Challenge Exercises and Problem
(20-30 min.) E 13-61
ORDER OF
COMPUTATION
Millions
Given
Current assets …………………………………………………….
$16,150
4
Property, plant, and equipment …………….
$9,750
Given
Less Accumulated depreciation ……………
(900)
8,850
3
Total assets ($12,500 ÷ 0.50) ………………………………..
$25,000
1
Current liabilities ($16,150 ÷ 1.90) …………………………
$ 8,500
6
(20-30 min.) E 13-62
ORDER OF
COMPUTATION
Millions
5
Sales ($1,750 ÷ 0.35) ………………………………………….
$5,000
6
Operating expenses ($5,000 − $1,750) ………………..
3,250
4
Operating income ……………………………………………..
1,750
Interest expense ……………………………………………….
2
Pretax income [$800 ÷ (1 − 0.36)] ……………………….
(30-40 min.) P 13–63
Emore Corporation
Comparative Income Statements
Years Ended December 31, 2016 and 2015
2016 2015
Sales revenue ………………………………… $2,100,000
$2,000,000
Cost of goods sold (a) ……………………. 1,575,000
1,100,000
Gross profit (b) ………………………………. 525,000
900,000
Operating expense (d) ……………………. 265,000
700,000
Operating income (c) ……………………… 260,000
200,000
Interest expense ……………………………. 20,000
Income before income tax (e) …………. 240,000
Income tax expense (30%) (f) ………….. 72,000
Net income (g) ……………………………….. $ 168,000
(continued) P 13-63
Emore Corporation
Comparative Balance Sheets
December 31, 2016 and 2015
2016 2015
ASSETS
Current:
Cash (l) …………………………………………… $ 73,000
$ 28,000
Accounts receivable, net (k)……………… 135,000
145,000
Inventory (j) …………………………………….. 152,000
180,000
Plant and equipment, net …………………….. 940,000
447,000
Total assets ……………………………………….. $1,300,000
$800,000
LIABILITIES
Current liabilities ………………………………… $ 160,000
$160,000
10% Bonds payable (r) ………………………… 580,000
240,000
Total liabilities (q) ……………………………….. 740,000
400,000
STOCKHOLDERS’ EQUITY
Common stock, $5 par (o) ………………… 351,000
203,200
Retained earnings (p) ………………………. 209,000
Total stockholders’ equity (n) ………………. 560,000
196,800
400,000
Total liabilities and stockholders’ equity (m) $1,300,000
$800,000
Computations (alternate order of calculations is possible)
(a) Cost of goods sold ($1,575,000) = Sales x COGS % ($2,100,000 × 75%)
(continued) P 13–63
(e) Income before income tax ($240,000) = Operating income – Interest expense
($260,000 – $20,000)
(f) Income tax expense ($72,000) = Income before income tax × tax rate ($240,000 ×
30%)
(g) Net income ($168,000) = Income before income tax – Income tax expense
($240,000 – $72,000)
(h) Current assets ($360,000) = Current ratio × Current liabilities (2.25 × $160,000)
(i) Cash + Accounts receivable = Quick assets ($208,000) = Quick ratio × Current
liabilities (1.30 × $160,000)
(j) Inventory ($152,000) = (h) – (i) ($360,000 – $208,000)
(k) Average accounts receivable ($140,000) = Sales ÷ Accounts receivable turnover
($2,100,000 ÷ 15)
Average accounts receivable = (Beginning + Ending) ÷ 2; $140,000 = ($145,000 +
Ending) ÷ 2; Ending = $135,000
Decision Cases
(30 min.) Decision Case 1
Req. 1
Trans-
action
Current
Ratio
Debt
Ratio
Times-
Interest-
Earned
Ratio
Return
on
Equity
Book
Value
Per Share
1
Increase
Decrease
No effect
Increase
Increase
2
Increase
Increase
No effect
No effect
No effect
3
Decrease
Increase
No effect
Increase
Indeterminate
4
No effect
Increase
No effect
Decrease
Decrease
5
Increase
Decrease
Increase
Increase
Increase
6
Decrease
Increase
No effect
No effect
No effect
Req. 2
Transaction
Overall Effect on the Company
1
Positive (due to gain)
2
Unclear
3
Unclear*
4
Negative (due to loss)
5
Positive (due to gross profit)
6
Unclear
____
*May be negative because of decreasing assets that shrink the company.
(20-30 min.) Decision Case 2
Ratio
CNH
Caterpillar
1.
Current ratio
Higher
Lower
2.
Quick (acid-test) ratio
No effect
No effect
3.
Inventory turnover
Lower
Higher
4.
Receivable turnover
No effect
No effect
and
5.
Debt ratio
Lower
Higher
6.
Times-interest-earned
Higher
Lower
7.
Return on sales, total assets,
Higher
Lower
and equity,
and earnings per share
8.
Price/earnings ratio
Lower*
Higher*
_____
*Assuming stock price is unaffected by the accounting
difference. If stock price is affected, the price/earnings
ratio could be higher (lower) for either company.
9.
Dividend yield
No effect
No effect
13.
Operating profit percentage
Higher
Lower
14.
Asset turnover
Lower
Higher
(continued) Decision Case 2
CONCLUSION:
Overall, CNH will look better than Caterpillar because of:
• Higher current ratio, times-interest-earned ratio, rate of return
measures, and book value per share of common stock.
• Lower debt ratio.
(20-30 min.) Decision Case 3
To reduce losses and establish profitable operations, Outward Bound
should take the following steps:
1. Make a dedicated effort to collect receivables and consider extending
less credit to customers. Receivables make up 15.2% of assets,
2. Reduce the amount of the company’s interest-bearing debt. The
company’s short-term notes payable equal 17.1% of total assets,
compared to 14.0% for the industry average. (Interest-bearing) long-
term debt equals 19.7% of total assets, compared to 16.4% for the
3. Sell higher profit-margin products. Cost of sales is 68.2% of sales,
compared to 64.8% for the industry average. Consequently, gross
profit is only 31.8% of net sales, which is less than the 35.2% industry
average.
4. Cut operating expenses below their current level of 37.1% of sales by
finding cheaper ways of doing business. The company should
Ethical Issue
Req. 1
The ethical issue is: Should Turnberry reclassify its investments from
long-term to short-term?
Req. 2 and Req. 3
The stakeholders in the decision are Turnberry Corporation, its
officers and directors, stockholders, and its current and future
creditors.
Economic analysis: Reclassifying the long-term investments as
short-term will increase current assets and, therefore, increase the
current ratio. Turnberry’s financial position is not improved by this
reclassification because the company’s asset position has not
Legal analysis: If Turnberry’s management truly believes that they
intend to sell the investments within a year, thus justifying
reclassification of the investments to current assets, nothing illegal
has happened. However, intentionally falsifying financial statements
is considered illegal in all states, and is also a federal crime, with
criminal or civil penalties, or both.
(continued) Ethical Issue
Ethical analysis: Reclassifying a long-term investment as current to
meet a debt agreement does not, in itself, brand Turnberry managers
Req. 4.
Reclassifying the investments from current back to long-term may
suggest to some observers that managers are playing a shell game.
However, the case states that sales subsequent to the first
reclassification have improved the current ratio. Under these
circumstances, Turnberry may not need to sell the investments. The
managers may prefer to hold the investments beyond one year and,
therefore, need to reclassify them as long-term. In that case, the
managers’ action is appropriate.
Focus on Financials: Apple Inc.
(1-2 hours)
Req. 1 (in millions)
2014
2013
2014
Vertical
Analysis
2013
Vertical
Analysis
Dollar
Change
Horizontal
Analysis
2014
Amount
2013
Amount
Dollar
Change
Net Sales
Net Sales
2013
Amount
Net Sales
$182,795
$170,910
100.00%
100.00%
$11,885
6.95%
Gross Margin
$70,537
$64,304
38.59%
37.62%
$6,233
9.69%
Operating
Income
$52,503
$48,999
28.72%
28.67%
$3,504
7.15%
Net Income
$39,510
$37,037
21.61%
21.67%
$2,473
6.68%
(continued) Apple Inc.
Req. 2 (in millions) – Assets
2014
2013
2014
Vertical
Analysis
2013
Vertical
Analysis
Dollar
Change
Horizonta
l Analysis
2014
Amount
2013
Amount
Dollar
Change
2014
Assets
2013
Assets
2013
Amount
Cash
$13,844
$14,259
5.97%
6.89%
$(415)
-2.91%
Short Term
Securities
$11,233
$26,287
4.85%
12.70%
$(15,054)
-57.27%
AR
$17,460
$13,102
7.53%
6.33%
$4,358
33.26%
Inventory
$2,111
$1,764
0.91%
0.85%
19.67%
Deferred Taxes
$4,318
$3,453
1.86%
1.67%
25.05%
Non-Trade
Receivables
$9,759
$7,539
4.21%
3.64%
$2,220
29.45%
Other Current
Assets
$9,806
$6,882
4.23%
3.32%
$2,924
42.49%
Total Current
Assets
$68,531
$73,286
29.56%
35.40%
$(4,755)
-6.49%
Long Term
Securities
$130,162
$106,215
56.14%
51.31%
$23,947
22.55%
PPE
$20,624
$16,597
8.90%
8.02%
$4,027
24.26%
Goodwill
$4,616
$1,577
1.99%
0.76%
$3,039
192.71%
Acquired
Intangibles
$4,142
$4,179
1.79%
2.02%
-0.89%
Other Assets
$3,764
$5,146
1.62%
2.49%
$(1,382)
-26.86%
(continued) Apple Inc.
Req. 2 (in millions) – Liabilities & Stockholder’s Equity
2014
2013
2014
Vertical
Analysis
2013
Vertical
Analysis
Dollar
Change
Horizontal
Analysis
2014
Amount
2013
Amount
Dollar
Change
2014
Assets
2013
Assets
2013
Amount
Accounts
Payable
$22,367
13.02%
10.81%
35.00%
Accrued
Expenses
$18,453
$13,856
7.96%
6.69%
$4,597
33.18%
Deferred
Revenue
$8,491
$7,435
3.66%
3.59%
$1,056
14.20%
Commercial
Paper
$6,308
2.72%
0.00%
$6,308
Total Current
Liabilities
$63,448
$43,658
27.37%
21.09%
$19,790
45.33%
Deferred
Revenue-
Noncurrent
$3,031
$2,625
1.31%
1.27%
$406
15.47%
Long Term
Debt
$28,987
$16,960
12.50%
8.19%
$12,027
70.91%
Other
Noncurrent
Liabilities
$24,826
$20,208
10.71%
9.76%
$4,618
22.85%
Total
Liabilities
$120,292
$83,451
51.89%
40.31%
$36,841
44.15%
Common
Stock
$23,313
$19,764
10.06%
9.55%
$3,549
17.96%
Retained
Earnings
$87,152
37.59%
50.37%
$(17,104)
-16.41%
Accumulated
OCI
$1,082
0.47%
$1,553
329.72%
Total Equity
$111,547
$123,549
48.11%
59.69%
$(12,002)
-9.71%
12.00%