Chapter 17 Solutions 7e

Chapter 17
Financial Statement Analysis
Quick Check
Answers:
1. b 3. d 5. a 7. b 9. c
2. c 4. a 6. b 8. d 10. a
Explanations:
1. b. 21% increase in Cash = ($2,345 $1,934) / $1,934 = .21
2. c. Cash = 9.6% of total assets = $2,345 / $24,501 = .096
3. d. a, b, and c are all true.
4. a. Acid-test ratio for 2002 = 0.61 [($2,345 + $2,097) / $7,341].

This value is less than 1.
5. a. Inventory turnover = 6 times

[$7,105 / ($1,294 + $1,055) / 2]
6. b. Days sales in receivables = 37 days, computed as

follows:
One days sales = $54 ($19,564 / 365 days)
Average receivables [($2,097 + $1,882) / 2].. $ 1,990
One days sales $54
Days sales in average receivables 37 days
Chapter 17 Financial Statement Analysis 1065

7. b. Times-interest-earned ratio = 27 times, computed as
follows:
Operating income / Interest expense
($5,458 / $199 = 27 times)
8. d. Strong return on common stockholders equity

for Liberty,
Return on common equity = Net income / Average common equity
0.263 = $3,050 / ($11,800 + $11,366) / 2
A 26% return on common stockholders equity is strong.
9. c. EPS = $1.22 = Net income / Number of common shares

outstanding
= $3,050 / 2,500 shares
10. a. Price/earnings ratio = 36 = Market price of stock / EPS

= $44 / $1.22
1066 Accounting 7/e Solutions Manual

Short Exercises
(5-10 min.) S 17-1

Increase (Decrease)
(Amounts in millions) 2006 2005
2006 2005 2004 Amount Percent Amount Percent
Revenues $9,993 $9,489 $8,995 $504 5.3% $494 5.5%
Cost of sales 5,905 5,785 5,404
Gross profit $4,088 $3,704 $3,591 $384 10.4% $113 3.1%
(5-10 min.) S 17-2

1. Trend percentages:
2006 2005 2004 2003

Revenues 114% 108% 102% 100%
Net income. 141 131 128 100
2. Net income increased far faster than revenues.

(10-15 min.) S 17-3
Vertical analysis of assets:
2006
Amount Percent
Cash $ 48,000 26.4%
Inventory 38,000 20.9
Property, plant, and
equipment, net 96,000 52.7
Total assets $182,000 100.0%
(10 min.) S 17-4

Sanchez Alioto
Amount Percent Amount Percent
Net sales $9,489 100.0% $19,536 100.0%
Cost of goods sold 5,785 61.0 14,101 72.2
Other expense 3,114 32.8 4,497 23.0
Net income $ 590 6.2% $ 938 4.8%
Alioto earns more net income.

Sanchezs net income is a higher percentage of net sales.
These data show how common-size financial statements enable

us to compare companies of different sizes.

(5-10 min.) S 17-5
1.
(Dollar amounts in billions)
2006 2005
Total current assets $6.7 $5.6

Total current liabilities $4.4 $3.6
= 1.52 = 1.55
2. Lowes current ratio deteriorated a little during 2006.

(10-15 min.) S 17-6
Cost of goods sold $21.2

a. Inventory turnover = =
Average inventory ($4.6 + $4.0) / 2
$21.2
= = 4.9 times
$ 4.3
b. Days sales in receivables:
One days $30.8

= = $.084
sales 365
Average net
Days sales in receivables $.15*
= = = 2 days
receivables One days $.084
sales
__________
*($.1 + $.2) / 2 = $.15

(5 min.) S 17-7
Total liabilities $ 8.7

1. Debt ratio = = = 0.46
Total assets $19.0
2. The debt ratio is fairly low. The companys ability to pay its
liabilities appears strong.

(10 min.) S 17-8
Net income $1.9

a. Rate of return on net sales = = = 6.2%
Net sales $30.8
Net Interest
b. Rate of return income + expense $1.9 + $.2
= =
on total assets Average total assets ($19.0 + $16.1) / 2
= 12.0%
c. Rate of return Net Preferred

on common Income dividends $1.9 $0
= = = 20.4%
stockholders' Average common ($10.3 + $8.3) / 2
equity stockholders' equity
These rates of return are strong.

(5-10 min.) S 17-9
Net income Preferred dividends $1.9 $0
1. EPS = =
Number of shares of common .8
stock outstanding
= $2.38
Market price per share

2. Price/earnings of common stock $66.50
= = = 28 times
ratio EPS $2.38

(10 min.) S 17-10
Income Statement
Thousands
Net sales $7,200
Cost of goods sold 4,235 (a)
Selling and administrative
expenses 1,710
Interest expense 105 (b)
Other expenses 150
Income before taxes 1,000
Income tax expense 316 (c)
Net income $ 684 (d)
$790 + $750
(a) = 5.5 = $4,235
2
(b) = $7,200 $4,235 $1,710 $150 $1,000 = $105
(d) = $7,200 0.095 = $684
(c) = $1,000 $684 = $316

(15-20 min.) S 17-11
Balance Sheet
(Amounts in thousands)
Cash $ 50
Receivables 580 (a) Total current liabilities $2,100
Inventories 750 Long-term note payable 1,480 (e)
Prepaid expenses 90 (b) Other long-term
Total current assets 1,470 (c) liabilities 820
Plant assets, net 3,180 (d)

Other assets 2,150
Stockholders equity 2,400
Total liabilities and
Total assets $6,800 equity $6,800 (f)
(f) = $6,800 (same as total assets)
(e) = $6,800 $2,100 $820 $2,400 = $1,480
(c) = $2,100 0.70 = $1,470
(a) = $2,100 0.30 = $630; $630 $50 = $580
(b) = $1,470 $50 $580 $750 = $90
(d) = $6,800 $1,470 $2,150 = $3,180

Exercises
(5-15 min.) E 17-12

2009 2008 2007
Total current assets $330,000 $300,000 $280,000
Total current liabilities 160,000 150,000 140,000
Working capital $170,000 $150,000 $140,000
Increase Increase
$20,000 $10,000
13.3% 7.1%
The increasing trend of working capital is favorable.

(10-15 min.) E 17-13
Enchanted Designs, Inc.
Horizontal Analysis of Comparative Income Statement
Years Ended December 31, 2007 and 2006
INCREASE
(DECREASE)
2007 2006 AMOUNT PERCENT
Net sales revenue $430,000 $373,000 $57,000 15.3%
Expenses:
Cost of goods sold. $202,000 $188,000 $14,000 7.4
Selling and general
expenses... 98,000 93,000 5,000 5.4
Other expense. 7,000 4,000 3,000 75.0
Total expenses 307,000 285,000 22,000 7.7
Net income. $123,000 $ 88,000 $35,000 39.8
Net income increased by a much higher percentage than total

revenues during 2007 because revenues increased at a higher
rate (15.3%) than did total expenses (7.7%).

(5-10 min.) E 17-14
Trend percentages:
2008 2007 2006 2005 2004
Total revenue. 126% 114% 106% 97% 100%
Net income..... 144 134 98 84 100
Net income grew by 44% during the period, compared to 26%

for total revenue.

(10-15 min.) E 17-15
Alpha Graphics, Inc.
Vertical Analysis of Balance Sheet
December 31, 2006
AMOUNT PERCENT
ASSETS
Total current assets.. $ 42,000 14.8%
Property, plant, and equipment, net. 207,000 72.9
Other assets 35,000 12.3
Total assets. $284,000 100.0%
LIABILITIES
Total current liabilities. $ 48,000 16.9%
Long-term debt.. 108,000 38.0
Total liabilities 156,000 54.9
STOCKHOLDERS EQUITY
Total stockholders equity.. 128,000 45.1
Total liabilities and stockholders equity $284,000 100.0%

(10-15 min.) E 17-16
Enchanted Designs, Inc.
Comparative Common-Size Income Statement
Years Ended December 31, 2007 and 2006
2007 2006
Net sales revenue.. 100.0% 100.0%
Expenses:
Cost of goods sold.. 47.0 50.4
Selling and general expenses.. 22.8 24.9
Other expense.. 1.6 1.1
Total expense... 71.4 76.4
Net income.. 28.6% 23.6%
An investor would be pleased with 2007 in comparison with

2006. Net sales and net income are both up significantly from
2006. Cost of goods sold and selling and general expenses
the two largest expenses consumed smaller percentages of
total revenues in 2007, and net income represents a higher
percentage of revenues. Overall, profits are rising.

(10-15 min.) E 17-17
$175,000
a. Current ratio = = 1.34
$131,000
b. Acid-test (quick) $17,000 + $11,000 + $54,000

= = 0.63
ratio $131,000
$317,000
c. Inventory turnover = = 4.28 times
($77,000 + $71,000) / 2
d. Days sales in ($54,000 + $73,000) / 2

= = 50 days
average receivables $464,000 / 365

(15-20 min.) E 17-18
a. Current ratio:
$61,000 + $28,000 + $122,000 + $237,000

2007: = 1.63
$275,000
$47,000 + $116,000 + $272,000

2006: = 2.15
$202,000
b. Acid-test ratio:
$61,000 + $28,000 + $122,000

2007: = 0.77
$275,000
$47,000 + $116,000
2006: = 0.81
$202,000
c. Debt ratio:
$315,000* $254,000**
2007: = 0.56 2006: = 0.52
$560,000 $490,000
__________ __________
*$275,000 + $40,000 = $315,000 **$202,000 + $52,000 = $254,000
d. Times-interest-earned ratio:
$165,000 $158,000
2007: = 3.44 times 2006: = 4.05 times
$48,000 $39,000
Summary: The companys ability to pay its current liabilities,

total liabilities, and interest expense deteriorated during 2007,
as shown by the worsening of all four ratios.

(10-15 min.) E 17-19
(Dollars in thousands)
a. Rate of return on net sales:
$16,000 $12,000
2006: = 0.092 2005: = 0.076
$174,000 $158,000
b. Rate of return on total assets:
$16,000 + $9,000 $12,000 + $10,000

2006: = 0.127 2005: = 0.122
$197,500* $181,000**
__________ __________
*($204,000 + $191,000) / 2 = $197,500 **($191,000 + $171,000) / 2 = $181,000
c. Rate of return on common stockholders equity:
$16,000 $3,000 $12,000 $3,000

2006: = 0.141 2005: = 0.107
$92,500*** $84,000****
__________ __________
***($96,000 + $89,000) / 2 = $92,500 ****($89,000 + $79,000) / 2 = $84,000
d. Earnings per share of common stock:
$16,000 $3,000 $12,000 $3,000

2006: = $0.65 2005: = $0.45
20,000 20,000
The companys operating performance improved during 2006.

All four profitability measures increased.

(10-15 min.) E 17-20
2008 2007
a. Price/earnings ratio:
$16.50 $13
= 27.5 = 26
($60,000 $12,000) / 80,000 ($52,000 $12,000) / 80,000
b. Dividend yield:
$20,000 / 80,000 $20,000 / 80,000

= 0.015 = 0.019
$16.50 $13
c. Book value per share of common stock:
$780,000 $200,000 $600,000 $200,000

= $7.25 = $5
80,000 80,000
The stocks attractiveness increased during 2008, as shown by

the increases in the price/earnings ratio and in book value per
share. The dividend yield decreased, but that would be
important only to investors who want dividends. Overall, the
common stock looks more attractive than it did a year ago.

(20-30 min.) E 17-21
ORDER OF
COMPUTATION Millions
Given Current assets... $10,500
4 Property, plant, and equipment. $16,500
Given Less Accumulated depreciation (2,000) 14,500
3 Total assets ($15,000 0.60). $25,000
1 Current liabilities ($10,500 1.50) $ 7,000

2 Long-term liabilities ($15,000 $7,000).. 8,000
6 Stockholders equity ($25,000 $15,000).. 10,000
5 Total liabilities and stockholders equity... $25,000

Problems
Group A
(20-30 min.) P 17-22A

Req. 1
Shawnee Mission Corporation

Trend Percentages
2008 2007 2006 2005

Net sales revenue 115% 106% 97% 100%
Net income 125 83 75 100
Common stock-
holders equity 124 120 111 100

(continued) P 17-22A
Req. 2 Dollar amounts in thousands
2008 2007 2006
Net income $60 $40 $36

= 0.167 = 0.117 = 0.115
Avg. common $360 $342 $313
S/E*
__________
2008 2007 2006
*Computation
of average com. $366 + $354 $354 + $330 $330 + $296
stockholders' 2 2 2
equity
= $360 = $342 = $313

(20-30 min.) P 17-23A
Req. 1
Todd Department Stores, Inc.
Common-Size Income Statement Compared
to Industry Average
Year Ended December 31, 2006
INDUSTRY
TODD AVERAGE
Net sales 100.0% 100.0%
Cost of goods sold. 67.6 65.8
Gross profit.. 32.4 34.2
Operating expenses.. 20.9 19.7
Operating income.. 11.5 14.5
Other expenses... 0.6 0.4
Net income 10.9% 14.1%
Todd Department Stores, Inc.

Common-Size Balance Sheet Compared to Industry Average
December 31, 2006
INDUSTRY
TODD AVERAGE
Current assets. 67.8% 70.9%
Fixed assets, net. 26.4 23.6
Intangible assets, net. 0.9 0.8
Other assets. 4.9 4.7
Total assets.. 100.0% 100.0%
Current liabilities. 46.0% 48.1%

Long-term liabilities 22.7 16.6
Stockholders equity... 31.3 35.3
Total liabilities and stockholders equity.. 100.0% 100.0%

Req. 2
Todds common-size income statement shows that its ratios of

(a) gross profit to net sales, (b) operating income to net sales,
and (c) net income to net sales are worse than the industry
averages. Overall, the companys profit performance is worse
than the average for the industry.
Req. 3
Todds common-size balance sheet shows that its (a) ratio of

current assets to total assets is less than that of the industry
average. Todds (b) ratio of stockholders equity to total assets
is also worse than the industry average. Overall, the companys
financial position is worse than the industry average.

(30-40 min.) P 17-24A
Req. 1 (ratios before the transactions)
(Dollar Amounts and Stock Quantities in Thousands)

Earnings
Current Ratio Debt Ratio per Share
$253 $381
$22 + $82 + $149 $190 + $191 $71

= 1.33 = 0.60 = $1.42*
$49 + $103 + $38 $637 50
$190
Req. 2 (ratios after the transactions)
Trans- Earnings per

action Current Ratio Debt Ratio Share
a. $253 + $46 $381 + $46 No effect

= 1.27 = 0.63
$190 + $46 $637 + $46
b. $253 + $125 $381 + $125 No effect

= 1.99 = 0.66
$190 $637 + $125
c. $253 + $120 $381 $71

= 1.96 = 0.50 = $1.29*
$190 $637 + $120 50 + 5
d. No effect No effect No effect

__________
*Not in thousands

(40-50 min.) P 17-25A
Req. 1
2009 2008
a. Current ratio: $371 $382
= 1.64 = 1.57
$226 $243
b. Times-interest- $86 $75

= 7.82 = 6.25
earned ratio: $11 $12
c. Inventory $240 $218

= 1.55 = 1.18
turnover: ($147 + $162) / 2 ($162 + $207) / 2
d. Return on $50 $6* $36 $6*

= 0.338 = 0.286
common stock- ($140 + $120) / 2 ($120 + $90) / 2
holders' equity:
e. Earnings per share $50 $6* $36 $6

= $4.40** = $3.33**
of common stock: 10 9
f. Price/earnings $49** $32.50**

= 11.1 = 9.8
ratio: $4.40** $3.33**
__________
*$100,000 .06 = $6,000
**Not in thousands

Req. 2
Decisions:
a. The companys ability to pay its debts and to sell inventory
improved during 2009, as shown by increases in the current
ratio, times-interest-earned ratio, and inventory turnover.
b. The common stocks attractiveness improved during 2009,

as shown by the rise in the stocks market price. This
increase in market price is consistent with the increases in
return on common stockholders equity and earnings per
share of common stock. Return on common stockholders
equity is very high. The price/earnings ratio also increased.

(45-60 min.) P 17-26A
Singular Very Zone

a. Acid-test ratio: $22 + $40 + $42 $19 + $18 + $46
= 1.04 = 0.85
$100 $98
b. Inventory $209 $258

= 2.79 = 2.74
turnover: ($67 + $83) / 2 ($100 + $88) / 2
c. Days sales in ($38 + $40) / 2 ($46 + $48) / 2

= 34 = 35
average $421 / 365 $497 / 365
receivables:
d. Debt ratio: $100 $131

= 0.38 = 0.40
$265 $328
e. Earnings per share $50 $72

= $5.00* = $4.80*
f. Price/earnings $80* $86.40*

= 16 = 18
ratio: $5* $4.8*
_________
*Not in thousands

Decision:
Singulars common stock seems to fit the investment strategy
better. Its price/earnings ratio is lower than that of Very Zone,
and Singular appears to be in a little better shape financially
than Very Zone, as indicated by all the ratio values.

(15-20 min.) P 17-27A
TO: Prudential Bache Investment Committee
FROM: Student Name
SUBJECT: Investment Recommendation
I recommend that we invest in Mocek Corp. for the following

reasons:
1. Moceks return on equity (ROE) is around 50% higher than

Colortimes. An investment in Mocek stock should therefore
produce a higher return than an investment in Colortime
stock.
2. Moceks ROE exceeds its return on assets by a wider margin

than does Colortimes. This means that Mocek is earning
more with its borrowed funds than Colortime is earning.
3. Mocek can cover its interest expense with operating income

16 times compared to 9 times for Colortime.
4. Mocek collects receivables faster than Colortime does. This

suggests that cash flow is stronger at Mocek.
5. Colortime is better than Mocek on inventory turnover and net

income as a percent of sales. These ratios provide insight
about companies operations, but ROE and interest coverage
are more bottom-line oriented. Days sales in receivables
provide insight about the companys cash collections from
customers. For this reason, I place more importance on ROE,
interest-coverage, and days sales in receivables, and Mocek
outstrips Colortime on these measures.

Problems
Group B
(20-30 min.) P 17-28B

Req. 1
Azbell Electronics
Trend Percentages
2008 2007 2006 2005

Net sales 109% 111% 95% 100%
Net income 50 117 61 100
Total assets 135 129 106 100
Req. 2 (Dollar amounts in thousands)
2008 2007 2006
Net income $9 $21 $11

= 0.029 = 0.067 = 0.041
Net sales $307 $313 $266

(20-30 min.) P 17-29B
Req. 1
Crescent City Music Company
Common-Size Income Statement Compared to Industry Average
Year Ended December 31, 2008
CRESCENT INDUSTRY
CITY AVERAGE
Net sales 100.0% 100.0%
Cost of goods sold. 64.1 65.9
Gross profit... 35.9 34.1
Operating expenses 21.3 28.1
Operating income 14.6 6.0
Other expenses 1.0 0.4
Net income 13.6% 5.6%
Crescent City Music Company

Common-Size Balance Sheet Compared to Industry Average
December 31, 2008
CRESCENT INDUSTRY
CITY AVERAGE
Current assets.. 77.1% 74.4%
Fixed assets, net. 18.6 20.0
Intangible assets, net. 3.8 0.6
Other assets. 0.5 5.0
Total assets.. 100.0% 100.0%
Current liabilities. 39.0% 45.6%

Long-term liabilities 21.6 19.0
Stockholders equity.. 39.4 35.4
Total liabilities and stockholders equity.. 100.0% 100.0%

(continued) P 17-29B
Req. 2
Crescent Citys common-size income statement shows that its

ratio of gross profit to net sales.
ratio of operating income to net sales.
ratio of net income to net sales.
are all better than the industry averages. Overall, Crescent
Citys profit performance is better than average for the
industry.
Req. 3
Crescent Citys common-size balance sheet shows that its

ratios of current assets and of current liabilities to
total assets.
ratio of stockholders equity to total assets is better
than the industry averages.
Overall, the companys financial position is better than average
for its industry.

(20-30 min.) P 17-30B
Req. 1 (ratios before the transactions)

Earnings per
Current Ratio Debt Ratio Share
$359 $442
$47 + $123 + $189 $218 + $224 $110

= 1.65 = 0.53 = $5.50*
$72 + $96 + $50 $833 20
$218
Req. 2 (ratios after the transactions)

Trans-
action Current Ratio Debt Ratio Earnings per Share
a. $359 + $27 $442 + $27 No effect

= 1.77 = 0.55
$218 $833 + $27
b. $359 + $108 $442 $110

= 2.14 = 0.47 = $3.67*
$218 $833 + $108 20 + 10
c. $359 + $48 $442 + $48 No effect

= 1.53 = 0.56
$218 + $48 $833 + $48
d. No effect No effect No effect

__________
*Not in thousands

(40-50 min.) P 17-31B
Req. 1
2006 2005
a. Current ratio: $548 $497
= 1.92 = 1.86
$286 $267
b. Times-interest- $160 $169

= 4.32 = 3.31
earned ratio: $37 $51
c. Inventory $378 $283

= 1.29 = 1.20
turnover: ($298 + $286) / 2 ($286 + $184) / 2
d. Return on $89 $2* $65 $2*

= 0.329 = 0.301
common stock- ($308 + $221) / 2 ($221 + $198) / 2
holders' equity:
e. Earnings per share $89 $2* $65 $2*

= $5.80** = $4.50**
f. Price/earnings $92.80** $67.50**

= 16 = 15
ratio: $5.80** $4.50**
__________
*$50,000 .04 = $2,000
**Not in thousands

Req. 2
Decisions:
a. The companys financial position improved during 2006 as
shown by increases in all the ratios.
b. The stocks attractiveness improved during 2006, as shown
by the increase in the market price of the common stock.
This increase is consistent with the increases in return on
common stockholders equity, earnings per share of
common stock, and the price/earnings ratio.

(45-60 min.) P 17-32B
MMM Carolina
a. Acid-test ratio: $45 + $76 + $169 $39 + $13 + $164
= 0.72 = 0.64
$306 $338
b. Inventory $484 $387

= 2.30 = 2.04
turnover: ($211 + $209) / 2 ($183 + $197) / 2
c. Days sales in ($99 + $102) / 2 ($164 + $193) / 2

= 61 = 126
average $603 / 365 $519 / 365
receivables:
d. Debt ratio: $667 $691

= 0.68 = 0.74
$974 $938
e. Earnings per share $75 $38

= $0.50* = $1.90*
f. Price/earnings $8.00* $41.80*

= 16 = 22
ratio: $.50* $1.90*
__________
*Not in thousands

Decision:
MMMs common stock seems to fit the investment strategy
better. Its price/earnings ratio is lower than that of Carolina,
and MMM appears to be in better shape financially than
Carolina. On all the ratios, MMM looks better than Carolina.

(15-20 min.) P 17-33B
TO: A.G. Edwards Investment Committee
FROM: Student Name
SUBJECT: Investment Recommendation
I recommend that we invest in Hourglass Company for the

following reasons:
1. Hourglasss return on equity (ROE) is 7% higher than PC

Techs. An investment in Hourglass stock should therefore
produce a higher return than an investment in PC Tech
stock.
2. Hourglasss ROE exceeds its return on assets by a wider
margin than does PC Techs. This means that Hourglass is
earning more with its borrowed funds than PC Tech is
earning.
3. Hourglass can cover its interest expense with operating
income 18 times compared to 12 times for PC Tech.
4. Hourglass collects receivables faster than PC Tech does.
This suggests that cash flow is stronger at Hourglass.
5. Hourglasss gross profit percentage is higher than PC
Techs.
6. PC Tech is better than Hourglass on inventory turnover and
net income as a percentage of sales. These ratios provide
insight about companies operations, but ROE and interest
coverage are more bottom-line oriented. And days sales in
receivables give an indication about cash flow. For these
reasons, I place more importance on ROE, interest-coverage,
and days sales in receivables, and Hourglass outstrips PC
Tech on these measures.

Decision Cases
(30 min.) Decision Case 1
Trans- Current Debt Return on

action Ratio Ratio Equity
1 Increase Increase No effect

2 Decrease Increase Increase
3 No effect Increase Decrease
4 Decrease Increase No effect
5 Decrease Increase No effect

(20-30 min.) Decision Case 2
Recording payments in December, but mailing the checks in

January, understates Accounts Payable and Cash at year-end.
This action makes the current ratio and the acid-test ratio look
better than they really areso long as the ratio values exceed
1.0. The following data illustrate the point:
Correct amounts Amount Reported amounts

(No cash payments of cash (Cash payment recorded
recorded in December) payment in December)
Current assets $100 $10 $100 $10 $90

= = 2.0 = = = 2.25
Current liabilities $50 $10 $50 $10 $40
Quick assets $70 $10 $70 $10 $60

= = 1.4 = = = 1.50
Current liabilities $50 $10 $50 $10 $40

Ethical Issue
1. Reclassifying the long-term investments as short-term will
increase current assets and, therefore, increase the current
ratio. Rosss true financial position is not improved by this
reclassification because the companys asset position has
not changed.
2. Reclassifying a long-term investment as current to meet a

debt agreement does not brand Ross managers as unethical.
The managers may have honestly intended to sell the
investments in order to meet obligations. In that case, the
managers took appropriate action.
Reclassifying the investments from current back to long-term

may suggest to some observers that managers are playing a
shell game. However, the case states that sales subsequent
to the first reclassification have improved the current ratio.
Under these circumstances, Ross may not need to sell the
investments. The managers may prefer to hold the
investments beyond one year and, therefore, need to
reclassify them as long-term. In that case, the managers
action is appropriate.
This case illustrates how gray accounting can be. Here the
debt agreement depends on the current ratio, which is
affected by an asset classification that managers control
simply by their intentions. Because the managers intentions
cannot be observed, it would be hard to prove that the
managers are behaving unethically.

Financial Statement Case
(15-25 min.) Financial Statement Case
Req. 1
Stockholders equity is very low.
Req. 2
Trend percentages: 2005 2004 2003
Net sales.. 161 131 100

Net income.. 10257 16800 100
The trend percentage for net income looks strange because the
base-year net income amount for 2003 was so low.
Req. 3
Inventory turnover: 2005 2004
Cost of sales = $6,451 $5,319

Average inventory ($566 + $480) / 2 ($480 + $294) / 2
= 12.3 times 13.7 times
The trend of net income from 2004 to 2005 and the change in
the rate of inventory turnover tell the same story. Both
measures deteriorated in 2005.

Comprehensive Problem, Chapters 16-17
(60-90 min.) Comprehensive Problem
There is no single correct answer to this problem. However, a

complete solution should examine most of the following items.
1. Trend analysis (20X1 = 100%) (Dollar Amounts, except Earnings Per Share, in Millions
20X5 20X4 20X3 20X2 20X1
Net sales 178% 158% 139% 120% 100%
Net income 181 151 142 121 100
2. Profitability analysis
Earnings per share
(Net income) $1.81 $1.49 $1.41 $1.21 $0.99
Return on $8,039 $6,671 $6,295 $5,377 $4,430

sales $244,524 $217,799 $191,329 $165,013 $137,634
= 3.3% = 3.1% = 3.3% = 3.3% = 3.2%

Return on
assets 9.2% 8.5% 8.7% 9.5% 9.6%
Return on common
stockholders
equity 21.6% 20.1% 22.0% 22.9% 22.4%
3. Measuring ability to sell inventory

Inventory $191.8 $171.6 $150.3 $129.7 $108.7
turnover ($24.9 + $22.6) / 2 ($22.6 + $21.4) / 2 ($21.4 + $19.8) / 2 ($19.8 + $17.1) / 2 ($17.1 + $16.5) / 2
= 8.08 = 7.80 = 7.30 = 7.03 = 6.47
4. Measuring ability to pay debts

Current ratio 0.9 1.0 0.9 0.9 1.3
$94.7 $39.3 $83.5 $35.1 $78.1 $31.3 $70.3 $25.8 $50.0 $21.1
Debt ratio
$94.7 $83.5 $78.1 $70.3 $50.0
= 58.5% = 58.0% = 59.9% = 63.3% = 57.8%
5. Measuring dividends
Dividends
per share $0.30 $0.28 $0.24 $0.20 $0.16

(continued) Comprehensive Problem
Discussion of trend analysis and ratios:
WRSs trends of net sales, net income, earnings per share, and
inventory turnover have increased.
All other measures have held steady or deteriorated a bit.

However, there are no apparent trouble spots in WRSs data.
Decision:
Invest in WRS for increasing dividends and steady growth.

Chapter 17 Solutions 7e

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Chapter 17 Solutions 7e

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Chapter 17

Financial Statement Analysis

1. b. 21% increase in Cash = ($2,345 $1,934) / $1,934 = .21

2. c. Cash = 9.6% of total assets = $2,345 / $24,501 = .096

3. d. a, b, and c are all true.

4. a. Acid-test ratio for 2002 = 0.61 [($2,345 + $2,097) / $7,341].

5. a. Inventory turnover = 6 times

6. b. Days sales in receivables = 37 days, computed as

Chapter 17 Financial Statement Analysis 1065

8. d. Strong return on common stockholders equity

A 26% return on common stockholders equity is strong.

9. c. EPS = $1.22 = Net income / Number of common shares

10. a. Price/earnings ratio = 36 = Market price of stock / EPS

1066 Accounting 7/e Solutions Manual

(5-10 min.) S 17-1

(5-10 min.) S 17-2

2006 2005 2004 2003

2. Net income increased far faster than revenues.

Chapter 17 Financial Statement Analysis 1067

(10 min.) S 17-4

Alioto earns more net income.

These data show how common-size financial statements enable

1068 Accounting 7/e Solutions Manual

Total current assets $6.7 $5.6

2. Lowes current ratio deteriorated a little during 2006.

Chapter 17 Financial Statement Analysis 1069

Cost of goods sold $21.2

b. Days sales in receivables:

One days $30.8

1070 Accounting 7/e Solutions Manual

Total liabilities $ 8.7

Chapter 17 Financial Statement Analysis 1071

Net income $1.9

c. Rate of return Net Preferred

These rates of return are strong.

1072 Accounting 7/e Solutions Manual

Market price per share

Chapter 17 Financial Statement Analysis 1073

(b) = $7,200 $4,235 $1,710 $150 $1,000 = $105

(d) = $7,200 0.095 = $684

(c) = $1,000 $684 = $316

1074 Accounting 7/e Solutions Manual

Plant assets, net 3,180 (d)

(f) = $6,800 (same as total assets)

(e) = $6,800 $2,100 $820 $2,400 = $1,480

(c) = $2,100 0.70 = $1,470

(a) = $2,100 0.30 = $630; $630 $50 = $580

(b) = $1,470 $50 $580 $750 = $90

(d) = $6,800 $1,470 $2,150 = $3,180

Chapter 17 Financial Statement Analysis 1075

(5-15 min.) E 17-12

The increasing trend of working capital is favorable.

1076 Accounting 7/e Solutions Manual

Net income increased by a much higher percentage than total

Chapter 17 Financial Statement Analysis 1077

2008 2007 2006 2005 2004

Total revenue. 126% 114% 106% 97% 100%

Net income..... 144 134 98 84 100

Net income grew by 44% during the period, compared to 26%

1078 Accounting 7/e Solutions Manual

Chapter 17 Financial Statement Analysis 1079

An investor would be pleased with 2007 in comparison with

1080 Accounting 7/e Solutions Manual

b. Acid-test (quick) $17,000 + $11,000 + $54,000

f. Price/earnings $49 $32.50