More Ratio Exercises

Financial and Managerial Accounting, 18e Williams
Chapter 14 Financial Statement Analysis
127) Accounting terminology

Listed below are eight technical accounting terms introduced in this chapter:
Current ratio Return on assets Price-earnings (p/e) ratio

Quick ratio Market share Earnings per share
Debt ratio Working capital
Each of the following statements may (or may not) describe one of these technical terms. For
each statement, indicate the term described, or answer "None" if the statement does not
correctly describe any of the terms.
________ (a) The percentage of total assets financed by creditors.
________ (b) A measure of the effectiveness with which management utilizes a company's
resources, regardless of how those resources are financed.
________ (c) A company's percentage share of total dollar sales within its industry.
________ (d) Current assets less current liabilities.
________ (e) A measure reflecting investors' expectations of future profitability.
________ (f) A measure of short-term solvency often used when a company has large
inventories that cannot be quickly converted into cash.
________ (g) A ratio that helps individual stockholders relate the net income of a large
corporation to their equity investment.
Answer:
(a) Debt ratio, (b) Return on assets, (c) Market share, (d) Working capital, (e) Price-earnings
(p/e) ratio, (f) Quick ratio, (g) Earnings per share
Difficulty: 1 Easy
Topic: Tools of Analysis; Quality of Earnings; Measures of Liquidity and Credit Risk; A
Classified Balance Sheet; Multiple-Step Income Statements; Net Income; Price-Earnings Ratio;
Analysis by Common Stockholders
Learning Objecti: 14-01 Explain the uses of dollar and percentage changes, trend percentages,
component percentages, and ratios.; 14-02 Discuss the quality of a company's earnings, assets,
and working capital.; 14-03 Explain the nature and purpose of classifications in financial
statements.; 14-04 Prepare a classified balance sheet and compute widely used measures of
liquidity and credit risk.; 14-05 Prepare a multiple-step and a single-step income statement and
compute widely used measures of profitability.; 14-06 Put a company's net income into
perspective by relating it to sales, assets, and stockholders' equity.; 14-07 Compute the ratios
widely used in financial statement analysis and explain the significance of each.; 14-08 Analyze
financial statements from the viewpoints of common stockholders, creditors, and others.
Bloom's: Remember
AACSB: Analytical Thinking
1
Copyright © 2018 McGraw-Hill
128) Percentage changes
Selected information from the financial statements of Perfectly Baked Cake Co. appears
below:
2018 2017
Net sales $1,692,000 $1,600,000
Total expenses 1,470,000 1,520,000
Net income $222,000 $80,000
(a) Compute the percentage change in each of the above items from 2017 to 2018. Use a + or
- to indicate increase or decrease.
(b) Compute net income as a percentage of net sales in each year. (Round to the nearest one-
tenth of 1%)
2017 _________%
2018 _________%
2
Answer:
(a) Percentage changes in:
Net sales: +5.8%
($1,692,000 − $1,600,000) ÷ $1,600,000
Total expenses: -3.3%

($1,470,000 − $1,520,000) ÷ $1,520,000
Net income: +177.5%

($222,000 − $80,000) ÷ $80,000
(b) Net income as a percentage of sales:

2017 5.0%
($80,000 ÷ $1,600,000)
2018 13.1%
($222,000 ÷ $1,692,000)
Difficulty: 2 Medium
Topic: Tools of Analysis
Learning Objecti: 14-01 Explain the uses of dollar and percentage changes, trend percentages,
component percentages, and ratios.
Bloom's: Apply
3
129) Current ratio and working capital
The balance sheet of Red Missile Company contained the following items, among others:
Cash $180,000
Accounts Receivable $84,000
Inventory $124,000
Store Equipment (net) $236,000
Other Assets $67,500
Mortgage Payable (due in 3 years) $169,000
Note Payable (due in 10 days) $163,000
Accounts Payable $96,000
Capital Stock $67,500
Retained Earnings $197,000
(a) From the above information compute:

(1) Current assets: $________
(2) Current liabilities: $________
(3) The current ratio: ________ to 1
(4) Working capital: $________
(b) Assume that Red Missile Company pays the note payable of $163,000, thus reducing cash
to $17,000. Compute the following after the completion of this transaction:
(1) The current ratio: ________ to 1
(2) Working capital: $________
4
Answer:
(a) (1) Current assets $388,000
($180,000 + $84,000 + $124,000)
(2) Current liabilities: $259,000
($163,000 + $96,000)
(3) Current ratio: 1.5 to 1
($388,000 ÷ $259,000)
(4) Working capital: $129,000
($388,000 − $259,000)
(b) (1) Current ratio: 2.3 to 1
($388,000 − $163,000) ÷ ($259,000 −
$163,000)
(2) Working capital: $129,000
($388,000 − $163,000) − ($259,000 −
$163,000)
Topic: A Classified Balance Sheet
Learning Objecti: 14-04 Prepare a classified balance sheet and compute widely used measures
of liquidity and credit risk.
Bloom's: Apply
5
130) Measures of solvency and credit risk
Shown below are selected items appearing in a recent balance sheet of Grant Products.
(Dollar amounts are in thousands.)
Cash and cash equivalents $620

Investments in marketable securities $300
Receivables $1,400
Inventories $1,100
Prepaid expense and other current assets $450
Plant and equipment $3,300
Accounts payable $1,600
Bank loans payable within one year $300
Income taxes payable $300
Retained earnings $1,700
(a) Compute the following:

(1) Total quick assets $________
(2) Total current assets $________
(3) Total current liabilities $________
(4) Quick ratio ________ to 1
(5) Current ratio ________ to 1
(b) Research indicates an industry average quick ratio is 1.3 to 1, and a current ratio of 2.3 to
1. Based upon this information, does Grant Products appear more or less solvent than the
average company in its industry? Explain briefly.
6
Answer:
(a) (1) Quick assets: $2,320
($620 + $300 + $1,400)
(2) Current assets: $3,870
($620 + $300 + $1,400 + $1,100 + $450)
(3) Current liabilities: $2,200
($1,600 + $300 + $300)
(4) Quick ratio: 1.06
($2,320 ÷ $2,200)
(5) Current ratio:
($3,870 ÷ $2,200) 1.76 to 1
(b) Grant Products' current ratio and quick ratio both are below the industry averages. This
means that Grant Products has less liquid assets in relation to its current liabilities, and
therefore appears less solvent, than the average company in the industry.
Difficulty: 3 Hard
Bloom's: Analyze
131) Improving the current ratio

Carter Corporation financed construction of a new addition to its facilities with a large long-
term note payable. As a condition of obtaining the loan, Carter agreed to maintain a current
ratio at year-end of at least 1.7 to 1. If Carter fails to maintain this ratio, the lender may
demand immediate repayment of the principal amount of the note and all unpaid accrued
interest. As the end of the year approaches, Carter is concerned about the magnitude of its
current ratio. Suggest some actions that the company might take to increase the magnitude of
the current ratio.
Answer: Paying any current liabilities will increase the current ratio. The company could
also consider postponing until after year-end any routine transactions that would reduce
current assets, such as the acquisition of equipment or scheduled maintenance and repair
expenditures. The sale of existing inventory (or any other current asset) for a price above cost
would also cause the current ratio to increase.
Difficulty: 3 Hard
Bloom's: Analyze
7
132) Multiple-step income statement
Shown below is a recent income statement for Phaeton, Inc.:
PHAETON, INC.
Income Statement
For the Year Ended December 31, 2018
Net sales $6,000,000
Cost and expenses:
Cost of goods sold $(4,200,000 )
Operating expenses (900,000 )
Interest expense (150,000 ) ($5,250,000)
Earnings before income taxes $ 750,000
Income taxes (360,000)
Net earnings $ 390,000
Prepare an income statement for the year in a multiple-step format. (Use the grid provided
below.)
PHAETON, INC.
Income Statement
8
Answer:
PHAETON, INC.
Income Statement

Cost of goods sold 4,200,000
Gross profit 1,800,000
Operating expenses 900,000
Operating income $900,000
Non-operating expenses:
Interest expense 150,000
Income before taxes $750,000
Income tax expense 360,000
Net income $390,000
Topic: Multiple-Step Income Statements
Learning Objecti: 14-05 Prepare a multiple-step and a single-step income statement and
compute widely used measures of profitability.
Bloom's: Apply
133) Evaluating the adequacy of net income

Assume that Delta Corp. earns net income of $1,000,000 in the current year. Identify two
important factors that investors should consider in evaluating the reasonableness of this
dollar amount. Explain what investors may learn from each of these considerations.
Answer: Students are to identify two important factors to be considered in the evaluation of
a company's earnings, and to explain what investors may learn from these considerations.
Most students identify two of the following factors:
-The resources invested in the effort to generate the company's earnings (i.e., size of the
company). This consideration indicates the efficiency with which economic resources are
employed.
-The earnings of the company in prior periods. The trend in earnings indicates whether
performance is improving or deteriorating.
-The earnings of comparable companies (in size, as well as in the nature of operations). This
comparison provides an indication of the company's ability to compete.
Difficulty: 3 Hard
Topic: Net Income
Learning Objecti: 14-06 Put a company's net income into perspective by relating it to sales,
assets, and stockholders' equity.
Bloom's: Analyze
9
134) Income statement classifications
Simon Hardware and Garfunkel Foods are sole proprietorships with similar amounts of total
assets. Also, both businesses earn similar amounts of revenue, incur similar amounts of
operating expenses, and report similar net incomes. However, Simon has a higher cost of
goods sold, while Garfunkel Foods has higher interest expense.
Indicate which of these companies has the higher (a) gross profit rate, and (b) return on
assets. In each case, explain the reasons for each answer.
Answer:
(a) Both companies earn similar amounts of revenue, but Simon Hardware has the higher
cost of goods sold. Therefore, Garfunkel Foods must have the higher total gross profit and
also the higher gross profit rate.
(b) Garfunkel Foods has the higher return on assets. Return on assets usually is computed by
expressing operating income as a percentage of average total assets. As both companies have
similar amounts of total assets, the company with the higher operating income will have the
higher return on assets.
Garfunkel Foods probably has the higher operating income. As both companies earn similar
amounts of revenue and net income, their total costs and expenses also must be similar.
Simon however, has a higher cost of goods sold, which is deducted in arriving at operating
income. Garfunkel Foods has higher interest expense, but interest is deducted after the
determination of operating income. Therefore, Garfunkel Foods probably has the higher
operating income of the two businesses.
Note to instructor: Income taxes is another "non-operating item" which may cause two
businesses with similar net incomes to have different levels of operating income. However, both
Simon Hardware and Garfunkel Foods are organized as sole proprietorships, and, therefore, do
not include income taxes expense in their income statements.
Difficulty: 3 Hard
Topic: Net Income
Learning Objecti: 14-06 Put a company's net income into perspective by relating it to sales,
assets, and stockholders' equity.
Bloom's: Analyze
AACSB: Communication
10
135) Return on investment
Shown below are selected data from a recent annual report of Quality Service. (Dollar
amounts are in millions.)
Beginning of End of
the Year the Year
Total assets $6,000 $6,600
Total stockholders' equity $3,200 $3,700
Net income $1,900
Compute for the year:

(a) Return on average total assets
(b) Return on average total equity
Answer:
(a) Return on average total assets 31.75%
$2,000 ÷ [($6,000 + $6,600) ÷ 2]
(b) Return on average total equity 55.07%
$1,900 ÷ [($3,200 + $3,700) ÷ 2]
Topic: Price-Earnings Ratio
Learning Objecti: 14-07 Compute the ratios widely used in financial statement analysis and
explain the significance of each.
Bloom's: Apply
11
136) Computation of profitability ratios
Shown below are selected data from a recent annual report of Tall Oaks Co. (Dollar amounts
are in thousands.)
Beginning of End of
the Year the Year
Total assets $7,400 $8,100
Total stockholders' equity $3,900 $4,600
Net sales $14,000
Gross profit $5,000
Net income $1,000
Compute for the year the company's:
Answer:
Bloom's: Apply
12
137) Profitability measures
Shown below is a recent income statement for B-D Electric.
B-D ELECTRIC
Income Statement
For the Year Ended January 31, 2018

Less: Cost of goods sold 4,100,000
Gross profit $3,400,000
Less: Operating expenses 1,975,000
Operating income $ 1,425,000
Less: Non-operating expenses:
Interest expense $175,000
Income taxes expense 280,000 455,000
Net Income $ 970,000
Assume that comparative balance sheets for B-D Electric indicate average total assets for the
year of $2,500,000, and average total equity of $2,050,000. Compute the following:
Answer:
(a) Gross profit rate: 45%
($3,400,000 ÷ $7,500,000)
(b) Net income as a percentage of net sales: 12.9%
($970,000 ÷ $7,500,000)
(c) Return on assets 57%
($1,425,000 ÷ $2,500,000)
(d) Return on equity 47%
($970,000 ÷ $2,050,000)
Bloom's: Apply
13
138) ROI: What and why?
In general terms, what do all "ROI" ratios measure? Why are such computations useful?
Answer: "ROI" ratios measure an investor's "return" as a percentage of the average amount
of the required investment. Such computations provide investors with a basis for comparing
the profitability of alternative investment opportunities.
Bloom's: Understand
AACSB: Communication
14
139) The following information is available for the Grant Company for 2018:

Net income $600,000
Market price per share of
common stock $32
Dividend per share of
common stock $1.80
Common shares authorized
par value $10 $100,000
Average common shares
Outstanding 50,000
7% $100 par preferred
stock authorized $70,000
Preferred stock outstanding $30,000
Average total stockholders'
Equity $160,000
Market price per share of
Preferred $118
Required:
What are earnings per share for the current year?
What is the P/E ratio?
What is the book value per share of common stock?
What is the dividend yield on common stock?
What is the net profit ratio?
What is the return on equity?
Answer: Earnings per share $600,000 − $2,100 ÷ 50,000 = $11.96
Price-earnings ratio $32 ÷ $11.96 = 2.68

Book value ($160,000 − $30,000) ÷ 50,000 = $2.60
Dividend yield $1.80 ÷ $32 = 5.63%
Net profit rate $600,000 ÷ $1,200,000 = 50%
Return on equity $600,000 ÷ $160,000 = 375%
Bloom's: Apply
15
140) Financial ratios
Shown below are some key figures from the balance sheets of Minuteman Gas Company for
two successive years:
December 31, 2018 December 31, 2017

Total assets (of which 30% are current) $2,820,000 $2,220,000
Current liabilities $336,000 $372,000
Bonds payable (long term) $1,080,000 $840,000
Capital stock, $6 par value $660,000 $660,000
Retained Earnings $828,000 $480,000
Dividends of $96,000 were declared and paid in 2018. Compute the following:
Current ratio at end of 2017.

Current ratio at end of 2018.
Working capital at end of 2017.
Working capital at end of 2018.
Debt ratio at end of 2017.
Debt ratio at end of 2018.
Earnings per share for 2018.
Answer:
Current ratio at end of 2017 ($666,000 ÷ $372,000) = 1.79 to 1
Current ratio at end of 2018 ($846,000 ÷ $336,000) = 2.52 to 1
Working capital at end of 2017 ($666,000 - $372,000) = $294,000
Working capital at end of 2018 ($846,000 - $336,000) = $510,000
Debt ratio at end of 2017 ($1,212,000 ÷ $2,220,000) = 54.6%
Debt ratio at end of 2018 ($1,416,000 ÷ $2,820,000) = 50.2%
Earnings per share for 2018 [($348,000 + $96,000) ÷ 110,000 shares) = $4.04
Bloom's: Apply
16
141) Financial ratios
Given below are comparative balance sheets and an income statement for the Excellent
Corporation:
Excellent Corporation Excellent Corporation

Balance Sheets — 2018 Income Statement for the year
ended 2018
Dec. 31 Jan. 1
Cash $ 34,000 $ 34,000 Sales $524,000
Accounts receivable 94,000 78,000 Cost of goods sold (328,000)
Inventory 68,000 74,000 Gross profit on sales $ 196,000
Equipment (net) 114,000 132,000 Operating expenses (118,700)
$310,000.00 $318,000.00 Operating income $ 77,300
Accounts payable 54,000 60,000 Interest expense and
income taxes (28,750)
Dividends payable 20,000 12,000 Net income $ 48,550
Long-term note 32,000 32,000
payable
Capital stock, $10 140,000 140,000
par
Retained earnings 64,000 74,000
$310,000 $318,000
All sales were made on account. Cash dividends declared during the year totaled $58,550.
Compute the following:
17
Answer:
(a) Average accounts receivable turnover 6.1 times
[$524,000 ÷ (($94,000 + $78,000) ÷ 2)]
(b) Average inventory turnover 4.6 times
[$328,000 ÷ (($68,000 + $74,000) ÷ 2)]
(c) Earnings per share of capital stock $3.47
($48,550 ÷ 14,000 shares)
(d) Book value per share of capital stock at year-end $14.57
($204,000 ÷ 14,000 shares)
(e) Current ratio at year-end 2.65
($196,000 ÷ $74,000)
(f) Quick ratio at beginning of year 1.56
($112,000 ÷ $72,000)
(g) Debt ratio at year-end 34%
($106,000 ÷ $310,000)
(h) Operating expense ratio 23%
($118,700 ÷ $524,000)
(i) Return on assets 24.6%
[$77,300 ÷ (($310,000 + $318,000) ÷ 2)]
(j) Return on common stockholders' equity 23.2%
[$48,550 ÷ (($204,000 + $214,000) ÷ 2)]
Bloom's: Apply
18
142) Effects of transactions upon analytical measurements
Determine the immediate effect of each of the transactions described below on the ratio listed
beside each transaction. In the blank space to the left of each statement, you are to indicate
the effect by writing the appropriate code letter. The code letters are as follows: I = increase
the ratio, D = decrease the ratio, and NE = no effect on this ratio.
Answer:
Bloom's: Analyze
19
143) Below are eight ratios. Match each equation to the correct ratio. If there is no match, use
"None" as your response.
Current ratio Working capital

A/R turnover rate Debt ratio
Earnings per share Return on assets
Return on equity Price-earnings ratio
________ (a.) Net income minus preferred dividends divided by average number of common
shares outstanding
________ (b.) Net sales divided by average accounts receivable
________ (c.) Operating income divided by average total assets
________ (d.) Current assets divided by current liabilities
________ (e.) Annual dividend divided by current stock price
________ (f). Current assets minus current liabilities
________ (g.) Total liabilities divided by total assets
________ (h.) Net income divided by average total equity
________ (i.) Common stockholders' equity divided by shares of common stock outstanding
________ (j) Current stock price divided by earnings per share
Answer:
(a.) Earnings per share (b.) A/R turnover rate (c.) Return on assets (d.) Current ratio (e.)
None (should be dividend yield) (f.) Working capital (g.) Debt ratio (h.) Return on equity (i)
None (should be book value per share) (j.) Price-earnings ratio
Difficulty: 1 Easy
Bloom's: Remember
20
144) Percentage changes; p/e ratios and investors' expectations
Shown below are Gamma, Inc.'s earnings per share for a four-year period, along with the per-
share market price of the company's stock at each year-end. The earnings in 2018 were the
highest in the company's history.
2018 2017 2016 2015

Earnings per share $ 9 $ 7 $ 6 $ 7
Percentage change __% __% __% __%
Year-end stock price $77 $140 $84 $70
Price-earnings ratio ___ ___ ___ ___
(a) Compute the percentage change in earnings per share in 2016, 2017, and 2018. (Place
your answers in the spaces provided above.)
(b) Compute the p/e ratio of stock at the end of each of the four years. (Place your answers in
the spaces provided above.)
(c) What does the p/e ratio at the end of 2018 indicate about investors' expectations of
earnings per share for the coming year? Explain your reasoning.
Answer:
2018 2017 2016 2015
Earnings per $ 9 $ 7 $ 6 $ 7
share
(a) Percentage change +28.6% +16.7% -14.3%
Year-end stock $77 $140 $84 $70
price
Price-earnings 8.6 20 14 10
(b) ratio
(c) The p/e ratio of 8.6 is low by historical standards, indicating that investors do not expect
the rapid earnings growth of recent years to continue. The sharp declines in stock price and
price-earnings ratio occurring during Gamma's "record year" suggest that investors may be
expecting earnings to decline from current levels. The current price-earnings ratio of 8.6 is
even less than that at the end of 2016 which was preceded by a decline in earnings per share.
Difficulty: 3 Hard
Topic: Analysis by Common Stockholders
Learning Objecti: 14-08 Analyze financial statements from the viewpoints of common
stockholders, creditors, and others.
Bloom's: Analyze
21
145) Effects of events on financial measurements
Indicate the probable effects of each of the following strategies or events upon the financial
measurements of Lindsay Corp. listed below. Use the code letters I = Increase, D = Decrease,
and NE = No Effect.
(a) A supplier raised by 3% the purchase price of several products sold by

Lindsay. Lindsay did not change its sales prices for these products.
Gross profit rate ______ Current liabilities ________
(b) Lindsay began purchasing larger than normal quantities from a particular
supplier in order to receive a "volume discount."
Gross profit rate ________ Quick ratio ________
(c) Lindsay has consistently earned a return on assets of 15%. Recently the
company borrowed money at an interest rate of 10% to expand its operations.
Lindsay expects its investment of these borrowed funds to earn a return
(operating income) of 20%.
Return on assets ________ Debt ratio ________
(d) Lindsay extended the credit terms allowed to customers buying merchandise
on account from 30 days to 90 days.
Net sales ________ Cash collected from customers:
Dollar amount of gross profit (over the next 90 days) ________
Dollar amount of gross profit (after the next 90 days) ________
Answer:
Bloom's: Analyze
22
146) Use and interpretation of financial measurements
Shown below are various financial measurements for two companies that are similar in size
and sell similar products:
Financial Measurement Co. X Co. Y Most Most

Interested Favorable
Group Result
(a) Accounts receivable 5 8 ________ ________
turnover
(b) Return on equity ratio 40% 60% ________ ________
(assume for both
companies the return on
assets is 10% and the rate
of interest paid to creditors
is 11%)
(c) Operating cycle 54 days 218 days ________ ________
(d) Percentage change in net +6% -12% ________ ________
income
(e) Interest coverage ratio 11 3 ________ ________
Instructions: You are to enter code letters in the spaces provided in the two right-hand
columns.
In the first column, indicate which of the following three groups probably would be most
interested in the specified financial measurement. Identify one group, using the following
code letters: STC = indicating short-term creditors, LTC = indicating long-term creditors,
and S = indicating stockholders.
In the second column, enter an × or a Y to indicate whether your "most interested group"
would prefer the measurement results reported by Co. × or Co. Y.
Consider each financial measurement independently of the others.
Answer:
Most
Interested Most Favorable
Group Result
(a) STC Y
(b) S Y
(c) STC X
(d) S X
(e) LTC X
Difficulty: 3 Hard
Bloom's: Analyze
23

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Financial and Managerial Accounting, 18e Williams

Chapter 14 Financial Statement Analysis

127) Accounting terminology

Current ratio Return on assets Price-earnings (p/e) ratio

Total expenses: -3.3%

Net income: +177.5%

(b) Net income as a percentage of sales:

(a) From the above information compute:

Cash and cash equivalents $620

(a) Compute the following:

131) Improving the current ratio

Net sales $6,000,000

Net sales $6,000,000

133) Evaluating the adequacy of net income

Compute for the year:

Compute for the year the company's:

Net sales $7,500,000

Net sales $1,200,000

Answer: Earnings per share $600,000 − $2,100 ÷ 50,000 = $11.96

Price-earnings ratio $32 ÷ $11.96 = 2.68

December 31, 2018 December 31, 2017

Current ratio at end of 2017.

Excellent Corporation Excellent Corporation

Current ratio Working capital

2018 2017 2016 2015

(a) A supplier raised by 3% the purchase price of several products sold by

Financial Measurement Co. X Co. Y Most Most

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