CHAPTER 19 - Part 1

_{<=
!--[if gte vml 1]>

=} =3D 4.3 t= imes

_{<=
!--[if gte vml 1]>

=} =3D 4.9 t= imes

Beginning inventory  &n= bsp;         $ 980,000

Purchases    =             &nb= sp;            = 4,340,000

Goods available for sale &nb= sp;    5,320,000

Ending inventory   = ;            &n= bsp; 1,020,000

Cost of goods sold  &nb= sp;            $4,300,000

$ 860,000

4,661,000
5,521,000

980,000
$4,541,000

CHAPTER 18

Financial Statement Analysis

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 18-1

Dear Uncle Frank,

It was so good to hear from y= ou! I hope you and Aunt Irene are still enjoying your new house.

You asked some interesting questions. They relate very well to the material that we are studying now i= n my financial accounting class. You said you heard that different users of financial statements are interested in different characteristics of companies. This is true. A short-term creditor, s= uch as a bank, is interested in the company’s liquidity, or abilit= y to pay obligations as they become due. The liquidity of a borrower is extremely important in evaluating the saf= ety of a loan. A long-term creditor, such as a bondholder, would be interested = in solvency, the company’s ability to survive over a long period of time= . A long-term creditor would also be interested in profitability. They are interested in the likelihood that the co= mpany will survive over the life of the debt and be able to meet interest payments. Stockholders are also interested in profitability, and in the solvency of the= company. They want to assess the likelihood of dividends and the growth poten= tial of the stock.

It is important to compare different financial statement elements to other items. The amount of a financial statement element such as cash does= not have much meaning unless it is compared to something else. Compariso= ns can be done on an intracompany basis. = This basis compares an item or financial relationship within a company for the current year to one or more previous years. Intracompany comparisons are useful in detecting changes in financial relationships and significant trends. Comparisons can also be done with industry averages. This basis compares an item or financial relationship with industry averages or norms. Comparisons= with industry averages provide infor= mation as to a company’s relative performance within the industry. Finally,<= /span> comparisons can be done on an intercom= pany basis. This basis compares
an item or financial relationship with the same item or relationship in= one or more competing companies. Intercompany comparison= s are useful in determining a company’s competitive position.

I hope this answers your ques= tions. If it does not, or you have more questions, please write me again or call. We could even meet for lunch sometime; it would be great to see you!<= /p>

Love,

Your niece (or nephew)

BRIEF EXERCISE 18-2

(a) The three tools of financial statement analysis are horizontal analysis, vertical analysis, and ratio analysis. Horiz= ontal analysis evaluates a series of = financial statement data over a period of time. Vertical analysis evaluat= es financial statement data by expressing each item in a financial statement as a percen= t of a base amount. Ratio analysis expresses the relationship among selected ite= ms of financial statement data.

(b) Horizontal Analysis

		2007		2008		2009
Current assets		100%		115%		120%

&nb= sp; = (115 =3D $230,000/$200,000; 120 =3D $240,000/$200,000)

&nb= sp; Vertical Analysis

		2007		2008		2009
Current assets*		40%		38%		39%

= ; &n= bsp; *as a percentage of total assets

= ; &n= bsp; (40% =3D $200,000/$500,000; 38% =3D $230,000= /$600,000;

&nbs= p; &= nbsp; 39% =3D $240,000/$620,000)

<= o:p>

&nb= sp; Ratio Analysis

		2007		2008		2009
Current ratio		1.25		1.37		1.30

= ; &n= bsp; (1.25 =3D $200,000/$160,000; 1.37 =3D $230,00= 0/$168,000;

= ; &n= bsp; 1.30 =3D $240,000/$184,000)

BRIEF EXERCISE 18-3

Horizontal analysis:

	&nbs= p;	&nbs= p;	&nbs= p;	&nbs= p;	Increase or (Decre= ase)

	Dec. 31, = 2009	&nbs= p;	Dec. 31, = 2008	&nbs= p;	Amount	&nbs= p;	Percentag= e

Accounts receivable Inventory Total assets	$ = 520,000 $ = 840,000 $3,000,00= 0	&nbs= p;	$ = 400,000 $ = 600,000 $2,500,00= 0	&nbs= p;	$120,000<= /p> $240,000<= /p> $500,000<= /p>	&nbs= p;	30% 40% 20%

_{=3D .30Q=
94; _{=3D .40 =
_{=3D .20}}}

BRIEF EXERCISE 18-4

Vertical analysis:

	Dec. 31, = 2009	&nbs= p;	Dec. 31, = 2008

	Amount	&nbs= p;	Percentag= e*	Amount	&nbs= p;	Percentag= e**

Accounts receivable Inventory Total assets	$ = 520,000 $ = 840,000 $3,000,00= 0	&nbs= p;	17.3% 28.0% 100= %	&nbs= p;	$ = 400,000 $ = 600,000 $2,500,00= 0	&nbs= p;	16.0% 24.0% 100= %

_{=3D .173=
194; _{=3D .16}}

_{=3D .28Q=
94; _{=3D .24}}

BRIEF EXERCISE 18-5

	2009	2008	2007

Net income	$522,000<= /p>	$450,000<= /p>	$500,000<= /p>

		Increase = or (Decrease)

		Amount	Percentag= e

(a) (b)	2007–2008 2008–2009	(50,000)<= /p> (72,000)	(10%) (16%)

_{=3D .10Q=
94; _{=3D .16}}

BRIEF EXERCISE 18-6

	2009	2008	Increase<= /p>

Net income	$585,000<= /p>	X	30%

X .30 =3D

.30X =3D 585,000 = 211; X

BRIEF EXERCISE= 18-6 (Continued)

1.30X =3D 585,000

X =3D= 450,000

2008 Net income =3D $450= ,000

BRIEF EXERCISE 18-7

Comparing the percentages presented results in the following conclusions: The net income for Epstein increased in 2008 because of the combination of an increase in sales and a decrease in both cost of goods sold and expenses= . However, the reverse was true in 2009 = as sales decreased while both cost of goods sold and expenses increased. This resulted in a decrease in net income.

BRIEF EXERCISE 18-8

2009

2008

2007

Sales

Cost of goods sold

Expenses

Net income

100.0

59= .2

= ;25.0

= ;15.8

100.0

62= .4

= ;25.6

= ;12.0

100.0

64= .5

= ;27.5

= ; 8.0

Net inco= me as a percent of sales for Charles increased over the three-year period because cost of goods sold and expens= es both decreased as a percent of sales every year.

BRIEF EXERCISE 18-9

(a) Working capital =3D Current assets – Current liabilities

&= nbsp; Current assets &= nbsp; $45,918,000

&= nbsp; Current liabilities = 194;40,644,000

&= nbsp; Working capital = $ 5,274,000

BRIEF EXERCISE 18-9 (Continued)

(b) Current ratio:

<= span style=3D'mso-tab-count:2'> &= nbsp; _=3D

&= nbsp; &nbs= p; &= nbsp; &nbs= p; =3D 1.13:1

_=3D

= &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; =3D

= &nb= sp; = &nb= sp; = =3D .63:1

BRIEF EXERCISE 18-10

= (a) Asset turnover =3D

= &= nbsp; &nbs= p; &= nbsp; =3D

= &nb= sp; =3D 5 times

= (b) Profit margin =3D

= &= nbsp; &nbs= p; &= nbsp; =3D

= &nb= sp; =3D 14.3%

BRIEF EXERCISE 18-11

(a) Receivables turnover =3D

	2009	2008

(1)	₌ =3D 7.4 t= imes	₌ =3D 6.2 t= imes
	*($520,000 + $550,000) ÷ 2	**($480,000 + $520,000) ÷ 2

(2)	Average collection pe= riod ₌ =3D 49.3 = days	₌ =3D 58.9 = days

(b) Marino Company should be pleased with the effectiveness of its credit and collec= tion policies. The company has decreased the average collection period by= 9.6 days and the collection period of approximately 49 days is well within the = 60 days allowed in the credit terms.

BRIEF EXERCISE 18-12

(a) Inventory turnover =3D _{<=
!--[if gte vml 1]>}

&nbs= p; (2) Days in inventory

<= span style=3D'mso-tab-count:2'> &= nbsp; _{=3D 84.9 da=
ys _{=3D 74.5 days}}

BRIEF EXERCISE 18-12 (Continued)

(b) Management should be concerned with the fact that inventory is movin= g slower in 2009 than it did in 2008. The decrease in the turnover could be because of poor pricing decisions = or because the company is stuck with obsolete inventory.

BRIEF EXERCISE 18-13

Payout ratio =3D

&n= bsp;

&= nbsp; &nbs= p; .20 =3D

&n= bsp;

&= nbsp; &nbs= p; X =3D $66,000 (.20) =3D $13,20= 0

&n= bsp;

Cash dividends =3D $13,200

Return on assets =3D

&n= bsp;

&= nbsp; &nbs= p; &= nbsp; .15 =3D

&n= bsp;

&= nbsp; &nbs= p; &= nbsp; .15X =3D $66,000

&n= bsp;

&= nbsp; &nbs= p; &= nbsp; X =3D

&n= bsp;

&= nbsp; &nbs= p; &= nbsp; X =3D $440,000

&n= bsp;

&= nbsp; Average assets =3D $440,000

BRIEF EXERCISE 18-14

MING CORPOR= ATION

Partial Inc= ome Statement

&nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp;

Income before income taxes.................= ................................. $400,000

Income tax expense ($400,000 X 30%)........= ......................... 120,000

Income before extraordinary item...........= .............................. 280,0= 00

Extraordinary loss from flood, net of $21,000

&= nbsp; tax savings ($70,000 X 30%).............= .............................. 49,000

Net income..............................= .................................................... $231,000

BRIEF EXERCISE 18-15

REEVES CORP= ORATION

Partial Inc= ome Statement

&nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp;

Loss from operations of M= exico facility, net

&= nbsp; of $90,000 tax saving ($300,000 X 30%).= ......... $210,000

Loss on disposal of Mexic= o facility, net of

&= nbsp; $36,000 tax saving ($120,000 X 30%).........= ....... 84,000 $294,000

SOLUTIONS TO EXERCISES

EXERCISE 18-1

BLEVINS INC= .

Condensed B= alance Sheets

December 31=

&nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp;

=	<= /p>	<= /p>	<= /p>	<= /p>	Increase or (Decrease)

=	<= /p>	2009	<= /p>	2008	<= /p>	Amount	<= /p>	Percentage

Assets	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>

Current assets Plant assets (net) Total assets	<= /p>	$125,000 396,000 $521,000	<= /p>	$100,000 330,000 $430,000	<= /p>	($25,000 ( 66= ,000 91,000	<= /p>	(25.0%) (20.0%) (21.2%)
=	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>
Liabilities	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>

Current liabilities Long-term liabilities Total liabiliti= es	<= /p>	$ 91,000 133,000 224,000	<= /p>	$ 70,000 95,000 165,000	<= /p>	($21,000) ( 38= ,000) ( 59= ,000)	<= /p>	(30.0%) (40.0%) (35.8%)
=	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>
Stockholders’ Equity	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>	<= /p>

Common stock, $1 par Retained earnings Total stockhold= ers’ e= quity Total liabiliti= es and s= tockholders’ e= quity = ;	<= /p>	161,000 136,000 297,000 $521,000	<= /p>	115,000 150,000 265,000 $430,000	<= /p>	( 46,000 = (15,000 &nbs= p; ) (14,000) &nb= sp; ( 32= ,000) ($91,000)	<= /p>	(40.0%) (= 9.3%) ( 12.1%= ) 21.2%

EXERCISE 18-2

GALLUP CORP= ORATION

Condensed I= ncome Statements

For the Yea= rs Ended December 31

&nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp;

<= /p>	<= /p>	2009	<= /p>	2008

<= /p>	<= /p>	Amount	<= /p>	Percent	<= /p>	Amount	<= /p>	Percent
		<= o:p>				<= o:p>
<= /p>	$750,000 465,000 285,000 120,000 60,000 180,000 105,000 33,000 $ 72,000	<= /p>	100.0% 62.0% 38.0% 16.0% 8.0% 24.0% 14.0% 4.4% 9.6%	<= /p>	$600,000 390,000 210,000 72,000 54,000 126,000 84,000 24,000 $ 60,000	<= /p>	100.0% 65.0% 35.0% 12.0% 9.0% 21.0% 14.0% 4.0% 10.0%

EXERCISE 18-3

(a) = &nb= sp; = CONARD CORPORATION

= &nb= sp; = Condensed Balance Sheets

= &nb= sp; = &nb= sp; December 31

= ; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p;

&nbs= p;

2009

&nbs= p;

2008

&nbs= p;

Increase<= /p>

(Decrease= )

Percentag= e

Change

from 2008=

Assets

Current assets

Property, plant &

equipment (net)

Intangibles

Total assets

&nbs= p;

$ 7= 4,000

&nbs= p;

&#= 8194;99,000

= ; 27,000

$200,0= 00

&nbs= p;

$ 8= 0,000

&nbs= p;

&#= 8194;90,000

= ; 40,000

$210,0= 00

&nbs= p;

$ (= 6,000)

&nbs= p;

( 9,000)

= ;(13,000)

$(10,0= 00)

&nbs= p;

(7= .5%)

&nbs= p;

(10.0%)

(32.5%)

(4= .8%)

EXERCISE 18-3 (Continued)

= &nb= sp; = CONARD CORPORATION

= &nb= sp; Condensed Balance Sheets (Continued)

= &nb= sp; = &nb= sp; December 31

= ; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p;

&nbs= p;

2009

&nbs= p;

2008

&nbs= p;

Increase<= /p>

(Decrease= )

Percentag= e

Change

from 2008=

Liabilities and stock-

holdersR= 17; equity

Current liabilities

Long-term

liabilities=

Stockholders’

equity

Total liabilities and

stockholder= s’

equity

&nbs= p;

$ 4= 2,000

&nbs= p;

14= 3,000

&nbs= p;

= ; 15,000

&nbs= p;

$200,0= 00

&nbs= p;

$ 4= 8,000

&nbs= p;

15= 0,000

&nbs= p;

= ; 12,000

&nbs= p;

$210,0= 00

&nbs= p;

$ (= 6,000)

&nbs= p;

(7,000)

3,000)

&nbs= p;

$(10,0= 00)

&nbs= p;

(12.5%)

&nbs= p;

(4= .7%)

&nbs= p;

(25.0%)

&nbs= p;

(4= .8%)

(b= ) &= nbsp; &nbs= p; &= nbsp; CONARD CORPORATION

= &nb= sp; = Condensed Balance Sheet

= &nb= sp; = &nb= sp; December 31, 2009

= ; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p;

Amount

Percent

<= /o:p>

Assets

Current assets

Property, plant, and equipment (net)

Intangibles

Total assets

Liabilities and stockholders’ equity

Current liabilities

Long-term liabilities

Stockholders’ equity

Total liabilities and stockholders’ equity

$ 74,000

99,000

27,000

$200,000

$ 42,000

143,000

15,000

$200,000

37.0%

49.5%

13.5%

100.0%

21.0%

71.5%

7.5%

100.0%

EXERCISE 18-4

(a) = &nb= sp; = HENDI CORPORATION

= &nb= sp; = Condensed Income Statements

= &nb= sp; = For the Years Ended December 31

= ; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p;

	&nbs= p;	&nbs= p;	Increase = or (Decrease) During 20= 08

	2009	2008	Amount	Percentage

Net sales Cost of goods sold Gross profit Opera= ting expenses Net income	$600,000 483,000 117,000 57,200 $ 59,800	$500,000 420,000 80,000 44,000 $ 36,000	$100,000<= /p> = ; 63,000 &#= 8194;37,000 = ; 13,200 $̳= 4;23,800	20.0% 15.0% 46.3% 30.0% 66.1= %

(b= ) &= nbsp; &nbs= p; &= nbsp; HE= NDI CORPORATION

= &nb= sp; = Condensed Income Statements

= &nb= sp; = For the Years Ended December 31

= ; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p;

	2009	2008

	Amount	Percent	Amount	Percent

Net sales Cost of goods sold Gross profit Oper= ating expenses Net income	$600,000 483,000 117,000 57,200 $ 59,800	100.0% 80.5% 19.5% 9.5% 10.0%	$500,000 420,000 80,000 44,000 $ 36,000	100.0% 84.0%= 16.0% 8.8% 7.2%

EXERCISE 18-5

(a) Current ratio =3D 1.9:1 ($2,572 ÷ $1,341)

Acid-test ratio =3D .75:1 ($1,007 ÷ $1,341)

Receivables turnover =3D 10.9 times ($7,131 ÷ $656.5)*

Inventory turnover =3D 5.0 times ($4,559 ÷ $909.5)**

*($646 + $667) ÷ 2=

**(917 + 902) ÷ 2<= /p>

EXERCISE 18-5 (Continued)

(b)

Ratio

Nordstrom

J.C. Penney

Industry<= /p>

Current

Acid-test

Receivables turnover

Inventory turnover

1.9:1

.75:1

10.9

5.0

5.7:1

1.2:1

69.0

3.6

1.3:1

.3= :1

10.8

6= .7

Nordstrom is be= low J.C. Penney for the current and acid-test ratios and the receivables turnov= er. Nordstrom is better than J.C. Penney for inventory turnover.

Nordstrom is better than the industry average for the current and acid test ratios and the receivables turnover, but below the industry average for the inventory turnover ratio.

EXERCISE 18-6

(a) Current ratio as of February = 1, 2008 =3D 2.6:1 ($130,000 ÷ $50,000).

Feb. 3 2.6:1 No change in total curr= ent assets or liabilities.

&= nbsp; 7 2.0:1 ($102,000 ÷ $50,000).

&= nbsp; 11 2.0:1 No change in total current assets or liabiliti= es.

&= nbsp; 14 2.4:1 ($90,000 ÷ $38,000).

&= nbsp; 18 2.1:1 ($90,000 ÷ $43,000).

(b) Acid-test ratio as of Februar= y 1, 2008 =3D 2.3:1 ($113,000* ÷ $50,000).

*$130,000 – $15,000 – $2,000

Feb. 3 2.3:1 No change in total quick assets or current liabilities.

&= nbsp; 7 1.7:1 ($85,000 ÷ $50,000).

&= nbsp; 11 1.6:1 ($82,000 ÷ $50,000).

&= nbsp; 14 1.8:1 ($70,000 ÷ $38,000).

&= nbsp; 18 1.6:1 ($70,000 ÷ $43,000).

EXERCISE 18-7

(a) _{=3D 2.9:1.}

(b) _{=3D 1.7:1.}

(d) _{=3D 3.6 times.}

&= nbsp;	(1)	_{<= !--[if gte vml 1]> =}	&= nbsp;	&= nbsp;	&= nbsp;

	(2)	_{<= !--[if gte vml 1]> =}

EXERCISE 18-8

= (a) Profit margin &= nbsp; &nbs= p; &= nbsp; _{=3D 6.6%.}

(b) Asset turnover &= nbsp; &nbs= p; _{=3D 1.4 times.}

(d)

Return on common stockholders’
equity
=

₌ =3D 13.2%= .

EXERCISE 18-9

(a) _{=3D $2.00.}

(b) _{=3D 6.5 times.}

(d) _{=3D _{=3D 6.6 tim=
es.}}

EXERCISE 18-10

(a) Inventory turnover =3D 3.5 = =3D

3.5 X $190,000 =3D Cost of goods sold

Cost of goods sold =3D $665,000.

(b) Receivables turnover =3D 8.8 = =3D

8.8 X $99,250 =3D Net sales (credit) =3D $873,400.

.24 X $507,250 =3D Net income =3D $121,740.

EXERCISE 18-10 (Continued)

(d) Return on assets =3D 20% =3D =

Average assets =3D _{=3D $608,70=
0}

_{=3D $608,70=
0}

Total assets (Dec. 31, 2009) =3D ($608,700 X 2) – $605,000 =3D $612,400.

EXERCISE 18-11

(a) ($4,300 + $21,200+ $10,000)/$12,370 =3D 2.87

(b) ($4,300 + $21,200)/$12,= 370 =3D 2.06

(d) $60,000/[($10,000 + $7,000)/2] =3D 7.06

(e) $15,000/$100,000 =3D 15%

(f) $100,000/[($110,5= 00 + $120,100)/2] =3D .87

(g) $15,000/[($110,500 + $120,100)/2] =3D 13%

(h) $15,000/[($98,130 + $89,000)/2] =3D 16%

(i) $12,370/$110,500 =3D 11.2%

EXERCISE 18-12

(a) = &nb= sp; = MOLINI CORPORATION

&nb= sp; Partial Income Statement

&= nbsp; For the Year Ended October 31, 2008

&nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp;

Income before income taxes.................= .................................. $540,000

Income tax expense ($540,000 X 30%)........= .......................... 162,000

Income before extraordinary item...........= .............................. 378,000

Extraordinary loss from flood, net of $45,000

&= nbsp; tax savings ($150,000 X 30%)............= .............................. 105,000

Net income..............................= .................................................... $273,000

EXERCISE 18-12 (Continued)

(= b) To: Chief Accountant

<= span style=3D'mso-tab-count:1'> From: Your name, Independent Auditor

After reviewing your income statement for the year ended 10/31/08, we believe it = is misleading for the following reasons:

The amount reported for income before extraordinary items is overstated by $45,000. The income tax expense should be 30% of $540,000, or $162,000, not $117,000.

Also, the effect of the extraordinary loss o= n net income is only $105,000, not $150,000. An income tax savings of $45,000 should be netted against = the extraordinary loss.

&n= bsp;

EXERCISE 18-13

(a) = &nb= sp; = YADIER CORPORATION

Partial Inc= ome Statement

For the Yea= r Ended December 31, 2008

&nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp;

Income from continuing operations..........= ............................ $290,000

Discontinued operations

&= nbsp; Gain on discontinued division, net of $9,000

&= nbsp; &nbs= p; income taxes...............................= .................................. 21,000

Income before extraordinary item...........= ............................... 311,000

Extraordinary item

&= nbsp; Extraordinary loss, net of $24,000 income tax saving = &nb= sp; 56,000

Net income..............................= ..................................................... $255,000

(b) The correction of an error in last year̵= 7;s financial statements is a prior period adjustment. The correction is reported in the 2008 retained earnings statement as an adjustment that increases the reported beginning balance of retained earnings by $14,000, or [$20,000 – ($20,000 X 30%)].

&n= bsp;