Chapter 1 - FS Analysis

(1)

The best changes often start as single,

The best changes often start as single, simple thoughts. Thinksimple thoughts. Think big, and discover how to make your dreams real.

big, and discover how to make your dreams real.

LEARNING OBJECTIVES: LEARNING OBJECTIVES:

After studying this chapter, you should be able to:

1. 1. Identi

Identify

fy the tools for f

the tools for financial statem

inancial statement analysis.

ent analysis.

2. 2. Explain why financial analysts use ratios to evaluate

Explain why financial analysts use ratios to evaluate

companies.

3. 3. Explain liquidity and show how ratios can measure a

Explain liquidity and show how ratios can measure a

company’s liquidity.

4. 4. Explain profitability and show how ratios can measure a

Explain profitability and show how ratios can measure a

company’s prof

company’s profitabilit

itability.

y.

4. Explain solvency and show how ratios can measure a

company’s solvency.

5. Explain some limitations of ratio analysis.

6. Discuss the need for comparative analysis.

CHAPTER I

FINANCIAL STATEMENT

ANALYSIS

(2)

Financial Statement Analysis involves the evaluation of

Financial Statement Analysis involves the evaluation of the firm’s pastthe firm’s past performance, present condition, and business potentials. The analysis provides performance, present condition, and business potentials. The analysis provides information about the

information about the following, among others:following, among others: 

 Profitability of the business firmProfitability of the business firm 

 Ability to meet company obligationsAbility to meet company obligations 

 Safety of investment in the businessSafety of investment in the business 

 Effectiveness of management in running the firmEffectiveness of management in running the firm

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

analysis include the followingfollowing::

1. Horizontal Analysis (Trend or

1. Horizontal Analysis (Trend or index analysis)index analysis) 2. Vertical Analysis (

2. Vertical Analysis (Common-size FS)Common-size FS) 3. Financial ratios

3. Financial ratios

4. Gross profit variation analysis 4. Gross profit variation analysis 5. Cash flow analysis

5. Cash flow analysis

Horizontal or index analysis involves comparison of figures shown in the financial Horizontal or index analysis involves comparison of figures shown in the financial statements of two or more consecutive periods. The difference of the amount statements of two or more consecutive periods. The difference of the amount between two periods is calculated, and the percentage change from one period between two periods is calculated, and the percentage change from one period to the next is computed using the earlier period as the base.

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

Percentage Change (∆ %) = Change (∆ %) =

Most Recent Value

Most Recent Value – – Base Period Value Base Period Value Base Period Value

Base Period Value

Comparisons can be between an actual amount compared against a budgeted Comparisons can be between an actual amount compared against a budgeted amount, with the ‘budget’ serving as the

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

FINANCIAL STATEMENTS ANALYSIS

FINANCIAL

STATEMENT

ANALYSIS

TOOLS

AND

FINANCIAL

STATEMENT

ANALYSIS

TOOLS

AND

TECHNIQUES

HORIZONTAL ANALYSIS

(3)

Vertical Analysis is the process of comparing figures in the financial statements of Vertical Analysis is the process of comparing figures in the financial statements of a single period. It involves conversion of figures in the statements to a common a single period. It involves conversion of figures in the statements to a common base. This is accomplished by expressing all figures in the statements as base. This is accomplished by expressing all figures in the statements as percentages of an important item such as total assets (in the balance sheet) or percentages of an important item such as total assets (in the balance sheet) or net sales (in the income statement). These converted statements are called net sales (in the income statement). These converted statements are called common-size statements or percentage

common-size statements or percentage composition statements.composition statements. Percentage composition statements are used for comparing:

Percentage composition statements are used for comparing: 1. Multiple years of data from the same firm.

1. Multiple years of data from the same firm. 2. Companies that is

2. Companies that is different in size.different in size. 3. Company to industry averages. 3. Company to industry averages.

Ratio analysis involves development of mathematical relationships among Ratio analysis involves development of mathematical relationships among accounts in the financial statements. Ratios calculated from these statements accounts in the financial statements. Ratios calculated from these statements provide users and analysts with relevant information about the firm’s

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

solvency and profitability.

BASIC RULES ON RATIO CALCULATIONS BASIC RULES ON RATIO CALCULATIONS

1. When calculating a ratio using balance sheet numbers only, the numerator and 1. When calculating a ratio using balance sheet numbers only, the numerator and denominator should be from the same balance sheet date. The same are true for denominator should be from the same balance sheet date. The same are true for ratios using only income statement numbers.

ratios using only income statement numbers. NOTE: Except if growth ratio is calculated. NOTE: Except if growth ratio is calculated.

2. If an income statement account and a balance sheet account are both used to 2. If an income statement account and a balance sheet account are both used to calculate a ratio, the balance sheet account should be expressed as

calculate a ratio, the balance sheet account should be expressed as an average foran average for the time period represented by

the time period represented by the income statement account.the income statement account.

3. If the beginning balance of a balance sheet account is not available, the ending 3. If the beginning balance of a balance sheet account is not available, the ending balance is normally used to represent the average balance of the account.

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

VERTICAL ANALYSIS

RATIO ANALYSIS

(4)

4. If sales and/ or purchases are given without making distinction as to whether 4. If sales and/ or purchases are given without making distinction as to whether made in cash or on credit, assumptions are made depending on the ratio being made in cash or on credit, assumptions are made depending on the ratio being calculated:

calculated: 

 Turnover ratios: Sales and purchases are made on credit.Turnover ratios: Sales and purchases are made on credit. 

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

5. Generally, the number of days in a month or year is not critical to the analysis: 5. Generally, the number of days in a month or year is not critical to the analysis: a year may have 360 days, 52 weeks, and 12 months; alternatively, a year may be a year may have 360 days, 52 weeks, and 12 months; alternatively, a year may be comprised of 365 calendar days, 300 working days or any appropriate number of comprised of 365 calendar days, 300 working days or any appropriate number of days.

days.

LIQUIDITY refers to the company’s ability to pay its cur

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

due.

1. Current Ratio/ Banker’s Ratio/

1. Current Ratio/ Banker’s Ratio/ Working Capital RatioWorking Capital Ratio It is a

It is a measure of adequacy of working capital. It is measure of adequacy of working capital. It is the primary test of solvency tothe primary test of solvency to meet current obligations from current assets.

meet current obligations from current assets. Computed as follows:

Computed as follows:

Current Ratio = Current Assets ÷

Current Ratio = Current Assets ÷ Current Liabilities.Current Liabilities.

2. Quick Ratio/ Acid Test Ratio 2. Quick Ratio/ Acid Test Ratio

It measures the number of times that the

It measures the number of times that the current liabilities could be paid with thecurrent liabilities could be paid with the available cash and near-cash assets (ex. Cash, marketable securities and current available cash and near-cash assets (ex. Cash, marketable securities and current receivables).

receivables).

Computed as follows: Computed as follows:

Quick Ratio = Quick Assets ÷

Quick Ratio = Quick Assets ÷ Current LiabilitiesCurrent Liabilities

LIQUIDITY RATIOS

(5)

1. Receivables Turnover 1. Receivables Turnover

It is the time required to complete one collection cycle from the time receivables It is the time required to complete one collection cycle from the time receivables are recorded, and then collected, to the time new receivables are recorded again. are recorded, and then collected, to the time new receivables are recorded again.

Receivable Turnover = Net Credit Sales ÷ Average Receivables Receivable Turnover = Net Credit Sales ÷ Average Receivables

2. Average Age of Receivables/ Average Collection Period/ Days’ Sales 2. Average Age of Receivables/ Average Collection Period/ Days’ Sales in

in ReceivablesReceivables

It indicates the average number of days during which the company must wait It indicates the average number of days during which the company must wait before receivables are collected.

before receivables are collected. Computed as follows: Computed as follows:

Average Collection Period = # of Working Days ÷ Receivables Turnover Average Collection Period = # of Working Days ÷ Receivables Turnover

3. Inventory Turnover 3. Inventory Turnover

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

Inventory Turnover = Cost of Goods Sold ÷ Average Merchandise Inventory Turnover = Cost of Goods Sold ÷ Average Merchandise Inventory

Inventory

4. Average Age of Inventory/ Inventory Conversion Period/ Days’ Sales 4. Average Age of Inventory/ Inventory Conversion Period/ Days’ Sales in Inventory

in Inventory

It indicates the average number of days during which the company must wait It indicates the average number of days during which the company must wait before the inventories are sold.

before the inventories are sold.

WORKING CAPITAL ACTIVITY RATIOS/ EFFICIENCY

RATIOS

(6)

Average Age of Inventory = # of Working Days ÷ Inventory Turnover Average Age of Inventory = # of Working Days ÷ Inventory Turnover

5.

5. Raw Raw Materials Materials TurnoverTurnover

The number of times raw materials are replaced or

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

period.

R Turnover = Cost of Materials Used ÷ Ave. Raw Materials Inventory R Turnover = Cost of Materials Used ÷ Ave. Raw Materials Inventory

6.

6. Work in Work in Process Process TurnoverTurnover

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

period.

WIP Turnover = Cost of goods manufactured ÷ Ave. WIP

WIP Turnover = Cost of goods manufactured ÷ Ave. WIP inventoryinventory

7.

7. Finished Finished goods goods turnoverturnover

The number of times finished goods inventory revolved or

The number of times finished goods inventory revolved or are replaced during theare replaced during the accounting period.

accounting period. Computed as follows: Computed as follows:

FG Turnover = Cost of

FG Turnover = Cost of goods sold ÷ Ave. FG goods sold ÷ Ave. FG inventoryinventory

8.

8. Normal Normal Operating Operating CycleCycle

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

(7)

Normal Operating Cycle = Ave. Age of Invty. + Ave. Age of Rec. Normal Operating Cycle = Ave. Age of Invty. + Ave. Age of Rec.

9.

9. Trade Trade Payables Payables TurnoverTurnover

It is the time required to complete one payment cycle from the time trade It is the time required to complete one payment cycle from the time trade payables are recorded, and then paid, to the time new trade payables are payables are recorded, and then paid, to the time new trade payables are recorded again.

recorded again.

TP Turnover = Net Credit

TP Turnover = Net Credit Purchases ÷ Ave. Trade PayablesPurchases ÷ Ave. Trade Payables

10.

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

Payables

It indicates the length o

It indicates the length of time during which payables remain unpaid.f time during which payables remain unpaid. Computed as follows:

Computed as follows: AD Period = #

AD Period = # of working days ÷ Payables Turnoverof working days ÷ Payables Turnover

11. Current Assets Turnover 11. Current Assets Turnover

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

requirements

Computed as follows: Computed as follows: CA Turnover = Cost

CA Turnover = Cost of Sales + Operating Expenses** ÷ Ave. Current Assetsof Sales + Operating Expenses** ÷ Ave. Current Assets

**NOTE: These exclude depreciation, amortization and other expenses **NOTE: These exclude depreciation, amortization and other expenses related to l

(8)

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

involve leverage ratios. LEVERAGE refers to how much of company’s resourcesleverage ratios. LEVERAGE refers to how much of company’s resources are financed by debt and/or preferred equity, both of which require fixed are financed by debt and/or preferred equity, both of which require fixed payment of interests and dividends.

payment of interests and dividends. 1. Times Interest Earned

1. Times Interest Earned It determines the extent to

It determines the extent to which operations cover interest expense.which operations cover interest expense. Computed as follows:

Times Interest Earned = EBIT ÷ Int. Expense Times Interest Earned = EBIT ÷ Int. Expense

2. Debt to Equity Ratio 2. Debt to Equity Ratio

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

provided by owners. Computed as follows: Computed as follows:

Debt to Equity Ratio = Total Liabilities ÷ Total SHE Debt to Equity Ratio = Total Liabilities ÷ Total SHE

3. Debt Ratio 3. Debt Ratio

Refers to the proportion of total assets provided by the

Refers to the proportion of total assets provided by the creditors.creditors. Computed as follows:

Computed as follows: Debt Ratio = T

Debt Ratio = Total Liabilities ÷ Total Assetsotal Liabilities ÷ Total Assets

4. Equity Ratio 4. Equity Ratio

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

SOLVENCY RATIOS

(9)

Computed as follows: Computed as follows: Equity Ratio = Total

Equity Ratio = Total SHE ÷ Total AssetsSHE ÷ Total Assets

1. Return on Sales 1. Return on Sales

This determines the portion of sales

This determines the portion of sales that went into the company’s earnings.that went into the company’s earnings. Computed as follows:

ROS = Income ÷ Net Sales ROS = Income ÷ Net Sales

2. Return on

2. Return on AssetsAssets

This refers to the efficiency with which assets are used to operate the business. This refers to the efficiency with which assets are used to operate the business. Computed as follows:

ROA = Income ÷ Ave. Assets ROA = Income ÷ Ave. Assets

What INCOME figure should be used? What INCOME figure should be used?



 If the intention is to measure OPERATIONAL PERFORMANCE, income isIf the intention is to measure OPERATIONAL PERFORMANCE, income is expressed

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

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

 If the intention is to evaluate TOTAL MANAGERIAL EFFORTS, income isIf the intention is to evaluate TOTAL MANAGERIAL EFFORTS, income is expressed after interest and tax.

expressed after interest and tax. 

 If used in DuPont Technique, income must be after interests, taxes andIf used in DuPont Technique, income must be after interests, taxes and preferred stock divid

preferred stock dividends.ends. 3. Return on Equity

3. Return on Equity

PROFITABILITY RATIOS

(10)

ROE = Income ÷ Ave. Equity ROE = Income ÷ Ave. Equity

4. Earnings per Share 4. Earnings per Share

Measures the amount of net income earned by each common share. Measures the amount of net income earned by each common share. Computed as follows:

Computed as follows: EPS = Net Income

EPS = Net Income – – P/S Div. ÷ WACSO P/S Div. ÷ WACSO

1. Price-Earnings Ratio 1. Price-Earnings Ratio

It indicates the number of pesos required to buy P1

It indicates the number of pesos required to buy P1 of earnings.of earnings. Computed as follows:

P/E Ratio = Price Per Share ÷ EPS P/E Ratio = Price Per Share ÷ EPS

2. Dividend Yield Ratio 2. Dividend Yield Ratio

Measures the rate of return in

Measures the rate of return in the investor’s common stock investments.the investor’s common stock investments. Computed as follows:

Div. Yield Ratio = Div. Per Share ÷ Price per Share Div. Yield Ratio = Div. Per Share ÷ Price per Share

3.

3. Dividend Dividend Payout Payout RatioRatio It indicates the proportion of

It indicates the proportion of earnings distributed as dividendsearnings distributed as dividends

MARKETABILITY RATIOS

(11)

Div. Payout Ratio = Div. per Share ÷ EPS Div. Payout Ratio = Div. per Share ÷ EPS

1. Fixed Asset to Total Equity 1. Fixed Asset to Total Equity

Measures the proportion of owners’ e

Measures the proportion of owners’ equity to fixed assets. This quity to fixed assets. This indicates whetherindicates whether investments by owners are over or under and also

investments by owners are over or under and also shows weakness in leverage.shows weakness in leverage. Computed as follows:

Fixed Assets to Total Equity = Fixed Assets ÷ Total Equity Fixed Assets to Total Equity = Fixed Assets ÷ Total Equity

2. Fixed Assets to Total

2. Fixed Assets to Total AssetsAssets

Indicates possible over-expansion of plant and

Indicates possible over-expansion of plant and equipmentequipment.. Computed as follows:

Fixed Asset to Total Assets =

Fixed Asset to Total Assets = Fixed Assets ÷ Total AssetsFixed Assets ÷ Total Assets

3. Sales to Fixed

3. Sales to Fixed Assets (Plant Turnover)Assets (Plant Turnover) Test roughly the efficiency of

Test roughly the efficiency of management in keeping plant properties employed.management in keeping plant properties employed. Computed as follows:

Sales to Fixed Assets = Net Sales ÷ Fixed Assets Sales to Fixed Assets = Net Sales ÷ Fixed Assets

4. Book Value Per

4. Book Value Per ShareShare

Measures recoverable amount by common stockholders in the event of Measures recoverable amount by common stockholders in the event of liquidation if assets are realized at

liquidation if assets are realized at their book values.their book values.

STABILITY RATIOS

(12)

BVPS = Common SHE ÷ CS

BVPS = Common SHE ÷ CS outstandingoutstanding

5. Times Preferred Dividends Earned 5. Times Preferred Dividends Earned It indicates ability to provide dividends to

It indicates ability to provide dividends to preferred stockholders.preferred stockholders. Computed as follows:

Computed as follows: Times PS Div. Earned =

Times PS Div. Earned = Net Income after Tax ÷ PS Net Income after Tax ÷ PS Div.Div.

6. Capital Intensity Ratio 6. Capital Intensity Ratio

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

resources.

Capital Intensity Ratio = Total Assets ÷ Net

Capital Intensity Ratio = Total Assets ÷ Net SalesSales

7. Times Fixed Charges Earned 7. Times Fixed Charges Earned

Measures ability to meet fixed charges. Measures ability to meet fixed charges. Computed as follows:

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

payment**

** Fixed charges

** Fixed charges shall include shall include rent, interesrent, interests and ts and other relevant other relevant fixedfixed expenses; sinking fund payment must be expressed before tax.

(13)

1. Working Capital

1. Working Capital TurnoverTurnover

Indicates adequacy of working capital to

Indicates adequacy of working capital to support operations (sale).support operations (sale). Computed as follows:

WC Turnover = Net Sales ÷

WC Turnover = Net Sales ÷ Ave. Working CapitalAve. Working Capital

2. Defensive Interval Ratio 2. Defensive Interval Ratio

Measures coverage of current liabilities Measures coverage of current liabilities

DIR = Current Liabilities ÷ Cash & Cash Equivalents DIR = Current Liabilities ÷ Cash & Cash Equivalents

3. Payable Turnover 3. Payable Turnover

Measures efficiency of the company in

Measures efficiency of the company in meeting the accounts payable.meeting the accounts payable. Computed as follows:

Payable Turnover = Net Purchases ÷ Ave. Accounts Payable Payable Turnover = Net Purchases ÷ Ave. Accounts Payable

4. Fixed Asset to

4. Fixed Asset to Long-term LiabilitiesLong-term Liabilities

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

sources of additional funds. Computed as follows: Computed as follows:

FA to LTL = Fixed

FA to LTL = Fixed Assets ÷ Long-term LiabilitiesAssets ÷ Long-term Liabilities

SOLVENCY RATIOS

(14)

1. Rate of

1. Rate of return on Average Current Assetreturn on Average Current Asset Measures profitability of current

Measures profitability of current assets invested.assets invested. Computed as follows:

RoR on ACA = Income ÷ Ave. Current Assets RoR on ACA = Income ÷ Ave. Current Assets

2. Operating profit margin 2. Operating profit margin

Measures profit generated after consideration of operating costs. Measures profit generated after consideration of operating costs.

OPM = Operating Profit ÷ Net Sales OPM = Operating Profit ÷ Net Sales

3. Cash Flow Margin 3. Cash Flow Margin

Measures the ability of the firm to translate sales to cash Measures the ability of the firm to translate sales to cash

CFM = Operating Cash Flow ÷

CFM = Operating Cash Flow ÷ Net SalesNet Sales

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

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

results of operations

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

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

operating expenses, financing, income taxes and a desired amount of profit. At. At times, the gross profit figure is also being used as a basis for performance times, the gross profit figure is also being used as a basis for performance

RATIOS INDICATIVE OF INCOME POSITION

GROSS PROFIT VARIANCE ANALYSIS

(15)

Gross profit is the difference between sales and cost of goods sold. It is a very Gross profit is the difference between sales and cost of goods sold. It is a very important figure in the income statement because it is one of the factors that important figure in the income statement because it is one of the factors that determine the final result of operations.

determine the final result of operations.

Changes in the financial statement may be attributed to the change in any, or a Changes in the financial statement may be attributed to the change in any, or a combination of the

combination of the followifollowing factors:ng factors: 1. Selling price

1. Selling price

2. Volume or quantity of products sold. 2. Volume or quantity of products sold. 3. Cost of product sold

3. Cost of product sold GP variance may be

GP variance may be analyzed through the following:analyzed through the following: 

 GP (Actual) vs. GP (Budget)GP (Actual) vs. GP (Budget) 

 GP (Current) vs. GP (Prior Period)GP (Current) vs. GP (Prior Period) NOTE:

NOTE:

FAVORABLE if actual (current) GP is

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

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

There are different ways of analyzing gross profit variances. Presented here are 4 There are different ways of analyzing gross profit variances. Presented here are 4 --way, 6-way and 3-way

way, 6-way and 3-way analyses.analyses.

Sales Variance: Sales Variance:

Price factor = (Change in

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

Volume/quantity factor = y factor = (Change in units x (Change in units x Standard/Budgeted SP)Standard/Budgeted SP) Cost Variance:

Cost Variance:

Price factor = (Change in CP

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

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

Note: The above procedures are the same as the one used in 2-way analysis for Note: The above procedures are the same as the one used in 2-way analysis for materials and labor variances.

materials and labor variances.

4-WAY ANALYSIS:

(16)

Sales Variance: Sales Variance: Price factor =

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

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

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

Cost Variance:

Price factor = (Change in CP

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

Volume/quantity factor = y factor = (Change in units/volume x Standard/Budgeted CP)(Change in units/volume x Standard/Budgeted CP) Price-volume factor = (Change in CP x Change in Units)

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

Note:

The price factor refers to the change in Selling or cost prices assuming that there The price factor refers to the change in Selling or cost prices assuming that there has been no change in units sold.

has been no change in units sold.

The quantity or volume factor refers to the change in the number of units sold The quantity or volume factor refers to the change in the number of units sold assuming that there has been no change in the selling or cost prices.

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

The price-volume factor refers to the sales or cost of sales variances due to the The price-volume factor refers to the sales or cost of sales variances due to the combined effect of the differences in price and units sold.

combined effect of the differences in price and units sold.

Quantity/volume factor = (Change in units x

Quantity/volume factor = (Change in units x Standard/Budgeted GP/unitStandard/Budgeted GP/unit)) Price factor = (Change in

Price factor = (Change in SP x Actual Volume/quantitySP x Actual Volume/quantity)) Cost factor = (Change in CP x

Cost factor = (Change in CP x Actual Volume/quantActual Volume/quantity)ity)

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

in units sold.

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

6-WAY ANALYSIS:

3-WAY ANALYSIS:

GROSS

(17)

the sales volume and cost volume variances are analyzed further, which results in the sales volume and cost volume variances are analyzed further, which results in the computation of a sales mix variance and final sales volume variance. The the computation of a sales mix variance and final sales volume variance. The formulas for these last two v

formulas for these last two variances are as follows:ariances are as follows: Sales mix variance:

Sales mix variance: Actual

Actual units units @ @ Standard/BudgStandard/Budgeted eted SP SP xxxx Less:

Less: Actual Actual units units @ @ Standard Standard CP CP (xx)(xx)

Difference xx

Less:

Less: Actual Actual units units @ @ Standard Standard Average Average GP GP (xx)(xx) SALES MIX VARIANCE

SALES MIX VARIANCE xxxx

Final Sales Volume

Final Sales Volume Variance:Variance: Actual

Actual units units @ @ Standard/BudgetStandard/Budgeted ed Ave. Ave. GP GP xxxx Less:

Less: Standard/Budgeted Standard/Budgeted GP GP (xx)(xx) FINAL SALES VOLUME VARIANCE

FINAL SALES VOLUME VARIANCE xxxx

ILLUSTRATIVE EXERCISES

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

below.

PHILIP MORRIS COMPANIES, INC. PHILIP MORRIS COMPANIES, INC.

Comparative Balance Sheets Comparative Balance Sheets

December 31 December 31 (In million Dollars) (In million Dollars)

2014 2013

ASSETS ASSETS Current

Current Assets Assets 21,382 21,382 17,44117,441 Property,

Property, plant plant and and equipment equipment (net) (net) 16,067 16,067 14,84614,846 Other

Other Assets Assets 58,726 58,726 55,25355,253 Total

Total Assets Assets 96,175 96,175 87,54087,540 LIABILITIES and SHE

LIABILITIES and SHE

VERTICAL AND HORIZONTAL ANALYSIS

(18)

Long-term

Long-term Liabilities Liabilities 49,705 49,705 48,98048,980 Stockholders’ Equity

Stockholders’ Equity 25,077 25,077 19,47819,478 Total

Total Liabilities Liabilities and and SHE SHE 96,175 96,175 87,54087,540

Required:

Required: (Round all computations to 2 decimal places). (Round all computations to 2 decimal places). 1.

1. Prepare aPrepare a horizontal analysishorizontal analysis of the balance sheet data for Philip Morris of the balance sheet data for Philip Morris using 2013 as a

using 2013 as a base.base. 2.

2. Prepare aPrepare a vertical analysisvertical analysis of the balance sheet data for Philip Morris for of the balance sheet data for Philip Morris for 2013 and 2014.

2013 and 2014.

Here are the

Here are the comparative income statements of Viking Corporationcomparative income statements of Viking Corporation VIKING CORPORATION

VIKING CORPORATION Comparative Income

Comparative Income StatementsStatements For the years ended December 31 For the years ended December 31

(In million Dollars) (In million Dollars)

2014 2013

Net

Net Sales Sales 550,000 550,000 550,000550,000 Cost

Cost of of goods goods sold sold 440,000 440,000 450,000450,000 Gross

Gross Profit Profit 110,000 110,000 100,000100,000 Operating

Operating Expenses Expenses 58,000 58,000 55,00055,000 Net

Net Income Income 52,000 52,000 45,00045,000

Required:

Required: (Round all computations to 2 decimal places) (Round all computations to 2 decimal places) 1.

1. Prepare a horizontal analysis of the income statement data for VikingPrepare a horizontal analysis of the income statement data for Viking Corporation using 2013 as a base.

Corporation using 2013 as a base. 2.

2. Prepare a vertical analysis of the income statement data for VikingPrepare a vertical analysis of the income statement data for Viking Corporation for both years.

Corporation for both years.

Indicate the effects of each of the following

Indicate the effects of each of the following transactions on the company’s (A)transactions on the company’s (A) current ratio and (B) acid-test ratio. There are the possible answers: (+) increase, current ratio and (B) acid-test ratio. There are the possible answers: (+) increase,

VERTICAL AND HORIZONTAL ANALYSIS

LIQUIDITY ANALYSIS

(19)

Effects on Effects on Transactions

Transactions Current Current ratio ratio Acid-test ratioAcid-test ratio Example: Sell merchandise for cash.

Example: Sell merchandise for cash. + + ++ 1. Buy inventory on account.

1. Buy inventory on account. 2. Pay an account payable. 2. Pay an account payable. 3. Borrow cash on a

3. Borrow cash on a short-term loan.short-term loan. 4. Issue long-term bonds payable. 4. Issue long-term bonds payable. 5. Collect an

5. Collect an accounts receivable.accounts receivable. 6. Record accrued expenses payable. 6. Record accrued expenses payable. 7. Sell a plant asset for

7. Sell a plant asset for cash at a profit.cash at a profit. 8. Sell a plant asset for

8. Sell a plant asset for cash at a loss.cash at a loss. 9. Buy marketable securities, for cash. 9. Buy marketable securities, for cash. 10. Sell merchandise on

10. Sell merchandise on credit.credit.

Leen has 1,000,000 common shares outstanding. The price of the stock is P8. Leen Leen has 1,000,000 common shares outstanding. The price of the stock is P8. Leen declared dividends per share of P0.10. The balance sheet at the end of 2013 declared dividends per share of P0.10. The balance sheet at the end of 2013 showed approximately the same amounts as that at the end of 2014.

showed approximately the same amounts as that at the end of 2014. The financial statements for Leen Merchandising are as

The financial statements for Leen Merchandising are as follows:follows: Leen Company, Income Statement for 2014

Leen Company, Income Statement for 2014 (in thousands)(in thousands)

Sales 4,700

Cost

Cost of of goods goods sold sold 2,3002,300 Gross

Gross profit profit 2,4002,400

Operating expenses: Operating expenses: Depreciation 320 Depreciation 320 Other Other 1,230 1,230 1,5501,550 Income

Income before before interest interest and and taxes taxes 850850 Interest

Interest expense expense 150150

Income

Income before before taxes taxes 700700

Income

Income taxes taxes 280280

Net income

Net income 420420

FINANCIAL RATIOS

(20)

Assets Liabilities

and SHE and SHE Cash

Cash 220 220 Accounts Accounts payable payable 190190 Accounts

Accounts receivable receivable 440 440 Accrued Accrued expenses expenses 180180 Inventory

Inventory 410 410 Total Total current current liabilitiesliabilities 370370 Total current assets

Total current assets 1,0701,070 Long-term Long-term debt debt 1,9601,960 Plant

Plant and and equipment equipment 5,600 5,600 Common Common stock stock 1,8101,810 Accumulated

Accumulated depreciation depreciation (2,100) (2,100) Retained Retained earnings earnings 430430 Total assets

Total assets 4,5704,570 Total liabilities and SHETotal liabilities and SHE 4,5704,570

Required:

Required: (Round all computations to 2 decimal places.) (Round all computations to 2 decimal places.) 1.

1. Current Current ratio ratio 11. 11. EPSEPS 2.

2. Acid-test Acid-test ratio ratio 12. 12. P/E P/E ratioratio 3.

3. Accounts Accounts receivable receivable turnover turnover 13. Dividend 13. Dividend yieldyield 4.

4. Inventory Inventory turnover turnover 14. 14. Payout Payout ratioratio 5.

5. Gross Gross profit profit margin margin 15. 15. Debt Debt ratioratio 6.

6. Operating Operating profit profit margin margin 16. 16. Debt-equity Debt-equity ratioratio 7.

7. Return Return on on sales sales 17. 17. Times Times interest interest earnedearned 8. ROA

8. ROA – – operational operational performance performance 18. 18. Defensive Defensive intervalinterval ratio

ratio 9. ROA

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

debt 10.

10. Return Return on on equity equity 20. 20. Cash Cash flow flow marginmargin

(Interpreting Financial

(Interpreting Financial Statements)Statements)

The Coca-Cola Company and PepsiCo, Inc. provide refreshments to every corner The Coca-Cola Company and PepsiCo, Inc. provide refreshments to every corner of the world. Selected data from the 2003 consolidated financial statements for of the world. Selected data from the 2003 consolidated financial statements for The Coca-Cola Company and for PepsiCo, Inc. are presented here (in millions of The Coca-Cola Company and for PepsiCo, Inc. are presented here (in millions of Dollars).

Dollars).

FINANCIAL RATIOS

(21)

Coca-Cola PepsiCo Coca-Cola PepsiCo Total

Total current current assets assets 8,396 8,396 6,9306,930 Total

Total current current liabilities liabilities 7,886 7,886 6,4156,415 Net

Net sales sales 21,044 21,044 26,97126,971 Cost

Cost of of goods goods sold sold 7,762 7,762 12,37912,379 Net

Net income income 4,347 4,347 3,5683,568 Average

Average receivables receivables for for the the year year 2,094 2,094 2,6812,681 Average

Average inventories inventories for for the the year year 1,273 1,273 1,3771,377 Average

Average total total assets assets 25,874 25,874 24,40124,401 Average common shareholders’ equity

Average common shareholders’ equity 12,945 12,945 10,71310,713 Average

Average current current liabilities liabilities 7,614 7,614 6,2346,234 Average

Average total total liabilitiliabilities es 12,929 12,929 13,70213,702 Total

Total assets assets 27,342 27,342 25,32725,327 Total

Total liabilities liabilities 13,252 13,252 13,45313,453 Income

Income taxes taxes 1,148 1,148 1,4241,424 Interest

Interest expense expense 178 178 163163

Cash

Cash provided provided by by operating operating activities activities 5,456 5,456 4,3284,328

Required:

Required: (Round all computations to 2 decimal places). (Round all computations to 2 decimal places). 1.

1. Compute the following liquidity ratios for 2003 for Coca-Cola and forCompute the following liquidity ratios for 2003 for Coca-Cola and for PepsiCo and comment on the

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

a. Current ratioCurrent ratio b.

b. Receivables turnoverReceivables turnover c.

c. Average collection periodAverage collection period d.

d. Inventory turnoverInventory turnover e.

e. Days in inventoryDays in inventory f.

f. Current cash debt coverageCurrent cash debt coverage 2.

2. Compute the following solvency ratios for the two companies andCompute the following solvency ratios for the two companies and comment on the relative solvency of

comment on the relative solvency of the two competitors.the two competitors. a.

a. Debt to total assets.Debt to total assets. b.

b. Times interest earned.Times interest earned. c.

c. Cash debt coverage ratio.Cash debt coverage ratio. 3.

3. Compute the following profitability ratios for the two companies andCompute the following profitability ratios for the two companies and comment on the relative profitability of the two

(22)

b.

b. Asset turnoverAsset turnover c.

c. Return on assetsReturn on assets d.

d. Return on common stockholders’ equityReturn on common stockholders’ equity

KOYOT CORPORATION has the following data: KOYOT CORPORATION has the following data:

2014 2013

Sales

Sales volume volume in in units units 5,000 5,000 8,0008,000 Selling

Selling price price per per unit unit P10 P10 P8P8 Cost

Cost per per unit unit P7 P7 P6P6

Required:

Required: (Round all computations to 2 decimal places).(Round all computations to 2 decimal places). Compute for the Gross

Compute for the Gross Profit Variance using:Profit Variance using: 1. 4-way analysis 1. 4-way analysis 2. 6-way analysis 2. 6-way analysis 3. 3-way analysis 3. 3-way analysis

Panda Company prepared the following budgetary information for January of Panda Company prepared the following budgetary information for January of 2014 for its toy gun:

2014 for its toy gun: Sales

Sales (12,000 (12,000 units) units) 432,000432,000 Cost

Cost of of goods goods sold sold 288,000288,000 Gross profit

Gross profit 144,000144,000

In January, actual operations resulted in the production and sale of 13,000 units In January, actual operations resulted in the production and sale of 13,000 units at an average selling price of P34 per unit. The cost of goods sold per unit at an average selling price of P34 per unit. The cost of goods sold per unit increased by P3.

increased by P3.

Required:

Required: (Round all computations to 2 decimal places). (Round all computations to 2 decimal places). 1. Overall GP variance.

1. Overall GP variance.

GROSS

GROSS PROFIT

PROFIT ANALYSIS

ANALYSIS SINGLE

SINGLE PRODUCT)

PRODUCT)

GROSS

GROSS PROFIT

PROFIT ANALYSIS

ANALYSIS SINGLE

SINGLE PRODUCT)

PRODUCT)

FULL INFORMATION) FULL INFORMATION)

(23)

4. Cost price variance. 4. Cost price variance. 5. Cost volume variance. 5. Cost volume variance.

Spaniard Company has requested you to determine the cause of the difference Spaniard Company has requested you to determine the cause of the difference between its 2013 and 2014 gross profit based on

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

2013 2014

Sales

Sales 200,000 200,000 252,000252,000 Cost

Cost of of Goods Goods Sold Sold 120,000 120,000 180,000180,000 Gross Profit

Gross Profit 80,000 80,000 72,00072,000

No additional data was made available except that unit sales increased by 20% in No additional data was made available except that unit sales increased by 20% in 2014.

2014.

Required:

Required: (Round all computations to 2 decimal places).(Round all computations to 2 decimal places). 1. Overall GP variance. 1. Overall GP variance. 2. Price factor. 2. Price factor. 3. Cost factor. 3. Cost factor. 4. Volume factor. 4. Volume factor.

The following are the

The following are the data for ARIUS LUKE ANGELO CORPORATION:data for ARIUS LUKE ANGELO CORPORATION:

2014 2013 2014 2013 Product Product A A Product Product LL Product Product R R Product Product A A Product Product LL Product Product R R Sales volume Sales volume in units in units 400 400 350 350 1,000 1,000 500 500 200 200 1,0001,000 Selling prices Selling prices per unit per unit P4 P4 P5 P5 P3 P3 P4.50 P4.50 P4.20 P4.20 P2.80P2.80 Cost

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

GROSS

GROSS PROFIT

PROFIT ANALYSIS

ANALYSIS SINGLE

SINGLE PRODUCT)

PRODUCT)

INCOMPLETE INFORMATION) INCOMPLETE INFORMATION)

GROSS

(24)

Required:

Required: (Round all computations to 2 decimal places). (Round all computations to 2 decimal places). Compute for the sales mix

Compute for the sales mix variance and final sales volume variancevariance and final sales volume variance

The following data were given

The following data were given for Vamos Company:for Vamos Company:

2013 2014 2013 2014 Product Product A A Product Product B B Product Product A A Product Product B B Sales

Sales volume volume 6,000 6,000 4,000 4,000 3,000 3,000 5,0005,000 Unit

Unit selling selling price price 10 10 6 6 9 9 55 Unit

Unit cost cost 6 6 3 3 4 4 33

Required:

Required: (Round all computations to 2 decimal places).(Round all computations to 2 decimal places). 1.

1. Overall Overall GP GP variance variance 4. 4. Volume Volume factorfactor 2.

2. Price Price factor factor 5. 5. Mix Mix factorfactor 3. Cost factor

3. Cost factor

PRACTICE EXERCISES

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

THEORIES THEORIES

1.

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

a. Unprofitable use of Unprofitable use of working capitalworking capital b.

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

c. The firm is The firm is undercapitalizundercapitalized.ed.

d.

d. The firm is not The firm is not susceptible to liquidity problems.susceptible to liquidity problems. 2.

2. Rice Inc. uses the allowance method to account for uncollectibleRice Inc. uses the allowance method to account for uncollectible accounts. An account receivable that was previously determined accounts. An account receivable that was previously determined uncollectible and written off was collected during May. The effect of the uncollectible and written off was collected during May. The effect of the collection on Rice’s current ratio and total working capital is

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

GROSS

(25)

c.

c. Decrease Decrease DecreaseDecrease d.

d. None None IncreaseIncrease 3.

3. Accounts receivable turnover ratio will normally decrease as Accounts receivable turnover ratio will normally decrease as a result ofa result of a.

a. The write-off of an uncollectible account (assume the use of theThe write-off of an uncollectible account (assume the use of the allowance for doubtful accounts method).

allowance for doubtful accounts method). b.

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

period. c.

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

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

4.

4. TheThe days’ salesdays’ sales-in-receivabl-in-receivables ratio will be es ratio will be understated if the companyunderstated if the company a.

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

b.

b. Uses a calendar year for its accounting period.Uses a calendar year for its accounting period. c.

c. Uses average receivables in the Uses average receivables in the ratio calculation.ratio calculation. d.

d. Does not use average receivables in the ratio calculationDoes not use average receivables in the ratio calculation Questions 5 through 11are based on the

Questions 5 through 11are based on the following information.following information.

Depoole Company is a manufacturer of Industrial products and uses a calendar Depoole Company is a manufacturer of Industrial products and uses a calendar year for financial reporting purposes. These questions present several of year for financial reporting purposes. These questions present several of Depoole’s transactions during the year. Assume that the total quick assets Depoole’s transactions during the year. Assume that the total quick assets exceeded total current liabilities both before and after each transaction exceeded total current liabilities both before and after each transaction described. Further assume that Depoole has positive profits during the

described. Further assume that Depoole has positive profits during the year and ayear and a credit balance throughout the year in its retained earnings account.

credit balance throughout the year in its retained earnings account. 5.

5. Payment of a trade account payable of P64,500 wouldPayment of a trade account payable of P64,500 would a.

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

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

c. Increase both the current and quick ratios.Increase both the current and quick ratios.

d.

d. Decrease both the current and quick ratios.Decrease both the current and quick ratios. 6.

6. The purchase of raw materials for P85,000 on open account wouldThe purchase of raw materials for P85,000 on open account would a.

a. Increase the current ratio.Increase the current ratio. b.

b. Decrease the current ratio.Decrease the current ratio.

c.

c. Increase net working capital.Increase net working capital. d.

(26)

7.

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

a. Increase the current ratioIncrease the current ratio b.

b. Decrease the current ratio and the quick ratioDecrease the current ratio and the quick ratio c.

c. Increase the quick ratioIncrease the quick ratio d.

d. Not affect the current or quick ratioNot affect the current or quick ratio

8.

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

transaction a.

a. Decreased the quick ratio.Decreased the quick ratio. b.

b. Increased the quick ratio.Increased the quick ratio. c.

c. Increased net working capital.Increased net working capital. d.

d. Decreased the current ratio.Decreased the current ratio.

9.

9. The issuance of new shares in a The issuance of new shares in a five-for-one split of common stockfive-for-one split of common stock a.

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

b.

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

c. Increases total shareholders’ equity.Increases total shareholders’ equity. d.

d. Decreases total sDecreases total shareholders’ equity.hareholders’ equity. 10.

10. The issuance of a serial bonds in exchange for an office building, with theThe issuance of a serial bonds in exchange for an office building, with the first installment of the bonds due late

first installment of the bonds due late this year,this year, a.

a. Decreases net working capital.Decreases net working capital. b.

b. Decreases the current ratio.Decreases the current ratio. c.

c. Decreases the quick ratio.Decreases the quick ratio. d.

d. Affects all of the Affects all of the answers as indicated.answers as indicated.

11.

11. Refer to the information preceding question 1. The early liquidation of aRefer to the information preceding question 1. The early liquidation of a long-term note with cash affects the

long-term note with cash affects the a.

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

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

c.

c. Current and quick ratio to the same degree.Current and quick ratio to the same degree. d.

d. Current ratio but not the quick ratio.Current ratio but not the quick ratio. 12.

(27)

c.

c. Accounts receivable turnover and inventory turnover.Accounts receivable turnover and inventory turnover.

d.

d. Asset turnover and return on sales.Asset turnover and return on sales. 13.

13. If the ratio of total liabilities to shareholders’ equity increases, a ratio thatIf the ratio of total liabilities to shareholders’ equity increases, a ratio that must also increase is

must also increase is a.

a. Times interest earned.Times interest earned. b.

b. Total liabilities to total Total liabilities to total assets.assets.

c.

c. Return on equity.Return on equity. d.

d. The current ratio.The current ratio. 14.

14. Return on investment may be calculated by multiplying total assetReturn on investment may be calculated by multiplying total asset turnover by

turnover by a.

a. Average collection period.Average collection period. b.

b. Profit margin.Profit margin.

c.

c. Debt ratio.Debt ratio. d.

d. Fixed-charge coverage.Fixed-charge coverage. 15.

15. If a company is profitable and is effectively using leverage, which one ofIf a company is profitable and is effectively using leverage, which one of the following ratios is likely to be the largest?

the following ratios is likely to be the largest? a.

a. Return on total assets.Return on total assets. b.

b. Return on operating assets.Return on operating assets. c.

c. Return on common equity.Return on common equity.

d.

d. Return on total equity.Return on total equity. 16.

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

increase its a.

a. Return on equity.Return on equity. b.

b. Dividend payout ratio.Dividend payout ratio. c.

c. Market-to-book ratio.Market-to-book ratio. d.

d. Dividend yield.Dividend yield.

17.

17. A debt-to-equity ratio isA debt-to-equity ratio is a.

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

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

c.

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

(28)

18.

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

comparability among firms?firms? a.

a. Different accounting policies.Different accounting policies. b.

b. Different fiscal years.Different fiscal years. c.

c. Different sources of Different sources of informatiinformation.on. d.

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

19.

19. Which of the following is the worst limitation of ratio analysis affectingWhich of the following is the worst limitation of ratio analysis affecting comparability from one interim period to the

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

a. Management has an incentive to window dress financial statementsManagement has an incentive to window dress financial statements to improve results.

to improve results. b.

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

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

c.

c. Comparability is impaired if different firms use different accountingComparability is impaired if different firms use different accounting policies.

policies. d.

d. Generalizations about which ratios are sGeneralizations about which ratios are strong indicators of a firm’strong indicators of a firm’s financial position may change from industry to industry and firm to financial position may change from industry to industry and firm to firm.

firm. 20.

20. In assessing the financial prospects for a firm, financial analysts useIn assessing the financial prospects for a firm, financial analysts use various techniques. Which of the following is an example of vertical various techniques. Which of the following is an example of vertical common-size

common-size analysis?analysis? a.

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

integration. b.

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

the same industry.industry. c.

c. A statement that current advertising expense is 2% greater than inA statement that current advertising expense is 2% greater than in the prior year.

the prior year. d.

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

21.

21. Under the direct method of determining net cash provided by operatingUnder the direct method of determining net cash provided by operating activities on the statement of cash flows, a gain on sale of plant assets activities on the statement of cash flows, a gain on sale of plant assets

(29)

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

the accrual basis.

c. Deducted from the amount of sales reported under the accrual basis. c. Deducted from the amount of sales reported under the accrual basis. d. Totally ignored since the gain is not a part of sales, cost of goods sold,

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

or operating expenses.

22.

22. Which of the following account changes would be classified as a use ofWhich of the following account changes would be classified as a use of funds?

funds?

a. An increase in accounts payable

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

b.

b. An An increase increase in in retained retained earnings earnings d. d. A A decrease decrease in in accountsaccounts receivable

receivable 23.

23. Shakey’s Corporation has an acid test ratio of 1.5 to 1.0. Which of theShakey’s Corporation has an acid test ratio of 1.5 to 1.0. Which of the following will cause this ratio to

following will cause this ratio to deteriorate?deteriorate? a. Payment of

a. Payment of cash dividends previously declared.cash dividends previously declared. b. Borrowing short-term loan from a bank.

b. Borrowing short-term loan from a bank.

c. Sale of inventory on

c. Sale of inventory on account.account. d. Sale of equipment at a loss d. Sale of equipment at a loss 24.

24. A Company has a current ratio A Company has a current ratio greater than 1:1 and a quick ratio less thangreater than 1:1 and a quick ratio less than 1:1. Soon thereafter, all cash was used to reduce accounts payable. How 1:1. Soon thereafter, all cash was used to reduce accounts payable. How did these cash payments affect (1) current ratio (2) quick

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

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

b.

b. (1) (1) Decreased Decreased (2) (2) Increased Increased d. d. (1) (1) Increased Increased (2) (2) IncreasedIncreased 25.

25. If Jonas Co. decides to change from FIFO to LIFO inventory method duringIf Jonas Co. decides to change from FIFO to LIFO inventory method during the period of rising prices, its

the period of rising prices, its

a. Current ratio would be reduced

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

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

b. Debt-to-equity ratio would be reducedd. Cash flow would be reducedCash flow would be reduced 26.

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

the following?following? Acid-test

Acid-test ratio ratio Inventory Inventory turnoverturnover a.

a. Numerator Numerator NumeratorNumerator b.

b. Numerator Numerator DenominatorDenominator c.

(30)

27.

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

Capital turnover turnover Profit Profit margin margin on on salessales a.

a. Yes Yes YesYes

b. b. Yes Yes NoNo c. c. No No NoNo d. d. No No YesYes 28.

28. Return on investment (ROI) is a term often used to express incomeReturn on investment (ROI) is a term often used to express income earned on capital invested in a business unit. A company’s ROI is earned on capital invested in a business unit. A company’s ROI is increased if

increased if

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

a. Sales increase by the same peso amount as expenses and total assets.assets. b. Sales remain the same and expenses are reduced by the same peso

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

amount that total assets

increase.

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

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

assets. 29.

29. ROA and ROE are measures ofROA and ROE are measures of a. Solvency

a. Solvency c. Pc. Profitabilitrofitabilityy

b.

b. Liquidity Liquidity d. d. Current Current asset asset activityactivity 30.

30. A fire has destroyed many of the financial records of National & Co. YouA fire has destroyed many of the financial records of National & Co. You are assigned to put together a financial report. You have found out that are assigned to put together a financial report. You have found out that the return on equity to be

the return on equity to be 12% and the debt ratio was 0.40.12% and the debt ratio was 0.40. What was the return on assets?

What was the return on assets? a. a. 5.35% 5.35% c. c. 6.60%6.60% b. 8.4% b. 8.4% d. 7.20%d. 7.20% PROBLEMS PROBLEMS 1.

1. Windham Company has current assets of P400,000 and current liabilitiesWindham Company has current assets of P400,000 and current liabilities of P500,000. Windham Company’s current ratio would be increased

(31)

c.

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

d. Refinancing a P100,000 long-term loan with short-term debt.Refinancing a P100,000 long-term loan with short-term debt. Questions 2 through 5 are based

Questions 2 through 5 are based on the following on the following information.information. Tosh Enterprises reported the following account information. Tosh Enterprises reported the following account information.

Accounts

Accounts receivable receivable 400,000400,000 Accounts

Accounts payable payable 160,000160,000 Bonds

Bonds payable, payable, due due in in 10 10 years years 600,000600,000

Cash 200,000

Interest

Interest payable, payable, due due in in 3 3 months months 20,00020,000

Inventory 800,000

Notes

Notes payable, payable, due due in in 6 6 months months 100,000100,000 Prepaid

Prepaid expenses expenses 80,00080,000 The company has a normal operating cycle of 6

The company has a normal operating cycle of 6 months.months. 2.

2. The current ratio for Tosh Enterprise isThe current ratio for Tosh Enterprise is a. a. 1.681.68 b. b. 2.142.14 c. c. 5.005.00 d. d. 5.295.29 3.

3. What is the company’s quick ratio?What is the company’s quick ratio? a. a. 0.680.68 b. b. 1.681.68 c. c. 2.142.14 d. d. 2.312.31 4.

4. What will happen to the ratios below if Tosh Enterprises uses cash to payWhat will happen to the ratios below if Tosh Enterprises uses cash to pay 25% of the accounts payable?

25% of the accounts payable? Current

Current Ratio Ratio Quick RatioQuick Ratio a.

a. Increase Increase IncreaseIncrease

b.

b. Decrease Decrease DecreaseDecrease c.

c. Increase Increase DecreaseDecrease d.

(32)

5.

5. The amount of working capital isThe amount of working capital is a. a. 600,000600,000 b. b. 1,120,0001,120,000 c. c. 1,200,0001,200,000 d. d. 1,220,0001,220,000

Questions 6 through 8 are based

Questions 6 through 8 are based on the following ion the following information.nformation. The selected data pertain to a company at December 31.

The selected data pertain to a company at December 31. Quick

Quick asset asset ratio ratio P203,000P203,000 Acid

Acid test test ratio ratio 2.6 to 2.6 to 11 Current

Current ratio ratio 3.5 3.5 to to 11 Net

Net sales sales for for the the year year P1,800,000P1,800,000 Cost

Cost of of sales sales for for the the year year P990,000P990,000 Average

Average total total assets assets for for the the year year P1,200,000P1,200,000 6.

6. The company’s current liabilities at December 31 The company’s current liabilities at December 31 equalequal a. a. 59,42959,429 b. b. 80,00080,000 c. c. 134,857134,857 d. d. 187,200187,200 7.

7. The company’s inventory balance at December 31 isThe company’s inventory balance at December 31 is a. a. 72,00072,000 b. b. 187,200187,200 c. c. 231,111231,111 d. d. 282,857282,857 8.

8. The company’s asset turnover ratio for the year The company’s asset turnover ratio for the year isis a. a. .675.675 b. b. .825.825 c. c. 1.211.21 d. d. 1.501.50