Practice Problems

Demonstration Problems

Demonstration problem A Comparative financial statements of Kellogg Company for 2003 and 2002 follow:

Kellogg Company
Comparative income statements
Fore the years ended 2003 December 31, and 2002
(USD millions)

	2003	2002
Net revenues	$6,954.7	$6,984.2
Cost of goods sold	3,327.0	3,325.1
Gross margin	$3,627.7	$3,659.1
Operating expense	2,551.4	2,585.7
Nonoperating expense (interest)	137.5	118.8
Income before income taxes	$ 938.8	$ 954.6
Income taxes	280.0	198.4
Net earnings	$ 658.8	$ 756.2

Kellogg Company
Comparative Balance sheets
2003 December 31, and 2002

	(USD millions)
Assets	2003	2002
Cash and temporary investments	$ 204.4	$ 150.6
Accounts receivable, net	685.3	678.5
Inventories	443.8	503.8
Other current assets	273.3	236.3
Property, net	2,526.90	2,640.90
Other assets	762.6	589.6
Total assets	$4,896.3	$4,808.7
Liabilities and stockholders' equity
Current liabilities	$2,492.6	$1,587.8
Long-term liabilities	1,506.20	2,407.70

Common stock	103.8	103.8
Capital in excess of par value	102	104.5
Retained earnings	1,501.00	1,317.20
Treasury stock	-374	-380.9
Currency translation adjustment	-435.3	-331.4
Total liabilities and stockholders' equity	$4,896.3	$4,808.7

Prepare comparative common-size income statements for 2003 and 2002.
Perform a horizontal analysis of the comparative balance sheets.

Demonstration problem B The balance sheet and supplementary data for Xerox Corporation follow:

Xerox corporation
Balance sheet with IOFS on an equity basis
2003 December 31
(USD millions)

Assets	2003
Cash	$1,741
Accounts receivable, net	2,281
Finance receivables, net	5,097
Inventories	1,932
Deferred taxes and other current assets	1,971
Total current assets	$13,022
Finance receivables due after one year, net	7,957
Land, buildings, and equipment, net	2,495
Investments in affiliates, at equity	1,362
Goodwill	1,578
Other assets	3,061
Total assets	$ 29,475
Liabilities and stockholders' equity
Short-term debt and current portion of long-term debt	$2,693
Accounts payable	1,033
Accrued compensation and benefit costs	662
Unearned income	250
Other current liabilities	1,630
Total current liabilities	$6,268
Long-term debt	15,404
Liabilities for post-retirement medical benefits	1,197
Deferred taxes and other liabilities	1,876
Discontinued policyholders' deposits and other operations liabilities	670
Deferred ESOP benefits	-221
Minorities' interests in equity of subsidiaries	141
Preferred stock	647
Common shareholders' equity (108.1 million)	3,493
Total liabilities and shareholders' equity	$29,475

Cost of goods sold, USD 6,197.
Net sales, USD 18,701.
Inventory, January 1, USD 2,290.
Net interest expense, USD 1,031.
Net income before interest and taxes, USD 647.
Net accounts receivable on January 1, USD 2,633.
Total assets on January 1, USD 28,531.

Compute the following ratios:

Current ratio.
Acid-test ratio.
Accounts receivable turnover.
Inventory turnover.
Total assets turnover.
Equity ratio.
Times interest earned ratio.

Source: James Don Edwards and Roger H. Hermanson, https://s3.amazonaws.com/saylordotorg-resources/wwwresources/site/wp-content/uploads/2012/10/Accounting-Principles-Vol.-1.pdf
This work is licensed under a Creative Commons Attribution 3.0 License.

Solution to demonstration problems

a.

Kellogg Company
Common-size comparative income statements
For the year ended 2003 December 31, and 2002

	Per cent
	2003	2002
Net revenues	100.00 %	100.00%
Cost of goods sold	47.84	47.61
Gross margin	52.16	52.39
Operating expenses	36.69	37.02
Nonoperating expense (interest)	1.98	1.70
Income before income taxes	13.49 %*	13.67 %
Income taxes	4.03	2.84
Net earnings	9.46 %*	10.83%

*Difference due to rounding.

b.

Kellogg company
Comparative balance sheets
2003 December 31, and 2002
(USD millions)

			Increase or Decrease
	2003	2002	2003 amount	2002 per cent
Assets
Cash and temporary investments;	$204.4	$150.6	$53.8	0.3572
Accounts receivable, net	685.3	678.5	6.8	1
Inventories	443.8	503.8	(60)	(11.91)
Other current assets	273.3	236.3	37	15.66
Property, net	2526.9	2640.9	(114)	(4.32)
Other assets	762.9	589.6	164	27.4
Total assets	$4,896.3	$4,808.7	$87.6	0.0182
Liabilities and stockholders' equity
Current liabilities	$2,492.6	$1,587.8	$904.8	0.5698
Long-term liabilities	1506.2	2407.7	(901.5)	(37.44)
Common stock	103.8	103.8	0	0
Capital in excess of par value	102	104.5	(2.5)	(2.39)
Retained earnings	1501	1317.2	183.8	13.95
Treasury stock	(374	(380.9	6.9	(1.81)
Currency translation adjustment	(435.3)	(331.4)	(103.9)	31.35
Total liabilities and stockholders' equity	$4,896.3	$4,808.7	$87.6	0.0182

Solution to demonstration problem B

Current ratio:
$\frac{\text { Currentassets }}{\text { Current liabilities }}=\frac{\text { USD 13,022,000,000 }}{\text { USD 6,268,000,000 }}=2.08: 1$
Acid-test ratio:
$\frac{\text { Quick assets }}{\text { Current liabilities }}=\frac{\text { USD } 9,119,000,000}{\text { USD } 6,268,000,000}=1.45: 1$
Accounts receivable turnover:

$\dfrac{\text { Net sales }}{\text { Average net accounts receivable }}=\dfrac{\operatorname{USD} 18,701,000,000}{\operatorname{USD} 2,457,000,000}=\text{7.61 time}$

Self-test

True-false

Indicate whether each of the following statements is true or false.

1. An objective of financial statement analysis is to provide information about the company's past performance and current financial position.

2. Vertical analysis helps detect changes in a company's performance over several periods and highlights trends.

3. Common-size statements provide information about changes in dollar amounts relative to the previous periods.

4. Liquidity ratios show a company's capacity to pay maturing current liabilities.

5. A company that is quite profitable may find it difficult to pay its accounts payable.

6. Financial statement analysts must be sure that comparable data are used among companies to make the comparisons valid.

Multiple-choice

Select the best answer for each of the following questions.

The following data were abstracted from the 2007 December 31, balance sheet of Andrews Company (use for the first two questions questions):

Cash	$136,000
Marketable securities	64,000
Accounts and notes receivable, net	184,000
Merchandise inventory	244,000
Prepaid expenses	12,000
Accounts and notes payable, short-term	256,000
Accrued liabilities	64,000
Bonds payable, long-term	400,000

1. The current ratio is:

a. 1:2.

b. 2:1.

c. 1.2:1.

d. 3:1.

2. The acid-test ratio is:

a. 1:2.

b. 2:1.

c. 1.2:1.

d. 3:1.

Benson Company shows the following data on its 2011 financial statements (use for the rest of the questions ):

Accounts receivable, January 1	$720,000
Accounts receivable, December 31	960,000
Merchandise inventory, January 1	900,000
Merchandise inventory, December 31	1,020,000
Gross sales	4,800,000
Sales returns and allowances	180,000
Net sales	4,620,000
Cost of goods sold	3,360,000
Income before interest and taxes	720,000
Interest on bonds	192,000
Net income	384,000

3. The accounts receivable turnover is:

a. 5.5 times per year.

b. 5.714 times per year.

c. 5 times per year.

d. 6.667 times per year.

4. The inventory turnover is:

a. 5 times per year.

b. 4.8125 times per year.

c. 3.5 times per year.

d. 4 times per year.

5. The times interest earned ratio is:

a. 4.75 times per year.

b. 3.75 times per year.

c. 2 times per year.

d. 3 times per year.

Check your answers on the next page.

Self-test - Answers

True-false

1. True. Financial statement analysis consists of applying analytical tools and techniques to financial statements and other relevant data to obtain useful information.

2. False. Horizontal analysis provides useful information about the changes in a company's performance over several periods by analyzing comparative financial statements of the same company for two or more successive periods.

3. False. Common-size statements show only percentage figures, such as percentages of total assets and percentages of net sales.

4. True. Liquidity ratios such as the current ratio and acid-test ratio indicate a company's short-term debt-paying ability.

5. True. The accrual net income shown on the income statement is not cash basis income and does not indicate cash flows.

6. True. Analysts must use comparable data when making comparisons of items for different periods or different companies.

Multiple-choice

1. b. Current assets: text { USD } 136,000 + text { USD } 64,000+ text { USD } 184,000+ text { USD } 244,000 + text { USD } 12,000= text { USD } 640,000

Current liabilities:

$\text { USD } 256,000 + \text { USD } 64,000 = \text { USD } 320,000$
Current ratio:

$\frac{ \text { USD } 640,000}{ \text { USD } 320,000} = 2:1$

2. c. Quick assets:

$\text { USD } 136,000 + \text { USD }64,000 + \text { USD }184,000 = \text { USD }384,000$

Current liabilities:

$256,000+ \text { USD } 64,000= \text { USD } 320,000$

Acid-test ratio:

$\frac{\text { USD }384,000}{\text { USD }320,000}=1.2:1$

3. a. Net sales:

$\text { USD } 4,620,000$

Average accounts receivable:

$\frac{ \text { USD } 720,000+\text { USD }9 60,000}{2}= \text { USD } 840,000$

Accounts receivable turnover:

$\frac{ \text { USD } 4,620,000}{ \text { USD } 840,000}=5.5$

4. c. Cost of goods sold:

$\text { USD } 3,360,000$

Average inventory:

$\frac{ \text { USD } 900,000+ \text { USD } 1,020,000}{2}= \text { USD } 960,000$

Inventory turnover:

$\frac{ \text { USD } 3,360,000}{ \text { USD } 960,000}=3.5$

5. b. Income before interest and taxes,

$\text { USD } 720,000$

Interest on bonds, 192,000

Times interest earned ratio:

$\text { USD } 720,000/ \text { USD } 192,000=3.75 \text {times}$

Site:	Saylor Academy
Course:	BUS103: Introduction to Financial Accounting
Book:	Practice Problems

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