Solution manual accounting principles 9e by kieso kimmel chapter 18

The industry averages basis provides information as to a company’s relative performance within the industry.. In this approach, the amount of the item on one statement is compared with t

CHAPTER 18

Financial Statement Analysis

ASSIGNMENT CLASSIFICATION TABLE

Brief Exercises Do It! Exercises Problems

1 Discuss the need for comparative

3 Explain and apply horizontal analysis 3, 4, 5, 25 2, 3, 5, 6, 7 6 1, 3, 4

4 Describe and apply vertical analysis 3, 4, 5, 25 2, 4, 8 3, 4, 5,

6, 7

2, 3, 4 1

5 Identify and compute ratios used

in analyzing a firm’s liquidity,

profitability, and solvency.

6 Understand the concept of earning

power, and how irregular items are

ASSIGNMENT CHARACTERISTICS TABLE

Problem

Difficulty Level

Time Allotted (min.)

1 Prepare vertical analysis and comment on profitability Simple 20–30

2 Compute ratios from balance sheet and income statement Simple 20–30

3 Perform ratio analysis, and evaluate financial position

and operating results.

4 Compute ratios, and comment on overall liquidity and

profitability.

5 Compute selected ratios, and compare liquidity, profitability,

and solvency for two companies.

7 Compute missing information given a set of ratios Complex 30–40

8 Prepare income statement with discontinued operations

and extraordinary loss.

9 Prepare income statement with nontypical items Moderate 30–40

WEYGANDT ACCOUNTING PRINCIPLES 9E

CHAPTER 18 FINANCIAL STATEMENT ANALYSIS

FINANCIAL STATEMENT ANALYSIS (Continued)

BLOOM’S TAXONOMY TABLE

Q18-4 BE18-2 BE18-3 BE18-5 BE18-6 BE18-7 DI18-1 E18-1 E18-3 E18-4

Describe and apply vertical analy

BE18-2 Q18-25 Q18-3 DI18-4

Q18-4 BE18-2 BE18-4 BE18-8

E18-2 E18-3 E18-4

E18-8 E18-9 E18-10 P18-2 P18-3 P18-6 BE18-11 BE18-12 BE18-13 E18-5 E18-11 P18-1 P18-2 P18-3 P18-4 P18-5 P18-7

earning power, and how irregular items are pre

ANSWERS TO QUESTIONS

creditors are primarily interested in the liquidity of the enterprise In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.

basis, and an industry average basis (or norms).

the current year with the same item or relationship in one or more prior years.

with industry averages (or norms) published by financial rating services.

the same item or relationship in one or more competing companies.

and significant trends within a company.

The industry averages basis provides information as to a company’s relative performance

within the industry.

The intercompany basis of comparison provides insight into a company’s competitive position.

decrease of an item over a period of time In this approach, the amount of the item on one statement

is compared with the amount of that same item on one or more earlier statements Vertical analysis (also called common-size analysis) expresses each item within a financial statement in terms of a percent of a base amount.

is expressed in terms of either a percentage (200%), a rate (2 times), or a simple proportion (2:1) Ratios can provide clues to underlying conditions that may not be apparent from individual financial statement components The ratio is more meaningful when compared to the same ratio in earlier periods or to competitors’ ratios or to industry ratios.

comparison with: (1) past ratios of the same company, (2) ratios of other companies, or (3) industry norms or predetermined standards In addition, other ratios of the enterprise are necessary to determine overall financial well-being.

and to meet unexpected needs for cash.

Questions Chapter 18 (Continued)

investments, and net receivables to current liabilities The current ratio includes inventory and prepaid expenses while the acid-test ratio excludes these The acid-test ratio provides additional information about short-term liquidity and is an important complement to the current ratio.

misleading in that some companies encourage credit and revolving charge sales and slow collections

in order to earn a healthy return on the outstanding receivables in the form of high rates of interest.

earnings In this question, investors favor Microsoft because it has the higher P/E ratio The investors feel that Microsoft will be able to generate even higher future earnings and so the investors are willing to pay more for the stock.

often low because the company is reinvesting earnings in the business.

sales is going towards income.

to sell the inventory and consequently there is a greater chance of inventory obsolescence.

to meet maturing short-term obligations.

company because it could mean a decrease in net income If there is an increase in stockholders’ investment (as a result of issuing additional shares) and a decrease in EPS, then this means that the additional investment is earning a lower return (as compared to the return on common equity before the additional investment) Generally, this is undesirable.

market price per share of stock has increased and investors are willing to pay that higher price for the stock An increase in the P/E ratio is good news for investors who own the stock and don’t want to buy any more It is bad news for investors who want to buy (or buy more of) the stock.

has increased its obligations to creditors and has lowered its equity “buffer.”

ability to meet interest payments as they come due has weakened.

Questions Chapter 18 (Continued)

(7.6%)

=

Assets Average

Income Net

Return on common stockholders’ equity

(12.8%)

=

Equity rs' Stockholde Common

Average

Dividends Preferred

– Income Net

The difference between the two rates can be explained by looking at the denominator value and

by remembering the basic accounting equation, A = L + SE The asset value will clearly be the larger

of the two denominator values; therefore, it will also give the smaller return.

payments, and the debt to total assets ratio, which indicates the company’s ability to withstand losses without impairing the interests of creditors.

debt-paying ability.

power of the investment.

subtracted from net income in computing EPS in order to obtain income available to common stockholders.

than it is able to earn by using the borrowed money Simply stated, it is using money supplied

by nonowners to increase the return to the owners.

indicates the profitability of trading on the equity.

19.

g outstandin shares

common average

Weighted

dividends Preferred

– income Net

= Earnings per share

50,000

00 = $2.40

EPS of $2.40 is high relative to what? Is it high relative to last year’s EPS? The president may be comparing the EPS of $2.40 to the market price of the company’s stock.

the stopping of an entire activity or eliminating a major class of customers It is important to report discontinued operations separately from continuing operations because the discontinued component will not affect future income statements.

than EPS on net income Income before extraordinary items represents the results of continuing and ordinary business activity It is therefore a better basis for predicting future operating results than an EPS figure which includes the effect of extraordinary items that are not expected to recur again in the foreseeable future.

Questions Chapter 18 (Continued)

Therefore, an extraordinary item is a one-time item which is not typical of the company’s operations When comparing EPS trends, extraordinary items should be omitted since they are not reflective

of normal operations In this example, the trend is unfavorable because EPS, exclusive of extraordinary items, has decreased from $3.20 to $2.99.

generally accepted accounting principles may hamper comparability.

by excluding items that the company believes are unusual or nonrecurring It is often difficult

to determine what was included and excluded.

involve recording items in the wrong period.

Horizontal Analysis: Financial Highlights; Results of operations-consolidated reviews; Result of Operations–Division Review; and Reconciliation of GAAP and Non-GAAP information.

Vertical Analysis: Pie charts; Asset category allocation; and Reconciliation of GAAP and GAAP information.

Non-SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 18-1

Dear Uncle Frank,

It was so good to hear from you! I hope you and Aunt Irene are still enjoying your new house.

You asked some interesting questions They relate very well to the material that we are studying now in my financial accounting class You said you heard that different users of financial statements are interested in different characteristics of companies This is true A short-term creditor, such as a bank,

is interested in the company’s liquidity, or ability to pay obligations as they become due The liquidity of a borrower is extremely important in evaluating the safety of a loan A long-term creditor, such as a bondholder, would be interested in solvency, the company’s ability to survive over a long period

of time A long-term creditor would also be interested in profitability They are interested in the likelihood that the company will survive over the life of the debt and be able to meet interest payments Stockholders are also interested

in profitability, and in the solvency of the company They want to assess the likelihood of dividends and the growth potential of the stock.

It is important to compare different financial statement elements to other items The amount of a financial statement element such as cash does not have much meaning unless it is compared to something else Comparisons can

be done on an intracompany basis This basis compares an item or financial relationship within a company for the current year to one or more previous years Intracompany comparisons are useful in detecting changes in financial relationships and significant trends Comparisons can also be done with industry averages This basis compares an item or financial relationship with industry averages or norms Comparisons with industry averages provide information as to a company’s relative performance within the industry Finally, comparisons can be done on an intercompany basis This basis compares

an item or financial relationship with the same item or relationship in one or more competing companies Intercompany comparisons are useful in determining

a company’s competitive position.

I hope this answers your questions If it does not, or you have more questions, please write me again or call We could even meet for lunch sometime; it would be great to see you!

Love,

Your niece (or nephew)

evalu-(b) Horizontal Analysis

2009 2010 2011 Current assets 100% 115% 120%

(115 = $230,000/$200,000; 120 = $240,000/$200,000)

Vertical Analysis

2009 2010 2011 Current assets* 40% 38% 39%

*as a percentage of total assets (40% = $200,000/$500,000; 38% = $230,000/$600,000;

39% = $240,000/$620,000)

Ratio Analysis

2009 2010 2011 Current ratio 1.25 1.37 1.30

400,000 = 30 600,000

240,000

= 40 500,000

2,500,000 = 20

BRIEF EXERCISE 18-4

Vertical analysis:

Dec 31, 2011 Dec 31, 2010 Amount Percentage* Amount Percentage** Accounts receivable

* 520,000

3,000,000 = 173

** 400,000 2,500,000 = 16

* 840,000

3,000,000 = 28

** 600,000 2,500,000 = 24

BRIEF EXERCISE 18-5

2011 2010 2009 Net income $522,000 $450,000 $500,000

Increase or (Decrease) Amount Percentage (a)

BRIEF EXERCISE 18-6

2011 2010 Increase Net income $585,000 X 30%

X 30 = 585,000 – X

X

30X = 585,000 – X

BRIEF EXERCISE 18-6 (Continued)

BRIEF EXERCISE 18-8

2011 2010 2009 Sales

Cost of goods sold

Expenses

Net income

100.0 59.2 25.0 15.8

100.0 62.4 25.6 12.0

100.0 64.5 27.5 8.0

Net income as a percent of sales for Charles increased over the three-year period because cost of goods sold and expenses both decreased as a percent

of sales every year.

BRIEF EXERCISE 18-9 (Continued)

(b) Current ratio:

Current assets Current liabilities =

$45,918,000

$40,644,000

= 1.13:1 (c) Acid-test ratio:

Cash + Short-term investments

+ Rec ceivables (net)

BRIEF EXERCISE 18-11

(a) Receivables turnover = Net credit sales

Average net receivables

365 6.2 = 58.9 days

(b) Marino Company should be pleased with the effectiveness of its credit and collection policies The company has decreased the average collection period by 9.6 days and the collection period of approximately 49 days

is well within the 60 days allowed in the credit terms.

BRIEF EXERCISE 18-12

(a) Inventory turnover =

inventory Average

sold goods of

BRIEF EXERCISE 18-12 (Continued)

(b) Management should be concerned with the fact that inventory is moving slower in 2011 than it did in 2010 The decrease in the turnover could be because of poor pricing decisions or because the company is stuck with obsolete inventory.

BRIEF EXERCISE 18-13

Payout ratio =

income Net

dividends Cash

.20 = X

$66,000

X = $66,000 (.20) = $13,200 Cash dividends = $13,200

Return on assets= Net income

BRIEF EXERCISE 18-14

MING CORPORATION Partial Income Statement Income before income taxes $400,000 Income tax expense ($400,000 X 30%) 120,000 Income before extraordinary item 280,000 Extraordinary loss from flood, net of $21,000

tax savings ($70,000 X 30%) 49,000 Net income $231,000

BRIEF EXERCISE 18-15

REEVES CORPORATION Partial Income Statement Loss from operations of Mexico facility, net

Total assets $ 20,000 2.0% [($1,020,000 – $1,000,000) ÷ $1,000,000]

DO IT! 18-2

2010 2009 (a) Current ratio:

DO IT! 18-3

SUPPLY CORPORATION Income Statement (Partial) Income before income taxes $500,000 Income tax expense 200,000 Income from continuing operations 300,000 Discontinued operations

Loss from operations of music

division, net of $24,000 tax saving $36,000

Gain from disposal of music

division, net of $16,000, taxes 24,000 12,000 Income before extraordinary item 288,000 Extraordinary earthquake loss,

net of $60,000 tax saving 90,000 Net income $198,000

DO IT! 18-4

1 Current ratio: A measure used to evaluate a company’s

liquidity.

2 Pro forma income: Usually excludes items that a company

thinks are unusual or nonrecurring.

3 Quality of earnings: Indicates the level of full and transparent

information provided to users of the financial statements.

4 Discontinued operations: The disposal of a significant segment of a

business.

5 Horizontal analysis: Determines increases or decreases in a

series of financial statement data.

6 Comprehensive income: Includes all changes in stockholders’ equity

during a period except those resulting from investments by stockholders and distribu- tions to stockholders.

Increase or (Decrease)

2011 2010 Amount Percentage Assets

Current assets

Plant assets (net)

Total assets

$125,000 396,000

$521,000

$100,000 330,000

$430,000

( $25,000

( 66,000 91,000

( 25.0% ) ( 20.0% ) ( 21.2% )

$ 70,000 95,000 165,000

( $21,000 ) ( 38,000 ) ( 59,000 )

( 30.0% ) ( 40.0% ) ( 35.8% )

$521,000

115,000 150,000 265,000

$430,000

( 46,000 (14,000)

EXERCISE 18-2

GALLUP CORPORATION Condensed Income Statements For the Years Ended December 31

Total operating expenses

Income before income taxes

Income tax expense

Net income

$750,000 465,000 285,000 120,000 60,000 180,000 105,000 33,000

$ 60,000

100.0% 65.0% 35.0% 12.0% 9.0% 21.0% 14.0% 4.0% 10.0%

EXERCISE 18-3

(a) CONARD CORPORATION

Condensed Balance Sheets

December 31

2011 2010

Increase (Decrease)

Percentage Change from 2010 Assets

$200,000

$ 80,000

90,000 40,000

EXERCISE 18-3 (Continued)

CONARD CORPORATION Condensed Balance Sheets (Continued)

December 31

2011 2010

Increase (Decrease)

Percentage Change from 2010 Liabilities and stock-

$200,000

$ 48,000 150,000 12,000

$210,000

$ (6,000) (7,000) 3,000 )

$(10,000)

(12.5%) (4.7%)

Amount Percent Assets

$200,000

$ 42,000 143,000 15,000

$200,000

37.0% 49.5% 13.5% 100.0%

21.0% 71.5% 7.5% 100.0%

EXERCISE 18-4

(a) HENDI CORPORATION

Condensed Income Statements For the Years Ended December 31

Increase or (Decrease)

During 2010

2011 2010 Amount Percentage Net sales

Cost of goods sold

Gross profit

Operating expenses

Net income

$600,000 483,000 117,000 57,200

$ 59,800

$500,000 420,000 80,000 44,000

$ 36,000

$100,000 63,000 37,000 13,200

$ 23,800

20.0% 15.0% 46.3% 30.0% 66.1%

(b) HENDI CORPORATION

Condensed Income Statements For the Years Ended December 31

$ 36,000

100.0% 84.0% 16.0% 8.8% 7.2%

EXERCISE 18-5

(a) Current ratio = 2.1:1 ($3,361 ÷ $1,635)

Acid-test ratio = 1.31:1 ($2,146 ÷ $1,635)

Receivables turnover = 7.1 times ($8,828 ÷ $1,236)*

Inventory turnover = 5.7 times ($5,526 ÷ $976.5)**

*($1,788 + $684) ÷ 2

**(956 + 997) ÷ 2

2.0:1 87:1 57.0 3.5

1.06:1 .29:1 28.2 7.0

Nordstrom is above J.C Penney for the current and acid-test ratios, but significantly below for the receivables turnover Nordstrom is also better than J.C Penney for inventory turnover.

Nordstrom is better than the industry average for the current and acid test ratios but below the industry average for the receivables turnover and the inventory turnover ratio.

EXERCISE 18-6

(a) Current ratio as of February 1, 2010 = 2.6:1 ($130,000 ÷ $50,000).

Feb 3 2.6:1 No change in total current assets or liabilities.

3.5 X $190,000 = Cost of goods sold

Cost of goods sold = $665,000.

(b) Receivables turnover = 8.8 = Net sales (credit)

8.8 X $99,250 = Net sales (credit) = $873,400.

(c) Return on common stockholders’ equity = 24% =

(a) MOLINI CORPORATION

Partial Income Statement For the Year Ended October 31, 2010 Income before income taxes $540,000 Income tax expense ($540,000 X 30%) 162,000 Income before extraordinary item 378,000 Extraordinary loss from flood, net of $45,000

tax savings ($150,000 X 30%) 105,000 Net income $273,000