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Chapter 14

Financial Statement Analysis

OBJECTIVES

Obj 1 List basic financial statement analytical procedures.


Obj 2 Apply financial statement analysis to assess the solvency of a business.
Obj 3 Apply financial statement analysis to assess the profitability of a business.
Obj 4 Describe the contents of corporate annual reports.

QUESTION GRID

True/False
No Objective Difficulty No. Objective Difficulty No. Objective Difficulty
.
1 14-01 Easy 24 14-02 Easy 47 14-03 Easy
2 14-01 Easy 25 14-02 Easy 48 14-03 Easy
3 14-01 Easy 26 14-02 Easy 49 14-03 Easy
4 14-01 Easy 27 14-02 Easy 50 14-03 Easy
5 14-01 Easy 28 14-02 Easy 51 14-03 Easy
6 14-01 Easy 29 14-02 Easy 52 14-03 Easy
7 14-01 Easy 30 14-02 Easy 53 14-03 Easy
8 14-01 Easy 31 14-02 Easy 54 14-03 Easy
9 14-01 Easy 32 14-02 Easy 55 14-03 Easy
10 14-01 Easy 33 14-02 Easy 56 14-03 Easy
11 14-01 Easy 34 14-02 Easy 57 14-03 Easy
12 14-01 Easy 35 14-02 Easy 58 14-03 Easy
13 14-01 Easy 36 14-02 Easy 59 14-03 Easy
14 14-01 Easy 37 14-02 Easy 60 14-03 Easy
15 14-01 Easy 38 14-02 Easy 61 14-03 Easy
16 14-01 Easy 39 14-02 Easy 62 14-03 Easy
15 14-01 Easy 40 14-02 Easy 63 14-03 Easy
18 14-01 Easy 41 14-02 Easy 64 14-03 Easy
19 14-01 Easy 42 14-02 Easy 65 14-04 Easy
20 14-01 Easy 43 14-02 Easy 66 14-04 Easy
21 14-01 Difficult 44 14-02 Easy 67 14-04 Easy
22 14-02 Easy 45 14-02 Easy 68 14-04 Easy
23 14-02 Easy 46 14-02 Easy

529
Chapter 14/Financial Statement Analysis 530

Multiple Choice
No Objective Difficulty No. Objective Difficulty No. Objective Difficulty
.
1 14-01 Easy 28 14-02 Easy 55 14-03 Easy
2 14-01 Easy 29 14-02 Easy 56 14-03 Moderate
3 14-01 Easy 30 14-02 Easy 57 14-03 Moderate
4 14-01 Easy 31 14-02 Easy 58 14-03 Easy
5 14-01 Easy 32 14-02 Moderate 59 14-03 Easy
6 14-01 Easy 33 14-02 Easy 60 14-03 Easy
7 14-01 Easy 34 14-02 Moderate 61 14-03 Easy
8 14-01 Easy 35 14-02 Moderate 62 14-03 Easy
9 14-01 Easy 36 14-02 Easy 63 14-03 Moderate
10 14-01 Easy 37 14-02 Moderate 64 14-03 Easy
11 14-01 Easy 38 14-02 Easy 65 14-03 Easy
12 14-01 Easy 39 14-02 Easy 66 14-03 Easy
13 14-01 Easy 40 14-02 Moderate 67 14-03 Easy
14 14-01 Easy 41 14-02 Easy 68 14-03 Easy
15 14-01 Easy 42 14-02 Moderate 69 14-03 Easy
16 14-01 Easy 43 14-02 Easy 70 14-03 Easy
15 14-01 Easy 44 14-02 Easy 71 14-03 Easy
18 14-01 Easy 45 14-02 Moderate 72 14-03 Easy
19 14-01 Easy 46 14-02 Moderate 73 14-03 Moderate
20 14-01 Easy 47 14-02 Moderate 74 14-03 Moderate
21 14-01 Easy 48 14-03 Easy 75 14-03 Easy
22 14-01 Easy 49 14-03 Moderate 76 14-03 Moderate
23 14-02 Easy 50 14-03 Easy 77 14-04 Easy
24 14-02 Easy 51 14-03 Moderate 78 14-04 Easy
25 14-02 Moderate 52 14-03 Moderate 79 14-04 Moderate
26 14-02 Moderate 53 14-03 Easy
27 14-02 Moderate 54 14-03 Easy

Exercise/Other
No Objectiv Difficulty No Objective Difficult No Objectiv Difficult
. e . y . e y
1 14-01 Easy 8 14-02 Easy 15 14-03 Easy
2 14-01 Easy 9 14-02 Easy 16 14-03 Easy
3 14-01 Easy 10 14-02 Easy 15 14-03 Easy
4 14-01 Moderate 11 14-02 Easy 18 14-03 Easy
5 14-01 Easy 12 14-02 Easy 19 14-03 Moderate
6 14-02 Easy 13 14-03 Easy
7 14-02 Easy 14 14-03 Moderat
e
Chapter 14/Financial Statement Analysis 531

Problem
No Objectiv Difficulty No Objective Difficult No Objectiv Difficult
. e . y . e y
1 14-01 Moderate 5 14-02 Moderat 9 14-03 Moderate
e
2 14-01 Moderate 6 14-02 Easy 10 14-03 Moderate
3 14-01 Moderate 7 14-02 Easy 11 14-03 Moderate
4 14-02 Moderate 8 14-02 Easy 12 14-03 Moderate

Chapter 14Financial Statement Analysis

TRUE/FALSE

1. If comparative balance sheets indicate no liability for bonds payable on the preceding year and a
liability of $500,000 on the current year, the increase of $500,000 can be stated as a 100% increase.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

2. Financial statements showing the current year's financial data in one column and preceding years'
financial data in other columns are called horizontal statements.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

3. Comparable financial statements are designed to compare the financial statements of two or more
corporations.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

4. The comparison of the financial data of a single company for two or more years is called horizontal
analysis.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

5. Examining relationships among data in the company's financial statements can provide knowledge
that can not be gained from just looking at individual items in the statements.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Reflective Thinking | AICPA BB-Critical Thinking

6. In horizontal analysis, the current year is the base year.


ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

7. On a common-size income statement, all items are stated as a percent of total assets or equities at
year-end.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement
532 Chapter 14/Financial Statement Analysis

8. The percentage analysis of increases and decreases in corresponding items in comparative financial
statements is referred to as horizontal analysis.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

9. Horizontal analysis may compare three or more statements and the earliest year could be used as the
base year.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

10. A 15% change in sales will result in a 15% change in net income.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

11. A financial statement showing each item on the statement as a percentage of one key item on the
statement is called common-sized financial statements.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

12. The relationship of each asset item as a percent of total assets is an example of vertical analysis.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

13. Statements in which all items are expressed in relative terms are called common-size statements.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

14. The relationship of 115 to 100 can be expressed as 1.15, 1.15:1, or 115%.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

15. Vertical analysis refers to comparing the financial statements of a single company for several years.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

16. In a common size income statement, net sales are represented by 100%.
ANS: T DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

17. In a common size income statement, each item is expressed as a percentage of net income.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

18. In the vertical analysis of a balance sheet, the base for current liabilities is total liabilities.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 533

19. Using vertical analysis of the income statement, a company's net income as a percentage of net sales
is 10%; therefore, the cost of goods sold as a percentage of sales must be 90%.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

20. In the vertical analysis of an income statement, each item is generally stated as a percentage of total
assets.
ANS: F DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

21. Financial analysis is normally done only from period to period, on such values as sales from the first
quarter to those of the second quarter rather than the change in cash or accounts receivable from the
end of the first quarter to the end of the second quarter.
ANS: F DIF: Difficult OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

22. Factors which reflect the ability of a business to pay its debts and earn a reasonable amount of
income are referred to as solvency and profitability.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

23. The excess of current assets over current liabilities is referred to as working capital.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

24. Dollar amounts of working capital are difficult to assess when comparing companies of different
sizes or in comparing such amounts with industry figures.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

25. Using measures to assess a business's ability to pay its current liabilities is called current position
analysis.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

26. The current ratio is sometimes called the bankers' ratio.


ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

27. Current position analysis indicates a company's ability to liquidate current liabilities.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

28. An advantage of the current ratio is that it considers the makeup of the current assets.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

29. If two companies have the same current ratio, their ability to pay short-term debt is the same.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA BB-Critical Thinking
534 Chapter 14/Financial Statement Analysis

30. The ratio of the sum of cash, receivables, and marketable securities to current liabilities is referred to
as the current ratio.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

31. A balance sheet shows cash, $75,000; marketable securities, $110,000; receivables, $90,000 and
$225,000 of inventories. Current liabilities are $200,000. The current ratio is 2.5 to 1.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

32. If a firm has a current ratio of 2, the subsequent receipt of a 60-day note receivable on account will
cause the ratio to decrease.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

33. If a firm has an quick ratio of 1, the subsequent payment of an account payable will cause the ratio to
increase.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

34. Solvency analysis focuses on the ability of a business to pay its current and noncurrent liabilities.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

35. If the accounts receivable turnover for the current year has decreased when compared with the ratio
for the preceding year, there has been an acceleration in the collection of receivables.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

36. An increase in the accounts receivable turnover may be due to an improvement in the collection of
receivable or to a change in the granting of credit and/or in collection practices.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

37. If the current credit terms are 2/10, n/30 for Jones Inc., an accounts receivable turnover of 3 for the
current year would be considered normal.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

38. The number of days' sales in receivables is one means of expressing the relationship between credit
sales and accounts receivable.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

39. Inventory turnover shows how many times the average inventory was sold during the year.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 535

40. A firm selling food should have higher inventory turnover rate than a firm selling office furniture.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA BB-Critical Thinking

41. The number of days' sales in inventory is one means of expressing the relationship between the cost
of goods sold and inventory.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

42. The number of days' sales in inventory is a rough measure of the length of time it takes to sell the
inventory.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

43. Assuming that the quantities of inventory on hand during the current year were sufficient to meet all
demands for sales, a decrease in the inventory turnover for the current year when compared with the
turnover for the preceding year indicates an improvement in the management of inventory.
ANS: F DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

44. The ratio of fixed assets to long-term liabilities can indicate the ability of the business to borrow
additional funds on a long-term basis.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

45. An increase in the ratio of stockholders' equity to liabilities indicates an improvement in the margin
of safety for creditors.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

46. The higher the ratio of number of times interest charges earned, the lower the risk that interest
payments will not be made if earnings decrease.
ANS: T DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

47. In computing the ratio of net sales to assets, any long-term investments are excluded from total
assets.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

48. The rate earned on total assets measures the profitability of total assets, without considering how the
assets are financed.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

49. In computing the rate earned on total assets, interest expense is added to net income before dividing
by total assets.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement
536 Chapter 14/Financial Statement Analysis

50. The denominator of the rate of return on total assets ratio is the average total assets.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

51. When the rate of return on total assets ratio is greater than the rate of return on common
stockholders' equity ratio, the management of the company has effectively used leverage.
ANS: F DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

52. The tendency of the rate earned on stockholders' equity to vary disproportionately from the rate
earned on total assets is referred to as solvency.
ANS: F DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

53. The rate earned on total common stockholders' equity for most thriving businesses will be higher
than the rate earned on total assets.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA BB-Critical Thinking

54. A company is using the concept of leverage or trading on equity, when it borrows money from
creditors in order to earn additional income in excess of the interest cost and thereby increases the
rate of return to the common stockholders.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

55. If a company's rate of return on common stockholders' equity is greater than its rate of return on total
assets, the company is effectively using leverage.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA BB-Critical Thinking

56. If a company has issued only one class of stock, the earnings per share are determined by dividing
net income plus interest expense by the number of shares outstanding.
ANS: F DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

57. The rate earned on current assets is one of the measures of solvency.
ANS: F DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

58. The ratio of the market price per share of common stock on a specific date to the annual earnings per
share is referred to as the price-earnings ratio.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

59. The dividend yield rate is equal to the dividends per share divided by the par value per share of
common stock.
ANS: F DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 537

60. Comparing dividends per share to earnings per share indicates the extent to which the corporation is
retaining its earnings for use in operations.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

61. When you are interpreting financial ratios, it is useful to compare a company's ratios to some form of
standard.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

62. Ratios and various other analytical measures are not a substitute for sound judgment, nor do they
provide definitive guides for action.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA BB-Critical Thinking

63. Interpreting financial analysis should be considered in light of conditions peculiar to the industry and
the general economic conditions.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Reflective Thinking | AICPA BB-Critical Thinking

64. A company can use comparisons of its financial data to the data of other companies and industry
values to evaluate its position.
ANS: T DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA BB-Critical Thinking

65. The effects of differences in accounting methods are of little importance when analyzing comparable
data from competing businesses.
ANS: F DIF: Easy OBJ: 14-04
NAT: AACSB Analytic | AICPA BB-Critical Thinking

66. Notes to the financial statements are generally not useful.


ANS: F DIF: Easy OBJ: 14-04
NAT: AACSB Analytic | AICPA FN-Reporting

67. The auditor's report is where the auditor certifies that the financial statements are correct and
accurate.
ANS: F DIF: Easy OBJ: 14-04
NAT: AACSB Analytic | AICPA FN-Reporting

68. In a company's annual report, the section called management discussion and analysis provides
critical information in interpreting the financial statements and assessing the future of the company.
ANS: T DIF: Easy OBJ: 14-04
NAT: AACSB Analytic | AICPA FN-Reporting
538 Chapter 14/Financial Statement Analysis

MULTIPLE CHOICE

1. The relationship of $225,000 to $125,000, expressed as a ratio, is


a. 2.0 to 1
b. 1.8 to 1
c. 1.5 to 1
d. 0.56 to 1
ANS: B DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

2. If comparative balance sheets indicate no notes receivable on the preceding year and a $40,000 note
receivable on the current year, the increase of $40,000
a. can be stated as 0%
b. can be stated as 100% increase
c. cannot be stated as a percentage
d. can be stated as 500% increase
ANS: C DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

3. Assume that Axle Company reported a net loss of $50,000 in 2006 and net income of $250,000 in
2007. The increase in net income of $300,000
a. can be stated as 0%
b. can be stated as 100% increase
c. cannot be stated as a percentage
d. can be stated as 200% increase
ANS: C DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

4. The percentage analysis of increases and decreases in individual items in comparative financial
statements is called
a. vertical analysis
b. solvency analysis
c. profitability analysis
d. horizontal analysis
ANS: D DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

5. Which of the following below generally is the most useful in analyzing companies of different sizes
a. comparative statements
b. common-sized financial statements
c. price-level accounting
d. audit report
ANS: B DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 539

6. The percent of fixed assets to total assets is an example of


a. vertical analysis
b. solvency analysis
c. profitability analysis
d. horizontal analysis
ANS: A DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

7. What type of analysis is indicated by the following?

Increase (Decrease*)
2007 2006 Amount Percent
Current assets $ 380,000 $ 500,000 $120,000* 24%*
Fixed assets 1,680,000 1,500,000 180,000 12%

a. vertical analysis
b. horizontal analysis
c. liquidity analysis
d. common-size analysis
ANS: B DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

8. An analysis in which all the components of an income statement are expressed as a percentage of net
sales is called
a. vertical analysis
b. horizontal analysis
c. liquidity analysis
d. common-size analysis
ANS: A DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

9. A balance sheet that displays only component percentages is called


a. trend balance sheet
b. comparative balance sheet
c. condensed balance sheet
d. common-sized balance sheet
ANS: D DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

10. One reason that a common-size statement is a useful tool in financial analysis is that it enables the
user to
a. judge the relative potential of two companies of similar size in different industries.
b. determine which companies in a single industry are of the same value.
c. determine which companies in a single industry are of the same size.
d. make a better comparison of two companies of different sizes in the same industry.
ANS: D DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement
540 Chapter 14/Financial Statement Analysis

11. Under which of the following cases may a percentage change be computed?
a. There is no amount in the base year.
b. There is a negative amount in the base year and a negative amount in the subsequent year.
c. The trend of the amounts is decreasing but all amounts are positive.
d. There is a negative amount in the base year and a positive amount in the subsequent year.
ANS: C DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

12. Assume the following sales data for a company:


2007 750,000
2006 600,000

What is the percentage increase in sales from 2006 to 2007?


a. 25%
b. 125%
c. 20%
d. 167%
ANS: A DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

13. In a common size balance sheet the 100 percent figure is


a. total property, plant and equipment.
b. total current assets.
c. total liabilities.
d. total assets.
ANS: D DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

14. In a common size income statement, the 100% figure is


a. net cost of goods sold.
b. net income.
c. gross profit.
d. net sales.
ANS: D DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

15. In performing a vertical analysis, the base for cost of goods sold is
a. total selling expenses.
b. net sales.
c. total expenses.
d. total revenues.
ANS: B DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 541

16. Horizontal analysis is a technique for evaluating financial statement data


a. for one period of time.
b. over a period of time.
c. on a certain date.
d. as it may appear in the future.
ANS: B DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

17. Horizontal analysis of comparative financial statements includes the


a. development of common size statements
b. calculation of liquidity ratios.
c. calculation of dollar amount changes and percentage changes from the previous to the current
year.
d. evaluation of financial statement data
ANS: C DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

18. In horizontal analysis each item is expressed as a percentage of the


a. base year figure.
b. retained earnings figure.
c. total assets figure.
d. net income figure.
ANS: A DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

19. Assume the following sales data for a company:


2007 $1,134,000
2006 945,000

What is the percentage increase in sales from 2006 to 2007?


a. 120%
b. 20%
c. 95%
d. 25%
ANS: B DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

20. Vertical analysis is also known as


a. perpendicular analysis.
b. trend analysis.
c. common size analysis
d. straight-line analysis.
ANS: C DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement
542 Chapter 14/Financial Statement Analysis

21. In a common size financial statement, which of the following is given a percentage of 100 percent?
a. Total liabilities
b. Net income
c. Cost of Goods sold
d. Total assets
ANS: D DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

22. In performing a vertical analysis, the base for cost of goods sold is
a. total selling expenses.
b. net sales.
c. total expenses.
d. total revenues.
ANS: B DIF: Easy OBJ: 14-01
NAT: AACSB Analytic | AICPA FN-Measurement

23. The ability of a business to pay its debts as they come due and to earn a reasonable amount of
income is referred to as
a. solvency and leverage
b. solvency and profitability
c. solvency and liquidity
d. solvency and equity
ANS: B DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

24. Which of the following is not an analysis used in assessing solvency?


a. number of times interest charges are earned
b. current position analysis
c. ratio of net sales to assets
d. inventory analysis
ANS: C DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

Accounts payable $ 30,000


Accounts receivable 65,000
Accrued liabilities 7,000
Cash 20,000
Intangible assets 40,000
Inventory 72,000
Long-term investments 100,000
Long-term liabilities 75,000
Marketable securities 36,000
Notes payable (short-term) 20,000
Property, plant, and equipment 625,000
Prepaid expenses 2,000
Chapter 14/Financial Statement Analysis 543

25. Based on the above data, what is the amount of quick assets?
a. $163,000
b. $195,000
c. $121,000
d. $56,000
ANS: C DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

26. Based on the above data, what is the amount of working capital?
a. $238,000
b. $138,000
c. $178,000
d. $64,000
ANS: B DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

27. Based on the above data, what is the quick ratio, rounded to one decimal point?
a. 2.4
b. 3.4
c. 2.1
d. 1.5
ANS: C DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

28. A company with working capital of $400,000 and a current ratio of 2.5 pays a $75,000 short-term
liability. The amount of working capital immediately after payment is
a. $475,000
b. $325,000
c. $400,000
d. $75,000
ANS: C DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

29. Which of the following is a measure of the liquid position of a corporation?


a. earnings per share
b. inventory turnover
c. current ratio
d. number of times interest charges earned
ANS: C DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

30. Which of the following is not included in the computation of the quick ratio?
a. inventory
b. marketable securities
c. accounts receivable
d. cash
ANS: A DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement
544 Chapter 14/Financial Statement Analysis

31. The numerator used to calculate accounts receivable turnover is


a. total sales
b. net sales
c. accounts receivable at year-end
d. average accounts receivable
ANS: B DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

32. Based on the following data for the current year, what is the accounts receivable turnover?

Net sales on account during year $400,000


Cost of goods sold during year 300,000
Accounts receivable, beginning of year 45,000
Accounts receivable, end of year 35,000
Inventory, beginning of year 90,000
Inventory, end of year 110,000

a. 10.0
b. 11.4
c. 8.9
d. 4.0
ANS: A DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

33. An acceleration in the collection of receivables will tend to cause the accounts receivable turnover to
a. decrease
b. remain the same
c. either increase or decrease
d. increase
ANS: D DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

34. Based on the following data for the current year, what is the number of days' sales in accounts
receivable?

Net sales on account during year $584,000


Cost of goods sold during year 300,000
Accounts receivable, beginning of year 45,000
Accounts receivable, end of year 35,000
Inventory, beginning of year 90,000
Inventory, end of year 110,000

a. 5.8
b. 11.4
c. 21.9
d. 22.5
ANS: C DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 545

35. Based on the following data for the current year, what is the inventory turnover?

Net sales on account during year $500,000


Cost of goods sold during year 330,000
Accounts receivable, beginning of year 45,000
Accounts receivable, end of year 35,000
Inventory, beginning of year 90,000
Inventory, end of year 110,000

a. 3.3
b. 8.3
c. 3.7
d. 3.0
ANS: A DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

36. Once inventory is excessive which item below is not true?


a. reduce solvency
b. increase taxes
c. increase ordering costs
d. increase storage costs
ANS: C DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

37. Based on the following data for the current year, what is the number of days' sales in inventory?

Net sales on account during year $1,204,500


Cost of goods sold during year 657,000
Accounts receivable, beginning of year 75,000
Accounts receivable, end of year 85,000
Inventory, beginning of year 81,600
Inventory, end of year 98,600

a. 54.8
b. 45.3
c. 24.7
d. 29.9
ANS: A DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

38. Which of the following ratios provides a solvency measure that shows the margin of safety of
noteholders or bondholders and also gives an indication of the potential ability of the business to
borrow additional funds on a long-term basis?
a. ratio of fixed assets to long-term liabilities
b. ratio of net sales to assets
c. number of days' sales in receivables
d. rate earned on stockholders' equity
ANS: A DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement
546 Chapter 14/Financial Statement Analysis

39. The number of times interest charges are earned is computed as


a. net income plus interest charges, divided by interest charges
b. income before income tax plus interest charges, divided by interest charges
c. net income divided by interest charges
d. income before income tax divided by interest charges
ANS: B DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

40. Balance sheet and income statement data indicate the following:

Bonds payable, 10% (issued 1988 due 2012) $1,000,000


Preferred 5% stock, $100 par (no change during year) 300,000
Common stock, $50 par (no change during year) 2,000,000
Income before income tax for year 350,000
Income tax for year 80,000
Common dividends paid 50,000
Preferred dividends paid 15,000

Based on the data presented above, what is the number of times bond interest charges were earned
(round to one decimal point)?
a. 3.7
b. 4.4
c. 4.5
d. 3.5
ANS: C DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

41. The current ratio is


a. used to evaluate a company's liquidity and short-term debt paying ability.
b. is a solvency measure that indicated the margin of safety of a noteholder or bondholder.
c. calculated by dividing current liabilities by current assets.
d. calculated by subtracting current liabilities from current assets.
ANS: A DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

42. A company with $60,000 in current assets and $40,000 in current liabilities pays a $1,000 current
liability. As a result of this transaction, the current ratio and working capital will
a. both decrease.
b. both increase.
c. increase and remain the same, respectively.
d. remain the same and decrease, respectively
ANS: C DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

43. Langley Company reported the following on its income statement:


Income before income taxes $420,000
Income tax expense 120,000
Net income $300,000
Chapter 14/Financial Statement Analysis 547

An analysis of the income statement revealed that interest expense was $80,000. Langley Company's
times interest earned was
a. 8 times.
b. 6.25 times.
c. 5.25 times.
d. 5 times.
ANS: B DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

44. The following information pertains to Tanzi Company. Assume that all balance sheet amounts
represent both average and ending balance figures. Assume that all sales were on credit.
Assets
Cash and short-term investments $ 40,000
Accounts receivable (net) 30,000
Inventory 25,000
Property, plant and equipment 215,000
Total Assets $310,000

Liabilities and Stockholders Equity


Current liabilities $ 60,000
Long-term liabilities 95,000
Stockholders equity-common 155,000
Total Liabilities and stockholders equity $310,000

Income Statement
Sales $ 90,000
Cost of goods sold 45,000
Gross margin 45,000
Operating expenses 20,000
Net income $ 25,000

Number of shares of common stock 6,000


Market price of common stock $20

What is the current ratio for this company?


a. 1.42%
b. .78%
c. 1.58%
d. .67%
ANS: C DIF: Easy OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement
548 Chapter 14/Financial Statement Analysis

45. Based on the following data, what is the amount of quick assets?
Accounts payable $ 30,000
Accounts receivable 65,000
Accrued liabilities 7,000
Cash 25,000
Intangible assets 40,000
Inventory 72,000
Long-term investments 100,000
Long-term liabilities 75,000
Marketable securities 36,000
Notes payable (short-term) 20,000
Property, plant, and equipment 625,000
Prepaid expenses 2,000

a. $198,000
b. $126,000
c. $90,000
d. $61,000
ANS: B DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

46. Based on the following data, what is the amount of working capital?

Accounts payable $ 30,000


Accounts receivable 65,000
Accrued liabilities 7,000
Cash 25,000
Intangible assets 40,000
Inventory 72,000
Long-term investments 100,000
Long-term liabilities 75,000
Marketable securities 36,000
Notes payable (short-term) 20,000
Property, plant, and equipment 625,000
Prepaid expenses 2,000

a. $243,000
b. $143,000
c. $183,000
d. $69,000
ANS: B DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 549

47. Based on the following data, what is the quick ratio, rounded to one decimal point?

Accounts payable $ 30,000


Accounts receivable 65,000
Accrued liabilities 7,000
Cash 25,000
Intangible assets 40,000
Inventory 72,000
Long-term investments 100,000
Long-term liabilities 75,000
Marketable securities 36,000
Notes payable (short-term) 20,000
Property, plant, and equipment 625,000
Prepaid expenses 2,000

a. 2.2
b. 3.5
c. 3.0
d. 1.6
ANS: A DIF: Moderate OBJ: 14-02
NAT: AACSB Analytic | AICPA FN-Measurement

48. The tendency of the rate earned on stockholders' equity to vary disproportionately from the rate
earned on total assets is sometimes referred to as
a. leverage
b. solvency
c. yield
d. quick assets
ANS: A DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

The balance sheets at the end of each of the first two years of operations indicate the following:

2006 2005
Total current assets $600,000 $560,000
Total investments 60,000 40,000
Total property, plant, and equipment 900,000 700,000
Total current liabilities 150,000 80,000
Total long-term liabilities 350,000 250,000
Preferred 9% stock, $100 par 100,000 100,000
Common stock, $10 par 600,000 600,000
Paid-in capital in excess of par-common stock 60,000 60,000
Retained earnings 325,000 210,000
550 Chapter 14/Financial Statement Analysis

49. If net income is $115,000 and interest expense is $30,000 for 2006 what is the rate earned on total
assets for 2006 (round percent to one decimal point)?
a. 9.3%
b. 10.1%
c. 8.0%
d. 7.4%
ANS: A DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

50. If net income is $115,000 and interest expense is $30,000 for 2006, what is the rate earned on
stockholders' equity for 2006 (round percent to one decimal point)?
a. 10.6%
b. 11.2%
c. 12.4%
d. 15.6%
ANS: B DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

51. If net income is $115,000 and interest expense is $30,000 for 2006, what are the earnings per share
on common stock for 2006, (round to two decimal places)?
a. $1.92
b. $1.89
c. $1.77
d. $1.42
ANS: C DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

52. If net income is $115,000 and interest expense is $30,000 for 2006, and the market price is $30,
What is the price-earnings ratio on common stock for 2006. (round to one decimal point)?
a. 17.0
b. 12.1
c. 12.4
d. 15.9
ANS: A DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

53. The numerator of the rate earned on common stockholders' equity ratio is equal to
a. net income
b. net income minus preferred dividends
c. income plus interest expense
d. income minus interest expense
ANS: B DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 551

54. The numerator of the rate earned on total assets ratio is equal to
a. net income
b. income before taxes
c. income before interest
d. net income minus preferred dividends
ANS: C DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

55. For most profitable companies, the rate earned on stockholders' equity will be less than
a. the rate earned on total assets
b. the rate earned on total liabilities and stockholders' equity
c. the rate earned on sales
d. the rate earned on common stockholders' equity
ANS: D DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

56. The following information is available for Watson Company.:

2007
Market price per share of common stock $25.00
Earnings per share on common stock 1.25

Which of the following statements is correct?


a. The price-earnings ratio is 20 and a share of common stock was selling for 20 times the amount
of earnings per share at the end of 2007.
b. The price-earnings ratio is 5.0% and a share of common stock was selling for 5.0% more than the
amount of earnings per share at the end of 2007.
c. The price-earnings ratio is 10 and a share of common stock was selling for 125 times the amount
of earnings per share at the end of 2007.
d. The market price per share and the earnings per share are not statistically related to each other.
ANS: A DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

57. The following information is available for Duncan Co.:

2007
Dividends per share of common stock $ 1.40
Market price per share of common stock 17.50

Which of the following statements is correct?


a. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market price of
their stocks.
b. The dividend yield is 8.0%, which is of special interest to investors seeking current returns on
their investments.
c. The dividend yield is 12.5%, which is of interest to bondholders.
d. The dividend yield is 8.0 times the market price, which is important in solvency analysis.
ANS: B DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement
552 Chapter 14/Financial Statement Analysis

58. The particular analytical measures chosen to analyze a company may be influenced by all but one of
the following. Which one?
a. industry type
b. capital structure
c. diversity of business operations
d. product quality or service effectiveness
ANS: D DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

59. The best way to study the relationship of the components within a financial statement is to prepare
a. ratio analysis.
b. common size statements.
c. a trend analysis.
d. profitability analysis.
ANS: B DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

60. Which one of the following is not a characteristic generally evaluated in ratio analysis?
a. Liquidity
b. Profitability
c. Solvency
d. Marketability
ANS: D DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

61. Short-term creditors are usually most interested in assessing


a. marketability.
b. profitability.
c. operating results.
d. solvency.
ANS: D DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

62. A common measure of liquidity is


a. ratio of net sales to assets.
b. dividends per share of common stock.
c. receivable turnover.
d. profit margin.
ANS: C DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 553

63. Tanner Corporation had net income of $250,000 and paid dividends to common stockholders of
$50,000 in 2007. The weighted average number of shares outstanding in 2007 was 50,000 shares.
Banner Corporation's common stock is selling for $50 per share on the New York Stock Exchange.

Tanner Corporation's price-earnings ratio is


a. 10 times.
b. 5 times.
c. 2 times.
d. 8 times.
ANS: A DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

64. A company that is leveraged is one that


a. contains debt financing.
b. contains equity financing.
c. has a high current ratio.
d. has a high earnings per share.
ANS: A DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

65. The following information pertains to Jantsen Company. Assume that all balance sheet amounts
represent both average and ending balance figures. Assume that all sales were on credit.
Assets
Cash and short-term investments $ 40,000
Accounts receivable (net) 25,000
Inventory 20,000
Property, plant and equipment 210,000
Total Assets $295,000
Liabilities and Stockholders Equity
Current liabilities 85,000
Long-term liabilities 85,000
Stockholders equity-common 150,000
Total Liabilities and stockholders equity $295,000

Income Statement
Sales $ 85,000
Cost of goods sold 45,000
Gross margin 40,000
Operating expenses 20,000
Net income $ 20,000

Number of shares of common stock 6,000


Market price of common stock $20
Dividends per share .90
Cash provided by operations $30,000
554 Chapter 14/Financial Statement Analysis

What is the current ratio for this company? Round your answer to one decimal point.
a. .60
b. 1.16
c. .80
d. 1.42
ANS: D
NAT:
DIF: Easy OBJ: 14-03
AACSB Analytic | AICPA FN-Measurement

66. The following information pertains to Jantsen Company. Assume that all balance sheet amounts
represent both average and ending balance figures. Assume that all sales were on credit.
Assets
Cash and short-term investments $ 40,000
Accounts receivable (net) 25,000
Inventory 20,000
Property, plant and equipment 210,000
Total Assets $295,000
Liabilities and Stockholders Equity
Current liabilities $ 60,000
Long-term liabilities 85,000
Stockholders equity-common 150,000
Total Liabilities and stockholders equity $295,000
Income Statement
Sales $ 85,000
Cost of goods sold 45,000
Gross margin 40,000
Operating expenses 20,000
Net income $ 20,000

Number of shares of common stock 6,000


Market price of common stock $20
Dividends per share .90
Cash provided by operations $30,000

What is the receivable turnover for this company? Round your answer to one decimal point.
a. 3.4 times
b. 2.8 times
c. 2 times
d. 3 times
ANS: A DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

The following information pertains to Jantsen Company. Assume that all balance sheet amounts represent
both average and ending balance figures. Assume that all sales were on credit.
Assets
Cash and short-term investments $ 40,000
Accounts receivable (net) 25,000
Inventory 20,000
Property, plant and equipment 210,000
Total Assets $295,000
Chapter 14/Financial Statement Analysis 555

Liabilities and Stockholders Equity


Current liabilities 85,000
Long-term liabilities 85,000
Stockholders equity-common 150,000
Total Liabilities and stockholders equity $295,000

Income Statement
Sales $ 85,000
Cost of goods sold 45,000
Gross margin 40,000
Operating expenses 20,000
Net income $ 20,000

Number of shares of common stock 6,000


Market price of common stock $20
Dividends per share .90
Cash provided by operations $30,000

67. What is the inventory turnover for this company? Round your answer to one decimal point.
a. .44 times
b. 2.25 times
c. 2 times
d. 1 times
ANS: B DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

68. What is the return on assets for this company? Round your answer to one decimal point.
a. 11.5%
b. 10.5%

c. 26.7%
d. 6.8%
ANS: D DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

69. What is the profit margin for this company? Round your answer to one decimal point.
a. 23.5%
b. 18.75%

c. 42.86%
d. 15.0%
ANS: A DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

70. What is the return on common stockholders equity for this company? Round your answer to one
decimal point.
a. 5.0%
b. 13.3%

c. 53.3%
d. 23.3%
ANS: B DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement
556 Chapter 14/Financial Statement Analysis

71. What is the price earnings ratio for this company? Round your answer to one decimal point.
a. 8 times b. 2.5 times

c. 4 times
d. 6 times
ANS: D DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

The following information pertains to Tanzi Company. Assume that all balance sheet amounts represent
both average and ending balance figures. Assume that all sales were on credit.
Assets

Cash and short-term investments

$ 40,000
Accounts receivable (net) 30,000
Inventory 25,000
Property, plant and equipment 215,000
Total Assets $310,000
Liabilities and Stockholders Equity
Current liabilities 60,000
Long-term liabilities 95,000
Stockholders equity-common 155,000
Total Liabilities and stockholders equity $310,000

Income Statement
Sales $ 90,000
Cost of goods sold 45,000
Gross margin 45,000
Operating expenses 20,000
Net income $ 25,000

Number of shares of common stock 6,000


Market price of common stock $20
Dividends per share 1.00
Cash provided by operations $40,000

72. What is the rate earned on total assets for this company?
a. 8.1%
b. 6.8%
c. 10.5%
d. 16.1%
ANS: A DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

73. What is the price earnings ratio for this company?


a. 6 times
b. 4.2 times
c. 8 times
d. 9.6 times
ANS: D DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 557

74. What is the earnings per share on common stock?


a. $4.17
b. $6.66
c. $1.00
d. $5.00
ANS: A DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

75. Percentage analyses, ratios, turnovers, and other measures of financial position and operating results
are
a. a substitute for sound judgment.
b. useful analytical measures.
c. enough information for analysis, industry information is not needed.
d. unnecessary for analysis, but reaction is better.
ANS: B DIF: Easy OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

76. The following information pertains to Tanzi Company. Assume that all balance sheet amounts
represent both average and ending balance figures. Assume that all sales were on credit.
Assets

Cash and short-term investments

$ 40,000
Accounts receivable (net) 30,000
Inventory 25,000
Property, plant and equipment 215,000
Total Assets $310,000

Liabilities and Stockholders Equity


Current liabilities 60,000
Long-term liabilities 95,000
Stockholders equity-common 155,000
Total Liabilities and stockholders equity $310,000

Income Statement
Sales $ 90,000
Cost of goods sold 45,000
Gross margin 45,000
Operating expenses 20,000
Net income $ 25,000

Number of shares of common stock 6,000


Market price of common stock $20
Dividends per share 1.00
Cash provided by operations $40,000
558 Chapter 14/Financial Statement Analysis

What is the rate earned on stockholders equity? Round answer to a single decimal point.
a. 7.3%
b. 16.1%
c. 23.5%
d. 53.3%
ANS: B DIF: Moderate OBJ: 14-03
NAT: AACSB Analytic | AICPA FN-Measurement

77. Corporate annual reports typically do not contain which of the following?
a. management discussion and analysis
b. SEC statement expressing an opinion
c. accompanying foot notes
d. auditor's report
ANS: B DIF: Easy OBJ: 14-04
NAT: AACSB Analytic | AICPA FN-Reporting

78. The independent auditor's report does which of the following?


a. describes which financial statements are covered by the audit
b. gives the auditor's opinion regarding the fairness of the financial statements
c. summarizes what the auditor did
d. states that the financial statements are truthful
ANS: B DIF: Easy OBJ: 14-04
NAT: AACSB Analytic | AICPA FN-Reporting

79. The purpose of an audit is to


a. determine whether or not a company is a good investment.
b. render an opinion on the fairness of the statements.
c. determine whether or not a company complies with income tax regulations.
d. determine whether or not a company is a good credit risk.
ANS: B DIF: Moderate OBJ: 14-04
NAT: AACSB Analytic | AICPA FN-Reporting

EXERCISE/OTHER

1. The Cash and Accounts Receivable for a company are provided below:

2008 2007
Cash $65,000 $50,000
Accounts receivable (net) $75,200 $80,000
Based on this information, what is the amount and percentage of increase or decrease that would be
shown in a balance sheet with horizontal analysis?
ANS:
Cash $15,000 increase ($65,000 $50,000), or 30%
Accounts Receivable $ 4,800 decrease ($80,000 $75,200), or - 6%

DIF: Easy OBJ: 14-01


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-1
Chapter 14/Financial Statement Analysis 559

2. The Cash and Accounts Receivable for a company are provided below:

2008 2007
Cash $64,800 $60,000
Accounts receivable (net) $46,000 $50,000
Based on this information, what is the amount and percentage of increase or decrease that would be
shown in a balance sheet with horizontal analysis?
ANS:
Cash $4,800 increase ($64,800 - $60,000), or 8%
Accounts Receivable $4,000 decrease($46,000 - $50,000), or - 8%

DIF: Easy OBJ: 14-01


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-1

3. Income statement information for Sims Company is provided below:

Sales $120,000
Cost of goods sold 84,000
Gross profit $ 36,000

Prepare a common sized income statement for Sims Company.


ANS:
Amount Percentage
Sales $120,000 100% ($120,000 / $120,000)
Cost of goods sold $ 84,000 70% (84,000 / $120,000)
Gross profit $ 36,000 30% (36,000 / $120,000)

DIF: Easy OBJ: 14-01


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-2

4. Why would you or why wouldnt you compare an organization like Ford Motor Company to the
local car dealer City Ford/Lincoln/Mercury in vertical and horizontal analysis?
ANS:
Ford Motor Company is an automobile manufacturer with many aspects within the overall company such
as military sales, foundries, credit and financing operations, and its car sales are usually limited to
resellers or large fleet purchasers.

City Ford/Lincoln/Mercury is a local reseller that does not have the diverse operations of the Ford
Motor Company. Most of its sales, which would new and used vehicles, would be to ultimate consumers
and to smaller fleet operations. Major revenues may come from repairs and upgrades of vehicles. Its
credit department may actually be a representative of another organization specializing in automobile
financing.

While they both sell cars and contain the same name elements, they are not comparable.

DIF: Moderate OBJ: 14-01


NAT: AACSB Reflective Thinking | AICPA BB-Critical Thinking
560 Chapter 14/Financial Statement Analysis

5. What is a major advantage of using percentages rather than dollar changes in doing horizontal and
vertical analysis?
ANS:
When percentages are utilized rather than dollars, companies that are not the same size can be compared.
If Bowl Full of Grain is a $10 billion per year net sales company and Midwest Cereal Grains is a
$500 million per year net sales company, these two companies can still be compared by using percentages
determined by the analysis. These companies can also be compared to industry standards to determine the
difference between themselves and the generic average.

DIF: Easy OBJ: 14-01


NAT: AACSB Analytic | AICPA FN-Measurement

6. The following items are reported on a companys balance sheet:

Cash $250,000
Marketable securities 100,000
Accounts receivable 200,000
Inventory 200,000
Accounts payable 300,000

Determine the (a) current ratio, and (b) quick ratio? Round your answer to one digit after the decimal
place.
ANS:
(a) Current ratio = Current assets (cash, marketable securities, accounts receivable, and
inventory) / current liabilities (accounts payable)
Current ration = ($250,000 + $100,000 + $200,000 + $200,000 / $300,000)
Current ratio = 2.5

(b) Quick ratio = 1.8 ($250,000 + $100,000 + $200,000/$300,000)

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-2

7. The following items are reported on a companys balance sheet:

Cash $250,000
Marketable securities 100,000
Accounts receivable 200,000
Inventory 200,000
Accounts payable 250,000

Determine the (a) current ratio, and (b) quick ratio? Round your answer to one digit after the decimal
place.
ANS:
(a) Current ratio = Current assets (cash, marketable securities, accounts receivable, and
inventory) / current liabilities (accounts payable)
Current ratio = ($250,000 + $100,000 + $200,000 + $200,000 / $250,000)
Current ratio = 3.0

(b) Quick ratio = 2.2 ($250,000 + $100,000 + $200,000/$250,000)


Chapter 14/Financial Statement Analysis 561

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-3

8. A Company reports the following:

Net sales $720,000


Average accounts receivable (net) $ 48,000

Determine the (a) accounts receivable turnover, and (b) number of days sales in receivables? Round
your answer to one digit after the decimal place.
ANS:
(a) Accounts receivable turnover = Sales / Average accounts receivable
Accounts receivable turnover = $720,000 / $48,000
Accounts receivable turnover = 15.0

(b) Number of days sales in receivable = Average accounts receivable / Average daily
sales
Number of days sales in receivable = $48,000 / (720,000 / 365)
Number of days sales in receivables = 24.3

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-4

9. A Company reports the following:

Net sales $900,000


Average accounts receivable (net) $ 45,000

Determine the (a) accounts receivable turnover, and (b) number of days sales in receivables? Round
your answer to one digit after the decimal place.
ANS:
(a) Accounts receivable turnover = Sales / Average accounts receivable
Accounts receivable turnover = $900,000 / $45,000
Accounts receivable turnover = 20.0

(b) Number of days sales in receivable = Average accounts receivable / Average daily
sales
Number of days sales in receivable = $45,000 / (900,000 / 365)
Number of days sales in receivables = 18.3

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-4

10. A company reports the following:

Cost of goods sold $575,000


Average inventory $115,000
562 Chapter 14/Financial Statement Analysis

Determine the (a) inventory turnover, and (b) number of days sales in inventory? Round your
answer to one digit after the decimal place.
ANS:
(a) Inventory turnover = Cost of good sold / Average inventory
Inventory turnover = $575,000 / $115,000
Inventory turnover = 5.0

(b) Number of days sales in inventory = Average inventory / Average daily cost of
goods sold
Number of days sales in inventory = $115,000 / ($575,000 / 365)
Number of days sales in inventory = 73 days

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-5

11. The following information was taken from Sloan Companys balance sheet:

Fixed assets (net) $1,750,000


Long-term liabilities $500,000
Total liabilities $375,000
Total stockholders equity $1,500,000

Determine the companys (a) Ratio of fixed assets to long-term liabilities, and (b) ratio of liabilities
to stockholders equity? Round your answer to one digit after the decimal place.
ANS:
(a) Ration of fixed assets to long-term liabilities = Fixed assets / Long-term liabilities
Ration of fixed assets to long-term liabilities = $1,750,000 / $500,000
Ration of fixed assets to long-term liabilities = 3.5

(b) Ratio of liabilities to total stockholders equity = Total liabilities / Total stockholders
equity
Ratio of liabilities to total stockholders equity = $375,000 / $1,500,000
Ratio of liabilities to total stockholders equity = .25

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-6

12. A company reports the following:

Income before income tax $300,000


Interest expense $150,000
Chapter 14/Financial Statement Analysis 563

Determine the number of times interest charges are earned. Round your answer to one digit after the
decimal place.
ANS:
Number of times interest charges are earned = (Income before income tax = interest expense) / interest
expense
Number of times interest charges are earned = ($300,000 + $150,000) / $150,000
Number of times interest charges are earned = 3

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-7

13. A company reports the following income statement and balance sheet information for the current
year:

Net income $ 150,000


Interest expense $ 25,000
Average total assets $2,000,000

Determine the rate earned on total assets. Round your answer to one digit after the decimal place.
ANS:
Rate earned on total assets = (Net income + interest expense) / Average total assets
Rate earned on total assets = ($150,000 + $25,000) / $2,000,000
Rate earned on total assets = ($175,000 / $2,000,000
Rate earned on total assets = 8.8%

DIF: Easy OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-9

14. A company reports the following:

Net income $150,000


Preferred dividends $10,000
Average stockholders equity $1,000,000
Average common stockholders equity $800,000

Determine the (a) rate earned on stockholders equity, and (b) rate earned on common stockholders
equity? Round your answer to one digit after the decimal place.
ANS:
(a) Rate earned on stockholders equity = Net income / Average stockholders equity
Rate earned on stockholders equity = $150,000 / $1,000,000
Rate earned on stockholders equity = 15.0%

(b) Rate earned on common stockholders equity = (Net income - preferred dividends) /
Average common stockholders equity
Rate earned on common stockholders equity = ($150,000 - $10,000) / $800,000
Rate earned on common stockholders equity = 1.75%
564 Chapter 14/Financial Statement Analysis

DIF: Moderate OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-10

15. A company reports the following:

Net income $240,000


Preferred dividends $ 10,000
Shares of common stock outstanding 20,000
Market price per share of common stock $35.00

Determine the companys earnings per share on common stock.


ANS:
Earnings per share on common stock = (Net income - preferred dividends) / shares of
common stock outstanding.
Earnings per share = ($240,000 - $10,000) / 20,000
Earnings per share = $11.50

DIF: Easy OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-11

16. A company reports the following:

Net income $240,000


Preferred dividends $ 10,000
Shares of common stock outstanding 20,000
Market price per share of common stock $35.00

Determine the companys price-earnings ratio. Round your answer to one digit after the decimal
place.
ANS:
Price-earnings ratio = Market price per share of common stock / Earnings per share on common stock
Earnings per share on common stock = (Net income - preferred dividends) / shares of common stock
outstanding.
Earnings per share = ($240,000 - $10,000) / 20,000
Earnings per share = $11.50
Price-earnings ratio = $35.00 / $11.50
Price-earnings ratio = 3.0

DIF: Easy OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-11

17. A company reports the following:

Net sales $2,700,000


Average total assets $1,500,000
Chapter 14/Financial Statement Analysis 565

Determine the ratio of net sales to total assets. Round your answer to one digit after the decimal
place.
ANS:
Ratio of net sales to total assets = Net sales / Average total assets
Ratio of net sales to total assets = $2,700,000 / 1,500,000
Ratio of net sales to total assets = 1.8

DIF: Easy OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-8

18. A company reports the following:

Net sales $2,660,000


Average total assets $1,400,000

Determine the ratio of net sales to total assets. Round your answer to one digit after the decimal
place.
ANS:
Ratio of net sales to total assets = Net sales / Average total assets
Ratio of net sales to total assets = $2,660,000 / 1,400,000
Ratio of net sales to total assets = 1.9

DIF: Easy OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement TOP: Example Exercise 14-8

19. Why would you compare or not compare Coca-Cola and Pepsi-Cola (PepsiCo) as companies to each
other?
ANS:
Coca-Cola has maintained its focus on the beverage market with little distraction. Pepsi-Cola (PepsiCo)
has diversified into the fast food market as well as beverages with such operations as Taco Bell, KFC, and
Pizza Hut. While their carbonated soft drinks may be comparable, the direct comparison of the two
companies is limited by their differences.

DIF: Moderate OBJ: 14-03


NAT: AACSB Reflective Thinking | AICPA BB-Critical Thinking

PROBLEM

1. Comparative information taken from the Aster Company financial statements is shown below:

2008__ 2007__
(a) Notes receivable $ 10,000 $ -0-
(b) Accounts receivable 172,000 140,000
(c) Retained earnings 30,000 (40,000)
(d) Sales 830,000 750,000
(e) Operating expenses 170,000 200,000
(f) Income taxes payable 25,000 20,000
566 Chapter 14/Financial Statement Analysis

Instructions
Using horizontal analysis, show the percentage change from 2007 to 2008 with 2007 as the base
year.
ANS:
(a) Base year is zero. Not possible to compute.
(b) $32,000 $140,000 = 23% increase
(c) Base year is negative. Not possible to compute.
(d) $80,000 $750,000 = 11% increase
(e) $30,000 $200,000 = 15% decrease
(f) $5,000 $20,000 = 25% increase

DIF: Moderate OBJ: 14-01


NAT: AACSB Analytic | AICPA FN-Measurement

2. The following items were taken from the financial statements of Saintley, Inc., over a three-year
period:

Item 2008 2007 2006


Net Sales $355,000 $336,000 $300,000
Cost of Goods Sold 214,000 206,000 186,000
Gross Profit $141,000 $130,000 $114,000

Compute the following for each of the above time periods.


(a) The amount and percentage change from 2007 to 2008.
(b) The amount and percentage change from 2006 to 2007.

ANS:

Item 2008 2007


$ Percent $ Percent
Net Sales 19,000 5.6 36,000 12.0
Cost of Goods Sold 8,000 3.9 20,000 10.8
1,000 0.8 16,000 14.0

DIF: Moderate OBJ: 14-01


NAT: AACSB Analytic | AICPA FN-Measurement
Chapter 14/Financial Statement Analysis 567

3. The comparative balance sheet of Drango Company appears below:

HUERTO COMPANY
Comparative Balance Sheet
December 31, 2007
Assets 2007 2006
Current assets $ 340 $280
Plant assets 675 520
Total assets $1,015 $800

Liabilities and stockholders' equity


Current liabilities $ 180 $120
Long-term debt 250 160
Common stock 325 320
Retained earnings 260 200
Total liabilities and stockholders' equity $1,015 $800

Instructions
(a) Using horizontal analysis, show the percentage change for each balance sheet item
using 2006 as a base year.
(b) Using vertical analysis, prepare a common size comparative balance sheet.

ANS:

HUERTO COMPANY
Comparative Balance Sheet
December 31, 2007
2007 2006
(b) (b) (a)
Percentage
Assets Amount Percent Amount Percent Change
Current assets $ 340 33% $280 35% 21%
Plant assets 675 67 520 65 30%
Total assets $1,015 100% $800 100% 27%
Liabilities and stockholders' equity
Current liabilities $ 180 18% $120 15% 50%
Long-term debt 250 25 160 20 56%
Common stock 325 32 320 40 2%
Retained earnings 260 25 200 25 30%
Total liabilities and
stockholders' equity $1,015 100% $800 100% 27%

DIF: Moderate OBJ: 14-01


NAT: AACSB Analytic | AICPA FN-Measurement
568 Chapter 14/Financial Statement Analysis

4. Condensed data taken from the ledger of Jefferson Company at December 31, 2006 and 2005, are as
follows:

2006 2005
Current assets $150,000 $130,000
Property, plant, and equipment 450,000 400,000
Intangible assets 20,700 30,000
Current liabilities 70,000 80,000
Long-term liabilities 200,000 250,000
Common stock 225,000 150,000
Retained earnings 125,700 80,000

Prepare a comparative balance sheet, with horizontal analysis, for December 31, 2006 and 2005.
(Round percents to one decimal point.)
ANS:

Jefferson Company
Comparative Balance Sheet
December 31, 2006 and 2005
Increase (Decrease)
2006 2005 Amount Percent
Assets
Current assets $150,000 $130,000 $ 20,000 15.4%
Property, plant, and equipment 450,000 400,000 50,000 12.5%
Intangible assets 20,700 30,000 (9,300) (31.0%)
Total assets $620,700 $560,000 $ 60,700 10.8%
Liabilities
Current liabilities $ 70,000 $ 80,000 $ (10,000) (12.5%)
Long-term liabilities 200,000 250,000 (50,000) (20.0%)
Total liabilities $270,000 $330,000 $(60,000) (18.2%)
Stockholders' Equity
Common stock $225,000 $150,000 $ 75,000 50.0%
Retained earnings 125,700 80,000 45,700 57.1%
Total stockholders' equity $350,700 $230,000 $120,700 52.5%
Total liabilities and
stockholders' equity $620,700 $560,000 $ 60,700 10.8%

DIF: Moderate OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement

5. Revenue and expense data for Malden Company are as follows:

2006 2005
Administrative expenses $ 37,000 $ 20,000
Cost of goods sold 400,000 320,000
Income tax 40,000 32,000
Net sales 900,000 700,000
Selling expenses 190,000 110,000
Chapter 14/Financial Statement Analysis 569

(a) Prepare a comparative income statement, with vertical analysis, stating each item for both
2006 and 2005 as a percent of sales.
(b) Comment upon significant changes disclosed by the comparative income statement.

ANS:
(a)
Malden Company
Comparative Income Statement
For Years Ended December 31, 2006 and 2005

2006 2005
Amount Percent Amount Percent
Net sales $900,000 100.0% $700,000 100.0%
Cost of goods sold 400,000 44.4 320,000 45.7
Gross profit $500,000 55.6% $380,000 54.3%
Selling expenses $190,000 21.1% $110,000 15.7%
Administrative expenses 37,000 4.1 20,000 2.9
Total operating expenses $227,000 25.2% $130,000 18.6%
Income before income tax $273,000 30.3% $250,000 35.7%
Income tax 40,000 4.4 32,000 4.6
Net income $233,000 25.9% $218,000 31.1%

(b) There was a 1.3% decrease in the cost of goods sold, and a 1.4% increase in administrative
expenses. However, the more significant increase of 5.4% in selling expenses offset the
1.3% decrease in cost of goods sold and contributed greatly to the 5.2% decrease in net
income.

DIF: Moderate OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement

6. The following data are taken from the balance sheet at the end of the current year. Determine the (a)
working capital, (b) current ratio, and (c) acid-test ratio. Present figures used in your computations.
Round ratios to the nearest tenth.

Accounts payable $145,000


Accounts receivable 110,000
Accrued liabilities 4,000
Cash 80,000
Income tax payable 10,000
Inventory 140,000
Marketable securities 250,000
Notes payable, short-term 85,000
Prepaid expenses 15,000

ANS:
(a) Current assets ($595,000) - current liabilities ($244,000) = $351,000
(b) Current assets ($595,000) / current liabilities ($244,000) = 2.4
(c) Cash + marketable securities + accounts receivable ($440,000) / current liabilities
($244,000) = 1.8
570 Chapter 14/Financial Statement Analysis

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement

7. The following data are taken from the financial statements:

Current Preceding
Year Year
Net sales $3,600,000 $4,000,000
Cost of goods sold 2,000,000 2,700,000
Average monthly inventory 332,000 328,000
Inventory, end of year 372,000 347,000

(a) Determine for each year (1) the inventory turnover and (2) the number of days' sales in
inventory.
(b) Comment on the favorable and unfavorable trends revealed by the data.

ANS:
(a)
Current Preceding
Year Year
(1) Cost of goods sold/average monthly
inventory 6.0 8.2
(2) End-of-year inventory/average daily cost
of goods sold* 67.90 46.91
*Average daily cost of good sold
(COGS 365 days) $5,479 $7,397

(b) Net sales decreased while gross profit increased. The cost of goods sold as a percentage of
sales decreased from 68% to 56%. The inventory turnover declined and the number of days'
sales in inventory increased, which are unfavorable trends.

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement

8. The following data are taken from the financial statements:

Current Preceding
Year Year
Average accounts receivable (net) $123,000 $ 95,000
Accounts receivable (net), end of year 129,012 87,516
Net sales on account 950,000 825,000

(a) Assuming that credit terms on all sales are n/45, determine for each year (1) the accounts
receivable turnover and (2) the number of days' sales in receivables.
(b) Comment on any significant trends revealed by the data.
Chapter 14/Financial Statement Analysis 571

ANS:
(a)
Current Preceding
Year Year
(1) Net sales on account/average
accounts receivable (net) 7.72 8.68
(2) Accounts receivable, end of year/
average daily sales on account 49.56 38.72

(b) Although net sales increased during the current year, a favorable trend, several unfavorable
trends are disclosed by the analysis. The accounts receivable turnover has declined from
8.68 in the preceding year to 7.72 in the current year. Based on credit terms of n/45, a
turnover of less than 8 indicates that some receivables are not being collected within the
45-day period. Likewise, the number of days' sales in receivables indicates an unfavorable
trend, increasing from 38.72 at the end of the preceding year to 49.56 at the end of the
current year.

DIF: Easy OBJ: 14-02


NAT: AACSB Analytic | AICPA FN-Measurement
9. From the following data, determine for the current year the (a) rate earned on total assets, (b) rate
earned on stockholders' equity, (c) rate earned on common stockholders' equity, (d) earnings per
share on common stock, (e) price-earnings ratio on common stock, and (f) dividend yield on
common stock. Assume that the current market price per share of common stock is $27. (Present key
figures used in your computations.)
Current Preceding
Year Year
Current assets $ 735,000 $ 820,000
Property, plant, and equipment 1,500,000 1,400,000
Current liabilities
(non-interest-bearing) 150,000 140,000
Long-term liabilities, 12% 400,000 400,000
Preferred 10% stock 250,000 250,000
Common stock, $25 par 1,200,000 1,200,000
Retained earnings:
Beginning of year 230,000 160,000
Net income for year 85,000 155,000
Preferred dividends declared (25,000) (25,000)
Common dividends declared (60,000) (60,000)

ANS:
(a)
Net income ($ 85,000) + Interest expense ($48,000)
------------------------------------------------------------ = 6.0%
($2,235,000 + $2,220,000)
Average total assets ----------------------------
2
572 Chapter 14/Financial Statement Analysis

(b)
Net income ($ 85,000)
---------------------------------------------------------------------- = 5.1%
($1,680,000 + $1,680,000)
Average stockholders' equity ---------------------------------
2

(c)
Net income ($85,000) - preferred dividends ($25,000)
-------------------------------------------------------------- = 4.2%
Average common ($1,430,000 + $1,430,000)
stockholders' equity -------------------------------
2

(d)
Net income ($85,000) - preferred dividends ($25,000)
------------------------------------------------------- = $1.25
Shares of common stock outstanding (48,000)

(e)
Market price per share of common stock ($27)
-------------------------------------------------------- = 21.6
Earnings per share of common stock ($1.25)

(f)
Dividends per share of common stock ($1.25)
------------------------------------------------------- = 4.6%
Market price per share of common stock ($27)

DIF: Moderate OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement

10. The following information has been condensed from the December 31 balance sheets of Henry Co.:

2006 2005
Assets:
Current assets $ 825,500 $ 674,300
Fixed assets (net) 1,473,600 1,275,300
Total assets $2,299,100 $1,949,600

Liabilities:
Current liabilities $ 313,500 $ 309,600
Long-term liabilities 703,000 545,000
Total liabilities $1,016,500 $ 854,600
Stockholders' equity $1,282,600 $1,095,000
Total liabilities and
stockholders' equity $2,299,100 $1,949,600
Chapter 14/Financial Statement Analysis 573

(a) Determine the ratio of fixed assets to long-term liabilities for 2006 and 2005.
(b) Determine the ratio of liabilities to stockholders' equity for 2006 and 2005.
(c) Comment on the year-to-year changes for both ratios.

ANS:
(a)
2006 2005
Ratio of fixed assets to
long-term liabilities 2.10 2.34

(b)
Ratio of liabilities to
stockholders' equity .79 .78

(c) There are fewer fixed assets on a proportionate basis to protect the interests of the long-
term creditors. The interests of all the creditors in the total assets of the company, however,
are rising slightly from year-to-year when compared to the shareholders' equity in those
same assets.

DIF: Moderate OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement

11. A company reports the following:

Net income $125,000


Preferred dividends $5,000
Average stockholders equity $1,000,000
Average common stockholders equity $700,000

Determine the (a) rate earned on stockholders equity, and (b) rate earned on common stockholders
equity? Round your answer to one digit after the decimal place.
ANS:
(a) Rate earned on stockholders equity = Net income / Average stockholders equity
Rate earned on stockholders equity = $125,000 / $1,000,000
Rate earned on stockholders equity = 12.5%
(b) Rate earned on common stockholders equity = (Net income - preferred dividends) /
Average common stockholders equity
Rate earned on common stockholders equity = ($125,000 - $5,000) / $700,000
Rate earned on common stockholders equity = 17.1%

DIF: Moderate OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement
574 Chapter 14/Financial Statement Analysis

12. Selected data from the Conner Company are presented below:
Total assets $1,500,000
Average assets 1,700,000
Net income 250,000
Net sales 1,400,000
Average common stockholders' equity 1,000,000
Net cash provided by operating activities 275,000
Shares of common stock outstanding 10,000

Instructions
Calculate the profitability ratios that can be computed from the above information.
ANS:
With the information provided, the profitability ratios that can be calculated are as follows:

1. Ratio of net sales to assets = Net sales Average total assets


= $1,400,000 $1,500,000
= 93.3%

2. Rate earned on total assets = Net income +Interest expense Average assets
= $250,000 + 0 $1,700,000
= 14.7%

3. Rate earned on common


stockholders' equity
= $250,000 - 0 $1,000,000
= 25%

4. Earnings per share on


common stock = $250,000 10,000
= $25 per share

DIF: Moderate OBJ: 14-03


NAT: AACSB Analytic | AICPA FN-Measurement