finman 5e chapter 13 sm

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Solutions Manual, Chapter 13 723

Chapter 13 Analyzing Financial Statements

QUESTIONS

1. Financial reporting includes the entire process of preparing and issuing financial information about a company. Financial statements are an important part of financial reporting but they are less than the whole.

2. With comparative statements, financial statement items for two or more successive accounting periods are placed side by side on a single statement, with the change in each item expressed as both a dollar amount and a percent. Common-size comparative statements express each financial statement item as a percent of some base amount that is assigned a value of 100%.

3. Total assets (or equivalently, the total of liabilities plus equity) are assigned a value of 100% on a common-size balance sheet. Net sales (revenues) are assigned a value of 100% on a common-size income statement.

4. The nature of a company's business, the composition of its current assets, and the turnover of its current assets are three important factors that should be considered in deciding whether a current ratio is good or bad.

5. A 2-to-1 current ratio may not be adequate if the company's current assets consist of a large proportion of slow-turning accounts, notes, and merchandise inventory. The general nature of the business also may make the 2-to-1 rule of thumb inadequate.

6. Adequate working capital enables a company to carry sufficient inventories, meet current debts, take advantage of cash discounts, and extend favorable terms to customers. Working capital is a major factor in determining the short-term liquidity position of a company.

7. When evaluated in light of a company's credit terms, the number of days' sales uncollected indicates how quickly accounts receivable are converted into cash. This provides information about the relevance of accounts receivable balances in meeting the current obligations of the business.

8. A high accounts receivable turnover implies that accounts are collected quickly, thereby providing cash that can be used to meet obligations. A high turnover also means that a given sales volume can be supported with a lower investment in accounts receivable.

9. Users are interested in the capital structure of a company, as measured by debt and equity ratios, for at least two reasons. First, as a company includes more debt in its capital structure, the risk that it will be unable to meet interest and principal payments increases. Second, the existence of debt introduces financial leverage. If the company can earn a rate of return on its investments that exceeds the rate of interest paid to creditors, the debt will increase the rate of return to stockholders.


Financial & Managerial Accounting, 5th Edition 724

10. Inventory turnover reflects on the efficiency of inventory management. That is, a high inventory turnover means that a given sales volume can be supported with a smaller investment in inventory. This insight into the speed with which inventory is sold determines the relevance of the available inventory in meeting the current obligations of the business, which is a focus of short-term liquidity.

11. Since management is responsible for a company's performance, all ratios that are useful in evaluating a company are of some usefulness in assessing management performance. Profit margin, total asset turnover, return on total assets, and return on stockholders' equity are especially useful for assessing management's responsibility for operating efficiently and profitably.

12. Almost all companies have some liabilities. Since total assets equals total liabilities plus equity, total assets are almost always higher than common stockholders' equity. Thus, the denominator in return on total assets is larger than common stockholders' equity. Since the numerator is the same for both, and return on total assets has a larger denominator, it yields a smaller percent. [Instructor note: A more complete measure of return on assets would add back (Interest Expense x {1 – Tax Rate}) to net income in the numerator—reflecting the after-tax cost of debt. We leave the rationale for this adjustment to advanced courses.]

13. This gain is considered to be unusual but not infrequent. It would be included in the calculation of income from continuing operations, with other unusual or infrequent gains and losses—in a category often labeled Other Gains and Losses.

14. Profit margin: Net Income / Sales ($ in thousands) 2011: $227,575/$2,656,949 = 8.6% 2010: $147,138/$1,991,139 = 7.4%

15. Equity ratio: Total Equity / Total Assets ($ in thousands)

2011: $183,036/$272,906 = 67.1% 2010: $167,339/$246,084 = 68.0%

16. Debt ratio: Total Liabilities / Total Assets (€ in thousands)

2011: €1,073,966/ €1,520,184 = 70.6% 2010: €1,102,832/ €1,545,722 = 71.3%

17. Return on total assets: Net Income / Average Total Assets (€ in thousands)

2011: €20,818/ ((€485,775 + €445,325)/2) = 4.5%



QUICK STUDY Quick Study 13-1 (5 minutes) Items not part of general-purpose financial statements:

d. Prospectus.

e. Stock price information and analysis.

g. Management discussion and analysis of financial performance.

i. Company news releases. Quick Study 13-2 (5 minutes) Trend percents

2013 177.0% ($801,810/ $453,000)

2012 100.0% (the given base amount) Quick Study 13-3 (5 minutes)

Common-size percents

2013 49.0% ($392,887 / $801,810)

2012 29.6% ($134,088 / $453,000)

Quick Study 13-4 (15 minutes)

2013

2012

Dollar Change

Percent Change

Short-term investments ............. $374,634 $234,000 $140,634 60.1%

Accounts receivable ................... 97,364 101,000 (3,636) -3.6%

Notes payable.............................. 0 88,000 88,000 (not calculable)



Quick Study 13-5 (10 minutes) The four usual standards of comparisons are:

Intracompany. The company under analysis provides standards for comparisons based on prior performance and relations between its financial items.

Competitor. One or more direct competitors of the company under analysis can provide standards for comparisons.

Industry. Industry statistics can provide standards of comparisons. Published industry statistics are available from several services such as Dun & Bradstreet, Standard and Poor's, and Moody's.

Guidelines (Rules of Thumb). General standards of comparisons can develop from past experiences. Examples are the 2-to-1 level for the current ratio or 1-to-1 level for the acid-test ratio.

All of these standards of comparisons are useful when properly applied. Yet, analysis measures taken from a selected competitor or group of competitors are often the best standards of comparisons. Also, intracompany and industry measures are important parts of all analyses.

The standard that is least likely to provide a good basis for comparison is the use of guidelines, or rules of thumb. Guidelines must be applied with care, and then only if they seem reasonable in light of past experience and industry's norms.

Quick Study 13-6 (10 minutes)

Ratio 2013 2012 Change 1. Profit Margin Ratio ................................ 9% 8% Favorable

2. Debt Ratio .............................................. 47% 42% Unfavorable

3. Gross Margin Ratio ............................... 34% 46% Unfavorable

4. Acid-test Ratio....................................... 1.00 1.15 Unfavorable

5. Accounts Receivable Turnover ........... 5.5 6.7 Unfavorable

6. Basic Earnings Per Share .................... $1.25 $1.10 Favorable

7. Inventory Turnover ............................... 3.6 3.4 Favorable

8. Dividend Yield ....................................... 2.0% 1.2% Favorable



Quick-Study 13-7 (30 minutes) Parker has a greater amount of working capital. This by itself does not

indicate whether the company is more capable of meeting its current

obligations. However, support is provided by the current ratio and acid-

test ratio, which show Parker is in a more liquid position than Morgan. This

evidence does not mean that Morgan's liquidity is inadequate. Such a

conclusion would require more information such as norms for the industry

or its other competitors. Notably, Morgan's acid-test ratios approximate

the traditional rule of thumb (1 to 1).

This evidence also shows that Parker's working capital, current ratio, and

acid-test ratio all increased dramatically over the three-year period. This

trend toward greater liquidity may be positive, but it can also suggest that

Parker holds an excess amount of highly liquid assets that typically earn

low returns.

The accounts receivable turnover and inventory turnover indicate that

Morgan is more efficient in collecting its accounts receivable and in

generating sales from available inventory. However, these statistics also

may suggest that Morgan is too conservative in granting credit and

investing in inventory. This could have a negative impact on sales and net

income. Parker's ratios may be acceptable, but no definitive determination

can be made without having information on industry (or other competitors’)

standards.

Quick Study 13-8A (5 minutes) This material error should be reported on the statement of retained

earnings (and/or the statement of stockholders’ equity) as a prior period

adjustment to the beginning retained earnings balance. Also, if prior year’s

financial numbers are reported, they should be revised to show the correct

numbers.



Quick Study 13-9 (10 minutes) a. Although ratio analysis can eliminate currency differences, it cannot

eliminate differences in the application of GAAP under different

accounting systems. For example, if we compare the gross margin

percent for a European company applying FIFO under IFRS versus an

American company applying LIFO under U.S. GAAP, the percents will be

impacted by differences in FIFO versus LIFO. Thus, we must still adjust

the accounting numbers for fundamental differences in accounting

methods when performing ratio analysis.

Additional examples that are arguably even more problematic: (1)

Consider two companies, one reporting under U.S. GAAP and the other

under IFRS, which we are reviewing via the Operating Cash Flow /

Average Total Assets ratio. We can potentially see the dividends and

the interest items reported differently for these two companies under the

two different reporting regimes. That type of difference would persist

(that is, not be reversed). (2) Consider the same type of comparison as

we look at the Return on Total Assets ratio. Again, we can potentially

see differences in asset values through IFRS’s more aggressive

methods. These methods include the mark up associated with reversals

of previous write-downs. Also some long-term asset revaluation

methods are also more aggressive than U.S. GAAP. Different from this

paragraph’s first example, however, many of these differences in asset

revaluations will be captured over time (multiple periods) with both

accounting systems.

b. A key advantage to using horizontal and vertical analyses when

examining companies reporting under different currencies is that the

computation of the percentages eliminates the currency effects. This

enhances our comparative analysis of companies. For example, the

gross margin percent from a European company using IFRS, and from a

Japanese company using Japan GAAP, and from an American company

using U.S. GAAP can be directly compared and assessed.



EXERCISES Exercise 13-1 (10 minutes) 1. B 6. A

2. C 7. B

3. D 8. B

4. C 9. C

5. A 10. A

Exercise 13-2 (5 minutes) 1. Profit Margin and the Total Asset Turnover.

Return on Total Assets. 2. Working Capital, also called net working capital. 3. Accounts Receivable Turnover and the Days' Sales Uncollected. Exercise 13-3 (20 minutes)

2015 2014 2013 2012 2011

Sales ........................................ 189 181 168 156 100

Cost of goods sold ................ 191 182 172 159 100

Accounts receivable .............. 201 192 182 169 100

Analysis: The trend in sales is positive. While this is better than no growth, one cannot definitively say whether the sales trend is favorable without additional information about the economic conditions in which this trend occurred such as inflation rates and competitors’ performances.

Given the trend in sales, the comparative trends in both cost of goods sold and accounts receivable are somewhat unfavorable. In particular, for the most recent year, both are increasing at slightly faster rates (indexes for cost of goods sold is 191 and accounts receivable is 201) compared to sales (index is 189).



Exercise 13-4 (25 minutes) Answer: Net income decreased.

Supporting calculations: When the sum of each year's common-size cost of goods sold and total expenses is subtracted from the common-size sales percent, the net income percent is as follows:

2012 net income percent: 100.0 - 59.1 - 15.1 = 25.8% of sales

2013 net income percent: 100.0 - 61.9 - 14.8 = 23.3% of sales

2014 net income percent: 100.0 - 63.4 - 15.3 = 21.3% of sales Next, if 2012 sales are assumed to be $100, then sales for 2013 are $104.20 and the sales for 2014 are $105.40. If the net income percents for the three years are applied to these amounts, the net incomes are:

2012 net income: $100.00 x 25.8% = $25.80

2013 net income: $104.20 x 23.3% = $24.28

2014 net income: $105.40 x 21.3% = $22.45 This shows that net income decreased over the three-year period.

Exercise 13-5 (25 minutes)

2013 2012

Sales .................................................... 100.0% 100.0%

Cost of goods sold ............................ 75.7 46.5

Gross profit ........................................ 24.3 53.5

Operating expenses........................... 17.3 35.0

Net income .......................................... 7.0% 18.5%

Analysis: Overall, this company’s situation has worsened. This is evident from

the substantial decline in net income as a percent of sales for 2013 (7.0%)

relative to 2012 (18.5%). The main culprit is the increase in cost of goods sold

as a percent of sales from 46.5% in 2012 to 75.7% in 2013. On a somewhat

positive note, the company has not experienced any increase in operating

expenses as a percent of sales; indeed, declining from 35.0% in 2012 to 17.3%

in 2013. Even more positive is the company’s level of sales increase from

$625,000 in 2012 to $740,000 in 2013.




COMPARATIVE ANALYSIS REPORT

Clay's profit margins are higher than Roak's. However, Roak has

significantly higher total asset turnover ratios. As a result, Roak generates

a substantially higher return on total assets.

The trends of both companies include evidence of growth in sales, total

asset turnover, and return on total assets. However, Clay's rates of

improvement are better than Roak's. These differences may result from the

fact that Clay is only three years old, while Roak is a somewhat more

established company. Clay's operations are considerably smaller than

Roak's, but that will not persist many more years if both companies

continue to grow at their current rates.

To some extent, Roak's higher total asset turnover ratios may result from

the fact that its assets may have been purchased years earlier. If the

turnover calculations had been based on current values, the differences

might be less striking. The relative ages of the assets also may explain

some of the difference in profit margins. Assuming Clay's assets are

newer, they may require smaller maintenance expenses.

Finally, Roak successfully employed financial leverage in 2015. Its return

on total assets is 9.0% compared to the 7% interest rate it paid to obtain

financing from creditors. In contrast, Clay's return is only 5.9% as

compared to the 7% interest rate paid to creditors.




Simon Company Common-Size Comparative Balance Sheets

December 31, 2012-2014 At December 31 2014 2013* 2012

Assets

Cash ................................................................... 6.1% 8.0% 10.0%

Accounts receivable, net .................................. 17.1 14.0 13.3

Merchandise inventory ..................................... 21.5 18.5 14.3

Prepaid expenses .............................................. 2.0 2.1 1.3

Plant assets, net ............................................... 53.3 57.3 61.1

Total assets ....................................................... 100.0% 100.0% 100.0%

Liabilities and Equity

Accounts payable ............................................. 24.8% 16.9% 13.6%

Long-term notes payable secured by mortgages on plant assets ..........................

18.8

22.9

22.1

Common stock, $10 par value ......................... 31.3 36.7 43.3

Retained earnings ............................................ 25.1 23.5 21.0

Total liabilities and equity ................................ 100.0% 100.0% 100.0%

* Column does not equal 100.0 due to rounding.

Analysis: Several observations can be made.

(1) Cash as a percent of assets has declined—this is favorable provided sufficient cash is available for operations.

(2) Accounts receivable have increased as a percent of assets—this may be unfavorable in that assets are tied up in an unproductive manner and there would be additional assets exposed to the risk of uncollection; it could be favorable if increased sales outweigh these costs and risk.

(3) Plant assets have declined as a percent of assets—this is favorable if the company is operating more efficiently; it could be unfavorable if the company is downsizing due to poor performance.

(4) Accounts payable have markedly increased as a percent of assets—this could reveal liquidity constraints.

(5) Common stock has markedly declined—this could reflect a stock buyback program or other mechanisms to reduce shares outstanding.




1. Current ratio

2014: = 1.88 to 1

2013: = 2.52 to 1

2012: = 2.87 to 1 2. Acid-test ratio 2014: = 0.93 to 1 2013: = 1.30 to 1 2012: = 1.72 to 1 Analysis and Interpretation: Simon's short-term liquidity position has

deteriorated over this three-year period. Both the current and acid-test

ratios show declining trends. Although we do not have information about

the nature of the company's business, the acid-test ratio shifts from ‘1.72 to

1’ down to ‘0.93 to 1’ and the current ratio shifts from ‘2.87 to 1’ down to

‘1.88 to 1’—both suggest a potential liquidity problem. Still, we must

recognize that industry standards could show that the 2012 ratios were too

high (instead of 2014 ratios as being too low).

$31,800 + $89,500 + $112,500 + $10,700

$129,900

$35,625 + $62,500 + $82,500 + $9,375

$75,250

$37,800 + $50,200 + $54,000 + $5,000

$51,250

$31,800 + $89,500

$129,900

$35,625 + $62,500

$75,250

$37,800 + $50,200

$51,250



Exercise 13-9 (25 minutes) 1. Days' sales uncollected 2014: x 365 = 48.5 days 2013: x 365 = 42.9 days 2. Accounts receivable turnover 2014: = 8.9 times 2013: = 9.4 times 3. Inventory turnover 2014: = 4.2 times 2013: = 5.1 times 4. Days’ sales in inventory 2014: x 365 = 99.9 days 2013: x 365 = 87.2 days Analysis and Interpretation: The number of days' sales uncollected has increased and the accounts receivable turnover has declined. Also, the inventory turnover has decreased and days’ sales in inventory has increased. While none of these changes in ratios that occurred from 2013 to 2014 appear dramatic, it seems that Simon is becoming less efficient in managing its inventory and in collecting its receivables.

$89,500

$673,500

$62,500

$532,000

$673,500

($89,500 + $62,500)/2

$532,000

($62,500 + $50,200)/2

$411,225

($112,500 + $82,500)/2

$345,500

($82,500 + $54,000)/2

$112,500

$411,225

$82,500

$345,500



Exercise 13-10 (25 minutes) 1. Debt and equity ratios

2014 2013

Total liabilities and debt ratio

$129,900 + $98,500 ....................... $228,400 43.7%

$75,250 + $101,500 ....................... $176,750 39.7%

Total equity and equity ratio

$163,500 + $131,100 ..................... 294,600 56.3

$163,500 + $104,750 ..................... _______ _____ 268,250 60.3

Total liabilities and equity ............... $523,000 100.0% $445,000 100.0%

2. Debt-to-equity ratio 2014: $228,400 / $294,600 = 0.78 to 1

2013: $176,750 / $268,250 = 0.66 to 1

3. Times interest earned 2014: ($31,100 + $9,525 + $12,100) / $12,100 = 4.4 times

2013: ($29,375 + $8,845 + $13,300) / $13,300 = 3.9 times Analysis and Interpretation: Simon added debt to its capital structure

during 2014, with the result that the debt ratio increased from 39.7% to

43.7%. In addition, the debt-to-equity ratio also increased from 0.66 to 1 to

0.78 to 1. We should note that the debt increase is mostly in current

liabilities, which places a greater stress on short-term liquidity.




1. Profit margin 2014: $31,100 / $673,500 = 4.6% 2013: $29,375 / $532,000 = 5.5%

2. Total asset turnover 2014: = 1.4 times 2013: = 1.3 times

3. Return on total assets

2014: = 6.4% 2013: = 7.1%

Analysis and Interpretation: Simon's operating efficiency appears to be

declining because the return on total assets decreased from 7.1% to 6.4%.

While the total asset turnover favorably increased slightly from 2013 to

2014, the profit margin unfavorably decreased from 5.5% to 4.6%. The

decline in profit margin indicates that Simon's ability to generate net

income from sales has declined.

$673,500

($523,000 + $445,000)/2

$532,000

($445,000 + $377,500)/2

$31,100

($523,000 + $445,000)/2

$29,375

($445,000 + $377,500)/2



Exercise 13-12 (20 minutes) 1. Return on common stockholders' equity 2014: = 11.1% 2013: = 11.5% 2. Price-earnings ratio, December 31 2014: $30 / $1.90 = 15.8

2013: $28 / $1.80 = 15.6 3. Dividend yield 2014: $0.29 / $30 = 0.1%

2013: $0.24 / $28 = 0.9%

Analysis and interpretation

The company’s return on common stockholders’ equity is good, but not great. An 11% return likely makes it an acceptable investment (in the business world) provided its risk is not too high.

The company’s price-earnings ratio is around 16. This suggests that the market does view this company to have some growth potential.

The dividend yield is on the low side. Thus, this stock would likely be classified as a “growth” stock, and the price-earnings ratio suggests that the market does perceive a high likelihood of some growth.

Exercise 13-13A (10 minutes)

1. A Income (loss) from continuing operations 2. C Extraordinary gain (loss) 3. A Income (loss) from continuing operations 4. A Income (loss) from continuing operations 5. A Income (loss) from continuing operations 6. B Gain (loss) from disposing of a discontinued segment 7. B Income (loss) from operating a discontinued segment 8 A Income (loss) from continuing operations

$31,100

($294,600 + $268,250)/2

$29,375

($268,250 + $242,750)/2




RANDA MERCHANDISING, INC. Income Statement

For Year Ended December 31, 2013

Net sales .......................................................................... $2,900,000

Expenses

Cost of goods sold ...................................................... $1,480,000

Salaries expense ......................................................... 640,000

Depreciation expense ................................................. 232,500

Total expenses ............................................................ 2,352,500

Income from continuing operations before taxes ....... 547,500

Income taxes expense ................................................... 217,000

Income from continuing operations ............................. 330,500

Discontinued segment

Loss from operating wholesale business segment (net of tax) .................................................

(444,000)

Gain on sale of wholesale business segment (net of tax) .................................................

775,000

331,000

Income before extraordinary gain ................................ 661,500

Extraordinary gain on condemnation of company property (net of tax) ....................................

230,000

Net income ...................................................................... $ 891,500




1. Current ratio = (in ¥s) ¥ 1,468,706 / ¥ 333,301 = 4.41

(in $s) $17,695,254 / $4,015,683 = 4.41

Net profit margin = (in ¥s) ¥ 77,621 / ¥ 1,014,345 = 7.65%

(in $s) $935,200 / $12,221,031 = 7.65%

Sales-to-assets = (in ¥s) ¥ 1,014,345 / ¥ 1,634,297 = 0.62

(in $s) $12,221,031 / $19,690,330 = 0.62

2. The results in part 1 reveal that ratios can help us overcome

differences attributable to currencies. However, ratios do not overcome

potential differences in application of accounting principles.



PROBLEM SET A Problem 13-1A (60 minutes) Part 1

Current ratio: December 31, 2014: $52,390 / $22,800 = 2.3 to 1

December 31, 2013: $37,924 / $19,960 = 1.9 to 1

December 31, 2012: $51,748 / $20,300 = 2.5 to 1

Part 2

KORBIN COMPANY Common-Size Comparative Income Statements

For Years Ended December 31, 2014, 2013, and 2012

2014 2013 2012

Sales ............................................................ 100.00% 100.00% 100.00%

Cost of goods sold .................................... 51.08 62.50 55.36

Gross profit ................................................ 48.92 37.50 44.64

Selling expenses ........................................ 18.54 13.80 18.27

Administrative expenses .......................... 9.13 8.80 8.20

Total expenses ........................................... 27.67 22.60 26.47

Income before taxes .................................. 21.25 14.90 18.17

Income taxes .............................................. 7.35 3.05 5.64

Net income ................................................. 13.90% 11.85% 12.53%



Problem 13-1A (Concluded)

Part 3

KORBIN COMPANY Balance Sheet Data in Trend Percents

December 31, 2014, 2013, and 2012

2014 2013 2012

Assets

Current assets .................................. 101.24% 73.29% 100.00%

Long-term investments ................... 0.00 12.66 100.00

Plant assets, net............................... 166.67 160.00 100.00

Total assets ...................................... 131.71 116.19 100.00


Current liabilities.............................. 112.32% 98.33% 100.00%

Common stock ................................. 120.00 120.00 100.00

Other paid-in capital ........................ 150.00 150.00 100.00

Retained earnings ............................ 165.28 113.83 100.00

Total liabilities and equity ............... 131.71 116.19 100.00

Part 4

Significant relations revealed Korbin’s selling expenses and income taxes consumed smaller portions of each sales dollar in 2013 than 2012. However, cost of goods sold and administrative expenses consumed a larger portion in 2013. Therefore, income as a percent of sales declined from 2012 to 2013. In 2014, selling expenses, administrative expenses, and income tax took a greater portion of each sales dollar while the gross profit portion improved. The reduction in cost of goods sold allowed income as a percent of sales to increase from 2013 to 2014 Korbin expanded its plant assets in 2013, financing the expansion through the sale of long-term investments, through a reduction in working capital (the current ratio decreased from 2.5-to-1 to 1.9-to-1), and perhaps through the sale of a small amount of stock. As to the stock increase, it is not possible to tell from these two statements whether the company sold shares or declared a stock dividend. In either case, the increase in retained earnings during 2013 indicates that net income was larger than the reductions from cash (and perhaps stock) dividends. In 2014, working capital increased, the current ratio increased from 1.9-to-1 to 2.3-to-1, and cash dividends were paid.



Problem 13-2A (120 minutes)

Part 1

HAROUN COMPANY Income Statement Trends

For Years Ended December 31, 2014-2008

2014 2013 2012 2011 2010 2009 2008

Sales ..................................... 182.5% 161.2% 147.6% 136.2% 127.8% 119.6% 100.0%

Cost of goods sold .............. 212.6 176.1 153.9 136.9 128.3 121.2 100.0

Gross profit .......................... 131.0 135.7 136.8 135.1 126.9 117.0 100.0

Operating expenses ............ 279.7 216.9 198.3 144.1 123.7 122.0 100.0

Net income ........................... 52.7 92.9 104.5 130.4 128.6 114.3 100.0

HAROUN COMPANY Balance Sheet Trends

December 31, 2014-2008

2014 2013 2012 2011 2010 2009 2008

Cash ...................................... 65.2% 87.6% 92.1% 94.4% 98.9% 96.6% 100.0%

Accounts recble., net .......... 226.9 238.0 215.7 166.7 147.2 139.8 100.0

Merchandise inventory ........ 298.9 221.8 195.8 167.8 152.2 131.7 100.0

Other current assets ............ 400.0 355.6 155.6 377.8 311.1 311.1 100.0

Long-term investments ....... — — — 100.0 100.0 100.0 100.0

Plant assets, net .................. 278.6 277.8 241.7 130.2 134.9 118.6 100.0

Total assets .......................... 246.8 222.3 195.4 144.4 138.6 124.0 100.0

Current liabilities ................. 432.6 369.5 254.6 217.7 193.6 185.1 100.0

Long-term liabilities ............. 323.5 285.0 278.0 142.5 145.0 155.0 100.0

Common stock ..................... 153.8 153.8 153.8 130.8 130.8 100.0 100.0

Other paid-in capital ............ 166.7 166.7 166.7 113.3 113.3 100.0 100.0

Retained earnings................ 213.2 179.2 137.7 124.5 109.4 91.2 100.0

Total liabilities & equity ....... 246.8 222.3 195.4 144.4 138.6 124.0 100.0



Problem 13-2A (concluded)

Part 2

Analysis and Interpretation

The statements and the trend percent data indicate that the company

significantly expanded its plant assets in 2012. Prior to that time, the

company enjoyed increasing gross profit and net income.

Sales grew steadily for the entire period of 2008 to 2014. However,

beginning in 2012, cost of goods sold and operating expenses increased

dramatically relative to sales, resulting in a significant reduction in net

income.

In 2014, net income was only 52.7% of the 2008 base year amount.

At the same time that net income was declining, assets were increasing.

This indicates that Haroun was becoming less efficient in using its

assets to generate income.

The short-term liquidity of the company continued to decline. Accounts

receivable did not change significantly for the period of 2012 to 2014,

but cash steadily declined and inventory sharply increased as did

current liabilities.




Trans-action

Current Assets

Quick Assets

Current Liabilities

Current Ratio

Acid-Test Ratio

Working Capital

Beginning* $700,000 $308,000 $280,000 2.50 1.10 $420,000

May 2 + 50,000 _______ + 50,000 ____ ____ _______

Bal. 750,000 308,000 330,000 2.27 0.93 420,000

May 8 +110,000 +110,000

- 55,000 _______ _______ ____ ____ _______

Bal. 805,000 418,000 330,000 2.44 1.27 475,000

May 10 + 20,000 + 20,000

- 20,000 - 20,000 _______ ____ ____ _______

Bal. 805,000 418,000 330,000 2.44 1.27 475,000

May 15 - 22,000 - 22,000 - 22,000 ____ ____ _______

Bal. 783,000 396,000 308,000 2.54 1.29 475,000

May 17 +0 +0 _______ ____ ____ _______

Bal. 783,000 396,000 308,000 2.54 1.29 475,000

May 22 _______ _______ + 50,000 ____ ____ _______

Bal. 783,000 396,000 358,000 2.19 1.11 425,000

May 26 - 50,000 - 50,000 - 50,000 ____ ____ _______

Bal. 733,000 346,000 308,000 2.38 1.12 425,000

May 27 +100,000 +100,000 +100,000 ____ ____ _______

Bal. 833,000 446,000 408,000 2.04 1.09 425,000

May 28 + 80,000 + 80,000 ________ ____ ____ _______

Bal. 913,000 526,000 408,000 2.24 1.29 505,000

May 29 - 180,000 - 180,000 ________ ____ ____ _______

Bal. $733,000 $346,000 $408,000 1.80 0.85 $325,000

*Beginning balances Current assets (given) ............................................ $700,000 Current liabilities ($700,000 / 2.50) ........................ 280,000 Quick assets ($280,000 x 1.10) ............................... 308,000



Problem 13-4A (50 minutes) 1. Current ratio = 3.6 to 1

2. Acid-test ratio = 2.2 to 1

3. Days' sales uncollected x 365 = 27.4 days

4. Inventory turnover = 7.3 times

5. Days’ sales in inventory x 365 = 39.5 days

6. Debt-to-equity ratio ($17,500 + $3,200 + $3,300 + $63,400) / ($90,000 + $62,800) = 0.57 to 1

7. Times interest earned ($151,350 - $98,600) / $4,100 = 12.9 times

8. Profit margin ratio = 6.5%

$10,000 + 8,400 + $29,200 + $4,500 + $32,150 + $2,650

$17,500 + $3,200 + $3,300

$10,000 + $8,400 + $29,200 + $4,500

$17,500 + $3,200 + $3,300

$29,200 + $4,500

$448,600

$297,250

($48,900 + $32,150)/2

$32,150

$297,250

$29,052

$448,600



Problem 13-4A (Concluded) 9. Total asset turnover = 2.1 times 10. Return on total assets = 13.5% 11. Return on common stockholders' equity = 21.9%

$448,600

($240,200 + $189,400)/2

$29,052

($240,200 + $189,400)/2

$29,052

($152,800 + $112,748)/2




Part 1

Barco Company Kyan Company

a. Current ratio

= 2.5 to 1

= 2.6 to 1

* $19,500 + $37,400 + $9,100 + $84,440 + $5,000 = $155,440 **$34,000 + $57,400 + $7,200 + $132,500 + $6,950 = $238,050

b. Acid-test ratio

= 1.1 to 1

= 1.1 to 1

* $19,500 + $37,400 +$9,100 = $66,000 **$34,000 + $57,400 + $ 7,200 = $98,600

c. Accounts receivable turnover

= 20.2 times = 14.8 times

d. Inventory turnover = 8.4 times = 5.3 times

e. Days’ sales in inventory x 365 = 52.7 days x 365 = 76.5 days

f. Days' sales uncollected x 365 = 22.0 days x 365 = 26.8 days

Short-term credit risk analysis: Barco and Kyan have essentially equal current ratios and equal acid-test ratios. However, Barco both turns its merchandise and collects its accounts receivable more rapidly than does Kyan. On this basis, Barco probably is the better short-term credit risk.

$770,000

($37,400 + $9,100 + $29,800)/2

$585,100

($84,440 + $55,600)/2

$84,440

$585,100

$37,400 + $9,100

$770,000

$880,200

($57,400 + $7,200 + $54,200)/2

$155,440*

$61,340

$66,000*

$61,340

$238,050**

$93,300

$98,600**

$93,300

$632,500

($132,500 + $107,400)/2

$132,500

$632,500

$57,400 + $7,200

$880,200



Problem 13-5A (Concluded)

Part 2

Barco Company Kyan Company

a. Profit margin ratio = 21.1% = 23.9%

b. Total asset turnover = 1.8 times = 1.9 times

c. Return on total assets = 38.5% = 45.5%

d. Return on common stockholders' equity

= 55.8% = 65.0%

e. Price-earnings ratio = 16.6 = 14.7

f. Dividend yield = 5.1% = 5.1%

Investment analysis: Kyan's profit margin ratio, total asset turnover, return on total assets, and return on common stockholders' equity are all higher than Barco’s. Although the companies pay the same dividend, Kyan's price-earnings ratio is lower. All of these factors suggest that Kyan's stock is likely the better investment.

$162,200

$770,000

$770,000

($445,440 + $398,000)/2

$162,200

($445,440 + $398,000)/2

$162,200

($303,300 + $278,300)/2

$75

$4.51

$3.80

$75

$210,400

$880,200

$880,200

($542,450 + $382,500)/2

$210,400

($542,450 + $382,500)/2

$210,400

($348,150 + $299,600)/2

$75

$5.11

$3.80

$75



Problem 13-6AA (60 minutes)

Part 1

Effect of income taxes (debits or losses in parentheses)

Pretax

30% Tax Effect

After-Tax

i. Loss from operating a discontinued segment .............. (18,250) (5,475) (12,775)

j. Gain on insurance recovery of tornado damage ...... 29,120 8,736 20,384

m. Correction of overstatement of prior year’s sales ........ (16,000) (4,800) (11,200)

n. Gain on sale of discontinued segment’s assets ........... 34,000 10,200 23,800

Part 2 Income from continuing operations (and its components)

k. Net sales .................................................................. $ 998,500

a. Interest revenue ...................................................... 14,000

g. Gain from settling lawsuit ...................................... 44,000

Total revenues and gains ...................................... 1,056,500

q. Cost of goods sold ................................................. $482,500

b. Depreciation expense—Equipment ...................... 34,000

l. Depreciation expense—Buildings ........................ 52,000

e. Other operating expenses ..................................... 106,400

c. Loss on sale of equipment .................................... 25,850

o. Loss from settling lawsuit ..................................... 23,750

Total expenses ........................................................ (724,500)

Income from continuing operations before taxes ..... 332,000

p. Income taxes expense (30%) ................................. (99,600)

Income from continuing operations after taxes ........ $ 232,400



Problem 13-6AA (Concluded) Part 3 Income from discontinued segment

i. Loss from operating a discontinued segment (after-tax) ....................................................................................

$ (12,775)

n. Gain on sale of discontinued segment’s assets (after-tax) .......................................................................................

23,800

Income from discontinued segment .......................................................... $ 11,025

Part 4 Income before extraordinary items

Income from continuing oper. after taxes (from Part 2) ................................ $232,400

Income from discontinued segment (from Part 3) ......................................... 11,025

Income before extraordinary items ............................................................ $221,375

Part 5 Net income

Income before extraordinary items ............................................................ $221,375

j. Extraordinary item

Gain on insurance recovery of tornado damage (after-tax) ..............................................................................................

20,384

Net income .................................................................................................... $241,759



PROBLEM SET B Problem 13-1B (60 minutes) Part 1

Current ratio: December 31, 2014: $54,860 / $22,370 = 2.5 to 1

December 31, 2013: $32,660 / $19,180 = 1.7 to 1

December 31, 2012: $36,300 / $16,500 = 2.2 to 1

Part 2

BLUEGRASS CORPORATION Common-Size Comparative Income Statements

For Years Ended December 31, 2014, 2013, and 2012

2014 2013 2012

Sales ............................................................ 100.00% 100.00% 100.00%

Cost of goods sold .................................... 54.77 51.91 46.04

Gross profit ................................................ 45.23 48.09 53.96

Selling expenses ........................................ 11.41 11.92 12.52

Administrative expenses .......................... 8.43 8.80 10.92

Total expenses ........................................... 19.84 20.72 23.44

Income before taxes .................................. 25.39 27.36 30.53

Income taxes .............................................. 3.04 3.56 3.69

Net income ................................................. 22.34% 23.80% 26.84%

* Some totals do not reconcile due to rounding.



Problem 13-1B (Concluded)

Part 3

BLUEGRASS CORPORATION Balance Sheet Data in Trend Percents

December 31, 2014, 2013, and 2012

2014 2013 2012

Assets

Current assets ............................................ 151.13% 89.97% 100.00%

Long-term investments ............................. 0.00 16.04 100.00

Plant assets ................................................ 142.80 143.87 100.00

Total assets ................................................ 133.18 117.57 100.00


Current liabilities........................................ 135.58% 116.24% 100.00%

Common stock ........................................... 125.68 125.68 100.00

Other paid in capital .................................. 122.57 122.57 100.00

Retained earnings ...................................... 139.03 112.09 100.00

Total liabilities and equity ......................... 133.18 117.57 100.00

Part 4

Significant relations revealed

Bluegrass's cost of goods sold took a larger percent of sales each year.

Selling and administrative expenses and income taxes took a somewhat

smaller portion each year, but not enough to offset the effect of cost of

goods sold. As a result, income became a smaller percent of sales each

year.

The large expansion of plant assets in 2013 was financed by a reduction in

current assets, an increase in current liabilities, a large reduction in long-

term investments, and apparently by a stock sale. One effect of this plan

was to reduce the current ratio. However, the current ratio recovered in

2014. This apparently resulted from profits, limiting the amount of

dividends paid, and the liquidation of long-term investments.



Problem 13-2B (120 minutes)

Part 1

TRIPOLY COMPANY Income Statement Trends

For Years Ended December 31, 2014-2008

2014 2013 2012 2011 2010 2009 2008

Sales ..................................... 65.1% 70.9% 73.3% 79.1% 86.0% 89.5% 100.0%

Cost of goods sold .............. 72.6 76.3 77.4 82.6 89.5 92.1 100.0

Gross profit .......................... 59.2 66.7 70.0 76.3 83.3 87.5 100.0

Operating expenses ............ 56.0 69.3 74.7 84.0 93.3 96.0 100.0

Net income ........................... 60.6 65.5 67.9 72.7 78.8 83.6 100.0

TRIPOLY COMPANY Balance Sheet Trends

December 31, 2014-2008

2014 2013 2012 2011 2010 2009 2008

Cash .................................... 64.7% 67.6% 76.5% 79.4% 88.2% 91.2% 100.0%

Accounts recble., net .......... 81.3 85.0 87.5 90.0 93.8 96.3 100.0

Merchandise inventory ........ 79.8 82.7 85.6 86.5 89.4 91.3 100.0

Other current assets ............ 85.0 85.0 90.0 95.0 95.0 100.0 100.0

Long-term investments ....... 32.7 27.3 23.6 100.0 100.0 100.0 100.0

Plant assets, net .................. 112.3 113.2 114.5 90.7 92.5 94.3 100.0

Total assets .......................... 88.5 89.6 91.5 90.2 92.7 94.6 100.0

Current liabilities ................. 52.9 55.7 66.4 67.9 75.0 92.9 100.0

Long-term liabilities ............. 35.4 46.2 54.6 56.9 74.6 82.3 100.0

Common stock ..................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Other paid-in capital ............ 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Retained earnings................ 166.7 157.8 145.9 137.0 122.2 103.7 100.0

Total liabilities & equity ....... 88.5 89.6 91.5 90.2 92.7 94.6 100.0



Problem 13-2B (Concluded) Part 2

Analysis and Interpretation

The statements and the trend percent data show that sales declined

every year. However, cost of goods sold did not fall as rapidly as sales.

As a result, gross profit fell more rapidly than sales.

Operating expenses fell less rapidly than gross profit, so the final result

was that net income fell to 60.6% of the base year.

Management was not able to reduce costs and expenses fast enough to

keep up with the sales decline.

Although the profits decreased during these years, the company did

continue to earn a net income.

It appears that the cash generated from operations was used primarily

to reduce both current and long-term liabilities.

The company made a large expansion of its plant assets during 2012,

financing this expansion primarily through the liquidation of long-term

investments.




Trans-action

Current Assets

Quick Assets

Current Liabilities

Current Ratio

Acid-Test Ratio

Working Capital

Beginning* $300,000 $168,000 $120,000 2.50 1.40 $180,000

June 1 +120,000 +120,000

- 75,000 _______ ________ ____ ____ _______

Bal. 345,000 288,000 120,000 2.88 2.40 225,000

June 3 + 88,000 + 88,000

- 88,000 - 88,000 ________ ____ ____ _______

Bal. 345,000 288,000 120,000 2.88 2.40 225,000

June 5 +150,000 ________ +150,000 ____ ____ _______

Bal. 495,000 288,000 270,000 1.83 1.07 225,000

June 7 +100,000 +100,000 +100,000 ____ ____ _______

Bal. 595,000 388,000 370,000 1.61 1.05 225,000

June 10 +120,000 +120,000 _______ ____ ____ _______

Bal. 715,000 508,000 370,000 1.93 1.37 345,000

June 12 - 275,000 - 275,000 ________ ____ ____ _______

Bal. 440,000 233,000 370,000 1.19 0.63 70,000

June 15 ________ ________ + 80,000 ____ ____ _______

Bal. 440,000 233,000 450,000 0.98 0.52 (10,000)

June 19 +0 +0 ________ ____ ____ _______

Bal. 440,000 233,000 450,000 0.98 0.52 (10,000)

June 22 - 12,000 - 12,000 - 12,000 ____ ____ _______

Bal. 428,000 221,000 438,000 0.98 0.50 (10,000)

June 30 - 80,000 - 80,000 - 80,000 ____ ____ _______

Bal. $348,000 $141,000 $358,000 0.97 0.39 (10,000)

*Beginning balances Current assets (given) ............................................ $300,000 Current liabilities ($300,000 / 2.50) ......................... 120,000 Quick assets ($120,000 x 1.40) ............................... 168,000




1. Current ratio = 2.5 to 1 2. Acid-test ratio = 1.6 to 1

3. Days' sales uncollected x 365 = 17.5 days

4. Inventory turnover = 15.3 times

5. Days’ sales in inventory x 365 = 20.9 days 6. Debt-to-equity ratio ($11,500 + $3,300 + $2,600 + $30,000) / ($35,000 + $35,100) = 0.68 to 1

7. Times interest earned $30,200 / $2,200 = 13.73 times

8. Profit margin ratio = 7.5%

$6,100 + $6,900 + $12,100 + $3,000 + $13,500 + $2,000

$11,500 + $3,300 + $2,600

$6,100 + $6,900 + $12,100 + $3,000

$11,500 + $3,300 + $2,600

$12,100 + $3,000

$315,500

$236,100

($13,500 + $17,400)/2

$13,500

$236,100

$23,800

$315,500



Problem 13-4B (Concluded) 9. Total asset turnover = 3.0 times 10. Return on total assets = 22.4% 11. Return on common stockholders' equity = 38.3%

$315,500

($117,500 + $94,900)/2

$23,800

($117,500 + $94,900)/2

$23,800

($70,100 + $54,300)/2




Part 1

Fargo Company Ball Company

a. Current ratio

= 2.3 to 1

= 2.1 to 1

b. Acid-test ratio

= 1.2 to 1

= 1.2 to 1

c. Accounts (and notes) receivable turnover

= 4.9 times = 8.7 times

d. Inventory turnover = 3.0 times = 5.9 times

e. Days’ sales in inventory x 365 = 109.0 days x 365 = 62.4 days

f. Days' sales uncollected x 365 = 82.3 days x 365 = 43.5 days

Short-term credit risk analysis: Fargo and Ball have nearly equal current ratios and equal acid-test ratios. However, Ball both turns its merchandise and collects its accounts receivable much more rapidly than Fargo. On this basis, Ball probably is the better short-term credit risk.

$393,600

($77,100 + $11,600 + $72,200)/2

$290,600

($86,800 + $105,100)/2

$86,800

$290,600

$77,100 + $11,600

$393,600

$205,200

$90,500

$108,700

$90,500

$208,100

$97,000

$116,000

$97,000

$480,000

($82,000 + $80,500)/2

$82,000

$480,000

$70,500 + $9,000

$667,500

$667,500

($70,500 + $9,000 + $73,300)/2



Problem 13-5B (Concluded)

Part 2

Fargo Company Ball Company

a. Profit margin ratio = 8.6% = 9.2%

b. Total asset turnover = 1.03 times = 1.48 times

c. Return on total assets = 8.8% = 13.7%

d. Return on common stockholders' equity

= 17.8% = 23.7%

e. Price-earnings ratio = 19.7 = 11.4

f. Dividend yield = 6.0% = 6.0%

Investment analysis: Ball’s profit margin, total asset turnover, return on total assets, and return on common stockholders' equity are all higher than Fargo's. Also, Ball has a lower price-earnings ratio, while paying the same dividend. These factors indicate that Ball stock is likely the better investment.

$33,850

$393,600

$393,600

($382,100 + $383,400)/2

$33,850

($382,100 + $383,400)/2

$33,850

($198,600 + $182,100)/2

$25

$1.27

$1.50

$25

$61,700

$667,500

$667,500

($460,400 + $443,000)/2

$61,700

($460,400 + $443,000)/2

$61,700

($270,100 + $250,700)/2

$25

$2.19

$1.50

$25



Problem 13-6BA (60 minutes)

Part 1 Effect of income taxes (debits or losses in parentheses)

Pretax

25% Tax Effect

After-Tax

e. Loss on hurricane damage ...................................................... (64,000) (16,000) (48,000)

l. Loss from operating a discontinued segment ......................... (120,000) (30,000) (90,000)

n. Correction of overstatement of prior year’s expense ............. 48,000 12,000 36,000

p. Loss on sale of discontinued segment’s assets ..................... (180,000) (45,000) (135,000)

Part 2 Income from continuing operations (and its components)

c. Net sales ......................................................................... $2,640,000

b. Interest revenue ............................................................. 20,000

j. Gain from settling lawsuit ............................................. 68,000

Total revenues and gains ............................................. 2,728,000

o. Cost of goods sold ........................................................ $1,040,000

h. Depreciation expense—Equipment ............................. 100,000

m. Depreciation expense—Buildings ............................... 156,000

g. Other operating expenses ............................................ 328,000

k. Loss on sale of equipment ........................................... 24,000

i. Loss from settling lawsuit ............................................ 36,000

Total expenses and losses ........................................... 1,684,000

Income from continuing operations before taxes ............ 1,044,000

d. Income taxes expense (25%) ........................................ (261,000)

Income from continuing operations after taxes ............... $ 783,000



Problem 13-6BA (Concluded)

Part 3 Income from discontinued segment

l. Loss from operating a discontinued segment (after-tax) .................. $ (90,000)

p. Loss on sale of discontinued segment’s assets (after-tax) .............. (135,000)

Loss from discontinued segment ................................................ $(225,000)

Part 4 Income before extraordinary items

Income from cont. operations after taxes (from Part 2) ................. $ 783,000

Loss from discontinued segment (from Part 3) .............................. (225,000)

Income before extraordinary items ............................................. $ 558,000

Part 5 Net income

Income before extraordinary items ............................................. $ 558,000

Extraordinary item:

e. Loss on hurricane damage (after-tax) ......................................... (48,000)

Net income ..................................................................................... $ 510,000



SERIAL PROBLEM — SP 13 Serial Problem — SP 13, Success Systems (45 minutes) 1. Gross margin with services revenue

Gross margin = Total revenue – Cost of goods sold

= $43,853 - $14,052 = $29,801

Gross margin ratio = $29,801 / $43,853 = 68.0%

Gross margin without services revenue

Gross margin = Net (goods) sales – Cost of goods sold

= $18,693 - $14,052 = $4,641

Gross margin ratio = $4,641 / $18,693 = 24.8%

Profit margin ratio = $18,686 / $43,853 = 42.6% 2. Current ratio = $105,209 / $875 = 120.2 Acid-test ratio = $100,205 / $875 = 114.5 3. Debt ratio = $875 / $129,909 = 0.7% Equity ratio = $129,034/$129,909 = 99.3% 4. Current assets are 81.0% of total assets ($105,209/$129,909)

Long-term assets are 19.0% of total assets ($24,700/$129,909)



Reporting in Action — BTN 13-1

1. Trend percents for selected income statement accounts

($ in thousands) 2011 2010 2009

Revenues .............................................................. 169.7% 127.2% 100.0% $2,656,949 $1,991,139 $1,565,887

Cost of goods sold .............................................. 163.4% 124.6% 100.0% $1,916,366 $1,460,926 $1,172,668

Operating income ................................................ 212.1% 133.8% 100.0% $349,924 $220,721 $164,970

Non-operating expense (income) ....................... 23.9% 15.8% 100.0% $3,298 $2,180 $13,796

Income taxes (provision for income taxes) ....... 237.4% 142.4% 100.0% $119,051 $71,403 $50,157

Net income ............................................................ 225.3% 145.7% 100.0% $227,575 $147,138 $101,017

2. Common-size percents for asset categories and accounts

($ in thousands) 2011 2010

Total current assets ............................................. 71.6% 76.1% $878,676 $808,145

Property and equipment, net .............................. 17.4% 17.3% $213,778 $184,011

Goodwill and other intangible assets ................ 6.3% 2.9% $77,718 $31,313

Total assets for 2011 and 2010 are $1,228,024 and $1,061,647, respectively.

3. For 2011 and 2010, revenues grew at a higher rate than cost of goods sold. Operating income grew at a higher rate than revenues for 2011 and 2010. Non-operating expenses declined substantially in 2011 and 2010. Consequently, income increased for 2011 and 2010, at a higher rate than revenue growth.

The common-size percent figures in part 2 show a shift away from current assets (71.6% in 2011 vs. 76.1% in 2010) and greater investment in goodwill and other intangible assets (6.3% in 2011 vs. 2.9% in 2010). Intangible assets show flat to slightly increased investment (17.4% in 2011 vs. 17.3% in 2010).

4. Answers depend on the financial statement information obtained.



Comparative Analysis — BTN 13-2 1.

Key figures ($ thousands) Polaris Arctic Cat

Cash and equivalents ............. 26.5% $325,336 5.4% $14,700

Accounts receivable, net ....... 9.4% 115,302 8.7% 23,732

Inventories .............................. 24.3% 298,042 22.5% 61,478

Retained earnings .................. 26.2% 321,831 65.0% 177,493

Cost of sales ........................... 72.1% 1,916,366 78.2% 363,142

Revenues ................................. 100.0% 2,656,949 100.0% 464,651

Total assets ............................. 100.0% 1,228,024 100.0% 272,906

2. Arctic Cat’s retained earnings make up a much greater percentage of its total liabilities and equity (65.0%) vis-à-vis Polaris (26.2%).

3. Arctic Cat’s cost of sales percent is slightly higher at 78.2% compared to Polaris’s at 72.1%.

This implies that Arctic Cat has the lower gross margin ratio on sales of 21.8%), while Polaris has the higher gross margin ratio at 27.9%.

4. Polaris has the higher percent of total assets in the form of inventory at 24.3%, compared to Arctic Cat’s 22.5%.



Ethics Challenge — BTN 13-3 1. The CEO appears to have selectively chosen from the 11 available

ratios to present only the ones that show trends that are favorable to

the company. (However, some analysts may not interpret a decline in

selling expenses as a percent of revenue as positive since it might

imply a scaling back on advertising or promotion campaigns.) The

CEO’s motivation might be to make her performance, or the company’s,

or both, appear better than it is in the eyes of the analysts.

2. The consequences of this action by the CEO might be mixed. It is likely

that the analysts will ask other questions that may reveal some

negative trends such as the trends in return and profit margins. The

CEO’s actions may become transparent to the analysts as they

discover the presence of less favorable trends through their questions.

If discovered, such a disclosure ploy by the CEO will not reflect

favorably on the company. Both the CEO and the company are likely to

suffer losses in reputation and credibility.

Even if the CEO is able to succeed with this strategy in the short term,

once the financial statements are issued all users can compile

additional ratio information and see that some of the trends are

unfavorable to the company. This is likely to damage the credibility of

the CEO.

Communicating in Practice — BTN 13-4

There is no set solution to this activity. Each team’s memorandum will

vary based on the industry and companies chosen for analysis.

(Instructor: Consider having each team do a brief presentation discussing

the findings in their memorandum to engage in a classroom discussion of

the findings.)



Taking It to the Net — BTN 13-5

($ thousands) As of 12/31/2010 As of 12/31/2011

1. Profit margin ratio ................. $509,799/$5,671,009 = 9.0% $628,962/$6,080,788 = 10.3%

2. Gross profit ratio .................. $2,415,208/ $5,671,009 = 42.6% $2,531,892/$6,080,788 = 41.6%

3. Return on total assets ...................................

$509,799 / ([$4,272,732 + $3,675,031]/2) = 12.8%

$628,962/ ([$4,412,199 + $4,272,732]/2) = 14.5%

4. Return on common stockholders’ equity* ............

$509,799 / ([$937,601 + $760,339]/2) = 60.0%

$628,962/ ([$872,648 + $937,601]/2) = 69.5%

5. Basic net income per common share** ...................

$ 2.29

$ 2.85

*An acceptable alternative solution would be to include minority interest in equity. **Taken from consolidated statement of income.

Analysis and Interpretation: Hershey’s performance generally improved in all areas evaluated for the profitability metrics reported in the table above.

Teamwork in Action — BTN 13-6

Part 1

Team reports should look something like the following: Horizontal Analysis Horizontal analysis is comparing a company’s financial statement amounts across time. We compare data from comparative statements that are horizontally aligned; that is, we compare the same items from one period to another period. The change disclosed by the comparison is generally expressed as a dollar amount and/or as a percent. For instance, we compare sales of one period to sales of another and determine the dollar amount of the increase or decrease.

We also determine the percent of increase or decrease in sales that this change represents. This type of comparison is generally completed on a line-by-line basis for both income statement and balance sheet items (and sometimes for other financial statements). Example: Assume that prior year sales equal $240,000, and current year sales equal $300,000. Horizontal analysis of sales yields a $60,000 increase or a 25% increase in sales. (Computation is defined as:

Amount of change / Base year [or $60,000/$240,000].)



Teamwork in Action (Concluded) If a horizontal comparison is made over a number of periods, the comparisons are made to corresponding amounts in a selected period called the base period. Each subsequent period’s amount is compared to the base period. The change is expressed as a percent of the base period. This is commonly referred to as trend analysis. Vertical Analysis Vertical analysis is comparing a company's financial statement amounts to a base amount. Usually this base amount is a total or aggregate amount. An income statement's base is usually total revenue and a balance sheet's base is usually total assets. We analyze what percent of the total (or base) the individual statement items represent. Example: Total assets for the period being analyzed = $500,000 (base number). Cash balance is $100,000. Cash is computed to be 20% of total assets. (Computation is defined as: Individual amount / Aggregate amount [or $100,000/$500,000].) Part 2

Explanations of the four categories or areas of ratio analysis follow:

a. Liquidity analysis measures the availability of resources to meet short-term cash requirements. Efficiency analysis measures how productive a company is in using its assets.

b. Solvency analysis measures a company's long-run financial viability and its ability to cover long-term obligations.

c. Profitability analysis measures a company's ability to generate an adequate return on invested capital.

d. Market analysis measures the company’s returns (for example, EPS and dividend) relative to its market price.

Note: Students will select various ratios to illustrate these categories. Use Exhibit 13.16 to verify the category, measurement, and use of each ratio.

Part 3

Each team member presents results to the entire team.



Entrepreneurial Decision — BTN 13-7 1. No. Although the current ratio improved over the three-year period, the

acid-test ratio declined and accounts receivable and merchandise inventory turned more slowly. These conditions indicate that an increasing portion of the current assets consisted of accounts receivable and inventories from which current liabilities could not be paid.

2. No. The decreasing turnover of accounts receivable indicates the company is collecting its receivables more slowly.

3. No. Sales are increasing and accounts receivable are turning more slowly. Either or both of these trends would produce an increase in accounts receivable, even if the other remained unchanged.

4. Yes. To illustrate, if sales are assumed to equal $100 in 2010, the sales trend shows that they would equal $125 in 2011 and $137 in 2012. Then, dividing each sales figure by its ratio of sales to plant assets would give $33.33 for plant assets in 2010 ($100/ 3.0), $37.88 in 2011 ($125/ 3.3) and $39.14 in 2012 ($137/ 3.5).

5. No. The percent of return on equity declines from 12.25% in 2010 to 9.75% in 2012.

6. The dollar amount of selling expenses increased in 2011 and decreased sharply in 2012. Again assuming sales figures of $100 in 2010, $125 in 2011, and $137 in 2012, and multiplying each by its selling expense to net sales ratio gives $15.30 of selling expenses in 2010, $17.13 in 2011, and $13.43 in 2012.

Hitting the Road — BTN 13-8 One possible strategy to fulfill the requirements of this assignment is: Assume that a $37,500 salary will be earned upon graduation at age 25. Also, assume that the level of investment will be at 8% of your salary (or $3,000 annually) starting at age 25. By starting at age 25 there will be 40 annual compounding periods until age 65.

If the annual amount invested does not change and you earn 10% for 40 years, then the investment will grow to $1,327,779 ($3,000 x 442.593 from Table B.4) at age 65. The $1,000,000 goal can also be reached at age 65 if the investment earns 9% ($3,000 x 337.882 = $1,013,646).



Global Decision — BTN 13-9

Key figures (Euro in thousands) KTM

Cash and equivalents ........................................ 3.1% $ 14,962

Accounts receivable, net ................................... 11.0% 53,594

Inventories .......................................................... 23.5% 113,979

Retained earnings .............................................. 43.0% 208,987

Cost of sales ....................................................... 70.6% 371,752

Revenues ............................................................ 100.0% 526,801

Total assets ........................................................ 100.0% 485,775

Comparisons and comments:

KTM’s cash and equivalents is less than that of Polaris and Arctic Cat as

a percent of assets.

KTM has the highest percentage of accounts receivable as a percentage

of total assets as compared to both Polaris and Arctic Cat.

KTM’s retained earnings make up a smaller percentage of its total

financing (liabilities and equity) compared to that of Arctic Cat.

Conversely, KTM’s retained earnings make up a larger percentage of its

total financing (liabilities and equity) compared to Polaris.

KTM’s cost of sales is lower than either of the other two companies.

finman 5e chapter 13 sm

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