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Mindanao State University

College of Business Administration and Accountancy

DEPARTMENT OF ACCOUNTANCY
Marawi City

UNDERSTANDING AND INTERPRETATION OF FINANCIAL STATEMENTS


Accounting 142

ANALYSIS OF FINANCIAL STATEMENTS


General purpose financial statements contain historical
financial information about a firms financial condition,
operating results and other business activities. They serve as
a communication link between the firm and various
interested parties.
Major users of an entitys financial statements are its
creditors, investors and management. Creditors, whether
short-term (i.e. suppliers) or long-term (i.e. lenders), want to
be assured of receiving prompt payment from the
company. Investors, on the other hand, want to determine
if the company will be able to distribute dividends in the
future and if its shares will rise in value. Finally, managers
monitor the companys overall performance as part of its
functions.
When users read a firms financial statements, they get an
overall picture of the firms profitability and financial
conditions. Merely reading such statements, however, is not
enough when for them make informed judgments and
decisions. A thorough analysis and interpretation of such
statements is required.
Financial statement analysis involves the careful selection
of data from financial statements in order to assess and
evaluate the firms past performance, its present condition
and future business potentials. Financial statement analysis
interprets financial statement data and presents it in a
summary form to simplify users analysis.
Objectives of Financial Statement Analysis
The primary purpose of financial statement analysis is to
evaluate and forecast the companys financial health.
Financial statement analysis helps identify the companys
financial strengths and weaknesses and provide information
about the:
A. Profitability of the business firm.
B. Ability of the firm to meet its obligations.
C. Safety of the investment in the business.
D. Effectiveness of management in running the firm.
Specifically, the uses and purposes of financial performance
analysis are:
A. To set goals and targets for future operations.
B. To compare the firms performance to others.
C. To measure financial strength for granting purposes.
D. To spot trends, weaknesses and potential problems.
E. To evaluate alternative courses of action.
F. To understand interactions that financial changes
have on a firms financial position.
Steps in the Analysis of Financial Statements
The analysis of financial statements does not merely involve
computation of some relevant ratios and amounts. Listed
below are the steps undertaken in performing an effective
analysis of financial statements:
A. Establish the objectives of the analysis to be
conducted.
B. Study the industry where the firm belongs.
C. Study the firms background and the quality of its
management.
D. Evaluate the firms financial statements using the
evaluation techniques available.
E. Summarize the results of the study and evaluation
conducted.
F. Develop conclusions relevant to established
objectives.
TECHNIQUES USED IN FINANCIAL STATEMENT ANALYSIS
There are various techniques available to analysts in
understanding and interpreting the financial statements of
a specific entity. Commonly used financial statement

analysis techniques are horizontal analysis, vertical analysis,


ratio analysis and gross profit variation analysis.
HORIZONTAL ANALYSIS
In horizontal or comparative analysis, data from two or
more consecutive time periods are compared. The
difference between the figures of the two periods is
calculated and the percentage change from one period
to the next is computed using the earlier period as the
base. Horizontal analysis may also involve comparison
between the actual and budgets or two versions of
budgets.
% of change =

Most recent value Base period value


Base period value

In performing horizontal analysis, the following are to be


considered:
A. If the base is zero or negative as in the case of
discounts on bonds payable, the percentage
change is not computed anymore.
B. Percentage changes and absolute amount
changes should both be considered in interpreting
the results of the analysis.
C. Comparative figures enhance analysis. It is better if
companies prepare comparative figures for a
period of longer than two years.
D. To highlight the trends in some important accounts,
long-term comparisons may be presented through
tables, graphs or charts.
E. Horizontal analysis of financial statements can also
be carried out by computing trend percentages.
Trend percentages state several years financial
data in terms of a base year. The base year equals
100%, with all other years stated as some
percentage of this base.
VERTICAL ANALYSIS
In vertical or common size analysis, figures in the financial
statements of a single period are compared by converting
them as a percentage of a common base. To accomplish
this, a common size or percentage composition statement
is prepared where all statement values are expressed as a
percentage of a base number which is set equal to 100%.
% of base value =

Value of item under consideration


Base value

In performing horizontal analysis, the following are to be


considered:
A. Normally, the base to be used is the net sales for
the income statement and total assets for the
statement of financial position.
B. Vertical analysis is more useful in comparing two
entities of differing size which first should be put in
equal standing by expressing their financial figures
into percentage and defining a common account
as base.
C. Vertical analysis gives additional information on
how the money coming from customers is
distributed among suppliers, employees, lessors,
creditors, government and owners.
RATIO ANALYSIS
In ratio analysis, one variable is selected as the numerator
while another variable is selected as the denominator to
show a relationship which can be expressed as a
percentage, a ratio or merely a number. In calculating
ratios, the following rules shall be observed:
A. Generally, when calculating a ratio, the amounts
for the numerator and the denominator must come
from the same statement.
B. If an income statement account and a statement
of financial position account are both used to

Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

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calculate a ratio, the statement of financial


position amount should be averaged for the time
period represented by the income statement
account.
C. If the beginning balance of the statement of
financial position account is not available, the
ending balance is normally used to represent the
average balance of the account.
D. If sales or purchases are given without making
distinction as to whether made in cash or on credit
assumptions are made depending on the ratio
being calculated. If turnover ratios, sales and
purchases are assumed to be made on credit. If
cash flow ratios, sales and purchases are assumed
to be made on cash.
There are several ratios that can be used for analysis.
However, these ratios can be grouped into four broad
categories depending needs of the users. Long-term
creditors are interested in ratios indicating the solvency of
the corporation while short-term creditors are more
interested in ratios indicating the liquidity of the firm.
Potential investors and stockholders, on the other hand, are
concerned with the firms profitability and the behavior of
its shares of stocks in the market.

Operating
Cycle

Average Age of
Receivables + Average
Age of Inventories

Measures the average


number of days to
convert the firms
inventories to cash

Working
Capital

Current Assets Current


Liabilities

Measures the firms


liquidity in terms of
absolute peso amounts

Working
Capital
Turnover

Net Sales Average


Working Capital

Measures the adequacy


of activity of working
capital

Asset Turnover

Net Sales Average Total


Assets

Measures the
effectiveness of asset
utilization in generating
revenue

Current Assets
Turnover

(Cost of Sales + Income


Taxes + Operating
Expenses excluding
Depreciation, Amortization
and Other Expenses
Related to Long-term
Assets) Average Current
Assets

Measures the
movement and
utilization of current
assets to meet the
operating requirements
of the firm

Fixed Assets
Turnover

Net Sales Average Fixed


Assets

Measures the
effectiveness of
utilization of fixed assets
in generating revenue

Liquidity Ratios

Leverage Ratios

Liquidity ratios provide information about the firms ability to


pay its current obligation and continue operations. These
ratios answer the question:

Also known as capital adequacy or solvency ratios,


leverage ratios provide information on the extent to which
borrowed or debt funds are used to finance assets. These
ratios are also a good way to assess the ability of the firm to
meet its debt payment obligations. These ratios are also
known as capital adequacy or solvency ratios. The ratios
answer the questions:

What liquid assets are available or accessible to meet demands


for cash from expected and unexpected sources?
TEST

FORMULA

SIGNIFICANCE

Current Ratio
(Working
Capital Ratio)

Current Assets Current


Liabilities

Measures the number of


times that the current
liabilities could be paid
with the available
current assets

Quick Ratio
(Acid Test
Ratio)

Receivables
Turnover

Quick Assets Current


Liabilities
Quick assets include cash
and cash equivalents,
marketable securities and
net receivables.

Net Credit Sales Average


Trade Receivables

Average Age
of Receivables
(Average
Collection
Period)

360 days Receivables


Turnover

Merchandise
Inventory
Turnover

Cost of Sales
Average Merchandise
Inventory

Finished Goods
Turnover

Cost of Sales Average


Finished Goods Inventory

Goods In
Process
Turnover

Cost of Goods
Manufactured
Average Goods In Process
Inventory

Raw Materials
Turnover

Cost of Raw Materials Used


Average Raw Materials
Inventory

Measures the firms


ability to pay its shortterm debts from its most
liquid assets without
having to rely on
inventory.
Measures the time
required to complete
one collection cycle
from the time
receivables are
recorded, and then
collected to the time
new receivables are
recorded again.
Measures the average
number of days to
collect a receivable or
the average credit term
extended to customers

Measures the number of


times that inventory is
replaced during the
period or the level of
inventory movement
during the year; for a
manufacturing firm, a
turnover ratio is
computed for each
type of inventories

Average Age
of Inventories
(Average
Conversion
Period)

360 days Inventory


Turnover Ratio

Measures the average


days inventory is kept in
company premises
whether for conversion
or in storage while
waiting to be sold

Payables
Turnover

Net Credit Purchases


Average Trade Payables

Measures the liquidity of


the firms payables

Average Age
of Payables
(Average
Payment
Period)

360 days Payables


Turnover Ratio

Measures the length of


time which trade
payables remain unpaid
and whether the firm
pays its invoices on time

How much capital is necessary to protect creditors and


shareholders against losses?
How little capital is necessary to allow shareholders to enjoy
maximum favorable returns on equity and dividends?
TEST

FORMULA

SIGNIFICANCE

Debt Ratio

Total Liabilities Total


Assets

Measures the relative


share of creditors over
the total resources of
the firm

Equity Ratio

Total Equity Total Assets

Measures the amount of


resources provided by
owners of the firm

Debt to Equity
Ratio

Total Liabilities Total


Equity

Indicates how much of


the debt is matched by
investment by owners.

Times Interest
Earned

Earnings Before Interests


and Taxes Interest
Expense

Measures how many


times interest expense is
covered by operating
profit

Equity
Multiplier

Total Assets Total Equity

Indicates how much


total investment can be
financed from ownerprovided equity

Profitability Ratios
Profitability ratios provide information on the ability of the
firm to generate earnings in relation to some base such
assets, sales or capital. The ratios answer the question:
Is net income adequate to satisfy investors dividend and rate of
return expectations and to support growth?
TEST

FORMULA

SIGNIFICANCE

Gross Profit Net Sales

Measures profit
generated after
consideration of cost of
goods sold which is
used to recover
operating expenses

Operating
Profit Margin

Operating Profit Net Sales

Measures profit
generated after
consideration of
operating costs and
cost of goods sold

Return on
Sales

Income Net Sales

Measures profit
percentage per peso
sales

Gross Profit
Margin

Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

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Income Average Total


Equity

Measures the rate of


return on resources
provided by owners

Return on
Assets

Income Average Total


Assets

Measures the overall


efficiency of the firm in
managing assets and
generating profits
regardless of how the
assets are financed

Earnings per
Share

(Net Income Preference


Dividends) Average
Outstanding Ordinary
Shares

Measures the peso


return on each ordinary
share which is indicative
of ability to pay
dividends

Cash Flow
Margin

Cash Flows from Operating


Activities Net Sales

Measures the ability


of the firm to translate
sales to cash

Return on
Equity

Important Notes:
A. If the intention is to measure operational
performance, income is expressed as before
interest and tax.
B. If the intention is to evaluate total managerial
effort, income is expressed after interest and
tax. The practice of expressing income after
interest but before tax is discouraged.
C. For return on asset calculation, income should
be before interest as it does not consider the
effect of the type of financing used.
D. Income should include dividends and interest
earned if the related investments are included
in the asset base.
E. If the DuPont model is used, income must be
after interest, tax and preferred dividends.
Growth Ratios
Growth ratios provide information of the organizations
potential and attractiveness as an option. The ratios answer
the question:
How do financial markets evaluate the financial condition of the
firm?
TEST

FORMULA

SIGNIFICANCE

Dividend Yield
Ratio

Dividends per Share


Market Value per Share of
Ordinary Shares

Measures rate earned


by shareholders from
dividends relative to
investment in stock

Dividend
Payout Ratio

Dividend per Share


Earnings per Share

Represents the
percentage of net
income distributed as
dividends

Price
Earnings Ratio

Market Value per Share of


Ordinary Shares Earnings
per Share of Ordinary
Shares

Measures the number of


period investment in
stock will be recovered;
measures investors
beliefs on the growth
potential of the stock

Analyzing Calculated Ratios


Understanding and interpreting calculated ratios may be
done through any of the following means:
A. Trend or time-series analysis uses ratios to
evaluate a firms performance over time.
B. Cross-section analysis uses ratios to compare
different companies at the same point in time.
C. Industry-comparative analysis used to compare
a firms ratios against average ratios for other
companies in the same industry.
GROSS PROFIT VARIATION ANALYSIS
Gross profit variation analysis is a detailed study on the
factors that caused the net change in gross profit. Changes
in gross profit may be attributed to the change in any or a
combination of the following factors:
A. Selling price(s) of the product(s).
B. Volume or quantity of product(s) sold: number of
physical units sold and product mix or sales mix
which refers to the composition of the products
sold.
C. Cost of the product sold: purchase cost of the
product for merchandising firms or manufacturing

costs of the product namely, materials, labor and


factory overhead for manufacturing firms.
Sales variances:
Sales this year
Sales this year at sales prices last year
Sales price variance

P xxx
X xxx
P xxx

Sales this year at sales prices last year


Sales last year
Sales volume variance

P xxx
X xxx
P xxx

Cost variances:
Cost of sales this year
Cost of sales this year at cost price last year
Cost price variance
Cost of sales this year at cost price last year
Cost of sales last year
Cost volume variance

P xxx
X xxx
P xxx
P xxx
X xxx
P xxx

Summary of Variances:
Sales price variance
Cost price variance
Net price variance

P xxx
X xxx
P xxx

Sales volume variance


Cost volume variance
Net volume variance
Gross profit variance

P xxx
X xxx
P xxx
P xxx

For multi-products, the net volume variance can be broken


down into its sales mix and sales yield components:
Net volume variance:
Gross profit this year at last year's UGP
Gross profit this year at average UGP last year
Sales mix variance

P xxx
X xxx
P xxx

Gross profit this year at average UGP last year


Gross profit last year
Sales yield or final sales volume variance

P xxx
X xxx
P xxx

OPERATING AND FINANCIAL LEVERAGE


Leverage refers the use of fixed cost assets or funds to
magnify returns to the firms owners. It is desirable as it
produces more earning power to owners. However,
leverage can also increase the risk exposure of firms.
A. Operating leverage the use of fixed operating
costs in a companys cost structure to enhance the
rate of return to equity owners. It is achieved by
increasing fixed costs while lowering variable costs.
The degree of operating leverage is used to
measure how sensitive profit before tax is to
percentage change in sales. It also is a measure of
operating or business risk, the risk associated with
projections of a firms future returns on assets or
returns on equity if the firm uses no debt.
Total contribution margin
Profit before tax

DOL =

Degree of OL =
B.

Percentage change in profit before tax


Percentage change in sales

Financial leverage also called trading on equity,


refers to a companys use of borrowed funds and
fixed income securities to enhance the rate of
return to equity owners. Financial leverage is equal
to:
Return on equity Return on assets
There is positive financial leverage when the rate
earned on borrowed assets exceeds the rate paid
for the privilege of borrowing. There is a good use
of the borrowed funds and profits were earned
from its use (ROE > Interest rate).
There is negative financial leverage when the rate
earned on borrowed assets is less than the
borrowing rate. Simply put, the returns supposedly
generated from borrowings did not cover for the
interest charges of the borrowing (ROE < Interest
rate).
The degree of financial leverage is used to
measure the effects on earnings per share of
changes in profit before tax. It is also a measure of
financial risk, the additional risk placed on the
common stockholders as a result of the firms
decision to use debt.

Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

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A. Differences among companies exists, may it be in


their size, nature and the business environment they
operate. As such, what is acceptable to one entity
may not be acceptable to another. Though
accountants are governed by GAAP, differences
might still be encountered because of variations in
the application of such principles.
B. Financial statements are prepared on an historical
cost basis and therefore do not reflect current
market value. Also, the gains or losses on
purchasing power are not reflected in the financial
statements.
C. The use of averages affect the ratios computed,
thereby, the analysis itself.
D. Most of the ratios used are merely approximations
and not accurate. The ratios computed themselves
are not conclusive and are not sufficient as a basis
to form judgments.
E. Financial statements do not show all the details
needed by external users in developing some
ratios.
F. Information gathered from the analysis of financial
statements is only a part of what is needed to
make good economic decisions.

Profit before tax


Profit before tax Interest Preferred
dividends before tax

DFL =

Degree of O =

Percentage change in EPS


Percentage change in profit before tax

C. Total leverage the use of fixed costs, whether


operating costs or financial costs, to enhance the
rate of return to equity owners.
The degree of total leverage measures the
combined effect of both operating leverage and
financial leverage. It is a measure of total risk.
Total contribution margin
Profit before tax Interest Preferred
dividends before tax

DTL =

Degree of O =

Percentage change in EPS


Percentage change in sales

Degree of O =

Degree of OL x Degree of FL

An increase in operating leverage can result in the lower


need for financial leverage.
LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS
Some problems and limitations might be encountered in
analyzing financial statements. Analysts must be aware with
and guard against these problems.

ILLUSTRATIVE PROBLEMS
PROBLEM 1: Following are comparative
financial statements of Jasmine Corporation:

condensed

c.
d.

Jasmine Corporation
Statement of Financial Position
As of December 31

e.

Cash
Accounts receivable, net
Inventories
Fixed assets, net
Total assets

2013
P 7,500
11,000
20,500
34,410
P 73,410

2012
P 5,250
8,250
19,000
37,500
P 70,000

Current liabilities
Bonds payable, 10%
Common stock, P2.50 par
Retained earnings
Total equities

P 11,500
25,000
25,000
11,910
P 73,410

P 12,500
22,500
25,000
10,000
P 70,000

P6.25 /share

P8.75/share

Market price of stock, 12/31

Jasmine Corporation
Statement of Income and Retained Earnings
For the Year Ended December 31
Sales
Cost of goods sold
Gross margin
Operating expenses
Interest expense
Income before taxes
Income taxes
Net income after tax
Retained earnings, 1/1
Total
Dividends paid
Retained earnings, 12/31

2013
P 100,000
61,250
P 38,750
(26,000)
(2,500)
P 10,250
3,590
P
6,660
10,000
P 16,660
4,750
P 11,910

2012
P 97,500
55,000
P 42,500
(26,250)
(2,250)
P 14,000
4,900
P
9,100
4,750
P 13,850
3,850
P 10,000

Net cash inflows from operating activities for 2013 was


P3,000.
Requirements:
1. Perform a horizontal analysis of Jasmines financial
statements. Show the increases and decreases in
each account in absolute peso values and
percentages.
2. Perform a vertical analysis on the financial statements
of Jasmines financial statements.
3. Using the data on the financial statements, perform a
ratio analysis by calculating the following ratios as of
and for 2013:
a. Working capital ratio, current ratio and quick
ratio (acid test ratio).
b. Receivables turnover and average collection
period.

f.
g.
h.
i.
j.
k.

Inventory turnover and average conversion


period.
Payables turnover and average payment
period.
Operating cycle and cash conversion cycle in
days.
Asset turnover and working capital turnover.
Debt ratio, equity ratio and debt-equity ratio,
equity multiplier and times interest earned.
Gross profit margin, operating profit margin
and cash flow margin.
Return on sales, return on assets and return on
equity.
Earnings per share (EPS) and price-earnings
(P/E) ratio.
Dividend yield, dividend payout and plowback
ratio.

PROBLEM 2: Parsons Company's sales and current assets


have been reported as follows over the last four years (in
thousands):
Sales
Cash
Accounts receivable
Inventory
Prepaid expenses

Year 4
P 800
35
75
78
47

Year 3
P700
30
50
75
39

Year 2
P600
24
58
80
11

Year 1
P 570
18
45
75
25

Requirements:
1.
2.

Express all the sales and current assets on trend index


or percentages using Year 1 as base year.
Express all the sales and current assets on trend index
or percentages using Year 3 as base year.

PROBLEM 3: Financial analysis may be used to test the


fairness of the relationships among current financial data
against those of prior financial information. Given
established financial relationship and key amounts, a CPA
could also prepare projected financial statements. June
Sales Corporation has in recent prior years maintained the
following relationships among the data on its financial
statements:
Net income rate on net sales
Gross income rate on net sales
Ratio of selling expense to net sales
Acid test ratio
Current ratio
Accounts receivable turnover
Inventory turnover
Composition of quick assets:
Cash
Marketable securities
Accounts receivable

Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

5 per cent
35 per cent
15 per cent
2 to 1
3 to 1
5 times
5 times
10 per cent
30 per cent
60 per cent

Page|4 of 7

Asset turnover
Ratio of total assets to intangible assets
Ratio of accounts receivable to accounts
payable
Ratio of working capital to shareholders
equity
Ratio of total liabilities to stockholders equity
Ratio of accumulated depreciation to cost of
fixed assets
Number of times interest earned

1 per year
20 to 1
1.5 to 1
1 to 1.6
1.4 to 1.6
1 to 3
2 times

For 2013, the company projects to have a net income of


P150,000 which will result in earnings per share of P10 per
share of common stock. Additional information includes the
following:
A. Common stock has a par value of P50 per share
and was issued at 20% premium.
B. 8% preferred stock has a par value of P50 per share
and was issued at 10% premium.
C. Preferred dividends paid in 2012 was P10,000. The
same amount will be paid in 2013.
D. The companys purchases and sales are all on
account.
For projection purposes, it is assumed that the above
relationships among the data on the financial statement of
June Sales Corporation shall also hold true for 2013.
Requirements:
1.
2.

Prepare a projected statement financial position for


the year 2013. Ignore income tax.
Prepare a projected income statement for the year
ended December 31, 2013. Ignore income tax.

PROBLEM 4: Joaquin Corporation asked you to interpret the


following ratios provided by its accountant:
Acid test ratio
Times interest earned
Gross margin ratio
Inventory turnover
Debt to equity ratio
Ratio of operating expenses to sales

1.2 to 1
8 times
40%
6 times
0.9 to 1
15%

Total stockholders equity on December 31, 2013 was


P900,000. Gross margin for 2013 amounted to P600,000.
Beginning balance of merchandise inventory was P200,000.
The companys long-term liabilities consisted of bonds
payable with interest of 15%. You decided to reconstruct
the companys financial statements based on the limited
information given to serve as basis for further analysis.
Requirements:
1.
2.
3.

What was the operating income of Joaquin for 2013?


What was the total of bonds payable as of
December 31, 2013?
What is the working capital of Joaquin as of
December 31, 2013?

PROBLEM 5: The management of Sonic Consumer Products


Company is preparing its plans for the year 2013. The
average assets to be employed for the year are estimated
at P2,600,000 with 20% of this amount borrowed at no
interest cost. Materials and labor cost for the year is
budgeted at P4,000,000 while operating cost is estimated
at P1,500,000. All sales are to be billed at 162.5% of
materials and labor cost. Income tax rate is at an average
of 35% of income before income tax.
Requirements:
1.
2.
3.

What is the estimated rate of return on sales and the


expected asset turnover for 2013?
What is the estimated rate of return on average total
assets for 2013?
What is the estimated rate of return on stockholders
equity for 2013?

PROBLEM 6: Supply the missing data in each independent


situation below using only the information given:
Case A: Payout ratio
40%
Earnings per share
P 50.00
Price-earnings ratio
4 to 1
Market price per share
?
Dividend per share
?
Yield rate
?

Case B: Equity to debt ratio


Stockholders equity
Return on assets
Return on shareholders equity
Case C: Return on equity
Debt ratio
Return on assets
Case D: Market price per share
Price-earnings ratio
Net income
Common stock outstanding
Case E: Total assets
Ordinary shares outstanding
Preference shares outstanding
Net income
Depreciation expense
Cash flow to total liabilities
Case F: Return on asset
Asset turnover
Profit margin ratio
Case G: Current assets
Inventory
Quick ratio
Current liabilities
Case H: Total assets, beginning
Net income for the year
Dividends paid during the year
Internal growth rate
Case I: Net purchases (all on account)
Cost of goods sold
Ending inventory
Net sales (10% on cash)
Beginning accounts receivable
Collections on accounts
Operating cycle
Case J: Sales
Bond interest expense
Income taxes
Net income
Times interest earned
Case K: Asset turnover
Return on assets
Return on equity
Debt ratio
Equity multiplier

60%
P 120 million
9%
?
12%
40%
?
P
120.00
4 times
P 1.5 million
?
P 5 million
2.5 million
1 million
P 750,000
500,000
?
24%
1.6 times
?
P

200,000
80,000
2 to 1
?
P 500,000
30,000
10,000
?
P 960,000
900,000
180,000
1.3 million
80,000
1.1 million
?
P 1.8 million
60,000
300,000
400,000
?
1.5 times
3%
5%
?
?

PROBLEM 7: The following information is available from the


Embargo Company accounting records:
A. Cash account balance is P43,000 on January 1,
2013 and P18,000 on December 31, 2013.
B. The balance in accounts receivable decreased by
P10,000 during the year from P60,000. The company
had no short-term investments.
C. Accounts payable increased P3,000 during the
year to P32,000. Income tax payable increased
P4,000 during the year to P8,000. Wages payable
decreased by P5,000 to P4,000. There were no
other current liabilities.
D. The companys inventory increased by P9,000 to
P80,000.
E. During December 2013, the company settled a
P10,000 note payable by issuing shares of its own
capital with equivalent value.
F. Sale of some old operational assets resulted in the
following entry:
Cash
Accumulated depreciation
Operational assets
Gain on sale of assets

P 5,000
12,000
P 15,000
2,000

G. Cash expenditures during 2013 were the following:


Payment of long-term debts, P64,000.
Purchase of new operational assets, P74,000.
Payment of cash dividend, P16,000.
Purchase of land as an investment, P25,000.
H. Sale and issuance of Embargo Company capital
stock for P20,000 cash.
I. Issuance of long-term mortgage note, P30,000.

Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

Page|5 of 7

J.
K.

Total assets at December 31, 2013 equaled


P1,000,000.
Income statement data for the year 2013 follows:
Sales, net
Cost of goods sold
Depreciation expense
Patent amortization
Income tax expense
Selling and administrative expenses
Gain on sale of operational assets
Net income

295,000
(140,000)
(14,000)
(1,000)
(17,000)
(42,000)
2,000
P
83,000

2.
3.

Requirements:
1. Compute for the current and quick ratio, working
capital to total assets ratio.
2. Compute for the accounts receivable turnover and
inventory turnover.
3. Compute for the age of accounts receivable and
age of inventory.
4. Compute for the working capital turnover and profit
margin on sales.
5. Compute for the net cash flow to current liabilities
and dividend payout ratio.
PROBLEM 8: Provide for what is asked by each independent
situation below.
A. Related Ventures has a total asset turnover of 0.30
and a profit margin of 10%. The president is
unhappy with the current return on assets and he
thinks it could be doubled. This could be
accomplished by increasing the profit margin to
15% and increasing the total assets turnover. What
new asset turnover ratio, along with the 15% profit
margin, is required to double the return on assets?
B. Linked Company has a debt ratio of 0.50, a total
assets turnover of 0.25 and a profit margin of 10%.
The president is unhappy with the current return on
equity and he thinks it could be doubled. This could
be accomplished by increasing the profit margin to
14% and by increasing debt utilization. Total assets
turnover will not change. What new debt ratio,
along with the 14% profit margin, is required to
double the return on equity?
C. Associated Corporation paid out of its 2012
earnings by dividends. Its earnings increased by
20% and the amounts of its dividends increased by
15% in 2013. What was Associateds dividend
payout ratio in 2013?
D. It is the policy of Attached Corporation that the
current ratio cannot fall below 1.5 to 1.0. Its current
liabilities are P400,000 and the present current ratio
is 2.0 to 1.0. How much is the maximum level of new
short-term loans it can secure without violating the
policy?
E. As of the end of 2012, Connected Company had
total assets of P375,000 and equity of P206,250. For
2013, its budget for capital investment projects is
P62,500. To finance a portion of the capital budget,
the company may borrow from a bank which set a
condition that the loan would be approved,
provided that the 2013s debt to equity ratio should
be the same as that of 2013. How much debt
should be incurred to satisfy the banks condition?
PROBLEM 9: Sta. Maria Company produces and sells cellular
phone blaster, a gadget which explodes when activated
with a remote commander. This is used by cell phone
owners when their unit is snatched from them or is taken by
thieves. The static master budget and the actual results of
operations for the month of June are as follows:
Budget
Actual
Sales
P 800,000
P 1,056,000
Cost of goods sold
480,000
556,800
Gross profit
P 320,000
P 499,200
Management wants an explanation of the favorable gross
profit variance of P179,200.
Requirements:
1. Compute for the sales price and sales volume
variances.

Compute for the cost price and cost volume


variances.
Determine the percentage changes in volume, in
sales price and cost price.

PROBLEM 10: The management of Seymour Corporation


asks you to prepare an analysis of the gross profit variance
based on their comparative income statements for 2012
and 2013:
2013
2012
Sales
P 990,000
P 800,000
Cost of goods sold
760,000
640,000
Gross profit
P 230,000
P 160,000
The only known information given to you is that volume
increased from 2012 to 2013 by 10%.
Requirements:
1.
2.
3.
4.

Determine the sales price and sales volume


variances.
Determine the cost price and cost volume variances.
What are the percentage changes in sales price and
cost price?
What is the variance in gross profit due to change in
volume?

PROBLEM 11: The income data of Escano Company for the


year 2012 and 2013 are as follows:
2013
2012
Sales
P 276,000
P 204,000
Cost of goods sold
151,800
122,400
Gross profit
P 124,200
P 81,600
The sales price in 2013 is approximately 20% higher than the
sales price in 2012.
Requirements:
1.
2.
3.

Compute for the sales price and sales volume


variances.
Compute for the cost price and cost volume
variances.
Determine the percentage changes in cost price
and volume.

PROBLEM 12: The gross profit statements for 2013 and 2012
of Mimi Company follow:
2013
2012
Sales
P 160,000
P 120,000
Cost of goods sold
120,000
72,000
Gross profit
P
40,000
P 48,000
Mimi Company informed you that the unit cost decreased
by 20% at the start of 2013.
Requirements:
1.
2.
3.

Determine the sales price and sales volume


variances.
Determine the cost price and cost volume variances.
Determine the percentage changes in sales price
and volume.

PROBLEM 13: Amoroso Traders, Inc. sells three consumer


products. Sales and other information pertaining to the
three products are as follows:
2013
Tic
Tac
Toc
Sales
P 120,000 P 128,000 P 24,000
Cost of goods sold
96,000
112,000
18,000
Gross profit
P 24,000 P 16,000 P 6,000
2012
Sales
Cost of goods sold
Gross profit

Tic
P 192,000
144,000
P 48,000

Tac
P 144,000
120,000
P 24,000

Toc
P 16,000
12,800
P 3,200

Requirements:
1.
2.
3.
4.

What are the sales price and sales volume


variances?
What are the cost price and cost volume variances?
What are the net gross profit price and net gross
profit volume variances?
What are the sales mix and the final sales volume
variances?

Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

Page|6 of 7

PROBLEM 14: Following is the income statement of


Annabelle Corporation for the year ended December 31,
2012:
Annabelle Corporation
Income Statement
For the Year Ended December 31, 2012
Sales (P100 each)
P 50,000,000
Less: Variable costs (P80 each)
40,000,000
Contribution margin
P 10,000,000
Less: Fixed costs
6,000,000
Operating income
P
4,000,000
Less: Interest expense
1,000,000
Income before tax
P
3,000,000
Less: Income tax (30%)
900,000
Income after tax
P
2,100,000

During the year, the company distributed cash dividends to


preferred shareholders in the amount of P700,000.
Annabelle Corporations earnings per share for 2012 is P5.00
per share.
Requirements:
1.
2.
3.

Determine Annabelle Corporations degree of


operating leverage, degree of financial leverage
and degree of total leverage.
If Annabelle expects its EPS to increase to P5.50 in
2013 with all other variables constant, what is the
expected sales and operating income in 2013?
If Annabelle did not have preferred shares, what will
happen to its degree of total leverage, degree of
financial leverage and degree of operating
leverage?

Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

Page|7 of 7