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# Chapter 17

## Analysis of Financial Statements

QUESTIONS
McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 145

2.

3.

4.

5.

6.

7.

8.

9.

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. Return on total assets (2007): \$1,377 (\$13,570 + \$11,864) / 2 Return on total assets (2006): \$1,140 (\$11,864 + \$10,294) / 2 15. Equity ratio (2007): \$1,791,244 \$4,007,283 Equity ratio (2006): \$1,954,633 \$4,069,044 16. Debt ratio (2006): \$1,416.2 \$2,070.0 Debt ratio (2005): \$1,616.3 \$2,205.1 17. Profit margin (2006):
McGraw-Hill Companies, 2009 146 Fundamental Accounting Principles, 19th Edition

= 10.8%

= 10.3%

= 44.7%

= 48.0%

= 68.4%

= 73.3%

\$1,989 \$19,315

= 10.3%

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 147

QUICK STUDY
Quick Study 17-1 (5 minutes) Items not part of general-purpose financial statements: 1. Stock price information and analysis. 3. Management discussion and analysis of financial performance. 5. Company news releases. 9. Prospectus.

Quick Study 17-2 (10 minutes) The four usual standards of comparisons are: Intracompany. The company under analysis provides standards for comparisons based on prior performance and relations between its financial items. Competitor. One or more direct competitors of the company under analysis can provide standards for comparisons. Industry. Industry statistics can provide standards of comparisons. Published industry statistics are available from several services such as Dun & Bradstreet, Standard and Poor's, and Moody's. Guidelines (Rules of Thumb). General standards of comparisons can develop from past experiences. Examples are the 2-to-1 level for the current ratio or 1-to-1 level for the acid-test ratio. All of these standards of comparisons are useful when properly applied. Yet, analysis measures taken from a selected competitor or group of competitors are often the best standards of comparisons. Also, intracompany and industry measures are important parts of all analyses. The standard that is least likely to provide a good basis for comparison is the use of guidelines, or rules of thumb. Guidelines must be applied with care, and then only if they seem reasonable in light of past experience and industry's norms.

## McGraw-Hill Companies, 2009 148 Fundamental Accounting Principles, 19th Edition

Quick Study 17-3 (10 minutes) 1. Common-size percents 2009 2008 2. 54.5% 52.8% (\$55,300 / \$101,400) (\$30,700 / \$ 58,100)

Trend percents 2009 2008 174.5% 100.0% (\$101,400 / \$ 58,100) (the given base amount)

Quick Study 17-4 (15 minutes) 2009 Short-term investments...... \$110,000 Accounts receivable........... Notes payable..................... 22,000 30,000 2008 \$80,000 25,000 0 Dollar Change \$30,000 (3,000) Percent Change 37.5% -12.0%

## Quick Study 17-5 (10 minutes) 1. 2. 3. 4. 5. C A B C D 6. 7. 8. 9. 10. C A A B B

Quick Study 17-6 (5 minutes) 1. Accounts Receivable Turnover and the Days' Sales Uncollected. 2. Working Capital, also called net working capital. 3. Profit Margin and the Total Asset Turnover. Return on Total Assets.
McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 149

Quick Study 17-7 (10 minutes) Ratio 1. Profit Margin Ratio.......................... 2. Debt Ratio........................................ 3. Gross Margin Ratio......................... 4. Acid-test Ratio................................ 5. Accounts Receivable Turnover..... 6. Basic Earnings Per Share.............. 7. Inventory Turnover......................... 8. Dividend Yield................................. 2009 10% 43% 32% 1.20 6.7 \$1.25 3.4 4.0% 2008 9% 39% 44% 1.05 5.5 \$1.10 3.6 3.2% Change Favorable Unfavorable Unfavorable Favorable Favorable Favorable Unfavorable Favorable

Quick Study 17-8A (5 minutes) This material error should be reported on the statement of retained earnings (and/or the statement of stockholders equity) as a prior period adjustment to the beginning retained earnings balance. Also, if prior years financial numbers are reported, they should be revised to show the correct numbers.

## McGraw-Hill Companies, 2009 150 Fundamental Accounting Principles, 19th Edition

EXERCISES
Exercise 17-1 (20 minutes) 2011 Sales................................ Cost of goods sold......... Accounts receivable....... 188 191 200 2010 180 182 191 2009 168 172 181 2008 156 159 168 2007 100 100 100

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 200) compared to sales (index is 188).

## Exercise 17-2 (25 minutes) Answer: Net income decreased.

Supporting calculations: When the sum of each year's common-size cost of goods sold and total expenses is subtracted from the common-size sales percent, the net income percent is as follows: 2008 net income percent: 100.0 - 58.4 - 14.2 = 27.4% of sales 2009 net income percent: 100.0 - 61.2 - 13.9 = 24.9% of sales 2010 net income percent: 100.0 - 67.7 - 14.4 = 17.9% of sales Next, we see that if 2008 sales are assumed to be \$100, then sales for 2009 are \$103.70 and the sales for 2010 are \$104.90. If the net income percents for the three years are applied to these amounts, the net incomes are: 2008 net income: \$100.00 x 27.4% = \$27.40 2009 net income: \$103.70 x 24.9% = \$25.82 2010 net income: \$104.90 x 17.9% = \$18.78 This shows that net income decreased over the three-year period.

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 151

Exercise 17-3 (25 minutes) 2009 100.0% 65.0 35.0 21.0 14.0% 2008 100.0% 58.6 41.4 19.4 22.0%

Sales......................................................... Cost of goods sold.................................. Gross profit.............................................. Operating expenses................................. Net income...............................................

Analysis: Overall, this companys situation has worsened. This is evident from the substantial decline in net income as a percent of sales for 2009 (14.0%) relative to 2008 (22.0%). The main culprit is the increase in cost of goods sold as a percent of sales from 58.6% in 2008 to 65.0% in 2009. In addition, operating expenses as a percent of sales has increased from 19.4% in 2008 to 21.0% in 2009. On the positive side is the companys level of sales increase from \$488,400 in 2008 to \$657,386 in 2009.

## Exercise 17-4 (30 minutes)

Lowes has a greater amount of working capital. This by itself does not indicate whether the company is more capable of meeting its current obligations. However, support is provided by the current ratio and acid-test ratio, which show Lowes is in a more liquid position than Orkay. This evidence does not mean that Orkay's liquidity is inadequate. Such a conclusion would require more information such as norms for the industry or its other competitors. However, Orkay's acid-test ratio for 2010 is less than the traditional rule of thumb (1 to 1), and has declined steadily since 2008. This evidence also shows that Lowes' 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 Lowes holds an excess amount of highly liquid assets that typically earn low returns. The accounts receivable turnover and inventory turnover indicate that Orkay is more efficient in collecting its accounts receivable and in generating sales from available inventory. However, these statistics also may suggest that Orkay is too conservative in granting credit and investing in inventory. This could have a negative impact on sales and net income. Lowes ratios may be

## McGraw-Hill Companies, 2009 152 Fundamental Accounting Principles, 19th Edition

acceptable, but no definitive determination can be made without having information on industry (or other competitors) standards.

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 153

Exercise 17-5 (30 minutes) COMPARATIVE ANALYSIS REPORT Revlon's profit margins are higher than Caren's. However, Caren has significantly higher total asset turnover ratios. As a result, Caren generates a substantially higher return on total assets. The trends of both companies include evidence of overall growth in sales, total asset turnover, and return on total assets. However, Revlon's rates of improvement are better than Carens. These differences might result from the fact that Revlon is only three years old, while Caren is a somewhat more established company. Revlon's operations are considerably smaller than Caren's, but that will not persist many more years if both companies continue to grow at their current rates. To some extent, Caren'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 Revlon's assets are newer, they may require smaller maintenance expenses. Finally, Caren did not successfully employ financial leverage in 2011. Its return on total assets is 6.9% compared to the 7% interest rate it paid to obtain financing from creditors. Even worse, Revlon's return is only 4.3% in 2011 as compared to the 7% interest rate paid to creditors.

## McGraw-Hill Companies, 2009 154 Fundamental Accounting Principles, 19th Edition

Exercise 17-6 (20 minutes) Nabisco Company Common-Size Comparative Balance Sheets December 31, 2008-2010 2010* 2009* Assets Cash................................................................. Accounts receivable, net................................. Merchandise inventory.................................... Prepaid expenses............................................. Plant assets, net .............................................. 5.8% 16.9 21.9 1.8 53.5 7.9% 14.1 18.3 2.0 57.6 100.0% 10.1% 12.9 14.1 1.1 61.8 100.0%

2008*

Total assets ..................................................... 100.0% Liabilities and Equity Accounts payable............................................ Long-term notes payable secured by mortgages on plant assets ......................... Common stock, \$10 par value........................ Retained earnings ..........................................
*

## 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.

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 155

Exercise 17-7 (25 minutes) 1. Current ratio 2010 \$36,229 + \$106,073 + \$137,408 + \$11,548 = 1.85 to 1 \$157,577 \$42,780 + \$76,377 + \$98,929 + \$11,003 \$94,024 \$44,562 + \$57,087 + \$62,038 + \$4,903 \$57,087

2009: 2008:

= 2.44 to 1 = 2.95 to 1

2.

Acid-test ratio 2010: 2009: 2008: \$36,229 + \$106,073 \$157,577 \$42,780 + \$76,377 \$94,024 \$44,562 + \$57,087 \$57,087 = 0.90 to 1 = 1.27 to 1 = 1.78 to 1

Analysis and Interpretation: The company'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 1.78 to 1 down to 0.90 to 1 and the current ratio shifts from 2.95 to 1 down to 1.85 to 1both suggest a potential liquidity problem. Still, we must recognize that industry standards could show that the 2008 ratios were too high (instead of 2010 ratios as being too low).

## McGraw-Hill Companies, 2009 156 Fundamental Accounting Principles, 19th Edition

Exercise 17-8 (25 minutes) 1. Days' sales uncollected 2010: 2009: 2. \$106,073 x 365 = 56.5 days \$685,000 \$76,377 x 365 = 50.0 days \$557,000

Accounts receivable turnover 2010: 2009: \$685,000 = 7.5 times (\$106,073 + \$76,377)/2 \$557,000 (\$76,377 + \$57,087)/2 = 8.3 times

3.

Inventory turnover 2010: 2009: \$417,850 = 3.5 times (\$137,408 + \$98,929)/2 \$356,265 (\$98,929 + \$62,038)/2 = 4.4 times

4.

Days sales in inventory 2010: 2009: \$137,408 \$417,850 x 365 = 120.0 days

## \$98,929 x 365 = 101.4 days \$356,265

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 2009 to 2010 appear dramatic, it seems that the company is becoming less efficient in managing its inventory and in collecting its receivables.

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 157

Exercise 17-9 (25 minutes) 1. Debt and equity ratios 2010 Total liabilities and debt ratio \$157,577 + \$116,618............... \$94,024 + \$127,962................. Total equity and equity ratio \$163,500 + \$188,880............... \$163,500 + \$154,665............... Total liabilities and equity........ 352,380 _______
56.2

2009

\$274,195

43.8%

\$221,986

41.1%

____

318,165

58.9

\$626,575 100.0%

\$540,151 100.0%

2. Debt-to-equity ratio 2010: \$274,195 / \$352,380 = 0.78 to 1 2009: \$221,986 / \$318,165 = 0.70 to 1 3. Times interest earned 2010: (\$38,793 + \$12,900 + \$8,175) / \$8,175 = 7.3 times 2009: (\$37,354 + \$12,450 + \$8,960) / \$8,960 = 6.6 times Analysis and Interpretation: The companys increase in debt exceeded its increase to its equity financing for 2010, with the result that the debt ratio increased from 41.1% to 43.8%. In addition, the debt-to-equity ratio also increased from 0.70 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.

## McGraw-Hill Companies, 2009 158 Fundamental Accounting Principles, 19th Edition

Exercise 17-10 (30 minutes) 1. Profit margin 2010: \$38,793 / \$685,000 = 5.7% 2009: \$37,354 / \$557,000 = 6.7% 2. Total asset turnover 2010: 2009 \$685,000 = 1.2 times (\$626,575 + \$540,151)/2 \$557,000 = 1.1 times (\$540,151 + \$441,300)/2

3.

Return on total assets \$38,793 2010: (\$626,575 + \$540,151)/2 \$37,354 2009: (\$540,151 + \$441,300)/2 = 6.6% = 7.6%

Analysis and Interpretation: The company's operating efficiency appears to be declining because the return on total assets decreased from 7.6% to 6.6%. While the total asset turnover favorably increased slightly from 2009 to 2010, the profit margin unfavorably decreased from 6.7% to 5.7%. The decline in profit margin indicates that the company's ability to generate net income from sales has declined.

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 159

Exercise 17-11 (20 minutes) 1. Return on common stockholders' equity 2010: 2009: 2. \$38,793 (\$352,380 + \$318,165)/2 \$37,354 (\$318,165 + \$284,735)/2 = 11.6% = 12.4%

Price-earnings ratio, December 31 2010: \$30 / \$2.37 = 12.7 2009: \$28 / \$2.28 = 12.3

3.

Dividend yield 2010: \$0.28 / \$30 = 0.9% 2009: \$0.24 / \$28 = 0.9% Analysis and interpretation The companys return on common stockholders equity is good, but not great. A 12% return makes it an acceptable investment provided its risk is not too high. The companys price-earnings ratio is around 13. This suggests that the market does view this company to have some growth potential. The dividend yield is on the low side. Thus, this stock would likely be classified as a growth stock, and the price-earnings ratio suggests that the market does perceive a high likelihood of some growth.

Exercise 17-12A (10 minutes) 1. A Income (loss) from continuing operations 2. C Extraordinary gain (loss) 3. A Income (loss) from continuing operations 4. A Income (loss) from continuing operations 5. A Income (loss) from continuing operations 6. B Gain (loss) from disposing of a discontinued segment 7. B Income (loss) from operating a discontinued segment 8 A Income (loss) from continuing operations
McGraw-Hill Companies, 2009 160 Fundamental Accounting Principles, 19th Edition

Exercise 17-13 (15 minutes) SIMPLON merchandisING, INC. Income Statement For Year Ended December 31, 2009 Net sales...................................................................... Expenses Cost of goods sold................................................... Salaries expense...................................................... Depreciation expense.............................................. Total expenses......................................................... Income from continuing operations before taxes.... Income taxes expense................................................ Income from continuing operations.......................... Discontinued segment Loss from operating wholesale business segment (net of tax).............................................. Gain on sale of wholesale business segment (net of tax).............................................. Income before extraordinary gain............................. Extraordinary gain on condemnation of company property (net of tax)................................. Net income.................................................................. (544,000) 875,000 331,000 561,500 330,000 \$ 891,500 \$1,580,000 740,000 332,500 2,652,500 347,500 117,000 230,500 \$3,000,000

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 161

PROBLEM SET A
Problem 17-1A (60 minutes) Part 1 Current ratio: December 31, 2010: \$48,242 / \$20,534 = 2.3 to 1 December 31, 2009: \$38,514 / \$20,349 = 1.9 to 1 December 31, 2008: \$51,484 / \$19,801 = 2.6 to 1 Part 2 ASTALON COMPANY Common-Size Comparative Income Statements For Years Ended December 31, 2010, 2009, and 2008 2010 Sales.................................................... Cost of goods sold............................. Gross profit......................................... Selling expenses................................. Administrative expenses.................... Total expenses.................................... Income before taxes........................... Income taxes....................................... Net income.......................................... 100.00% 60.20 39.80 14.20 9.00 23.20 16.60 3.09 13.51% 2009 100.00% 63.40 36.60 13.80 8.80 22.60 14.00 2.87 11.13% 2008 100.00% 64.00 36.00 13.20 8.30 21.50 14.50 2.94 11.56%

## McGraw-Hill Companies, 2009 162 Fundamental Accounting Principles, 19th Edition

Problem 17-1A (Concluded) Part 3 ASTALON COMPANY Balance Sheet Data in Trend Percents December 31, 2010, 2009, and 2008 2010 Assets Current assets................................... Long-term investments.................... Plant assets....................................... Total assets....................................... Liabilities and Equity Current liabilities............................... Common stock.................................. Other contributed capital................. Retained earnings............................. Total liabilities and equity................ 103.70% 135.29 152.20 115.82 124.30 102.77% 135.29 152.20 105.22 120.70 100.00% 100.00 100.00 100.00 100.00 93.70% 0.00 159.19 124.30 74.81% 22.10 167.55 120.70 100.00% 100.00 100.00 100.00 2009 2008

Part 4
Significant relations revealed Astalons cost of goods sold and income taxes consumed smaller portions of each sales dollar in 2009 than 2008. However, selling expenses and administrative expenses consumed a larger portion in 2009. Therefore, income as a percent of sales declined from 2008 to 2009. In 2010, 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 2009 to 2010. Astalon expanded its plant assets in 2009, financing the expansion through the sale of long-term investments, through a reduction in working capital (the current ratio decreased from 2.6-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 2009 indicates that net income was larger than the reductions from cash (and perhaps stock) dividends. In 2010, working capital increased, the current ratio increased from 1.9-to-1 to 2.3-to-1, and cash dividends were paid.
McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 163

Problem 17-2A (120 minutes) Part 1 ADOBE COMPANY Income Statement Trends For Years Ended December 31, 2010-2004
2010 2009 2008 2007 2006 2005 2004 Sales................................. 192.5% 168.6% 153.4% 140.6% 131.2% 122.0% 100.0% Cost of goods sold........... 235.8 Gross profit...................... 131.0 Operating expenses......... 265.8 Net income........................
50.0 191.8 135.6 207.7 92.3 165.0 136.8 190.8 104.3 144.4 135.2 140.8 131.9 134.1 127.0 121.9 130.1 125.5 117.0 120.4 115.0 100.0 100.0 100.0 100.0

## ADOBE COMPANY Balance Sheet Trends December 31, 2010-2004

2010 Cash..................................
67.4%

2009
89.3% 244.9 245.6 204.2 256.7 222.9

2008
92.6% 221.7 214.5 125.0 224.6 196.0

2007
94.6% 170.0 180.8 225.0 100.0 126.7 144.4

2006
98.3% 149.7 162.4 189.6 100.0 131.0 138.6

2005
97.1% 141.9 137.9 193.8 100.0 116.4 124.0

2004
100.0%

Accounts recble., net....... 233.2 Merchandise inventory.... 337.4 Other current assets........ 227.1 Long-term investments....

## 100.0 100.0 100.0 100.0 100.0 100.0

Plant assets, net............... 257.7 Total assets...................... 247.3 Current liabilities.............. 411.7 Long-term liabilities......... 306.2 Common stock................. 128.6 Other paid-in capital......... 128.6 Retained earnings............ 321.0 Total liabilities & equity. . . 247.3
McGraw-Hill Companies, 2009 164

## Fundamental Accounting Principles, 19th Edition

Problem 17-2A (concluded) Part 2 Analysis and Interpretation The statements and the trend percent data indicate that the company significantly expanded its plant assets in 2008. Prior to that time, the company enjoyed increasing gross profit and net income. Sales grew steadily for the entire period of 2004 to 2010. However, beginning in 2008, cost of goods sold and operating expenses increased dramatically relative to sales, resulting in a significant reduction in net income. In 2010 net income was only 50% of the 2004 base year amount. At the same time that net income was declining, assets were increasing. This indicates that the company 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 2008 to 2010, but cash steadily declined and inventory sharply increased as did current liabilities.

## Problem 17-3A (60 minutes)

Transaction Current Assets Quick Assets Current Liabilities Current Acid-Test Ratio Ratio Working Capital

Beginning* May 2 Bal. May 8 Bal. May 10 Bal. May 15 Bal. May 17 Bal. May 22 Bal. May 26 Bal. May 27 Bal. May 28 Bal. May 29 Bal.

\$884,000 + 70,000 954,000 +130,000 - 60,000 1,024,000 + 30,000 - 30,000 1,024,000 - 31,000 993,000 + 0 993,000 _______ 993,000 - 67,000 926,000 + 85,000 1,011,000 + 100,000 1,111,000 - 185,000 \$926,000

\$510,000 _______ 510,000 +130,000 _______ 640,000 + 30,000 - 30,000 640,000 - 31,000 609,000 + 0 609,000 _______ 609,000 - 67,000 542,000 + 85,000 627,000 +100,000 727,000 - 185,000 \$542,000

\$340,000 + 70,000 410,000 _______ 410,000 _______ 410,000 - 31,000 379,000 _______ 379,000 + 67,000 446,000 - 67,000 379,000 + 85,000 464,000
________

2.60 ____ 2.33 ____ 2.50 ____ 2.50 ____ 2.62 ____ 2.62 ____ 2.23 ____ 2.44 ____ 2.18 ____ 2.39 ____ 2.00

1.50 \$544,000 ____ 1.24 ____ 1.56 ____ 1.56 ____ 1.61 ____ 1.61 ____ 1.37 ____ 1.43 ____ 1.35 ____ 1.57 ____ 1.17 _______ 544,000 _______ 614,000 _______ 614,000 _______ 614,000 _______ 614,000 _______ 547,000 _______ 547,000 _______ 547,000 _______ 647,000 _______ \$462,000

464,000
________

\$464,000

*Beginning balances Current assets (given)............................... Current liabilities (\$884,000 / 2.60)............ Quick assets (\$340,000 x 1.50)..................

## McGraw-Hill Companies, 2009 166 Fundamental Accounting Principles, 19th Edition

Problem 17-4A (50 minutes) 1. Current ratio \$20,000 + 8,200 + \$29,400 + \$7,000 + \$34,150 + \$2,700 \$21,500 + \$4,400 + \$3,700 = 3.4 to 1

2.

Acid-test ratio \$20,000 + \$8,200 + \$29,400 + \$7,000 \$21,500 + \$4,400 + \$3,700 = 2.2 to 1

3.

4.

5.

6.

7.

8.

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 167

Problem 17-4A (Concluded) 9. Total asset turnover \$456,600 = 1.95 times (\$248,750 + \$219,400)/2

## Problem 17-5A (60 minutes) Part 1 Karto Company a. Current ratio

\$156,240* \$63,340 = 2.5 to 1
*\$19,500 + \$36,400 + \$9,400 + \$84,740 + \$6,200 = \$156,240 **\$36,000 + \$53,400 + \$7,600 + \$134,500 + \$7,250 = \$238,750

Bryan Company
\$238,750** \$73,819 = 3.2 to 1

b. Acid-test ratio
\$65,300* \$63,340
*\$19,500 + \$36,400 +\$9,400 = \$65,300 **\$36,000 + \$53,400 + \$ 7,600 = \$97,000

= 1.0 to 1

## c. Accounts receivable turnover

\$790,000 (\$36,400 + \$9,400 + \$26,800)/2 = 21.8 times \$897,200 (\$53,400 + \$7,600 + \$51,200)/2 = 16.0 times

d. Inventory turnover
\$588,100 (\$84,740 + \$55,600)/2 = 8.4 times \$634,500 (\$134,500 + \$107,400)/2 = 5.2 times

## e. Days sales in inventory

\$84,740 \$588,100 x 365 = 52.6 days \$134,500 x 365 = 77.4 days \$634,500

## f. Days' sales uncollected

\$36,400 + \$9,400 x 365 = 21.2 days \$790,000 \$53,400 + \$7,600 x 365 = 24.8 days \$897,200

Short-term credit risk analysis: Bryan has both a higher current ratio and acidtest ratio than Karto. However, Karto both turns its merchandise and collects

## McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 169

its accounts receivable much more rapidly than does Bryan. On this basis, Karto is probably the better short-term credit risk.

## Problem 17-5A (Concluded) Part 2 Karto Company a. Profit margin ratio

\$179,115 \$790,000 = 22.7% \$218,931 = 24.4% \$897,200

Bryan Company

## b. Total asset turnover

\$790,000 (\$506,240 + \$408,000)/2 = 1.7 times \$897,200 = 1.9 times (\$546,150 + \$422,500)/2

## c. Return on total assets

\$179,115 (\$506,240 + \$408,000)/2 = 39.2% \$218,931 (\$546,150 + \$422,500)/2 = 45.2%

## d. Return on common stockholders' equity

\$179,115 (\$360,415 + \$314,300)/2 = 53.1% \$218,931 = 65.9% (\$373,331 + \$291,600)/2

e. Price-earnings ratio
\$85 \$4.71 = 18.0 \$85 \$5.58 = 15.2

f. Dividend yield
\$3.50 \$85 = 4.1% \$3.50 \$85 = 4.1%

Investment analysis: Bryan's profit margin ratio, total asset turnover, return on total assets, and return on common stockholders' equity are all higher than Kartos. Although the companies pay the same dividend, Bryan's priceearnings ratio is lower. All of these factors suggest that Bryan's stock is likely the better investment.
McGraw-Hill Companies, 2009 Solutions Manual, Chapter 17 171

Problem 17-6AA (60 minutes) Part 1 Effect of income taxes (debits or losses in parentheses)
Pretax i. Loss from operating a discontinued segment......... 30% Tax Effect After-Tax

## j. Gain on insurance recovery of tornado damage.. .

m.Correction of overstatement of prior years sales... n. Gain on sale of discontinued segments assets......

## 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.......................................... \$483,500 Depreciation expenseEquipment................ 35,000 Depreciation expenseBuildings.................. 53,000 Other operating expenses............................... 107,400 Loss on sale of equipment.............................. 26,850 Loss from settling lawsuit............................... 24,750 Total expenses................................................. Income from continuing operations before taxes.... Income taxes expense (30%).......................... Income from continuing operations after taxes.

## Problem 17-6AA (Concluded) Part 3 Income from discontinued segment

i. n.

Loss from operating a discontinued segment (after-tax)........................................................... Gain on sale of discontinued segments assets (after-tax)............................................................... Income from discontinued segment..................................

## \$ (13,475) 24,500 \$ 11,025

Part 4 Income before extraordinary items Income from continuing oper. after taxes (from Part 2)........ Income from discontinued segment (from Part 3)................. Income before extraordinary items.................................... \$230,300 11,025 \$241,325

Part 5 Net income Income before extraordinary items.................................... Extraordinary item Gain on insurance recovery of tornado damage (aftertax)................................................................................... Net income........................................................................... \$241,325

j.

21,084 \$262,409