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Chapter 24: 1Q (page 1445)
What are the major advantages of notes to financial statements? What types of items are usually reported in notes?
The Financial Statement notes may disclose mandatory data on related party exchanges, including outstanding balances and commitments.
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What type of disclosure or accounting do you believe is necessary for the following items?
a) Because of a general increase in the number of labor disputes and strikes, both within and outside the industry, there is an increased likelihood that a company will suffer a costly strike in the near future.
b) A company reports a material unusual and infrequent loss on the income statement. No other mention is made of this item in the annual report.
c) A company expects to recover a substantial amount in connection with a pending refund claim for a prior year’s taxes. Although the claim is being contested, counsel for the company has confirmed the client’s expectation of recovery.
Foley Corporation has seven industry segments with total revenues as follows.
Penley \(600 Cheng \)225
Konami 650 Takuhi 200
KSC 250 Molina 700
Red Moon 275
Based only on the revenues test, which industry segments are reportable?
In calculating inventory turnover, why is cost of goods sold used as the numerator? As the inventory turnover increases, what increasing risk does the business assume?
Edna Millay Inc. is a manufacturer of electronic components and accessories with total assets of $20,000,000. Selected financial ratios for Millay and the industry averages for firms of similar size are presented below.
Edna Millay | 2017 Industry | |||
2015 | 2016 | 2017 | Averages | |
Current ratio | 2.09 | 2.27 | 2.51 | 2.24 |
Quick ratio | 1.15 | 1.12 | 1.19 | 1.22 |
Inventory turnover | 2.40 | 2.18 | 2.02 | 3.50 |
Net sales to stockholders’ equity | 2.71 | 2.80 | 2.99 | 2.85 |
Return on common stockholders’ equity | 0.14 | 0.15 | 0.17 | 0.11 |
Total liabilities to stockholders’ equity | 1.41 | 1.37 | 1.44 | 0.95 |
Millay is being reviewed by several entities whose interests vary, and the company’s financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Millay’s financial position.
Archibald MacLeish Bank. The bank is processing Millay’s application for a new 5-year term note. Archibald MacLeish has been Millay’s banker for several years but must reevaluate the company’s financial position for each major transaction.
Robert Penn Warren. A brokerage firm specializing in the stock of electronics firms that are sold over-the-counter, Robert Penn Warren must decide if it will include Millay in a new fund being established for sale to Robert Penn Warren’s clients.
Working Capital Management Committee. This is a committee of Millay’s management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the company’s working capital position, comparing actual data against budgets, and recommending changes in strategy as needed.
Instructions
b) For each of the four entities, identify two financial ratios, from the ratios presented above that would be most valuable as a basis for its decision regarding Millay.
Picasso Company is a wholesale distributor of packaging equipment and supplies. The company’s sales have averaged about \(900,000 annually for the 3-year period 2015–2017. The firm’s total assets at the end of 2017 amounted to \)850,000.
The president of Picasso Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s operations for the past 3 years. This report will be presented to the board of directors at their next meeting.
In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios which can assist in the identification and interpretation of trends. At the request of the controller, the accounting staff has calculated the following ratios for the 3-year period 2015–2017.
2015 | 2016 | 2017 | |
Current ratio | 1.80 | 1.89 | 1.96 |
Acid-test (quick) ratio | 1.04 | 0.99 | 0.87 |
Accounts receivable turnover | 8.75 | 7.71 | 6.42 |
Inventory turnover | 4.91 | 4.32 | 3.42 |
Debt to assets ratio | 51.0% | 46.0% | 41.0% |
Long-term debt to assets ratio | 31.0% | 27.0% | 24.0% |
Sales to fixed assets (fixed asset turnover) | 1.58 | 1.69 | 1.79 |
Sales as a percent of 2015 sales | 1.00 | 1.03 | 1.07 |
Gross margin percentage | 36.0% | 35.1% | 34.6% |
Net income to sales | 6.9% | 7.0% | 7.2% |
Return on assets | 7.7% | 7.7% | 7.8% |
Return on common stockholders’ equity | 13.6% | 13.1% | 12.7% |
In preparation of the report, the controller has decided first to examine the financial ratios independent of any other data to determine if the ratios themselves reveal any significant trends over the 3-year period.
Instructions
a) The current ratio is increasing while the acid-test (quick) ratio is decreasing. Using the ratios provided, identify and explain the contributing factor(s) for this apparently divergent trend.
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