Chapter 13: Financial Statement Analysis
141. Presented below are selected data from the financial statements of Provost Corp.
2017
2016
Net income
$110,000
$123,000
Cash dividends paid on common stock
$42,000
$38,000
Market price per share of common stock at the end of the year
$16.00
$13.00
Shares of common stock outstanding
140,000
140,000
The dividend payout ratio for 2017 is
a.
1.8%
b.
30.0%
c.
36.3%
d.
38.0%
ANSWER:
d
RATIONALE:
$42,000 / 140,000 = 0.30
$110,000 / 140,000 = 0.79
0.30 / 0.79 = 38.0%
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Analyzing
142. Squid Lips, Inc. wants to measure the relationship between profitability and the investment made by stockholders.
Squid Lips should use the
a.
return on stockholders’ equity ratio.
b.
earnings per share.
c.
profit margin.
d.
statement of retained earnings.
ANSWER:
a
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Understanding
143. Because of its relationship to dividends and market price, which ratio is important to investors?
a.
current ratio
b.
debt-to-equity ratio
c.
price/earnings ratio
d.
asset turnover ratio
ANSWER:
c
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Understanding
144. The concept of leverage is
a.
it is appropriate to borrow if the return on the assets is greater than the cost of the financing.
b.
it is appropriate to borrow as long as the lender approves the loan.
c.
it is unfavorable to borrow funds rather than raise the capital from stockholders.
d.
that a high debt-to–equity ratio is favorable.
ANSWER:
a
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Understanding
145. Which of the following is not a characteristic of extraordinary items reported on the income statement?
a.
appear near the end of the income statement
b.
reported separately from continuing operations
c.
shown net of tax effects
d.
is shown as a combined amount with discontinued operations
ANSWER:
d
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-07 – LO: 13-07
KEYWORDS:
Bloom’s: Understanding
146. Which of the following is true concerning discontinued operations?
a.
Only the gain or loss is reported on the income statement.
b.
It must be both unusual in nature and infrequent in occurrence.
c.
Analysts would not normally include this item in making their decisions.
d.
Net income or loss from prior years must also be disclosed in the year of disposition.
ANSWER:
c
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-07 – LO: 13-07
KEYWORDS:
Bloom’s: Understanding
147. Which of the following items need not be reported separately at the bottom of the income statement?
a.
Profitability ratios
b.
Discontinued operations
c.
Extraordinary gains and losses
d.
Cumulative effect of a change in accounting principle
ANSWER:
a
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-07 – LO: 13-07
KEYWORDS:
Bloom’s: Understanding
148. A gain or loss that qualifies for extraordinary treatment on the income statement must have which of the following
qualities?
I. Unusual in Nature
II. Discontinued Segment
III. Infrequent in Occurrence
IV. Nonoperating in Nature
V. Never Occurred
a.
I and V
b.
III and IV
c.
I and III
d.
I, II, and III
ANSWER:
c
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-07 – LO: 13-07
KEYWORDS:
Bloom’s: Understanding
Multiple Response
have more than one response to each ratio. Some accounts or amounts may not be used at all. (Select all that apply.)
a.
Total liabilities
b.
Total stockholders’ equity
c.
Net income
d.
Interest expense
e.
Income tax expense
Cash flow from operations before interest and tax payments
g.
Cash paid for acquisitions
h.
Cash flow from operations
ANSWER:
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-05 – LO: 13-05
KEYWORDS:
Bloom’s: Remembering
150. Cash flow from operations to capital expenditures ratio
a.
Interest expense
b.
Income tax expense
c.
Cash flow from operations before interest and tax payments
d.
Cash paid for acquisitions
e.
Cash flow from operations
f.
Total dividends paid
g.
Interest payments
h.
Principal payments on debt
ANSWER:
d, e, f
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-05 – LO: 13-05
KEYWORDS:
Bloom’s: Remembering
151. Debt-to-equity ratio
a.
Total liabilities
b.
Total stockholders’ equity
c.
Net income
d.
Interest expense
e.
Cash flow from operations before interest and tax payments
f.
Cash paid for acquisitions
g.
Cash flow from operations
h.
Total dividends paid
ANSWER:
a, b
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-05 – LO: 13-05
KEYWORDS:
Bloom’s: Remembering
152. Debt service coverage ratio
a.
Interest expense
b.
Income tax expense
c.
Cash flow from operations before interest and tax payments
d.
Cash paid for acquisitions
e.
Cash flow from operations
f.
Total dividends paid
g.
Interest payments
h.
Principal payments on debt
ANSWER:
c, g, h
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-05 – LO: 13-05
KEYWORDS:
Bloom’s: Remembering
156. Return on sales ratio
a.
Market price per share
b.
Net sales
c.
Gross profit
d.
Average total assets
e.
Interest expense, net of tax
f.
Net income
g.
Total liabilities
h.
Total assets
ANSWER:
b, e, f
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Remembering
157. Dividend yield ratio
a.
Market price per share
b.
Net sales
c.
Average inventory outstanding
d.
Interest expense, net of tax
e.
Common dividends per share
f.
Preferred dividends per share
g.
Weighted average number of common shares outstanding
h.
Total stockholders’ equity
ANSWER:
a, e
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Remembering
Completion
158. ______________, or an increase in the level of prices, is another important consideration in analyzing financial
statements.
ANSWER:
Inflation
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-01 – LO: 13-01
KEYWORDS:
Bloom’s: Remembering
159. _____________ ratio is capable of telling the user everything there is to know about a particular company.
ANSWER:
No single
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-01 – LO: 13-01
KEYWORDS:
Bloom’s: Remembering
160. Trend analysis is another name for ____________________ analysis.
ANSWER:
horizontal
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-02 – LO: 13-02
KEYWORDS:
Bloom’s: Remembering
161. The ratio of net income to net sales is the relationship presented by the ______________ ratio.
ANSWER:
profit margin
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-03 – LO: 13-03
KEYWORDS:
Bloom’s: Remembering
162. In a vertical analysis, the base, or benchmark, on which all other items in the income statement are compared is:
___________________.
ANSWER:
net sales
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-03 – LO: 13-03
KEYWORDS:
Bloom’s: Remembering
163. ___________________ statements recast all items on the statement as a percentage of a
selected item on the statement.
ANSWER:
Common-size
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-03 – LO: 13-03
KEYWORDS:
Bloom’s: Remembering
164. The three types of analysis that involve ratios are ____________________, ____________________, and
____________________.
ANSWER:
liquidity, solvency, profitability
liquidity, profitability, solvency
solvency, liquidity, profitability
solvency, profitability, liquidity
profitability, liquidity, solvency
profitability, solvency, liquidity
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
FACC.PONO.13.13-05 – LO: 13-05
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Remembering
165. The ______________________ ratio indicates the company’s ability to meet the current year’s interest payments out
of the current year’s earnings.
ANSWER:
times interest earned
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-05 – LO: 13-05
KEYWORDS:
Bloom’s: Remembering
166. In the numerator of the debt service coverage ratio, ________________ is a good substitute for cash flow from
operations before interest and tax payments, especially where changes in these accounts are insignificant.
ANSWER:
EBITDA or earnings before interest, taxes, depreciation, and amortization
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-05 – LO: 13-05
KEYWORDS:
Bloom’s: Remembering
167. The two groups of users that are especially interested in profitability are ____________________ and
____________________.
ANSWER:
creditors, stockholders
stockholders, creditors
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Remembering
168. ______________________________________ is a line item on the income statement to reflect the net income or
loss of a discontinued business segment as well as any gain or loss incurred from its disposal.
ANSWER:
Discontinued operations
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-07 – LO: 13-07
KEYWORDS:
Bloom’s: Remembering
169. ______________________________________ is a line item on the income statement to reflect any gain or loss from
an event that is both unusual in nature and infrequent in occurrence.
ANSWER:
Extraordinary item
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-07 – LO: 13-07
KEYWORDS:
Bloom’s: Remembering
Matching
Select the term below most properly satisfies each statement.
a.
total assets
b.
horizontal analysis
c.
vertical analysis
d.
net sales
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-02 – LO: 13-02
FACC.PONO.13.13-03 – LO: 13-03
KEYWORDS:
Bloom’s: Remembering
170. A comparison of financial statement items within a single period
ANSWER:
c
171. A comparison of financial statement items over a period of time
ANSWER:
b
172. When using vertical analysis, accounts on the balance sheet should be stated as a percentage of this amount
ANSWER:
a
173. When using vertical analysis, accounts on the income statement should be stated as a percentage of this amount
ANSWER:
d
For each of the following sentences, select the phrase or group of words that best completes the statement.
a.
Earnings per share
b.
Dividend yield ratio
c.
Dividend payout ratio
d.
Leverage
e.
Return on assets ratio
f.
Return on common stockholders’ equity ratio
g.
Debt-to-equity ratio
h.
Price/earnings ratio
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Remembering
174. The percentage of earnings paid out as dividends.
ANSWER:
c
175. A measure of a company’s success in earning a return for all providers of capital.
ANSWER:
e
176. The relationship between dividends and the market price of a company’s stock.
ANSWER:
b
177. The measure of a company’s success in earning a return for the common stockholders.
ANSWER:
f
178. A company’s bottom line stated on a per-share basis.
ANSWER:
a
Indicate the type of each ratio listed below.
a.
liquidity ratio
b.
solvency ratio
c.
profitability ratio
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
FACC.PONO.13.13-05 – LO: 13-05
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Remembering
179. Current ratio
ANSWER:
a
180. Debt-to-equity ratio
ANSWER:
b
181. Earnings per share
ANSWER:
c
182. Gross profit ratio
ANSWER:
c
183. Dividend payout ratio
ANSWER:
c
184. Inventory turnover ratio
ANSWER:
a
185. Times interest earned ratio
ANSWER:
b
186. Return on assets ratio
ANSWER:
c
187. Profit margin ratio
ANSWER:
c
188. Price/earnings ratio
ANSWER:
c
For each ratio listed, select whether an increase or decrease in the ratio is generally considered to be better.
a.
increase
b.
decrease
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
FACC.PONO.13.13-05 – LO: 13-05
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Remembering
189. Current ratio
ANSWER:
a
190. Dividend yield ratio
ANSWER:
a
191. Asset turnover ratio
ANSWER:
a
192. Number of days’ sales in receivables
ANSWER:
b
193. Times interest earned ratio
ANSWER:
a
Select the ratio that each statement below most properly satisfies.
a.
Dividend yield ratio
b.
Cash flow from operations to capital expenditures ratio
c.
Debt service coverage ratio
d.
Return on common stockholders’ equity ratio
e.
Times interest earned ratio
f.
Asset turnover ratio
g.
Debt-to-equity ratio
h.
Dividend payout ratio
i.
Price/earnings ratio
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-05 – LO: 13-05
FACC.PONO.13.13-06 – LO: 13-06
KEYWORDS:
Bloom’s: Remembering
194. A measure of a company’s success in earning a return for the common stockholders
ANSWER:
d
195. The relationship between net sales and total assets
ANSWER:
f
196. The relationship between dividends and the market price of a company’s stock
ANSWER:
a
197. An income statement measure of the ability of a company to make its interest payments
ANSWER:
e
198. A measure of the ability of a company to finance long-term asset acquisitions from cash from operations
ANSWER:
b
Subjective Short Answer
199. What are two difficulties that are encountered when two companies are compared?
ANSWER:
Alternative accounting principles may be used; the companies being compared could be in
different industries
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-01 – LO: 13-01
KEYWORDS:
Bloom’s: Evaluating
200. What are two reasons for why a company’s accounts receivable turnover may decrease?
ANSWER:
1. The total amount of accounts receivable may increase due to additional credit sales or lack
of collections.
2. Credit sales could decline because of economic conditions.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
KEYWORDS:
Bloom’s: Evaluating
201. What are three specific ratios that are especially useful for creditors and lenders?
ANSWER:
Current ratio
Acid-test ratio
Cash flow from operations to current liabilities ratio
Accounts receivable turnover ratio
Inventory turnover ratio
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
KEYWORDS:
Bloom’s: Evaluating
202. Dormont, Inc., a supplier, is thinking of extending credit to a Fab Company but decides not to because the Fab’s
current ratio is only 0.60. Do you agree with the supplier’s decision? What other factors need to be considered in drawing
any conclusions about a company’s liquidity?
ANSWER:
Although a current ratio of 0.60 is certainly low, other factors need to be considered before
making a decision on whether to extend credit. Has the company operated successfully in the
past with a low current ratio? How does this ratio compare with other companies in the same
industry? What is the composition of the company’s current assets?
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-01 – LO: 13-01
KEYWORDS:
Bloom’s: Remembering
203. Income statements for Bloomfield Corp. for the past two years are as follows:
(amounts in thousands of dollars)
2017
2016
Sales revenue
$70,000
$60,000
Cost of goods sold
42,000
30,000
Gross profit
$28,000
$30,000
Selling and administrative expense
20,000
14,000
Operating income
$ 8,000
$16,000
Interest expense
2,000
2,000
Income before tax
$ 6,000
$14,000
Income tax expense
2,000
3,000
Net income
$ 4,000
$11,000
Required:
1. Prepare common-size comparative income statements for the two years for Bloomfield Corp.
2. What observations can you make about the common-size statements? List at least four observations.
3. Prepare comparative income statements for Bloomfield Corp., including columns for the dollars and for the percentage
increase or decrease in each item on the statement.
4. Assume that you are interested in identifying reasons for the changes in selling and administrative expenses and income
tax expense. Explain where you would look to find additional information about the change.
ANSWER:
1. MALTESE CORP.
COMMON-SIZE COMPARATIVE INCOME STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
(IN THOUSANDS OF DOLLARS)
significantly because of a higher ratio of cost of goods sold to sales that grew from 50% to
60%.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
4. Largest changes Refer to
Selling and administrative expenses Individual records, for the various expenses
Income tax expense Income tax return and supporting records
Income tax
204. Use the current asset section of the balance sheets of the Breeze Company as of June 30, 2017 and 2016 presented
below to answer the questions that follow.
2017
2016
Cash and cash equivalents
$ 75,000
$ 58,800
Trade accounts receivable, net
157,500
193,200
Inventory
208,200
253,400
Other current assets
18,400
15,500
Total current assets
$ 459,100
$ 520,900
Total assets
$2,650,000
$3,430,000
Required:
Complete a horizontal analysis of the current asset section of Breeze Company’s balance sheet for 2017. Your answers for
“% Change” should be rounded to one decimal place, e.g., 10.3%. Provide a short evaluation of this analysis.
ANSWER:
$ Change
% Change
Cash and cash equivalents
$ 16,200
27.6 %
Trade accounts receivable, net
( 35,700)
(18.5)%
Inventory
( 45,200)
(17.8)%
Other current assets
2,900
18.7 %
Breeze Company experienced a large gain in cash and cash equivalents, which indicates the
company is more liquid than the previous accounting period. Accounts receivable decreased,
perhaps as a result of decreased sales or better collections by the credit department. The
increase in other current assets is also large, although compared to the dollar amount of cash,
is not as significant. Inventory declined which could mean goods are moving faster, which in
turn generates additional sales.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-02 – LO: 13-02
KEYWORDS:
Bloom’s: Analyzing
205. Use the current asset section of the balance sheets of the Breeze Company as of June 30, 2017 and 2016 presented
below to answer the questions that follow.
2017
2016
Cash and cash equivalents
$ 75,000
$ 58,800
Trade accounts receivable, net
157,500
193,200
Inventory
208,200
253,400
Other current assets
18,400
15,500
Total current assets
$ 459,100
$ 520,900
Total assets
$2,650,000
$3,430,000
Required:
Complete a vertical analysis of the current asset section of Breeze Company’s balance sheets for 2017 and 2016. Your
answers should be rounded to one decimal place, e.g., 10.3%.
ANSWER:
2017
2016
Cash and cash equivalents
2.8%
1.7%
Trade accounts receivable, net
5.9%
5.6%
Inventory
7.9%
7.4%
Other current assets
0.7%
0.5%
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-03 – LO: 13-03
KEYWORDS:
Bloom’s: Analyzing
206. Presented below are selected data from the financial statements of Wave Company for 2018, 2017, and 2016.
2018
2017
2016
Total assets
$1,205,000
$952,000
$945,000
Cost of goods sold
360,000
420,000
440,000
Inventory
56,000
64,000
53,000
Net income
65,000
25,000
16,000
A)
Calculate Wave’s inventory turnover ratio for 2018 and 2017.
B)
How many days would it take to sell the entire inventory at December 31, 2018? At
December 31, 2017? Assume 360 days in a year.
C)
What problems do you see in the company’s inventory management?
ANSWER:
A)
Cost of goods sold/Average inventory =
2018 $360,000/[($56,000 + $64,000)/2] = 6.0 times
2017: $420,000/[($64,000 + $53,000)/2] = 7.2 times
B)
Number of days in the period/Inventory turnover =
2018: 360/6.0 = 60 days
2017: 360/7.2 = 50 days
C)
During 2018, this company is holding its inventory an average of 60 days before selling
it. This is up 10 days from 2017. This could indicate a large amount of obsolete
inventory or problems in the sales department. It may also indicate that the company is
pricing its goods too high, and the market is reacting by reducing demand for the
company’s products.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
KEYWORDS:
Bloom’s: Analyzing
207. Presented below are selected data from the financial statements of Medtech Company for 2018, 2017, and 2016.
2018
2017
2016
Total assets
$487,500
$615,750
$600,000
Net credit sales
600,000
487,500
540,000
Accounts receivable
63,750
60,000
55,500
Net income
11,250
65,000
9,000
A)
Calculate Medtech’s accounts receivable turnover ratio for 2018 and 2017.
B)
What could have caused the change? Explain.
ANSWER:
A)
Net credit sales/Average accounts receivable =
2018: $600,000/[($63,750 + $60,000)/2] = 9.7 times
2017: $487,500/[($60,000 + $55,500)/2] = 8.4 times
B)
Among the situations that can cause an increase are: an increase in credit sales by
customers, a decrease in the receivable balance either from reduced sales, or better
efforts by the collection department.
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
KEYWORDS:
Bloom’s: Analyzing
208. Presented below are selected data from the financial statements of Hospital Supply Company for 2018, 2017, and
2016.
2018
2017
2013
Total assets
$650,000
$821,000
$800,000
Net credit sales
800,000
650,000
720,000
Accounts receivable
85,000
79,000
74,000
Accounts receivable turnover ratio
9.8 times
8.5 times
8.0 times
A)
Calculate Hospital Supply’s number of days’ sales in receivables for 2018 and 2017.
Assume 360 days in a year.
B)
What is the meaning of your answer in part A?
ANSWER:
A)
2018: 360/9.8 = 36.7
2017: 360/8.5 = 42.4
B)
During 2018, it took 36.7 days to collect each dollar of receivables. This is a decrease
from 2017 which was 42.4 days.
DIFFICULTY:
Moderate
KEYWORDS:
Bloom’s: Analyzing
209. Use the following information that was obtained from the 2017 and 2016 financial statements of Pacific Company,
River Corporation, and Ocean Company to answer the questions that follow.
(In millions)
Pacific
River
Ocean
Accounts receivable
December 31, 2017
$ 33,000
$ 22,000
$ 41,500
December 31, 2016
30,000
12,800
42,600
Inventory
December 31, 2017
22,600
12,600
54,200
December 31, 2016
23,900
32,800
44,000
Net sales (Credit)
2017
620,000
320,000
510,000
2016
610,000
310,000
760,000
Cost of goods sold
2017
211,000
406,000
311,000
2016
156,000
200,000
310,000
Required: Compare the three companies and answer the following:
A)
Compute the accounts receivable turnover ratio for each company for 2017.
B)
Which company appears to have the best liquidity position based solely on the
accounts receivable turnover? Explain.
ANSWER:
A) Net credit sales/Average accounts receivable =
Pacific
$620,000/[($33,000 + $30,000)/2] = 19.7 times
River
$320,000/[($22,000 + $12,800)/2] = 18.4 times
Ocean
$510,000/[($41,500 + $42,600)/2] = 12.1 times
B)
Pacific appears to have the best liquidity position, although River is not far behind.
Pacific collects its receivables 19.7 times per year, while River collects receivables
18.4 times per year, and Ocean collects receivables only 12.1 times per year.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
KEYWORDS:
Bloom’s: Analyzing
210. Use the following information that was obtained from the 2017 and 2016 financial statements of Pacific Company,
River Corporation, and Ocean Company to answer the questions that follow.
(In millions)
Pacific
River
Ocean
Accounts receivable
December 31, 2017
$ 33,000
$ 22,000
$ 41,500
December 31, 2016
30,000
12,800
42,600
Inventory
December 31, 2017
22,600
12,600
54,200
December 31, 2016
23,900
32,800
44,000
Net sales (Credit)
2017
620,000
320,000
510,000
2016
610,000
310,000
760,000
Cost of goods sold
2017
211,000
406,000
311,000
2016
156,000
200,000
310,000
Required:
Compare the three companies and answer the following:
A)
Compute the number of days’ sales in inventory for each company for 2017.
B)
Which company appears to have the best liquidity position based solely on the
inventory analysis? Explain.
C)
What information is provided to users with your calculations in part A?
ANSWER:
A)
Inventory turnover ratio = Cost of goods sold/Average inventory
Pacific
$211,000/[($22,600 + $23,900)/2] = 9.1 times
River
$406,000/[($12,600 + $32,800)/2] = 17.9 times
Ocean
$311,000/[($54,200 + $44,000)/2] = 6.3 times
Number of days’ sales in inventory = 360 days/inventory turnover ratio
Pacific
360/9.1 = 40 days
River
360/17.9 = 20 days
Ocean
360/6.3 = 57 days
B)
River Corporation appears to be in the best liquidity position based on the number of
days’ sales in inventory. River holds inventory 20 days before selling, Pacific holds
inventory 40 days, while Ocean holds inventory 57 days.
C)
The number of days’ sales in inventory indicates how long a company holds its
inventory before selling. The shorter the period, the better off a company is.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.13-04 – LO: 13-04
KEYWORDS:
Bloom’s: Analyzing