EXERCISES
Exercise 13-1 (20 minutes)
2010
Sales........................................189
Cost of goods sold ................191
Accounts receivable ..............201
2009
181
182
192
2008
168
172
182
2007
156
159
169
2006
100
100
100
Analysis: The trend in sales is positive. While this is better than no growth, one
cannot definitively say whether the sales trend is favorable without additional
information about the economic conditions in which this trend occurred such as
inflation rates and competitors’ performances.
Given the trend in sales, the comparative trends in both cost of goods sold and
accounts receivable are somewhat unfavorable. In particular, for the most recent
year, both are increasing at slightly faster rates (indexes for cost of goods sold is
191 and accounts receivable is 201) compared to sales (index is 189).
Exercise 13-2 (25 minutes)
Answer: Net income decreased.
Supporting calculations: When the sum of each year's common-size cost of
goods sold and total expenses is subtracted from the common-size sales
percent, the net income percent is as follows:
2007 net income percent: 100.0 - 59.1 - 15.1 = 25.8% of sales
2008 net income percent: 100.0 - 61.9 - 14.8 = 23.3% of sales
2009 net income percent: 100.0 - 63.4 - 15.3 = 21.3% of sales
Next, notice that if 2007 sales are assumed to be $100, then sales for 2008 are
$104.20 and the sales for 2009 are $105.40. If the net income percents for the
three years are applied to these amounts, the net incomes are:
2007 net income: $100.00 x 25.8% = $25.80
2008 net income: $104.20 x 23.3% = $24.28
2009 net income: $105.40 x 21.3% = $22.45
This shows that net income decreased over the three-year period.
©McGraw-Hill Companies, 2008
Solutions Manual, Chapter 13
671
Exercise 13-3 (25 minutes)
Sales....................................................
Cost of goods sold ............................
Gross profit ........................................
Operating expenses...........................
Net income..........................................
2008
100.0%
75.7
24.3
17.3
7.0%
2007
100.0%
46.5
53.5
35.0
18.5%
Analysis: Overall, this company’s situation has worsened. This is evident from
the substantial decline in net income as a percent of sales for 2008 (7.0%) relative
to 2007 (18.5%). The main culprit is the increase in cost of goods sold as a
percent of sales from 46.5% in 2007 to 75.7% in 2008. On a somewhat positive
note, the company has not experienced any increase in operating expenses as a
percent of sales; indeed, declining from 35.0% in 2007 to 17.3% in 2008. Even
more positive is the company’s level of sales increase from $625,000 in 2007 to
$740,000 in 2008.
Exercise 13-4 (30 minutes)
Parker has a greater amount of working capital. This by itself does not
indicate whether the company is more capable of meeting its current
obligations. However, support is provided by the current ratio and acid-test
ratio, which show Parker is in a more liquid position than Morgan. This
evidence does not mean that Morgan's liquidity is inadequate. Such a
conclusion would require more information such as norms for the industry or
its other competitors. Notably, Morgan's acid-test ratios approximate the
traditional rule of thumb (1 to 1).
This evidence also shows that Parker's working capital, current ratio, and
acid-test ratio all increased dramatically over the three-year period. This trend
toward greater liquidity may be positive, but it can also suggest that Parker
holds an excess amount of highly liquid assets that typically earn low returns.
The accounts receivable turnover and inventory turnover indicate that Morgan
is more efficient in collecting its accounts receivable and in generating sales
from available inventory. However, these statistics also may suggest that
Morgan is too conservative in granting credit and investing in inventory. This
could have a negative impact on sales and net income. Parker's ratios may be
acceptable, but no definitive determination can be made without having
information on industry (or other competitors’) standards.
©McGraw-Hill Companies, 2008
672
Financial Accounting, 4th Edition
Exercise 13-5 (30 minutes)
COMPARATIVE ANALYSIS REPORT
Clay's profit margins are higher than Roak's.
However, Roak has
significantly higher total asset turnover ratios. As a result, Roak generates
a substantially higher return on total assets.
The trends of both companies include evidence of growth in sales, total
asset turnover, and return on total assets. However, Clay's rates of
improvement are better than Roak's. These differences may result from the
fact that Clay is only three years old, while Roak is a somewhat more
established company. Clay's operations are considerably smaller than
Roak's, but that will not persist many more years if both companies
continue to grow at their current rates.
To some extent, Roak's higher total asset turnover ratios may result from
the fact that its assets may have been purchased years earlier. If the
turnover calculations had been based on current values, the differences
might be less striking. The relative ages of the assets also may explain
some of the difference in profit margins. Assuming Clay's assets are
newer, they may require smaller maintenance expenses.
Finally, Roak successfully employed financial leverage in 2010. Its return
on total assets is 9.0% compared to the 7% interest rate it paid to obtain
financing from creditors. In contrast, Clay's return is only 5.9% as
compared to the 7% interest rate paid to creditors.
©McGraw-Hill Companies, 2008
Solutions Manual, Chapter 13
673
Exercise 13-6 (20 minutes)
Simeon Company
Common-Size Comparative Balance Sheets
December 31, 2007-2009
At December 31
2009
2008*
2007
Assets
Cash ...................................................................
6.1%
8.0%
10.0%
Accounts receivable, net ..................................
17.1
14.0
13.3
Merchandise inventory .....................................
21.5
18.5
14.3
Prepaid expenses ..............................................
2.0
2.1
1.3
Plant assets, net ...............................................
53.3
57.3
61.1
100.0%
100.0%
Total assets ....................................................... 100.0%
Liabilities and Equity
Accounts payable .............................................
Long-term notes payable secured by
mortgages on plant assets ..........................
24.8%
16.9%
13.6%
18.8
22.9
22.1
Common stock, $10 par value .........................
31.3
36.7
43.3
Retained earnings ............................................
25.1
23.5
21.0
100.0%
100.0%
Total liabilities and equity ................................ 100.0%
*
Column does not equal 100.0 due to rounding.
Analysis: Several observations can be made.
(1) Cash as a percent of assets has declined—this is favorable provided sufficient
cash is available for operations.
(2) Accounts receivable have increased as a percent of assets—this may be
unfavorable in that assets are tied up in an unproductive manner and there would
be additional assets exposed to the risk of uncollection; it could be favorable if
increased sales outweigh these costs and risk.
(3) Plant assets have declined as a percent of assets—this is favorable if the
company is operating more efficiently; it could be unfavorable if the company is
downsizing due to poor performance.
(4) Accounts payable have markedly increased as a percent of assets—this could
reveal liquidity constraints.
©McGraw-Hill Companies, 2008
674
Financial Accounting, 4th Edition
Exercise 13-7 (25 minutes)
1.
2.
Current ratio
2009:
$31,800 + $89,500 + $112,500 + $10,700
$129,900
= 1.88 to 1
2008:
$35,625 + $62,500 + $82,500 + $9,375
$75,250
= 2.52 to 1
2007:
$37,800 + $50,200 + $54,000 + $5,000
$51,250
= 2.87 to 1
Acid-test ratio
2009:
$31,800 + $89,500
$129,900
= 0.93 to 1
2008:
$35,625 + $62,500
$75,250
= 1.30 to 1
2007:
$37,800 + $50,200
$51,250
= 1.72 to 1
Analysis and Interpretation: Simeon's short-term liquidity position has
deteriorated over this three-year period. Both the current and acid-test
ratios show declining trends. Although we do not have information about
the nature of the company's business, the acid-test ratio shifts from ‘1.72 to
1’ down to ‘0.93 to 1’ and the current ratio shifts from ‘2.87 to 1’ down to
‘1.88 to 1’—both suggest a potential liquidity problem. Still, we must
recognize that industry standards could show that the 2007 ratios were too
high (instead of 2009 ratios as being too low).
©McGraw-Hill Companies, 2008
Solutions Manual, Chapter 13
675
Exercise 13-8 (25 minutes)
1.
2.
3.
4.
Days' sales uncollected
2009:
$89,500
x 365 = 48.5 days
$673,500
2008:
$62,500
x 365 = 42.9 days
$532,000
Accounts receivable turnover
2009:
$673,500
($89,500 + $62,500)/2
= 8.9 times
2008:
$532,000
($62,500 + $50,200)/2
= 9.4 times
Inventory turnover
2009:
$411,225
= 4.2 times
($112,500 + $82,500)/2
2008:
$345,500
($82,500 + $54,000)/2
= 5.1 times
Days’ sales in inventory
2009:
2008:
$112,500
$411,225
x 365 = 99.9 days
$82,500
x 365 = 87.2 days
$345,500
Analysis and Interpretation: The number of days' sales uncollected has
increased and the accounts receivable turnover has declined. Also, the
inventory turnover has decreased and days’ sales in inventory has
increased. While none of these changes in ratios that occurred from 2008
to 2009 appear dramatic, it seems that Simeon is becoming less efficient in
managing its inventory and in collecting its receivables.
©McGraw-Hill Companies, 2008
676
Financial Accounting, 4th Edition
Exercise 13-9 (25 minutes)
1. Debt and equity ratios
2009
2008
Total liabilities and debt ratio
$129,900 + $98,500 .......................
$228,400
43.7%
$75,250 + $101,500 .......................
$176,750
39.7%
Total equity and equity ratio
$163,500 + $131,100 .....................294,600
56.3
$163,500 + $104,750 .....................
_______ _____
Total liabilities and equity ...............
$523,000
100.0%
268,250
60.3
$445,000 100.0%
2. Debt-to-equity ratio
2009: $228,400 / $294,600 = 0.78 to 1
2008: $176,750 / $268,250 = 0.66 to 1
3. Times interest earned
2009: ($31,100 + $9,525 + $12,100) / $12,100 = 4.4 times
2009: ($29,375 + $8,845 + $13,300) / $13,300 = 3.9 times
Analysis and Interpretation: Simeon added debt to its capital structure
during 2009, with the result that the debt ratio increased from 39.7% to
43.7%. In addition, the debt-to-equity ratio also increased from 0.66 to 1 to
0.78 to 1.
We should note that the debt increase is mostly in current
liabilities, which places a greater stress on short-term liquidity.
©McGraw-Hill Companies, 2008
Solutions Manual, Chapter 13
677
Exercise 13-10 (30 minutes)
1.
Profit margin
2009: $31,100 / $673,500 = 4.6%
2008: $29,375 / $532,000 = 5.5%
2.
3.
Total asset turnover
2009:
$673,500
= 1.4 times
($523,000 + $445,000)/2
2008:
$532,000
= 1.3 times
($445,000 + $377,500)/2
Return on total assets
2009:
$31,100
($523,000 + $445,000)/2
= 6.4%
2008:
$29,375
($445,000 + $377,500)/2
= 7.1%
Analysis and Interpretation: Simeon's operating efficiency appears to be
declining because the return on total assets decreased from 7.1% to 6.4%.
While the total asset turnover favorably increased slightly from 2008 to
2009, the profit margin unfavorably decreased from 5.5% to 4.6%. The
decline in profit margin indicates that Simeon's ability to generate net
income from sales has declined.
©McGraw-Hill Companies, 2008
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Financial Accounting, 4th Edition
Exercise 13-11 (20 minutes)
1.
2.
Return on common stockholders' equity
2009:
$31,100
($294,600 + $268,250)/2
= 11.1%
2008:
$29,375
($268,250 + $242,750)/2
= 11.5%
Price-earnings ratio, December 31
2009: $30 / $1.90 = 15.8
2008: $28 / $1.80 = 15.6
3.
Dividend yield
2009: $0.29 / $30 = 0.1%
2008: $0.24 / $28 = 0.9%
Analysis and interpretation
 The company’s return on common stockholders’ equity is good, but not
great. An 11% return makes it an acceptable investment provided its
risk is not too high.
 The company’s price-earnings ratio is around 16. This suggests that the
market does view this company to have some growth potential.
 The dividend yield is on the low side. Thus, this stock would likely be
classified as a “growth” stock, and the price-earnings ratio suggests
that the market does perceive a high likelihood of some growth.
Exercise 13-12A (10 minutes)
1.
2.
3.
4.
5.
6.
7.
8
A
C
A
A
A
B
B
A
Income (loss) from continuing operations
Extraordinary gain (loss)
Income (loss) from continuing operations
Income (loss) from continuing operations
Income (loss) from continuing operations
Gain (loss) from disposing of a discontinued segment
Income (loss) from operating a discontinued segment
Income (loss) from continuing operations
©McGraw-Hill Companies, 2008
Solutions Manual, Chapter 13
679
Exercise 13-13 (15 minutes)
RANDA MERCHANDISING, INC.
Income Statement
For Year Ended December 31, 2008
Net sales ..........................................................................
Expenses
Cost of goods sold ......................................................$1,480,000
Salaries expense ......................................................... 640,000
Depreciation expense ................................................. 232,500
Total expenses ............................................................
Income from continuing operations before taxes .......
$2,900,000
Income taxes expense ...................................................
Income from continuing operations .............................
Discontinued segment
Loss from operating wholesale business
segment (net of tax) ................................................. (444,000)
Gain on sale of wholesale business
segment (net of tax) ................................................. 775,000
Income before extraordinary gain ................................
217,000
330,500
2,352,500
547,500
331,000
661,500
Extraordinary gain on condemnation of
company property (net of tax)....................................
230,000
Net income ......................................................................
$ 891,500
©McGraw-Hill Companies, 2008
680
Financial Accounting, 4th Edition
©McGraw-Hill Companies, 2008
Solutions Manual, Chapter 13
681