Solution manual intermediate accounting 9e by nicolai ch05

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER ADDITIONAL ASPECTS OF FINANCIAL REPORTING AND FINANCIAL ANALYSIS CONTENT ANALYSIS OF EXERCISES AND PROBLEMS Number Content Time Range (minutes) E5-1 Segment Reporting Schedule showing segment revenues, profit, and assets 5-10 E5-2 Segment Reporting Schedule showing segment revenues, profit, and assets 10-15 E5-3 Segment Reporting Schedule showing segment revenues and profit Notes to schedule 10-15 E5-4 Determination of Reportable Segments Schedule showing segment revenues, profit, and assets 10-15 E5-5 Interim Reporting First quarter income statement, balance sheet Gross profit method for inventory Trial balance, additional information given 10-15 E5-6 Interim Reporting First quarter income statement, balance sheet Gross profit method for inventory Trial balance, additional information given 10-15 E5-7 Interim Reporting Year-to-date, 6-month income statement Second-quarter income statement 10-15 E5-8 Interim Taxes Schedule to compute the income tax expense to be listed on each quarterly income statement 5-15 E5-9 (Appendix) Horizontal Analyses Of comparative income statements, balance sheets Year-to-year and base-year-todate approaches 10-15 E5-10 (Appendix) Vertical Analyses Of comparative income statements, balance sheets 10-15 E5-11 (Appendix) Ratios Price/earnings, profit margin, return on total assets, return on stockholders' equity, current, inventory turnover, payables turnover, debt 10-20 5-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Number Content Time Range (minutes) E5-12 (Appendix) Ratios Earnings per share, dividend yield, return on stockholders' equity, current, acid-test, receivables turnover, times interest earned, book value per common share 10-20 E5-13 (Appendix) (AICPA adapted) Ratio Analysis Current, inventory turnover, and debt ratios Determine effects on ratios of various transactions and events 10-20 P5-1 Income Statement and Segment Reporting Single-step income statement Allocation of revenues, expenses, assets to segments Schedule Related notes Compute profit margin (Appendix) 45-75 P5-2 Income Statement and Segment Reporting Multiple-step income statement Allocation of revenues, expenses, assets to segments Schedule Related notes Compute return on identifiable assets (Appendix) 45-75 P5-3 Interim Reporting Income statements for first six months, second quarter Balance sheet, retained earnings statement Gross profit method for inventory Worksheet 60-80 P5-4 Interim Reporting Income statements for first six months, second quarter Balance sheet, retained earnings statement Retail inventory method Worksheet 60-80 P5-5 (AICPA adapted) Interim Reporting Identification of standards of disclosure, weaknesses in form and content of the given report Indication of preferable treatment 40-45 P5-6 (AICPA adapted) Financial Statement Presentation and Ratios Identification of appropriate and inappropriate disclosures Justification Description of ratio significance Ratio computations 20-40 P5-7 (AICPA adapted) Multiple-Step Income Statement Preparation of income statement, including extraordinary item and deferred taxes Reconciliation of net income and taxable income 45-60 P5-8 (Appendix A) The Coca-Cola Company Disclosures Numerous questions relating to the financial report in Appendix A at the end of the book 25-45 P5-9 (Appendix) Horizontal Analysis and Ratios Year-to-year approach Current, acid-test, inventory turnover, receivables turnover, earnings per share, dividend yield, return on total assets, return on stockholders' equity, debt 60-75 5-2 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Number Content Time Range (minutes) P5-10 (Appendix) Vertical Analysis and Ratios Current, acid-test, inventory turnover, receivables turnover, payables turnover, return on total assets, return on stockholders' equity, debt, times interest earned 60-75 P5-11 (Appendix) Horizontal and Vertical Analyses Base-year-todate approach Two year analyses 45-60 P5-12 (Appendix) Ratio Analysis Dividend yield, price/earnings, profit margin, return on total assets, return on stockholders' equity, current, acid-test, inventory turnover, receivables turnover, average operating cycle, debt, times interest earned, book value per common share 30-45 P5-13 (Appendix) (AICPA adapted) Ratio Analysis Current, acidtest, number of days sales in average receivables, inventory turnover, book value per share, earnings per share, price/earnings, dividend yield 30-40 ANSWERS TO QUESTIONS Q5-1 A standard auditor's report includes the following statements: The auditor is independent, An audit was performed on specified financial statements, The financial statements are the responsibility of the company's management; the opinion is the responsibility of the auditors, The audit was conducted according to generally accepted auditing standards, The audit was planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatement, The audit included examination, assessment, and evaluation stages, The audit provides a reasonable basis for an opinion, and An expression of an opinion concerning the fair presentation The report is also signed and dated by the auditing firm Q5-2 An audit committee is a group that has oversight over the financial reporting process of a company A management report is a report in which management acknowledges that it is responsible for the preparation and presentation of the financial statements This report frequently includes a discussion of internal control, references to the audit committee's responsibilities, and may identify the independent auditor's responsibilities 5-3 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q5-3 Management's discussion and analysis (MD&A) is a narrative explanation of the financial statements so that investors can judge the quality of earnings and the likelihood that past performance is indicative of future performance in regard to cash flows from operations and from outside sources The MD&A is included in the company's annual report to give investors the opportunity to look at the company "through the eyes of management" by providing both a short-term and long-term analysis of the company's business Q5-4 Investors and creditors desire operating segment information about a company in order to evaluate both risk and return in their investment and credit decisions Risk involves uncertainty or unpredictability that results from the way in which the company is organized and how its divisions are operated, the nature and current status of the economy(ies) within which a company operates, the changing conditions in the geographic areas within which the company operates, and the characteristics of its major customers Similarly, the return (profitability) generated by a company is also affected by the same factors Disclosure of financial information concerning the operating segments of a company leads to insights about risk and return and improves the predictive value and feedback value of the accounting information that may not be discernible from the consolidated financial statements Q5-5 An operating segment is considered a reportable segment if it satisfies one of three tests The three tests are the revenue test, operating profit test, and asset test Revenue test Its reported revenues (including sales to external customers and intersegment sales) are 10% or more of the combined revenues of all the company's reported operating segments Profit test The absolute amount of its profit (loss) is 10% or more of the combined reported profits of all the operating segments that did not report an operating loss (If the combined losses of all operating segments that reported a loss exceed the combined profits as calculated, the combined loss amount would be used for this 10% test.) Asset test Its segment assets are 10% or more of the combined assets of all operating segments Q5-6 Information about profit (or loss) A company must report a measure of the profit (or loss) for each reportable segment It must also disclose certain amounts used in computing each segment's profit (or loss), as long as these amounts are included in the reports reviewed by the chief operating officer These amounts are the segment's: (a) revenues (separated into sales to external customers and intersegment sales), (b) interest revenue and interest expense, and (c) depreciation, depletion, and amortization expense Information about assets A company must report a measure of the total assets of each reportable segment Only those segment assets that are included in the reports reviewed by the chief operating officer are included For these assets, a company also must disclose the total capital expenditures for additions to longlived assets for each reportable segment 5-4 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q5-7 A company (even one with only a single operating segment) must disclose (a) its revenue from external customers for each product and service, and (b) information about geographic areas including (1) revenues from external customers in the U.S., and revenues from customers in individual foreign countries, and (2) total long-lived assets located in the U.S., and total long-lived assets located in all foreign countries If a company's revenues from transactions with a single external customer are 10% or more of the company's total revenues, then the company must disclose this fact and identify the segment(s) reporting the revenues Q5-8 Interim financial statements are financial reports for periods of less than one year (usually by quarters) These interim reports are issued because many external users desire information on a more timely basis than once a year Furthermore, these reports are required to be issued by all publicly-held companies Q5-9 In regard to the reporting of its inventories in interim reports, a company using an estimation technique must report the method used and any significant adjustments resulting from the reconciliation with the annual physical inventory A company using LIFO and encountering a temporary partial liquidation of its base inventory that is expected to be replaced by year end must not give effect to the liquidation in its interim cost of goods sold A permanent loss (and any subsequent recovery) due to inventory decline must be recognized in accordance with lower of cost or market procedures Finally, when a company uses a standard cost accounting system, the accounting for all variances must follow routine annual procedures and any significant unexpected purchase price or volume variances should be disclosed Q5-10 A company matches its expenses not directly associated with product sales during an interim period against its revenues using a variety of bases In this regard, (a) expenses affecting more than one interim period are allocated to the interim periods on the basis of time expired, benefits received, or activity associated with the periods; (b) expenses identified only with activities of the current interim period are allocated to that period; and (c) gains and losses incurred in an interim period are recognized in that period Q5-11 (a) The accounting procedures used in the preparation of a company's interim reports are similar to those for its annual reports in that a year-to-date trial balance is taken, the trial balance is entered on a worksheet or other working paper, year-todate adjusting entries are recorded on the worksheet, and financial statements are prepared (b) The interim accounting procedures differ in that the determination of the interim ending inventory is based on an estimate rather than a physical inventory, the interim adjusting entries are usually not entered into the accounts, and closing entries are not usually made at the end of each interim period Q5-12 The minimum interim report disclosures include: Sales or gross revenues, income taxes, extraordinary items (net of tax), the cumulative effect of a change in accounting principle, and net income Earnings per share for each period presented Seasonal revenues, costs, and expenses Significant changes in estimates of income taxes 5-5 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q5-12 (continued) Results of discontinued operations and material unusual or infrequent items Contingent items Changes in accounting principles or estimates Significant changes in financial position (i.e., cash flows) Q5-13 The Chief Accountant of the SEC helps in the establishment of administrative policies regarding accounting matters, is directly responsible for Regulation S-X, and is primarily responsible for the Financial Reporting Releases The Division of Corporation Finance of the SEC is responsible for the establishment of SEC reporting standards (except those delegated to the Chief Accountant) and the requirements for adherence to these standards by regulated companies It is also responsible for reviewing the financial reports submitted to the SEC by these companies Q5-14 The two SEC reports that are important to accountants are: Form 10-K An annual report Form 10-Q A quarterly report of operations Q5-15 External users may make comparisons of a company's current financial performance and financial position with its financial performance and position during previous accounting periods These are referred to as intracompany comparisons External users may also compare a company's performance and position with those of competitors, the average for the industry in which it operates, or with results in related industries This is referred to as intercompany comparison It is important for accountants to be knowledgeable about these comparisons because they are the preparers of the financial statements used Accountants must present information that is consistent across time, and, to the extent possible, consistent across companies Furthermore, a better understanding may also lead to insights on how to improve the information contained in the financial statements Q5-16 In horizontal analysis, changes in a company's operating results and financial position over time are shown in percentages as well as in dollars When a 2-year comparison is made, the earlier year is used as the base year and the amount of change in each item is shown as a percentage of that item's base-year amount When a horizontal analysis of more than years is made, two alternative approaches may be used In the "year-to-year"approach, the preceding year is used as the base year in developing the percentage changes In the "base-year-to-date" approach, the initial year is used as the base year and the cumulative results from the later years are compared with this base year to determine the percentage changes 5-6 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q5-17 In vertical analysis, percentages are developed that show the monetary relationships between items on the financial statements of a company for a particular period These percentages are shown in addition to the dollar amounts for each item In horizontal analysis, changes in the items on a company's financial statements over time are shown as a percentage as well as in dollars Thus, vertical analysis develops "within period" percentage relationships whereas horizontal analysis develops "across period" percentage changes Q5-18 Ratio analysis is a form of percentage analysis in which one or more items on a company's financial statements are divided by another related item or items The various ratios computed for a company in a particular year are compared with that company's ratio results from previous years (intracompany comparison) or with the ratio results from other companies (intercompany comparison) in order to evaluate the financial aspects (i.e., return, risk, financial flexibility, liquidity, and operating capability) of the company Q5-19 The stockholder profitability ratios are the earnings per share, price/earnings, and dividend yield They are computed as follows: Q5-20 Earnings per share: Net income – Preferred dividends Average common shares outstanding Price/earnings: Market price per common share Earnings per share Dividend yield: Dividends per common share Market price per common share The company profitability ratios are the profit margin, return on total assets, and return on stockholders' equity They are computed as follows: Profit margin: Net income Net sales Return on total assets: Net income + Interest expense (net of tax) Average total assets Return on stockholders’ equity: Q5-21 Net income Average stockholders’ equity The ratios that may be applied in regard to a company's reportable operating segments include the profit margin, return on total assets, and return on stockholders' equity 5-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Q5-22 Q5-23 Q5-24 The liquidity ratios include the current ratio and acid-test ratio They are computed as follows: Current: Current assets Current liabilities Acid-test: Quick assets Current liabilities The activity ratios include the inventory turnover, the accounts receivable turnover, and the accounts payable turnover They are computed as follows: Inventory turnover: Cost of goods sold Average inventory Receivables turnover: Net credit sales Average net receivables Payables turnover: Cost of goods sold Average accounts payable The stability ratios include the debt ratio, times interest earned, and book value per common share They are computed as follows: Debt: Total liabilities Total assets Times interest earned: Pretax operating income Interest expense Book value per common share: Common stockholders’ equity Outstanding common shares 5-8 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO CASES C5-1 In an audit, the certified public accountant conducts an examination of the accounting system, records, and financial statements in accordance with generally accepted auditing standards Based on the examination, the auditor expresses an opinion concerning the fairness of the financial statements in conformity with generally accepted accounting principles An unqualified opinion includes three paragraphs The first paragraph, known as the introductory paragraph, lists the financial statements that were audited, states that the management of the company is responsible for those statements, and that the auditor is responsible for expressing an opinion on them The second paragraph, known as the scope paragraph, describes what the auditor has done Specifically, it states that the auditor has examined the financial statements in accordance with generally accepted auditing standards and has performed appropriate tests The third paragraph, known as the opinion paragraph, gives the auditor's opinion When the opinion is unqualified, the auditor states that the financial statements present fairly the financial position, results of operations, and cash flows of the company in conformity with generally accepted accounting principles C5-2 (CMA adapted solution) Note to Instructor: This case is slightly more advanced than the text explanation, but is useful for class discussion The general purposes of the management report are to communicate management's responsibility for the financial statements, the adequacy of the company's internal controls, the role of the board of directors, the role of the corporation's audit committee, and the role and responsibilities of the external auditors Five subject areas or topics that have been recommended for inclusion in the management report include the following: management's responsibility for the financial statements and other financial information management's responsibility for the system of internal accounting controls and its response to material weaknesses identified by the independent auditor a description of the role of the company's internal auditors an assertion regarding the board of directors' role in overseeing and reviewing management's preparation of the financial statements a reference to the company's code of conduct or ethical and legal policies 5-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C5-2 (continued) The management report itself does not create any new audit requirements However, the content of the management report probably will influence the activities of the external auditor during the audit engagement Therefore, the external auditor should read the management report but has no obligation to corroborate the information contained therein Additionally, the external auditor should consider whether the report by management is consistent with information appearing in the financial statements and also should consider whether the report contains a material misstatement of fact C5-3 (CMA adapted solution) Note to Instructor: This case is slightly more advanced than the text explanation, but is useful for class discussion The SEC is an independent federal agency that receives its authority from federal legislation The Securities Exchange Act of 1934 created the SEC and empowered it to administer compliance with provisions of that Act and the Securities Act of 1933 a The SEC supports fair securities markets by regulating brokers, exchanges, and the publicly held companies themselves The Commission monitors the trading practices and financial condition of brokers The Commission oversees the activities and trading rules of securities exchanges Finally, the Commission requires registration and continuing public disclosure of financial and other information by publicly held companies b The SEC fosters enlightened shareholder participation in major corporate decisions by requiring corporate management to keep stockholders informed by various means Management is required to issue proxy solicitations, file periodic reports with the SEC, hold annual stockholders' meetings, and issue annual reports to stockholders that include audited financial statements The SEC requires publicly held companies to file audited financial statements and other disclosures in accordance with its regulations The Commission relies primarily on the integrity and legal responsibility of the reporting entities and the external auditors for the material accuracy and completeness of the filings The Commission reviews filings on a selective basis in an attempt to discover untrue, incomplete, or misleading information C5-4 An operating segment is a component of a company: (a) (b) (c) that engages in business activities to earn revenues and incur expenses, whose operating results are regularly reviewed by the company's chief operating officer to make decisions about resources to be allocated to the segment and to assess its performance, and for which financial information is available Not all departments in a company are operating segments For instance, a corporate headquarters normally does not earn revenues directly and is not an operating segment Generally, an operating segment has a segment manager who is directly accountable for the segment’s operating activities, and who maintains regular contact with the chief operating officer 5-10 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-7 (continued) PITT CORP Reconciliation of Net Income to Taxable Income per Tax Return For the Year Ended December 31, 2004 Net income Add: Income tax on continuing operations Officers' life insurance expense Deduct: Income tax benefit extraordinary loss Taxable income per tax return $ 368,500 369,000 70,000 $ 807,500 (142,500) $ 665,000 Explanation of amounts [1] [2] Total income tax excluding extraordinary item for 2004: Income before income tax and extraordinary item $1,070,000 Officers' life insurance expense Income subject to tax Income tax rate Income tax excluding extraordinary item Deferred income tax for 2004: Excess of book basis over tax basis in depreciable assets (Expected to reverse equally over next years) Deferred income tax liability, 12/31/04 ($90,000 x 30%) Less: beginning balance, 1/1/04 Net change in deferred tax liability for 2004 [3] [4] Extraordinary item Loss from earthquake damage (net of income tax) for 2004: Loss from earthquake damage Income tax benefit (30% x $475,000) Net of income tax effect Earnings per share on income before extraordinary item for 2004: Income before extraordinary item Weighted average number of shares outstanding for 2004 [200,000 + 20,000 + 15,000 (½ x 30,000)] Earnings per share ($701,000 [5] 235,000) 70,000 $1,140,000 x 30% $ 342,000 $ 90,000 $ 27,000 -0$ 27,000 $ 475,000 (142,500) $332,500 $ 701,000 235,000 $2.98 Earnings per share on net income for 2004: Net income $ 368,500 Weighted average number of shares Earnings per share ($368,500 235,000) 5-52 235,000 $1.57 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-8 Gross profit, 2001: $14,048 million (p 57) Operating income, 2001: $5,352 million (p 57) 2001 net income: $3,969 million; Basic EPS: $1.60; Diluted EPS: $1.60 (p 57) Total assets, December 31, 2001: $22,417 million (p 58) Current assets: $7,171 million (p 58) Total liabilities, December 31, 2001: $11,051 million (p 59); ($22,417 million total liabilities and share-owners' equity - $11,366 million total share-owners' equity Total share-owners' equity, December 31, 2001: $11,366 million (p 59); Treasury stock: $13,682 million (p 59); the company uses the cost method to account for treasury stock (p 59) Net increase in cash and cash equivalents, 2001: $47 million (p 60); Net cash provided by operating activities: $4,110 million (p 60) Summary of accounting policies: Note to financial statements (p 62) Inventories are valued at lower of cost or market, and generally average cost or first-in, first-out methods of costing are used (p 62) Property, plant, and equipment are depreciated principally by the straight-line method over the estimated useful lives of the assets (p 63) At December 31, 2001, the company had $2,468 million in lines of credit and other short-term credit facilities available, of which $382 million was outstanding (p 67) Percent of total debt to total capital, 2001: 31.0% (p 86); 2000: 37.8% (p 86) 10 Return on capital, 2001: 26.6% (p 86); 2000: 16.2% (p 86) 11 Net cash used in financing activities in 2001: $(2,830 million) (p 60); Net cash used in investing activities in 2001: $(1,188 million) (p 60) 5-53 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-8 (continued) 12 Stock options outstanding at December 31, 2001: 141 million (p 74); Weightedaverage price per share for options exercised, 2001: $24.30 (p 74) 13 Net periodic pension cost for the company’s pension and other defined benefit plans, 2001: $62 million (p 75); Fair value of the company’s benefit plan assets at December 31, 2001: $1,492 million (p 76) 14 Fourth quarter, 2001 (a) net operating revenues: $4,923 million (p 85); (b) gross profit: $3,495 million (p 85); (c) net income: $914 million (p 85) Fourth quarter, 2001 Basic EPS: $0.37 (p 85); Diluted EPS: $0.37 (p 85) 15 Net operating revenues in Africa, 2001: $621 million (p 82); Identifiable operating assets, Latin America, December 31, 2001: $1,681 million (p 82) 16 The auditors are Ernst & Young LLP The audit report was issued on January 25, 2001 (p 83) 17 The internal accounting control system is augmented by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel and a written Code of Business Conduct adopted by the Board of Directors, applicable to all employees of the company and its subsidiaries (p 84) Note to Instructor: Certain of the answers may also be located on pages other than the ones listed in parentheses 5-54 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-9 COHEN COMPANY Comparative Income Statements (Horizontal Analysis) For Years Ended December 31 2005 2004 2003 Sales (net) Cost of goods sold Gross profit Selling expenses Administrative expenses Interest expense Total expenses Income before income taxes Income tax Net income Earnings per share Year-to-Year Increase (Decrease) 2004 to 2005 2003 to 2004 Amount % Amount % $102,200 (61,100) $ 41,100 (11,400) $ 91,500 (52,800) $ 38,700 (10,000) $ 81,700 (47,150) $ 34,550 (8,900) $10,700 8,300 $ 2,400 1,400 (8,700) (3,000) $ (23,100) (7,843) (4,000) $ (21,843) (6,950) (4,000) $ (19,850) $ 18,000 (5,400) $ 12,600 $ 16,857 (5,057) $ 11,800 $ 14,700 (4,410) $ 10,290 $3.00 $3.11 $2.71 $9,800 5,650 $4,150 1,100 12.0 12.0 12.0 12.4 857 10.9 (1,000) (25.0) $ 1,257 5.8 893 $1,993 12.8 0.0 10.0 $ 1,143 343 $ 800 6.8 $2,157 647 $1,510 14.7 14.7 14.7 (3.5) $0.40 14.8 $(0.11) 11.7 15.7 6.2 14.0 COHEN COMPANY Comparative Retained Earnings Statements (Horizontal Analysis) Beginning retained earnings Add: Net income Less: Dividends Ending retained earnings For Years Ended December 31 2005 2004 2003 Year-to-Year Increase (Decrease) 2004 to 2005 2003 to 2004 Amount % Amount % $28,800 12,600 $41,400 (4,410) $20,800 11,800 $32,600 (3,800) $14,310 10,290 $24,600 (3,800) $8,000 800 $8,800 (610) 38.5 6.8 27.0 16.1 $6,490 1,510 $8,000 45.4 14.7 32.5 0.0 $36,990 $28,800 $20,800 $8,190 28.4 $8,000 38.5 5-55 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-9 (continued) (continued) COHEN COMPANY Comparative Balance Sheets (Horizontal Analysis) December 31, 2003, 2004, and 2005 2005 December 2004 2003 Year-to-Year Increase (Decrease) 2004 to 2005 2003 to 2004 Amount % Amount % Cash Receivables (net) Inventories Noncurrent assets Total assets $ 4,200 7,600 9,800 119,390 $140,990 $ 4,000 7,000 9,000 112,000 $132,000 $ 4,100 6,200 8,600 107,100 $126,000 $ Current liabilities Bonds payable, 10% Common stock, $2 par Premium on common stock Retained earnings Total liabilities & stockholders' equity $ 12,000 30,000 8,400 $ 10,000 40,000 7,600 $ 12,000 40,000 7,600 $ 2,000 20.0 (10,000) (25.0) 800 10.5 53,600 36,990 45,600 28,800 45,600 20,800 8,000 8,190 $140,990 $132,000 $126,000 $ 8,990 200 600 800 7,390 $ 8,990 5.0 8.6 8.9 6.6 6.8 $ (100) 800 400 4,900 $ 6,000 (2.4) 12.9 4.7 4.6 4.8 (2,000) 0 (16.7) 0.0 0.0 17.5 28.4 8,000 0.0 38.5 6.8 $ 6,000 4.8 (On the following page) The current ratio, acid-test ratio, receivables turnover, return on total assets, return on stockholders' equity, and earnings per share for 2005 are less than the related results in 2004 These results suggest that the financial condition of this company is not as strong as it was in all of 2004, a likely reason for the decrease in the market price Although the dividend yield is up slightly in 2005 as compared with 2004, it is still relatively low A review of the horizontal analysis of the income statement reveals that the percentage increase in net income from 2004 to 2005 is lower than from 2003 to 2004, due in great part to the higher percentage increases in cost of goods sold and selling expenses, than the percentage increase in sales The horizontal analysis of the balance sheet also indicates (as does the debt ratio) that the company in 2005 is relying more upon stockholders to finance operations than creditors even though it has been favorably trading on the equity 5-56 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 2004 2005 a Current $4,000 $7,000 $9,000 $10,000 b Acid-test $4,000 $7,000 $10,000 c Inventory turnover $52,800 $(9,000 8,600)/2 times $61,000 $(9,800 9,000)/2 6.5 times d Receivables turnover $91,500 x 0.65 $(7,000 6,200)/2 9.01times $102,200 x 0.60 $(7,600 7,000)/2 8.4 times e Earnings per share $11,800 $7,600/$2 f $3,800/3,800 $22 Dividend yield g Return on total assets i Debt 0.045 0.113 0.379 $3.00 $4,410/4,200 $21 4.5% 11.3% 0.151 37.91% *Effective income tax rate in each year is 30% (2004: $5,057 15.1% 1.8 times 0.98 times $12,600 $8,400/$2 $3.11 $11,800 $(82,000 74,000)/2 $50,000 $132,000 $4,200 $7,600 $12,000 1.1 times $11,800 ($4,000x0.7*) $(132,000 126,000)/2 h Return on stockholders’ equity $4,200 $7,600 $9,800 $12,000 times 0.05 5% $12,600 ($3,000x0.7*) $(140,990 132,000)/2 $12,600 $(98,990 82,000)/2 $42,000 $140,990 $16,857; 2005: $5,400 0.298 0.108 0.139 29.8% $18,000) 10.8% 13.9% To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-10 PIERCE COMPANY Comparative Income Statements (Vertical Analysis) For Years Ended December 31 2005 Amount Sales (net) Cost of goods sold Gross profit Selling expenses Administrative expenses Interest expense Income before income taxes Income tax expense Net income $180,000 (108,000) $ 72,000 (21,600) (23,770) (3,200) $ 23,430 (7,030) $ 16,400 Earnings per share (6,000 shares) 2004 Amount % 100.0 (60.0) 40.0 (12.0) (13.2) (1.8) 13.0 (3.9) 9.1 $150,000 (85,500) $ 64,500 (15,000) (23,410) (2,800) $ 23,290 (6,990) $ 16,300 $2.73 % 100.0 (57.0) 43.0 (10.0) (15.6) (1.9) 15.5 (4.6)* 10.9 $2.72 *Rounded down to balance PIERCE COMPANY Comparative Balance Sheets (Vertical Analysis) December 31 2005 Amount Cash Investments (short-term) Receivables (net) Inventory Noncurrent assets (net) Total assets $ 4,200 2,000 8,600 11,300 129,900 $156,000 Account payable Other current liabilities Bonds payable Common stock, $3 par Additional paid-in capital Unrealized capital Retained earnings Total liabilities and stockholders' equity $ 12,000 1,000 40,000 18,000 30,000 900 54,100 $156,000 *Rounded to balance 5-58 2004 Amount % 2.7 1.3 5.5 7.2 83.3 100.0 7.7 0.6 25.6 11.6* 19.2 0.6 34.7 100.0 $ 3,000 2,100 6,400 9,700 118,800 $140,000 $ 10,000 2,400 35,000 18,000 30,000 1,000 43,600 $140,000 % 2.1 1.5 4.6 6.9 84.9 100.0 7.2* 1.7 25.0 12.9 21.4 0.7 31.1 100.0 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com b c d e 5-59 f g h i *Effective income tax rate in each year is 30% (2004: $6,990 $23,290; 2005: $7,030 $23,430) P5-10 (continued) a 2004 2005 Current $3,000 $2,100 $6,400 $9,700 $4,200 $2,000 $8,600 $11,300 1.71times 2.01times $10,000 $2,400 $12,000 $1,000 Acid-test $3,000 $2,100 $6,400 $4,200 $2,000 $8,600 0.93 times 1.14 times $10,000 $2,400 $12,000 $1,000 Inventory turnover $85,500 $108,000 8.26 times 10.29 times $(11,000 9,700)/2 $(9,700 11,300)/2 $150,000 x 0.50 $180,000 x 0.50 Receivables turnover 10.71times 12.0 times $(7,600 6,400)/2 $(6,400 8,600)/2 Payables turnover $85,500 $108,000 $9.83 times $9.81 times $(7,400 $10,000)/2 $(10,000 12,000)/2 $16,300 ($2,800x0.7*) Return on total assets $16,400 ($3,200x0.7*) 13.5% 12.6% $(44,600 85,400 140,000)/2 $(140,000 156,000)/2 Return on stockholders’ $16,300 $16,400 18.3% 16.8% equity $(85,400 92,600)/2 $(92,600 103,000)/2 Debt $53,000 $47,400 0.34 34% 0.339 33.9% $156,000)/ $140,000 Times interest earned $23,290 $2,800 $23,430 $3,200 9.32 times 8.32 times $2,800 $3,200 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-10 (continued) Management should be informed that "tightening up" the operating cycle has a relatively direct impact on the company's liquidity position but only an indirect impact on its profitability and common stock market price A review of the return on total assets and the return on stockholders' equity indicates that these percentage returns are lower in 2005 as compared with 2004 Furthermore, a review of the vertical analysis on the income statement reveals that, even though profits were up modestly, net income as a percentage of sales decreased slightly while earnings per share remained virtually unchanged The slight improvement in the liquidity position and absolute profits probably offset the slight reduction in the rates of return and profit margin, causing the stock market price to remain unchanged P5-11 PEREZ COMPANY Comparative Income Statements (Horizontal Analysis) For Years Ended December 31 2005 2004 2003 Sales Sales returns Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Interest expense Total expenses Income before income taxes Income tax expense Net income Number of common shares Earnings per share Base Year-to-Date Increase (Decrease) 2003 to 2004 2003 to 2005 Amount % Amount % $ 407,000 (7,000) $ 400,000 (244,000) $ 156,000 (45,825) $361,500 (11,500) $350,000 (222,000) $128,000 (39,550) $332,000 (12,000) $320,000 (205,000) $115,000 (35,690) $29,500 (500) $30,000 17,000 $13,000 3,860 8.9 (4.2) 9.4 8.3 11.3 10.8 $75,000 22.6 (5,000) (41.7) $80,000 25.0 39,000 19.0 $41,000 35.7 10,135 28.4 (60,232) (4,150) $(110,207) (46,664) (4,200) $(90,414) (44,213) (3,580) $(83,483) 2,451 620 $ 6,931 5.5 17.3 8.3 13,568 570 $26,724 29.1 15.9 32.0 $ 45,793 (13,738) $ 32,055 $ 37,586 (11,276) $ 26,310 $ 31,517 (9,455) $ 22,062 $ 6,069 1,821 $ 4,248 19.3 19.3 19.3 $14,276 4,283 $ 9,993 45.3 45.3 45.3 10,000 9,000 8,000 1,000 12.5 2,000 25.0 $3.21 $2.92 $2.76 $0.16 5.8 $0.45 16.3 5-60 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-11 (continued) (continued) PEREZ COMPANY Comparative Balance Sheets (Horizontal Analysis) December 31, 2003, 2004, and 2005 2005 December 31 2004 2003 Base-Year-to-Date Increase (Decrease) 2003 to 2004 2003 to 2005 Amount % Amount % Cash Receivables (net) Inventories Noncurrent assets Total assets $ 15,500 11,000 38,000 286,500 $351,000 $ 12,650 9,350 30,000 250,000 $302,000 $ 9,300 $ 3,350 6,600 2,750 22,250 7,750 220,350 29,650 $258,500 $43,500 36.0 41.7 34.8 13.5 16.8 $ 6,200 4,400 15,750 66,150 $92,500 66.7 66.7 70.8 30.0 35.8 Accounts payable Notes payable Bonds payable Common stock, $5 par Premium on common stock Retained earnings Total liabilities & stockholders' equity $ 11,800 16,200 38,000 50,000 $ $ 2.2 15,4 6.8 12.5 $ 2,500 4,500 1,500 10,000 26.9 38.5 4.1 25.0 16,000 18,000 28.6 17.1 34,000 40,000 60.7 38.1 $258,500 $43,500 16.8 $92,500 35.8 9,500 13,500 39,000 45,000 90,000 145,000 72,000 123,000 $351,000 $302,000 5-61 9,300 $ 200 11,700 1,800 36,500 2,500 40,000 5,000 56,000 105,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-11 (continued) PEREZ COMPANY Comparative Income Statements (Vertical Analysis) For Years Ended December 31, 2004 and 2005 2005 Amount Sales Sales returns Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Interest expense Total expenses Income before income taxes Income tax expense Net income Earnings per share $ 407,000 (7,000) $ 400,000 (244,000) $ 156,000 (45,825) (60,232) (4,150) $(110,207) $ 45,793 (13,738) $ 32,055 2004 Amount % 101.8 (1.8) 100.0 (61.0) 39.0 ( 11.5) ( 15.1) (1.0) (27.6) 11.4 (3.4) 8.0 $ 361,500 (11,500) $ 350,000 (222,000) $ 128,000 ( 39,550) (46,664) (4,200) $ (90,414) $ 37,586 (11,276) $ 26,310 $3.21 % 103.3 (3.3) 100.0 (63.5)* 36.5 (11.3) (13.3) (1.2) (25.8) 10.7 (3.2) 7.5 $2.92 *Rounded up to balance PEREZ COMPANY Comparative Balance Sheets (Vertical Analysis) December 31, 2004 and 2005 2005 Amount Cash Receivables (net) Inventories Noncurrent assets Total assets $ 15,500 11,000 38,000 286,500 $351,000 4.4 3.1 10.8 81.7* 100.0 Accounts payable Notes payable Bonds payable Common stock, $5 par Premium on common stock Retained earnings Total liabilities and stockholders' equity $ 11,800 16,200 38,000 50,000 90,000 145,000 3.4 4.6 10.8 14.2 25.7* 41.3 $351,000 *Rounded up to balance 5-62 2004 Amount % 100.0 $ 12,650 9,350 30,000 250,000 $302,000 $ 9,500 13,500 39,000 45,000 72,000 123,000 $302,000 % 4.2 3.1 9.9 82.8 100.0 3.1 4.5 12.9 14.9 23.9* 40.7 100.0 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-12 a Dividend yield b Price/earnings c Profit margin d Return on total assets e Return on stockholders' f Current g Acid-test h Inventory turnover $7,000/($35,000 $5) $17 $28,800 Receivables turnover $28,800 Payables turnover 4.13 times 10.67% $270,000 ($4,300 x 0.7*) $264,600 216,000)/2 $28,800 $(158,600 120,000)/2 $83,000 13.2% 20.7% 2.77 times $30,000 $7,940 $10,060 $18,000 $30,000 $175,500 $(32,000 27,000)/2 1.20 times 5.95 times 5.95 = 61 days $270,000 x 0.68 $(18,000 19,500)/2 365 j 7,000 $ 28,000 365 i 5.88% $17 9.79 times 9.79 = 37 days $175,500 $(17,800 16,500)/2 365 10.2 times 10.2 = 36 days k Average operation cycle (in days): Inventory turnover + Receivables turnover - Payable turnover = 61 days + 37 days - 36 days = 62 days l Debt m Times interest earned n Book value per common share $106,000 40.1% $264,600 $41,140 $4,300 $4,300 $158,600 7,000 5-63 $22.66 10.57 times To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-12 (continued) (continued) *The effective income tax rate is 30% ($12,340 $41,140) A potential investor might compare the results from these ratios in 2004 with the results from the same ratios of previous periods for the same company The investor might also compare this company's 2004 ratio results with the results of ratios for similar companies within the same industry In the interfirm comparisons, consideration should be given to the comparability of the numbers used in the numerators and denominators of the ratios by the various companies P5-13 (AICPA adapted solution) Current (working capital) ratio Total current assets Total current liabilitie s $250,000,000 $ 75,000,000 Quick (acid-test) ratio Total quick (acid test)assets Total current liabilitie s $121,500,000 $ 75,000,000 1.62 to Number of days’ sales in average receivables Average accounts receivable Sales on account 300 business days 3.33 to $100,000,000 $ 2,000,000 Inventory turnover Cost of goods sold Average inventorie s $490,000,000 $140,000,000 5-64 3.50 to 50 days To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com P5-13 (continued) Book value per share of common stock Total stockholders’ equity less liquidating value of preferred stock Common shares issued and outstanding at December 31,2004 = $259,000,000 $10,000,000 = $25.90 Earnings per share on common stock Net income less dividends on preferred stock Average common shares issued and outstanding during 2004 = $20,000,000 $10,000,000 = $2.00 Price-earnings ratio on common stock Market value of common stock Earnings per share on common stock $10.00 $2.00 to Dividend-yield ratio on common stock Dividends on common stock Market price per common stock $1.20 $10.00 5-65 512% To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-66 ... information by publicly held companies b The SEC fosters enlightened shareholder participation in major corporate decisions by requiring corporate management to keep stockholders informed by various... outside users is considered by many to be great 5-14 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com C5-7 (AICPA adapted solution) Note to Instructor:... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 5-18 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTIONS TO