are condensed financial statements adapted from those of two actual companies competing in the pharmaceutical industry—Johnson and Johnson (J&J) and Pfizer, Inc. ($ in millions, except per share amounts). Note: Because two-year comparative statements are not provided, you should use year-end balances in place of

-2-2

average balances as appropriate.

Balance Sheets($ in millions, except per share data)

J&J Pfizer Assets Cash $ 5,377 $ 1,520 Short-term investments

4,146 10,432

Accounts receivable (net)

6,574 8,775

Inventories 3,588 5,837

Other current assets

3,310 3,177

Current assets 22,995 29,741

Property, plant, and equipment (net)

9,846 18,287

Intangibles and other assets

15,422 68,747

Total assets $ 48,263 $ 116,775

Liabilities and Shareholders' Equity

Accounts payable $ 4,966 $ 2,601

Short-term notes 1,139 8,818

Other current liabilities

7,343 12,238

Current liabilities

13,448 23,657

Long-term debt 2,955 5,755

Other long-term

4,991 21,986

liabilities Total liabilities 21,394 51,398

Common stock (par and additional paid-in capital)

3,120 67,050

Retained earnings 30,503 29,382

Accumulated other comprehensive income (loss)

(590) 195

Less: treasury stock and other equity adjustments

(6,164) (31,250)

Total shareholders' equity

26,869 65,377

Total liabilities and shareholders' equity

$ 48,263 $ 116,775

Income Statements Net sales $ 41,862 $ 45,188 Cost of goods sold 12,176 9,832

Gross profit 29,686 35,356

Operating expenses 19,763 28,486

Other (income) expense—net

(385) 3,610

Income before taxes

10,308 3,260

Tax expense 3,111 1,621

Net income $ 7,197 $ 1,639*

Basic net income per share

$ 2.42 $ 0.22

*This is before income from discontinued operations. There were no other separately reported items for either company. Evaluate and compare the two companies by responding to the following questions.

Required:(1-a) Compute the receivables turnover for both the companies. (Round your answers to 2 decimal places.)

Receivables Turnover J&J times Pfizer times

(1-b) Compute the average collection for both the companies. (Consider 365 days a year. Round your answers to the nearest whole days.)

Average CollectionPeriod

J&J days Pfizer days

(1-c) Which of the two companies appears more efficient in collecting its accounts receivable?

J&J

(1-d) Compute the inventory turnover for both the companies. (Round your answers to 2 decimal places.)

Inventory Turnover

6.37

5.15

57

71

J&J times Pfizer times

(1-e) Compute the average days in inventory for both the companies. (Consider 365 days a year. Round your answers to the nearest whole number.)

Average Days in Inventory J&J days Pfizer days

(1-f) Which of the two companies appears more efficient in managing its inventory?

J&J

(2-a) Compute the rate of return on assets for both the companies. (Round your answers to 1 decimal place. Omit the "%" sign in your response.)

Rate of Return on Assets J&J % Pfizer %

(2-b) Which of the two firms had greater earnings relative to resources available?

J&J

(3-a) Compute the profit margin, asset turnover and return on assets.(Round your answers to 2 decimal places.Omit the "%" sign in your response.)

Profit Margin Asset Turnover Return on Assets J&J % times % Pfizer % times %

(3-b) Have the two companies achieved their respective rates of return on assets with similar combinations of profit margin and turnover?

3.39

1.68

108

217

14.9

1.4

17.19 .87 14.9

3.63 .39 1.4

J&J

(4-a) Compute the rate of return on shareholders’ equity for both the companies. (Round your answers to 1 decimal place. Omit the "%" sign in your response.)

Shareholders’ Equity J&J % Pfizer %

(4-b) From the perspective of a common shareholder, which of the two firms provided a greater rate of return?

J&J

(5) Compute the equity multiplier shareholders’ equity for both the companies. (Round your answers to 2 decimal places.)

Equity multiplier J&J Pfizer

Explanation:(1)

Receivables turnover =Net sales

Accounts receivable

J&J =$41,862

= 6.37 times$6,574

Pfizer =$45,188

= 5.15 times$8,775

Average collection period =365

Receivables turnover

J&J =365

= 57 days6.37

Pfizer = 365 = 71 days

26.8

2.5

1.80

1.79

5.15

On average, J&J collects its receivables in 14 days less than Pfizer.

Inventory turnover =Cost of goods sold

Inventories

J&J =$12,176

= 3.39 times$3,588

Pfizer =$9,832

= 1.68 times$5,837

Average days in inventory =365

Inventory turnover

J&J =365

= 108 days3.39

Pfizer =365

= 217 days1.68

On average, J&J sells its inventory twice as fast as Pfizer.

(2)

Rate of return on assets =Net income

Total assets

J&J =$7,197

= 14.9%$48,263

Pfizer =$1,639

= 1.4%$116,775

The return on assets indicates a company's overall profitability, ignoring specific sources of financing. In this regard, J&J's profitability is significantly higher than that of Pfizer.

(3)

Profitability can be achieved by a high profit margin, high turnover, or a combination of the two.

Rate of return on assets = Profit marginon sales × Asset

turnover

=

Net income×

Net sales Net sales Total assets

J&J =$7,197

×$41,862

$41,862 $48,263

= 17.19% × .867 times = 14.9%

Pfizer =$1,639

×$45,188

$45,188 $116,775

= 3.63% × .387 times = 1.4%

J&J's profit margin is much higher than that of Pfizer, as is its asset turnover. These differences combine to produce a significantly higher return on assets for J&J.

(4)

Rate of return on shareholders’ equity =Net income

Shareholders’ equity

J&J =$7,197

= 26.8%$26,869

Pfizer =$1,639

= 2.5%$65,377

J&J provided a much greater return to shareholders.

(5)

Equity multiplier shareholders’ equity =Net income

Shareholders’ equity

J&J =$48,263

= 1.80$26,869

Pfizer =$116,775

= 1.79$65,377

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