 CHAPTER 21 

Analysis of Financial Statements

MULTIPLE CHOICE QUESTIONS

Theory/Definitional Questions

1 Usefulness of the common-size financial statement

2 Use of common-size statements
3 True/false statements about financial statement analysis
4 Effect of current asset/liability increase on working capital
5 Current ratio as measure of short-term solvency
6 Effect of FIFO to LIFO change just before rising prices
7 Examples of transactions increasing current ratio
8 Use of trade receivables in acid test and receivable turnover
9 Whether a higher current ratio always means a better company
10 Definition of historical cost/constant dollar accounting
11 Definition of current cost/nominal dollar accounting
12 Definition of an unrealized holding gain
13 Example of monetary item
14 Holding bonds payable as a hedge against inflationary times
15 Example of nonmonetary item
16 Current cost accounting--can be either nominal dollars or constant
dollars
17 Primary factor in determining functional currency of subsidiary
18 Disclosure of translation adjustments
19 Meeting the needs of international investors

Computational Questions
20 Computation of current ratio
21 Computation of accounts receivable turnover
22 Computation of inventory turnover
23 Computation of gross margin
24 Computation of times bond interest earned
25 Computation of return on common stockholders' equity
26 Computation of number of days’ sales in average inventories
27 Computation of price-earnings ratio
28 Computation of times interest earned ratio
29 Computation of inventory turnover

769
770 Chapter 21  Analysis of Financial
Statements

30 Computation of price-earnings ratio

31 Effect of preparing financial statements adjusted for price-level changes
32 Valuation of machinery on a price-level adjusted balance sheet
33 Computation of purchasing power loss on net monetary items
34 Computation of realized holding gain under current cost/nominal dollar
accounting
35 Determination of ending inventory on comparative constant purchasing
power adjusted balance sheet
36 Computation of unrealized holding gain under current cost/nominal
dollar accounting
37 Computation of unrealized holding gain
38 Computation of net monetary position
39 Computation of translated net income
40 Computation of translation adjustment amount

PROBLEMS

1 Prepare common-size balance sheet comparing percentages

2 Computation of inventory turnover rate and number of days' sales in
inventory
3 Computation of current ratio, net and gross margin, debt-to-equity ratio,
etc.
4 Computation of inventory turnover, number of days' sales in inventory,
gross margin
5 Computation of receivables turnover, number of days' sales in
receivables
6 Computation of earnings on equity, times bond interest earned, EPS,
price-earnings ratio, book value per share, debt-to-equity ratio
7 Computation of total equipment purchases, cash paid for taxes and
dividends
8 Computation of end of year purchasing power gains/losses
9 Prepare balance sheet restatement
10 Computation of realized holding gain or loss and unrealized holding gain
or loss
11 Prepare an income statement restated in terms of end-of-year constant
dollars.
12 Prepare translated balance sheet
13 Prepare translated trial balance
14 Preparation of Form 20F reconciliation
15 Comprehensive statement of cash flows
16 Accounting differences and ratio analysis
17 Accounting differences and ratio analysis
Test Bank, Intermediate Accounting, 14th ed.
771

18 Accounting differences and ratio analysis

19 Preparation of Form 20F reconciliation
20 Preparation of Form 20F reconciliation
21 Analyzing accounts receivable

MULTIPLE CHOICE QUESTIONS

d 1. A useful tool in financial statement analysis is the common-size financial

LO1 statement. What does this tool enable the financial analyst to do?
a. Evaluate financial statements of companies within a given industry of
approximately the same value.
b. Determine which companies in the same industry are at approximately
the same stage of development.
c. Ascertain the relative potential of companies of similar size in different
industries.
d. Compare the mix of assets, liabilities, capital, revenue, and expenses
within a company over time or between companies within a given
industry without respect to relative size.

a 2. When using common-size statements

LO1 a. data may be selected for the same business as of different dates, or for
two or more businesses as of the same date.
b. relationships should be stated in terms of ratios.
c. dollar changes are reported over a period of at least three years.
d. All of the above are correct.

a 3. Which of the following statements best describes the use of financial

statement
LO1 analysis?
a. Financial statement analysis techniques are merely guides to
interpretation of financial data.
b. Financial statement analysis can eliminate the risk in investment
decisions.
c. Measurements for a specific company should be compared only with
data from past periods.
d. All of the above are correct.

b 4. Rauh Corporation had a current ratio of 2.0 at the end of 2001. Current
assets
LO1 and current liabilities increased by equal amounts during 2002. The effects
on net working capital and on the current ratio, respectively, were
a. no effect; increase.
772 Chapter 21  Analysis of Financial
Statements

b. no effect; decrease.
c. increase; increase.
d. decrease; decrease.
Test Bank, Intermediate Accounting, 14th ed.
773

a 5. Which of the following ratios measures short-term solvency?

LO1 a. Current ratio
b. Creditors' equity to total assets
c. Return on investment
d. Total asset turnover

d 6. If a firm changes its inventory method from FIFO to LIFO just prior to a
period
LO2 of rising prices, the effect in the next period will be
Current Ratio Inventory Turnover
a. No effect Increase
b. No effect Decrease
c. Increase Decrease
d. Decrease Increase

b 7. Which of the following transactions would increase a firm's current ratio?

LO1 a. Purchase of inventory on account
b. Payment of accounts payable
c. Collection of accounts receivable
d. Purchase of temporary investments for cash

c 8. How are trade receivables used in the calculation of each of the following?
LO1 Receivable
Current Ratio Turnover
a. Not used Numerator
b. Numerator Numerator
c. Numerator Denominator
d. Denominator Numerator

b 9. In comparing the current ratios of two companies, why is it invalid to

assume
LO1 that the company with the higher current ratio is the better company?
a. A high current ratio may indicate inadequate inventory on hand.
b. A high current ratio may indicate inefficient use of various assets and
liabilities.
c. The two companies may define working capital in different terms.
d. The two companies may be different sizes.

c 10. A method of accounting based on measures of historical prices in dollars,

each
LO4 of which has the same general purchasing power, is
a. current cost/constant dollar accounting.
774 Chapter 21  Analysis of Financial
Statements

b. current cost/nominal dollar accounting.

c. historical cost/constant dollar accounting.
d. historical cost/nominal dollar accounting.

d 11. Which of the following is a method of accounting based on measures of

current
LO4 cost, without restatement into units having the same general purchasing
power?
a. Historical cost/constant dollar accounting
b. Historical cost/nominal dollar accounting
c. Current cost/constant dollar accounting
d. Current cost/nominal dollar accounting

d 12. An unrealized holding gain is

LO4 a. a component of operating income.
b. the difference between the current cost of an asset and the book value
of an asset.
c. the difference between the current cost of an asset and the historical
cost of the asset, adjusted for any depreciation charged against income.
d. the increase in the current value of an asset held during the period but
not sold or used.

c 13. When computing information on the historical cost/constant dollar basis,

which
LO4 of the following is classified as a monetary item?
a. Common stock
b. Obligations under warranties
c. Bonds payable
d. Inventories

a 14. Which item should a company hold during an inflationary period to

experience the greatest gain in general purchasing power?
LO4 a. Bonds payable
b. Cash
c. Accounts receivable
d. Certificate of deposit

c 15. In the context of general price level adjustments, which of the following is a
LO4 nonmonetary item?
a. Receivables under capitalized leases
b. Obligations under capitalized leases
Test Bank, Intermediate Accounting, 14th ed.
775

c. Goodwill
d. Accounts payable
 d 16. In current cost accounting
LO4 a. general price level gains or losses are recognized on net monetary
items.
b. amounts are always stated in common purchasing power units of
measurement.
c. holding gains are ignored.
d. current values may be measured in nominal dollars or constant dollars.

d 17. Which of the following is the primary factor in determining the functional
LO5 currency of a foreign subsidiary?
a. How the costs for the foreign entity’s product are determined
b. The denomination of the foreign entity’s financing
c. The location of the primary sales market that influences the price of the
foreign entity’s product
d. Management’s assessment of all relevant factors

a 18. A translation adjustment resulting from the translation process is disclosed

on
LO5 the financial statements
a. as a separate component of stockholders’ equity.
b. as a below-the-line item on the income statement.
c. as an adjustment to retained earnings.
d. as a part of income from operations on the income statement.

d 19. Which of the following is the least likely means a company might choose to
LO3 meet the needs of international investors?
a. Translation of financial statements or annual reports into the language
of the user.
b. Denomination of the financial statements in the currency of the country
where the financial statements will be used.
c. Partial or complete restatement of financial statements to the accounting
principles of the financial statement users’ country.
d. Mutual recognition in which one country accepts the financial statements
of another country for regulatory purposes such as listing on stock
exchanges or filing annual reports.
 d 20. Information from Blain Company's balance sheet is as follows:
LO1 Current assets:
Cash...................................................................... $ 1,200,000
Marketable securities............................................ 3,750,000
Accounts receivable.............................................. 28,800,000
Inventories............................................................. 33,150,000
Prepaid expenses................................................. 600,000
Total current assets.............................................. $67,500,000
Current liabilities:
Notes payable....................................................... $ 750,000
Accounts payable.................................................. 9,750,000
Accrued expenses................................................. 6,250,000
Income taxes payable........................................... 250,000
Payments due within one year on long-term debt 1,750,000
Total current liabilities........................................... $18,750,000

What is Blain's current ratio?

a. 0.26 to 1
b. 0.30 to 1
c. 1.80 to 1
d. 3.60 to 1

c 21. Millward Corporation's books disclosed the following information for the
year
LO1 ended December 31, 2002:
Net credit sales........................................................... $1,500,000
Net cash sales............................................................ 240,000
Accounts receivable at beginning of year.................. 200,000
Accounts receivable at end of year............................ 400,000

Millward's accounts receivable turnover is

a. 3.75 times.
b. 4.35 times.
c. 5.00 times.
d. 5.80 times.
 d 22. Selected information from the accounting records of Thorne Company is as
LO1 follows:
Net sales for 2002...................................................... $900,000
Cost of goods sold for 2002....................................... 600,000
Inventory at December 31, 2001................................ 180,000
Inventory at December 31, 2002................................ 156,000

Thorne's inventory turnover for 2002 is

a. 5.36 times.
b. 3.85 times.
c. 3.67 times.
d. 3.57 times.

a 23. Selected information from the accounting records of the Vassar Company is
LO1 as follows:
Net accounts receivable at December 31, 2001........ $ 900,000
Net accounts receivable at December 31, 2002........ 1,000,000
Accounts receivable turnover..................................... 5 to 1
Inventories at December 31, 2001............................. $1,100,000
Inventories at December 31, 2002............................. 1,200,000
Inventory turnover....................................................... 4 to 1

What was Vassar's gross margin for 2002?

a. $150,000
b. $200,000
c. $400,000
d. $500,000

c 24. The following data were abstracted from the records of Johnson
Corporation
LO1 for the year:
Sales........................................................................... $1,800,000
Bond interest expense................................................ 60,000
Income taxes.............................................................. 300,000
Net income.................................................................. 400,000

How many times was bond interest earned?

a. 7.67
b. 11.67
c. 12.67
d. 13.67
 b 25. Selected information for Henry Company is as follows:
LO1 December 31
2001 2002
Common stock...................................................... $600,000 $600,000
Additional paid-in capital.................................... 250,000 250,000
Retained earnings.............................................. 170,000 370,000
Net income for year............................................ 120,000 240,000

Henry's return on common stockholder's equity, rounded to the nearest

percentage point, for 2002 is
a. 20 percent.
b. 21 percent.
c. 28 percent.
d. 40 percent.

b 26. Selected information from the accounting records of Ellison Manufacturing

LO1 Company follows:
Net sales............................................................. $3,600,000
Cost of goods sold.............................................. 2,400,000
Inventories at January 1..................................... 672,000
Inventories at December 31............................... 576,000

What is the number of days' sales in average inventories for the year?
a. 102.2
b. 94.9
c. 87.6
d. 68.1
 c 27. Orchard Corporation’s capital stock at December 31 consisted of the
following:
LO1 (a) Common stock, $2 par value; 100,000 shares authorized, issued, and
outstanding.
(b) 10% noncumulative, nonconvertible preferred stock, $100 par value;
1,000
shares authorized, issued, and outstanding.
Orchard's common stock, which is listed on a major stock exchange, was
quoted at $4 per share on December 31. Orchard's net income for the year
ended December 31 was $50,000. The yearly preferred dividend was
declared. No capital stock transactions occurred. What was the price-
earnings ratio on Orchard's common stock at December 31?
a. 6 to 1
b. 8 to 1
c. 10 to 1
d. 16 to 1

d 28. Selected financial data of Alexander Corporation for the year ended
December
LO1 31, 2002, is presented below:
Operating income............................................... $900,000
Interest expense................................................. (100,000)
Income before income tax.................................. $800,000
Income tax expense........................................... (320,000)
Net income......................................................... $480,000
Preferred stock dividends................................... (200,000)
Net income available to common stockholders. $280,000

Common stock dividends were $120,000. The times-interest-earned ratio

is
a. 2.8 to 1.
b. 4.8 to 1.
c. 6.0 to 1.
d. 9.0 to 1.

c 29. During the year, The Grap Company purchased $1,920,000 of inventory.
The
LO1 cost of goods sold for the year was $1,800,000 and the ending inventory at
December 31 was $360,000. What was the inventory turnover for the
year?
a. 5.0
b. 5.3
c. 6.0
d. 6.4
 d 30. On December 31, 2001 and 2002, Taft Corporation had 100,000 shares of
LO1 common stock and 50,000 shares of noncumulative and nonconvertible
preferred stock issued and outstanding. Additional information:
Stockholders' equity at 12/31/2002....................................... $4,500,000
Net income year ended 12/31/2002...................................... 1,200,000
Dividends on preferred stock year ended 12/31/2002.......... 300,000
Market price per share of common stock at 12/31/2002...... 144

The price-earnings ratio on common stock at December 31, 2002, was

a. 10 to 1.
b. 12 to 1.
c. 14 to 1.
d. 16 to 1.

b 31. Cougar Corporation began operations on January 1, 2002, with $12,000 of

LO4 cash and immediately purchased for cash $7,000 of inventory. By
December 31, 2002, the replacement cost of the inventory had increased to
$7,400 and the general price-level index increased from 100 to 110. If
Cougar prepares financial statements adjusted for price-level changes,
what is Cougar's purchasing power loss?
a. $400
b. $500
c. $600
d. $700

c 32. Lobo Corporation purchased a machine for $90,000 on January 1, 2002,

when
LO4 the price-level index was 120. At December 31, 2002, the price-level index
was 160. On a price-level adjusted balance sheet, at what value would this
machine be disclosed?
a. $67,500
b. $108,000
c. $120,000
d. $144,000

b 33. At both the beginning and end of the year, Meiss Distributing’s monetary
LO4 assets exceeded monetary liabilities by $6,000,000. On January 1, the
general price level was 125. On December 31, the general price level was
 150. How much was Meiss’ purchasing power loss on net monetary items
during the year?
a. $0
b. $1,200,000
c. $1,500,000
d. $2,250,000

a 34. Mario Enterprises paid $240,000 to purchase inventory at the beginning of

LO4 2002. At the end of 2002, one-half of the inventory was sold for $200,000,
when the replacement cost of the entire original inventory was $280,000.
Using current cost/nominal dollar accounting, what is the realized holding
gain for 2002?
a. $20,000
b. $40,000
c. $60,000
d. $80,000

c 35. Falcon Corporation prepares comparative financial statements as well as

LO4 comparative constant purchasing power adjusted financial statements.
When preparing the comparative constant purchasing power adjusted
financial statements, Falcon adjusts balance sheet accounts to the year-
end price index. Price indexes for 2002 are as follows:
January 2002.............................................................. 260
December 2002.......................................................... 320
Average for 2002........................................................ 290

Ending inventory on Falcon's comparative balance sheet for the year ended
December 31, 2002, was $160,000. Assuming this inventory was
purchased evenly throughout the year, what amount should Falcon report
for ending inventory on its comparative constant purchasing power adjusted
balance sheet?
a. $143,448
b. $145,000
c. $176,552
d. $178,462

c 36. Stetson Corporation paid $480,000 to purchase inventory at the beginning

of
LO4 2002. At the end of 2002, one-fourth of the inventory was sold for
$100,000, when the replacement cost of the entire original inventory was
 $560,000. Using current cost/nominal dollar accounting, what is the
unrealized holding gain for 2002?
a. $20,000
b. $40,000
c. $60,000
d. $80,000

a 37. On October 15, 2002, the Fenmore Department Store purchased 2,000
LO4 dresses at $35 for resale. The store had sold 1,100 dresses by December
31, 2002, at $65. At that time the replacement cost was $45. What was
Fenmore’s unrealized holding gain during 2002?
a. $9,000
b. $11,000
c. $20,000
d. $24,000

d 38. The following accounts were taken from the records of High Tech
Electronics
LO4 Inc.:
Accounts Payable....................................................... $ 52,000
Accounts Receivable.................................................. 66,000
Advances to Employees............................................. 2,000
Equipment................................................................... 60,000
Dividends Payable...................................................... 48,000
Inventory..................................................................... 164,000
Patents........................................................................ 36,000
Unearned Service Revenue....................................... 78,000

Based on these accounts, what is High Tech’s net monetary position?

a. $32,000 negative
b. $4,000 positive
c. $34,000 negative
d. $110,000 negative
 b 39. Albright Distributing Inc. converts its foreign subsidiary financial statements
LO5 using the translation process. Their German subsidiary reported the
following for 2002: revenues and expenses of 10,050,000 and 7,800,000
marks, respectively, earned or incurred evenly throughout the year,
dividends of 2,000,000 marks were paid during the year. The following
exchange rates are available:
On January 1, 2002............................................................... $.250
On December 31, 2002......................................................... .285
Average rate for 2002............................................................ .270
Rate when dividends were declared and paid...................... .255

Translated net income for 2002 is

a. $641,250.
b. $607,500.
c. $131,250.
d. $97,500.
 b 40. Tokyo Enterprises, a subsidiary of Worldwide Enterprises based in Dallas,
LO5 reported the following information at the end of its first year of operations
(all in yen): assets--110,000,000; expenses--41,000,000; liabilities--
97,500,000; capital stock--5,500,000; revenues--48,000,000. Relevant
exchange rates are as follows:
On date subsidiary stock was purchased............................. $.085
Average rate for the year...................................................... .078
At year end............................................................................ .075

As a result of the translation process, what amount is recorded on the

financial statements as the translation adjustment?
a. $21,000 debit adjustment
b. $76,000 debit adjustment
c. $21,000 credit adjustment
d. $76,000 credit adjustment

PROBLEMS

Problem 1
Comparative balance sheet data for the Addyson Co. at the end of 2001 and 2002
follows:
Addyson Company
Condensed Comparative Balance Sheet
December 31, 2002 and 2001

Assets 2002 2001

Current assets................................................................... $ 71,000 $ 68,000
Long-term investments...................................................... 67,000 43,000
Land, buildings, and equipment (net)............................... 195,000 162,000
Intangible assets............................................................... 9,400 11,300
Other assets...................................................................... 5,000 8,000
Total assets ...................................................................... $347,400 $292,300

Liabilities
Current liabilities................................................................ $ 37,100 $ 34,000
Long-term liabilities--8% bonds......................................... 23,500 17,900
Total liabilities..................................................................... $ 60,600 $ 51,900
Stockholders' Equity
6% preferred stock............................................................ $ 7,500 $ 7,500
Common stock................................................................... 50,000 50,000
Additional paid-in capital................................................... 46,000 46,000
Retained earnings............................................................. 183,300 136,900
Total stockholders' equity.................................................. $286,800 $240,400
Total liabilities and stockholders' equity............................. $347,400 $292,300

Prepare a common-size balance sheet comparing financial structure percentages

for the two-year period.

Solution 1
LO1
Addyson Company
Condensed Common-Size Balance Sheet
For Years Ended December 31, 2002 and 2001

Assets 2002 2001

Current assets......................................................................... 20% 23%
Long-term investments........................................................... 19 15
Land, buildings, and equipment (net)..................................... 57 55
Intangible assets..................................................................... 3 4
Other assets............................................................................ 1 3
Total assets ............................................................................ 100% 100%

Liabilities
Current liabilities..................................................................... 11% 12%
Long-term liabilities--8% bonds.............................................. 7 6
Total liabilities.......................................................................... 18% 18%

Stockholders' Equity
6% preferred stock.................................................................. 2% 2%
Common stock........................................................................ 14 17
Additional paid-in capital......................................................... 13 16
Retained earnings................................................................... 53 47
Total stockholders' equity........................................................ 82% 82%
Total liabilities and stockholders' equity.................................. 100% 100%
Problem 2
The inventory of Brett Company averages $1,255,002 at cost. During 2002, sales
of $7,341,750 were made at 30 percent above cost.

Using the given data, compute the following:

(1) Inventory turnover rate for 2002.

(2) Number of days' sales in inventory.

Solution 2
LO1
(1) $7,341,750 / 1.30 = $5,647,500
$5,647,500 / $1,255,002 = 4.50 times (rounded)

(2) 365 / 4.50 = 81.1 days

Problem 3
Comparative data for Kerry Inc. for the two-year period 2001-2002 are given as
follows:
Income Statement Data
2002 2001
Net sales...................................................................... $1,400,000 $ 800,000
Cost of goods sold....................................................... 840,000 440,000
Gross profit on sales.................................................... $ 560,000 $ 360,000
Selling, general, and other expenses.......................... 400,000 130,000
Income tax expense..................................................... 40,000 30,000
Net income................................................................... $ 120,000 $ 200,000
Dividends paid............................................................. 80,000 80,000
Net increase in retained earnings................................ $ 40,000 $ 120,000
 Balance Sheet Data
2002 2001
Assets
Current assets.............................................................. $ 540,000 $ 440,000
Land, buildings, and equipment................................... 800,000 720,000
Total assets........................................................... $1,340,000 $1,160,000

Liabilities and Stockholders' Equity

Current liabilities.......................................................... $ 300,000 $ 240,000
Bonds payable (8%)..................................................... 320,000 320,000
Common stock ($5 par)............................................... 480,000 400,000
Retained earnings........................................................ 240,000 200,000
Total liabilities and stockholders' equity................ $1,340,000 $1,160,000

From the given data, compute the following for 2001 and 2002:
(1) Current ratio.
(2) Net profit margin on sales.
(3) Gross profit margin on sales.
(4) Debt-to-equity ratio.
(5) Times interest earned.

Solution 3
LO1
(1) 2002: $540,000 / $300,000 = 1.80 to 1
2001: $440,000 / $240,000 = 1.83 to 1

(2) 2002: $120,000 / $1,400,000 = 8.57%

2001: $200,000 / $800,000 = 25%

(3) 2002: $560,000 / $1,400,000 = 40%

2001: $360,000 / $800,000 = 45%

(4) 2002: $620,000 / $720,000 = 0.86 to 1

2001: $560,000 / $600,000 = 0.93 to 1

(5) 2002: ($120,000 + $40,000 + $25,600*) / $25,600 = 7.25 times

2001: ($200,000 + $30,000 + $25,600*) / $25,600 = 9.98 times
* (8% x $320,000)
Problem 4
Income statements for LaRue Co. show the following:

2002 2001 2000

Sales (net)................................................... $500,000 $400,000 $350,000
Cost of goods sold:
Beginning inventory.............................. 110,000 90,000 20,000
Purchases............................................. 420,000 330,000 370,000
$530,000 $420,000 $390,000
Ending inventory................................... 170,000 110,000 90,000
360,000 310,000 300,000
Gross profit.................................................. $140,000 $ 90,000 $ 50,000

From the data presented, calculate the following ratios for 2002 and 2001:
(1) Inventory turnover rate.
(2) Number of days' sales in inventories.
(3) Gross profit margin on sales.

Solution 4
LO1
(1) 2002 2001
Cost of goods sold...................................................... $360,000 $310,000
Inventory:
Beginning of year............................................... 110,000 90,000
End of year......................................................... 170,000 110,000
Average inventory....................................................... 140,000 100,000
Inventory turnover....................................................... 2.57 times 3.10 times

(2) Inventory turnover for year......................................... 2.57 3.10

Number of days' sales in average inventory.............. 365/2.57 = 365/3.10 =
142.0 days 117.7 days

(3) Gross profit................................................................. $140,000 $ 90,000

Sales (net).................................................................. 500,000 400,000

Gross profit margin on sales...................................... 28% 22.5%

Problem 5
The following are comparative data for Gates Company for the three-year period
2000-2002:
Income Statement Data
2002 2001 2000
Net sales (80% are on credit each period).... $900,000 $720,000 $840,000
Net purchases................................................ 480,000 390,000 330,000

Balance Sheet Data

Accounts receivable, December 31............... $150,000 $132,000 $126,000

Compute the following measurements for 2002 and 2001:

(1) The receivables turnover rate.
(2) The average collection period for accounts receivable.

Solution 5
LO1
(1) 2002 2001
Net credit sales........................................................... $720,000 $576,000
Net receivables:
Beginning of year............................................... 132,000 126,000
End of year......................................................... 150,000 132,000
Average receivables................................................... 141,000 129,000

Receivables turnover.................................................. 5.11 times 4.47 times

(2) Average receivables................................................... $141,000 $129,000

Net credit sales........................................................... $720,000 $576,000

Average daily credit sales.......................................... 1,973* 1,578
**
Average collection period (average receivables 
average daily credit sales).......................................... 71.5 days 81.7 days
* ($900,000 x .80)/365 = $1,973
** ($720,000 x .80)/365 = $1,578
Problem 6
The balance sheet for the Byrne Dareed Corp. showed liabilities and stockholders'
equity balances at the end of each year as given below:

2002 2001
Current liabilities................................................................ $ 750,000 $ 600,000
12% Bonds payable.......................................................... 1,200,000 1,200,000
Preferred 10% stock, $100 par......................................... 900,000 750,000
Common stock, $20 par.................................................... 2,250,000 1,875,000
Additional paid-in capital................................................... 450,000 375,000
Retained earnings............................................................. 750,000 540,000

Net income........................................................................ 375,000 300,000

Market price per share, December 31.............................. 65 60
Common stock dividends.................................................. 75,000 45,000

Based on the data provided, compute the following ratios for 2002:
(1) The rate of earnings on average total stockholders' equity.
(2) The number of times bond interest requirements were earned.
(3) The earnings per share on common stock.
(4) The price-earnings ratio.
(5) Debt-to-equity ratio.

Solution 6
LO1
(1) $375,000 / [($4,350,000 + $3,540,000)/2] =
$375,000 / $3,945,000 =
9.51%

(2) ($375,000 + $144,000) / $144,000 = 3.6 times

(3) ($375,000 - $90,000) / 112,500 shares = $2.53 per share

(4) $65 / $2.53 = 25.69 times

(5) $1,950,000 / $4,350,000 = 0.45 to 1

Problem 7
The following partial balance sheet information is for Ollie Company:

12/31/02
12/31/01
Dividends Payable............................................................. $ 3,400 $ 2,200
Deferred Income Taxes (Liability)..................................... 46,000 41,500
Equipment......................................................................... 92,500 78,000
Accumulated Depreciation--Equipment............................ 28,300 30,000
Unappropriated Retained Earnings................................... 71,000 50,000
Appropriated Retained Earnings....................................... 2,000 0
Cash.................................................................................. 670 350
Income Tax Refund Receivable........................................ 1,750 1,400

The following additional information relates to 2002:

(a) Net income for the year, $100,000.
(b) Depreciation expense for the year, $7,400.
(c) Income tax expense for the year, $35,000.
(d) During the year, equipment was overhauled at a cost of $2,500. The cost
was debited to accumulated depreciation.
(e) During the year, equipment with a book value of $10,000 was sold. A loss
of $1,100 was realized on the sale.

Compute the following:

(1) Total equipment purchases during the year.
(2) Cash paid for income taxes during the year.
(3) Cash paid for dividends during the year.

Solution 7
LO6
(1)

Accumulated Depreciation--Equipment
Beginning balance 30,000
Depreciation expense 7,400
Equipment overhaul 2,500
Accumulated depreciation of 6,600
equipment sold

Ending balance 28,300

 Equipment
78,000
Beginning balance
Cost of equipment sold 16,600
Purchase of new equipment 31,100

Ending balance 92,500

Total equipment purchases = $31,100

(2)
Deferred Income Taxes
Beginning balance 41,500
Total income tax expense 35,000
Current portion of income tax 30,500

Ending balance 46,000

Income Tax Refund Receivable

Beginning balance 1,400
Current portion of income tax 30,500
Cash payments for income tax 30,850

Ending balance 1,750

Cash payments for income tax = $30,850

(3)
Unappropriated Retained Earnings
Beginning balance 50,000
Appropriation 2,000
Net income 100,000
Dividends declared 77,000

Ending balance 71,000

 Dividends Payable
Beginning balance 2,200
Dividends declared 77,000
Dividends paid 75,800

Ending balance 3,400

Cash payments for dividends = $75,800

Problem 8
Assuming assets and liabilities are held during a period in which the price index
rises from 100 to 106, compute the purchasing power gain or loss for each of the
following cases. (Use end-of-year dollars.)

(1) Time deposits................................................................................... $ 600,000

Long-term investment in bonds........................................................ 260,000
Prepaid interest on notes payable................................................... 80,000

(2) Demand deposits............................................................................. $ 200,000

Accounts payable............................................................................. 120,000
Salaries payable............................................................................... 160,000

(3) Cash................................................................................................. $ 320,000

Long-term receivables...................................................................... 600,000
Goodwill............................................................................................ 200,000
Long-term bonds payable................................................................ 1,400,000

(4) Cash................................................................................................. $ 240,000

Long-term investment in bonds........................................................ 400,000
Land and buildings........................................................................... 600,000
Accounts payable............................................................................. 40,000
Unearned rent revenue.................................................................... 160,000
Solution 8
LO4
Historical Conversion Restated
Amount Factor Amount
(1) Monetary assets at beginning of year. . $940,000 106/100 $ 996,400
Monetary assets at end of year............ 940,000
Purchasing power loss.......................... $ 56,400

(2) Excess of monetary liabilities over

monetary assets at beginning of year $ 80,000 106/100 $ 84,800
Excess of monetary liabilities over
monetary assets at end of year....... 80,000
Purchasing power gain......................... $ 4,800

(3) Excess of monetary liabilities over

monetary assets at beginning of year $480,000 106/100 $ 508,800
Excess of monetary liabilities over
monetary assets at end of year....... 480,000
Purchasing power gain......................... $ 28,800

(4) Net monetary assets at beginning of year $600,000 106/100 $ 636,000

Net monetary assets at end of year..... 600,000
Purchasing power loss.......................... $ 36,000
Problem 9
On January 1, 2002, the account balances for the Westlon Corp. were:
Cash............................................................................ $82,500
Liability........................................................................ $30,000
Capital Stock............................................................... 37,500
Retained Earnings...................................................... 15,000
$82,500

The general price index for 2002 is as follows:

Date Price Index
January 1 100
July 1 110

During the first half of 2002, the general price index rose evenly and the following
transactions occurred:

April 1 Purchased equipment with a three-year estimated useful life and no

salvage value for $52,500 cash (straight-line depreciation used).
May 1 Paid $15,000 toward the outstanding liability.
July 1 Recorded depreciation on equipment (depreciation is the amount of
operating loss as there were no revenue-producing activities).

Prepare a balance sheet restated in terms of July 1, 2002, dollars.

Solution 9
LO4
Westlon Corp.
Balance Sheet
July 1, 2002
(Constant Dollar Basis)

HC/ND Conversion HC/CD

Assets Amounts Factor Amounts
Cash........................................................... $15,000 $15,000
Equipment.................................................. 52,500 110/105 55,000
Less accumulated depreciation................. (4,375) 110/105 (4,583)
Total assets................................................ $63,125 $65,417
Liabilities and Stockholders’ Equity
Liability........................................................ $15,000 $15,000
Capital stock............................................... 37,500 110/100 41,250
Retained earnings...................................... 10,625 (to balance) 9,167
Total liabilities and stockholders’ equity..... $63,125 $65,417

Problem 10
Compute the realized holding gain or loss and unrealized holding gain or loss for
each independent case given below:

(1) Land was purchased for $160,000. The current cost on December 31 was
$145,000.
(2) Inventory was purchased for $75,000. Three-fourths of the inventory was sold
on December 1 when the current cost for the total inventory was $90,000. The
current cost for ending inventory on December 31 was $25,000.
(3) Land was purchased for $160,000. One half of the land was sold on
September 10 for $120,000 when the current cost of the entire property was
$230,000. The current cost on December 31 was $140,000.
(4) Inventory was purchased for $70,000 and $96,000 on April 1 and November 1,
respectively. The April purchase was sold on November 15 for $112,000 when
the current cost was $82,000. The current cost of the November 1 inventory
on December 31 was $95,000.

Solution 10
LO4
(1) Current cost...................................................................... $145,000
Purchase price................................................................. 160,000
Unrealized holding loss.................................................... $ (15,000)

(2) Current cost…………………………………………………. $ 67,500 $ 25,000

Purchase price................................................................. 56,250 18,750
Realized holding gain……………………………………… $ 11,250
Unrealized holding gain................................................... $ 6,250

(3) Current cost...................................................................... $115,000 $140,000

Purchase price................................................................. 80,000 80,000
Realized holding gain....................................................... $ 35,000
Unrealized holding gain................................................... $ 60,000

(4) Current cost…………………………………………………. $ 82,000 $ 95,000

Purchase price................................................................. 70,000 96,000
Realized holding gain……………………………………… $ 12,000
Unrealized holding loss.................................................... $ (1,000)
Problem 11
The income statement prepared in conventional form for the Thon Co. on
December 31, 2002, is as follows:
Thon Co.
Income Statement
For Year Ended December 31, 2002

Sales..................................................................................... $990,000
Cost of goods sold:
Inventory, January 1, 2002........................................... $157,500
Purchases...................................................................... 570,000
Goods available for sale................................................ $727,500
Inventory, December 31, 2002...................................... 82,500 645,000
Gross profit on sales............................................................ $345,000
Operating expenses.............................................................. 225,000
Income before income taxes................................................ $120,000
Income taxes........................................................................ 47,850
Net income........................................................................... $ 72,150

The following data were available in adjusting the income statement:

Consumer Price Index
Beginning of 2001 (prior year) 110
Beginning of 2002 (current year) 120
End of 2002 (current year) 130

(a) During 2002, sales and purchases were made evenly, and operating expenses
were incurred evenly throughout the year.
(b) The average index is regarded as applicable in restating inventories.
(c) Declared dividends of $60,000 at the end of 2000.

Prepare an income statement for the year ended December 31, 2002, that is
restated in terms of end-of-year constant dollars.
Solution 11
LO4
Thon Co.
Income Statement
For Year Ended December 31, 2002
(Historical Cost/Constant Dollar Basis)

HC/ND Conversion HC/CD

Amounts Factor Amounts
Sales................................................................. $990,000 130/125 $1,029,600
Cost of goods sold:
Inventory, January 1, 2000........................ $157,500 130/115 $ 178,044
Purchases.................................................. 570,000 130/125 592,800
Goods available for sale............................ $727,500 $ 770,844
Inventory, December 31, 2000.................. 82,500 130/125 85,800
Cost of goods sold..................................... $645,000 $ 685,044
Gross profit on sales......................................... $345,000 $ 344,556
Operating expenses.......................................... 225,000 130/125 234,000
Income before income taxes............................. $120,000 $ 110,556
Income taxes..................................................... 47,850 130/125 49,764
Net income........................................................ $ 72,150 $ 60,792

Problem 12
On July 15, 2002, United Manufacturing Inc., a New York based conglomerate,
purchased, Sky Inc., a Korean-based company. Sky Inc.’s balance sheet on the
date of purchase is as follows:
In Korean Won
(in thousands)
Cash......................................................................... 11,250
Accounts receivable................................................. 62,500
Inventory.................................................................. 57,250
Plant assets (net)..................................................... 48,900
179,900

Accounts payable..................................................... 64,000

Non-current liabilities............................................... 74,900
Capital stock............................................................ 12,500
Retained earnings.................................................... 28,500
179,900

The exchange rate for Korean won on July 15, 2002, is $.007.

Prepare a translated balance sheet as of July 15, 2002.

Solution 12
LO5
In Korean Won Exchange
(in thousands) Rate In U.S. $
Cash............................................ 11,250 $0.007 $ 78,750
Accounts receivable.................... 62,500 0.007 437,500
Inventory...................................... 57,250 0.007 400,750
Plant assets (net)........................ 48,900 0.007 342,300
179,900 $1,259,300

Accounts payable........................ 64,000 0.007 $ 448,000

Non-current liabilities................... 74,900 0.007 524,300
Capital stock................................ 12,500 0.007 87,500
Retained earnings....................... 28,500 0.007 199,500
179,900
$1,259,300

Problem 13
Financial information for Toro Enterprises at the end of 2002 is as follows:
French Francs
Current assets.................................................... 14,500,000
Equipment.......................................................... 9,750,000
Current liabilities................................................. 6,500,000
Long-term debt................................................... 3,200,000
Capital stock....................................................... 1,600,000
Retained earnings (January 1, 2002)................ 9,250,000
Revenues........................................................... 10,450,000
Expenses............................................................ 6,750,000

Relevant exchange rates are as follows:

When Toro was purchased................................ $ 0.20
Current exchange rate....................................... 0.32
Average rate for the year................................... 0.28

In addition, the computed retained earnings balance from the prior year’s translated
financial statements is $2,405,000.

Prepare a translated trial balance for Toro Enterprises.

 Solution 13
LO5
In Francs Exchange In U.S. $
(in thousands) Rate (in thousands)
Current assets............................. 14,500 0.32 $ 4,640
Equipment................................... 9,750 0.32 3,120
Expenses..................................... 6,750 0.28 1,890
31,000 $ 9,650

Current liabilities.......................... 6,500 0.32 $ 2,080

Long-term debt............................ 3,200 0.32 1,024
Capital stock................................ 1,600 0.20 320
Retained earnings (January 1, 1999) 9,250 computed 2,405
Revenues.................................... 10,450 0.28 2,926
Translation adjustment................ 895
31,000 $ 9,650

Problem 14
The following financial information is available for Paul Company, a hypothetical
non- U.S. firm with shares listed on a U.S. stock exchange:

Net income computed according to home country GAAP………….. 800,000

Stockholders’ equity computed according to home country GAAP.. 8,000,000
Possible obligation for severance benefits to be paid to employees
in future years; recognized this year…………………………………. 3,000,000
Goodwill recorded as a subtraction from equity rather than as an
asset (occurred three years ago)…………………………………….. 3,200,000

If Paul were following U.S. GAAP, the goodwill would have been recorded as an
asset
and amortized over a period of 40 years. According to U.S. GAAP, the possible
obligation for severance benefits would not be recognized until it had become
probable.

Prepare a reconciliation of Paul’s reported stockholders’ equity and net income to

the amounts of these items under U.S. GAAP.
802 Chapter 21  Analysis of Financial Statements

Solution 14
LO3
Paul Company
Reconciliation of Stockholders’ Equity to U.S. GAAP

Stockholders’ equity computed according to U.S. GAAP………… $ 8,000,000

Adjustments required to conform to U.S. GAAP:
Goodwill, adjusted for amortization:
(3,200,000 – [3,200,000 x 3/40])……………………………… 2,960,000
Possible obligation for severance benefits………………………. 3,000,000
Stockholders’ equity in accordance with U.S. GAAP……………. $13,960,000

Paul Company
Reconciliation of Net Income to U.S. GAAP

Net income according to home country GAAP………………….. $ 800,000

Adjustments required to conform to U.S. GAAP:
Possible obligation for severance benefits…………………. 3,000,000
Goodwill amortization (3,200,000/40 years)……………….. (80,000)
Net income in accordance with U.S. GAAP…………………….. $3,720,000

Problem 15
The following schedule shows the net changes in the balance sheet accounts at
December 31, 2001, as compared to December 31, 2002, for the Williams
Company. The statement of cash flows for the year ended December 31, 2002,
has not been prepared.
Increase
Assets (Decrease)
Cash and cash equivalents..............................................$ 60,000
Accounts receivable (net)................................................ 66,000
Inventories........................................................................ 37,000
Prepaid expenses............................................................ 2,000
Property, plant, and equipment (net)............................... 63,000
Total assets......................................................................$228,000

Liabilites
Accounts payable.............................................................$ (46,000)
Short-term notes payable................................................ (20,000)
Accrued liabilities............................................................. 28,500
Bonds payable................................................................. 28,000
Less: Amortized bond discount....................................... 1,200
Total liabilities...................................................................$ (64,300)
 Stockholders’ Equity
Common stock.................................................................$500,000
Paid-in capital in excess of par........................................ 200,000
Retained earnings............................................................ (437,700)
Appropriation of retained earnings for possible
plant expansion................................................................ 30,000
Total stockholders’ equity................................................$292,300

The following additional information has been gathered:

(a) The net income for the year ended December 31, 2002, was $172,300.
(b) During the year ended December 31, 2002, uncollectible accounts
receivable
of $26,400 were written off by a debit to Allowance for Doubtful Accounts.
(c) A comparison of Property, Plant, and Equipment, as of the end of each
year ....................................................................................follows:

December 31 Increase
2002 2001 (Decrease)
Property, plant, and equipment..............................$570,500 $510,000 $60,500
Less: Accumulated depreciation........................... 225,500 228,000 (2,500)
$345,000 $282,000 $63,000

During 2002, machinery was purchased at a cost of $45,000. In addition,

machinery that was acquired in 1995 at a cost of $48,000 was sold for
$3,600. At the date of sale, the machinery had an undepreciated cost of
$4,200. The remaining increase in property, plant, and equipment resulted
from the acquisition of a tract of land for a new plant site.
(d) The bonds payable mature at the rate of $28,000 every year.
(e) In January 2002, the company issued an additional 10,000 shares of
common stock at $14 per share upon exercise of outstanding stock options
held by key employees. In May 2002, the company declared and issued a
5% stock dividend on its outstanding stock. During the year, a cash
dividend was paid on the common stock. On December 31, 2002, there
were 840,000 shares of common stock outstanding.
(f) The appropriation of retained earnings was made in anticipation of the
construction of a new plant.
(g) The notes payable relate to operating activities.

Prepare a statement of cash flows for the year ended December 31, 2002, using
the indirect method.
804 Chapter 21  Analysis of Financial Statements

Solution 15
LO6 Williams Company
Statement of Cash Flows
For the Year Ended December 31, 2002
Cash flows from operating activities:
Net income.......................................................................$172,300
Adjustments:
Depreciation..................................................................... 41,3001
Amortization of bond discount......................................... 1,200
Loss on sale of machinery............................................... 6002
Increase in accounts receivable...................................... (66,000)
Increase in inventory........................................................ (37,000)
Increase in prepaid expenses.......................................... (2,000)
Decrease in accounts payable......................................... (46,000)
Decrease in short-term notes payable............................ (20,000)
Increase in accrued liabilities........................................... 28,500
Net cash flow provided by operations.................................... $ 72,900

Cash flows from investing activities:

Sale of machinery............................................................$ 3,600
Purchase of machinery.................................................... (45,000)
Purchase of land.............................................................. (63,500)3
Net cash flow used by investing activities.............................. (104,900)

Cash flows from financing activities:

Issuance of common stock4.............................................$140,000
Retirement of bonds......................................................... (28,000)
Payment of dividends....................................................... (20,000)5
Net cash flow provided by financing activities........................ 92,000
Net increase in cash and cash equivalents............................ $ 60,000

Note: Completion of the formal statement of cash flows would require disclosure of
the beginning and ending cash and cash equivalents.

Computations:
1
Accumulated depreciation--beginning balance............................... $(228,000)
Accumulated depreciation--machine sold ($48,000 - $4,200)........ 43,800
Accumulated depreciation--ending balance..................................... 225,500
Depreciation expense for the year 2002......................................... $ 41,300
2
Book value of machine sold ($48,000 - $43,800)........................... $ 4,200
Proceeds on sale............................................................................. 3,600
Loss on sale..................................................................................... $ 600
3
Property, plant, and equipment--beginning balance....................... $(510,000)
Purchase of machine....................................................................... (45,000)
Sale of machine............................................................................... 48,000
Property, plant, and equipment--ending balance............................ 570,500
Purchase of land.............................................................................. $ 63,500
4
Additional stock issued as a result of 5% stock dividend:
800,000 shares x .05 = 40,000 shares.
5
Net decrease in retained earnings.................................................. $ 437,700
Appropriation of retained earnings.................................................. (30,000)
Stock dividend (40,000 shares x $14)............................................. (560,000)
Net income....................................................................................... 172,300
Dividends declared and paid........................................................... $ 20,000

Problem 16
The following 3 ratios have been computed using the financial statements for the
year ended December 31, 2002, for James Company:

Current ratio = (Current assets/Current liabilities

= $70,000  $40,000
= 1.75
Debt-to-equity ratio = (Total liabilities/ Stockholders’ equity)
= $100,000  $120,000
= .83
Return on sales = $40,000  $390,000
= .10

The following additional information has been assembled:

(a) James uses the LIFO method of inventory valuation. Beginning inventory was
$30,000 and ending inventory was $40,000. If James had used FIFO,
beginning inventory would have been $40,000 and ending inventory would
have been $55,000.
(b) James’ sole depreciable asset was purchased on January 1, 1999. The asset
cost $110,000 and is being depreciated over 10 years with no estimated
salvage value. Although the 10-year life is within the acceptable range, most
firms in James’ industry depreciate similar assets over 8 years.
806 Chapter 21  Analysis of Financial Statements

(c) For 2002, James decided to recognize a $15,000 liability for future
environmental cleanup costs. Most other firms in James’ industry have similar
environmental cleanup obligations but have decided that the amounts of the
obligations are not reasonably estimable at this time; on average, these firms
recognized only 5% of their total environmental cleanup obligation.

Show how the values for the 3 ratios computed above differ if James had used
FIFO,
depreciated the asset over 8 years, and recognized only 5% of its environmental
cleanup obligation. Compute how the financial statements would differ if the
alternative accounting methods had been used. Do not treat the use of these
alternative methods as accounting changes. Ignore any income tax effects.

Solution 16
LO2
Adjustments:
(a) Using FIFO:
Ending inventory increases by $15,000 ($55,000 - $40,000).
Net income for 2002 increases by $5,000 [($55,000 - $40,000) - ($40,000 -
$30,000)].
Beginning retained earnings increases by $10,000 ($40,000 - $30,000).
(b) 8-year useful life:
Book value at December 31, 2002:
10-year life: $110,000 - [($110,000  10) x 4 years] = $66,000
8-year life: $110,000 - [($110,000  8) x 4 years] = $55,000
Book value decreases by $11,000 ($66,000 - $55,000).
Net income for 2002 decreases by $2,750 [($130,000  8) - ($130,000  10)]
Beginning retained earnings decreases by $8,250 [($110,000  8) x 3 years] -
[($110,000  10) x 3 years].

(c) Environmental cleanup obligation:

Net income for 2002 increases by $14,250 [($15,000 - ($15,000 x .05)].
Environmental cleanup obligation decreases by $14,250.

Adjusted current ratio: ($70,000 + $15,000)  $40,000 = 2.13

Adjusted debt-to-equity ratio: ($100,000 - $14,250)  ($120,000 + $5,000 +
$10,000 - $2,750 - $8,250 + $14,250) = .62
Adjusted return on sales ratio: ($40,000 + $5,000 - $2,750 + $14,250)  $390,000
= 0.145
Problem 17
The following 3 ratios have been computed using the financial statements for the
year ended December 31, 2002, for Arthur Company:
Current ratio = (Current assets/Current liabilities
= $85,000  $55,000
= 1.55
Debt-to-equity ratio = (Total liabilities/ Stockholders’ equity)
= $150,000  $130,000
= 1.15
Return on sales = $50,000  $410,000
= .12

The following additional information has been assembled:

(a) Arthur uses the LIFO method of inventory valuation. Beginning inventory was
$25,000 and ending inventory was $35,000. If Arthur had used FIFO,
beginning inventory would have been $50,000 and ending inventory would
have been $65,000.
(b) Arthur’s sole depreciable asset was purchased on January 1, 1999. The asset
cost $130,000 and is being depreciated over 15 years with no estimated
salvage value. Although the 15-year life is within the acceptable range, most
firms in Arthur’s industry depreciate similar assets over 10 years.
(c) For 2002, Arthur decided to recognize a $22,000 liability for future
environmental cleanup costs. Most other firms in Arthur’s industry have similar
environmental cleanup obligations but have decided that the amounts of the
obligations are not reasonably estimable at this time; on average, these firms
recognized only 5% of their total environmental cleanup obligation.

Show how the values for the 3 ratios computed above differ if Arthur had used
FIFO,
depreciated the asset over 8 years, and recognized only 5% of its environmental
cleanup obligation. Compute how the financial statements would differ if the
alternative accounting methods had been used. Do not treat the use of these
alternative methods as accounting changes. Ignore any income tax effects.

Solution 17
LO2
Adjustments:
(a) Using FIFO:
Ending inventory increases by $30,000 ($65,000 - $35,000).
Net income for 2002 increases by $5,000 [($65,000 - $35,000) - ($50,000 -
$25,000)].
Beginning retained earnings increases by $25,000 ($50,000 - $25,000).
808 Chapter 21  Analysis of Financial Statements

(b) 10-year useful life:

Book value at December 31, 2002:
15-year life: $130,000 - [($130,000  15) x 4 years] = $95,333
10-year life: $130,000 - [($130,000  10) x 4 years] = $78,000
Book value decreases by $17,333 ($95,333 - $78,000).
Net income for 2002 decreases by $4,333 [($130,000  10) - ($130,000  15)]
Beginning retained earnings decreases by $13,000 [($130,000  10) x 3 years]
- [($130,000  15) x 3 years].

(c) Environmental cleanup obligation:

Net income for 2002 increases by $20,900 [($22,000 - ($22,000 x .05)].
Environmental cleanup obligation decreases by $14,250.

Adjusted current ratio: ($85,000 + $30,000)  $55,000 = 2.09

Adjusted debt-to-equity ratio: ($150,000 - $20,900)  ($130,000 + $5,000 +
$25,000 - $4,333 - $13,000 + $20,900) = .78
Adjusted return on sales ratio: ($50,000 + $5,000 - $4,333 + $20,900)  $410,000
= 0.18

Problem 18
The following 3 ratios have been computed using the financial statements for the
year ended December 31, 2002, for CR Company:
Current ratio = (Current assets/Current liabilities
= $80,000  $43,000
= 1.86
Debt-to-equity ratio = (Total liabilities/ Stockholders’ equity)
= $110,000  $125,000
= .88
Return on sales = $45,000  $400,000
= .11

The following additional information has been assembled:

(a) CR uses the FIFO method of inventory valuation. Beginning inventory was
$48,000 and ending inventory was $58,500. If CR had used LIFO, beginning
inventory would have been $36,000 and ending inventory would have been
$43,000.
(b) CR’s sole depreciable asset was purchased on January 1, 1999. The asset
cost $120,000 and is being depreciated over 7 years with no estimated salvage
value. Although the 7-year life is within the acceptable range, most firms in
CR’s industry depreciate similar assets over 12 years.
(c) For 2002, CR decided to recognize only 5% of an $18,000 liability for future
environmental cleanup costs. Most other firms in CR’s industry have similar
environmental cleanup obligations but have decided that the amounts of the
obligations are reasonably estimable and have recognized the full amount of
the liability.
Show how the values for the 3 ratios computed above differ if CR had used LIFO,
depreciated the asset over 12 years, and recognized the full amount of its
environmental cleanup obligation. Compute how the financial statements would
differ
if the alternative accounting methods had been used. Do not treat the use of these
alternative methods as accounting changes. Ignore any income tax effects.

Solution 18
LO2
Adjustments:
(a) Using LIFO:
Ending inventory decreases by $15,500 ($43,000 - $58,500).
Net income for 2002 decreases by $3,500 [($43,000 - $36,000) - ($58,500 -
$48,000)].
Beginning retained earnings decreases by $12,000 ($36,000 - $48,000).

(b) 12-year useful life:

Book value at December 31, 2002:
7-year life: $120,000 - [($120,000  7) x 4 years] = $51,429
12-year life: $120,000 - [($120,000  12) x 4 years] = $80,000
Book value increases by $28,571 ($51,429 - $80,000).
Net income for 2002 increases by $7,143 [($120,000  7) - ($120,000  12)]
Beginning retained earnings increases by $21,428 [($120,000  7) x 3 years] -
[($130,000  12) x 3 years].

(c) Environmental cleanup obligation:

Net income for 2002 decreases by $17,100 [($18,000 x .05) - $18,000].
Environmental cleanup obligation increases by $17,100.

Adjusted current ratio: ($80,000 - $15,500)  $43,000 = 1.5

Adjusted debt-to-equity ratio: ($110,000 + $17,100)  ($125,000 - $3,500 -
$12,000 + $7,143 + $21,428 - $17,100) = 1.05
Adjusted return on sales ratio: ($45,000 - $3,500 + $7,143 - $17,100)  $400,000
= 0.079
810 Chapter 21  Analysis of Financial Statements

Problem 19
The following financial information is for DC Company, a non-U.S. firm with shares
listed on a U.S. stock exchange:

Net income computed according to home country GAAP...................... $

40,000
Stockholders’ equity, computed according to home country GAAP.......
170,000
Minority interest, recorded as an addition to stockholders’ equity.........
35,000

Market value of investment securities acquired this year

that were reported at cost of $4,000.......................................................
$5,000
Interest on the financing of self-constructed assets...............................
6,000

If DC Company were following U.S. GAAP, the minority interest would have been
classified as a liability instead of as part of stockholders’ equity. In addition,
minority interest income of $4,000 for the year would have been excluded from the
computation of net income. Under U.S. GAAP the investment securities would
have been classified as trading securities and the interest on financing of self-
constructed assets would have been capitalized rather than expensed.

Prepare reconciliations of DC’s reported stockholders’ equity and net income to

U.S. GAAP.

Solution 19
LO3
Reconciliation of stockholders’ equity:
Stockholders’ equity computed according to home country GAAP........$170,000
Adjustments required to conform to U.S. GAAP:
Minority interest included in stockholders’ equity............................ (35,000)
Unrealized gain on trading securities ($5,000 - $4,000).................. 1,000
Interest on financing of self-constructed assets.............................. 6,000
Stockholders’ equity according to U.S. GAAP........................................$142,000

Reconciliation of net income:

Net income computed according to home country GAAP......................$ 40,000
Minority interest income.......................................................................... (4,000)
Unrealized gain on trading securities ($5,000 - $4,000)........................ 1,000
Interest on financing of self-constructed assets..................................... 6,000
Net income in accordance with U.S. GAAP............................................$ 43,000
812 Chapter 21  Analysis of Financial Statements

Problem 20
The following financial information is for Olaf Company, a non-U.S. firm with shares
listed on a U.S. stock exchange:

Net income computed according to home country GAAP......................$ 350,000

Stockholders’ equity, computed according to home country GAAP....... 4,100,000
Possible obligation for severance benefits to be paid to employees
in future years, recognized this year....................................................... 1,000,000
Goodwill recognized as a subtraction from equity rather than as
an asset (occurred 4 years ago)............................................................. 1,600,000

Minority interest, recorded as an addition to stockholders’ equity......... 30,000

Market value of investment securities acquired this year
that were reported at cost of $2,000....................................................... $ 3,200
Interest on the financing of self-constructed assets............................... 4,000

If Olaf Company were following U.S. GAAP, the minority interest would have been
classified as a liability instead of as part of stockholders’ equity. In addition,
minority interest income of $3,000 for the year would have been excluded from the
computation of net income. Under U.S. GAAP the investment securities would
have been classified as trading securities and the interest on financing of self-
constructed assets would have been capitalized rather than expensed.

Prepare reconciliations of Olaf’s reported stockholders’ equity and net income to

U.S. GAAP.

Solution 20
LO3
Reconciliation of stockholders’ equity:
Stockholders’ equity computed according to home country GAAP........$4,100,000
Adjustments required to conform to U.S. GAAP:
Goodwill adjusted for amortization
($1,600,000 - ($1,600,000 x 4/20)................................................... 1,280,000
Possible obligation for severance benefits...................................... 1,000,000
Minority interest included in stockholders’ equity............................ (30,000)
Unrealized gain on trading securities ($3,200 - $2,000).................. 1,200
Interest on financing of self-constructed assets.............................. 4,000
Stockholders’ equity according to U.S. GAAP........................................$6,355,200
 Reconciliation of net income:
Net income computed according to home country GAAP......................$ 350,000
Possible obligation for severance benefits............................................. 1,000,000
Goodwill amortization ($1,600,000  20)................................................ (80,000)
Minority interest income.......................................................................... (3,000)
Unrealized gain on trading securities ($3,200 - $2,000)........................ 1,200
Interest on financing of self-constructed assets..................................... 4,000
Net income in accordance with U.S. GAAP............................................$1,278,200

Problem 21
Assume that you have just been hired as the controller of the Trent Manufacturing
Company. In order to be fully apprised of the financial and operating condition of the
company, you have decided to analyze several of the key accounts appearing on the
company’s financial statements. An account of obvious interest to you is the
company’s trade accounts receivable.
Identify specific attributes of the accounts receivable that you would examine as
well as any ratios that might be useful to you in your analysis.

Solution 21
LO1
An analysis of the accounts receivable of the company might include the following:

1. Identify receivables with the following characteristics and assess their effect on
the company’s financial health generally:

a. Receivables from customers having severe financial difficulties.

b. Receivables from customers in economically unstable foreign countries.

2. Determine if the receivables are concentrated in just a few customers or are

diversified among many customers.

3. Nothing is said in the facts of the problem about whether Trent’s trade
receivables are from other business enterprises or consumers. Trade
receivables from consumers would be riskier than those from other enterprises.

4. Calculate the accounts receivable turnover. A high turnover rate usually shows
that the company is collecting quickly from customers. An excessively high
turnover might indicate a credit policy that is too stringent with the result that
sales are lost. A low ratio may indicate that large amounts of receivables are
uncollectible as a result of weak collection policies or credit terms that are too
lenient. Quarterly or monthly sales figures may be required for use in the
turnover ratio if sales vary greatly during the year.
814 Chapter 21  Analysis of Financial Statements

5. Calculate the accounts receivable-to-total-assets and accounts-receivable-to

sales ratios to determine if receivables are accumulating beyond what would
reasonable be expected.

6. Calculate the sales-returns-to-sales and sales-returns-to-accounts receivable

ratios. An upward trend in these ratios may indicate errors in filling orders or
problems with the quality of merchandise sold.

7. Calculate the-bad-debts-to-accounts-receivable and bad-debts-to-net-sales

ratios. These ratios give some indication as to the adequacy of the bad debt
provision the company is making in its financial statements.
CHAPTER 21 -- QUIZ A
Name _________________________
Section ________________________

T F 1. Liquidity relates to the ability of an enterprise to pay its liabilities as they

come due.

T F 2. A measure of the overall efficiency of asset utilization is the ratio of net sales
to total assets, often called the asset turnover rate.

T F 3. In developing the asset turnover rate, long-term investments should be

included in total assets even though they make no contribution to sales.

T F 4. Financial leverage is a measure of an entity's ability to increase profitability to

shareholders by using borrowed funds whose cost is less than the profit that
can be earned with the borrowed funds.

T F 5. The fixed asset turnover ratio is computed as sales divided by total assets.

T F 6. The comparison of current assets with current liabilities is regarded as a

fundamental measurement of a company's liquidity and is known as the acid
test ratio.

T F 7. A ratio of current assets to current liabilities of less than 2 to 1 is considered

unsatisfactory for all industries.

T F 8. The number of times interest is earned is calculated by dividing income after

charges for interest and income tax by the interest requirements for the
period.

T F 9. The accounts receivable turnover rate is determined by dividing net credit

sales by the average accounts receivable outstanding.

T F 10. Inventory turnover is computed by dividing cost of goods sold by average

inventory.
CHAPTER 21 -- QUIZ B
Name _________________________
Section ________________________

T F 1. Realized holding gains or losses are increases or decreases in the current

value of assets held during a period but not sold or used.

T F 2. An unrealized holding gain is an increase in the current value of assets held

during a period but not sold or used.

T F 3. Monetary items are assets, liabilities, and equities whose balances are fixed
in terms of numbers of dollars regardless of changes in the general price
level.

T F 4. Constant dollar accounting is an accounting concept that adjusts for the

impact of changes in the prices of specific items.

T F 5. Accounts payable and mortgage payable are both considered nonmonetary

liabilities.

T F 6. Nominal dollars reflect a monetary measurement that is adjusted for changes

in the general price level.

T F 7. The currency of the primary economic environment in which an entity

operates is termed the local currency.

T F 8. Remeasurement uses the current exchange rate to translate most balance

sheet items.

T F 9. The difference between a company’s monetary assets and its total liabilities
and equities at a specified time is defined as its net monetary position.

T F 10. When performing the translation process, the building account is translated
using the current exchange rate.

816
CHAPTER 21 -- QUIZ C
Name _________________________
Section ________________________

A. Cash flow adequacy ratio I. Currency cost accounting

B. Realized holding gains (losses) J. Leverage
C. Number of days’ sales in inventory K. Average collection period
D. Functional currency L. Common-size financial statements
E. Monetary items M. Constant dollar accounting
F. Unrealized holding gains (losses) N. Return on equity
G. Translation O. Return on assets
H. DuPont framework P. Price-earnings ratio

Select the term that best fits each of following independent situations. Indicate your answer by
placing the appropriate letter in the space provided.
____ 1. Accounting for the impact of inflation, or the change in the general level of prices.

____ 2. Increases or decreases in the current value of assets held during a period but not
sold or used.

____ 3. Currency in which most of a foreign subsidiary’s transactions are denominated.

____ 4. Number of times that cash from operations can cover predictable cash
requirements.

____ 5. Average number of days’ sales on hand in inventory.

____ 6. Decomposes return on equity into profitability, efficiency, and leverage components.

____ 7. Amount investors are willing to pay now to buy one dollar of earnings per share.

____ 8. Differences between the current costs and the historical costs of assets sold or
used during a period.

____ 9. Method of converting a foreign subsidiary’s financial statements into U.S. dollars.

____ 10. Number of pennies of net income generated by each dollar of assets.

____ 11. Average number of days that elapses between sale and cash collection.

____ 12. Financial statements standardized by a measure of size, either sales or total assets.

____ 13. Accounting for the impact of changes in the prices of specific items.

____ 14. Assets, liabilities, and equities whose values and settlement amounts are fixed in
terms of numbers of dollars.

817
____ 15. Number of pennies earned during the year for each dollar invested .

818
Test Bank, Intermediate Accounting, 14th ed. 819

CHAPTER 21 -- QUIZ SOLUTIONS

Quiz A Quiz B Quiz C

1. T 1. F 1. M
2. T 2. T 2. F
3. F 3. T 3. D
4. T 4. F 4. A
5. F 5. F 5. C
6. F 6. F 6. H
7. F 7. F 7. P
8. F 8. T 8. B
9. T 9. F 9. G
10. T 10. T 10. O
11. K
12. L
13. I
14. E
15. N
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