Chapter 12 -Financial Statement Analysis

Chapter 12 -Financial Statement Analysis

Chapter 12

Financial Statement Analysis

Match terms with their definitions(LO12-1, 12-2, 12-3, 12-4, 12-5, 12-6)

E12–1Match (by letter) the following items with the description or example that best fits. Each letter is used only once.

Items

1.Conservative accounting practices.

2.Discontinued operation.

3.Extraordinary item.

4.Horizontal analysis.

5.Liquidity.

6.Quality of earnings.

7.Solvency.

8.Vertical analysis.

Descriptions

a.A profit or loss unusual in nature and infrequent in occurrence.

b.The ability of reported earnings to reflect the company’s true earnings as well as the usefulness of reported earnings to help investors predict future earnings.

c.A tool to analyze trends in financial statement data for a single company over time.

d.The sale or disposal of a significant component of a company’s operations.

e.A means to express each item in a financial statement as a percentage of a base amount.

f.A company’s ability to pay its long-term liabilities.

g.A company’s ability to pay its current liabilities.

h.Accounting choices that result in reporting lower income, lower assets, and higher liabilities.

Prepare vertical analysis(LO12-1)

E12–2The following table shows Federer Sports Apparel’s income statements for 2016 and 2015.

Federer Sports Apparel
Income Statements
For the Years Ended December 31
2016 / 2015
Revenues / $20,000,000 / $18,200,000
Cost of goods sold / 15,000,000 / 11,300,000
Gross profit / 5,000,000 / 6,900,000
Operating expenses / 1,800,000 / 2,000,000
Depreciation expense / 1,200,000 / 1,100,000
Inventory write-down / 500,000
Loss (litigation) / 600,000 / 200,000
Income before tax / 1,400,000 / 3,100,000
Income tax expense / 400,000 / 1,000,000
Net income / $ 1,000,000 / $ 2,100,000

Required:

Prepare a vertical analysis of the data for 2016 and 2015.

Prepare horizontal analysis(LO12-2)

E12–3Refer to the information provided in E12–2.

Required:

Prepare a horizontal analysis for 2016 using 2015 as the base year.

Prepare vertical and horizontal analyses(LO12-1, 12-2)

E12–4The comparative balance sheets for Federer Sports Apparel are presented below.

Federer Sports Apparel
Balance Sheets
December 31
2016 / 2015
Assets
Cash / $ 2,600,000 / $ 1,100,000
Accounts receivable / 1,200,000 / 1,700,000
Inventory / 2,200,000 / 1,900,000
Buildings / 12,000,000 / 10,000,000
Less: Accumulated depreciation / (2,300,000) / (1,100,000)
Total assets / $15,700,000 / $13,600,000
Liabilities and Stockholders’ Equity
Accounts payable / $ 2,500,000 / $ 1,800,000
Contingent liability / 600,000 / 200,000
Common stock / 9,500,000 / 9,500,000
Retained earnings / 3,100,000 / 2,100,000
Total liabilities and stockholders’ equity / $15,700,000 / $13,600,000

Required:

1.Prepare a vertical analysis of the balance sheet data for 2016 and 2015. Express each amount as a percentage of total assets.

2.Prepare a horizontal analysis for 2016 using 2015 as the base year.

Evaluate risk ratios(LO12-3)

E12–5The 2015 income statement of Adrian Express reports sales of $15.2 million, cost of goods sold of $10 million, and net income of $3.2 million. Balance sheet information is provided in the following table.

Adrian Express
Balance Sheets
December 31, 2015 and 2014
2015 / 2014
Assets
Current assets:
Cash / $ 800,000 / $ 900,000
Accounts receivable / 2,100,000 / 1,800,000
Inventory / 1,500,000 / 1,600,000
Long-term assets / 5,200,000 / 5,400,000
Total assets / $9,600,000 / $9,700,000
Liabilities and Stockholders’ Equity
Current liabilities / $1,800,000 / $2,000,000
Long-term liabilities / 1,500,000 / 2,100,000
Common stock / 3,000,000 / 3,000,000
Retained earnings / 3,300,000 / 2,600,000
Total liabilities and stockholders’ equity / $9,600,000 / $9,700,000

Industry averages for the following four risk ratios are as follows:

Average collection period50 days

Average days in inventory60 days

Current ratio2 to 1

Debt to equity ratio60%

Required:

1.Calculate the four risk ratios listed above for Adrian Express in 2015.

2.Do you think the company is more risky or less risky than the industry average? Explain your answer.

Evaluate profitability ratios(LO12-4)

E12–6Refer to the information for Adrian Express in E12–5. Industry averages for the following profitability ratios are as follows:

Gross profit ratio25%

Return on assets15%

Profit margin10%

Asset turnover1.5 times

Return on equity25%

Required:

1.Calculate the five profitability ratios listed above for Adrian Express.

2.Do you think the company is more profitable or less profitable than the industry average? Explain your answer.

Calculate risk ratios(LO12-3)

E12–7Balance sheets for Plasma Screens Corporation along with additional information are provided below.

Plasma Screens Corporation
Balance Sheets
December 31, 2015 and 2014
2015 / 2014
Assets
Current assets:
Cash / $ 192,000 / $ 120,000
Accounts receivable / 84,000 / 74,000
Inventory / 75,000 / 60,000
Investments / 6,000 / 8,000
Long-term assets:
Land / 500,000 / 500,000
Equipment / 800,000 / 800,000
Less: Accumulated depreciation / (320,000) / (160,000)
Total assets / $1,337,000 / $1,402,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable / $ 172,000 / $ 175,000
Interest payable / 4,000 / 10,000
Income tax payable / 6,000 / 7,000
Long-term liabilities:
Notes payable / 100,000 / 250,000
Stockholders’ equity:
Common stock / 800,000 / 800,000
Retained earnings / 255,000 / 160,000
Total liabilities and stockholders’ equity / $1,337,000 / $1,402,000

Additional Information for 2015:

1.Net income is $95,000.

2.Sales on account are $1,800,000.

3.Cost of goods sold is $1,100,000.

Required:

1.Calculate the following risk ratios for 2015:

a.Receivables turnover ratio.

b.Inventory turnover ratio.

c.Current ratio.

d.Acid-test ratio.

e.Debt to equity ratio.

2.For the same company, will the current ratio always be higher than the acid-test ratio? Explain your answer.

Calculate profitability ratios(LO12-4)

E12–8Refer to the information provided for Plasma Screens Corporation in E12–7.

Required:

1.Calculate the following profitability ratios for 2015:

a.Gross profit ratio.

b.Return on assets.

c.Profit margin.

d.Asset turnover.

e.Return on equity.

2.When we compare two companies, can one have a higher return on assets while the other has a higher return on equity? Explain your answer.

Calculate profitability ratios(LO12-4)

E12–9The following condensed information is reported by Sporting Collectibles.

2015 / 2014
Income Statement Information
Sales revenue / $10,000,000 / $8,600,000
Cost of goods sold / 6,600,000 / 5,200,000
Net income / 270,000 / 228,000
Balance Sheet Information
Current assets / $ 1,400,000 / $1,200,000
Long-term assets / 2,100,000 / 1,700,000
Total assets / $ 3,500,000 / $2,900,000
Current liabilities / $ 1,150,000 / $ 900,000
Long-term liabilities / 1,200,000 / 1,500,000
Common stock / 800,000 / 300,000
Retained earnings / 350,000 / 200,000
Total liabilities and stockholders’ equity / $ 3,500,000 / $2,900,000

Required:

1.Calculate the following profitability ratios for 2015:

a.Gross profit ratio.

b.Return on assets.

c.Profit margin.

d.Asset turnover.

e.Return on equity.

2. Determine the amount of dividends paid to shareholders in 2015.

Calculate profitability ratios(LO12-4)

E12–10The income statement for Stretch-Tape Corporation reports net sales of $800,000 and net income of $80,000. Average total assets for the year are $400,000. Stockholders’ equity at the beginning of the year was $275,000, and $30,000 was paid to stockholders as dividends during the year. There were no other stockholders’ equity transactions that occurred during the year.

Required:

Calculate the return on assets, profit margin, asset turnover, and return on equity ratios.

Classify income statement items(LO12-5)

E12–11As an auditor for Bernard and Thomas, you are responsible for determining the proper classification of income statement items in the audit of California Sports Grill.

a.Restructuring costs to centralize all administrative activities are estimated to cost of $150,000.

b.One of the company’s restaurants incurs flood damage from a hurricane. Uninsured losses are estimated to be $200,000.

c.A customer was injured and received a settlement for $60,000, but California Sports Grill has not yet paid the settlement.

d.California Sports Grill has three operating divisions: restaurants, catering, and frozen retail foods. The company sells the catering division of the business for a profit of $1.0 million in order to focus more on the restaurant business.

e.The company owns and operates over 100 restaurants. They sold an underperforming restaurant this year at a loss of $120,000.

Required:

Indicate whether each item should be classified as discontinued operations, extraordinary items, other revenues, or other expenses. Provide a brief justification for each answer.

Record discontinued operations(LO12-5)

E12–12LeBron’s Bookstores has two divisions: books and electronics. The electronics division had another great year in 2015 with net sales of $14 million, cost of goods sold of $8 million, operating expenses of $3 million, and income tax expense of $900,000. The book division did not do as well and was sold during the year. The loss from operations and sale of the book division was $400,000 before taxes and $280,000 after taxes.

Required:

Prepare the income statement for LeBron’s Bookstores, including the proper reporting for the discontinued book division.

Record discontinued operations and extraordinary items(LO12-5)

E12–13Shaquille Corporation has income before tax of $1.6 million and income tax expense of $480,000 for the year ended December 31, 2015, before considering the following items: (1) a $125,000 loss, after tax, from the disposal of an operating segment, and (2) an extraordinary loss of $100,000, after tax, due to a plant explosion.

Required:

Prepare the 2015 income statement for Shaquille Corporation beginning with income before tax.

Distinguish between conservative and aggressive accounting practices(LO12-6)

E12–14Dwight’s Trophy Shop is considering the following accounting changes:

a.Decrease the allowance for uncollectible accounts.

b.Write off a larger estimate of obsolete inventory.

c.Change from the double-declining-balance to the straight-line method of depreciation in the second year of equipment with a 10-year life.

d.Record a larger estimate of costs related to litigation.

Required:

Classify each accounting change as either conservative or aggressive.

Distinguish between conservative and aggressive accounting practices(LO12-6)

E12–15Attached is a schedule of five proposed changes at the end of the year.

Before the
Change / Proposed Change / After the Change
Net sales / $16,000,000 / (a) (200,000) / $15,800,000
Cost of goods sold / 12,000,000 / (b) 300,000 / 12,300,000
Operating expenses / 1,500,000 / (c) (100,000) / 1,400,000
Other revenue / 800,000 / (d) (5,000) / 795,000
Other expense / 400,000 / (e) (80,000) / 320,000
Net income / $ 2,900,000 / $ 2,575,000

Required:

1.Indicate whether each of the proposed changes is conservative, aggressive, or neutral.

2. Indicate whether the total effect of all the changes is conservative, aggressive, or neutral.

© The McGraw-Hill Companies, Inc., 2014

Chapter 1212-1