Solution manual accounting 25th editon warren chapter 17

CHAPTER 17
FINANCIAL STATEMENT ANALYSIS
DISCUSSION QUESTIONS
1.

Horizontal analysis is the percentage analysis of increases and decreases in corresponding
statements. The percent change in the cash balances at the end of the preceding year from the
end of the current year is an example. Vertical analysis is the percentage analysis showing the
relationship of the component parts to the total in a single statement. The percent of cash as a
portion of total assets at the end of the current year is an example.

2.

Comparative statements provide information as to changes between dates or periods. Trends
indicated by comparisons may be far more significant than the data for a single date or
period.

3.

Before this question can be answered, the increase in net income should be compared with
changes in sales, expenses, and assets devoted to the business for the current year. The return
on assets for both periods should also be compared. If these comparisons indicate favorable
trends, the operating performance has improved; if not, the apparent favorable increase in net
income may be offset by unfavorable trends in other areas.

4.

Generally, the two ratios would be very close, because most service businesses sell services
and hold very little inventory.

5.

a.

A high inventory turnover minimizes the amount invested in inventories, thus freeing
funds for more advantageous use. Storage costs, administrative expenses, and losses
caused by obsolescence and adverse changes in prices are also kept to a minimum.

b.

Yes. The inventory turnover relates to the “turnover” of inventory during the year, while
the number of days’ sales in inventory relates to the amount of inventory on hand at the
beginning and end of the year. Therefore, a business could have a high inventory turnover
during the year, yet have a high number of days’ sales in inventory based on the
beginning and end-of-year inventory amounts.

6.

The ratio of fixed assets to long-term liabilities increased from 3.4 for the preceding year to
4.2 for the current year, indicating that the company is in a stronger position now than in the
preceding year to borrow additional funds on a long-term basis.

7.

a.

The rate earned on total assets adds interest expense to the net income, which is divided
by average total assets. It measures the profitability of the total assets, without regard for how
the assets are financed. The rate earned on stockholders’ equity divides net income by the
average total stockholders’ equity. It measures the profitability of the stockholders’
investment.

b.

The rate earned on stockholders’ equity is normally higher than the rate earned on total
assets. This is because of leverage, which compensates stockholders for the higher risk of
their investments.

17-1
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CHAPTER 17

Financial Statement Analysis

DISCUSSION QUESTIONS (Concluded)
8. a.

b.

Due to leverage, the rate on stockholders’ equity will often be greater than the rate on
total assets. This occurs because the amount earned on assets acquired through the use of
funds provided by creditors exceeds the interest charges paid to creditors.
Higher. The concept of leverage applies to preferred stock as well as debt. The rate earned
on common stockholders’ equity ordinarily exceeds the rate earned on total stockholders’
equity because the amount earned on assets acquired through the use of funds provided by
preferred stockholders normally exceeds the dividends paid to preferred stockholders.

9. The earnings per share in the preceding year were $3 per share ($6/2), adjusted for the
stock split in the latest year. McCants’ earnings per share has deteriorated.

10. One report is the Report on Internal Control, which verifies management’s conclusions on
internal control. Another report is the Report on Fairness of the Financial Statements of
Independent Registered Public Accounting Firm, where the Certified Public Accounting
(CPA) firm that conducts the audit renders an opinion on the fairness of the statements.


CHAPTER 17

Financial Statement Analysis

PRACTICE EXERCISES
PE 17–1A
Temporary investments………
Inventory…………………………

$6,400 increase ($46,400 – $40,000), or 16%
$6,400 decrease ($73,600 – $80,000), or –8%

PE 17–1B
Accounts payable………………
Long-term debt…………………

$11,000 increase ($111,000 – $100,000), or 11%
$8,680 increase ($132,680 – $124,000), or 7%

PE 17–2A
Sales………………………………
Cost of goods sold……………
Gross profit……………………

PE 17–2B
Sales……………………………
Cost of goods sold……………
Gross profit………………………

Amount

Percentage

$850,000
493,000
$357,000

Amount

100% ($850,000 ÷ $850,000)
58% ($493,000 ÷ $850,000)
42% ($357,000 ÷ $850,000)

Percentage

$1,200,000
780,000
$ 420,000

100%
65%
35%

($1,200,000 ÷ $1,200,000)

($780,000 ÷ $1,200,000)
($420,000 ÷ $1,200,000)

PE 17–3A
a.

Current Ratio = Current Assets ÷ Current Liabilities
Current Ratio = ($130,000 + $50,000 + $60,000 + $120,000) ÷ $150,000
Current Ratio = 2.4

b.

Quick Ratio = Quick Assets ÷ Current Liabilities
Quick Ratio = ($130,000 + $50,000 + $60,000) ÷ $150,000
Quick Ratio = 1.6


CHAPTER 17

Financial Statement Analysis

PE 17–3B
a.

Current Ratio = Current Assets ÷ Current Liabilities
Current Ratio = ($210,000 + $120,000 + $110,000 + $160,000) ÷ $200,000
Current Ratio = 3.0

b.

Quick Ratio = Quick Assets ÷ Current Liabilities
Quick Ratio = ($210,000 + $120,000 + $110,000) ÷ $200,000
Quick Ratio = 2.2

PE 17–4A
a.

Accounts Receivable Turnover = Net Sales ÷ Average Accounts Receivable
Accounts Receivable Turnover = $1,200,000 ÷ $100,000
Accounts Receivable Turnover = 12.0

b.

Average Accounts Receivable
Average Daily Sales

Number of Days’ Sales in Receivables

=

Number of Days’ Sales in Receivables

= $100,000 ÷ ($1,200,000 ÷ 365)
= $100,000 ÷ $3,288

Number of Days’ Sales in Receivables

= 30.4 days

PE 17–4B

a.

Accounts Receivable Turnover = Net Sales ÷ Average Accounts Receivable
Accounts Receivable Turnover = $3,150,000 ÷ $210,000
Accounts Receivable Turnover = 15.0

b.

Average Accounts Receivable
Average Daily Sales

Number of Days’ Sales in Receivables

=

Number of Days’ Sales in Receivables

= $210,000 ÷ ($3,150,000 ÷ 365)
= $210,000 ÷ $8,630

Number of Days’ Sales in Receivables

= 24.3 days

17-4
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PE 17–5A
a.

Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
Inventory Turnover = $630,000 ÷ $90,000
Inventory Turnover = 7.0

b.

Average Inventory

Number of Days’ Sales in Inventory

=

Number of Days’ Sales in Inventory

= $90,000 ÷ ($630,000 ÷ 365)

Average Daily Cost of Goods Sold

= $90,000 ÷ $1,726
Number of Days’ Sales in Inventory

= 52.1 days

PE 17–5B
a.

Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
Inventory Turnover = $435,000 ÷ $72,500
Inventory Turnover = 6.0

b.

Average Inventory
Average Daily Cost of Goods Sold

Number of Days’ Sales in Inventory

=

Number of Days’ Sales in Inventory

= $72,500 ÷ ($435,000 ÷ 365)
= $72,500 ÷ $1,192

Number of Days’ Sales in Inventory

= 60.8 days


PE 17–6A
a. Ratio of Fixed Assets to Long-Term Liabilities

Fixed Assets

=

Long-Term Liabilities

Ratio of Fixed Assets to Long-Term Liabilities

= $1,800,000 ÷ $600,000

Ratio of Fixed Assets to Long-Term Liabilities

= 3.0
=

b. Ratio of Liabilities to Stockholders’ Equity

Total Liabilities
Total Stockholders’ Equity

Ratio of Liabilities to Stockholders’ Equity

= $900,000 ÷ $750,000

Ratio of Liabilities to Stockholders’ Equity

= 1.2

PE 17–6B
a. Ratio of Fixed Assets to Long-Term Liabilities

Fixed Assets

=

Long-Term Liabilities

Ratio of Fixed Assets to Long-Term Liabilities

= $2,000,000 ÷ $800,000

Ratio of Fixed Assets to Long-Term Liabilities

= 2.5

b. Ratio of Liabilities to Stockholders’ Equity

=

Total Liabilities
Total Stockholders’ Equity

Ratio of Liabilities to Stockholders’ Equity

= $1,000,000 ÷ $625,000

Ratio of Liabilities to Stockholders’ Equity

= 1.6

PE 17–7A
Number of Times

=

Income Before Income Tax +
Interest Expense

Interest Charges Are Earned

Interest Expense

Number of Times
=
Interest Charges Are Earned

$4,000,000 + $400,000
$400,000

Number of Times
Interest Charges Are Earned

= 11.0

PE 17–7B

Income Before Income Tax +
Interest Expense

Number of Times
Interest Charges Are Earned
Number of Times
Interest Charges Are Earned
Number of Times

=

=

Interest Expense
$8,000,000 + $500,000
=
Int
Charges Are Earned
er
est


17.0

$500,000


PE 17–8A
Ratio of Net Sales to Assets = Net Sales ÷ Average Total Assets
Ratio of Net Sales to Assets = $1,800,000 ÷ $1,125,000
Ratio of Net Sales to Assets = 1.6

PE 17–8B
Ratio of Net Sales to Assets = Net Sales ÷ Average Total Assets
Ratio of Net Sales to Assets = $4,400,000 ÷ $2,000,000
Ratio of Net Sales to Assets = 2.2

PE 17–9A
Rate Earned on Total Assets =

Net Income + Interest Expense

Average Total Assets

Rate Earned on Total Assets =

$250,000 + $100,000
$2,500,000

Rate Earned on Total Assets =

$350,000
$2,500,000

Rate Earned on Total Assets = 14.0%

PE 17–9B
Rate Earned on Total Assets =
Rate Earned on Total Assets =

Net Income + Interest Expense
Average Total Assets
$410,000 + $90,000
$5,000,000

Rate Earned on Total Assets =
Rate Earned on Total Assets = 10.0%

$500,000
$5,000,000

PE 17–10A
a. Rate Earned on Stockholders’ Equity
Rate Earned on Stockholders’ Equity
Rate Earned on Stockholders’ Equity
Rate Earned on Common
b.

=

Stockholders’ Equity
Rate Earned on Common
Stockholders’ Equity
Rate Earned on Common
Stockholders’ Equity

=

=

= $375,000 ÷ $2,500,000
= 15.0%
Net Income – Preferred Dividends
Average Common Stockholders’ Equity
$375,000 – $75,000
$1,875,000

= 16.0%

PE 17–10B
a. Rate Earned on Stockholders’ Equity

Rate Earned on Stockholders’ Equity
Rate Earned on Stockholders’ Equity

b.

Rate Earned on Common
Stockholders’ Equity
Rate Earned on Common
Stockholders’ Equity
Rate Earned on Common
Stockholders’ Equity

Net Income
Average Stockholders’ Equity

=
=

=

Net Income
Average Stockholders’ Equity

= $1,000,000 ÷ $6,250,000
= 16.0%

Net Income – Preferred Dividends
Average Common Stockholders’ Equity
$1,000,000 – $50,000
$3,800,000

= 25.0%


PE 17–11A
a. Earnings per Share
on Common Stock

=

Net Income – Preferred Dividends
Shares of Common Stock Outstanding

Earnings per Share
on Common Stock

= ($185,000 – $25,000) ÷ $100,000

Earnings per Share
on Common Stock

=

b. Price-Earnings Ratio

=

Price-Earnings Ratio

=

Price-Earnings Ratio

=

$1.60

Market Price per Share of Common Stock
Earnings per Share on Common Stock
$20.00 ÷ $1.60
12.5

PE 17–11B
a. Earnings per Share
on Common Stock

=

Net Income – Preferred Dividends
Shares of Common Stock Outstanding

Earnings per Share
on Common Stock

= ($410,000 – $60,000) ÷ $50,000

Earnings per Share
on Common Stock

=

b. Price-Earnings Ratio

=

$7.00

Market Price per Share of Common Stock
Earnings per Share on Common Stock

Price-Earnings Ratio

= $84.00 ÷ $7.00

Price-Earnings Ratio

= 12.0


EXERCISES
Ex. 17–1
SOLDNER, Inc.

a.

Comparative Income Statement
For the Years Ended December 31, 2014 and 2013
2014
Amount

Sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income from operations
Income tax expense
Net income
b.

$1,500,000
930,000
$ 570,000
210,000
255,000
$ 465,000
105,000
52,500
$ 52,500

2013
Percent

100%
62%
38%
14%
17%
31%

7%
3.5%
3.5%

Amount

Percent

$1,450,000
812,000
$ 638,000
261,000
232,000
$ 493,000
145,000
72,500
$ 72,500

100%
56%
44%
18%
16%
34%
10%
5%
5%

The vertical analysis indicates that the cost of goods sold as a percent of sales
increased by 6 percentage points (62% – 56%), while selling expenses decreased

by 4 percentage points (14% – 18%), and administrative expenses increased by 1%
(17% – 16%). Thus, net income as a percent of sales dropped by 1.5% (5% – 3.5%).

17-11
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Ex. 17–2
a.

SPEEDWAY MOTORSPORTS, INC.
Comparative Income Statement (in thousands of dollars)
For the Years Ended December 31
Current Year
Amount

Revenues:
Admissions
Event-related revenue
NASCAR broadcasting
revenue
Other operating revenue
Total revenue
Expenses and other:
Direct expense of events
NASCAR purse and
sanction fees
Other direct expenses
General and administrative
Total expenses and other

Income from continuing
operations
b.

Percent

Prior Year
Amount

Percent

$139,125
156,691

27.7%
31.2%

$163,087
178,805

29.6%
32.5%

178,722
27,705
$502,243

35.6%
5.5%
100.0%

173,803
34,827
$550,522

31.6%
6.3%
100.0%

$100,843

20.1%

$100,922

18.3%

120,273
21,846
188,196
$431,158

23.9%
4.3%
37.5%
85.8%

123,078
26,208
266,252

$516,460

22.4%
4.8%
48.3%
93.8%

$ 71,085

14.2%

$ 34,062

6.2%

While overall revenue decreased some between the two years, the overall mix of
revenue sources did change somewhat. The NASCAR broadcasting revenue
increased as a percent of total revenue by 4 percentage points, while the percent
of admissions revenue to total revenue decreased by almost 2%. Two of the major
expense categories (direct expense of events and NASCAR purse and sanction fees)
as a percent of total revenue increased by approximately 4%. Other direct expenses,
however, decreased by 0.5%, and general and administrative expenses decreased
by about 11%. Overall, the income from continuing operations increased by 8% of total
revenue between the two years, which is a favorable trend. The income from continuing
operations as a percent of sales exceeds 14% in the current year, which is excellent.
Apparently, owning and operating motor speedways is a business that produces high
operating profit margins.
Note to Instructors: The high operating margin is probably necessary to compensate
for the extensive investment in speedway assets.

Ex. 17–3
BULL RUN COMPANY

a.

Common-Sized Income Statement
For the Year Ended December 31, 20—
Electronics
Industry
Average

Bull Run
Company
Amount

Sales
Sales returns and allowances

$2,100,000
100,000

Net sales
Cost of goods sold

$2,000,000
1,040,000
$ 960,000

Gross profit

Selling expenses
Administrative expenses
Total operating expenses
Operating income
Other income
Other expense
Income before income tax
Income tax expense
Net income
b.

560,000
300,000
$ 860,000
100,000
60,000
$ 160,000
40,000
$ 120,000
60,000
$ 60,000

Percent

105%
5%
100%
52%
48%
28%

15%
43%
5%
3%
8%
2%
6%
3%
3%

105%
5%
100%
60%
40%
22%
12%
34%
6%
3%
9%
2%
7%
6%
1%

The cost of goods sold is 8% lower than the industry average, but the selling
expenses and administrative expenses are 6% and 3% higher than the industry
average. The combined impact causes net income as a percent of sales to be 2%
better than the industry average. Apparently, the company is managing the cost of

manufacturing product better than the industry, but has slightly higher selling and
administrative expenses relative to the industry. The cause of the higher selling and
administrative expenses as a percent of sales, relative to the industry, can be
investigated further.


Ex. 17–4
PEACOCK COMPANY
Comparative Balance Sheet
December 31, 2014 and 2013
2014
Amount

2013
Percent

Amount

Percent

Current assets
Property, plant, and equipment
Intangible assets
Total assets

$1,050,000
1,960,000
490,000
$3,500,000

30%
56%
14%
100%

$ 750,000
2,100,000
150,000
$3,000,000

25%
70%
5%
100%

Current liabilities
Long-term liabilities
Common stock
Retained earnings

$ 630,000
1,260,000
350,000
1,260,000

18%
36%
10%
36%

$ 420,000
1,200,000
300,000
1,080,000

14%
40%
10%
36%

Total liabilities and
stockholders’ equity

$3,500,000

100%

$3,000,000

100%

Ex. 17–5
BEZOS COMPANY

a.

Comparative Income Statement
For the Years Ended December 31, 2014 and 2013

Sales

Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income before income tax
Income tax expense
Net income
b.

2014

2013

Amount

Amount

Increase (Decrease)
Amount

$840,000
724,500
$115,500

$600,000
525,000
$ 75,000

$240,000

199,500
$ 40,500

52,500
41,400
$ 93,900
21,600
10,800
$ 10,800

37,500
30,000
$ 67,500
7,500
2,700
$ 4,800

15,000
11,400
$ 26,400
14,100
8,100
$ 6,000

Percent

40.0%
38.0%
54.0%
40.0%

38.0%
39.1%
188.0%
300.0%
125.0%

The net income for Bezos Company increased by approximately 125% from 2013
to 2014. This increase was the combined result of an increase in sales of 40%
and lower percentage increases in cost of goods sold and administrative expenses.
The cost of goods sold increased at a slower rate than the increase in sales, thus
causing the percentage increase in gross profit to exceed the percentage increase
in sales.


Ex. 17–6
a.

(1) Working Capital = Current Assets – Current Liabilities
2014: $2,420,000 = $3,520,000 – $1,100,000
2013: $2,000,000 = $3,000,000 – $1,000,000
(2)

2014:

(3)

Quick Assets
Current Liabilities
$2,420,000 = 2.2
$1,100,000

2013:

$3,000,000
$1,000,000

= 3.0

2013:

$2,000,000
$1,000,000

= 2.0

Quick Ratio =
2014:

b.

Current Assets
Current Liabilities
$3,520,000 = 3.2
$1,100,000

Current Ratio =

The liquidity of Mossberg has improved from the preceding year to the current year.
The working capital, current ratio, and quick ratio have all increased. Most of
these changes are the result of an increase in current assets relative to current

liabilities.

Ex. 17–7
a.

(1)

Current Ratio =

Current Assets
Current Liabilities
$17,569
= 1.1

Current Year:

Prior Year:

$15,892
(2)

Quick Ratio =

b.

= 1.4

$8,756

Quick Assets

Current Liabilities
$8,759

$12,692
Current Year:

$12,571

$15,892

= 0.8

Prior Year:

$8,756

= 1.0

The solvency of PepsiCo has decreased some over this time period. Both the
current and quick ratios have decreased. The current ratio decreased from 1.4 to
1.1, and the quick ratio decreased from 1.0 to 0.8. While PepsiCo is a strong
company with ample resources for meeting short-term obligations, its solvency
as measured by the current and quick ratios has deteriorated during this period.


Ex. 17–8
a.

The working capital, current ratio, and quick ratio are calculated incorrectly. The
working capital and current ratio incorrectly include intangible assets and property,

plant, and equipment as a part of current assets. Both are noncurrent. The quick
ratio has both an incorrect numerator and denominator. The numerator of the quick
ratio is incorrectly calculated as the sum of inventories, prepaid expenses, and
property, plant, and equipment ($36,000 + $24,000 + $55,200). The denominator is
also incorrect, as it does not include accrued liabilities. The denominator of the
quick ratio should be total current liabilities.
The correct calculations are as follows:
Working Capital = Current Assets – Current Liabilities
$30,000 = $330,000 – $300,000
Current Ratio =

Current Assets
Current Liabilities
$330,000
$300,000

Quick Ratio =

= 1.1

Quick Assets
Current Liabilities
$102,000 + $48,000 + $120,000
$300,000

b.

= 0.9

Unfortunately, the working capital, current ratio, and quick ratio are below the

minimum threshold required by the bond indenture. This may require the company
to renegotiate the bond contract, including a possible unfavorable change in the
interest rate.


Ex. 17–9
a.

Average Accounts Receivable

2014:

$3,412,500
$487,500 *

= 7.0

Number of Days’ Sales in Receivables

(2)

2013:

$2,836,500

= 6.2

$457,500 **

*$487,500 = ($475,000 + $500,000) ÷ 2

**$457,500 = ($440,000 + $475,000) ÷ 2

=

Average Accounts Receivable
Average Daily Sales

$487,500

1

2014:

= 52.1 days
$9,349

1
2
3
4

b.

Net Sales

Accounts Receivable Turnover =

(1)

2

2013:

$457,500

3

= 58.9 days

$7,771 4

$487,500 = ($475,000 + $500,000) ÷ 2
$9,349 = $3,412,500 ÷ 365 days
$457,500 = ($440,000 + $475,000) ÷ 2
$7,771 = $2,836,500 ÷ 365 days

The collection of accounts receivable has improved. This can be seen in both the
increase in accounts receivable turnover and the reduction in the collection period.
The credit terms require payment in 55 days. In 2013, the collection period exceeded
these terms. However, the company apparently became more aggressive in
collecting accounts receivable or more restrictive in granting credit to customers.
Thus, in 2014, the collection period is within the credit terms of the company.


Ex. 17–10
a.

(1)

Accounts Receivable Turnover

Net Sales

=

Average Accounts Receivable

Xavier:

$8,500,000
($820,000 + $880,000) ÷ 2

=

10.0

Lestrade:

$4,585,000
($600,000 + $710,000) ÷ 2

=

7.0

Number of Days’ Sales in Receivables =

(2)

Average Accounts Receivable
Average Daily Sales

36.5 days

($820,000 + $880,000) ÷ 2
Xavier:

=
$23,287.7 *

Lestrade:

($600,000 + $710,000) ÷ 2
$12,561.6 **

=

52.1 days

* $23,287.7 = $8,500,000 ÷ 365 days
** $12,561.6 = $4,585,000 ÷ 365 days
b.

Xavier’s accounts receivable turnover is much higher than Lestrade’s (10.0 for Xavier
vs. 7.0 for Lestrade). The number of days’ sales in receivables is lower for Xavier than
for Lestrade (36.5 days for Xavier vs. 52.1 days for Lestrade). These differences
indicate that Xavier is able to turn over its receivables more quickly than Lestrade. As
a result, it takes Xavier less time to collect its receivables.

Ex. 17–11
a.

(1)

(2)

Inventory Turnover

Cost of Goods Sold

=

Average Inventory

Current Year:

$6,375,000
($860,000 + $840,000) ÷ 2

= 7.5

Preceding Year:

$7,380,000
($840,000 + $800,000) ÷ 2

= 9.0

Number of Days’ Sales in Inventory

Current Year:

Preceding Year:

=

Average Inventory
Average Daily Cost of Goods Sold

($860,000 + $840,000) ÷ 2
$17,466 *

=

48.7 days

($840,000 + $800,000) ÷ 2

=

40.6 days

$20,219 **

* $17,466 = $6,375,000 ÷ 365 days
** $20,219 = $7,380,000 ÷ 365 days
b.

The inventory position of the business has deteriorated. The inventory turnover
has decreased, while the number of days’ sales in inventory has increased. The
sales volume has declined faster than the inventory has declined, thus resulting
in the deteriorating inventory position.


CHAPTER 17

Financial Statement Analysis

Ex. 17–12
a.

(1)

Inventory Turnover

=

Cost of Goods Sold
Average Inventory

Dell:

HP:

$50,
098 ($1,051
+ $1,301) ÷
2

= 42.6

= 15.3

$96,
089 ($6,128
+ $6,466) ÷
2

(2)

Number of Days’
Sales in Inventory =

A
v
e
r
a
g
e
I
n
v
e
n
t
o
r

y
Average Daily
Cost of Goods
Sold

Dell:

HP:

($1,051 +
$1,301) ÷ 2
$
1
3
7
.
3
*
($6,128 +
$6,466) ÷ 2

$263.3 **


CHAPTER 17

=

Ex. 17–12
days

23.9 days

8.6
* $137.3 = $50,098 ÷ 365 days
** $263.3 = $96,089 ÷ 365 days
b. Dell has a much higher
inventory turnover ratio than
does HP (42.6 vs. 15.3).
Likewise, Dell has a
much smaller number
of days’ sales in
inventory (8.6 days vs.
23.9 days). These
significant differences
are a result of Dell’s
make-to-order strategy.
Dell has successfully
developed a
manufacturing process
that is able to
fill a customer order
quickly. As a result, Dell
does not pre-build as
many computers to
inventory. HP, in contrast,
pre-builds computers,
printers, and other
equipment
to be sold by retail stores

and other retail channels.
In this industry, there is
great obsolescence risk
in holding computers in
inventory. New
technology can make an
inventory of computers
difficult to sell; therefore,
inventory is costly and
risky. Dell’s operating
strategy is considered
revolutionary and is now
being adopted by many
both in and out of the
computer industry.

Financial Statement Analysis


CHAPTER 17

Financial Statement Analysis

Ex. 17–13
a.

b.

Ratio of Liabilities to Stockholders’ Equity =

Dec. 31, 2014:

$2,124,000
$2,360,000

= 0.9

Dec. 31, 2013:

$2,200,000
$2,000,000

= 1.1

Number of Times Bond
=
Interest Charges Are Earned

Dec. 31, 2013:

$120,000
$420,000 + $140,000 **
$140,000

Total Stockholders’ Equity

Income Before Income Tax + Interest Expense

$480,000 + $120,000 *
Dec. 31, 2014:

Total Liabilities

Interest Expense

5.0
=
4.0
=

* ($1,000,000 + $200,000) × 10% = $120,000
** ($1,200,000 + $200,000) × 10% = $140,000
c.

Both the ratio of liabilities to stockholders’ equity and the number of times bond
interest charges were earned have improved from 2013 to 2014. These results
are the combined result of a larger income before income taxes and lower serial
bonds payable in the year 2014 compared to 2013.


Ex. 17–14
a.

b.

Ratio of Liabilities to Stockholders’ Equity =

Hasbro:

$2,477,806

$1,615,420

= 1.5

Mattel, Inc.:

$2,789,149
$2,628,584

= 1.1

Number of Times

Total Liabilities
Total Stockholders’ Equity

Income Before Income Tax + Interest Expense
=

Interest Expense

Interest Charges Are Earned

c.

Hasbro:

$397,752 + $82,112
$82,112

= 5.8

Mattel, Inc.:

$684,863 + $64,839
$64,839

= 11.6

Both companies carry a moderate proportion of debt to the stockholders’ equity,
with Hasbro carrying slightly more debt than Mattel (1.5 and 1.1 times stockholders’
equity). Therefore, the companies’ debt as a percent of stockholders’ equity is
similar. Both companies also have very strong interest coverage; however,
Mattel’s ratio is stronger than Hasbro’s. Together, these ratios indicate that both
companies provide creditors with a margin of safety, and that earnings appear more
than enough to make interest payments.


Ex. 17–15
a.

H.J. Heinz:

Hershey:

b.

= 2.9

$1,298,845 + $1,541,825 + $529,746

$902,316

= 3.7

Long-Term Liabilities

$2,505,083
$4,835,554

=

$2,071,571

Fixed Assets (net)
Long-Term Liabilities

= 0.5

0.7

$1,437,702
Hershey:

Total Stockholders’ Equity

$4,161,460 + $3,078,128 + $1,757,426
$3,108,962

Ratio of Fixed Assets to

H.J. Heinz:

c.

Total Liabilities

Ratio of Liabilities to

Stockholders’ Equity =

=

Hershey uses more debt than does H.J. Heinz. As a result, Hershey’s total liabilities
to stockholders’ equity ratio is higher than H.J. Heinz’s (3.7 vs. 2.9). H.J. Heinz has
a lower ratio of fixed assets to long-term liabilities than Hershey. This ratio divides
the property, plant, and equipment (net) by the long-term debt. The ratio for H.J. Heinz
is aggressive, with fixed assets covering only 50% of the long-term debt. That is,
the creditors of H.J. Heinz have 50 cents of property, plant, and equipment
covering every dollar of long-term debt. The same ratio for Hershey shows fixed
assets covering 70% of the long-term debt. That is, Hershey’s creditors have
$0.70 of property, plant, and equipment covering every dollar of long-term debt.
This would suggest that Hershey has slightly stronger creditor protection and
borrowing capacity than does H.J. Heinz.


Ex. 17–16
a.

b.

Ratio of Net Sales to Total Assets

=

Net Sales
Average Total Assets

YRC Worldwide:

$4,334,640
$2,812,504

= 1.5

Union Pacific:

$16,965,000
$42,636,000

= 0.4

C.H. Robinson Worldwide Inc.:

$9,274,305
$1,914,974

= 4.8

The ratio of net sales to assets measures the number of sales dollars earned for
each dollar of assets. The greater the number of sales dollars earned for every

dollar of assets, the more efficient a firm is in using assets. Thus, the ratio is a
measure of the efficiency in using assets. The three companies are different in their
efficiency in using assets, because they are different in the nature of their
operations. Union Pacific earns only 40 cents for every dollar of assets. This is
because Union Pacific is very asset intensive. That is, Union Pacific must invest in
locomotives, railcars, terminals, tracks, right-of-way, and information systems in
order to earn revenues. These investments are significant. YRC Worldwide is able to
earn $1.50 for every dollar of assets, and thus is able to earn more revenue for every
dollar of assets than the railroad. This is because the motor carrier invests in trucks,
trailers, and terminals, which require less investment per dollar of revenue than does
the railroad. Moreover, the motor carrier does not invest in the highway system,
because the government owns the highway system. Thus, the motor carrier has no
investment in the transportation network itself, unlike the railroad. C.H. Robinson
Worldwide Inc., the transportation arranger, hires transportation services from motor
carriers and railroads, but does not own these assets itself. The transportation
arranger has assets in accounts receivable and information systems but does not
require transportation assets; thus, it is able to earn the highest revenue per dollar
of assets.
Note to Instructors: Students may wonder how asset-intensive companies
overcome their asset efficiency disadvantages to competitors with better asset
efficiencies, as in the case between railroads and motor carriers. Asset efficiency
is part of the financial equation; the other part is the profit margin made on each
dollar of sales. Thus, companies with high asset efficiency often operate on thinner
margins than do companies with lower asset efficiency. For example, the motor
carrier must pay highway taxes, which lowers its operating margins when
compared to railroads that own their right-of-way, and thus do not have the tax
expense of the highway. While not required in this exercise, the railroad has the
highest profit margins, the motor carrier is in the middle, while the transportation
arranger operates on very thin margins.