MAS FS Analysis 40pages

FINANCIAL STATEMENT ANALYSIS

TRUE-FALSE STATEMENTS

1. Earning power refers to a company’s ability to sustain its profits from operations.

2. When the disposal of a significant segment occurs, the income statement should report both incomefrom continuing operations and income (loss) from discontinued operations.

3. An event or transaction should be classified as an extraordinary item if it is unusual in nature or if itoccurs infrequently.

4. If a firm has only one change in accounting principle over several years, it would be classified onthe income statement as an extraordinary item.

5. A change in accounting principle occurs when the principle used in the current year is differentfrom the one used by competitors in the current year.

6. Comprehensive income includes all changes in stockholders’ equity during a period except thoseresulting from investments by stockholders and distributions to stockholders.

7. Intracompany comparisons of the same financial statement items are often useful to detect changesin financial relationships and significant trends.

8. Comparisons of company data with industry averages provide information about a company'srelative position within the industry.

9. Horizontal, vertical, and circular analyses are the basic tools of financial statement analysis.

10. Horizontal analysis is a technique for evaluating a financial statement item in the current year withother items in the current year.

11. Another name for horizontal analysis is trend analysis.

12. If a company has sales of $110 in 2001 and $154 in 2002, the percentage increase in sales from2001 to 2002 is 140%.

13. In horizontal analysis, if an item has a negative amount in the base year, and a positive amount inthe following year, no percentage change for that item can be computed.

14. Vertical analysis is a technique for evaluating a series of financial statement data over a period oftime to determine the increase (decrease) that has taken place.

15. Common size analysis expresses each item in a financial statement as a percent of a base amount.

16. In the vertical analysis of a balance sheet, the base for current liabilities is total liabilities.

17. Vertical analysis is useful in making comparisons of companies of different sizes.

18. Using vertical analysis of the income statement, a company's net income as a percentage of netsales is 15%; therefore, the cost of goods sold as a percentage of sales must be 85%.

19. In the vertical analysis of an income statement, each item is generally stated as a percentage of net

Financial Statement Analysis 13-

income.

20. Liquidity ratios measure the ability of the enterprise to survive over a long period of time.

21. A solvency ratio measures the income or operating success of an enterprise for a given period oftime.

22. The current ratio is a measure of all the ratios calculated for the current year.

23. Inventory turnover measures the number of times on the average the inventory was sold during theperiod.

24. Profitability ratios are frequently used as a basis for evaluating management's operatingeffectiveness.

25. The return on assets ratio will be greater than the rate of return on common stockholders' equity ifthe company has been successful in trading on the equity at a gain.

26. An advantage of the current and acid-test ratios is they use year-end balances of current asset andcurrent liability accounts.

27. From a creditor's point of view, the higher the total debt to total assets ratio, the lower the risk thatthe company may be unable to pay its obligations.

28. A current ratio of 1.2 to 1 indicates that a company's assets exceed its current liabilities.

29. Using borrowed money to increase the rate of return on common stockholders' equity is called"trading on the equity."

30. Diversification in American industry limits the usefulness of financial analysis.

Answers to True-False Statements

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.1. T 6. T 11. T 16. F 21. F 26. F2. T 7. T 12. F 17. T 22. F 27. F3. F 8. T 13. T 18. F 23. T 28. T4. F 9. F 14. F 19. F 24. T 29. T5. F 10. F 15. T 20. F 25. F 30. T


MULTIPLE CHOICE QUESTIONS31. The discontinued operations section of the income statement refers to

a. discontinuance of a product line.b. the income or loss on products that have been completed and sold.c. obsolete equipment and discontinued inventory items.d. the disposal of a significant segment of a business.

32. Which one of the following would be classified as an extraordinary item?a. Expropriation of property by a foreign governmentb. Losses attributed to a labor strikec. Write-down of inventoriesd. Gains or losses from sales of equipment

33. When a change in accounting principle occurs,a. all prior years' financial statements should be changed to reflect the newly adopted principle.b. the new principle should be used in reporting the results of operations of the current year.c. the cumulative effect of the change in principle should be reflected on the income statement as

of the beginning of the next year.d. the cumulative effect of the change in accounting principle should be classified as an

extraordinary item on the income statement.

34. If an item meets one (but not both) of the criteria for an extraordinary item, ita. only needs to be disclosed in the footnotes of the financial statements.b. may be treated as sales revenue (if it is a gain) and as an operating expense (if it is a loss).c. is reported as an "other revenue or gain" or "other expense and loss," net of tax.d. is reported at its gross amount as an "other revenue or gain" or "other expense or loss."

35. The order of presentation of nontypical items that may appear on the income statement isa. Extraordinary items, Discontinued operations, Change in accounting principle.b. Discontinued operations, Extraordinary items, Change in accounting principle.c. Change in accounting principle, Discontinued operations, Extraordinary items.d. Change in accounting principle, Extraordinary items, Discontinued operations.

36. In analyzing the financial statements of a company, a single item on the financial statementsa. should be reported in boldface type.b. must be compared with other financial data to provide more information.c. is significant only if it is large.d. should be accompanied by a footnote.

37. Comparisons of financial data made within a company are calleda. intracompany comparisons.b. interior comparisons.c. intercompany comparisons.d. intramural comparisons.

Test Bank for Managerial Accounting, Second Edition

38. Which one of the following is not a tool in financial statement analysis?a. Horizontal analysisb. Circular analysisc. Vertical analysisd. Ratio analysis

39 In analyzing financial statements, horizontal analysis is aa. requirement.b. tool.c. principle.d. theory.

40. Horizontal analysis is also known asa. linear analysis.b. vertical analysis.c. trend analysis.d. common size analysis.

41. Under which of the following cases may a percentage change be computed?a. The trend of the amounts is decreasing but all amounts are positive.b. There is no amount in the base year.c. There is a negative amount in the base year and a negative amount in the subsequent year.d. There is a negative amount in the base year and a positive amount in the subsequent year.

42. Horizontal analysis is a technique for evaluating a series of financial statement data over a periodof timea. that has been arranged from the highest number to the lowest number.b. that has been arranged from the lowest number to the highest number.c. to determine which items are in error.d. to determine the amount and/or percentage increase or decrease that has taken place.

43. Horizontal analysis is a technique for evaluating financial statement dataa. within a period of time.b. over a period of time.c. on a certain date.d. as it may appear in the future.

44. Assume the following sales data for a company:

2003 $1,800,0002002 1,500,0002001 1,000,000

If 2001 is the base year, what is the percentage increase in sales from 2001 to 2003?a. 100%b. 180%c. 80%d. 55.5%

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45. Comparative balance sheets are usually prepared fora. one year.b. two years.c. three years.d. four years.

46. Vertical analysis is also known asa. perpendicular analysis.b. common size analysis.c. trend analysis.d. straight-line analysis.

47. Vertical analysis is a technique that expresses each item in a financial statementa. in dollars and cents.b. as a percent of the item in the previous year.c. as a percent of a base amount.d. starting with the highest value down to the lowest value.

48. In vertical analysis,a. a base amount is required.b. a base amount is optional.c. the same base is used across all financial statements analyzed.d. the results of the horizontal analysis are necessary inputs for performing the analysis.

49. In performing a vertical analysis, the base for prepaid expenses isa. total current assets.b. total assets.c. total liabilities.d. prepaid expenses in a previous year.

50. In performing a vertical analysis, the base for sales revenues on the income statement isa. net sales.b. sales.c. net income.d. cost of goods available for sale.

51. In performing a vertical analysis, the base for sales returns and allowances isa. sales.b. sales discounts.c. net sales.d. total revenues.

52. In performing a vertical analysis, the base for cost of goods sold isa. total selling expenses.b. net sales.c. total revenues.d. total expenses.

53. Which one of the following is not a characteristic generally evaluated in ratio analysis?a. Liquidityb. Profitabilityc. Marketabilityd. Solvency


54. Short-term creditors are usually most interested in assessinga. solvency.b. liquidity.c. marketability.d. profitability.

55. Long-term creditors are usually most interested in evaluatinga. liquidity.b. marketability.c. profitability.d. solvency.

56. Stockholders are most interested in evaluatinga. liquidity.b. solvency.c. profitability.d. marketability.

57. In ratio analysis, the ratios are never expressed as aa. rate.b. logarithm.c. percentage.d. simple proportion.

58. The current ratio isa. calculated by dividing current liabilities by current assets.b. used to evaluate a company's liquidity and short-term debt paying ability.c. used to evaluate a company's solvency and long-term debt paying ability.d. calculated by subtracting current liabilities from current assets.

59. The acid-test or quick ratioa. is used to quickly determine a company's solvency and long-term debt paying ability.b. relates cash, short-term investments, and net receivables to current liabilities.c. is calculated by taking one item from the income statement and one item from the balance

sheet.d. is the same as the current ratio except it is rounded to the nearest whole percent.

60. Winter Clothing Store had a balance in the Accounts Receivable account of $390,000 at thebeginning of the year and a balance of $410,000 at the end of the year. Net credit sales during theyear amounted to $4,000,000. The average collection period of the receivables in terms of days wasa. 30 days.b. 365 days.c. 73 days.d. 37 days.

61. Pine Hardware Store had net credit sales of $6,500,000 and cost of goods sold of $5,000,000 forthe year. The Accounts Receivable balances at the beginning and end of the year were $600,000and $700,000, respectively. The receivables turnover wasa. 7.7 times.b. 10.8 times.c. 9.3 times.d. 10 times.

Use the following information for questions 62-63.

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Winslow Department Store had net credit sales of $16,000,000 and cost of goods sold of $12,000,000 forthe year. The average inventory for the year amounted to $2,000,000.

62. Inventory turnover for the year isa. 8 times.b. 14 times.c. 6 times.d. 4 times.

63. The average days in inventory during the year wasa. 91 days.b. 61 days.c. 46 days.d. 26 days.

64. Which one of the following would not be considered a liquidity ratio?a. Current ratiob. Inventory turnoverc. Quick ratiod. Return on assets

65. Asset turnover measuresa. how often a company replaces its assets.b. how efficiently a company uses its assets to generate sales.c. the portion of the assets that have been financed by creditors.d. the overall rate of return on assets.

66. The profit margin ratio is calculated by dividinga. sales by cost of goods sold.b. gross profit by net sales.c. net income by stockholders' equity.d. net income by net sales.

Use the following information for questions 67-68.

Terry Corporation had net income of $200,000 and paid dividends to common stockholders of $40,000 in2002. The weighted average number of shares outstanding in 2002 was 50,000 shares. Terry Corporation'scommon stock is selling for $60 per share on the New York Stock Exchange.

67. Terry Corporation's price-earnings ratio isa. 3.8 times.b. 15 times.c. 18.8 times.d. 6 times.

68. Terry Corporation's payout ratio for 2002 isa. $4 per share.b. 25%.c. 20%.d. 12.5%.

69. Grand Company reported the following on its income statement:


Income before income taxes $400,000Income tax expense 100,000Net income $300,000

An analysis of the income statement revealed that interest expense was $100,000. GrandCompany's times interest earned wasa. 5 times.b. 4 times.c. 3.5 times.d. 3 times.

70. The debt to total assets ratio measuresa. the company's profitability.b. whether interest can be paid on debt in the current year.c. the proportion of interest paid relative to dividends paid.d. the percentage of the total assets provided by creditors.

71. Trading on the equity (leverage) refers to thea. amount of working capital.b. amount of capital provided by owners.c. use of borrowed money to increase the return to owners.d. number of times interest is earned.

72. The current assets of Key Company are $150,000. The current liabilities are $100,000. The currentratio expressed as a proportion isa. 150%.b. 1.5:1c. .67:1d. $150,000 ÷ $100,000.

73. The acid-test ratio is also referred to as thea. short run ratio.b. quick ratio.c. working capital ratio.d. contemporary ratio.

74. A weakness of the current ratio isa. the difficulty of the calculation.b. that it doesn't take into account the composition of the current assets.c. that it is rarely used by sophisticated analysts.d. that it can be expressed as a percentage, as a rate, or as a proportion.

75. A supplier to a company would be most interested in thea. asset turnover ratio.b. profit margin ratio.c. current ratio.d. earnings per share.

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76. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company?

a. Current ratiob. Acid-test ratioc. Asset turnoverd. Receivables turnover

77. Ratios are used as tools in financial analysisa. instead of horizontal and vertical analyses.b. because they can provide information that may not be apparent from inspection of the

individual components of a particular ratio.c. because even single ratios by themselves are quite meaningful.d. because they are prescribed by GAAP.

78. The ratios that are used to determine a company's short-term debt paying ability area. asset turnover, times interest earned, current ratio, and receivables turnover.b. times interest earned, inventory turnover, current ratio, and receivables turnover.c. times interest earned, acid-test ratio, current ratio, and inventory turnover.d. current ratio, acid-test ratio, receivables turnover, and inventory turnover.

79. Tyner Company had $250,000 of current assets and $90,000 of current liabilities beforeborrowing $60,000 from the bank with a 3-month note payable. What effect did theborrowing transaction have on Tyner Company's current ratio?

a. The ratio remained unchanged.b. The change in the current ratio cannot be determined.c. The ratio decreased.d. The ratio increased.

80. A liquidity ratio measures thea. income or operating success of an enterprise over a period of time.b. ability of the enterprise to survive over a long period of time.c. short-term ability of the enterprise to pay its maturing obligations and to

meet unexpected needs for cash.d. number of times interest is earned.

81. If equal amounts are added to the numerator and the denominator of the current ratio, the ratio will always

a. increase.b. decrease.c. stay the same.d. equal zero.

82. The acid-test ratioa. is a quick calculation of an approximation of the current ratio.b. does not include all current liabilities in the calculation.c. does not include inventory as part of the numerator.d. does include prepaid expenses as part of the numerator.


83. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of cash by short-term debt and collection of accounts receivable have on the ratio?

Short-term BorrowingCollection of Receivablea. Increase No effectb. Increase Increasec. Decrease No effectd. Decrease Decrease

84. A company has a receivables turnover of 10 times. The average net receivables during the period are $300,000. What is the amount of net credit sales for the period?

a. $30,000.b. $3,000,000.c. $360,000.d. Cannot be determined from the information given.

85. If the average collection period is 30 days, what is the receivables turnover?a. 11.1 timesb. 12.2 timesc. 6.1 timesd. None of these

86. A general rule to use in assessing the average collection period isa. that it should not exceed 30 days.b. it can be any length as long as the customer continues to buy merchandise.c. that it should not greatly exceed the discount period.d. that it should not greatly exceed the credit term period.

87. Inventory turnover is calculated by dividinga. cost of goods sold by the ending inventory.b. cost of goods sold by the beginning inventory.c. cost of goods sold by the average inventory.d. average inventory by cost of goods sold.

88. A company has an average inventory on hand of $40,000 and its average days in inventory is 73 days. What is the cost of goods sold?

a. $200,000.b. $2,920,000.c. $400,000.d. $1,460,000.

89. A successful grocery store would probably havea. a low inventory turnover.b. a high inventory turnover.c. zero profit margin.d. low volume.

90. An aircraft company would most likely have

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a. a high inventory turnover.b. a low profit margin.c. high volume.d. a low inventory turnover.


91. Net sales are $6,000,000, beginning total assets are $2,800,000, and the asset turnover is 3.0. What is the ending total asset balance?

a. $2,000,000.b. $1,200,000.c. $2,800,000.d. $1,600,000.

92. The numerator of the times interest earned ratio isa. income before income taxes.b. net income.c. net income + interest expense.d. net income + interest expense + income taxes.

93. The return on common stockholders’ equity ratio is computed by dividing net income

a. by average common stockholders’ equity.b. by ending common stockholders’ equity.c. minus preferred stock dividends by average common stockholders’ equity.d. minus preferred stock dividends by ending common stockholders’ equity.

94. The return on assets ratio is affected by thea. asset turnover ratio.b. debt to total assets ratio.c. profit margin ratio.d. asset turnover and profit margin ratios.

95. Measures of the short-term ability of the enterprise to pay its maturing obligations are

a. liquidity ratios.b. marketability ratios.c. profitability ratios.d. solvency ratios.

96. A measure of a company’s immediate short-term liquidity is thea. current ratio.b. current cash debt coverage ratio.c. cash debt coverage ratio.d. acid-test ratio.

97. The ratio that indicates a company’s degree of financial leverage is thea. cash debt coverage ratio.b. debt to total assets ratio.c. free cash flow ratio.d. times interest earned ratio.

98. Earnings per share is computed by dividing net incomea. by average common shares outstanding.b. by ending common shares outstanding.

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c. less preferred stock dividends by average common shares outstanding.d. less preferred stock dividends by ending common shares outstanding.


99. A measure of how efficiently a company uses its assets to generate sales is thea. return on assets ratio.b. profit margin ratio.c. cash return on sales ratio.d. asset turnover ratio.

100. A limitation in calculating ratios in financial statement analysis is thata. it requires a calculator.b. no one other than management would be interested in them.c. some account balances may reflect atypical data at year end.d. they seldom identify problem areas in a company.

101. Which of the following is not a limitation of financial statement analysis?a. The cost basisb. The use of estimatesc. The diversification of firmsd. The availability of information

102. The use of alternative accounting methodsa. is not a problem in ratio analysis because the footnotes disclose the method

used.b. may be a problem in ratio analysis even if disclosed.c. is not a problem in ratio analysis since eventually all methods will lead to

the same end.d. is only a problem in ratio analysis with respect to inventory.

103. Traditional financial statements are based on a. unadjusted cost.b. price-level adjusted cost.c. the lower of cost or price-level adjusted historical cost.d. fair market value.

104. Estimates are used in financial statements in determining all of the following excepta. contingent losses.b. cost of goods sold.c. periodic depreciation.d. warranty costs.

105. In addition to differences in inventory costing methods, differences also exist in reporting all of the following except

a. amortization.b. depletion.c. depreciation.d. warranty costs.

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Answers to Multiple Choice Questions

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.31. d 42. d 53. c 64. d 75. c 86. d 97. b32. a 43. b 54. b 65. b 76. c 87. c 98. c33. b 44. c 55. d 66. d 77. b 88. a 99. d34. d 45. b 56. c 67. b 78. d 89. b 100. c35. b 46. b 57. b 68. c 79. c 90. d 101. d36. b 47. c 58. b 69. a 80. c 91. b 102. b37. a 48. a 59. b 70. d 81. b 92. d 103. a38. b 49. b 60. d 71. c 82. c 93. c 104. b39. b 50. a 61. d 72. b 83. c 94. d 105. d40. c 51. c 62. c 73. b 84. b 95. a41. a 52. b 63. b 74. b 85. b 96. d

EXERCISES

Ex. 106

Indicate whether the following items would be reported as an ordinary or an extraordinary item inHartley Corporation's income statement.

(a) Loss attributable to labor strike.(b) Gain on sale of fixed assets.(c) Loss from fire. Hartley is a chemical company.(d) Loss from sale of marketable securities.(e) Expropriation of property by a foreign government.(f) Loss from tornado damage. Hartley Corporation is located in the Midwest's tornado alley.(g) Loss from government condemnation of property through a newly enacted law.

Solution 106 (6-9 min.)

(a) ordinary (e)extraordinary

(b) ordinary (f) ordinary(c) ordinary (g) extraordinary(d) ordinary

Ex. 107

Stiner Company has income from continuing operations of $480,000 for the year endedDecember 31, 2002. It also has the following items (before considering income taxes):

(1) An extraordinary fire loss of $180,000.(2) A gain of $120,000 on the discontinuance of a major segment.(3) A cumulative effect of a change in accounting principle that resulted in an increase in prior


years' depreciation of $70,000.

Assume all items are subject to income taxes at a 30% tax rate.

InstructionsPrepare an income statement, beginning with income from continuing operations.


STINER COMPANYPartial Income Statement

For the Year Ended December 31, 2002

Income from continuing operations $480,000

Discontinued operationsGain on discontinued segment, net of $36,000 income taxes

84,000Income before extraordinary item and cumulative effect of change in

accounting principle 564,000Extraordinary item

Fire loss, net of $54,000 tax saving (126,000)Cumulative effect of change in accounting principle

Effect on prior years of change in depreciation method, net of $21,000 income tax saving (49,000)

Net income $389,000

Ex. 108

Comparative information taken from the Walters Company financial statements is shown below:

2002 2001 (a) Notes receivable $ 20,000 $ -0-(b) Accounts receivable 182,000 140,000(c) Retained earnings 30,000 (40,000)(d) Income taxes payable 45,000 20,000(e) Sales 900,000 750,000(f) Operating expenses 170,000 200,000

InstructionsUsing horizontal analysis, show the percentage change from 2001 to 2002 with 2001 as the baseyear.


(a) Base year is zero. Not possible to compute.(b) $42,000 ÷ $140,000 = 30% increase(c) Base year is negative. Not possible to compute.

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(d) $25,000 ÷ $20,000 = 125% increase(e) $150,000 ÷ $750,000 = 20% increase(f) $30,000 ÷ $200,000 = 15% decrease

Ex. 109

Cline Corporation had net income of $2,000,000 in 2001. Using 2001 as the base year, net incomedecreased by 70% in 2002 and increased by 175% in 2003.

InstructionsCompute the net income reported by Cline Corporation for 2002 and 2003.


2002: X ÷ $2,000,000 = 70%X = $2,000,000 × .70 = $1,400,000

The decrease is $1,400,000; therefore net income for 2002 is $600,000.

2003: X ÷ $2,000,000 = 175%X = $2,000,000 × 1.75X = $3,500,000

The net income for 2003 is $5,500,000 ($2,000,000 + $3,500,000).

Ex. 110

The following items were taken from the financial statements of Smalley, Inc., over a four-yearperiod:

Item 2003 2002 2001 2000 Net Sales $800,000 $650,000 $600,000 $500,000Cost of Goods Sold 580,000 460,000 420,000 400,000Gross Profit $220,000 $190,000 $180,000 $100,000

InstructionsUsing horizontal analysis and 2000 as the base year, compute the trend percentages for net sales,cost of goods sold, and gross profit. Explain whether the trends are favorable or unfavorable foreach item.


Item 2003 2002 2001 2000Net Sales 160% 130% 120% 100%Cost of Goods Sold 145% 115% 105% 100%


Gross Profit 220% 190% 180% 100%

The trend in net sales is increasing and favorable. The cost of goods sold trend is increasing whichcould be unfavorable, but the sales are increasing each year at a faster pace than cost of goodssold. This is apparent by examining the gross profit percentages, which show a favorable,increasing trend.

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Ex. 111The comparative balance sheet of Grider Company appears below:

GRIDER COMPANYComparative Balance Sheet

December 31,

Assets 2003 2002 Current assets $ 360 $300Plant assets 640 500

Total assets $1,000 $800

Liabilities and stockholders' equityCurrent liabilities $ 150 $120Long-term debt 240 160Common stock 350 280Retained earnings 260 240

Total liabilities and stockholders' equity $1,000 $800

Instructions(a) Using horizontal analysis, show the percentage change for each balance sheet item using

2002 as a base year.(b) Using vertical analysis, prepare a common size comparative balance sheet.


GRIDER COMPANYComparative Balance Sheet

December 31,

(b) (b) (a)Assets 2003 Percent 2002 Percent PercentCurrent assets $ 360 36% $300 38% 20%Plant assets 640 64 500 62 28%

Total assets $1,000 100% $800 100% 25%

Liabilities and stockholders' equityCurrent liabilities $ 150 15% $120 15% 25%Long-term debt 240 24 160 20 50%Common stock 350 35

280 3525%

Retained earnings 260 26 240 30 30%Total liabilities and stockholders' equity $1,000 100% $800 100% 25%

Test Bank for Managerial Accounting, Second Edition13-20


Ex. 112Using the following selected items from the comparative balance sheet of Abbott Company,illustrate horizontal and vertical analysis.

December 31, 2003 December 31, 2002Accounts Receivable $ 840,000 $ 600,000Inventory 975,000 780,000Total Assets 4,000,000 2,500,000


HORIZONTAL ANALYSIS

December 31, 2003 December 31, 2002Accounts Receivable 140% 100%Inventory 125% 100%Total Assets 160% 100%

VERTICAL ANALYSIS

December 31, 2003 December 31, 2002Accounts Receivable 21.0% 24.0%Inventory 24.4% 31.2%Total Assets 100% 100%

Ex. 113

The following information was taken from the financial statements of Larkin Company:

2003 2002 Gross profit on sales $900,000 $840,000Income before income taxes 280,000 230,000Net income 240,000 216,000Net income as a percentage of net sales 8% 9%

Instructions

(a) Compute the net sales for each year.(b) Compute the cost of goods sold in dollars and as a percentage of net sales for each year.(c) Compute operating expenses in dollars and as a percentage of net sales for each year.

(Income taxes are not operating expenses).



Solution 113 (12-15 min.)(a) To calculate net sales divide the net income by the percentage of net income to net sales.

2003 2002 Net Sales $240,000 ÷ 8% = $3,000,000 $216,000 ÷ 9% = $2,400,000

(b) Using the net sales information from (a) and the gross profits given, it is possible to calculatethe cost of goods sold.

2003 2002 Net Sales $3,000,000 $2,400,000Less: Gross profit 900,000 840,000Cost of goods sold $2,100,000 $1,560,000

% of net sales 70% 65%

(c) 2003 2002 Gross profit $900,000 $840,000Less: Income before income taxes 280,000 230,000Operating Expenses $620,000 $610,000

% of net sales 20.7% 25.4%

Ex. 114

Selected information from the comparative financial statements of Fryman Company for the yearended December 31, appears below:

2002 2001 Accounts receivable (net) $ 180,000 $200,000Inventory 140,000 160,000Total assets 1,200,000 800,000Current liabilities 140,000 110,000Long-term debt 400,000 300,000Net credit sales 1,330,000 700,000Cost of goods sold 900,000 530,000Interest expense 50,000 25,000Income tax expense 60,000 29,000Net income 150,000 85,000Net cash provided by operating activities 220,000 135,000

InstructionsAnswer the following questions relating to the year ended December 31, 2002. Show computa-tions.1. The inventory turnover ratio for 2002 is __________.2. The times interest earned ratio in 2002 is __________.3. The debt to total assets ratio for 2002 is __________.


4. The receivables turnover ratio for 2002 is __________.5. The return on assets ratio for 2002 is __________.6. The cash return on sales ratio for 2002 is __________.7. The current cash debt coverage ratio for 2002 is __________.


$900,0001. The inventory turnover ratio for 2002 is 6 times. ———————————— = 6 times.

($140,000 + $160,000) ÷ 2

2. The times interest earned ratio in 2002 is 5.2 times.

$150,000 + $60,000 + $50,000—————————————— = 5.2 times.

$50,000

$140,000 + $400,0003. The debt to total assets ratio for 2002 is 45%. —————————— = 45%.

$1,200,000

$1,330,0004. The receivables turnover ratio for 2002 is 7 times. ———————————— = 7 times.

($180,000 + $200,000) ÷ 2

5. The return on assets ratio for 2002 is 15%.

$150,000

($1,200,000 + $800,000) 2 = 15%

6. The cash return on sales ratio for 2002 is 16.5%. $1,330,000

$220,000

= 16.5%

7. The current cash debt coverage ratio for 2002 is 1.76 times.

2 $140,000) + ($110,000

$220,000

= 1.76 times.

Ex. 115

The comparative balance sheet for Johnson Stoll Company is given below:JOHNSON STOLL COMPANY

Comparative Balance SheetDecember 31,

———————————————————————————————————————————Assets 2003 2002 Cash $ 30,000 $ 45,000Accounts receivable (net) 97,500 90,000Inventory 90,000 75,000Plant assets (net) 300,000 270,000

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Total assets $517,500 $480,000Liabilities and Stockholders' EquityAccounts payable $ 75,000 $ 90,000Mortgage payable (8%) 150,000 150,000Common stock, $10 par 210,000 180,000Retained earnings 82,500 60,000

Total liabilities and stockholders' equity $517,500 $480,000

Ex. 115 (cont.)

Additional information for 2003:1. Income before interest expense and income taxes was $168,000.2. Sales on account were $990,000. Sales returns and allowances amounted to $5,625.3. Cost of goods sold was $676,500.4. Net cash provided by operating activities was $185,625.5. Interest expense totaled $12,000.

InstructionsCompute the following ratios at December 31, 2003:a. Current ratiob. Acid-test ratioc. Current cash debt coverage ratiod. Receivables turnover ratioe. Average collection periodf. Inventory turnoverg. Average days in inventoryh. Debt to total assets ratioi. Times interest earnedj. Cash debt coverage ratio


a. Current ratio = $217,500 ÷ $75,000 = 2.9

b. Acid-test ratio = $127,000 ÷ $75,000 = 1.7

$185,625c. Current cash debt coverage ratio = ——————————— = 2.25

($75,000 + $90,000) ÷ 2

$984,375d. Receivables turnover ratio = ——————————— = 10.5

($97,500 + $90,000) ÷ 2

e. Average collection period = 365 ÷ 10.5 = 35 days


$676,500f. Inventory turnover = ——————————— = 8.2

($90,000 + $75,000) ÷ 2

g. Average days in inventory = 365 ÷ 8.2 = 44.5 days

h. Debt to total assets ratio = $225,000 ÷ $517,500 = .43

i. Times interest earned = $168,000 ÷ $12,000 = 14

$185,625j. Cash debt coverage ratio = ———————————— = .80

($225,000 + $240,000) ÷ 2

Ex. 116

The financial statements of Albert Company appear below:ALBERT COMPANY


———————————————————————————————————————————Assets 2002 2001 Cash $ 25,000 $ 40,000Short-term investments 15,000 60,000Accounts receivable (net) 50,000 30,000Inventory 50,000 70,000Property, plant and equipment (net) 260,000 300,000

Total assets $400,000 $500,000Liabilities and stockholders' equityAccounts payable $ 20,000 $ 30,000Short-term notes payable 30,000 90,000Bonds payable 90,000 160,000Common stock 150,000 150,000Retained earnings 110,000 70,000


ALBERT COMPANYIncome Statement


Net sales $400,000Cost of goods sold 240,000Gross profit 160,000Expenses

Interest expense $18,000Selling expenses 28,000Administrative expenses 24,000

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Total expenses 70,000Income before income taxes 90,000Income tax expense 27,000Net income $ 63,000

Additional information:a. Cash dividends of $23,000 were declared and paid in 2002.b. Weighted-average number of shares of common stock outstanding during 2002 was 30,000

shares.c. Market value of common stock on December 31, 2002, was $21 per share.d. Net cash provided by operating activities for 2002 was $60,000.


Ex. 116 (cont.)InstructionsUsing the financial statements and additional information, compute the following ratios for AlbertCompany for 2002. Show all computations.

Computations

1. Current ratio _________.

2. Return on common stockholders' equity _________.

3. Price-earnings ratio _________.

4. Acid-test ratio _________.

5. Receivables turnover _________.

6. Times interest earned _________.

7. Profit margin ratio _________.

8. Average days in inventory _________.

9. Payout ratio _________.

10. Return on assets _________.

11. Cash return on sales ratio _________.

12. Cash debt coverage ratio _________.


$140,0001. Current ratio 2.8:1. ————— = 2.8

$50,000

$63,0002. Return on common stockholders' equity 26.8%. ———————————— = .268

($250,000 + $220,000) ÷ 2

$63,0003. Price-earnings ratio 10 times. EPS = ———— = $2.10;

30,000

$21——— = 10 times $2.10

$90,0004. Acid-test ratio 1.8:1. ———— = 1.8:1

$50,000

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$400,0005. Receivables turnover 10 times. ——————————— = 10

($50,000 + $30,000) ÷ 2

Solution 116 (cont.)

$63,000 + $27,000 + $18,0006. Times interest earned 6 times.————————————— = 6

$18,000

$63,0007. Profit margin ratio 15.8%. ———— = .158

$400,000

8. Average days in inventory 91.3 days. Inventory turnover =

$240,000——————————— = 4($50,000 + $70,000) ÷ 2

365 days———— = 91.3

4

$23,0009. Payout ratio 36.5%. ———— = .365

$63,000

$63,00010. Return on assets 14%.———————————— = .14

($400,000 + $500,000) ÷ 2

11. Cash return on sales ratio 15%. $400,000

$60,000

= .15

12. Cash debt coverage ratio .29 times. 2 $140,000) + ($280,000

$60,000

= .29 times

Ex. 117

The following ratios have been computed for Ryder Company for 2002.

Profit margin ratio 20%Times interest earned ratio 9 timesReceivable turnover ratio 3 timesAcid test ratio 2:1Current ratio 3:1Debt to total assets ratio 20%

The 2002 financial statements for Ryder Company with missing information follows:



Ex. 117 (cont.)RYDER COMPANY


——————————————————————————————————————————Assets 2002 2001 Cash $ 30,000 $ 45,000Short-term investments 10,000 25,000Accounts receivable (net) ? (6) 40,000Inventory ? (8) 50,000Property, plant, and equipment (net) 200,000 160,000

Total assets $ ? (9) $320,000Liabilities and stockholders' equityAccounts payable $ ? (7) $ 30,000Short-term notes payable 40,000 35,000Bonds payable ? (10) 20,000Common stock 220,000 200,000Retained earnings 60,000 35,000

Total liabilities and stockholders' equity $ ? (11) $320,000

RYDER COMPANYIncome Statement

For the Year Ended December 31, 2002——————————————————————————————————————————Net sales $150,000Cost of goods sold 75,000Gross profit 75,000Expenses:

Depreciation expense $ ? (5)Interest expense 5,000Selling expenses 8,000Administrative expenses 12,000

Total expenses ? (4)Income before income taxes ? (2)

Income tax expense ? (3)Net income $ ? (1)

InstructionsUse the above ratios and information from Ryder Company financial statements to fill in themissing information on the financial statements. Follow the sequence indicated. Showcomputations that support your answers.


Solution 117 (35-40 min.)RYDER COMPANY


———————————————————————————————————————————Assets 2002 2001 Cash $ 30,000 $ 45,000Short-term investments 10,000 25,000Accounts receivable (net) 60,000 (6) 40,000Inventory 50,000 (8) 50,000Property, plant, and equipment (net) 200,000 160,000

Total assets $350,000 (9) $320,000

Liabilities and stockholders' equityAccounts payable $ 10,000 (7) $ 30,000Short-term notes payable 40,000 35,000Bonds payable 20,000 (10) 20,000Common stock 220,000 200,000Retained earnings 60,000 35,000

Total liabilities and stockholders' equity $350,000 (11) $320,000

RYDER COMPANYIncome Statement

For the Year Ended December 31, 2002———————————————————————————————————————————Net sales $150,000Cost of goods sold 75,000Gross profit 75,000Expenses

Depreciation expense $10,000 (5)Interest expense 5,000Selling expenses 8,000Administrative expenses 12,000

Total expenses 35,000 (4)Income before income taxes 40,000 (2)Income tax expense 10,000 (3)Net income $ 30,000 (1)

(1) Net income = $30,000 ($150,000 × 20%).

(2) Income before income taxes = $40,000.Let X = Income before income taxes and interest expense. X——— = 9 times; X = $45,000; $45,000 – $5,000 = $40,000. 5,000

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(3) Income tax expense = $10,000 ($40,000 – $30,000).

(4) Total operating expenses = $35,000 ($75,000 – $40,000).

(5) Depreciation expense = $10,000 [$35,000 – ($5,000 + $8,000 + $12,000)].


(6) Accounts receivable (net) = $60,000.Let X = Average receivables.$150,000———— = 3 times; 3X = $150,000; X = $50,000. X

Let Y = Accounts receivable at 12/31/02. $40,000 + Y—————— = $50,000; $40,000 + Y = $100,000; Y = $60,000.

2

(7) Accounts payable = $10,000.Let X = Current liabilities.$30,000 + $10,000 + $60,000————————————— = 2; 2X= $100,000; X = $50,000; X$50,000 – $40,000 = $10,000.

(8) Inventory = $50,000Let X = Total current assets

X ———— = 3; X = $150,000; $150,000 – ($30,000 + $10,000 + $60,000) = $50,000. $50,000

(9) Total assets = $350,000 ($30,000 + $10,000 + $60,000 + $50,000 + $200,000)

(10) Bonds payable = $20,000Let X = Total debt X———— = 20%; X = $70,000; $70,000 – ($10,000 + $40,000) = $20,000.$350,000

(11) Total liabilities and stockholders' equity = $350,000; same as total assets—see (9) above.


Ex. 118The financial statements for Jacqueline’s Rodeo Wear are given below:

JACQUELINE’S RODEO WEARComparative Balance Sheet

December 31,——————————————————————————————————————————Assets 2003 2002 Current assets

Cash and short-term investments $ 5,040 $ 4,920Accounts receivable (net) 30,240 28,960Inventory 60,480 54,800

Total current assets95,76088,680

Plant assets (net) 156,240 148,200Total assets $252,000 $236,880

Liabilities and stockholders' equityCurrent liabilities $ 42,000 $ 38,600Long-term liabilities 67,200 72,000Common stock 25,000 25,000Retained earnings 117,800 101,280


JACQUELINE’S RODEO WEARIncome Statement


Net sales $360,000Cost of goods sold 252,000Gross profit 108,000Operating expenses (including $7,200 interest and $9,000 income taxes) 68,400Net income $ 39,600

Net cash provided by operating activities totaled $46,800.

Instructions

Compute the following ratios at December 31, 2003:a. Return on assetsb. Profit marginc. Asset turnoverd. Gross profit ratee. Operating expenses to salesf. Cash return on sales

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$39,600a. Return on assets ratio = ———————————— = 16.2%

($252,000 + $236,880) ÷ 2

b. Profit margin ratio = $39,600 ÷ $360,000 = 11%

$360,000c. Asset turnover ratio = ———————————— = 1.47

$252,000 + $236,880) ÷ 2

d. Gross profit rate = $108,00 ÷ $360,000 = 30%

e. Operating expenses to sales ratio = $68,400 ÷ $360,000 = 19%

f. Cash return on sales ratio = $46,800 ÷ $360,000 = 13%

Ex. 119

Selected data for Mary's Store appear below.

2002 2001 Net sales $800,000 $520,000Cost of goods sold 600,000 345,000Inventory at end of year 65,000 85,000Accounts receivable at end of year 90,000 70,000

InstructionsCompute the following for 2002:(a) Gross profit percentage.(b) Inventory turnover.(c) Receivables turnover.


(a) Gross profit = Net Sales – Cost of goods sold= $800,000 – $600,000= $200,000

Gross profit percentage = Gross profit ÷ Net sales


= $200,000 ÷ $800,000= 25%

(b) Inventory turnover = Cost of goods sold ÷ Average inventory= $600,000 ÷ [($65,000 + $85,000) ÷ 2]= 8 times

(c) Receivables turnover = Net credit sales ÷ Average accounts receivables= $800,000 ÷ [($90,000 + $70,000) ÷ 2]= $800,000 ÷ $80,000= 10 times

Ex. 120

Walbeck Corporation has issued common stock only. The company has been successful and has agross profit rate of 20%. The information shown below was taken from the company's financialstatements.

Beginning inventory $ 482,000Purchases 4,836,000Ending inventory ?Average accounts receivable 800,000Average common stockholders' equity 3,500,000Sales (all on credit) 6,000,000Net income 420,000

InstructionsCompute the following:(a) Receivables turnover and the average collection period.(b) The inventory turnover and the average days in inventory.(c) Return on common stockholders' equity.


(a) Credit salesReceivables turnover = —————————————

Average accounts receivable= $6,000,000 ÷ $800,000 =7.5 times

365 days Average collection period = ——————————

Receivables turnover

=365 ÷ 7.5 times = 48.7 days

(b) Inventory turnover = Cost of goods sold ÷ Average inventoryFirst calculate ending inventory.

Beginning Inventory $ 482,000

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+ Purchases 4,836,000– Cost of Goods Sold (4,800,000)*Ending Inventory $ 518,000

*Since the gross profit ratio is 20%, the cost of goods sold ratio is 80%. 80% × $6,000,000 (net sales) = $4,800,000.

Ending Inventory = $518,000 (per above) Average Inventory = ($482,000 + $518,000) ÷ 2 = $500,000 Inventory Turnover = $4,800,000 ÷ $500,000 = 9.6 times Days in Inventory = 365 days ÷ 9.6 times = 38 days

(c) Net incomeReturn on common stockholders' equity =

————————————————— Average common stockholders' equity

= $420,000 ÷ $3,500,000 = 12%

Ex. 121

Bradley Corporation had the following comparative current assets and current liabilities:Dec. 31, 2002 Dec. 31, 2001Current assets

Cash $ 60,000 $ 30,000Short-term investments 40,000 10,000Accounts receivable 55,000 95,000Inventory 110,000 90,000Prepaid expenses 35,000 20,000

Total current assets $300,000 $245,000Current liabilities

Accounts payable $140,000 $110,000Salaries payable 40,000 30,000Income tax payable 20,000 15,000

Total current liabilities $200,000 $155,000

During 2002, credit sales and cost of goods sold were $750,000 and $400,000, respectively. Netcash provided by operating activities for 2002 was $213,000.

InstructionsCompute the following liquidity measures for 2002:1. Current ratio.2. Quick ratio.3. Current cash debt coverage ratio.4. Receivables turnover.5. Inventory turnover.



1. Current ratio = Current assets ÷ Current liabilities= $300,000 ÷ $200,000 =1.5:1

Cash + Short-term investments + Accounts receivable2. Quick ratio = ————————————————————————

Current liabilities

$60,000 + $40,000 + $55,000= ————————————— = .78:1

$200,000

3. Current cash debt coverage ratio = sliabilitie current Average

activities operatingby provided Cash

= $177,500

$213,000

= 1.2 times

Net credit sales4. Receivables turnover = —————————————

Average accounts receivables

$750,000= ———— = 10 times

$75,000


Cost of goods sold5. Inventory turnover = —————————

Average inventory

$400,000= ———— = 4 times

$100,000

Ex. 122

Selected data from O'Brien Company are presented below:

Total assets $1,600,000Average assets1,750,000Net income 245,000Net sales 1,225,000Average common stockholders' equity 1,000,000Net cash provided by operating activities 294,000

InstructionsCalculate the profitability ratios that can be computed from the above information.

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With the information provided, the profitability ratios that can be calculated are as follows:

1. Profit margin =Net income ÷ Net sales

= $245,000 ÷ $1,225,000 = 20%

2. Asset turnover = Net sales ÷ Average assets= $1,225,000 ÷ $1,750,000 = 70%

3. Return on assets = Net income ÷ Average assets= $245,000 ÷ $1,750,000 = 14%

Net income4. Return on common stockholders' equity =

—————————————————Average common stockholders' equity

=$245,000 ÷ $1,000,000 = 24.5%

5. Cash return on sales =

Net cash from operations

Net sales

= $294,000 ÷ $1,225,000 = 24%


Ex. 123The following data are taken from the financial statements of Duncan Company:

2003 2002 Monthly average accounts receivable$ 520,000 $ 500,000Net sales on account 5,200,000 4,500,000Terms for all sales are 2/10, n/30

Instructions

(a) Compute the accounts receivable turnover and the average collection period for both years.(b) What conclusion can an analyst draw about the management of the accounts receivable?


(a) Accounts receivable turnover ratio. 2003 2002

$5,200,000 $4,500,000Accounts receivable turnover ————— —————

520,000 500,000

10 times 9times

365 days 365 daysAverage collection period ———— ————

10 times 9 times

36.5 days40.6 days

(b) The receivables are turning faster in 2003 than they did in 2002. There is still a problemsince the normal credit period is 30 days, and the average collection period for both yearsexceed this target. Therefore, improvement in the management of the receivables wouldappear to be desirable.

Ex. 124

State the effect of the following transactions on the current ratio. Use increase, decrease, or noeffect for your answer.

(a) Collection of an accounts receivable.(b) Declaration of cash dividends.(c) Additional stock is sold for cash.(d) Stock investments are purchased for cash.(e) Equipment is purchased for cash.(f) Inventory purchases are made for cash.(g) Accounts payable are paid.

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(a) no effect (e) decrease(b) decrease (f) no effect(c) increase (g) increase(d) no effect

Ex. 125

The balance sheet for Finley Corporation at the end of the current year indicates the following:

Bonds payable, 8% $4,000,0006% Preferred stock, $100 par 1,000,000Common stock, $10 par 2,000,000

Income before income taxes was $480,000 and income tax expense for the current year amountedto $144,000. Cash dividends paid on common stock were $300,000, and the common stock wasselling for $22 per share at the end of the year. There were no ownership changes during the year.

InstructionsDetermine each of the following:(a) times that bond interest was earned.(b) earnings per share for common stock.(c) price-earnings ratio.


(a) Income before income taxes and interest expenseTimes interest earned = ——————————————————————

Interest expense

$480,000 + $320,000= —————————— = 2.5 times

$320,000

(b) Net income – Preferred dividendsEarnings per share = —————————————————————

Weighted average common shares outstanding

$336,000 – $60,000= ————————— = $1.38 per share

200,000 shares

(c) Market price per share $22.00Price-earnings ratio = —————————— = ——— = 15.9

Earnings per share $1.38


Ex. 126

The income statement for Pine Company for the year ended December 31, 2002 appears below.

Sales $620,000Cost of goods sold 380,000Gross profit 240,000Expenses 190,000*Net income $ 50,000

*Includes $20,000 of interest expense and $22,000 of income tax expense.

Ex. 126 (cont.)

Additional information:1. Common stock outstanding on January 1, 2002 was 50,000 shares. On July 1, 2002, 10,000

more shares were issued.2. The market price of Pine's stock was $16 at the end of 2002.3. Cash dividends of $30,000 were paid, $6,000 of which were paid to preferred stockholders.

InstructionsCompute the following ratios for 2002:(a) earnings per share.(b) price-earnings.(c) times interest earned.


$50,000 – $6,000$44,000

(a) Earnings per share = —————————— =———— = $0.80

[50,000 + (10,000 ÷ 2)] 55,000

$16.00(b) Price-earnings = ——— =20 times

0.80

$50,000 + $20,000 + $22,000(c) Times interest earned =————————————— = 4.6 times

$20,000

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COMPLETION STATEMENTS

127. Discontinued operations refers to the disposal of a __________________ of a business.

128. The two criteria necessary for an item to be classified as an extraordinary item are that the

transaction or event must be (1) _______________ and (2) ________________.

129. A change in depreciation methods during the year would be classified as a change in

____________________.

130. ______________ analysis, also called trend analysis, is a technique for evaluating a series of

financial statement data over a period of time.

131. Expressing each item in a financial statement as a percent of a base amount is called

______________ analysis.

132. For analysis of the financial statements, ratios can be classified into three types:

(1)_____________ ratios, (2)_____________ ratios, and (3)______________ ratios.

133. The times interest earned ratio is calculated by dividing ___________________ before

__________________ and __________________ by interest expense.

134. The ratios used in evaluating a company's liquidity and short-term debt paying ability that

complement each other are the ______________ ratio and the ______________ ratio.

135. The receivables turnover ratio is calculated by dividing ________________ by average

___________________.

136. If the inventory turnover ratio is 5 times, and the average inventory was $600,000, the cost of

goods sold during the year was $______________ and the average days to sell the inventory was

______________ days.

137. Hansen Corporation had net income for the year of $300,000 and a profit margin ratio of 25%. If

total average assets were $200,000, the asset turnover ratio was ____________ times.

138. The ______________ ratio measures the percentage of earnings distributed in the form of cash

dividends.

139. The lower the _______________ to _______________ ratio, the more equity "buffer" is available

to the creditors if the company becomes insolvent.


Answers to Completion Statements127. significant segment 134. current, acid-test (quick)128. unusual in nature, infrequent in occurrence 135. net credit sales, net receivables129. accounting principle 136. 3,000,000, 73130. Horizontal 137. 6131. vertical (common size) 138. payout132. liquidity, solvency, profitability (any order) 139. debt, total assets133. income, income taxes, interest expense

MATCHING

Set 1

140. For each of the ratios listed below, indicate by the appropriate code letter, whether it is aliquidity ratio, a profitability ratio, or a solvency ratio.

Code:L = Liquidity ratioP = Profitability ratioS = Solvency ratio

____ 1. Cash return on sales ratio____ 2. Return on assets ratio____ 3. Receivables turnover ratio____ 4. Earnings per share ratio____ 5. Payout ratio____ 6. Current cash debt coverage ratio____ 7. Acid-test ratio____ 8. Debt to total assets ratio____ 9. Free cash flow____ 10. Inventory turnover ratio

Answers to Matching Set 1

P 1. Cash return on sales ratio L 6. Current

cash debt coverage ratio

P 2. Return on assets ratio L 7. Acid-test ratio

L 3. Receivables turnover ratio S 8. Debt to

total assets ratio

P 4. Earnings per share ratio S 9. Free

cash flow

P 5. Payout ratio L 10. Inventory turnover ratio

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Set 2141. Match the ratios with the appropriate ratio computation by entering the appropriate letter in

the space provided.

A. Current ratio F. Times interest earned ratioB. Acid-test ratio G. Inventory turnover ratioC. Profit margin ratio H. Average collection periodD. Asset turnover ratio I. Average days in inventoryE. Price-earnings ratio J. Payout ratio

Cost of goods sold ____ 1. —————————

Average inventory

Net income____ 2. —————

Net sales

Cash dividends____ 3. ———————

Net income

Net sales____ 4. ———————

Average assets

Current assets____ 5. ————————

Current liabilities

365 days____ 6. ——————————

Receivables turnover

Market price per share of stock____ 7. ——————————————

Earnings per share

365 days____ 8. ————————

Inventory turnover

Income before income taxes and interest expense____ 9. ——————————————————————

Interest expense

Cash + Short-term investments + Receivables (net)____ 10. ———————————————————————

Current liabilities

Answers to Matching Set 2

1. G 6. H2. C 7. E3. J 8. I

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4. D 9. F5. A 10. B

SHORT-ANSWER ESSAY QUESTIONS

S-A E 142

Horizontal and vertical analyses are analytical tools frequently used to analyze financialstatements. What type of information or insights can be obtained by using these two techniques?Explain how the output of horizontal analysis and vertical analysis can be compared to industryaverages and/or competitive companies.

Solution 142

Horizontal analysis allows an analyst to develop a picture of current trends in a company'soperations. The analyst can see whether the accounts are increasing or decreasing and how largethese changes actually are. Vertical analysis allows an analyst to evaluate financial statementitems within a single financial statement. This technique helps the analyst to evaluate the relativesize of the financial statement items and how the items relate to the financial statement as a whole.An example would be if current liabilities were a very large percentage of total liabilities andstockholders' equity.

Both techniques allow the company to evaluate their performance and position relative to theircompetitors and their industry as a whole. For example, the company could evaluate their currenttrend in sales and see how favorably their sales performance compared to the sales performance ofother companies in the industry. Another example would be comparing the relative size of long-term liabilities or retained earnings. This would show which companies have taken on a largeamount of debt and which companies have reinvested earnings.

S-A E 143

The use of estimates, cost, alternative accounting methods, the presence of atypical data, anddiversification of firms have been cited as factors that limit the usefulness of financial statementanalysis. Identify a ratio and explain how one or more of the limiting factors can affect theusefulness of that ratio.

Solution 143

Any of the profitability ratios that involve net income will be affected by the method ofdepreciation chosen. The use of an accelerated method, such as double-declining balance, willresult in higher depreciation costs in the early years and lower depreciation costs in the later years.These costs will differ from the depreciation costs that would have been incurred if the straight-line method had been used. Therefore, because of the different costs, net income will also be


different. Thus, the choice of depreciation method affects net income, which in turn affects theratio.

Both the acid-test ratio and the receivables turnover ratio are affected by the estimate ofuncollectible accounts. The estimate will determine the amount of net receivables used tocalculate the ratio. A high estimate will lower the net receivables and a low estimate will increasethe net receivables. Thus, the accuracy of the estimate will have a direct effect on the accuracy ofthe ratio.

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S-A E 144 (Ethics)A trusted employee of Wilderness Tours was caught in the act of embezzling funds. He confessedto earlier embezzlements, but retracted the confession on the advice of his attorney. Over thecourse of the most recent quarter, it has been determined that $20,000 was embezzled.

Wilderness Tours has suffered adverse publicity in the recent past because of serious injury to fivetourists that occurred during a two week "Winter Wilds Adventure" tour. The company hastherefore decided to avoid publicity and has agreed to drop all charges against the embezzlingemployee. In return, the employee has agreed to a notation of "Terminated—Not to be Rehired" tobe appended to his personnel file.

Required:1. Who are the stakeholders in the decision not to prosecute?2. Was it ethical for the company to decide not to prosecute? Explain.

Solution 144

1. The stakeholders includeThe embezzling employeeThe other employeesCompany managementOther companies who might hire the embezzling employee

2. The company was certainly within its legal rights not to prosecute the embezzling employee.However, the decision not to prosecute may not be ethical. First, it does not serve publicjustice. The embezzling employee could find a job elsewhere, and harm someone elsefinancially. Second, to the extent that other employees know of the act and of the decision,morale may be harmed. The decision is also not the best one for the employee. Having neverbeen forced to face the consequences of his dishonest acts, he is not deterred from (and mayeven feel encouraged to) commit similar acts in the future. The one argument that wouldsupport the premise that the decision was ethical is that the public disclosure would causeharm greater than that caused by keeping silent. Even this argument lacks force, because itimplies a lack of moral courageousness.

S-A E 145 (Communication)

Fast Express specializes in the transportation of medical equipment and laboratory specimensovernight. The company has selected the following information from its most recent annual reportto be the subject of an immediate press release.The financial statements are being released.Net income this year was $2.1 million. Last year's net income had been $1.8 million.The current ratio has changed to 2:1 from last year's 1.5:1The debt/total assets ratio has changed to 4:5 from last year's 3:5The company expanded its truck fleet substantially by purchasing ten new delivery vans.The company already had twelve delivery vans. The company is now the largest medical courier

in the mid-Atlantic region.


Required:Prepare a brief press release incorporating the information above. Include all information. Thinkcarefully which information (if any) is good news for the company, and which (if any) is badnews.

Solution 145

Fast Express released its financial statements today, disclosing a 17% increase in earnings, to $2.1million from $1.8 million last year. The company also improved its short-term liquidity. Itscurrent ratio improved to 2:1 from last year's 1.5:1. Part of the improved performance is no doubtdue to the addition of ten new delivery vans to its fleet, allowing it to become the largest medicalcourier in the mid-Atlantic region. The purchase of the vans, however, caused the debt/total assetratio to decline. There are now $4 of debt for every $5 in assets, while last year, there were only$3 of debt to $5 in assets.

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Documents

MAS FS Analysis 40pages