Exercise 3 – Analysis of Financial Statements

Assistant Professor Ronaldo C. Reyes

1. Indicate the peso change, the percentage change, and also the ratio that would be reported for each case
below, assuming horizontal analysis:

2019 2018 2019 2018

a. P45,000 P 20,000 f. P(30,000) 0
b. 20,000 40,000 g. 5,000 P(5,000)
c. 30,000 - h. (20,000) 5,000
d. 0 40,000 i. (10,000) (10,000 )
e. (30,000) 10,000 j. 20,000 20,000

2. Sales for the Caresome Company for a five-year period and an industry sales index for this period are
listed below. Convert both series into indexes employing 2015 as the base year.

2020 2019 2018 2016 2015

Sales of Caresome Co.
(in thousands of pesos) P4,200 P4,515 P4,355 P4,425 P4,265
Industry sales index 120 134 133 108 106
(2013-2015 equals 100) 190 212 210 170 158

3. The Atlas Company develops the following measurements for 2019 as compared with the year 2018.
What additional information would you require before arriving at favorable or unfavorable conclusions
for each item?

a. Net income has increased P70,000.

b. Sales returns and allowances have increased by P25,000.
c. The gross profit rate has increased by 5%.
d. Purchase discounts have increased by P5,000.
e. Working capital has increased by P85,000.
f. Accounts receivable have increased by P150,000.
g. Inventories have decreased by P100,000
h. Retained earnings have decreased by P300,000

4. Study the following selected UNRELATED GROUPS of Department Store data and point out favorable or
unfavorable tendencies:
20-A 20-B 20-C 20-D 20-E
a. Receivable, net (P) 75,150 88,270 99,340 98,430 100,900
TREND (%) 100 117 120 131 134
Merchandise inventory (P) 52,330 59,280 99,670 120,240 151,400
Trend (%) 100 113 190 230 289
Fixed assets, net (P) 271,420 275,310 290,440 292,670 287,310
Trend (%) 100 102 107 108 106
Net sales (P) 280,910 291,680 295,810 380,470 540,110
Trend (%) 100 104 105 133 190
Net income (P) 31,150 38,130 36,360 51,670 82,620
Trend (%) 100 122 117 166 260
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - - - - - - - - - - - - - - - - - -
b. Current assets 151,670 182,920 240,260 290,140 355,110
Trend (%) 100 121 158 191 230
Current liabilities (P) 102,820 125,160 138,930 146,820 169,960
Trend (%) 100 122 135 143 160
Total non-current assets, net (P) 361,420 382,240 471,320 580,960 940,670
Trend (%) 100 106 130 161 260
Owners’ equity (P) 300,120 329,550 472,650 634,200 1,049,820
Trend (%) 100 110 157 211 350
Net sales (P) 186,710 188,630 195,430 210,690 230,330
Trend (%) 100 101 105 113 120
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c. Net sales (P) 301,650 325,710 375,240 378,960 401,280
Trend (%) 100 108 124 126 130
Cost of goods sold (P) 173,750 187,130 220,180 229,170 244,810
Trend (%) 100 107 127 132 140
Selling expenses (P) 45,000 56,400 59,400 63,810 77,120
Trend (%) 100 125 132 146 171
General and admin. expenses (P) 15,000 16,510 19,570 21,240 24,160

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 Exercise 3 – Analysis of Financial Statements
Assistant Professor Ronaldo C. Reyes
Trend (%) 100 110 130 142 161
Operating income (P) 67,900 69,470 76,270 62,740 55,190
Trend (%) 100 102 112 92 81
Net income (Transferred to
Retained earnings (P) 15,140 20,670 16,820 9,915 1,270
Trend (%) 100 137 111 65 80
- - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
5. Comparative data for Lively Co. for the three year period 20-A, 20-B and 20-C are presented below
Income Statement Data
20- A 20- B 20- C
Net sales P800,000 P1,000,000 P1,200,000
Cost of goods sold 500,000 660,000 760,000
Gross profit on sales 300,000 340,000 440,000
Selling, general and administrative exp. 280,000 300,000 350,000
Net operating income 20,000 40,000 90,000
Income taxes 5,000 15,000 35,000
Net income 15,000 25,000 55,000
Dividends paid 15,000 30,000 40,000
Net increase (decrease) in
Retained earnings P (P ) P
Depreciation & Other Non-cash expenses P 40,000 P 55,000 P 60,000
Balance Sheet Data
20- A 20- B 20- C
ASSETS
Cash P 20,000 P 15,000 P 25,000
Marketable securities 30,000 20,000 30,000
Trade notes & accounts receivable (net) 245,000 320,000 400,000
Inventory (at cost) 320,000 380,000 420,000
Prepaid expenses 20,000 10,000 30,000
Plant equipment (net) 650,000 600,000 680,000
Intangibles 100,000 100,000 100,000
Other assets 5,000 5,000 15,000
P1,390,000 P1,450,000 P1,700,000
LIABILITIES & STOCKHOLDERS’ EQUITY
Trade notes and accounts payable P 130,000 P 165,000 P 255,000
Wages, interest, dividends payable 15,000 25,000 45,000
Income taxes payable 5,000 15,000 35,000
Misc. current liabilities 10,000 15,000 10,000
3% bonds payable 300,000 300,000 300,000
Deferred revenues 9,000 10,000 10,000
6% Preferred stock, non-cumulative,
non-participating, P100 par 200,000 200,000 200,000
No-par common stock , P10 stated value 400,000 400,000 500,000
Additional paid-in capital 200,000 200,000 200,000
Retained earnings –appropriated 60,000 60,000 80,000
Retained earnings – free 65,000 60,000 65,000
P 1,390,000 P 1,450,000 P 1,700,000
Market value of common, December 31 P9 P 15 P 17

Instructions: From the data, calculate comparative structural measurements for 20-B and 20-C as follows:
1. Net working capital (amount) 9. Interval mearsure
2. Current ratio 10. Ratio of total liabilities to total
3. Net monetary assets (amount) assets (debits to assets ratio)
4. Quick ratio 11.Equity to asset ratio
5. Acid test ratio (“refined) 12.D.E ratio –ratio of total liabilities
6. Inventory to working capital to total owners’ equity
7. Accumulation of working 13. Ratio od plant & equipment to
capital ratio bonds payable
8.Current assets to total asset
14. Ratio of plant and equipment stockholders’ equity
15. Ratio of current liabilities to stockholders’ equity
16. Number of times bond interest were earned
17. Number of times preferred dividends were earned
18. Asset turnover
19. Fixed asset turnover
20. Equity turnover
21. Current asset turnover – based on sale

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 Exercise 3 – Analysis of Financial Statements
Assistant Professor Ronaldo C. Reyes
22. Current asset turnover –based on cash cost and expenses
23. Working capital turnover –based on sale
24. Working capital turnover – based on cash cost and expenses
25. Trade receivables turnover for the year
26. Average collection period for the year
27. Average day’s sales in trade receivable at the end of the year (assume 360-day business year and all sales on
credit basis)
28. Trade payables turnover for the year
29. Average payment period of trade payables for the year
30. Average days’ purchases in trade payable at the end of the year
31. Ratio of trade payables to purchases
32. Inventory turnover
33. No. of days sales in average inventory
34. No. of days in inventory at the end
35. Average conversion period
36. Cash cycle
37. Sales margin ratio (net income to net sales)
38. Gross profit ratio
39. Operation ratio
40. Rate of return in total assets
41. Rate of return in fixed assets
42. Rate of return in equity
43. Rate of return in current assets
44. Rate of return per current unit turnover
45. Earnings per share
46. Rate earned per average of common stockholders’ equity
47. Price earning ratio
48. Yield or P/E reciprocal
49. Dividends per share
50. Dividend payout ratio
51. Book value per share – preferred
52. Book value per share – common
53. Cash yield

6. The President of the Quincy Company has made arrangement to obtain a loan from the Urban National Bank.
One of the requirements of the loan is that the Quincy Company have a current ratio of two to one as of the
date of the loan, and three to one after the loan. The controller has made the following projected balance
sheet for the date of the loan (May 15, 2019) which does not include the loan.

Quincy Company
Projected Balance Sheet
As of May 15, 2019

Cash P210,000 Accounts Payable P100,000

Accounts Receivable, net 40,000 Taxes Payable 150,000
Inventories 50,000 Common Stock 60,000
Plant assets, net 200,000 Retained Earnings 190,000
P500,000 P500,000

A computation of the current ratio as of May 15 indicates a current ratio of 300,000/250,000 or 1.2 to 1. There
is not enough time to issue additional share of common stock of long-term debt securities.
Required:
(a) What would you suggest to be done in order to attained the desired current ratio of two to one?
(b) What does this suggest about the reliability of current ratios?

7. Current assets and current liabilities of Lualhati Terminal company at September 30, 2019 are listed below:
Current assets
Cash P103,000
Marketable securities 86,000
Accounts receivable 184,300
Inventories:
Raw materials 116,200
Work in process 53,600
Finished goods 83,700
Prepaid insurance, taxes, etc. 4,800
Total current assets P632,300

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 Exercise 3 – Analysis of Financial Statements
Assistant Professor Ronaldo C. Reyes

Current liabilities:
Accounts payable P 87,310
Accrued operating expenses 21,420
Notes payable 45,000
Interest payable 1,870
Income taxes payable 63,430
Total current liabilities P 219,030

Early in October, the company had some of its properties damaged by a severe storm. It is estimated that
inventory losses not covered by insurance will amount to P48,000 and that expenditures of P76,000 will be made
to restore facilities.

Required:
(a) What was the current ratio at September 30, 2019? The acid test ratio? The net working capital?
(b) Assuming that there was no significant change in current assets or current liabilities as a result of
operations since September 30, compute the revised current ratio, acid test ratio and net working capital
after giving effect to the liability created as a consequence of the storm and inventory loss.

8. In making an examination of the financial statements of certain business, you find that the following items
have either been handled improperly or overlooked.

(a) Notes payable that become due in six months have been classified as long –term debt.
(b) Cash receipts collected on accounts receivable after the end of the year have been improperly reported
as receipts for the year.
(c) Depreciation on equipment for the year was not recorded.
(d) Checks were written at the end of the year and were reported as disbursements of the year. The checks
were mailed early in the following year.
(e) Cost pertaining to the year were improperly listed as prepayments.
(f) Merchandise purchased during the year was not recorded until the following year. The inventory at the
end of the year was also understated by the amount of purchase.

Required: In each situation outlined above, point out the effect of the omission or the error. Also in each
circumstances, state whether or not the current ratio would be affected. Would the current ratio be shown too
high or too low?

9. The Mezzee Corp. has a current ratio of 2:1 before considering the transaction listed below. You are to
indicate the effect (Increase, Decrease, no effect) of each of the following transactions on the current ratio
and net working capital. Each transaction is independent of the other.
(a) Trade accounts payable of P600 is paid in cash.
(b) A P5,000 cash dividend is declared.
(c) 10-year bonds payable are issued for cash at par value of P100,000.
(d) Accounts receivable of P1,000 is collected.
(e) A fully depreciated fixed asset is retired
(f) Additional shares of capital stocks are issued for cash at par value of P100 per share
(g) Equipment is purchased on credit, payable in six months.
(h) Merchandise inventory is sold at 20% above cost
(i) Treasury stock originally repurchased and carried at 101 per share was sold for cash at P103.50 per
share
(j) A fixed asset is sold for cash at a loss.

10. Give the answer to the following questions

(a) The acid test ratio is 1:1 . The total quick assets amount to 120,000. How much are the current
liabilities?
(b) The current ratio is 3:1. Current liabilities total P15,000. What is the net working capital?
(c) Merchandise inventory amounts to P56,000. Total current liabilities is P80,000. Acid test ratio is 8;1.
What is the current ratio?
(d) Total current liabilities amount to P50,000. Acid test ratio is 2:1. Merchandise inventory is P30,000.
What are the total current assets?
(e) The acid test ratio is 2:1, the current ratio is 3:1. Merchandise inventory is P25,000. what is the total
current liabilities?

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 Exercise 3 – Analysis of Financial Statements
Assistant Professor Ronaldo C. Reyes
11. Condensed balance sheets of three companies are shown below.

Co. A Co. B Co. C

Assets 6,000,000 10,000,000 15,000,000
Liabilities 2,000,000 6,000,000 5,000,000
Stockholders’ equity 4,000,000 4,000,000 10,000,000
Total 6,000,000 10,000,000 15,000,000

Required: Compute for each year –

(a) Debt to asset ratios
(b) Stockholder’s equity to assets ratio
(c) DE ratios

12. Give the answer for each filling the blanks.

(a) Debt to asset ratio 40%; SHE to asset is _______:

(b) Equity to asset is 75%; debt to asset is _______;
(c) DE ratio is 50%; equity to debt is _______;
(d) DE ratio is 1/3; equity to debt is _______;
(e) If the debt to asset is 60% and liabilities total P300,000, the SHE amount to P_______.

13. Net income closed to retained earnings was P240,000 after tax of P40%. The company had an outstanding
loan for the entire year of P2,000,000 at 9% interest. How many times is interest earned?

14. Below are the data supplied by Wunder Corporation:

(000 omitted)
Sale P1,000
Cost of sales 600
Gross Profit 400
Operating Expenses 300
Net income 100

Assets P800
Total liabilities 200
Stockholders’ equity 600
Total P800

The demand for the products is very strong and it is appropriate to expand in order to double the sales. The
company has two options,
1.) to sell new shares of stocks for P700,000
2.) borrow money, P700,000
(a) 12% interest (possibility 1)
(b) 30% interest (possibility 2)

Required: For the (a) present situation, (b) option 1 and (c) option 2, compute the following.
(a) Total liabilities to assets
(b) Owners’ equity to assets
(c) Debt to equity ratio

15. In 2019, the Karnapp Auto Supply enjoyed sales of P2,000,000 and gross profits of P800,000. During 2019,
inventories at the end of each month were:
January P290,000 July P420,000
February 320,000 August 370,000
March 370,000 September 330,000
April 410,000 October 220,000
May 390,000 November 250,000
June 450,000 December 260,000
Required:
(a) Rate of stock turn in 2019
(b) If the company plans for an improvement of 10% in the rate of stock turn for 2010 what average
inventory will be carried? Assume the same peso volume of sales and the same gross profit for 2020 as
for 2019.
(c) What percent of gross profit was earned on the investment in the inventory in 2019? What percent would
have been earned if the expected 2020 rate of stock turn had been realized in 2019?

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 Exercise 3 – Analysis of Financial Statements
Assistant Professor Ronaldo C. Reyes
16. With improved control over inventory , Langit Inc. has been able to increase sales volume, revenue and
gross profits over the past three years with a smaller investment held in the form of inventory . Sales
and inventory data are given below:
2019 2018 2017
Net sales P7,355,000 P6,820,000 P6,250,000
Cost of goods sold 5,030,000 4,560,000 4,070,000
Average inventory investment
For the year 850,000 910,000 925,000
Required:
(a) Compute the inventory turnovers for each fiscal year and the number of days for inventory conversion.
Use 360-day year.
(b) Did the company earn more profit per turnover in 2019 or in 2018 than it earned in 2017? Show
calculations.

17. The production cycle for Gloria Manufacturing Company is relatively long. During this period, the
company obtains credit from industrial loan companies. Production costs for three years are given below:
2019 2018 2017
Raw materials used P2,800,000 P1,580,000 P1,420,000
Labor 980,000 650,000 630,000
Other production costs 380,000 280,000 260,000
Total production costs P4,160,000 P2,510,000 P2,310,000

There was no work in process on hand at any time during the three years. Other inventories are listed
at cost.
2019 2018 2017
Inventory of raw materials, beginning P 650,000 P 630,000 P 610,000
Inventory of raw materials, ending 700,000 650,000 630,000
Inventory of finished goods, beg 1,200,000 1,100,000 1,080,000
Inventory of finished goods, end 1,800,000 1,200,000 1,100,000

Improved methods of handling inventories have made it possible to reduce the amount of inventories on
hand.
Required:
(a) Compute inventory turnovers
(b) How many days are required each year on the average to process materials and sell the finished products
to customers?

(c) Assuming that the collection period on accounts receivable remains the same for the three years,
calculate the net time advantage (fewer days per turnover) in financing by reducing the inventory
turnover periods. Compare 2019 and 2018 with 2017…Use 360-day year.

18. In 2019, Paraiso Stores, Inc. reported sales revenue of P6,000,000. Sales revenue in 2020 will probably
be the same, and the gross profit will also remain at 105% of sales revenue. There are some opportunities
for cost savings that are expected to increase net profits. For example, the average inventory in 2019 of
P800,000 is to be reduced to P700,000 in 2020. This reduction is not expected to interfere with customer
service, but it will reduce losses from spoilage and obsolescence and will reduce the interest cost
required to finance inventories. Studies have been made that show losses of inventory and financing cost
for the year are approximately equal to 15% of the total average inventory cost.
Required:
(a) Compute the inventory turnover for 2019 and 2020.
(b) Determine the gross profit per turnover
(c) What effect should the inventory reduction have on net income after taxes, assuming an income
tax rate of 50%

19. Nirvana fixtures, Inc. operates a narrow profit margin and frequently finds it necessary to finance at
local banks with interest at the rate of 6% per annum. Last year sales revenue amounted to P990,000 and
the cost of sales amount to P810,000. The inventory of goods purchased for resale was maintained
throughout the year at about the same level and had a cost of P180,000. Inventory prices did not change
during the year. The accounts receivable averaged P165,000 during the year. It is believed that the same
sales volume can be maintained with an average inventory investment of P135,000. Also, arrangements
have been made with customers for payment of their account s in 30 days.
Required:
a. How long did it take to convert inventory to cash last year? Use a 360-day year.
b. How long did it take to convert inventory to cash under the new plan? Use a 360-day year
c. Compute the anticipated saving an interest cost by reducing the turnover periods and the
inventory investment
****************The End***************

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