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a. Asset turnover = Net sales ÷ Total assets

a. Asset turnover = Net sales ÷ Total assets

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14-62



Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition



Days’ sales in receivables = 365 ÷ Accounts receivable turnover

2013 = 365 ÷ 11.804 = 30.920 days

2014 = 365 ÷ 9.600 = 38.021 days

Inventory turnover = Cost of goods sold ÷ Inventory

2013 = $2,700,000 ÷ $4,950,000 = 0.545

2014 = $2,900,000 ÷ $5,010,000 = 0.579

Days’ sales in inventory = 365 ÷ Inventory turnover

2013 = 365 ÷ .545 = 669.72 days

2014 = 365 ÷ .579 = 630.40 days

b.



152.



There appears to be a very significant problem related to excess inventory. The company

has approximately 1.7 years of inventory on hand! Quite possibly, return on total assets

could be improved by decreasing inventory. Accounts receivable may need some

attention as the number of days to collect its entire dollar amount of receivables is

increasing.



Hank Hatley is interested in purchasing the stock of Brinker, a company that sells bricks to the

construction industry. Before purchasing the stock, Hatley would like to learn as much as possible

about the company in which he is contemplating a potential investment. However, the only

information that Hatley has is a portion of Brinker’s annual report for the current year (Year 3),

which contains no comparative data other than the summary of the ratios listed below:

Year 3

Year 2

Year 1

Current ratio

2.6:1

2.3:1

2.1:1

Acid-test ratio

0.8:1

1.0:1

1.2:1

Accounts receivable turnover

10.0 times

10.1 times

10.5 times

Inventory turnover

6.1 times

8.1 times

8.3 times

Return on total assets

15.50%

12.10%

10.30%

Return on common stockholders' equity

18.10%

14.70%

11.90%

Price-earnings ratio

12.3

17.2

17.7

Earnings per share

$1.53

$1.52

$1.55

Are customers paying their accounts as well as they were in Year 1? Support your answer with

accounting justification citing specific information in the analysis.



Answer

Yes, customers are paying their accounts almost as well in year 3 as they did in Year 1. In Year 1,

Brinker’s accounts receivable turnover was 10.5, but in Year 3, it dropped to 10.0. This drop

indicates that the balance of accounts receivable is increasing slightly due to lack of collection of

the entire receivable balance. Hatley should consider adding the calculation and assessment of

days’ sales outstanding in the company’s analysis.



Chapter 14 Analyzing Financial Statements: A Managerial Perspective



153.



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The following information for 2014 and 2013 is presented for BuyRite:

Assets

Current assets:

Cash

Accounts receivable

Inventory

Prepaid expenses

Total current assets

Building and equipment, net

Total assets



December 31

2014

2013

$



42,000

580,000

5,010,000

84,000

5,716,000

1,097,000

$6,813,000



$



54,000

445,000

4,950,000

79,000

5,528,000

1,095,000

$6,623,000



Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable

Bank loan payable

Other accrued payables

Total current liabilities

Long-term debt

Total liabilities



$ 605,000

679,000

215,000

1,499,000

1,729,000

3,228,000



$ 628,000

625,000

315,000

1,568,000

1,791,000

3,359,000



Stockholders’ equity:

Common stock

Retained earnings

Total stockholders’ equity

Total liabilities and stockholders’ equity



1,307,000

2,278,000

3,585,000

$6,813,000



1,307,000

1,957,000

3,264,000

$6,623,000



There were 100,000 shares of common stock outstanding throughout both 2013 and 2014. Additional

information follows:

2014

2013

Market price per share at the end of year

$

134

$

110

Net income for the year

815,000

639,000

Cost of goods sold for the year

2,900,000

2,700,000

Net sales for the year

5,568,000

5,253,000



a.

b.

Answer

a.



Calculate the 1) current ratio, 2) acid-test ratio, and the 3) debt-to-equity ratio for 2013

and 2014. Calculate to three significant digits.

The company intends to apply for a loan. What concerns might the loan officer have

about lending to the company?

1.



2013 = $5,528,000 ÷ $1,568,000 = 3.526

2014 = $5,716,000 ÷ $1,499,000 = 3.813



2.



2013 = ($55,000 + $445,000) ÷ $1,568,000 = 0.318

2014 = ($42,000 + $580,000) ÷ $1,499,000 = 0.414



3.



2013 = $3,359,000 ÷ $3,264,000 = 1.029

2014 = $3,228,000 ÷ $3,565,000 = 0.905



14-64



Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition



b.



154.



The acid-test ratio is low, while the current ratio deceivingly appears to be adequate to

pay current debts when due. The low acid-test ratio is due to a large amount of inventory,

which cannot be turned into cash quickly. The debt-to-equity ratio is reasonable. The loan

officer may be concerned that the company does not have enough cash to pay its current

obligations when due.



Wyatt Parks is interested in purchasing the stock of Dobbins Products, a company that sells bricks

to the construction industry. Before purchasing the stock, Parks would like to learn as much as

possible about the company. However, all he has to go on is the current year’s (Year 3) annual

report, which contains no comparative data other than the summary of the ratios given below:

Current ratio

Acid-test (quick) ratio

Accounts receivable turnover

Inventory turnover

Return on total assets

Return on common stockholders' equity

Price-earnings ratio

Earnings per share



Year 3

1.7

0.8

8.9 times

6.1 times

15.50%

18.10%

12.3

$1.53



Year 2

2.3

1.0

10.1 times

8.1 times

12.10%

14.70%

17.2

$1.52



Year 1

2.1

1.2

12.5 times

8.3 times

10.30%

11.90%

17.7

$1.55



Is it becoming easier for the company to pay its bills as they come due? Support your answer with

accounting justification citing specific information in the analysis.

Answer

It is becoming more difficult for Dobbins Products to pay its bills as they come due given that its

current ratio has decreased in the most recent year (Year 3) to 1.7. In addition, in the very short

term, Dobbins Products may not be able to quickly turn its receivables and inventory into cash as

demonstrated by its decline in the acid-test ratio.



Chapter 14 Analyzing Financial Statements: A Managerial Perspective



155.



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Comparative financial statements for Smart Buy for the years ending December 31, 2014 and

2013 are shown below:

December 31

Assets

2014

2013

Current assets:

Cash

$ 14,000

$ 12,458

Accounts receivable

45,489

35,486

Inventory

39,239

32,568

Prepaid expenses

3,400

2,581

Total current assets

102,128

83,093

Long-term investments

128,580

104,600

Property, plant and equipment, net

789,145

771,258

Total assets

$1,019,853

$958,951

Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable

Other current liabilities

Total current liabilities

Long-term debt

Total liabilities

Stockholders’ equity:

Common stock

Additional paid-in capital

Retained earnings

Total stockholders’ equity

Total liabilities and stockholders’ equity



Net sales

Cost of goods sold

Gross margin

Operating expenses

Operating income

Interest expense

Earnings before income taxes

Income tax expense

Net earnings



$



$ 85,451

5,157

90,608

414,760

505,368



100,000

275,000

85,827

460,827

$1,019,853



100,000

275,000

78,583

453,583

$ 958,951



Year Ended December 31

2014

2013

$2,281,789

$2,074,354

1,505,981

1,348,330

775,808

726,024

458,245

420,408

317,563

305,616

36,542

33,181

281,021

272,435

98,357

95,352

$ 182,664

$ 177,083



Calculate the following ratios for 2014 for Smart Buy:

a.

Current ratio

b.

Quick ratio

c.

Debt-to-equity ratio

d.

Times interest earned

Answer

a.

$102,128 ÷ $102,245 = 1.00

b.

$59,489 ÷ $102,245 = 0.58

c.

$559,026 ÷ $460,827 = 1.21

d.

$317,563 ÷ $36,542 = 8.69 times



98,789

3,456

102,245

456,781

559,026



14-66



Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition



CHALLENGE EXERCISES

156.



Comparative balance sheets for Save-A-Penny for the years ending December 31, 2014 and 2013

are shown below:

December 31

2014

2013



Assets

Current assets:

Cash

Accounts receivable

Inventory

Prepaid expenses

Total current assets

Property, plant and equipment, net

Total assets

Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable

Other current liabilities

Total current liabilities

Long-term debt

Total liabilities

Stockholders’ equity:

Common stock

Retained earnings

Total stockholders’ equity

Total liabilities and stockholders’ equity



$ 15,600

19,800

21,200

3,100

59,700

285,300

$345,000



$ 14,200

17,500

24,500

4,800

61,000

266,000

$327,000



$ 14,500

26,500

41,000

216,000

257,000



$ 15,900

23,100

39,000

204,000

243,000



22,000

66,000

88,000

$345,000



19,800

64,200

84,000

$327,000



Selected additional amounts for Save-A-Penny follow for the years ending December 31, 2014

and 2013:

Net sales

Interest expense

Income tax expense

Net earnings



Year Ended December 31

2014

2013

$432,000

$398,000

12,900

12,000

15,900

15,600

37,100

36,400



Calculate at least 3 debt-related ratios for Save-A-Penny for 2014 and 2013. Evaluate the risk

considerations and any changes between the two years as it relates to Save-A-Penny’s ability to

satisfy its obligations.

Answer

Current ratio:



2014: $59,700 ÷ $41,000 = 1.46

2013: $61,000 ÷ $39,000 = 1.56



Acid-test ratio: 2014: ($15,600 + $19,800) ÷ $41,000 = 0.86

2013: ($14,200 + $17,500) ÷ $39,000 = 0.81

Debt-to-equity ratio:



2014: $257,000 ÷ $88,000 = 2.92

2013: $243,000 ÷ $84,000 = 2.89



Times interest earned: 2014: $65,900 ÷ $12,900 = 5.11

2013: $64,000 ÷ 12,000 = 5.33



Chapter 14 Analyzing Financial Statements: A Managerial Perspective



14-67



While the current ratio has dropped slightly, there is a slight increase in the acid-test ratio

indicating that the company is better prepared to pay its obligations on a very short-term basis.

The slight increase in the debt-to-equity ratio indicates the company has a higher amount of debt

relative to its equity in 2014 as compared to 2013. There is also a slight drop in the company’s

ability to make interest payment between the two years. All four of the ratios declined somewhat

creating a slight increase in the risk of Save-A-Penny’s ability to satisfy its obligations.

157.



Harry’s Fresh Seafood just completed its first three years of operations. The accountant

performed the following ratio analysis for the company:

Accounts receivable turnover

Inventory turnover

a.

b.



c.



Year 3

16.9 times

144.1 times



Year 2

13.1 times

120.3 times



Year 1

11.5 times

99.3 times



Calculate day’s sale in receivables and day’s sales in inventory for all three years.

Interpret the ratios.

Evaluate the efficiency with which Harry’s Fresh Seafood manages its receivables and

inventory. Interpret the ratios and support your answer with accounting justification citing

specific information in the analysis.

For what reason do the two turnovers differ so dramatically?



Answer

a.



Days’ sales in receivables:

Year 3: 365 ÷ 16.9 = 21.6 days

Year 2: 365 ÷ 13.1 = 27.9 days

Year 1: 365 ÷ 11.5 = 31.8 days

Days’ sales in inventory:

Year 3: 365 ÷ 144.1= 2.5 days

Year 2: 365 ÷ 120.3 = 3.0 days

Year 1: 365 ÷ 99.3 = 3.7 days

Harry’s has been selling the total dollar amount of its inventory about 144.1 times during

year 3, compared to 120.3 times in year 2, and 99.3 times in year 1. During year 3, it took

only 2.5 days to sell the inventory on hand, a decline from 3 days in year 2, and 3.7 days

in year 1. Harry’s has improved its holding period for inventory and is selling its

inventory more quickly during the three-year period.

Harry’s Fresh Seafood is collecting the amounts due from customers more

quickly each year, with a significant reduction of receivables on hand from 21.6 days in

year 3 to 27.9 days in year 2, and 31.8 days in year 3. This represents an increase in the

collection of amounts owed by customers from 11.5 times year 1 to 16.9 times in year 3,

a significantly favorable trend.

The nature of the business operations is likely the reason that inventory turns

over so much more quickly than receivables turnover, because fresh seafood has a short

shelf life and must be sold in a short period of time.



14-68



Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition



158.



Comparative balance sheets for Save-A-Penny for the years ending December 31, 2014 and 2013

are shown below:

December 31

Assets

2014

2013

Current assets:

Cash

$ 15,600

$ 14,200

Accounts receivable

19,800

17,500

Inventory

21,200

24,500

Prepaid expenses

3,100

4,800

Total current assets

59,700

61,000

Property, plant and equipment, net

285,300

266,000

Total assets

$345,000

$327,000

Liabilities and Stockholders’ Equity

Current liabilities:

Accounts payable

Other current liabilities

Total current liabilities

Long-term debt

Total liabilities

Stockholders’ equity:

Common stock, $2 par value

Retained earnings

Total stockholders’ equity

Total liabilities and stockholders’ equity



$ 14,500

26,500

41,000

216,000

257,000



$ 15,900

23,100

39,000

204,000

243,000



22,000

66,000

88,000

$345,000



19,800

64,200

84,000

$327,000



Additional information follows for the years ending December 31, 2014 and 2013:

Year Ended December 31



Net sales

Net earnings

Income tax expense

End of year stock price per share

Dividends paid



2014

$432,000

37,100

15,900

18.00

4,000



2013

$398,000

36,400

14,200

15.00

1,800



The shares outstanding during 2014 totaled 10,200, with 9,900 outstanding during 2013.

Calculate earnings per share, the price-earnings ratio, and return on common stockholders’ equity

for Save-A-Penny for 2014 and 2013. Evaluate the company’s profitability and any changes

between the two years.

Answer

Earnings per share:

2014: $37,100 ÷ 10,200 = $3.64 per share

2013: $36,400 ÷ 9,900 = $3.67 per share

Price-earnings ratio:

2014: $18 ÷ $3.64 = $4.94

2013: $15 ÷ $3.67 = $4.08



Chapter 14 Analyzing Financial Statements: A Managerial Perspective



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Test Bank to accompany Jiambalvo Managerial Accounting, 5th Edition



Return on common stockholder’s equity:

2014: $37,100 ÷ $88,000 = 0.422

2013: $36,400 ÷ $84,000 = 0.433

Earnings per share was relatively steady due to additional shares of stock issued during 2014 and

higher net earnings in 2014. The rise in the price-earnings ratio indicates that shareholders were

willing to pay $4.94 per dollar of sales in 2014, a significant increase from $4.08 in 2013. Return

on common stockholders’ equity increased slightly due to the company’s ability to earn a higher

return on the funds invested by shareholders.

SHORT-ANSWER ESSAYS

159.



List three reasons why managers need to be able to analyze financial statements.



Answer

Managers need to be able to use financial statements to control operations, to assess the viability

of vendors, customers and other business partners, and to understand how the company appears to

shareholders and creditors.

160.



What are the three major financial statements and what information does each contain?



Answer

The balance sheet is a snapshot of the company’s assets, liabilities, and equities at a point in time.

The income statement shows the revenues and expenses of a company for a period of time.

The statement of cash flows shows the amount of cash used or generated for a period of time

from operating, investing, and financing activities.

161.



Explain the nature of horizontal and vertical analysis.



Answer

Horizontal analysis looks at the changes from one period to the next in the line items on the

financial statements. It allows managers to see how the various items are changing relative to

each other.

Vertical analysis looks at how the items within a given period relate to each other. All

items on the statements are expressed as a percentage of a base amount, usually assets or sales.

162.



Explain why net interest is added back to net income to calculate return on total assets.



Answer

Assets are supported by both debt and equity funding. Return on total assets measures the

profitability of a firm independently of how it is financed. Thus the return to debt, which is

interest, needs to be added to the return to equity, which is net income. The cost of interest is

reduced by the tax effect since interest reduces income taxes paid.



Chapter 14 Analyzing Financial Statements: A Managerial Perspective



163.



14-71



What sources other than financial statements are used to analyze a company and what information

is available from those sources?



Answer

Management’s discussion and analysis is presented in the company’s annual report and gives an

explanation from management as to why financial statement items have changed.

Credit reports will provide information about a company’s historical credit record. This will help

assess a customer’s ability to meet its obligations.

News articles appear frequently and can provide information on a variety of topics.

164.



Why is the accounts receivable turnover that is computed from published financial statements

often misleading?



Answer

The financial statements do not disclose credit sales, so it is unclear what sales figure should

relate to accounts receivable in computing the ratio.

165.



What is financial leverage and how can you tell if it is being used effectively?



Answer

Financial leverage is utilizing debt to increase the return to equity. It is being utilized effectively

if the return on common stockholders’ equity is higher than the return on total assets.

166.



Turnover ratios measure a key business ‘efficiency’. What efficiency is measured by asset

turnover? Why is efficiency important for a company?



Answer

Asset turnover measures the efficiency with which a company uses its assets to generate sales

revenue. Assets are economic resources and their purpose is to generate future benefits for a

company. As a company’s assets are used in operations, they generate sales, which in turn are

expected to increase a company’s net income, and increase shareholder value of the company by

adding to a company’s equity.



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a. Asset turnover = Net sales ÷ Total assets

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