CH 13 SM FAF5e

Chapter 13
Analysis of 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.
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Solutions Manual, Chapter 13
735
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.
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 numeratorreflecting 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 lossesin a category often labeled Other Gains and Losses.
14. Profit margin: Net Income / Sales ($ in millions)
Fiscal 2013: $37,037 / $170,910 = 21.7%
Fiscal 2012: $41,733 / $156,508 = 26.7%
15. Equity ratio: Total Equity / Total Assets ($ in millions)
2013:
2012:
$87,309 / $110,920 = 78.7%

$71,715 / $93,798 = 76.5%
16. Debt ratio: Total Liabilities / Total Assets ( in millions)

2013:
2012:
64,059,008 / 214,075,018 = 29.9%

59,591,364 / 181,071,570 = 32.9%
17. Return on total assets: Net Income / Average Total Assets ( in millions)
2013:
30,474,764 / [(214,075,018 + 181,071,570)/2] = 15.4%
737
QUICK STUDY
Quick Study 13-1 (5 minutes)
is
a. Income statement
is
b. Balance sheet
NOT c. Prospectus
is
d. Financial statement notes
NOT e. Company news releases
is
f. Statement of cash flows
NOT g. Stock price information and analysis
is
h. Statement of shareholders equity
NOT i. Management discussion and analysis of financial performance
In sum: Items c, e, g and i are not part of general-purpose financial statements.

1. (b) competitor
2. (d) guidelines
3. (a) intracompany
4. (c) industry
Dollar
Change
Percent
Change
Short-term investments..............
$374,634 $234,000 $140,634
60.1%
Accounts receivable...................
97,364
-3.6%
2015
Notes payable..............................
2014
101,000
(3,636)
88,000
88,000
(not calculable)
739

Trend percents
2015
177.0%
($801,810/ $453,000)
2014
100.0%
(the given base amount)

Common-size percents
2015
49.0%
($392,887 / $801,810)
2014
29.6%
($134,088 / $453,000)

Ratio
2015
2014
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
741
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 acidtest 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 increase the beginning retained earnings balance by $800.
Also, if prior years financial numbers are reported, they should be revised
to show the correct numbers. The correction would be to increase the
prior year income by $800.
743

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 IFRSs 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
paragraphs 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.
745
EXERCISES
Exercise 13-1 (10 minutes)
1.
2.
3.
4.
5.
B
C
D
C
A
6.
7.
8.
9.
10.
A
B
B
C
A

1. Profit Margin (f); Total Asset Turnover (e)
--in either order
Return on Total Assets (d)

2. Working Capital (c)
--also called net working capital
3. Accounts Receivable Turnover (b); Days' Sales Uncollected (a)
--in either order

2015
Sales........................................189
2014
181
2013
168
2012
156
2011
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).
747

2015
Sales.................................................... 100.0%
2014
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 companys situation has worsened. This is evident from
the substantial decline in net income as a percent of sales for 2015 (7.0%)
relative to 2014 (18.5%). The main culprit is the increase in cost of goods sold
as a percent of sales from 46.5% in 2014 to 75.7% in 2015. 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 2014 to 17.3%
in 2015. Even more positive is the companys level of sales increase from
$625,000 in 2014 to $740,000 in 2015.

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:
2013 net income percent: 100.0 - 59.1 - 15.1 = 25.8% of sales
Next, if 2013 sales are assumed to be $100, then sales for 2014 are $104.20 and
the sales for 2015 are $105.40. If the net income percents for the three years are
applied to these amounts, the net incomes are:
2013 net income: $100.00 x 25.8% = $25.80
2014 net income: $104.20 x 23.3% = $24.28
2015 net income: $105.40 x 21.3% = $22.45
This shows that net income decreased over the three-year period.
749

Simon Company
Common-Size Comparative Balance Sheets
December 31, 2013-2015
At December 31
2015
2014*
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
2.0
2.1
1.3
Plant assets, net ............................................... 53.3
57.3
61.1
100.0%
100.0%
Accounts payable.............................................. 24.8%

Long-term notes payable secured by
mortgages on plant assets ........................... 18.8
16.9%
13.6%
22.9
22.1
Common stock, $10 par value.......................... 31.3
36.7
43.3
Retained earnings ............................................ 25.1
23.5
21.0
100.0%
100.0%
Prepaid expenses..............................................
Total assets ....................................................... 100.0%
2013
Liabilities and Equity
Total liabilities and equity................................. 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 declinedthis is favorable provided sufficient
cash is available for operations.
(2) Accounts receivable have increased as a percent of assetsthis 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 assetsthis 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 assetsthis could
reveal liquidity constraints.
(5) Common stock has markedly declinedthis could reflect a stock buyback
program or other mechanisms to reduce shares outstanding.
751

1.
2.
Current ratio
2015:
$31,800 + $89,500 + $112,500 + $10,700

$129,900
= 1.88 to 1
2014:
$35,625 + $62,500 + $82,500 + $9,375

$75,250
= 2.52 to 1
2013:
$37,800 + $50,200 + $54,000 + $5,000

$51,250
= 2.87 to 1
Acid-test ratio
2015:
$31,800 + $89,500
$129,900
= 0.93 to 1
2014:
$35,625 + $62,500
$75,250
= 1.30 to 1
2013:
$37,800 + $50,200
$51,250
= 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 1both suggest a potential liquidity problem. Still, we must
recognize that industry standards could show that the 2013 ratios were too
high (instead of 2015 ratios as being too low).
753

1.
2.
3.
4.
Days' sales uncollected

2015:
$89,500
x 365 = 48.5 days
$673,500
2014:
$62,500
x 365 = 42.9 days
$532,000
Accounts receivable turnover

2015:
$673,500
($89,500 + $62,500)/2
= 8.9 times
2014:
$532,000
($62,500 + $50,200)/2
= 9.4 times
Inventory turnover
2015:
$411,225
= 4.2 times
($112,500 + $82,500)/2
2014:
$345,500
($82,500 + $54,000)/2
= 5.1 times
Days sales in inventory

2015:
2014:
$112,500
$411,225
x 365 = 99.9 days
$82,500
x 365 = 87.2 days
$345,500
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 2014
to 2015 appear dramatic, it seems that Simon is becoming less efficient in
managing its inventory and in collecting its receivables.
755

1. Debt and equity ratios
2015
2014
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....................._______ _____

Total liabilities and equity...............
$523,000 100.0%
268,250
60.3
$445,000 100.0%
2. Debt-to-equity ratio
2015: $228,400 / $294,600 = 0.78 to 1
2014: $176,750 / $268,250 = 0.66 to 1
3. Times interest earned

2015: ($31,100 + $9,525 + $12,100) / $12,100 = 4.4 times
2014: ($29,375 + $8,845 + $13,300) / $13,300 = 3.9 times
Analysis and Interpretation: Simon added debt to its capital structure

during 2015, 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.
757

1.
Profit margin
2015: $31,100 / $673,500 = 4.6%
2014: $29,375 / $532,000 = 5.5%
2.
3.
Total asset turnover

2015:
$673,500
= 1.4 times
($523,000 + $445,000)/2
2014:
$532,000
= 1.3 times
($445,000 + $377,500)/2
Return on total assets

2015:
$31,100
($523,000 + $445,000)/2
= 6.4%
2014:
$29,375
($445,000 + $377,500)/2
= 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 2014 to
2015, 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.
759

1.
2.
Return on common stockholders' equity

2015:
$31,100
($294,600 + $268,250)/2
= 11.1%
2014:
$29,375
($268,250 + $242,750)/2
= 11.5%
Price-earnings ratio, December 31

2015: $30 / $1.90 = 15.8
2014: $28 / $1.80 = 15.6
3.
Dividend yield
2015: $0.29 / $30 = 0.1%
2014: $0.24 / $28 = 0.9%
Analysis and interpretation
The companys 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 companys 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.
761

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.
Exercise 13-13A (10 minutes)

1.
2.
3.
4.
5.
6.
7.
8
A
C
A
A
A
B
B
A
Income (loss) from continuing operations

Extraordinary gain (loss)
Gain (loss) from disposing of a discontinued segment
Income (loss) from operating a discontinued segment
763

RANDA MERCHANDISING, INC.
Income Statement
For Year Ended December 31, 2015
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
765

1.
Current ratio =
(in s)
1,192,250 / 194,475
= 6.13
(in $s)
$12,683,516 / $2,068,887
= 6.13
7,099 / 635,422
= 1.12%
(in $s)
$75,527 / $6,759,818
= 1.12%
(in s)
635,422 / 1,447,878
= 0.44
(in $s)
$6,759,818 / $15,402,966
= 0.44
Net profit margin = (in s)
Sales-to-assets =
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.
767
PROBLEM SET A
Problem 13-1A (120 minutes)
Part 1
HAROUN COMPANY
Income Statement Trends
For Years Ended December 31, 2015-2009
2015
2014
2013
2012
2011
2010
2009
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
2009
HAROUN COMPANY
Balance Sheet Trends
December 31, 2015-2009
2015
2014
2013
2012
2011
2010
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
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
Long-term investments.......
769
Problem 13-1A (concluded)

Part 2
Analysis and Interpretation
The statements and the trend percent data indicate that the company
significantly expanded its plant assets in 2013. Prior to that time, the
company enjoyed increasing gross profit and net income.
Sales grew steadily for the entire period of 2009 to 2015. However,
beginning in 2013, cost of goods sold and operating expenses increased
dramatically relative to sales, resulting in a significant reduction in net
income.
In 2015, net income was only 52.7% of the 2009 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 2013 to 2015,
but cash steadily declined and inventory sharply increased as did
current liabilities.
771

Part 1
Current ratio:
December 31, 2015: $52,390 / $22,800 = 2.3 to 1

December 31, 2014: $37,924 / $19,960 = 1.9 to 1
December 31, 2013: $51,748 / $20,300 = 2.5 to 1
Part 2
KORBIN COMPANY
Common-Size Comparative Income Statements
For Years Ended December 31, 2015, 2014, and 2013
2015
2014
2013
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
11.85%
12.53%
Sales............................................................
100.00%
Net income..................................................13.90%
773
Problem 13-2A (Concluded)

Part 3
KORBIN COMPANY
Balance Sheet Data in Trend Percents
December 31, 2015, 2014, and 2013
2015
2014
2013
Assets
Current assets..................................
Long-term investments....................
Plant assets, net...............................
Total assets.......................................
101.24% 73.29%
0.00
12.66
166.67
160.00
131.71
116.19
100.00%
100.00
100.00
100.00
Current liabilities..............................
Common stock.................................
Other paid-in capital.........................
Retained earnings............................
112.32% 98.33%
120.00
120.00
150.00
150.00
165.28
113.83
100.00%
100.00
100.00
100.00
Total liabilities and equity................
131.71
100.00
116.19
Part 4
Significant relations revealed
Korbins selling expenses and income taxes consumed smaller portions of
each sales dollar in 2014 than 2013. However, cost of goods sold and
administrative expenses consumed a larger portion in 2014. Therefore, income
as a percent of sales declined from 2013 to 2014. In 2015, 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 2014 to 2015.
Korbin expanded its plant assets in 2014, 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 2014
indicates that net income was larger than the reductions from cash (and
perhaps stock) dividends. In 2015, working capital increased, the current ratio
increased from 1.9-to-1 to 2.3-to-1, and cash dividends were paid.
775

Transaction
Current
Assets
Quick
Assets
Current
Liabilities
Beginning*
$700,000
$308,000
$280,000
2.50
1.10 $420,000
May 2
+ 50,000
_______
+ 50,000
____
____
_______
750,000
308,000
330,000
2.27
0.93
420,000
+110,000
+110,000
- 55,000
_______
_______
____
____
_______
805,000
418,000
330,000
2.44
1.27
475,000
+ 20,000
+ 20,000
- 20,000
- 20,000
_______
____
____
_______
805,000
418,000
330,000
2.44
1.27
475,000
- 22,000
- 22,000
- 22,000
____
____
_______
783,000
396,000
308,000
2.54
1.29
475,000
+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
- 50,000
- 50,000
- 50,000
____
____
_______
733,000
346,000
308,000
2.38
1.12
425,000
+100,000
+100,000
+100,000
____
____
_______
833,000
446,000
408,000
2.04
1.09
425,000
+ 80,000
+ 80,000
________
____
____
_______
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
Bal.
May 8
Bal.
May 10
Bal.
May 15
Bal.
May 17
May 26
Bal.
May 27
Bal.
May 28
Bal.
Current Acid-Test
Ratio
Ratio
Working
Capital
*Beginning balances
Current assets (given).............................................
$700,000
Current liabilities ($700,000 / 2.50).........................
280,000
Quick assets ($280,000 x 1.10)................................
308,000
777

1.
Current ratio
$10,000 + 8,400 + $29,200 + $4,500 + $32,150 + $2,650
= 3.6 to 1
$17,500 + $3,200 + $3,300
2.
Acid-test ratio
$10,000 + $8,400 + $29,200 + $4,500 = 2.2 to 1
$17,500 + $3,200 + $3,300
3.

$29,200 + $4,500
$448,600
4.
x 365 = 27.4 days
Inventory turnover
$297,250
($48,900 + $32,150)/2
5.
= 7.3 times

$32,150 x 365 = 39.5 days
$297,250
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

$29,052
$448,600
= 6.5%
779

9.

$448,600
= 2.1 times
($240,200 + $189,400)/2
10.

$29,052
= 13.5%
($240,200 + $189,400)/2
11.

$29,052
= 21.9%
($152,800 + $112,748)/2
781

Part 1
Barco Company
Kyan Company
a. Current ratio
$155,440*
= 2.5 to 1
$61,340
$238,050**
= 2.6 to 1
$93,300
* $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
$66,000*
$61,340
$98,600**
$93,300 = 1.1 to 1
* $19,500 + $37,400 +$9,100 = $66,000

**$34,000 + $57,400 + $ 7,200 = $98,600
c. Accounts receivable turnover

$770,000
($37,400 + $9,100 + $29,800)/2 = 20.2 times
$880,200
($57,400 + $7,200 + $54,200)/2 = 14.8 times
d. Inventory turnover
$585,100
= 8.4 times
($84,440 + $55,600)/2
$632,500
= 5.3 times
($132,500 + $107,400)/2
e. Days sales in inventory

$84,440
x 365 = 52.7 days
$585,100
$132,500 x 365 = 76.5 days

$632,500
f. Days' sales uncollected

$37,400 + $9,100
x 365 = 22.0 days
$770,000
$57,400 + $7,200
$880,200
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.
783

Part 2
Barco Company
Kyan Company
a. Profit margin ratio

$162,200
= 21.1%
$770,000
$210,400 = 23.9%
$880,200
b. Total asset turnover

$770,000
= 1.8 times
($445,440 + $398,000)/2
$880,200
= 1.9 times
($542,450 + $382,500)/2
c. Return on total assets

$162,200
= 38.5%
($445,440 + $398,000)/2
$210,400
($542,450 + $382,500)/2
= 45.5%
d. Return on common stockholders' equity

$162,200
= 55.8%
($303,300 + $278,260)/2
$210,400
= 65.0%
($348,150 + $299,666)/2
e. Price-earnings ratio
$75
$4.51
= 16.6
$75
$5.11
= 14.7
$3.93
$75
= 5.2%
f. Dividend yield
$3.81
$75
= 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
Barcos. Although the companies pay roughly the same dividend, Kyan's
price-earnings ratio is lower. All of these factors suggest that Kyan's stock is
likely the better investment.
785
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 years sales.......(16,000)
(4,800)
(11,200)
n. Gain on sale of discontinued segments assets.......... 34,000
10,200
23,800
Part 2 Income from continuing operations (and its components)

k.
a.
g.
q.
b.
l.
e.
c.
o.
p.
Net sales..................................................................
Interest revenue......................................................
Gain from settling lawsuit......................................
Total revenues and gains.......................................
Cost of goods sold.................................................$482,500
Depreciation expenseEquipment...................... 34,000
Depreciation expenseBuildings........................ 52,000
Other operating expenses..................................... 106,400
Loss on sale of equipment.................................... 25,850
Loss from settling lawsuit..................................... 23,750
Total expenses........................................................
Income from continuing operations before taxes.....
Income taxes expense (30%).................................
Income from continuing operations after taxes........
$ 998,500
14,000
44,000
1,056,500
(724,500)
332,000
(99,600)
$ 232,400
787
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 segments

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............................................................
$243,425
Part 5 Net income
j.
Income before extraordinary items............................................................

$243,425
Extraordinary item
Gain on insurance recovery of tornado damage
20,384
(after-tax)..............................................................................................
Net income....................................................................................................
$263,809
789
PROBLEM SET B
Problem 13-1B (120 minutes)
Part 1
TRIPOLY COMPANY
Income Statement Trends
For Years Ended December 31, 2015-2009
2015
2014
2013
2012
2011
2010
2009
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
2011
2010
2009
TRIPOLY COMPANY
Balance Sheet Trends
December 31, 2015-2009
2015
2014
2013
2012
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
791
Problem 13-1B (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.
Except for the most recent period, 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 2013,
financing this expansion primarily through the liquidation of long-term
investments.
793

Part 1
Current ratio:
December 31, 2015: $54,860 / $22,370 = 2.5 to 1

December 31, 2014: $32,660 / $19,180 = 1.7 to 1
December 31, 2013: $36,300 / $16,500 = 2.2 to 1
Part 2
BLUEGRASS CORPORATION
Common-Size Comparative Income Statements
For Years Ended December 31, 2015, 2014, and 2013
2015
Sales............................................................
100.00%
2014
2013
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
23.80%
26.84%
Net income..................................................22.34%
* Some totals do not reconcile due to rounding.
795

Part 3
BLUEGRASS CORPORATION
Balance Sheet Data in Trend Percents
December 31, 2015, 2014, and 2013
2015
2014
2013
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 2014 was financed by a reduction in
current assets, an increase in current liabilities, a large reduction in longterm investments, and apparently by a stock sale. One effect of this plan
was to reduce the current ratio. However, the current ratio recovered in
2015. This apparently resulted from profits, limiting the amount of
dividends paid, and the liquidation of long-term investments.
797

Transaction
Current
Assets
Quick
Assets
Current
Liabilities
Current
Ratio
Beginning*
$300,000
$168,000
$120,000
2.50
1.40
$180,000
June 1
+120,000
+120,000
- 75,000
_______
________
____
____
_______
345,000
288,000
120,000
2.88
2.40
225,000
+ 88,000
+ 88,000
- 88,000
- 88,000
________
____
____
_______
345,000
288,000
120,000
2.88
2.40
225,000
________ +150,000
____
____
_______
Bal.
June 3
Bal.
June 5
Bal.
June 7
Bal.
June 10
Bal.
June 12
Bal.
June 15
Bal.
+150,000
Acid-Test
Ratio
Working
Capital
495,000
288,000
270,000
1.83
1.07
225,000
+100,000
+100,000
+100,000
____
____
_______
595,000
388,000
370,000
1.61
1.05
225,000
+120,000
+120,000
_______
____
____
_______
715,000
508,000
370,000
1.93
1.37
345,000
- 275,000
- 275,000
________
____
____
_______
440,000
233,000
370,000
1.19
0.63
70,000
________ ________ + 80,000
____
____
_______
440,000
233,000
450,000
0.98
0.52
(10,000)
+0
+0
________
____
____
_______
440,000
233,000
450,000
0.98
0.52
(10,000)
- 12,000
- 12,000
- 12,000
____
____
_______
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)
June 19
Bal.
June 22
Bal.
*Beginning balances
Current assets (given).............................................
$300,000
Current liabilities ($300,000 / 2.50).........................
120,000
Quick assets ($120,000 x 1.40)................................
168,000
799

1.
Current ratio
$6,100 + $6,900 + $12,100 + $3,000 + $13,500 + $2,000 = 2.5 to 1
$11,500 + $3,300 + $2,600
2.
Acid-test ratio
$6,100 + $6,900 + $12,100 + $3,000
$11,500 + $3,300 + $2,600
3.
= 1.6 to 1

$12,100 + $3,000 x 365 = 17.5 days
$315,500
4.
Inventory turnover
$236,100
= 15.3 times
($13,500 + $17,400)/2
5.

$13,500 x 365 = 20.9 days
$236,100
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 = 13.7 times
8.
Profit margin ratio

$23,800 = 7.5%
$315,500
801

9.

$315,500
= 3.0 times
($117,500 + $94,900)/2
10.

$23,800
= 22.4%
($117,500 + $94,900)/2
11.

$23,800
($70,100 + $54,300)/2
= 38.3%
803

Part 1
Fargo Company
Ball Company
a. Current ratio
$205,200
= 2.3 to 1
$90,500
$208,100
= 2.1 to 1
$97,000
$108,700
= 1.2 to 1
$90,500
$116,000
= 1.2 to 1
$97,000
b. Acid-test ratio
c. Accounts (and notes) receivable turnover

$393,600
= 4.9 times
($77,100 + $11,600 + $72,200)/2
$667,500
= 8.7 times
($70,500 + $9,000 + $73,300)/2
d. Inventory turnover
$290,600
= 3.0 times
($86,800 + $105,100)/2
$480,000
($82,000 + $80,500)/2
= 5.9 times
e. Days sales in inventory

$86,800
x 365 = 109.0 days
$290,600
$82,000
$480,000
x 365 = 62.4 days
f. Days' sales uncollected

$77,100 + $11,600
x 365 = 82.3 days
$393,600
$70,500 + $9,000
x 365 = 43.5 days
$667,500
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.
805

Part 2
Fargo Company
Ball Company
a. Profit margin ratio

$33,850
= 8.6%
$393,600
$61,700
$667,500
= 9.2%
b. Total asset turnover

$393,600
($382,100 + $383,400)/2
= 1.03 times
$667,500
= 1.48 times
($460,400 + $443,000)/2
c. Return on total assets

$33,850
($382,100 + $383,400)/2
= 8.8%
$61,700
= 13.7%
($460,400 + $443,000)/2
d. Return on common stockholders' equity

$33,850
($198,600 + $182,100)/2
= 17.8%
$61,700
($270,100 + $250,700)/2
= 23.7%
e. Price-earnings ratio
$25
= 19.7
$1.27
$25
= 11.4
$2.19
f. Dividend yield
$1.50
= 6.0%
$25
$1.50
= 6.0%
$25
Investment analysis: Balls 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.
807
Problem 13-6BA (60 minutes)

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

Pretax
e. Loss on hurricane damage..............................................

(64,000)
l. Loss from operating a discontinued segment......................

(120,000)
25% Tax
Effect After-Tax
(48,000)
(16,000)
(90,000)
(30,000)
n. Correction of overstatement of prior years expense...........

48,000
12,000
36,000
p. Loss on sale of discontinued segments assets...................

(180,000)
(135,000)
(45,000)
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.
h.
m.
g.
k.
i.
d.
Cost of goods sold.........................................................

$1,040,000
Depreciation expenseEquipment..............................
100,000
Depreciation expenseBuildings................................
156,000
Other operating expenses.............................................
328,000
Loss on sale of equipment............................................
24,000
Loss from settling lawsuit.............................................
36,000
Total expenses and losses............................................
1,684,000
Income from continuing operations before taxes.............
1,044,000
Income taxes expense (25%).........................................
(261,000)
Income from continuing operations after taxes................
$ 783,000
809
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 segments 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
811
SERIAL PROBLEM SP 13
Serial Problem SP 13, Business Solutions (45 minutes)
1. Gross margin with services revenue
Gross margin
= Total revenue Cost of goods sold
= $44,000 - $14,052
= $29,948
Gross margin ratio = $29,948 / $44,000
= 68.1%
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
= $18,833 / $44,000
= 42.8%
= $95,568 / $875
= 109.2
= $90,924 / $875
= 103.9
= $875 / $120,268
= 0.7%
= $119,393/$120,268
= 99.3%
2. Current ratio
Acid-test ratio
3. Debt ratio
Equity ratio
4. Current assets are 79.4% of total assets ($95,568/$120,268)

Long-term assets are 20.5% of total assets ($24,700/$120,268)
813
Reporting in Action
BTN 13-1
1. Trend percents for selected income statement accounts

($ in millions)
Fiscal
2013
Fiscal
2012
Fiscal
2011
Net Sales...............................................................157.9%
144.6%
100.0%
$170,910
$156,508
$108,249
Cost of sales.........................................................165.5%
136.3%
100.0%
$106,606
$87,846
$64,431
Operating income.................................................145.0%
163.5%
100.0%
$48,999
$55,241
$33,790
Other income/(expense)......................................278.6%
125.8%
100.0%
$1,156
$522
$415
Income taxes (provision for income taxes).......158.4%
169.4%
100.0%
$13,118
$14,030
$8,283
Net income............................................................142.9%
161.0%
100.0%
$37,037
$41,733
$25,922
2. Common-size percents for asset categories and accounts

($ in millions)
Sep. 28, 2013
Total current assets.............................................

Property, plant and equipment, net....................
Goodwill and other intangible assets.................
Sep. 29, 2012
35.4%
32.7%
$73,286
$57,653
8.0%
8.8%
$16,597
$15,452
2.8%
3.0%
$5,756
$5,359
Total assets as of September 28, 2013 and September 29, 2012 are $207,000 and $176,064, respectively.
3. For fiscal 2013, revenues grew at a lower rate than cost of sales,
however, for fiscal 2012, revenues grew at a higher rate than cost of
sales. Operating income grew at a higher rate than revenues for fiscal
2012; but the reverse occurred for 2013. Other income increased
substantially in 2013 (and to a lesser degree in 2012), relative to fiscal
2011. Consequently, net income declined in 2013 and its trend percent
was lower than revenue growth for 2013 (the reverse occurred in 2012).
The common-size percent figures in part 2 show a increase in current
assets (35.4% in 2013 vs. 32.7% in 2012) and smaller investment in
property, plant and equipment (8.0% in 2013 vs. 8.8% in 2012). Goodwill
and intangible assets show slightly decreased investment (2.8% in 2013
vs. 3.0% in 2012).
4. Answers depend on the financial statement information obtained.
815
Comparative Analysis
BTN 13-2
1.
Key figures ($ millions)
Apple
Google
Cash and equivalents.............
6.9%
$14,259
17.0%
$18,898
Accounts receivable, net.......
6.3%
13,102
8.0%
8,882
Inventories...............................
0.9%
1,764
0.4%
426
Retained earnings...................
50.4%
104,256
55.2%
61,262
Cost of sales...........................
62.4%
106,606
43.2%
25,858
Revenues................................. 100.0%
170,910
100.0%
59,825
Total assets............................. 100.0%
207,000
100.0%
110,920
2. Apples retained earnings make up a smaller percentage of its total

liabilities and equity (50.4%) vis--vis Google (55.2%).
3. Apples cost of sales percent is higher at 62.4% compared to Googles
at 43.2%.
This implies that Apple has a lower gross margin ratio on sales of
37.6% (computed from 100% less 62.4%), while Google has the higher
gross margin ratio at 56.8% (computed from 100% less 43.2%).
4. Although Apple has almost twice as much inventory as a percent of
total assets (0.9%) compared to Google (0.4%), both of these ratios
suggest a rather low inventory level for both companies (both under 1%
of assets).
817
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
CEOs motivation might be to make her performance, or the companys,
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
CEOs 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 teams 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.)
819
Taking It to the Net

($ thousands)
BTN 13-5
As of 12/31/2012
As of 12/31/2013
$660,931/$6,644,252 = 9.9%
1. Profit margin ratio.................
$820,470/$7,146,079= 11.5%
$2,859,882/ $6,644,252 = 43.0% $3,280,848/$7,146,079 = 45.9%

2. Gross profit ratio...................
$660,931 / ([$4,754,839 +
$820,470/ ([$5,357,488 +
3. Return on total
$4,407,094]/2)
=
14.4%
$4,754,839]/2) = 16.2%
assets...................................
$660,931 / ([$880,943 +
$820,470/ ([$1,048,373 +
4. Return on common
$1,048,373]/2)
=
68.5%
$1,616,052]/2) = 61.6%
stockholders equity*............
5. Basic net income per

common share**...................
$ 3.01
$ 3.76
*An acceptable alternative solution would be to include minority interest in equity.

**Taken from consolidated statement of income.
Analysis and Interpretation: Hersheys performance generally improved in

all areas evaluated for the profitability metrics reported in the table above
with the exception of return on common equity.
Teamwork in Action
BTN 13-6
Part 1
Team reports should look something like the following:
Horizontal Analysis
Horizontal analysis is comparing a companys 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:
821
Amount of change / Base year [or $60,000/$240,000].)
823
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 periods 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 shortterm 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 companys 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.
825
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 2013, the sales
trend shows that they would equal $125 in 2014 and $137 in 2015. Then,
dividing each sales figure by its ratio of sales to plant assets would give
$33.33 for plant assets in 2013 ($100/ 3.0), $37.88 in 2014 ($125/ 3.3) and
$39.14 in 2015 ($137/ 3.5).
5. No. The percent of return on equity declines from 12.25% in 2013 to
9.75% in 2015.
6. The dollar amount of selling expenses increased in 2014 and decreased
sharply in 2015. Again assuming sales figures of $100 in 2013, $125 in
2014, and $137 in 2015, and multiplying each by its selling expense to
net sales ratio gives $15.30 of selling expenses in 2013, $17.13 in 2014,
and $13.43 in 2015.
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).
827
Global Decision
BTN 13-9
Key figures (KRW in millions)
Samsung
Cash and equivalents.........................................
7.6%
16,284,780
Accounts receivable, net...................................
13.0%
27,875,934
Inventories...........................................................
8.9%
19,134,868
Retained earnings...............................................
69.4%
148,600,282
Cost of sales........................................................
60.2%
137,696,309
Revenues.............................................................
100.0%
228,692,667
Total assets.........................................................
100.0%
214,075,018
Comparisons and comments:

Samsungs cash and equivalents is greater than Apple and less than
Google as a percent of assets.
Samsung has the highest percentage of accounts receivable as a
percentage of total assets as compared to both Apple and Google.
Samsungs retained earnings make up a larger percentage of its total
financing (liabilities and equity) compared to that of Apple and Google.
Samsungs cost of sales is higher than Google and lower than Apple.
829

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CH 13 SM FAF5e

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Chapter 13

Analysis of Financial Statements

Solutions Manual, Chapter 13

$87,309 / $110,920 = 78.7%

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

64,059,008 / 214,075,018 = 29.9%

30,474,764 / [(214,075,018 + 181,071,570)/2] = 15.4%

Solutions Manual, Chapter 13

Quick Study 13-2 (10 minutes)

Solutions Manual, Chapter 13

Quick Study 13-4 (5 minutes)

(the given base amount)

Quick Study 13-5 (5 minutes)

Quick Study 13-6 (10 minutes)

1. Profit Margin Ratio................................ 9%

3. Gross Margin Ratio...............................34%

5. Accounts Receivable Turnover............ 5.5

6. Basic Earnings Per Share.....................

7. Inventory Turnover................................ 3.6

Solutions Manual, Chapter 13

Quick-Study 13-7 (30 minutes)

Quick Study 13-8A (5 minutes)

Solutions Manual, Chapter 13

Quick Study 13-9 (10 minutes)

Solutions Manual, Chapter 13

Exercise 13-2 (5 minutes)

--in either order

Return on Total Assets (d)

--also called net working capital

3. Accounts Receivable Turnover (b); Days' Sales Uncollected (a)

--in either order

Exercise 13-3 (20 minutes)

Cost of goods sold.................191

Solutions Manual, Chapter 13

Exercise 13-4 (25 minutes)

Cost of goods sold.............................

Exercise 13-5 (25 minutes)

Solutions Manual, Chapter 13

Exercise 13-6 (20 minutes)

Accounts receivable, net.................................. 17.1

Merchandise inventory..................................... 21.5

Plant assets, net ............................................... 53.3

Accounts payable.............................................. 24.8%

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

Retained earnings ............................................ 25.1

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

Liabilities and Equity

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

Column does not equal 100.0 due to rounding.

Analysis: Several observations can be made.

Solutions Manual, Chapter 13

Exercise 13-7 (25 minutes)

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

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

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

Analysis and Interpretation: Simon's short-term liquidity position has

Solutions Manual, Chapter 13

Exercise 13-8 (25 minutes)

Days' sales uncollected

Accounts receivable turnover

Days sales in inventory

x 365 = 99.9 days

$163,500 + $104,750.....................___ _