Solutions Manual for Financial Accounting, 16th Edition By Carl Warren, Christine Jonick, Jennifer Schneider (All Chapters 1-17)
All Chapters Arranged Reverse: 17-1
CHAPTER 17
FINANCIAL STATEMENT ANALYSIS
DISCUSSION QUESTIONS
1. Liquidity is the ability of a company to convert assets into cash. Short-term creditors such as banks
and financial institutions are most concerned with liquidity. Solvency is the ability of a company to
pay its debts. Long-term creditors such as bondholders are concerned primarily with a company’s
solvency. Profitability is the ability of a company to generate earnings. Investors such as
stockholders are concerned primarily with profitability because it determines whether the
company’s stock price will increase.
2. Comparative statements provide information as to changes between dates or periods. Trends
indicated by comparisons may be far more significant than the data for a single date or
period.
3. Before this question can be answered, the increase in net income should be compared with
changes in sales, expenses, and assets devoted to the business for the current year. The return
on assets for both periods should also be compared. If these comparisons indicate favorable
trends, the operating performance has improved; if not, the apparent favorable increase in net
income may be offset by unfavorable trends in other areas.
4. Generally, the two ratios would be very close because most service businesses sell services
and hold very little inventory.
5. a. A high inventory turnover minimizes the amount invested in inventories, thus freeing
funds for more advantageous use. Storage costs, administrative expenses, and losses
caused by obsolescence and adverse changes in prices are also kept to a minimum.
b. Yes. The inventory turnover relates to the “turnover” of inventory during the year, while
the number of days’ sales in inventory relates to the amount of inventory on hand at the
beginning and end of the year. Therefore, a business could have a high inventory turnover
during the year yet have a high number of days’ sales in inventory based on the
beginning and end-of-year inventory amounts.
6. The ratio of fixed assets to long-term liabilities increased from 3.4 ($1,360,000 ÷ $400,000) for
the preceding year to 4.2 ($1,260,000 ÷ $300,000) for the current year, indicating that the
company is in a stronger position now than in the preceding year to borrow additional funds
on a long-term basis.
7. a. The return on total assets adds interest expense to the net income, which is divided by
average total assets. It measures the profitability of the total assets without regard for how
the assets are financed. The return on stockholders’ equity divides net income by the
average total stockholders’ equity. It measures the profitability of the stockholders’
investment.
b. The return on stockholders’ equity is normally higher than the return on total assets. This
is because of leverage, which compensates stockholders for the higher risk of their
investments.
17-1
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 17 Financial Statement Analysis
DISCUSSION QUESTIONS (Continued)
8. The price-earnings ratio measures the market’s expectations of a company’s future earnings
prospects. Kroger’s low price-earnings ratio compared to the industry average suggests that
the market has low expectations about the company’s future earnings.
9. The dividend yield measures the rate of return common stockholders receive from a cash dividend.
The high dividend yield for Suburban Propane indicates that a significant portion of the return to
its shareholders comes in the form of a cash dividend. The lack of a dividend yield for Alphabet
indicates that the return to shareholders comes solely from stock appreciation.
10. One report is the Report on Internal Control, which verifies management’s conclusions on
internal control. Another report is the Report of Independent Registered Public Accounting
Firm, where the Certified Public Accounting (CPA) firm that conducts the audit renders an
opinion on the fairness of the statements.
17-2
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 17 Financial Statement Analysis
PRACTICE EXERCISES
PE 17-1A
Temporary investments……… $6,000 increase ($36,000 – $30,000),
or 20% ($6,000 ÷ $30,000)
Merchandise inventory……… $3,000 decrease ($72,000 – $75,000),
or (4)% ($3,000 ÷ $75,000)
PE 17-1B
Accounts payable…………… $24,000 decrease ($176,000 – $200,000),
or (12)% ($24,000 ÷ $200,000)
Long-term debt……………… $13,950 increase ($168,950 – $155,000),
or 9% ($13,950 ÷ $155,000)
PE 17-2A
Amount Percentage
Sales…………………………… $200,000 100% ($200,000 ÷ $200,000)
Cost of merchandise sold…… 140,000 70% ($140,000 ÷ $200,000)
Gross profit…………………… $ 60,000 30% ($60,000 ÷ $200,000)
PE 17-2B
Amount Percentage
Sales…………………………… $1,400,000 100% ($1,400,000 ÷ $1,400,000)
Cost of merchandise sold…… 812,000 58% ($812,000 ÷ $1,400,000)
Gross profit…………………… $ 588,000 42% ($588,000 ÷ $1,400,000)
PE 17-3A
a. Current Ratio = Current Assets ÷ Current Liabilities
= ($120,000 + $40,000 + $50,000 + $90,000) ÷ $150,000
= 2.0
b. Quick Ratio = Quick Assets ÷ Current Liabilities
= ($120,000 + $40,000 + $50,000) ÷ $150,000
= 1.4
17-3
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 17 Financial Statement Analysis
PE 17-3B
a. Current Ratio = Current Assets ÷ Current Liabilities
= ($320,000 + $170,000 + $140,000 + $450,000) ÷ $300,000
= 3.6
b. Quick Ratio = Quick Assets ÷ Current Liabilities
= ($320,000 + $170,000 + $140,000) ÷ $300,000
= 2.1
PE 17-4A
a. Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable
= $1,460,000 ÷ $100,000
= 14.6
Average Accounts Receivable
b. Number of Days’ Sales in Receivables =
Average Daily Sales
= $100,000 ÷ ($1,460,000 ÷ 365)
= $100,000 ÷ $4,000
= 25.0 days
PE 17-4B
a. Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable
= $6,862,000 ÷ $365,000
= 18.8
Average Accounts Receivable
b. Number of Days’ Sales in Receivables =
Average Daily Sales
= $365,000 ÷ ($6,862,000 ÷ 365)
= $365,000 ÷ $18,800
= 19.4 days
17-4
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
All Chapters Arranged Reverse: 17-1
CHAPTER 17
FINANCIAL STATEMENT ANALYSIS
DISCUSSION QUESTIONS
1. Liquidity is the ability of a company to convert assets into cash. Short-term creditors such as banks
and financial institutions are most concerned with liquidity. Solvency is the ability of a company to
pay its debts. Long-term creditors such as bondholders are concerned primarily with a company’s
solvency. Profitability is the ability of a company to generate earnings. Investors such as
stockholders are concerned primarily with profitability because it determines whether the
company’s stock price will increase.
2. Comparative statements provide information as to changes between dates or periods. Trends
indicated by comparisons may be far more significant than the data for a single date or
period.
3. Before this question can be answered, the increase in net income should be compared with
changes in sales, expenses, and assets devoted to the business for the current year. The return
on assets for both periods should also be compared. If these comparisons indicate favorable
trends, the operating performance has improved; if not, the apparent favorable increase in net
income may be offset by unfavorable trends in other areas.
4. Generally, the two ratios would be very close because most service businesses sell services
and hold very little inventory.
5. a. A high inventory turnover minimizes the amount invested in inventories, thus freeing
funds for more advantageous use. Storage costs, administrative expenses, and losses
caused by obsolescence and adverse changes in prices are also kept to a minimum.
b. Yes. The inventory turnover relates to the “turnover” of inventory during the year, while
the number of days’ sales in inventory relates to the amount of inventory on hand at the
beginning and end of the year. Therefore, a business could have a high inventory turnover
during the year yet have a high number of days’ sales in inventory based on the
beginning and end-of-year inventory amounts.
6. The ratio of fixed assets to long-term liabilities increased from 3.4 ($1,360,000 ÷ $400,000) for
the preceding year to 4.2 ($1,260,000 ÷ $300,000) for the current year, indicating that the
company is in a stronger position now than in the preceding year to borrow additional funds
on a long-term basis.
7. a. The return on total assets adds interest expense to the net income, which is divided by
average total assets. It measures the profitability of the total assets without regard for how
the assets are financed. The return on stockholders’ equity divides net income by the
average total stockholders’ equity. It measures the profitability of the stockholders’
investment.
b. The return on stockholders’ equity is normally higher than the return on total assets. This
is because of leverage, which compensates stockholders for the higher risk of their
investments.
17-1
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 17 Financial Statement Analysis
DISCUSSION QUESTIONS (Continued)
8. The price-earnings ratio measures the market’s expectations of a company’s future earnings
prospects. Kroger’s low price-earnings ratio compared to the industry average suggests that
the market has low expectations about the company’s future earnings.
9. The dividend yield measures the rate of return common stockholders receive from a cash dividend.
The high dividend yield for Suburban Propane indicates that a significant portion of the return to
its shareholders comes in the form of a cash dividend. The lack of a dividend yield for Alphabet
indicates that the return to shareholders comes solely from stock appreciation.
10. One report is the Report on Internal Control, which verifies management’s conclusions on
internal control. Another report is the Report of Independent Registered Public Accounting
Firm, where the Certified Public Accounting (CPA) firm that conducts the audit renders an
opinion on the fairness of the statements.
17-2
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 17 Financial Statement Analysis
PRACTICE EXERCISES
PE 17-1A
Temporary investments……… $6,000 increase ($36,000 – $30,000),
or 20% ($6,000 ÷ $30,000)
Merchandise inventory……… $3,000 decrease ($72,000 – $75,000),
or (4)% ($3,000 ÷ $75,000)
PE 17-1B
Accounts payable…………… $24,000 decrease ($176,000 – $200,000),
or (12)% ($24,000 ÷ $200,000)
Long-term debt……………… $13,950 increase ($168,950 – $155,000),
or 9% ($13,950 ÷ $155,000)
PE 17-2A
Amount Percentage
Sales…………………………… $200,000 100% ($200,000 ÷ $200,000)
Cost of merchandise sold…… 140,000 70% ($140,000 ÷ $200,000)
Gross profit…………………… $ 60,000 30% ($60,000 ÷ $200,000)
PE 17-2B
Amount Percentage
Sales…………………………… $1,400,000 100% ($1,400,000 ÷ $1,400,000)
Cost of merchandise sold…… 812,000 58% ($812,000 ÷ $1,400,000)
Gross profit…………………… $ 588,000 42% ($588,000 ÷ $1,400,000)
PE 17-3A
a. Current Ratio = Current Assets ÷ Current Liabilities
= ($120,000 + $40,000 + $50,000 + $90,000) ÷ $150,000
= 2.0
b. Quick Ratio = Quick Assets ÷ Current Liabilities
= ($120,000 + $40,000 + $50,000) ÷ $150,000
= 1.4
17-3
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 17 Financial Statement Analysis
PE 17-3B
a. Current Ratio = Current Assets ÷ Current Liabilities
= ($320,000 + $170,000 + $140,000 + $450,000) ÷ $300,000
= 3.6
b. Quick Ratio = Quick Assets ÷ Current Liabilities
= ($320,000 + $170,000 + $140,000) ÷ $300,000
= 2.1
PE 17-4A
a. Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable
= $1,460,000 ÷ $100,000
= 14.6
Average Accounts Receivable
b. Number of Days’ Sales in Receivables =
Average Daily Sales
= $100,000 ÷ ($1,460,000 ÷ 365)
= $100,000 ÷ $4,000
= 25.0 days
PE 17-4B
a. Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable
= $6,862,000 ÷ $365,000
= 18.8
Average Accounts Receivable
b. Number of Days’ Sales in Receivables =
Average Daily Sales
= $365,000 ÷ ($6,862,000 ÷ 365)
= $365,000 ÷ $18,800
= 19.4 days
17-4
© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
