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FS Analysis

# FS Analysis

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08/17/2013

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The income statement for Pine Company for the year ended December 31, 2002 appears below.

Sales

\$620,000

Cost of goods sold

380,000

Gross profit

240,000

Expenses

190,000*

Net income

\$ 50,000

*Includes \$20,000 of interest expense and \$22,000 of income tax expense.

Test Bank for Managerial Accounting, Second Edition

Ex. 126 (cont.)
1.Common stock outstanding on January 1, 2002 was 50,000 shares. On July 1, 2002, 10,000
more shares were issued.
2.The market price of Pine's stock was \$16 at the end of 2002.
3.Cash dividends of \$30,000 were paid, \$6,000 of which were paid to preferred stockholders.

Instructions

Compute the following ratios for 2002:
(a)earnings per share.
(b)price-earnings.
(c)times interest earned.

Solution 126(8-13 min.)

\$50,000 – \$6,000

\$44,000
(a)Earnings per share = —————————— =———— = \$0.80
[50,000 + (10,000 ÷ 2)] 55,000

\$16.00
(b)Price-earnings =———= 20 times
0.80

\$50,000 + \$20,000 + \$22,000
(c)Times interest earned =————————————— = 4.6 times
\$20,000

13-
34

Financial Statement Analysis

13-35

COMPLETION STATEMENTS

127.Discontinued operations refers to the disposal of a __________________ of a business.

128.The two criteria necessary for an item to be classified as an extraordinary item are that the
transaction or event must be (1) _______________ and (2) ________________.

129.A change in depreciation methods during the year would be classified as a change in
____________________.

130.______________ analysis, also called trend analysis, is a technique for evaluating a
series of financial statement data over a period of time.

131.Expressing each item in a financial statement as a percent of a base amount is called
______________ analysis.

132.For analysis of the financial statements, ratios can be classified into three types:
(1)_____________ ratios, (2)_____________ ratios, and (3)______________ ratios.

133.The times interest earned ratio is calculated by dividing ___________________ before
__________________ and __________________ by interest expense.

134.The ratios used in evaluating a company's liquidity and short-term debt paying ability that
complement each other are the ______________ ratio and the ______________ ratio.

135.The receivables turnover ratio is calculated by dividing ________________ by average
___________________.

136.If the inventory turnover ratio is 5 times, and the average inventory was \$600,000, the cost
of goods sold during the year was \$______________ and the average days to sell the
inventory was ______________ days.

137.Hansen Corporation had net income for the year of \$300,000 and a profit margin ratio of
25%. If total average assets were \$200,000, the asset turnover ratio was ____________
times.

138.The ______________ ratio measures the percentage of earnings distributed in the form of
cash dividends.

139.The lower the _______________ to _______________ ratio, the more equity "buffer" is
available to the creditors if the company becomes insolvent.

Test Bank for Managerial Accounting, Second Edition

127.significant segment

134.current, acid-test (quick)

128.unusual in nature, infrequent in occurrence

135.net credit sales, net receivables

129.accounting principle

136.3,000,000, 73

130.Horizontal

137.6

131.vertical (common size)

138.payout

132.liquidity, solvency, profitability (any order)

139.debt, total assets

133.income, income taxes, interest expense

MATCHING

Set 1

140.For each of the ratios listed below, indicate by the appropriate code letter, whether it is a
liquidity ratio, a profitability ratio, or a solvency ratio.

Code:
L =

Liquidity ratio

P =

Profitability ratio

S=

Solvency ratio

____1.Cash return on sales ratio

____2.Return on assets ratio

____3.Receivables turnover ratio

____4.Earnings per share ratio

____5.Payout ratio

____6.Current cash debt coverage ratio

____7.Acid-test ratio

____8.Debt to total assets ratio

____9.Free cash flow

____10.Inventory turnover ratio

P 1.Cash return on sales ratio

L 6.Current cash debt coverage ratio

P 2.Return on assets ratio

L 7.Acid-test ratio

L 3.Receivables turnover ratio

S 8.Debt to total assets ratio

P 4.Earnings per share ratio

S 9.Free cash flow

P 5.Payout ratio

L 10.Inventory turnover ratio

13-
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Financial Statement Analysis

13-37

Set 2

141.Match the ratios with the appropriate ratio computation by entering the appropriate letter in
the space provided.

A.Current ratio

F.Times interest earned ratio

B.Acid-test ratio

G.Inventory turnover ratio

C.Profit margin ratio

H.Average collection period

D.Asset turnover ratio

I.Average days in inventory

E.Price-earnings ratio

J.Payout ratio

Cost of goods sold
____1.—————————
Average inventory

Net income
____2.—————
Net sales

Cash dividends
____3.———————
Net income

Net sales
____4.———————
Average assets

Current assets
____5.————————
Current liabilities

365 days
____6.——————————
Receivables turnover

Market price per share of stock
____7.——————————————
Earnings per share

365 days
____8.————————
Inventory turnover

Income before income taxes and interest expense
____9.——————————————————————
Interest expense

Cash + Short-term investments + Receivables (net)
____10.———————————————————————
Current liabilities

1.G

6.H

2.C

7.E

3.J

8.I

4.D

9.F

5.A

10.B

Test Bank for Managerial Accounting, Second Edition

S-A E 142

Horizontal and vertical analyses are analytical tools frequently used to analyze financial
statements. What type of information or insights can be obtained by using these two techniques?
Explain how the output of horizontal analysis and vertical analysis can be compared to industry
averages and/or competitive companies.

Solution 142

Horizontal analysis allows an analyst to develop a picture of current trends in a company's
operations. The analyst can see whether the accounts are increasing or decreasing and how
large these changes actually are. Vertical analysis allows an analyst to evaluate financial
statement items within a single financial statement. This technique helps the analyst to evaluate
the relative size of the financial statement items and how the items relate to the financial
statement as a whole. An example would be if current liabilities were a very large percentage of
total liabilities and stockholders' equity.

Both techniques allow the company to evaluate their performance and position relative to their
competitors and their industry as a whole. For example, the company could evaluate their current
trend in sales and see how favorably their sales performance compared to the sales performance
of other companies in the industry. Another example would be comparing the relative size of
long-term liabilities or retained earnings. This would show which companies have taken on a
large amount of debt and which companies have reinvested earnings.

S-A E 143

The use of estimates, cost, alternative accounting methods, the presence of atypical data, and
diversification of firms have been cited as factors that limit the usefulness of financial statement
analysis. Identify a ratio and explain how one or more of the limiting factors can affect the
usefulness of that ratio.

Solution 143

Any of the profitability ratios that involve net income will be affected by the method of depreciation
chosen. The use of an accelerated method, such as double-declining balance, will result in higher
depreciation costs in the early years and lower depreciation costs in the later years. These costs
will differ from the depreciation costs that would have been incurred if the straight-line method
had been used. Therefore, because of the different costs, net income will also be different. Thus,
the choice of depreciation method affects net income, which in turn affects the ratio.

Both the acid-test ratio and the receivables turnover ratio are affected by the estimate of
uncollectible accounts. The estimate will determine the amount of net receivables used to
calculate the ratio. A high estimate will lower the net receivables and a low estimate will increase
the net receivables. Thus, the accuracy of the estimate will have a direct effect on the accuracy
of the ratio.

13-
38

Financial Statement Analysis

13-39

S-A E 144(Ethics)
A trusted employee of Wilderness Tours was caught in the act of embezzling funds. He
confessed to earlier embezzlements, but retracted the confession on the advice of his attorney.
Over the course of the most recent quarter, it has been determined that \$20,000 was embezzled.

Wilderness Tours has suffered adverse publicity in the recent past because of serious injury to
five tourists that occurred during a two week "Winter Wilds Adventure" tour. The company has
therefore decided to avoid publicity and has agreed to drop all charges against the embezzling
employee. In return, the employee has agreed to a notation of "Terminated—Not to be Rehired"
to be appended to his personnel file.

Required:

1.Who are the stakeholders in the decision not to prosecute?
2.Was it ethical for the company to decide not to prosecute? Explain.

Solution 144

1.The stakeholders include

The embezzling employee

The other employees

Company management

Other companies who might hire the embezzling employee

2.The company was certainly within its legal rights not to prosecute the embezzling employee.
However, the decision not to prosecute may not be ethical. First, it does not serve public
justice. The embezzling employee could find a job elsewhere, and harm someone else
financially. Second, to the extent that other employees know of the act and of the decision,
morale may be harmed. The decision is also not the best one for the employee. Having never
been forced to face the consequences of his dishonest acts, he is not deterred from (and may
even feel encouraged to) commit similar acts in the future. The one argument that would
support the premise that the decision was ethical is that the public disclosure would cause
harm greater than that caused by keeping silent. Even this argument lacks force, because it
implies a lack of moral courageousness.

S-A E 145(Communication)
Fast Express specializes in the transportation of medical equipment and laboratory specimens
overnight. The company has selected the following information from its most recent annual report
to be the subject of an immediate press release.

The financial statements are being released.

Net income this year was \$2.1 million. Last year's net income had been \$1.8 million.

The current ratio has changed to 2:1 from last year's 1.5:1

The debt/total assets ratio has changed to 4:5 from last year's 3:5

The company expanded its truck fleet substantially by purchasing ten new delivery vans.

The company already had twelve delivery vans. The company is now the largest medical
courier in the mid-Atlantic region.

Required:

Prepare a brief press release incorporating the information above. Include all information. Think
carefully which information (if any) is good news for the company, and which (if any) is bad news.

Test Bank for Managerial Accounting, Second Edition

Solution 145

Fast Express released its financial statements today, disclosing a 17% increase in earnings, to
\$2.1 million from \$1.8 million last year. The company also improved its short-term liquidity. Its
current ratio improved to 2:1 from last year's 1.5:1. Part of the improved performance is no doubt
due to the addition of ten new delivery vans to its fleet, allowing it to become the largest medical
courier in the mid-Atlantic region. The purchase of the vans, however, caused the debt/total
asset ratio to decline. There are now \$4 of debt for every \$5 in assets, while last year, there were
only \$3 of debt to \$5 in assets.

13-
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