CH 13

Chapter – 13 Analyzing and Interpreting
Financial Statements
QUICK STUDY
Quick Study 13-1 (5 minutes)
a. Included
b. Included
c. Not included
d. Included
e. Not included
f. Included
g. Not included
h. Included

1. competitor
2. guidelines
3. intracompany
4. industry
$50,400 = 1.12 x prior year income

$50,400 / 1.12 = $45,000 prior year income
Current Prior Dollar Percent

Year Year Change Change
Short-term investments $374,634 $234,000 $140,634 60.1%
Accounts receivable 97,364 101,000 (3,636) (3.6)%
Notes payable 0 88,000 (88,000) (100.0)%
Current Prior Dollar Percent

Year Year Change Change
Cash $ 7,440 $ 8,000 $ (560) (7.0)%
Accounts receivable 54,000 18,000 36,000 200.0%
Equipment, net 44,000 40,000 4,000 10.0%
Land 91,680 66,000 25,680 38.9%
Total assets $197,120 $132,000 65,120 49.3%
Trend percents
Current Year 177.0% ($801,810/ $453,000)
Prior Year 100.0% (the given base amount)

Common-size percents
Current Year 49.0% ($392,887 / $801,810)
Prior Year 29.6% ($134,088 / $453,000)
Current Year Prior Year
Cash 3.8% 6.1%
Accounts receivable 27.4 13.6
Equipment, net 22.3 30.3
Land 46.5 50.0
Total assets 100.0% 100.0%

a.
Current Ratio: $15,000 + $5,000 + $8,000 + $20,000 + $6,000 = 2.7 to 1
$20,000
b.
Acid-Test Ratio: $15,000 + $5,000 + $8,000 = 1.4 to 1
$20,000
Transaction Current Assets Current Liabilities Current Ratio

1. No Effect No Effect No Effect
2. Increase No Effect Increase
3. No effect Increase Decrease

a.
Accounts Receivable Turnover: $60,000 = 6.0 times
($14,000 + $6,000)/2
b.
Days’ sales uncollected: $6,000 x 365 = 36.5 days
$60,000
a.
Inventory Turnover: $40,000 = 8.0 times
($2,000 + $8,000)/2
b.
Days’ sales in inventory: $8,000 x 365 = 73.0 days
$40,000
Total Asset Turnover: $80,000 = 0.8 times

($115,000 + $85,000)/2

a.
Debt-to-equity Ratio: $20,000 = 0.4
$50,000
b.
Times Interest Earned: $30,000 = 20.0 times
$1,500

a.
Profit Margin: $16,000 = 20%
$80,000
b.
Return on Total Assets: $16,0000 = 25%
($60,000 + $68,000)/2

a.
Price-earnings ratio: $150 = 15
$10
b.
Dividend Yield: $3 = 2%
$150
Current Prior
Ratio Year Year Change
1. Profit Margin Ratio 9% 8% Favorable
2. Debt Ratio 47% 42% Unfavorable
3. Gross Margin Ratio 34% 46% Unfavorable
4. Acid-test Ratio 1.00 1.15 Unfavorable
5. Accounts Receivable Turnover 5.5 6.7 Unfavorable
6. Basic Earnings Per Share $1.25 $1.10 Favorable
7. Inventory Turnover 3.6 3.4 Favorable
8. Dividend Yield 2.0% 1.2% Favorable
Quick-Study 13-18 (30 minutes)
1. Parker. Explanation: Parker’s higher current ratio and acid-test ratio

puts it in a better position to pay current liabilities.
2. Morgan. Explanation: Morgan’s higher accounts receivable turnover

suggests it converts receivables more quickly into cash.
3. Morgan. Explanation: Morgan’s higher inventory turnover suggests it

holds inventory for less time before selling it.
Quick Study 13-19A (10 minutes)
a. Unusual and/or Infrequent. The destruction of rainwater tanks is an
unusual and/or infrequent loss because a hurricane is considered an
unusual and infrequent calamity (“act of God”).
b. Not Unusual and/or Infrequent. The sale of a delivery truck at a loss is

an ordinary loss on the sale of assets in the normal course of business.
c. Unusual and/or Infrequent. The seizure of its foreign assets by a foreign

government is an unusual and/or infrequent loss because it is outside
the normal course of business.
Quick Study 13-20A (10 minutes)
Income from continuing operations $180,000
Discontinued segment
Income from consulting segment (net of tax) $20,000
Gain on sale of consulting segment (net of tax) 75,000 95,000
Net income $275,000
EXERCISES
Exercise 13-1 (10 minutes)
1. B 4. A 7. B
2. C 5. A 8. C
3. D 6. B 9. A
1. Profit Margin (f); Total Asset Turnover (e) --in either order
Return on Total Assets (d)
2. Working Capital (c) --also called net working capital
3. Accounts Receivable Turnover (b); Days' Sales Uncollected (a) --in either order

2020 2019 2018 2017 2016
Sales 189 181 168 156 100
Cost of goods sold 191 182 172 159 100
Accounts receivable 201 192 182 169 100
Analysis:
Sales trend is favorable. Further analysis can consider economic conditions in
which this trend occurred such as competitor performance and inflation rates.
Cost of goods sold trend is unfavorable. Costs are increasing; further, given
the trend in sales, the COGS trend exceeds the trend in sales.
Accounts receivable trend is unfavorable. Receivables are increasing; further,

this increase in trend exceeds the increase in sales—not a favorable situation.
Current Yr Prior Yr
Sales 100.0% 100.0%
Cost of goods sold 75.7 46.5
Gross profit 24.3 53.5
Operating expenses 17.3 35.0
Net income 7.0% 18.5%
Analysis:
Cost of goods sold increase is most responsible for the income decline.
There is substantial decline in net income as a percent of sales for the current
year (7.0%) relative to the prior year (18.5%). The main culprit is the increase in
cost of goods sold as a percent of sales from 46.5% to 75.7%.
Answer: Net income decreased.
Supporting calculations: When the sum of each year's common-size cost of

goods sold and operating expenses is subtracted from the common-size sales
percent, the net income percent is as follows:
2 Years Ago net income percent: 100.0 - 59.1 - 15.1 = 25.8% of sales
1 Year Ago net income percent: 100.0 - 61.9 - 14.8 = 23.3% of sales
Current Year net income percent: 100.0 - 63.4 - 15.3 = 21.3% of sales
Next, if 2 Years Ago sales are assumed to be $100, then sales from 1 Year Ago
are $104.20 and the sales from the Current Year are $105.40. If the net income
percents for the three years are applied to these amounts, the net incomes are:
2 Years Ago net income: $100.00 x 25.8% = $25.80
1 Year Ago net income: $104.20 x 23.3% = $24.28
Current Year net income: $105.40 x 21.3% = $22.45
This shows that net income decreased over the three-year period.
1.
Simon Company
Common-Size Comparative Balance Sheets
Current 1 Year 2 Years
At December 31 Year Ago* Ago
Assets
Cash 6.1% 8.0% 10.0%
Accounts receivable, net 17.1 14.0 13.3
Merchandise inventory 21.5 18.5 14.3
Prepaid expenses 2.0 2.1 1.3
Plant assets, net 53.3 57.3 61.1
Total assets 100.0% 100.0% 100.0%
Liabilities and Equity

Accounts payable 24.8% 16.9% 13.6%
Long-term notes payable 18.8 22.9 22.1
Common stock, $10 par value 31.3 36.7 43.3
Retained earnings 25.1 23.5 21.0
Total liabilities and equity 100.0% 100.0% 100.0%
*
Column does not equal 100.0 due to rounding.
2. Unfavorable.
The increase in accounts receivable as a percentage of total assets is an
unfavorable development. Assuming sales have not increased, a higher
balance in accounts receivable simply means more assets are tied up in an
unproductive manner. Further, there is additional risk that these receivables
may not be collected.
3. Unfavorable.
The increase in merchandise inventory as a percentage of total assets is an
unfavorable development. More inventory means more assets are tied up in an
unproductive manner.
1. Current ratio
Current Yr: $31,800 + $89,500 + $112,500 + $10,700 = 1.88 to 1

$129,900
$35,625 + $62,500 + $82,500 + $9,375

1 Yr Ago: $75,250 = 2.52 to 1
2 Yrs Ago: $37,800 + $50,200 + $54,000 + $5,000 = 2.87 to 1

$51,250
Analysis: Worsened.
Simon's current ratio has worsened over this three-year period. The
current ratio shifts from ‘2.87 to 1’ down to ‘1.88 to 1’ over the three-
year period. Simon's short-term liquidity position has deteriorated.
2. Acid-test ratio
$31,800 + $89,500
Current Yr: = 0.93 to 1
$129,900
$35,625 + $62,500
1 Yr Ago: = 1.30 to 1
$75,250
$37,800 + $50,200
2 Yrs Ago: = 1.72 to 1
$51,250
Analysis: Worsened.
Simon's acid test ratio has worsened over this three-year period. The
current ratio shifts from ‘1.72 to 1’ down to ‘0.93 to 1’ over the three-
year period. Simon's short-term liquidity position has deteriorated.
Date Current Assets Current Liabilities Current Ratio

Jan. 1 $72,000 $60,000 1.20
Jan. 5 -18,000 0
Bal., Jan. 5 54,000 60,000 0.90
Jan. 12 -5,000 -5,000

Bal., Jan. 12 49,000 55,000 0.89
Jan. 18 0 0
Bal., Jan. 18 49,000 55,000 0.89
Jan. 22 +12,000 +12,000

Bal., Jan. 22 61,000 67,000 0.91
Jan. 31 +12,700 0
Bal., Jan. 31 73,700 67,000 1.10
1. Days' sales uncollected
$89,500
Current Yr: x 365 = 48.5 days
$673,500
$62,500
1 Yr Ago: x 365 = 42.9 days
$532,000
Analysis: Worsened.
The ratio has worsened. The number of days' sales uncollected
increased and this is not a positive trend.
2. Accounts receivable turnover

$673,500
Current Yr: = 8.9 times
($89,500 + $62,500)/2
$532,000
1 Yr Ago: = 9.4 times
($62,500 + $50,200)/2
Analysis: Worsened.
The ratio has worsened. Accounts receivable turnover declined and
this is not a positive trend.
3. Inventory turnover
$411,225
Current Yr: = 4.2 times
($112,500 + $82,500)/2
$345,500
1 Yr Ago: = 5.1 times
($82,500 + $54,000)/2
Analysis: Worsened.
The ratio has worsened. Inventory turnover declined and this is not a
positive trend.
4. Days’ sales in inventory
$112,500
Current Yr: x 365 = 99.9 days
$411,225
$82,500
1 Yr Ago: x 365 = 87.2 days
$345,500
Analysis: Worsened.
The ratio has worsened. Days’ sales in inventory increased and this
is not a positive trend.
1. Debt and equity ratios
Current Year 1 Year Ago

Total liabilities and debt ratio
$129,900 + $98,500 $228,400 43.7%
$75,250 + $101,500 $176,750 39.7%
Total equity and equity ratio

$163,500 + $131,100 294,600 56.3
$163,500 + $104,750 _______ _____ 268,250 60.3
Total liabilities and equity $523,000 100.0% $445,000 100.0%
2. Debt-to-equity ratio
Current Year: $228,400 / $294,600 = 0.78 to 1

1 Year Ago: $176,750 / $268,250 = 0.66 to 1
Analysis: More debt.

Simon’s capital structure has more debt in the Current Year versus 1
Year Ago. This is shown in the debt-to-equity ratio, which increased
from 0.66 to 1 to the level 0.78 to 1.
3. Times interest earned
Current Year: ($31,100 + $9,525 + $12,100) / $12,100 = 4.4 times

1 Year Ago: ($29,375 + $8,845 + $13,300) / $13,300 = 3.9 times
Analysis: Less risky.

Based on times interest earned, the company is less risky for creditors
in the current year versus 1 year ago. The times interest earned ratio
improved from 3.9 to 4.4, suggesting Simon has a greater ability to pay
interest expense. This is a result of increasing net income and
decreasing interest expense.
1. Profit margin
Current Year: $31,100 / $673,500 = 4.6%
1 Year Ago: $29,375 / $532,000 = 5.5%
Analysis: Worsened.
The profit margin worsened from 5.5% to 4.6%. The decline in profit
margin indicates that Simon's ability to generate net income from
sales has declined.
2. Total asset turnover
$673,500
Current Year: = 1.4 times
($523,000 + $445,000)/2
$532,000
1 Year Ago: = 1.3 times
($445,000 + $377,500)/2
3. Return on total assets
$31,100
Current Year: = 6.4%
($523,000 + $445,000)/2
$29,375
1 Year Ago: = 7.1%
($445,000 + $377,500)/2
Analysis: Worsened.
Simon's operating efficiency appears to have worsened because the
return on total assets decreased from 7.1% to 6.4%.
1. Return on common stockholders' equity

$31,100
Current Year: = 11.1%
($294,600 + $268,250)/2
$29,375
1 Year Ago: = 11.5%
($268,250 + $242,750)/2
2. Dividend yield
Current Year: $0.29 / $30 = 1.0%

1 Year Ago: $0.24 / $28 = 0.9%
3. Price-earnings ratio
Current Year: $30 / $1.90 = 15.8

1 Year Ago: $28 / $1.80 = 15.6
Analysis: Simon has higher market expectations for future growth

This conclusion is evident from Simon’s superior 15.8 price-earnings
ratio versus its competitor’s price-earnings ratio of 10.
Current ratio = $9,036 / $871 = 10.37
Profit margin = $146 / $4,464 = 3.27%

1. Profit margin
BioBeans: $15,000 / $75,000 = 20%
GreenKale: $9,000 / $60,000 = 15%
Return on total assets
BioBeans: $15,000 / $187,500 = 8%
GreenKale: $9,000 / $150,000 = 6%
2. BioBeans
Explanation: BioBeans has a profit margin of 20%, which is greater than
GreenKale’s margin of 15%. BioBeans also has a higher return on total
assets than GreenKale. Therefore, based on analysis of these two
metrics, we would invest in BioBeans.

a.
Accounts Receivable Turnover: ? = 8
$6,250
? = $6,250 x 8
? = $50,000 Net Sales
b.
Inventory Turnover: ? = 5
$6,000
? = $6,000 x 5
? = $30,000 Cost of Goods Sold
c.
Return on Total Assets: ? = 16%
$68,750
? = $68,750 x 0.16
? = $11,000 Net Income*
*Alternatively, given solutions for parts a and b:
Net income = $50,000 - $30,000 - $7,000 - $2,000 = $11,000
1. a. Clay. Clay's profit margins are better than Roak's.
b. Roak. Roak has markedly better total asset turnover ratios.
c. Roak. Following from parts a and b, Roak has a substantially higher

return on total assets.
2. Clay. Clay's rates of improvement in sales growth are better than

Roak's—current year: 24% ($210,000/$170,000); and 1 year ago: 55%.
3. a. Yes. Roak successfully employed financial leverage in the current

year. Its return on total assets is 7.4% compared to the 6% interest
rate it paid to obtain financing from creditors.
b. No. Clay did not successfully employed financial leverage in the
current year. Clay's return is only 4.8% as compared to the 6%
interest rate it paid to creditors for financing.
Exercise 13-17A (10 minutes)
1. A Net sales less operating expense section

2. B Other unusual and/or infrequent gains (losses)
4. C Taxes reported on income (loss) from continuing operations
6. D Income (loss) from operating a discontinued segment, or gain
(loss) from disposal
7. D Income (loss) from operating a discontinued segment, or gain
(loss) from disposal
8. B Other unusual and/or infrequent gains (losses)
Exercise 13-18A (20 minutes)
RANDA MERCHANDISING, INC.

Income Statement
For Year Ended December 31
Net sales $2,900,000

Expenses
Cost of goods sold $1,480,000
Depreciation expense 232,000
Total operating expenses 1,712,000
Other unusual and/or infrequent gains (losses)
Gain on state’s condemnation of company
property 230,000
Loss of assets from meteor strike (640,000)
Income from continuing operations before taxes 778,000
Income tax expense 217,000

Income from continuing operations 561,000
Discontinued segment
Loss from operating wholesale business
segment (net of tax) (444,000)
Gain on sale of wholesale business
segment (net of tax) 775,000 331,000
Net income $ 892,000

PROBLEM SET A
Problem 13-1A (120 minutes)
Part 1
HAROUN COMPANY
Income Statement Trends
For Years Ended December 31
2020 2019 2018 2017 2016 2015 2014
Sales 182.5% 161.2% 147.6% 136.2% 127.8% 119.6% 100.0%
Cost of goods sold 212.6 176.1 153.9 136.9 128.3 121.2 100.0
Gross profit 131.0 135.7 136.8 135.1 126.9 117.0 100.0
Operating expenses 279.7 216.9 198.3 144.1 123.7 122.0 100.0
Net income 52.7 92.9 104.5 130.4 128.6 114.3 100.0
HAROUN COMPANY
Balance Sheet Trends
At December 31 2020 2019 2018 2017 2016 2015 2014
Cash 65.2% 87.6% 92.1% 94.4% 98.9% 96.6% 100.0%
Accounts recble., net 226.9 238.0 215.7 166.7 147.2 139.8 100.0
Merchandise inventory 298.9 221.8 195.8 167.8 152.2 131.7 100.0
Other current assets 400.0 355.6 155.6 377.8 311.1 311.1 100.0
Long-term investments — — — 100.0 100.0 100.0 100.0
Plant assets, net 278.6 277.8 241.7 130.2 134.9 118.6 100.0
Total assets 246.8 222.3 195.4 144.4 138.6 124.0 100.0
Current liabilities 432.6 369.5 254.6 217.7 193.6 185.1 100.0
Long-term liabilities 323.5 285.0 278.0 142.5 145.0 155.0 100.0
Common stock 153.8 153.8 153.8 130.8 130.8 100.0 100.0
Other paid-in capital 166.7 166.7 166.7 113.3 113.3 100.0 100.0
Retained earnings 213.2 179.2 137.7 124.5 109.4 91.2 100.0
Total liabilities & equity 246.8 222.3 195.4 144.4 138.6 124.0 100.0
Problem 13-1A (concluded)
Part 2
2. a. Yes.
Sales grew steadily for the entire period of 2014 to 2020. (However,
beginning in 2018, cost of goods sold and operating expenses
increased dramatically relative to sales, resulting in a significant
reduction in net income.)
b. No.
In 2020, net income was only 52.7% of the 2014 base year amount.
Further, that percent was greatest in 2017 at 130.4% and declined in
each year since that time.
c. Yes.
Inventory sharply increased over this period.

Part 1
Current ratio: December 31, 2020: $52,390 / $22,800 = 2.3 to 1
December 31, 2019: $37,924 / $19,960 = 1.9 to 1
December 31, 2018: $51,748 / $20,300 = 2.5 to 1
Part 2
KORBIN COMPANY
Common-Size Comparative Income Statements
2020 2019 2018
Sales 100.00% 100.00% 100.00%
Cost of goods sold 51.08 62.50 55.36
Gross profit 48.92 37.50 44.64
Selling expenses 18.54 13.80 18.27
Administrative expenses 9.13 8.80 8.20
Total expenses 27.67 22.60 26.47
Income before taxes 21.25 14.90 18.17
Income tax expense 7.35 3.05 5.64
Net income 13.90% 11.85% 12.53%

Problem 13-2A (Concluded)
Part 3
KORBIN COMPANY
Balance Sheet Data in Trend Percents
At December 31 2020 2019 2018
Assets
Current assets 101.24% 73.29% 100.00%
Long-term investments 0.00 12.66 100.00
Plant assets, net 166.67 160.00 100.00
Total assets 131.71 116.19 100.00

Current liabilities 112.32% 98.33% 100.00%
Common stock 120.00 120.00 100.00
Other paid-in capital 150.00 150.00 100.00
Total liabilities and equity 131.71 116.19 100.00
Part 4
a. No.
Cost of goods sold as a percent of sales was 51.08% in 2020. This
compares to 62.50% in the prior year.
b. Yes.
Net income as a percent of sales was 13.90% in the recent year. This
compares to 11.85% in the prior year.
c. Yes.
The company expanded its plant assets in 2019, and again in 2020. The
trend percents were 160.00 and 166.67, respectively, for the two recent
years.
Trans- Current Quick Current Current Acid-Test Working
action Assets Assets Liabilities Ratio Ratio Capital
Beginning* $700,000 $308,000 $280,000 2.50 1.10 $420,000
May 2 + 50,000 _______ + 50,000 ____ ____ _______
Bal. 750,000 308,000 330,000 2.27 0.93 420,000
May 8 +110,000 +110,000
- 55,000 _______ _______ ____ ____ _______
Bal. 805,000 418,000 330,000 2.44 1.27 475,000
May 10 + 20,000 + 20,000

- 20,000 - 20,000 _______ ____ ____ _______
Bal. 805,000 418,000 330,000 2.44 1.27 475,000
May 15 - 22,000 - 22,000 - 22,000 ____ ____ _______

Bal. 783,000 396,000 308,000 2.54 1.29 475,000
May 17 +0 +0 _______ ____ ____ _______

Bal. 783,000 396,000 308,000 2.54 1.29 475,000
May 22 _______ _______ + 50,000 ____ ____ _______

Bal. 783,000 396,000 358,000 2.19 1.11 425,000
May 26 - 50,000 - 50,000 - 50,000 ____ ____ _______
Bal. 733,000 346,000 308,000 2.38 1.12 425,000
May 27 +100,000 +100,000 +100,000 ____ ____ _______
Bal. 833,000 446,000 408,000 2.04 1.09 425,000
May 28 + 80,000 + 80,000 ________ ____ ____ _______
Bal. 913,000 526,000 408,000 2.24 1.29 505,000
May 29 - 180,000 - 180,000 ________ ____ ____ _______
Bal. $733,000 $346,000 $408,000 1.80 0.85 $325,000
*Beginning balances
Current assets (given) $700,000
Current liabilities ($700,000 / 2.50) 280,000
Quick assets ($280,000 x 1.10) 308,000
1. Current ratio
$10,000 + 8,400 + $33,700 + $32,150 + $2,650
$17,500 + $3,200 + $3,300 = 3.6 to 1
2. Acid-test ratio
$10,000 + $8,400 + $33,700 = 2.2 to 1
$17,500 + $3,200 + $3,300

$33,700 x 365 = 27.4 days
$448,600
$297,250 = 7.3 times
($48,900 + $32,150)/2

$32,150 x 365 = 39.5 days
$297,250
($17,500 + $3,200 + $3,300 + $63,400) / ($90,000 + $62,800) = 0.57 to 1
($151,350 - $98,600) / $4,100 = 12.9 times

8. Profit margin ratio

$29,052 = 6.5%
$448,600

$448,600 = 2.1 times
($240,200 + $189,400)/2

$29,052 = 13.5%
($240,200 + $189,400)/2

$29,052 = 21.0%
($152,800 + $123,748)/2
Part 1
Barco Company Kyan Company
a. Current ratio
$155,440* $238,050
= 2.5 to 1 = 2.6 to 1
$61,340 $93,300
* $19,500 + $46,500 + $84,440 + $5,000 = $155,440
**$34,000 + $64,600 + $132,500 + $6,950 = $238,050
b. Acid-test ratio
$66,000* $98,600
= 1.1 to 1 = 1.1 to 1 $93,30
$61,340
* $19,500 + $46,500 = $66,000
**$34,000 + $64,600 = $98,600
c. Accounts receivable turnover

$770,000 $880,200
($46,500 + $29,800)/2 = 20.2 times ($64,600 + $54,200)/2 = 14.8 times
d. Inventory turnover
$585,100 $632,500
= 8.4 times = 5.3 times
($84,440 + $55,600)/2 ($132,500 + $107,400)/2
e. Days’ sales in inventory
$84,440 $132,500 x 365 = 76.5 days

x 365 = 52.7 days
$585,100 $632,500
f. Days' sales uncollected
$46,500 $64,600
x 365 = 22.0 days x 365 = 26.8 days
$770,000 $880,200
Short-term credit risk analysis: Barco and Kyan have essentially equal
current ratios and equal acid-test ratios. However, Barco both turns its
merchandise and collects its accounts receivable more rapidly than does
Kyan. On this basis, Barco probably is the better short-term credit risk.
Part 2
Barco Company Kyan Company
a. Profit margin ratio

$162,200 $210,400 = 23.9%
= 21.1%
$770,000 $880,200
b. Total asset turnover

$770,000 $880,200
($445,440 + $398,000)/2 ($542,450 + $382,500)/2
c. Return on total assets

$162,200 $210,400
= 38.5% = 45.5%
($445,440 + $398,000)/2 ($542,450 + $382,500)/2
d. Return on common stockholders' equity

$162,200 $210,400
= 55.8% = 65.0%
($303,300 + $278,300)/2 ($348,150 + $299,600)/2
e. Price-earnings ratio
$75 $75
= 16.6 = 14.7
$4.51 $5.11
f. Dividend yield
$3.81 $3.93
= 5.1% = 5.2%
$75 $75
Investment analysis: Kyan's profit margin ratio, total asset turnover, return on
total assets, and return on common stockholders' equity are all higher than
Barco’s. Although the companies pay roughly the same dividend, Kyan's
price-earnings ratio is lower. All of these factors suggest that Kyan's stock is
likely the better investment.
Problem 13-6AA (60 minutes)
Part 1
Effect of income taxes (debits or losses in parentheses)
30% Tax
Pretax Effect After-Tax
i. Loss from operating a discontinued segment (18,250) (5,475) (12,775)
m.Correction of overstatement of prior year’s sales (16,000) (4,800) (11,200)
n. Gain on sale of discontinued segment’s assets 34,000 10,200 23,800
Part 2 Income from continuing operations (and its components)
k. Net sales $ 998,000

a. Interest revenue 14,000
g. Gain from settling lawsuit 44,000
j. Gain on insurance recovery of tornado damage 20,000
Total revenues and gains 1,076,000
q. Cost of goods sold $482,500
b. Depreciation expense—Equipment 34,000
l. Depreciation expense—Buildings 52,000
e. Other operating expenses 106,400
c. Loss on sale of equipment 25,850
o. Loss from settling lawsuit 23,250
Total expenses (724,000)
p. Income tax expense (30%) (105,600)
Income from continuing operations after taxes $ 246,400
Problem 13-6AA (Concluded)
Part 3 Income from discontinued segment
i. Loss from operating a discontinued

segment (after-tax) $ (12,775)
n. Gain on sale of discontinued segment’s
assets (after-tax) 23,800
Income from discontinued segment $ 11,025
Part 4 Net income
Income from continuing operations after taxes $246,400
Income from discontinued segment 11,025
Net income $257,425

PROBLEM SET B
Problem 13-1B (120 minutes)
Part 1
TRIPOLY COMPANY
Income Statement Trends
2020 2019 2018 2017 2016 2015 2014
Sales 65.1% 70.9% 73.3% 79.1% 86.0% 89.5% 100.0%
Cost of goods sold 72.6 76.3 77.4 82.6 89.5 92.1 100.0
Gross profit 59.2 66.7 70.0 76.3 83.3 87.5 100.0
Operating expenses 56.0 69.3 74.7 84.0 93.3 96.0 100.0
Net income 60.6 65.5 67.9 72.7 78.8 83.6 100.0
TRIPOLY COMPANY
Balance Sheet Trends
At December 31 2020 2019 2018 2017 2016 2015 2014
Cash 64.7% 67.6% 76.5% 79.4% 88.2% 91.2% 100.0%
Accounts recble., net 81.3 85.0 87.5 90.0 93.8 96.3 100.0
Merchandise inventory 79.8 82.7 85.6 86.5 89.4 91.3 100.0
Other current assets 85.0 85.0 90.0 95.0 95.0 100.0 100.0
Long-term investments 32.7 27.3 23.6 100.0 100.0 100.0 100.0
Plant assets, net 112.3 113.2 114.5 90.7 92.5 94.3 100.0
Total assets 88.5 89.6 91.5 90.2 92.7 94.6 100.0
Current liabilities 52.9 55.7 66.4 67.9 75.0 92.9 100.0

Long-term liabilities 35.4 46.2 54.6 56.9 74.6 82.3 100.0
Common stock 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Other paid-in capital 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Retained earnings 166.7 157.8 145.9 137.0 122.2 103.7 100.0
Total liabilities & equity 88.5 89.6 91.5 90.2 92.7 94.6 100.0
Problem 13-1B (Concluded)
Part 2
Analysis and Interpretation
 The statements and the trend percent data show that sales declined
every year. However, cost of goods sold did not fall as rapidly as sales.
As a result, gross profit fell more rapidly than sales.
 Except for the most recent period, operating expenses fell less rapidly
than gross profit, so the final result was that net income fell to 60.6% of
the base year.
 Management was not able to reduce costs and expenses fast enough to
keep up with the sales decline.
 Although the profits decreased during these years, the company did
continue to earn a net income.
 It appears that the cash generated from operations was used primarily
to reduce both current and long-term liabilities.
 The company made a large expansion of its plant assets during 2018,
financing this expansion primarily through the liquidation of long-term
investments.
Part 1
Current ratio: December 31, 2020: $54,860 / $22,370 = 2.5 to 1
December 31, 2019: $32,660 / $19,180 = 1.7 to 1
December 31, 2018: $36,300 / $16,500 = 2.2 to 1
Part 2
BLUEGRASS CORPORATION
Common-Size Comparative Income Statements
2020 2019 2018
Sales 100.00% 100.00% 100.00%
Cost of goods sold 54.77 51.91 46.04
Gross profit 45.23 48.09 53.96
Selling expenses 11.41 11.92 12.52
Administrative expenses 8.43 8.80 10.92
Total expenses 19.84 20.72 23.44
Income before taxes 25.39 27.36 30.53
Income tax expense 3.04 3.56 3.69
Net income 22.34% 23.80% 26.84%
* Some totals do not reconcile due to rounding.

Part 3
BLUEGRASS CORPORATION
Balance Sheet Data in Trend Percents
At December 31 2020 2019 2018
Assets
Current assets 151.13% 89.97% 100.00%
Long-term investments 0.00 16.04 100.00
Plant assets 142.80 143.87 100.00
Total assets 133.18 117.57 100.00
Current liabilities 135.58% 116.24% 100.00%
Common stock 125.68 125.68 100.00
Other paid in capital 122.57 122.57 100.00
Total liabilities and equity 133.18 117.57 100.00
Part 4
Significant relations revealed
Bluegrass's cost of goods sold took a larger percent of sales each year.
Selling and administrative expenses and income taxes took a somewhat
smaller portion each year, but not enough to offset the effect of cost of
goods sold. As a result, income became a smaller percent of sales each
year.
The large expansion of plant assets in 2019 was financed by a reduction in

current assets, an increase in current liabilities, a large reduction in long-
term investments, and apparently by a stock sale. One effect of this plan
was to reduce the current ratio. However, the current ratio recovered in
2020. This apparently resulted from profits, limiting the amount of
dividends paid, and the liquidation of long-term investments.
Trans- Current Quick Current Current Acid-Test Working
action Assets Assets Liabilities Ratio Ratio Capital
Beginning* $300,000 $168,000 $120,000 2.50 1.40 $180,000
June 1 +120,000 +120,000
- 75,000 _______ ________ ____ ____ _______
Bal. 345,000 288,000 120,000 2.88 2.40 225,000
June 3 + 88,000 + 88,000
- 88,000 - 88,000 ________ ____ ____ _______
Bal. 345,000 288,000 120,000 2.88 2.40 225,000
June 5 +150,000 ________ +150,000 ____ ____ _______

Bal. 495,000 288,000 270,000 1.83 1.07 225,000
June 7 +100,000 +100,000 +100,000 ____ ____ _______

Bal. 595,000 388,000 370,000 1.61 1.05 225,000
June 10 +120,000 +120,000 _______ ____ ____ _______

Bal. 715,000 508,000 370,000 1.93 1.37 345,000
June 12 - 275,000 - 275,000 ________ ____ ____ _______

Bal. 440,000 233,000 370,000 1.19 0.63 70,000
June 15 ________ ________ + 80,000 ____ ____ _______

Bal. 440,000 233,000 450,000 0.98 0.52 (10,000)
June 19 +0 +0 ________ ____ ____ _______
Bal. 440,000 233,000 450,000 0.98 0.52 (10,000)
June 22 - 12,000 - 12,000 - 12,000 ____ ____ _______
Bal. 428,000 221,000 438,000 0.98 0.50 (10,000)
June 30 - 80,000 - 80,000 - 80,000 ____ ____ _______
Bal. $348,000 $141,000 $358,000 0.97 0.39 (10,000)
*Beginning balances
Current assets (given) $300,000
Current liabilities ($300,000 / 2.50) 120,000
Quick assets ($120,000 x 1.40) 168,000
1. Current ratio
$6,100 + $6,900 + $15,100 + $13,500 + $2,000 = 2.5 to 1
$11,500 + $3,300 + $2,600
2. Acid-test ratio
$6,100 + $6,900 + $15,100 = 1.6 to 1
$11,500 + $3,300 + $2,600

$15,100 x 365 = 17.5 days
$315,500
$236,100 = 15.3 times
($13,500 + $17,400)/2

$13,500 x 365 = 20.9 days
$236,100
($11,500 + $3,300 + $2,600 + $30,000) / ($35,000 + $35,100) = 0.68 to 1
$30,200 / $2,200 = 13.7 times

8. Profit margin ratio

$23,800 = 7.5%
$315,500

$315,500 = 3.0 times
($117,500 + $94,900)/2

$23,800 = 22.4%
($117,500 + $94,900)/2

$23,800 = 38.3%
($70,100 + $54,300)/2
Part 1
Fargo Company Ball Company
a. Current ratio
$205,200 $208,100
= 2.3 to 1 = 2.1 to 1
$90,500 $97,000
b. Acid-test ratio
$108,700 $116,000
= 1.2 to 1 = 1.2 to 1
$90,500 $97,000
c. Accounts receivable turnover

$393,600 = 4.9 times $667,500 = 8.7 times
($88,700 + $72,200)/2 ($79,500 + $73,300)/2
d. Inventory turnover
$290,600 $480,000
($86,800 + $105,100)/2 ($82,000 + $80,500)/2
e. Days’ sales in inventory

$86,800 $82,000
x 365 = 109.0 days x 365 = 62.4 days
$290,600 $480,000
f. Days' sales uncollected
$88,700 $79,500
x 365 = 82.3 days x 365 = 43.5 days
$393,600 $667,500
Short-term credit risk analysis: Fargo and Ball have nearly equal current
ratios and equal acid-test ratios. However, Ball both turns its merchandise
and collects its accounts receivable much more rapidly than Fargo. On this
basis, Ball probably is the better short-term credit risk.
Part 2
Fargo Company Ball Company
a. Profit margin ratio

$33,850 $61,700
= 8.6% = 9.2%
$393,600 $667,500
b. Total asset turnover

$393,600 $667,500
($382,100 + $383,400)/2 ($460,400 + $443,000)/2
c. Return on total assets

$33,850 $61,700
= 8.8% = 13.7%
($382,100 + $383,400)/2 ($460,400 + $443,000)/2
d. Return on common stockholders' equity

$33,850 $61,700
= 17.8% = 23.7%
($198,600 + $182,100)/2 ($270,100 + $250,700)/2
e. Price-earnings ratio
$25 $25
= 19.7 = 11.4
$1.27 $2.19
f. Dividend yield
$1.50 $1.50
= 6.0% = 6.0%
$25 $25
Investment analysis: Ball’s profit margin, total asset turnover, return on total
assets, and return on common stockholders' equity are all higher than
Fargo's. Also, Ball has a lower price-earnings ratio, while paying the same
dividend. These factors indicate that Ball stock is likely the better investment.
Problem 13-6BA (60 minutes)
Part 1 Effect of income taxes (debits or losses in parentheses)
25% Tax
Pretax Effect After-Tax
l. Loss from operating a discontinued segment (120,000) (90,000)

(30,000)
n. Correction of overstatement of prior year’s expense 48,000 12,000 36,000
p. Loss on sale of discontinued segment’s assets (180,000) (135,000)

(45,000)
Part 2 Income from continuing operations (and its components)
c. Net sales $2,640,000

b. Interest revenue 20,000
j. Gain from settling lawsuit 68,000
Total revenues and gains 2,728,000
o. Cost of goods sold $1,040,000
h. Depreciation expense—Equipment 100,000
m. Depreciation expense—Buildings 156,000
g. Other operating expenses 328,000
k. Loss on sale of equipment 24,000
e. Loss on hurricane damage 48,000
i. Loss from settling lawsuit 36,000
Total expenses and losses 1,732,000
d. Income tax expense (25%) (249,000)
Income from continuing operations after taxes $ 747,000
Problem 13-6BA (Concluded)
Part 3 Income from discontinued segment
l. Loss from operating a discontinued segment (after-tax) $ (90,000)

p. Loss on sale of discontinued segment’s assets (after-tax) (135,000)
Loss from discontinued segment $(225,000)
Part 4 Net income
Income from continuing operations after taxes $747,000
Income (loss) from discontinued segment (225,000)
Net income $522,000

SERIAL PROBLEM — SP 13
Serial Problem — SP 13, Business Solutions (45 minutes)
1. Gross margin with services revenue

Gross margin = Total revenue – Cost of goods sold
= $44,000 - $14,052 = $29,948
Gross margin ratio = $29,948 / $44,000 = 68.1%
Gross margin without services revenue

Gross margin = Net (goods) sales – Cost of goods sold
= $18,693 - $14,052 = $4,641
Gross margin ratio = $4,641 / $18,693 = 24.8%
Profit margin ratio = $18,833 / $44,000 = 42.8%
2. Current ratio = $95,568 / $875 = 109.2
Acid-test ratio = $90,924 / $875 = 103.9
3. Debt ratio = $875 / $120,268 = 0.7%
Equity ratio = $119,393/$120,268 = 99.3%
4. Current assets are 79.4% of total assets ($95,568/$120,268)
Long-term assets are 20.5% of total assets ($24,700/$120,268)

CH 13

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CH 13

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Chapter – 13 Analyzing and Interpreting

Quick Study 13-2 (10 minutes)

Quick Study 13-3 (5 minutes)

$50,400 = 1.12 x prior year income

Current Prior Dollar Percent

Quick Study 13-5 (15 minutes)

Current Prior Dollar Percent

Quick Study 13-6 (5 minutes)

Quick Study 13-7 (5 minutes)

Quick Study 13-9 (15 minutes)

Quick Study 13-10 (10 minutes)

Transaction Current Assets Current Liabilities Current Ratio

Quick Study 13-11 (15 minutes)

Quick Study 13-13 (10 minutes)

Total Asset Turnover: $80,000 = 0.8 times

Quick Study 13-14 (15 minutes)

Quick Study 13-15 (15 minutes)

Quick Study 13-16 (15 minutes)

1. Profit Margin Ratio 9% 8% Favorable

2. Debt Ratio 47% 42% Unfavorable

3. Gross Margin Ratio 34% 46% Unfavorable

4. Acid-test Ratio 1.00 1.15 Unfavorable

5. Accounts Receivable Turnover 5.5 6.7 Unfavorable

6. Basic Earnings Per Share $1.25 $1.10 Favorable

7. Inventory Turnover 3.6 3.4 Favorable

8. Dividend Yield 2.0% 1.2% Favorable

Quick-Study 13-18 (30 minutes)

1. Parker. Explanation: Parker’s higher current ratio and acid-test ratio

2. Morgan. Explanation: Morgan’s higher accounts receivable turnover

3. Morgan. Explanation: Morgan’s higher inventory turnover suggests it

b. Not Unusual and/or Infrequent. The sale of a delivery truck at a loss is

c. Unusual and/or Infrequent. The seizure of its foreign assets by a foreign

Quick Study 13-20A (10 minutes)

Income from continuing operations $180,000

Exercise 13-2 (5 minutes)

Return on Total Assets (d)

2. Working Capital (c) --also called net working capital

Exercise 13-3 (20 minutes)

Accounts receivable trend is unfavorable. Receivables are increasing; further,

Exercise 13-5 (25 minutes)

Answer: Net income decreased.

Supporting calculations: When the sum of each year's common-size cost of

Liabilities and Equity

Current Yr: $31,800 + $89,500 + $112,500 + $10,700 = 1.88 to 1

$35,625 + $62,500 + $82,500 + $9,375

2 Yrs Ago: $37,800 + $50,200 + $54,000 + $5,000 = 2.87 to 1

Date Current Assets Current Liabilities Current Ratio

Jan. 12 -5,000 -5,000

Jan. 22 +12,000 +12,000

2. Accounts receivable turnover

1. Debt and equity ratios

Current Year 1 Year Ago

Total equity and equity ratio

Current Year: $228,400 / $294,600 = 0.78 to 1

Analysis: More debt.

3. Times interest earned

Current Year: ($31,100 + $9,525 + $12,100) / $12,100 = 4.4 times

Analysis: Less risky.

Current Year: $31,100 / $673,500 = 4.6%

1 Year Ago: $29,375 / $532,000 = 5.5%

2. Total asset turnover

3. Return on total assets

1. Return on common stockholders' equity

May 15 - 22,000 - 22,000 - 22,000 ___

May 17 +0 +0 _ _

May 22 ___ _ + 50,000 _____