Problem 2

By calculating some ratios based on the average of opening and closing balances, we
make the implicit assumption that changes in these accounts occurred uniformly
throughout the year. Sometimes, however, the actual change occurs unevenly,
perhaps due to an acquisition. In such cases, ratios based on averages will be
distorted. Discuss how you would calculate the return on assets ratio if the growth
in assets occurred:
(i) At the beginning of the year
(ii) At the end of the first quarter
(iii) At the end of the second quarter
(iv) At the end of the fourth quarter
Answers:

Since the assumption in using average of opening and closing balance is that
changes occurs evenly throughout the year, our goal is to minimize the impact of
uneven distribution of asset growth;

At the beginning of the year:

Use the usual computation average of beginning and ending assets in the
denominator or,

Use the average of end of year and end of first quarter assets in denominator.
Example:

Given








Since the increase in Assets is in the beginning of the year, we will assume that these
assets will be carried though to all of the years balances. But assuming that the
beginning balance is way too different compare to the ending balances of each
quarter. Use the below computation;

New given:






This way, you have eliminated the effect of the beginning inventories and
considered the normal asset level thought the year.

At the end of the first quarter increase:

Use weighted average: .25 x opening assets + .75 closing assets; this matches the
numerator that reflects a return on the additional assets for 3/4 of the year.
Alternatively, use end of first quarter assets.


Given:






In giving the beginning balance 25% of average assets, you have given more weight
to the inventory level of assets carried at most time of the year (75%).

Here you completely eliminated the effect of the lower beginning balance of assets
and based the average assets on the level it carries most of the year.

At the end of the second quarter increase

Average of opening and closing assets is weighted average


Here you equally have given importance to both beginning and ending balance.
Because beginning balance level of assets were carried at the first half of the year
and the increased level of assets were carried at the second have of the year.



At the end of the fourth quarter increase

Use weighted average: 0.75 x opening assets + 0.25 closing assets. If assets added at
the very end of the fourth quarter, use opening assets, or alternatively the Ave of
beginning assets and ending of the third quarter.

This is giving more weight to the level of average assets carried most of the year.

This is to eliminate the effect of sudden increased in Assets at the end of the year,
may it be deliberate or not. This effect should only be reflected on its succeeding
periods.