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ACC 206 Accounting Principles Week 10 Quiz – Strayer

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CHAPTER 18

FINANCIALSTATEMENT ANALYSIS

CHAPTERSTUDY OBJECTIVES

1. Discuss the need for comparative analysis.

2. Identify the tools of financial statement analysis.

3. Explain and apply horizontal (trend) analysis.

4. Describe and apply vertical analysis.

5. Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

6. Understand the concept of earning power, and indicate how irregular items are presented.

7. Understand the concept of quality of earnings.

TRUE-FALSESTATEMENTS

1. Intracompany comparisons of the same financial statement items can often detect changes in financial relationships and significant trends.

2. Calculating financial ratios is a financial reporting requirement under generally accepted accounting principles.

3. Measures of a company’s liquidity are concerned with the frequency and amounts of dividend payments.

4. Analysis of financial statements is enhanced with the use of comparative data.

5. Comparisons of company data with industry averages can provide some insight into the company’s relative position in the industry.

6. Vertical and horizontal analyses are concerned with the format used to prepare financial statements.

7. Horizontal, vertical, and circular analyses are the most common tools of financial statement analysis.

8. Horizontal analysis is a technique for evaluating a financial statement item in the current year with other items in the current year.

9. Another name for trend analysis is horizontal analysis.

10. If a company has sales of $110 in 2008 and $154 in 2009, the percentage increase in sales from 2008 to 2009 is 140%.

11. In horizontal analysis, if an item has a negative amount in the base year, and a positive amount in the following year, no percentage change for that item can be computed.

12. Common size analysis expresses each item within a financial statement in terms of a percent of a base amount.

13. Vertical analysis is a more sophisticated analytical tool than horizontal analysis.

14. Vertical analysis is useful in making comparisonsof companies of different sizes.

15. Meaningful analysis of financial statements will include either horizontal or vertical analysis, but not both.

16. Using vertical analysis of the income statement, a company’s net income as a percentage of net sales is 10%; therefore, the cost of goods sold as a percentage of sales must be 90%.

17. In the vertical analysis of the income statement, each item is generally stated as a percentage of net income.

18. A ratio can be expressed as a percentage, a rate, or a proportion.

19. A solvency ratio measures the income or operating success of an enterprise for a given period of time.

20. The current ratio is a measure of all the ratios calculated for the current year.

21. Inventory turnover measures the number of times on the average the inventory was sold during the period.

22. Profitability ratios are frequently used as a basis for evaluating management’s operating effectiveness.

23. The rate of return on total assets will be greater than the rate of return on common stockholders’ equity if the company has been successful in trading on the equity at a gain.

24. From a creditor’s point of view, the higher the total debt to total assets ratio, the lower the risk that the company may be unable to pay its obligations.

25. A current ratio of 1.2 to 1 indicates that a company’s current assets exceed its current liabilities.

26. Using borrowed money to increase the rate of return on common stockholders’ equity is called “trading on the equity.”

27. When the disposal of a significant segment occurs, the income statement should report both income from continuing operations and income (loss) from discontinued operations.

28. An event or transaction should be classified as an extraordinary item if it is unusual in nature or if it occurs infrequently.

29. Variations among companies in the application of generally accepted accounting principles may reduce quality of earnings.

30. Pro forma income usually excludes items that the company thinks are unusual or nonrecurring.

Additional True-False Questions

31. The three basic tools of analysis are horizontal analysis, vertical analysis, and ratio analysis.

32. A percentage change can be computed only if the base amount is zero or positive.

33. In vertical analysis, the base amount in an income statement is usually net sales.

34. Profitability ratios measure the ability of the enterprise to survive over a long period of time.

35. The days in inventory is computed by multiplying inventory turnover by 365.

36. Extraordinary items are reported net of applicable taxes in a separate section of the income statement.

MULTIPLECHOICE QUESTIONS

37. Which one of the following is primarily interested in the liquidity of a company? a. Federal government
b. Stockholders
c. Long-term creditors d. Short-term creditors

38. Which one of the following is not a characteristic generally evaluated in analyzing financial statements?
a. Liquidity
b. Profitability c. Marketability d. Solvency

39. In analyzing the financial statements of a company, a single item on the financial statements
a. should be reported in bold-face type.
b. is more meaningful if compared to other financial information. c. is significant only if it is large.
d. should be accompanied by a footnote.

40. Short-term creditors are usually most interested in evaluating a. solvency.
b. liquidity.
c. marketability. d. profitability.

41. Long-term creditors are usually most interested in evaluating a. liquidity and solvency.
b. solvency and marketability. c. liquidity and profitability.
d. profitabilityand solvency.

42. Stockholders are most interested in evaluating a. liquidity and solvency.
b. profitabilityand solvency. c. liquidity and profitability.
d. marketability and solvency.
FinancialStatement Analysis 18 – 7

43. A stockholder is interested in the ability of a firm to a. pay consistent dividends.
b. appreciate in share price. c. survive over a long period. d. all of these.

44. Comparisons of financial data made within a company are called a. intracompanycomparisons.
b. interior comparisons.
c. intercompanycomparisons. d. intramural comparisons.

45. A technique for evaluating financial statements that expresses the relationship among selected items of financial statement data is
a. common size analysis. b. horizontal analysis.
c. ratio analysis.
d. vertical analysis.

46. Which one of the following is not a tool in financial statement analysis? a. Horizontal analysis
b. Circular analysis c. Vertical analysis d. Ratio analysis

47. In analyzing financial statements, horizontal analysis is a a. requirement.
b. tool.
c. principle. d. theory.

48. Horizontal analysis is also called a. linear analysis.
b. vertical analysis. c. trend analysis.
d. common size analysis.

49. Vertical analysis is also known as a. perpendicular analysis.
b. common size analysis. c. trend analysis.
d. straight-line analysis.

50. In ratio analysis, the ratios are never expressed as a a. rate.
b. negative figure. c. percentage.
d. simple proportion.
18 – 8

51. The formula for horizontal analysis of changes since the base period is the current year amount
a. divided by the base year amount.
b. minus the base year amount divided by the base year amount. c. minus the base year amount divided by the current year amount. d. plus the base year amount divided by the base year amount.

52. Horizontal analysis evaluates a series of financial statement data over a period of time a. that has been arranged from the highest number to the lowest number.
b. that has been arranged from the lowest number to the highest number. c. to determine which items are in error.
d. to determine the amount and/or percentage increase or decrease that has taken place.

53. Horizontal analysis evaluates financial statement data a. within a period of time.
b. over a period of time. c. on a certain date.
d. as it may appear in the future.

54. Assume the following sales data for a company:

2010 $1,000,000 2009 900,000 2008 750,000 2007 600,000

If 2007 is the base year, what is the percentage increase in sales from 2007 to 2009? a. 100%
b. 150% c. 50% d. 66.7%

55. Comparative balance sheets are usually prepared for a. one year.
b. two years. c. three years. d. four years.

56. Horizontal analysis is appropriately performed a. only on the income statement.
b. only on the balance sheet.
c. only on the statement of retained earnings. d. on all three of these statements.

57. A horizontal analysis performed on a statement of retained earnings would not show a percentage change in
a. dividends paid. b. net income.
c. expenses.
d. beginning retained earnings.
FinancialStatement Analysis 18 – 9

58. Under which of the following cases may a percentage change be computed? a. The trend of the balances is decreasing but all balances are positive.
b. There is no balance in the base year.
c. There is a positive balance in the base year and a negative balance in the subsequent year.
d. There is a negative balance in the base year and a positive balance in the subsequent year.

59. Assume the following sales data for a company:

2009 $945,000 2008 780,000 2007 650,000

If 2007 is the base year, what is the percentage increase in sales from 2007 to 2008? a. 25%
b. 20% c. 125% d. 143%

60. Assume the following cost of goods sold data for a company:

2009 $1,500,000 2008 1,200,000 2007 900,000

If 2007 is the base year, what is the percentage increase in cost of goods sold from 2007 to 2009?
a. 167% b. 67% c. 60% d. 40%

Use the following information for questions 61–62:

Moon Beam, Inc. has the following income statement (in millions):

MOON BEAM, INC. IncomeStatement
For the Year Ended December 31, 2008

Net Sales $180 Cost of Goods Sold 120 Gross Profit 60 OperatingExpenses 33 Net Income $ 27

61. Using vertical analysis, what percentage is assigned to Cost of Goods Sold? a. 67%
b. 33% c. 100%
d. None of the above
18 – 10

62. Using vertical analysis, what percentage is assigned to Net Income? a. 100%
b. 85% c. 15%
d. None of the above

63. Vertical analysis is also called a. common size analysis.
b. horizontal analysis. c. ratio analysis.
d. trend analysis.

64. Vertical analysis is a technique which expresses each item within a financial statement a. in dollars and cents.
b. in terms of a percentage of the item in the previous year. c. in terms of a percent of a base amount.
d. starting with the highest value down to the lowest value.

65. In common size analysis,
a. a base amount is required. b. a base amount is optional.
c. the same base is used across all financial statements analyzed.
d. the results of the horizontal analysis are necessary inputs for performing the analysis.

66. In performing a vertical analysis, the base for prepaid expenses is a. total current assets.
b. total assets.
c. total liabilities and stockholders’ equity. d. prepaid expenses.

67. In performing a vertical analysis, the base for sales revenues on the income statement is a. net sales.
b. sales.
c. net income.
d. cost of goods available for sale.

68. In performing a vertical analysis, the base for sales returns and allowances is a. sales.
b. sales discounts. c. net sales.
d. total revenues.

69. In performing a vertical analysis, the base for cost of goods sold is a. total selling expenses.
b. net sales.
c. total revenues. d. total expenses.
FinancialStatement Analysis 18 – 11

70. Each of the following is a liquidity ratio except the a. acid-test ratio.
b. current ratio.
c. debt to total assets ratio. d. inventory turnover.

71. A ratio calculated in the analysis of financial statements
a. expresses a mathematical relationship between two numbers. b. shows the percentage increase from one year to another.
c. restates all items on a financial statement in terms of dollars of the same purchasing power.
d. is meaningful only if the numerator is greater than the denominator.

72. A liquidity ratio measures the
a. income or operating success of an enterprise over a period of time. b. ability of the enterprise to survive over a long period of time.
c. short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash.
d. number of times interest is earned.

73. The current ratio is
a. calculated by dividing current liabilities by current assets.
b. used to evaluate a company’s liquidity and short-term debt paying ability. c. used to evaluate a company’s solvency and long-term debt paying ability. d. calculated by subtracting current liabilities from current assets.

74. The acid-test (quick) ratio
a. is used to quickly determine a company’s solvency and long-term debt paying ability. b. relates cash, short-term investments, and net receivables to current liabilities.
c. is calculated by taking one item from the income statement and one item from the balance sheet.
d. is the same as the current ratio except it is rounded to the nearest whole percent.

75. Walker Clothing Store had a balance in the Accounts Receivable account of $780,000 at the beginning of the year and a balance of $820,000 at the end of the year. Net credit sales during the year amounted to $8,000,000. The average collection period of the receivables in terms of days was
a. 30 days. b. 365 days. c. 10 days. d. 37 days.

76. Parr Hardware Store had net credit sales of $5,200,000 and cost of goods sold of $4,000,000 for the year. The Accounts Receivable balances at the beginning and end of the year were $600,000and $700,000, respectively. The receivables turnover was
a. 7.4 times. b. 8.7 times. c. 6.2 times. d. 8 times.
18 – 12

Use the following information for questions 77–78.

Waters Department Store had net credit sales of $12,000,000 and cost of goods sold of $9,000,000for the year. The average inventory for the year amounted to $2,000,000.

77. Inventory turnover for the year is a. 6 times.
b. 10.5 times. c. 4.5 times. d. 3 times.

78. The average number of days in inventory during the year was a. 122 days.
b. 81 days. c. 61 days. d. 35 days.

79. Each of the following is included in computing the acid-test ratio except a. cash.
b. inventory. c. receivables.
d. short-term investments.

80. Which one of the following would not be considered a liquidity ratio? a. Current ratio
b. Inventory turnover c. Acid-test ratio
d. Return on assets

81. Asset turnover measures
a. how often a company replaces its assets.
b. how efficiently a company uses its assets to generate sales. c. the portion of the assets that have been financed by creditors. d. the overall rate of return on assets.

82. Profit margin is calculated by dividing a. sales by cost of goods sold.
b. gross profit by net sales.
c. net income by stockholders’ equity. d. net income by net sales.

Use the following information for questions 83–84.

Raney Corporation had net income of $200,000 and paid dividends to common stockholders of $50,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Raney Corporation’s common stock is selling for $40 per share on the New York Stock Exchange.

83. Raney Corporation’s price-earningsratio is a. 2.5 times.
b. 10 times. c. 13.3 times. d. 4 times.
FinancialStatement Analysis 18 – 13

84 Raney Corporation’s payout ratio for 2008 is a. $4 per share.
b 33.3%. c. 25%. d. 10%.

85 Holt Company reported the following on its income statement:

Incomebefore income taxes Incometax expense
Net income
$420,000
120,000 $300,000

An analysis of the income statement revealed that interest expense was $50,000. Holt Company’s times interest earned was
a. 9 times. b. 8 times. c. 7 times. d. 6 times.

86. The debt to total assets ratio measures a. the company’s profitability.
b. whether interest can be paid on debt in the current year. c. the proportion of interest paid relative to dividends paid. d. the percentage of the total assets provided by creditors.

87. Trading on the equity (leverage) refers to the a. amount of working capital.
b. amount of capital provided by owners.
c. use of borrowed money to increase the return to owners. d. number of times interest is earned.

88. The current assets of Kile Company are $150,000. The current liabilities are $120,000. The current ratio expressed as a proportion is
a. 125%. b. 1.25 : 1 c. .80 : 1
d. $150,000 ÷ $120,000.

89. The current ratio may also be referred to as the a. short run ratio.
b. acid-test ratio.
c. working capital ratio. d. contemporary ratio.

90. A weakness of the current ratio is a. the difficulty of the calculation.
b. that it doesn’t take into account the composition of the current assets. c. that it is rarely used by sophisticated analysts.
d. that it can be expressed as a percentage, as a rate, or as a proportion.
18 – 14

91. A supplier to a company would be most interested in the company’s a. asset turnover.
b. profit margin. c. current ratio.
d. earnings per share.

92. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company?
a. Current ratio b. Acid-test ratio c. Asset turnover
d. Receivables turnover

93. Ratios are used as tools in financial analysis a. instead of horizontal and vertical analyses.
b. because they may provide information that is not apparent from inspection of the individual components of the ratio.
c. because even single ratios by themselves are quite meaningful. d. because they are prescribed by GAAP.

94. The ratios that are used to determine a company’s short-term debt paying ability are a. asset turnover, times interest earned, current ratio, and receivables turnover.
b. times interest earned, inventory turnover, current ratio, and receivables turnover. c. times interest earned, acid-test ratio, current ratio, and inventory turnover.
d. current ratio, acid-test ratio, receivables turnover, and inventory turnover.

95. A measure of the percentage of each dollar of sales that results in net income is a. profit margin.
b. return on assets.
c. return on common stockholders’ equity. d. earnings per share.

Use the following information for questions 96–97.

Risen Company had $250,000 of current assets and $90,000 of current liabilities before borrowing $50,000 from the bank with a 3-month note payable.

96. What effect did the borrowing transaction have on the amount of Risen Company’s working capital?
a. No effect
b. $50,000 increase c. $90,000 increase d. $50,000 decrease

97. What effect did the borrowing transaction have on Risen Company’s current ratio? a. The ratio remained unchanged.
b. The change in the current ratio cannot be determined. c. The ratio decreased.
d. The ratio increased.
FinancialStatement Analysis 18 – 15

98. If equal amounts are added to the numerator and the denominator of the current ratio, the ratio will always
a. increase. b. decrease.
c. stay the same. d. equal zero.

99. The acid-test ratio
a. is a quick calculation of an approximationof the current ratio. b. does not include all current liabilities in the calculation.
c. does not include inventory as part of the numerator.
d. does include prepaid expenses as part of the numerator.

100. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of cash by short-term debt and collection of accounts receivable have on the ratio?

Short-term Borrowing a. Increase
b. Increase c. Decrease d. Decrease
Collection of Receivable No effect Increase
No effect Decrease

101. A company has a receivables turnover of 10 times. The average netceivables during the period are $500,000. What is the amount of net credit sales for the period?
a. $50,000
b. $5,000,000 c. $600,000
d. Cannot be determined from the information given

102. If the average collection period is 35 days, what is the receivables turnover? a. 9.49 times
b. 10.43 times c. 5.22 times
d. None of these

103. A general rule to use in assessing the average collection period is that a. it should not exceed 30 days.
b. it can be any length as long as the customer continues to buy merchandise. c. it should not greatly exceed the discount period.
d. it should not greatly exceed the credit term period.

104. Inventory turnover is calculated by dividing
a. cost of goods sold by the ending inventory.
b. cost of goods sold by the beginning inventory. c. cost of goods sold by the average inventory. d. average inventory by cost of goods sold.

105. A company has an average inventory on hand of $100,000 and the days in inventory is 73 days. What is the cost of goods sold?
a. $500,000 b. $7,300,000 c. $1,000,000 d. $3,650,000
18 – 16

106. A successful grocery store would probably have a. a low inventory turnover.
b. a high inventory turnover. c. zero profit margin.
d. low volume.

107. An aircraft company would most likely have a. a high inventory turnover.
b. low profit margin. c. high volume.
d. a low inventory turnover.

108. Net sales are $4,500,000, beginning total assets are $2,100,000, and the asset turnover is 3.0 times. What is the ending total asset balance?
a. $1,500,000 b. $900,000 c. $2,100,000 d. $1,200,000

109. Earnings per share is calculated a. only for common stock.
b. only for preferred stock.
c. for common and preferred stock. d. only for treasury stock.

110. Which of the following is not a profitability ratio? a. Payout ratio
b. Profit margin
c. Times interest earned
d. Return on common stockholders’ equity

111. Times interest earned is also called the a. money multiplier.
b. interest coverage ratio. c. coupon coverage ratio. d. premium ratio.

112. The ratio that uses weighted average common shares outstanding in the denominator is the
a. price-earnings ratio.
b. return on common stockholders’ equity. c. earnings per share.
d. payout ratio.

113. Net income does not appear in the numerator of the a. profit margin.
b. return on assets.
c. return on common stockholders’ equity. d. payout ratio.
FinancialStatement Analysis 18 – 17

114. Fall Clothing Store had a balance in the Accounts Receivable account of $820,000 at the beginning of the year and a balance of $880,000 at the end of the year. Net credit sales during the year amounted to $6,120,000. The receivables turnover ratio was
a. 7.2 times. b. 7 times. c. 6.9 times. d. 6.8 times.

115. Fall Clothing Store had a balance in the Accounts Receivable account of $810,000 at the beginning of the year and a balance of $850,000 at the end of the year. Net credit sales during the year amounted to $5,814,980. The average collection period of the receivables in terms of days was
a. 50 days. b. 52.1 days. c. 365 days. d. 52.9 days.

Use the following information for questions 116–117.

Luthor Corporation had net income of $160,000 and paid dividends to common stockholders of $40,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Luthor Corporation’s common stock is selling for $50 per share on the New York Stock Exchange.

116. Luthor Corporation’s price-earningsratio is a. 3.2 times.
b. 15.6 times. c. 10 times. d. 5 times.

117. Luthor Corporation’s payout ratio for 2008 is a. $5 per share.
b. 25%. c. 20%. d. 12.5%.

118. Raye Company reported the following on its income statement:

Incomebefore income taxes Incometax expense
Net income
$500,000
150,000 $350,000

An analysis of the income statement revealed that interest expense was $80,000. Raye Company’s times interest earned was
a. 8 times.
b. 7.25 times. c. 6.25 times. d. 4.4 times.
18 – 18

Use the following information for questions 119-125.

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

Assets

Cash and short-term investments Accountsreceivable (net) Inventory
Property, plant and equipment Total Assets

Liabilities and Stockholders’ Equity Current liabilities
Long-termliabilities Stockholders’ equity—common
Total Liabilities and Stockholders’Equity

$ 40,000 25,000 20,000
210,000 $295,000

$ 60,000 85,000
150,000 $295,000

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

Numberof shares of common stock 6,000 Market price of common stock $20 Dividendsper share .90

119. What is the current ratio for this company? a. 1.42
b. .80 c. 1.16 d. .60

120. What is the receivables turnover for this company? a. 2.8 times
b. 2 times c. 3.4 times d. 3 times

121. What is the inventory turnover for this company? a. 2 times
b. 2.25 times c. 1 time
d. .44 times

122. What is the return on assets for this company? a. 6.8%
b. 10.5% c. 11.7% d. 26.7%
FinancialStatement Analysis 18 – 19

123. What is the profit margin for this company? a. 42.86%
b. 18.75% c. 23.5% d. 15.0%

124. What is the return on common stockholders’ equity for this company? a. 13.3%
b. 5%
c. 23.3% d. 53.3%

125. What is the price-earnings ratio for this company? a. 6 times
b. 2.5 times c. 8 times d. 4 times

Use the following information for questions 126–129.

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

Assets Cash and short-term investments Accountsreceivable (net)
Inventory
Property, plant and equipment Total Assets

$ 40,000 30,000 25,000
215,000 $310,000

Liabilities and Stockholders’ Equity Current liabilities
Long-termliabilities Stockholders’ equity—common
Total Liabilities and Stockholders’Equity

$ 60,000 95,000
155,000 $310,000

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

Numberof shares of common stock 6,000 Market price of common stock $20 Dividendsper share 1.00

126. What is the return on assets for this company? a. 6.8%
b. 10.5% c. 8.1% d. 16.1%
18 – 20

127. What is the profit margin for this company? a. 50.0%
b. 55.6% c. 23.5% d. 27.8%

128. What is the return on common stockholders’ equity for this company? a. 7.3%
b. 16.1% c. 23.5% d. 53.3%

129. What is the price-earnings ratio for this company? a. 6 times
b. 4.2 times c. 8 times d. 4.8 times

Use the following information for questions 130–131.

The following information is available for Charles Company:

Accountsreceivable Inventory
Net credit sales Cost of goods sold Net income
2008
$ 360,000 280,000 3,000,000 1,200,000 300,000
2007
$ 400,000 320,000 1,400,000 1,060,000 170,000

130. The receivables turnover ratio for 2008 is a. 8.3 times.
b. 3.9 times. c. 7.9 times. d. 10.0 times.

131. The inventory turnover ratio for 2008 is a. 4.3 times.
b. 4.0 times. c. 2.0 times. d. 2.4 times.

Use the following information for questions 132–134.

The following amounts were taken from the financial statements of Palmer Company:

Total assets Net sales Gross profit Net income
Weightedaverage number of common shares outstanding Market price of common stock
2008
$800,000 720,000 352,000 144,000 120,000 $36
2007
$1,000,000 650,000 320,000 117,000 120,000 $40
FinancialStatement Analysis 18 – 21

132. The return on assets ratio for 2008 is a. 18%.
b. 16%. c. 36%. d. 32%.

133. The profit margin ratio for 2008 is a. 10%.
b. 15%. c. 20%. d. 30%.

134. The price-earnings ratio for 2008 is a. 30 times.
b. 20 times. c. 10 times. d. 5 times.

Use the following information for questions 135–136.

Panza Corporation had net income of $250,000 and paid dividends to common stockholders of $50,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Panza Corporation’s common stock is selling for $40 per share on the New York Stock Exchange.

135. Panza Corporation’s price-earningsratio is a. 2 times.
b. 8 times. c. 10 times. d. 5 times.

136. Panza Corporation’s payout ratio for 2008 is a. $5 per share.
b. 25%. c. 20%. d. 12.5%.

137. Ester’s Bunny Barn has experienced a $40,000 loss due to tornado damage to its inventory. Tornados have never before occurred in this area. Assuming that the company’s tax rate is 30%, what amount will be reported for this loss on the income statement?
a. $40,000 b. $28,000 c. $12,000 d. $36,000

138. Wenger Company reported income before taxes of $600,000 and an extraordinary loss of $150,000. Assume that the company’s tax rate is 30%. What amounts will be reported on the income statement for income before irregular items and extraordinary items, respectively?
a. $420,000 and $150,000 b. $420,000 and $105,000 c. $495,000 and $150,000 d. $495,000 and $105,000
18 – 22

139. Kandy Kane Corporation has income before taxes of $400,000 and an extraordinary gain of $100,000. If the income tax rate is 25% on all items, the income statement should show income before irregular items and extraordinary items, respectively, of
a. $325,000 and $100,000. b. $325,000 and $75,000. c. $300,000 and $100,000. d. $300,000 and $75,000.

140. Hardy Inc. has an investment in available-for-sale securities of $50,000. This investment experienced an unrealized loss of $3,000 during the current year. Assuming a 35% tax rate, the effect of this loss on comprehensive income will be
a. no effect.
b. $50,000 increase. c. $17,500 decrease. d. $3,000 decrease.

141. The disposal of a significant segment of a business is called a. a change in accounting principle.
b. an extraordinary item. c. an other expense.
d. discontinued operations.

142. ABC Company reports income before income taxes of $1,800,000 and had an extra-ordinary loss of $600,000. If the tax rate is 30%,
a. the income before the extraordinary item is $1,440,000.
b. the extraordinary loss would be reported on the income statement at $600,000. c. the income before the extraordinary item is $1,260,000.
d. the extraordinary loss will be reported at $180,000.

143. Evers, Inc. disposes of an unprofitable segment of its business. The operation of the segment suffered a $240,000 loss in the year of disposal. The loss on disposal of the segment was $120,000. If the tax rate is 30%, and income before income taxes was $1,500,000,
a. the income tax expense on the income before discontinued operations is $342,000. b. the income from continuing operations is $1,050,000.
c. net income is $1,140,000.
d. the losses from discontinued operations are reported net of income taxes at $180,000.

144. Each of the following is an extraordinaryitem except the a. effects of major casualties, if rare in the area.
b. effects of a newly enacted law or regulation.
c. expropriation of property by a foreign government. d. losses attributable to labor strikes.

145. The discontinued operations section of the income statement refers to a. discontinuance of a product line.
b. the income or loss on products that have been completed and sold. c. obsolete equipment and discontinued inventory items.
d. the disposal of a significant segment of a business.
FinancialStatement Analysis 18 – 23

146. Which one of the following would be classified as an extraordinaryitem? a. Expropriation of property by a foreign government
b. Losses attributed to a labor strike c. Write-down of inventories
d. Gains or losses from sales of equipment

147. A loss on the write down of obsolete inventory should be reported as a. “other expenses and losses.”
b. part of discontinued operations. c. an operating expense.
d. an extraordinary item.

148. If an item meets one (but not both) of the criteria for an extraordinaryitem, it a. only needs to be disclosed in the footnotes of the financial statements.
b. may be treated as sales revenue (if it is a gain) and as an operating expense (if it is a loss).
c. is reported as an “other revenue or gain” or “other expense and loss,” net of tax.
d. is reported at its gross amount as an “other revenue or gain” or “other expense or loss.”

149. The order of presentation of nontypical items that may appear on the income statement is a. Extraordinaryitems, Discontinued operations, Other revenues and expenses.
b. Discontinued operations, Extraordinary items, Other revenues and expenses. c. Other revenues and expenses, Discontinued operations, Extraordinary items. d. Other revenues and expenses, Extraordinaryitems, Discontinuedoperations.

150. Each of the following is a factor affecting quality of earnings except a. alternative accounting methods.
b. improper recognition. c. pro forma income.
d. extraordinaryitems.

Additional Multiple Choice Questions

151. Comparisonscan be made on each of the following bases except a. industry averages.
b. intercompanybasis. c. intracompanybasis.
d. Each of these is a basis for comparison.

152. Comparisons of data within a company are an example of the following comparative basis:
a. Industry averages b. Intercompany
c. Intracompany d. Interregional
18 – 24

153. Silva Corporation reported net sales of $240,000, $420,000, and $540,000 in the years 2007, 2008, and 2009 respectively. If 2007 is the base year, what is the trend percentage for 2009?
a. 129% b. 135% c. 164% d. 225%

154. In vertical analysis, the base amount for each income statement item is a. gross profit.
b. net income. c. net sales. d. sales.

155. When performing vertical analysis, the base amount for administrative expense is generally
a. administrative expense in a previous year. b. net sales.
c. gross profit. d. fixed assets.

156. Ratios that measure the short-term ability of the company to pay its maturing obligations are
a. liquidity ratios.
b. profitability ratios. c. solvency ratios. d. trend ratios.

157. What type of ratios best measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash?
a. Leverage b. Solvency c. Profitability d. Liquidity

158. The acid-test ratio is also known as the a. current ratio.
b. quick ratio. c. fast ratio.
d. times interest earned ratio.

159. The debt to total assets ratio a. is a solvency ratio.
b. is computed by dividing total assets by total debt.
c. measures the total assets provided by stockholders. d. is a profitability ratio.

160. An extraordinaryitem is one that
a. occurs infrequently and is uncontrollable in nature. b. occurs infrequently and is unusual in nature.
c. is material and is unusual in nature.
d. is material and is uncontrollable in nature.
FinancialStatement Analysis 18 – 25

161. Galileo, Inc. decided on January 1 to discontinue its telescope manufacturing division. On July 1, the division’s assets with a book value of $630,000 are sold for $450,000. Operating income from January 1 to June 30 for the division amounted to $75,000. Ignoring income taxes, what total amount should be reported on Galileo’s income statement for the current year under the caption, Discontinued Operations?
a. $75,000
b. $105,000 loss c. $180,000 loss d. $255,000

162. When there has been a change in accounting principle,
a. the old principle should be used in reporting the results of operations for the current year.
b. the cumulative effect of the change should be reported in the current year’s retained earnings statement.
c. the change should be reported retroactively.
d. the new principle should be used un reporting the results of operations of the current year, but there is no change to prior years.

BRIEFEXERCISES
BE 163
The following items were taken from the financial statements of Horace, Inc., over a three-year period:

Item
Net Sales
Cost of Goods Sold Gross Profit
2009
$355,000
214,000 $141,000
2008
$336,000
206,000 $130,000
2007
$300,000
186,000 $114,000

Instructions
Computethe following for each of the above time periods. a. The amount and percentage change from 2007 to 2008. b. The amount and percentage change from 2008 to 2009.

BE 164

If Parthenon Company had net income of $672,300 in 2009 and it experienced a 20% increase in net income over 2008, what was its 2008 net income?

BE 165

Horizontal analysis (trend analysis) percentages for Vishnu Company’s sales, cost of goods sold, and expenses are listed here.

Horizontal Analysis 2009
Sales 98.2% Cost of goods sold 102.5 Expenses 108.6
2008 2007
104.8% 100.0% 98.0 100.0 96.4 100.0
FinancialStatement Analysis 18 – 27

BE 165 (cont.)

Instructions

Explain whether Vishnu’s net income increased, decreased, or remained unchanged over the 3-year period.

BE 166

Using the following operating data for Manchac Corporation, illustrate horizontal analysis.

Net sales
Cost of goods sold Operating expenses Net income
2008 2007
$350,000 $320,000 200,000 180,000 120,000 100,000 30,000 40,000

BE 167

Using the data presented for Manchac Company in BE 166, prepare a schedule showing a vertical analysis for 2008.

BE 168

Using these data from the comparative balance sheet of Luca Company, perform vertical analysis.

Accounts receivable Inventory
Total assets
December 31, 2009 $ 500,000
780,000 3,220,000
December 31, 2008 $ 400,000
600,000 2,800,000

BE 169

For each of the ratios listed below, indicate by the appropriate code letter, whether it is a liquidity ratio (L), a profitability ratio (P), or a solvency ratio (S).

1. Times interest earned ratio 2. Asset turnover
3. Receivables turnover

4. Debt to total assets ratio 5. Current ratio
6. Payout ratio

BE 170

Selected financial statement data for Meyer Company are presented below.

Cash
Short-term investments Accounts receivable Inventories
Total current liabilities
12/31/08 $ 10,000 15,000 60,000 75,000 110,000

Instructions
Compute the following ratios at December 31, 2008: (a) Current.
(b) Acid-test.

BE 171
Breaktown Company had net income of $152,000 and net sales of $625,000 in 2008. The company’s total assets for 2007/2008 averaged $3,900,000. Its common stockholders’ equity for the period averaged $2,340,000. Calculate (a) profit margin, (b) return on assets, and (c) return on common stockholders’ equity.

BE 172

Berman Company reported the following financial information:

Accounts receivable Net credit sales
12/31/08 $ 320,000
2,100,000
12/31/07 $ 360,000
2,420,000

Compute (a) the receivables turnover and (b) the average collection period for 2008.

BE 173

Prepare a partial income statement, beginning with income before income taxes using the following information for Slidell Corporation for the fiscal year ended December 31, 2008:

Sales Extraordinary loss
Selling and administrative expenses Cost of goods sold
Loss on sale of land
$800,000 100,000 180,000 500,000 25,000

Slidell Corporation is subject to a 30% income tax rate.

EXERCISES
Ex. 174
Selected financial information for Bradley Corporation is presented below.

Current assets Long-term liabilities Retained earnings
December 31, 2009 $ 60,000
100,000 115,000
December 31, 2008 $ 50,000
80,000 100,000

Instructions
Prepare a schedule showing a horizontal analysis for 2009 using 2008 as the base year.

Ex. 175

Comparative information taken from the Wells Company financial statements is shown below:

(a) Notes receivable (b) Accounts receivable (c) Retained earnings
(d) Income taxes payable (e) Sales
(f) Operating expenses
2009 2008
$ 20,000 $ -0-182,000 140,000
30,000 (40,000) 44,000 20,000 960,000 750,000 170,000 200,000

Instructions

Using horizontal analysis, show the percentage change from 2008 to 2009 with 2008 as the base year.

Ex. 176

Eaton Corporation had net income of $6,000,000 in 2007. Using 2007 as the base year, net income decreased by 70% in 2008 and increased by 140% in 2009.

Instructions

Compute the net income reported by Eaton Corporation for 2008 and 2009.

Ex. 177

The following items were taken from the financial statements of Ritz, Inc., over a four-year period:

Item
Net Sales
Cost of Goods Sold Gross Profit
2010
$800,000
560,000 $240,000
2009
$700,000
500,000 $200,000
2008
$550,000
420,000 $130,000
2007
$500,000
400,000 $100,000

Instructions
Using horizontal analysis and 2007 as the base year, compute the trend percentages for net sales, cost of goods sold, and gross profit. Explain whether the trends are favorable or unfavorable for each item.

Ex. 178

The comparative balance sheet of Greer Company appears below:

GREER COMPANY Comparative Balance Sheet December 31,
———————————————————————————————————————————

Assets 2009 2008
Current assets ………………………………………………………………………….. $ 330 $280 Plant assets ……………………………………………………………………………… 670 520 Total assets ……………………………………………………………………………… $1,000 $800

Liabilities and stockholders’ equity
Current liabilities ……………………………………………………………………….. $ 160 $120 Long-term debt …………………………………………………………………………. 240 160 Common stock …………………………………………………………………………. 340 320 Retained earnings …………………………………………………………………….. 260 200 Total liabilities and stockholders’ equity ………………………………….. $1,000 $800
FinancialStatement Analysis 18 – 33

Ex. 178 (cont.)

Instructions
(a) Using horizontal analysis, show the percentage change for each balance sheet item using 2008 as a base year.

(b) Using vertical analysis, prepare a common size comparative balance sheet.

Ex. 179

Using the following selected items from the comparative balance sheet of Anders Company, illustrate horizontal and vertical analysis.

Accounts Receivable Inventory
Total Assets
December 31, 2009 $ 900,000
975,000 4,000,000
December 31, 2008 $ 600,000
750,000 2,500,000

Ex. 180

Operating data for Manning Corporation are presented below.

Net sales
Cost of goods sold Operating expenses Net income
2008
$500,000 340,000 120,000 40,000

Instructions
Prepare a schedule showing a vertical analysis for 2008.

Ex. 181

The following information was taken from the financial statements of Lee Company:

Gross profit on sales …………………………………………………… Income before income taxes ………………………………………… Net income………………………………………………………………… Net income as a percentage of net sales………………………..
2009
$750,000 280,000 200,000 8%
2008
$800,000 230,000 180,000 9%

Instructions
(a) Compute the net sales for each year.
(b) Compute the cost of goods sold in dollars and as a percentage of net sales for each year. (c) Compute operating expenses in dollars and as a percentage of net sales for each year.
(Income taxes are not operating expenses).

Ex. 182

Selected financial statement data for Morton Company are presented below.

Cash
Short-term investments Receivables (net) Inventories
Total current liabilities
December 31, 2009 $ 20,000
25,000 100,000 85,000 100,000
December 31, 2008 $30,000
18,000 80,000 65,000 90,000

During 2009, net sales were $810,000, and cost of goods sold was $615,000.

Instructions
Compute the following ratios at December 31, 2009: (a) Current.
(b) Acid-test.
(c) Receivables turnover. (d) Inventory turnover.

Ex. 183

Selected information from the comparative financial statements of Fryman Company for the year ended December 31, appears below:
2009 2008
Accounts receivable (net) $ 180,000 $200,000 Inventory 140,000 160,000 Total assets 1,200,000 800,000 Current liabilities 140,000 110,000 Long-term debt 340,000 300,000 Net credit sales 1,520,000 700,000 Cost of goods sold 750,000 530,000 Interest expense 40,000 25,000 Income tax expense 60,000 29,000 Net income 160,000 85,000

Instructions
Answer the following questions relating to the year ended December 31, 2009. Show computa-tions.

1. Inventory turnover for 2009 is .

2. Times interest earned in 2009 is .

3. The debt to total assets ratio for 2009 is .

4. Receivables turnover for 2009 is .

5. Return on assets for 2009 is .

$750,000
————————————
Ex. 184

The financial statements of Dobson Company appear below:

DOBSON COMPANY Comparative Balance Sheet December 31,
———————————————————————————————————————————

Assets Cash……………………………………………………………………………………. Short-term investments………………………………………………………….. Accounts receivable (net) ………………………………………………………. Inventory……………………………………………………………………………… Property, plant and equipment (net) …………………………………………
Total assets …………………………………………………………………….

Liabilities and stockholders’ equity
Accounts payable………………………………………………………………….. Short-term notes payable……………………………………………………….. Bonds payable……………………………………………………………………… Common stock……………………………………………………………………… Retained earnings…………………………………………………………………. Total liabilities and stockholders’ equity……………………………….
2009
$ 35,000 15,000 50,000 50,000
250,000 $400,000

$ 10,000 40,000 88,000 160,000
102,000 $400,000
2008
$ 40,000 60,000 30,000 70,000
300,000 $500,000

$ 30,000 90,000 160,000 145,000
75,000 $500,000

DOBSON COMPANY Income Statement
For the Year Ended December 31, 2009

Net sales……………………………………………………………………………… Cost of goods sold………………………………………………………………… Gross profit ………………………………………………………………………….. Expenses
Interest expense………………………………………………………………. Selling expenses……………………………………………………………… Administrative expenses…………………………………………………… Total expenses…………………………………………………………… Income before income taxes…………………………………………………… Income tax expense………………………………………………………………. Net income……………………………………………………………………………

$12,000 40,000
59,000
$360,000
198,000 162,000

111,000 51,000
15,000 $ 36,000

Additional information:
a. Cash dividends of $9,000 were declared and paid in 2009.
b. Weighted-average number of shares of common stock outstanding during 2009 was 30,000 shares.
c. Market value of common stock on December 31, 2009, was $21 per share.
———— = 3
$50,000
$12,000
18 – 38

Ex. 184 (cont.)

Instructions
Using the financial statements and additional information, compute the following ratios for Coulter Company for 2009. Show all computations.
Computations

1. Current ratio .

2. Return on common stockholders’ equity .

3. Price-earnings ratio .

4. Acid-test ratio .

5. Receivables turnover .

6. Times interest earned .

7. Profit margin .

8. Days in inventory .

9. Payout ratio .

10. Return on assets .

Ex. 185

The following ratios have been computed for Pratt Company for 2009.

Profit margin
Times interest earned Receivables turnover Acid-test ratio Current ratio
Debt to total assets ratio
20% 15 times
5 times 1.60 : 1
3 : 1 26%

Pratt Company’s 2009 financial statements with missing information follow:

PRATT COMPANY Comparative Balance Sheet December 31,
———————————————————————————————————————————

Assets Cash………………………………………………………………………………. Short-term Investments…………………………………………………….. Accounts receivable (net) …………………………………………………. Inventory………………………………………………………………………… Property, plant, and equipment (net) …………………………………..
Total assets………………………………………………………………

Liabilities and stockholders’ equity
Accounts payable…………………………………………………………….. Short-term notes payable………………………………………………….. Bonds payable………………………………………………………………… Common stock………………………………………………………………… Retained earnings……………………………………………………………. Total liabilities and stockholders’ equity…………………………
2009
$ 25,000 15,000
? (6) ? (8)
200,000
$ ? (9)

$ ? (7) 35,000
? (10) 200,000
59,000
$ ? (11)
2008
$ 35,000 15,000 60,000 50,000
150,000 $310,000

$ 25,000 30,000 20,000 200,000
35,000 $310,000
18 – 40

Ex. 185 (cont.)

PRATT COMPANY Income Statement
For the Year Ended December 31, 2009 ———————————————————————————————————————————

Net sales ………………………………………………………………………… Cost of goods sold……………………………………………………………. Gross profit……………………………………………………………………… Expenses:
Depreciation expense………………………………………………….. Interest expense…………………………………………………………. Selling expenses………………………………………………………… Administrative expenses ……………………………………………… Total expenses……………………………………………………… Income before income taxes……………………………………………… Income tax expense……………………………………………………. Net income………………………………………………………………………
$250,000
125,000 125,000

$ ? (5) 5,000
10,000
15,000
? (4) ? (2)
? (3) $ ? (1)

Instructions

Use the above ratios and information from the Pratt Company financial statements to fill in the missing information on the financial statements. Follow the sequence indicated. Show computations that support your answers.

Ex. 186

Selected data for Nancy’s Store appear below.

Net sales
Cost of goods sold Inventory at end of year
Accounts receivable at end of year

2009 2008
$650,000 $520,000 455,000 345,000 65,000 85,000 80,000 50,000

Instructions
Compute the following for 2009: (a) Gross profit rate.
(b) Inventory turnover. (c) Receivables turnover.

Ex. 187

Selected financial statement data for Holmes Company are presented below.

Net sales
Cost of goods sold Interest expense Net income
Total assets (ending)
Total common stockholders’ equity (ending)
$1,200,000 700,000 10,000 180,000 850,000 650,000

Total assets at the beginning of the year were $750,000; total common stockholders’ equity was $550,000 at the beginning of the period.

Instructions
Compute each of the following: (a) Asset turnover
(b) Profit margin
(c) Return on assets
(d) Return on common stockholders’ equity

Ex. 188

Winter Corporation has issued common stock only. The company has been successful and has a gross profit rate of 20%. The information shown below was taken from the company’s financial statements.

Beginning inventory Purchases
Ending inventory
Average accounts receivable
Average common stockholders’ equity Sales (all on credit)
Net income
$ 482,000 5,636,000
? 700,000
3,500,000 7,000,000 525,000

Instructions
Compute the following:
(a) Receivables turnover and the average collection period. (b) Inventory turnover and the days in inventory.
(c) Return on common stockholders’ equity.

Ex. 189

Boyle Corporation had the following comparative current assets and current liabilities:

Current assets Cash
Short-term investments Accounts receivable Inventory
Prepaid expenses Total current assets

Current liabilities Accounts payable Salaries payable Income tax payable
Total current liabilities
Dec. 31, 2009

$ 20,000 40,000 55,000 110,000
35,000 $260,000

$140,000 40,000
20,000 $200,000
Dec. 31, 2008

$ 30,000 10,000 95,000 90,000
20,000 $245,000

$110,000 30,000
15,000 $155,000

During 2009, credit sales and cost of goods sold were $600,000 and $350,000, respectively.

Instructions
Compute the following liquidity measures for 2009: 1. Current ratio.
2. Working capital. 3. Acid-test ratio.
4. Receivables turnover. 5. Inventory turnover.

Ex. 190

Selected data from Oates Company are presented below:

Total assets Average assets Net income Net sales
Average common stockholders’ equity
$1,600,000 1,750,000 175,000 1,225,000 1,000,000

Instructions
Calculate the profitability ratios that can be computed from the above information.

Ex. 191

The following data are taken from the financial statements of Doyle Company:

Monthly average accounts receivable Net sales on account
Terms for all sales are 2/10, n/30
2009
$ 520,000 5,460,000
2008
$ 500,000 4,500,000

Instructions
(a) Compute the receivables turnover and the average collection period for both years.
(b) What conclusion can an analyst draw about the management of the accounts receivable?
—————
—————
FinancialStatement Analysis 18 – 47

Ex. 192

State the effect of the following transactions on the current ratio. Use increase, decrease, or no effect for your answer.

(a) Collection of an accounts receivable. (b) Declaration of cash dividends.
(c) Additional stock is sold for cash.

(d) Short-term investments are purchased for cash. (e) Equipment is purchased for cash.
(f) Inventory purchases are made for cash. (g) Accounts payable are paid.

Ex. 193

The balance sheet for Farley Corporation at the end of the current year indicates the following:

Bonds payable, 7% …………………………………………………….. 6% Preferred stock, $100 par……………………………………….. Common stock, $10 par……………………………………………….
$4,000,000 1,000,000 3,000,000

Income before income taxes was $1,120,000 and income taxes expense for the current year amounted to $336,000. Cash dividends paid on common stock were $300,000, and the common stock was selling for $45 per share at the end of the year. There were no ownership changes during the year.

Instructions
Determine each of the following:
(a) times that bond interest was earned. (b) earnings per share for common stock. (c) price-earnings ratio.

Ex. 194

The income statement for Stoval Company for the year ended December 31, 2008 appears below.

Sales
Cost of goods sold Gross profit Expenses
Net income
$610,000
380,000 230,000
170,000* $ 60,000

*Includes $30,000 of interest expense and $18,000 of income tax expense.
—————————————

Ex. 194 (cont.) Additional information:
1. Common stock outstanding on January 1, 2008 was 40,000 shares. On July 1, 2008, 10,000 more shares were issued.

2. The market price of Stoval’s stock was $15 at the end of 2008.

3. Cash dividends of $30,000 were paid, $6,000 of which were paid to preferred stockholders.

Instructions
Compute the following ratios for 2008: (a) earnings per share.
(b) price-earnings.
(c) times interest earned.

$60,000 – $6,000 54,000

Ex. 195

Gumble Corporation had income from continuing operations of $300,000 for the year ended December 31, 2008. It also had the following items (before income taxes):
1. Extraordinary flood loss of $150,000.
2. Loss of $60,000 on discontinuance of a division.

All items are subject to income taxes at a 30% tax rate.

Instructions
Prepare a partial income statement, beginning with income from continuing operations.

Ex. 196

Lawrenz Corporation gathered the following information for the fiscal year ended December 31, 2008:
Sales $1,400,000 Extraordinary fire loss 140,000 Selling and administrative expenses 160,000 Cost of goods sold 900,000 Loss on sale of equipment 40,000

Lawrenz Corporation is subject to a 30% income tax rate.

Instructions

Prepare a partial income statement, beginning with income before income taxes.

Ex. 197

Dennehy Corporation had the information listed below available in preparing an income statement for the year ended December 31, 2008. All amounts are before income taxes. Assume a 30% income tax rate for all items.

Sales
Expropriation of property by a foreign government (loss) Income from operation of discontinued cement division Loss from disposal of cement division
Operating expenses
Gain on sale of equipment Cost of goods sold
$ 600,000 $(120,000) $ 100,000 $ (80,000) $ 125,000 $ 85,000 $ 360,000
FinancialStatement Analysis 18 – 51

Ex. 197 (cont.)

Instructions
Prepare a multiple-step income statement in good form which takes into account intraperiod income tax allocation. Ignore EPS computations.

Ex. 198

Indicate whether the following items would be reported as an ordinary or an extraordinary item in Logan Corporation’s income statement.

(a) Loss attributable to labor strike. (b) Gain on sale of fixed assets.
(c) Loss from fire. Logan is a chemical company. (d) Loss from sale of short-term investments.
(e) Expropriation of property by a foreign government.

(f) Loss from tornado damage. Logan Corporation is located in the Midwest’s tornado alley. (g) Loss from government condemnation of property through newly enacted law.

Ex. 199

Potter Company has income from continuing operations of $480,000 for the year ended December 31, 2008. It also has the following items (before considering income taxes):

(1) An extraordinary fire loss of $180,000.

(2) A gain of $110,000 on the discontinuance of a major segment.

(3) A correction of an error in last year’s financial statement that resulted in a $100,000 overstatement of 2007 net income.

Assume all items are subject to income taxes at a 30% tax rate.

Instructions

(a) Prepare an income statement, beginning with income from continuing operations. (b) Indicate the statement presentation of any item not included in (a) above.

COMPLETION STATEMENTS

200. In analyzing and interpreting financial statement information, three major characteristics are generally evaluated: (1) , (2) , and (3) .

201. analysis, also called trend analysis, is a technique for evaluating a percentage increase or decrease for a financial statement item over a period of time.

202. Expressing each item within a financial statement as a percentage of a base amount is called analysis.

203. The ratios used in evaluating a company’s liquidity and short-term debt paying ability that complement each other are the ratio and the ratio.

204. The receivables turnover is calculated by dividing by average

.

205. If inventory turnover is 5 times, and the average inventory was $400,000, the cost of goods sold during the year was $ and the days in inventory was
days.

206. Hansen Corporation had net income for the year of $300,000 and a profit margin of 25%. If total average assets were $400,000, the asset turnover ratio was times.

207. The ratio measures the percentage of earnings distributed in the form of cash dividends.

208. The lower the to ratio, the more equity “buffer” there is available to the creditors.

209. Times interest earned is calculated by dividing before

and by interest expense.

210. Discontinued operations refers to the disposal of a of a business.

211. The two criteria necessary for an item to be classified as an extraordinary item are that the transaction or event must be (1) and (2) .

212. A change in inventory methods during the year would be classified as a change in

.

MATCHING

SET A

213. For each of the ratios listed below, indicate by the appropriate code letter, whether it is a liquidity ratio, a profitability ratio, or a solvency ratio.

Code:
L = Liquidity ratio
P = Profitability ratio S = Solvency ratio

1. Price-earnings ratio

2. Asset turnover

3. Receivables turnover

4. Earnings per share

5. Payout ratio

6. Current ratio

7. Acid-test ratio

8. Debt to total assets ratio

9. Times interest earned

10. Inventory turnover

SET B

214. Match the ratios with the appropriate ratio computation by entering the appropriate letter in the space provided.

A. Current ratio B. Acid-test ratio C. Profit margin D. Asset turnover
E. Price-earnings ratio
F. Times interest earned G. Inventory turnover
H. Average collection period I. Days in inventory
J. Payout ratio

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.
Cost of goods sold Average inventory

—————
Net income Net sales

———————
Cash dividends Net income

———————
Net sales Average assets

————————
Current assets Current liabilities

——————————
365 days Receivables turnover

——————————————
Market price per share of stock Earnings per share

————————
365 days Inventory turnover

——————————————————————
Income before income taxes and interest expense Interest expense

Cash + short-term investments + receivables (net)

Current liabilities

SHORT-ANSWERESSAY QUESTIONS
S-AE 215
Horizontal and vertical analyses are analytical tools frequently used to analyze financial statements. What type of information or insights can be obtained by using these two techniques? Explain how the output of horizontal analysis and vertical analysis can be compared to industry averages and/or competitive companies.

S-AE 216

Manuel Mentirosa, the CEO of Mystical Products, is a successful entrepreneur but a poor student of accounting. He asks you to explain to him, in a memo, the bases of comparison for ratio analysis.

S-AE 217 (Ethics)

A trusted employee of Wilderness Tours was caught in the act of embezzling funds. He confessed to earlier embezzlements, but retracted the confession on the advice of his attorney. Over the course of the most recent quarter, it has been determined that $20,000 was embezzled.

Wilderness Tours has suffered adverse publicity in the recent past because of serious injury to five tourists that occurred during a two week “Winter Wilds Adventure” tour. The company has therefore decided to avoid publicity and has agreed to drop all charges against the embezzling employee. In return, the employee has agreed to a notation of “Terminated—Not to be Rehired” to be appended to his personnel file.

Required:
1. Who are the stakeholders in the decision not to prosecute?

2. Was it ethical for the company to decide not to prosecute? Explain.

S-AE 218 (Communication)

Kwik Express specializes in the overnight transportation of medical equipment and laboratory specimens. The company has selected the following information from its most recent annual report to be the subject of an immediate press release.
• The financial statements are being released.
• Net income this year was $2.2 million. Last year’s net income had been $2.0 million. • The current ratio has changed to 2:1 from last year’s 1.5:1
• The debt/total assets ratio has changed to 4:5 from last year’s 3:5
• The company expanded its truck fleet substantially by purchasing ten new delivery vans. The company already had twelve delivery vans.
• The company is now the largest medical courier in the mid-Atlantic region.

Required:

Prepare a brief press release incorporating the information above. Include all information. Think
carefully which information (if any) is good news for thetcompany, and which (if any) is bad news.