CHAPTER 5- FINANCIAL STATEMENTS ANALYSIS- II

PROBLEM 1 (Common Size Income Statements)

Prepare common size income statements for Wise Company, a sole

proprietorship, for the two years shown below by converting the peso
amounts into percentages. For each year, sales will appear as 100% and
other items will be expressed as a percentage of sales. (Income taxes are
not involved as the business is not incorporated.) Comment on whether the
changes from 20X8 to 20X9 are favorable or unfavorable.

20X9 20X8

Sales………………………………………...... ₱500,000 ₱400,000

Cost of goods sold…………………………... 330,000 268,000

Gross Profit…………………………………… ₱170,000 ₱132,000

Operating Expense…………………………... 140,000 116,000

Net Income……………………………………. ₱ 30,000 ₱ 16,000

SOLUTION:

20X9 20X8

Sales………………………………………...... 100% 100%

Cost of goods sold…………………………... 66% 67%
Gross Profit…………………………………… 34% 33%
Operating Expense…………………………... 28% 29%
Net Income……………………………………. 6% 4%

20X9
*₱330,000/500,000= 66%
*₱170,000/500,000= 34%
*₱140,000/500,000= 28%
*₱30,000/500,000= 6%

20X8
*₱268,000/400,000= 67%
*₱132,000/400,000= 33%
*₱116,000/400,000= 29%
*₱16,000/400,000= 4%

The changes from 20X8 to 20X9 are all favorable. Sales increased and the
gross profit per peso of sales also increased. These two factors led to a
substantial increase in gross profit. Although operating expenses increased
in peso amount, the operating expenses per peso of sales decreased from
29 cents to 28 cents. The combination of these three favorable factors
caused net income to rise from 4 cents to 6 cents out of each peso of
sales.
PROBLEM 2 (Common-Size Income Statement)

A comparative income statement is given below for Rainbow Company:

Rainbow Company
Comparative Income Statement
For the Years Ended June 30, 20X9 and 20X8

20X9 20X8
Sales……………………………………… ₱5,000,000 ₱4,000,000
Less cost of goods sold……………….. 3,160,000 2,400,000
Gross margin…………………………….. 1,840,000 1,600,000
Selling expenses…………………………. 900,000 700,000
Administrative expenses……………….... 680,000 584,000
Total expenses……………………………. 1,580,000 1,284,000
Net operating income…………………….. 260,000 316,000
Interest expense…………………………... 70,000 40,000
Net income before taxes…………………. ₱ 190,000 ₱ 276,000

The President is concerned that net income is down in 20X9 even though
sales have increased during the year. The President is also concerned that
administrative expenses have increased, since the company made a
concerted effort during 20X9 to pare “fat” out of the organization.
Required 1.
Express each year’s income statement in common-size percentages.
Carry computation to one decimal place.

Rainbow Company
Income Statement, Common-size Percentages
For the Years Ended June 30, 20X9 and 20X8

20X9 20X8

Sales………………………………………...... 100.0 100.0

Less cost of goods sold…………………….. 63.2 60.0
Gross Margin………………………………… 36.8 40.0
Selling Expenses…………… ……………... 18.0 17.5
Administrative expenses………………....... 13.6 14.6
Total expenses……………………………… 31.6 32.1
Net operating income………………………. 5.2 7.9
Interest expense………………………….... 1.4 1.0
Net income before taxes…………………… 3.8 6.9

20X9

*₱3,160,000/5,000,000= 63.2%
*₱1,840,000/5,000,000= 36.8%
*₱900,000/5,000,000= 18%
*₱680,000/5,000,000= 13.6%
*₱1,580,000//5,000,000= 31.6%
*₱260,000/5,000,000= 5.2%
*₱70,000/5,000,000= 1.4%
*₱190,000/5,000,000= 3.8%

20X8
*₱2,400,000/4,000,000= 60%
*₱1,600,000/4,000,000= 40%
*₱700,000/4,000,000= 17.5%
*₱584,000/4,000,000= 14.6%
*₱1,284,000/4,000,000= 32.1%
*₱316,000/4,000,000= 7.9%
*₱40,000/4,000,000= 1%
*₱276,000/4,000,000= 6.9%

Required 2.
Comment briefly on the changes between the two years.

- The company’s major problem seems to be the increase in cost of

goods sold, which increased from 60% of sales in 20X8 to 63.2% of
sales in 20X9. This suggests that the company is not passing the
increases in costs of its products on to its customers. As a result, cost
of goods sold as a percentage of sales hast increased and gross
margin has decreased. Selling expenses and interest expense have
both increased slightly during the year, which suggests that costs
generally are going up in the company. The only exception is the
administrative expenses, which have decreased from 14.6% of sales
in 20X8 to 13.6% of sales in 20X9. This probably is a result of the
company’s efforts to reduce administrative expenses during the year.
PROBLEM 3 (Selected Financial Ratios)

Recent financial statements for Marina Company are given below:

Marina Company
Statement of Financial Position
June 30,20X8

Assets
Current assets:
Cash………………………………..… ₱ 21,000
Accounts receivable, net………..…. 160,000
Merchandise inventory……….......... 300,000
Prepaid expenses…………….......... 9,000
Total current assets…………………..…. 490,000
Property and equipment, net………....... 810,000
Total Assets……………………………... ₱1,300,000

Liabilities and Equity

Liabilities:
Current liabilities………..…………. ₱ 200,000
Bonds payable, 10%..................... 300,000
Total liabilities………………,,………….. 500,000
Equity:
Ordinary shares, ₱5 par value……….... ₱ 100,000
Retained earnings……………………… 700,000
Total equity……………………………… 800,000
Total liabilities and equity…................. ₱1,300,000
Marina Company
Income Statement
For the Year Ended June 30, 20X8

Sales………………………………………………………… ₱2,100,000
Less cost of goods sold…………………………………… 1,260,000
Gross margin……………………………………………… 840,000
Less operating expense…………………………………. 660,000
Net operating income…………………………………….. 180,000
Less interest expense……………………………………. 30,000
Net income before taxes………………………………… 150,000
Less income taxes………………………………………… 45,000
Net income………………………………………………… ₱ 105,000

Account balances at the beginning of the company’s fiscal year were:

accounts receivable, ₱140,000; and inventory, ₱260,000. All sales were on
account.

Required: Compute the following financial ratios:

1. Gross margin percentage.

Grossmargin ₱ 840,000
=
Sales ₱ 2,100,000

= 40%
2. Current ratio.

Current assets ₱ 490,000

=
Current liabilities ₱ 200,000

= 2.45

3. Acid-test (quick) ratio.

Quick assets ( Cash+ Marketable Securities + Accounts Receivable , net ) 181,000∗¿

=₱ ¿
Current liabilities ₱ 200,000

= 0.91

*₱21,000+0+160,000= ₱181,000

4. Accounts receivable turnover in days.

Credit Sales ₱ 2 , 10 0,000

=
Average accounts receivable ₱ 150,000∗¿ ¿

Accounts Receivable Turnover = 14 times

365 days
14׿ ¿
= 26.1 days

*₱ 160,000+140,000= ₱300,000/2= ₱150,000

5. Inventory turnover in days.

Cost of goods sold ₱ 1 , 26 0,000

=
Average inventory ₱ 280,000∗¿ ¿

Inventory turnover = 4.5 times

365 days
4.5׿ ¿ = 81.1 days

*₱300,000+260,000= ₱560,000/2= ₱280,000

6. Debt-to-equity ratio.

Total liabilities ₱ 500 , 000

=
Total equity ₱ 800,000

= 0.63

7. Times interest earned.

Earningsbefore interest ∧taxes ₱ 180 , 000

=
Interest expense ₱ 3 0,000

= 6 times

8. Book value per share.

 Total equity ₱ 800 , 000
=
Ordinary shares outs tanding ¿ 20,000 shares

= ₱40 per share

*₱100,000 total par value/₱5 par value per share= 20,000 shares