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Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Spiceland | Thomas | Herrmann
Financial Accounting
Financial
Statement
Analysis
Chapter 12
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objectives
• Perform vertical analysis
• Perform horizontal analysis
• Use ratios to analyze a company’s risk
• Use ratios to analyze a company’s profitability
• Distinguish persistent earnings from one-time
items
• Explain quality of earnings and distinguish
between conservative and aggressive accounting
practices
12-2
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Part A
Comparison of Financial Accounting Information
12-3
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Illustration 12.1—Three Types of
Comparisons
12-4
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Learning Objective 1
Perform vertical analysis
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Vertical Analysis
• Express each item in a financial statement as a
percentage of the same base amount
• Income statement items expressed as a
percentage of sales
• Balance sheet items expressed as a percentage
of assets
12-6
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Illustration 12.2—Common-Size
Income Statements
12-7
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Illustration 12.2—Common-Size
Balance Sheets
12-8
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Learning Objective 2
Perform horizontal analysis
12-9
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Horizontal Analysis
• Analyze trends in financial statement data for a
single company over time
12-10
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Illustration 12.4—Horizontal Analysis
of the Income Statement
12-11
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Illustration 12.5—Horizontal Analysis
of the Balance Sheet
12-12
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Part B
Using Ratios to Assess Risk and Profitability
12-13
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Learning Objective 3
Use ratios to analyze a company’s risk
12-14
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Illustration 12.7—Risk Ratios
12-15
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Receivables Turnover Ratio
• Measures how many times receivables are
collected during the year
• Low ratio indicates trouble collecting its accounts
receivable
• High ratio indicates quick collection of receivables
into cash
12-16
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Average Collection Period
• Days it takes to convert receivables into cash
• Shorter collection period is better
12-17
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Inventory Turnover Ratio
• Measures how many times average inventory is
sold during the year
• High ratio indicates that inventory is selling quickly
• Extremely high ratio might indicate lost sales due
to inventory shortages
12-18
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Average Days in Inventory
• Days it takes to sell inventory
• Lower is better
12-19
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Current Ratio
• Compares current assets to current liabilities
• High ratio indicates sufficient assets to cover
current liabilities
12-20
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Acid-Test Ratio
• More conservative measure of ability to pay
current liabilities
• Ignores current assets such as inventories and
prepaid expenses
12-21
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Debt to Equity Ratio
• Indicates the risk of bankruptcy
• Higher ratio indicates higher risk
12-22
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Times Interest Earned Ratio
• Compare interest payments with income available
to pay them
• Associated with long-term liabilities
12-23
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Learning Objective 4
Use ratios to analyze a company’s profitability
12-24
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Illustration 12.16—Profitability
Ratios
12-25
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Gross Profit Ratio
• Indicates the portion of each dollar of sales above
its cost of goods sold
12-26
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Return on Assets
• Measures the income the company earns on each
dollar invested in assets
12-27
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Profit Margin
• Measures the income earned on each dollar of
sales
12-28
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Asset Turnover
• Measures sales volume in relation to the
investment in assets
12-29
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Return on Equity
• Measures the income earned for each dollar in
stockholders’ equity
12-30
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Price-Earnings Ratio
• Compares a company’s share price with its
earnings per share
• Indication of investors’ expectations of future
earnings
12-31
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Part C
Earnings Persistence and Earnings Quality
12-32
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Learning Objective 5
Distinguish persistent earnings from one-time items
12-33
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Earnings Persistence and One-Time
Income Items
Earnings
Persistence
Current earnings that
will continue or persist
into future years
One-Time
Income Items
Certain items are part
of net income in the
current year but are not
expected to persist
Discontinued
operationsExtraordinary
items
12-34
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Discontinued Operations
• Sale or disposal of a significant component of a
company’s operations
• Any gains or losses on discontinued operations in
the current year are reported separately
12-35
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Illustration 12.24—Presentation of
a Discontinued Operation
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Extraordinary Items
• Gains or losses that do not reflect normal
operations and that are not likely to happen again
• Event that produces a gain or loss must meet two
conditions:
• Unusual in nature
• Infrequent in occurrence
12-37
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Illustration 12.25—Presentation of
an Extraordinary Item
12-38
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Illustration 12.26—Comparison of
Extraordinary Items with Other Revenues and
Expenses
12-39
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Learning Objective 6
Explain quality of earnings and distinguish between
conservative and aggressive accounting practices
12-40
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Quality of Earnings
• Ability of reported earnings to reflect true earnings
• Usefulness of reported earnings to predict future
earnings
Result in
reporting lower
income, lower
assets, and
higher liabilities
Result in
reporting higher
income, higher
assets, and
lower liabilities
Conservative
Accounting Practices
Aggressive
Accounting Practices
12-41
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Illustration 12.27—Financial
Statements Prepared by Mr. Nadal
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Illustration 12.27—(continued)
12-43
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Mr. Djokovic's Proposed Changes
• Decrease estimate of bad debts
• Reverse write-down of inventory
• Increase asset’s useful life changing depreciation
estimate
• Remove loss contingency
12-44
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Illustration 12.29—Income
Statement Revised by Mr. Djokovic
12-45
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Illustration 12.30—Balance Sheet
Revised by Mr. Djokovic
12-46
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Illustration 12.31—Statement of
Cash Flows Revised by Mr. Djokovic
12-47
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Symbolism Revealed
• Mr. Nadal represents conservative accounting
practices
• Mr. Djokovic represents aggressive accounting
practices
12-48
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End of Chapter 12
12-49
