Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter Outline Notes
3. Ratios in this block:
a. Profit margin—net income divided by net sales;
describes the ability to earn a net income from sales.
b. Return on total assets—net income divided by average
stockholders' equity; measures the success of a
company in earning net income for its owners.
D. Market Prospects
1. Market measures are useful for analyzing corporations with
publicly traded stock.
2. Market measures use stock price in their computation.
3. Ratios in this block:
a. Price-earnings ratio—market price per share of common
stock divided by earnings per share; used to evaluate the
profitability of alternative common stock investments.
b. Dividend yield—annual cash dividends paid per share of
stock divided by market price per share; used to compare
the dividend paying performance of different investment
alternatives.
E. Summary of Ratios
Exhibit 13.16 on p. 737 of text sets forth the names of each of the
common ratios by category, and includes the formula and a
description of what is measured by each ratio.
V. Global View—Compares U.S. GAAP to IFRS
A. Horizontal and vertical analyses help eliminate many differences
between U.S. GAAP and IFRS when analyzing and interpreting
financial statements. Percentages are consistently applied across
and within periods. However, where reporting rules differ, users
should exercise caution in drawing conclusions.
B. Ratio analysis has many of the advantages and disadvantages of
horizontal and vertical analysis as mentioned above.
13-7
Chapter Outline Notes
VI. Decision Analysis—Analysis Reporting
1. Executive summary
2. Analysis overview
3. Evidential matter
4. Assumptions
5. Key factors
6. Inferences
VI. Sustainable Income—Appendix 13A—When a revenue and expense
transactions are from normal, continuing operations, a simple income
statement is adequate. When activities include events that are not
normal, it must disclose this information by separating the income
statement into different sections as follows (A-D):
A. Continuing Operations
Reports the revenues, expenses, and income generated by the
company’s continuing operations.
B. Discontinued Segments
1. A business segment is a part of a company’s operations that
serves a particular line of business or class of customers.
2. Section reports:
a. Income (loss) from operating the discontinued business
1. An unusual gain or loss is abnormal or otherwise unrelated to
the company’s regular activities and environment.
2. An infrequent gain or loss is not expected to recur given the
company’s operating environment.
3. Items that are unusual or infrequent, but not both, are reported
in the income statement as part of continuing operations but
below the normal revenues and expenses.
D. Earnings per Share
1. Final section of income statement
2. Reports EPS for three subcategories of income (continuing
operations, discontinued segments, and extraordinary items).
13-8
Chapter Outline Notes
E. Changes in Accounting Principles
1. The consistency principle directs a company to apply the same
accounting principle across periods. Changes from one
accounting principles to another (Example: LIFO to FIFO) are
acceptable if justified as improvements in financial reporting.
2. A footnote would describe change and why it is an
improvement.
3. Requires retrospective application (application of new
accounting principle to prior periods as if that principle had
always been used).
13-9
Alternate Demonstration Problem
Chapter 13
Following are data from the statements of two companies selling similar
products:
Current Year-End Balance Sheets
Sled
Company
Zip
Company
Cash........................................................................ $ 11,900 $ 20,000
Notes receivable—short-term.............................. 7,700 3,200
Accounts receivable, net...................................... 42,000 64,000
Inventory................................................................ 58,800 87,680
Prepaid expenses.................................................. 1,680 3,520
Plant and equipment, net...................................... 232,120 274,400
Total assets............................................................ $354,200 $452,800
Current liabilities................................................... $ 56,000 $ 80,000
Mortgage payable.................................................. 70,000 80,000
Common stock, $10 par value.............................. 140,000 160,000
Retained earnings................................................. 88,200 132,800
Total liabilities and stockholders’ equity............ $354,200 $452,800
Data from the Current Year’s Income Statement
Sales....................................................................... $672,000 $880,000
Cost of goods sold................................................ 528,080 699,840
Interest expense.................................................... 4,200 5,600
Net income............................................................. 23,373 28,896
Beginning-of-Year Data
Inventory................................................................ $ 53,200 $ 85,120
Total assets............................................................ 345,800 443,200
Stockholders’ equity............................................. 217,000 285,120
Required:
1. Calculate current ratios, acid-test ratios, inventory turnovers, and days’ sales
uncollected for the two companies. Then state which company you think is
the better short-term credit risk and why.
2. Calculate return on total assets employed and return on stockholders’
equity. Then, under the assumption that each company’s stock can be
purchased at book value, state which company’s stock you think is the
better investment and why.
13-10
Solution: Alternate Demonstration Problem
Chapter 13
Part 1
Sled Company Zip Company
Current ratio: $122,080
$ 56,000
= 2.18 to 1 $178,400
$ 80,000
= 2.23 to 1
turnover:
$ 56,000
$ 86,400
Days’ sales
uncollected:
$ 42,000
$672,000
x 365 = 22.8 $ 64,000
$880,000
x 365 = 26.5
Sled Company and Zip Company have almost equal current and acid-test
ratios, so near the same that the differences are not significant. However,
Part 2
Return on total assets: $ 23,373
$350,000 = 6.68% $ 28,896
$448,000 = 6.45%
Assuming that the stock of each company could be purchased at book
value, Sled Company’s stock seems to be the better investment. This
conclusion is based on Sled’s slightly better return on stockholders’ equity
13-11
