Ch14 Full Test Bank Financial Analysis: The Big Picture - Managerial Acct. 9e | Final Test Bank by Jerry J. Weygandt. DOCX document preview.
CHAPTER 14
FINANCIAL ANALYSIS: THE BIG PICTURE
CHAPTER LEARNING OBJECTIVES
1. Apply the concepts of sustainable income and quality of earnings. Sustainable income analysis is useful in evaluating a company’s performance. Sustainable income is the most likely level of income to be obtained by the company in the future and omits unusual items. Discontinued operations and other comprehensive income items are presented separately to highlight their unusual nature. Items below income from continuing operations must be presented net of tax.
A high quality of earnings provides full and transparent information that will not confuse or mislead users of the financial statements. Issues related to quality of earnings are (1) alternative accounting methods, (2) pro forma income, and (3) improper recognition.
2. Apply horizontal analysis and vertical analysis. Horizontal analysis is a technique for evaluating a series of data over a period of time to determine the increase or decrease that has taken place, expressed as either a dollar amount or a percentage.
Vertical analysis is a technique that expresses each item in a financial statement as a percentage of a relevant total or a base amount.
3. Analyze a company's performance using ratio analysis. Financial ratios are provided in Illustration 14.14 (liquidity), Illustration 14.15 (solvency) and Illustration 14.16 (profitability). Analysis is enhanced by intracompany, intercompany, and industry comparisons of these three classes of ratios.
TRUE-FALSE STATEMENTS
1. Analysts are interested in sustainable income, which is equal to the past year’s net income.
2. In evaluating the sustainability of income, it is necessary to separate the results of continuing operations from those of discontinued operations.
3. When a disposal of a significant component of a business occurs, its income statement should report both income (loss) from continuing operations and income (loss) from discontinued operations.
4. Other comprehensive income includes all changes in stockholders’ equity during a period including those changes resulting from investments by stockholders.
5. Companies report the effects of most changes in accounting principle in the period in which the change was made.
6. The gain or loss on the disposal of a significant component of a business is reported in the statement of retained earnings.
7. A change in accounting principle occurs when the principle used by a company in the current year is different from the one used by its competitors in the current year.
8. Comprehensive income includes all changes in stockholders’ equity during a period except those resulting from investments by stockholders and distributions to stockholders.
9. Comprehensive income includes all revenues, expenses, gains, losses, and dividends.
10. Alternative accounting methods affect the quality of earnings.
11. Improper recognition of revenue is not one of the factors affecting the quality of earnings.
12. Because pro forma earnings are based on specific rules, these amounts are highly reliable.
13. In horizontal analysis, the base year is the most current year being examined.
14. Horizontal analysis is a technique for evaluating a financial statement item in the current year relative to other financial statement items in the current year.
15. Another name for horizontal analysis is trend analysis.
16. If a company had sales of $130 in 2023 and $182 in 2021, the percentage decrease in sales from 2023 to 2021 was 40%.
17. In horizontal analysis, if a financial statement item has no value in the base year, and a positive amount in the following year, no percentage change for that item can be computed.
18. A primary purpose of vertical analysis is to observe trends over a three-year period.
19. Vertical analysis is a technique for evaluating a series of financial statement data over a period of time to determine the increase (decrease) that has taken place.
20. Common size analysis expresses each item in a financial statement as a percent of a base amount.
21. In a common size income statement, net sales are represented by 100%.
22. In a common size income statement, each item is expressed as a percentage of net income.
23. In a common size balance sheet, total assets are represented by 100%.
24. In the vertical analysis of a balance sheet, the base for current liabilities is total liabilities.
25. Vertical analysis is useful in making comparisons of companies of different sizes.
26. Using vertical analysis of the income statement, a company's net income as a percentage of net sales is 15%; therefore, the cost of goods sold as a percentage of sales must be 85%.
27. In the vertical analysis of an income statement, each item is generally stated as a percentage of net income.
28. Intracompany comparisons of the same financial statement items can be used to detect changes in financial relationships and significant trends.
29. Comparisons of company data with industry averages provide information about a company's relative position within the industry.
30. Horizontal, vertical, and circular analyses are the basic tools of financial statement analysis.
31. Accounts receivable turnover is useful in assessing the profitability of receivables.
32. Inventory turnover measures the number of times on average the inventory was sold during the period.
33. Inventory turnover is a measure of liquidity that focuses on efficient management of inventory.
34. Profitability ratios are frequently used as a basis for evaluating management's operating effectiveness.
35. A company’s profit margin and its asset turnover both affect its return on assets.
36. Leverage and return on equity are closely related.
37. The return on assets will be greater than the rate of return on common stockholders' equity if the company has been successful in trading on the equity at a gain.
38. The current ratio is one of the most utilized measures of profitability.
39. From a creditor's point of view, the higher the debt to assets ratio, the lower the risk that the company may be unable to pay its obligations.
40. A current ratio of 1.2 to 1 indicates that a company's current assets exceed its current liabilities.
41. Using borrowed money to increase the rate of return on common stockholders' equity is called "trading on the equity."
42. Declining profitability and liquidity ratios are indications that a company may not survive.
43. Liquidity ratios measure the ability of the company to survive over a long period of time.
44. A solvency ratio measures the income or operating success of a company for a given period of time.
45. The current ratio is a measure of all the ratios calculated for the current year.
MULTIPLE CHOICE QUESTIONS
46. Which of the following income statement items would likely be the best indicator of a company’s future performance?
a. Total revenues
b. Income from operations
c. Net income
d. Gross profit
47. Which of the following is the best definition of sustainable income?
a. Sustainable income is a measure of solvency that does not include capital expenditures.
b. Sustainable income is the same as net income.
c. Sustainable income is income that is unusual in nature and infrequent in occurrence.
d. Sustainable income is the most likely level of income to be obtained in the future.
48. When preparing an income statement and statement of comprehensive income, which of the following is the proper order for the statement components?
a. Comprehensive income, Other comprehensive income items, Net income
b. Net income, Comprehensive income, Other comprehensive income items
c. Net income, Other comprehensive income items, Comprehensive income
d. Other comprehensive income items, Net income, Comprehensive income
49. If a company has a discontinued operation gain of $30,000 and a 21% tax rate, what is the effect on net income?
a. Increase of $30,000.
b. Increase of $23,700.
c. Increase of $6,300.
d. No effect.
$75,000 | = 0.25* | $180,000 | = 0.30 | $420,000 | = 0.15 | ||
$300,000 | $600,000 | $2,800,000 |
0.19 = | $620,000 – X |
X |
$400,000 | = 0.125 |
| $400,000 | = 0.133 | |
$3,200,000 | $3,000,000 | ||||
$864,000 | = 0.270 |
| $600,000 | = 0.200 | |
$3,200,000 | $3,000,000 | ||||
(a) Times interest earned = | Income before income taxes and interest expense | ||
Interest expense | |||
= | $565,000 + $285,000 + $300,000(1) | = 3.8 times | |
$300,000 | |||
(1) ($5,000,000 x 6%) = $300,000 | |||
(b) Earnings per share = | Net income - Preferred dividends (2) | ||
Weighted average common shares outstanding | |||
= | $565,000 - $60,000(3) | = $2.53 per share | |
200,000 shares | |||
(2) ($5,000,000 x 6%) = $300,000 (3) ($1,000,000 x 6%) = $60,000 | |||
(c) Price-earnings ratio = | Market price per share | ||
Earnings per share | |||
= | $28 | = 11.1 times | |
$2.53 | |||
Ex. 228
Exeter Corporation had net income of $3,000,000 in 2020. Using 2020 as the base year, net income decreased by 40% in 2021 and increased by 110% in 2022.
Instructions
Compute the net income reported by Exeter Corporation for 2021 and 2022.
Ex. 229
The following items were taken from the financial statements of St. Johns, Inc., over a four-year period:
Item 2022 2021 2020 2019
Net Sales $655,000 $640,000 $575,000 $500,000
Cost of Goods Sold 520,000 480,000 435,000 400,000
Gross Profit $135,000 $160,000 $140,000 $100,000
Instructions
Using horizontal analysis and 2019 as the base year, compute the trend percentages for net sales, cost of goods sold, and gross profit. Explain whether the trends are favorable or unfavorable for each item.
Ex. 230
Here is financial information for Valdez Express Inc.
December 31, 2021 December 31, 2020
Current assets $114,000 $80,000
Property, plant and equipment 414,000 360,000
Current liabilities 91,000 65,000
Long-term liabilities 134,500 90,000
Common stock, $1 par 149,500 115,000
Retained earnings 153,000 170,000
Instructions
Prepare a horizontal analysis for 2021 using 2020 as the base year.
Ex. 231
The comparative income statements of Georgia Development Corporation are as follows:
GEORGIA DEVELOPMENT CORPORATION
Comparative Income Statements
For the Years Ended December 31
December 31, 2021 December 31, 2020
Net sales $600,000 $500,000
Cost of goods sold 414,000 350,000
Gross profit 186,000 150,000
Operating expenses 150,000 120,000
Net income $ 36,000 $ 30,000
Instructions
(a) Prepare a horizontal analysis of the income statement data for Georgia Development Corporation using 2020 as a base. Show the amounts of increase of decrease.
(b) Prepare a vertical analysis of the income statement data for Georgia Development Corporation for both years.
Ex. 232
The comparative balance sheet of Delta Company appears below:
DELTA COMPANY
Comparative Balance Sheet
December 31,
Assets 2021 2020
Current assets $ 450 $280
Property, plant and equipment 550 520
Total assets $1,000 $800
Liabilities and stockholders' equity
Current liabilities $ 180 $120
Long-term debt 250 160
Common stock 310 320
Retained earnings 260 200
Total liabilities and stockholders' equity $1,000 $800
Ex. 232 (Cont.)
Instructions
(a) Using horizontal analysis, show the percentage change for each balance sheet item using 2020 as a base year.
(b) Using vertical analysis, prepare a common size comparative balance sheet.
Ex. 233
The following information was taken from the financial statements of Bjorg Company:
2021 2020
Gross profit on sales $600,000 $680,000
Income before income taxes 230,000 221,000
Net income 180,000 153,000
Net income as a percentage of net sales 10% 9%
Instructions
(a) Compute the net sales for each year.
(b) Compute the cost of goods sold in dollars and as a percentage of net sales for each year.
(c) Compute operating expenses in dollars and as a percentage of net sales for each year. (Note: Income taxes are not operating expenses).
Ex. 234
Operating data for Panola Land Corporation are presented below:
2021 2020
Sales revenue $800,000 $600,000
Cost of goods sold 480,000 390,000
Selling expenses 120,000 78,000
Administrative expenses 80,000 54,000
Income tax expense 24,000 25,000
Net income 96,000 53,000
Instructions
Prepare a schedule showing a vertical analysis for 2021 and 2020.
Ex. 235
Armada Company has these comparative balance sheet data:
ARMADA COMPANY
Balance Sheets
December 31
2021 2020
Cash $ 40,000 $ 30,000
Accounts receivable (net) 65,000 60,000
Inventory 60,000 50,000
Property, plant and equipment (net) 185,000 180,000
$350,000 $320,000
Accounts payable $ 50,000 $ 60,000
Mortgage payable (15%, due in 15 years) 100,000 100,000
Common stock, $10 par 140,000 120,000
Retained earnings 60,000 40,000
$350,000 $320,000
Additional information for 2021:
1. Net income was $25,000.
2. Sales on account were $450,000. Sales returns and allowances amounted to $25,000.
3. Cost of goods sold was $275,000.
4. Net cash provided by operating activities was $49,000.
5. Capital expenditures were $23,000, and cash dividends were $18,000.
Ex. 235 (Cont.)
Instructions
Compute the following ratios at December 31, 2021:
(a) Current ratio. (d) Inventory turnover
(b) Accounts receivable turnover (e) Days in inventory
(c) Average collection period
(a) Current ratio = | $165,000 | = 3.3:1 | ||||
$50,000 | ||||||
(b) Accounts | $425,000* | = 6.8 times | ||||
($65,000 + $60,000) / 2 | ||||||
*($450,000 - $25,000) | ||||||
(c) Average collection period = 365 days ÷ 6.8 = 53.7 days | ||||||
(d) Inventory turnover = | $275,000 | = 5.0 times | ||||
($60,000 + $50,000) / 2 | ||||||
(e) Days in inventory = 365 days ÷ 5.0 = 73 days | ||||||
Ex. 236
The income statement for Ginsberg, Inc. is as follows:
GINSBERG, INC.
Income Statement
For the Year Ended December 31, 2021
Sales revenue $400,000
Cost of goods sold 250,000
Gross profit 150,000
Expenses (including $12,000 interest and $22,000 income taxes) 100,000
Net income $ 50,000
Additional information:
1. Common stock outstanding January 1, 2021 was 30,000 shares and 40,000 shares were outstanding at December 31, 2021.
2. The market price of Ginsberg, Inc., stock was $15.86 in 2021.
3. Cash dividends of $16,000 were paid, $4,500 of which were to preferred stockholders.
Instructions
Compute the following measures for 2021:
(a) Earnings per share (c) Payout ratio
(b) Price-earnings ratio (d) Times interest earned
(a) Earnings per share = | $50,000 - $4,500 | = | $45,500 | = $1.30 | |||||||
(30,000 + 40,000) / 2 | 35,000 | ||||||||||
(b) Price-earnings ratio = | $15.86 | = 12.2 times | |||||||||
$1.30 | |||||||||||
(c) Payout ratio = | $16,000 - $4,500 | = 23% | |||||||||
$50,000 | |||||||||||
(d) Times interest earned = | $50,000 + $12,000 + $22,000 | = | $84,000 | = 7 times | |||||||
$12,000 | $12,000 | ||||||||||
Ex. 237
Belcanto Corporation experienced a fire on December 31, 2021 in which its financial records were partially destroyed. It has been able to salvage some of the records and has ascertained the following balances.
December 31, 2021 December 31, 2020
Cash $ 40,000 $ 15,000
Accounts receivable (net) 84,000 126,000
Inventory 200,000 180,000
Accounts payable 50,000 10,000
Notes payable 30,000 20,000
Common stock, $100 par 400,000 400,000
Retained earnings 170,000 101,000
Additional information is as follows:
1. The inventory turnover is 4.2 times
2. The return on common stockholders' equity is 14%. The company had no additional paid-in-capital.
3. The accounts receivable turnover is 10.2 times.
4. The return on assets is 12.5%.
5. Total assets at Dec. 31, 2020 is $604,750.
Instructions
Compute the following amounts for 2021:
(a) Cost of goods sold
(b) Net credit sales
(c) Net income
(d) Total assets
(a) Inventory turnover = | Cost of goods sold | = 4.2 times | ||
Average inventory | ||||
Cost of goods sold | = 4.2 times | |||
($200,000 + $180,000) / 2 | ||||
Cost of goods sold | = 4.2 times | |||
$190,000 | ||||
$190,000 X 4.2 times | = Cost of goods sold | |||
$798,000 | = Cost of goods sold | |||
(b) Accounts | Net sales (Credit) | = 10.2 | ||
Average net accounts receivable | ||||
Net sales (Credit) | = 10.2 | |||
($126,000 + $84,000) / 2 | ||||
Net sales (Credit) | = 10.2 | |||
$105,000 | ||||
$105,000 X 10.2 | = Net sales (Credit) | |||
$1,071,000 | = Net sales (Credit) | |||
(c) Return on common stockholders' equity | = | Net income - Preferred dividends | = 14% | |
Average common stockholders’ equity | ||||
Net income - $0 | = 14% | |||
($400,000 + $170,000 + $400,000 + $101,000) / 2 | ||||
Net income | = 14% | |||
$535,500 | ||||
$535,500 X 14% | = Net income | |||
$74,970 | = Net income | |||
(d) Return on assets = | Net income | = 12.5% | ||
Average total assets | ||||
$74,970 (See c, above) | = 12.5% | |||
Average total assets | ||||
$74,970 / 12.5% | = Average assets | |||
Solution 237 (Cont.) | $599,760 | = Average assets | ||
($599,760 X 2) - $604,750 | = Total assets 2021 | |||
($1,199,520) - $604,750 | = Total assets 2021 | |||
$594,770 | = Total assets 2021 | |||
Ex. 238
The financial statements of El Camino Company appear below:
EL CAMINO COMPANY
Comparative Balance Sheet
December 31,
Assets 2021 2020
Cash $ 25,000 $ 40,000
Debt investments 20,000 60,000
Accounts receivable (net) 50,000 30,000
Inventory 140,000 170,000
Property, plant and equipment (net) 170,000 200,000
Total assets $405,000 $500,000
Liabilities and stockholders' equity
Accounts payable $ 25,000 $ 30,000
Short-term notes payable 40,000 90,000
Bonds payable 75,000 160,000
Common stock 160,000 145,000
Retained earnings 105,000 75,000
Total liabilities and stockholders' equity $405,000 $500,000
EL CAMINO COMPANY
Income Statement
For the Year Ended December 31, 2021
Net sales (all on credit) $360,000
Cost of goods sold 184,000
Gross profit 176,000
Expenses
Interest expense $11,000
Selling expenses 30,000
Administrative expenses 20,000
Total expenses 61,000
Income before income taxes 115,000
Income tax expense 35,000
Net income $ 80,000
Ex. 238 (Cont.)
Additional information:
a. Cash dividends of $50,000 were declared and paid on common stock in 2021.
b. The weighted-average number of shares of common stock outstanding during 2021 was 50,000.
c. The market price of common stock on December 31, 2021, was $16 per share.
d. Net cash provided by operating activities for 2021 was $70,000.
Instructions
Using the financial statements and additional information, compute the following ratios for the El Camino Company for 2021. Show all computations.
Computations
1. Current ratio _________.
2. Return on common stockholders' equity _________.
3. Price-earnings ratio _________.
4. Inventory turnover _________.
5. Accounts receivable turnover _________.
6. Times interest earned _________.
7. Profit margin _________.
8. Days in inventory _________.
9. Payout ratio _________.
10. Return on assets _________.
Ex. 239
The following ratios have been computed for Southern Company for 2021:
Profit margin ratio 20%
Times interest earned 12 times Current ratio 2.5:1
Accounts receivable turnover 5 times Debt to assets ratio 24%
The 2021 financial statements for Southern Company with missing information follow:
SOUTHERN COMPANY
Comparative Balance Sheet
December 31,
——————————————————————————————————————————
Assets
2021 2020
Cash $ 25,000 $ 35,000
Debt Investments 15,000 15,000
Accounts receivable (net) ? (6) 50,000
Inventory ? (7) 50,000
Property, plant, and equipment (net) 200,000 160,000
Total assets $ ? (8) $310,000
Ex. 239 (Cont.)
Liabilities and stockholders' equity
Accounts payable $ 15,000 $ 25,000
Short-term notes payable 35,000 30,000
Bonds payable ? (9) 20,000
Common stock 200,000 200,000
Retained earnings 47,000 35,000
Total liabilities and stockholders' equity $ ? (10) $310,000
SOUTHERN COMPANY
Income Statement
For the Year Ended December 31, 2021
——————————————————————————————————————————
Net sales $200,000
Cost of goods sold 100,000
Gross profit 100,000
Expenses:
Depreciation expense $ ? (5)
Interest expense 5,000
Selling expenses 10,000
Administrative expenses 15,000
Total expenses ? (4)
Income before income taxes ? (2)
Income tax expense ? (3)
Net income $ ? (1)
Instructions
Use the above ratios and information from the Southern Company financial statements to fill in the missing information on the financial statements. Follow the sequence indicated. Show computations that support your answers.
Ex. 240
B. Jones Corporation has issued common stock only. The company has been successful and has a gross profit rate of 20%. The information shown below was taken from the company's financial statements.
Beginning inventory $ 482,000
Purchases 4,346,000
Ending inventory ?
Average net accounts receivable 700,000
Average common stockholders' equity 3,100,000
Sales revenue (all on credit) 5,600,000
Net income 341,000
Instructions
Compute the following:
(a) Accounts receivable turnover and the average number of days required to collect the accounts receivable
(b) The inventory turnover and the days in inventory
(c) Return on common stockholders' equity
____ 1. | Cost of goods sold | |
Average inventory | ||
____ 2. | Net income | |
Net sales | ||
____ 3. | Cash dividends declared on common stock | |
Net income | ||
____ 4. | Net sales | |
Average total assets | ||
____ 5. | Current assets | |
Current liabilities | ||
____ 6. | 365 days | |
Accounts receivable turnover | ||
____ 7. | Net income − preferred dividends | |
Weighted-Average common shares outstanding | ||
____ 8. | 365 days | |
Inventory turnover | ||
____ 9. | Income before income taxes and interest expense | |
Interest expense | ||
____ 10. | Market price per share | |
Earnings per share | ||