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 firm’s 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 entity’s 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 company’s overall performance as part of its
functions.
When users read a firm’s financial statements, they get an
overall picture of the firm’s profitability and financial
conditions. Merely reading such statements, however, is not
enough when for them make informed judgments and
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decisions. A thorough analysis and interpretation of such
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statements is required.
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Financial statement analysis involves the careful selection
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of data from financial statements in order to assess and
evaluate the firm’s past performance, its present condition
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and future business potentials. Financial statement analysis
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interprets financial statement data and presents it in a
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summary form to simplify users’ analysis.
Objectives of Financial Statement Analysis
The primary purpose of financial statement analysis is to
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evaluate and forecast the company’s financial health.
Financial statement analysis helps identify the company’s
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financial strengths and weaknesses and provide information
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about the:
A. Profitability of the business firm.
B. Ability of the firm to meet its obligations.
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C. Safety of the investment in the business.
D. Effectiveness of management in running the firm.
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Specifically, the uses and purposes of financial performance
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analysis are:
A. To set goals and targets for future operations.
B. To compare the firm’s performance to others.
C. To measure financial strength for granting purposes.
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D. To spot trends, weaknesses and potential problems.
E. To evaluate alternative courses of action.
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F. To understand interactions that financial changes
have on a firm’s financial position.
Steps in the Analysis of Financial Statements
The analysis of financial statements does not merely involve
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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 firm’s background and the quality of its
management.
D. Evaluate the firm’s 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
This study source was downloaded by 100000832308392 from CourseHero.com on 11-09-2021
a specific entity. Commonly used financial statement
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
https://www.coursehero.com/file/14425445/9-Financial-Statement-Analysis-final/
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.
Most recent value – Base period value
% of change =
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%.
Value of item under consideration
% of base value =
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.06:12:07
If anGMT
income
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of financial position account are both used to
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 calculate a ratio, the statement of financial Measures the average
Average Age of
position amount should be averaged for the time Operating
Receivables + Average
number of days to
period represented by the income statement Cycle convert the firm’s
Age of Inventories
inventories to cash
account.
C. If the beginning balance of the statement of Working Current Assets – Current
Measures the firm’s
liquidity in terms of
financial position account is not available, the Capital Liabilities
absolute peso amounts
ending balance is normally used to represent the
Working Measures the adequacy
average balance of the account. Net Sales ÷ Average
Capital of activity of working
D. If sales or purchases are given without making Turnover
Working Capital
capital
distinction as to whether made in cash or on credit
Measures the
assumptions are made depending on the ratio
Net Sales÷ Average Total effectiveness of asset
being calculated. If turnover ratios, sales and Asset Turnover
Assets utilization in generating
purchases are assumed to be made on credit. If revenue
cash flow ratios, sales and purchases are assumed
(Cost of Sales + Income
to be made on cash. Taxes + Operating Measures the
There are several ratios that can be used for analysis. Expenses excluding movement and
Current Assets Depreciation, Amortization utilization of current
However, these ratios can be grouped into four broad Turnover and Other Expenses assets to meet the
categories depending needs of the users. Long-term Related to Long-term operating requirements
creditors are interested in ratios indicating the solvency of Assets) ÷ Average Current of the firm
the corporation while short-term creditors are more Assets

interested in ratios indicating the liquidity of the firm. Measures the

Potential investors and stockholders, on the other hand, are Fixed Assets Net Sales ÷ Average Fixed effectiveness of
concerned with the firm’s profitability and the behavior of Turnover Assets utilization of fixed assets
in generating revenue
its shares of stocks in the market.
Liquidity Ratios Leverage Ratios
Liquidity ratios provide information about the firm’s ability to Also known as capital adequacy or solvency ratios,
pay its current obligation and continue operations. These leverage ratios provide information on the extent to which

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ratios answer the question: borrowed or debt funds are used to finance assets. These

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“What liquid assets are available or accessible to meet demands ratios are also a good way to assess the ability of the firm to
for cash from expected and unexpected sources? meet its debt payment obligations. These ratios are also

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TEST FORMULA SIGNIFICANCE
answer the questions:

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Measures the number of “How much capital is necessary to protect creditors and
Current Ratio times that the current
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Current Assets ÷ Current shareholders against losses?”
(Working liabilities could be paid
Liabilities
“How little capital is necessary to allow shareholders to enjoy
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Capital Ratio) with the available

current assets maximum favorable returns on equity and dividends?”
Quick Assets ÷ Current Measures the firm’s TEST FORMULA SIGNIFICANCE
Liabilities ability to pay its short-
Quick Ratio
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Quick assets include cash term debts from its most Measures the relative
(Acid Test
and cash equivalents, liquid assets without Total Liabilities ÷ Total share of creditors over
Ratio) Debt Ratio
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marketable securities and having to rely on Assets the total resources of

net receivables. inventory. the firm
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Measures the time Measures the amount of

required to complete Equity Ratio Total Equity ÷ Total Assets resources provided by
one collection cycle – owners of the firm
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from the time

Receivables Net Credit Sales ÷ Average
receivables are Indicates how much of
Debt to Equity Total Liabilities ÷ Total
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Turnover Trade Receivables the debt is matched by

recorded, and then Ratio Equity
collected to the time investment by owners.
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new receivables are

recorded again. Measures how many
Earnings Before Interests
Times Interest times interest expense is
Average Age and Taxes ÷ Interest
Measures the average Earned covered by operating
of Receivables Expense
number of days to profit
360 days ÷ Receivables
(Average collect a receivable or
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Turnover
Collection the average credit term Indicates how much
Period) extended to customers Equity total investment can be
Total Assets ÷ Total Equity
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Multiplier financed from owner-

Merchandise Cost of Sales÷
provided equity
Inventory Average Merchandise
Turnover Inventory Measures the number of
times that inventory is Profitability Ratios
Finished Goods Cost of Sales ÷ Average replaced during the
Turnover Finished Goods Inventory Profitability ratios provide information on the ability of the
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period or the level of

inventory movement firm to generate earnings in relation to some base such
Cost of Goods
Goods In
Manufactured ÷ during the year; for a assets, sales or capital. The ratios answer the question:
Process manufacturing firm, a
Average Goods In Process “Is net income adequate to satisfy investors’ dividend and rate of
Turnover turnover ratio is
Inventory
computed for each return expectations and to support growth?”
Cost of Raw Materials Used type of inventories
Raw Materials TEST FORMULA SIGNIFICANCE
÷ Average Raw Materials
Turnover
Inventory
Measures profit
Measures the average generated after
Average Age Gross Profit consideration of cost of
days inventory is kept in Gross Profit ÷ Net Sales
of Inventories Margin goods sold which is
360 days ÷ Inventory company premises
(Average used to recover
Turnover Ratio whether for conversion
Conversion operating expenses
or in storage while
Period)
waiting to be sold
Measures profit
Payables Net Credit Purchases ÷ Measures the liquidity of generated after
Operating
Turnover Average Trade Payables the firm’s payables Operating Profit ÷Net Sales consideration of
Profit Margin
operating costs and
Average Age Measures the length of cost of goods sold
of Payables time which trade
360 days ÷ Payables
(Average payables remain unpaid Measures profit
Turnover Ratio Return on
Payment Income ÷Net Sales percentage per peso
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Period) pays its invoices on time sales

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

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 Measures the rate of costs of the product namely, materials, labor and
Return on Income ÷ Average Total
Equity Equity
return on resources factory overhead for manufacturing firms.
provided by owners
Sales variances:
Measures the overall Sales this year P xxx
efficiency of the firm in Sales this year at sales prices last year X xxx
Return on Income ÷ Average Total managing assets and Sales price variance P xxx
Assets Assets generating profits
regardless of how the Sales this year at sales prices last year P xxx
assets are financed Sales last year X xxx
Sales volume variance P xxx
Measures the peso
(Net Income – Preference Cost variances:
return on each ordinary
Earnings per Dividends) ÷ Average
share which is indicative Cost of sales this year P xxx
Share Outstanding Ordinary
of ability to pay Cost of sales this year at cost price last year X xxx
Shares
dividends Cost price variance P xxx
Measures the ability Cost of sales this year at cost price last year P xxx
Cash Flow Cash Flows from Operating Cost of sales last year X xxx
of the firm to translate
Margin Activities ÷ Net Sales
sales to cash Cost volume variance P xxx

Important Notes: Summary of Variances:

Sales price variance P xxx
A. If the intention is to measure operational Cost price variance X xxx
performance, income is expressed as before Net price variance P xxx
interest and tax.
B. If the intention is to evaluate total managerial Sales volume variance P xxx
Cost volume variance X xxx
effort, income is expressed after interest and
Net volume variance P xxx
tax. The practice of expressing income after
Gross profit variance P xxx
interest but before tax is discouraged.
C. For return on asset calculation, income should For multi-products, the net volume variance can be broken
be before interest as it does not consider the down into its sales mix and sales yield components:
effect of the type of financing used. Net volume variance:
Gross profit this year at last year's UGP P xxx
D. Income should include dividends and interest

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Gross profit this year at average UGP last year X xxx
earned if the related investments are included

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Sales mix variance P xxx
in the asset base.

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E. If the DuPont model is used, income must be Gross profit this year at average UGP last year P xxx
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after interest, tax and preferred dividends.
Growth Ratios
Gross profit last year
Sales yield or final sales volume variance
X xxx
P xxx

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OPERATING AND FINANCIAL LEVERAGE
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Growth ratios provide information of the organization’s
potential and attractiveness as an option. The ratios answer Leverage refers the use of fixed cost assets or funds to
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the question: magnify returns to the firm’s owners. It is desirable as it

produces more earning power to owners. However,
“How do financial markets evaluate the financial condition of the
firm?”
leverage can also increase the risk exposure of firms.
A. Operating leverage – the use of fixed operating
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TEST FORMULA SIGNIFICANCE costs in a company’s cost structure to enhance the

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Measures rate earned rate of return to equity owners. It is achieved by

Dividends per Share ÷
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Dividend Yield by shareholders from increasing fixed costs while lowering variable costs.
Market Value per Share of
Ratio dividends relative to
Ordinary Shares
investment in stock
The degree of operating leverage is used to
measure how sensitive profit before tax is to
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Represents the percentage change in sales. It also is a measure of

Dividend Dividend per Share percentage of net
operating or business risk, the risk associated with
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Payout Ratio ÷Earnings per Share income distributed as

dividends projections of a firm’s future returns on assets or
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returns on equity if the firm uses no debt.

Measures the number of
Market Value per Share of period investment in
Total contribution margin
DOL = Profit before tax
Price – Ordinary Shares ÷ Earnings stock will be recovered;
Earnings Ratio per Share of Ordinary measures investor’s Percentage change in profit before tax
Shares beliefs on the growth Degree of OL =
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potential of the stock

Percentage change in sales
B. Financial leverage– also called trading on equity,
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Analyzing Calculated Ratios refers to a company’s use of borrowed funds and

Understanding and interpreting calculated ratios may be fixed income securities to enhance the rate of
done through any of the following means: return to equity owners. Financial leverage is equal
A. Trend or time-series analysis – uses ratios to to:
evaluate a firm’s performance over time.
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Return on equity – Return on assets

B. Cross-section analysis – uses ratios to compare
different companies at the same point in time.
C. Industry-comparative analysis – used to compare
a firm’s 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
This study source for merchandising
was downloaded firms from
by 100000832308392 or manufacturing
CourseHero.com on 11-09-2021 06:12:07 GMT to use debt.
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 firm’s
decision
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Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

https://www.coursehero.com/file/14425445/9-Financial-Statement-Analysis-final/ Page|3 of 7
 Profit before tax A. Differences among companies exists, may it be in
DFL = Profit before tax – Interest – Preferred their size, nature and the business environment they
dividends before tax operate. As such, what is acceptable to one entity
Percentage change in EPS may not be acceptable to another. Though
Degree of O =
Percentage change in profit before tax accountants are governed by GAAP, differences
C. Total leverage – the use of fixed costs, whether might still be encountered because of variations in
operating costs or financial costs, to enhance the the application of such principles.
rate of return to equity owners. B. Financial statements are prepared on an historical
The degree of total leverage measures the cost basis and therefore do not reflect current
combined effect of both operating leverage and market value. Also, the gains or losses on
financial leverage. It is a measure of total risk. purchasing power are not reflected in the financial
Total contribution margin statements.
DTL = Profit before tax – Interest – Preferred C. The use of averages affect the ratios computed,
dividends before tax thereby, the analysis itself.
Percentage change in EPS D. Most of the ratios used are merely approximations
Degree of O = Percentage change in sales and not accurate. The ratios computed themselves
Degree of O = are not conclusive and are not sufficient as a basis
Degree of OL x Degree of FL
to form judgments.
An increase in operating leverage can result in the lower
E. Financial statements do not show all the details
need for financial leverage.
needed by external users in developing some
LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS ratios.
Some problems and limitations might be encountered in F. Information gathered from the analysis of financial
analyzing financial statements. Analysts must be aware with statements is only a part of what is needed to
and guard against these problems. make good economic decisions.

ILLUSTRATIVE PROBLEMS

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PROBLEM 1: Following are comparative condensed c. Inventory turnover and average conversion

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financial statements of Jasmine Corporation: period.
d. Payables turnover and average payment

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Jasmine Corporation
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Statement of Financial Position period.
As of December 31 e. Operating cycle and cash conversion cycle in
days.

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2013 2012
f. Asset turnover and working capital turnover.
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Cash P 7,500 P 5,250
Accounts receivable, net 11,000 8,250 g. Debt ratio, equity ratio and debt-equity ratio,
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Inventories 20,500 19,000 equity multiplier and times interest earned.

Fixed assets, net 34,410 37,500 h. Gross profit margin, operating profit margin
Total assets P 73,410 P 70,000 and cash flow margin.
i. Return on sales, return on assets and return on
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Current liabilities P 11,500 P 12,500 equity.

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Bonds payable, 10% 25,000 22,500 j. Earnings per share (EPS) and price-earnings
Common stock, P2.50 par 25,000 25,000
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(P/E) ratio.
Retained earnings 11,910 10,000
k. Dividend yield, dividend payout and plowback
Total equities P 73,410 P 70,000
ratio.
Market price of stock, 12/31
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P6.25 /share P8.75/share

PROBLEM 2: Parsons Company's sales and current assets
Jasmine Corporation
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have been reported as follows over the last four years (in
Statement of Income and Retained Earnings thousands):
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For the Year Ended December 31 Year 4 Year 3 Year 2 Year 1

2013 2012 Sales P 800 P700 P600 P 570
Sales P 100,000 P 97,500 Cash 35 30 24 18
Cost of goods sold 61,250 55,000 Accounts receivable 75 50 58 45
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Gross margin P 38,750 P 42,500 Inventory 78 75 80 75

Operating expenses (26,000) (26,250) Prepaid expenses 47 39 11 25
Interest expense (2,500) (2,250)
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Requirements:
Income before taxes P 10,250 P 14,000
Income taxes 3,590 4,900 1. Express all the sales and current assets on trend index
Net income after tax P 6,660 P 9,100 or percentages using Year 1 as base year.
Retained earnings, 1/1 10,000 4,750 2. Express all the sales and current assets on trend index
Total P 16,660 P 13,850 or percentages using Year 3 as base year.
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Dividends paid 4,750 3,850

Retained earnings, 12/31 P 11,910 P 10,000 PROBLEM 3: Financial analysis may be used to test the
Net cash inflows from operating activities for 2013 was fairness of the relationships among current financial data
P3,000. against those of prior financial information. Given
established financial relationship and key amounts, a CPA
Requirements:
could also prepare projected financial statements. June
1. Perform a horizontal analysis of Jasmine’s financial Sales Corporation has in recent prior years maintained the
statements. Show the increases and decreases in following relationships among the data on its financial
each account in absolute peso values and statements:
percentages. Net income rate on net sales 5 per cent
2. Perform a vertical analysis on the financial statements Gross income rate on net sales 35 per cent
of Jasmine’s financial statements. Ratio of selling expense to net sales 15 per cent
3. Using the data on the financial statements, perform a Acid test ratio 2 to 1
ratio analysis by calculating the following ratios as of Current ratio 3 to 1
Accounts receivable turnover 5 times
and for 2013:
Inventory turnover 5 times
a. Working capital ratio, current ratio and quick Composition of quick assets:
ratio (acid test ratio). Cash 10 per cent
b. was
This study source Receivables turnover
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period. Accounts receivable 60 per cent

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 Asset turnover 1 per year Case B: Equity to debt ratio 60%
Ratio of total assets to intangible assets 20 to 1 Stockholder’s equity P 120 million
Ratio of accounts receivable to accounts Return on assets 9%
payable 1.5 to 1
Return on shareholders’ equity ?
Ratio of working capital to shareholders’
equity 1 to 1.6 Case C: Return on equity 12%
Ratio of total liabilities to stockholders’ equity 1.4 to 1.6 Debt ratio 40%
Ratio of accumulated depreciation to cost of Return on assets ?
fixed assets 1 to 3
Case D: Market price per share P 120.00
Number of times interest earned 2 times
Price-earnings ratio 4 times
For 2013, the company projects to have a net income of Net income P 1.5 million
P150,000 which will result in earnings per share of P10 per Common stock outstanding ?
share of common stock. Additional information includes the
Case E: Total assets P 5 million
following:
Ordinary shares outstanding 2.5 million
A. Common stock has a par value of P50 per share
Preference shares outstanding 1 million
and was issued at 20% premium.
Net income P 750,000
B. 8% preferred stock has a par value of P50 per share
Depreciation expense 500,000
and was issued at 10% premium.
Cash flow to total liabilities ?
C. Preferred dividends paid in 2012 was P10,000. The
same amount will be paid in 2013. Case F: Return on asset 24%
D. The company’s purchases and sales are all on Asset turnover 1.6 times
account. Profit margin ratio ?
For projection purposes, it is assumed that the above Case G: Current assets P 200,000
relationships among the data on the financial statement of Inventory 80,000
June Sales Corporation shall also hold true for 2013. Quick ratio 2 to 1
Current liabilities ?
Requirements:
Case H: Total assets, beginning P 500,000
1. Prepare a projected statement financial position for
Net income for the year 30,000
the year 2013. Ignore income tax.
Dividends paid during the year 10,000

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2. Prepare a projected income statement for the year
Internal growth rate ?

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ended December 31, 2013. Ignore income tax.
Case I: Net purchases (all on account) P 960,000

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PROBLEM 4: Joaquin Corporation asked you to interpret the
eH w Cost of goods sold 900,000
following ratios provided by its accountant: Ending inventory 180,000
Acid test ratio 1.2 to 1 Net sales (10% on cash) 1.3 million

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Times interest earned 8 times Beginning accounts receivable 80,000
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Gross margin ratio 40% Collections on accounts 1.1 million
Inventory turnover 6 times
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Operating cycle ?
Debt to equity ratio 0.9 to 1
Ratio of operating expenses to sales 15% Case J: Sales P 1.8 million
Total stockholders’ equity on December 31, 2013 was Bond interest expense 60,000
P900,000. Gross margin for 2013 amounted to P600,000. Income taxes 300,000
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Beginning balance of merchandise inventory was P200,000. Net income 400,000

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The company’s long-term liabilities consisted of bonds Times interest earned ?

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payable with interest of 15%. You decided to reconstruct Case K: Asset turnover 1.5 times
the company’s financial statements based on the limited Return on assets 3%
information given to serve as basis for further analysis. Return on equity 5%
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Requirements: Debt ratio ?

Equity multiplier ?
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1. What was the operating income of Joaquin for 2013?

2. What was the total of bonds payable as of PROBLEM 7: The following information is available from the
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December 31, 2013? Embargo Company accounting records:

3. What is the working capital of Joaquin as of A. Cash account balance is P43,000 on January 1,
December 31, 2013? 2013 and P18,000 on December 31, 2013.
B. The balance in accounts receivable decreased by
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PROBLEM 5: The management of Sonic Consumer Products P10,000 during the year from P60,000. The company
Company is preparing its plans for the year 2013. The had no short-term investments.
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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
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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.

materials and labor cost. Income tax rate is at an average D. The company’s inventory increased by P9,000 to
of 35% of income before income tax. P80,000.
Requirements: E. During December 2013, the company settled a
P10,000 note payable by issuing shares of its own
1. What is the estimated rate of return on sales and the
capital with equivalent value.
expected asset turnover for 2013?
F. Sale of some old operational assets resulted in the
2. What is the estimated rate of return on average total
following entry:
assets for 2013?
Cash P 5,000
3. What is the estimated rate of return on stockholders’ Accumulated depreciation 12,000
equity for 2013? Operational assets P 15,000
Gain on sale of assets 2,000
PROBLEM 6: Supply the missing data in each independent
G. Cash expenditures during 2013 were the following:
situation below using only the information given:
 Payment of long-term debts, P64,000.
Case A: Payout ratio 40%  Purchase of new operational assets, P74,000.
Earnings per share P 50.00  Payment of cash dividend, P16,000.
Price-earnings ratio 4 to 1  Purchase of land as an investment, P25,000.
Market price per share ? H. Sale and issuance of Embargo Company capital
Dividend per share ? stockGMT
for P20,000 cash.
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Yield rate ? I. Issuance of long-term mortgage note, P30,000.

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

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 J. Total assets at December 31, 2013 equaled 2. Compute for the cost price and cost volume
P1,000,000. variances.
K. Income statement data for the year 2013 follows: 3. Determine the percentage changes in volume, in
Sales, net P 295,000 sales price and cost price.
Cost of goods sold (140,000)
Depreciation expense (14,000) PROBLEM 10: The management of Seymour Corporation
Patent amortization (1,000) asks you to prepare an analysis of the gross profit variance
Income tax expense (17,000) based on their comparative income statements for 2012
Selling and administrative expenses (42,000) and 2013:
Gain on sale of operational assets 2,000
2013 2012
Net income P 83,000
Sales P 990,000 P 800,000
Requirements: Cost of goods sold 760,000 640,000
1. Compute for the current and quick ratio, working Gross profit P 230,000 P 160,000
capital to total assets ratio. The only known information given to you is that volume
2. Compute for the accounts receivable turnover and increased from 2012 to 2013 by 10%.
inventory turnover.
3. Compute for the age of accounts receivable and Requirements:
age of inventory. 1. Determine the sales price and sales volume
4. Compute for the working capital turnover and profit variances.
margin on sales. 2. Determine the cost price and cost volume variances.
5. Compute for the net cash flow to current liabilities 3. What are the percentage changes in sales price and
and dividend payout ratio. cost price?
4. What is the variance in gross profit due to change in
PROBLEM 8: Provide for what is asked by each independent volume?
situation below.
A. Related Ventures has a total asset turnover of 0.30 PROBLEM 11: The income data of Escano Company for the
and a profit margin of 10%. The president is year 2012 and 2013 are as follows:
unhappy with the current return on assets and he 2013 2012
thinks it could be doubled. This could be Sales P 276,000 P 204,000

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accomplished by increasing the profit margin to Cost of goods sold 151,800 122,400

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15% and increasing the total assets turnover. What Gross profit P 124,200 P 81,600

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new asset turnover ratio, along with the 15% profit
eH w The sales price in 2013 is approximately 20% higher than the
margin, is required to double the return on assets?
sales price in 2012.
B. Linked Company has a debt ratio of 0.50, a total

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assets turnover of 0.25 and a profit margin of 10%. Requirements:
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The president is unhappy with the current return on 1. Compute for the sales price and sales volume
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equity and he thinks it could be doubled. This could variances.

be accomplished by increasing the profit margin to 2. Compute for the cost price and cost volume
14% and by increasing debt utilization. Total assets variances.
turnover will not change. What new debt ratio, 3. Determine the percentage changes in cost price
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along with the 14% profit margin, is required to and volume.

double the return on equity?
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C. Associated Corporation paid out ½ of its 2012 PROBLEM 12: The gross profit statements for 2013 and 2012
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earnings by dividends. Its earnings increased by of Mimi Company follow:

20% and the amounts of its dividends increased by 2013 2012
15% in 2013. What was Associated’s dividend Sales P 160,000 P 120,000
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payout ratio in 2013? Cost of goods sold 120,000 72,000

D. It is the policy of Attached Corporation that the Gross profit P 40,000 P 48,000
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current ratio cannot fall below 1.5 to 1.0. Its current Mimi Company informed you that the unit cost decreased
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liabilities are P400,000 and the present current ratio by 20% at the start of 2013.
is 2.0 to 1.0. How much is the maximum level of new
short-term loans it can secure without violating the Requirements:
policy? 1. Determine the sales price and sales volume
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E. As of the end of 2012, Connected Company had variances.

total assets of P375,000 and equity of P206,250. For 2. Determine the cost price and cost volume variances.
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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 2013’s debt to equity ratio should
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3. 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

be the same as that of 2013. How much debt three products are as follows:
should be incurred to satisfy the bank’s condition? 2013 Tic Tac Toc
Sales P 120,000 P 128,000 P 24,000
PROBLEM 9: Sta. Maria Company produces and sells cellular Cost of goods sold 96,000 112,000 18,000
phone blaster, a gadget which explodes when activated Gross profit P 24,000 P 16,000 P 6,000
with a remote commander. This is used by cell phone
owners when their unit is snatched from them or is taken by 2012 Tic Tac Toc
thieves. The static master budget and the actual results of Sales P 192,000 P 144,000 P 16,000
operations for the month of June are as follows: Cost of goods sold 144,000 120,000 12,800
Budget Actual Gross profit P 48,000 P 24,000 P 3,200
Sales P 800,000 P 1,056,000 Requirements:
Cost of goods sold 480,000 556,800
1. What are the sales price and sales volume
Gross profit P 320,000 P 499,200
variances?
Management wants an explanation of the favorable gross 2. What are the cost price and cost volume variances?
profit variance of P179,200. 3. What are the net gross profit price and net gross
Requirements: profit volume variances?
1. Compute for the sales price and sales volume 4. What are the sales mix and the final sales volume
This studyvariances. variances?
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Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

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 PROBLEM 14: Following is the income statement of During the year, the company distributed cash dividends to
Annabelle Corporation for the year ended December 31, preferred shareholders in the amount of P700,000.
2012: Annabelle Corporation’s earnings per share for 2012 is P5.00
Annabelle Corporation per share.
Income Statement Requirements:
For the Year Ended December 31, 2012
1. Determine Annabelle Corporation’s degree of
Sales (P100 each) P 50,000,000 operating leverage, degree of financial leverage
Less: Variable costs (P80 each) 40,000,000 and degree of total leverage.
Contribution margin P 10,000,000 2. If Annabelle expects its EPS to increase to P5.50 in
Less: Fixed costs 6,000,000 2013 with all other variables constant, what is the
Operating income P 4,000,000 expected sales and operating income in 2013?
Less: Interest expense 1,000,000 3. If Annabelle did not have preferred shares, what will
Income before tax P 3,000,000 happen to its degree of total leverage, degree of
Less: Income tax (30%) 900,000 financial leverage and degree of operating
Income after tax P 2,100,000 leverage?

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