Q24E - Horngren'S Financial And Managerial Accounting

Question

The following financial information was obtained from the year ended 2018 income statements for Cash Automotive and Pennington Automotive:

                                                                  Cash                       Pennington

Net income                                          \( 26,070                        \) 74,188

Income tax expense                                9,270                           27,080

Interest expense                                         300                             2,900

 

Requirements

1. Compute the times-interest-earned ratio for each company. Round to two decimals.

 

2. Which company was better able to cover its interest expense?

Step-by-Step Solution

Answer

Times Interest Earned Ratio 

For Cash Automotive: 119 times

For Pennington Automotive: 35.92 times

Step 1: Computation of times interest earned ratio

 $$\begin{gathered} \mathbf{For}\mathbf{ }\mathbf{cash}\mathbf{ }\mathbf{Automative}\mathbf{ }\mathbf{Co}\mathbf{.}\mathbf{=}\mathbf{ }\frac{\mathbf{Net}\mathbf{ }\mathbf{Income}\mathbf{ }\mathbf{+}\mathbf{ }\mathbf{Income}\mathbf{ }\mathbf{Tax}\mathbf{ }\mathbf{Expense}\mathbf{ }\mathbf{+}\mathbf{ }\mathbf{Interest}\mathbf{ }\mathbf{Expense}}{\mathbf{Interest}\mathbf{ }\mathbf{Expense}} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\frac{\mathbf{\$}\mathbf{26}\mathbf{,}\mathbf{070}\mathbf{+}\mathbf{\$}\mathbf{9}\mathbf{,}\mathbf{270}\mathbf{+}\mathbf{\$}\mathbf{300}}{\mathbf{\$}\mathbf{300}} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\mathbf{119}\mathbf{times} \\ \mathbf{For}\mathbf{ }\mathbf{Peninngton}\mathbf{ }\mathbf{Automative}\mathbf{ }\mathbf{Co}\mathbf{.}\mathbf{=}\mathbf{ }\frac{\mathbf{Net}\mathbf{ }\mathbf{Income}\mathbf{ }\mathbf{+}\mathbf{ }\mathbf{Income}\mathbf{ }\mathbf{Tax}\mathbf{ }\mathbf{Expense}\mathbf{ }\mathbf{+}\mathbf{ }\mathbf{Interest}\mathbf{ }\mathbf{Expense}}{\mathbf{Interest}\mathbf{ }\mathbf{Expense}} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\frac{\mathbf{\$}\mathbf{74}\mathbf{,}\mathbf{188}\mathbf{+}\mathbf{\$}\mathbf{27}\mathbf{,}\mathbf{080}\mathbf{+}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{900}}{\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{900}} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\mathbf{ }\mathbf{35}\mathbf{.}\mathbf{92}\mathbf{times}\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ } \end{gathered}$$

Step 2: Conclusion

Based on the above-computed ratio, Cash Automotive is better enough to cover its interest expense as the income before interest and tax is 119 times more than the Pennington Automotive.