MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 4
FINANCIAL STATEMENTS ANALYSIS - I
I. Questions
1. The objective of financial statements analysis is to determine the extent of
a firms success in attaining its financial goals, namely:
a. To earn maximum profit
b. To maintain solvency
c. To attain stability
2. ome of the indications of satisfactory short!term solvency or "or#ing
capital position of a business firm are:
1. $avorable credit position
2. atisfactory proportion of cash to the re%uirements of the current
volume
&. 'bility to pay current debts in the regular course of business
(. 'bility to extend more credit to customers
). 'bility to replenish inventory promptly
&. These tests are:
1. Improvement in the financial position
2. *ell!balanced financial structure bet"een borro"ed funds and
e%uity
&. +ffective employment of borro"ed funds and e%uity
(. 'bility to declare satisfactory amount of dividends to
shareholders
). 'bility to "ithstand adverse business conditions
,. 'bility to engage in research and development in an attempt to
provide ne" products or improve old products, methods or
processes
(. ome indicators of managerial efficiency are:
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Chapter 4 Financial Statements Analysis - I
1. 'bility to earn a reasonable return on its investment of borro"ed
funds and e%uity
2. 'bility to control operating costs "ithin reasonable limits
&. -o overinvestment in fixed assets, receivables and inventories
). The techni%ues used in $inancial tatement 'nalysis are:
I. .ertical analysis "hich sho"s the relationships of the items in the
same year: also referred to as /static measure.0
a. $inancial ratios
b. 1ommon!si2e statements
II. 3ori2ontal analysis "hich sho"s the changes or tendencies of an
item for 2 or more years4 also referred to as /dynamic measure.0
a. 1omparative statements ! sho"ing changes in absolute
amount and percentages
b. Trend percentages
III. 5se of special reports or statements
a. tatements of 1hanges in $inancial 6osition
b. 7ross 6rofit 8 -et Income .ariation 'nalysis
,. 9efer to page 1&& of the textboo#.
:. 3ori2ontal analysis involves the comparison of items on financial
statements bet"een years. 'nalysis of comparative financial statements
or the increase8decrease method of analysis and trend percentages are the
t"o techni%ues that may be applied under hori2ontal analysis.
.ertical analysis involves the study of items on a single statement for a
single year, such as the analysis of an income statement for some given
year. 1ommon!si2e statement and financial ratios are techni%ues used in
vertical analysis.
;. Trends can indicate "hether a situation is improving, remaining the same
or deteriorating. They can also give insight to the probable future course
of events in a firm.
<. Trend percentages represent the expression of several years financial data
in percentage form in terms of a base year.
1=. 9efer to page 1&& of the textboo#.
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Financial Statements Analysis - I Chapter 4
11. >bservation of trends is useful primarily in determining "hether a
situation is improving, "orsening, or remaining constant. ?y comparing
current data "ith similar data of prior periods "e gain insight into the
direction in "hich future results are li#ely to move.
ome other standards of comparison include comparison "ith other
similar companies, comparison "ith industry standards, and comparison
"ith previous years information. ?y comparing analytical data for one
company "ith some independent yardstic#, the analyst hopes to determine
ho" the position of the company in %uestion compares "ith some standard
of performance.
12. Trend percentages are used to sho" the increase or decrease in a financial
statement amount over a period of years by comparing the amount in each
year "ith the base!year amount. ' component percentage is the
percentage relationship bet"een some financial amount and a total of
"hich it is a part.
@easuring the change in sales over a period of several years "ould call
for use of trend percentages. The sales in the base year are assigned a
"eight of 1==A. The percentage for each later year is computed by
dividing that years sales by the sales in the base year.
1&. +xpenses Bincluding the cost of goods soldC have been increasing at an
even faster rate than net sales. Thus 6remiere is apparently having
difficulty in effectively controlling its expenses.
1(. ' corporate net income of 61 million "ould be unreasonably lo" for a
large corporation, "ith, say, 61== million in sales, 6)= million in assets,
and 6(= million in e%uity. ' return of only 61 million for a company of
this si2e "ould suggest that the o"ners could do much better by investing
in insured ban# savings accounts or in government bonds "hich "ould be
virtually ris#!free and "ould pay a higher return.
>n the other hand, a profit of 61 million "ould be unreasonably high for a
corporation "hich had sales of only 6) million, assets of, say, 6& million,
and e%uity of perhaps one!half million pesos. In other "ords, the net
income of a corporation must be judged in relation to the scale of
operations and the amount invested.
II. True or False
1. True &. True ). $alse :. True <. True
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Chapter 4 Financial Statements Analysis - I
2. $alse (. True ,. $alse ;. $alse 1=. True
III. Problems
"ro#le$ 1 ("er%enta&e Chan&es)
a. 'ccounts receivable decreased 1,A B62(,=== decrease 61)=,=== D
1,A decreaseC.
b. @ar#etable securities decreased 1==A B62)=,=== decrease 62)=,=== D
1==A decreaseC.
c. ' percentage change cannot be calculated because retained earnings
sho"ed a negative amount Ba deficitC in the base year and a positive
amount in the follo"ing year.
d. ' percentage change cannot be calculated because of the 2ero amount of
notes receivable in 2==), the base year.
e. -otes payable increased : EA B6,=,=== increase 6;==,=== D : EA
increaseC.
f. 1ash increased &A B62,(== increase 6;=,=== D &A increaseC.
g. ales increased 1=A B6<=,=== increase 6<==,=== D 1=A increaseC.
"ro#le$ (Co$putin& an' Interpretin& (ates o) Chan&e)
Requirement (a)
1omputation of percentage changes:
1. -et sales increased 1=A B62==,=== increase 62,===,=== D 1=A
increaseC.
2. Total expenses increased 11A B61<;,=== increase 61,;==,=== D 11A
increaseC.
Requirement (b)
1. Total expenses gre" faster than net sales. -et income cannot also have
gro"n faster than net sales, or the sum of the parts "ould exceed the si2e
of the "hole.
2. -et income must represent a smaller percentage of net sales in 2==, than
it did in 2==). 'gain, the reason is that the expenses have gro"n at a
faster rate than net sales. Thus, total expenses represent a larger
percentage of total sales in 2==, than in 2==), and net income must
represent a smaller percentage.
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Financial Statements Analysis - I Chapter 4
"ro#le$ ! (*inan%ial State$ent Anal+sis usin& Co$parati,e State$ents
or In%rease--e%rease Metho')
Requirement 1
./0 Corporation
1alan%e Sheet
As o) -e%e$#er !1
Change
Peso %
2005 2006
Assets
1ash and e%uivalents 1(,=== 1,,=== 2,=== 14234
9eceivables 2;,;== )),,== 2,,;== <&.=,A
Inventories )(,=== ;),,== !15677 89284
6repayments and others (,;== :,(== 2,,== )(.1:A
Total current assets 1=1,,== 1,(,,== 6!5777 ,2.=1A
6roperty, plant F e%uipment ! net
of dep. &=,2== :&,(== (&,2== 1(&.=)A
Total assets 1&1,;== 2&;,=== 176577 972894
Lia#ilities an' E:uit+
-otes payable to ban#s 1=,=== )(,=== ((,=== ((=.==A
'ccounts payable &1,,== )),(== 2&,;== ;!2!4
'ccrued liabilities (,2== ,,;== 2,,== ,1.<=A
Income taxes payable ),;== :,=== 1577 72634
Total current liabilities )1,,== 12&,2== ;15677 1!92;64
hare capital ((,,== ((,,== = =.==A
9etained earnings &),,== :=,2== &(,,== 3;2134
Total e%uity ;=,2== 11(,;== &(,,== (&.1(A
Total liabilities and e%uity 1&1,;== 2&;,=== 176577 972894
./0 Corporation
In%o$e State$ent
/ears en'e' -e%e$#er !1
(" thousan's)
Change
Peso %
2005 2006
-et sales 2,,,(== (2(,=== 1):,,== 832164
1ost of goods sold 1<1,(== &1(,,== 12&,2== ,(.&:A
7ross profit :),=== 1=<,(== !45477 4829;4
elling, general and administrative
expenses &),)== );,(== 5377 ,(.)1A
Income before income taxes &<,)== )1,=== 11,)== 2<.11A
Income taxes 12,&== 1,,(== (,1== &&.&&A
-et income 2:,2== &(,,== ;5477 ;214
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Chapter 4 Financial Statements Analysis - I
Requirement 2
Short-ter$ )inan%ial position
1. 1urrent
'ssets
increased by ,2.=1A "hile
1urrent
Giabilities
increased by 1&;.:,A
nfa!orab"e
2. Huic#
'ssets
increased by ,2.(=A "hile
1urrent
Giabilities
increased by 1&;.:,A
nfa!orab"e
&. -et
ales
increased by )<.1,A "hile
'ccounts
9eceivable
increased by <&.=,A
nfa!orab"e
(. 1ost of
7oods old
increased by ,(.&:A "hile
Inventories
increased by );.)2A
#a!orab"e
Le,era&e
). Total
'ssets
increased by ;=.);A "hile
Total
Giabilities
increased by 1&;.:,A
nfa!orab"e
,. Total
Giabilities
increased by 1&;.:,A "hile
Total
+%uity
increased by (&.1(A
nfa!orab"e
"ro)ita#ilit+
:. -et
ales
increased by )<.1,A "hile
1ost of
7oods old
increased by ,(.&:A
nfa!orab"e
;. -et
ales increased by )<.1,A "hile
elling,
7eneral F
'dministrative
+xpenses
increased by ,(.)1A
nfa!orab"e
<. -et
ales
increased by )<.1,A "hile
-et
Income
increased by 2:.21A
nfa!orab"e
1=. -et
Income
increased by 2:.21A "hile
Total
'ssets
increased by ;=.);A
nfa!orab"e
"ro#le$ 4 (Tren' "er%enta&es)
Requirement (1)
The trend percentages are:
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Financial Statements Analysis - I Chapter 4
$ear 5 $ear % $ear & $ear 2 $ear 1
ales 12).= 12=.= 11=.= 1=).= 1==.=
1ash ;=.= <=.= 1=).= 11=.= 1==.=
'ccounts receivable 1(=.= 12(.= 1=;.= 1=(.= 1==.=
Inventory 112.= 11=.= 1=2.= 1=;.= 1==.=
Total current assets 11;.; 11&.1 1=(.1 1=,.< 1==.=
1urrent liabilities 1&=.= 1=,.= 1=;.= 11=.= 1==.=
Requirement (2)
ales: The sales are increasing at a steady rate, "ith a particularly
strong gain in Iear (.
'ssets: 1ash declined from Iear & through Iear ). This may have been
due to the gro"th in both inventories and accounts receivable.
In particular, the accounts receivable gre" far faster than sales
in Iear ). The decline in cash may reflect delays in collecting
receivables. This is a matter for management to investigate
further.
Giabilities: The current liabilities jumped up in Iear ). This "as probably
due to the buildup in accounts receivable in that the company
doesnt have the cash needed to pay bills as they come due.
"ro#le$ 8 (Use o) Tren' "er%enta&es)
a. 1. 'n unfavorable tendency could be observed in 9eceivables in relation
to -et ales from 2==& J 2==) because receivables had been
increasing at a much faster rate than -et ales. This could indicate
inefficiency in the collection of receivables or simply poor company
credit policy. The situation ho"ever, improved in 2==, and 2==:
"hen sales started to move up at a faster rate than accounts
receivable. This "ould indicate improvement in the credit and
collection policy or more cash sales "ere being generated.
2. 5nfavorable tendency in inventory persisted from 2==& to 2==:
because it had been going up at a much faster rate than -et ales. If
this continues, the company "ill end up "ith over!investment in
inventory because the buying rate is faster than the selling price.
&. $avorable tendencies could be noted in $ixed 'ssets in relation to -et
ales because inspite of the minimal additions to fixed assets made by
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Chapter 4 Financial Statements Analysis - I
the company from 2==& through 2==:, sales had been increasing at a
very encouraging rate.
(. -et Income had li#e"ise been increasing at a much faster rate than
net sales. This is favorable because this "ould indicate that the
company had been successfully controlling the increases in 1ost of
ales and >perating +xpenses.
b. 9evie" computations of the Trend 6ercentages. It "ill be noted that the
Trend 6ercentages in Total -oncurrent Giabilities and +%uity from 2==)
to 2==: "ere interchanged. 1orrection should be made first before
interpretation is done.
1. The up"ard tendency in current assets had been accompanied by an
up"ard trend in current liabilities. It could be noted that current
assets had been moving up at a much faster rate than current
liabilities. This is favorable because the margin of safety of the short!
term creditors is "idened.
2. $avorable tendencies could also be observed in noncurrent assets
"hich had been increasing and "hich increases had been accompanied
by do"n"ard trend in noncurrent liabilities. This "ould mean better
security on the part of creditors and stronger financial position.
&. There is an unfavorable tendency in -et ales in relation to non!
current assets. ales had not been increasing at the same rate as the
increases in fixed assets. This could indicate that more investments
are made in noncurrent assets "ithout considering "hether or not they
could sell the additional units of product they are producing.
c. The unfavorable trend in net income could be attributed to the follo"ing
tendencies:
1. 3igher rates of increases in cost of sales as compared to sales.
2. 3igher rates of increases in selling, general and administrative
expenses in relation to net sales.
&. 3igher rates of increases in other financial expenses than the rates of
increases in net sales.
I.. Multiple Choice Questions
1. K 11. ', 1, K
2. ' 12. ?L
&. ' 1&. K
(. ?
). K
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Financial Statements Analysis - I Chapter 4
,. 1
:. 1
;. '
<. K
1=. 1
' (P%00(000 ) P160(000) P160(000 * 150%
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