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CHAPTER 8
COMPREHENSIVE REVIEW
INTRODUCTION
This chapter presents a series of activities designed to review and integrate the concepts learned
throughout the course. It would be relatively easy to look at one aspect of a company, to the exclusion of
and explain one another.
When considering a company’s investment potential, profitability is generally considered the most
important factor. Well-run companies earn profits that grow reliably at a steady pace. That said, the
DuPont Model demonstrates how efficiency (as measured by asset turnover) and solvency (as measured
by financial leverage) can be multiplied by return on sales to increase return on equity; efficiency and
measured over time.
Chapter 9, the Capstone Project, provides further comprehensive review, using a company of your choice.
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ACTIVITY 97 TRANSACTIONS AFFECTING TOTAL ASSETS
Purpose: • Review the effect of various transactions on total assets.
Circle whether each of the following events/transactions will (I)ncrease, (D)ecrease, or have (No) effect on
total assets.
TOTAL ASSETS
(Circle the answer)
a. Record a cash sale to Customer Grant. (I / D / No)
h. Purchase short-term trading securities for cash. (I / D / No)
i. At the end of the accounting period, the short-term trading
securities purchased in (h) have increased in market value. (I / D / No)
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ACTIVITY 98 TRANSACTIONS AFFECTING TOTAL LIABILITIES
Purpose: • Review the effect of various transactions on total liabilities.
Circle whether each of the following events/transactions will (I)ncrease, (D)ecrease, or have (No) effect on
total liabilities.
TOTAL LIABILITIES
(Circle the answer)
c. Sell inventory to customers for cash. (I / D / No)
These costs will not be paid until an employee retires
in a future accounting period. (I / D / No)
j. At the end of the accounting period, estimate the
amount of income taxes owed for the fiscal year. (I / D / No)
k. Company ABC files a lawsuit. Company lawyers
evaluate the case and estimate the company will
probably win a substantial amount for damages.
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Circle whether each of the following events/transactions will (I)ncrease, (D)ecrease, or have (No) effect on
stockholders’ equity.
STOCKHOLDERS’ EQUITY
(Circle the answer)
a. Issue preferred stock at par value. (I / D / No)
depreciation expense in the previous accounting period. (I / D / No)
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ACTIVITY 100 TRANSACTIONS AFFECTING NET INCOME
Purpose: • Review the effect of various transactions on net income.
Circle whether each of the following events/transactions will (I)ncrease, (D)ecrease, or have (No) effect on
net income.
NET INCOME
(Circle the answer)
a. Record a sale for Customer Ashley paying cash. (I / D / No)
c2. At the end of the accounting period, make the adjusting entry
to record depreciation for the equipment. (I / D / No)
e. Pay rent for this accounting period. (I / D / No)
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ACTIVITY 101 WHICH FINANCIAL STATEMENT?
Purpose: • Reinforce understanding of the information provided by each financial statement.
Circle the financial statement you would consult to find the following information.
BS = Balance sheet
IS = Income statement
SE = Statement of stockholders’ equity
CF = Statement of cash flows
Not = Not found on any of the financial statements
FINANCIAL STATEMENTS
(Circle only one correct answer)
a. Rental costs incurred this year. (BS / IS / SE / CF / Not)
f. Market value of equipment purchased ten years ago. (BS / IS / SE / CF / Not)
g. Accrual-basis accounting used to compute operating results. (BS / IS / SE / CF / Not)
o. If we use the FIFO inventory cost flow assumption, the
most recent inventory costs will end up on this statement. (BS / IS / SE / CF / Not)
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ACTIVITY 102 FINANCIAL STATEMENT PREPARATION
Purpose: • Apply the revenue recognition and the matching principles.
• Differentiate between accrual accounting and cash accounting.
• Prepare a multi-step income statement, the statement of retained earnings, a
classified balance sheet, and the statement of cash flows.
Yonghong opened Books Galore, Inc., for business on January 1, Year 1. The following financial items
summarize the first year of operations. Use these items to prepare the Year 1 multi-step income
statement, the Year 1 statement of stockholders’ equity, the December 31, Year 1 classified balance
sheet, and the Year 1 statement of cash flows in the space provided.
a. Yonghong and her friend each invested $50,000 in cash (for a total of $100,000) in exchange for
shares of common stock in Books Galore, Inc.
b. On January 1, Year 1, purchased new equipment costing $70,000 with a 10-year useful life and no
residual value. Paid cash. Straight-line depreciation is used.
c. Rental costs for the year total $48,000. Of that amount, $4,000 remains unpaid at the end of the
year, December 31, Year 1.
d. January 1, Year 1, purchased and paid $2,000 for a two-year property insurance policy.
e. January 1, Year 1, purchased a piece of land next to the store for $20,000 in cash. Later in the year,
the land was sold to another small business owner for $30,000 in cash.
f. During Year 1, customers purchased $300,000 of books. Of that amount, $250,000 has been
collected from customers in cash and the remaining amounts will be collected next year.
g. Inventory purchases totaled $200,000 for the year. All purchases have been paid for, and $18,000
of those purchases remains in inventory at the end of the year.
h. On July 1, Year 1, borrowed $25,000 from a local bank and signed a one-year, 10% note payable.
Principal and interest are due on June 30, Year 2.
i. During Year 1, the company paid shareholders cash dividends totaling $8,000.
j. At the end of the year, adjusting entries were recorded for depreciation expense and interest
expense.
Multi-Step Income Statement
Year 1
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STATEMENT OF STOCKHOLDERS’ EQUITY
Year 1
Contributed
Capital
Retained
Earnings
Total SE
Beginning balances
$ -0-
$ -0-
$ -0-
Additions:
CLASSIFIED BALANCE SHEET
December 31, Year 1
Deductions:
Ending balances
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STATEMENT OF CASH FLOWS
Year 1 (Prepared using the direct method)
Cash from operating activities :
Cash from customers
$ 250,000
Cash paid to suppliers
Cash paid for property insurance
Cash paid for rent
Cash from investing activities:
Purchase of equipment
Purchase of land
Cash from financing activities:
Issuance of note payable
Issuance of common stock
Dividends paid
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ACTIVITY 103 RATIO ANALYSIS
Purpose: • Understand that reviewing many ratios helps give an overall impression of corporate
financial strength.
• Understand that meaning is added to a ratio by comparing that ratio to industry norms
or to a company within the same industry because norms may vary by industry.
• Analyze profitability, efficiency, liquidity, solvency, and investment ratios.
RATIOS
As of January 28, 2012
Industry
Average*
The GAP
(GPS)
American Eagle
Outfitters (AEO)
Return on equity (ROE)
20.9%
32.2%
10.9%
Gross profit margin (GP%)
39.9%
Earnings per share (EPS)
$0.85
Quality of income
NA
1.64
1.58
EFFICIENCY
Asset turnover (A TO)
1.62
Accounts receivable turnover
Accounts receivable days
Inventory turnover
4.5
Inventory days
LIQUIDITY
Current ratio
2.1
2.0
3.2
Cash flow liquidity
NA
Debt ratio
Financial leverage (LEV)
2.1
2.7
1.4
Times interest earned
20.8
Free cash flow (in millions)
Cash flow adequacy
NA
1.28
INVESTMENT
Price earnings ratio (PE)
**19.3
14.4
16.9
Dividend rate
NA
Market value per share:
Close March, 2012
NA
$16.10
52-week high
NA
52-week low
NA
DUPONT ANALYSIS OF ROE
Return on sales (ROS)
6.5%
5.7%
4.8%
Asset turnover (A TO)
1.62
Return on assets (ROA)
9.9%
7.8%
Financial leverage (LEV)
2.1
Return on equity (ROE)
20.9%
30.2%
10.9%
NA = Not available
XXXXX = Not comparable among companies
* Industry: Apparel Stores—Industry averages from money.msn.com
** Industry: Apparel Stores—Industry ratio averages from morningstar.com
There are no official rules governing how these ratios are calculated. Therefore, the ratio formulas used may differ from the
formulas in the text.
PROFITABILITY
Return on sales (ROS)
6.5%
4.8%
Return on assets (ROA)
9.9%
7.8%
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Refer to the ratio information on the previous page to answer the following questions.
For ratio formulas and explanations refer to Appendix B—Ratios.
slower).
Q2 Compare The GAP and American Eagle Outfitters.
a. For profitability and efficiency ratios … Circle the stronger ratio.
b. For liquidity and solvency ratios … Circle the ratio reporting the least amount of risk.
Q3 Compare The GAP and American Eagle Outfitters to industry averages.
a. For profitability and efficiency ratios … Cross out any company ratio weaker than the
industry average.
b. For liquidity and solvency ratios … Cross out any company ratio reporting higher risk.
Q4 Review the DUPONT ANALYSIS of ROE for American Eagle Outfitters.
Q5 Analyze American Eagle Outfitters by reviewing each category of ratio information presented on
the previous page to answer the following questions.
a. PROFITABILITY RATIOS measure the overall performance of a firm. Is American Eagle Outfitters
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b. EFFICIENCY RATIOS measure the effectiveness of managing cash, accounts receivable,
inventory, PPE, and other assets. Is American Eagle Outfitters efficiently managing its assets?
(Yes / No) How can you tell?
c. LIQUIDITY RATIOS measure a firm’s ability to meet cash needs as they arise. Does American
How can you tell?
A current ratio of 3.2 and the cash flow liquidity ratio of 2.43 both indicate AEO
d. SOLVENCY RATIOS measure the extent of debt relative to equity, if financial leverage is being
used effectively, and the ability to cover required payments for interest, capital
expenditures, dividends, and other fixed payments.
Is American Eagle Outfitters effectively managing its debt? (Yes / No)
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e. INVESTMENT RATIOS compare the market value per share to other per share amounts and
the level of dividend payment. Is American Eagle Outfitters providing an adequate return to
Q6 Based on all of the information presented on the previous page, would you recommend investing in
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ACTIVITY 104 TEST YOUR UNDERSTANDING—GOOGLE
Purpose: • Analyze the income statement, the balance sheet, and the statement of cash flows.
• Prepare a statement of retained earnings.
Google (GOOG) BALANCE SHEET ($ in millions)
ASSETS
12/31/2011
12/31/2010
12/31/2009
12/31/2008
Cash and cash equivalents
$ 9,983
$ 13,630
$ 10,198
$ 8,657
Short-term investments
34,643
21,345
14,287
7,189
LIABILITIES
Accounts payable
$ 588
$ 483
$ 216
$ 178
Short-term debt
1,218
3,465
0
0
Accrued expenses
3,256
2,247
1,824
Other current liabilities
2,751
2,792
TOTAL Current liabilities
8,913
9,996
2,748
2,302
Long-term debt
0
0
0
Deferred income taxes
0
0
Other noncurrent liabilities
2,243
1,614
1,745
1,214
TOTAL Noncurrent liabilities
1,614
1,745
1,227
TOTAL Liabilities
14,429
11,610
4,493
3,529
STOCKHOLDERS’ EQUITY
Preferred stock
0
0
0
0
Common stock
20,264
18,235
15,817
14,450
Retained earnings
37,605
27,868
20,082
13,562
Other stockholders’ equity
Treasury stock
0
0
0
0
TOTAL Stockholders’ equity
58,145
46,241
36,004
28,239
TOTAL L & SE
Accounts receivable
5,427
4,252
3,178
2,642
Inventories
0
0
0
0
Other current assets
1,504
1,690
TOTAL Current assets
52,758
41,562
29,167
20,178
Property, plant, equipment, net
9,603
7,759
4,845
5,234
Goodwill
7,346
6,256
4,903
4,840
Intangibles
1,044
Other noncurrent assets
1,230
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Google (GOOG) INCOME STATEMENT ($ in millions)
For the years ended December 31,
2011
2010
2009
2008
Revenue
$
37,905
$
29,321
$
23,651
$
21,796
Cost of goods sold (COGS)
13,188
10,417
8,844
8,622
Operating income
11,742
10,381
8,312
6,632
Other revenues and expenses, net
+584
+415
+69
(778)
Income before income tax
12,326
10,796
8,381
5,854
Provision for income tax
2,589
2,291
1,861
1,627
Net income
$
9,737
$
8,505
$
6,520
$
4,227
Outstanding Shares (in millions)
323
319
316
314
Google (GOOG) STATEMENT OF CASH FLOWS ($ in millions)
For the years ended December 31,
2011
2010
2009
2008
Cash flows from (for) operating activities
Net income (loss)
$
9,737
$
8,505
$
6,520
$
4,227
Depreciation and amortization
1,851
1,396
1,524
1,500
Deferred income tax
343
9
(268)
(225)
Operating (gains) losses
2,004
1,270
1,054
2,024
Changes in working capital
630
(99)
486
327
Net cash from operating activities (NCOA)
14,565
11,081
9,316
7,853
Cash flows from (for) investing activities
Sale of investments
48,746
37,099
22,103
15,763
Purchase of PPE, net
(3,438)
(4,018)
(810)
(2,358)
Purchase of investments
Other investing cash flow items
(2,254)
1,294
(108)
(3,321)
Net cash (for) investing activities (NCIA)
(8,019)
(5,319)
Cash flows from (for) financing activities
Issuance (repayment) of debt, net
726
3,463
0
0
Issuance (repurchase) of capital stock, net
0
(801)
0
(72)
Cash dividends paid
0
0
0
0
Other financing cash flow items
81
388
233
160
Net cash from financing activities (NCFA)
807
3,050
233
88
Effect of exchange rate changes
22
(19)
11
Net change in cash
(3,647)
3,432
1,541
2,575
+ Beginning cash and cash equivalents
13,630
10,198
8,657
6,082
= Ending cash and cash equivalents
$
9,983
$
13,630
$
10,198
$
8,657
Supplemental information
$
$
$
$
1,336
883
Gross profit
18,904
14,807
13,174
Sales and marketing
4,589
2,799
1,984
1,946
General and administrative
2,724
1,962
1,668
1,803
Research and development
5,162
3,762
2,843
2,793
Unusual expense
0
0
0
Total operating expenses
12,975
8,523
6,495
6,542
Refer to the financial statements presented for Google on the previous two pages to answer the following
questions.
BALANCE SHEET
Q1 Review the following accounts, subtotals, and totals; (1) describe your observations; and then (2)
identify what your observations indicate. A response is given for Cash and Short-term Investments
to help with understanding.
a. Cash and short–term investments… more than doubled from 12/31/2008 to 12/31/2011,
comprising more than 80% of total assets on 12/31/2011, indicating a company that is rich
in cash.
Q2 Compute the ratios requested in the chart below. For ratio formulas and explanation refer to
Appendix B—Ratios.
* Industry: Internet Information Provider—Industry ratio averages from money.msn.com
For each ratio, (a) compare the two years of company ratios and circle the ratio indicating lower
financial risk, (b) cross out any company ratio indicating greater financial risk than the industry
norm, and (c) comment on the results.
Q3 Overall, the balance sheet and related ratios indicate a (strengthening / steady / weakening)
financial position. Why? List observations that support your conclusion and explain why.
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INCOME STATEMENT
Q4 Compute the ratios requested in the chart below. For ratio formulas and explanation refer to
Appendix B—Ratios.
Google DUPONT ANALYSIS of ROE
Industry Norm*
2011
2008
* Industry: Internet Information Provider—Industry ratio averages from money.msn.com
Q5 Review the DUPONT ANALYSIS of ROE for Google on the previous page.
a. Regarding overall profitability (ROA), the most significant influence can be attributed to
b. Regarding ROE, the most significant influence can be attributed to
c. For each ratio, (a) circle the stronger ratio, (b) cross out any ratio that is weaker than the
industry norm, and (c) comment on the results.
Q6 Compute the missing information for 2011 in Google’s common-size income statements below.
Google Common-Size
INCOME STATEMENT
2011
2010
2009
2008
Revenue
100%
100%
100%
100%
Cost of goods sold
Operating expenses
Nonoperating revenues (expense)
Provision for income tax
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earnings potential. Why? List observations that support your conclusion and explain why.
Answers will vary, but should include variations of the following.
Q9 Compute the ratios requested in the chart below. For ratio formulas and explanation refer to
Appendix B—Ratios.
Google RATIOS
Industry Norm
2011
2008
For each ratio, (a) circle the company ratio the strongest cash position and (b) comment on the
results.
Overall, the cash flow ratios indicate a strong cash position. Specifically, in 2011 Google
reports…
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Q10 a. Complete the missing information in the common-sized statement of cash flows for 2011.
Google STATEMENT OF CASH FLOWS Common-Size ($ in millions)
2011
2010
2009
2008
Net cash from operating activities
100%
100%
100%
* Only select amounts are listed above so will not sum to the total.
weakening) cash position. Why? List observations that support your conclusion and explain why.
Answers will vary, but should include some variation of the following:
STATEMENT OF RETAINED EARNINGS
Q12 a. Complete the statement of retained earnings below.
Google STATEMENT OF RETAINED EARNINGS ($ in millions)
For the years ended December 31,
2011
2010
2009
2008
Retained earnings, beginning
Net income
Dividends paid
Other adjustments
Retained earnings, ending
b. As of 12/31/2011, since incorporation Google has earned profits and losses totaling $37,605
million.
Sale of investments
335%
237%
201%
Purchase of investments
Purchase of PPE, net
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OTHER
Q13 Based on the financial statements presented for Google, would you invest in this company?
Answers will vary, but should include at least five of the following observations: