CH A PTER 14 Analyzing Financial Statements: A Managerial Perspective Summary of Questions by Objectives and Bloom’s Taxonomy Item SO BT Item True-False Statements 1 K K C C 10 K 11 C 12 Multiple Choice Questions 31 K 53 32 K 54 33 K 55 34 K 56 35 C 57 36 K 58 37 K 59 38 5,6 K 60 39 5,6 C 61 40 K 62 41 K 63 42 K 64 43 K 65 44 K 66 45 K 67 46 K 68 47 K 69 48 C 70 49 C 71 50 AP 72 51 C 73 52 K 74 Matching 139 1,2, K 4,5 Exercises 140 AP 144 141 AP 145 142 AN 146 143 AN 147 Challenge Exercises 156 AN 157 Short-Answer Essays 159 K 161 160 K 162 SO BT Item SO BT 2 2 C K K C K K 13 14 15 16 17 18 2 2 3 K K K K K K 5 5 5 6,7 5 5 5 5 5 5 K K C K K C K K K C C AP AP AP AP AN AN AP AP AP AP AP 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 6 6 6 6 6 6 6 6 7 7 AP K K K K K K AP AP AP AP AP K K C AP AP AP K K C C 4 AN AN AN AN 148 5,6,7 AN 149 AP 150 AP 151 AN AN 158 AN K C 163 164 C C Item SO BT 19 20 21 22 23 24 4 5 5 K K K K K C 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 7 7 5 2 5 5 6 6 7 C AP AP AP AP AP AP AP AP AP C AP AP AP C AP AP AP AP AP AP AP 152 5,6,7 153 154 155 165 166 AN AN AN AP C C Item SO BT 25 26 27 28 29 30 6 7 7 K K K K K K 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 5 5 6 6 7 7 7 7 AP AP AP AP C AP AP AP AP AP AP C AP AP AP AP AP AN AN AN 14-2 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition TRUE-FALSE A managerial accountant may analyze his/her company’s own financial statements in order to assess the appearance of his/her firm to investors One reason a managerial accountant might need to analyze financial statements of other firms is to assess the viability of a vendor To assess control of operations, managers expect that successful implementation of their plan will be reflected in subsequent financial statements as substantially increased profits It is important for managers to analyze their company’s financial statements so that they can anticipate and answer questions from investors and creditors In general, managers should analyze financial statements primarily from the perspective of their customers Whenever an asset increases, the corresponding part of the transaction will always be an increase to net income Vertical analysis is performed on the balance sheet because it represents a point in time, while horizontal analysis is performed on the income statement because it covers a period of time An increase in gross margin of 7% from one period to the next implies that the company’s net income will have increased by 7% as well The statement of cash flows divides a company’s profitability into operating, investing, and financing activities 10 If sales revenue of a retail company increases by 10% because the company sells more units of product, the company’s cost of goods sold will increase by 10% as well 11 If a company records fictitious sales, income will increase, but operating cash flows will not be affected 12 Common size financial statements are an example of horizontal analysis 13 Horizontal analysis examines the change in financial statement amounts over time 14 One example of vertical analysis is the determination that long-term assets increased by 2.5% over time 15 One example of vertical analysis is the determination that interest expense rose from 1.2% of net sales to 1.4% of net sales from one period to the next period 16 When the amount of net sales is used as the base amount for all income statement items, horizontal analysis is being performed 17 If net income is substantially less than operating cash flows, this is a sign of possible accounting irregularities Chapter 14 Analyzing Financial Statements: A Managerial Perspective 14-3 18 Recording fictitious sales will cause operating cash flows and net income to increase 19 The management discussion and analysis section of the annual report explains financial results that are not obvious simply from reading the basic financial statements 20 News articles and credit reports are valuable sources of financial information 21 Financial leverage relates to a company’s use of debt financing to acquire and use productive assets 22 Earnings per share is the amount of net income earned in a company that is paid out as cash dividends to shareholders 23 The gross margin percentage is a turnover ratio that measures the efficiency with which a company sells its products 24 If a company’s return on total assets is higher than its return on common stockholders’ equity, a company is using financial leverage effectively 25 An increase in inventory turnover implies that a company is selling its inventory and collecting cash from customers more quickly 26 Turnover ratios involve both a balance sheet and an income statement account 27 Debt-related ratios reveal the ability of a company to pays its obligations when they become due 28 A high debt-to-equity ratio implies that a company has more risk than a company with a low ratio 29 Times interest earned measures how many times operating income is able to pay the company’s interest expense 30 The acid-test ratio is a more stringent test of a company’s ability to pay its short-term debt compared to the current ratio Answers T T F T F F 10 11 12 F F F T T F 13 14 15 16 17 18 T F T F F F 19 20 21 22 23 24 T T T F F F 25 26 27 28 29 30 F T T T T T 14-4 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition MULTIPLE CHOICE 31 Which of the following is not a reason that managers need to analyze financial reports? A To assess control of operations B To assess the ability of customers to pay their bills C To assess the viability of suppliers D To maximize annual bonuses 32 Which of the following is a reason that managers use financial statements? A To assess the company’s image B To assess the product cost of competitors C To assess competitors’ contribution margins D To assess the long-term viability of key customers 33 Which of the following does accounts receivable turnover measure? A The ability of a company to pay its short-term obligations B The number of times receiveables are collected during the period C The efficiency with which a company generates sales on credit D The length of time it takes to collect receivables 34 Which of the following indicates the amount investors are willing to pay per dollar of earnings? A Market price per share of a company’s stock B Earnings per share C Price-earnings ratio D Return on total assets 35 Using the balance sheet equation, which of the following is not a possible transaction? A Increase an asset and increase stockholders’ equity B Increase a liability and decrease stockholders’ equity C Increase an asset and decrease a liability D Decrease an asset and decrease a liability 36 Which of the following is the return a company is able to earn on funds invested by shareholders? A Return on total assets B Return on common stockholders’ equity C Price-earning ratio D Dividends paid 37 Which of the following is not an operating activity on the statement of cash flows? A Paying a dividend B Paying for inventory purchases C Collecting cash from the sale of merchandise D Paying cash for income taxes 38 Which of the following is not a profitability ratio? A Price-earnings ratio B Return on total assets C Earnings per share D Asset turnover Chapter 14 Analyzing Financial Statements: A Managerial Perspective 14-5 39 Which of the following changes is the least favorable? A An increase in inventory turnover B A decrease in operating expenses C An increase in the price-earnings ratio D A decrease in the asset turnover 40 Net cash provided by operations represents A net income converted to a cash basis B the net increase in cash and cash equivalents for a period C the cash provided by selling inventory to customers D a measure of profitability 41 What does financial leverage measure? A How quickly a company generates profit from its assets B How quickly a company is turning its net income into cash C The overall efficiency with which a company uses assets to generate revenues D How effectively the company uses debt financing to acquire economic resources 42 What is asset turnover? A How quickly a company generates profit from its assets B How quickly a company is turning its net income into cash C The overall efficiency with which the company uses assets to generate revenues D How quickly the company acquires economic resources 43 Which of the following is true concerning vertical analysis? A It is a technique for evaluating a series of financial statement data over a period of time B It is used to determine the increase or decrease that has taken place over a period of time C It is expressed as a percentage of the base year amount of the same account D It is also called common size analysis 44 Which of the following is true concerning horizontal analysis? A It is also called common size analysis B It consists of analyzing changes in financial statement amounts across time C It consists of analyzing financial statements in terms of a base amount D It restates each income statement line item as a percentage of net sales 45 Which type of analysis would highlight the percentage increase in sales from one year to the next? A Horizontal analysis B Vertical analysis C Common size analysis D Comprehensive analysis 46 What type of analysis will you perform to compare the gross margin percentage from one year to the next? A Debt-related analysis B Turnover analysis C Horizontal analysis D Vertical analysis 14-6 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 47 In which of the following will the percentage increase in sales from one year to the next be most obvious? A Profitability analysis B Turnover analysis C Horizontal analysis D Vertical analysis 48 If the rate of growth in sales is greater than the rate of growth in cost of goods sold from one year to the next, which of the following will you most likely expect? A The gross margin percentage is increasing B The gross margin percentage is decreasing C Accounts receivable turnover is declining D Inventory turnover is declining 49 Which of the following will vertical analysis allow managers to readily identify? A Sales are increasing at a faster rate than selling expenses B The percentage change in sales from the prior year C Sales are growing at a faster rate than assets D Income taxes are a larger percentage of sales in the current year compared to a previous year 50 Gross margin in 2014 for Beaver Enterprises totaled $1,000,000 If cost of goods sold is 60% of sales, how much is sales? A $400,000 B $600,000 C $1,666,667 D $2,500,000 51 If management is manipulating earnings to achieve performance targets, what outcome may result? A Net income may exceed cash from operations B Cash from investing activities will exceed cash from financing activities C Cash will experience a net decrease D Total assets will increase 52 Where can you find insight of why sales has increased by 32% from a prior period? A Common size financial statements B Management’s discussion and analysis C The balance sheet D Horizontal analysis 53 Which of the following is a stringent measure of a company’s ability to repay obligations in a short period of time? A Return on total assets B Current ratio C Acid-test ratio D Debt turnover Chapter 14 Analyzing Financial Statements: A Managerial Perspective 14-7 54 Which of the following ratios measures how many multiples of the firm’s earnings that investors are willing to pay for the company’s stock? A Return on total assets B Earnings per share C Price-earnings ratio D Time interest earned 55 Which of the following most likely indicates that a company is making good use of financial leverage? A The price-earnings ratio exceeds that of competitors B Earnings per share is higher than the dividends paid per share C Net income is higher than cash from operations D Return on common stockholders’ equity is higher than the return on total assets 56 What effect does financing with debt have on a company? A It will increase financial risk B It will decrease the potential return for shareholders C It will create a requirement to pay dividends D It will decrease turnover 57 Which of the following is not a profitability ratio? A Inventory turnover B Gross margin percentage C Earnings per share D Return on total assets 58 Which ratio measures the rate earned on a company’s total economic resources? A Price-earnings ratio B Earnings per share C Return on total assets D Return on common stockholders’ equity 59 Which ratio is a measure of the profit available to common shareholders on each share of common stock outstanding? A Price-earnings ratio B Earnings per share C Return on total assets D Return on common stockholders’ equity 60 Which statement is true concerning the gross margin percentage? A It indicates how much a company earns per dollar of sales taking into account the cost of items it sells B It indicates how much earnings are generated on each share of common stock C It indicates the amount of sales generated for each dollar of assets D It measures the amount of net income generated for each dollar of sales 61 Which of the following ratios is a measure of the company’s profitability to its market price? A Price-earnings ratio B Earnings per share C Return on total assets D Return on common stockholders’ equity 14-8 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 62 Which of the following is not used to measure the efficiency with which a firm uses its assets? A Inventory turnover ratio B Current ratio C Accounts receivable turnover ratio D Asset turnover 63 Which of the following is a common effect when return on common stockholders’ equity is greater than return on total assets? A Financial leverage is being used effectively B The company has no debt C The company’s profit is declining D Earnings per share will be extremely large 64 Cost of goods sold in 2014 for Reno Parts Company totaled $4,530,000 If the gross margin percentage is 56%, how much are sales ? A $10,295,454 B $7,066,800 C $8,089,286 D None of these answer choices are correct 65 The gross margin amount in 2014 for the Billings Corporation totaled $800,000 If cost of goods sold is 80% of sales, how much is sales? A $960,000 B $4,000,000 C $3,200,000 D $1,440,000 66 Bonanza, Incorporated’s net income in 2014 was $378,000 The company had 75,000 shares of common stock outstanding and 35,000 shares of preferred stock outstanding No shares were issued or repurchased during the year The company paid dividends of $1.50 per share on the common stock and $1.80 per share on the preferred stock How much is earnings per share for 2014? A $3.44 B $4.20 C $4.34 D $5.04 67 Best Corporation’s net income in 2014 was $1,295,000 The company had 500,000 shares of common stock outstanding and 90,000 shares of preferred stock outstanding No shares were issued or repurchased during the year The company paid dividends of $0.70 per share on the common stock and $0.80 per share on the preferred stock How much profit did Best generate for each share of outanding common stock in 2014? A $1.15 B $2.45 C $2.59 D $2.19 Chapter 14 Analyzing Financial Statements: A Managerial Perspective 68 14-9 Bread Enterprises had a current ratio of 3.5 on December 31 of the current year On that date, the company’s assets were as follows: Cash Accounts receivable, net Inventory Prepaid expenses Equipment, net Total assets $ 200,000 600,000 960,000 25,000 2,200,000 $3,985,000 What impact will issuing common stock for cash have on the company’s earnings per share? A It will increase earnings per share B It will decrease earnings per share C There will be no change D The number of common shares outstanding is needed to determine the answer 69 Bread Enterprises had a current ratio of 2.5 on December 31 of the current year On that date, the company’s assets were as follows: Cash Accounts receivable, net Inventory Prepaid expenses Equipment, net Total assets $ 100,000 600,000 960,000 25,000 2,200,000 $3,985,000 What impact will an increase in the market price of the company’s common stock from $24.50 to $37.20 have on a company’s price-earnings ratio? A It will increase the price-earnings ratio B It will decrease the price-earnings ratio C There will be no change D There is not enough information to determine the answer 70 Lane Class Company had 50,000 shares of common stock outstanding and 10,000 shares of preferred stock outstanding No shares were issued or repurchased during the year The company paid a dividend of $0.80 per share of common stock and $0.60 per share of preferred stock If the company reports earnings per common share of $0.85, how much is net income? A $42,500 B $56,500 C $48,500 D $57,000 71 Blue Corporation reported earnings per share of common stock at $12 in 2014 and paid dividends of $3 per share The current market price per share is $102 and the book value per share is $54 Blue Corporation has no preferred stock How much is the company’s price-earnings ratio? A $11.80 B $1.90 C $8.50 D $11.30 14-10 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 72 McDonald Company’s net income in 2014 was $200,000 The company paid preferred dividends of $32,000 and common stock dividends of $10,000 It average common stockholders’ equity was $850,000 during 2014 How much is the company’s return on common stockholders’ equity for 2014? A 19.8% B 23.5% C 18.6% D 4.3% 73 The following is from Nantucket Limited’s records for 2014: Account Balances Common stock Additional paid-in-capital Retained earnings January $210,000 95,000 105,000 December 31 $250,000 110,000 195,000 During 2014, the company paid dividends of $15,000 on its common stock The company’s net income for the year was $105,000 How much is the company’s return on common stockholders’ equity for the year ending December 31, 2014? A 18.9% B 16.2% C 22.0% D 25.6% 74 Relish Holdings had 250,000 shares of common stock outstanding and 40,000 shares of preferred stock outstanding No shares were issued or repurchased during the year The company paid a dividend of $1.50 per share of common stock and $2 per share of preferred stock If the company reported earnings per common share of $1.60, how much would net income have been? A $480,000 B $400,000 C $156,250 D $320,000 75 Denton Limited Company reported earnings per share of common stock $2 in 2014 and paid dividends of $1.50 per share Denton has no preferred stock issued The current market price per share is $15 and the book value per share is $14 How much is Denton’s price-earnings ratio? A $6.75 B $7.50 C $7.00 D $30.00 76 Asset turnover is A net income divided by sales B net sales divided by total assets C net sales divided by current assets D earnings per share divided by the market price per share of stock 77 Asset turnover is a measure of A how quickly a company is replacing its old plant assets with new plant assets B how quickly a company is turning its sales into cash C the overall efficiency with which the company uses assets to generate revenues D how rapidly the stock market believes the company will grow Chapter 14 Analyzing Financial Statements: A Managerial Perspective 147 14-57 The following information for Kinnis, Inc., a retail furniture and design firm, is presented at December 31, 2014 and 2013: December 31 Assets Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets Building and equipment Total assets 2014 2013 $ 42,000 480,000 5,010,000 84,000 5,616,000 1,591,000 $7,207,000 $ 54,000 345,000 4,950,000 79,000 5,428,000 1,193,000 $6,621,000 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Bank loan payable Other accrued payables Total current liabilities Long-term debt Total liabilities $ 705,000 679,000 215,000 1,599,000 1,729,000 3,328,000 $ 628,000 625,000 315,000 1,568,000 1,791,000 3,359,000 Stockholders’ equity: Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 1,307,000 2,572,000 3,879,000 $7,207,000 1,305,000 1,957,000 3,262,000 $6,621,000 There were 100,000 shares of common stock outstanding at the end of both years The income tax rate is 35% Interest expense totaled $139,000 for 2014 and $158,000 for 2013 The market price per share was $110 at the end of 2013 and $134 at the end of 2014 Net income was $615,000 for 2014 and $739,000 in 2013 Net sales totaled $4,568,000 and $3,253,000 for 2014 and 2013, respectively a b Calculate the following for 2014 and 2013: Earnings per share Price–earnings ratio Return on total assets Return on common stockholders’ equity Comment on any trends apparent in the ratios Answer a 2014 = $615,000 ÷ 100,000 = $6.15 2013 = $739,000 ÷ 100,000 = $7.39 2014 = $134 ÷ $6.15 = $21.79 2013 = $110 ÷ $7.39 = $14.88 2014 = [$615,000 + ($139,000 ì (1 0.35))] ữ $7,207,000 = 0.098 2013 = [$739,000 + ($158,000 × (1 – 0.35))] ÷ $6,621,000 = 0.127 2014 = $615,000 ÷ $3,879,000 = 0.159 2013 = $739,000 ÷ $3,262,000 = 0.227 14-58 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition b 148 Earnings per share decreased due to the decrease in net income from 2013 to 2014 However, since the stock price increased, the price-earnings ratio increased The return on total assets indicates the company is earning 9.8 cents per dollar of assets invested rather than 12.7 cents form 2013, a modest decrease The return on common equity decreased in 2014 due to the decrease in net income and an increase in equity Jim Parker is interested in purchasing the stock of Hackett, a company that sells bricks to the construction industry Before purchasing the stock, Parker would like to learn as much as possible about the company in which he is contemplating the potential investment However, the only information that Parker has is a portion of Hackett’s annual report for the current year (Year 3), which contains no comparative data other than the summary of the ratios listed below: Current ratio Acid-test ratio Accounts receivable turnover Inventory turnover Return on total assets Return on common stockholders' equity Price-earnings ratio Earnings per share Year 2.8:1 0.8:1 8.9 times 6.1 times 15.50% 18.10% 12.3 $1.53 Year 2.3:1 1.0:1 10.1 times 8.1 times 12.10% 14.70% 17.2 $1.52 Year 2.1:1 1.2:1 12.5 times 8.3 times 10.30% 11.90% 17.7 $1.55 Is the market price of the company’s stock increasing or decreasing? Support your answer with accounting justification citing specific information in the analysis Answer Hackett’s market price is declining as seen in the decline of its price-earnings ratio in Year and Year The price-earnings ratio indicates that the market price per share compared to the earnings produced by the company is declining Given the steady earnings per share over the three years, the factor causing the price-earnings ratio to drop is the stock price Chapter 14 Analyzing Financial Statements: A Managerial Perspective 149 14-59 Comparative financial statements for Smart Buy are shown below for the year’s ending December 31, 2014 and 2013: Assets Current assets: Cash Accounts receivable Inventory Other Total current assets Long-term investments Property, plant and equipment, net Total assets Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Other current liabilities Total current liabilities Long-term debt Total liabilities Stockholders’ equity: Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity Net sales Cost of goods sold Gross margin Operating expenses Operating income Interest expense Earnings before income taxes Income tax expense Net earnings 2014 December 31 2013 $ 14,000 45,489 39,239 3,400 102,128 128,580 789,145 $1,019,853 $ 12,458 35,486 32,568 2,581 83,093 104,600 771,258 $958,951 $ 98,789 3,456 102,245 456,781 559,026 $ 85,451 5,157 90,608 414,760 505,368 375,000 85,827 460,827 $1,019,853 375,000 78,583 453,583 $958,951 Year Ended December 31 2014 2013 $2,281,789 $2,074,354 1,505,981 1,348,330 775,808 726,024 458,245 420,408 317,563 305,616 36,542 33,181 281,021 272,435 98,357 95,352 $ 182,664 $ 177,083 Smart Buy had 50,000 common shares outstanding throughout 2014 The December 31, 2014 market price is $43 per share Calculate the following profitability ratios for 2014 for Smart Buy: a Earnings per share b Price-earnings ratio c Gross margin percentage d Return on total assets e Return on common stockholders’ equity Answer a b c d e $182,664 ÷ 50,000 = $3.65 $43 ÷ $3.65 = $11.78 $775,808 ÷ $2,281,789 = 34.0% ($182,664 + ($36,542 ì (1 35%)) ữ $1,019,853) = 20.2% $182,664 ÷ $460,827 = 39.6% 14-60 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 150 Comparative financial statements for TJ Cleaners for December 31, 2014 and 2013 follow: Assets Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets Long-term investments Property, plant, and equipment, net Total assets December 31 2014 2013 12,000 45,489 40,239 3,400 101,128 128,580 867,565 $1,097,273 $ 12,458 37,486 33,568 2,581 86,093 104,600 739,258 $929,951 $ 98,789 5,456 104,245 486,781 591,026 $ 85,451 5,157 90,608 424,760 515,368 Stockholders’ equity: Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 375,000 131,247 506,247 $1,097,273 336,000 78,583 414,583 $929,951 Net sales Cost of goods sold Gross margin Operating expenses Operating income Interest expense Earnings before income taxes Income taxes expense Net earnings Year Ended December 31 2014 2013 $2,111,789 $2,174,354 1,505,981 1,648,330 605,808 526,024 418,245 420,408 187,563 105,616 36,542 33,181 151,021 72,435 98,357 15,352 $ 52,664 $ 57,083 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Other current liabilities Total current liabilities Long-term debt Total liabilities $ TJ sells all items on account Calculate the following for TJ Cleaners for 2014: a Asset turnover b Accounts receivable turnover c Days’ sales in inventory d Inventory turnover e Days’ sales in inventory Answer a b c d e $2,111,789 ÷ $1,097,273 = 1.92 times $2,111,789 ÷ $45,489 = 46.42 times 365 ÷ 46.42 = 7.86 days $1,505,981 ÷ $40,239 = 37.42 times 365 ÷ 37.42 = 9.75 days Chapter 14 Analyzing Financial Statements: A Managerial Perspective 151 14-61 The following information for BuyRite Rooms, a retail furniture and design firm, is presented for 2014 and 2013: December 31 Assets 2014 2013 Current assets: Cash $ 42,000 $ 54,000 Accounts receivable 580,000 445,000 Inventory 5,010,000 4,950,000 Prepaid expenses 84,000 79,000 Total current assets 5,716,000 5,528,000 Building and equipment, net 1,097,000 1,095,000 Total assets $6,813,000 $6,623,000 Liabilities and stockholders’ equity Current liabilities: Accounts payable Bank loan payable Other accrued payables Total current liabilities Long-term debt Total liabilities $ 605,000 679,000 215,000 1,499,000 1,729,000 3,228,000 $ 628,000 625,000 315,000 1,568,000 1,791,000 3,359,000 Stockholders’ equity: Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 1,307,000 2,278,000 3,585,000 $6,813,000 1,307,000 1,957,000 3,264,000 $6,623,000 There were 100,000 shares of common stock outstanding during both years In addition, the following information is provided: 2014 2013 Market price per share at the end of year $ 134 $ 110 Net income for the year 815,000 639,000 Cost of goods sold for the year 2,900,000 2,700,000 Net sales for the year 5,568,000 5,253,000 a b Answer a Calculate asset turnover, accounts receivable turnover, days’ sales in receivables, inventory turnover, and days’ sales in inventory for 2013 and 2014 Use three significant digits for all calculations How well does BuyRite Rooms appear to manage its accounts receivable and inventory? What suggestions you have for the company’s managers? Asset turnover = Net sales ÷ Total assets 2013 = $5,253,000 ÷ $6,623,000 = 0.793 2014 = $5,568,000 ÷ $6,813,000 = 0.817 Accounts receivable turnover = Net credit sales ÷ Accounts receivable 2013 = $5,253,000 ÷ $445,000 = 11.804 2014 = $5,568,000 ÷ $580,000 = 9.600 14-62 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition Days’ sales in receivables = 365 ÷ Accounts receivable turnover 2013 = 365 ÷ 11.804 = 30.920 days 2014 = 365 ÷ 9.600 = 38.021 days Inventory turnover = Cost of goods sold ÷ Inventory 2013 = $2,700,000 ÷ $4,950,000 = 0.545 2014 = $2,900,000 ÷ $5,010,000 = 0.579 Days’ sales in inventory = 365 ÷ Inventory turnover 2013 = 365 ÷ 545 = 669.72 days 2014 = 365 ÷ 579 = 630.40 days b 152 There appears to be a very significant problem related to excess inventory The company has approximately 1.7 years of inventory on hand! Quite possibly, return on total assets could be improved by decreasing inventory Accounts receivable may need some attention as the number of days to collect its entire dollar amount of receivables is increasing Hank Hatley is interested in purchasing the stock of Brinker, a company that sells bricks to the construction industry Before purchasing the stock, Hatley would like to learn as much as possible about the company in which he is contemplating a potential investment However, the only information that Hatley has is a portion of Brinker’s annual report for the current year (Year 3), which contains no comparative data other than the summary of the ratios listed below: Year Year Year Current ratio 2.6:1 2.3:1 2.1:1 Acid-test ratio 0.8:1 1.0:1 1.2:1 Accounts receivable turnover 10.0 times 10.1 times 10.5 times Inventory turnover 6.1 times 8.1 times 8.3 times Return on total assets 15.50% 12.10% 10.30% Return on common stockholders' equity 18.10% 14.70% 11.90% Price-earnings ratio 12.3 17.2 17.7 Earnings per share $1.53 $1.52 $1.55 Are customers paying their accounts as well as they were in Year 1? Support your answer with accounting justification citing specific information in the analysis Answer Yes, customers are paying their accounts almost as well in year as they did in Year In Year 1, Brinker’s accounts receivable turnover was 10.5, but in Year 3, it dropped to 10.0 This drop indicates that the balance of accounts receivable is increasing slightly due to lack of collection of the entire receivable balance Hatley should consider adding the calculation and assessment of days’ sales outstanding in the company’s analysis Chapter 14 Analyzing Financial Statements: A Managerial Perspective 153 14-63 The following information for 2014 and 2013 is presented for BuyRite: Assets Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets Building and equipment, net Total assets December 31 2014 2013 $ 42,000 580,000 5,010,000 84,000 5,716,000 1,097,000 $6,813,000 $ 54,000 445,000 4,950,000 79,000 5,528,000 1,095,000 $6,623,000 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Bank loan payable Other accrued payables Total current liabilities Long-term debt Total liabilities $ 605,000 679,000 215,000 1,499,000 1,729,000 3,228,000 $ 628,000 625,000 315,000 1,568,000 1,791,000 3,359,000 Stockholders’ equity: Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 1,307,000 2,278,000 3,585,000 $6,813,000 1,307,000 1,957,000 3,264,000 $6,623,000 There were 100,000 shares of common stock outstanding throughout both 2013 and 2014 Additional information follows: 2014 2013 Market price per share at the end of year $ 134 $ 110 Net income for the year 815,000 639,000 Cost of goods sold for the year 2,900,000 2,700,000 Net sales for the year 5,568,000 5,253,000 a b Answer a Calculate the 1) current ratio, 2) acid-test ratio, and the 3) debt-to-equity ratio for 2013 and 2014 Calculate to three significant digits The company intends to apply for a loan What concerns might the loan officer have about lending to the company? 2013 = $5,528,000 ÷ $1,568,000 = 3.526 2014 = $5,716,000 ÷ $1,499,000 = 3.813 2013 = ($55,000 + $445,000) ÷ $1,568,000 = 0.318 2014 = ($42,000 + $580,000) ÷ $1,499,000 = 0.414 2013 = $3,359,000 ÷ $3,264,000 = 1.029 2014 = $3,228,000 ÷ $3,565,000 = 0.905 14-64 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition b 154 The acid-test ratio is low, while the current ratio deceivingly appears to be adequate to pay current debts when due The low acid-test ratio is due to a large amount of inventory, which cannot be turned into cash quickly The debt-to-equity ratio is reasonable The loan officer may be concerned that the company does not have enough cash to pay its current obligations when due Wyatt Parks is interested in purchasing the stock of Dobbins Products, a company that sells bricks to the construction industry Before purchasing the stock, Parks would like to learn as much as possible about the company However, all he has to go on is the current year’s (Year 3) annual report, which contains no comparative data other than the summary of the ratios given below: Current ratio Acid-test (quick) ratio Accounts receivable turnover Inventory turnover Return on total assets Return on common stockholders' equity Price-earnings ratio Earnings per share Year 1.7 0.8 8.9 times 6.1 times 15.50% 18.10% 12.3 $1.53 Year 2.3 1.0 10.1 times 8.1 times 12.10% 14.70% 17.2 $1.52 Year 2.1 1.2 12.5 times 8.3 times 10.30% 11.90% 17.7 $1.55 Is it becoming easier for the company to pay its bills as they come due? Support your answer with accounting justification citing specific information in the analysis Answer It is becoming more difficult for Dobbins Products to pay its bills as they come due given that its current ratio has decreased in the most recent year (Year 3) to 1.7 In addition, in the very short term, Dobbins Products may not be able to quickly turn its receivables and inventory into cash as demonstrated by its decline in the acid-test ratio Chapter 14 Analyzing Financial Statements: A Managerial Perspective 155 14-65 Comparative financial statements for Smart Buy for the years ending December 31, 2014 and 2013 are shown below: December 31 Assets 2014 2013 Current assets: Cash $ 14,000 $ 12,458 Accounts receivable 45,489 35,486 Inventory 39,239 32,568 Prepaid expenses 3,400 2,581 Total current assets 102,128 83,093 Long-term investments 128,580 104,600 Property, plant and equipment, net 789,145 771,258 Total assets $1,019,853 $958,951 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Other current liabilities Total current liabilities Long-term debt Total liabilities Stockholders’ equity: Common stock Additional paid-in capital Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity Net sales Cost of goods sold Gross margin Operating expenses Operating income Interest expense Earnings before income taxes Income tax expense Net earnings $ $ 85,451 5,157 90,608 414,760 505,368 100,000 275,000 85,827 460,827 $1,019,853 100,000 275,000 78,583 453,583 $ 958,951 Year Ended December 31 2014 2013 $2,281,789 $2,074,354 1,505,981 1,348,330 775,808 726,024 458,245 420,408 317,563 305,616 36,542 33,181 281,021 272,435 98,357 95,352 $ 182,664 $ 177,083 Calculate the following ratios for 2014 for Smart Buy: a Current ratio b Quick ratio c Debt-to-equity ratio d Times interest earned Answer a $102,128 ÷ $102,245 = 1.00 b $59,489 ÷ $102,245 = 0.58 c $559,026 ÷ $460,827 = 1.21 d $317,563 ÷ $36,542 = 8.69 times 98,789 3,456 102,245 456,781 559,026 14-66 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition CHALLENGE EXERCISES 156 Comparative balance sheets for Save-A-Penny for the years ending December 31, 2014 and 2013 are shown below: December 31 2014 2013 Assets Current assets: Cash Accounts receivable Inventory Prepaid expenses Total current assets Property, plant and equipment, net Total assets Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Other current liabilities Total current liabilities Long-term debt Total liabilities Stockholders’ equity: Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity $ 15,600 19,800 21,200 3,100 59,700 285,300 $345,000 $ 14,200 17,500 24,500 4,800 61,000 266,000 $327,000 $ 14,500 26,500 41,000 216,000 257,000 $ 15,900 23,100 39,000 204,000 243,000 22,000 66,000 88,000 $345,000 19,800 64,200 84,000 $327,000 Selected additional amounts for Save-A-Penny follow for the years ending December 31, 2014 and 2013: Net sales Interest expense Income tax expense Net earnings Year Ended December 31 2014 2013 $432,000 $398,000 12,900 12,000 15,900 15,600 37,100 36,400 Calculate at least debt-related ratios for Save-A-Penny for 2014 and 2013 Evaluate the risk considerations and any changes between the two years as it relates to Save-A-Penny’s ability to satisfy its obligations Answer Current ratio: 2014: $59,700 ÷ $41,000 = 1.46 2013: $61,000 ÷ $39,000 = 1.56 Acid-test ratio: 2014: ($15,600 + $19,800) ÷ $41,000 = 0.86 2013: ($14,200 + $17,500) ÷ $39,000 = 0.81 Debt-to-equity ratio: 2014: $257,000 ÷ $88,000 = 2.92 2013: $243,000 ÷ $84,000 = 2.89 Times interest earned: 2014: $65,900 ÷ $12,900 = 5.11 2013: $64,000 ÷ 12,000 = 5.33 Chapter 14 Analyzing Financial Statements: A Managerial Perspective 14-67 While the current ratio has dropped slightly, there is a slight increase in the acid-test ratio indicating that the company is better prepared to pay its obligations on a very short-term basis The slight increase in the debt-to-equity ratio indicates the company has a higher amount of debt relative to its equity in 2014 as compared to 2013 There is also a slight drop in the company’s ability to make interest payment between the two years All four of the ratios declined somewhat creating a slight increase in the risk of Save-A-Penny’s ability to satisfy its obligations 157 Harry’s Fresh Seafood just completed its first three years of operations The accountant performed the following ratio analysis for the company: Accounts receivable turnover Inventory turnover a b c Year 16.9 times 144.1 times Year 13.1 times 120.3 times Year 11.5 times 99.3 times Calculate day’s sale in receivables and day’s sales in inventory for all three years Interpret the ratios Evaluate the efficiency with which Harry’s Fresh Seafood manages its receivables and inventory Interpret the ratios and support your answer with accounting justification citing specific information in the analysis For what reason the two turnovers differ so dramatically? Answer a Days’ sales in receivables: Year 3: 365 ÷ 16.9 = 21.6 days Year 2: 365 ÷ 13.1 = 27.9 days Year 1: 365 ÷ 11.5 = 31.8 days Days’ sales in inventory: Year 3: 365 ÷ 144.1= 2.5 days Year 2: 365 ÷ 120.3 = 3.0 days Year 1: 365 ÷ 99.3 = 3.7 days Harry’s has been selling the total dollar amount of its inventory about 144.1 times during year 3, compared to 120.3 times in year 2, and 99.3 times in year During year 3, it took only 2.5 days to sell the inventory on hand, a decline from days in year 2, and 3.7 days in year Harry’s has improved its holding period for inventory and is selling its inventory more quickly during the three-year period Harry’s Fresh Seafood is collecting the amounts due from customers more quickly each year, with a significant reduction of receivables on hand from 21.6 days in year to 27.9 days in year 2, and 31.8 days in year This represents an increase in the collection of amounts owed by customers from 11.5 times year to 16.9 times in year 3, a significantly favorable trend The nature of the business operations is likely the reason that inventory turns over so much more quickly than receivables turnover, because fresh seafood has a short shelf life and must be sold in a short period of time 14-68 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 158 Comparative balance sheets for Save-A-Penny for the years ending December 31, 2014 and 2013 are shown below: December 31 Assets 2014 2013 Current assets: Cash $ 15,600 $ 14,200 Accounts receivable 19,800 17,500 Inventory 21,200 24,500 Prepaid expenses 3,100 4,800 Total current assets 59,700 61,000 Property, plant and equipment, net 285,300 266,000 Total assets $345,000 $327,000 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Other current liabilities Total current liabilities Long-term debt Total liabilities Stockholders’ equity: Common stock, $2 par value Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity $ 14,500 26,500 41,000 216,000 257,000 $ 15,900 23,100 39,000 204,000 243,000 22,000 66,000 88,000 $345,000 19,800 64,200 84,000 $327,000 Additional information follows for the years ending December 31, 2014 and 2013: Year Ended December 31 Net sales Net earnings Income tax expense End of year stock price per share Dividends paid 2014 $432,000 37,100 15,900 18.00 4,000 2013 $398,000 36,400 14,200 15.00 1,800 The shares outstanding during 2014 totaled 10,200, with 9,900 outstanding during 2013 Calculate earnings per share, the price-earnings ratio, and return on common stockholders’ equity for Save-A-Penny for 2014 and 2013 Evaluate the company’s profitability and any changes between the two years Answer Earnings per share: 2014: $37,100 ÷ 10,200 = $3.64 per share 2013: $36,400 ÷ 9,900 = $3.67 per share Price-earnings ratio: 2014: $18 ÷ $3.64 = $4.94 2013: $15 ÷ $3.67 = $4.08 Chapter 14 Analyzing Financial Statements: A Managerial Perspective 14-69 14-70 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition Return on common stockholder’s equity: 2014: $37,100 ÷ $88,000 = 0.422 2013: $36,400 ÷ $84,000 = 0.433 Earnings per share was relatively steady due to additional shares of stock issued during 2014 and higher net earnings in 2014 The rise in the price-earnings ratio indicates that shareholders were willing to pay $4.94 per dollar of sales in 2014, a significant increase from $4.08 in 2013 Return on common stockholders’ equity increased slightly due to the company’s ability to earn a higher return on the funds invested by shareholders SHORT-ANSWER ESSAYS 159 List three reasons why managers need to be able to analyze financial statements Answer Managers need to be able to use financial statements to control operations, to assess the viability of vendors, customers and other business partners, and to understand how the company appears to shareholders and creditors 160 What are the three major financial statements and what information does each contain? Answer The balance sheet is a snapshot of the company’s assets, liabilities, and equities at a point in time The income statement shows the revenues and expenses of a company for a period of time The statement of cash flows shows the amount of cash used or generated for a period of time from operating, investing, and financing activities 161 Explain the nature of horizontal and vertical analysis Answer Horizontal analysis looks at the changes from one period to the next in the line items on the financial statements It allows managers to see how the various items are changing relative to each other Vertical analysis looks at how the items within a given period relate to each other All items on the statements are expressed as a percentage of a base amount, usually assets or sales 162 Explain why net interest is added back to net income to calculate return on total assets Answer Assets are supported by both debt and equity funding Return on total assets measures the profitability of a firm independently of how it is financed Thus the return to debt, which is interest, needs to be added to the return to equity, which is net income The cost of interest is reduced by the tax effect since interest reduces income taxes paid Chapter 14 Analyzing Financial Statements: A Managerial Perspective 163 14-71 What sources other than financial statements are used to analyze a company and what information is available from those sources? Answer Management’s discussion and analysis is presented in the company’s annual report and gives an explanation from management as to why financial statement items have changed Credit reports will provide information about a company’s historical credit record This will help assess a customer’s ability to meet its obligations News articles appear frequently and can provide information on a variety of topics 164 Why is the accounts receivable turnover that is computed from published financial statements often misleading? Answer The financial statements not disclose credit sales, so it is unclear what sales figure should relate to accounts receivable in computing the ratio 165 What is financial leverage and how can you tell if it is being used effectively? Answer Financial leverage is utilizing debt to increase the return to equity It is being utilized effectively if the return on common stockholders’ equity is higher than the return on total assets 166 Turnover ratios measure a key business ‘efficiency’ What efficiency is measured by asset turnover? Why is efficiency important for a company? Answer Asset turnover measures the efficiency with which a company uses its assets to generate sales revenue Assets are economic resources and their purpose is to generate future benefits for a company As a company’s assets are used in operations, they generate sales, which in turn are expected to increase a company’s net income, and increase shareholder value of the company by adding to a company’s equity ...14-2 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition TRUE-FALSE A managerial accountant may analyze his/her company’s own... F 19 20 21 22 23 24 T T T F F F 25 26 27 28 29 30 F T T T T T 14-4 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition MULTIPLE CHOICE 31 Which of the following is not a reason... B Turnover analysis C Horizontal analysis D Vertical analysis 14-6 Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition 47 In which of the following will the percentage increase