accounting chapter 12
for horizontal analysis of an income statement, we calculate the percentage increase or decrease based on the following formula:
%increase (decease) = (current year amount-prior year amount) / prior year amount.
three types of comparisons
1. comparisons between companies 2. comparisons over time 3. comparisons to industry
Recipes, Inc. had Sales of $120,000 and Cost of goods sold of $80,000 for the year. All sales were credit sales. Accounts receivable was $10,000 at the beginning of the year and $14,000 at the end. Inventory was $18,000 at the beginning of the year and $22,000 at the end. Recipes' accounts receivables turnover equals:
10.0 120,000/((10,000+14000)/2)=10.0
Compute the inventory turnover ratio using the following information: Net sales is $100,000 for the year, costs of goods sold are $40,000, last year's assets in place were $900,000, and this year's assets in place are $1,100,000. Receivables for both years are $50,000. Inventory changed from $30,000 last year to $10,000 this year.
2. cost of goods sold/ average inventory= 40,000/[(30,000 + 10,000)/2]= 2.
What is the formula to compute the average days in inventory?
365 days/inventory turnover ratio
Green Company has net credit sales of $100,000, an asset turnover ratio of 4, and a receivables turnover ratio of 9. What is the average collection period?
40.6 days. 365/receivable turnover=40.6
Receipts, Inc.'s Sales were $200,000 while its Accounts receivable was $23,000 at the beginning of the year and $27,000 at the end. All sales were credit sales. Receipts' receivables turnover equals:
8.0 200,000/((23,000 + 27,000)/2)= 8.0.
Company A has an accounts receivable turnover of 8.0. Company B has an accounts receivable turnover of 10.0. Which of the following is true?
Company B collects its receivables faster than Company A.
Which of the following is the formula for the current ratio?
Current assets divided by current liabilities.
Which statements about the inventory turnover ratio are correct?
It shows the number of times the average inventory balance is sold during a reporting period and It indicates how quickly inventory is sold.
What is the formula to compute return on shareholders' equity?
Net income divided by average shareholders' equity
What is the formula to compute the return on assets?
Net income divided by average total assets.
What is the formula for the profit margin ratio?
Net income divided by net sales.
What is the formula for the asset turnover ratio?
Net sales divided by average total assets.
What does the inventory turnover ratio measure?
The average number of times inventory is sold during a period.
Which ratio indicates the portion of each sales dollar above its cost of goods sold?
The gross profit ratio
Which is typically preferable for a company?
a short average collection period
the _______ ________ ratio provides a more conservative measure of a company's ability to pay its current liabilities from current sources.
acid test
The sum of cash, current investments, and accounts receivable divided by current liabilities equals the
acid-test ratio
increase the useful life for calculating depreciation
aggressive
when costs are going up, change from LIFO to FIFO
aggressive
horizontal analysis (trend-analysis/time-series analysis)
analyzes trends in financial statement data for a single company over time.
average collection period
approximate number of days the average accounts receivable balance is outstanding. it equals 365 divided by the receivables turnover ratio. the shorter the average collection period, the better.
average days in inventory
approximate number of days the average inventory is held. it equals 365 days divided by the inventory turnover ratio.
Asset turnover ratio is net sales divided by
average total assets
Return on assets is calculated as net income divided by
average total assets.
Common types of analysis that help assess a specific company's performance include comparisons:
between companies, to the same industry, and over time.
acid test ratio
cash, current investments, and accounts receivable divided by current liabilities; measures the availability of liquid current assets to pay current liabilities. because it eliminates current assets such as inventories and prepaid expenses that are less readily convertible to cash, the acid test ratio often provides a better indication of a company's liquidity than does the current ratio.
price earnings ratio
compares a company's share price with its earnings per share. this ratio represents investors' expectations of earnings growth.
increase the allowance for uncollectible accounts
conservative
record a larger expense for warranties
conservative
wait to record revenue until the cash is collected
conservative
The formula for the inventory turnover ratio is
cost of goods sold divided by average inventory.
What is the formula for the inventory turnover ratio?
cost of goods sold divided by average inventory.
current ratio
current assets divided by current liabilities; measures the availability of current assets to pay current liabilities. most widely used of all liquidity ratios. a high current ratio indicates that a company has sufficient current assets to pay current liabilities as they become due.
Mathematically, the current ratio is expressed as current assets divided by
current liabilities
Which of the following is a ratio used to evaluate a company's solvency?
debt to equity
An item that requires separate disclosure on the income statement after income from continuing operations is
discontinued operations
Which of the following items requires separate disclosure after income from continuing operations?
discontinued operations
vertical analysis (common-size analysis)
expresses each item in a financial statement as a percentage of the same base amount.
True or false: The debt to equity ratio is calculated as total liabilities divided by common stock.
false. The debt to equity ratio is total liabilities divided by total owners' equity.
True or false: The times interest earned formula is net income divided by interest expense.
fasle. The times interest earned formula is calculated as earnings before interest and taxes divided by interest expense
the _____ profit ratio indicates the portion of each dollar of sales above the cost of goods sold.
gross
The times interest earned formula is calculated as earnings before interest and taxes divided by
interest expense
Average days in inventory is calculated as 365 days divided by the
inventory turnover ratio
Which information regarding the receivables turnover ratio is true?
it provides an indication of a company's efficiency in collecting receivables, and it shows the number of times during a period that the average accounts receivable balance is collected.
Mark wants to determine whether a specific company has become more profitable over time. Mark should compare the company's performance to:
its prior years' performance
The current ratio, acid-test ratio, and average collection period are ratios that provide information about a company's:
liquidity
Which term best describes a company having a suitable amount of cash or easily-convertible assets to pay incurred current liabilities?
liquidity
gross profit ratio
measure of the amount by which the sale of inventory exceeds its cost per dollar of sales. it equals gross profit divided by net sales.
profitability ratios
measure the earnings or operating effectiveness of a company.
The formula for return on equity is _______ _______ divided by average total shareholders' equity.
net income
The profit margin ratio is defined as ______ ________ divided by net sales.
net income
earnings per share
net income available to common shareholders divided by average shares of common stock outstanding. measures a company's current profitability per share.
The profit margin is calculated by dividing
net income by net sales.
return on equity
net income divided by average stockholders' equity; measures the income generated per dollar of equity.
return on assets
net income divided by average total assets; measures the amount of net income generated for each dollar invested in assets.
profit margin
net income divided by net sales; indicates the earnings per dollar of sales.
asset turnover
net sales divided by average total assets, which measures the sales per dollar of assets invested.
receivables turnover ratio
number of times during a year that the average accounts receivable balance is collected. it equals net credit sakes divided by average accounts receivable.
The profit margin measures the income earned
on each dollar of sales.
aggressive accounting practices
practices that result in reporting higher income, higher assets, and lower liabilities.
conservative accounting practices
practices that result in reporting lower income, lower assets, and higher liabilities.
Which of the following items are included in the numerator for the current ratio but are excluded from the numerator of the quick or acid-test ratio?
prepaid expenses and inventory
Which of the following are profitability ratios?
price earnings ratio, gross profit ratio, and return on assets
the _____ margin measures the income earned on each dollar of sales
profit
Which of the following are profitability ratios?
profit margin and return on equity
The group of ratios that measure the earnings or operating effectiveness of a company are referred to as ______ ratios
profitability
When comparing the financial statements of two different companies, a financial analyst would use which two categories of ratios?
profitability and risk ratios
Which type of ratios do investors and creditors use most frequently in making financial decisions?
profitability ratios
The ability of reported earnings to reflect the company's true earnings is referred to as:
quality of earnings
________ of ________ refers to the ability of reported earnings to reflect a company's true earnings, as well as the usefulness of reported earnings to predict future earnings.
quality of earnings
times interest earned ratio
ratio that compares interest expense with income available to pay those charges. we calculate the times interest earned ratio by dividing net income before interest expense and income taxes by interest expense. to get this amount, we just add interest expense and tax expense back to net income. better when its higher.
solvency
refers to a company's ability to pay all its liabilities, which includes long-term liabilities as well.
liquidity
refers to having sufficient cash (or other assets readily convertible into cash) to pay its current liabilities. the accounts used to calculate liquidity ratios are located in the current assets and current liabilities sections of the balance sheet.
quality of earnings
refers to the ability of reported earnings to reflect the company's true earnings, as well as the usefulness of reported earnings to predict future earnings.
two categories of ratios
risk ratios and profitability ratios
P/E ratio equals ______.
stock price divided by earnings per share
growth stocks
stocks that tend to have higher price earnings ratios and are expected to have higher future earnings. great stocks at a good price. best future potential
value stocks
stocks that tend to have lower price-earnings ratios and are priced low in relation to current earnings. good stocks at a great price. best bargains
The price of a single share of stock divided by earnings per share is:
the PE ratio
Which of the following ratios provides the most conservative measure of a firms ability to pay its current liabilities?
the acid-test ratio
capital structure
the mixture of liabilities and stockholders' equity in a business. when two companies maintain similar proportions of long term liabilities and are financed approximately equally by equity and debt, it suggests they have a similar capital structure.
The average collection period is an estimate of
the number of days the average account receivable balance is outstanding.
inventory turnover ratio
the number of times a firm sells its average inventory balance during a reporting period. it equals cost of goods sold divided by average inventory. a high inventory turnover ratio is usually a positive sign. it indicates that inventory is selling quickly. however, an extremely high inventory turnover ratio might be a signal that the company is losing sales due to inventory shortages.
discontinued operation
the sale or disposal of a significant component of a company's operations.
Which of the following ratios are used to evaluate a company's ability to pay long-term debts?
times interest earned ratio and debt to equity ratio
debt to equity ratio
total liabilities divided by stockholders' equity; measures a company's risk. the higher the debt to equity ratio, the higher the risk of bankruptcy. however, it also increases the potential returns investors can enjoy.
Risk ratios and profitability ratios represent common ratios used for analysis.
true
