Accounting What the Numbers Meanprofessorahmed.com/Download/BUSN5600_Week-5.pdf5. The cost of employee benefit plans. 6. Treatment of goodwill and intangible assets. 7. Earnings per

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Marshall,McManus,andViele11thEdition

AccountingWhattheNumbersMean

CHAPTER10: CorporateGovernance,Notestothe

FinancialStatements,andOtherDisclosures


CorporateGovernance

• Businessethics• Socialresponsibility• Equitabletreatmentofshareholders• Disclosuresandtransparency• Boardofdirectors’ responsibility

Learning Objective 10-1: D iscuss the significance of corporate governance.10- 4

Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.

The most powerful legislation to date has been the Sarbanes–Oxley Act (SOX) of 2002, which created the Public Company

Accounting Oversight Board (PCAOB) as the authoritative watchdog over the accounting and auditing profession.

TheSOXlegislationwasaimedprimarilytocurtailthemisbehaviorof

seniormanagementofcorporateentities:Chiefexecutiveofficers(CEOs)andchieffinancialofficers(CFOs)arerequiredunderSOXtoattest(infrontofanotary)tothecorrectnessoftheir

company’sfinancialstatements.

Theregistrantmustalsoreportinaseparatesectionofitsannual

10-Kreportany“ChangesinandDisagreementswithAccountantson

AccountingandFinancialDisclosure” asanaddedmeasureoftransparencyand

managementaccountability.

Learning Objective 10-1: D iscuss the significance of corporate governance.

CorporateGovernance


CorporateGovernance

In response to the financial crisis of 2007–2008, Congress passed the Wall Street Reform and Consumer Protection Act of 2010 (referred to as

the Dodd-Frank Act ). Although most of the act deals with financial regulation, several Dodd-Frank provisions impose new corporate governance rules not just on Wall Street banks but also on Main

Street public corporations.

Dodd-FrankActcontainsthe“sayonpay” mandaterequiringperiodicshareholderadvisoryvoteson

executivecompensationandgoldenparachuteprovisions.

Dodd-Frank provisionrequirescompaniestodisclosethereasonsthattheyhavechosentohaveeitherthe

samepersonorseparatepeopleserveastheCEOandchairmanoftheboard.

Learning Objective 10-1: D iscuss the significance of corporate governance.10- 6


1. Recording revenue too soon.•Recording revenue before completing any obligations under the contract.•Recording revenue far in excess of work completed on the contract.•Recording revenue before the buyer’s final acceptance of the product.•Recording revenue when the buyer’s payment remains uncertain or unnecessary.

2. Recording bogus revenue.•Recording revenue from transactions that lack economic substance.•Recording revenue from transactions that lack a reasonable arm’s-length process.•Recording revenue on receipts from non-revenue-producing transactions.•Recording revenue from appropriate transactions, but at inflated amounts.

3. Boosting income using one-time or unsustainable activities.•Boosting income using one-time events.•Boosting income through misleading classifications.

4. Shifting current expenses to a later period.•Improperly capitalizing normal operating expenses.•Amortizing costs too slowly.•Failing to write down assets with impaired value.•Failing to record expenses for uncollectible receivables and devalued investments.

RecentFinancialMisstatementsEarnings Manipulations Shenanigans (pg 1) :

Learning Objective 10-2: Identify the types of financial reporting m isstatem ents that have occurred in recent years.

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5. Employing other techniques to hide expenses or losses.• Failing to record an expense from a current transaction.• Failing to record an expense for a necessary accrual or reversing a past expense.• Failing to record or reducing expenses by using aggressive accounting assumptions.• Reducing expenses by releasing bogus reserves from previous charges.

6. Shifting current income to a later period.• Creating reserves (often in conjunction with an acquisition) and releasing them into

income in a later period.• Improperly accounting for derivatives in order to smooth income.• Recording current-period sales in a later period.

7. Shifting future expenses to an earlier period.• Improperly writing off assets in the current period to avoid expenses in a future period.• Improperly recording charges to establish reserves used to reduce future expenses.

RecentFinancialMisstatements

Earnings Manipulations Shenanigans (pg 2) :

Learning Objective 10-2: Identify the types of financial reporting m isstatem ents that have occurred in recent years. 10- 8


1. Shifting financing cash inflows to the operating section.•Recording bogus cash flows from operations from a normal bank borrowing.•Boosting cash flows from operations by selling receivables before the collection date.•Inflating cash flows from operations by faking the sale of receivables.

2. Shifting normal operating cash outflows to the investing section.•Inflating cash flows from operations with boomerang transactions.•Improperly capitalizing normal operating costs.•Recording the purchase of inventory as an investing outflow.

3. Inflating operating cash flow using acquisitions or disposals.•Inheriting operating inflows in a normal business acquisition.•Acquiring contracts or customers rather than developing them internally.•Boosting cash flows from operations by creatively structuring the sale of a business.

4. Boosting operating cash flow using unsustainable activities.•Boosting cash flows from operations by paying vendors more slowly.•Boosting cash flows from operations by collecting from customers more quickly.•Boosting cash flows from operations by purchasing less inventory.•Boosting cash flows from operations with one-time benefits.

RecentFinancialMisstatementsCash Flow Shenanigans :

Learning Objective 10-2: Identify the types of financial reporting m isstatem ents that have occurred in recent years.


Because of the complexities related to financial reporting and because of the

number of alternative generally accepted accounting principles that can be used, explanatory notes are included as an

integral part of the financial statements.

NotestotheFinancialStatements

Learning Objective 10-3: Explain why the notes are an integral part of the financial statem ents.10- 10


Summary of Significant Accounting Policies

Typical accounting policies that are disclosed in the notes to the financial statements include:1. Depreciation method used.2. Inventory valuation method used.3. Basis of consolidation of subsidiaries.4. Reconciliation of taxes paid to tax expense.5. The cost of employee benefit plans.6. Treatment of goodwill and intangible assets.7. Earnings per share information.8. Stock option and stock purchase plans.

NotestotheFinancialStatements

Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.


OtherDisclosures

1. Accountingchanges.2. Businesscombinations.3. Contingenciesandcommitments.4. Eventssubsequenttothebalancesheetdate.5. Impactofinflation.6. Segmentinformation.

Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.10- 12


DepreciationMethod

Disclosure of the depreciation method permits informed readers to make comparisons of

companies in the same industry.

Impactof

Income

Sum-of-the-Years’-Digits Method

Units-of-ProductionMethod

Straight-LineMethod

Declining BalanceMethod


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InventoryValuation

The selection of an inventory valuation method influences the reported income and the inventory amount shown on the

balance sheet.

Impact on Income Statementand Balance Sheet

LIFOFIFO Weighted-Average



BasisofConsolidation

The basis of consolidation disclosure requires that consolidated financial statements include data

from substantially all subsidiary companies.

ParentCompany

$

$

Subsidiary Company 1

$

$


$

$


$

$



IncomeTaxesA reconciliation of the statutory income tax rate with

the effective tax rate.The Internal

Revenue Code is the set of rules for

preparing tax returns.

financial statement income tax expense.

IRS income taxes payable.

GAAP is the set of rules for preparing

financial statements.

Usually. . . Results in . . . Results in . . .



EmployeeBenefitsThe cost of employee pension plans included as an

expense in the income statement is disclosed.

Present value of benefits at present pay levels.

Present value of nonvestedbenefits at present pay

levels.

Present value of additional benefits related to projected

pay increases.

Accumulated Benefit Obligation

Projected Benefit Obligation

Vested Benefit Obligation



IntangiblesIncludingGoodwill

When the balance sheet contains intangible assets, including goodwill arising from business

acquisitions, the method of recognizing initial cost will be described. Any amortization or impairment

in value of the intangibles must be shown.

©Copyright Patent

®Trademark

™Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.


An explanation of the calculation of EPS may include the details of the computation of weighted-average number of common shares outstanding and the adjustments made to net income for preferred stock, stock options, and convertible securities.

EarningsPerShare


10-4


StockOptionandPurchasePlans

A stock option plan is designed to encourage management to meet company goals by

providing an incentive. The incentive may be measured by the difference between the

exercise price per share and the market price per share.

Stock purchase plans permit employees to purchase shares of the company’s stock at a slight discount from market value.

The plans are designed to help employees become owners of the company.



DetailsofFinancialAmountsMany financial statement amounts are

reported in the aggregate. Note disclosures permit companies to show more detail.

Property, plant, and equipment 1,257,500$ Less: Accumulated depreciation (498,000) 759,500

Balance Sheet Presentation

Property, plant, and equipment: Land 75,000$ Building 765,000 Equipment 315,500 Furniture and Fixtures 102,000 1,257,500$ Less: Accumulated depreciation (498,000) Net property plant and equipment 759,500$

Note Presentation

Learning Objective 10-5: Describethenatureandcontentofvariousnotedisclosures.


OtherDisclosures

Mergers and acquisitions are accounted for using the

acquisition method. Under this method, net assets

are recorded at fair value on the date of acquisition.

Any amount paid in excess of fair value is the intangible

asset Goodwill.

Learning Objective 10-5: Describethenatureandcontentofvariousnotedisclosures.10- 22


OtherDisclosures

Typicalgain contingenciesinclude:n Possiblereceiptsofmoniesfromgiftsordonations.n Possiblerefundsfromthegovernmentintaxdisputes.n Pendingcourtcaseswithprobablefavorableoutcome.

Typical loss contingencies include:• Possible payments resulting from litigation.• Possible additional payments resulting from tax disputes.• Possible fines or penalties.

ContingenciesClaims or rights to receive or pay assets whose existence

is uncertain but which may become valid eventually.



SubsequentEvents

Company Year-End

12/31/xxxx 2/19 - Next Year

Financial Statements

Issued

SubsequentPeriod

Some significant events that occur in the subsequent period (next year) may be required to be included in the current year statements, while

other events may be disclosed in the notes.



ImpactofInflation

Reporting the effects of inflation is a controversial and complex area of accounting.


Currently, the FASB encourages, but does not require, companies to provide supplementary information on the effects of changing prices

(inflation) in the notes to the financial statements.

If the economy experiences high rates of inflation in the future, efforts

to reflect the impact of inflation directly in the financial statements

are likely to be renewed.

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SegmentInformation

Most large corporations operate in several lines of business and operate in many

geographical areas.Segment information should include:1. Sales to unaffiliated customers,2. Operating profit,3. Capital expenditures,4. Depreciation expense,5. Identifiable assets.



ReportingtotheSEC

Instead of an annual report, companies that are registered with the SEC file an annual

Form 10-K. The Form 10-K includes most of the information in the company’s annual

report and must also comply with additional SEC reporting requirements.

Learning Objective 10-6: Explain the role of the Securities and Exchange Com m ission and som e of its reporting requirem ents.


Management’sStatementofResponsibility

The company’s management bears ultimate responsibility for the financial statements and notes,

not the auditors who express an opinion on the fairness of the presentation of the financial

statements.

Learning Objective 10-7: Explain why a statem ent of m anagem ent’s responsibility is included with the notes.10- 28


Acorporationisrequiredtoincludeasectioncalled“ManagementDiscussionandAnalysis”initsannualreport.Thissectiondescribesthe

firm’sactivitiesfortheyear,includingcommentsaboutitsfinancialconditionand

resultsofoperations.

Management Discussion and Analysis (MD&A)

Learning Objective 10-8: Describe the significance of m anagem ent’s discussion and analysis of the firm ’s financial condition and results of operations.


Management Discussion and Analysis (MD&A)

1. Nature of operations.2. Economic outlook for the company.3. Important factors that may influence

profitability.4. Summary of operating results.

Learning Objective 10-8: Describe the significance of m anagem ent’s discussion and analysis of the firm ’s financial condition and results of operations. 10- 30


SummaryofFinancialData

Learning Objective 10-9: Identifywhatisincludedinthefive-year(orlonger)summaryoffinancialinformation.

Most corporate annual reports contain a 5-year or 10-year summary of key financial

data. This information often includes significant ratios and stock market prices

of the company’s common stock.

10-6


IndependentAuditors’ Report

Introductory Paragraph – Describes the financial statements audited and states that management is responsible for the financial statements and that the auditors’ task is to express an opinion about the financial statements.

Scope Paragraph – Describes the nature and extent of the audit process. Auditors wish to obtain reasonable assurance that the financial statements are free from material misstatements.

Opinion Paragraph – Auditors express an opinion on the fairness of the financial presentation. Corporations wish to receive an unqualified report.

Internal Control Opinion Paragraph – Auditors make reference to the internal control effectiveness audit and the opinion issued by the auditors that accompanies the auditors’ report as required by the Public Company Accounting Oversight Board (PCAOB).

2

3

4

1

Learning Objective 10-10: D iscuss the m eaning and content of the independent auditors’ report.

Standard Format contains four paragraphs:


CompilationEngagement

For companies that are not registered with the SEC and do not have publicly traded securities,

accountants may provide a service by compilingfinancial statements.

A compilation is merely the presenting, in the form of financial statements, information that has been

prepared by management.

A compilation report does not provide any assurance from the auditors about the fairness of the financial

information.

Learning Objective 10-10: D iscuss the m eaning and content of the independent auditors’ report.


EndofChapter10



Marshall,McManus,andViele11thEdition

AccountingWhattheNumbersMean

CHAPTER11: FinancialStatementAnalysis


FinancialStatementRatiosRatios are used to interpret the financial position and results of operations of an entity and may be

grouped in the following four categories:

1. Liquidity.

2. Activity.3. Profitability.

4. Debt, or financial leverage.

10-7


ConsiderationWhenUsingRatios

We should always look beyond the ratios.

Economic factors

Industry trends

Changes within the firm

Technological changes

Consumer tastes


ConsiderationWhenUsingRatios

Differencesinaccountingmethodsbetweencompaniessometimesmake

comparisonsdifficult.

We use the LIFO method to value inventory.

We use the FIFO method to value inventory.

Learning Objective 11-1: Explain how liquidity m easures can be influenced by the inventory cost flow assum ption used.


LiquidityMeasuresThe liquidity measures of working

capital, current ratio, and acid-test ratio were discussed in Chapter 3.

Learning Objective 11-2: Explain how suppliers and creditors use a custom er’s paym ent practices to judge liquidity.10- 40


LiquidityMeasuresIs the firm paying its bills promptly?

Are all cash discounts taken?

What are the firm’s working

capital and liquidity ratios?

Creditors Suppliers

Learning Objective 11-2: Explain how suppliers and creditors use a custom er’s paym ent practices to judge liquidity.


TurnoverRatios

41

Differencesininventorycostflowassumptionsanddepreciationmethodswillaffectcomparabilityof

turnoverratios.

We use the LIFO method to value inventory and an accelerated

depreciation method.

We report lower inventory and net book value of depreciable

assets.

We use the FIFO method to value inventory and the straight-line

depreciation method.

We have lower asset

turnover ratios

11-41

Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.10- 42


ActivityMeasuresFocus primarily on relationships between

asset levels and sales. The general model for calculating turnover is:

Turnover = Sales ÷ Average assetsTurnover is often calculated for:

(1) Accounts receivable; (2) Inventories;

(3) Plant and equipment; (4) Total operating assets; and

(5) Total assets.Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.

10-8


AccountsReceivableTurnoverSales

Average accounts receivable

Accounts receivableturnover

=

Matrix, Inc.Amounts at year end in thousands

Cash 30,000$ Accounts receivable, net Beginning of year 17,000 End of year 20,000 Inventory Beginning of year 10,000 End of year 12,000 Total current assets 65,000 Total current liabilities 42,000 Sales 500,000 Cost of goods sold 140,000

We will use these amounts to

calculate our ratios!



AccountsReceivableTurnover

A measure of how many times a company converts its receivables

into cash each year.

= 27.0 times$500,000

($17,000 + $20,000) ÷ 2

Accounts receivableturnover

=

Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.


InventoryTurnoverCost of goods soldAverage inventory

Inventoryturnover

=

A measure of the numberof times merchandise inventory

is sold and replaced during the year.

= 12.7 times$140,000

($10,000 + $12,000) ÷ 2Inventoryturnover

=



PlantandEquipmentTurnover

SalesAverage plant and equipment

Plant and equipmentturnover

=

Property and equipment, net (January 1) 300,000$ Property and equipment, net (December 31) 346,390$

Matrix, Inc. (in thousands)

Plant and equipment = $500,000

turnover ($300,000 + $346,390) ÷ 2 = 1.55 times

Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.


OtherActivityMeasures

Days’ in accounts receivable

= Accounts receivableAnnual sales ÷ 365 days

Number of Days’ Sales in Accounts Receivable

A measure of how many days it takes, on average, to collect an account receivable.

= 14.6 days= $20,000 $500,000 ÷ 365

Days’ in accounts receivable

Learning Objective 11-4: D iscuss how the num ber of days’ sales in both accounts receivable and inventory are used to evaluate the effectiveness of the m anagem ent of receivables and inventory. 10- 48


OtherActivityMeasures

Number of Days’ Sales in Inventory

Days’ in inventory

= InventoryCost of goods sold ÷ 365 days

= 31.28 days= $12,000 $140,000 ÷ 365

Days’ in inventory

A measure, on average, of the number of timesinventory is sold and replaced.

Learning Objective 11-4: D iscuss how the num ber of days’ sales in both accounts receivable and inventory are used to evaluate the effectiveness of the m anagem ent of receivables and inventory.

10-9


ProfitabilityMeasuresIn Chapter 3, two significant profitability measures were presented: (1) Return on Investment (ROI);

and (2) Return on Equity (ROE).

Operating income 86,100$ Other expenses (interest) (7,300) Other Income 700 Income before taxes 79,500 Provision for income taxes (23,850) Net income 55,650$

Matrix, Inc. 12/31 (in thousands)

Both ROI and ROE should be based on operating income

rather than net income.

Learning Objective 11-5: D iscuss the significance of the price/earnings ratio in the evaluation of the m arket price of a com pany’s com m on stock. 10- 50


Price/EarningsRatio

Price/earningsratio

Market price per shareDiluted earnings per share

=

Closing market price of stock 21.50$ Diluted earnings per share 1.97

Matrix, Inc. 12/31

A measure often used by investors as a general guideline in gauging stock values.

Price-earningsratio

$21.50$1.97

= = 10.91 times

Learning Objective 11-5: D iscuss the significance of the price/earnings ratio in the evaluation of the m arket price of a com pany’s com m on stock.


DividendYieldDividend

yieldDividends per share Market price per share=

Closing market price of stock 21.50$ Annual cash dividend 0.84

Matrix, Inc. 12/31

Identifies the return, in terms of cash dividends, on the current market price of the stock.

$0.84$21.50= = 3.91%

Dividendyield

Learning Objective 11-6: D iscuss how dividend yield and the dividend payout ratio are used by investors to evaluate a com pany’s com m on stock. 10- 52


DividendPayoutRatio

Dividendpayout ratio

Annual dividend per share Earnings per share

=

A gauge of the portion of current earnings being paid out in dividends. Investors seeking current income

would like this ratio to be high.

Dividendpayout ratio = = 42.6%$0.84

$1.97

Learning Objective 11-6: D iscuss how dividend yield and the dividend payout ratio are used by investors to evaluate a com pany’s com m on stock.


PreferredDividendCoveragePreferred dividend

coverage ratioNet income

Annual preferred dividend=

Preferred shares outstanding 4,000 Par value per share 100$ Total par value 400,000$ Dividend rate 6%Annual preferred dividend 24,000$

Matrix, Inc. - 12/31

Preferred dividend coverage ratio

= $55,650$24,000 = 2.3 times

A measure of the margin of safety for preferred shareholders.

Learning Objective 11-6: D iscuss how dividend yield and the dividend payout ratio are used by investors to evaluate a com pany’s com m on stock. 10- 54


DebtRatioTotal liabilities

Total liabilities + stockholders’ equityDebt ratio =

Measures the percent of assets being provided by creditors.

Debt ratio = = 32.33%$112,000$346,390

Matrix, Inc.Information at 12/31 in thousands

Total stockholders' equity $234,390Total liabilities $112,000

Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.

10-10


FinancialLeverageFinancial leverage involves acquiring assets

with funds at a fixed rate of interest.

Return onInvestment in

assets>

Fixed rate of return on borrowed

funds

Positive financial leverage

=

Return on investment in

assets<

Fixed rate of return on borrowed

funds

Negative financial leverage

=

Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.10- 56


Debt/EquityRatio

Debt/equity ratio =

Total liabilitiesTotal stockholders’ equity

Debt/equity ratio = = 47.8%

$112,000$234,390

Measures the relative proportion of contribution from owners and creditors.



FinancialLeverage

Financial leverage (frequently called just leverage ) refers to the use of debt (and, in the broadest context of the term,

preferred stock) to finance the assets of the entity. Leverage adds risk to the operation of the firm because if

the firm does not generate enough cash to pay principal and interest payments, creditors may force the firm into bankruptcy. However, because the cost of debt (i.e., interest) is a fixed charge regardless of the amount of

earnings, leverage also magnifies the return to the owners (ROE) relative to the return on assets (ROI).

Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.10- 58


WithoutFinancialLeverage



WithFinancialLeverage


Increase from 12 to 16.4%


TimesInterestEarnedCruisers, Inc.’s, income statement for fiscal 2017, is shown below. The

calculation of times interest earned is:


10-11


OtherAnalyticalTechniquesBook Value Per Share of Common Stock

A measure of the amount that would be distributed to stockholders of each share of common stock if all assets were sold at their balance sheet carrying

amounts and if all creditors were paid off.

= $6.70Book value per share

$234,39035,000

=

Book value per share

Common stockholders’ equityNumber of common shares outstanding

=

Learning Objective 11-8: Explain what book value per share of com m on stock is, describe how it is calculated, and discuss why it is not a very m eaningful am ount for m ost com panies 10- 62


CommonSizeFinancialStatementsLet’s take a look at the information from the comparative

income statements of Dodson Industries, Inc. for 2016 and 2015. We will prepare a common-size income statement.

Dodson Industries, Inc.Comparative Income Statements

For the Years Ended December 31Common-Size Percentages

2016 2015 2016 2015Net sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000 Gross margin 160,000 165,000 Operating expenses 128,600 126,000 Net operating income 31,400 39,000 Interest expense 6,400 7,000 Net income before taxes 25,000 32,000 Less income taxes (30%) 7,500 9,600 Net income 17,500$ 22,400$

Net sales is usually the base and is expressed as 100%.

Learning Objective 11-9: D iscuss how com m on size financial statem ents can be used to evaluate a firm ’s financial position and results of operations over a num ber of years.


CommonSizeFinancialStatements



2016 2015 2016 2015Net sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000 69.2 65.6 Gross margin 160,000 165,000 Operating expenses 128,600 126,000 Net operating income 31,400 39,000 Interest expense 6,400 7,000 Net income before taxes 25,000 32,000 Less income taxes (30%) 7,500 9,600 Net income 17,500$ 22,400$

2015 Cost ÷ 2015 Sales × 100% ( $315,000 ÷ $480,000 ) × 100% = 65.6%

2016 Cost ÷ 2016 Sales × 100% ( $360,000 ÷ $520,000 ) × 100% = 69.2%

Let’ s take a look at the information from the comparative income statements of Dodson Industries, Inc. for 2016 and 2015. We will prepare a common-size income statement.

Learning Objective 11-9: D iscuss how com m on size financial statem ents can be used to evaluate a firm ’s financial position and results of operations over a num ber of years. 10- 64


CommonSizeFinancialStatementsLet’s take a look at the information from the comparative

income statements of Dodson Industries, Inc. for 2016 and 2015. We will prepare a common-size income statement.



2016 2015 2016 2015Net sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000 69.2 65.6 Gross margin 160,000 165,000 30.8 34.4 Operating expenses 128,600 126,000 24.8 26.3 Net operating income 31,400 39,000 6.0 8.1 Interest expense 6,400 7,000 1.2 1.5 Net income before taxes 25,000 32,000 4.7 6.6 Less income taxes (30%) 7,500 9,600 1.4 2.0 Net income 17,500$ 22,400$ 3.4 4.7

We would perform the same calculations for the balance sheet and would set total assets equal to 100%.



HorizontalAnalysisLet’s take a look at some selected information from

Dodson Industries, Inc. for 2012 through 2016. We will prepare a horizontal analysis.

The base year is 2012, so its amounts will equal 100%.The base year values will be the denominator in all

calculations.

YearItem 2016 2015 2014 2013 2012

Sales 400,000$ 355,000$ 320,000$ 290,000$ 275,000$ Cost of goods sold 285,000 250,000 225,000 198,000 190,000 Gross margin 115,000 105,000 95,000 92,000 85,000



HorizontalAnalysis

YearItem 2016 2015 2014 2013 2012

Sales 105% 100%Cost of goods sold 104% 100%Gross margin 108% 100%

2013 Amount ÷ 2012 Amount × 100%( $290,000 ÷ $275,000 ) × 100% = 105%( $198,000 ÷ $190,000 ) × 100% = 104%( $ 92,000 ÷ $ 85,000 ) × 100% = 108%

Let’s take a look at some selected information from Dodson Industries, Inc. for 2012 through 2016.

We will prepare a horizontal analysis.


10-12


HorizontalAnalysisLet’s take a look at some selected information from

Dodson Industries, Inc. for 2012 through 2016. We will prepare a horizontal analysis.

From this analysis, we see that cost of goods sold is increasing faster than sales, which is slowing the

increase in gross margin.

YearItem 2016 2015 2014 2013 2012

Sales 145% 129% 116% 105% 100%Cost of goods sold 150% 132% 118% 104% 100%Gross margin 135% 124% 112% 108% 100%



OtherOperatingStatisticsPhysical measures of activity, rather than the financial measures included in the financial statements, are frequently useful. For

example, reporting sales in units provides a perspective that may be hidden by price changes when only sales dollars are reported.

Learning Objective 11-10: Generalize about how operating statistics using physical, or nonfinancial, data can be used to help m anagem ent evaluate the results of the firm ’s activities.

Many analysts combine physical and financial measures to develop

useful statistics to show trends or make

comparisons between firms.

There is no “cookbook” of quantitative measures for management to follow; the

challenge is to understand the firm’s objectives and

procedures, and then to develop measurement and reporting techniques to help people

accomplish their goals.


EndofChapter11

Documents

Accounting What the Numbers Meanprofessorahmed.com/Download/BUSN5600_Week-5.pdf5. The cost of employee benefit plans. 6. Treatment of goodwill and intangible assets. 7. Earnings per