Accounting Homework 2 | Complete Solution
• A Purpose of financial statement analysis for these users is to provide strategic information to improve
... [Show More] company efficiency and effectiveness in providing products and services. (Financial statement analysis tools are also used for personal financial investment decisions.) (Financial statement analysis is a topic on the CPA, CMA, CIA, and CFA exams.)
• Our analysis emphasizes four areas of inquiry---with varying degrees of importance. These four areas are described and illustrated in this chapter and are considered the building blocks of financial statement analysis:
1. Liquidity and efficiency----ability to meet short-term obligations and to efficiently generate revenues.
2. Solvency----ability to generate future revenues and meet long-term obligations.
3. Profitability----ability to provide financial rewards sufficient to attract and retain financing.
4. Market prospects----ability to generate positive market expectations.
• Most users must rely on general-purpose financial statements that in the (1) income statement, (2) balance sheet, (3) statement of stockholders’ equity (or statement of retained earnings), (4) statement of cash flows, and (5) notes to these statements.
• Financial reporting refers to the communication of financial information useful for making investment, credit, and other business decisions. Financial reporting includes not only general-purpose financial statements but also information for SEC 10-K or other filings, press releases, shareholders’ meetings, forecasts, management letters, auditors’ reports, and webcasts.
• Management’s Discussion and Analysis (MD&A) is one example of useful information outside traditional financial statements. Apple’s MD&A for example, begins with an overview, followed by critical accounting policies and estimates. It then discusses operating results followed by financial condition (liquidity, capital resources, and cash flows). The final few parts discuss legal proceedings, market risk of financial instruments, and risks from interest rate and foreign currency fluctuations. The MD&S is an excellent starting point in understanding a company’s business activities.
• When interpreting measures from financial statement analysis, we need to decide whether the measures indicate good, bad, or average performance. To make such judgments, we need standards (benchmarks) for comparisons that include the following:
1. Intracompany----The company under analysis can provide standards for comparisons based on its own prior performance and relations between its financial items
2. Competitor----One or more direct competitors of the company being analyzed can provide standards for comparisons.
3. Industry----Industry statistics can provide standards of comparisons.
4. Guidelines (rule of thumb)----General standards of comparisons can develop from experience.
• Three of the most common tools of financial statement analysis are
1. Horizontal analysis----comparison of a company’s financial condition and performance across time.
2. Vertical analysis----comparison of a company’s financial condition and performance to a base amount.
3. Ratio analysis----measurement of key relations between financial statement items.
• Comparative financial statements facilitate this comparison by showing financial amounts in side-by-side columns on a single statement, called a comparative format.
• Dollar change = Analysis period amount – Base period amount
• Analysis period is the point or period of time for the financial statements under analysis, and base period is the point or period of time for the financial statements used for comparison purposes.
Analysis period amount – Base period amount
• Percent change % = Base period amount x 100
• Trend analysis, also called trend percent analysis or index number trend analysis, is a form of horizontal analysis that can reveal patterns in data across successive periods. It involves computing trend percents for a series of financial numbers and is a variation on the use of percent changes. The difference is that trend analysis does not subtract the base period amount in the numerator. To compute trend percents, we do the following:
1. Select a base period and assign each item in the base period a weight of 100%.
2. Express financial numbers as a percent of their base period number.
Specifically, a trend percent, also called an index number, is computed as follows:
Analysis period amount
Trend percent % = Base period amount x 100
• Vertical analysis is a tool evaluate individual financial statement items or a group of items in terms of a specific base amount. (The term vertical analysis arises from the up-down [or down-up] movement of our eyes as we review common-size financial statements. Vertical analysis is also called common-size analysis.)
• Common-size financial statements to reveal changes in the relative importance of each financial statement item. A common-size percent is measured by dividing each individual financial statement amount under analysis by its base amount:
Analysis amount
Common-size percent % = Base amount x 100
• The purpose of financial statement is for internal users to provide strategic information to improve company efficiency and effectiveness in providing products and services.
• Most users must rely on general-purpose financial statements that in the (1) income statement, (2) balance sheet, (3) statement of stockholders’ equity (or statement of retained earnings), (4) statement of cash flows, and (5) notes to these statements.
• Stella, Inc. needs to communicate financial information to outside users that is useful for making investment, credit, and other business decisions. This is called financial reporting.
• Management’s discussion and analysis begins with an overview, followed by critical accounting policies, and a discussion of operating results and financial condition. It is an excellent starting point in understanding a company’s business activities.
• When interpreting measures from financial statement analysis, we need to decide whether the measures indicate good, bad, or average performance. To make such judgments, we need standards (or benchmarks) for comparisons.
• A ratio expresses a mathematical relation between two quantities. It can be expressed as a percent, rate, or proportion. It is a simple arithmetic operation, but its interpretation is not.
• An investor in Able Inc. would like to understand Able’s funding requirements, also known as the availability of Able’s resources to meet its short-term cash requirements. This type of analysis is known as a liquidity measure.
• Efficiency refers to how productive a company is in using its assets. It is measured relative to how much revenue is generated from a certain level of assets.
• Working capital can be computed by taking current assets – current liabilities.
• The current ratio, or current assets divided by current liabilities, is used to evaluate a company’s ability to pay its short-term obligations.
Current assets
Current ratio= Current liabilities
• Vito Co. had current assets of $9,000 and current liabilities of $6,000 at the end of 2010. Net income during the year was $21,000. The current ratio for the period is: 1.5
• A good analysis report usually consists of six sections:
1. Executive summary---brief focus on important analysis results and conclusions.
2. Analysis overview---background on the company, its industry, and its economic setting.
3. Evidential matter---financial statements and information used in the analysis, including ratios, trends, comparisons, statistics, and all analytical measures assembled; often organized under the building blocks of analysis.
4. Assumptions---identification of important assumptions regarding a company’s industry and economic environment, and other important assumptions for estimates.
5. Key factors---list of important favorable and unfavorable factors, both quantitative and qualitative, for company performance; usually organized by areas of analysis.
6. Inferences---forecasts, estimates, interpretations, and conclusions drawing on all sections of the report.
• Earning per share---Reports information for each of the three subcategories of income.
• Continuing Operations---Shows revenues, expenses, and income from ongoing operations.
• Extraordinary Items---Reports gains and losses that are both unusual and infrequent.
• Discontinued Segments---Reports income from operating the and selling or closing down a segment.
• The inventory turnover is calculated by dividing the cost of goods sold by the average inventory.
Cost of goods sold
Inventory turnover = Average inventory
• Total asset turnover—reflects a company’s ability to use its assets to generate sales and is an important indication of operation efficiency. It is computer by taking net sales divided by average total assets.
• Income before interest expense and income taxes
Times interest earned= Interest expense
The times interest earned ratio is computed by taking income before interest expense and income taxes divided by interest expense.
• The amount of income before deductions for interest expense and income taxes is the amount available to pay interest. The times interest earned ratio takes this income divided by interest expense to determine the risk for creditors.
Income before interest expense and income taxes
Times interest earned= Interest expense
• A company reports Net Sales of $100,000 in 2010 and $90,000 in 2009. At the beginning of 2010, Accounts Receivable was $6,000; at the end of the period Accounts Receivable was $10,000. Accounts receivable turnover for 2010 is 12.5
Net sales
Accounts receivable turnover= Average accounts receivable, net
• Profit margin reflects a company’s ability to earn net income from sales. It is measured by expressing net income as a percent of sales.
• Dividend Yield is used to compare the dividend-paying performance of different investment alternatives. It is computed by taking annual cash dividends per share divided by market price per share.
• Days’ Sales Uncollected is a measure of the liquidity of receivables. It is computed by dividing the current balance of receivables by the annual credit (or net) sales and then multiplying by 365
• A company has Total Assets of $135,000 including $29,000 in Accounts Receivable, and Net Sales of $380,000. Days’ sales uncollected is 27.9 29,000/380,000= 0.0763157894736842 x 365= 27.85526315789474
• A company has 20,000 shares of $5 par-value common stock issued and outstanding. Earnings per share were $4, annual cash dividends per share were $0.09, and market price per share is $90. Dividend yield is 1% ( 0.01% must move 2 decimals to the right)
Annual cash dividends per share
Dividend yield= Market price per share
• Return on common stockholders’ equity is computed by taking (net income less preferred dividends) divided by: average common stockholders’ equity
• Profit margin is computed by taking net income divided by net sales
Net income
Profit margin= Net sales
• Solvency refers to a company’s long-run financial viability and its ability to cover long-term obligations.
• Days’ sales uncollected is computed by taking accounts receivable, net divided by net sales multiplied by 365.
1.
2015 2014 2013 2012 2011
Sales $ 673,986 $ 443,412 $ 350,523 $ 252,175 $ 192,500
Cost of goods sold 326,113 214,488 171,751 122,994 92,400
Accounts receivable 32,756 26,028 23,976 14,677 13,205
________________________________________
Compute trend percents for the above accounts, using 2011 as the base year.
Trend Percent for Net Sales:
Choose Numerator: / Choose Denominator:
Analysis period net sales / Base year net sales = Sales
2015: $673,986 / $192,500 = 350 %
2014: $443,412 / $192,500 = 230 %
2013: $350,523 / $192,500 = 182 %
2012: $252,175 / $192,500 = 131 %
Trend Percent for Cost of Goods Sold:
Choose Numerator: / Choose Denominator:
Analysis period cost of goods sold / Base year cost of goods sold = Cost of goods sold
2015: $326,113 / $92,400 = 353 %
2014: $214,488 / $92,400 = 232 %
2013: $171,751 / $92,400 = 186 %
2012: $122,994 / $92,400 = 133 %
Trend Percent for Accounts Receivables:
Choose Numerator: / Choose Denominator:
Analysis period accounts receivable / Base year accounts receivable = Accounts receivable
2015: $32,756 / $13,205 = 248 %
2014: $26,028 / $13,205 = 197 %
2013: $23,976 / $13,205 = 182 %
2012: $14,677 / $13,205 = 111 %
2.
Express the following comparative income statements in common-size percents. (Round your percentage answers to 1 decimal place.)
GOMEZ CORPORATION
Comparative Income Statements
For Years Ended December 31, 2015 and 2014
2015 2014
$ % $ %
Sales $745,000 100.0 $675,000 100.0
Cost of goods sold 568,100 76.3 291,000 43.1
Gross profit 176,900 23.7 384,000 56.9
Operating expenses 129,200 17.3 240,800 35.7
Net income $47,700 6.4 $143,200 21.2
745,000 / 745,000 x100= 100.0% 675,000 / 675,000 x 100= 100%
568,100 / 745,000 x 100= 76.3% 291,000 / 675,000 x 100= 43.1%
176,900 / 745,000 x 100= 23.7% 384,000 / 675,000 x 100= 56.9%
129,200 / 745,000 x 100= 17.3% 240,800 / 675,000 x 100= 35.7%
47,000 / 745,000 x 100= 6.4% 143,200 / 675,000 x 100= 21.2%
Has the company's situation improved in the most recent year?
No
Explanation:
Analysis Overall, this company’s situation has worsened. This is evident from the substantial decline in net income as a percent of sales for 2015 (6.4%) relative to 2014 (21.2%). The main culprit is the increase in cost of goods sold as a percent of sales from 43.1% in 2014 to 76.3% in 2015. On a somewhat positive note, the company has not experienced any increase in operating expenses as a percent of sales; indeed, declining from 35.7% in 2014 to 17.3% in 2015. Even more positive is the company’s level of sales increase from $675,000 in 2014 to $745,000 in 2015.
3.
Common-size and trend percents for Rustynail Company's sales, cost of goods sold, and expenses follow.
Common-Size Percents Trend Percents
2015 2014 2013 2015 2014 2013
Sales 100.0 % 100.0 % 100.0 % 104.7 % 103.5 % 100.0 %
Cost of goods sold 63.3 61.1 57.9 114.5 109.2 100.0
Total expenses 14.3 13.8 14.1 106.3 101.3 100.0
________________________________________
Determine the net income for the following years. (Enter all amounts as positive values. Round your answers to nearest whole dollar.)
2015 2014 2013
Sales $104,700 $103,500 $100,000
Cost of Goods Sold 66,296 63,226 57,900
Total Expenses 14,988 14,283 14,100
Net Income $23,416 $25,991 $28,000
Did the net income increase, decrease, or remain unchanged in this three-year period?
Net income decreased
4.
Simon Company's year-end balance sheets follow.
At December 31 2015 2014 2013
Assets
Cash $ 31,364 $ 36,661 $ 36,695
Accounts receivable, net 93,629 63,516 49,421
Merchandise inventory 115,435 84,779 53,165
Prepaid expenses 9,999 9,816 4,118
Plant assets, net 281,162 263,494 231,001
________________________________________ ________________________________________ ________________________________________ ________________________________________ ________________________________________ ________________________________________
Total assets $ 531,589 $ 458,266 $ 374,400
________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________
Liabilities and Equity
Accounts payable $ 133,689 $ 76,672 $ 48,432
Long-term notes payable secured by
mortgages on plant assets 102,937 103,293 83,570
Common stock, $10 par value 163,500 163,500 163,500
Retained earnings 131,463 114,801 78,898
________________________________________ ________________________________________ ________________________________________ ________________________________________ ________________________________________ ________________________________________
Total liabilities and equity $ 531,589 $ 458,266 $ 374,400
________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________
________________________________________
Express the balance sheets in common-size percents. (Do not round intermediate calculations and round your final percentage answers to 1 decimal place.)
SIMON COMPANY
Common-Size Comparative Balance Sheets
December 31, 2013-2015
2015 2014 2013
Cash 5.9 % 8.0 % 9.8 %
Accounts receivable, net 17.6 13.9 13.2
Merchandise inventory 21.7 18.5 14.2
Prepaid expenses 1.9 2.1 1.1
Plant assets, net 52.9 57.5 61.7
Total assets 100.0 % 100.0 % 100.0 %
Accounts payable 25.1 % 16.7 % 12.9 %
Long-term notes payable secured by mortgages on plant assets 19.4 22.5 22.3
Common stock, $10 par 30.8 35.7 43.7
Retained earnings 24.7 25.1 21.1
Total liabilities and equity 100.0 % 100.0 % 100.0 % [Show Less]