1. 23–1 McQuaig Bille 1 College Accounting 10 th Edition McQuaig Bille Nobles © 2011 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University Chapter 23 Comparative Financial Statements

2. 23–2 Accounting Language  Accounting is the process of analyzing, classifying, recording, summarizing, and interpreting business transactions.  Everybody is interested in two aspects of an enterprise: 1.Its solvency, or its ability to pay its debts. 2.Its profitability, or its ability to earn a reasonable profit on the owners’ investment.

3. 23–3 Types of Comparisons A company’s financial statements are meaningful only if you analyze them on a comparative basis. Three bases are useful for making such a comparison: 1.Statements of the same company for the current year and one or more prior years. 2.Financial data for other companies in the same industry. 3.Previously established financial standards or objectives.

4. 23–4 Horizontal Analysis—Income Statement  Horizontal analysis is a comparison of the same item in a company’s financial statements for two or more periods.  We will analyze the comparative income statements for Dynamo Bike Shop, Inc.

5. 23–5 $120,400 $861,700 = 14.0% Sales Horizontal Analysis—Income Statement

6. 23–6 $(600) $13,100 = (4.6)% Sales Returns and Allowances Horizontal Analysis—Income Statement

7. 23–7 $20,070 $184,400 = 10.9% Total Operating Expenses Horizontal Analysis—Income Statement

8. 23–8 $6,360 $69,530 = 9.1% Net Income Horizontal Analysis—Income Statement

9. 23–9 By using the Total Asset section of the comparative balance sheet, let’s calculate the percentage change for Cash and Merchandise Inventory. Then, we will calculate the change in Accounts Payable using the Liabilities and Stockholders’ Equity sections of Dynamo Bike Shop Inc.’s balance sheet. Horizontal Analysis—Balance Sheet

10. 23–10 $(16,900) $38,900 = (43.7)% Cash Horizontal Analysis—Balance Sheet

11. 23–11 $141,900 $206,500 = 68.7% Merchandise Inventory Horizontal Analysis—Balance Sheet

12. 23–12 $41,100 $29,000 = 141.7% Accounts Payable Horizontal Analysis—Balance Sheet

13. 23–13  Using vertical analysis, you can see in a single statement the relationship of each part to the whole.  When you arrange an income statement for vertical analysis, you express each item as a percentage of net sales. Vertical Analysis—Income Statement

14. 23–14 $306,700 $969,600 = 31.6% Gross Profit, 2011 Vertical Analysis—Income Statement

15. 23–15 $279,800 $848,600 = 33.0% Gross Profit, 2010 Vertical Analysis—Income Statement

16. 23–16  In 2011, the vertical analysis provided a 31.6 percent ratio of Gross Profit to Net Sales. This can be interpreted to mean that for every $100 in net sales, gross profit was $31.60.  In 2010, the ratio of Gross Profit to Net Sales was 33.0%. This means that for every $100 in net sales, gross profit was $33.00. Vertical Analysis—Income Statement

17. 23–17  When you perform a vertical analysis of a comparative balance sheet, you express the figure for each item as a percentage of total assets.  Or, you can express the figure for each item as a percentage of the total of liabilities and stockholders equity, which is the same figure. Vertical Analysis—Balance Sheet

18. 23–18 $21,800 $708,200 = 3.1% Cash, 2011 Vertical Analysis—Balance Sheet

19. 23–19 $38,700 $604,500 = 6.4% Cash, 2010 (continued) Vertical Analysis—Balance Sheet

20. 23–20 $76,400 $708,200 = 10.8% Accounts Receivable (net) 2011 Vertical Analysis—Balance Sheet

21. 23–21 $78,800 $604,500 = 13.0% Accounts Receivable (net) 2011 rounded Vertical Analysis—Balance Sheet

22. 23–22 $348,400 $708,200 = 49.2% Merchandise Inventory, 2011 Vertical Analysis—Balance Sheet

23. 23–23 $206,500 $604,500 = 34.2% Merchandise Inventory, 2010 Vertical Analysis—Balance Sheet

24. 23–24 Trend Percentages 1.Select a representative year as the base year. 2.Label the base year 100 percent. 3.Express all other years a percentages of the base year. Here is the way to calculate trend percentages:

25. 23–25 Trend Percentages 100.0% For 2008: $782,380 $714,200 = 1.095 x 100 = 109.5% 109.5%

26. 23–26 Trend Percentages 100.0% For 2009: $806,400 $714,200 = 1.129 x 100 = 112.9% 109.5%112.9%

27. 23–27 Trend Percentages 100.0% For 2010: $848,600 $714,200 = 1.188 x 100 = 118.8% 109.5%112.9% 118.8%

28. 23–28 Trend Percentages 100.0% For 2011: $969,600 $714,200 = 1.358 x 100 = 135.8% 109.5%112.9% 118.8%135.8%

29. 23–29 Trend Percentages Repeat the procedure for Cost of Goods Sold and Gross Profit to get the trend percentage chart. Observe that, over the five-year period, the trend of Net Sales is upward. However, Cost of Goods Sold is going up at a more rapid rate than Net Sales. This resulted in smaller increases in Gross Profit.

30. 23–30 Industry Comparisons  Vertical analysis, using percentage figures, is useful when you wish to compare the figures for one company with the average figures for the given industry.  The format of the financial statement defines it as a common-size statement.  Common-size statements can be used to compare one company with another as well as with the industry averages.  Trade and marketing associations often gather information and publish common-size statements.

31. 23–31 Analysis by Creditors and Management  Bankers and other short-term creditors are primarily interested in the current position of a given firm, which can be assessed using comparative financial statements.

32. 23–32 Working Capital Working capital is the excess of current assets over current liabilities. Working Capital = Current Assets – Current Liabilities

33. 23–33 Current Ratio The relationship of a company’s current assets to its current liabilities is its current ratio. Current Ratio = Current Assets Current Liabilities A firm’s current ratio reveals its current debt- paying ability.

34. 23–34 Quick Ratio  The relationship of a company’s current assets that can be quickly converted into cash to its current liabilities is known as is its quick ratio or acid-test ratio.  Quick assets are Cash, Notes receivable, net Accounts Receivable, Interest Receivable, and Marketable Securities.  Quick assets do not include inventories and prepaid expenses. Quick Ratio = Quick Assets Current Liabilities

35. 23–35 Quick Ratio  A quick ratio of 1 is considered satisfactory.  Although working capital and a current ratio are two indicators of a firm’s ability to meet its current obligations, they don’t reveal the composition of its current assets—a very important factor.

36. 23–36 Relationship of Each Current Asset to Total Current Assets $21,800 $448,600 = 0.0486 = 4.9%

37. 23–37 Accounts Receivable Turnover  Accounts receivable turnover is the number of times charge accounts are turned over (or paid off) per year.  A turnover implies a sale on account followed by payment of the debt in cash. Accounts Receivable Turnover Net Sales on Account Average Accounts Receivable (Net) = Average Accounts Receivable Beginning Accounts Receivable (Net) = Ending Accounts Receivable (Net) + 2

38. 23–38 Merchandise Inventory Turnover Cost of Goods Sold Average Merchandise Inventory = Merchandise inventory turnover is the number of times a company’s average inventory is sold during a given year. Average Merchandise Inventory Beginning Merchandise Inventory = + Ending Merchandise Inventory 2

39. 23–39 Ratio of Stockholders’ Equity to Liabilities The ratio of stockholders’ equity to liabilities is the ratio of the stockholders’ investment to the creditors’ claims. Ratio of Stockholders’ Equity to Liabilities Stockholders’ Equity Liabilities = Creditors like to see a high proportion of stockholders’ equity because stockholders’ equity acts as a buffer in case the company has to absorb losses.

40. 23–40 Ratio of Property and Equipment to Long-Term Liabilities  Another factor that provides a margin of safety to mortgage holders and bondholders is the ratio of the value of a firm’s total property and equipment to its long-term liabilities.  This ratio also indicates the potential ability of the enterprise to borrow more money on a long-term basis. Ratio of Property and Equipment to Long- Term Liabilities Property and Equipment Long-Term Liabilities =

41. 23–41 Analysis by Owners and Management  Owners and managers are vitally interested in the value of and return on investment in the company.  In many cases, the owners are the managers.  In other situations, managers are employed by the owners.

42. 23–42 Equity per Share  When you examine the annual report of a corporation, you encounter the term book value per share, also referred to as equity per share.  If a corporation has only one class of common stock outstanding, the formula for equity per share is straight-forward. Equity per Share Total Stockholders’ Equity Available to a Class of Stock Number of Shares Issued and Outstanding =

43. 23–43 Equity per Share  The term equity per share does not mean the cash value or market value of a share.  It means the amount that would be distributed per share of stock on a book basis if the corporation were to liquidate without incurring any expenses, gains, or losses in selling assets and paying its liabilities.  When there are preferred stock outstanding, you must deduct the liquidation value of the preferred stockholders’ equity, including any dividends in arrears on cumulative preferred stock, to arrive at the stockholders’ equity available to holders of common stock.

44. 23–44 Rate of Return on Common Stockholders’ Equity  A corporation exists first and foremost to earn a net income for its stockholders.  The rate of return on the common stockholders’ equity is important as a means of measuring how good or bad the investment is.  The formula: Rate of Return on Common Stockholders’ Equity = Net Income Available to Common Stockholders Average Common Stockholders’ Equity

45. 23–45 Rate of Return on Common Stockholders’ Equity  First, you must calculate the average common stockholders’ equity. Beginning Common Stockholders’ Equity + Ending Common Stockholders’ Equity 2

46. 23–46 Earnings per Share of Common Stock Net Income Available to Common Stockholders Average Number of Shares of Common Stock Outstanding =

47. 23–47 Price-Earnings Ratio The price-earnings ratio is a measure commonly used to determine whether the market price of a corporation’s stock is reasonable. Price-Earnings Ratio = Market Price per Share Earnings per Share

48. 23–48 Summary of Analytical Tools

49. 23–49 Summary of Analytical Tools