Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13–79
Ex. 252 (Cont.)
Additional information:
1. Common stock outstanding January 1, 2014, was 30,000 shares, and 40,000 shares were
outstanding at December 31, 2014.
2. The market price of Gillman, Inc., stock was $15.86 in 2014.
3. Cash dividends of $16,000 were paid, $4,500 of which were to preferred stockholders.
Instructions
Compute the following measures for 2014.
(a) Earnings per share.
(b) Price-earnings ratio.
(c) Payout ratio.
(d) Times interest earned.
Ans: N/A, LO: 6, 8, Bloom: AP, Difficulty: Hard, Min: 10, AACSB: Analytic, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA PC:
Problem Solving, IMA: Performance Measurement
Solution 252 (10 min.)
Ex. 253
Belcanto Corporation experienced a fire on December 31, 2014, in which its financial records were
partially destroyed. It has been able to salvage some of the records and has ascertained the
following balances.
December 31, 2014 December 31, 2013
Cash $ 40,000 $ 15,000
Accounts receivable (net) 84,000 126,000
Inventory 200,000 180,000
Accounts payable 50,000 10,000
Notes payable 30,000 20,000
Common stock, $100 par 400,000 400,000
Retained earnings 170,000 101,000
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
13–80
Ex. 253 (Cont.)
Additional information:
1. The inventory turnover is 4.2 times
2. The return on common stockholders’ equity is 14%. The company had no additional paid–in–
capital.
3. The accounts receivable turnover is 10.2 times.
4. The return on assets is 12.5%.
5. Total assets, Dec. 31, 2013 = 604,750.
Instructions
Compute the following values for 2014.
(a) Cost of goods sold.
(b) Net credit sales.
(c) Net income.
(d) Total assets.
Ans: N/A, LO: 6, 8, Bloom: AN, Difficulty: Hard, Min: 25, AACSB: Analytic, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA PC:
Problem Solving, IMA: Reporting
Solution 253 (25 min.)
Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13–81
Solution 253 (Cont.)
Ex. 254
The financial statements of Elcamino Company appear below:
ELCAMINO COMPANY
Comparative Balance Sheet
December 31,
___________________________________________________________________________
Assets 2014 2013
Cash …………………………………………………………………………………… $ 25,000 $ 40,000
Debt investments …………………………………………………………………. 20,000 60,000
Accounts receivable (net) ……………………………………………………… 50,000 30,000
Inventory …………………………………………………………………………….. 140,000 170,000
Property, plant and equipment (net) ……………………………………….. 170,000 200,000
Total assets ……………………………………………………………………. $405,000 $500,000
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
13–82
Ex. 254 (Cont.)
Liabilities and stockholders’ equity
Accounts payable ………………………………………………………………… $ 25,000 $ 30,000
Short-term notes payable ……………………………………………………… 40,000 90,000
Bonds payable …………………………………………………………………….. 75,000 160,000
Common stock …………………………………………………………………….. 160,000 145,000
Retained earnings ……………………………………………………………….. 105,000 75,000
Total liabilities and stockholders‘ equity ………………………………. $405,000 $500,000
ELCAMINO COMPANY
Income Statement
For the Year Ended December 31, 2014
Net sales (all on credit) …………………………………………………………. $360,000
Cost of goods sold ……………………………………………………………….. 184,000
Gross profit …………………………………………………………………………. 176,000
Expenses
Interest expense …………………………………………………………….. $11,000
Selling expenses ……………………………………………………………. 30,000
Administrative expenses ………………………………………………….. 20,000
Total expenses …………………………………………………………. 61,000
Income before income taxes …………………………………………………. 115,000
Income tax expense …………………………………………………………….. 35,000
Net income …………………………………………………………………………. $ 80,000
Additional information:
a. Cash dividends of $50,000 were declared and paid on common stock in 2014.
b. Weighted-average number of shares of common stock outstanding during 2014 was 50,000
shares.
c. Market value of common stock on December 31, 2014, was $16 per share.
d. Net cash provided by operating activities for 2014 was $70,000.
Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13–83
Ex. 254 (Cont.)
Instructions
Using the financial statements and additional information, compute the following ratios for the
Lewis Company for 2012. Show all computations.
Computations
1. Current ratio _________.
2. Return on common stockholders’ equity _________.
3. Price-earnings ratio _________.
4. Inventory turnover _________.
5. Accounts receivable turnover _________.
6. Times interest earned _________.
7. Profit margin _________.
8. Average days in inventory _________.
9. Payout ratio _________.
10. Return on assets _________.
11. Cash debt coverage _________.
Ans: N/A, LO: 6, 8, Bloom: AP, Difficulty: Hard, Min: 15, AACSB: Analytic, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA PC:
Problem Solving, IMA: Performance Measurement
Solution 254 (15-20 min.)
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
13–84
Solution 254 (Cont.)
Ex. 255
The following ratios have been computed for Southern Company for 2014.
Profit margin ratio 20%
Times interest earned 12 times Current ratio 2.5:1
Accounts receivable turnover 5 times Debt to assets ratio 24%
The 2014 financial statements for Southern Company with missing information follows:
SOUTHERN COMPANY
Comparative Balance Sheet
December 31,
——————————————————————————————————————————
Assets
2014 2013
Cash ……………………………………………………………………………… $ 25,000 $ 35,000
Debt Investments ……………………………………………………………… 15,000 15,000
Accounts receivable (net) …………………………………………………. ? (6) 50,000
Inventory ………………………………………………………………………… ? (7) 50,000
Property, plant, and equipment (net) ………………………………….. 200,000 160,000
Total assets ……………………………………………………………… $ ? (8) $310,000
Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13–85
Ex. 255 (Cont.)
Liabilities and stockholders’ equity
Accounts payable ……………………………………………………………. $ 15,000 $ 25,000
Short-term notes payable …………………………………………………. 35,000 30,000
Bonds payable ……………………………………………………………….. ? (9) 20,000
Common stock ……………………………………………………………….. 200,000 200,000
Retained earnings …………………………………………………………… 47,000 35,000
Total liabilities and stockholders’ equity ………………………… $ ? (10) $310,000
SOUTHERN COMPANY
Income Statement
For the Year Ended December 31, 2014
——————————————————————————————————————————
Net sales ……………………………………………………………………….. $200,000
Cost of goods sold ………………………………………………………….. 100,000
Gross profit …………………………………………………………………….. 100,000
Expenses:
Depreciation expense ………………………………………………… $ ? (5)
Interest expense ………………………………………………………… 5,000
Selling expenses ……………………………………………………….. 10,000
Administrative expenses …………………………………………….. 15,000
Total expenses …………………………………………………….. ? (4)
Income before income taxes …………………………………………….. ? (2)
Income tax expense …………………………………………………… ? (3)
Net income ……………………………………………………….……………. $ ? (1)
Instructions
Use the above ratios and information from the Southern Company financial statements to fill in the
missing information on the financial statements. Follow the sequence indicated. Show
computations that support your answers.
Ans: N/A, LO: 6, 8, Bloom: AN, Difficulty: Medium, Min: 35, AACSB: Analytic, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA PC:
Problem Solving, IMA: Performance Measurement
Solution 255 (35-40 min.)
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
13–86
Solution 255 (Cont.)
Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13–87
Solution 255 (Cont.)
Ex. 256
B. Jones Corporation has issued common stock only. The company has been successful and has
a gross profit rate of 20%. The information shown below was taken from the company’s financial
statements.
Beginning inventory $ 482,000
Purchases 4,346,000
Ending inventory ?
Average accounts receivable 700,000
Average common stockholders’ equity 3,100,000
Sales revenue (all on credit) 5,600,000
Net income 341,000
Instructions
Compute the following:
(a) Accounts receivable turnover and the average number of days required to collect the
accounts receivable.
(b) The inventory turnover and the average days in inventory.
(c) Return on common stockholders’ equity.
Ans: N/A, LO: 6, 8, Bloom: AP, Difficulty: Medium, Min: 13, AACSB: Analytic, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA PC:
Problem Solving, IMA: Performance Measurement
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
13–88
Solution 256 (13-18 min.)
COMPLETION STATEMENTS
257. Discontinued operations refers to the disposal of a __________________ of a business.
258. 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) ________________.
259. A change in depreciation methods during the year would be classified as a change in
____________________.
Financial Analysis: The Big Picture
13–89
260. ______________ analysis, also called trend analysis, is a technique for evaluating a series
of financial statement data over a period of time.
261. Expressing each item in a financial statement as a percent of a base amount is called
______________ analysis.
262. For analysis of the financial statements, ratios can be classified into three types:
(1)_____________ ratios, (2)_____________ ratios, and (3)______________ ratios.
263. The times interest earned is calculated by dividing ___________________ before
__________________ and __________________ by interest expense.
264. The liquidity ratio, known as the _______________ ratio, has a disadvantage that it uses
year-end balances for current assets and current liabilities. The ___________ partially
corrects for this problem by using cash provided by operating activities and average
current liabilities rather than point in time numbers.
265. The accounts receivable turnover is calculated by dividing ________________ by average
___________________.
266. If the inventory turnover is 7.3 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.
267. Hobson Corporation had net sales for the year of $300,000 and average total assets of
$200,000. The asset turnover is ____________ times.
268. The ______________ ratio measures the percentage of earnings distributed in the form of
cash dividends.
269. The lower the _______________ to _______________ ratio, the more equity “buffer” is
available to the creditors if the company becomes insolvent.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
13–90
Answers to Completion Statements
MATCHING
SET A
270. For each of the ratios listed below, indicate by the appropriate code letter, whether it is a
liquidity ratio, a profitability ratio, or a solvency ratio.
Code:
L = Liquidity ratio
P = Profitability ratio
S = Solvency ratio
____ 1. Price-earnings ratio
____ 2. Return on assets
____ 3. Accounts receivable turnover ratio
____ 4. Earnings per share
____ 5. Payout ratio
____ 6. Current cash debt coverage
____ 7. Current ratio
____ 8. Debt to assets ratio
____ 9. Free cash flow
____ 10. Inventory turnover
Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
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SET B
271. Match the ratios with their formulas by entering the appropriate letter in the space provided.
A. Current ratio F. Times interest earned
B. Current cash debt coverage G. Inventory turnover
C. Profit margin H. Average collection period
D. Asset turnover I. Average days in inventory
E. Price-earnings ratio J. Payout ratio
____ 1.
Cost of goods sold
Average inventory
____ 2.
Net income
Net sales
____ 3.
Cash dividends declared on common stock
Net income
____ 4.
Net sales
Average total assets
____ 5.
Current assets
Current liabilities
____ 6.
365 days
Accounts receivable turnover
____ 7.
Market price per share of stock
Earnings per share
____ 8.
365 days
Inventory turnover
____ 9.
Income before income taxes and interest expense
Interest expense
____ 10.
Net cash provided by operating activities
Average current liabilities
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
13–92
SHORT-ANSWER ESSAY QUESTIONS
S-A E 272
Explain sustainable income. What relationship does this concept have to the treatment of irregular
items on the income statement?
Ans: N/A, LO: 1, Bloom: C, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA PC:
Communications, IMA: Reporting
Solution 272
S-A E 273
What issues must be considered when determining whether or not a loss from earthquake
destruction should be treated as an extraordinary item?
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Measurement, AICPA
PC: Communications, IMA: FSA
Solution 273
S-A E 274
Tim Forsyth, the CEO of Magical Products, is a successful entrepreneur and his focus is his
products, not his accounting system. He asks you to explain to him, in a memo, the bases of
comparison for ratio analysis.
Ans: N/A, LO: 3, Bloom: K, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA PC:
Communications, IMA: Performance Measurement
Solution 274
Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13–93
S-A E 275
Horizontal and vertical analyses are analytical tools frequently used to analyze financial
statements. 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 industry
averages and/or competitive companies.
Ans: N/A, LO: 4, 5, Bloom: C, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA
PC: Communications, IMA: Performance Measurement
Solution 275
S-A E 276
What does each type of ratio measure?
(a) Liquidity ratios.
(b) Solvency ratios.
(c) Profitability ratios.
Ans: N/A, LO: 6, 8, Bloom: K, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA
PC: Communications, IMA: Performance Measurement
Solution 276
S-A E 277
Identify and explain factors that affect quality of earnings.
Ans: N/A, LO: 7, Bloom: C, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA PC:
Communications, IMA: Performance Measurement
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
FOR INSTRUCTOR USE ONLY
13–94
Solution 277
S-A E 278 (Communication)
Zip Delivery specializes in the overnight transportation of medical equipment and laboratory
specimens. The company has selected the following information from its most recent annual
report to be the subject of an immediate press release.
• The financial statements are being released.
• Net income this year was $3.1 million. Last year’s net income had been $2.8 million.
• The current ratio has changed to 2:1 from last year’s 1.6:1.
• The debt to assets ratio has changed to 4:6 from last year’s 3:6.
• The 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 above information. Include all information. Think
carefully which information (if any) is good news for the company, and which (if any) is bad news.
Ans: N/A, LO: 6, 8, Bloom: S, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Legal/Regulatory Perspective, AICPA FN: Reporting, AICPA
PC: Communications, IMA: Performance Measurement
Solution 278
Financial Analysis: The Big Picture
13–95
IFRS QUESTIONS
1. Under IFRS, there is no classification for
a. changes in accounting estimates.
b. changes in accounting principles.
c. discontinued operations.
d. extraordinary items.
2. The accounting for each of the following is the same under IFRS and GAAP except for
a. extraordinary items.
b. discontinued operations.
c. changes in accounting principles.
d. changes in accounting estimates.
3. Distinguishing normal levels of income from irregular items is of interest for the
FASB IASB
a. no no
b. no yes
c. yes no
d. yes yes
4. All revenue and expense items are considered ordinary in nature under
a. both IFRS and GAAP.
b. GAAP.
c. IFRS.
d. neither IFRS or GAAP.
5. Under IFRS, the statement of comprehensive income can be prepared under
a. the one-statement approach only.
b. the two-statement approach only.
c. either the one-statement approach or the two-statement approach.
d. either the two-statement approach or the stockholders’ equity statement approach.
6. Under IFRS, the components of other comprehensive income can be reported in each of the
following ways except
a. the one-statement approach.
b. the two-statement approach.
c. the statement of stockholders’ equity approach.
d. All of the above are acceptable.
Test Bank for Accounting: Tools for Business Decision Making, Fifth Edition
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7. Which of the following is not an acceptable way of displaying the components of other
comprehensive income?
a. Combined statement of retained earnings
b. Second income statement
c. Combined statement of comprehensive income
d. All of these answer choices are acceptable.
8. Under IFRS, other comprehensive income must be displayed(reported) in
a. the equity section of the statement of financial position.
b. a second income income statement.
c. the income statement.
d. the retained earnings statement.