chapter 17 - financial accounting

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CHAPTER 17 FINANCIAL STATEMENT ANALYSIS

DISCUSSION QUESTIONS

1. Horizontal analysis is the percentage analy-sis of increases and decreases in corre-sponding statements. The percent change in the cash balances at the end of the pre-ceding year from the end of the current year is an example. Vertical analysis is the percentage analysis showing the relation-ship of the component parts to the total in a single statement. The percent of cash as a portion of total assets at the end of the current year is an example.

2. Comparative statements provide information as to changes between dates or periods. Trends indicated by comparisons may be far more significant than the data for a single date or period.

3. Before this question can be answered, the increase in net income should be compared with changes in sales, expenses, and assets devoted to the business for the current year. The return on assets for both periods should also be compared. If these comparisons indicate favorable trends, the operating per-formance has improved; if not, the apparent favorable increase in net income may be off-set by unfavorable trends in other areas.

4. Generally, the two ratios would be very close, because most service businesses sell services and hold very little inventory.

5. a. A high inventory turnover minimizes the amount invested in inventories, thus freeing funds for more advantageous use. Storage costs, administrative ex-penses, and losses caused by obsoles-cence and adverse changes in prices are also kept to a minimum.

b. Yes. The inventory turnover could be high because the quantity of inventory on hand is very low. This condition might result in the lack of sufficient goods on hand to meet sales orders.

c. Yes. The inventory turnover relates to the “turnover” of inventory during the year, while the number of days’ sales in inventory relates to the amount of inven-tory on hand at the beginning and end of the year. Therefore, a business could

have a high inventory turnover during the year, yet have a high number of days’ sales in inventory based on the beginning and end-of-year inventory amounts.

6. The ratio of fixed assets to long-term liabili-ties increased from 4.0 for the preceding year to 5.0 for the current year, indicating that the company is in a stronger position now than in the preceding year to borrow additional funds on a long-term basis.

7. a. The rate earned on total assets adds interest expense to the net income, which is divided by average total assets. It measures the profitability of total as-sets, without regard for how the assets are financed. The rate earned on stock-holders’ equity divides net income by average total stockholders’ equity. It measures the profitability of the stock-holders’ investment.

b. The rate earned on stockholders’ equity is normally higher than the rate earned on total assets. This is because of lev-erage, which compensates stockholders for the higher risk of their investments.

8. a. Due to leverage, the rate on stockhold-ers’ equity will often be greater than the rate on total assets. This occurs be-cause the amount earned on assets ac-quired through the use of funds provided by creditors exceeds the interest charges paid to creditors.

b. Higher. The concept of leverage applies to preferred stock as well as debt. The rate earned on common stockholders’ equity ordinarily exceeds the rate earned on total stockholders’ equity be-cause the amount earned on assets ac-quired through the use of funds provided by preferred stockholders normally ex-ceeds the dividends paid to preferred stockholders.

9. The earnings per share in the preceding year were $50 per share ($100/2), adjusted for the stock split in the latest year.



10. One report is the Report on Internal Control, which verifies management’s conclusions on internal control. Another report is the Report on Fairness of the Financial Statements,

where the Certified Public Accounting (CPA) firm that conducts the audit renders an opin-ion on the fairness of the statements.



PRACTICE EXERCISES

PE 17–1A

Accounts payable $14,000 increase ($114,000 – $100,000), or 14% Long-term debt $13,000 increase ($143,000 – $130,000), or 10%

PE 17–1B

Temporary investments $21,600 decrease ($218,400 – $240,000), or –9% Inventory $14,200 decrease ($269,800 – $284,000), or –5%

PE 17–2A

Amount Percentage Sales $680,000 100% ($680,000 ÷ $680,000) Gross profit 231,200 34 ($231,200 ÷ $680,000) Net income 74,800 11 ($74,800 ÷ $680,000)

PE 17–2B

Amount Percentage Sales $ 1,400,000 100% ($1,400,000 ÷ $1,400,000) Cost of goods sold 910,000 65 ($910,000 ÷ $1,400,000) Gross profit $ 490,000 35% ($490,000 ÷ $1,400,000)

PE 17–3A

a. Current Ratio = Current Assets ÷ Current Liabilities Current Ratio = ($200,000 + $100,000 + $60,000 + $100,000) ÷ $200,000 Current Ratio = 2.3

b. Quick Ratio = Quick Assets ÷ Current Liabilities Quick Ratio = ($200,000 + $100,000 + $60,000) ÷ $200,000 Quick Ratio = 1.8



PE 17–3B

a. Current Ratio = Current Assets ÷ Current Liabilities Current Ratio = ($250,000 + $180,000 + $220,000 + $200,000) ÷ $500,000 Current Ratio = 1.7

b. Quick Ratio = Quick Assets ÷ Current Liabilities Quick Ratio = ($250,000 + $180,000 + $220,000) ÷ $500,000 Quick Ratio = 1.3

PE 17–4A

a. Accounts Receivable Turnover = Net Sales ÷ Average Accounts Receivable Accounts Receivable Turnover = $1,600,000 ÷ $100,000 Accounts Receivable Turnover = 16.0

b. Number of Days’ Sales in Receivables = Average Accounts Receivable ÷ Average Daily Sales

Number of Days’ Sales in Receivables = $100,000 ÷ ($1,600,000 ÷ 365) = $100,000 ÷ $4,384 Number of Days’ Sales in Receivables = 22.8 days

PE 17–4B

a. Accounts Receivable Turnover = Net Sales ÷ Average Accounts Receivable Accounts Receivable Turnover = $700,000 ÷ $50,000 Accounts Receivable Turnover = 14.0

b. Number of Days’ Sales in Receivables = Average Accounts Receivable ÷ Average Daily Sales

Number of Days’ Sales in Receivables = $50,000 ÷ ($700,000 ÷ 365) = $50,000 ÷ $1,918

Number of Days’ Sales in Receivables = 26.1 days



PE 17–5A

a. Inventory Turnover = Cost of Goods Sold ÷ Average Inventory Inventory Turnover = $880,000 ÷ $110,000 Inventory Turnover = 8.0

b. Number of Days’ Sales in Inventory = Average Inventory ÷ Average Daily Cost of Goods Sold

Number of Days’ Sales in Inventory = $110,000 ÷ ($880,000 ÷ 365) = $110,000 ÷ $2,411 Number of Days’ Sales in Inventory = 45.6 days

PE 17–5B

a. Inventory Turnover = Cost of Goods Sold ÷ Average Inventory Inventory Turnover = $360,000 ÷ $50,000 Inventory Turnover = 7.2

b. Number of Days’ Sales in Inventory = Average Inventory ÷ Average Daily Cost of Goods Sold

Number of Days’ Sales in Inventory = $50,000 ÷ ($360,000 ÷ 365) = $50,000 ÷ $986 Number of Days’ Sales in Inventory = 50.7 days

PE 17–6A

a. Ratio of Fixed Assets to Long-Term Liabilities = Fixed Assets ÷ Long-Term Liabilities Ratio of Fixed Assets to Long-Term Liabilities = $836,000 ÷ $380,000 Ratio of Fixed Assets to Long-Term Liabilities = 2.2

b. Ratio of Liabilities to Stockholders’ Equity = Total Liabilities ÷ Total Stockholders’ Equity Ratio of Liabilities to Stockholders’ Equity = $550,000 ÷ $500,000 Ratio of Liabilities to Stockholders’ Equity = 1.1



PE 17–6B

a. Ratio of Fixed Assets to Long-Term Liabilities = Fixed Assets ÷ Long-Term Liabilities Ratio of Fixed Assets to Long-Term Liabilities = $1,000,000 ÷ $625,000 Ratio of Fixed Assets to Long-Term Liabilities = 1.6

b. Ratio of Liabilities to Stockholders’ Equity = Total Liabilities ÷ Total Stockholders’ Equity Ratio of Liabilities to Stockholders’ Equity = $840,000 ÷ $600,000 Ratio of Liabilities to Stockholders’ Equity = 1.4

PE 17–7A

Number of Times Interest Charges Are Earned = (Income Before Income Tax + Interest Expense) ÷ Interest Expense Number of Times Interest Charges Are Earned = ($4,000,000 + $500,000) ÷

$500,000 Number of Times Interest Charges Are Earned = 9.0

PE 17–7B

Number of Times Interest Charges Are Earned = (Income Before Income Tax + Interest Expense) ÷ Interest Expense Number of Times Interest Charges Are Earned = ($10,000,000 + $800,000) ÷ $800,000 Number of Times Interest Charges Are Earned = 13.5

PE 17–8A

Ratio of Net Sales to Assets = Net Sales ÷ Average Total Assets Ratio of Net Sales to Assets = $1,200,000 ÷ $750,000 Ratio of Net Sales to Assets = 1.6



PE 17–8B

Ratio of Net Sales to Assets = Net Sales ÷ Average Total Assets Ratio of Net Sales to Assets = $3,500,000 ÷ $2,500,000 Ratio of Net Sales to Assets = 1.4

PE 17–9A

Rate Earned on Total Assets = (Net Income + Interest Expense) ÷ Average Total Assets

Rate Earned on Total Assets = ($820,000 + $80,000) ÷ $5,000,000 Rate Earned on Total Assets = $900,000 ÷ $5,000,000 Rate Earned on Total Assets = 18.0%

PE 17–9B

Rate Earned on Total Assets = (Net Income + Interest Expense) ÷ Average Total Assets

Rate Earned on Total Assets = ($700,000 + $50,000) ÷ $4,687,500 Rate Earned on Total Assets = $750,000 ÷ $4,687,500 Rate Earned on Total Assets = 16.0%

PE 17–10A

a. Rate Earned on Stockholders’ Equity = Net Income ÷ Average Stockholders’ Equity

Rate Earned on Stockholders’ Equity = $210,000 ÷ $1,750,000 Rate Earned on Stockholders’ Equity = 12.0%

b. Rate Earned on Common Stockholders’ Equity = (Net Income – Preferred Div-idends) ÷ Average Common Stockholders’ Equity

Rate Earned on Common Stockholders’ Equity = ($210,000 – $30,000) ÷ $1,000,000

Rate Earned on Common Stockholders’ Equity = 18.0%



PE 17–10B

a. Rate Earned on Stockholders’ Equity = Net Income ÷ Average Stockholders’ Equity

Rate Earned on Stockholders’ Equity = $600,000 ÷ $6,000,000 Rate Earned on Stockholders’ Equity = 10.0%

b. Rate Earned on Common Stockholders’ Equity = (Net Income – Preferred Div-idends) ÷ Average Common Stockholders’ Equity

Rate Earned on Common Stockholders’ Equity = ($600,000 – $50,000) ÷ $5,000,000

Rate Earned on Common Stockholders’ Equity = 11.0%

PE 17–11A

a. Earnings per Share on Common Stock = (Net Income – Preferred Dividends) ÷ Shares of Common Stock Out-standing

Earnings per Share = ($440,000 – $40,000) ÷ 50,000 Earnings per Share = $8.00

b. Price-Earnings Ratio = Market Price per Share of Common Stock ÷ Earnings per Share on Common Stock

Price-Earnings Ratio = $100.00 ÷ $8.00 Price-Earnings Ratio = 12.5

PE 17–11B

a. Earnings per Share on Common Stock = (Net Income – Preferred Dividends) ÷ Shares of Common Stock Out-standing

Earnings per Share = ($650,000 – $50,000) ÷ 120,000 Earnings per Share = $5.00

b. Price-Earnings Ratio = Market Price per Share of Common Stock ÷ Earnings per Share on Common Stock

Price-Earnings Ratio = $75.00 ÷ $5.00 Price-Earnings Ratio = 15.0



EXERCISES

Ex. 17–1

a. MANDELL TECHNOLOGIES CO. Comparative Income Statement

For the Years Ended December 31, 2012 and 2011

2012 2011 Amount Percent Amount Percent

Sales ..................................... $800,000 100.0% $740,000 100.0% Cost of goods sold .............. 504,000 63.0 407,000 55.0 Gross profit .......................... $296,000 37.0% $333,000 45.0% Selling expenses ................. $120,000 15.0% $140,600 19.0% Administrative expenses .... 128,000 16.0 125,800 17.0

Total expenses..................... $248,000 31.0% $266,400 36.0% Income from operations...... $ 48,000 6.0% $ 66,600 9.0% Income tax expense ............ 33,600 4.2 48,100 6.5 Net income ........................... $ 14,400 1.8% $ 18,500 2.5%

b. The vertical analysis indicates that the cost of goods sold as a percent of sales increased by 8 percentage points (63.0% – 55.0%), while selling ex-penses decreased by 4 percentage points (15.0% – 19.0%), administrative ex-penses decreased by 1.0% (16.0% – 17.0%), and income tax expense de-creased by 2.3 percentage points (4.2% – 6.5%). Thus, net income as a per-cent of sales dropped by 0.7% (4.0% + 1.0% + 2.3% – 8.0%).



Ex. 17–2

a. SPEEDWAY MOTORSPORTS, INC.

Comparative Income Statement (in thousands of dollars) For the Years Ended December 31, 2008 and 2007

2008 2007

Revenues: Admissions............................... $188,036 30.8% $179,765 32.0% Event-related revenue.............. 211,630 34.6 197,321 35.1 NASCAR broadcasting revenue ................................ 168,159 27.5 142,517 25.4 Other operating revenue.......... 43,168 7.1 42,030 7.5 Total revenue ...................... $610,993 100.0% $561,633 100.0% Expenses and other: Direct expense of events ......... $113,477 18.6% $100,414 17.9% NASCAR purse and sanction fees....................... 118,766 19.4 100,608 17.9 Other direct expenses.............. 116,376 19.0 163,222 29.1 General and administrative ..... 84,029 13.8 80,913 14.4 Total expenses and other... $432,648 70.8% $445,157 79.3% Income from continuing operations................................. $178,345 29.2% $116,476 20.7% b. While overall revenue increased some between the two years, the overall mix

of revenue sources did change somewhat. The NASCAR broadcasting reve-nue increased as a percent of total revenue by almost two percentage points, while the percent of admissions revenue to total revenue decreased by about 1%. Two of the major expense categories (direct expense of events and NASCAR purse and sanction fees) as a percent of total revenue increased by approximately 2 percentage points. Other direct expenses, however, decreased by about 10%, and general and administrative expenses decreased by almost 1%. Overall, the income from continuing operations increased 8.5 percentage points of total revenue between the two years, which is a favor-able trend. The income from continuing operations as a percent of sales exceeds 29% in the most recent year, which is excellent. Apparently, owning and operating motor speedways is a business that produces high operating profit margins.

Note to Instructors: The high operating margin is probably necessary to com-

pensate for the extensive investment in speedway assets.



Ex. 17–3

a. SHOESMITH ELECTRONICS COMPANY

Common-Sized Income Statement For the Year Ended December 31, 20—

Shoesmith Electronics Electronics Industry Company Average Amount Percent

Sales .......................................................... $4,200,000 105.0% 105.0% Sales returns and allowances ................. 200,000 5.0 5.0 Net sales.................................................... $4,000,000 100.0% 100.0% Cost of goods sold ................................... 2,120,000 53.0 59.0 Gross profit ............................................... $1,880,000 47.0% 41.0% Selling expenses ...................................... $1,160,000 29.0% 24.0% Administrative expenses ......................... 480,000 12.0 10.5 Total operating expenses ........................ $1,640,000 41.0% 34.5% Operating income ..................................... $ 240,000 6.0% 6.5% Other income ............................................ 84,000 2.1 2.1 $ 324,000 8.1% 8.6% Other expense........................................... 60,000 1.5 1.5 Income before income tax ....................... $ 264,000 6.6% 7.1% Income expense........................................ 120,000 3.0 6.0 Net income ................................................ $ 144,000 3.6% 1.1%

b. The cost of goods sold is 6 percentage points lower than the industry aver-

age, but the selling expenses and administrative expenses are 5 percentage points and 1.5 percentage points higher than the industry average. The com-bined impact is for net income as a percent of sales to be 2.5 percentage points better than the industry average. Apparently, the company is managing the cost of manufacturing product better than the industry but has slightly higher selling and administrative expenses relative to the industry. The cause of the higher selling and administrative expenses as a percent of sales, rela-tive to the industry, can be investigated further.



Ex. 17–4

BRYANT COMPANY Comparative Balance Sheet December 31, 2012 and 2011


Current assets ............................. $ 775,000 31.0% $ 585,000 26.0% Property, plant, and equipment.. 1,425,000 57.0 1,597,500 71.0 Intangible assets ......................... 300,000 12.0 67,500 3.0 Total assets ................................. $ 2,500,000 100.0% $ 2,250,000 100.0%

Current liabilities......................... $ 525,000 21.0% $ 360,000 16.0% Long-term liabilities .................... 900,000 36.0 855,000 38.0 Common stock ............................ 250,000 10.0 270,000 12.0 Retained earnings ....................... 825,000 33.0 765,000 34.0 Total liabilities and stockholders’ equity .............. $ 2,500,000 100.0% $ 2,250,000 100.0%

Ex. 17–5

a. BOONE COMPANY Comparative Income Statement

For the Years Ended December 31, 2012 and 2011

2012 2011 Increase (Decrease) Amount Amount Amount Percent

Sales ..................................... $446,400 $360,000 $ 86,400 24.0% Cost of goods sold .............. 387,450 315,000 72,450 23.0 Gross profit .......................... $ 58,950 $ 45,000 $ 13,950 31.0 Selling expenses ................. $ 27,900 $ 22,500 $ 5,400 24.0 Administrative expenses .... 21,960 18,000 3,960 22.0 Total operating expenses ... $ 49,860 $ 40,500 $ 9,360 23.1 Income before income tax .. $ 9,090 $ 4,500 $ 4,590 102.0 Income tax expense ............ 5,400 2,700 2,700 100.0 Net income ........................... $ 3,690 $ 1,800 $ 1,890 105.0

b. The net income for Boone Company increased by approximately 105.0% from 2011 to 2012. This increase was the combined result of an increase in sales of 24.0% and lower percentage increases in operating expenses. The cost of goods sold increased at a slower rate than the increase in sales, thus causing the percentage increase in gross profit to exceed the percentage increase in sales.



Ex. 17–6

a. (1) Working Capital = Current Assets – Current Liabilities 2012: $1,342,000 = $1,952,000 – $610,000 2011: $810,000 = $1,350,000 – $540,000

(2) Current Ratio = sLiabilitie Current AssetsCurrent

2012: $610,000

$1,952,000 = 3.2 2011: $540,000

$1,350,000 = 2.5

(3) Quick Ratio = sLiabilitie Current

AssetsQuick

2012: $610,000

$1,220,000 = 2.0 2011: $540,000$918,000 = 1.7

b. The liquidity of Beatty has improved from the preceding year to the current year. The working capital, current ratio, and quick ratio have all increased. Most of these changes are the result of an increase in current assets.

Ex. 17–7

a. (1) Current Ratio = sLiabilitie Current AssetsCurrent

Dec. 26, 2009: $8,756$12,571 = 1.4 Dec. 27, 2008:

,7878$806,10$ = 1.2

(2) Quick Ratio = sLiabilitie Current

AssetsQuick

Dec. 26, 2009: $8,756$8,759 = 1.0 Dec. 27, 2008:

,7878$,9606$ = 0.8

b. The liquidity of PepsiCo has increased some over this time period. Both the

current and quick ratios have increased. The current ratio increased from 1.2 to 1.4, and the quick ratio increased from 0.8 to 1.0. PepsiCo is a strong com-pany with ample resources for meeting short-term obligations.



Ex. 17–8

a. The working capital, current ratio, and quick ratio are calculated incorrectly. The working capital and current ratio incorrectly include intangible assets and property, plant, and equipment as a part of current assets. Both are non-current. The quick ratio has both an incorrect numerator and denominator. The numerator of the quick ratio is incorrectly calculated as the sum of inven-tories, prepaid expenses, and property, plant, and equipment ($114,400 + $45,600 + $172,000). The denominator is also incorrect, as it does not include accrued liabilities. The denominator of the quick ratio should be total current liabilities.

The correct calculations are as follows: Working Capital = Current Assets – Current Liabilities $160,000 = $960,000 – $800,000

Current Ratio = sLiabilitie Current AssetsCurrent

$800,000$960,000 = 1.2

Quick Ratio = sLiabilitie Current

AssetsQuick

$800,000

$353,600 + $144,000 + $302,400 = 1.0

b. Unfortunately, the current ratio and quick ratio are both below the minimum

threshold required by the bond indenture. This may require the company to renegotiate the bond contract, including a possible unfavorable change in the interest rate.



Ex. 17–9

a. (1) Accounts Receivable Turnover = Receivable AccountsMonthly Average Accounton SalesNet

2012: $229,125

$1,512,225 = 6.6 2011: $242,250

$1,380,825 = 5.7

(2) Number of Days’ Sales in Receivables = Accounton Sales Daily AverageReceivable AccountsAverage

2012: 2

1

$4,143$229,125 = 55.3 days

2011: 4

3

$3,783$242,250 = 64.0 days

1$229,125 = ($221,250 + $237,000) ÷ 2

2$4,143 = $1,512,225 ÷ 365 days

3$242,250 = ($237,000 + $247,500) ÷ 2

4$3,783 = $1,380,825 ÷ 365 days

b. The collection of accounts receivable has improved. This can be seen in both

the increase in accounts receivable turnover and the reduction in the collec-tion period. The credit terms require payment in 60 days. In 2011, the collec-tion period exceeded these terms. However, the company apparently became more aggressive in collecting accounts receivable or more restrictive in granting credit to customers. Thus, in 2012, the collection period is within the credit terms of the company.



Ex. 17–10

a. (1) Accounts Receivable Turnover = Receivable AccountsAverage Accounton SalesNet

Klick: 2÷)700,2$+300,3($000,18$

= 6.0

Klack: 2÷)600,6$+000,9($980,07$

= 9.1

(2) Number of Days’ Sales in Receivables = Accounton Sales Daily AverageReceivable Accounts

Klick: ( )

1$49.322÷700,2$ + $3,300

= 60.8 days

Klack: ( )

247.941$2÷600,6$ + $9,000

= 40.1 days

1$49.32 = $18,000 ÷ 365 days 2$194.47 = $70,980 ÷ 365 days b. Klack’s accounts receivable turnover is much higher than Klick’s (9.1 for

Klack vs. 6.0 for Klick). The number of days’ sales in receivables is lower for Klack than for Klick (40.1 days for Klack vs. 60.8 days for Klick). These differ-ences indicate that Klack is able to turn over its receivables more quickly than Klick. As a result, it takes Klack less time to collect its receivables.



Ex. 17–11

a. (1) Inventory Turnover = Inventory AverageSold Goods ofCost

Current Year: 2÷)000,158$+000,140($$1,221,800

= 8.2

Preceding Year: 2÷)000,130$+000,158($$1,440,000

= 10.0

(2) Number of Days’ Sales in Inventory = Sold Goods ofCost Daily AverageInventory Average

Current Year: 1$3,3472÷)000,158$+000,140($

= 44.5 days

Preceding Year: 2$3,9452÷)000,130$+000,158($

= 36.5 days

1$3,347 = $1,221,800 ÷ 365 days

2$3,945 = $1,440,000 ÷ 365 days

b. The inventory position of the business has deteriorated. The inventory turn-

over has decreased, while the number of days’ sales in inventory has increased. The sales volume has declined faster than the inventory has declined, thus resulting in the deteriorating inventory position.



Ex. 17–12

a. (1) Inventory Turnover = Inventory AverageSold Goods ofCost

Dell: 2÷)867$+180,1($$50,144

= 49.0

HP: 2÷)128,6$+879,7($$56,503

= 8.1

(2) Number of Days’ Sales in Inventory = Sold Goods ofCost Daily AverageInventory Average

Dell: 138.137$2÷)867$+180,1($

= 7.5 days

HP: 2$154.802÷)128,6$+879,7($

= 45.2 days

1$137.38 = $50,144 ÷ 365 days

2$154.80 = $56,503 ÷ 365 days

b. Dell has a much higher inventory turnover ratio than does HP (49.0 vs. 8.1 for

HP). Likewise, Dell has a much smaller number of days’ sales in inventory (7.5 days vs. 45.2 days for HP). These significant differences are a result of Dell’s make-to-order strategy. Dell has successfully developed a manufacturing process that is able to fill a customer order quickly. As a result, Dell does not need to pre-build computers to inventory. HP, in contrast, pre-builds com-puters, printers, and other equipment to be sold by retail stores and other retail channels. In this industry, there is great obsolescence risk in holding computers in inventory. New technology can make an inventory of computers difficult to sell; therefore, inventory is costly and risky. Dell’s operating strat-egy is considered revolutionary and is now being adopted by many both in and out of the computer industry. Apple Computer, Inc., also employs similar manufacturing techniques and thus enjoys excellent inventory efficiency.



Ex. 17–13

a. Ratio of Liabilities to Stockholders’ Equity = Equity rs'Stockholde Total

sLiabilitieTotal

Dec. 31, 2012: $4,962,800$3,473,960 = 0.7 Dec. 31, 2011:

$4,250,000$3,825,000 = 0.9

b. Earned AreChargesInterest Bond Times of Number = ExpenseInterest

ExpenseInterest + Tax Before Income

Dec. 31, 2012: $270,000*000,$270 + $891,000

= 4.3

Dec. 31, 2011: $315,000**$315,000 + $787,500

= 3.5

*($2,500,000 + $500,000) × 9% = $270,000 **($3,000,000 + $500,000) × 9% = $315,000

c. Both the ratio of liabilities to stockholders’ equity and the number of times bond interest charges were earned have improved from 2011 to 2012. These results are the combined result of a larger income before taxes and lower se-rial bonds payable in the year 2012 compared to 2011.

Ex. 17–14


sLiabilitieTotal

Hasbro: $1,390,786$1,778,011 = 1.3

Mattel, Inc.: $2,117,135$2,557,904 = 1.2

b. Earned AreChargesInterest Times of Number = ExpenseInterest

ExpenseInterest + Tax Before Income

Hasbro: $47,143$47,143 + $494,296

= 11.5

Mattel, Inc.: $81,944$81,944 + $541,792

= 7.6



Ex. 17–14 (Concluded)

c. Both companies carry a moderate proportion of debt to the stockholders’ equity, at 1.3 and 1.2 times stockholders’ equity. Therefore, the companies’ debt as a percent of stockholders’ equity is similar. Both companies also have very strong interest coverage; however, Hasbro’s ratio is a bit stronger than Mattel’s. Together, these ratios indicate that both companies provide creditors with a margin of safety, and that earnings appear more than enough to make interest payments.

Ex. 17–15


sLiabilitieTotal

H.J. Heinz: $1,219,938$1,305,214 + $5,076,186 + $2,062,846

= 6.9

Hershey: $318,199$540,354 + $1,505,954 + $1,270,212

= 10.4

b. Ratio of Fixed Assets to Long-Term Liabilities = sLiabilitie Term-Long(net) AssetsFixed

H.J. Heinz: $6,381,400$1,978,302 = 0.3

Hershey: $2,046,308$1,458,949 = 0.7

c. Hershey uses more debt than does H.J. Heinz. As a result, Hershey’s total li-

abilities to stockholders’ equity ratio is higher than H.J. Heinz (10.4 vs. 6.9). H.J. Heinz has a much lower ratio of fixed assets to long-term liabilities than Hershey. This ratio divides the property, plant, and equipment (net) by the long-term debt. The ratio for H.J. Heinz is aggressive with fixed assets cover-ing only 30% of the long-term debt. That is, the creditors of H.J. Heinz have 30 cents of property, plant, and equipment covering every dollar of long-term debt. The same ratio for Hershey shows fixed assets covering 0.7 times the long-term debt. That is, Hershey’s creditors have $0.70 of property, plant, and equipment covering every dollar of long-term debt. This would suggest that Hershey has stronger creditor protection and borrowing capacity than does H.J. Heinz.



Ex. 17–16

a. Ratio of Net Sales to Total Assets: AssetsTotalSalesNet

YRC Worldwide: $4,514,368$8,940,401 = 2.0

Union Pacific: 0$38,877,500$17,970,00 = 0.5

C.H. Robinson Worldwide Inc.: $1,813,514$8,578,614 = 4.7

b. The ratio of net sales to assets measures the number of sales dollars earned for each dollar of assets. The greater the number of sales dollars earned for every dollar of assets, the more efficient a firm is in using assets. Thus, the ratio is a measure of the efficiency in using assets. The three companies are different in their efficiency in using assets, because they are different in the nature of their operations. Union Pacific earns only 50 cents for every dollar of assets. This is because Union Pacific is very asset intensive. That is, Union Pacific must invest in locomotives, railcars, terminals, tracks, right-of-way, and information systems in order to earn revenues. These investments are significant. YRC Worldwide is able to earn $2.00 for every dollar of assets, and thus, is able to earn more revenue for every dollar of assets than the railroad. This is because the motor carrier invests in trucks, trailers, and ter-minals, which require less investment per dollar of revenue than does the railroad. Moreover, the motor carrier does not invest in the highway system, because the government owns the highway system. Thus, the motor carrier has no investment in the transportation network itself unlike the railroad. C.H. Robinson Worldwide Inc., the transportation arranger, hires transportation services from motor carriers and railroads, but does not own these assets itself. The transportation arranger has assets in accounts receivable and in-formation systems but does not require transportation assets; thus, it is able to earn the highest revenue per dollar of assets.

Note to Instructors: Students may wonder how asset-intensive companies overcome their asset efficiency disadvantages to competitors with better asset efficiencies, as in the case between railroads and motor carriers. Asset efficiency is part of the financial equation; the other part is the profit margin made on each dollar of sales. Thus, companies with high asset efficiency often operate on thinner margins than do companies with lower asset effi-ciency. For example, the motor carrier must pay highway taxes, which lowers its operating margins when compared to railroads that own their right-of-way, and thus do not have the tax expense of the highway. While not required in this exercise, the railroad has the highest profit margins, the motor carrier is in the middle, while the transportation arranger operates on very thin mar-gins.



Ex. 17–17

a. Rate Earned on Total Assets = AssetsTotal AverageExpenseInterest + IncomeNet

2012: *$4,275,000000,120$ + $435,750

= 13.0% 2011: **$3,825,000

000,120$ + $453,750 = 15.0%

*($4,500,000 + $4,050,000) ÷ 2 **($4,050,000 + $3,600,000) ÷ 2

Rate Earned on Stockholders’ Equity = Equity rs'Stockholde Average

IncomeNet

2012: *$2,453,625

$435,750 = 17.8% 2011: **$2,020,875$453,750

= 22.5%

*($2,665,500 + $2,241,750) ÷ 2 **($2,241,750 + $1,800,000) ÷ 2

Equity rs'Stockholde Commonon Earned Rate = Equity rs'Stockholde Common Average

Dividends Preferred - IncomeNet

2012: *$2,153,625$12,000 $435,750 -

= 19.7% 2011: **$1,720,875$12,000 $453,750 -

= 25.7%

*($2,365,500 + $1,941,750) ÷ 2 **($1,941,750 + $1,500,000) ÷ 2

b. The profitability ratios indicate that Preslar Inc.’s profitability has deterio-rated. Most of this change is from net income falling from $453,750 in 2011 to $435,750 in 2012. The cost of debt is 8%. Since the rate of return on assets exceeds this amount in either year, there is positive leverage from use of debt. However, this leverage is greater in 2011 because the rate of return on assets exceeds the cost of debt by a greater amount in 2011.



Ex. 17–18

a. Rate Earned on Total Assets = AssetsTotal AverageExpenseInterest + IncomeNet

Fiscal Year 2007: 2 ÷ )$1,568,503 + 5($1,393,75$2,172 + $97,235

= 6.7%

Fiscal Year 2006: 2 ÷ )$1,492,906 + 3($1,568,50$2,230 + $142,982

= 9.5%

b. Rate Earned on Stockholders’ Equity = Equity rs'Stockholde Total Average

IncomeNet

Fiscal Year 2007: 2 ÷ )$1,049,911 + ($839,484 $97,235

= 10.3%

Fiscal Year 2006: 2 ÷ )$1,034,482 + 1($1,049,91 $142,982

= 13.7%

c. Both the rate earned on total assets and the rate earned on stockholders’ eq-uity have decreased over the two-year period. The rate earned on total assets decreased from 9.5% to 6.7%, and the rate earned on stockholders’ equity decreased from 13.7% to 10.3%. The rate earned on stockholders’ equity ex-ceeds the rate earned on total assets due to the positive use of leverage.

d. During fiscal 2007, Ann Taylor’s results were strong compared to the industry average. The rate earned on total assets for Ann Taylor was more than the in-dustry average (6.7% vs. 5.0%). The rate earned on stockholders’ equity was more than the industry average (10.3% vs. 8.0%). These relationships suggest that Ann Taylor has more leverage than the industry, on average.



Ex. 17–19

a. Ratio of Fixed Assets to Long-Term Liabilities = sLiabilitie Term-Long

AssetsFixed

$1,800,000$2,700,000 = 1.5

b. Ratio of Liabilities to Stockholders’ Equity = Equity rs'Stockholde TotalsLiabilitie Total

$4,933,000$2,466,500 = 0.5

c. Ratio of Net Sales to Assets = s)investment (excluding AssetsTotal AverageSalesNet

*$3,824,7505$17,211,37 = 4.5

*[($6,250,000 + $7,399,500) ÷ 2] – $3,000,000. The end-of-period total assets are equal to the sum of total liabilities ($2,466,500) and stockholders’ equity ($4,933,000).

d. Rate Earned on Total Assets = AssetsTotal AverageExpenseInterest + IncomeNet

*$6,824,750

$144,000 + $750,000 = 13.1%

*($6,250,000 + $7,399,500) ÷ 2

e. Rate Earned on Stockholders’ Equity = Equity rs'Stockholde Average

IncomeNet

*$4,668,000

$750,000 = 16.1%

*[($1,200,000 + $1,000,000 + $2,203,000) + $4,933,000] ÷ 2

f. Equity rs'Stockholde Commonon Earned Rate =

Equity rs'Stockholde Common AverageDividends Preferred IncomeNet −

*$3,468,000

$120,000 $750,000 - = 18.2%

*[($1,000,000 + $2,733,000) + ($1,000,000 + $2,203,000)] ÷ 2



Ex. 17–20

a. Earned AreChargesInterest Bond Times of Number =

ExpenseInterest ExpenseInterest + Tax Before Income

$375,000

*$375,000 + $2,400,000 = 7.4 times

*$3,750,000 bonds payable × 10%

b. Number of Times Preferred Dividends Are Earned = Dividends Preferred

IncomeNet

$200,000

**$2,000,000 = 10.0 times

**$2,400,000 income before tax – $400,000 income tax

c. Earnings per Share on Common Stock = gOutstandin Shares Common

Dividends Preferred IncomeNet −

shares 360,000

$200,000 $2,000,000 − = $5.00

d. Price-Earnings Ratio = Share per Earnings

Share per PriceMarket

$5.00$72 = 14.4

e. Dividends per Share of Common Stock = gOutstandin Shares CommonDividends Common

shares 360,000

$720,000 = $2.00

f. Dividend Yield = Price ShareShare per Dividends Common

$72.00$2.00 = 2.8%



Ex. 17–21

a. Earnings per Share = gOutstandin Shares CommonDividends Preferred IncomeNet -

shares **400,000

*$250,000 $1,250,000 − = $2.50

*($1,250,000/$25) × $5 **$4,000,000/$10

b. Price-Earnings Ratio = Share per Earnings


$2.50

$40.00 = 16.0

c. Dividends per Share = gOutstandin Shares Common

Dividends Common

shares 400,000

$800,000 = $2.00

d. Dividend Yield = Price ShareShare per Dividends Common

$40.00$2.00 = 5.0%



Ex. 17–22

a. Price-Earnings Ratio = Share per Earnings


The Home Depot: 57.1$43.33$

= 21.3

Google: 99.21$14.493$

= 22.4

Coca-Cola: 04.3$67.52$ = 17.3

Dividend Yield = Share per PriceMarket Share per Dividends

The Home Depot: 43.33$95$.

= 2.8%

Google: 14.493$00.0$

= 0.0%

Coca-Cola: 67.52$

76.1$ = 3.3%

b. Coca-Cola has the largest dividend yield, but the smallest price-earnings

ratio. Stock market participants value Coca-Cola common stock on the basis of its dividend. The dividend is an attractive yield at this date. Because of this attractive yield, stock market participants do not expect the share price to grow significantly, hence the low price-earnings valuation. This is a typical pattern for companies that pay high dividends. Google shows the opposite extreme. Google pays no dividend, and thus has no dividend yield. However, Google has the largest price-earnings ratio of the three companies. Stock market participants are expecting a return on their investment from apprecia-tion in the stock price. The Home Depot is priced in between the other two companies. The Home Depot has a moderate dividend producing a yield of 2.8%. The price-earnings ratio is slightly over 21. Thus, The Home Depot is expected to produce shareholder returns through a combination of some share price appreciation and a small dividend.



Appendix Ex. 17–23

a. Earnings per share on income before extraordinary items: Net income ..................................................................... $3,200,000 Less gain on condemnation ......................................... (700,000) Plus loss from flood damage........................................ 350,000 Income before extraordinary items.............................. $2,850,000

Earnings Before Extraordinary Items per Share on Common Stock =

gOutstandin Shares CommonDividends Preferred Items aryExtraordin Before Income -

shares 250,000

*$250,000 $2,850,000 - = $10.40 per share

*250,000 shares × $1.00 per share

b. Earnings per Share on Common Stock = gOutstandin Shares Common

Dividends Preferred Income Net −

shares 250,000

$250,000 $3,200,000 − = $11.80 per share


a. E e. NR b. NR f. E c. NR g. NR d. NR




a. ERIS, INC.

Partial Income Statement For the Year Ended December 31, 2012

Income from continuing operations before income tax ................. $800,000 Income tax expense........................................................................... 320,000* Income from continuing operations................................................. $480,000 Loss from discontinued operations ................................................. 120,000 Income before extraordinary item .................................................... $360,000 Extraordinary item: Loss due to hurricane................................................................. 100,000 Net income ......................................................................................... $260,000

*$800,000 × 40% b.

ERIS, INC. Partial Income Statement

For the Year Ended December 31, 2012

Earnings per common share: Income from continuing operations................................................. $9.601 Loss from discontinued operations ................................................. 2.402 Income before extraordinary item .................................................... $7.20 Extraordinary item: Loss due to hurricane................................................................. 2.003 Net income ......................................................................................... $5.20 1$9.60 = $480,000 ÷ 50,000 2$2.40 = $120,000 ÷ 50,000 3$2.00 = $100,000 ÷ 50,000


a. Daphne Company reported this item correctly in the financial statements. This item is an error in the recognition, measurement, or presentation in the financial statements, which is correctly handled by retroactively restating prior-period earnings.

b. Daphne Company did not report this item correctly. This item is a change from one generally accepted accounting principle to another, which is cor-rectly handled by retroactively restating prior-period earnings. In this case, Daphne reports this change cumulatively in the current period, which is in-correct.



PROBLEMS

Prob. 17–1A

1. EURIE COMPANY

Comparative Income Statement For the Years Ended December 31, 2012 and 2011

Increase (Decrease) 2012 2011 Amount Percent

Sales ....................................... $928,000 $800,000 $128,000 16.0% Sales returns and allowances 70,000 50,000 20,000 40.0 Net sales................................. $858,000 $750,000 $108,000 14.4 Cost of goods sold ................ 640,000 500,000 140,000 28.0 Gross profit ............................ $218,000 $250,000 $ (32,000) (12.8) Selling expenses ................... $ 85,800 $ 65,000 $ 20,800 32.0 Administrative expenses ...... 43,400 35,000 8,400 24.0 Total operating expenses ..... $129,200 $100,000 $ 29,200 29.2 Income from operations........ $ 88,800 $150,000 $ (61,200) (40.8) Other income ......................... 16,000 10,000 6,000 60.0 Income before income tax .... $104,800 $160,000 $ (55,200) (34.5) Income tax expense .............. 9,200 8,000 1,200 15.0 Net income ............................. $ 95,600 $152,000 $ (56,400) (37.1)

2. Net income has declined from 2011 to 2012. Net sales have increased by 14.4%; however, cost of goods sold has increased by 28.0%, causing the gross profit to decline while sales are increasing. In addition, total operating expenses have increased at a faster rate than sales (29.2% increase vs. 14.4% net sales increase). Increases in costs and expenses that are higher than the increase in sales have caused the net income to decline by 37.1%.



Prob. 17–2A

1. SELENE COMPANY



Sales ..................................... $999,600 102.0% $867,000 102.0% Sales returns and allowances ....................... 19,600 2.0 17,000 2.0 Net sales............................... $980,000 100.0% $850,000 100.0% Cost of goods sold .............. 460,600 47.0 433,500 51.0 Gross profit .......................... $519,400 53.0% $416,500 49.0% Selling expenses ................. $225,400 23.0% $178,500 21.0% Administrative expenses .... 107,800 11.0 102,000 12.0 Total operating expenses ... $333,200 34.0% $280,500 33.0% Income from operations...... $186,200 19.0% $136,000 16.0% Other income ....................... 49,000 5.0 42,500 5.0 Income before income tax .. $235,200 24.0% $178,500 21.0% Income tax............................ 98,000 10.0 85,000 10.0 Net income ........................... $137,200 14.0% $ 93,500 11.0%

2. The vertical analysis indicates that the costs other than selling expenses

(cost of goods sold and administrative expenses) improved as a percentage of sales. As a result, net income as a percentage of sales increased from 11.0% to 14.0%. The sales promotion campaign appears to have been suc-cessful. While selling expenses as a percent of sales increased slightly (2.0%), the increased cost was more than made up for by increased sales.



Prob. 17–3A

1. a. Working Capital = Current Assets – Current Liabilities $2,400,000 – $1,000,000 = $1,400,000

b. Current Ratio = sLiabilitie Current AssetsCurrent

$1,000,000$2,400,000 = 2.4

c. Quick Ratio = sLiabilitie Current

AssetsQuick

$1,000,000

$700,000 + $380,000 + $520,000 = 1.6

2. Supporting Data Working Current Quick Current Quick Current Transaction Capital Ratio Ratio Assets Assets Liabilities

a. $1,400,000 2.4 1.6 $2,400,000 $1,600,000 $1,000,000 b. 1,400,000 2.7 1.7 2,225,000 1,425,000 825,000 c. 1,400,000 2.2 1.4 2,525,000 1,600,000 1,125,000 d. 1,400,000 2.8 1.8 2,200,000 1,400,000 800,000 e. 1,240,000 2.1 1.4 2,400,000 1,600,000 1,160,000 f. 1,400,000 2.4 1.6 2,400,000 1,600,000 1,000,000 g. 1,700,000 2.7 1.9 2,700,000 1,900,000 1,000,000 h. 1,400,000 2.4 1.6 2,400,000 1,600,000 1,000,000 i. 2,100,000 3.1 2.3 3,100,000 2,300,000 1,000,000 j. 1,400,000 2.4 1.5 2,400,000 1,520,000 1,000,000



Prob. 17–4A

1. Working Capital: $2,163,000 – $720,000 = $1,443,000

Calculated Ratio Numerator Denominator Value

2. Current ratio .................. $2,163,000 $720,000 3.0 3. Quick ratio ..................... $1,753,000 $720,000 2.4 4. Accounts receivable turnover.......................... $2,200,000 ($425,000 + $400,000) ÷ 2 5.3 5. Number of days’ sales in receivables ...... ($425,000 + $400,000) ÷ 2 ($2,200,000 ÷ 365) 68.4 6. Inventory turnover ........ $825,000 ($310,000 + $240,000) ÷ 2 3.0 7. Number of days’ sales in inventory.......... ($310,000 + $240,000) ÷ 2 ($825,000 ÷ 365) 121.7 8. Ratio of fixed assets to long-term liabilities ....... $3,146,750 $2,200,000 1.4 9. Ratio of liabilities to stockholders’ equity ..... $2,920,000 $3,022,750 1.0 10. Number of times interest charges earned ............................ $464,750 + $176,000 $176,000 3.6 11. Number of times preferred dividends earned ............................ $410,750 $16,000 25.7 12. Ratio of net sales to assets ............................. $2,200,000 ($5,309,750 + $4,000,000) ÷ 2 0.5 13. Rate earned on total assets ............................. $410,750 + $176,000 ($5,942,750 + $4,560,000) ÷ 2 11.2% 14. Rate earned on stockholders’ equity............... $410,750 ($3,022,750 + $2,650,000) ÷ 2 14.5% 15. Rate earned on common stockholders’ equity............... ($410,750 – $16,000) ($2,622,750 + $2,250,000) ÷ 2 16.2% 16. Earnings per share on common stock ......... ($410,750 – $16,000) 44,000 $8.97 17. Price-earnings ratio ...... 60.00 8.97 6.7 18. Dividends per share of common stock .......... $22,000 44,000 $0.50 19. Dividend yield................ $0.50 $60.00 0.8%



Prob. 17–5A

1. a.

Rate Earned on Total Assets = AssetsTotal Average

Expense nterest I IncomeNet +

2012: $5,823,769$520,905 = 8.9% 2009:

$4,151,250$833,750 = 20.1%

2011: $5,356,904$554,987

= 10.4% 2008: $3,375,000$750,000 = 22.2%

2010: $4,821,098$694,579 = 14.4%



Prob. 17–5A (Continued)

1. b.

Rate Earned on Stockholders’ Equity = Equity rs'Stockholde Total Average

IncomeNet

2012: $2,562,409$170,879 = 6.7% 2009:

$1,576,250$552,500 = 35.1%

2011: $2,361,977$229,985 = 9.7% 2008:

$1,050,000$500,000 = 47.6%

2010: $2,049,743$394,485

= 19.2%




1. c.

Earned

ChargesInterest Times of Number

= ExpenseInterest

ExpenseInterest Expense Tax Income Income Net ++

2012: $350,027$570,398

= 1.6 2009: $281,250$958,550 = 3.4

2011: $325,002$638,166

= 2.0 2008: $250,000$906,000 = 3.6

2010: $300,094$860,937

= 2.9




1. d.

Ratio of Liabilities to Stockholders’ Equity = Equity rs'Stockholde TotalsLiabilitie Total

2012: $2,647,848$3,375,577 = 1.3 2009:

$1,852,500$2,700,000 = 1.5

2011: $2,476,970$3,147,143 = 1.3 2008:

$1,300,000$2,450,000 = 1.9

2010: $2,246,985$2,842,710 = 1.3

Note: The total liabilities are the difference between the total assets and total stockholders’ equity ending balances.



Prob. 17–5A (Concluded)

2. Both the rate earned on total assets and the rate earned on stockholders’ eq-uity have been moving in a negative direction in the last five years. Both measures have moved below the industry average over the last two years. The cause of this decline is driven by a rapid decline in earnings. The use of debt can be seen from the ratio of liabilities to stockholders’ equity. The ratio has declined over the time period and has declined below the industry aver-age. Thus, the level of debt relative to the stockholders’ equity has gradually improved over the five years. The number of times interest charges were earned has been falling below the industry average for several years. This is the result of low profitability combined with high interest costs. The number of times interest is earned has fallen to a dangerously low level in 2010. The low profitability and time interest charges are earned.



Prob. 17–1B

1. MCFADDEN INC.


Increase (Decrease) 2012 2011 Amount Percent

Sales .......................................... $516,600 $410,000 $ 106,600 26.0% Sales returns and allowances 12,200 10,000 2,200 22.0 Net sales.................................... $504,400 $400,000 $ 104,400 26.1 Cost of goods sold ................... 240,000 200,000 40,000 20.0 Gross profit ............................... $264,400 $200,000 $ 64,400 32.2 Selling expenses ...................... $ 69,600 $ 60,000 $ 9,600 16.0 Administrative expenses ......... 44,800 40,000 4,800 12.0 Total operating expenses ........ $114,400 $100,000 $ 14,400 14.4 Income from operations........... $150,000 $100,000 $ 50,000 50.0 Other income ............................ 12,600 10,000 2,600 26.0 Income before income tax ....... $162,600 $110,000 $ 52,600 47.8 Income tax expense ................. 9,000 5,000 4,000 80.0 Net income ................................ $153,600 $105,000 $ 48,600 46.3

2. The profitability has significantly improved. Net sales have increased by

26.1% over the 2011 base year. However, cost of goods sold, selling ex-penses, and administrative expenses grew at a slower rate. Increasing sales combined with costs that increase at a slower rate results in strong earnings growth. In this case, net income grew 46.3% over the base year.



Prob. 17–2B

1. AVATAR INDUSTRIES INC.



Sales ...................................... $630,000 105.0% $504,000 105.0% Sales returns and allowances 30,000 5.0 24,000 5.0 Net sales................................ $600,000 100.0% $480,000 100.0% Cost of goods sold ............... 330,000 55.0 259,200 54.0 Gross profit ........................... $270,000 45.0% $220,800 46.0% Selling expenses .................. $144,000 24.0% $ 86,400 18.0% Administrative expenses ..... 72,000 12.0 62,400 13.0 Total operating expenses .... $216,000 36.0% $148,800 31.0% Income from operations....... $ 54,000 9.0% $ 72,000 15.0% Other income ........................ 24,000 4.0 19,200 4.0 Income before income tax ... $ 78,000 13.0% $ 91,200 19.0% Income tax expense ............. 48,000 8.0 38,400 8.0 Net income ............................ $ 30,000 5.0% $ 52,800 11.0%

2. The net income as a percent of sales has declined. All the costs and

expenses, other than selling expenses, have maintained their approximate cost as a percent of sales relationship between 2011 and 2012. Selling ex-penses as a percent of sales, however, have grown from 18.0% to 24.0% of sales. Apparently, the new advertising campaign has not been successful. The increased expense has not produced sufficient sales to maintain relative profitability. Thus, selling expenses as a percent of sales have increased.



Prob. 17–3B

1. a. Working Capital = Current Assets – Current Liabilities $2,880,000 – $1,800,000 = $1,080,000

b. Current Ratio = sLiabilitieCurrent setsCurrent As

$1,800,000$2,880,000 = 1.6

c. Quick Ratio = sLiabilitieCurrent AssetsQuick

$1,800,000

$800,000 + $520,000 + $560,000 = 1.0

2. Supporting Data Working Current Quick Current Quick Current Transaction Capital Ratio Ratio Assets Assets Liabilities

a. $1,080,000 1.6 1.0 $2,880,000 $1,880,000 $1,800,000 b. 1,080,000 1.8 1.1 2,480,000 1,480,000 1,400,000 c. 1,080,000 1.6 1.0 3,030,000 1,880,000 1,950,000 d. 1,080,000 1.8 1.1 2,500,000 1,500,000 1,420,000 e. 860,000 1.4 0.9 2,880,000 1,880,000 2,020,000 f. 1,080,000 1.6 1.0 2,880,000 1,880,000 1,800,000 g. 1,760,000 2.0 1.4 3,560,000 2,560,000 1,800,000 h. 1,080,000 1.6 1.0 2,880,000 1,880,000 1,800,000 i. 2,480,000 2.4 1.8 4,280,000 3,280,000 1,800,000 j. 1,080,000 1.6 1.0 2,880,000 1,830,000 1,800,000



Prob. 17–4B

1. Working capital: $3,008,100 – $770,000 = $2,238,100

Calculated Ratio Numerator Denominator Value

2. Current ratio .................. $3,008,100 $770,000 3.9 3. Quick ratio ..................... $1,843,000 $770,000 2.4 4. Accounts receivable turnover.......................... $9,000,000 ($663,000 + $482,120) ÷ 2 15.7 5. Number of days’ sales in receivables ................ ($663,000 + $482,120) ÷ 2 ($9,000,000 ÷ 365) 23.2 6. Inventory turnover ........ $4,500,000 ($1,072,700 + $850,000) ÷ 2 4.7 7. Number of days’ sales in inventory.................... ($1,072,700 + $850,000) ÷ 2 ($4,500,000 ÷ 365) 78.0 8. Ratio of fixed assets to long-term liabilities ....... $6,450,020 $2,700,000 2.4 9. Ratio of liabilities to stockholders’ equity ..... $3,470,000 $6,813,120 0.5 10. Number of times interest charges earned.............. $1,087,000 + $309,000 $309,000 4.5 11. Number of times preferred dividends earned ............................ $847,000 $30,000 28.2 12. Ratio of net sales to assets ............................. $9,000,000 ($9,458,120 + $7,235,370) ÷ 2 1.1 13. Rate earned on total assets ............................. $847,000 + $309,000 ($10,283,120 + $7,872,870) ÷ 2 12.7% 14. Rate earned on stockholders’ equity............... $847,000 ($6,813,120 + $6,146,120) ÷ 2 13.1% 15. Rate earned on common stockholders’ equity............... ($847,000 – $30,000) ($5,313,120 + $4,646,120) ÷ 2 16.4% 16. Earnings per share on common stock ......... ($847,000 – $30,000) 600,000 $1.36 17. Price-earnings ratio ...... 25.00 1.36 18.4 18. Dividends per share of common stock .......... $150,000 600,000 $0.25 19. Dividend yield................ $0.25 $25.00 1.0%



Prob. 17–5B

1. a.

Rate Earned on Total Assets = AssetsTotal AverageExpenseInterest + IncomeNet

2012: 7$14,438,14

$3,522,302 = 24.4% 2009: $6,316,800$1,351,000 = 21.4%

2011: 3$11,033,10

$2,481,343 = 22.5% 2008: $4,820,000$1,050,000 = 21.8%

2010: $8,252,448$1,924,020

= 23.3%



Prob. 17–5B (Continued)

1. b.

Rate Earned on Stockholders’ Equity = Equity rs'Stockholde Total Average

IncomeNet

2012: $8,260,170$2,785,860 = 33.7% 2009:

$3,162,000$924,000 = 29.2%

2011: $5,938,620$1,857,240 = 31.3% 2008: $2,350,000

$700,000 = 29.8%

2010: $4,317,000$1,386,000

= 32.1%

Rat

e Ea

rned

on

Stoc

khol

ders

’ Equ

ity




1. c.

Earned

ChargesInterest Times of Number =

ExpenseInterest ExpenseInterest Expense Tax Income IncomeNet ++

2012: $736,442

$4,135,088 = 5.6 2009: $427,000

$1,571,800 = 3.7

2011: $624,103

$2,903,954 = 4.7 2008: $350,000

$1,210,000 = 3.5

2010: $538,020$2,244,180

= 4.2




1. d.

Ratio of Liabilities to Stockholders’ Equity = Equity rs'Stockholde TotalsLiabilitie Total

2012: $9,653,100$6,668,284 = 0.7 2009:

$3,624,000$3,369,600 = 0.9

2011: $6,867,240$5,687,671 = 0.8 2008:

$2,700,000$2,940,000 = 1.1

2010: $5,010,000$4,501,296 = 0.9

Note: Total liabilities are determined by subtracting stockholders’ equity (end-ing balance) from the total assets (ending balance).



Prob. 17–5B (Concluded)

2. Both the rate earned on total assets and the rate earned on stockholders’ eq-uity are above the industry average for all five years. The rate earned on total assets is actually improving gradually. The rate earned on stockholders’ equity exceeds the rate earned on total assets, providing evidence of the pos-itive use of leverage. The company is clearly growing earnings as fast as the asset and equity base. In addition, the ratio of liabilities to stockholders’ eq-uity indicates that the proportion of debt to stockholders’ equity has been declining over the period. The firm is adding to debt at a slower rate than the assets are growing from earnings. The number of times interest charges were earned ratio is improving during this time period. Again, the firm is increasing earnings faster than the increase in interest charges. Overall, these ratios indicate excellent financial performance coupled with appropriate use of debt (leverage).



NIKE, INC., PROBLEM

1. a. 2009 2008 Total current assets .................................................... $10,959.2 $9,734.0 Total current liabilities................................................ 3,364.2 3,277.0 Working capital........................................................ $ 7,595.0 $6,457.0 b. 2009 2008 Total current assets .................................................... $10,959.2 $9,734.0 /Total current liabilities............................................... 3,364.2 3,277.0 Current ratio............................................................. 3.3 3.0 c. 2009 2008 Cash ............................................................................. $3,079.1 $2,291.1 Short-term investments.............................................. 2,066.8 1,164.0 Accounts receivable ................................................... 2,649.8 2,883.9 Total quick assets ................................................... $7,795.7 $6,339.0 /Total current liabilities ........................................... $3,364.2 $3,277.0 Quick ratio ................................................................... 2.3 1.9 d. Net sales ...................................................................... $19,014.0 $19,176.1 Accounts receivable (net): Beginning of year .................................................... 2,883.9 2,795.3 End of year ............................................................... 2,649.8 2,883.9 Total ............................................................................. $ 5,533.7 $ 5,679.2 Average (Total/2) ......................................................... 2,766.9 2,839.6 Accounts receivable turnover (Net sales/Average accounts receivable) .............. 6.9 6.8 e. Accounts receivable (average): 2,766.9 2,839.6 Net sales................................................................... $19,014.0 $19,176.1 Average daily sales (Sales/365).............................. 52.1 52.5 Number of days’ sales in receivables........................ 53.1 54.1 f. Cost of goods sold...................................................... $10,213.6 $10,571.7 Inventories: Beginning of year .................................................... 2,357.0 2,438.4 End of year ............................................................... 2,040.8 2,357.0 Total.......................................................................... $ 4,397.8 $4,795.4 Average (Total/2) ......................................................... 2,198.9 2,397.7 Inventory turnover (Cost of goods sold/Average inventory)................ 4.6 4.4



NIKE, Inc., Problem (Continued)

g. Inventory (average) ..................................................... 2,198.9 2,397.7 Cost of goods sold...................................................... 10,213.6 10,571.7 Average daily cost of goods sold .............................. 28.0 29.0 Number of days’ sales in inventory (Average inventory/Average daily cost of goods sold) ........ 78.5 82.7 h. Total liabilities ............................................................. 4,665.6 4,556.5 /Total stockholders’ equity......................................... 9,753.7 8,693.1 Ratio of liabilities to stockholders’ equity ................ 0.5 0.5 i. Net sales ...................................................................... $19,014.0 $19,176.1 Total assets (excluding long-term investments): Beginning of year .................................................... $13,249.6 $12,442.7 End of year ............................................................... 14,419.3 13,249.6 Total.......................................................................... $27,668.9 $25,692.3 Average total assets ................................................... 13,834.5 12,846.2 Ratio of net sales to assets ........................................ 1.4 1.5 j. Net income................................................................... $ 1,906.7 $ 1,486.7 Plus interest expense ................................................. 36.4* 40.2* Total.......................................................................... $ 1,943.1 $ 1,526.9 Total assets: Beginning of year .................................................... $13,249.6 $12,442.7 End of year ............................................................... 14,419.3 13,249.6 Total.......................................................................... $27,668.9 $25,692.3 Average total assets ................................................... 13,834.5 12,846.2 Rate earned on total assets (Net income/Average total assets) ......................... 14.0% 11.9% * See Nike Footnote 6 k. Net income................................................................... $ 1,906.7 $ 1,486.7 Stockholders’ equity: Beginning of year .................................................... $ 8,693.1 $ 7,825.3 End of year ............................................................... 9,753.7 8,693.1 Total.......................................................................... $18,446.8 $16,518.4 Average stockholders’ equity .................................... 9,223.4 8,259.2 Rate earned on stockholders’ equity......................... 20.7% 18.0% l. Market price per share of common stock ................. $57.05 $68.37 Earnings per share on common stock ...................... $3.93 $3.07 Price-earnings ratio on common stock..................... 14.5 22.3



NIKE, Inc., Problem (Continued)

m. Net income................................................................... $1,906.7 $1,486.7 Net sales ...................................................................... $19,014.0 $19,176.1 Net income to net sales .............................................. 10.0% 7.8% 2. Before reaching definitive conclusions, each measure should be compared

with past years, industry averages, and similar firms in the industry. a. The working capital increased significantly.

b. and c. The current and quick ratios increased during 2009.

d. and e. The accounts receivable turnover and number of days’ sales in receiv-ables indicate a slight increase in efficiency of collecting accounts receivable. The accounts receivable turnover increased from 6.8 to 6.9. The number of days’ sales in receivables decreased slightly from 54.1 to 53.1. Thus, it takes the company about two months to collect its accounts receivable from credit sales. These numbers should be compared to their competitors, industry av-erages, and Nike’s credit policy to draw definitive conclusions.

f. and g. The results of these two analyses show a very slight increase in inven-tory turnover and a decrease in the number of days’ sales in inventory. Both trends are small. Inventory management is critical to Nike, so this indicates a favorable trend.

h. The margin of protection to creditors remained the same. Overall, Nike pro-vides sound protection to its creditors.

i. These analyses indicate that the effectiveness in the use of assets to gener-ate revenues was very similar in both years.

j. The rate earned on average total assets increased during 2009. This increase was due to Nike’s strong earnings performance in 2009 relative to 2008. Overall, rates earned on assets that exceed 10% are usually considered good performance.

k. The rate earned on average common stockholders’ equity increased. This in-crease was due to Nike’s strong earnings performance in 2009 relative to 2008.



NIKE, Inc., Problem (Concluded)

l. The price-earnings ratio decreased significantly from 2008 to 2009. This de-crease was driven by an increase in Nike’s earnings per share (from $3.07 in fiscal 2008 to $3.93 in fiscal 2009) and a decrease in its stock price (from $68.37 at the end of fiscal 2008 to $57.05 at the end of fiscal 2009).

m. The percent of net income to sales improved during 2009 as Nike’s growth in earnings outpaced its growth in sales.



CASES & PROJECTS

CP 17–1

This position does not allow the shareholders to take advantage of leverage. As a result, the return on shareholders’ equity cannot be improved by using debt. In contrast, a low or no debt load does provide the company great flexibility in the case of a national calamity. However, the “no debt” position only makes sense within the “national calamity” scenario. Within normal business operations, most companies can assume some debt without much loss of flexibility or control. Smokey Mountain Brewery is competing against companies that will not be so inclined to avoid debt. As a result, they will likely be able to grow faster than Smokey Mountain. The Smokey Mountain management should consider the risk of not being able to keep up with the competition because of their conservative financing policies.

CP 17–2

Bill is concerned about the inventory and accounts receivable levels because he must determine their value. Inventory that cannot be sold (or sold at a large dis-count) or accounts receivable that cannot be collected must be written down to reflect their reduced value. Bill has conducted the ratio analysis and interviewed Rob to help make this determination. The inventory and accounts receivable levels have grown alarmingly. Rob’s response to Bill is not reassuring. The inven-tory represents obsolete technology that is left over after the holiday season. The accounts receivable have apparently grown from loosening the credit standards. Bill may need to insist on write-downs of the inventory and accounts receivable balances to reflect their net realizable values. Rob is correct in pointing out that the current ratio has probably improved. Thus, although Rob calls this “good,” it is only such if the current assets in the numerator are fairly valued. Under these circumstances, the current ratio is probably overstated because the inventory and accounts receivable balances are inflated relative to their net realizable val-ues.



CP 17–3

DELL INC. AND APPLE COMPUTER, INC. Common-Sized Statements

Apple Dell Inc. Computer, Inc.

Sales (net) ..................................................... 100.0% 100.0% Cost of sales................................................. 82.1 64.0 Gross profit................................................... 17.9% 36.0% Operating expenses: Selling, general, and administrative...... 11.6% 11.4% Research and development ................... 1.1 3.6 Total operating expenses................... 12.7% 15.0%* Operating income......................................... 5.2% 21.0%

*Rounded to the nearest tenth of a percent.

The common-sized analysis indicates that Dell and Apple are very different computer companies. Dell’s income from operations was 5.2% of sales, while Apple’s was 21.0% of sales. There is almost a 16 percentage point difference be-tween the two companies. What explains this difference? The gross profit for Dell was 17.9% of sales, which is fairly narrow. Apple, in contrast, had a gross profit of 36.0% of sales, which is over 18 points better than Dell’s. This suggests that Apple is able to charge higher prices than Dell for its products (assuming that they are both equally efficient in making products). Apple’s selling, general, and administra-tive expenses were at about 11.4% of sales, while Dell’s are 11.6% of sales. Apple has larger operating expenses as a percent of sales. It attempts to sell a unique array of products to a wide audience. This requires significant research and devel-opment. Dell’s R&D was a narrow 1.1% of sales, while Apple’s was 3.6% of sales. Essentially, Dell focuses its R&D effort on the final assembly of computers. Dell relies on its suppliers to develop innovation in the components and operating system software (Microsoft). Apple, on the other hand, must constantly spend R&D on computers, peripherals, and its own operating system software. This is because Apple chooses not to follow the industry standards and thus must pave its own way on both hardware and software. The higher gross profit as a percentage of sales for Apple carries through to its income from operations, generating a signifi-cantly higher operating income as a percentage of sales compared to Dell.



CP 17–4

1. a. Rate Earned on Total Assets = AssetsTotal Average

ExpenseInterest IncomeNet +

2008: $6,743$4.50 + $655

= 9.8%

2007: $5,595$0.00 + $934

= 16.7%

2006: 394,5$$0.00 + 043,1$

= 19.3%

b. Rate Earned on Total Stockholders’ Equity = Equity rs'Stockholde Total Average

IncomeNet

2008: $2,246$655 = 29.2%

2007: $2,566$934 = 36.4%

2006: 921,2$043,1$ = 35.7%

c. Earnings per Share = gOutstandin Shares Common

Dividends Preferred IncomeNet −

2008: 233

$0.00 $655 − = $2.81

2007: 238

$0.00 $934 − = $3.92

2006: 258

0.00$ $1,043 − = $4.04



CP 17–4 (Continued)

d. Dividend Yield = Stock Common of Share per PriceMarket

Stock Common of Share per Dividend

2008: $31.29

.291$ = 4.1%

2007: $58.44$1.06 = 1.8%

2006: $60.98$0.81 = 1.3%

e. Price-Earnings Ratio = Stock Common of Share per Earnings

Stock Common of Share per PriceMarket

2008: $2.81

$31.29 = 11.1

2007: $3.92

$58.44 = 14.9

2006: $4.04$60.98 = 15.1

2. Ratio of Average Liabilities to Average Liabilities Average Stockholders’ Equity = Average Stockholders’ Equity

2008: $2,246

$2,246 $6,743 − = 2.0



CP 17–4 (Concluded)

3. Harley-Davidson’s profitability, as measured by earnings per share, deterio-rated dramatically from 2006 levels. The rate earned on total assets also deteriorated significantly, as did the rate earned on stockholders’ equity. This is most likely due to the significant deterioration in the overall economy dur-ing this period, which was primarily concentrated in 2008. The dividend yield, however, increased dramatically during this period from 1.3% in 2006 to 4.1% in 2008. This appears to be caused by the dramatic drop in the average stock price from $60.98 in 2006 to $31.29 in 2008. The company’s stock price dropped significantly, while the cash dividend increased during this period. The price-earnings ratio also deteriorated during the three-year period. This is predominantly due to the significant drop in stock price that was driven by an overall decline in stock prices during 2008.

4. Apparently, stock market participants are not willing to pay as high a price for

future earnings because of concern over Harley-Davidson’s future earnings. While it appears that Harley-Davidson’s expansion to international markets has been quite successful, the negative economic climate that existed at the end of 2008 seems to be creating significant concern over future earnings on the part of investors.



CP 17–5

1.

a. Rate Earned on Total Assets = AssetsTotal Average

ExpenseInterest IncomeNet +

Marriott: $7,494$163 + $359

= 7.0%

Starwood: $9,663$210 + $254

= 4.8%

b. Rate Earned on Total Stockholders’ Equity = Equity rs'Stockholde Total Average

IncomeNet

Marriott: $1,405$359 = 25.6%

Starwood: $1,849$254 = 13.7%

c. Earned AreCharges

Interest Times of Number

= ExpenseInterest

ExpenseInterest Expense Tax Income Before Income +

Marriott: $163$163 + $709

= 5.4

Starwood: $210$210 + $330

= 2.6

d. Ratio of Liabilities to Stockholders’ Equity = Equity rs'Stockholde TotalsLiabilitie Total

Marriott: $1,380$7,523 = 5.5

Starwood: $1,621$8,082 = 5.0



CP 17–5 (Concluded)

Summary Table:

Marriott Starwood Rate earned on total assets ......................................... 7.0% 4.8% Rate earned on total stockholders’ equity ................. 25.6% 13.7% Number of times interest charges are earned............ 5.4 2.6 Ratio of liabilities to stockholders’ equity.................. 5.5 5.0

2. Marriott has a higher rate earned on total assets (7.0% vs. 4.8%), and a higher

rate on stockholders’ equity (25.6% vs. 13.7%), compared to Starwood. Star-wood’s weaker performance relative to Marriott appears to be due to its weak earnings relative to its debt level. Starwood has slightly more leverage than Marriott. This is confirmed by the ratio of liabilities to stockholders’ eq-uity, which shows the relative debt held by Marriott is 5.5 times stockholders’ equity, compared to 5.0 times for Starwood. The number of times interest charges are earned shows that Marriott covers its interest charges 5.4 times. The comparable number for Starwood is 2.6, which is marginally sufficient. Starwood is not generating enough earnings to cover the interest expense on its debt, which is negatively affecting the rate earned on total assets and stockholders’ equity. In summary, Starwood’s weak earnings and high debt levels are affecting the company’s ability to earn returns for stockholders.

chapter 17 - financial accounting

Documents

current year

turnover of inventory

year inventory amounts

preceding year

high inventory turnover

average total assets

quantity of inventory

little inventory