NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila.

NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila Elworthy and Tana Kristjanson Copyright © 2014 by Nelson Education Ltd.1

After studying this chapter, you should be able to: 1.Describe basic financial statement analytical methods. 2.Use ratio analysis to assess the liquidity of a business. 3.Use ratio analysis to assess the efficiency of a business. Financial Statement Analysis Copyright © 2014 by Nelson Education Ltd.3

After studying this chapter, you should be able to: 4.Use ratio analysis to assess the solvency of a business. 5.Use ratio analysis to assess the profitability of a business. 6.Describe the contents of corporate annual reports. Financial Statement Analysis Copyright © 2014 by Nelson Education Ltd.4

Basic Analytical Methods Users analyze a company’s financial statements using a variety of analytical methods. Three such methods are as follows: 1.Horizontal analysis 2.Vertical analysis 3.Common-sized statements 4.Ratio analysis Copyright © 2014 by Nelson Education Ltd.6

9 Horizontal Analysis: Difference $17,000 Base year (2014) $533,000 = 3.2%

EXAMPLE EXERCISE 17-1 Horizontal Analysis The cash and accounts receivable balances for a company are provided below. Based on this information, what is the amount and percentage of increase or decrease that would be shown in a balance sheet with horizontal analysis? Copyright © 2014 by Nelson Education Ltd.14

FOLLOW MY EXAMPLE 17-1 Horizontal Analysis Cash $12,500 increase ($62,500 – $50,000), 25% Accounts receivable $5,600 decrease ($74,400 – $80,000), 7% For Practice: PE 17-1 Copyright © 2014 by Nelson Education Ltd.15

Vertical Analysis of Balance Sheet In a vertical analysis of the balance sheet, the percentages are computed as follows: Each asset item is stated as a percent of the total assets. Each liability and shareholders’ equity item is stated as a percent of the total liabilities and shareholders’ equity. Copyright © 2014 by Nelson Education Ltd.17

EXAMPLE EXERCISE 17-2 Vertical Analysis Income statement information for Lee Corporation is provided below. Prepare a vertical analysis of this income statement information for Lee Corporation. Copyright © 2014 by Nelson Education Ltd.18

Common-Size Statements In a common-sized statement, a presentation form of vertical analysis, all items are expressed as a percentage. Common-sized statements are useful for comparing one company with another or for comparing a company with industry averages. Copyright © 2014 by Nelson Education Ltd.25

Ratio Analysis Users of financial statements are interested in the ability of a company to do the following: Meet its short-term financial obligations (debts), known as liquidity. Use its assets to the best of its ability, known as efficiency. Copyright © 2014 by Nelson Education Ltd.27

Ratio Analysis Meet its long-term financial obligations (debts), or solvency. Earn income, known as profitability. Ratio analysis helps provide this information. Copyright © 2014 by Nelson Education Ltd.28

Working Capital Working Capital = Current Assets – Current Liabilities The excess of current assets of a business over its current liabilities is called working capital. The working capital is often used in evaluating a company’s ability to pay current liabilities. Copyright © 2014 by Nelson Education Ltd.33

The working capital for Langley Company is computed below: Copyright © 2014 by Nelson Education Ltd.34 2015 2014 Current assets$550,000$533,000 Current liabilities –210,000–243,000 Working capital$340,000$290,000 Working Capital = Current Assets – Current Liabilities

Current Ratio The current ratio, sometimes called the working capital ratio, measures a company’s ability to pay its current liabilities. Copyright © 2014 by Nelson Education Ltd.35 Current Ratio = Current Assets Current Liabilities

Quick Ratio A ratio that measures the “instant” debt-paying ability of a company is called the quick ratio or acid-test ratio. Copyright © 2014 by Nelson Education Ltd.37 Quick Ratio = Quick Assets Quick Liabilities

Copyright © 2014 by Nelson Education Ltd.38 2015 2014 Quick assets: Cash$90,500$64,700 Temporary Investments75,00060,000 Accounts Receivable (net)115,000120,000 a. Total quick assets$280,500$244,700 b. Current liabilities $210,000 $243,000 Quick ratio (a/b) 1.31 1.02 Quick assets are cash and other current assets that can be quickly converted to cash.

EXAMPLE EXERCISE 17-3 Liquidity Analysis The following items are reported on a company’s balance sheet: Cash $300,000 Temporary investments 100,000 Accounts receivable (net) 200,000 Inventories 200,000 Accounts payable 400,000 Determine (a) the current ratio and (b) the quick ratio. Copyright © 2014 by Nelson Education Ltd.39

EXAMPLE EXERCISE 17-3 Liquidity Analysis Copyright © 2014 by Nelson Education Ltd.40 a.Current Ratio = Current Assets ÷ Current Liabilities Current Ratio = ($300,000 + $100,000 + $200,000 + $200,000) ÷ $400,000 Current Ratio = 2.0 b.Quick Ratio = Quick Assets ÷ Current Liabilities Quick Ratio = ($300,000 + $100,000 + $200,000) ÷ $400,000 Quick Ratio = 1.5 For Practice: PE 17-3

Efficiency Analysis Accounts receivable turnover Days’ sales in receivables Inventory turnover Days’ sales in inventory Total asset turnover Copyright © 2014 by Nelson Education Ltd.43 Accounts Receivable Analysis Inventory Analysis

Accounts Receivable Turnover The relationship between sales and accounts receivable may be stated as the accounts receivable turnover. Collecting accounts receivable as quickly as possible improves a company’s liquidity. Copyright © 2014 by Nelson Education Ltd.44 Accounts Receivable Turnover Net Sales Average Net Accounts Receivable =

Copyright © 2014 by Nelson Education Ltd.45 2015 2014 a. Net Sales$1,498,000 $1,200,000 Accounts Receivable (net): Beginning of year$120,000$140,000 End of year115,000120,000 b. Average (Total/2)$235,000$260,000 Accounts receivable turnover (a/b)12.7 times9.2 times Langley Company:

Copyright © 2014 by Nelson Education Ltd.48 2015 2014 a. Average accounts receivable (net) (Total accounts receivable/2)$117,500$130,000 Net sales$1,498,000$1,200,000 b. Average daily sales (Sales/365)$4,104$3,288 Days’ sales in Receivables (a/b)28.6 days39.5 days

EXAMPLE EXERCISE 17-4 Accounts Receivable Analysis A company reports the following: Net sales $960,000 Average accounts receivable (net) 48,000 Determine (a) the accounts receivable turnover and (b) the days’ sales in receivables, using both methods for calculating the days’ sales in receivables ratio. Round to one decimal place. Copyright © 2014 by Nelson Education Ltd.50

FOLLOW MY EXAMPLE 17-4 Accounts Receivable Analysis a.Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable Accounts Receivable Turnover = $960,000 ÷ $48,000 Accounts Receivable Turnover = 20.0 times Copyright © 2014 by Nelson Education Ltd.51

FOLLOW MY EXAMPLE 17-4 Accounts Receivable Analysis b.Days’ Sales in Receivables = Average Accounts Receivable ÷ Average Daily Sales Days’ Sales in Receivables = $48,000 ÷ ($960,000/365) = $48,000 ÷ $2,630 Days’ Sales in Receivables = 18.3 days Days’ Sales in Receivables = 365 ÷ Accounts Receivable Turnover Days’ Sales in Receivables = 365 ÷ 20.0 Days’ Sales in Receivables = 18.3 days For Practice: PE 17-4 Copyright © 2014 by Nelson Education Ltd.52

Inventory Analysis While a company should keep enough inventory in stock so that it doesn’t lose sales, excess inventory decreases working capital, increases inventory related expenses, and increases the risk of losses due to price declines or obsolescence. Copyright © 2014 by Nelson Education Ltd.54

Inventory Turnover The relationship between the volume of goods (merchandise) sold and inventory may be stated as the inventory turnover. The purpose of this ratio is to assess the efficiency of the firm in managing its inventory. Copyright © 2014 by Nelson Education Ltd.55 Inventory Turnover = Cost of Goods Sold Average Inventory

a. Costs of goods sold$1,043,000$ 820,000 Inventories: Beginning of year$283,000$311,000 End of year264,000283,000 Total$547,000$594,000 b. Average (Total/2) $ 273,500$297,000 Inventory turnover (a/b) 3.8 times2.8 times Copyright © 2014 by Nelson Education Ltd.56 2015 2014

Copyright © 2014 by Nelson Education Ltd.59 a. Average inventory (Total/2)$273,500$ 297,000 Cost of goods sold$1,043,000$ 820,000 b. Average daily cost of goods sold (COGS/365 days)$ 2,858$2,247 Days’ sales in inventory (a/b) 95.7 days132.2 days 2015 2014

Days’ Sales in Inventory The days’ sales in inventory can also be calculated from the inventory turnover ratio as follows: Copyright © 2014 by Nelson Education Ltd.60 Days’ Sales in Inventory 365 Inventory Turnover =

EXAMPLE EXERCISE 17-5 Inventory Analysis A company reports the following: Cost of goods sold $560,000 Average inventory 112,000 Determine (a) the inventory turnover and (b) the days’ sales in inventory, using both methods for calculating the days’ sales in inventory ratio. Round to one decimal place. Copyright © 2014 by Nelson Education Ltd.61

FOLLOW MY EXAMPLE 17-5 Inventory Analysis a.Inventory Turnover = Cost of Goods Sold ÷ Average Inventory Inventory Turnover = $560,000 ÷ $112,000 Inventory Turnover = 5.0 times Copyright © 2014 by Nelson Education Ltd.62

FOLLOW MY EXAMPLE 17-5 Inventory Analysis b.Days’ Sales in Inventory = Average Inventory ÷ Average Daily Cost of Goods Sold Days’ Sales in Inventory = $112,000 ÷ ($560,000/365) = $112,000 ÷ $1,534 Days’ Sales in Inventory = 73.0 days Days’ Sales in Inventory = 365 ÷ Inventory Turnover Days’ Sales in Inventory = 365 ÷ 5.0 Days’ Sales in Inventory = 73.0 days For Practice: PE17-5 Copyright © 2014 by Nelson Education Ltd.63

Copyright © 2014 by Nelson Education Ltd.65 a. Net sales$1,498,000$1,200,000 Total Assets: Beginning of year$1,230,500$1,187,500 End of year1,139.5001,230,500 Total $2,370,000$2,418,000 b. Average (Total/2)$1,185,000$2,418,000 Total asset turnover (a/b) 1.3 times 1.0 times 2015 2014

Solvency Analysis Solvency analysis focuses on the ability of a company to pay its long- term liabilities. It is normally assessed using the following ratios: Debt ratio Times interest earned ratio Copyright © 2014 by Nelson Education Ltd.67

Debt Ratio The debt ratio measures the percentage of assets that are financed with debt and is computed as follows: Copyright © 2014 by Nelson Education Ltd.68 Debt Ratio Total Liabilities Total Assets =

EXAMPLE EXERCISE 17-6 Debt Ratio The following information was taken from Acme Company’s balance sheet: Total assets $1,960,000 Long-term liabilities 400,000 Total liabilities 560,000 Total shareholders’ equity 1,400,000 Determine the company’s debt ratio. Copyright © 2014 by Nelson Education Ltd.70

Times Interest Earned Ratio The times interest earned ratio measures the risk that interest payments will not be made if earnings decrease. It is computed as follows: Copyright © 2014 by Nelson Education Ltd.72 Times Interest Earned Income Before Income Taxes + Interest Expense Interest Expense =

Copyright © 2014 by Nelson Education Ltd.73 Income before income taxes$162,500$134,600 a. Add interest expense6,000 12,000 Amount available to meet interest charges$168,500 $146,600 Times interest earned (b/a)28.1 times 12.2 times 2015 2014 Langley Company:

EXAMPLE EXERCISE 17-7 Times Interest Earned Ratio A company reports the following: Income before income taxes $250,000 Interest expense 100,000 Determine the times interest earned ratio. Copyright © 2014 by Nelson Education Ltd.74

FOLLOW MY EXAMPLE 17-7 Times Interest Earned Ratio Times Interest Earned = (Income Before Income Taxes + Interest Expense) ÷ Interest Expense Times Interest Earned = ($250,000 + $100,000) ÷ $100,000 Times Interest Earned = 3.5 times For Practice: PE 17-7 Copyright © 2014 by Nelson Education Ltd.75

Profitability Analysis Profitability analysis focuses primarily on the relationship between operating results and the resources available to a business. It includes the following: Copyright © 2014 by Nelson Education Ltd.77

Profitability Analysis Profit margin Gross margin Return on assets Return on common shareholders’ equity Earnings per share Price-earnings ratio Dividend yield Copyright © 2014 by Nelson Education Ltd.78

Gross Margin The gross margin, also referred to as the gross profit margin, assesses a company’s ability to earn a return on merchandise sold before other expenses are considered. Copyright © 2014 by Nelson Education Ltd.81 Gross Margin Gross Profit Net Sales =

EXAMPLE EXERCISE 17-8 Profit Margin and Gross Margin A company reports the following: Net Sales $1,450,000 Gross profit 754,000 Net income 101,500 Determine (a) the company’s profit margin and (b) the company’s gross margin. Copyright © 2014 by Nelson Education Ltd.83

FOLLOW MY EXAMPLE 17-8 Profit Margin and Gross Margin a.Profit Margin = Net Income ÷ Net Sales Profit Margin = $101,500 ÷ $1,450,000 Profit Margin = 7.0% b.Gross Margin = Gross Profit ÷ Net Sales Gross Margin = $754,000 ÷ $1,450,000 Gross Margin = 52.0% For Practice: PE 17-8 Copyright © 2014 by Nelson Education Ltd.84

Return on Assets The return on assets measures the profitability of total assets, without considering how the assets are financed. Copyright © 2014 by Nelson Education Ltd.85 Return on Assets Net Income Average Total Assets =

Copyright © 2014 by Nelson Education Ltd.86 a. Net income$ 91,000$ 76,500 Total assets: Beginning of year$1,230,500 $1,187,500 End of year1,139,5001,230,500 Total$2,370,000$2,418,000 b. Average (Total/2)$1,185,000$1,209,000 Return on total assets (a/b)7.7% 6.3% 2015 2014

Return on Operating Assets The return on operating assets is sometimes computed when there are large amounts of nonoperating income and expenses. Copyright © 2014 by Nelson Education Ltd.87 Return on Operating Assets Income from Operations Average Operating Assets =

EXAMPLE EXERCISE 17-9 Return on Assets A company reports the following income statement and balance sheet information for the current year: Net income $ 125,000 Total assets, beginning of year1,770,000 Total assets, end of year 2,000,000 Determine the return on assets. Copyright © 2014 by Nelson Education Ltd.88

FOLLOW MY EXAMPLE 17-9 Return on Assets Return on Assets = Net Income ÷ Average Total Assets Return on Assets = $125,000 ÷ (($1,770,000 + $2,000,000) ÷ 2) Return on Assets = $125,000 ÷ $1,885,000 Return on Assets = 6.6% For Practice: PE 17-9 Copyright © 2014 by Nelson Education Ltd.89

Return on Common Shareholders’ Equity The return on common shareholders’ equity measures the rate of income earned on the amount invested by the common shareholders. Copyright © 2014 by Nelson Education Ltd.90 Return on Common Shareholders’ Equity Net Income – Preferred Dividends Average Common Shareholders’ Equity = Includes both contributed capital and retained earnings

Copyright © 2014 by Nelson Education Ltd.91 a. Net income$ 91,000$ 76,500 Less preferred dividends 9,0009,000 Total$ 82,000$ 67,500 Common shareholders’ equity: Beginning of year$ 637,500$ 600,000 End of year679,500 637,500 Total$1,317,000$1,237,500 b. Average (Total/2)$ 658,500$618,750 Return on common shareholders’ equity (a/b) 12.5% 10.9% 2015 2014

Leverage The use of debt to finance operations is called leverage. Leverage magnifies both gains and losses. Common shareholders may receive a higher return if the company performs well, but the loss will be greater if the company does not perform well. Copyright © 2014 by Nelson Education Ltd.92

EXAMPLE EXERCISE 17-10 Return on Common Shareholders’ Equity A company reports the following: Net income $ 125,000 Preferred dividends 5,000 Average shareholders’ equity 1,000,000 Average common shareholders’ equity 800,000 Determine the return on common shareholders’ equity. Copyright © 2014 by Nelson Education Ltd.93

FOLLOW MY EXAMPLE 17-10 Return on Common Shareholders’ Equity Return on Common Shareholders’ Equity = (Net Income – Preferred Dividends) ÷ Average Common Shareholders’ Equity Return on Common Shareholders’ Equity = ($125,000 – $5,000) ÷ $800,000 Return on Common Shareholders’ Equity = 15% For Practice: PE 17-10 Copyright © 2014 by Nelson Education Ltd.94

Earnings per Share Earning per share (EPS) measures the share of profits that are earned by a common share. Companies preparing financial statements using IFRS must report earnings per share in the statement of comprehensive income. Copyright © 2014 by Nelson Education Ltd.95

Copyright © 2014 by Nelson Education Ltd.97 Net income$91,000$76,500 Preferred dividends9,000 9,000 a. Total$82,000$67,500 b. Number of common shares50,00050,000 outstanding Earnings per share (a/b)$1.64 $1.35 2015 2014

Weighted Average Number of Common Shares If there is a change in the number of common shares outstanding during the year, it is necessary to calculate the weighted average number of common shares for the EPS ratio. Copyright © 2014 by Nelson Education Ltd.98

Norman Company started the year with 100,000 common shares, issued an additional 35,000 shares on July 1 and repurchased 12,000 shares on November 1. The company had net income of $1,246,200 and paid preferred dividends of $45,000. Copyright © 2014 by Nelson Education Ltd.99

EXAMPLE EXERCISE 17-11 Earnings per Share A company reports the following: Net income $1,000,000 Preferred dividends $ 50,000 Number of common shares outstanding at December 31 year-end20,000 a.Determine the weighted average number of shares, given that 4,000 shares were issued on October 3. b.Determine the company’s earnings per share, rounding to two decimal places. Copyright © 2014 by Nelson Education Ltd.101

FOLLOW MY EXAMPLE 17-11 Earnings per Share a.Weighted average number of shares = 16,000 × 9/12 + 20,000 × 3/12 Weighted average number of shares = 12,000 + 5,000 Weighted average number of shares = 17,000 b.Earnings per Share = ($1,000,000 – $50,000) ÷ 17,000 Earnings per Share = $55.882, rounded to $55.88 For Practice: PE 17-11 Copyright © 2014 by Nelson Education Ltd.102

Price-Earnings Ratio Another profitability measure quoted by the financial press is the price-earnings (P/E) ratio on common shares. The price- earnings ratio on common shares measures a company’s future earnings prospects. Copyright © 2014 by Nelson Education Ltd.103 Price-Earnings (P/E) Ratio Market Price per Common Share Earnings per Share =

EXAMPLE EXERCISE 17-12 Earnings per Share and Price-Earnings Ratio A company reports the following: Net income $250,000 Preferred dividends $15,000 Number of common shares outstanding 20,000 Market price per common share $ 35.00 a.Determine the company’s earnings per share. b.Determine the company’s price-earnings ratio. Round to one decimal place. Copyright © 2014 by Nelson Education Ltd.105

FOLLOW MY EXAMPLE 17-12 Earnings per Share and Price-Earnings Ratio a.Earnings per Share = (Net Income – Preferred Dividends) ÷ Weighted Average Number of Common Shares Outstanding Earnings per Share = ($250,000 – $15,000) ÷ 20,000 Earnings per Share = $11.75 Copyright © 2014 by Nelson Education Ltd.106

FOLLOW MY EXAMPLE 17-12 Earnings per Share and Price-Earnings Ratio b.Price-Earnings Ratio = Market Price per Share ÷ Earnings per Share Price-Earnings Ratio = $35.00 ÷ $11.75 Price-Earnings Ratio = 3.0 For Practice: PE 17-12 Copyright © 2014 by Nelson Education Ltd.107

Dividend Yield The dividend yield measures the rate of return to common shareholders from cash dividends. Copyright © 2014 by Nelson Education Ltd.108 Dividend Yield Annual Dividends per Share Market Price per Share =

Notes to the Financial Statements Notes provide: Additional detail. Improved understandability of information contained in the statements. Information on accounting policies choices. Copyright © 2014 by Nelson Education Ltd.113

Notes to the Financial Statements Information on items not shown on the statements. Better comparability between statements prepared by different companies. (Understandability and comparability are two qualitative characteristics of the conceptual framework) Copyright © 2014 by Nelson Education Ltd.114

Corporate Annual Reports In addition to the financial statements and the accompanying notes, corporate annual reports usually include the following sections: Management discussion and analysis Management letter Auditor’s report Copyright © 2014 by Nelson Education Ltd.115

Management Discussion and Analysis The Management Discussion and Analysis (MD&A) includes an analysis of the results of operations and discusses management’s opinion about future performance. It compares the prior year’s income statement with the current year’s. It also contains an analysis of the firm’s financial condition. Copyright © 2014 by Nelson Education Ltd.116

Management Letter The report by management, entitled Management Responsibility for Financial Reporting, states management’s responsibility for establishing and maintaining internal control. In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report. Copyright © 2014 by Nelson Education Ltd.117

Auditor’s Report All publicly held corporations are required to have an independent audit (examination) of their financial statements. The professional accounting firm that conducts the audit renders an opinion on the fairness of the statements called the Auditor’s Report. Copyright © 2014 by Nelson Education Ltd.118

NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila.

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NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila.

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Presentation on theme: "NETA POWERPOINT PRESENTATIONS TO ACCOMPANY VOLUME 2 Accounting Second Canadian Edition BY WARREN/REEVE/DUCHAC/ELWORTHY/KRISTJANSON/TOBER Adapted by Sheila."— Presentation transcript:

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