Chap 017 Acc

Chapter 17 - Analysis of Financial Statements
Chapter 17
Analysis of Financial Statements
QUESTIONS
1. 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%.
2. 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.
3. 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.
4. The nature of a company's business, the composition of its current assets, and the
turnover of its current assets are three important factors that should be considered in
deciding whether a current ratio is good or bad.
5. A 2-to-1 current ratio may not be adequate if the company's current assets consist of
a large proportion of slow-turning accounts, notes, and merchandise inventory. The
general nature of the business also may make the 2-to-1 rule of thumb inadequate.
6. Adequate working capital enables a company to carry sufficient inventories, meet
current debts, take advantage of cash discounts, and extend favorable terms to
customers. Working capital is a major factor in determining the short-term liquidity
position of a company.
7. When evaluated in light of a company's credit terms, the number of days' sales
uncollected indicates how quickly accounts receivable are converted into cash. This
provides information about the relevance of accounts receivable balances in meeting
the current obligations of the business.
8. A high accounts receivable turnover implies that accounts are collected quickly,
thereby providing cash that can be used to meet obligations. A high turnover also
means that a given sales volume can be supported with a lower investment in
accounts receivable.
9. Users are interested in the capital structure of a company, as measured by debt and
equity ratios, for at least two reasons. First, as a company includes more debt in its
capital structure, the risk that it will be unable to meet interest and principal payments
increases. Second, the existence of debt introduces financial leverage. If the
company can earn a rate of return on its investments that exceeds the rate of interest
paid to creditors, the debt will increase the rate of return to stockholders.
17-1
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 (fiscal 2010 and 2009):
2010: $2,457,144/ (($10,204,409 + $8,101,372)/2) = 26.8%
2009: $1,892,616/ (( $8,101,372 + $5,511,187)/2) = 27.8%
15. Equity ratio (2009):
$(413,865)/$643,236 = (64.3%) [note: negative return ratios are effectively non-interpretable]
Equity ratio (2008):
$111,020/$1,180,262 = 9.4%
16. Debt ratio (2009):
EURm 20,989/ EURm 35,738 = 58.7%
Debt ratio (2008):
EURm 23,072/EURm 39,582 = 58.3%
17. Profit margin (2009):
$8,235/$42,905 = 19.2%
17-2
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.

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.
17-3
Trend percents
2011
175.6%
($201,600 / $114,800)
2010
100.0%
(the given base amount)

Common-size percents
2011
54.2%
($109,200 / $201,600)
2010
52.4%
($60,200 / $114,800)

2011
2010
Short-term investments..... $217,800 $165,000
Accounts receivable..........
42,120
48,000
Notes payable.....................
57,000
Dollar
Change
$52,800
Percent
Change
32.0%
(5,880)
-12.3%
57,000 (not calculable)

Ratio
2011
2010
1. Profit Margin...................................
8%
6%
2. Debt Ratio.......................................
45%
40%
Unfavorable
3. Gross Margin..................................
33%
45%
Unfavorable
4. Acid-test Ratio................................
0.99
1.10
Unfavorable
5. Accounts Receivable Turnover....
5.4
6.6
Unfavorable
6. Basic Earnings Per Share.............
$1.24
$1.20
Favorable
7. Inventory Turnover........................
3.5
3.3
Favorable
8. Dividend Yield................................
1.0%
0.8%
Favorable
17-4
Change
Favorable
Quick-Study 17-7 (30 minutes)

Titan 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 Titan is in a more liquid position than Silverado.
This evidence does not mean that Silverado's liquidity is inadequate. Such
a conclusion would require more information such as norms for the
industry or its other competitors. However, Silverado's acid-test ratio for
2012 is less than the traditional rule of thumb (1 to 1), and has declined
steadily since 2010.
This evidence also shows that Titan'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
Titan holds an excess amount of highly liquid assets that typically earn low
returns.
The accounts receivable turnover and inventory turnover indicate that
Silverado is more efficient in collecting its accounts receivable and in
generating sales from available inventory. However, these statistics also
may suggest that Silverado is too conservative in granting credit and
investing in inventory. This could have a negative impact on sales and net
income. Titans ratios may be acceptable, but no definitive determination
can be made without having information on industry (or other competitors)
standards.
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.
17-5

a. 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.
b. 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 and
we look at the Return on Total Assets ratio. Again, we can potentially
differences in asset values through the IFRS more aggressive methods
to mark up reversals of previous write-downs and through some longterm asset revaluation methods that differ from 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.
17-6
EXERCISES
Exercise 17-1 (10 minutes)
1.
2.
3.
4.
5.
C
A
A
B
B
6.
7.
8.
9.
10.
C
A
B
C
D

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.
Sales................................
Cost of goods sold.........
Accounts receivable......
2013
188
190
191
2012
180
181
183
2011
168
171
174
2010
156
158
162
2009
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 (index for cost of goods
sold is 190 and accounts receivable is 191) compared to sales (index is 188).
17-7

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:
2010 net income percent: 100.0 - 58.1 - 14.1 = 27.8% of sales
Next, notice that if 2010 sales are assumed to be $100, then sales for 2011 are
$103.20 and the sales for 2012 are $104.40. If the net income percents for the
three years are applied to these amounts, the net incomes are:
2010 net income: $100.00 x 27.8% = $27.80
2011 net income: $103.20 x 25.3% = $26.11
2012 net income: $104.40 x 23.3% = $24.33
This shows that net income decreased over the three-year period.
Sales....................................................................
2011
100.0%
2010
100.0%
Cost of goods sold.............................................
66.0
52.4
Gross profit.........................................................
34.0
47.6
Operating expenses...........................................
21.0
19.4
Net income..........................................................
13.0%
28.2%
Analysis: Overall, this companys situation has worsened. This is evident

from the substantial decline in net income as a percent of sales for 2011
(13.0%) relative to 2010 (28.2%). The main culprit is the increase in cost of
goods sold as a percent of sales from 52.4% in 2010 to 66.0% in 2011. On a
somewhat positive note, the company has not experienced as large of an
increase in operating expenses as a percent of sales; from 19.4% in 2010 to
21.0% in 2011. Even more positive is the companys level of sales increase
from $535,000 in 2010 to $720,000 in 2011.
17-8

COMPARATIVE ANALYSIS REPORT
Kent's profit margins are higher than Rolf's.
However, Rolf has
significantly higher total asset turnover ratios. As a result, Rolf 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, Kent's rates of
improvement are better than Rolfs. These differences might result from
the fact that Kent is only three years old, while Rolf is a somewhat more
established company. Kent's operations are considerably smaller than
Rolf's, but that will not persist many more years if both companies
continue to grow at their current rates.
To some extent, Rolf'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 Kent's assets are
newer, they may require smaller maintenance expenses.
Finally, Rolf 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, Kent's return is only 4.3% in
2011 as compared to the 7% interest rate paid to creditors.
17-9

Sanderson Company
Common-Size Comparative Balance Sheets
December 31, 2010-2012
2012
2011*
Cash.................................................................
5.9%
8.0%
2010*
9.9%
Accounts receivable, net................................
17.1
14.0
13.2
Merchandise inventory....................................
21.5
18.5
14.2
Prepaid expenses............................................
1.9
2.1
1.1
Plant assets, net .............................................
53.6
57.3
61.6
100.0%
100.0%
Total assets ..................................................... 100.0%

Accounts payable...........................................
Long-term notes payable secured by
mortgages on plant assets ........................
24.9%
16.9%
13.2%
18.8
23.0
22.1
Common stock, $10 par value.......................
31.4
36.5
43.6
Retained earnings ..........................................
24.9
23.5
21.0
100.0%
100.0%
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 are
more assets at risk of uncollection; it could be favorable if increased sales
outweigh these costs and risks.
(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.
17-10

1.
2.
Current ratio
2012:
$30,800 + $88,500 + $111,500 + $9,700

$128,900
= 1.87 to 1
2011:
$35,625 + $62,500 + $82,500 + $9,375

$75,250
= 2.52 to 1
2010:
$36,800 + $49,200 + $53,000 + $4,000

$49,250
= 2.90 to 1
Acid-test ratio
2012:
$30,800 + $88,500
$128,900
= 0.93 to 1
2011:
$35,625 + $62,500
$75,250
= 1.30 to 1
2010:
$36,800 + $49,200
$49,250
= 1.75 to 1
Analysis and Interpretation: Sanderson's short-term liquidity position has

weakened 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 1.75 to 1
down to 0.93 to 1 and the current ratio shifts from 2.90 to 1 down to 1.87
to 1both suggest a potential liquidity problem. Still, we must recognize
that industry standards could show that the 2010 ratios were too high
(instead of 2012 ratios as being too low).
17-11

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

2012:
$88,500
x 365 = 48.0 days
$672,500
2011:
$62,500
x 365 = 43.0 days
$530,000
Accounts receivable turnover

2012:
$672,500
($88,500 + $62,500)/2
= 8.9 times
2011:
$530,000
($62,500 + $49,200)/2
= 9.5 times
Inventory turnover
2012:
$410,225
= 4.2 times
($111,500 + $82,500)/2
2011:
$344,500
($82,500 + $53,000)/2
= 5.1 times
Days sales in inventory

2012:
$111,500
$410,225
x 365 = 99 days
2011:
$82,500
$344,500
x 365 = 87 days
Analysis and Interpretation: The number of days' sales uncollected has

increased and the accounts receivable turnover has declined. Also, the
inventory turnover has decreased and days sales in inventory has
increased. While none of these changes in ratios that occurred from 2011
to 2012 appear dramatic, it seems that Sanderson is becoming less
efficient in managing its inventory and in collecting its receivables.
17-12

1. Debt and equity ratios
2012
2011
Total liabilities and debt ratio

$128,900 + $97,500................
$226,40
0
43.7%
$75,250 + $102,500................
$177,750
39.9%
Total equity and equity ratio

$162,500 + $129,100..............
291,600
56.3
$162,500 + $104,750.............. _______
____
Total liabilities and equity.......
$518,00
100.0%
267,250
60.1
$445,000 100.0%
0
2. Debt-to-equity ratio
2012: $226,400 / $291,600 = 0.78 to 1
2011: $177,750 / $267,250 = 0.67 to 1
3. Times interest earned
2012: ($34,100 + $8,525 + $11,100) / $11,100 = 4.8 times
2011: ($31,375 + $7,845 + $12,300) / $12,300 = 4.2 times
Analysis and Interpretation: Sanderson added debt to its capital structure
during 2012, with the result that the debt ratio increased from 39.9% to
43.7%. In addition, the debt-to-equity ratio also increased from 0.67 to 1 to
0.78 to 1. However, the increased profitability of the company allowed it to
increase the times interest earned from 4.2 to 4.8 times. Apparently, the
company is able to handle the increased debt. However, we should note
that the debt increase is entirely in current liabilities, which places a
greater stress on short-term liquidity.
17-13

1.
Profit margin
2012: $34,100 / $672,500 = 5.1%
2011: $31,375 / $530,000 = 5.9%
2.
3.
Total asset turnover

2012:
$672,500
= 1.4 times
($518,000 + $445,000)/2
2011:
$530,000
= 1.3 times
($445,000 + $372,500)/2
Return on total assets

$34,100
2012: ($518,000 + $445,000)/2
= 7.1%
$31,375
2011: ($445,000 + $372,500)/2
= 7.7%
Analysis and Interpretation: Sanderson's operating efficiency appears to

be declining because the return on total assets decreased from 7.7% to
7.1%. While the total asset turnover favorably increased slightly from 2011
to 2012, the profit margin unfavorably decreased from 5.9% to 5.1%. The
decline in profit margin indicates that Sanderson's ability to generate net
income from sales has declined.
17-14

1.
2.
Return on common stockholders' equity

2012:
$34,100
($291,600 + $267,250)/2
= 12.2%
2011:
$31,375
($267,250 + $240,750)/2
= 12.4%
Price-earnings ratio, December 31

2012: $15 / $2.10 = 7.1
2011: $14 / $1.93 = 7.3
3.
Dividend yield
2012: $0.30 / $15 = 2.0%
2011: $0.15 / $14 = 1.1%
Analysis and interpretation

This companys return on common stockholders equity is good, but not
great. A roughly 12% return makes it an acceptable investment
provided its risk is not too high.
This companys price-earnings ratio is somewhat low as the market has
historically averaged between 10 to 15 for PE. This suggests that the
market does not have high expectations about future earnings or growth
for this company.
The dividend yield is on the low side. This stock is likely considered a
potential growth stockhowever, the price-earnings ratio suggests
that the market does not perceive a high likelihood of growth.
Exercise 17-13A (10 minutes)
1.
A Income (loss) from continuing operations
2.
C Extraordinary gain (loss)
3.
4.
5.
6.
B Gain (loss) from disposing of a discontinued segment
7.
B Income (loss) from operating a discontinued segment
17-15
Income (loss) from continuing operations
17-16

JIN MERCHANDISING, INC.
Income Statement
For Year Ended December 31, 2011
Net sales......................................................................
Expenses
Cost of goods sold.................................................. $1,580,000
Salaries expense.....................................................
640,000
Depreciation expense.............................................
432,500
Total expenses........................................................
Income from continuing operations before taxes...
Income taxes expense...............................................
Income from continuing operations.........................
Discontinued segment
Loss from operating retail business
segment (net of tax).............................................
Gain on sale of retail business
segment (net of tax).............................................
Income before extraordinary gain............................
$3,000,000
2,652,500
347,500
117,000
230,500
(544,000)
875,000
331,000
561,500
Extraordinary gain on condemnation of

company property (net of tax)................................
330,000
Net income..................................................................
$ 891,500

1.
2.
Current ratio =
(in s)
(in $s)
1,646,834 / 567,222
$16,468.348 / $5,672.229
= 2.90
= 2.90
Net profit margin = (in s)

(in $s)
257,342 / 1,672,423
$2,573.426 / $16,724.230
= 15.4%
= 15.4%
Sales-to-assets =
1,672,423 / 1,802,490
$16,724.230 / $18,024.903
= 0.93
= 0.93
(in s)
(in $s)
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.
17-17
PROBLEM SET A
Problem 17-1A (60 minutes)
Part 1
Current ratio:
December 31, 2012: $48,480 / $20,200 = 2.4 to 1

December 31, 2011: $37,924 / $19,960 = 1.9 to 1
December 31, 2010 $50,648 / $19,480 = 2.6 to 1
Part 2
BENNINGTON COMPANY
Common-Size Comparative Income Statements
For Years Ended December 31, 2012, 2011, and 2010
2012
2011
2010
Sales....................................................
100.00%
100.00%
100.00%
Cost of goods sold.............................
60.20
62.50
64.00
Gross profit.........................................
39.80
37.50
36.00
Selling expenses................................
14.12
13.80
13.20
Administrative expenses...................
9.04
8.80
8.25
Total expenses...................................
23.16
22.60
21.45
Income before taxes...........................
16.64
14.90
14.55
Income taxes.......................................
3.10
3.05
2.95
Net income..........................................
13.54%
11.85%
11.60%
17-18
Problem 17-1A (Concluded)

Part 3
BENNINGTON COMPANY
Balance Sheet Data in Trend Percents
December 31, 2012, 2011, and 2010
2012
2011
2010
Assets
Current assets..................................
95.72%
74.88%
100.00%
Long-term investments....................
0.00
13.44
100.00
Plant assets......................................
157.89
168.42
100.00
Total assets.......................................
124.34
120.70
100.00
Liabilities and Equity

Current liabilities..............................
103.70% 102.46%
100.00%
Common stock.................................
133.33
133.33
100.00
Other contributed capital.................
150.00
150.00
100.00
Retained earnings............................
116.91
104.94
100.00
Total liabilities and equity...............
124.34
120.70
100.00
Part 4
Significant relations revealed
Benningtons selling expenses, administrative expenses, and income taxes
took larger portions of each sales dollar in 2011 than 2010. However, because
the cost of goods sold took a smaller portion in 2011, some efficiency was
gained. In 2012 these trends continued. Selling expenses, administrative
expenses, and income taxes continued to take a greater portion of each sales
dollar while the gross profit portion continued to improve.
Bennington expanded its plant assets in 2011, 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 2011 indicates that net income was larger than the reductions from
cash (and perhaps stock) dividends. From the 2012 large income relative to
the smaller increase in retained earnings, it appears cash dividends were paid.
17-19

Part 1
SUGO COMPANY
Income Statement Trends
For Years Ended December 31, 2012-2006
2012
2011
2010
2009
2008
2007
2006
Sales.................................. 192.5% 168.6% 153.4% 140.6% 131.2% 122.0% 100.0%

Cost of goods sold........... 235.8
191.8
165.0
144.4
134.2
125.5
100.0
Gross profit....................... 131.0
135.7
136.8
135.1
126.9
117.0
100.0
Operating expenses......... 265.6
207.8
190.6
140.6
121.9
120.3
100.0
92.5
104.7
131.8
129.9
115.0
100.0
2006
Net income........................
50.5
SUGO COMPANY
Balance Sheet Trends
December 31, 2012-2006
2012
2011
2010
2009
2008
2007
68.7%
88.9%
92.9%
94.9%
99.0%
97.0%
Accounts recble., net....... 233.0
244.7
221.4
169.9
149.5
141.7
100.0
Merchandise inventory.... 337.5
245.4
214.4
181.0
162.3
137.9
100.0
Other current assets........ 242.1
221.1
126.3
231.6
200.0
200.0
100.0
100.0
100.0
100.0
100.0
Plant assets, net............... 257.0
256.2
224.5
126.5
130.7
116.4
100.0
Total assets....................... 247.3
222.9
196.0
144.4
138.6
124.0
100.0
Current liabilities.............. 411.8
346.3
227.2
189.0
164.0
155.1
100.0
Long-term liabilities......... 306.2
266.7
259.5
120.5
123.1
133.3
100.0
Common stock.................. 156.3
156.3
156.3
131.3
131.3
100.0
100.0
Other paid-in capital......... 156.3
156.3
156.3
112.5
112.5
100.0
100.0
Retained earnings............ 262.7
230.8
191.7
176.3
162.1
145.0
100.0
Total liabilities & equity. . . 247.3
222.9
196.0
144.4
138.6
124.0
100.0
Cash...................................
Long-term investments....
17-20
100.0%
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 2010. Prior to that time, the
company enjoyed increasing gross profit and net income.
Sales grew steadily for the entire period of 2006 to 2012. However,
beginning in 2010, cost of goods sold and operating expenses increased
dramatically relative to sales, resulting in a significant reduction in net
income.
In 2012, net income was only 50.5% of the 2006 base year amount.
At the same time that net income was declining, assets were increasing.
This indicates that Sugo 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 2010 to 2012,
but cash steadily declined and inventory sharply increased as did
current liabilities.
17-21

Transaction
Current
Assets
Quick
Assets
Current
Liabilities
Beginning*
$650,000
$286,000
$260,000
2.50
1.10 $390,000
May 2
+ 75,000
_______
+ 75,000
____
____
_______
725,000
286,000
335,000
2.16
0.85
390,000
+103,000
+103,000
- 58,000
_______
_______
____
____
_______
770,000
389,000
335,000
2.30
1.16
435,000
+ 19,000
+ 19,000
- 19,000
- 19,000
_______
____
____
_______
770,000
389,000
335,000
2.30
1.16
435,000
- 21,000
- 21,000
- 21,000
____
____
_______
749,000
368,000
314,000
2.39
1.17
435,000
+0
+0
_______
____
____
_______
Bal.
749,000
368,000
314,000
2.39
1.17
435,000
May 22
_______
_______
+ 40,000
____
____
_______
Bal.
749,000
368,000
354,000
2.12
1.04
395,000
- 40,000
- 40,000
- 40,000
____
____
_______
709,000
328,000
314,000
2.26
1.04
395,000
+ 75,000
+ 75,000
+ 75,000
____
____
_______
784,000
403,000
389,000
2.02
1.04
395,000
+ 90,000
+ 90,000
________
____
____
_______
874,000
493,000
389,000
2.25
1.27
485,000
May 29
- 165,000
- 165,000
________
____
____
_______
Bal.
$709,000
$328,000
$389,000
1.82
0.84
$320,000
Bal.
May 8
Bal.
May 10
Bal.
May 15
Bal.
May 17
May 26
Bal.
May 27
Bal.
May 28
Bal.
*Beginning balances
Current assets (given)...............................
Current liabilities ($650,000 / 2.50)............
Quick assets ($260,000 x 1.10)..................
17-22
Current Acid-Test
Ratio
Ratio
$650,000
260,000
286,000
Working
Capital

1.
Current ratio
$9,000 + $7,400 + $28,200 + $3,500 + $31,150 + $1,650
$16,500 + $2,200 + $2,300
2.
Acid-test ratio
$9,000 + $7,400 + $28,200 + $3,500
$16,500 + $2,200 + $2,300
3.
x 365 = 33.2 days
Inventory turnover
$229,150
($32,400 + $31,150)/2
5.
= 7.2 times

$31,150
$229,150
6.
= 2.3 to 1

$28,200 + $3,500
$348,600
4.
= 3.9 to 1
x 365 = 49.6 days
Debt-to-equity ratio
($16,500 + $2,200 + $2,300 + $62,400) / ($90,000 + $59,800) = 0.56 to 1
7.
Times interest earned

$66,950 / $3,100 = 21.6 times
8.
Profit margin ratio

$48,050
$348,600
= 13.8%
17-23

9.

$348,600
= 1.7 times
($233,200 + $182,400)/2
10.

$48,050
= 23.1%
($233,200 + $182,400)/2
11.

$48,050
= 35.4%
($149,800 + $121,300)/2
17-24

Part 1
Ryan Company
Priest Company
a. Current ratio
$150,440
$60,340 = 2.5 to 1
$233,050
$92,300 = 2.5 to 1
b. Acid-test ratio
= 1.0 to 1
$63,000
$60,340
$95,600
$92,300
= 1.0 to 1
c. Accounts receivable turnover

$660,000
($36,400 + $8,100 + $28,800)/2 = 18.0 times
$780,200
($56,400 + $6,200 + $53,200)/2 = 13.5 times
d. Inventory turnover
$532,500
($131,500 + $106,400)/2 = 4.5 times
$485,100
($83,440 + $54,600)/2 = 7.0 times
e. Days sales in inventory

$83,440
$485,100 x 365 = 62.8 days
$131,500
x 365 = 90.1 days
$532,500
f. Days' sales uncollected

$36,400 + $8,100
x 365 = 24.6 days
$660,000
$56,400 + $6,200
$780,200
x 365 = 29.3 days
Short-term credit risk analysis: Ryan and Priest have essentially equal current
ratios and equal acid-test ratios. However, Ryan both turns its merchandise
and collects its accounts receivable more rapidly than does Priest. On this
basis, Ryan probably is the better short-term credit risk.
17-25

Part 2
Ryan Company
Priest Company
a. Profit margin ratio

$67,770
$660,000 = 10.3%
$105,000
= 13.5%
$780,200
b. Total asset turnover

$660,000
($434,440 + $388,000)/2 = 1.6 times
$780,200
= 1.7 times
($536,450 + $372,500)/2
c. Return on total assets

$67,770
($434,440 + $388,000)/2 = 16.5%
$105,000
($536,450 + $372,500)/2
= 23.1%
d. Return on common stockholders' equity

$67,770
($294,300 + $269,300)/2 = 24.0%
$105,000
= 32.8%
($344,150 + $295,600)/2
e. Price-earnings ratio
$25
$1.94
= 12.9
$25
$2.56
= 9.8
$1.50
$25
= 6.0%
f. Dividend yield
$1.50
$25
= 6.0%
Investment analysis: Priest's profit margin ratio, total asset turnover, return
on total assets, and return on common stockholders' equity are all higher than
Ryan's. Although the companies pay the same dividend, Priest's priceearnings ratio is lower. All of these factors suggest that Priest's stock is likely
the better investment.
17-26
Problem 17-6AA (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.........
(19,250)
(5,775)
(13,475)
j. Gain on insurance recovery of tornado damage..
30,120
9,036
21,084
b. Correction of overstatement of prior years sales...
(17,000)
(5,100)
(11,900)
n. Gain on sale of discontinued segments assets......
35,000
10,500
24,500
Part 2 Income from continuing operations (and its components)

k.
p.
g.
q.
m.
l.
e.
c.
d.
a.
Net sales..........................................................
Interest revenue..............................................
Gain from settling lawsuit..............................
Total revenues and gains...............................
Cost of goods sold..........................................
$483,500
Depreciation expenseMachinery...............
35,000
Depreciation expenseBuildings.................
53,000
Other operating expenses..............................
107,400
Loss on sale of machinery.............................
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.
17-27
$ 999,500
15,000
45,000
1,059,500
(730,500)
329,000
(98,700)
$ 230,300
Problem 17-6AA (Concluded)

Part 3 Income from discontinued segment
i.
n.
Loss from operating a discontinued

segment (after-tax, see part 1)........................................
$ (13,475)
Gain on sale of discontinued segments

assets (after-tax)..............................................................
24,500
Income from discontinued segment (after-tax)...............
$ 11,025
Part 4 Income before extraordinary items

Income from continuing oper. after taxes (from Part 2)......
$230,300
Income from discontinued segment (from Part 3)...............
11,025
Income before extraordinary items...................................
$241,325
Part 5 Net income
j.
Income before extraordinary items...................................

Extraordinary item
Gain on insurance recovery of tornado damage (aftertax)...................................................................................
$241,325
Net income...........................................................................
$262,409
17-28
21,084
PROBLEM SET B
Problem 17-1B (60 minutes)
Part 1
Current ratio:
December 31, 2012: $55,860 / $23,370 = 2.4 to 1

December 31, 2011: $33,660 / $20,180 = 1.7 to 1
December 31, 2010: $37,300 / $17,500 = 2.1 to 1
Part 2
SAWGRASS CORPORATION
Common-Size Comparative Income Statements*
For Years Ended December 31, 2012, 2011, and 2010
2012
2011
2010
Sales....................................................
100.00%
100.00%
100.00%
Cost of goods sold.............................
55.00
52.20
46.41
Gross profit.........................................
45.00
47.80
53.59
Selling expenses................................
11.85
12.45
13.12
Administrative expenses...................
8.89
9.35
11.53
Total expenses...................................
20.74
21.80
24.65
Income before taxes...........................
24.26
26.00
28.94
Income taxes.......................................
2.53
2.94
2.97
Net income..........................................
21.73%
23.06%
25.97%
* Some totals may not foot due to rounding.
17-29
Problem 17-1B (Concluded)

Part 3
SAWGRASS CORPORATION
Balance Sheet Data in Trend Percents
December 31, 2012, 2011, and 2010
2012
2011
2010
Current assets....................................
149.76%
90.24%
100.00%
Long-term investments......................
0.00
23.28
100.00
Plant assets........................................
142.26
143.33
100.00
Total assets.........................................
131.63
117.16
100.00
Assets
Liabilities and Equity

Current liabilities................................
133.54% 115.31%
100.00%
Common stock...................................
125.00
125.00
100.00
Other contributed capital...................
120.73
120.73
100.00
Retained earnings..............................
137.40
112.09
100.00
Total liabilities and equity.................
131.63
117.16
100.00
Part 4
Significant relations revealed
Sawgrass'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 2011 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 in 2011. However, the current ratio
recovered in 2012. This apparently resulted from profits, limiting the
amount of dividends paid, and the liquidation of long-term investments.
17-30

Part 1
DEUCE COMPANY
Income Statement Trends
For Years Ended December 31, 2012-2006
2012
2011
2010
2009
2008
2007
2006
Sales..................................
68.8%
74.0%
76.0%
81.3%
87.5%
90.6% 100.0%
Cost of goods sold...........
78.3
81.3
82.1
86.3
91.7
93.8
100.0
Gross profit.......................
59.2
66.7
70.0
76.3
83.3
87.5
100.0
Operating expenses.........
73.6
81.6
84.8
90.4
96.0
97.6
100.0
Net income........................
43.5
50.4
53.9
60.9
69.6
76.5
100.0
2008
2007
2006
DEUCE COMPANY
Balance Sheet Trends
December 31, 2012-2006
2012
2011
2010
2009
Cash..................................... 58.6% 62.1% 72.4% 75.9% 86.2%
89.7% 100.0%
Accounts recble., net.......
80.0
84.0
86.7
89.3
93.3
96.0
100.0
Merchandise inventory....
78.8
81.8
84.8
85.9
88.9
90.9
100.0
Other current assets........
80.0
80.0
86.7
93.3
93.3
100.0
100.0
Long-term investments....
26.0
20.0
16.0
100.0
100.0
100.0
100.0
Plant assets, net............... 115.8
116.9
118.6
88.1
90.4
92.7
100.0
Total assets.......................
86.5
87.9
90.1
88.5
91.5
93.7
100.0
Current liabilities..............
51.1
54.1
65.2
66.7
74.1
92.6
100.0
Long-term liabilities.........
32.8
44.0
52.8
55.2
73.6
81.6
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............ 212.5
197.5
177.5
162.5
137.5
106.3
100.0
87.9
90.1
88.5
91.5
93.7
100.0
Total liabilities & equity. . .
86.5
17-31

Part 2
Analysis and Interpretation
The statements and the trend percent data show that sales declined
every year. However, cost of goods sold did not fall as rapidly as sales.
As a result, gross profit fell more rapidly than sales.
Operating expenses fell less rapidly than gross profit, so the final result
was that net income fell to 43.5% 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 2010,
financing this expansion primarily through the liquidation of long-term
investments.
17-32

Transaction
Current
Assets
Quick
Assets
Current
Liabilities
Beginning*
$280,000
$120,000
$100,000
2.80
1.20
$180,000
June 1
+101,000
+101,000
- 62,000
________
________
____
____
_______
319,000
221,000
100,000
3.19
2.21
219,000
+ 78,000
+ 78,000
- 78,000
- 78,000
________
____
____
_______
319,000
221,000
100,000
3.19
2.21
219,000
________ +130,000
____
____
_______
Bal.
June 3
Bal.
June 5
Bal.
June 7
Bal.
June 10
Bal.
June 12
Bal.
June 15
Bal.
+130,000
Current Acid-Test
Ratio
Ratio
Working
Capital
449,000
221,000
230,000
1.95
0.96
219,000
+ 90,000
+ 90,000
+ 90,000
____
____
_______
539,000
311,000
320,000
1.68
0.97
219,000
+180,000
+180,000
_______
____
____
_______
719,000
491,000
320,000
2.25
1.53
399,000
- 280,000
- 280,000
________
____
____
_______
439,000
211,000
320,000
1.37
0.66
119,000
________ ________ + 60,000
____
____
_______
439,000
211,000
380,000
1.16
0.56
59,000
+0
+0
________
____
____
_______
439,000
211,000
380,000
1.16
0.56
59,000
- 11,000
- 11,000
- 11,000
____
____
_______
428,000
200,000
369,000
1.16
0.54
59,000
June 30
- 60,000
- 60,000
- 60,000
____
____
_______
Bal.
$368,000
$140,000
$309,000
1.19
0.45
59,000
June 19
Bal.
June 22
Bal.
*Beginning balances
Current assets (given)............................
Current liabilities ($280,000 / 2.80).........
Quick assets ($100,000 x 1.20)...............
17-33
$280,000
100,000
120,000

1.
Current ratio
$5,100 + $5,900 + $11,100 + $2,000 + $12,500 + $1,000
$10,500 + $2,300 + $1,600
2.
Acid-test ratio
$5,100 + $5,900 + $11,100 + $2,000
$10,500 + $2,300 + $1,600
3.
= 2.6 to 1
= 1.7 to 1

$11,100 + $2,000 x 365 = 22.2 days
$215,500
4.
Inventory turnover
$136,100
= 9.4 times
($12,500 + $16,400)/2
5.

$12,500 x 365 = 33.5 days
$136,100
6.
Debt-to-equity ratio
($10,500 + $2,300 + $1,600 + $25,000) / ($41,000 + $30,100) = 0.55 to 1
7.
Times interest earned

$29,200 / $1,200 = 24.3 times
8.
Profit margin ratio

$25,800 = 12.0%
$215,500
17-34

9.

$215,500
= 2.1 times
($110,500 + $95,900)/2
10.

$25,800
= 25.0%
($110,500 + $95,900)/2
11.

$25,800
($71,100 + $61,300)/2
= 39.0%
17-35

Part 1
Loud Company
Clear Company
a. Current ratio
$215,200
$92,500 = 2.3 to 1
$218,100
$99,000 = 2.2 to 1
$114,700
$92,500 = 1.2 to 1
$122,000
$99,000 = 1.2 to 1
b. Acid-test ratio
c. Accounts (and notes) receivable turnover

$395,600
= 4.7 times
($79,100 + $13,600 + $74,200)/2
$669,500
= 8.4 times
($72,500 + $11,000 + $75,300)/2
d. Inventory turnover
$292,600
($88,800 + $107,100)/2 = 3.0 times
$482,000
($84,000 + $82,500)/2
= 5.8 times
e. Days sales in inventory

$88,800
$292,600 x 365 = 110.8 days
$84,000
$482,000
x 365 = 63.6 days
f. Days' sales uncollected

$79,100 + $13,600
x 365 = 85.5 days
$395,600
$72,500 + $11,000
x 365 = 45.5 days
$669,500
Short-term credit risk analysis: Loud and Clear have nearly equal current
ratios and equal acid-test ratios.
However, Clear both turns its
merchandise and collects its accounts receivable much more rapidly than
Loud. On this basis, Clear probably is the better short-term credit risk.
17-36

Part 2
Loud Company
Clear Company
a. Profit margin ratio

$35,850
$395,600 = 9.1%
$63,700
$669,500
= 9.5%
b. Total asset turnover

$395,600
($394,100 + $385,400)/2
$669,500
= 1.46 times
($472,400 + $445,000)/2
= 1.02 times
c. Return on total assets

$35,850
($394,100 + $385,400)/2
$63,700
= 13.9%
($472,400 + $445,000)/2
= 9.2%
d. Return on common stockholders' equity

$35,850
($206,600 + $186,100)/2
$63,700
($278,100 + $254,700)/2
= 18.3%
= 23.9%
e. Price-earnings ratio
$25
$1.33 = 18.8
$25
= 11.2
$2.23
f. Dividend yield
$3
$25 = 12.0%
$3
= 12.0%
$25
Investment analysis: Clear's profit margin, total asset turnover, return on

total assets, and return on common stockholders' equity are all higher than
Loud's. Also, Clear has a lower price-earnings ratio, while paying the same
dividend. These factors indicate that Clear stock is likely the better
investment.
17-37
Problem 17-6BA (60 minutes)

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

25% Tax
Effect After-Tax
Pretax
e. Loss on hurricane damage...................................
(74,000)
(55,500)
(18,500)
l. Loss from operating a discontinued segment........... (130,000)
(97,500)
(32,500)
n. Correction of overstatement of prior years expense
58,000
14,500
43,500
p. Loss on sale of discontinued segments assets....... (190,000)
(142,500)
(47,500)
Part 2
Income from continuing operations (and its components)
i.
Net sales.............................................................
$2,650,000
h.
Interest revenue.................................................
30,000
j.
Gain from settling lawsuit................................
78,000
Total revenues and gains.................................
2,758,000
o.
Cost of goods sold............................................ $1,050,000
b.
Depreciation expenseBuildings...................
110,000
q.
Depreciation expenseEquipment.................
166,000
a.
Other operating expenses................................
338,000
k.
Loss on sale of building...................................
34,000
c.
Loss from settling lawsuit................................
46,000
d.
Total expenses and losses...............................
1,744,000
Income from continuing operations before taxes
1,014,000
Income taxes expense (25%)............................

Income from continuing operations after taxes...
17-38
(253,500)
$ 760,500
Problem 17-6BA (Concluded)

Part 3
Income from discontinued segment
l.
Loss from operating a discontinued segment (after-tax).......
$ (97,500)
p.
Loss on sale of discontinued segments assets (after-tax). . .
(142,500)
Loss from discontinued segment (after-tax)....................
$(240,000)
Part 4
Income before extraordinary items

Income from cont. oper. after taxes (from Part 2)...............
$ 760,500
Loss from discontinued segment (from Part 3)..................
(240,000)
Income before extraordinary items..................................
$ 520,500
Part 5 Net income

Income before extraordinary items.............................................
$ 520,500
Extraordinary item:
e.
Loss on hurricane damage (after-tax)......................................... (55,500)

Net income.....................................................................................
$ 465,000
17-39
SERIAL PROBLEM SP 17
Serial Problem SP 17, 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
2. Current ratio
Acid-test ratio
3. Debt ratio
Equity 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%
4. Current assets are 79% of total assets ($95,568/$120,268)

Long-term assets are 21% of total assets ($24,700/$120,268)
17-40
Reporting in Action
BTN 17-1
1. Trend percents for selected income statement accounts

Fiscal Year
2010
2009
2008
Revenues.......................................................... 248.8%
184.1%
100.0%
$14,953
$11,065
$6,009
Cost of goods sold.......................................... 285.7%
203.8%
100.0%
$8,369
$5,968
$2,929
Operating expenses........................................ 248.0%
176.1%
100.0%
$3,346
$2,375
$1,349
Income taxes (provision for income taxes). . 156.5%
175.6%
100.0%
$809
$908
$517
Net income....................................................... 189.9%
146.3%
100.0%
$2,457
$1,893
$1,294
2. Common-size percents for asset categories and accounts

Fiscal Year
2010
2009
Total current assets......................................
57.0%
59.8%
$5,813
$4,842
19.2%
16.5%
$1,957
$1,335
13.0%
13.2%
$1,326
Total assets for 2010 and 2009 are $10,204 and $8,101, respectively.
$1,067
Property and equipment, net........................

Intangible assets...........................................
3. For 2010 and 2009, revenues grew at a lower rate than cost of goods
sold. Operating expenses grew slower than revenues for both 2010 and
2009. Consequently, income increased for 2010 and 2009, but at a lower
rate than revenue growth.
The common-size percent figures in part 2 show a shift away from
current assets (59.8% in 2009 vs. 57.0% in 2010) and greater investment
in property and equipment (16.5% in 2009 vs. 19.2% in 2010). Intangible
assets show flat to slightly declined investment (13.2% in 2009 vs. 13.0%
in 2010).
4. Answers depend on the financial statement information obtained.
17-41
Comparative Analysis
BTN 17-2
1.
Key figures ($ millions)
RIM
Apple
Cash and equivalents......
15.2%
$1,551
11.1%
$5,263
Accounts receivable, net.
25.4%
2,594
7.1%
3,361
Inventories........................
6.1%
622
1.0%
455
Retained earnings............
51.7%
5,274
49.2%
23,353
Cost of sales.....................
56.0%
8,369
59.9%
25,683
Revenues..........................
100.0%
14,953
100.0%
42,905
Total assets......................
100.0%
10,204
100.0%
47,501
2. RIMs retained earnings make up a slightly greater percentage of its

total liabilities and equity (51.7%) vis--vis Apple (49.2%).
3. Apples cost of sales percent is slightly higher at 59.9% compared to
RIMs at 56.0%.
This implies that Apple has the lower gross margin ratio on sales of
40.1%), while RIM has the higher gross margin ratio at 44.0%.
4. RIM has the higher percent of total assets in the form of inventory at
6.1%, compared to Apples 1.0%.
17-42
Ethics Challenge
BTN 17-3
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 17-4
There is no set solution to this activity. Each teams memorandum will

vary based on the industry and companies chosen for analysis.
(Instructor: Consider making a transparency of each teams memorandum
for use in a classroom discussion of the findings.)
17-43
Taking It to the Net

($ thousands)
BTN 17-5
As of 12/31/2008
1. Profit margin ratio.....
As of 12/31/2009
$311,405/$5,132,768 = 6.1%
$435,994/$5,298,668 = 8.2%
2. Gross profit ratio....... $1,757,718/ $5,132,768 = 34.2% $2,053,137/$5,298,668 = 38.7%

$311,405 / ([$3,634,719 +
$435,994/ ([$3,675,031 +
3. Return on total
$4,247,113]/2) = 7.9%
$3,634,719]/2) = 11.9%
assets........................
$311,405 / ([$318,199 +
$435,994/ ([$720,459 +
4. Return on common
$592,922]/2) = 68.4%
$318,199]/2) = 84.0%
stockholders equity*.
5. Basic net income per

common share**.........
$1.41
$1.97
*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.
Teamwork in Action
BTN 17-6
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: Amount of
change / Base year [or $60,000/$240,000].)
17-44
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 17.16 to verify the category, measurement, and use of each ratio.
Part 3
Each team member presents results to the entire team.
17-45
Entrepreneurial Decision
BTN 17-7
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 2008, the sales
trend shows that they would equal $125 in 2009 and $137 in 2010. Then,
dividing each sales figure by its ratio of sales to plant assets would give
$33.33 for plant assets in 2008 ($100/ 3.0), $37.88 in 2009 ($125/ 3.3) and
$39.14 in 2010 ($137/ 3.5).
5. No. The percent of return on equity declines from 12.25% in 2008 to
9.75% in 2010.
6. The dollar amount of selling expenses increased in 2009 and decreased
sharply in 2010. Again assuming sales figures of $100 in 2008, $125 in
2009, and $137 in 2010, and multiplying each by its selling expense to
net sales ratio gives $15.30 of selling expenses in 2008, $17.13 in 2009,
and $13.43 in 2010.
Hitting the Road
BTN 17-8
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).
17-46
Global Decision
BTN 17-9
Key figures (in EURm)
NOKIA
Cash and equivalents....................................
3.2%
1,142
Accounts receivable, net...............................
22.3
7,981
Inventories......................................................
5.2
1,865
Retained earnings..........................................
28.4
10,132
Cost of sales...................................................
67.6
27,720
Revenues........................................................
100.0
40,984
Total assets....................................................
100.0
35,738
Comparisons and comments:

NOKIAs cash and receivables is far below that of Research In Motion
and Apple as a percent of assets.
NOKIA has the a higher percentage of accounts receivable as a
percentage of total assets as compared to Apple and is just under that
of Research In Motion.
NOKIAs retained earnings make up a smaller percentage of its total
financing (liabilities and equity) compared to Research In Motion and
Apple.
NOKIAs cost of sales is higher than either of the other two companies.
17-47

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What are the three important factors that should be considered in deciding whether a current ratio is good or bad?

What are the three important factors that should be considered in deciding whether a current ratio is good or bad?

What does inventory turnover reflect on?

What does inventory turnover reflect on?

Chapter 17 - Analysis of Financial Statements

Chapter 17 - Analysis of Financial Statements

Chapter 17 - Analysis of Financial Statements

Quick Study 17-2 (10 minutes)

Chapter 17 - Analysis of Financial Statements

Quick Study 17-3 (5 minutes)

(the given base amount)

Quick Study 17-4 (5 minutes)

Quick Study 17-5 (15 minutes)

57,000 (not calculable)

Quick Study 17-6 (10 minutes)

5. Accounts Receivable Turnover....

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

Chapter 17 - Analysis of Financial Statements

Quick-Study 17-7 (30 minutes)

Quick Study 17-8A (5 minutes)

Chapter 17 - Analysis of Financial Statements

Quick Study 17-9 (10 minutes)

Chapter 17 - Analysis of Financial Statements

Quick Study 17-2 (5 minutes)

Exercise 17-3 (20 minutes)

Chapter 17 - Analysis of Financial Statements

Exercise 17-4 (25 minutes)

Exercise 17-5 (25 minutes)

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

Analysis: Overall, this companys situation has worsened. This is evident

Chapter 17 - Analysis of Financial Statements

Exercise 17-6 (30 minutes)

Chapter 17 - Analysis of Financial Statements

Exercise 17-7 (20 minutes)

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

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

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

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.

Chapter 17 - Analysis of Financial Statements

Exercise 17-8 (25 minutes)

$30,800 + $88,500 + $111,500 + $9,700

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

$36,800 + $49,200 + $53,000 + $4,000

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

Chapter 17 - Analysis of Financial Statements

Exercise 17-9 (25 minutes)

Days' sales uncollected

Accounts receivable turnover

Days sales in inventory

Analysis and Interpretation: The number of days' sales uncollected has

Chapter 17 - Analysis of Financial Statements

Exercise 17-10 (25 minutes)

Total liabilities and debt ratio

Total equity and equity ratio

$162,500 + $104,750.............. _______