Solution Manual

Jerry J. Weygandt, Paul D. Kimmel, Donald E. Kieso

Chapter - 14

Financial Statement Analysis

 ANSWERS TO QUESTIONS

1. (a) Kurt is not correct. There are three characteristics: liquidity, profitability, and solvency.
(b) The three parties are not primarily interested in the same characteristics of a company. Short-term
creditors are primarily interested in the liquidity of the company. In contrast, long-term creditors
and shareholders are primarily interested in the profitability and solvency of the company.

LO: 14.1
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

2. (a) Comparison of financial information can be made on an intracompany basis, an intercompany

basis, and an industry average basis (or norms).
(1) An intracompany basis compares an item or financial relationship within a company in
the current year with the same item or relationship in one or more prior years.
(2) The industry averages basis compares an item or financial relationship of a company
with industry averages (or norms) published by financial rating services.
(3) An intercompany basis compares an item or financial relationship of one company with
the same item or relationship in one or more competing companies.
(b) The intracompany basis of comparison is useful in detecting changes in financial relationships
and significant trends within a company.
The industry averages basis provides information as to a company’s relative performance
within the industry.
The intercompany basis of comparison provides insight into a company’s competitive position.

LO: 14.2
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

3. Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or
decrease of an item over a period of time. In this approach, the amount of the item on one statement
is compared with the amount of that same item on one or more earlier statements. Vertical analysis
(also called common-size analysis) expresses each item within a financial statement in terms of a
percent of a base amount.

LO: 14.2, 14.3, 14.4

Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making

14-6
 IMA: Reporting

4. (a) €350,000 X 1.224 = €428,400, 2017 net income.

(b) €350,000 ÷ .05 = €7,000,000, 2016 revenue.

LO:14.3
Difficulty: Easy
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

5. A ratio expresses the mathematical relationship between one quantity and another. The relationship
is expressed in terms of either a percentage (200%), a rate (2 times), or a simple proportion (2:1).
Ratios can provide clues to underlying conditions that may not be apparent from individual financial
statement components. The ratio is more meaningful when compared to the same ratio in earlier
periods or to competitors’ ratios or to industry ratios.

LO: 14.2
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting
6. (a) Liquidity ratios: Current ratio, acid-test ratio, accounts receivable turnover, and inventory
turnover.
(b) Solvency ratios: Debt to assets and times interest earned.

LO: 14.4
Difficulty: Easy
BLOOMCODE: Knowledge
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

7. Gordon is correct. A single ratio by itself may not be very meaningful and is best interpreted by
comparison with: (1) past ratios of the same company, (2) ratios of other companies, or (3) industry
norms or predetermined standards. In addition, other ratios of the company are necessary to
determine overall financial well-being.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-7
 8. (a) Liquidity ratios measure the short-term ability of a company to pay its maturing obligations
and to meet unexpected needs for cash.
(b) Profitability ratios measure the income or operating success of a company for a given period of time.
(c) Solvency ratios measure the ability of the company to survive over a long period of time.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Knowledge
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-8
Questions Chapter 14 (Continued)

9. The current ratio relates current assets to current liabilities. The acid-test ratio relates cash, short-term
investments, and net receivables to current liabilities. The current ratio includes inventory and
prepaid expenses while the acid-test ratio excludes these. The acid-test ratio provides additional
information about short-term liquidity and is an important complement to the current ratio.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

10. Monte Company does not necessarily have a problem. The accounts receivable turnover can be
misleading in that some companies encourage credit and revolving charge sales and slow collections
in order to earn a healthy return on the outstanding accounts receivable in the form of high rates of
interest.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

11. (a) Asset turnover.

(b) Inventory turnover.
(c) Return on ordinary shareholders’ equity.
(d) Times interest earned.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

12. The price earnings (P/E) ratio is a reflection of investors’ assessments of a company’s future
earnings. In this question, investors favor Microsoft because it has the higher P/E ratio. The investors
feel that Microsoft will be able to generate even higher future earnings and so the investors are
willing to pay more for the shares.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking

14-9
 AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

13. The payout ratio is cash dividends declared on ordinary shares divided by net income. In a growth
company, the payout ratio is often low because the company is reinvesting earnings in the
business.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14. (a) The increase in profit margin is good news because it means that a greater percentage of net
sales is going towards income.
(b) The decrease in inventory turnover signals bad news because it is taking the company longer
to sell the inventory and consequently there is a greater chance of inventory obsolescence.
(c) An increase in the current ratio signals good news because the company improved its ability
to meet maturing short-term obligations.
(d) The earnings per share ratio is a deceptive ratio. The decrease might be bad news to the
company because it could mean a decrease in net income. If there is an increase in shareholders’
investment (as a result of issuing additional shares) and a decrease in EPS, then this means
that the additional investment is earning a lower return (as compared to the return on ordinary
shareholders’ equity before the additional investment). Generally, this is undesirable.
(e) The increase in the price-earnings ratio is generally good news because it means that the
market price per share has increased and investors are willing to pay that higher price for
the shares. An increase in the P/E ratio is good news for investors who own the shares and
don’t want to buy any more. It is bad news for investors who want to buy (or buy more of) the
shares.
(f) The increase in the debt to assets ratio is bad news because it means that the company has
increased its obligations to creditors and has lowered its equity “buffer.”
(g) The decrease in the times interest earned ratio is bad news because it means that the company’s
ability to meet interest payments as they come due has weakened.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-10
Questions Chapter 14 (Continued)

Net Income
15. Return on assets =
Average Assets
(7.6%)
Net Income – Preference Dividends
Return on ordinary shareholders’ equity =
Average Ordinary Shareholders' Equity
(12.8%)

The difference between the two rates can be explained by looking at the denominator value and
by remembering the basic accounting equation, A = L + E. The asset value will clearly be the larger
of the two denominator values; therefore, it will also give the smaller return.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

16. (a) The times interest earned ratio, which is an indication of the company’s ability to meet interest
payments, and the debt to assets ratio, which indicates the company’s ability to withstand losses
without impairing the interests of creditors.
(b) The current ratio and the acid-test ratio, which indicate a company’s liquidity and short-term
debt-paying ability.
(c) The earnings per share and the return on ordinary shareholders’ equity, both of which indicate the
earning power of the investment.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

17. Earnings per share means earnings per ordinary share. Preference share dividends are
subtracted from net income in computing EPS in order to obtain income available to ordinary
shareholders.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-11
18. (a) Trading on the equity means that the company has borrowed money at a lower rate of interest
than it is able to earn by using the borrowed money. Simply stated, it is using money supplied
by non-owners to increase the return to the owners.
(b) A comparison of the return on total assets with the rate of interest paid for borrowed money
indicates the profitability of trading on the equity.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

Net income – Preference dividends

19. = Earnings per share
Weighted average – ordinary shares outstanding

R$160,000 – R$30,000
= R$2.60
50,000
EPS of R$2.60 is high relative to what? Is it high relative to last year’s EPS? The president may
be comparing the EPS of R$2.60 to the market price of the company’s stock.

LO: 14.5
Difficulty: Easy
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

20. Discontinued operations refers to the disposal of a significant component of the business such as
the stopping of an entire activity or eliminating a major class of customers. It is important to report
discontinued operations separately from continuing operations because the discontinued component
will not affect future income statements.

LO: 14.6
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

21. EPS on income from continuing operations usually is more relevant to an investment decision
than EPS on net income. Income from continuing operations represents the results of continuing
and ordinary business activity. It is therefore a better basis for predicting future operating results
than an EPS figure which includes the effect of discontinued operations that are not expected to
recur again in the foreseeable future.

14-12
Questions Chapter 14 (Continued)

22. When comparing EPS trends, discontinued operations should be omitted since they are not
reflective of normal operations. In this example, the trend is unfavorable because EPS, exclusive of
discontinued operations, has decreased from £3.20 to £2.99.

LO: 14.6
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

23. (1) Use of alternative accounting methods. Variations among companies in the application of
IFRS may hamper comparability.

(2) Use of pro forma income measures that do not follow IFRS. Pro forma income is calculated
by excluding items that the company believes are unusual or nonrecurring. It is often difficult
to determine what was included and excluded.

(3) Improper revenue and expense recognition. Many high-profile cases of inappropriate accounting
involve recording items in the wrong period.
LO: 14.7
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-14
 SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 14-1

Dear Uncle Liam,
It was so good to hear from you! I hope you and Aunt Doreen are still
enjoying your new house.
You asked some interesting questions. They relate very well to the material
that we are studying now in 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, such as a bank,
is interested in the company’s liquidity, or ability to pay obligations as they
become due. The liquidity of a borrower is extremely important in evaluating
the safety 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 company will survive over the life of the
debt and be able to meet interest payments. Shareholders are also interested
in profitability, and in the solvency of the company. They want to assess the
likelihood of dividends and the growth potential of the shares.

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. Comparisons 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
information as to a company’s relative performance within the industry. Finally,
comparisons can be done on an intercompany basis. This basis compares
an item or financial relationship with the same item or relationship in one or more
competing companies. Intercompany comparisons are useful in determining
a company’s competitive position.
I hope this answers your questions. 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!
Love,

14-15
Your niece (or nephew)
LO: 14.7
Difficulty: Easy
BLOOMCODE: Comprehension
AACSB: Reflective thinking, Communication
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

BRIEF EXERCISE 14-2

(a) The three tools of financial statement analysis are horizontal analysis,
vertical analysis, and ratio analysis. Horizontal analysis evaluates a series
of financial statement data over a period of time. Vertical analysis evalu-
ates financial statement data by expressing each item in a financial
statement as a percent of a base amount. Ratio analysis expresses the
relationship among selected items of financial statement data.

(b) Horizontal Analysis

2015 2016 2017
Current assets 100% 105% 109%

(105% = €230,000/€220,000; 109% = €240,000/€220,000)

Vertical Analysis
2015 2016 2017
Current assets* 44% 38% 38%

*as a percentage of total assets

(44% = €220,000/€500,000; 38% = €230,000/€600,000;
38% = €240,000/€630,000)

Ratio Analysis
2015 2016 2017
Current ratio 1.38 1.35 1.30
(1.38 = €220,000/€160,000; 1.35 = €230,000/€170,000;
1.30 = €240,000/€184,000)

LO: 14.3, 14.4, 14.5

Difficulty: Medium
BLOOMCODE: Application

14-16
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

BRIEF EXERCISE 14-3

Horizontal analysis:
Increase
or (Decrease)
Dec. 31, 2017 Dec. 31, 2016 Amount Percentage
Inventory € 840,000 € 500,000 €340,000 68%
Accounts receivable € 520,000 € 350,000 €170,000 49%
Total assets €2,500,000 €3,000,000 (€500,000) (17)%

340,000 170,000 (500,000)

= .68 = .49 = (.17)
500,000 350,000 3,000,000
LO: 14.3
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-17
BRIEF EXERCISE 14-4

Vertical analysis:
Dec. 31, 2017 Dec. 31, 2016
Amount Percentage* Amount Percentage**
Inventory € 840,000 33.6% € 500,000 16.7%
Accounts receivable € 520,000 20.8% € 350,000 11.7%
Total assets €2,500,000 100% €3,000,000 100%

* 840,000 ** 500,000
= .336 = .167
2,500,000 3,000,000

* 520,000 ** 350,000
= .208 = .117
2,500,000 3,000,000

LO: 14.4
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

BRIEF EXERCISE 14-5

2017 2016 2015

Net income €525,000 €500,000 €550,000

Increase or (Decrease)
Amount Percentage
(a) 2015–2016 (50,000) (9%)
(b) 2016–2017 (25,000) (5%)

50,000 25,000
= .09 = .05
550,000 500,000

LO: 14.3
Difficulty: Medium
14-18
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting
BRIEF EXERCISE 14-6

2017 2016 Increase

Net income £560,000 X 40%

£560,000 – X
X .40 =
X
.40X = £560,000 – X

14-19
BRIEF EXERCISE 14-6 (Continued)

1.40X = £560,000
X = £400,000

2016 Net income = £400,000

LO: 14.3
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

BRIEF EXERCISE 14-7

Comparing the percentages presented results in the following conclusions:

The net income for Kemplar increased in 2016 because of the combination
of an increase in sales revenue and a decrease in both cost of goods sold and
expenses. However, the reverse was true in 2017 as sales revenue decreased
while both cost of goods sold and expenses increased. This resulted in a
decrease in net income.

LO: 14.3
Difficulty: Medium
BLOOMCODE: Application
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

BRIEF EXERCISE 14-8

2017 2016 2015

Sales revenue 100.0 100.0 100.0
Cost of goods sold 59.2 62.4 64.5
Expenses 25.0 25.6 27.5
Net income 15.8 12.0 8.0

14-20
Net income as a percent of sales revenue for Dagman increased over the
three-year period because cost of goods sold and expenses both decreased
as a percent of sales every year.

LO: 14.4
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

BRIEF EXERCISE 14-9

(a) Working capital = Current assets – Current liabilities

Current assets £46,690,000

Current liabilities 41,200,000
Working capital £ 5,490,000

14-21
BRIEF EXERCISE 14-9 (Continued)

(b) Current ratio:

Current assets £46,690,000

=
Current liabilities £41,200,000

= 1.13:1

(c) Acid-test ratio:

Cash + Short-term investments

+ Receivables (net) £8,113,000 + £4,947,000 + £12,545,000
=
Current liabilities £41,200,000

£25,605,000
=
£41,200,000

= .62:1
LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting
BRIEF EXERCISE 14-10

Net sales
(a) Asset turnover =
Average assets

€88,000,000
=
€14,000,000 + €18,000,000
2
= 5.5 times

14-22
 Net income
(b) Profit margin =
Net sales

€12,760,000
=
€88,000,000

= 14.5%
LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-23
BRIEF EXERCISE 14-11

Net credit sales

(a) Accounts receivable turnover =
Average net accounts receivable

2017 2016
(1) €3,680,000 €3,000,000
= 6.9 times = 6.0 times
€535,000* €500,000**
*($520,000 + $550,000) ÷ 2 **($480,000 + $520,000) ÷ 2

(2) Average collection period

365 365
= 52.9 days = 60.8 days
6.9 6.0

(b) Gladow Company should be pleased with the effectiveness of its credit
and collection policies. The company has decreased the average collection
period by 7.9 days and the collection period of approximately 53 days
is well within the 60 days allowed in the credit terms.

LO: 14.5
Difficulty: Medium
BLOOMCODE: Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

BRIEF EXERCISE 14-12

Cost of goods sold

(a) Inventory turnover =
Average inventory

(1) 2017 2016

4,400,000 4,600,000
= 4.4 times = 5.0 times
980,000 + 1,020,000 860,000 + 980,000
2 2
Beginning inventory 980,000 860,000
Purchases 4,440,000 4,720,000
Goods available for sale 5,420,000 5,580,000

14-24
 Ending inventory 1,020,000 980,000
Cost of goods sold 4,400,000 4,600,000

(2) Days in inventory

365 365
= 83.0 days = 73.0 days
4.4 5.0

14-25
BRIEF EXERCISE 14-12 (Continued)

(b) Management should be concerned with the fact that inventory is moving
slower in 2017 than it did in 2016. The decrease in the turnover could be
because of poor pricing decisions or because the company is stuck
with obsolete inventory.

LO: 14.5
Difficulty: Medium
BLOOMCODE: Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

BRIEF EXERCISE 14-13

Cash dividends
Payout ratio =
Net income

X
.22 =
HK$680,000

X = HK$680,000 (.22) = HK$149,600

Cash dividends = HK$149,600

Net income
Return on assets =
Average assets

HK$680,000
.16 =
X

.16X = HK$680,000

HK$680,000
X=
.16

X = HK$4,250,000

Average assets = HK$4,250,000

14-26
BRIEF EXERCISE 14-14

MING LIMITED
Partial Income Statement

Income before income taxes .......................................... ₤400,000

Income tax expense (₤400,000 X 30%) .......................... 120,000
Income from continuing operations .............................. 280,000
Discontinued operations
Income from operations of retail division,
net of ₤3,000 tax (₤10,000 X 30%)……………… ₤ 7,000
Loss on disposal of retail division, net of
₤24,000 tax saving (₤80,000 X 30%)………….. (56,000) (49,000)
Net income ....................................................................................... ₤231,000

LO: 14.6
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting
BRIEF EXERCISE 14-15

BLEVINS ASA
Partial Income Statement

Loss from operations of European facilities, net

of €96,000 income tax saving (€320,000 X 30%) ..... €224,000
Loss on disposal of European facilities, net of
€45,000 income tax saving (€150,000 X 30%).......... 105,000 €329,000

LO: 14.6
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-28
BRIEF EXERCISE 14-16

SILVA AG
Partial Statement of Comprehensive Income

Income before income taxes ........................................................... €450,000

Income tax expense (€450,000 X 25%) ........................................... 112,500
Net income ........................................................................................ 337,500
Other comprehensive income
Unrealized gain on non-trading securities,
net of €17,500 tax (€70,000 X 25%) ......................................... 52,500
Comprehensive income................................................................... €390,000

LO: 14.6
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-29
SOLUTIONS FOR DO IT! REVIEW EXERCISES

DO IT! 14-1

Increase (Decrease) in 2017

Amount Percent
Plant assets ₤71,000 9.5% [(₤821,000 – ₤750,000) ÷ ₤750,000]
Current assets (37,000) (16.4)% [(₤188,000 – ₤225,000) ÷ ₤225,000]
Total assets ₤34,000 3.5% [(₤1,009,000 – ₤975,000) ÷ ₤975,000]

LO: 14.3
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

DO IT! 14-2

2017 2016
(a) Current ratio:
€1,350 ÷ €900 = 1.50:1
€1,343 ÷ €810 = 1.66:1

(b) Inventory turnover:

€984/[(€430 + €390) ÷ 2)] = 2.40 times
€895/[(€390 + €326) ÷ 2)]= 2.50 times

(c) Profit margin:

€364 ÷ €4,000 = 9.1%
€213 ÷ €3,600 = 5.9%

(d) Return on assets:

€364/[(€2,310 + €2,243) ÷ 2)] = 16.0%
€213/[(€2,243 + €2,100) ÷ 2)] = 9.8%

(e) Return on ordinary shareholders’ equity:

€364/[(€1,020 + €1,040) ÷ 2)] = 35.3%
€213/[€1,040 + €960) ÷ 2)] = 21.3%

14-30
(f) Debt to assets ratio:
€1,290 ÷ €2,310 = 55.8%
€1,203 ÷ €2,243 = 53.6%

(g) Times interest earned:

(€364 + €242 + €10) ÷ €10 = 62 times
(€213 + €142 + €20) ÷ €20 = 19 times

LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-31
DO IT! 14-3

GRINDERS LIMITED
Partial statement of Comprehensive Income

Income before income taxes ......................................... ₤500,000

Income tax expense........................................................ 160,000
Income from continuing operations ............................. 340,000
Discontinued operations
Loss from operations of music
division, net of ₤19,200 income tax savings ...... ₤40,800
Gain from disposal of music
division, net of ₤16,000 taxes .............................. 34,000 (6,800)
Net income ...................................................................... 333,200
Other comprehensive income:
Unrealized loss on non-trading
securities, net of ₤9,600 tax savings ................... 20,400
Comprehensive Income ................................................. ₤312,800

LO: 14.6
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

DO IT! 14-4

1. Current ratio: A measure used to evaluate a company’s

liquidity.
2. Pro forma income: Usually excludes items that a company
thinks are unusual or non-recurring.
3. Quality of earnings: Indicates the level of full and transparent
information provided to users of the
financial statements.
4. Discontinued operations: The disposal of a significant component of a
business.
5. Horizontal analysis: Determines increases or decreases in a
series of financial statement data.
6. Comprehensive income: Includes all changes in equity during a

14-32
 period except those resulting from
investments by shareholders and
distributions to shareholders.
LO: 14.5, 14.6, 14.7
Difficulty: Medium
BLOOMCODE: Comprehension
AACSB: Reflective thinking
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting
SOLUTIONS TO EXERCISES

EXERCISE 14-1

GALLUP SA
Condensed Statements of Financial Position
December 31

Increase or (Decrease)
2017 2016 Amount Percentage
Assets
Plant assets (net) €396,000 €320,000 (€76,000 (23.8%)
Current assets 128,000 110,000 ( 18,000 (16.4%)
Total assets €524,000 €430,000 €94,000 (21.9%)

Equity
Share capital— (
ordinary, €1 par € 159,000 € 115,000 €44,000) (38.3%)
Retained earnings 135,300 150,000 ((14,700)) (((9.8%))
Total equity 294,300 265,000 ( 29,300) ( 11.1%)

Liabilities
Non-current liabilities 138,700 95,000 ( 43,700 (46.0%)
Current liabilities 91,000 70,000 21,000 30.0%
Total liabilities 229,700 165,000 ( 64,700) ( 39.2%)
Total equity and
liabilities €524,000 €430,000 (€94,000) 21.9%

LO: 14.3
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-34
EXERCISE 14-2

CONARD LIMITED
Condensed Income Statements
For the Years Ended December 31

2017 2016
Amount Percent Amount Percent
Net sales £750,000 100.0% £600,000 100.0%
Cost of goods sold 480,000 64.0% 408,000 68.0%
Gross profit 270,000 36.0% 192,000 32.0%
Selling expenses 105,000 14.0% 84,000 14.0%
Administrative expenses 75,000 10.0% 54,000 9.0%
Total operating expenses 180,000 24.0% 138,000 23.0%
Income before income taxes 90,000 12.0% 54,000 9.0%
Income tax expense 36,000 4.8% 18,000 3.0%
Net income £ 54,000 7.2% £ 36,000 6.0%

LO: 14.4
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

EXERCISE 14-3

(a) GARCIA SLU

Condensed Statements of Financial Position
December 31

Percentage
Increase Change
2017 2016 (Decrease) from 2016
Assets
Intangibles € 24,000 € 40,000 € (16,000) (40.0%)
Property, plant &
equipment (net) 100,000 92,000 ( 8,000) ( 8.7%)
Current assets 76,000 82,000 (6,000) (7.3%)
14-35
Total assets €200,000 €214,000 € (14,000) (6.5%)

14-36
EXERCISE 14-3 (Continued)

GARCIA SLU
Condensed Statements of Financial Position (Continued)
December 31

Percentage
Increase Change
2017 2016 (Decrease) from 2016
Equity and liabilities
Equity € 20,000 € 16,000 € 4,000 25.0%
Non-current
liabilities 140,000 150,000 (10,000) (6.7%)
Current liabilities 40,000 48,000 (8,000) ((16.7%))
Total equity and
liabilities €200,000 €214,000 €(14,000) (6.5%)

(b) GARCIA SLU

Condensed Statements of Financial Position
December 31, 2017

Amount Percent
Assets
Intangibles € 24,000 12.0%
Property, plant, and equipment (net) 100,000 50.0%
Current assets 76,000 38.0%
Total assets €200,000 100.0%

Equity and liabilities

Equity € 20,000 10%
Non-current liabilities 140,000 70%
Current liabilities 40,000 20%
Total equity and liabilities €200,000 100%

LO: 14.3, 14.4

Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
14-37
EXERCISE 14-4

(a) HENDI COMPANY A.S.

Condensed Income Statements
For the Years Ended December 31

Increase or (Decrease)
During 2016
2017 2016 Amount Percentage
Net sales 600,000 500,000 100,000 20.0%
Cost of goods sold 468,000 400,000 68,000 17.0%
Gross profit 132,000 100,000 32,000 32.0%
Operating expenses 60,000 54,000 6,000 11.1%
Net income 72,000 46,000 26,000 56.5%

(b) HENDI COMPANY A.S.

Condensed Income Statements
For the Years Ended December 31

2017 2016
Amount Percent Amount Percent
Net sales 600,000 100.0% 500,000 100.0%
Cost of goods sold 468,000 78.0% 400,000 80.0%
Gross profit 132,000 22.0% 100,000 20.0%
Operating expenses 60,000 10.0% 54,000 10.8%
Net income 72,000 12.0% 46,000 9.2%

LO: 14.3, 14.4

Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

EXERCISE 14-5

(a) Current ratio = 2.1:1 ($5,228 ÷ $2,541)

14-39
Acid-test ratio = 1.3:1 ($3,371 ÷ $2,541)
Accounts receivable turnover = 5.7 times ($12,166 ÷ $2,153)*
Inventory turnover = 5.4 times ($7,737 ÷ $1,445.5)**

*($2,177 + $2,129) ÷ 2
**(1,531 + 1,360) ÷ 2

14-40
EXERCISE 14-5 (Continued)

(b) Ratio Nordstrom Park Street Industry

Current 2.1:1 2.05:1 1.70:1
Acid-test 1.3:1 1.05:1 .70:1
Accounts receivable
turnover 5.7 37.2 46.4
Inventory turnover 5.4 3.1 4.3

Nordstrom is similar to Park Street for the current and acid-test ratios
but significantly below for the accounts receivable turnover.
Nordstrom is much better than Park Street for the inventory turnover.

Nordstrom is better than the industry average for the current and acid-
test ratios but below the industry average for the accounts receivable
turnover. Its inventory turnover ratio however is higher than the industry
average.

LO: 14.4
Difficulty: Medium
BLOOMCODE: Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting
EXERCISE 14-6

(a) Current ratio as of February 1, 2017 = 2.8:1 (R$140,000 ÷ R$50,000).

Feb. 3 2.8:1 No change in total current assets or liabilities.

7 2.2:1 (R$112,000 ÷ R$50,000).
11 2.2:1 No change in total current assets or liabilities.
14 2.6:1 (R$100,000 ÷ R$38,000).
18 2.3:1 (R$100,000 ÷ R$43,000).

(b) Acid-test ratio as of February 1, 2017 = 2.5:1 (R$125,000* ÷ R$50,000).

* R$140,000 – R$10,000 – R$5,000

Feb. 3 2.5:1 No change in total quick assets or current liabilities.

14-41
 7 1.9:1 (R$97,000 ÷ R$50,000).
11 1.9:1 (R$94,000 ÷ R$50,000).
14 2.2:1 (R$82,000 ÷ R$38,000).
18 1.9:1 (R$82,000 ÷ R$43,000).
LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-42
EXERCISE 14-7

£140,000
(a) = 2.8:1.
£50,000

£80,000
(b) = 1.6:1.
£50,000

£396,000
(c) = 6.6 times.
£60,000 (1)

£190,000
(d) = 3.5 times.
£55,000 (2)

£70,000 + £50,000
(1)
2
£60,000 + £50,000
(2)
2

LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

EXERCISE 14-8
£42,000
(a) Profit margin = 6.0%.
£700,000

£700,000
(b) Asset turnover = 1.25 times.
 £540,000 + £580,000 
 2 

£42,000
(c) Return on assets = 7.5%.
£560,000

14-43
 £42,000
(d) Return on ordinary shareholders’ = 11.2%.
equity  £325,000 + £425,000 
 2 
LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-44
EXERCISE 14-9

€ 60,000 – € 5,000
(a) = €1.72.
32,000 shares

€ 10.80
(b) = 6.3 times.
€1.72

€15,000
(c) = 25%.
€60,000

€ 60,000 + € 14,000 + €17,000 € 91,000

(d) = = 6.5 times.
€ 14 ,000 € 14,000

LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting
EXERCISE 14-10

Cost of goods sold

(a) Inventory turnover = 3.4 =
 € 200,000 + € 180,000 
 2 

3.4 X €190,000 = Cost of goods sold

Cost of goods sold = €646,000.

Net sales (credit)

(b) Accounts receivable turnover = 8.8 =
 €73,000 + € 126,000 
 2 

8.8 X €99,500 = Net sales (credit) = €875,600.

(c) Return on ordinary shareholders’ equity = 25% =

14-45
 Net income
 € 400,000 + € 134,000 + €400,000 + €122,000 
 2 

.25 X €528,000 = Net income = €132,000.

14-46
EXERCISE 14-10 (Continued)

€132,000 [see (c) above]

(d) Return on assets = 20% =
Average assets

€ 132,000
Average assets = = €660,000
.20
Total assets (Dec. 31, 2017) + €650,000
= €660,000
2
Total assets (Dec. 31, 2017) = (€660,000 X 2) – €650,000 = €670,000.

LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

EXERCISE 14-11

(a) (€4,300 + €22,000+ €10,000)/€15,000 = 2.42:1

(b) (€4,300 + €22,000)/€15,000 = 1.75:1
(c) €100,000/[(€22,000 + €24,000)/2] = 4.35 times
(d) €60,350/[(€10,000 + €7,000)/2] = 7.10 times
(e) €14,000/€100,000 = 14%
(f) €100,000/[(€111,300 + €120,700)/2] = .86 times
(g) €14,000/[(€111,300 + €120,700)/2] = 12.1%
(h) €14,000/[(€96,300 + €89,600)/2] = 15.1%
(i) €15,000/€111,300 = 13.5%

LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective

14-47
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

EXERCISE 14-12

(a) DOUGLAS LIMITED

Partial Income Statement
For the Year Ended October 31, 2017

Income before income taxes...................................... £550,000

Income tax expense (£550,000 X 30%) ...................... 165,000
Income from continuing operations………………… 385,000
Discontinued operations
Loss from operations of discontinued
division, net of £18,000 income
tax saving……………………………………………. £42,000
Loss from disposal of discontinued
division, net of £27,000 income
tax savings………………………………………… 63,000 (105,000)
Net income ..................................................................... £280,000

(b) To: Chief Accountant

From: Your name, Independent Auditor

After reviewing your income statement for the year ended 10/31/17, we
believe it is misleading for the following reasons:

14-48
 The amount reported for income before discontinued operations is
overstated by £45,000. The income tax expense should be 30% of
£550,000, or £165,000, not £120,000.

Also, the effect of the loss from the discontinued division on net income
is only £105,000, not £150,000. An income tax savings of £45,000 should
be netted against the loss on the discontinued division.

LO: 14.6
Difficulty: Medium
BLOOMCODE: Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

EXERCISE 14-13

TRAYER PLC
Partial Statement of Comprehensive Income
For the Year Ended December 31, 2017

Income from continuing operations ....................................... ₤290,000

Discontinued operations
Loss from operations, net of ₤2,000
income taxes ................................................... ₤8,000
Gain from disposal, net of ₤8,000
income taxes .................................................... 32,000 24,000
Net income ................................................................................ ₤314,000
Other comprehensive income
Unrealized loss on non-trading securities,
net of ₤16,000 income taxes ............................................ 64,000
Comprehensive income................................................................... ₤250,000

LO: 14.6

14-49
SOLUTIONS TO PROBLEMS

PROBLEM 14-1

(a) Condensed Income Statement

For the Year Ended December 31, 2017

Barrymore
Lionel Company Company
Pounds Percent Pounds Percent
Net sales ₤1,549,035 100.0% ₤339,038 100.0%
Cost of goods sold 1,053,345 68.0% 237,325 70.0%
Gross profit 495,690 32.0% 101,713 30.0%
Operating expenses 263,336 17.0% 77,979 23.0%
Income from operations 232,354 15.0% 23,734 7.0%
Interest expense 7,745 .5% 2,034 .6%
Income before income taxes 224,609 14.5% 21,700 6.4%
Income tax expense 61,960 4.0% 8,476 2.5%
Net income ₤ 162,649 10.5% ₤ 13,224 3.9%

(b) Lionel Company appears to be more profitable. It has higher relative

gross profit, income from operations, income before taxes, and net income.
 £162,649 a
Lionel’s return on assets of 16.6%   is higher than Barrymore’s
 £981,067 
 £14,580 b
return on assets of 6.6%   . Also, Lionel’s return on ordinary
 £220,400 
 £162,649 c
shareholders’ equity of 19.9%   is higher than Barrymore’s
 £817,556 
 £13,224  d
return on ordinary shareholders’ equity of 7.7%   .
 £188,914 

14-51
PROBLEM 14-1 (Continued)
a
₤162,649 is Lionel’s 2017 net income. ₤981,067 is Lionel’s 2017
average assets:

2017 2016
Plant assets ₤596,920 ₤575,610
Current assets 401,584 388,020 £1, 962, 134
Total assets ₤998,504 + ₤963,630 = 2

b
₤13,224 is Barrymore’s 2017 net income. $220,400 is Barrymore’s 2017
average assets:

2017 2016
Plant assets ₤142,842 ₤128,927
Current assets 86,450 82,581 £ 440,800
Total assets ₤229,292 + ₤211,508 = 2

c
₤162,649 is Lionel’s 2017 net income. $817,556 is Lionel’s 2017
average ordinary shareholders’ equity:

2017 2016
Share capital ordinary ₤578,765 ₤578,765
Retained earnings 252,224 225,358 £1,635,112
Total equity ₤830,989 + ₤804,123 = 2

d
₤13,224 is Barrymore’s 2017 net income. ₤188,914 is Barrymore’s
2017 average ordinary shareholders’ equity:

2017 2016
Share capital ordinary ₤137,435 ₤137,435
Retained earnings 55,528 47,430 £ 377, 828
Total equity ₤192,963 + ₤184,865 = 2

LO: 14.4, 14.5

Difficulty: Hard
BLOOMCODE: Application/Analysis
AACSB: Analytic

14-52
 PROBLEM 14-2

R$192,000
(a) Earnings per share = = R$3.20.
60,000

R$192,000
(b) Return on ordinary shareholders’ equity =
 R$465,400 + R$542,600 
 2 

R$ 192,000
=
R$ 504,000

= 38.1%.

R$ 192,000 R$192,000
(c) Return on assets = = = 21.3%.
 R$852,800 + R $ 946,100  R$899,450
 2 

R$345,800
(d) Current ratio = = 1.70:1
R$203,500

R$234,850
(e) Acid-test ratio = = 1.15:1
R$203,500

R$1,818,500
(f) Accounts receivable turnover =
 (R$102,800 + R$105,750 ) 
 2 

R$1,818,500
=
R$104,275

= 17.4 times.

14-54
PROBLEM 14-2 (Continued)

R $ 1,011,500 R$1,011,500
(g) Inventory turnover = =
 R$115,500 + R $ 110,950  R$113,225
 2 
= 8.9 times.

R$291,000
(h) Times interest earned = = 19.4 times.
R$15,000

R$1,818,500
(i) Asset turnover = = 2.0 times.
R$899,450*

*(R$852,800 + R$946,100) ÷ 2

R$403,500
(j) Debt to assets = = 42.6%.
R$946,100

LO: 14.5
Difficulty: Medium
BLOOMCODE: Application/Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-55
 PROBLEM 14-3

(a) 2016 2017

(1) Profit margin.

£30,000 £44,000
= 4.7% = 6.3%
£640,000 £700,000

(2) Asset turnover.

£640,000 £700,000
= 1.1 times = 1.1 times
 £533,000 + £600,000   £600,000 + £640,000 
 2   2 

(3) Earnings per share.

£30,000 £44,000
= ₤0.97 = ₤1.38
31,000 32,000

(4) Price-earnings ratio.

£5.00 £7.00
= 5.2 times = 5.1 times
£0.97 £1.38

(5) Payout ratio.

£20,000* £22,000**
= 66.7% = 50.0%
£30,000 £44,000
*(₤113,000 + ₤30,000 – ₤123,000) **(₤123,000 + ₤44,000 – ₤145,000)

(6) Debt to assets.

£162,000 £150,000
= 27.0% = 23.4%
£600,000 £640,000

14-56
PROBLEM 14-3 (Continued)

(b) The underlying profitability of the corporation appears to have improved.

For example, profit margin and earnings per share have both increased.
Also, the corporation appears to be involved in attempting to reduce
its debt burden as its debt to assets ratio has decreased. Similarly, its
payout ratio has decreased, which should help its overall solvency.

LO: 14.5
Difficulty: Medium
BLOOMCODE: Application/Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-57
 PROBLEM 14-4
(a) LIQUIDITY

2015 2016 Change

€343,000 € 374,000
Current = 1.9:1 =1.9:1 No change
€182,000 € 192,000

€185,000 €220,000
Acid-test = 1.0:1 = 1.1:1 Increase
€182,000 €192,000

Accounts €798,000 € 858,000

receivable = 9.5 times = 9.6 times Increase
€ 84,000* € 89,000**
turnover
*(€88,000 + €80,000) ÷ 2 **(€80,000 + €98,000) ÷ 2
€ 611,000
Inventory €575,000 = 4.7 Increase
= 4.5 times € 130,000**
turnover € 126,500*
times
*(€118,000 + €135,000) ÷ 2 **(€135,000 + €125,000) ÷ 2

An overall increase in short-term liquidity has occurred.

PROFITABILITY

Profit € 42,000 € 42,500

= 5.3% = 5.0% Decrease
margin €798,000 €858,000

Asset € 798,000 € 858,000

= 1.2 times = 1.3 times Increase
turnover € 640,000 * € 660,000 * *

*(€632,000 + €648,000) ÷ 2 **(€648,000 + €672,000) ÷ 2

Return on € 42,000 € 42,500

= 6.6% = 6.4% Decrease
assets €640,000 €660,000

Earnings € 42,000 € 42,500

= €2.10 = €2.13 Increase
per share 20,000 20,000
Profitability has remained relatively the same.
14-58
PROBLEM 14-4 (Continued)

(b) 2016 2017 Change

1. Return on € 42,500 € 50,000
ordinary = 13.2% = 11.2% Decrease
€ 323,000 (a) € 445,000 (b)
shareholders’
equity

2. Debt to assets € 342,000 (c) € 242,000

= 50.9% = 34.6% Decrease
€ 672,000 € 700,000

3. Price-earnings € 9.00 € 12.50

ratio = 4.2 times = 5.0 times Increase
€ 2.13 € 2.50 (d)

(a) (€200,000 + €130,000 + €200,000 + €116,000) ÷ 2.

(b) (€380,000 + €180,000 + €200,000 + €130,000) ÷ 2.
(c) €100,000 + €48,000 + €44,000 + €150,000.
(d) €50,000 ÷ 20,000.

LO: 14.5
Difficulty: Hard
BLOOMCODE: Application/Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-59
 PROBLEM 14-5

(a) Ratio Target Wal-Mart

(All Dollars Are in Millions)
(1) Current .9:1 ($11,573 ÷ $12,777) .9:1 ($61,185 ÷ $69,345)
(2) Accounts receivable
turnover 24.9 ($72,596 ÷ $2,921) 70.8 ($476,294 ÷ $6,723)
(3) Average collection
period 14.7 (365 ÷ 24.9) 5.2 (365 ÷ 70.8)
(4) Inventory turnover 6.1 ($51,160 ÷ $8,335) 8.1 ($358,069 ÷ $44,331)
(5) Days in inventory 59.8 (365 ÷ 6.1) 45.1 (365 ÷ 8.1)
(6) Profit margin 2.7% ($1,971 ÷ $72,596) 3.3% ($16,022 ÷ $476,294)
(7) Asset turnover 1.6 ($72,596 ÷ $46,358a) 2.3 ($476,294 ÷ $203,928c)
(8) Return on assets 4.3% ($1,971 ÷ $46,358a) 7.9% ($16,022 ÷ $203,928c)
(9) Return on ordinary
shareholders’ equity 12.0% ($1,971 ÷ $16,394.5b) 19.7% ($16,022 ÷ $81,538.5d)
(10) Debt to total assets 63.6% ($28,322 ÷ $44,553) 60.3% ($123,412 ÷ $204,751)
(11) Times interest earned 3.8 ($4,229 ÷ $1,126) 11.3 ($26,462 ÷ $2,335)

a c
($44,553 + $48,163) ÷ 2 ($204,751 + $203,105) ÷ 2
b d
($16,231 + $16,558) ÷ 2 ($81,339 + $81,738) ÷ 2

(b) The comparison of the two companies shows the following:

Liquidity—Target’s current ratio of .9:1 is the same as Wal-Mart’s, .9:1.

However, Wal-Mart has a better inventory turnover ratio than Target and
its accounts receivable turnover is substantially better than Target’s.

Profitability—Wal-Mart betters Target in all of the profitability ratios. Thus,

it is more profitable than Target.

Solvency—Wal-Mart betters Target in both of the solvency ratios. Thus, it

is more solvent than Target.

LO: 14.5
Difficulty: Hard
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting

14-60
 PROBLEM 14-6

£204,000
(a) Current ratio = = 1.5:1.
£134,000

£21,000 + £18,000 + £85,000

(b) Acid-test ratio = = 0.93:1.
£134,000

£500,000
(c) Accounts receivable turnover =
 (£85,000 + £75,000) 
 2 
= 6.3 times.

£315,000
(d) Inventory turnover = = 4.5 times.
 £80,000 + £60,000 
 2 

£36,700
(e) Profit margin ratio = = 7.3%.
£500,000

£500,000
(f) Asset turnover = = 0.8 times.
 £627,000 + £551,000 
 2 

£36,700
(g) Return on assets = = 6.2%.
 £627,000 + £551,000 
 2 

£36,700
(h) Return on ordinary shareholders’ equity =
 £373,000 + £350,000 
 2 
= 10.2%.

14-62
PROBLEM 14-6 (Continued)

£36,700
(i) Earnings per share = = £1.22.
30,000 (1)

(1) £150,000 ÷ £5.00

£19.50
(j) Price-earnings ratio = = 16.0 times.
£1.22

£13,700 (2)
(k) Payout ratio = = 37.3%.
£36,700

(2) £200,000 + £36,700 – £223,000

£254,000
(l) Debt to assets = = 40.5%.
£627,000

£64,200 (3)
(m) Times interest earned = = 8.6 times.
£7,500

(3) £36,700 + £20,000 + £7,500

LO: 14.5
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-63
 PROBLEM 14-7

€10,500,000
Accounts receivable turnover = 8 =
Average net accounts receivable

€10,500,000
Average net accounts receivable = = €1,312,500
8
Net accounts receivable 12/31/17 + €1,050,000
= €1,312,500
2
Net accounts receivable 12/31/17 + €1,050,000 = €2,625,000

Net accounts receivable 12/31/17 = €1,575,000

Net income
Profit margin = 14.5% = .145 =
€10,500,000

Net income = €10,500,000 X .145 = €1,522,500

Income before income taxes = €1,522,500 + €550,000 = €2,072,500

€1,522,500
Return on assets = 20% = .20 =
Average assets

Average assets = €1,522,500 ÷ .20 = €7,612,500

Assets (12/31/17) + €7,500,000

= €7,612,500
2
Assets (12/31/17) = €7,725,000

Total current assets = €7,725,000 – €4,620,000 = €3,105,000

Inventory = €3,105,000 – €1,575,000 – €480,000 = €1,050,000

Total liabilities and equity = €7,725,000

Total liabilities = €7,725,000 – €3,400,000 = €4,325,000

14-64
PROBLEM 14-7 (Continued)

€3,105,000
Current ratio = 2.5 =
Current liabilities

Current liabilities = €3,105,000 ÷ 2.5 = $1,242,000

Long-term notes payable = $4,325,000 – $1,242,000 = $3,083,000

Cost of goods sold

Inventory turnover = 4.2 =
 €1,720,000 +€1,050,000 
 2 

Cost of goods sold = €1,385,000 X 4.9 = €6,786,500

Gross profit = €10,500,000 – €6,786,500 = €3,713,500

Income from operations = €3,713,500 – €1,500,000 = €2,213,500

Interest expense = €2,213,500 – €2,072,500 = €141,000

LO: 14.5
Difficulty: Hard
BLOOMCODE: Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-65
 PROBLEM 14-8

VIOLET BICK SA
Condensed Statement of Comprehensive Income
For the Year Ended December 31, 2017

Operating revenues
(€12,900,000 – €2,000,000)......................... €10,900,000
Operating expenses
(€8,700,000 – €2,500,000)........................... 6,200,000
Income from operations ................................ 4,700,000
Other expenses and losses .......................... 200,000
Income before income taxes......................... 4,500,000
Income tax expense (€4,500,000 X 30%) ...... 1,350,000
Income from continuing operations............. 3,150,000
Discontinued operations
Loss from operations of hotel
chain*, net of €150,000 income
tax saving ............................................ (€350,000)
Gain on sale of hotels, net of
€90,000 income taxes ........................ 210,000 (140,000)
Net income ...................................................... 3,010,000
Other comprehensive income
Unrealized gain on
non-trading securities, net of
€45,000 income tax ............................ 105,000
Comprehensive income ................................ € 3,115,000
*€2,000,000 – €2,500,000 = (€500,000)

LO: 14.6
Difficulty: Hard
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-66
 PROBLEM 14-9

GOWER LIMITED
Statement of Comprehensive Income
For the Year Ended December 31, 2017

Net sales .............................................................. ₤1,580,000

Cost of goods sold ............................................. 1,100,000
Gross profit ......................................................... 480,000
Selling and administrative expenses ............... 160,000
Income from operations .................................... 320,000
Other income and expense ............................... (6,000)
Income before income taxes ............................. 314,000
Income tax expense (₤314,000 X 30%) ............. 94,200
Income from continuing operations ................. 219,800
Discontinued operations
Income from operations of discontinued
division, net of ₤4,500 income taxes ....... 10,500
Loss on sale of discontinued division,
net of ₤22,200 income tax saving.......... (51,800) (41,300)
Net income ......................................................... 178,500
Other Comprehensive income
Unrealized gain on
nontrading securities, net of
₤36,000 income taxes ............................. 84,000
Comprehensive income ..................................... ₤ 262,500

LO: 14.6
Difficulty: Hard
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-67
MC14 MATCHA CREATIONS

(a) 1. Current ratio

$107,366
$38,976 = 2.75:1

2. Accounts receivable turnover

$462, 500
= 142.3 times
$3, 250

3. Inventory turnover

$231, 250
= 12.9 times
$17, 897

4. Debt to assets
$44,976 = 30.2%
$149,166

5. Times interest earned

$98,863
$413 = 239 times

6. Gross profit rate

$231, 250
= 50.0%
$462, 500

7. Profit margin
$78,760 = 17.0%
$462,500

14-68
MC14 (Continued)
(a) (Continued)

8. Asset turnover
$462,500 = 3.1 times
$149,166

9. Return on assets
$78,760 = 52.8%
$149,166

10. Return on common stockholders’ equity

$78,760 = 75.6%
$104,190

(b) The company had a very good year. It was very profitable and has a
healthy balance sheet. The company is carrying very little debt and can
cover the interest charges easily. There are no liquidity or solvency
problems.

(c) The bank should have no qualms about lending money to the company.
The new debt ratio would still be reasonably low [($44,976 + $20,000) ÷
($149,166 + $20,000) = 38.4%]. Even if there were no increases in
revenue, operating income would still be more than adequate to cover
the additional interest expense. The company is very profitable and is
an acceptable credit risk for the bank.

(d) Instead of bank financing, Matcha & Coffee Creations could lease the
equipment. The company could also consider equity financing or
paying cash for the equipment.

LO: 14.6
Difficulty: Hard
BLOOMCODE: Synthesis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making

14-69
 BYP 14-1 FINANCIAL REPORTING PROBLEM

(a) (Taiwan new dollar amounts in millions)

(1) Profit Margin

2013: NT$183,849.7 ÷ NT$597,024.2 = 30.8%

2012: NT$159,286.4 ÷ NT$506,745.3 = 31.4%

(2) Asset Turnover

2013: NT$597,024.2 ÷ [(NT$1,262,800.7 + NT$961,343.7) ÷ 2] = .54 times

2012: NT$506,745.3 ÷ [(NT$961,343.7 + NT$779,541.6) ÷ 2] = .58 times

(3) Return on Assets

2013: NT$183,849.7 ÷ [(NT$1,262,800.7 + NT$961,343.7) ÷ 2] = 16.5%

2012: NT$159,286.4÷ [(NT$961,343.7 + NT$779,541.6) ÷ 2] = 18.3%

14-71
BYP 14-1 (Continued)

(4) Return on Ordinary Shareholders’ Equity

2013: NT$183,849.7 ÷ [(NT$834,113.0 + NT$713,594.3) ÷ 2] = 23.8%

2012: NT$159,286.4 ÷ [(NT$713,594.3 + NT$779,541.6) ÷ 2] = 21.3%

TSMC’S profitability decreased from 2012 to 2013.

(b) (dollar amounts in millions)

(1) Debt to Total Assets

2013: NT$428,687.7 ÷ NT$1,262,800.7 = 34.0%

2012: NT$247,749.4 ÷ NT$961,343.7 = 25.8%

(2) Times Interest Earned

2013: (NT$215,961.5 + NT$2,646.8) ÷ NT$2,646.8 = 82.6 times

2012: (NT$159,286.4 + NT$1,020.4) ÷ NT$1,020.4 = 157.1 times

Creditors provide roughly one-third of TSMC’s total assets, so its long-

term solvency is not in jeopardy. TSMC’s times interest earned ratio is
very high indicating that the company has the ability to pay the interest
on its debt.

(c) Substantial amounts of important information about a company are not

in its financial statements. Events involving such things as industry
changes, management changes, competitors’ actions, technological
developments, governmental actions, and union activities are often
critical to the successful operation of a company. Financial reports in
the media and publications of financial service firms (Standard & Poors,
Dun & Bradstreet) will provide relevant information not usually found
in the annual report.

Difficulty: Hard
BLOOMCODE: Analysis
AACSB: Analytic
AICPA BB: Industry/Sector Perspective

14-72
 BYP 14-2 COMPARATIVE ANALYSIS PROBLEM

(a) Petra Foods Nestlé

(1) (i) Percentage US$508,800  US$471,647 = 7.9% CHF92,158  CHF89,721 = 2.7%

increase US$471,647 CHF89,721
in net sales

(ii) Percentage
US$20,555  US$25,826 CHF10,015  CHF10,228 = (2.1%)
increase = (20.4%)
(decrease) in US$25,826 CHF10,228
net income

(2) (i) Percentage

US$465,896  US$1,219,770 CHF120,442  CHF125,877 = (4.3%)
increase = (61.8%)
(decrease) in US$1,219,770 CHF125,877
total assets

(ii) Percentage
US$290,386  US$326,817 CHF64,139  CHF62,664
increase = (11.2%) = 2.4%
(decrease) in US$326,817 CHF62,664
total ordinary
shareholders’
equity

Both companies had decreases in net income and total assets but
Petra Foods’ amounts were much more significant, Nestle’s total
Shareholders’ equity increased 2.4% white Petra Foods’ decreased.

Difficulty: Medium
BLOOMCODE: Evaluation
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-74
BYP 14-3 DECISION-MAKING ACROSS THE ORGANIZATION

The current ratio increase is a favorable indication as to liquidity, but

alone tells little about the going-concern prospects of the client. From
this ratio change alone, it is impossible to know the amount and direction
of the changes in individual accounts, total current assets, and total
current liabilities. Also unknown are the reasons for the changes.

The acid-test ratio decrease is an unfavorable indication as to liquidity,

especially when the current-ratio increase is also considered. This decline
is also unfavorable as to the going-concern prospects of the client because
it reflects a declining cash position and raises questions as to reasons
for the increases in other current assets, such as inventories.

The change in asset turnover cannot alone tell anything about either
solvency or going-concern prospects. There is no way to know the amount
and direction of the changes in sales and assets. An increase in sales
would be favorable for going-concern prospects, while a decrease in
assets could represent a number of possible scenarios and would need to
be investigated further.

The increase in net income is a favorable indicator for both solvency

and going-concern prospects, although much depends on the quality of
receivables generated from sales and how quickly they can be converted
into cash. If there has been a decline in sales, a significant factor is that
management has been able to reduce costs to produce an increase in
earnings. Indirectly, the improved income picture may have a favorable
impact on solvency and going-concern potential by enabling the client
to borrow currently (if it needs to do so) to meet cash requirements.

The 32-percent increase in earnings per share, which is identical to the

percentage increase in net income, is an indication that there has probably
been no change in the number of ordinary shares outstanding. This, in
turn, indicates that financing was not obtained through the issuance of
ordinary shares. It is not possible to reach conclusions about solvency
and going-concern prospects without additional information about the
nature and extent of financing.

14-75
BYP 14-3 (Continued)

The collective implications of these data alone are that the client entity
is about as solvent and as viable a going concern at the end of the current
year as it was at the beginning although there may be a need for short-term
operating cash.

Difficulty: Medium
BLOOMCODE: Evaluation
AACSB: Reflective thinking/Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-76
 BYP 14-4 COMMUNICATION ACTIVITY

To: Kyle Benson

From: Accounting Major

Subject: Financial Statement Analysis

There are two fundamental considerations in financial statement analysis:

(1) the bases of comparison and (2) the factors affecting quality of earnings.
Each of these considerations is explained below.

1. Bases of comparison. The bases of comparison are:

a. Intracompany—This basis compares an item or financial relationship

within a company in the current year with the same item or relation-
ship in one or more prior years.

b. Industry averages—This basis compares an item or financial rela-

tionship of a company with industry averages (or norms).

c. Intercompany—This basis compares an item or financial relationship

of one company with the same item or relationship in one or more
competing companies.

2. Factors affecting quality of earnings are:

a. Alternative accounting methods—Variations among companies in

the application of IFRS may hamper comparability and reduce
quality of earnings.

b. Pro forma income—This income figure usually excludes items that

the company thinks are unusual or nonrecurring.
c. Improper recognition—Because some managers feel pressure from
investors to continually increase earnings, they manipulate the
earnings numbers to meet these expectations.

Difficulty: Medium

14-77
 BYP 14-5 ETHICS CASE

(a) The stakeholders in this case are:

 Robert Turnbull, president of Turnbull Industries.

 Perry Jarvis, public relations director.
 You, as controller of Turnbull Industries.
 Shareholders of Turnbull Industries.
 Potential investors in Turnbull Industries.
 Any readers of the press release.

(b) The president’s press release is deceptive and incomplete and to that
extent his actions are unethical.

(c) As controller you should at least inform Perry, the public relations
director, about the biased content of the release. He should be aware
that the information he is about to release, while factually accurate, is
deceptive and incomplete. Both the controller and the public relations
director (if he agrees) have the responsibility to inform the president of
the bias of the about to be released information.

Difficulty: Medium
BLOOMCODE: Evaluation
AACSB: Reflective thinking/Ethics
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Business applications

14-79
 GAAP EXERCISES

GAAP 14-1

CHEN COMPANY
Statement of Comprehensive Income
For the Year Ended December 31, 2017

Sales revenue ...................................................... $1,000,000

Cost of goods sold ............................................. 700,000
Gross profit ......................................................... 300,000
Operating expenses ............................................ 200,000
Net income ........................................................... 100,000
Other comprehensive income ...........................
Unrealized gain on non-trading securities 75,000
Comprehensive income ..................................... $ 175,000

LO: 14.8
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

GAAP 14-2

CHEN COMPANY
Income Statement
For the Year Ended December 31, 2017

Sales revenue ...................................................... $1,000,000

Cost of goods sold ............................................. 700,000
Gross profit ......................................................... 300,000
Operating expenses ............................................ 200,000
Net income ........................................................... $ 100,000

CHEN COMPANY
14-80
 Comprehensive Income Statement
For the Year Ended December 31, 2017

Net income .......................................................... $100,000

Other comprehensive income ...........................
Unrealized gain on non-trading
securities ................................................. 75,000
Comprehensive income ..................................... $175,000

LO: 14.8
Difficulty: Medium
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting
AICPA PC: Problem solving and Decision making
IMA: Reporting

14-81
 GAAP 14-3 GAAP FINACIAL REPORTING PROBLEM

(a) APPLE, INC.

Trend Analysis of Net Sales and Net Income
For the Three Years Ended 2013

Base Period 2011—(in millions)

2013 2012 2011

(1) Net sales $170,910 $156,508 $108,429
Trend 158% 144% 100%

(2) Net income 37,037 41,733 25,922

Trend 143% 161% 100%

Between 2013 and 2011 Apple’s net sales increased by 58%. Apple’s
net income increased by 61% between 2011 and 2012 and increased by
almost 43% from 2011 to 2013.

(b) (dollar amounts in millions)

(1) Debt to Assets ratio

2013: $83,451 ÷ $207,000 = 40.3%

2012: $57,854 ÷ $176,064 = 32.9%

(2) Times Interest Earned

2013: ($50,155 + $136) ÷ $136 = 369.8 times

2012: No interest expense incurred
Since creditors are providing about 40% of Apple's total assets, its
long-term solvency is not in jeopardy. Apple very easily has the ability
to pay the interest on its debt as indicated by the times interest earned
of over 300 times in 2013.

14-82
GAAP 14-3 (Continued)

(c) (dollar amounts in millions)

(1) Profit Margin

2013: $37,037 ÷ $170,910 = 21.6%

2012: $41,733 ÷ $156,508 = 26.7%

(2) Asset Turnover

2013: $170,910 ÷ [($207,000 + $176,064) ÷ 2] = .89 times

2012: $156,608 ÷ [($176,064 + $116,371) ÷ 2] = 1.07 times

(3) Return on Assets

2013: $37,037 ÷ [($207,000 + $176,064) ÷ 2] = 19.3%

2012: $41,733 ÷ [($176,064 + $116,371) ÷ 2] = 28.5%

(4) Return on Common Stockholders’ Equity

2013: $37,037 ÷ [($123,549 + $118,210) ÷ 2] = 30.6%

2012: $41,733 ÷ [($118,210 + $76,615) ÷ 2] = 42.8%

In general, Apple’s profitability has decreased from 2012 to 2013.

(d) Substantial amounts of important information about a company are not

in its financial statements. Events involving such things as industry
changes, management changes, competitors’ actions, technological
developments, governmental actions, and union activities are often
critical to the successful operation of a company. Financial reports in
the media and publications of financial service firms (Standard & Poors,
Dun & Bradstreet) will provide relevant information not usually found
in the annual report.

LO: 14.8
Difficulty: Hard
BLOOMCODE: Application
AACSB: Analytic
AICPA BB: Industry/Sector Perspective
AICPA FN: Reporting

14-83