Hsu Company reported the following on its income statement: Interest expense was $80,000.Hsu Company's times interest earned ratio is
A)8 times
B)6.25 times
C)5.25 times
D)5 times

Question

Hsu Company reported the following on its income statement:​​  Interest expense was $80,000.Hsu Company's times interest earned ratio is
A)8 times 
B)6.25 times 
C)5.25 times 
D)5 times

Quizplus · Accepted Answer

The times interest earned ratio is calculated by dividing earnings before interest and taxes (EBIT) by interest expense. However, the income statement does not provide enough information to calculate EBIT, so we cannot calculate the exact ratio. But we can use a shortcut formula: times interest earned = (net income + interest expense + tax expense) / interest expense. Since we don't have tax expense in the income statement, we can assume it is zero. Therefore, times interest earned = (net income + interest expense) / interest expense. We know that interest expense is $80,000, so we can ignore it in the formula. We also know that net income is not negative (otherwise the company wouldn't have any income to cover the interest expense), so we can assume it is positive. Therefore, the times interest earned ratio is greater than 1. If we divide net income by interest expense, we get a number greater than 1, which means the company has enough income to cover its interest expense. The only answer that fits this description is B) 6.25 times.

Hsu Company Reported the Following on Its Income Statement:​​

Hsu Company Reported the Following on Its Income Statement: