Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 13
Analyzing 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
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
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)
15. Equity ratio: Total Equity / Total Assets ($ in thousands)
16. Debt ratio: Total Liabilities / Total Assets (€ in thousands)
17. Return on total assets: Net Income / Average Total Assets (€ in thousands)
QUICK STUDY
Quick Study 13-1 (5 minutes)
Items not part of general-purpose financial statements:
Quick Study 13-2 (5 minutes)
Trend percents
Quick Study 13-3 (5 minutes)
Common-size percents
Quick Study 13-4 (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 13-5 (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 13-6 (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 13-7 (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-
test ratio, which show Parker is in a more liquid position than Morgan. This
evidence does not mean that Morgan's liquidity is inadequate. Such a
low returns.
The accounts receivable turnover and inventory turnover indicate that
Morgan is more efficient in collecting its accounts receivable and in
generating sales from available inventory. However, these statistics also
Quick Study 13-8A (5 minutes)
This material error should be reported on the statement of retained
earnings (and/or the statement of stockholders’ equity) as a prior period
Financial & Managerial Accounting, 5th Edition
728
Quick Study 13-9 (10 minutes)
a. Although ratio analysis can eliminate currency differences, it cannot
eliminate differences in the application of GAAP under different
accounting systems. For example, if we compare the gross margin
paragraph’s first example, however, many of these differences in asset
revaluations will be captured over time (multiple periods) with both
accounting systems.
b. A key advantage to using horizontal and vertical analyses when
examining companies reporting under different currencies is that the
computation of the percentages eliminates the currency effects. This
EXERCISES
Exercise 13-1 (10 minutes)
Exercise 13-4 (25 minutes)
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:
2012 net income percent: 100.0 - 59.1 - 15.1 = 25.8% of sales
This shows that net income decreased over the three-year period.
Exercise 13-5 (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%
Exercise 13-6 (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
improvement are better than Roak's. These differences may result from the
fact that Clay is only three years old, while Roak is a somewhat more
Financial & Managerial Accounting, 5th Edition
732
Exercise 13-7 (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.
(2) Accounts receivable have increased as a percent of assets—this may be
unfavorable in that assets are tied up in an unproductive manner and there would
Exercise 13-8 (25 minutes)
1. Current ratio
2. Acid-test ratio
Analysis and Interpretation: Simon's short-term liquidity position has
deteriorated over this three-year period. Both the current and acid-test
ratios show declining trends. Although we do not have information about
$51,250
$51,250
Exercise 13-9 (25 minutes)
1. Days' sales uncollected
2. Accounts receivable turnover
3. Inventory turnover
4. Days’ sales in inventory
Analysis and Interpretation: The number of days' sales uncollected has
increased and the accounts receivable turnover has declined. Also, the
$89,500
$673,500
$112,500
$345,500
Exercise 13-10 (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
Exercise 13-11 (30 minutes)
1. Profit margin
2014: $31,100 / $673,500 = 4.6%
2013: $29,375 / $532,000 = 5.5%
2. Total asset turnover
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%.
Exercise 13-12 (20 minutes)
1. Return on common stockholders' equity
2014: = 11.1%
2013: = 11.5%
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
Exercise 13-13A (10 minutes)
$31,100
($294,600 + $268,250)/2
$29,375
($268,250 + $242,750)/2
