CHAPTER 14
Financial Statement Analysis
ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Questions
Brief
Exercises
Do It!
Exercises
1. Discuss the need for comparative
analysis.
1, 2, 3, 5
1
2. Identify the tools of financial
statement analysis.
2, 3, 5, 6
2
3. Explain and apply horizontal analysis.
3, 4, 25
2, 3, 5, 6, 7
1, 4
1, 3, 4
4. Describe and apply vertical analysis.
3, 4, 25
2, 4, 8
4
2, 3, 4
5. Identify and compute ratios used
in analyzing a firm’s liquidity,
profitability, and solvency.
5, 6, 7, 8, 9,
10, 11,12, 13,
14, 15, 16,
17, 18, 19
2, 9, 10, 11,
12, 13
2, 4
5, 6, 7, 8,
9, 10, 11
6. Understand the concept of earning
power, and how irregular items are
presented.
20, 21, 22, 23
14, 15
3, 4
12, 13
7. Understand the concept of quality
of earnings.
24
4
ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
1
Prepare vertical analysis and comment on profitability.
Simple
20–30
2
Compute ratios from balance sheet and income statement.
Simple
20–30
3
Perform ratio analysis, and evaluate financial position
and operating results.
Simple
20–30
4
Compute ratios, and comment on overall liquidity and
profitability.
Moderate
30–40
5
Compute selected ratios, and compare liquidity, profitability,
and solvency for two companies.
Moderate
50–60
6
Compute numerous ratios.
Simple
30–40
7
Compute missing information given a set of ratios.
Complex
30–40
8
Prepare income statement with discontinued operations
and extraordinary loss.
Moderate
30–40
9
Prepare income statement with nontypical items.
Moderate
30–40
BLOOM’S TAXONOMY TABLE
Copyright © 2012 John Wiley & Sons, Inc. Weygandt, Managerial Accounting, 6/e, Solutions Manual (For Instructor Use Only) 14-3
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End–of-Chapter Exercises and Problems
Learning Objective
Knowledge
Comprehension
Application
Analysis
Synthesis
Evaluation
1. Discuss the need for comparative
analysis.
Q14-1
Q14-2
Q14-3
Q14-5
BE14-1
2. Identify the tools of financial
statement analysis.
Q14-6
BE14-2
Q14-2
Q14-3
Q14-5
BE14-2
3. Explain and apply horizontal
analysis.
BE14-2
Q14-25
Q14-3
DI14-4
Q14-4
BE14-2
BE14-3
BE14-5
BE14-6
BE14-7
DI14-1
E14-1
E14-3
E14-4
4. Describe and apply vertical
analysis.
BE14-2
Q14-25
Q14-3
DI14-4
Q14-4
BE14-2
BE14-4
BE14-8
E14-2
E14-3
E14-4
P14-1
5. Identify and compute ratios
used in analyzing a firm’s
liquidity, profitability, and
solvency.
Q14-6
Q14-8
BE14-2
Q14-5
Q14-7
Q14-9
Q14-10
Q14-11
Q14-12
Q14-13
Q14-14
Q14-15
Q14-16
Q14-17
Q14-18
DI14-4
Q14-19
BE14-2
BE14-9
BE14-10
DI14-2
E14-6
E14-7
E14-8
E14-9
E14-10
P14-2
P14-3
P14-5
P14-6
BE14-11
BE14-12
BE14-13
E14-5
E14-11
P14-1
P14-2
P14-3
P14-4
P14-7
6. Understand the concept of
earning power, and how
irregular items are presented.
Q14-20
Q14-21
Q14-22
Q14-23
DI14-4
BE14-14
BE14-15
DI14-3
E14-12
E14-13
P14-8
P14-9
7. Understand the concept of
quality of earnings.
Q14-24
DI14-4
Broadening Your Perspective
BYP14-4
BYP14-5
BYP14-8
BYP14-1
BYP14-3
BYP14-2
BYP14-6
BYP14-7
ANSWERS TO QUESTIONS
1. (a) Kurt is not correct. There are three characteristics: liquidity, profitability, and solvency.
2. (a) Comparison of financial information can be made on an intracompany basis, an intercompany
basis, and an industry average basis (or norms).
(3) An intercompany basis compares an item or financial relationship of one company with
the same item or relationship in one or more competing companies.
and significant trends within a company.
The industry averages basis provides information as to a company’s relative performance
within the industry.
3. Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or
percent of a base amount.
4. (a) $350,000 X 1.224 = $428,400, 2014 net income.
5. A ratio expresses the mathematical relationship between one quantity and another. The relationship
periods or to competitors’ ratios or to industry ratios.
6. (a) Liquidity ratios: Current ratio, acid-test ratio, receivables turnover, and inventory turnover.
7. Gordon is correct. A single ratio by itself may not be very meaningful and is best interpreted by
determine overall financial well-being.
8. (a) Liquidity ratios measure the short-term ability of the enterprise to pay its maturing obligations
and to meet unexpected needs for cash.
Questions Chapter 14 (Continued)
9. The current ratio relates current assets to current liabilities. The acid–test ratio relates cash, short–term
11. (a) Asset turnover.
(b) Inventory turnover.
(c) Return on common stockholders’ equity.
(d) Times interest earned.
12. The price earnings (P/E) ratio is a reflection of investors’ assessments of a company’s future
willing to pay more for the stock.
13. The payout ratio is cash dividends divided by net income. In a growth company, the payout ratio is
14. (a) The increase in profit margin is good news because it means that a greater percentage of net
sales is going towards income.
to meet maturing short-term obligations.
(d) The earnings per share ratio is a deceptive ratio. The decrease might be bad news to the
company because it could mean a decrease in net income. If there is an increase in stockholders’
market price per share of stock has increased and investors are willing to pay that higher
price for the stock. An increase in the P/E ratio is good news for investors who own the stock
the stock.
(f) The increase in the debt to total assets ratio is bad news because it means that the company
has increased its obligations to creditors and has lowered its equity “buffer.”
Questions Chapter 14 (Continued)
15.
Return on assets
(7.6%)
=
AssetsAverage
Income Net
Return on common stockholders’ equity
(12.8%)
=
Equity rs‘Stockholde Common Average
Dividends Preferred – Income Net
The difference between the two rates can be explained by looking at the denominator value and
by remembering the basic accounting equation, A = L + SE. The asset value will clearly be the larger
of the two denominator values; therefore, it will also give the smaller return.
16. (a) The times interest earned ratio, which is an indication of the company’s ability to meet interest
payments, and the debt to total assets ratio, which indicates the company’s ability to withstand
losses without impairing the interests of creditors.
(b) The current ratio and the acid-test ratio, which indicate a company’s liquidity and short–term
debt-paying ability.
19.
goutstandin shares common average Weighted
dividends Preferred – income Net
= Earnings per share
$160,000 – $30,000
50,000
= $2.60
EPS of $2.60 is high relative to what? Is it high relative to last year’s EPS? The president may be
comparing the EPS of $2.60 to the market price of the company’s stock.
20. Discontinued operations refers to the disposal of a significant component of the business such as
21. EPS on income before extraordinary items usually is more relevant to an investment decision
than EPS on net income. Income before extraordinary items represents the results of continuing
Questions Chapter 14 (Continued)
22. Extraordinary items are events and transactions that are unusual in nature and infrequent in occurrence.
Therefore, an extraordinary item is a one–time item which is not typical of the company’s operations.
23. Items (a), (d), and (g) are extraordinary items.
24. (1) Use of alternative accounting methods. Variations among companies in the application of
(2) Use of pro forma income measures that do not follow GAAP. Pro forma income is calculated
(3) Improper revenue and expense recognition. Many high–profile cases of inappropriate accounting
25. The following provide examples of horizontal and vertical analysis:
Horizontal Analysis: Financial Highlights; Results of operations-consolidated reviews; Result of
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 14-1
Dear Uncle Liam,
It was so good to hear from you! I hope you and Aunt Doreen are still
enjoying your new house.
You asked some interesting questions. They relate very well to the material
that we are studying now in my financial accounting class. You said you
heard that different users of financial statements are interested in different
characteristics of companies. This is true. A short–term creditor, such as a bank,
is interested in the company’s liquidity, or ability to pay obligations as they
It is important to compare different financial statement elements to other
items. The amount of a financial statement element such as cash does not have
much meaning unless it is compared to something else. Comparisons can
be done on an intracompany basis. This basis compares an item or financial
relationship within a company for the current year to one or more previous
an item or financial relationship with the same item or relationship in one or more
competing companies. Intercompany comparisons are useful in determining
a company’s competitive position.
would be great to see you!
Love,
Your niece (or nephew)
BRIEF EXERCISE 14-2
(a) The three tools of financial statement analysis are horizontal analysis,
vertical analysis, and ratio analysis. Horizontal analysis evaluates a series
of financial statement data over a period of time. Vertical analysis evalu-
(b) Horizontal Analysis
2012
2013
2014
Current assets
100%
105%
109%
(105% = $230,000/$220,000; 109% = $240,000/$220,000)
Vertical Analysis
2012
2013
2014
Current assets*
44%
38%
38%
Ratio Analysis
2012
2013
2014
Current ratio
1.38
1.35
1.30
BRIEF EXERCISE 14-3
Horizontal analysis:
Increase
or (Decrease)
Dec. 31, 2014
Dec. 31, 2013
Amount
Percentage
Accounts receivable
Inventory
Total assets
$ 520,000
$ 840,000
$2,500,000
$ 350,000
$ 500,000
$3,000,000
$170,000
$340,000
($500,000)
49%
68%
(17)%
170,000
350,000
= .49
340,000
500,000
= .68
(500,000)
3,000,000
= (.17)
BRIEF EXERCISE 14-4
Vertical analysis:
Dec. 31, 2014
Dec. 31, 2013
Amount
Percentage*
Amount
Percentage**
Accounts receivable
Inventory
Total assets
$ 520,000
$ 840,000
$2,500,000
20.8%
33.6%
100%
$ 350,000
$ 500,000
$3,000,000
11.7%
16.7%
100%
*520,000
2,500,000
= .208
** 350,000
3,000,000
= .117
* 840,000
2,500,000
= .336
** 500,000
3,000,000
= .167
BRIEF EXERCISE 14-5
2014
2013
2012
Net income
$525,000
$475,000
$550,000
Increase or (Decrease)
Amount
Percentage
(a)
(b)
2012–2013
2013–2014
(75,000)
(50,000)
(14%)
(11%)
75,000
550,000
= .14
50,000
475,000
= .11
BRIEF EXERCISE 14-6
2014
2013
Increase
Net income
$560,000
X
40%
X .40 =
560,000 – X
X
.40X = 560,000 – X