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Chapter 17
Analysis of Financial Statements
QUESTIONS
1. Financial reporting includes the entire process of preparing and issuing financial
2. With comparative statements, financial statement items for two or more successive
accounting periods are placed side by side on a single statement, with the change in
3. Total assets (or equivalently, the total of liabilities plus equity) are assigned a value of
100% on a common-size balance sheet. Net sales (revenues) are assigned a value of
100% on a common-size income statement.
4. The nature of a company's business, the composition of its current assets, and the
5. A 2-to-1 current ratio may not be adequate if the company's current assets consist of
6. Adequate working capital enables a company to carry sufficient inventories, meet
7. When evaluated in light of a company's credit terms, the number of days' sales
8. A high accounts receivable turnover implies that accounts are collected quickly,
9. Users are interested in the capital structure of a company, as measured by debt and
equity ratios, for at least two reasons. First, as a company includes more debt in its
10. Inventory turnover reflects on the efficiency of inventory management. That is, a
high inventory turnover means that a given sales volume can be supported with a
11. Since management is responsible for a company's performance, all ratios that are
useful in evaluating a company are of some usefulness in assessing management
12. Almost all companies have some liabilities. Since total assets equals total liabilities
plus equity, total assets are almost always higher than common stockholders'
13. This gain is considered to be unusual but not infrequent. It would be included in the
14. Profit margin: Net Income / Sales ($ in thousands)
2011: $227,575/$2,656,949 = 8.6%
2010: $147,138/$1,991,139 = 7.4%
17. Return on total assets: Net Income / Average Total Assets (€ in thousands)
2011: €20,818/ ((€485,775 + €445,325)/2) = 4.5%
QUICK STUDY
Quick Study 17-1 (5 minutes)
Items not part of general-purpose financial statements:
Quick Study 17-2 (5 minutes)
Trend percents
Quick Study 17-3 (5 minutes)
Common-size percents
2013 49.0% ($392,887 / $801,810)
Quick Study 17-4 (15 minutes)
2013
2012
Dollar
Change
Percent
Change
Short-term investments .............
$374,634
$234,000
$140,634
60.1%
Accounts receivable ...................
97,364
101,000
(3,636)
-3.6%
Notes payable..............................
0
88,000
88,000
(not calculable)
Quick Study 17-5 (10 minutes)
The four usual standards of comparisons are:
• Intracompany. The company under analysis provides standards for
comparisons based on prior performance and relations between its
financial items.
All of these standards of comparisons are useful when properly applied.
Yet, analysis measures taken from a selected competitor or group of
Quick Study 17-6 (10 minutes)
Ratio
2013
2012
Change
1. Profit Margin Ratio ................................
9%
8%
Favorable
2. Debt Ratio ..............................................
47%
42%
Unfavorable
3. Gross Margin Ratio ...............................
34%
46%
Unfavorable
4. Acid-test Ratio.......................................
1.00
1.15
Unfavorable
5. Accounts Receivable Turnover ...........
5.5
6.7
Unfavorable
6. Basic Earnings Per Share ....................
$1.25
$1.10
Favorable
7. Inventory Turnover ...............................
3.6
3.4
Favorable
8. Dividend Yield .......................................
2.0%
1.2%
Favorable
Quick-Study 17-7 (30 minutes)
Parker has a greater amount of working capital. This by itself does not
indicate whether the company is more capable of meeting its current
obligations. However, support is provided by the current ratio and acid-
This evidence also shows that Parker's working capital, current ratio, and
acid-test ratio all increased dramatically over the three-year period. This
trend toward greater liquidity may be positive, but it can also suggest that
Parker holds an excess amount of highly liquid assets that typically earn
low returns.
Quick Study 17-8A (5 minutes)
This material error should be reported on the statement of retained
Fundamental Accounting Principles, 21st Edition
982
Quick Study 17-9 (10 minutes)
a. Although ratio analysis can eliminate currency differences, it cannot
eliminate differences in the application of GAAP under different
Additional examples that are arguably even more problematic: (1)
Consider two companies, one reporting under U.S. GAAP and the other
under IFRS, which we are reviewing via the Operating Cash Flow /
Average Total Assets ratio. We can potentially see the dividends and
the interest items reported differently for these two companies under the
b. A key advantage to using horizontal and vertical analyses when
examining companies reporting under different currencies is that the
EXERCISES
Exercise 17-1 (10 minutes)
1.
B
6.
A
2.
C
7.
B
3.
D
8.
B
4.
C
9.
C
5.
A
10.
A
Exercise 17-2 (5 minutes)
1. Profit Margin and the Total Asset Turnover.
Return on Total Assets.
Exercise 17-3 (20 minutes)
2015
2014
2013
2012
2011
Sales ........................................
189
181
168
156
100
Cost of goods sold ................
191
182
172
159
100
Accounts receivable ..............
201
192
182
169
100
Analysis: The trend in sales is positive. While this is better than no growth,
one cannot definitively say whether the sales trend is favorable without
Exercise 17-4 (25 minutes)
Answer: Net income decreased.
Supporting calculations: When the sum of each year's common-size cost of
goods sold and total expenses is subtracted from the common-size sales
percent, the net income percent is as follows:
Next, if 2012 sales are assumed to be $100, then sales for 2013 are $104.20 and
the sales for 2014 are $105.40. If the net income percents for the three years are
applied to these amounts, the net incomes are:
This shows that net income decreased over the three-year period.
Exercise 17-5 (25 minutes)
2013
2012
Sales ....................................................
100.0%
100.0%
Cost of goods sold ............................
75.7
46.5
Gross profit ........................................
24.3
53.5
Operating expenses...........................
17.3
35.0
Net income ..........................................
7.0%
18.5%
Analysis: Overall, this company’s situation has worsened. This is evident from
the substantial decline in net income as a percent of sales for 2013 (7.0%)
Exercise 17-6 (30 minutes)
COMPARATIVE ANALYSIS REPORT
Clay's profit margins are higher than Roak's. However, Roak has
significantly higher total asset turnover ratios. As a result, Roak generates
a substantially higher return on total assets.
The trends of both companies include evidence of growth in sales, total
asset turnover, and return on total assets. However, Clay's rates of
To some extent, Roak's higher total asset turnover ratios may result from
the fact that its assets may have been purchased years earlier. If the
turnover calculations had been based on current values, the differences
Fundamental Accounting Principles, 21st Edition
986
Exercise 17-7 (20 minutes)
Simon Company
Common-Size Comparative Balance Sheets
December 31, 2012-2014
At December 31
2014
2013*
2012
Assets
Cash ...................................................................
6.1%
8.0%
10.0%
Accounts receivable, net ..................................
17.1
14.0
13.3
Merchandise inventory .....................................
21.5
18.5
14.3
Prepaid expenses ..............................................
2.0
2.1
1.3
Plant assets, net ...............................................
53.3
57.3
61.1
Total assets .......................................................
100.0%
100.0%
100.0%
Liabilities and Equity
Accounts payable .............................................
24.8%
16.9%
13.6%
Long-term notes payable secured by
mortgages on plant assets ..........................
18.8
22.9
22.1
Common stock, $10 par value .........................
31.3
36.7
43.3
Retained earnings ............................................
25.1
23.5
21.0
Total liabilities and equity ................................
100.0%
100.0%
100.0%
* Column does not equal 100.0 due to rounding.
Analysis: Several observations can be made.
(1) Cash as a percent of assets has declined—this is favorable provided sufficient
cash is available for operations.
(4) Accounts payable have markedly increased as a percent of assets—this could
reveal liquidity constraints.
Exercise 17-8 (25 minutes)
1. Current ratio
2014: = 1.88 to 1
2. Acid-test ratio
2014: = 0.93 to 1
Analysis and Interpretation: Simon's short-term liquidity position has
deteriorated over this three-year period. Both the current and acid-test
$31,800 + $89,500 + $112,500 + $10,700
$129,900
$31,800 + $89,500
$129,900
$51,250
Exercise 17-9 (25 minutes)
1. Days' sales uncollected
2014: x 365 = 48.5 days
2. Accounts receivable turnover
2014: = 8.9 times
3. Inventory turnover
2014: = 4.2 times
4. Days’ sales in inventory
2014: x 365 = 99.9 days
Analysis and Interpretation: The number of days' sales uncollected has
increased and the accounts receivable turnover has declined. Also, the
$89,500
$673,500
$673,500
($89,500 + $62,500)/2
$411,225
($112,500 + $82,500)/2
($82,500 + $54,000)/2
$112,500
$411,225
$345,500
Exercise 17-10 (25 minutes)
1. Debt and equity ratios
2014
2013
Total liabilities and debt ratio
$129,900 + $98,500 .......................
$228,400
43.7%
$75,250 + $101,500 .......................
$176,750
39.7%
Total equity and equity ratio
$163,500 + $131,100 .....................
294,600
56.3
$163,500 + $104,750 .....................
_______
_____
268,250
60.3
Total liabilities and equity ...............
$523,000
100.0%
$445,000
100.0%
2. Debt-to-equity ratio
3. Times interest earned
Analysis and Interpretation: Simon added debt to its capital structure
during 2014, with the result that the debt ratio increased from 39.7% to
Fundamental Accounting Principles, 21st Edition
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Exercise 17-11 (30 minutes)
1. Profit margin
2. Total asset turnover
2014: = 1.4 times
3. Return on total assets
Analysis and Interpretation: Simon's operating efficiency appears to be
declining because the return on total assets decreased from 7.1% to 6.4%.
$673,500
($523,000 + $445,000)/2
($445,000 + $377,500)/2
Exercise 17-12 (20 minutes)
1. Return on common stockholders' equity
2014: = 11.1%
2. Price-earnings ratio, December 31
3. Dividend yield
Analysis and interpretation
• The company’s return on common stockholders’ equity is good, but not
great. An 11% return likely makes it an acceptable investment (in the
business world) provided its risk is not too high.
Exercise 17-13A (10 minutes)
1. A Income (loss) from continuing operations
2. C Extraordinary gain (loss)
$31,100
($294,600 + $268,250)/2
($268,250 + $242,750)/2
