h1. Conservative accounting practices
d2. Discontinued operation
a3. Extraordinary item
c4. Horizontal analysis
g5. Liquidity
b6. Quality of earnings
f7. Solvency
e8. Vertical analysis
Descriptions
a. A profit or loss unusual in nature and infrequent in occurrence.
b. The ability of reported earnings to reflect the company’s true earnings as well as
c. A tool to analyze trends in financial statement data for a single company over
d. The sale or disposal of a significant component of a company’s operations.
e. A means to express each item in a financial statement as a percentage of a base
h. Accounting choices that result in reporting lower income, lower assets, and
Chapter 12
Financial Statement Analysis
Exercise 12-1
Items
Federer Sports Apparel
Income Statement
For the Years Ended December 31
2016 2015
Amount % Amount %
Revenues $20,000,000 100.0 $18,200,000 100.0
Cost of goods sold 15,000,000 75.0 11,300,000 62.1
Gross profit 5,000,000 25.0 6,900,000 37.9
Operating expenses 1,800,000 9.0 2,000,000 11.0
Depreciation expense 1,200,000 6.0 1,100,000 6.0
Inventory write-down 0.0 500,000 2.8
Litigation expense 600,000 3.0 200,000 1.1
Federer Sports Apparel
Income Statement
For the Years Ended December 31
Year Increase (Decrease)
2016 2015 Amount %
Revenues $20,000,000 $18,200,000 $1,800,000 9.9
Cost of goods sold 15,000,000 11,300,000 3,700,000 32.7
Gross profit 5,000,000 6,900,000 (1,900,000) (27.5)
Operating expenses 1,800,000 2,000,000 (200,000) 10.0
Depreciation expense 1,200,000 1,100,000 100,000 9.1
Inventory write-down 500,000 (500,000) (100.0)
Loss (litigation) 600,000 200,000 400,000 200.0
Exercise 12-2
Exercise 12-3
Federer Sports Apparel
Balance Sheet
December 31
2016 2015
Assets Amount % Amount %
Cash $ 2,600,000 16.6 $ 1,100,000 8.1
Accounts receivable 1,200,000 7.6 1,700,000 12.5
Inventory 2,200,000 14.0 1,900,000 14.0
Buildings 12,000,000 76.4 10,000,000 73.5
Less: Accumulated depreciation (2,300,000) (14.7) (1,100,000) (8.1)
Total assets $15,700,000 100.0 $13,600,000 100.0
Accounts payable $ 2,500,000 15.9 $ 1,800,000 13.2
Federer Sports Apparel
Balance Sheet
December 31
Year Increase (Decrease)
Assets 2016 2015 Amount %
Cash $ 2,600,000 $ 1,100,000 $1,500,000 136.4
Accounts receivable 1,200,000 1,700,000 (500,000) (29.4)
Exercise 12-4
Requirement 1
Requirement 2
Total assets $15,700,000 $13,600,000 2,100,000 15.4
Accounts payable $ 2,500,000 $ 1,800,000 700,000 38.9
Litigation liability 600,000 200,000 400,000 200.0
Risk Ratios Calculations
Receivables turnover ratio $15,200,000
Average collection period 365
Inventory turnover ratio $10,000,000
Average days in inventory 365
Current ratio $4,400
Debt to equity ratio $3,300
Exercise 12-5
Requirement 1
Profitability Ratios Calculations
Gross profit ratio $5,200,000
Return on assets $3,200,000
Profit margin $3,200,000
Asset turnover $15,200,000
Return on equity $3,200,000
Requirement 2
Based on the above ratios, Adrian Express is less risky than the industry average. The
Exercise 12-6
Requirement 1
Risk Ratios Calculations
a. Receivables turnover ratio $1,800,000
b. Inventory turnover ratio $1,100,000
c. Current ratio $357,000
d. Acid-test ratio $192,000 + $84,000 + $6,000
e. Debt to equity ratio $213,000
Requirement 2
Adrian Express is more profitable than the industry average. The gross profit ratio,
Exercise 12-7
Requirement 1
Profitability Ratios Calculations
a. Gross profit ratio $700,000
b. Return on assets $95,000
c. Profit margin $95,000
d. Asset turnover $1,800,000
e. Return on equity $95,000
Requirement 2
Note that, for the same company, the current ratio will always be higher than the
acid-test ratio. This is true because the current ratio includes all current assets in
Exercise 12-8
Requirement 1
Profitability Ratios Calculations
a. Gross profit ratio $3,400,000
b. Return on assets $270,000
c. Profit margin $270,000
d. Asset turnover $10,000,000
e. Return on equity $270,000
Requirement 2
One company can have a higher return on assets while the other company has a higher
return on equity. The return on equity takes into consideration leverage – the amount
Exercise 12-9
Requirement 1
Profitability Ratios Calculations
Return on assets $80,000
Profit margin $80,000
Asset turnover $800,000
Return on equity $80,000
Requirement 2
Dividends paid to shareholders in 2016 were $120,000. This amount can be determined
by analyzing the changes to retained earnings as follows:
Retained earnings, 2015 $200,000
+ Net income 270,000
– Dividends paid (120,000)
Exercise 12-10
LeBron’s Bookstores
Income Statement
For the Year Ended December 31, 2015
Revenues $ 14,000,000
Cost of goods sold 8,000,000
Gross profit 6,000,000
Operating expenses 3,000,000
Stockholders’ equity, beginning $275,000
+ Net income 80,000
– Dividends paid (30,000)
Exercise 12-11
Classification Brief Justification
a. Other expenses Restructuring costs are not considered extraordinary.
b. Extraordinary items Unusual in nature and infrequent in occurrence.
c. Other expenses Litigation is not considered extraordinary.
d. Discontinued operations Sale of a major component of the business.
e. Other expenses One restaurant out of 100 restaurants is not considered to
be a major component of the business.
Exercise 12-12
Discontinued operation:
Loss from disposal of book division, net of tax (280,000)
Shaquille Corporation
Income Statement
For the Year Ended December 31, 2015
Income before tax $1,600,000
Income tax expense 480,000
Discontinued operation:
Extraordinary item:
Loss from plant explosion, net of tax (100,000)
Exercise 12-13
Exercise 12-14
a. Aggressive (higher income, lower liabilities)
b. Conservative (lower income, lower assets)
c. Aggressive (higher income, higher assets)
d. Conservative (lower income, lower assets)
Exercise 12-15
Requirement 1
(a) Conservative
(b) Conservative
(c) Aggressive
(d) Conservative
(e) Aggressive
Note: Changes resulting in higher revenues or lower expenses are considered aggressive.
Changes resulting in lower revenues or higher expenses are considered conservative.
Requirement 2
The total effect is conservative because net income is lower after the proposed changes
by $325,000.