ch15

CHAPTER 15

FINANCIAL STATEMENT ANALYSIS

SUMMARY OF QUESTIONS BY STUDY OBJECTIVES AND BLOOM’S TAXONOMY Item SO BT Item SO BT Item SO BT Item SO BT Item SO BT

True-False Statements 1. 1 C 9. 3 K 17. 4 K 25. 5 C sg33. 4 K2. 1 K 10. 3 AP 18. 5 K 26. 5 C sg34. 5 K 3. 1 K 11. 3 C 19. 5 K 27. 6 K sg35. 5 K 4. 1 K 12. 4 K 20. 5 K 28. 6 K sg36. 6 K 5. 1 K 13. 4 C 21. 5 K 29. 7 K 6. 2 K 14. 4 C 22. 5 C 30. 7 K 7. 2 K 15. 4 C 23. 5 C sg31. 2 K 8. 3 K 16. 4 C 24. 5 C sg32. 3 K

Multiple Choice Questions 37. 1 K 63. 4 K 89. 5 K 115. 5 AP 141. 6 K38. 1 K 64. 4 K 90. 5 C 116. 5 AP 142. 6 AP 39. 1 C 65. 4 C 91. 5 C 117. 5 AP 143. 6 AP 40. 1 C 66. 4 C 92. 5 C 118. 5 AP 144. 6 C 41. 1 C 67. 4 C 93. 5 C 119. 5 AP 145. 6 K 42. 1 C 68. 4 C 94. 5 C 120. 5 AP 146. 6 K 43. 1 C 69. 4 C 95. 5 C 121. 5 AP 147. 6 K 44. 1 K 70. 5 C 96. 5 AP 122. 5 AP 148. 6 C 45. 2 K 71. 5 C 97. 5 C 123. 5 AP 149. 6 K 46. 2 K 72. 5 K 98. 5 C 124. 5 AP 150. 7 C 47. 2 K 73. 5 K 99. 5 K 125. 5 AP 151. 1 K 48. 2 K 74. 5 K 100. 5 C 126. 5 AP sg152. 1 K 49. 2 K 75. 5 AP 101. 5 AP 127. 5 AP sg153. 3 K 50. 2 K 76. 5 AP 102. 5 AP 128. 5 AP st154. 4 K 51. 3 K 77. 5 AP 103. 5 C 129. 5 AP sg155. 4 K 52. 3 K 78. 5 AP 104. 5 K 130. 5 AP sg156. 5 K 53. 3 K 79. 5 K 105. 5 AP 131. 5 AP sg157. 5 K 54. 3 AP 80. 5 C 106. 5 C 132. 5 AP sg158. 5 K 55. 3 K 81. 5 C 107. 5 C 133. 5 AP sg159. 5 K 56. 3 C 82. 5 K 108. 5 AP 134. 5 AP sg160. 6 K 57. 3 C 83. 5 AP 109. 5 K 135. 5 AP sg161. 6 K 58. 3 C 84. 5 AP 110. 5 C 136. 5 AP sg162. 6 K 59. 3 AP 85. 5 AP 111. 5 K 137. 6 AP 60. 3 AP 86. 5 C 112. 5 K 138. 6 AP 61. 4 AP 87. 5 K 113. 5 K 139. 6 AP 62. 4 AP 88. 5 AP 114. 5 AP 140. 6 K

sg This question also appears in the Study Guide. st This question also appears in a self-test at the student companion website.

Test Bank for Financial Accounting, Sixth Edition

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SUMMARY OF QUESTIONS BY STUDY OBJECTIVES AND BLOOM’S TAXONOMY

Brief Exercises 163. 3 AP 166. 3 AP 169. 5 K 172. 5 AP 164. 3 AP 167. 4 AP 170. 5 AP 173. 6 AP 165. 3 AN 168. 4 AP 171. 5 AP

Exercises 174. 3 AP 180. 4 AP 186. 5 AP 192. 5 AN 198. 6 AP175. 3 AP 181. 4 AN 187. 5 AP 193. 5 AP 199. 6 AP 176. 3 AP 182. 5 AP 188. 5 AP 194. 5 AP 177. 3 AN 183. 5 AP 189. 5 AP 195. 6 AP 178. 3,4 AP 184. 5 AP 190. 5 AP 196. 6 AP 179. 3,4 AP 185. 5 AN 191. 5 E 197. 6 AP

Completion Statements 200. 1 K 203. 5 K 206. 5 AP 209. 5 K 212. 6 K201. 3 K 204. 5 K 207. 5 K 210. 6 K 202. 4 K 205. 5 AP 208. 5 K 211. 6 K

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type Study Objective 1

1. TF 4. TF 38. MC 41. MC 44. MC 200. C 2. TF 5. TF 39. MC 42. MC 151. MC 3. TF 37. MC 40. MC 43. MC 152. MC

Study Objective 2 6. TF 31. TF 46. MC 48. MC 50. MC 7. TF 45. MC 47. MC 49. MC

Study Objective 3 8. TF 32. TF 54. MC 58. MC 163. BE 174. Ex 178. Ex 9. TF 51. MC 55. MC 59. MC 164. BE 175. Ex 179. Ex

10. TF 52. MC 56. MC 60. MC 165. BE 176. Ex 201. C 11. TF 53. MC 57. MC 153. MC 166. BE 177. Ex

Study Objective 4 12. TF 16. TF 62. MC 66. MC 154. MC 178. Ex 202. C 13. TF 17. TF 63. MC 67. MC 155. MC 179. Ex 14. TF 33. TF 64. MC 68. MC 167. BE 180. Ex 15. TF 61. MC 65. MC 69. MC 168. BE 181. Ex

Study Objective 5 18. TF 75. MC 91. MC 107. MC 123. MC 158. MC 188. Ex 19. TF 76. MC 92. MC 108. MC 124. MC 159. MC 193. Ex 20. TF 77. MC 93. MC 109. MC 125. MC 169. BE 194. Ex 21. TF 78. MC 94. MC 110. MC 126. MC 170. BE 203. C 22. TF 79. MC 95. MC 111. MC 127. MC 171. BE 204. C 23. TF 80. MC 96. MC 112. MC 128. MC 172. BE 205. C 24. TF 81. MC 97. MC 113. MC 129. MC 182. Ex 206. C 25. TF 82. MC 98. MC 114. MC 130. MC 183. Ex 207. C

Financial Statement Analysis

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Study Objective 5 (cont.) 26. TF 83. MC 99. MC 115. MC 131. MC 184. Ex 208. C 34. TF 84. MC 100. MC 116. MC 132. MC 185. Ex 209. C 35. TF 85. MC 101. MC 117. MC 133. MC 186. Ex 70. MC 86. MC 102. MC 118. MC 134. MC 187. Ex 71. MC 87. MC 103. MC 119. MC 135. MC 189. Ex 72. MC 88. MC 104. MC 120. MC 136. MC 190. Ex 73. MC 89. MC 105. MC 121. MC 156. MC 191. Ex 74. MC 90. MC 106. MC 122. MC 157. MC 192. Ex

Study Objective 6 27. TF 138. MC 142. MC 146. MC 160. MC 195. Ex 199. Ex 28. TF 139. MC 143. MC 147. MC 161. MC 196. Ex 210. C 36. TF 140. MC 144. MC 148. MC 162. MC 197. Ex 211. C

137. MC 141. MC 145. MC 149. MC 173. BE 198. Ex 212. C Study Objective7

29. TF 30. TF 150. MC

Note: TF = True-False BE = Brief Exercise C = Completion MC = Multiple Choice Ex = Exercise The chapter also contains two sets of ten Matching questions and four Short-Answer Essay questions.

CHAPTER STUDY OBJECTIVES 1. Discuss the need for comparative analysis. There are three bases of comparison: (1)

intracompany, which compares an item or financial relationship with other data within a company. (2) Industry, which compares company data with industry averages. (3) Intercompany, which compares an item or financial relationship of a company with data of one or more competing companies.

2. Identify the tools of financial statement analysis. Financial statements can be analyzed horizontally, vertically, and with ratios.

3. Explain and apply horizontal (trend) analysis. Horizontal analysis is a technique for evaluating a series of data over a period of time to determine the increase or decrease that has taken place, expressed as either an amount or a percentage.

4. Describe and apply vertical analysis. Vertical analysis is a technique that expresses each item within a financial statement in terms of a percentage of a relevant total or a base amount.

5. Identify and compute ratios used in analyzing a firm's liquidity, profitability, and solvency. The formula and purpose of each ratio is presented in Illustration 18-27.

6. Understand the concept of earning power, and indicate how irregular items are presented. Earning power refers to a company’s ability to sustain its profits from operations. “Irregular items”—discontinued operations and extraordinary items—are presented net of tax below income from continuing operations to highlight their unusual nature.

7. Understand the concept of quality of earnings. A high quality of earnings provides full and transparent information that will not confuse or mislead users of financial statements. Issues related to quality of earnings are (1) alternative accounting methods, (2) pro forma income, and (3) improper recognition.


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TRUE-FALSE STATEMENTS 1. Intracompany comparisons of the same financial statement items can often detect

changes in financial relationships and significant trends. 2. Calculating financial ratios is a financial reporting requirement under generally accepted

accounting principles. 3. Measures of a company's liquidity are concerned with the frequency and amounts of

dividend payments. 4. Analysis of financial statements is enhanced with the use of comparative data. 5. Comparisons of company data with industry averages can provide some insight into the

company's relative position in the industry. 6. Vertical and horizontal analyses are concerned with the format used to prepare financial

statements. 7. Horizontal, vertical, and circular analyses are the most common tools of financial

statement analysis. 8. Horizontal analysis is a technique for evaluating a financial statement item in the current

year with other items in the current year. 9. Another name for trend analysis is horizontal analysis. 10. If a company has sales of $110 in 2008 and $154 in 2009, the percentage increase in

sales from 2008 to 2009 is 140%. 11. In horizontal analysis, if an item has a negative amount in the base year, and a positive

amount in the following year, no percentage change for that item can be computed. 12. Common size analysis expresses each item within a financial statement in terms of a

percent of a base amount. 13. Vertical analysis is a more sophisticated analytical tool than horizontal analysis. 14. Vertical analysis is useful in making comparisons of companies of different sizes. 15. Meaningful analysis of financial statements will include either horizontal or vertical

analysis, but not both. 16. Using vertical analysis of the income statement, a company's net income as a percentage

of net sales is 10%; therefore, the cost of goods sold as a percentage of sales must be 90%.

17. In the vertical analysis of the income statement, each item is generally stated as a

percentage of net income. 18. A ratio can be expressed as a percentage, a rate, or a proportion.


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19. A solvency ratio measures the income or operating success of an enterprise for a given period of time.

20. The current ratio is a measure of all the ratios calculated for the current year. 21. Inventory turnover measures the number of times on the average the inventory was sold

during the period. 22. Profitability ratios are frequently used as a basis for evaluating management's operating

effectiveness. 23. The rate of return on total assets will be greater than the rate of return on common

stockholders' equity if the company has been successful in trading on the equity at a gain. 24. From a creditor's point of view, the higher the total debt to total assets ratio, the lower the

risk that the company may be unable to pay its obligations. 25. A current ratio of 1.2 to 1 indicates that a company's current assets exceed its current

liabilities. 26. Using borrowed money to increase the rate of return on common stockholders' equity is

called "trading on the equity." 27. When the disposal of a significant segment occurs, the income statement should report

both income from continuing operations and income (loss) from discontinued operations. 28. An event or transaction should be classified as an extraordinary item if it is unusual in

nature or if it occurs infrequently. 29. Variations among companies in the application of generally accepted accounting

principles may reduce quality of earnings. 30. Pro forma income usually excludes items that the company thinks are unusual or

nonrecurring. Additional True-False Questions 31. The three basic tools of analysis are horizontal analysis, vertical analysis, and ratio

analysis. 32. A percentage change can be computed only if the base amount is zero or positive. 33. In vertical analysis, the base amount in an income statement is usually net sales. 34. Profitability ratios measure the ability of the enterprise to survive over a long period of

time. 35. The days in inventory is computed by multiplying inventory turnover by 365. 36. Extraordinary items are reported net of applicable taxes in a separate section of the

income statement.


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Answers to True-False Statements Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.

1. T 7. F 13. F 19. F 25. T 31. T 2. F 8. F 14. T 20. F 26. F 32. F 3. F 9. T 15. F 21. T 27. T 33. T 4. T 10. F 16. F 22. T 28. F 34. F 5. T 11. T 17. F 23. F 29. T 35. F 6. F 12. T 18. T 24. F 30. T 36. T

MULTIPLE CHOICE QUESTIONS 37. Which one of the following is primarily interested in the liquidity of a company?

a. Federal government b. Stockholders c. Long-term creditors d. Short-term creditors

38. Which one of the following is not a characteristic generally evaluated in analyzing financial

statements? a. Liquidity b. Profitability c. Marketability d. Solvency

39. In analyzing the financial statements of a company, a single item on the financial

statements a. should be reported in bold-face type. b. is more meaningful if compared to other financial information. c. is significant only if it is large. d. should be accompanied by a footnote.

40. Short-term creditors are usually most interested in evaluating

a. solvency. b. liquidity. c. marketability. d. profitability.

41. Long-term creditors are usually most interested in evaluating

a. liquidity and solvency. b. solvency and marketability. c. liquidity and profitability. d. profitability and solvency.

42. Stockholders are most interested in evaluating

a. liquidity and solvency. b. profitability and solvency. c. liquidity and profitability. d. marketability and solvency.


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43. A stockholder is interested in the ability of a firm to a. pay consistent dividends. b. appreciate in share price. c. survive over a long period. d. all of these.

44. Comparisons of financial data made within a company are called

a. intracompany comparisons. b. interior comparisons. c. intercompany comparisons. d. intramural comparisons.

45. A technique for evaluating financial statements that expresses the relationship among

selected items of financial statement data is a. common size analysis. b. horizontal analysis. c. ratio analysis. d. vertical analysis.

46. Which one of the following is not a tool in financial statement analysis?

a. Horizontal analysis b. Circular analysis c. Vertical analysis d. Ratio analysis

47. In analyzing financial statements, horizontal analysis is a

a. requirement. b. tool. c. principle. d. theory.

48. Horizontal analysis is also called

a. linear analysis. b. vertical analysis. c. trend analysis. d. common size analysis.

49. Vertical analysis is also known as

a. perpendicular analysis. b. common size analysis. c. trend analysis. d. straight-line analysis.

50. In ratio analysis, the ratios are never expressed as a

a. rate. b. negative figure. c. percentage. d. simple proportion.


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51. The formula for horizontal analysis of changes since the base period is the current year amount a. divided by the base year amount. b. minus the base year amount divided by the base year amount. c. minus the base year amount divided by the current year amount. d. plus the base year amount divided by the base year amount.

52. Horizontal analysis evaluates a series of financial statement data over a period of time

a. that has been arranged from the highest number to the lowest number. b. that has been arranged from the lowest number to the highest number. c. to determine which items are in error. d. to determine the amount and/or percentage increase or decrease that has taken

place. 53. Horizontal analysis evaluates financial statement data

a. within a period of time. b. over a period of time. c. on a certain date. d. as it may appear in the future.

54. Assume the following sales data for a company:

2010 $1,000,000 2009 900,000 2008 750,000 2007 600,000

If 2007 is the base year, what is the percentage increase in sales from 2007 to 2009? a. 100% b. 150% c. 50% d. 66.7%

55. Comparative balance sheets are usually prepared for

a. one year. b. two years. c. three years. d. four years.

56. Horizontal analysis is appropriately performed

a. only on the income statement. b. only on the balance sheet. c. only on the statement of retained earnings. d. on all three of these statements.

57. A horizontal analysis performed on a statement of retained earnings would not show a

percentage change in a. dividends paid. b. net income. c. expenses. d. beginning retained earnings.


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58. Under which of the following cases may a percentage change be computed? a. The trend of the balances is decreasing but all balances are positive. b. There is no balance in the base year. c. There is a positive balance in the base year and a negative balance in the subsequent

year. d. There is a negative balance in the base year and a positive balance in the subsequent

year. 59. Assume the following sales data for a company:

2009 $945,000 2008 780,000 2007 650,000

If 2007 is the base year, what is the percentage increase in sales from 2007 to 2008? a. 25% b. 20% c. 125% d. 143%

60. Assume the following cost of goods sold data for a company:

2009 $1,500,000 2008 1,200,000 2007 900,000

If 2007 is the base year, what is the percentage increase in cost of goods sold from 2007 to 2009? a. 167% b. 67% c. 60% d. 40%

Use the following information for questions 61–62: Moon Beam, Inc. has the following income statement (in millions):

MOON BEAM, INC. Income Statement For the Year Ended December 31, 2008

Net Sales $180 Cost of Goods Sold 120 Gross Profit 60 Operating Expenses 33 Net Income $ 27

61. Using vertical analysis, what percentage is assigned to Cost of Goods Sold?

a. 67% b. 33% c. 100% d. None of the above


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62. Using vertical analysis, what percentage is assigned to Net Income? a. 100% b. 85% c. 15% d. None of the above

63. Vertical analysis is also called

a. common size analysis. b. horizontal analysis. c. ratio analysis. d. trend analysis.

64. Vertical analysis is a technique which expresses each item within a financial statement

a. in dollars and cents. b. in terms of a percentage of the item in the previous year. c. in terms of a percent of a base amount. d. starting with the highest value down to the lowest value.

65. In common size analysis,

a. a base amount is required. b. a base amount is optional. c. the same base is used across all financial statements analyzed. d. the results of the horizontal analysis are necessary inputs for performing the analysis.

66. In performing a vertical analysis, the base for prepaid expenses is

a. total current assets. b. total assets. c. total liabilities and stockholders' equity. d. prepaid expenses.

67. In performing a vertical analysis, the base for sales revenues on the income statement is

a. net sales. b. sales. c. net income. d. cost of goods available for sale.

68. In performing a vertical analysis, the base for sales returns and allowances is

a. sales. b. sales discounts. c. net sales. d. total revenues.

69. In performing a vertical analysis, the base for cost of goods sold is

a. total selling expenses. b. net sales. c. total revenues. d. total expenses.


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70. Each of the following is a liquidity ratio except the a. acid-test ratio. b. current ratio. c. debt to total assets ratio. d. inventory turnover.

71. A ratio calculated in the analysis of financial statements

a. expresses a mathematical relationship between two numbers. b. shows the percentage increase from one year to another. c. restates all items on a financial statement in terms of dollars of the same purchasing

power. d. is meaningful only if the numerator is greater than the denominator.

72. A liquidity ratio measures the

a. income or operating success of an enterprise over a period of time. b. ability of the enterprise to survive over a long period of time. c. short-term ability of the enterprise to pay its maturing obligations and to meet

unexpected needs for cash. d. number of times interest is earned.

73. The current ratio is

a. calculated by dividing current liabilities by current assets. b. used to evaluate a company's liquidity and short-term debt paying ability. c. used to evaluate a company's solvency and long-term debt paying ability. d. calculated by subtracting current liabilities from current assets.

74. The acid-test (quick) ratio

a. is used to quickly determine a company's solvency and long-term debt paying ability. b. relates cash, short-term investments, and net receivables to current liabilities. c. is calculated by taking one item from the income statement and one item from the

balance sheet. d. is the same as the current ratio except it is rounded to the nearest whole percent.

75. Walker Clothing Store had a balance in the Accounts Receivable account of $780,000 at

the beginning of the year and a balance of $820,000 at the end of the year. Net credit sales during the year amounted to $8,000,000. The average collection period of the receivables in terms of days was a. 30 days. b. 365 days. c. 10 days. d. 37 days.

76. Parr Hardware Store had net credit sales of $5,200,000 and cost of goods sold of

$4,000,000 for the year. The Accounts Receivable balances at the beginning and end of the year were $600,000 and $700,000, respectively. The receivables turnover was a. 7.4 times. b. 8.7 times. c. 6.2 times. d. 8 times.


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Use the following information for questions 77–78. Waters Department Store had net credit sales of $12,000,000 and cost of goods sold of $9,000,000 for the year. The average inventory for the year amounted to $2,000,000. 77. Inventory turnover for the year is

a. 6 times. b. 10.5 times. c. 4.5 times. d. 3 times.

78. The average number of days in inventory during the year was

a. 122 days. b. 81 days. c. 61 days. d. 35 days.

79. Each of the following is included in computing the acid-test ratio except

a. cash. b. inventory. c. receivables. d. short-term investments.

80. Which one of the following would not be considered a liquidity ratio?

a. Current ratio b. Inventory turnover c. Acid-test ratio d. Return on assets

81. Asset turnover measures

a. how often a company replaces its assets. b. how efficiently a company uses its assets to generate sales. c. the portion of the assets that have been financed by creditors. d. the overall rate of return on assets.

82. Profit margin is calculated by dividing

a. sales by cost of goods sold. b. gross profit by net sales. c. net income by stockholders' equity. d. net income by net sales.

Use the following information for questions 83–84.

Raney Corporation had net income of $200,000 and paid dividends to common stockholders of $50,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Raney Corporation's common stock is selling for $40 per share on the New York Stock Exchange. 83. Raney Corporation's price-earnings ratio is

a. 2.5 times. b. 10 times. c. 13.3 times. d. 4 times.


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84 Raney Corporation's payout ratio for 2008 is a. $4 per share. b 33.3%. c. 25%. d. 10%.

85 Holt Company reported the following on its income statement:

Income before income taxes $420,000 Income tax expense 120,000 Net income $300,000

An analysis of the income statement revealed that interest expense was $52,500. Holt Company's times interest earned was a. 9 times. b. 8 times. c. 7 times. d. 6 times.

86. The debt to total assets ratio measures

a. the company's profitability. b. whether interest can be paid on debt in the current year. c. the proportion of interest paid relative to dividends paid. d. the percentage of the total assets provided by creditors.

87. Trading on the equity (leverage) refers to the

a. amount of working capital. b. amount of capital provided by owners. c. use of borrowed money to increase the return to owners. d. number of times interest is earned.

88. The current assets of Kile Company are $150,000. The current liabilities are $120,000.

The current ratio expressed as a proportion is a. 125%. b. 1.25 : 1 c. .80 : 1 d. $150,000 ÷ $120,000.

89. The current ratio may also be referred to as the

a. short run ratio. b. acid-test ratio. c. working capital ratio. d. contemporary ratio.

90. A weakness of the current ratio is

a. the difficulty of the calculation. b. that it doesn't take into account the composition of the current assets. c. that it is rarely used by sophisticated analysts. d. that it can be expressed as a percentage, as a rate, or as a proportion.


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91. A supplier to a company would be most interested in the company’s a. asset turnover. b. profit margin. c. current ratio. d. earnings per share.

92. Which one of the following ratios would not likely be used by a short-term creditor in

evaluating whether to sell on credit to a company? a. Current ratio b. Acid-test ratio c. Asset turnover d. Receivables turnover

93. Ratios are used as tools in financial analysis

a. instead of horizontal and vertical analyses. b. because they may provide information that is not apparent from inspection of the

individual components of the ratio. c. because even single ratios by themselves are quite meaningful. d. because they are prescribed by GAAP.

94. The ratios that are used to determine a company's short-term debt paying ability are

a. asset turnover, times interest earned, current ratio, and receivables turnover. b. times interest earned, inventory turnover, current ratio, and receivables turnover. c. times interest earned, acid-test ratio, current ratio, and inventory turnover. d. current ratio, acid-test ratio, receivables turnover, and inventory turnover.

95. A measure of the percentage of each dollar of sales that results in net income is

a. profit margin. b. return on assets. c. return on common stockholders' equity. d. earnings per share.

Use the following information for questions 96–97. Risen Company had $250,000 of current assets and $90,000 of current liabilities before borrowing $50,000 from the bank with a 3-month note payable. 96. What effect did the borrowing transaction have on the amount of Risen Company's

working capital? a. No effect b. $50,000 increase c. $90,000 increase d. $50,000 decrease

97. What effect did the borrowing transaction have on Risen Company's current ratio?

a. The ratio remained unchanged. b. The change in the current ratio cannot be determined. c. The ratio decreased. d. The ratio increased.


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98. If the current ratio exceeds one and the current assets increase relative to the current liabilities, the current ratio will a. increase. b. decrease. c. stay the same. d. equal zero.

99. The acid-test ratio

a. is a quick calculation of an approximation of the current ratio. b. does not include all current liabilities in the calculation. c. does not include inventory as part of the numerator. d. does include prepaid expenses as part of the numerator.

100. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of

cash by short-term debt and collection of accounts receivable have on the ratio? Short-term Borrowing Collection of Receivable a. Increase No effect b. Increase Increase c. Decrease No effect d. Decrease Decrease

101. A company has a receivables turnover of 10 times. The average net receivables during

the period are $500,000. What is the amount of net credit sales for the period? a. $50,000 b. $5,000,000 c. $600,000 d. Cannot be determined from the information given

102. If the average collection period is 35 days, what is the receivables turnover?

a. 9.49 times b. 10.43 times c. 5.22 times d. None of these

103. A general rule to use in assessing the average collection period is that

a. it should not exceed 30 days. b. it can be any length as long as the customer continues to buy merchandise. c. it should not greatly exceed the discount period. d. it should not greatly exceed the credit term period.

104. Inventory turnover is calculated by dividing

a. cost of goods sold by the ending inventory. b. cost of goods sold by the beginning inventory. c. cost of goods sold by the average inventory. d. average inventory by cost of goods sold.

105. A company has an average inventory on hand of $100,000 and the days in inventory is 73

days. What is the cost of goods sold? a. $500,000 b. $7,300,000 c. $1,000,000 d. $3,650,000


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106. A successful grocery store would probably have

a. a low inventory turnover. b. a high inventory turnover. c. zero profit margin. d. low volume.

107. An aircraft company would most likely have

a. a high inventory turnover. b. low profit margin. c. high volume. d. a low inventory turnover.

108. Net sales are $4,500,000, beginning total assets are $2,100,000, and the asset turnover is

3.0 times. What is the ending total asset balance? a. $1,500,000 b. $900,000 c. $2,100,000 d. $1,200,000

109. Earnings per share is calculated

a. only for common stock. b. only for preferred stock. c. for common and preferred stock. d. only for treasury stock.

110. Which of the following is not a profitability ratio?

a. Payout ratio b. Profit margin c. Times interest earned d. Return on common stockholders' equity

111. Times interest earned is also called the

a. money multiplier. b. interest coverage ratio. c. coupon coverage ratio. d. premium ratio.

112. The ratio that uses weighted average common shares outstanding in the denominator is

the a. price-earnings ratio. b. return on common stockholders' equity. c. earnings per share. d. payout ratio.

113. Net income does not appear in the numerator of the

a. profit margin. b. return on assets. c. return on common stockholders' equity. d. payout ratio.


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114. Fall Clothing Store had a balance in the Accounts Receivable account of $820,000 at the beginning of the year and a balance of $880,000 at the end of the year. Net credit sales during the year amounted to $6,120,000. The receivables turnover ratio was a. 7.2 times. b. 7 times. c. 6.9 times. d. 6.8 times.

115. Fall Clothing Store had a balance in the Accounts Receivable account of $810,000 at the

beginning of the year and a balance of $850,000 at the end of the year. Net credit sales during the year amounted to $5,814,980. The average collection period of the receivables in terms of days was a. 50 days. b. 52.1 days. c. 365 days. d. 52.9 days.

Use the following information for questions 116–117. Luthor Corporation had net income of $160,000 and paid dividends to common stockholders of $40,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Luthor Corporation's common stock is selling for $50 per share on the New York Stock Exchange. 116. Luthor Corporation's price-earnings ratio is

a. 3.2 times. b. 15.6 times. c. 10 times. d. 5 times.

117. Luthor Corporation's payout ratio for 2008 is

a. $5 per share. b. 25%. c. 20%. d. 12.5%.

118. Raye Company reported the following on its income statement:

Income before income taxes $500,000 Income tax expense 150,000 Net income $350,000

An analysis of the income statement revealed that interest expense was $80,000. Raye Company's times interest earned was a. 8 times. b. 7.25 times. c. 6.25 times. d. 4.4 times.


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Use the following information for questions 119-125.

The following information pertains to Soho Company. Assume that all balance sheet amounts represent both average and ending balance figures. Assume that all sales were on credit.

Assets

Cash and short-term investments $ 40,000 Accounts receivable (net) 25,000 Inventory 20,000 Property, plant and equipment 210,000 Total Assets $295,000

Liabilities and Stockholders’ Equity

Current liabilities $ 60,000 Long-term liabilities 85,000 Stockholders’ equity—common 150,000 Total Liabilities and Stockholders’ Equity $295,000

Income Statement

Sales $ 85,000 Cost of goods sold 45,000 Gross margin 40,000 Operating expenses 20,000 Net income $ 20,000

Number of shares of common stock 6,000 Market price of common stock $20 Dividends per share .90

119. What is the current ratio for this company?

a. 1.42 b. .80 c. 1.16 d. .60

120. What is the receivables turnover for this company?

a. 2.8 times b. 2 times c. 3.4 times d. 3 times

121. What is the inventory turnover for this company?

a. 2 times b. 2.25 times c. 1 time d. .44 times

122. What is the return on assets for this company?

a. 6.8% b. 10.5% c. 11.7% d. 26.7%


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123. What is the profit margin for this company? a. 42.86% b. 18.75% c. 23.5% d. 15.0%

124. What is the return on common stockholders’ equity for this company?

a. 13.3% b. 5% c. 23.3% d. 53.3%

125. What is the price-earnings ratio for this company?

a. 6 times b. 2.5 times c. 8 times d. 4 times


The following information pertains to Cashe Company. Assume that all balance sheet amounts represent both average and ending balance figures. Assume that all sales were on credit.

Assets Cash and short-term investments $ 40,000 Accounts receivable (net) 30,000 Inventory 25,000 Property, plant and equipment 215,000 Total Assets $310,000

Liabilities and Stockholders’ Equity Current liabilities $ 60,000 Long-term liabilities 95,000 Stockholders’ equity—common 155,000

Total Liabilities and Stockholders’ Equity $310,000

Income Statement Sales $ 90,000 Cost of goods sold 45,000 Gross margin 45,000 Operating expenses 20,000

Net income $ 25,000

Number of shares of common stock 6,000 Market price of common stock $20 Dividends per share 1.00

126. What is the return on assets for this company?

a. 6.8% b. 10.5% c. 8.1% d. 16.1%


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127. What is the profit margin for this company? a. 50.0% b. 55.6% c. 23.5% d. 27.8%

128. What is the return on common stockholders’ equity for this company?

a. 7.3% b. 16.1% c. 23.5% d. 53.3%

129. What is the price-earnings ratio for this company?

a. 6 times b. 4.2 times c. 8 times d. 4.8 times

Use the following information for questions 130–131. The following information is available for Charles Company: 12/31/2008 12/31/2007

Accounts receivable $ 360,000 $ 400,000 Inventory 280,000 320,000 Net credit sales 3,000,000 1,400,000 Cost of goods sold 1,200,000 1,060,000 Net income 300,000 170,000

130. The receivables turnover ratio for 2008 is

a. 8.3 times. b. 3.9 times. c. 7.9 times. d. 10.0 times.

131. The inventory turnover ratio for 2008 is

a. 4.3 times. b. 4.0 times. c. 2.0 times. d. 2.4 times.

Use the following information for questions 132–134. The following amounts were taken from the financial statements of Palmer Company:

12/31/2008 12/31/2007 Total assets $800,000 $1,000,000 Net sales 720,000 650,000 Gross profit 352,000 320,000 Net income 144,000 117,000 Weighted average number of common shares outstanding 120,000 120,000 Market price of common stock $36 $40


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132. The return on assets for 2008 is a. 18%. b. 16%. c. 36%. d. 32%.

133. The profit margin for 2008 is

a. 10%. b. 15%. c. 20%. d. 30%.

134. The price-earnings ratio 2008 is

a. 30 times. b. 20 times. c. 10 times. d. 5 times.


Panza Corporation had net income of $250,000 and paid dividends to common stockholders of $50,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Panza Corporation's common stock is selling for $40 per share on the New York Stock Exchange. 135. Panza Corporation's price-earnings ratio is

a. 2 times. b. 8 times. c. 10 times. d. 5 times.

136. Panza Corporation's payout ratio for 2008 is

a. $5 per share. b. 25%. c. 20%. d. 12.5%.

137. Ester’s Bunny Barn has experienced a $40,000 loss due to tornado damage to its

inventory. Tornados have never before occurred in this area. Assuming that the company’s tax rate is 30%, what amount will be reported for this loss on the income statement? a. $40,000 b. $28,000 c. $12,000 d. $36,000

138. Wenger Company reported income before taxes of $600,000 and an extraordinary loss of

$150,000. Assume that the company’s tax rate is 30%. What amounts will be reported on the income statement for income before irregular items and extraordinary items, respectively? a. $420,000 and $150,000 b. $420,000 and $105,000 c. $495,000 and $150,000 d. $495,000 and $105,000


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139. Kandy Kane Corporation has income before taxes of $400,000 and an extraordinary gain of $100,000. If the income tax rate is 25% on all items, the income statement should show income before irregular items and extraordinary items, respectively, of a. $325,000 and $100,000. b. $325,000 and $75,000. c. $300,000 and $100,000. d. $300,000 and $75,000.

140. Hardy Inc. has an investment in available-for-sale securities of $50,000. This investment

experienced an unrealized loss of $3,000 during the current year. Assuming a 35% tax rate, the effect of this loss on comprehensive income will be a. no effect. b. $50,000 increase. c. $17,500 decrease. d. $3,000 decrease.

141. The disposal of a significant segment of a business is called

a. a change in accounting principle. b. an extraordinary item. c. an other expense. d. discontinued operations.

142. ABC Company reports income before income taxes of $1,800,000 and had an extra-

ordinary loss of $600,000. If the tax rate is 30%, a. the income before the extraordinary item is $1,440,000. b. the extraordinary loss would be reported on the income statement at $600,000. c. the income before the extraordinary item is $1,260,000. d. the extraordinary loss will be reported at $180,000.

143. Evers, Inc. disposes of an unprofitable segment of its business. The operation of the

segment suffered a $240,000 loss in the year of disposal. The loss on disposal of the segment was $120,000. If the tax rate is 30%, and income before income taxes was $1,500,000, a. the income tax expense on the income before discontinued operations is $342,000. b. the income from continuing operations is $1,050,000. c. net income is $1,140,000. d. the losses from discontinued operations are reported net of income taxes at $180,000.

144. Each of the following is an extraordinary item except the

a. effects of major casualties, if rare in the area. b. effects of a newly enacted law or regulation. c. expropriation of property by a foreign government. d. losses attributable to labor strikes.

145. The discontinued operations section of the income statement refers to

a. discontinuance of a product line. b. the income or loss on products that have been completed and sold. c. obsolete equipment and discontinued inventory items. d. the disposal of a significant segment of a business.


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146. Which one of the following would be classified as an extraordinary item? a. Expropriation of property by a foreign government b. Losses attributed to a labor strike c. Write-down of inventories d. Gains or losses from sales of equipment

147. A loss on the write down of obsolete inventory should be reported as

a. "other expenses and losses." b. part of discontinued operations. c. an operating expense. d. an extraordinary item.

148. If an item meets one (but not both) of the criteria for an extraordinary item, it

a. only needs to be disclosed in the footnotes of the financial statements. b. may be treated as sales revenue (if it is a gain) and as an operating expense (if it is a

loss). c. is reported as an "other revenue or gain" or "other expense and loss," net of tax. d. is reported at its gross amount as an "other revenue or gain" or "other expense or

loss." 149. The order of presentation of nontypical items that may appear on the income statement is

a. Extraordinary items, Discontinued operations, Other revenues and expenses. b. Discontinued operations, Extraordinary items, Other revenues and expenses. c. Other revenues and expenses, Discontinued operations, Extraordinary items. d. Other revenues and expenses, Extraordinary items, Discontinued operations.

150. Each of the following is a factor affecting quality of earnings except

a. alternative accounting methods. b. improper recognition. c. pro forma income. d. extraordinary items.

Additional Multiple Choice Questions 151. Comparisons can be made on each of the following bases except

a. industry averages. b. intercompany basis. c. intracompany basis. d. Each of these is a basis for comparison.

152. Comparisons of data within a company are an example of the following comparative

basis: a. Industry averages b. Intercompany c. Intracompany d. Interregional


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153. Silva Corporation reported net sales of $240,000, $420,000, and $540,000 in the years 2007, 2008, and 2009 respectively. If 2007 is the base year, what is the trend percentage for 2009? a. 129% b. 135% c. 164% d. 225%

154. In vertical analysis, the base amount for each income statement item is

a. gross profit. b. net income. c. net sales. d. sales.

155. When performing vertical analysis, the base amount for administrative expense is

generally a. administrative expense in a previous year. b. net sales. c. gross profit. d. fixed assets.

156. Ratios that measure the short-term ability of the company to pay its maturing obligations

are a. liquidity ratios. b. profitability ratios. c. solvency ratios. d. trend ratios.

157. What type of ratios best measure the short-term ability of the enterprise to pay its

maturing obligations and to meet unexpected needs for cash? a. Leverage b. Solvency c. Profitability d. Liquidity

158. The acid-test ratio is also known as the

a. current ratio. b. quick ratio. c. fast ratio. d. times interest earned ratio.

159. The debt to total assets ratio

a. is a solvency ratio. b. is computed by dividing total assets by total debt. c. measures the total assets provided by stockholders. d. is a profitability ratio.

160. An extraordinary item is one that

a. occurs infrequently and is uncontrollable in nature. b. occurs infrequently and is unusual in nature. c. is material and is unusual in nature. d. is material and is uncontrollable in nature.


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161. Galileo, Inc. decided on January 1 to discontinue its telescope manufacturing division. On July 1, the division’s assets with a book value of $630,000 are sold for $450,000. Operating income from January 1 to June 30 for the division amounted to $75,000. Ignoring income taxes, what total amount should be reported on Galileo’s income statement for the current year under the caption, Discontinued Operations? a. $75,000 b. $105,000 loss c. $180,000 loss d. $255,000

162. When there has been a change in accounting principle,

a. the old principle should be used in reporting the results of operations for the current year.

b. the cumulative effect of the change should be reported in the current year’s retained earnings statement.

c. the change should be reported retroactively. d. the new principle should be used un reporting the results of operations of the current

year, but there is no change to prior years. Answers to Multiple Choice Questions

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.37. d 55. b 73. b 91. c 109. a 127. d 145. d38. c 56. d 74. b 92. c 110. c 128. b 146. a 39. b 57. c 75. d 93. b 111. b 129. d 147. a 40. b 58. a 76. d 94. d 112. c 130. c 148. d 41. d 59. b 77. c 95. a 113. d 131. b 149. c 42. b 60. b 78. b 96. a 114. a 132. b 150. d 43. d 61. a 79. b 97. c 115. b 133. c 151. d 44. a 62. c 80. d 98. a 116. b 134. a 152. c 45. c 63. a 81. b 99. c 117. b 135. b 153. d 46. b 64. c 82. d 100. c 118. b 136. c 154. c 47. b 65. a 83. b 101. b 119. a 137. b 155. b 48. c 66. b 84. c 102. b 120. c 138. b 156. a 49. b 67. a 85. a 103. d 121. b 139. d 157. d 50. b 68. c 86. d 104. c 122. a 140. d 158. b 51. b 69. b 87. c 105. a 123. c 141. d 159. a 52. d 70. c 88. b 106. b 124. a 142. c 160. b 53. b 71. a 89. c 107. d 125. a 143. b 161. b 54. c 72. c 90. b 108. b 126. c 144. d 162. c


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BRIEF EXERCISES BE 163 The following items were taken from the financial statements of Horace, Inc., over a three-year period:

Item 2009 2008 2007 Net Sales $355,000 $336,000 $300,000 Cost of Goods Sold 214,000 206,000 186,000 Gross Profit $141,000 $130,000 $114,000 Instructions Compute the following for each of the above time periods. a. The amount and percentage change from 2007 to 2008. b. The amount and percentage change from 2008 to 2009. Solution 163 (6 min.)

Item 2009 2008 $ Percent $___ Percent Net Sales 19,000 5.65 36,000 12.0 Cost of Goods Sold 8,000 3.9 20,000 10.8 Gross Profit 11,000 8.5 16,000 14.0 BE 164 If Parthenon Company had net income of $672,300 in 2009 and it experienced a 20% increase in net income over 2008, what was its 2008 net income? Solution 164 (4 min.)

2009 2008 Increase Net Income $672,300 X 20%

XX$672,300.20 −

=

.20X = $672,300 – X 1.20X = $672,300 X = $560,250 BE 165 Horizontal analysis (trend analysis) percentages for Vishnu Company’s sales, cost of goods sold, and expenses are listed here.

Horizontal Analysis 2009 2008 2007 Sales 98.2% 104.8% 100.0% Cost of goods sold 102.5 98.0 100.0 Expenses 108.6 96.4 100.0


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BE 165 (cont.) Instructions Explain whether Vishnu’s net income increased, decreased, or remained unchanged over the 3-year period. Solution 165 (5 min.)

Comparing the percentages presented results in the following conclusions: The net income for Vishnu increased in 2008 because of the combination of an increase in sales and a decrease in both cost of goods sold and expenses. However, the reverse was true in 2009 as sales decreased, while both cost of goods sold and expenses increased. This resulted in a decrease in net income. BE 166 Using the following operating data for Manchac Corporation, illustrate horizontal analysis.

2008 2007 Net sales $350,000 $320,000 Cost of goods sold 200,000 180,000 Operating expenses 120,000 100,000 Net income 30,000 40,000

Solution 166 (5 min.)

2008 2007_ Net sales 109% 100% Cost of goods sold 111% 100% Operating expenses 120% 100% Net income 75% 100%

BE 167 Using the data presented for Manchac Company in BE 166, prepare a schedule showing a vertical analysis for 2008. Solution 167 (4 min.)

Amount Percent Net sales $350,000 100% Cost of goods sold 200,000 57% Gross profit 150,000 43% Operating expenses 120,000 34% Net income $ 30,000 9%


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BE 168 Using these data from the comparative balance sheet of Luca Company, perform vertical analysis for both 2008 and 2009. December 31, 2009 December 31, 2008

Accounts receivable $ 500,000 $ 400,000 Inventory 780,000 600,000 Total assets 3,220,000 2,800,000


Dec. 31, 2009 Dec. 31, 2008 Amount Percentage* Amount Percentage**

Accounts receivable $ 500,000 15.5% $ 400,000 14.3% Inventory 780,000 24.2% 600,000 21.4% Total assets 3,220,000 100.0% 2,800,000 100.0%

.155$3,220,000$500,000

= .143$2,800,000$400,000

=

.242$3,220,000$780,000

= .214$2,800,000$600,000

=

BE 169 For each of the ratios listed below, indicate by the appropriate code letter, whether it is a liquidity ratio (L), a profitability ratio (P), or a solvency ratio (S). ____ 1. Times interest earned ratio

____ 2. Asset turnover

____ 3. Receivables turnover

____ 4. Debt to total assets ratio

____ 5. Current ratio

____ 6. Payout ratio Solution 169 (3 min.)

1. S 2. P 3. L 4. S 5. L 6. P

* **


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BE 170 Selected financial statement data for Meyer Company are presented below.

12/31/08 Cash $ 10,000 Short-term investments 15,000 Accounts receivable 60,000 Inventories 75,000 Total current liabilities 110,000

Instructions Compute the following ratios at December 31, 2008: (a) Current. (b) Acid-test. Solution 170 (3 min.)

(a) Current = 1.45:1 ($160,000 ÷ $110,000) (b) Acid-test = .77:1 ($85,000 ÷ $110,000) BE 171 Breaktown Company had net income of $152,000 and net sales of $625,000 in 2008. The company’s total assets for 2007/2008 averaged $3,900,000. Its common stockholders’ equity for the period averaged $2,340,000. Calculate (a) profit margin, (b) return on assets, and (c) return on common stockholders’ equity. Solution 171 (5 min.)

(a) Profit margin = $152,000 ÷ $625,000 = 24% (b) Return on assets = $152,000 ÷ $3,900,000 = 3.9% (c) Return on common stockholders’ equity = $152,000 ÷ $2,340,000 = 6.5% BE 172 Berman Company reported the following financial information: 12/31/08 12/31/07

Accounts receivable $ 320,000 $ 360,000 Net credit sales 2,100,000 2,420,000

Compute (a) the receivables turnover and (b) the average collection period for 2008.


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a) Receivables turnover = $2,100,000 ÷ $340,000 = 6.18 times b) Average collection period = 365 ÷ 6.18 = 59 days BE 173 Prepare a partial income statement, beginning with income before income taxes using the following information for Slidell Corporation for the fiscal year ended December 31, 2008:

Sales $800,000 Extraordinary loss 100,000 Selling and administrative expenses 180,000 Cost of goods sold 500,000 Loss on sale of land 25,000

Slidell Corporation is subject to a 30% income tax rate. Solution 173 (5 min.)

SLIDELL CORPORATION Partial Income Statement

For the Year Ended December 31, 2008

Income before income taxes ($800,000 – $500,000 – $180,000 – $25,000) $95,000 Income tax expense ($95,000 × 30%) 28,500 Income before extraordinary item 66,500 Extraordinary loss, net of $30,000 tax savings ($100,000 × 30%) (70,000) Net income (loss) ($3,500)

EXERCISES Ex. 174 Selected financial information for Bradley Corporation is presented below.

December 31, 2009 December 31, 2008 Current assets $ 60,000 $ 50,000 Long-term liabilities 100,000 80,000 Retained earnings 115,000 100,000

Instructions Prepare a schedule showing a horizontal analysis for 2009 using 2008 as the base year.


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Increase (Decrease) 2009 2008 Amount Percentage Current assets $ 60,000 $ 50,000 $10,000 20% Long-term liabilities 100,000 80,000 20,000 25% Retained earnings 115,000 100,000 15,000 15% Ex. 175 Comparative information taken from the Wells Company financial statements is shown below:

2009 2008 (a) Notes receivable $ 20,000 $ -0- (b) Accounts receivable 182,000 140,000 (c) Retained earnings 30,000 (40,000) (d) Income taxes payable 44,000 20,000 (e) Sales 960,000 750,000 (f) Operating expenses 170,000 200,000 Instructions Using horizontal analysis, show the percentage change from 2008 to 2009 with 2008 as the base year. Solution 175 (8–12 min.)

(a) Base year is zero. Not possible to compute. (b) $42,000 ÷ $140,000 = 30% increase (c) Base year is negative. Not possible to compute. (d) $24,000 ÷ $20,000 = 120% increase (e) $210,000 ÷ $750,000 = 28% increase (f) $30,000 ÷ $200,000 = 15% decrease Ex. 176 Eaton Corporation had net income of $6,000,000 in 2007. Using 2007 as the base year, net income decreased by 70% in 2008 and increased by 140% in 2009. Instructions Compute the net income reported by Eaton Corporation for 2008 and 2009. Solution 176 (6–9 min.)

2008: X ÷ $6,000,000 = 70% X = $6,000,000 × .70 = $4,200,000

The decrease is $4,200,000; therefore net income for 2008 is $1,800,000.


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Solution 176 (cont.)

2009: X ÷ $6,000,000 = 140% X = $6,000,000 × 1.4 X = $8,400,000

The net income for 2009 is $14,400,000 ($6,000,000 + $8,400,000). Ex. 177 The following items were taken from the financial statements of Ritz, Inc., over a four-year period:

Item 2010 2009 2008 2007 Net Sales $800,000 $700,000 $550,000 $500,000 Cost of Goods Sold 560,000 500,000 420,000 400,000 Gross Profit $240,000 $200,000 $130,000 $100,000 Instructions Using horizontal analysis and 2007 as the base year, compute the trend percentages for net sales, cost of goods sold, and gross profit. Explain whether the trends are favorable or unfavorable for each item. Solution 177 (10–15 min.)

Item 2010 2009 2008 2007 Net Sales 160% 140% 110% 100% Cost of Goods Sold 140% 125% 105% 100% Gross Profit 240% 200% 130% 100% The trend in net sales is increasing and favorable. The cost of goods sold trend is increasing which could be unfavorable, but the sales are increasing each year at a faster pace than cost of goods sold. This is apparent by examining the gross profit percentages, which show a favorable, increasing trend. Ex. 178 The comparative balance sheet of Greer Company appears below:

GREER COMPANY Comparative Balance Sheet

December 31, ——————————————————————————————————————————— Assets 2009 2008 Current assets ...................................................................................... $ 330 $280 Plant assets .......................................................................................... 670 520 Total assets .......................................................................................... $1,000 $800 Liabilities and stockholders' equity Current liabilities ................................................................................... $ 160 $120 Long-term debt ..................................................................................... 240 160 Common stock ..................................................................................... 340 320 Retained earnings ................................................................................ 260 200 Total liabilities and stockholders' equity ......................................... $1,000 $800


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Ex. 178 (cont.) Instructions (a) Using horizontal analysis, show the percentage change for each balance sheet item using

2008 as a base year. (b) Using vertical analysis, prepare a common size comparative balance sheet. Solution 178 (14–19 min.)

GREER COMPANY Comparative Balance Sheet

December 31,

(b) (b) (a) Assets 2009 Percent 2008 Percent Percent Current assets $ 330 33% $280 35% 18% Plant assets 670 67 520 65 29% Total assets $1,000 100% $800 100% 25% Liabilities and stockholders' equity Current liabilities $ 160 16% $120 15% 33% Long-term debt 240 24 160 20 50% Common stock 340 34 320 40 6% Retained earnings 260 26 200 25 30% Total liabilities and stockholders' equity $1,000 100% $800 100% 25% Ex. 179 Using the following selected items from the comparative balance sheet of Anders Company, illustrate horizontal and vertical analysis.

December 31, 2009 December 31, 2008 Accounts Receivable $ 900,000 $ 600,000 Inventory 975,000 750,000 Total Assets 4,000,000 2,500,000

Solution 179 (10–15 min.)

HORIZONTAL ANALYSIS

December 31, 2009 December 31, 2008 Accounts Receivable 150% 100% Inventory 130% 100% Total Assets 160% 100%

VERTICAL ANALYSIS

December 31, 2009 December 31, 2008 Accounts Receivable 22.5% 24% Inventory 24.4% 30% Total Assets 100% 100%


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Ex. 180 Operating data for Manning Corporation are presented below.

2008 Net sales $500,000 Cost of goods sold 340,000 Operating expenses 120,000 Net income 40,000

Instructions Prepare a schedule showing a vertical analysis for 2008. Solution 180 (10 min.)

Amount Percent Net sales $500,000 100% Cost of goods sold 340,000 68% Gross profit 160,000 32% Operating expenses 120,000 24% Net income $ 40,000 8% Ex. 181 The following information was taken from the financial statements of Lee Company:

2009 2008 Gross profit on sales ............................................................ $750,000 $800,000 Income before income taxes ................................................ 280,000 230,000 Net income ........................................................................... 200,000 180,000 Net income as a percentage of net sales ............................. 8% 9%

Instructions (a) Compute the net sales for each year. (b) Compute the cost of goods sold in dollars and as a percentage of net sales for each year. (c) Compute operating expenses in dollars and as a percentage of net sales for each year.

(Income taxes are not operating expenses). Solution 181 (12–15 min.)

(a) To calculate net sales, divide the net income by the percentage of net income to net sales. 2009 2008 Net Sales $200,000 ÷ 8% = $2,500,000 $180,000 ÷ 9% = $2,000,000


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(b) Using the net sales information from (a) and the gross profits given, it is possible to calculate the cost of goods sold.

2009 2008 Net Sales $2,500,000 $2,000,000 Less: Gross profit 750,000 800,000 Cost of goods sold $1,750,000 $1,200,000 % of net sales 70% 60% (c) 2009 2008 Gross profit $750,000 $800,000 Less: Income before income taxes 280,000 230,000 Operating Expenses $470,000 $570,000 % of net sales 18.8% 28.5% Ex. 182 Selected financial statement data for Morton Company are presented below.

December 31, 2009 December 31, 2008 Cash $ 20,000 $30,000 Short-term investments 25,000 18,000 Receivables (net) 100,000 80,000 Inventories 85,000 65,000 Total current liabilities 100,000 90,000 During 2009, net sales were $810,000, and cost of goods sold was $615,000. Instructions Compute the following ratios at December 31, 2009: (a) Current. (b) Acid-test. (c) Receivables turnover. (d) Inventory turnover. Solution 182 (10 min.)

(a) Current = 2.3:1 ($230,000 ÷ $100,000) (b) Acid-test = 1.45:1 ($145,000 ÷ $100,000) (c) Receivables turnover = 9 times [$810,000 ÷ ($100,000 + $80,000) ÷ 2] (d) Inventory turnover = 8.2 times [$615,000 ÷ ($85,000 + $65,000) ÷ 2]


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Ex. 183 Selected information from the comparative financial statements of Fryman Company for the year ended December 31, appears below: 2009 2008 Accounts receivable (net) $ 180,000 $200,000 Inventory 140,000 160,000 Total assets 1,200,000 800,000 Current liabilities 140,000 110,000 Long-term debt 340,000 300,000 Net credit sales 1,520,000 700,000 Cost of goods sold 750,000 530,000 Interest expense 40,000 25,000 Income tax expense 60,000 29,000 Net income 160,000 85,000 Instructions Answer the following questions relating to the year ended December 31, 2009. Show computa-tions.

1. Inventory turnover for 2009 is __________.

2. Times interest earned in 2009 is __________.

3. The debt to total assets ratio for 2009 is __________.

4. Receivables turnover for 2009 is __________.

5. Return on assets for 2009 is __________. Solution 183 (9–14 min.)

$750,000 1. Inventory turnover for 2009 is 5 times. ———————————— = 5 times. ($140,000 + $160,000) ÷ 2 $160,000 + $60,000 + $40,000 2. Times interest earned in 2009 is 6.5 times. —————————————— = 6.5 times. $40,000 $140,000 + $340,000 3. The debt to total assets ratio for 2009 is 40%. —————————— = 40%. $1,200,000 $1,520,000 4. Receivables turnover for 2009 is 8 times. ———————————— = 8 times. ($180,000 + $200,000) ÷ 2 $160,000 5. Return on assets for 2009 is 16%. ————————————— = 16%. ($1,200,000 + $800,000) ÷ 2


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Ex. 184 The financial statements of Dobson Company appear below:

DOBSON COMPANY Comparative Balance Sheet

December 31, ——————————————————————————————————————————— Assets 2009 2008 Cash................................................................................................. $ 35,000 $ 40,000 Short-term investments.................................................................... 15,000 60,000 Accounts receivable (net) ................................................................ 50,000 30,000 Inventory .......................................................................................... 50,000 70,000 Property, plant and equipment (net) ................................................ 250,000 300,000 Total assets ............................................................................... $400,000 $500,000 Liabilities and stockholders' equity Accounts payable............................................................................. $ 10,000 $ 30,000 Short-term notes payable................................................................. 40,000 90,000 Bonds payable ................................................................................. 88,000 160,000 Common stock ................................................................................. 160,000 145,000 Retained earnings............................................................................ 102,000 75,000 Total liabilities and stockholders' equity ..................................... $400,000 $500,000

DOBSON COMPANY Income Statement

For the Year Ended December 31, 2009 Net sales .......................................................................................... $360,000 Cost of goods sold ........................................................................... 198,000 Gross profit ...................................................................................... 162,000 Expenses Interest expense......................................................................... $12,000 Selling expenses........................................................................ 40,000 Administrative expenses ............................................................ 59,000 Total expenses..................................................................... 111,000 Income before income taxes............................................................ 51,000 Income tax expense......................................................................... 15,000 Net income....................................................................................... $ 36,000 Additional information: a. Cash dividends of $9,000 were declared and paid in 2009. b. Weighted-average number of shares of common stock outstanding during 2009 was 30,000

shares. c. Market value of common stock on December 31, 2009, was $21 per share.


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Ex. 184 (cont.)

Instructions Using the financial statements and additional information, compute the following ratios for Coulter Company for 2009. Show all computations. Computations

1. Current ratio _________.

2. Return on common stockholders' equity _________.

3. Price-earnings ratio _________.

4. Acid-test ratio _________.

5. Receivables turnover _________.

6. Times interest earned _________.

7. Profit margin _________.

8. Days in inventory _________.

9. Payout ratio _________.

10. Return on assets _________. Solution 184 (15–20 min.)

$150,000 1. Current ratio 3:1. ———— = 3 $50,000 $36,000 2. Return on common stockholders' equity 15%. ———————————— = .15 ($262,000 + $220,000) ÷ 2 $36,000 3. Price-earnings ratio 17.5 times. EPS = ———— = $1.20; 30,000 $21 ——— = 17.5 times $1.20 $100,000 4. Acid-test ratio 2:1. ———— = 2:1 $50,000 $360,000 5. Receivables turnover 9 times. ——————————— = 9 ($50,000 + $30,000) ÷ 2 $36,000 + $15,000 + $12,000 6. Times interest earned 5.25 times. ————————————— = 5.25 $12,000 $36,000 7. Profit margin 10%. ———— = .10 $360,000


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8. Days in inventory 110.6 days. $198,000 Inventory turnover = ——————————— = 3.3; ($50,000 + $70,000) ÷ 2 365 days ———— = 110.6 3.3 $9,000 9. Payout ratio 25%. ———— = .25 $36,000 $36,000 10. Return on assets 8%. ———————————— = .08 ($400,000 + $500,000) ÷ 2 Ex. 185 The following ratios have been computed for Pratt Company for 2009. Profit margin 20% Times interest earned 15 times Receivables turnover 5 times Acid-test ratio 1.60 : 1 Current ratio 3 : 1 Debt to total assets ratio 26% Pratt Company’s 2009 financial statements with missing information follow:

PRATT COMPANY Comparative Balance Sheet

December 31, ——————————————————————————————————————————— Assets 2009 2008 Cash........................................................................................... $ 25,000 $ 35,000 Short-term Investments.............................................................. 15,000 15,000 Accounts receivable (net) .......................................................... ? (6) 60,000 Inventory .................................................................................... ? (8) 50,000 Property, plant, and equipment (net) ......................................... 200,000 150,000 Total assets ........................................................................ $ ? (9) $310,000 Liabilities and stockholders' equity Accounts payable....................................................................... $ ? (7) $ 25,000 Short-term notes payable........................................................... 35,000 30,000 Bonds payable ........................................................................... ? (10) 20,000 Common stock ........................................................................... 200,000 200,000 Retained earnings...................................................................... 59,000 35,000 Total liabilities and stockholders' equity.............................. $ ? (11) $310,000


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Ex. 185 (cont.)

PRATT COMPANY Income Statement

For the Year Ended December 31, 2009 ——————————————————————————————————————————— Net sales .................................................................................... $250,000 Cost of goods sold...................................................................... 125,000 Gross profit................................................................................. 125,000 Expenses: Depreciation expense........................................................... $ ? (5) Interest expense................................................................... 5,000 Selling expenses .................................................................. 10,000 Administrative expenses ...................................................... 15,000 Total expenses ............................................................... ? (4) Income before income taxes ...................................................... ? (2) Income tax expense ............................................................. ? (3) Net income ................................................................................. $ ? (1) Instructions Use the above ratios and information from the Pratt Company financial statements to fill in the missing information on the financial statements. Follow the sequence indicated. Show computations that support your answers. Solution 185 (35–45 min.)

PRATT COMPANY Comparative Balance Sheet

December 31, ——————————————————————————————————————————— Assets 2009 2008 Cash..................................................................................... $ 25,000 $ 35,000 Marketable securities ........................................................... 15,000 15,000 Accounts receivable (net)..................................................... 40,000 (6) 60,000 Inventory............................................................................... 70,000 (8) 50,000 Property, plant, and equipment (net).................................... 200,000 150,000 Total assets................................................................... $350,000 (9) $310,000 Liabilities and stockholders' equity Accounts payable ................................................................. $ 15,000 (7) $ 25,000 Short-term notes payable ..................................................... 35,000 30,000 Bonds payable...................................................................... 41,000 (10) 20,000 Common stock ..................................................................... 200,000 200,000 Retained earnings ................................................................ 59,000 35,000 Total liabilities and stockholders' equity ........................ $350,000 (11) $310,000


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Solution 185 (cont.) PRATT COMPANY Income Statement

For the Year Ended December 31, 2009 ——————————————————————————————————————————— Net sales .............................................................................. $250,000 Cost of goods sold ............................................................... 125,000 Gross profit .......................................................................... 125,000 Expenses Depreciation expense .................................................... $25,000 (5) Interest expense............................................................. 5,000 Selling expenses............................................................ 10,000 Administrative expenses ................................................ 15,000 Total expenses......................................................... 55,000 (4) Income before income taxes................................................ 70,000 (2) Income tax expense............................................................. 20,000 (3) Net income........................................................................... $ 50,000 (1) (1) Net income = $50,000 ($250,000 × 20%). (2) Income before income taxes = $70,000. Let X = Income before income taxes and interest expense. X ——— = 15 times $5,000 X = $75,000 $75,000 – $5,000 = $70,000 (3) Income tax expense = $20,000 ($70,000 – $50,000). (4) Total operating expenses = $55,000 ($125,000 – $70,000). (5) Depreciation expense = $25,000 [$55,000 – ($5,000 + $10,000 + $15,000)]. (6) Accounts receivable (net) = $40,000. Let X = Average receivables. $250,000 ———— = 5 times X 5X = $250,000. X = $50,000. Let Y = Accounts receivable at 12/31/09. $60,000 + Y —————— = $50,000 2 $60,000 + Y = $100,000 Y = $40,000


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(7) Accounts payable = $15,000. Let X = Current liabilities. $25,000 + $15,000 + $40,000 ————————————— = 1.60 X 1.60X = $80,000 X = $50,000 $50,000 – $35,000 = $15,000 (8) Inventory = $70,000 Let X = Total current assets X ———— = 3 $50,000 X = $150,000 $150,000 – ($25,000 + $15,000 + $40,000) = $70,000 (9) Total assets = $350,000 ($25,000 + $15,000 + $40,000 + $70,000 + $200,000) (10) Bonds payable = $41,000 Let X = Total debt X ———— = 26% $350,000 X = $91,000 $91,000 – ($15,000 + $35,000) = $41,000 (11) Total liabilities and stockholders' equity = $350,000; same as total assets—see (9) above. Ex. 186 Selected data for Nancy's Store appear below. 2009 2008 Net sales $650,000 $520,000 Cost of goods sold 455,000 345,000 Inventory at end of year 65,000 85,000 Accounts receivable at end of year 80,000 50,000 Instructions Compute the following for 2009: (a) Gross profit rate. (b) Inventory turnover. (c) Receivables turnover.


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(a) Gross profit = Net Sales – Cost of goods sold = $650,000 – $455,000 = $195,000 Gross profit rate = Gross profit ÷ Net sales = $195,000 ÷ $650,000 = 30% (b) Inventory turnover = Cost of goods sold ÷ Average inventory = $455,000 ÷ [($65,000 + $85,000) ÷ 2] = 6.1 times (c) Receivables turnover = Net credit sales ÷ Average accounts receivables = $650,000 ÷ [($80,000 + $50,000) ÷ 2] = $650,000 ÷ $65,000 = 10 times Ex. 187 Selected financial statement data for Holmes Company are presented below.

Net sales $1,200,000 Cost of goods sold 700,000 Interest expense 10,000 Net income 180,000 Total assets (ending) 850,000 Total common stockholders' equity (ending) 650,000

Total assets at the beginning of the year were $750,000; total common stockholders' equity was $550,000 at the beginning of the period. Instructions Compute each of the following: (a) Asset turnover (b) Profit margin (c) Return on assets (d) Return on common stockholders' equity Solution 187 (10 min.)

(a) Asset turnover = 1.5 [$1,200,000 ÷ ($750,000 + $850,000) ÷ 2] (b) Profit margin = 15% ($180,000 ÷ $1,200,000) (c) Return on assets = 22.5% [$180,000 ÷ ($750,000 + $850,000) ÷ 2] (d) Return on common stockholders' equity = 30% [$180,000 ÷ ($550,000 + $650,000) ÷ 2]


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Ex. 188 Winter Corporation has issued common stock only. The company has been successful and has a gross profit rate of 20%. The information shown below was taken from the company's financial statements.

Beginning inventory $ 482,000 Purchases 5,636,000 Ending inventory ? Average accounts receivable 700,000 Average common stockholders' equity 3,500,000 Sales (all on credit) 7,000,000 Net income 525,000 Instructions Compute the following: (a) Receivables turnover and the average collection period. (b) Inventory turnover and the days in inventory. (c) Return on common stockholders' equity. Solution 188 (13–18 min.)

(a) Credit sales Receivables turnover = ————————————— Average accounts receivable = $7,000,000 ÷ $700,000 = 10 times

365 days Average collection period = ————————— Receivables turnover = 365 ÷ 10 times = 36.5 days (b) Inventory turnover = Cost of goods sold ÷ Average inventory First calculate ending inventory. Beginning Inventory $ 482,000 + Purchases 5,636,000 – Cost of Goods Sold (5,600,000)* Ending Inventory $ 518,000 *Since the gross profit ratio is 20%, the cost of goods sold ratio is 80%. 80% × $7,000,000 (net sales) = $5,600,000. Ending Inventory = $518,000 (per above) Average Inventory = ($482,000 + $518,000) ÷ 2 = $500,000 Inventory Turnover = $5,600,000 ÷ $500,000 = 11.2 times Days in Inventory = 365 days ÷ 11.2 times = 32.6 days (c) Net income Return on common stockholders' equity = ————————————————— Average common stockholders' equity $525,000 ÷ $3,500,000 = 15%


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Ex. 189 Boyle Corporation had the following comparative current assets and current liabilities: Dec. 31, 2009 Dec. 31, 2008 Current assets Cash $ 20,000 $ 30,000 Short-term investments 40,000 10,000 Accounts receivable 55,000 95,000 Inventory 110,000 90,000 Prepaid expenses 35,000 20,000 Total current assets $260,000 $245,000 Current liabilities Accounts payable $140,000 $110,000 Salaries payable 40,000 30,000 Income tax payable 20,000 15,000 Total current liabilities $200,000 $155,000 During 2009, credit sales and cost of goods sold were $600,000 and $350,000, respectively.

Instructions Compute the following liquidity measures for 2009: 1. Current ratio. 2. Working capital. 3. Acid-test ratio. 4. Receivables turnover. 5. Inventory turnover. Solution 189 (10–15 min.)

1. Current ratio = Current assets ÷ Current liabilities = $260,000 ÷ $200,000 = 1.3 : 1 2. Working capital = $260,000 – $200,000 = $60,000 Cash + Short-term investments + Accounts receivable 3. Acid-test ratio = ———————————————————————— Current liabilities $20,000 + $40,000 + $55,000 = ————————————— = .58 : 1 $200,000 Net credit sales 4. Receivables turnover = ————————————— Average accounts receivables $600,000 = ———— = 8 times $75,000 Cost of goods sold 5. Inventory turnover = ————————— Average inventory $350,000 = ———— = 3.5 times $100,000


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Ex. 190 Selected data from Oates Company are presented below:

Total assets $1,600,000 Average assets 1,750,000 Net income 175,000 Net sales 1,225,000 Average common stockholders' equity 1,000,000 Instructions Calculate the profitability ratios that can be computed from the above information. Solution 190 (9–13 min.)

With the information provided, the profitability ratios that can be calculated are as follows: 1. Profit margin = Net income ÷ Net sales = $175,000 ÷ $1,225,000 = 14.3% 2. Asset turnover = Net sales ÷ Average assets = $1,225,000 ÷ $1,750,000 = 70% 3. Return on assets = Net income ÷ Average assets = $175,000 ÷ $1,750,000 = 10% Net income 4. Return on common stockholders' equity = ————————————————— Average common stockholders' equity = $175,000 ÷ $1,000,000 = 17.5% Ex. 191 The following data are taken from the financial statements of Doyle Company: 2009 2008 Monthly average accounts receivable $ 520,000 $ 500,000 Net sales on account 5,460,000 4,500,000 Terms for all sales are 2/10, n/30 Instructions (a) Compute the receivables turnover and the average collection period for both years. (b) What conclusion can an analyst draw about the management of the accounts receivable?


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(a) 2009 2008 $5,460,000 $4,500,000 Receivables turnover ————— ————— 520,000 500,000 10.5 times 9.0 times 365 days 365 days Average collection period ————– ———— 10.5 times 9.0 times 34.8 days 40.6 days (b) The receivables are turning faster in 2009 than they did in 2008. There is still a problem

since the normal credit period is 30 days, and the average collection period for both years exceeds this target. Therefore, improvement in the management of the receivables would appear to be desirable.

Ex. 192 Assuming a starting point of a 1:1 relationship, state the effect of the following transactions on the current ratio. Use increase, decrease, or no effect for your answer. (a) Collection of an accounts receivable. (b) Declaration of cash dividends. (c) Additional stock is sold for cash. (d) Short-term investments are purchased for cash. (e) Equipment is purchased for cash. (f) Inventory purchases are made for cash. (g) Accounts payable are paid. Solution 192 (7–11 min.)

(a) no effect (b) decrease (c) increase (d) no effect (e) decrease (f) no effect (g) increase


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Ex. 193 The balance sheet for Farley Corporation at the end of the current year indicates the following:

Bonds payable, 7% .............................................................. $4,000,000 6% Preferred stock, $100 par............................................... 1,000,000 Common stock, $10 par ....................................................... 3,000,000 Income before income taxes was $1,120,000 and income taxes expense for the current year amounted to $336,000. Cash dividends paid on common stock were $300,000, and the common stock was selling for $45 per share at the end of the year. There were no ownership changes during the year.

Instructions Determine each of the following: (a) times that bond interest was earned. (b) earnings per share for common stock. (c) price-earnings ratio. Solution 193 (9–14 min.)

(a) Income before income taxes and interest expense Times interest earned = —————————————————————— Interest expense $1,120,000 + $280,000 —————————— = 5 times $280,000 (b) Net income – Preferred dividends Earnings per share = ————————————————————— Weighted average common shares outstanding $784,000 – $60,000 ————————— = $2.41 per share 300,000 shares (c) Market price per share Price-earnings ratio = —————————— Earnings per share $45.00 ——— = 18.67 $2.41 Ex. 194 The income statement for Stoval Company for the year ended December 31, 2008 appears below.

Sales $610,000 Cost of goods sold 380,000 Gross profit 230,000 Expenses 170,000* Net income $ 60,000 *Includes $30,000 of interest expense and $18,000 of income tax expense.


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Ex. 194 (cont.) Additional information:

1. Common stock outstanding on January 1, 2008 was 40,000 shares. On July 1, 2008, 10,000 more shares were issued.

2. The market price of Stoval's stock was $15 at the end of 2008.

3. Cash dividends of $30,000 were paid, $6,000 of which were paid to preferred stockholders. Instructions Compute the following ratios for 2008: (a) earnings per share. (b) price-earnings. (c) times interest earned. Solution 194 (8–13 min.)

(a) Earnings per share

$60,000 – $6,000 $54,000 —————————— = ———— = $1.20 [40,000 + (10,000 ÷ 2)] 45,000 (b) Price-earnings

$15.00 ——— = 12.5 times 1.20 (c) Times interest earned

$60,000 + $30,000 + $18,000 ————————————— = 3.6 times $30,000 Ex. 195 Gumble Corporation had income from continuing operations of $300,000 for the year ended December 31, 2008. It also had the following items (before income taxes): 1. Extraordinary flood loss of $150,000. 2. Loss of $60,000 on discontinuance of a division. All items are subject to income taxes at a 30% tax rate.

Instructions Prepare a partial income statement, beginning with income from continuing operations.


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Income from continuing operations $300,000 Discontinued operations Loss on discontinued division, net of $18,000 income tax savings (42,000) Income before extraordinary item 258,000 Extraordinary item Flood loss, net of $45,000 income tax savings (105,000) Net income $153,000 Ex. 196 Lawrenz Corporation gathered the following information for the fiscal year ended December 31, 2008: Sales $1,400,000 Extraordinary fire loss 140,000 Selling and administrative expenses 160,000 Cost of goods sold 900,000 Loss on sale of equipment 40,000

Lawrenz Corporation is subject to a 30% income tax rate. Instructions Prepare a partial income statement, beginning with income before income taxes. Solution 196 (8–12 min.)

LAWRENZ CORPORATION Partial Income Statement

For the Fiscal Year Ended December 31, 2008

Income before income taxes ($1,400,000 – $900,000 – $160,000 – $40,000) $300,000 Income tax expense ($300,000 × 30%) 90,000 Income before extraordinary item 210,000 Extraordinary fire loss, net of $42,000 tax saving ($140,000 × 30%) (98,000) Net income $112,000 Ex. 197 Dennehy Corporation had the information listed below available in preparing an income statement for the year ended December 31, 2008. All amounts are before income taxes. Assume a 30% income tax rate for all items.

Sales $ 600,000 Expropriation of property by a foreign government (loss) $(120,000) Income from operation of discontinued cement division $ 100,000 Loss from disposal of cement division $ (80,000) Operating expenses $ 125,000 Gain on sale of equipment $ 85,000 Cost of goods sold $ 360,000


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Ex. 197 (cont.)

Instructions Prepare a multiple-step income statement in good form which takes into account intraperiod income tax allocation. Ignore EPS computations. Solution 197 (17–22 min.)

DENNEHY CORPORATION Income Statement

or the Year Ended December 31, 2008 ——————————————————————————————————————————— Sales ................................................................................................. $600,000 Cost of goods sold ............................................................................ 360,000 Gross profit ....................................................................................... 240,000 Operating expenses.......................................................................... 125,000 Operating income.............................................................................. 115,000 Other revenues and gains Gain on sale of equipment ....................................................... 85,000 Income before income taxes............................................................. 200,000 Income taxes..................................................................................... 60,000 Income from continuing operations................................................... 140,000 Discontinued operations Income from operation of discontinued cement division, net of $30,000 income taxes .................................... $70,000 Loss from disposal of cement division, net of $24,000 income tax savings......................................... (56,000) 14,000 Income before extraordinary item ..................................................... 154,000 Extraordinary item Loss on expropriation of property, net of $36,000 income tax saving .......................................... (84,000) Net income ....................................................................................... $ 70,000 Ex. 198 Indicate whether the following items would be reported as an ordinary or an extraordinary item in Logan Corporation's income statement.

(a) Loss attributable to labor strike.

(b) Gain on sale of fixed assets.

(c) Loss from fire. Logan is a chemical company.

(d) Loss from sale of short-term investments.

(e) Expropriation of property by a foreign government.

(f) Loss from tornado damage. Logan Corporation is located in the Midwest's tornado alley.

(g) Loss from government condemnation of property through newly enacted law.


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(a) ordinary (e) extraordinary (b) ordinary (f) ordinary (c) ordinary (g) extraordinary (d) ordinary Ex. 199 Potter Company has income from continuing operations of $480,000 for the year ended December 31, 2008. It also has the following items (before considering income taxes):

(1) An extraordinary fire loss of $180,000.

(2) A gain of $110,000 on the discontinuance of a major segment.

(3) A correction of an error in last year's financial statement that resulted in a $100,000 overstatement of 2007 net income.

Assume all items are subject to income taxes at a 30% tax rate. Instructions (a) Prepare an income statement, beginning with income from continuing operations. (b) Indicate the statement presentation of any item not included in (a) above. Solution 199 (10–15 min.)

(a) POTTER COMPANY Partial Income Statement

For the Year Ended December 31, 2008 Income from continuing operations ............................................................. $480,000 Discontinued operations Gain on discontinued segment, net of $33,000 income taxes ............ 77,000 Income before extraordinary item................................................................ 557,000 Extraordinary item Fire loss, net of $54,000 tax saving .................................................... (126,000) Net income ................................................................................................. $431,000 (b) The correction of an error in last year's financial statements is a prior period adjustment. The

correction is reported in the 2008 retained earnings statement as an adjustment that decreases the reported beginning balance of retained earnings by $70,000 [$100,000 – ($100,000 × 30%)].


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COMPLETION STATEMENTS

200. In analyzing and interpreting financial statement information, three major characteristics are generally evaluated: (1)____________, (2)_____________, and (3)_____________.

201. ______________ analysis, also called trend analysis, is a technique for evaluating a percentage increase or decrease for a financial statement item over a period of time.

202. Expressing each item within a financial statement as a percentage of a base amount is called ______________ analysis.

203. The ratios used in evaluating a company's liquidity and short-term debt paying ability that complement each other are the ______________ ratio and the ______________ ratio.

204. The receivables turnover is calculated by dividing _________________ by average ___________________.

205. If inventory turnover is 5 times, and the average inventory was $400,000, the cost of goods sold during the year was $______________ and the days in inventory was ______________ days.

206. Hansen Corporation had net income for the year of $300,000 and a profit margin of 25%. If total average assets were $400,000, the asset turnover ratio was ____________ times.

207. The ______________ ratio measures the percentage of earnings distributed in the form of cash dividends.

208. The lower the ______________ to ______________ ratio, the more equity "buffer" there is available to the creditors.

209. Times interest earned is calculated by dividing _____________ before _______________ and ________________ by interest expense.

210. Discontinued operations refers to the disposal of a ______________ of a business.

211. The two criteria necessary for an item to be classified as an extraordinary item are that the transaction or event must be (1) __________________ and (2) ___________________.

212. A change in inventory methods during the year would be classified as a change in __________________.

Answers to Completion Statements 200. liquidity, profitability, solvency 207. payout 201. Horizontal 208. debt, total assets 202. vertical (common size) 209. income, income taxes, interest expense 203. current, acid-test (quick) 210. significant segment 204. net credit sales, gross receivables 211. unusual in nature, infrequent in 205. 2,000,000, 73 occurrence 206. 3 212. accounting principle


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MATCHING SET A 213. For each of the ratios listed below, indicate by the appropriate code letter, whether it is a

liquidity ratio, a profitability ratio, or a solvency ratio. Code: L = Liquidity ratio P = Profitability ratio S = Solvency ratio ____ 1. Price-earnings ratio ____ 2. Asset turnover ____ 3. Receivables turnover ____ 4. Earnings per share ____ 5. Payout ratio ____ 6. Current ratio ____ 7. Acid-test ratio ____ 8. Debt to total assets ratio ____ 9. Times interest earned ____ 10. Inventory turnover Answers to Matching

P 1. Price-earnings ratio P 2. Asset turnover L 3. Receivables turnover P 4. Earnings per share P 5. Payout ratio L 6. Current ratio L 7. Acid-test ratio S 8. Debt to total assets ratio S 9. Times interest earned L 10. Inventory turnover


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SET B 214. Match the ratios with the appropriate ratio computation by entering the appropriate letter in

the space provided. A. Current ratio F. Times interest earned B. Acid-test ratio G. Inventory turnover C. Profit margin H. Average collection period D. Asset turnover I. Days in inventory E. Price-earnings ratio J. Payout ratio Cost of goods sold ____ 1. ————————— Average inventory Net income ____ 2. ————— Net sales Cash dividends ____ 3. ——————— Net income Net sales ____ 4. ——————— Average assets Current assets ____ 5. ———————— Current liabilities 365 days ____ 6. —————————— Receivables turnover Market price per share of stock ____ 7. —————————————— Earnings per share 365 days ____ 8. ———————— Inventory turnover Income before income taxes and interest expense ____ 9. —————————————————————— Interest expense Cash + short-term investments + receivables (net) ____ 10. ——————————————————————— Current liabilities

Answers to Matching 1. G 6. H 2. C 7. E 3. J 8. I 4. D 9. F 5. A 10. B


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SHORT-ANSWER ESSAY QUESTIONS S-A E 215 Horizontal and vertical analyses are analytical tools frequently used to analyze financial statements. What type of information or insights can be obtained by using these two techniques? Explain how the output of horizontal analysis and vertical analysis can be compared to industry averages and/or competitive companies. Solution 215 Horizontal analysis allows an analyst to develop a picture of current trends in a company's operations. The analyst can see whether the accounts are increasing or decreasing and how large these changes actually are. Vertical analysis allows an analyst to evaluate financial statement items within a single financial statement. This technique helps the analyst to evaluate the relative size of the financial statement items and how the items relate to the financial statement as a whole. An example would be if current liabilities were a very large percentage of total liabilities and stockholders' equity. Both techniques allow the company to evaluate their performance and position relative to their competitors and their industry as a whole. For example, the company could evaluate its current trend in sales and see how favorably its sales performance compared to the sales performance of other companies in the industry. Another example would be comparing the relative size of long-term liabilities or retained earnings. This would show which companies have taken on a large amount of debt and which companies have invested in themselves. S-A E 216 Manuel Mentirosa, the CEO of Mystical Products, is a successful entrepreneur but a poor student of accounting. He asks you to explain to him, in a memo, the bases of comparison for ratio analysis. Solution 216

To: Manuel Mentirosa From: Student name Re: Bases of Comparison for Ratio Analysis There are three bases of comparison for ratio analysis. They include:

Intra-company: This basis compares a ratio for the current year to the same ratio for one or more prior years.

Inter-company: This basis compares a ratio for one company with the same ratio for one or more competing companies.

Industry averages: This basis compares a ratio for a company with the industry average for the same ratio.

(Signed)


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S-A E 217 (Ethics)

A trusted employee of Wilderness Tours was caught in the act of embezzling funds. He confessed to earlier embezzlements, but retracted the confession on the advice of his attorney. Over the course of the most recent quarter, it has been determined that $20,000 was embezzled.

Wilderness Tours has suffered adverse publicity in the recent past because of serious injury to five tourists that occurred during a two week "Winter Wilds Adventure" tour. The company has therefore decided to avoid publicity and has agreed to drop all charges against the embezzling employee. In return, the employee has agreed to a notation of "Terminated—Not to be Rehired" to be appended to his personnel file.

Required: 1. Who are the stakeholders in the decision not to prosecute? 2. Was it ethical for the company to decide not to prosecute? Explain. Solution 217 1. The stakeholders include

• The embezzling employee • The other employees • Company management • Other companies who might hire the embezzling employee

2. The company was certainly within its legal rights not to prosecute the embezzling employee.

However, the decision not to prosecute may not be ethical. First, it does not serve public justice. The embezzling employee could find a job elsewhere, and harm someone else financially. Second, to the extent that other employees know of the act and of the decision, morale may be harmed. The decision is also not the best one for the employee. Having never been forced to face the consequences of his dishonest acts, he is not deterred from (and may even feel encouraged to) commit similar acts in the future. The one argument that would support the premise that the decision was ethical is that the public disclosure would cause harm greater than that caused by keeping silent. Even this argument lacks force, because it implies a lack of moral courageousness.

S-A E 218 (Communication)

Kwik Express specializes in the overnight transportation of medical equipment and laboratory specimens. The company has selected the following information from its most recent annual report to be the subject of an immediate press release. • The financial statements are being released. • Net income this year was $2.2 million. Last year's net income had been $2.0 million. • The current ratio has changed to 2:1 from last year's 1.5:1 • The debt/total assets ratio has changed to 4:5 from last year's 3:5 • The company expanded its truck fleet substantially by purchasing ten new delivery vans. The

company already had twelve delivery vans. • The company is now the largest medical courier in the mid-Atlantic region.

Required: Prepare a brief press release incorporating the information above. Include all information. Think carefully which information (if any) is good news for the company, and which (if any) is bad news.


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Solution 218 Press Release

Kwik Express released its financial statements today, disclosing a 10% increase in earnings, to $2.2 million from $2 million last year. The company also improved its short-term liquidity. Its current ratio improved to 2:1 from last year's 1.5:1. Part of the improved performance is no doubt due to the addition of ten new delivery vans to its fleet, allowing it to become the largest medical courier in the mid-Atlantic region. The purchase of the vans, however, caused the debt/total asset ratio to decline. There are now $4 of debt for every $5 in assets, while last year, there were only $3 of debt to $5 in assets.


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