Larson SM Ch20

Chapter 20
Analyzing Financial Statements

Questions
1. Financial reporting includes the entire process of preparing and issuing financial
information about a company. Financial statements are an important part of financial
reporting but less than the whole.
2. In comparative statements, financial statement items for two or more successive
accounting periods are placed side by side on a single statement, with the change in
each item expressed as both a dollar amount and a percent. Common-size comparative
statements express each financial statement item as a percent of some base amount
that is assigned a value of 100%.
3. Total assets (or equivalently, the total of liabilities plus equity) are assigned a value of
100% on a common-size comparative balance sheet. Net sales are assigned a value of
100% on a common-size comparative income statement.
4. Adequate working capital enables a company to carry sufficient inventories, meet
current debts, take advantage of cash discounts, and extend favourable terms to
customers. Generally, working capital determines the short-term liquidity position of a
company.
5. The nature of a companys business, the composition of its current assets, and the
turnover of its current assets are factors that should be considered in deciding whether
a current ratio is good or bad.
6. A 2-to-1 current ratio may not be adequate if the companys current assets consist of a
large proportion of slow-turning accounts, notes, and merchandise. The general nature
of the business also may make the 2-to-1 rule of thumb inadequate.
7. Quick assets are cash, temporary investments and short-term receivables.
8. A high accounts receivable turnover implies that accounts are collected quickly,
thereby providing cash that can be used to meet obligations. A high turnover also
means that a given sales volume can be supported with a lower investment in accounts
receivable.
9. When evaluated in light of a companys credit terms, the number of days sales
uncollected indicates how quickly accounts receivable are converted into cash. This
provides information about the relevance of accounts receivable balances in meeting
the current obligations of the business.
10. A high merchandise turnover means that a given sales volume can be supported with a
smaller investment in inventory. Also, the speed with which merchandise is sold
determines the relevance of the available merchandise in meeting the current
obligations of the business.
11. Analysts are interested in the capital structure of a company, as measured by debt and
equity ratios, for two reasons. First, as a company includes more debt in its capital
structure, the risk that it will be unable to meet interest and principal payments
increases. Second, the existence of debt introduces financial leverage. If the company
can earn a rate of return on its investments that exceeds the rate of interest paid to
creditors, the debt will increase the rate of return to shareholders.
Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

422 Fundamental Accounting Principles, Eleventh Canadian Edition
12. The ratio of pledged assets to secured liabilities must be interpreted with care because
the book value of the pledged assets is used in calculating the ratio, and the book value
is unlikely to always approximate the assets fair value.
13. Almost all companies have some liabilities. Since total assets equals total liabilities
plus equity, total assets are almost always higher than common shareholders equity.
Thus, the denominator in return on total assets is larger than common shareholders
equity. Since the numerator is the same for both and return on total assets has a larger
denominator, it yields a smaller percent.
14. Since management is responsible for a companys performance, all ratios that are
useful in evaluating a company are of some usefulness in assessing management
performance. Profit margin, total asset turnover, return on total assets, and return on
shareholders equity are especially useful for assessing managements responsibility
for operating efficiency and profitability.
15. Percentage change in total revenues from 2001 to 2002 is an increase of 42% calculated
as $679,996,000 - $478,393,000 = $201,603,000/$478,393,000 = 42%.
16. Percentage change in the category Operating expenses (income) from 2001 to 2002 is
an increase of 9% calculated as $124,697,000 - $114,397,000 = $10,300,000/$114,397,000
= 9%.

Solutions Manual for Chapter 20 423
QUICK STUDY
Quick Study 20-1 (5 minutes)

b. Company news releases.
d. Certain reports filed with CCRA.
f. Management discussions and analyses of financial performance.

a. Common-size percents: 45.8% in 2004; 47.6% in 2005.
b. Trend percents: 100% in 2004; 85.4% in 2005.

McKenna will have a higher current ratio because FIFO yields a higher ending inventory (a
current asset) during a period of rising prices.

a. Accounts receivable turnover, and days sales uncollected.
b. Working capital, or net working capital.
c. Profit margin and total asset turnover; return on total assets.

The four usual bases of comparison are:
Intracompany. The company under analysis provides standards for comparisons
based on prior performance and relations between its financial items.
Competitor. One or more direct competitors of the company under analysis can
provide standards for comparisons.
Industry. Industry statistics can provide standards of comparisons. Published industry
statistics are available from several services such as Dun & Bradstreet, Standard and
Poors, and Moodys.
Guidelines (Rules of Thumb). General standards of comparisons can develop from
past experiences. Examples are the 2-to-1 levels for the current ratio or 1-to-1 levels
for the acid-test ratio.
All of these standards of comparisons are useful when properly applied. Yet analysis
measures taken from a selected competitor or group of competitors are often the best
standards of comparisons. Also, intracompany and industry measures are important
parts of all analyses.
Guidelines, or rules of thumb, should be applied with care, and then only if they seem
reasonable in light of past experience and industry norms.

1. Higher current ratio for Campbell due to higher current assets
2. Higher ending inventory leads to lower CGS, and therefore a higher profit
margin for Campbell.
3. Lower debt ratio because of higher retained earnings for Campbell.
4. Lower inventory turnover because of both higher ending inventory and lower
cost of good sold for Campbell.
5. Higher interest coverage because of higher net income for Campbell.

1. C 6. A
2. D 7. B
3. C 8. C
4. A 9. A
5. B 10. B

Cash $ 1,680
Accounts receivable 3,780
Inventory 7,000
Prepaid expenses 840
Total current assets $13,300
Current ratio = Current assets Current liabilities
$13,300 ($4,650 + $1,050= $5,700) = 2.33 times
The current ratio is a measure of short-term debt paying ability. For every $1 of current
liabilities this company has $2.33 of current assets.
The current ratio of 2.33 is favourable in comparison to the industry average of 1.6 in
Exhibit 20.11.

Cash $1,680
Accounts receivable 3,780
Total quick assets $5,460
Acid-test ratio = Quick assets Current liabilities

$ 5,460 Current liabilities ($4,650 + $1,050= $5,700) = .96 times or .96:1
The acid-test ratio of .96 is unfavourable in comparison to the industry average of 1.1 in
Exhibit 20.11. The acid-test ratio evaluates the relative liquidity of a firms current assets.
It is a more stringent measure of debt paying ability than the current ratio. An acid-test
ratio of .96 means that for every $1 of current liabilities the company has $0.96 of quick
assets.

(b)
Comparison of
(a) 2005 to
Trend from Industry
Ratio 2005 2004 2004 to 2005 Average
1. Profit Margin 8% 9% Unfavourable Unfavourable
2. Debt Ratio 43% 40% Unfavourable Unfavourable
3. Gross Profit Ratio 33% 45% Unfavourable Favourable
4. Acid-test Ratio .99 1.10 Unfavourable Unfavourable
5. Accounts Receivable Turnover 6.4 5.6 Favourable Unfavourable
6. Basic Earnings Per Share $1.18 $1.20 Unfavourable Unfavourable
7. Merchandise Turnover 3.5 3.3 Favourable Unfavourable
8. Dividend Yield 1% .8% Favourable Unfavourable

Account receivable turnover = Net sales Average accounts receivable
$672,000 [($89,600 + $67,200) 2]
$672,000 $78,400 = 8.57 times

This accounts receivable turnover of 8.57 times compares unfavourably to the industry
average of 16 times.

Total asset turnover = Net sales Average total assets
$9,050 ($10,690 + $13,435/2)
$9,050 $12,063 = 0.75 times

The total asset turnover of 0.75 times compares unfavourably to the industry average of
2.3 times.
EXERCISES
Exercise 20-1 (20 minutes)
2005 2004 2003 2002 2001

Sales ..................................... 125 120 112 104 100
Cost of goods sold.............. 127 121 114 105 100
Accounts receivable ........... 127 122 116 108 100
The trend in sales is positive. While this is better than no growth, one cannot definitively
say whether the sales trend is favourable without additional information about the
economic conditions in which this trend occurred. Given the trend in sales, the
comparative trends in cost of goods sold and accounts receivable both appear to be
unfavourable. Both are increasing at faster rates than sales.
Dollar Percent
Item Change Base Amount Change
Temporary investments........ $49,000 $154,000 32%
Accounts receivable ............. (4,312) 35,200 12%
Notes payable ........................ 25,000 0 (not calculable)

2005 2004
Sales ............................................ 100.0% 100.0%
Cost of goods sold..................... 60.0 52.0
Gross profit from sales.............. 40.0 48.0
Operating expenses ................... 22.5 20.2
Net income.................................. 17.5% 27.8%
This situation appears to be unfavourable. Both cost of goods sold and operating
expenses are taking a larger percent of each sales dollar in year 2005 compared to the
prior year. Also, even though sales volume increased, net income decreased in absolute
terms and dropped to only 17.5% of sales as compared to 27.8% in the year before.

CARMON INC.
Common-Size Comparative Balance Sheet
December 31, 2003-2005
2005 2004 2003
Cash.......................................................................... 5.0% 7.9% 9.9%
Accounts receivable, net ........................................ 18.0 14.2 13.2
Merchandise inventory ........................................... 21.5 18.5 14.2
Prepaid expenses.................................................... 1.9 2.1 1.1
Plant assets, net ..................................................... 53.6 57.3 61.6
Total assets 100.0 100.0 100.0
Accounts payable.................................................... 24.9% 16.9% 13.2%

Long-term notes payable secured by
mortgages on plant assets ................................. 18.8 23.0 22.2
Common shares ...................................................... 31.4 36.5 43.6
Retained earnings .................................................. 24.9 23.5* 21.0
Total liabilities and equity 100.0 100.0 100.0
* Column does not equal 100.0 due to rounding error.

a. Current ratio:
2005: $51,800 + $186,800 + $223,000 + $19,400 = 1.87 to 1

$257,800
2004: $70,310 + $125,940 + $165,000 + $18,750 = 2.52 to 1

$150,500
2003: $73,600 + $98,400 + $106,000 + $8,000 = 2.90 to 1

$98,500
b. Acid-test ratio:
2005: $51,800 + $186,800
= 0.93 to 1
$257,800
2004: $70,310 + $125,940
= 1.30 to 1
$150,500
2003: $73,600 + $98,400

= 1.75 to 1
$98,500
Interpretation: Carmons short-term liquidity position has weakened over the two-year
period. Both the current and acid-test ratios show this declining trend. Although we do
not have information about the nature of the companys business, the acid-test shift from
1.75 to 1 down to .93 to 1 and the current ratio shift from 2.90 to 1 down to 1.87 to 1
indicate a potential liquidity problem. The current ratio in 2005 of 1.87 compares
favourably against the industry average of 1.6 while the acid-test ratio in 2005 of 0.93
compares unfavourably against the industry average of 1.1.

Case X Case Y Case Z
Current assets..................................................... $4,000 $3,500 $7,300

Current liabilities ................................................ $2,200 $1,100 $3,650
Current ratio ........................................................ 1.82 3.18 2.00
Cash ..................................................................... $ 800 $ 910 $1,100

Temporary investments ..................................... 500
Accounts receivable........................................... 990 800
Quick assets........................................................ $ 800 $1,900 $2,400
Current liabilities ................................................ $2,200 $1,100 $3,650

Acid-test ratio...................................................... 0.36 1.73 0.66
Case Y exhibits the superior ability to meet short-term obligations as they come due. The
acid-test ratio of 1.73 exceeds the common benchmark of 1.0. Cases X and Z fall far short
of the 1.0 benchmark.

a. Days sales uncollected:
2005: $186,800 365 = 50.7 days
$1,345,000
2004: $125,940 365 = 43.4 days
$1,060,000

Exercise 20-7 (continued)
b. Accounts receivable turnover:
2005: $1,345,000 = 8.6 times

($186,800 + $125,940)/2
2004: $1,060,000 = 9.5 times

($125,940 + $98,400)/2
c. Merchandise turnover:
2005: $820,450 = 4.2 times

($223,000 + $165,000)/2
2004: $689,000 = 5.1 times
($165,000 + $106,000)/2
d. Days sales in inventory:
2005: $223,000 365 = 99 days

$820,450
2004: $165,000 365 = 87 days
$689,000
The number of days sales uncollected has increased and the accounts receivable
turnover has declined. The merchandise turnover has decreased and days sales in
inventory has increased. Although none of the changes that occurred from 2004 to
2005 appears to be dramatic, it may be true that Carmon is becoming less efficient in
managing its inventory and collecting its receivables. All of these 2005 ratios
compare unfavourably to the industry averages.

Days sales uncollected:
2005: $83,000 365 = 46.8 days
$647,000
2004:$51,000 365 = 32.9 days
$565,000
The number of days sales uncollected has increased reflecting a weakening liquidity
position.

1. Accounts Receivable Turnover:
Tate:
December 31, 2005
$282,599
------------------------------------------- = 4.18 times
($82,184 + $53,081)/2
Young:
December 31, 2005
$137,984
--------------------------------- = 1.87 times
($78,448 + $69,055)/2
2. Tate:
$82,184
--------------------------------- x 365 = 106.15 days
$282,599
Young:
$78,448
--------------------------------- x 365 = 207.51 days
$137,984
3. Tate is more efficient at collecting accounts receivable since it collected its

receivables 4.18 times per year which is faster than Youngs 1.87 times per year.
Also, Tate had only 106.15 days of uncollected sales at December 31, 2005 while
Young had 207.51 days of uncollected sales for the same date.

2005 2004
Days sales uncollected:
Accounts receivable $ 64,000 $ 48,000
Sales $480,000 $440,000
x 365 days x 365 days

= Days sales uncollected 48.67 days 39.82 days
Accounts receivable turnover: $480,000 = 8.6 $440,000 = 11.1

56,0001 39,5002
1. 64,000 + 48,000 = 112,000/2 = 56,000
2. 48,000 + 31,000 = 79,000/2 = 39,500
The trends in the accounts receivable ratios are deteriorating. Days sales uncollected is
increasing and accounts receivable turnover is decreasing. Receivables are increasing at
a faster rate than sales. However, we cannot say conclusively that things are bad because
it is possible that the company is earning higher income from what appears to be a
loosening of credit terms. Ernest Blue Corp.s 2005 ratios compare unfavourably to the
industry averages.
Merchandise turnover:
2005 2004
COGS/ average inventory
Cost of goods sold......................... $310,000 $290,000
Average merchandise inventory:
($52,000 +$44,000) 2 $ 48,000
($44,000 + $38,000) 2 $ 41,000
Merchandise turnover 6.5 7.1
The companys merchandise turnover has decreased by 8.5%. If this is the beginning of a
downward trend then it could be serious. However, a slowdown in merchandise turnover
is not bad if the company can achieve higher profits as a consequence of keeping more
inventory on hand. Not enough information is given to reach a conclusion. Other things
being equal, however, a decrease in merchandise turnover is not good.

Days sales in inventory
2005 2004
Days sales inventory:
Inventory $ 52,000 $ 44,000
Cost of goods sold $310,000 $290,000
x 365 days x 365 days

= Days sales in inventory 61 days 55 days
The days sales in inventory has increased by 6 days. If this is the beginning of a longer
trend then it could be serious. However, an increase in days sales in inventory is not bad
if the company can achieve higher profits as a consequence of keeping more inventory on
hand. Not enough information is given to reach a conclusion. Other things being equal,
however, an increase of days sales in inventory is unfavourable. The 2005 days sales in
inventory of 61 days is favourable in comparison to the industry average of 70 days.

$2,431,000
Total asset turnover for 2004 = = 2.96
($793,000 + $850,000)/2
$3,771,000
Total asset turnover for 2005 = = 4.21
($850,000 + $941,000)/2
Based on these calculations, Godoto turned its assets over 1.25 (4.21 2.96) more times
in 2005 than in 2004. This increase indicates that Godoto became more efficient in using
its assets. Godotos overall efficiency in using its assets in 2005 is also favourable when
compared to the industry average total asset turnover of 2.3 times.

Ratio of pledged assets to secured liabilities:
Grant Inc. Singh Inc.

Pledged assets ............................. $541,800 $240,800
Secured liabilities......................... $228,200 $229,300
Ratio .............................................. 2.37 to 1 1.05 to 1
Singhs liabilities appear more risky as it only has $1.05 in pledged assets for every $1 in
secured liabilities. Every $1 of Grants secured liabilities is covered by $2.37 in pledged
assets.

a. Debt and equity ratios:
2005 2004
Total liabilities (and debt ratio):
$257,800 + $195,000 .................. $ 452,800 43.7%
$150,500 + $205,000 .................. $355,500 39.9%
Total equity (and equity
ratio):
$325,000 + $258,200 .................. 583,200 56.3
$325,000 + $209,500 .................. _________ _______ 534,500 60.1
Total liabilities and equity .............. $1,036,000 100.0% $890,000 100.0%
b. Pledged assets to secured liabilities:

2005: $555,000/$195,000 = 2.85 to 1
2004: $510,000/$205,000 = 2.49 to 1
c. Times interest earned:
2005: ($68,200 + $17,050 + $22,200)/$22,200 = 4.84 times

2004: ($62,750 + $15,690 + $24,600)/$24,600 = 4.19 times
Interpretation: Carmon added debt to its capital structure during 2005, with the result that
the debt ratio increased from 39.9% to 43.7% (higher than the industry average).
However, the book value of pledged assets is well above secured liabilities (2.85 to 1 in
2005 and 2.49 to 1 in 2004; industry average unavailable), and the increased profitability of
the company allowed it to increase the times interest earned from 4.19 to 4.84 times
(unfavourable in comparison to the industry average of 50 times). Apparently, the
company is able to handle the increased debt. However, we should note that the debt
increase is entirely in current liabilities, which places a greater stress on short-term
liquidity.

a. Profit margin:
2005: ($68,200/$1,345,000) 100 = 5.1%
2004: ($62,750/$1,060,000) 100 = 5.9%
b. Total asset turnover:

2005: $1,345,000 = 1.4 times
($1,036,000 + $890,000)/2
2004: $1,060,000 = 1.3 times
($890,000 + $745,000)/2
c. Return on total assets:

2005: $68,200 100 = 7.1%
($1,036,000 + $890,000)/2
2004: $62,750 100 = 7.7%
($890,000 + $745,000)/2
Interpretation: Carmons operating efficiency appears to be declining because the return
on total assets decreased from 7.7% to 7.1% (unfavourable when compared to the
industry average of 20%). While the total asset turnover favourably increased slightly
from 2004 to 2005 (unfavourable in comparison to the industry average of 2.3 times), the
profit margin unfavourably decreased from 5.9% to 5.1% (unfavourable when compared to
the industry average of 14%). The decline in profit margin indicates that Carmons ability
to generate net income from sales has declined.

Return on total assets = (Net income/Average total assets) 100
2004: $36,400/[($320,000 + $750,000)/2] = .0680 100 = 6.8%
2005: $28,200/[($190,000 + $320,000)/2] = .1106 100 = 11.1%
Comment: Rawhide used its assets more efficiently in generating income in 2005 over
2004. However, this is unfavourable when compared to the industry average return on
total assets of 20%.

a. Return on common shareholders equity:
2005: $68,200 100 = 12.2%
($583,200 + $534,500)/2
2004: $62,750 100 = 12.4%

($534,500 + $481,500)/2
b. Price earnings ratio, December 31:
2005: $30/$2.10 = 14.3

2004: $28/$1.93 = 14.5
c. Dividend yield:
2005: ($.60/$30) x 100 = 200%
2004: ($.30/$28) x 100 = 107%

Answer: The net income decreased.
Supporting calculations: When the sums of each years common-size cost of goods sold
and expenses are subtracted from the common-size sales percents, net income percents
are as follows:
2003: 100.0 60.2 16.2 = 23.6% of sales
2004: 100.0 63.0 15.9 = 21.1% of sales
2005: 100.0 64.5 16.4 = 19.1% of sales
This means, for example, if 2003 sales are assumed to be $100, then sales for 2004 are
$105.30 and the sales for 2005 are $106.50. If the income percents for the years are
applied to these amounts, the net incomes are:
2003: $100.00 23.6% = $23.60
2004: $105.30 21.1% = $22.22
2005: $106.50 19.1% = $20.34
This shows that the companys net income decreased over the three years.

PROBLEMS
Problem 20-1A (60 minutes)
Part 1
Current ratios: December 31, 2005: $24,240/$10,100 = 2.4 to 1
December 31, 2004: $18,962/$9,980 = 1.9 to 1
December 31, 2003: $25,324/$9,740 = 2.6 to 1
Part 2
CRANE CORP.
Common-Size Comparative Income Statement
For Years Ended December 31, 2005, 2004, and 2003
2005 2004 2003
Sales .......................................................... 100.00% 100.00% 100.00%
Cost of goods sold................................... 60.20 62.50 64.00
Gross profit............................................... 39.80 37.50 36.00
Selling expenses ...................................... 14.12 13.80 13.20
Administrative expenses ......................... 9.04 8.80 8.25
Total expenses ......................................... 23.16 22.60 21.45
Income before taxes................................. 16.64 14.90 14.55
Income taxes............................................. 3.10 3.05 2.95
Net income................................................ 13.54 11.85 11.60
Part 3
CRANE CORP.
Balance Sheet Data in Trend Percentages
December 31, 2005, 2004, and 2003
2005 2004 2003
Assets
Current assets .......................................... 95.72% 74.88% 100.00%
Long-term investments ........................... 0.00 13.44 100.00
Plant and equipment................................ 157.89 168.42 100.00
Total assets............................................... 124.34 120.70 100.00
Liabilities and Shareholders Equity
Current liabilities...................................... 103.70 102.46 100.00
Common shares ....................................... 135.00 135.00 100.00
Retained earnings .................................... 116.91 104.94 100.00
Total liabilities and equity ...................... 124.34 120.70 100.00

Problem 20-1A (continued)
Part 4
Cranes selling expenses, administrative expenses, and income taxes took larger portions
of each sales dollar in 2004 than in 2003. However, because the cost of goods sold took a
smaller portion in 2004, some efficiency was gained. In 2005, these trends continued.
Selling expenses, administrative expenses, and income taxes continued to take a greater
portion of each sales dollar while the gross profit portion continued to improve.
Crane expanded its plant in 2004, financing the expansion through the sale of long-term
investments, through a reduction in working capital (the current ratio decreased from 2.6
to 1 to 1.9 to 1), and perhaps through the sale of a small amount of shares. As to the
share increase, it is not possible to tell from these two statements whether the company
sold shares or declared a share dividend. In either case, the increase in retained earnings
during 2004 indicates that net income was larger than the reductions from cash (and
perhaps share) dividends. In 2005 and 2004, cash dividends were paid.
Part 1
GLACE BAY CORPORATION
Income Statement Trends
For Years Ended December 31, 2005-1999
2005 2004 2003 2002 2001 2000 1999
Sales ................................... 189.8 166.2 151.2 138.6 129.3 120.2 100.0
Cost of goods sold............ 229.2 186.4 160.4 140.4 130.4 122.0 100.0
Gross profit........................ 131.8 136.5 137.6 135.9 127.6 117.6 100.0
Operating expenses.......... 261.5 204.6 187.7 138.5 120.0 118.5 100.0
Net income ......................... 51.4 94.3 106.7 134.3 132.4 117.1 100.0

GLACE BAY CORPORATION

Balance Sheet Trends
December 31, 2005-1999
2005 2004 2003 2002 2001 2000 1999
Cash....................................... 68.0 88.0 92.0 94.0 98.0 96.0 100.0
Accounts receivable, net ..... 235.3 247.1 223.5 171.6 151.0 143.1 100.0
Merchandise inventory ........ 334.2 243.1 212.3 179.2 160.8 136.5 100.0
Other current assets ............ 230.0 210.0 120.0 220.0 190.0 190.0 100.0
Long-term investments........ 0 0 0 100.0 100.0 100.0 100.0
Plant and equip., net ............ 257.3 256.6 224.8 126.7 130.8 116.5 100.0
Total assets........................... 246.8 222.4 195.6 144.1 138.2 123.7 100.0
Current liabilities .................. 411.8 346.3 227.2 189.0 164.0 155.1 100.0
Long-term liabilities ............. 301.5 262.6 255.6 118.7 121.2 131.3 100.0
Common shares ................... 156.3 156.3 156.3 127.5 127.5 100.0 100.0
Retained earnings ................ 264.3 232.1 192.9 177.4 163.1 145.8 100.0
Total liabilities and
equity.................................. 246.8 222.4 195.6 144.1 138.2 123.7 100.0
Part 2
The statements and the trend percent data indicate that the company significantly
expanded its plant and equipment in 2003. Prior to that time, the company enjoyed
increasing gross profit and net income. Sales grew steadily for the entire period of 1999
to 2005. However, beginning in 2003, cost of goods sold and operating expenses
increased dramatically relative to sales, resulting in a significant reduction in net income.
In 2005, net income was only 51.4% of the 1999 base year amount.
At the same time that net income was declining, assets were increasing. This indicates
that Glace Bay was becoming less efficient in using its assets to generate income. Also,
the short-term liquidity of the company continued to decline. Accounts receivable did not
change significantly for the period of 2003 to 2005, but cash steadily declined and
merchandise inventory and current liabilities increased sharply.

Parts 1 and 2
a. Current ratio:
$18,500 +$20,400 + $43,400 + $8,800 + $49,200 + $4,800 = 2.81 to 1

$40,700 + $5,200 + $5,800
The industry average current ratio is 1.6 to 1 therefore 2.81 to 1 compares favourably.
b. Acid-test ratio:
$18,500 + $20,400 + $43,400 + $8,800 = 1.76 to 1
$40,700 + $5,200 + $5,800
The industry average acid-test ratio is 1.1 to 1 therefore 1.76 to 1 compares favourably.
c. Days sales uncollected:
$43,400 365 = 19.7 days
$805,000
The industry average days sales uncollected is 21 days therefore 19.7 days compares
favourably.
d. Merchandise turnover:
$514,300 = 9.2 times
($62,800 + $49,200)/2
The industry average merchandise turnover is 5 times therefore 9.2 times compares
favourably.
e. Days sales in inventory:
$49,200 365 = 34.9 days
$514,300
The industry average days sales in inventory is 70 days therefore 34.9 days compares
favourably.
f. Ratio of pledged assets to secured liabilities:
$272,100/$95,000 = 2.86 to 1
The industry average ratio of pledged assets to secured liabilities is not available
therefore a comparison cannot be made.

g. Times interest earned:
$62,900/$9,500 = 6.6 times

The industry average times interest earned is 50 times therefore 6.6 times compares
unfavourably.
h. Profit margin:
$37,680 100 = 4.7%
$805,000
The industry average profit margin is 14% therefore 4.7% compares unfavourably.
i. Total asset turnover:
$805,000 = 2.07 times
($417,200 + $360,600)/2
The industry average total asset turnover is 2.3 times therefore 2.07 times compares
unfavourably.
j. Return on total assets:
$37,680 100 = 9.7%
($417,200 + $360,600)/2
The industry average return on total assets is 20% therefore 9.7% compares unfavourably.
k. Return on common shareholders equity:

$37,680 100 = 14.5%
($270,500 + $249,700)/2
The industry average return on common shareholders equity is 32.7% therefore 14.5%
compares unfavourably.

Trans- Current Quick Current Current Acid-Test Working
action Assets Assets Liabilities Ratio Ratio Capital
Beginning* $ 750,000 $ 330,000 $ 300,000 2.50 1.10 $450,000
Mar. 6 + 85,000 + 85,000
Bal. 835,000 330,000 385,000 2.17 0.86 450,000
Mar. 11 +113,000 +113,000
68,000
Bal. 880,000 443,000 385,000 2.29 1.15 495,000
Mar. 15 + 29,000 + 29,000
29,000 29,000
Bal. 880,000 443,000 385,000 2.29 1.15 495,000
Mar. 17 31,000 31,000 31,000
Bal. 849,000 412,000 354,000 2.40 1.16 495,000
Mar. 19 + 0 + 0
Bal. 849,000 412,000 354,000 2.40 1.16 495,000
Mar. 24 + 50,000
Bal. 849,000 412,000 404,000 2.10 1.02 445,000
Mar. 28 50,000 50,000 50,000
Bal. 799,000 362,000 354,000 2.26 1.02 445,000
Mar. 29 + 85,000 + 85,000 + 85,000
Bal. 884,000 447,000 439,000 2.01 1.02 445,000
Mar. 30 +100,000 +100,000
Bal. 984,000 547,000 439,000 2.24 1.25 545,000
Mar. 31 185,000 185,000
Bal. $ 799,000 $ 362,000 $ 439,000 1.82 0.82 360,000
*Beginning balances:
Current assets (given) ......................................... $750,000
Current liabilities ($750,000/2.50) ....................... $300,000
Quick assets ($300,000 x 1.10) ........................... $330,000

Telcom has a greater amount of working capital. However, working capital may not
indicate whether Telcom is more capable of meeting its current obligations. The current
ratios and acid-test ratios show that Telcom is in a more liquid position than Kerbey.
However, that does not mean that Kerbeys liquidity is inadequate. Such a conclusion
would require more information, such as norms for the industry. Notably, Kerbeys
current and acid-test ratios approximate the traditional rule of thumb (2 to 1 for the
current ratio and 1 to 1 for the acid-test ratio).
Telcoms working capital, current ratio, and acid-test ratio all increase dramatically over
the three-year period. This trend toward greater liquidity may be positive but may suggest
that Telcom holds an excess amount of liquid assets that typically earn a low return.
The accounts receivable turnover and merchandise turnover indicate that Kerbey
Company is more efficient in collecting its accounts receivable and in generating sales
from available merchandise inventory. However, these statistics may suggest that Kerbey
is too conservative in granting credit and investing in inventory. This could have a
negative effect on sales and net income. Telcoms statistics may be acceptable, but no
determination can be made without having information on industry standards.

Comparison
to Industry
2005 2004 Trend Average
Current ratio ............................... 1.2:1 1.1:1 F U
Acid-test ratio............................. 0.98:1 0.94:1 F U
Accounts receivable turnover... 18 21 U F
Days sales uncollected............. 26 35 F U
Merchandise turnover................ 7 8 U F
Days sales in inventory ............ 55 42 U F
Total asset turnover................... 3.6 2.1 F F
Debt ratio .................................... 75 53 U* U
Times interest earned................ 2.4 7.1 U U
Profit margin............................... 17 21 U F
Gross profit ratio........................ 19 18 F F
*Generally, an increase in debt is considered to be unfavourable because of the increased
risk.

ALTERNATE PROBLEMS
Problem 20-1B (60 minutes)

Part 1
Current ratios: December 31, 2005: $226,000/$110,000 = 2.05 to 1

December 31, 2004: $125,000/$92,000 = 1.36 to 1
December 31, 2003: $179,000/$77,000 = 2.32 to 1
Part 2
DEXTER CORPORATION
Common-Size Comparative Income Statement
For Years Ended December 31, 2005, 2004, and 2003
2005 2004 2003
Sales .......................................................... 100.00% 100.00% 100.00%
Cost of goods sold................................... 55.61 52.55 47.61
Gross profit............................................... 44.39 47.45 52.39
Selling expenses ...................................... 13.37 12.56 15.35
Administrative expenses......................... 10.00 12.68 13.38
Total expenses ......................................... 23.37 25.24 28.73
Income before taxes................................. 21.02 22.21 23.66
Income taxes............................................. 7.36 7.77 8.28
Net income................................................ 13.66 14.44 15.38
Part 3
DEXTER CORPORATION
Balance Sheet Data in Trend Percentages
December 31, 2005, 2004, and 2003
2005 2004 2003
Assets
Current assets .......................................... 126.26 69.83 100.00%
Long-term investments............................ 0.00 25.93 100.00
Capital assets ........................................... 130.10 135.20 100.00
Total assets............................................... 123.08 110.70 100.00
Liabilities and Shareholders Equity
Current liabilities ...................................... 142.86 119.48 100.00
Common shares ....................................... 122.50 122.50 100.00
Retained earnings .................................... 119.11 103.60 100.00
Total liabilities and equity ...................... 123.08 110.70 100.00

Problem 20-1B (continued)
Part 4
Dexters cost of goods sold took a larger percent of sales each year. Selling and
administrative expenses and income taxes took a somewhat smaller portion each year,
but not enough to offset the effect of cost of goods sold. As a result, income became a
smaller percent of sales each year.
The large expansion of plant and equipment in 2004 was financed by a reduction in
current assets, an increase in current liabilities, a large reduction in long-term
investments, and apparently by a shares sale. One effect of this plan was to reduce the
current ratio. However, the current ratio recovered in 2005. This apparently resulted from
profits, limiting the amount of dividends paid, and the liquidation of long-term
investments.

Part 1
DOVER LTD
Income Statement Trends
For Years Ended December 31, 2005-1999
2005 2004 2003 2002 2001 2000 1999
Sales ...................................... 80.4 83.9 82.1 87.5 94.6 92.9 100.0
Cost of goods sold............... 88.8 92.1 90.7 97.2 102.3 99.1 100.0
Operating expenses ............. 78.4 81.2 80.4 87.8 90.6 92.2 100.0
Income before taxes............. 65.9 72.5 67.0 63.7 87.9 80.2 100.0

DOVER LTD
Balance Sheet Trends
December 31, 2005-1999
2005 2004 2003 2002 2001 2000 1999
Cash........................................ 65.2 71.7 69.6 78.3 97.8 91.3 100.0
Accounts receivable, net ...... 78.0 87.3 83.9 85.6 94.9 93.2 100.0
Merchandise inventory ......... 88.3 92.0 90.7 96.3 98.1 104.3 100.0
Other current assets ............. 71.4 75.0 78.6 85.7 82.1 92.9 100.0
Long-term investments......... 88.9 66.7 44.4 96.7 96.7 96.7 100.0
Plant and equip., net ............. 119.9 121.9 123.2 95.0 96.7 98.3 100.0
Total assets............................ 97.5 98.4 95.4 92.6 96.2 98.0 100.0
Current liabilities ................... 75.0 78.2 70.4 56.0 66.2 79.2 100.0
Long-term liabilities .............. 59.1 65.9 72.7 79.5 86.4 93.2 100.0
Common shares .................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Retained earnings ................. 219.0 204.8 185.7 181.0 171.4 142.9 100.0
Total liabilities and equity .... 97.5 98.4 95.4 92.6 96.2 98.0 100.0
Part 2
The statements and the trend percent data show that sales declined every year. However,
cost of goods sold did not fall as rapidly as sales. As a result, gross profit fell more
rapidly than sales. Operating expenses fell less rapidly than gross profit. Management
was not able to reduce costs and expenses fast enough to keep up with the sales decline.
Although the profits decreased during these years, the company did continue to earn a
net income. It appears that the cash generated from operations was used primarily to
reduce both current and long-term liabilities. In addition, the company made a large
expansion of its plant and equipment during 2003, financing this expansion primarily
through the liquidation of long-term investments.

Parts 1 and 2
a. Current ratio:
$18,000 + $14,700 + $55,800 + $6,200 + $62,300 + $2,800 = 3.84 to 1

$32,600 + $4,200 + $4,800
The industry average current ratio is 1.6 to 1 therefore 3.84 to 1 compares favourably.
b. Acid-test ratio:
$18,000 + $14,700 + $55,800 + $6,200 = 2.28 to 1
$32,600 + $4,200 + $4,800
The industry average acid-test ratio is 1.1 to 1 therefore 2.28 to 1 compares favourably.
c. Days sales uncollected:
$55,800 + $6,200 365 = 32.5 days
$697,200
The industry average days sales uncollected is 21 days therefore 32.5 days compares
unfavourably.
d. Merchandise turnover:
$458,300 = 7.2 times
($64,800 + $62,300)/2
The industry average merchandise turnover is 5 times therefore 7.2 times compares
favourably.
e. Days sales in inventory:
$62,300 365 = 49.6 days

$458,300
The industry average days sales in inventory is 70 days therefore 49.6 days compares
favourably.
f. Ratio of pledged assets to secured liabilities:
$306,300/$125,000 = 2.45 to 1
The industry average ratio of pledged assets to secured liabilities is not available there
no comparison can be made.

g. Times interest earned:
$116,200/$7,100 = 16.4 times

The industry average times interest earned is 50 times therefore 16.4 times compares
unfavourably.
h. Profit margin:
$91,300 100 = 13.1%
$697,200
The industry average profit margin is 14% therefore 13.1% compares unfavourably.
i. Total asset turnover:
$697,200 = 1.7 times
($466,100 + $367,500)/2
The industry average total asset turnover is 2.3 times therefore 1.7 times compares
unfavourably.
j. Return on total assets:
$91,300 100= 21.9%
($466,100 + $367,500)/2
The industry average return on total assets is 20% therefore 21.9% compares favourably.
k. Return on common Shareholders equity:

$91,300 100= 32.3%
($299,500 + $266,700)/2
The industry average return on common shareholders equity is 32.7% therefore 32.3% is
marginally unfavourable in comparison.

Trans- Current Quick Current Current Acid-Test Working
action Assets Assets Liabilities Ratio Ratio Capital
Beginning* $ 286,000 $ 117,000 $ 130,000 2.2 to 1 0.9 to 1 $156,000
Mar. 3 + 55,000 + 55,000
36,000
Bal. $ 305,000 $ 172,000 $ 130,000 2.35:1 1.32:1 175,000
Mar. 5 + 35,000 + 35,000
35,000 35,000
Bal. $ 305,000 $ 172,000 $ 130,000 2.35:1 1.32:1 175,000
Mar. 10 + 56,000 + 56,000
Bal. $ 361,000 $ 172,000 $ 186,000 1.94:1 0.92:1 175,000
Mar. 12 + 60,000 + 60,000 + 60,000
Bal. $ 421,000 $ 232,000 $ 246,000 1.71:1 0.94:1 175,000
Mar. 15 + 90,000 + 90,000
Bal. $ 511,000 $ 322,000 $ 246,000 2.08:1 1.31:1 265,000
Mar. 22 150,000 150,000
Bal. $ 361,000 $ 172,000 $ 246,000 1.47:1 0.70:1 115,000
Mar. 24 + 70,000
Bal. $ 361,000 $ 172,000 $ 316,000 1.14:1 0.54:1 45,000
Mar. 26
Bal. $ 361,000 $ 172,000 $ 316,000 1.14:1 0.54:1 45,000
Mar. 28 45,000 45,000 45,000
Bal. $ 316,000 $ 127,000 $ 271,000 1.17:1 0.47:1 45,000
Mar 30 70,000 70,000 70,000
Bal. $ 246,000 $ 57,000 $ 201,000 1.22:1 0.28:1 45,000
*Beginning balances:
Current assets (given) ......................................... $286,000
Current liabilities ($286,000/2.20) ....................... $130,000
Quick assets ($130,000 0.90) ........................... $117,000

Evanss profit margins are consistently higher than Bowers. However, Bower has
significantly higher total asset turnovers. As a result, Bower generates a substantially
higher return on total assets.
The trends of both companies include growth in sales, total asset turnover, and return on
total assets. However, Evanss rates of improvement are better than Bowers. These
differences may result from the fact that Evans is only three years old while Bower is an
older, more established company. Evanss operation is considerably smaller than
Bowers, but that will not persist many more years if both companies continue to grow at
their historical rates.
To some extent, Bowers higher total asset turnovers may result from the fact that its
assets may have been purchased years earlier. If the turnover calculations had been
based on current values, the differences might be less striking. The relative ages of the
assets may explain some of the difference in profit margins. Assuming Evanss assets are
newer, they may require smaller maintenance expenses.
Bower successfully employed financial leverage in 2005. Its return on total assets was
9.2% compared to the 7% interest rate it paid to obtain assets from creditors. In contrast,
Evanss return was only 6.1% as compared to the 7% interest rate.
2005 2004
Comparison Trend
to Industry
Average
Current ratio ............................... 1.3:1 1.4:1 U U
Acid-test ratio............................. 1.14:1 1.12:1 F F
Accounts receivable turnover .. 12 10 F U
Days sales uncollected ............ 35 33 U U
Merchandise turnover ............... 4.8 4.2 F U
Days sales in inventory ............ 72 76 F U
Total asset turnover................... 2.1 2.3 U U
Debt ratio .................................... 40 50 F* U
Times interest earned................ 52 51 F F
Profit margin............................... 13 11 F U
Gross profit ratio........................ 16 18 U U
*Generally, an increase in debt is considered to be unfavourable because of the increased
risk while a decrease in debt is considered to be favourable because of the decreased
risk.

ANALYTICAL AND REVIEW PROBLEMS
A&R Problem 20-1
HOPE CORPORATION
Balance Sheet
December 31, 2005
Liabilities and
Assets Shareholders Equity
Cash ......................................... $ 15,000 Current liabilities .................. $ 50,000
Accounts receivable, net ....... 75,000 12% bonds payable .............. 100,000
Merchandise inventory ........... 60,000 Common shares .................... 104,000
Capital assets, net .................. 150,000 Retained earnings ................ 46,000
Total liabilities and
Total assets ............................. $300,000 shareholders equity.......... $300,000
Note: One approach is to first prepare a rough income statement as shown below. This
gives the Cost of Goods Sold figure. COGS is then divided by the merchandise turnover
of 5 to equal an estimate of the inventory ($60,000).
Sales (given) $450,000

CGS (plug) 300,000
Gross Profit (plug) 150,000
Expenses (given) 114,000
Net income (given) $ 36,000
Accounts receivable = 365 days 60.83 (ave. collection period) to give the accounts
receivable turnover of 6 times. Then divide the turnover into sales to arrive at $75,000.
Total assets = Sales ($450,000) divided by turnover of 1.5 times to give $300,000 total
assets. This is also the total of the right-hand side of the balance sheet.
Merchandise inventory = COGS/Merchandise turnover = $300,000/5 = $60,000
Capital assets = Sales divided by turnover of 3 to give $150,000.
Cash = Total assets minus all other assets to give $15,000.
Current liabilities = Current assets ($150,000) divided by current ratio of 3 to give $50,000.
Bonds Payable = Total liabilities are half of assets ($150,000). Deduct current liabilities
from this amount to arrive at $100,000.
Retained earnings = Beginning balance plus net income ($10,000 + $36,000).
Common shares = plug.

A&R Problem 20-2
Part 1
Current Ratio Acid-Test Ratio
Increase Decrease No Increase Decrease No
Change Change
a. Bought $50,000 of
merchandise on
account.
b. Credit sales: $70,000
of merchandise costing
$40,000.
c. Collected an $8,500
account receivable.
d. Paid a $30,000
account payable.
e. Wrote off a $2,000
bad debt against the
allowance account.
f. Declared a $1 per
share cash dividend on
the 20,000 common
shares outstanding.
g. Paid the dividend
declared in (f).
h. Borrowed $25,000 by
giving the bank a 60-
day, 10% note.
i. Borrowed $100,000 by
placing a 10-year
mortgage on the capital
assets.
j. Used $50,000 of
proceeds of the
mortgage to buy
additional machinery.
Part 2
(i) $305,000 $145,000 = 2.1 to 1
(ii) $195,000 $145,000 = 1.3 to 1
(iii) $160,000

A&R 20-3
1.
Key figures Demer Corp. LitWel Inc.
Cash and equivalents 8.3% $ 445,421 13.0% $ 232,365
Accounts receivable 32.7 1,754,137 33.1 590,504
Inventory 25.0 1,338,640 30.5 544,522
Retained earnings 55.5 2,973,663 55.6 992,563
Cost of sales 59.9 5,502,993 61.6 2,144,422
Income taxes 5.4 499,400 2.4 84,083
Net sales (Demer) 100.0 9,186,539
Net sales (LitWel) 100.0 3,478,604
Total assets 100.0 5,361,207 100.0 1,786,184
2. Demer Corp. incurred tax expense at 5.4% of revenues while LitWel Inc. incurred tax
expense at 2.4% of revenues.
3. The companies have retained similar percentages of earnings at 55.5% and 55.6%.
4. Since Demers cost of sales percent is lower at 59.9% compared to LitWels 61.6%,
Demer has a higher gross margin on sales (40.1%).
5. LitWel has a higher percent of total assets in the form of inventory at 30.5%,
compared to Demers 25.0%.
A&R 20-4 (45 minutes)

1. No. The current ratio has improved but the acid-test ratio has been declining.
Also, the accounts receivable and inventory are turning over more slowly. These
conditions indicate that an increasing portion of current assets consists of
accounts receivable and inventories from which debts cannot be paid.
2. No, the company is collecting debts more slowly as indicated by the slower
accounts receivable turnover.
3. No. Sales are increasing and accounts receivable are turning over more slowly.
Either of these trends would produce an increase in accounts receivable, even if
the other remained unchanged.
4. Probably yes. Since there is nothing to indicate the contrary, cost of goods sold is
probably increasing in proportion to sales. Consequently, with sales increasing,
cost of goods sold increasing in proportion, and merchandise turning more slowly,
the amount of investment in the inventory must be increasing.
5. Yes. If sales were assumed to have been $100 in 2003, the sales trend shows that
they would be $117 in 2004 and $128 in 2005. Then, dividing each sales figure by
its ratio of sales to capital assets would give $30.30 for capital assets (100/3.3) in
2003; $33.43 ($117/3.5) in 2004; and $33.68 ($128/3.8) in 2005.

A&R 20-4 (continued)
6. No. The percentage of return on shareholders equity declined from 12.25% to
9.75%.
7. The ratio of sales to capital assets increased from 3.3 in 2003 to 3.8 in 2005.
However, the return on total assets fell from 10.1% in 2003 to 8.8% in 2005.
Whether these results are derived from a more efficient use of assets depends on
a comparison with other companies and on the expectations of the individual
doing the evaluation.
8. The dollar amount of selling expense increased in 2004 and decreased sharply in
2005. Assuming sales figures of $100 in 2003, $117 in 2004 and $128 in 2005, and
multiplying each by its ratio of selling expense to net sales ratio gives $15.30 of
selling expenses in 2003. In 2004, selling expenses were $16.03 and $12.54 in
2005.
Ethics Challenge
1. The CEO appears to have chosen selectively from the 11 available ratios in order to
present only the ones that show trends that are favourable to the company
(However, some may not interpret a decline in selling expenses as a percent of
revenue as positive since it might imply scaling back on advertising campaigns).
2. The consequences for this action by the CEO might be mixed. It is likely that the
analysts will ask other questions that may reveal some negative trends such as the
trends in return and profit margins. The CEOs actions may become transparent to
the analysts as they discover the presence of less favourable trends through their
questions. If discovered such a disclosure ploy by the CEO will not reflect
favourably on the company.
Even if the CEO is able to succeed with this strategy in the short term once the
financial statements are issued all users can compile additional ratio information
and see that some of the trends are unfavourable to the company.

Focus on Financial Statements
Part 1
DRINKWATER INC.
Income Statement
For Year Ended March 31, 2005
Revenues: 2005 2004
Net sales .................................................................. $ 929,000 $ 787,000
Investment income ................................................. 9,000 7,000
Total revenues ........................................................ $ 938,000 $ 794,000
Expenses:
Cost of goods sold ................................................. $ 424,000 $ 335,000
Other operating expenses ..................................... 141,000 103,000
Interest expense ..................................................... 5,700 6,500
Income tax expense................................................ 73,000 69,000
Total expenses .................................................... $ 643,700 $ 513,500
Net income .................................................................. $ 294,300 $ 280,500
Retained earnings, April 1 ......................................... $ 772,050 $ 491,550

Add: Net income ........................................................ 294,300 280,500
Retained earnings, March 31..................................... $1,066,350 $ 772,050

Focus on Financial Statements (continued)
DRINKWATER INC.
Balance Sheet
March 31, 2005
2005 2004
Assets
Current assets:.......................................................
Cash .................................................................... $ 136,000 $ 98,000
Accounts receivable .......................................... $ 238,000 $ 219,000
Less: Allowance for doubtful accounts.......... 2,300 235,700 2,100 216,900
Merchandise inventory ...................................... 84,000 71,000
Prepaid insurance .............................................. 50 30
Notes receivable, due in six months................ 600 400
Total current assets ........................................... $ 456,350 $ 386,330
Property, plant and equipment:
Property, plant and equipment assets............. $1,621,100 $1,234,670
Less: Accumulated amortization.................. 325,000 1,296,100 208,000 1,026,670
Total assets ................................................................. $1,752,450 $1,413,000
Liabilities
Current liabilities:
Accounts payable ............................................. $ 219,000 $ 174,000
Unearned sales.................................................. 3,100 750
Total current liabilities...................................... $222,100 $174,750
Long-term liabilities:
Notes payable, due in 2010................................ 114,000 116,200
Total liabilities........................................................ $ 336,100 $ 290,950
Shareholders Equity
Contributed capital
Preferred shares; $1 non-cumulative;
20,000 shares issued and outstanding ......... $ 100,000 $ 100,000
Common shares
50,000 shares issued and outstanding ......... 250,000 250,000
Total contributed capital ................................... $ 350,000 $ 350,000
Retained earnings .................................................. 1,066,350 772,050
Total shareholders equity .................................... 1,416,350 1,122,050
Total liabilities and owners equity............................ $1,752,450 $1,413,000

2.
F* or U* F or U Relative to
Change Industry Average
Calculate the ratio for 2005: Calculate the ratio for 2004: from for 2005
Previous Industry F* or
Year Average U*
a. Current ratio 456,350 = 2.05 386,330 = 2.22 U 1.96:1 F
222,100 174,350
b. Acid-test ratio 372,300 = 1.68 315,300 = 1.81
222,100 U 1.42:1 F
174,350
c. Accounts 929,000 = 4.11 787,000 = 3.74
receivable turnover F 4.35 U
226,300 210,450
d. Days sales 235,700 X 365 = 92.61 216,900 X 365 = 100.60
F 95.12 F
uncollected 929,000 787,000
e. Merchandise 424,000 = 5.47 335,000 = 5.63
turnover U 5.20 F
77,500 59,500
f. Days sales in 84,000 X 365 = 72.31 71,000 X 365 = 77.36
F* 75.08 F*
inventory 424,000 335,000
g. Total asset 929,000 = .59 787,000 = .64
turnover U 1.8 U
1,582,725 1,238,908
h. Debt ratio 336,100 X 100 = 19.18 290,950 X 100 = 20.59 F** 24% F**
1,752,450 1,413,000
i. Equity ratio 100 - 19.18 = 80.82 100 - 20.59 = 79.41 F 79% F
j. Times interest 373,000 = 65.44 356,000 = 54.77
F 50.16 F
earned 5,700 6,500

k. Profit margin 294,300 X 100 = 31.68 280,500 X 100 = 35.64 U 30.14 F

929,000 787,000
l. Gross profit ratio 525,000 X 100 = 54.86 452,000 X 100 = 57.43 U 52.16 F
929,000 787,000
m. Return on total 294,300 X 100 = 18.59 280,500 X 100 = 22.64
assets U 17.24 F
1,582,725 1,238,908
n. Return on common 294,300 X 100 = 25.17 280,500 X 100 = 31.81
shareholders equity U 31.4 U
1,169,200 881,800
o. Book value per 1,316,350 = 26.33 1,022,050 = 20.44
common share F 14.91 F
50,000 50,000
p. Book value per 100,000 = 5 100,000 = 5 No
preferred share 22 U
20,000 20,000 change
q. Basic earnings per 294,300 = 5.89 280,500 = 5.61
share F 4.32 F
50,000 50,000
r. Price-earnings 29 = 4.92 25 = 4.46
ratio F 6.91 U
5.89 5.61
* provided there is sufficient inventory to meet demand
** generally speaking, when debt is decreasing this is favourable because it reflects a decrease in risk. However, it is possible that an increase in debt would create
opportunities that outweigh any associated risks.


Larson SM Ch20

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Chapter 20

Analyzing Financial Statements

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Quick Study 20-1 (5 minutes)

Quick Study 20-2 (5 minutes)

Quick Study 20-3 (5 minutes)

Quick Study 20-4 (5 minutes)

Quick Study 20-5 (10 minutes)

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Quick Study 20-7 (10 minutes)

Quick Study 20-8 (10 minutes)

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Acid-test ratio = Quick assets Current liabilities

Quick Study 20-10 (10 minutes)

Quick Study 20-11 (5 minutes)

$672,000 $78,400 = 8.57 times

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

$9,050 ($10,690 + $13,435/2)

$9,050 $12,063 = 0.75 times

Exercise 20-1 (20 minutes)

2005 2004 2003 2002 2001

Exercise 20-2 (15 minutes)

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Exercise 20-4 (20 minutes)

Accounts payable.................................................... 24.9% 16.9% 13.2%

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

2005: $51,800 + $186,800 + $223,000 + $19,400 = 1.87 to 1

2004: $70,310 + $125,940 + $165,000 + $18,750 = 2.52 to 1

2003: $73,600 + $98,400 + $106,000 + $8,000 = 2.90 to 1

2003: $73,600 + $98,400

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Current assets..................................................... $4,000 $3,500 $7,300

Cash ..................................................................... $ 800 $ 910 $1,100

Current liabilities ................................................ $2,200 $1,100 $3,650

Exercise 20-7 (25 minutes)

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2005: $1,345,000 = 8.6 times

2004: $1,060,000 = 9.5 times

2005: $820,450 = 4.2 times

2005: $223,000 365 = 99 days

Exercise 20-8 (10 minutes)

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

3. Tate is more efficient at collecting accounts receivable since it collected its

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

x 365 days x 365 days

Accounts receivable turnover: $480,000 = 8.6 $440,000 = 11.1

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

x 365 days x 365 days

Exercise 20-13 (15 minutes)

Exercise 20-14 (15 minutes)

Grant Inc. Singh Inc.

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

b. Pledged assets to secured liabilities:

2005: ($68,200 + $17,050 + $22,200)/$22,200 = 4.84 times

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

b. Total asset turnover:

c. Return on total assets:

Exercise 20-17 (15 minutes)

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

2004: $62,750 100 = 12.4%

2005: $30/$2.10 = 14.3

Exercise 20-19 (25 minutes)

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.