CHAPTER 17
FINANCIAL STATEMENT ANALYSIS
DISCUSSION QUESTIONS
1. Horizontal analysis is the percentage analysis of increases and decreases in corresponding
statements. The percent change in the cash balances at the end of the preceding year from the
end of the current year is an example. Vertical analysis is the percentage analysis showing the
relationship of the component parts to the total in a single statement. The percent of cash as a
portion of total assets at the end of the current year is an example.
2. Comparative statements provide information as to changes between dates or periods. Trends
indicated by comparisons may be far more significant than the data for a single date or
period.
3. Before this question can be answered, the increase in net income should be compared with
changes in sales, expenses, and assets devoted to the business for the current year. The return
on assets for both periods should also be compared. If these comparisons indicate favorable
trends, the operating performance has improved; if not, the apparent favorable increase in net
income may be offset by unfavorable trends in other areas.
4. Generally, the two ratios would be very close, because most service businesses sell services
and hold very little inventory.
5. a. A high inventory turnover minimizes the amount invested in inventories, thus freeing
funds for more advantageous use. Storage costs, administrative expenses, and losses
caused by obsolescence and adverse changes in prices are also kept to a minimum.
b. Yes. The inventory turnover relates to the “turnover” of inventory during the year, while
the number of days’ sales in inventory relates to the amount of inventory on hand at the
beginning and end of the year. Therefore, a business could have a high inventory turnover
during the year, yet have a high number of days’ sales in inventory based on the
beginning and end-of-year inventory amounts.
6. The ratio of fixed assets to long-term liabilities increased from 3.4 for the preceding year to
4.2 for the current year, indicating that the company is in a stronger position now than in the
preceding year to borrow additional funds on a long-term basis.
7. a. The rate earned on total assets adds interest expense to the net income, which is divided
by average total assets. It measures the profitability of the total assets, without regard for how
the assets are financed. The rate earned on stockholders’ equity divides net income by the
average total stockholders’ equity. It measures the profitability of the stockholders’
investment.
b. The rate earned on stockholders’ equity is normally higher than the rate earned on total
assets. This is because of leverage, which compensates stockholders for the higher risk of
their investments.
17-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 17 Financial Statement Analysis
DISCUSSION QUESTIONS (Concluded)
8. a. Due to leverage, the rate on stockholders’ equity will often be greater than the rate on
total assets. This occurs because the amount earned on assets acquired through the use of
funds provided by creditors exceeds the interest charges paid to creditors.
b. Higher. The concept of leverage applies to preferred stock as well as debt. The rate earned
on common stockholders’ equity ordinarily exceeds the rate earned on total stockholders’
equity because the amount earned on assets acquired through the use of funds provided by
preferred stockholders normally exceeds the dividends paid to preferred stockholders.
9. The earnings per share in the preceding year were $3 per share ($6/2), adjusted for the
stock split in the latest year. McCants’ earnings per share has deteriorated.
10. One report is the Report on Internal Control, which verifies management’s conclusions on
internal control. Another report is the Report on Fairness of the Financial Statements of
Independent Registered Public Accounting Firm, where the Certified Public Accounting
(CPA) firm that conducts the audit renders an opinion on the fairness of the statements.
17-2
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
, CHAPTER 17 Financial Statement Analysis
PRACTICE EXERCISES
PE 17–1A
Temporary investments……… $6,400 increase ($46,400 – $40,000), or 16%
Inventory.......................................$6,400 decrease ($73,600 – $80,000), or –8%
PE 17–1B
Accounts payable….....................$11,000 increase ($111,000 – $100,000), or 11%
Long-term debt.............................$8,680 increase ($132,680 – $124,000), or 7%
PE 17–2A
Amount Percentage
Sales……………………………… $850,000 100% ($850,000 ÷ $850,000)
Cost of goods sold…………… 493,000 58% ($493,000 ÷ $850,000)
Gross profit…………………… $357,000 42% ($357,000 ÷ $850,000)
PE 17–2B
Amount Percentage
Sales…………………………… $1,200,000 100% ($1,200,000 ÷ $1,200,000)
Cost of goods sold…………… 780,000 65% ($780,000 ÷ $1,200,000)
Gross profit……………………… $ 420,000 35% ($420,000 ÷ $1,200,000)
PE 17–3A
a. Current Ratio = Current Assets ÷ Current Liabilities
Current Ratio = ($130,000 + $50,000 + $60,000 + $120,000) ÷ $150,000
Current Ratio = 2.4
b. Quick Ratio = Quick Assets ÷ Current Liabilities
Quick Ratio = ($130,000 + $50,000 + $60,000) ÷ $150,000
Quick Ratio = 1.6
17-3
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
, CHAPTER 17 Financial Statement Analysis
PE 17–3B
a. Current Ratio = Current Assets ÷ Current Liabilities
Current Ratio = ($210,000 + $120,000 + $110,000 + $160,000) ÷ $200,000
Current Ratio = 3.0
b. Quick Ratio = Quick Assets ÷ Current Liabilities
Quick Ratio = ($210,000 + $120,000 + $110,000) ÷ $200,000
Quick Ratio = 2.2
PE 17–4A
a. Accounts Receivable Turnover = Net Sales ÷ Average Accounts Receivable
Accounts Receivable Turnover = $1,200,000 ÷ $100,000
Accounts Receivable Turnover = 12.0
Average Accounts Receivable
b. Number of Days’ Sales in Receivables =
Average Daily Sales
Number of Days’ Sales in Receivables = $100,000 ÷ ($1,200,000 ÷
365)
= $100,000 ÷ $3,288
Number of Days’ Sales in Receivables = 30.4 days
PE 17–4B
a. Accounts Receivable Turnover = Net Sales ÷ Average Accounts Receivable
Accounts Receivable Turnover = $3,150,000 ÷ $210,000
Accounts Receivable Turnover = 15.0
b. Number of Days’ Sales in Receivables =
Average Daily Sales
Number of Days’ Sales in Receivables = $210,000 ÷ ($3,150,000 ÷ 365)
= $210,000 ÷ $8,630
Number of Days’ Sales in Receivables = 24.3 days
17-4
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
FINANCIAL STATEMENT ANALYSIS
DISCUSSION QUESTIONS
1. Horizontal analysis is the percentage analysis of increases and decreases in corresponding
statements. The percent change in the cash balances at the end of the preceding year from the
end of the current year is an example. Vertical analysis is the percentage analysis showing the
relationship of the component parts to the total in a single statement. The percent of cash as a
portion of total assets at the end of the current year is an example.
2. Comparative statements provide information as to changes between dates or periods. Trends
indicated by comparisons may be far more significant than the data for a single date or
period.
3. Before this question can be answered, the increase in net income should be compared with
changes in sales, expenses, and assets devoted to the business for the current year. The return
on assets for both periods should also be compared. If these comparisons indicate favorable
trends, the operating performance has improved; if not, the apparent favorable increase in net
income may be offset by unfavorable trends in other areas.
4. Generally, the two ratios would be very close, because most service businesses sell services
and hold very little inventory.
5. a. A high inventory turnover minimizes the amount invested in inventories, thus freeing
funds for more advantageous use. Storage costs, administrative expenses, and losses
caused by obsolescence and adverse changes in prices are also kept to a minimum.
b. Yes. The inventory turnover relates to the “turnover” of inventory during the year, while
the number of days’ sales in inventory relates to the amount of inventory on hand at the
beginning and end of the year. Therefore, a business could have a high inventory turnover
during the year, yet have a high number of days’ sales in inventory based on the
beginning and end-of-year inventory amounts.
6. The ratio of fixed assets to long-term liabilities increased from 3.4 for the preceding year to
4.2 for the current year, indicating that the company is in a stronger position now than in the
preceding year to borrow additional funds on a long-term basis.
7. a. The rate earned on total assets adds interest expense to the net income, which is divided
by average total assets. It measures the profitability of the total assets, without regard for how
the assets are financed. The rate earned on stockholders’ equity divides net income by the
average total stockholders’ equity. It measures the profitability of the stockholders’
investment.
b. The rate earned on stockholders’ equity is normally higher than the rate earned on total
assets. This is because of leverage, which compensates stockholders for the higher risk of
their investments.
17-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 17 Financial Statement Analysis
DISCUSSION QUESTIONS (Concluded)
8. a. Due to leverage, the rate on stockholders’ equity will often be greater than the rate on
total assets. This occurs because the amount earned on assets acquired through the use of
funds provided by creditors exceeds the interest charges paid to creditors.
b. Higher. The concept of leverage applies to preferred stock as well as debt. The rate earned
on common stockholders’ equity ordinarily exceeds the rate earned on total stockholders’
equity because the amount earned on assets acquired through the use of funds provided by
preferred stockholders normally exceeds the dividends paid to preferred stockholders.
9. The earnings per share in the preceding year were $3 per share ($6/2), adjusted for the
stock split in the latest year. McCants’ earnings per share has deteriorated.
10. One report is the Report on Internal Control, which verifies management’s conclusions on
internal control. Another report is the Report on Fairness of the Financial Statements of
Independent Registered Public Accounting Firm, where the Certified Public Accounting
(CPA) firm that conducts the audit renders an opinion on the fairness of the statements.
17-2
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
, CHAPTER 17 Financial Statement Analysis
PRACTICE EXERCISES
PE 17–1A
Temporary investments……… $6,400 increase ($46,400 – $40,000), or 16%
Inventory.......................................$6,400 decrease ($73,600 – $80,000), or –8%
PE 17–1B
Accounts payable….....................$11,000 increase ($111,000 – $100,000), or 11%
Long-term debt.............................$8,680 increase ($132,680 – $124,000), or 7%
PE 17–2A
Amount Percentage
Sales……………………………… $850,000 100% ($850,000 ÷ $850,000)
Cost of goods sold…………… 493,000 58% ($493,000 ÷ $850,000)
Gross profit…………………… $357,000 42% ($357,000 ÷ $850,000)
PE 17–2B
Amount Percentage
Sales…………………………… $1,200,000 100% ($1,200,000 ÷ $1,200,000)
Cost of goods sold…………… 780,000 65% ($780,000 ÷ $1,200,000)
Gross profit……………………… $ 420,000 35% ($420,000 ÷ $1,200,000)
PE 17–3A
a. Current Ratio = Current Assets ÷ Current Liabilities
Current Ratio = ($130,000 + $50,000 + $60,000 + $120,000) ÷ $150,000
Current Ratio = 2.4
b. Quick Ratio = Quick Assets ÷ Current Liabilities
Quick Ratio = ($130,000 + $50,000 + $60,000) ÷ $150,000
Quick Ratio = 1.6
17-3
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
, CHAPTER 17 Financial Statement Analysis
PE 17–3B
a. Current Ratio = Current Assets ÷ Current Liabilities
Current Ratio = ($210,000 + $120,000 + $110,000 + $160,000) ÷ $200,000
Current Ratio = 3.0
b. Quick Ratio = Quick Assets ÷ Current Liabilities
Quick Ratio = ($210,000 + $120,000 + $110,000) ÷ $200,000
Quick Ratio = 2.2
PE 17–4A
a. Accounts Receivable Turnover = Net Sales ÷ Average Accounts Receivable
Accounts Receivable Turnover = $1,200,000 ÷ $100,000
Accounts Receivable Turnover = 12.0
Average Accounts Receivable
b. Number of Days’ Sales in Receivables =
Average Daily Sales
Number of Days’ Sales in Receivables = $100,000 ÷ ($1,200,000 ÷
365)
= $100,000 ÷ $3,288
Number of Days’ Sales in Receivables = 30.4 days
PE 17–4B
a. Accounts Receivable Turnover = Net Sales ÷ Average Accounts Receivable
Accounts Receivable Turnover = $3,150,000 ÷ $210,000
Accounts Receivable Turnover = 15.0
b. Number of Days’ Sales in Receivables =
Average Daily Sales
Number of Days’ Sales in Receivables = $210,000 ÷ ($3,150,000 ÷ 365)
= $210,000 ÷ $8,630
Number of Days’ Sales in Receivables = 24.3 days
17-4
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
