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Chapter 15: Q4RQ (page 835)
Question: What is trend analysis, and how does it differ from horizontal analysis?
Answer
Trend analysis is done by the companies to see the directions in which their business is going.
Both the analysis, i.e., trend and horizontal are almost similar.
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Ross’s Lipstick Company’s long-term debt agreements make certain demands on the business. For example, Ross may not purchase treasury stock in excess of the balance of retained earnings. Also, long-term debt may not exceed stockholders’ equity, and the current ratio may not fall below 1.50. If Ross fails to meet any of these requirements, the company’s lenders have the authority to take over management of the company.Changes in consumer demand have made it hard for Ross to attract customers.
Current liabilities have mounted faster than current assets, causing the current ratio to fall to 1.47. Before releasing financial statements, Ross’s management is scrambling to improve the current ratio. The controller points out that an investment can be classified as either long-term or short-term, depending on management’s intention. By deciding to convert an investment to cash within one year, Ross can classify the investment as short-term—a current asset. On the controller’s recommendation, Ross’s board of directors votes to reclassify long-term investments as short-term.
Requirements
1. What effect will reclassifying the investments have on the current ratio? Is Ross’s true financial position stronger as a result of reclassifying the investments?
2. Shortly after the financial statements are released, sales improve; so, too, does the current ratio. As a result, Ross’s management decides not to sell the investments it had reclassified as short-term. Accordingly, the company reclassified the investments as long-term. Has management behaved unethically? Give the reasoning underlying of your answer.
Theta Designs, Inc. has the following data:
| Theta Designs INC | ||
| Vertical Analysis | ||
| For the year ended December 31, 2017, and 2018 | ||
Assets | 2018 (\() | 2017 (\)) |
Total current assets | 25,000 | 73,440 |
Property, Plant and Equipment, Net | 153,600 | 168,300 |
Other Assets | 21,400 | 64,260 |
Total Assets | 200,000 | 306,000 |
Liabilities | ||
Total current liabilities | 27,600 | 49,266 |
Long term debt | 72,400 | 208,998 |
Total Liabilities | 100,000 | 258,264 |
Stockholders’ Equity | ||
Total stockholders’ Equity | 100,000 | 47,736 |
Total liabilities and stockholders’ equity | 200,000 | 306,000 |
Perform a vertical analysis of Theta Designs’s balance sheet for each year.
The financial statements of Ion Corporation include the following items:
Current Year Preceding Year
Balance Sheet:
Cash \( 6,000 \) 8,000
Short-term Investments 4,400 10,700
Net Accounts Receivable 21,600 29,200
Merchandise Inventory 30,800 27,600
Prepaid Expenses 6,000 3,600
Total Current Assets 68,800 79,100
Total Current Liabilities 53,200 37,200
Income Statement:
Net Sales Revenue $ 184,800
Cost of Goods Sold 126,000
Compute the following ratios for the current year:
7. Current ratio
8. Acid-test ratio
9. Inventory turnover
10. Gross profit percentage
Net sales revenue, net income, and commonA stockholders’ equity for Azbel Mission Corporation, a manufacturer of contact lenses, follow for a four-year period.
Requirements
1.Compute trend analyses for each item for 2017–2019. Use 2016 as the base year,and round to the nearest whole percent.
2.Compute the rate of return on common stockholders’ equity for 2017–2019, rounding to three decimal places.
Lance Berkman is the controller of Saturn, a dance club whose year-end is December 31. Berkman prepares checks for suppliers in December, makes the proper journal entries, and posts them to the appropriate accounts in that month. However, he holds on to the checks and mails them to the suppliers in January.
Requirements
1. What financial ratio(s) is(are) most affected by the action to hold onto the checks until January?
2. What is Berkman’s purpose in undertaking this activity?
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