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FINANCIAL STATEMENT

ANALYSIS

big, and discover how to make your dreams real.

LEARNING OBJECTIVES:

After studying this chapter, you should be able to:

1. Identify the tools for financial statement analysis.

2. Explain why financial analysts use ratios to evaluate

companies.

3. Explain liquidity and show how ratios can measure a

company’s liquidity.

4. Explain profitability and show how ratios can measure a

company’s profitability.

4. Explain solvency and show how ratios can measure a

company’s solvency.

5. Explain some limitations of ratio analysis.

6. Discuss the need for comparative analysis.

1

FINANCIAL STATEMENTS ANALYSIS

Financial Statement Analysis involves the evaluation of the firm’s past

performance, present condition, and business potentials. The analysis provides

information about the following, among others:

Ability to meet company obligations

Safety of investment in the business

Effectiveness of management in running the firm

TECHNIQUES

Some of the evaluative tools and techniques used in the financial statement

analysis include the following:

2. Vertical Analysis (Common-size FS)

3. Financial ratios

4. Gross profit variation analysis

5. Cash flow analysis

HORIZONTAL ANALYSIS

Horizontal or index analysis involves comparison of figures shown in the financial

statements of two or more consecutive periods. The difference of the amount

between two periods is calculated, and the percentage change from one period

to the next is computed using the earlier period as the base.

Change (∆ %) = Base Period Value

amount, with the ‘budget’ serving as the base or pattern of performance.

change cannot be computed.

2

VERTICAL ANALYSIS

Vertical Analysis is the process of comparing figures in the financial statements of

a single period. It involves conversion of figures in the statements to a common

base. This is accomplished by expressing all figures in the statements as

percentages of an important item such as total assets (in the balance sheet) or

net sales (in the income statement). These converted statements are called

common-size statements or percentage composition statements.

1. Multiple years of data from the same firm.

2. Companies that is different in size.

3. Company to industry averages.

RATIO ANALYSIS

Ratio analysis involves development of mathematical relationships among

accounts in the financial statements. Ratios calculated from these statements

provide users and analysts with relevant information about the firm’s liquidity,

solvency and profitability.

1. When calculating a ratio using balance sheet numbers only, the numerator and

denominator should be from the same balance sheet date. The same are true for

ratios using only income statement numbers.

2. If an income statement account and a balance sheet account are both used to

calculate a ratio, the balance sheet account should be expressed as an average for

the time period represented by the income statement account.

3. If the beginning balance of a balance sheet account is not available, the ending

balance is normally used to represent the average balance of the account.

3

4. If sales and/ or purchases are given without making distinction as to whether

made in cash or on credit, assumptions are made depending on the ratio being

calculated:

Cash flow ratios: Sales and purchases are made on cash.

5. Generally, the number of days in a month or year is not critical to the analysis:

a year may have 360 days, 52 weeks, and 12 months; alternatively, a year may be

comprised of 365 calendar days, 300 working days or any appropriate number of

days.

LIQUIDITY RATIOS

LIQUIDITY refers to the company’s ability to pay its current liabilities as they fall

due.

It is a measure of adequacy of working capital. It is the primary test of solvency to

meet current obligations from current assets.

Computed as follows:

It measures the number of times that the current liabilities could be paid with the

available cash and near-cash assets (ex. Cash, marketable securities and current

receivables).

Computed as follows:

4

WORKING CAPITAL ACTIVITY RATIOS/ EFFICIENCY

RATIOS

1. Receivables Turnover

It is the time required to complete one collection cycle from the time receivables

are recorded, and then collected, to the time new receivables are recorded again.

Computed as follows:

in Receivables

It indicates the average number of days during which the company must wait

before receivables are collected.

Computed as follows:

3. Inventory Turnover

It measures the number of times that the inventory is replaced during the period.

Computed as follows:

Inventory

in Inventory

It indicates the average number of days during which the company must wait

before the inventories are sold.

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Computed as follows:

The number of times raw materials are replaced or revolved during an accounting

period.

Computed as follows:

The number of times work in process inventory revolved during the accounting

period.

Computed as follows:

The number of times finished goods inventory revolved or are replaced during the

accounting period.

Computed as follows:

The period of time required to convert cash into raw materials, raw materials

into inventory finished goods, finished good inventory into sales and accounts

receivable, and accounts receivable into cash.

6

Computed as follows:

It is the time required to complete one payment cycle from the time trade

payables are recorded, and then paid, to the time new trade payables are

recorded again.

Computed as follows:

10. Average Age of Trade Payables/ Payable Deferral Period/ Days’ Purchases in

Payables

It indicates the length of time during which payables remain unpaid.

Computed as follows:

It measures the movement and utilization of current assets to meet operating

requirements

Computed as follows:

related to long-term assets.

7

SOLVENCY RATIOS

SOLVENCY refers to the ability of the company to pay its debts. These ratios

involve leverage ratios. LEVERAGE refers to how much of company’s resources

are financed by debt and/or preferred equity, both of which require fixed

payment of interests and dividends.

It determines the extent to which operations cover interest expense.

Computed as follows:

This refers to the proportion of assets provided by creditors compared to that

provided by owners.

Computed as follows:

3. Debt Ratio

Refers to the proportion of total assets provided by the creditors.

Computed as follows:

4. Equity Ratio

Refers to the proportion of total assets provided by owners.

8

Computed as follows:

PROFITABILITY RATIOS

1. Return on Sales

This determines the portion of sales that went into the company’s earnings.

Computed as follows:

2. Return on Assets

This refers to the efficiency with which assets are used to operate the business.

Computed as follows:

If the intention is to measure OPERATIONAL PERFORMANCE, income is

expressed as before interest and tax; alternatively, income before ‘after-

tax’ interest may be used to exclude the effect of capital structure.

expressed after interest and tax.

preferred stock dividends.

3. Return on Equity

Measures the amount earned on the owners’ or stockholders’ investment.

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Computed as follows:

Measures the amount of net income earned by each common share.

Computed as follows:

MARKETABILITY RATIOS

1. Price-Earnings Ratio

It indicates the number of pesos required to buy P1 of earnings.

Computed as follows:

Measures the rate of return in the investor’s common stock investments.

Computed as follows:

It indicates the proportion of earnings distributed as dividends

10

Computed as follows:

STABILITY RATIOS

1. Fixed Asset to Total Equity

Measures the proportion of owners’ equity to fixed assets. This indicates whether

investments by owners are over or under and also shows weakness in leverage.

Computed as follows:

Indicates possible over-expansion of plant and equipment.

Computed as follows:

Test roughly the efficiency of management in keeping plant properties employed.

Computed as follows:

Measures recoverable amount by common stockholders in the event of

liquidation if assets are realized at their book values.

11

Computed as follows:

It indicates ability to provide dividends to preferred stockholders.

Computed as follows:

Measures efficiency of the firm to generate sales through employment of its

resources.

Computed as follows:

Measures ability to meet fixed charges.

Computed as follows:

TFCE = Net Income before taxes & charges ÷ Fixed charges + sinking fund

payment**

** Fixed charges shall include rent, interests and other relevant fixed

expenses; sinking fund payment must be expressed before tax.

12

SOLVENCY RATIOS

1. Working Capital Turnover

Indicates adequacy of working capital to support operations (sale).

Computed as follows:

Measures coverage of current liabilities

Computed as follows:

3. Payable Turnover

Measures efficiency of the company in meeting the accounts payable.

Computed as follows:

Reflects extent of the utilization of resources from long-term debt. Indicative of

sources of additional funds.

Computed as follows:

13

RATIOS INDICATIVE OF INCOME POSITION

1. Rate of return on Average Current Asset

Measures profitability of current assets invested.

Computed as follows:

Measures profit generated after consideration of operating costs.

Computed as follows:

Measures the ability of the firm to translate sales to cash

Computed as follows:

Analysis of variation in gross profit is an indispensable tool in controlling

operations; the adequacy or inadequacy of gross profit determines the final

results of operations (net income). Gross profit must be adequate to cover

operating expenses, financing, income taxes and a desired amount of profit. At

times, the gross profit figure is also being used as a basis for performance

evaluation.

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Gross profit is the difference between sales and cost of goods sold. It is a very

important figure in the income statement because it is one of the factors that

determine the final result of operations.

combination of the following factors:

1. Selling price

2. Volume or quantity of products sold.

3. Cost of product sold

GP (Actual) vs. GP (Budget)

GP (Current) vs. GP (Prior Period)

NOTE:

FAVORABLE if actual (current) GP is greater than budgeted (prior-period) GP.

UNFAVORABLE if actual (current) GP is less than budgeted (prior-period) GP.

There are different ways of analyzing gross profit variances. Presented here are 4-

way, 6-way and 3-way analyses.

4-WAY ANALYSIS:

Sales Variance:

Price factor = (Change in SP x Actual Volume or quantity)

Volume/quantity factor = (Change in units x Standard/Budgeted SP)

Cost Variance:

Price factor = (Change in CP x Actual Volume or quantity)

Volume/quantity factor = (Change in units x Standard/Budgeted CP)

Note: The above procedures are the same as the one used in 2-way analysis for

materials and labor variances.

15

6-WAY ANALYSIS:

Sales Variance:

Price factor = (Change in SP x Standard/Budgeted Volume/quantity)

Volume/quantity factor = (Change in units/volume x Standard/Budgeted SP)

Price-volume factor = (Change in SP x Change in Units)

Cost Variance:

Price factor = (Change in CP x Standard/Budgeted Volume/quantity)

Volume/quantity factor = (Change in units/volume x Standard/Budgeted CP)

Price-volume factor = (Change in CP x Change in Units)

Note:

The price factor refers to the change in Selling or cost prices assuming that there

has been no change in units sold.

The quantity or volume factor refers to the change in the number of units sold

assuming that there has been no change in the selling or cost prices.

The price-volume factor refers to the sales or cost of sales variances due to the

combined effect of the differences in price and units sold.

3-WAY ANALYSIS:

Note: The quantity factor refers to the change in gross profit due to the difference

in units sold.

The price factor refers to the change in gross profit due to the difference in

selling price.

The sales price, sales volume, cost price and cost volume variances are first

computed using the approach similar to the one used for 4-way analysis. Then,

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the sales volume and cost volume variances are analyzed further, which results in

the computation of a sales mix variance and final sales volume variance. The

formulas for these last two variances are as follows:

Actual units @ Standard/Budgeted SP xx

Less: Actual units @ Standard CP (xx)

Difference xx

Less: Actual units @ Standard Average GP (xx)

SALES MIX VARIANCE xx

Actual units @ Standard/Budgeted Ave. GP xx

Less: Standard/Budgeted GP (xx)

FINAL SALES VOLUME VARIANCE xx

ILLUSTRATIVE EXERCISES

VERTICAL AND HORIZONTAL ANALYSIS

The comparative balance sheets of Philip Morris Companies, Inc. are presented

below.

Comparative Balance Sheets

December 31

(In million Dollars)

2014 2013

ASSETS

Current Assets 21,382 17,441

Property, plant and equipment (net) 16,067 14,846

Other Assets 58,726 55,253

Total Assets 96,175 87,540

Current Liabilities 21,393 19,082

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Long-term Liabilities 49,705 48,980

Stockholders’ Equity 25,077 19,478

Total Liabilities and SHE 96,175 87,540

1. Prepare a horizontal analysis of the balance sheet data for Philip Morris

using 2013 as a base.

2. Prepare a vertical analysis of the balance sheet data for Philip Morris for

2013 and 2014.

Here are the comparative income statements of Viking Corporation

VIKING CORPORATION

Comparative Income Statements

For the years ended December 31

(In million Dollars)

2014 2013

Net Sales 550,000 550,000

Cost of goods sold 440,000 450,000

Gross Profit 110,000 100,000

Operating Expenses 58,000 55,000

Net Income 52,000 45,000

1. Prepare a horizontal analysis of the income statement data for Viking

Corporation using 2013 as a base.

2. Prepare a vertical analysis of the income statement data for Viking

Corporation for both years.

LIQUIDITY ANALYSIS

Indicate the effects of each of the following transactions on the company’s (A)

current ratio and (B) acid-test ratio. There are the possible answers: (+) increase,

(-) decrease, and (0) no effect. Before each transaction takes place, both ratios

are greater than 1 to 1.

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Effects on

Transactions Current ratio Acid-test ratio

Example: Sell merchandise for cash. + +

1. Buy inventory on account.

2. Pay an account payable.

3. Borrow cash on a short-term loan.

4. Issue long-term bonds payable.

5. Collect an accounts receivable.

6. Record accrued expenses payable.

7. Sell a plant asset for cash at a profit.

8. Sell a plant asset for cash at a loss.

9. Buy marketable securities, for cash.

10. Sell merchandise on credit.

FINANCIAL RATIOS

Leen has 1,000,000 common shares outstanding. The price of the stock is P8. Leen

declared dividends per share of P0.10. The balance sheet at the end of 2013

showed approximately the same amounts as that at the end of 2014.

Sales 4,700

Cost of goods sold 2,300

Gross profit 2,400

Operating expenses:

Depreciation 320

Other 1,230 1,550

Income before interest and taxes 850

Interest expense 150

Income before taxes 700

Income taxes 280

Net income 420

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Assets Liabilities

and SHE

Cash 220 Accounts payable 190

Accounts receivable 440 Accrued expenses 180

Inventory 410 Total current liabilities 370

Total current assets 1,070 Long-term debt 1,960

Plant and equipment 5,600 Common stock 1,810

Accumulated depreciation (2,100) Retained earnings 430

Total assets 4,570 Total liabilities and SHE 4,570

1. Current ratio 11. EPS

2. Acid-test ratio 12. P/E ratio

3. Accounts receivable turnover 13. Dividend yield

4. Inventory turnover 14. Payout ratio

5. Gross profit margin 15. Debt ratio

6. Operating profit margin 16. Debt-equity ratio

7. Return on sales 17. Times interest earned

8. ROA – operational performance 18. Defensive interval

ratio

9. ROA – total management effort 19. Cash flow to total

debt

10. Return on equity 20. Cash flow margin

FINANCIAL RATIOS

(Interpreting Financial Statements)

The Coca-Cola Company and PepsiCo, Inc. provide refreshments to every corner

of the world. Selected data from the 2003 consolidated financial statements for

The Coca-Cola Company and for PepsiCo, Inc. are presented here (in millions of

Dollars).

20

Coca-Cola PepsiCo

Total current assets 8,396 6,930

Total current liabilities 7,886 6,415

Net sales 21,044 26,971

Cost of goods sold 7,762 12,379

Net income 4,347 3,568

Average receivables for the year 2,094 2,681

Average inventories for the year 1,273 1,377

Average total assets 25,874 24,401

Average common shareholders’ equity 12,945 10,713

Average current liabilities 7,614 6,234

Average total liabilities 12,929 13,702

Total assets 27,342 25,327

Total liabilities 13,252 13,453

Income taxes 1,148 1,424

Interest expense 178 163

Cash provided by operating activities 5,456 4,328

1. Compute the following liquidity ratios for 2003 for Coca-Cola and for

PepsiCo and comment on the relative liquidity of the two competitors.

a. Current ratio

b. Receivables turnover

c. Average collection period

d. Inventory turnover

e. Days in inventory

f. Current cash debt coverage

2. Compute the following solvency ratios for the two companies and

comment on the relative solvency of the two competitors.

a. Debt to total assets.

b. Times interest earned.

c. Cash debt coverage ratio.

3. Compute the following profitability ratios for the two companies and

comment on the relative profitability of the two competitors.

a. Profit margin

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b. Asset turnover

c. Return on assets

d. Return on common stockholders’ equity

KOYOT CORPORATION has the following data:

2014 2013

Sales volume in units 5,000 8,000

Selling price per unit P10 P8

Cost per unit P7 P6

Compute for the Gross Profit Variance using:

1. 4-way analysis

2. 6-way analysis

3. 3-way analysis

(FULL INFORMATION)

2014 for its toy gun:

Cost of goods sold 288,000

Gross profit 144,000

In January, actual operations resulted in the production and sale of 13,000 units

at an average selling price of P34 per unit. The cost of goods sold per unit

increased by P3.

1. Overall GP variance.

2. Sales price variance.

3. Sales volume variance.

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4. Cost price variance.

5. Cost volume variance.

(INCOMPLETE INFORMATION)

Spaniard Company has requested you to determine the cause of the difference

between its 2013 and 2014 gross profit based on the following data:

2013 2014

Sales 200,000 252,000

Cost of Goods Sold 120,000 180,000

Gross Profit 80,000 72,000

No additional data was made available except that unit sales increased by 20% in

2014.

1. Overall GP variance.

2. Price factor.

3. Cost factor.

4. Volume factor.

The following are the data for ARIUS LUKE ANGELO CORPORATION:

2014 2013

Product Product Product Product Product Product

A L R A L R

Sales volume 400 350 1,000 500 200 1,000

in units

Selling prices P4 P5 P3 P4.50 P4.20 P2.80

per unit

Cost per unit P1.60 P2 P1.20 P1.68 P1.80 P1.12

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Required: (Round all computations to 2 decimal places).

Compute for the sales mix variance and final sales volume variance

The following data were given for Vamos Company:

2013 2014

Product Product Product Product

A B A B

Sales volume 6,000 4,000 3,000 5,000

Unit selling price 10 6 9 5

Unit cost 6 3 4 3

1. Overall GP variance 4. Volume factor

2. Price factor 5. Mix factor

3. Cost factor

PRACTICE EXERCISES

(Sources: CMA/CIA/RPCPA/AICPA/Various test banks)

THEORIES

1. A high sales-to-working capital ratio could indicate

a. Unprofitable use of working capital

b. Sales are not adequate relative to available working capital.

c. The firm is undercapitalized.

d. The firm is not susceptible to liquidity problems.

accounts. An account receivable that was previously determined

uncollectible and written off was collected during May. The effect of the

collection on Rice’s current ratio and total working capital is

Current Ratio Working Capital

a. None None

b. Increase Increase

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c. Decrease Decrease

d. None Increase

a. The write-off of an uncollectible account (assume the use of the

allowance for doubtful accounts method).

b. A significant sales volume decrease near the end of the accounting

period.

c. An increase in cash sales in proportion to credit sales.

d. A change in credit policy to lengthen the period of cash discounts.

a. Uses a natural business year for its accounting period.

b. Uses a calendar year for its accounting period.

c. Uses average receivables in the ratio calculation.

d. Does not use average receivables in the ratio calculation

Depoole Company is a manufacturer of Industrial products and uses a calendar

year for financial reporting purposes. These questions present several of

Depoole’s transactions during the year. Assume that the total quick assets

exceeded total current liabilities both before and after each transaction

described. Further assume that Depoole has positive profits during the year and a

credit balance throughout the year in its retained earnings account.

a. Increase the current ratio, but the quick ratio would not be affected.

b. Increase the quick ratio, but the current ratio would not be affected.

c. Increase both the current and quick ratios.

d. Decrease both the current and quick ratios.

a. Increase the current ratio.

b. Decrease the current ratio.

c. Increase net working capital.

d. Decrease net working capital.

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7. The collection of a current account receivable of P29,000 would

a. Increase the current ratio

b. Decrease the current ratio and the quick ratio

c. Increase the quick ratio

d. Not affect the current or quick ratio

8. Obsolete inventory of P125,000 was written off during the year. This

transaction

a. Decreased the quick ratio.

b. Increased the quick ratio.

c. Increased net working capital.

d. Decreased the current ratio.

a. Decreases the book value per share of common stock.

b. Increases the book value per share of common stock.

c. Increases total shareholders’ equity.

d. Decreases total shareholders’ equity.

10. The issuance of a serial bonds in exchange for an office building, with the

first installment of the bonds due late this year,

a. Decreases net working capital.

b. Decreases the current ratio.

c. Decreases the quick ratio.

d. Affects all of the answers as indicated.

long-term note with cash affects the

a. Current ratio to a greater degree than the quick ratio.

b. Quick ratio to a greater degree than the current ratio.

c. Current and quick ratio to the same degree.

d. Current ratio but not the quick ratio.

12. To determine the operating cycle for a retail department store, which one

of the following pairs of items is needed?

a. Days sales in accounts receivable and average merchandise inventory.

b. Cash turnover and net sales.

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c. Accounts receivable turnover and inventory turnover.

d. Asset turnover and return on sales.

13. If the ratio of total liabilities to shareholders’ equity increases, a ratio that

must also increase is

a. Times interest earned.

b. Total liabilities to total assets.

c. Return on equity.

d. The current ratio.

turnover by

a. Average collection period.

b. Profit margin.

c. Debt ratio.

d. Fixed-charge coverage.

the following ratios is likely to be the largest?

a. Return on total assets.

b. Return on operating assets.

c. Return on common equity.

d. Return on total equity.

16. A drop in the market price of a firm’s common stock will immediately

increase its

a. Return on equity.

b. Dividend payout ratio.

c. Market-to-book ratio.

d. Dividend yield.

a. About the same as the debt-to-assets ratio.

b. Higher than the debt-to-assets ratio.

c. Lower than the debt-to-assets ratio.

d. Not correlated with the debt-to-assets ratio.

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18. Which of the following is not a limitation of ratio analysis affecting

comparability among firms?

a. Different accounting policies.

b. Different fiscal years.

c. Different sources of information.

d. All of the above are limitations of ratio analysis.

19. Which of the following is the worst limitation of ratio analysis affecting

comparability from one interim period to the next within the firm?

a. Management has an incentive to window dress financial statements

to improve results.

b. In a seasonal business, inventory and receivables may vary widely

with year-end balances not reflecting the averages for the period.

c. Comparability is impaired if different firms use different accounting

policies.

d. Generalizations about which ratios are strong indicators of a firm’s

financial position may change from industry to industry and firm to

firm.

20. In assessing the financial prospects for a firm, financial analysts use

various techniques. Which of the following is an example of vertical

common-size analysis?

a. An assessment of the relative stability of a firm’s level of vertical

integration.

b. A comparison in financial ratio form between two or more firms in

the same industry.

c. A statement that current advertising expense is 2% greater than in

the prior year.

d. A statement that current advertising expense is 2% of sales.

21. Under the direct method of determining net cash provided by operating

activities on the statement of cash flows, a gain on sale of plant assets

would be:

a. Added to the amount of operating expenses reported under the accrual

basis.

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b. Deducted from the amount of the operating expenses reported under

the accrual basis.

c. Deducted from the amount of sales reported under the accrual basis.

d. Totally ignored since the gain is not a part of sales, cost of goods sold,

or operating expenses.

funds?

a. An increase in accounts payable c. A decrease in bonds payable

b. An increase in retained earnings d. A decrease in accounts

receivable

23. Shakey’s Corporation has an acid test ratio of 1.5 to 1.0. Which of the

following will cause this ratio to deteriorate?

a. Payment of cash dividends previously declared.

b. Borrowing short-term loan from a bank.

c. Sale of inventory on account.

d. Sale of equipment at a loss

24. A Company has a current ratio greater than 1:1 and a quick ratio less than

1:1. Soon thereafter, all cash was used to reduce accounts payable. How

did these cash payments affect (1) current ratio (2) quick ratio?

a. (1) Decreased (2) Decreased c. (1) Increased (2) Decreased

b. (1) Decreased (2) Increased d. (1) Increased (2) Increased

25. If Jonas Co. decides to change from FIFO to LIFO inventory method during

the period of rising prices, its

a. Current ratio would be reduced c. Inventory turnover will be

reduced

b. Debt-to-equity ratio would be reducedd. Cash flow would be reduced

26. How is the average inventory balance used in the calculation of each of

the following?

Acid-test ratio Inventory turnover

a. Numerator Numerator

b. Numerator Denominator

c. Not used Denominator

d. Not used Numerator

29

27. A company’s return on investment is affected by a change in

Capital turnover Profit margin on sales

a. Yes Yes

b. Yes No

c. No No

d. No Yes

earned on capital invested in a business unit. A company’s ROI is

increased if

a. Sales increase by the same peso amount as expenses and total assets.

b. Sales remain the same and expenses are reduced by the same peso

amount that total assets

increase.

c. Sales decrease by the same dollar amount that expenses increase.

d. Net profit margin on sales increases by the same percentage as total

assets.

a. Solvency c. Profitability

b. Liquidity d. Current asset activity

30. A fire has destroyed many of the financial records of National & Co. You

are assigned to put together a financial report. You have found out that

the return on equity to be 12% and the debt ratio was 0.40.

What was the return on assets?

a. 5.35% c. 6.60%

b. 8.4% d. 7.20%

PROBLEMS

1. Windham Company has current assets of P400,000 and current liabilities

of P500,000. Windham Company’s current ratio would be increased by

a. The purchase of P100,000 of inventory on account.

b. The payment of P100,000 of accounts payable.

30

c. The collection of P100,000 of accounts receivable.

d. Refinancing a P100,000 long-term loan with short-term debt.

Tosh Enterprises reported the following account information.

Accounts payable 160,000

Bonds payable, due in 10 years 600,000

Cash 200,000

Interest payable, due in 3 months 20,000

Inventory 800,000

Notes payable, due in 6 months 100,000

Prepaid expenses 80,000

The company has a normal operating cycle of 6 months.

a. 1.68

b. 2.14

c. 5.00

d. 5.29

a. 0.68

b. 1.68

c. 2.14

d. 2.31

4. What will happen to the ratios below if Tosh Enterprises uses cash to pay

25% of the accounts payable?

Current Ratio Quick Ratio

a. Increase Increase

b. Decrease Decrease

c. Increase Decrease

d. Decrease Increase

31

5. The amount of working capital is

a. 600,000

b. 1,120,000

c. 1,200,000

d. 1,220,000

The selected data pertain to a company at December 31.

Acid test ratio 2.6 to 1

Current ratio 3.5 to 1

Net sales for the year P1,800,000

Cost of sales for the year P990,000

Average total assets for the year P1,200,000

a. 59,429

b. 80,000

c. 134,857

d. 187,200

a. 72,000

b. 187,200

c. 231,111

d. 282,857

a. .675

b. .825

c. 1.21

d. 1.50

32

9. Watson Corporation computed the following items from its financial

records for the year:

Price earnings ratio 12

Payout ratio .6

Asset turnover ratio .9

a. 5.0%

b. 7.2%

c. 7.5%

d. 10.8%

Evergreen Inc., at the end of the fiscal year:

Number of shares outstanding 1,800,000

Par value per share 10.00

Dividends paid per share(last 12 months) 12.00

Market price per share 108.00

Basic earnings per share 36.00

Diluted earnings per share 24.00

a. 3.0 times

b. 4.5 times

c. 9.0 times

d. 10.8 times

11. Baylor Company paid out one-half of last year’s earnings in dividends.

Baylor’s earnings increased by 20%, and the amount of its dividends

increased by 15% in the current year. Baylor’s dividend payout ratio for

the current year was

a. 50%

b. 57.5%

c. 47.9%

d. 78%

33

12. Selected data from Starbucks are presented below. The difference

between average and ending inventories is immaterial. Current assets are

comprised mainly of cash, receivables and inventories.

Quick ratio 1.5

Current liabilities 600,000

Inventory turnover (based on cost of sales) 8 times

Gross profit margin 40%

a. 2.4 million c. 1.2 million

b. 4.0 million d. 6.0 million

13. Based on the data presented below, what is Goldilocks Corporation’s cost

of sales for the year?

Acid test ratio 3.0

Year end current liabilities 600,000

Beginning inventory 500,000

Inventory turnover 8.0

a. 1,600,000 c. 3,200,000

b. 2,400,000 d. 6,400,000

2012 2013 2014

Accounts receivable, net 40,000 42,500 45,000

Inventory 40,000 50,000 45,000

Current assets 120,000 140,000 130,000

Total assets, net 700,000 750,000 725,000

Current liabilities 70,000 80,000 50,000

Cash sales 400,000 420,000 450,000

Credit sales 120,000 125,000 131,250

Cost of sales 310,000 324,000 345,000

34

14. What would be the age of receivables in 2014?

a. 110 days c. 130 days

b. 120 days d. None of these

a. 50 days c. 70 days

b. 60 days d. None of these

a. 9.9 c. 7.15

b. 8.3 d. None of these

Average inventory 1,800,000

Net sales 7,200,000

Average receivables 960,000

Net income 720,000

Assuming 360 days in a year, what was the average number of days in

operating cycle for 2014?

a. 72 days c. 144 days

b. 84 days d. 168 days

The statement of financial position for King Products Corporation for the fiscal

years ended June 30, 2014 and June 30, 2013 is presented below. Net sales and

cost of goods sold for the year ended June 30, 2014 were P600,000 and P440,000

respectively.

35

King Products Corporation

Statement of Financial Position

(In Thousands)

June 30, June 30,

2014 2013

Cash 60 50

Trading securities (at Fair Value) 40 30

Accounts receivable (net) 90 60

Inventories (at lower of cost or market) 120 100

Prepaid items 30 40

Total current assets 340 280

Building (net) 160 180

Equipment 190 200

Patents (net) 70 34

Goodwill (net) 40 26

Total long-term assets 600 630

TOTAL ASSETS 1,000 910

Notes payable 46 24

Accounts payable 94 56

Accrued interest 30 30

Total current liabilities 170 110

Notes payable, 10% due 12/31/19 20 20

Bonds payable, 12% due 6/30/21 30 30

Total long-term debt 50 50

Total Liabilities 220 160

Preferred stock-5% cumulative, P100 par,

nonparticipating, authorized, issued and 200 200

outstanding 2,000 shares

Common stock-P10 par, 40,000 shares

authorized, 30,000 shares issued and 300 300

outstanding

Additional paid in capital 150 150

Retained earnings 130 100

36

Total Equity 780 750

TOTAL LIABILITIES AND EQUITY 1,000 910

18. King Products Corporation’s inventory turnover ratio for the fiscal year at

June 2014 was

a. 3.7

b. 4.0

c. 4.4

d. 6.0

19. King Products Corporation’s receivables turnover ratio for this period was

a. 4.9

b. 5.9

c. 6.7

d. 8.0

20. King Products Corporation’s average collection period for the fiscal year

ended June 30, 2014 using a 360-day year was

a. 36 days

b. 45 days

c. 54 days

d. 61 days

21. King Products Corporation’s quick ratio at June 30, 2014 was

a. 0.6

b. 1.1

c. 1.8

d. 2.0

22. Assuming that King Products Corporation’s net income for the year ended

June 30, 2014 was P70,000 and there are no preferred stock dividends in

arrears, King Products’ return on common equity was

a. 7.8%

b. 10.6%

c. 10.9%

d. 12.4%

37

23. Assuming that there are no preferred stock dividends in arrears, King

Products Corporation’s book value per share of common stock at June 30,

2014 was

a. 10.00

b. 14.50

c. 18.33

d. 19.33

24. Given an acid test ratio of 2.0, current assets of P5,000 and inventory of

P2,000, the value of current liabilities is

a. 1,500

b. 2,500

c. 3,500

d. 6,000

Company.

Statement of Financial Position as of May 31

(In Thousands)

2014 2013

Assets

Current assets

Cash 45 39

Trading securities 30 20

Accounts receivable (net) 68 48

Inventory 90 80

Prepaid expenses 22 30

Total current assets 255 216

Investments, at equity 38 30

Property, plant, and equipment (net) 375 400

Intangible assets (net) 80 45

TOTAL ASSETS 748 691

38

Liabilities and equity

Current liabilities

Notes payable 36 18

Accounts payable 70 42

Accrued expenses 5 4

Income taxes payable 15 16

Total current liabilities 125 80

Long-term debt 35 35

Deferred taxes 3 2

Total liabilities 163 117

Equity

Preferred stock, 6%, P100 par value 150 150

cumulative

Common stock, P10 par value 225 195

Additional paid-in capital common stock 114 100

Retained earnings 96 129

Total equity 585 574

TOTAL LIABILITIES AND EQUITY 748 691

(in thousands)

2014 2013

Net sales 480 460

Costs and expenses

Cost of goods sold 330 315

Selling, general and administrative 52 51

Interest expense 8 9

Income before taxes 90 85

Income taxes 36 34

Net income 54 51

a. 0.60 to 1

b. 0.90 to 1

c. 1.14 to 1

d. 1.86 to 1

39

26. Assuming there are no preferred stock dividends in arrears, Devlin

Company’s return on common equity for the year ended May 31, 2014

was

a. 6.3%

b. 7.5%

c. 7.8%

d. 10.5%

27. Devlin Company’s inventory turnover for the year ended May 31, 2014

was

a. 3.67 times

b. 3.88 times

c. 5.33 times

d. 5.65 times

28. Devlin Company’s asset turnover for the year ended May 31, 2014

a. 0.08 times

b. 0.46 times

c. 0.67 times

d. 0.83 times

29. Devlin Company’s rate of return on assets for the year ended May 31,

2014

a. 7.2%

b. 7.5%

c. 7.8%

d. 11.2%

30. Devlin Company’s time-interest-earned ratio for the year ended May 31,

2014 was

a. 6.75 times

b. 11.25 times

c. 12.25 times

d. 18.75 times

40

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