Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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CHAPTER 17
ANALYSIS OF FINANCIAL STATEMENTS
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Explain the purpose and identify
the building blocks of analysis.
1
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17-1
17-8
C2. Describe standards for
comparisons in analysis.
2, 3
17-2, 17-9
17-2
17-2
Analytical objectives:
A1 Summarize and report results of
analysis.
13
17-7
17–12
17-1, 17-5
17–1, 17-3,
17–4, 17–7,
17-9
A2A Explain the form and assess the
content of a complete income
statement. (Appendix 17A)
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17-8
17-13, 17–14
17-6
Procedural objectives:
horizontal analysis.
17-7
P2. Describe and apply methods of
vertical analysis.
17-5
17–4, 17–5,
17-6
17-2
17–1, 17–2,
17–6, 17-7
P3. Define and apply ratio analysis.
14,15, 16, 17
17-11, 17–15
SP, ES
17-8
4, 5, 6, 7, 8, 9,
10, 11, 12,
17-6
17–7, 17-8
17– 9, 17-10,
17-2, 17-3,
17–4, 17-5,
17–4, 17-5,
17–6, 17–7,
17-3, 17-4
17–3, 17-5
17–1, 17-2
17–1, 17–6,
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Additional Information on Related Assignment Material
Connect
Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all Exercises and
Problems Set A. Connect also provides algorithmic versions for Quick Study, Exercises and Problems. It allows
instructors to monitor, promote, and assess student learning. It can be used in practice, homework, or exam mode.
Connect Insight
The first and only analytics tool of its kind, Connect Insight is a series of visual data displays that are each framed
by an intuitive question and provide at-a-glance information regarding how an instructor’s class is performing.
Connect Insight is available through Connect titles.
The Serial Problem for Success Systems continues in this chapter.
General Ledger
Assignable within Connect, General Ledger (GL) problems offer students the ability to see how transactions post
Excel Simulations
Assignable within Connect, Excel Simulations allow students to practice their Excel skills—such as basic formulas
and formatting—within the context of accounting. These questions feature animated, narrated Help and Show Me
tutorials (when enabled). Excel Simulations are auto-graded and provide instant feedback to the student.
Synopsis of Chapter Revisions
NEW opener—Morgan Stanley and entrepreneurial assignment.
Streamlined the “Basics of Analysis” section.
Simplified computations for comparative statements.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
Notes
I. Basics of Analysis—Transforming data into useful information.
A. Purpose of Analysis
To help users (both internal and external) make better business
decisions.
1. Internal users (managers, officers, internal auditors,
consultants, budget officers, and market researchers) make the
pursuing their own goals.
2. External users (shareholders, lenders, and suppliers) rely on
3. The common goal of all users is to evaluate:
a. Past and current performance.
b. Current financial position.
c. Future performance and risk.
B. Building Blocks of Analysis
The four areas of inquiry or building blocks are:
1. Liquidity and efficiency—ability to meet short-term
2. Solvency—ability to generate future revenues and meet long-
term obligations.
4. Market prospects—ability to generate positive market
expectations.
C. Information for Analysis
Most users conduct analysis using general purpose financial
statements that include:
reports.
1. Income statement
3. Statement of stockholders’ equity (or statement of retained
earnings)
5. Notes related to the statements
6. Other useful financial data—10K/other SEC filings, news
and services.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
Notes
D. Standards for Comparisons
We need standards (benchmarks) can include the following types
of comparisons:
Moody’s) provide standards for comparisons.
2. Competitor—competitors provide standards for comparisons.
3. Industry—published industry statistics (available from
4. Guidelines (rules-of-thumb)—standards of comparisons
developed from experience.
E. Tools of Analysis
2. Vertical analysis
3. Ratio analysis
II. Horizontal Analysis—Tool to evaluate changes in financial statement
data across time. This analysis utilizes:
1. Reports where financial amounts for more than one period are
A. Comparative Statements
2. Dollar changes and percentage changes—usually shown in
line items.
by 100. Note:
(1) When a negative amount appears in the base period
(3) When an item has a value in the base period and zero
in the next period—the decrease is 100 percent.
3. Comparative Balance Sheets—balance sheets from two or
4. Comparative Income Statements—also compares two or more
periods presented side-by side with dollar and percentage
changes.
Chapter Outline
Notes
B. Trend analysis (also called trend percent analysis or index number
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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trend analysis)
2. Involves computing trend percents (or index number) as
3. Often aided by graphical depiction.
III. Vertical Analysis—(also called common-size analysis) Comparing
financial condition and performance to a base amount. The analysis
tools include:
A. Common-Size Statements—reveal changes in the relative
importance of each financial statement item by redefining each in
terms of common-size percents.
1. Base amount is commonly defined as 100%. Usually a key
2. Sum of individual items is 100%.
3. Common-size percentage equals (Analysis amount divided by
Base amounts) multiplied by 100.
Graphical analysis (ex. pie charts and bar charts) of common-size
statements that visually highlight comparison information.
B. Common-Size Graphics
IV. Ratio Analysis—widely used in financial analysis because they help
to uncover conditions and trends difficult to detect by inspecting
individual amounts. Ratios are organized into the four (A to D below)
building blocks of analysis:
A. Liquidity and Efficiency
2. Efficiency refers to how productive a company is in using its
3. Ratios in this block:
a. Working capital—the excess of current assets less current
liabilities.
b. Current ratio—current assets divided by current liabilities;
describes a company’s ability to pay its short-term
obligations.
c. Acid-test ratio—similar to current ratio but focuses on
quick assets (i.e., cash, short-term investments, current
1. A form of horizontal analysis used to reveal patterns in data
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
Notes
d. Accounts receivable turnover—net sales or credit sales
divided by average accounts receivable; a measure of how
long it takes a company to collect its accounts.
e. Inventory turnover—cost of goods sold divided by
f. Days’ sales uncollected—(accounts receivable divided by net
credit sales) multiplied by 365 days; measures how
frequently a company collects its accounts receivable.
g. Days’ sales in inventory—(ending inventory divided by
cost of goods sold) multiplied by 365; measures how
many days it will take to convert the inventory on hand at
the end of the period into accounts receivable or cash.
B. Solvency
1. Solvency refers to a company’s long-run financial viability and
2. Capital structure refers to a company’s sources of financing.
3. Ratios in this block:
a. Debt ratio—total liabilities divided by total assets.
b. Equity ratio—total stockholders’ equity divided by total
assets; compliment of debt ratio.
c. Debt-to-equity ratio—total liabilities divided by total
equity.
structure (equity and long-term debt) is composed more of
Note: A company is considered less risky if its capital
d. Times interest earned—income before interest expense
and income taxes divided by interest expense; reflects the
risk of repayments with interest to creditors.
C. Profitability
2. Return is judged by assessing earnings relative to the level
and sources of financing.
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Chapter Outline
Notes
3. Ratios in this block:
a. Profit margin—net income divided by net sales;
describes the ability to earn a net income from sales.
b. Return on total assets—net income divided by average
total assets; a summary measure of operating
turnover.
c. Return on common stockholders’ equity—net income
less preferred dividends divided by average common
D. Market Prospects
1. Market measures are useful for analyzing corporations with
publicly traded stock.
3. Ratios in this block:
a. Price-earnings ratio—market price per share of common
stock divided by earnings per share; used to evaluate the
profitability of alternative common stock investments.
b. Dividend yield—annual cash dividends paid per share of
stock divided by market price per share; used to compare
E. Summary of Ratios
Exhibit 17.16 in the text sets forth the names of each of the
common ratios by category, and includes the formula and a
description of what is measured by each ratio.
V. Decision Analysis—Analysis Reporting
Goal of financial statement analysis report is to reduce uncertainty
through rigorous and sound evaluation. A good analysis report usually
consists of six sections:
1. Executive summary
3. Evidential matter
5. Key factors
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
Notes
VI. Sustainable Income—Appendix 17A
When a revenue and expense transactions are from normal, continuing
operations, a simple income statement is adequate. When activities
include events that are not normal, it must disclose this information by
separating the income statement into different sections as follows (A-
D):
A. Continuing Operations
Reports the revenues, expenses, and income generated by the
company’s continuing operations.
B. Discontinued Segments
1. A business segment is a part of a company’s operations that
serves a particular line of business or class of customers.
2. Section reports:
a. Income (loss) from operating the discontinued business
segment for the current period prior to disposal (net of
taxes).
C. Extraordinary Items—reports extraordinary gains and losses that
are both unusual and infrequent.
2. An infrequent gain or loss is not expected to recur given the
company’s operating environment.
3. Items that are unusual or infrequent, but not both, are reported
in the income statement as part of continuing operations but
below the normal revenues and expenses.
D. Earnings per Share
1. Final section of income statement
E. Changes in Accounting Principles
always been used).
1. The consistency principle directs a company to apply the same
2. A footnote would describe change and why it is an
improvement.
3. Requires retrospective application (application of new
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter 17 Alternate Demonstration Problem
Following are data from the statements of two companies selling similar
products:
Current Year-End Balance Sheets
Sled
Company
Zip
Company
Cash ………………………………………………………………
$ 11,900
$ 20,000
Notes receivable—short-term …………………………
7,700
3,200
Accounts receivable, net ………………………………..
42,000
64,000
Inventory ……………………………………………………….
58,800
87,680
Prepaid expenses …………………………………………..
1,680
3,520
Plant and equipment, net ………………………………..
232,120
274,400
Total assets ……………………………………………………
$354,200
$452,800
Current liabilities …………………………..……………….
$ 56,000
$ 80,000
Mortgage payable …………………………………………..
70,000
80,000
Common stock, $10 par value …………………………
140,000
160,000
Retained earnings ………………………………………….
88,200
132,800
Total liabilities and stockholders’ equity …………
$354,200
$452,800
Data from the Current Year’s Income Statement
Sales ……………………………………………………………..
$672,000
$880,000
Cost of goods sold …………………………………………
528,080
699,840
Interest expense …………………………………………….
4,200
5,600
Net income …………………………..………………………..
23,373
28,896
Beginning–of-Year Data
Inventory ……………………………………………………….
$ 53,200
$ 85,120
Total assets ……………………………………………………
345,800
443,200
Stockholders’ equity ………………………………………
217,000
285,120
Required:
1. Calculate current ratios, acid–test ratios, inventory turnovers, and days’ sales
uncollected for the two companies. Then state which company you think is
the better short-term credit risk and why.
2. Calculate return on total assets employed and return on stockholders’
equity. Then, under the assumption that each company’s stock can be
purchased at book value, state which company’s stock you think is the
better investment and why.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
Solution: Chapter 17 Alternate Demonstration Problem
Part 1
Sled Company
Zip Company
Current ratio:
$ 61,600
= 1.10 to 1
$ 87,200
= 1.09 to 1
$122,080
= 2.18 to 1
$178,400
= 2.23 to 1
Part 2
$ 23,373
$ 28,896
$ 23,373
$ 28,896