Introduction to Financial Accounting, 10e (Horngren)
Chapter 12 Financial Statement Analysis
Learning Objective 12.1 Questions
12.1-1) In addition to annual reports, financial information regarding a company can come from all of the
following sources except
A) a company’s own press releases.
B) the popular press.
C) stockbrokers.
D) the Web site.
E) the Internal Revenue Service.
12.1-2) Timely information can be found in a company’s press release. Companies provide the public with
news about all the following company developments except
A) the most profitable products.
B) issuance or retirement of debt.
C) changes in production plans.
D) acquisition or sale of assets or business units.
E) new orders.
12.1-3) A proforma statement is
A) a comparative financial statement of the current year’s results versus the prior year’s results.
B) a statement by management, commenting on the results of the current operating period.
C) a carefully formulated expression of predicted results.
D) an agreement between a company and its lenders, describing details concerning the loan payback.
E) a statement by the Internal Revenue Service, accepting a company’s tax returns.
12.1-4) Which of the following statement(s) describe the principal reason(s) why investors and creditors
use financial statement analysis?
1. To assess the risks associated with expected returns
2. To evaluate top and middle level management
3. To predict the amount of expected returns
4. To establish recommended dividend and interest payments
A) 1 and 2
B) 1, 2, and 3
C) 1 and 3
D) 1 and 4
E) 2, 3, and 4
12.1-5) Short–term liquidity is
A) a company’s ability to turn accounts receivable into cash.
B) a company’s ability to meet current payments as they become due.
C) current assets divided by current liabilities.
D) a company’s ability to sell inventory.
E) a company’s ability to shift current liabilities into long–term liabilities.
12.1-6) List the assets in the order from most liquid to least liquid.
A) Inventory, accounts receivable, cash
B) Inventory, cash, accounts receivable
C) Accounts receivable, inventory, cash
D) Cash, inventory, accounts receivable
E) Cash, accounts receivable, inventory
12.1-7) With respect to creditors and equity investors, which of the following statements is incorrect?
A) Creditors are concerned with assessing the short–term liquidity of a company.
B) Creditors are concerned with assessing the long–term solvency of a company.
C) Equity investors are concerned about dividend payments.
D) Both creditors and equity investors are concerned about profitability.
E) Creditors are more concerned about future security prices.
12.1-8) The internet is a powerful, useful tool used by investors. Which statement is false regarding the
internet as it relates to investors?
A) The internet provides almost immediate access to company press releases including company
profitability.
B) Investors can purchase and sell securities online without the use of a broker.
C) The Internet is always an accurate source of investor relations.
D) An investor can use the Internet to check credit information on potential investment companies.
E) Often purchasing and selling stock online is free, but there are instances when an investor must have a
brokerage account and pay for services.
12.1-9) Since financial statements report on past results, they are not particularly useful to investors and
creditors, who want to predict future returns and their risks.
12.1-10) A pro forma statement is a carefully formulated expression of predicted results.
12.1-11) Short–term liquidity refers to an organization’s ability to generate enough cash to repay long–term
debts as they mature.
12.1-12) Long–term solvency refers to an organization’s ability to meet current payments as they become
due.
12.1-13) The disclosure practices that have evolved in the United States have the specific purpose of
providing information to tax authorities.
12.1-14) Annual reports and Securities and Exchange Commission (SEC) reports are timely, since they
usually precede the events being reported.
12.1-15) Investors purchase capital stock expecting to receive dividends and an increase in the value of
the stock.
12.1-16) Describe several advantages and several disadvantages to investor access to the Internet.
Learning Objective 12.2 Questions
Table 12–1
Bandroni Company
Income Statement
For Years Ended December 31, 2X10 and 2X09
2X10 2X09
Sales $900 $800
Less Cost of Goods Sold 470 440
Gross Profit $430 $360
Operating Expenses:
Wage Expense $ 95 $ 90
Rent Expense 35 30
Miscellaneous Expense 20 15
Depreciation Expense 25 20
Total Operating Expenses $175 $155
Operating Income $255 $205
Less Other Expenses:
Interest Expense 15 10
Income Before Tax $240 $195
Less Income Tax Expense 110 85
Net Income $130 $110
12.2-1) Referring to Table 12–1, what is the percentage increase or (decrease) in wage expense for
Bandroni Company?
A) 5.3%
B) (5.3)%
C) 2.6%
D) (5.6)%
E) 5.6%
12.2-2) Referring to Table 12–1, what is the percentage increase or (decrease) in interest expense for
Bandroni Company?
A) 33.3%
B) (50.0)%
C) (33.3)%
D) (100.0)%
E) 50.0%
12.2-3) Referring to Table 12–1, what is the percentage increase or (decrease) in gross profit for Bandroni
Company?
A) (19.4)%
B) (12.5)%
C) 6.8%
D) 12.5%
E) 19.4%
12.2-4) Referring to Table 12–1, what issue would be of most concern or source of optimism, from the
perspective of equity investors regarding the financial performance of Bandroni Company?
A) Income taxes increased 29.4% concern.
B) Miscellaneous expense increased 33% concern.
C) There was a 23% increase in income before taxes optimism.
D) There was only a 6.8% increase in cost of goods sold with a 12.5% increase in sales optimism.
E) Income tax rates went up 2.2% concern.
12.2-5) Referring to Table 12–1, if a common size income statement were prepared, what percentage
would be attributable to the 2X09 wage expense of Bandroni Company?
A) 10.5%
B) 81.8%
C) 46.2%
D) 58.1%
E) 11.3%
12.2-6) Referring to Table 12–1, if a common size income statement were prepared, what percentage
would be attributable to the 2X10 wage expense of Bandroni Company?
A) 10.6%
B) 11.2%
C) 46.2%
D) 58.1%
E) 81.8%
12.2-7) Referring to Table 12–1, if a common size income statement were prepared, what percentage
would be attributable to the 2X10 cost of goods sold of Bandroni Company?
A) 52.2%
B) 19.4%
C) 28.3%
D) 2.2%
E) 100%
12.2-8) Referring to Table 12–1, if a common size income statement were prepared, what percentage
would be attributable to the 2X10 sales of Bandroni Company?
A) 2.2%
B) 19.4%
C) 28.3%
D) 52.2%
E) 100%
Table 12–2
Broadsheet Publishing Group
Balance Sheet
December 31, 2X10 and 2X09
Current Assets: 2X10 2X09
Cash $200 $130
Accounts Receivable 220 100
Inventory 120 200
Prepaid Insurance 15 40
Total Current Assets $555 $470
Long–Term Assets:
Fixed Assets $210 $230
Less Accumulated Depreciation (135) (115)
Total Long–Term Assets $ 75 $115
Total Assets $630 $585
Current Liabilities:
Accounts Payable $ 90 $ 75
Wages Payable 20 15
Current Portion of Long–term Notes Payable 120 30
Total Current Liabilities $230 $120
Long–Term Liabilities:
Notes Payable 90 180
Total Liabilities $320 $300
Stockholders’ Equity:
Common Stock $100 $ 80
Retained Earnings 210 205
Total Stockholders’ Equity $310 $285
Total Liabilities & Stockholders’ Equity $630 $585
12.2-9) Referring to Table 12–2, what is the percentage increase or (decrease) in wages payable for
Broadsheet Publishing Group?
A) (33.3)%
B) (25.0)%
C) (12.5)%
D) 25.0%
E) 33.3%
12.2-10) Referring to Table 12–2, what is the percentage increase or (decrease) in accounts receivable for
Broadsheet Publishing Group?
A) (120.0)%
B) (54.5)%
C) 27.3%
D) 54.5%
E) 120.0%
12.2-11) Referring to Table 12–2, what is the percentage increase or (decrease) in inventory for Broadsheet
Publishing Group?
A) (120.0)%
B) 120.0%
C) 40.0%
D) 62.5%
E) (40.0)%
12.2-12) Referring to Table 12–2, what issue would be of most concern or source of optimism on behalf of
banks or other creditors of Broadsheet Publishing Group?
A) Prepaid insurance decreased 62.5% concern.
B) The current portion of long–term notes payable increased by 300% concern.
C) Accounts receivable increased 120% concern.
D) Fixed assets decreased 9% concern.
E) Total liabilities increased 7% concern.
12.2-13) Referring to Table 12–2, if a common size balance sheet were prepared, what percentage would be
attributable to the 2X09 long–term note payable of Broadsheet Publishing Group?
A) 30.8%
B) 60.0%
C) 63.2%
D) 69.2%
E) 100.0%
12.2-14) Referring to Table 12–2, if a common size balance sheet were prepared, what percentage would be
attributable to the 2X10 inventory of Broadsheet Publishing Group?
A) 19.0%
B) 21.6%
C) 38.7%
D) 52.2%
E) 60.0%
12.2-15) The Management Discussion and Analysis (MDA) section of the annual report concentrates on
A) analyzing the possible acquisition of other companies, and how those new acquisitions would mesh
within the current corporate structure.
B) describing the background of management personnel, how long they have held their current position,
and how long and in what capacities each manager has worked for the company.
C) examining how the company is performing relative to other companies in the industry.
D) explaining the major changes in the income statement and the major changes in liquidity and capital
resources.
E) explaining the auditor report.
12.2-16) Segment reporting can disclose information on all except which of the following?
A) Each top executive’s area of responsibility
B) Export disclosures
C) Major customers
D) Geographic segments
E) Industry segments
12.2-17) Horizontal analysis should be used
A) only with income statement accounts.
B) only with balance sheet accounts.
C) only with statement of stockholders’ equity accounts.
D) only when common–size statements are prepared.
E) on income statement and balance sheet accounts as warranted.
12.2-18) Trend analysis involves comparing data on one financial statement with other data on the same
financial statement.
12.2-19) Trend analysis prompts investors to ask themselves what could cause the trends to end.
12.2-20) For a given account, both the amount of the change from one year to the next and the percentage
of change are needed to recognize trends and understand their true meaning.
12.2-21) Percentage changes from one year to the next cannot be added and subtracted to obtain subtotals
from a company’s comparative balance sheets.
12.2-22) Percentage changes cannot be added and subtracted to obtain subtotals from common–size
income statements and balance sheets.
12.2-23) A management discussion and analysis (MD&A), as well as segment reporting, are part of a
company’s annual report.
12.2-24) Common–size statements aid in comparing companies of different sizes.
12.2-25) The common–size income statement percentages are based on cost of goods sold = 100%.
12.2-26) Each element on a common–size balance sheet is compared to total liabilities.
12.2-27) Component percentages are elements of financial statements that express each component as a
percentage of the total.
12
12.2-28) The MD&A section of a corporation‘s annual report contains information about changes in the
income statement, liquidity, and capital resources.
Table 12–3
Clorinator, Inc.
Comparative Statements of Income
For the Years Ending December 31, 2X10 and 2X09
2X10 2X09
Sales $750 $690
Cost of Goods Sold 440 400
Gross Profit $310 $290
Less: Operating Expenses 220 205
Operating Income $ 90 $ 85
Less: Income Tax Expense 40 37
Net Income $ 50 $ 48
Clorinator, Inc.
Comparative Balance Sheets
December 31, 2X10 and 2X09
2X10 2X09 2X10 2X09
Current Assets: Liabilities:
Cash $ 20 $ 15 Accounts Payable $ 24 $ 20
Accounts Receivable 45 37 Taxes Payable 11 15
Inventory 60 70 Note Payable–Current 7 18
Total Current Assets $125 $122 Total Current Liab. $ 42 $ 53
Long–Term Assets: Long–Term Liabilities 80 30
Equipment $290 $200 Total Liabilities $122 $ 83
Less: Accum. Depr. (160) (140) Stockholders’ Equity:
Total Long–Term Assets $130 $ 60 Common Stock $ 40 $ 40
Retained Earnings 93 59
Stockholders Equity $133 $ 99
Total Liab. &
Total Assets $255 $182 Stockholders’ Equity $255 $182
12.2-29) Referring to Table 12–3, determine the increase or decrease in dollars and percentage for each line
in the income statement.
12.2-30) Referring to Table 12–3, determine the increase or decrease in dollars and percentage for each line
on the balance sheet.
12.2-31) Referring to Table 12–3, prepare a common–size statement for Clorinator, Inc.’s Comparative
Statements of Income for 2X10 and 2X09.
12.2-32) Referring to Table 12–3, prepare a common–size statement for Clorinator, Inc.’s Balance Sheet for
2X10.
12.2-33) Trend analysis and common–size financial statements are important analytical techniques used to
evaluate the strength of published financial statements.
a. Define:
1. trend analysis
2. common–size financial statements
b. How is each of these techniques helpful in the analysis of financial statements?
Learning Objective 12.3 Questions
12.3-1) How is working capital calculated?
A) (total current assets) minus (total current liabilities)
B) (total current assets) minus (inventories and prepaid assets)
C) (total current assets) divided by (total current liabilities)
D) (total current assets)
E) (total current liabilities)
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Table 12–4
Carson Picture Company
Income Statement
(in thousands)
For the Years Ended December 31, 2X10 and 2X09
2X10 2X09
Sales $999 $800
Less Cost of Goods Sold 399 336
Gross Profit $600 $464
Less Operating Expenses:
Wage Expenses $214 $150
Rent Expense 120 120
Miscellaneous Expense 100 50
Depreciation Expense 40 40
Total Operating Expenses $474 $360
Operating Income $126 $104
Less Other Expense:
Interest Revenue $ 36 $ 36
Interest Expense (12) (12)
Income before Tax $150 $128
Less: Income Tax Expense 60 48
Net Income $ 90 $ 80
Earnings Per Share $ .45 $ .40
Annual Common Dividends Per Share $ .40 $ .20
Closing Market Price Common Stock, 12/31 $9.00 $6.00
Current Assets: 2X10 2X09
Cash $150 $ 57
Accounts Receivable 95 70
Accrued Interest Receivable 15 15
Inventory 20 60
Prepaid Rent 10 —
Total Current Assets $290 $202
Long–Term Assets:
Long–Term Note Receivable $288 $288
Equipment, less Accumulated Depreciation
of $120 and $80 80 120
Total Long–Term Assets $368 $408
Total Assets $658 $610
Current Liabilities:
Accounts Payable $ 90 $ 65
Accrued Wages Payable 24 10
Accrued Income Taxes Payable 16 12
Accrued Interest Payable 9 9
Unearned Sales Revenue — 5
Current Portion
of Long–Term Notes Payable 80 —
Total Current Liabilities $219 $101
Long–Term Liabilities:
Notes Payable 40 120
Total Liabilities $259 $221
Stockholders’ Equity:
Common Stock $102 $102
Retained Earnings 297 287
Total Stockholders’ Equity $399 $389
Total Liabilities and
Stockholders’ Equity $658 $610
12.3-2) Referring to Table 12–4, what is the gross profit rate for Carson Picture Company in 2X10? Has the
gross profit rate improved or not improved since 2X09?
A) 58.0%, improved
B) 39.9%, not improved
C) 58.0%, not improved
D) 39.9%, improved
E) 60.1%, improved
12.3-3) Referring to Table 12–4, what is the working capital for Carson Picture Company in 2X10? Has the
working capital improved or not improved since 2X09?
A) $101, not improved
B) $101, improved
C) $ 71, improved
D) $ 71, not improved
E) $150, not improved
12.3-4) Referring to Table 12–4, what is the current ratio for Carson Picture Company in 2X10? Has the
current ratio improved or not improved since 2X09?
A) 2.0, improved
B) 1.3, improved
C) 1.3, not improved
D) 0.5, improved
E) 2.0, not improved
12.3-5) Referring to Table 12–4, what is the quick ratio for Carson Picture Company in 2X10? Has the
quick ratio improved or not improved since 2X09?
A) 2.0, not improved
B) 1.2, not improved
C) 1.3, improved
D) 1.3, not improved
E) 1.1, improved
12.3-6) Referring to Table 12–4, what is the average collection period in days for Carson Picture Company
in 2X10? Has the average collection period in days improved or not improved since 2X09?
A) 30.0, not improved
B) 10.0, unknown
C) 10.0, improved
D) 30.0, improved
E) 30.2, unknown
12.3-7) Referring to Table 12–4, what is the inventory turnover for Carson Picture Company in 2X10? Has
the inventory turnover improved or not improved since 2X09?
A) 10.0, improved
B) 10.0, unknown
C) 10.0, not improved
D) 30.0, improved
E) 30.0, not improved
12.3-8) Referring to Table 12–4, what is the earnings per share for Carson Picture Company in 2X10? Has
the earnings per share improved or not improved since 2X09?
A) $.40, improved
B) $.40, not improved
C) $.40, unknown
D) $.45, not improved
E) $.45, improved
12.3-9) Referring to Table 12–4, what is the price–earnings ratio for Carson Picture Company in 2X10? Has
the price–earnings ratio improved or not improved since 2X09?
A) 15, not improved
B) 15, improved
C) 15, unknown
D) 20, improved
E) 20, not improved
12.3-10) Referring to Table 12–4, what is the dividend–yield for Carson Picture Company in 2X10? Has the
dividend–yield increased or decreased since 2X09?
A) 10.0%, decreased
B) 3.3%, decreased
C) 4.4%, increased
D) 4.4%, decreased
E) 3.3%, increased
12.3-11) Referring to Table 12–4, what is the dividend–payout for Carson Picture Company in 2X10? Has
the dividend–payout increased or decreased since 2X09?
A) 100%, increased
B) 89%, decreased
C) 89%, increased
D) 50%, increased
E) 50%, decreased
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Table 12–5
The following are the income statements and balance sheets for Amazon Pools and Spas at and for the
years ended December 31, 2X10, 2X09, and 2X08:
Amazon Pools and Spas
Combined Statements of Income
For the Years Ended December 31, 2X10, 2X09, and 2X08
2X10 2X09 2X08
Sales (all credit sales) $800 $740 $675
Less Cost of Goods Sold 525 490 450
Gross Profit $275 $250 $225
Less Operating Expenses 150 140 125
Operating Income $125 $110 $100
Less Other Expense: Interest 10 8 5
Income before Tax $115 $102 $ 95
Less Income Tax Expense 51 46 43
Net Income $ 64 $ 56 $ 52
Amazon Pools and Spas
Consolidated Balance Sheets
December 31, 2X10, 2X09, and 2X08
2X10 2X09 2X08
Current Assets:
Cash $ 25 $ 20 $ 15
Accts Receivable 90 70 60
Inventory 65 50 40
Prepaid Rent 10 15 5
Total Current Assets $190 $155 $120
Long–Term Assets:
Equipment $160 $155 $140
Accumulated Depreciation (100) (95) (85)
Total Long–Term Assets $ 60 $ 60 $ 55
Total Assets $250 $215 $175