Managerial accounting

If possible please explain how you got the answer i’m trying to get a clear understanding which is the reason I need help with the assignment. The first question is in the read upload, I will be sending on page 621 (title )supply missing balance sheet numbers.Please cite sources.Using Problem 13-20A, complete the below.1.Complete the balance sheet by supplying the missing amounts. 2.Why are externally presented reports required to be prepared according to generally accepted accounting principles while internally presented managerial accounting reports are not? 3.How can a misstatement in one financial statement, whether intentional or not, affect a presentation in another financial statement? Give an example of an error that occurs on one financial statement and the error flows through to a second financial statement.
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CHAPTER 13
Financial Statement Analysis
LEARNING OBJECTIVES
After you have mastered the material in this chapter, you will be able to:
LO 13-1
LO 13-2
LO 13-3
LO 13-4
LO 13-5
Differentiate between horizontal and vertical analysis.
G
A
Calculate ratios for assessing a companyâ??s solvency.
T
Calculate ratios for assessing a companyâ??s
managerial effectiveness.
E
Calculate ratios for assessing a companyâ??s
position in the stock market.
S
,
Video lectures and accompanying self-assessment
quizzes are available in Connect®
Calculate ratios for assessing a companyâ??s liquidity.
for all learning objectives.
CHAPTER
D
E
A
N
OPENING
D
R
Expressing financial statement information in the form of ratios enhances its usefulness.
A
Ratios permit comparisons over time and among companies, highlighting similarities, differences, and trends. Proficiency
1 with common financial statement analysis techniques bene-
1 users. Before beginning detailed explanations of numerous
fits both internal and external
2
3
T
S
ratios and percentages, however, we consider factors relevant to communicating useful
­information.
The Curious Accountant
Precision Castings Corp. manufactures metal components and products, and
­provides castings, forgings, fastener systems, and other structures for customers in
© Aleksej Penkov/123RF
the aerospace and power industries. On August 10,
G2015, Berkshire Hathaway, Inc.,
which is run by Warren Buffett, purchased Precision
A Castings Corp. for $235 per
share, or $32.4 billion in total. This price of $235 per share was 21 percent higher
T
than the stock was currently trading on the New York Stock Exchange.
E
On September 2, 2013, Microsoft Corp. announced that it had purchased the
S
cell phone business of Nokia Corp. for $7 billion. As a part of the acquisition,
,
32,000 employees of Nokia would now work for Microsoft. At least one observer
on CNBC noted that Microsoft probably could have purchased Nokia for 25 percent
D
less a year or so earlier.
© Kunanon Tuntasoot/123RF
E
How do companies such as Berkshire Hathaway and Microsoft determine that
A
a business they want to own is worth more than the current market price? What
N
types of analysis would they use to make such decisions? Do you think the highly educated, experienced,
D
and well-paid individuals involved in making these high-dollar acquisitions made the right decisions?
R
­(Answer on page 595.)
A
1
1
2
3
T
S
592
Chapter 13
FACTORS IN COMMUNICATING
USEFUL INFORMATION
The primary objective of accounting is to provide information useful for decision making.
To provide information that supports this objective, accountants must consider the intended
users, the types of decisions users make with financial statement information, and available
means of analyzing the information.
The Users
© Susan van Etten/PhotoEdit
Users of financial statement information include managers, creditors, stockholders,
­potential investors, and regulatory agencies. These individuals and organizations use
­financial statements for different purposes and bring varying levels of sophistication to
understanding business activities. For example, investors range from private individuals
who know little about financial statements to large investment brokers and institutional
investors capable of using complex statistical analysis techniques. At what level of user
knowledge should financial statements be aimed? Condensing and reporting complex
business transactions at a level easily understood by nonprofessional investors is increasingly difficult. Current
Greporting standards target users that have a reasonably informed
knowledge of business, though that level of sophistication is difficult to define.
A
T
The Types of Decisions
Just as the knowledge level
E of potential users varies, the information needs of users varies,
depending on the decision at hand. A supplier considering whether or not to sell goods on
S
account to a particular company
wants to evaluate the likelihood of getting paid; a potential
investor in that company, wants to predict the likelihood of increases in the market value of
the companyâ??s common stock. Financial statements, however, are designed for general purposes; they are not aimed at any specific user group. Some disclosed information, therefore,
D users but vital to others. Users must employ different forms of
may be irrelevant to some
analysis to identify information
most relevant to a particular decision.
E
Financial statements can provide only highly summarized economic information. The
A
costs to a company of providing
excessively detailed information would be prohibitive. In
addition, too much detail
leads
to
information overload, the problem of having so much
N
data that important information becomes obscured by trivial information. Users faced with
D so frustrated attempting to use it that they lose the value of key
reams of data may become
information that is provided.
R
A
Information Analysis
Because of the diversity of users, their different levels of knowledge, the varying information needs for particular 1
decisions, and the general nature of financial statements, a variety
of analysis techniques has been developed. In the following sections, we explain several
1 The choice of method depends on which technique appears to
common methods of analysis.
provide the most relevant2information in a given situation.
3
METHODS OFTANALYSIS
S
LO 13-1
Differentiate between
horizontal and vertical
analysis.
Financial statement analysis should focus primarily on isolating information useful for
­making a particular decision. The information required can take many forms but usually
­involves comparisons, such as comparing changes in the same item for the same company
over a number of years, comparing key relationships within the same year, or comparing the
operations of several different companies in the same industry. This chapter discusses three
categories of analysis methods: horizontal, vertical, and ratio. Exhibits 13.1 and 13.2 present
comparative financial statements for Milavec Company. We refer to these statements in the
examples of analysis techniques.
593
Financial Statement Analysis
EXHIBIT 13.1
EXHIBIT 13.2
MILAVEC COMPANY
MILAVEC COMPANY
Income Statements and Statements of
Retained Earnings
For the Years Ending December 31
Balance Sheet
As of December 31
2018
Sales
$900,000
Cost of goods sold
Beginning inventory
43,000
Purchases
637,000
Goods available for sale
680,000
Ending inventory
70,000
Cost of goods sold
610,000
Gross margin
290,000
Operating expenses
248,000
Income before taxes
42,000
Income taxes
17,000
Net income
25,000
Plus: Retained earnings,
beginning balance
137,000
Less: Dividends
0
Retained earnings,
ending balance
$162,000
2017
$800,000
40,000
483,000
523,000
43,000
480,000
320,000
280,000
40,000
G18,000
22,000
A
130,000
T
15,000
E
$137,000
S
,
Assets
Cash
Marketable securities
Notes receivable
Accounts receivable
Merchandise inventory
Prepaid expenses
Property, plant, and
equipment (net)
Total assets
2018
2017
$ 20,000
20,000
4,000
50,000
70,000
4,000
$ 17,000
22,000
3,000
56,000
43,000
4,000
340,000
$508,000
310,000
$455,000
Liabilities and Stockholdersâ?? Equity
Accounts payable
$ 40,000
Salaries payable
2,000
Taxes payable
4,000
Bonds payable, 8%
100,000
Preferred stock, 6%,
$100 par, cumulative
50,000
Common stock, $10 par
150,000
Retained earnings
162,000
Total liabilities and
stockholdersâ?? equity
$508,000
D
E
Horizontal Analysis
Horizontal analysis, also called trend analysis,Arefers to studying the behavior of individual financial statement items over several accounting periods. These periods may be
N
several quarters within the same fiscal year or they may be several different years. The
D absolute dollar amount of the item or
analysis of a given item may focus on trends in the
trends in p­ ercentages. For example, a user may observe
that revenue increased from one
R
period to the next by $42 million (an absolute dollar amount) or that it increased by a perA
centage such as 15 percent.
Absolute Amounts
1
The absolute amounts of particular financial statement
items have many uses. Various
­national economic statistics, such as gross domestic
product
and the amount spent to replace
1
productive capacity, are derived by combining absolute amounts reported by businesses.
2
Financial statement users with expertise in particular industries might evaluate amounts
3 whether a company is spending exces­reported for research and development costs to judge
sively or conservatively. Users are particularly concerned with how amounts change over
T
time. For example, a user might compare a pharmaceutical companyâ??s revenue before and
S
after the patent expired on one of its drugs.
Comparing only absolute amounts has drawbacks, however, because materiality levels
differ from company to company or even from year to year for a given company. The
­materiality of information refers to its relative importance. An item is considered material
if knowledge of it would influence the decision of a reasonably informed user. Generally
accepted accounting principles permit companies to account for immaterial items in the
most convenient way, regardless of technical accounting rules. For example, companies may
expense, rather than capitalize and depreciate, relatively inexpensive long-term assets like
pencil sharpeners or wastebaskets even if the assets have useful lives of many years. The
$ 38,000
3,000
2,000
100,000
50,000
125,000
137,000
$455,000
594
Chapter 13
concept of materiality, which has both quantitative and qualitative aspects, underlies all
­accounting principles.
It is difficult to judge the materiality of an absolute financial statement amount without
considering the size of the company reporting it. For reporting purposes, Exxon
­Corporationâ??s financial statements are rounded to the nearest million dollars. For Exxon, a
$400,000 increase in sales is not material. For a small company, however, $400,000 could
represent total sales, a highly material amount. Meaningful comparisons between the two
companiesâ?? operating performance are impossible using only absolute amounts. Users can
surmount these difficulties with percentage analysis.
Percentage Analysis
Percentage analysis involves computing the percentage relationship between two
amounts. In horizontal percentage analysis, a financial statement item is expressed as a
percentage of the previous balance for the
EXHIBIT 13.3
same item. Percentage analysis sidesteps the
materiality problems of comparing different
MILAVEC COMPANY
size companies by measuring changes in perComparative Income Statements
centages rather than absolute amounts. Each
For the Years Ending December 31
change is converted to a percentage of the
G
Percentage
base year. Exhibit 13.3 presents a condensed
2018
2017
version of Milavecâ??s income statement with
A Difference
horizontal percentages for each item.
Sales
$900,000
$800,000
.5%*
T
The percentage changes disclose that, even
Cost of goods sold
610,000
480,000
.1
E â??9.4
though Milavecâ??s net income increased slightly
Gross margin
290,000
320,000
more than sales, products may be underpriced.
Operating expenses
248,000
280,000
S â??11.4
Cost of goods sold increased much more than
Income before taxes
42,000
40,000
.0
,
sales, resulting in a lower gross margin. Users
Income taxes
17,000
18,000
â??5.6
would also want to investigate why operating
Net income
$ 25,000
$ 22,000
.6
expenses decreased substantially despite the
D of previous
*($900,000 â?? $800,000) ÷ $800,000; all changes expressed as percentages
­increase in sales.
totals.
Whether basing their analyses on absolute
E
amounts, percentages, or ratios, users must
A
avoid drawing overly simplistic
conclusions about the reasons for the results. Numerical
­relationships flag conditions
N requiring further study. Recall that a change that appears
­favorable on the surface may not necessarily be a good sign. Users must evaluate the underD
lying reasons for the change.
R
A
CHECK YOURSELF 13.1
1
The following information was drawn from the annual reports of two retail companies (amounts are
1 is an upscale department store; the other is a discount store. Based on
shown in millions). One company
this limited information, identify
2 which company is the upscale department store.
3
T
Sales
S
Cost of goods sold
Gross margin
Jenkins Co.
Hornâ??s, Inc.
$325
130
$195
$680
408
$272
Jenkinsâ?? gross margin represents 60 percent ($195 ÷ $325) of sales. Hornâ??s gross margin
represents 40 percent ($272 ÷ $680) of sales. Since an upscale department store would have higher
margins than a discount store, the data suggest that Jenkins is the upscale department store.
Answer
Financial Statement Analysis
Answers to The Curious Accountant
Obviously Berkshire Hathawayâ??s and
Microsoftâ??s acquisitions were based on
a desire to make a profit on their investments. Even though Berkshireâ??s $235 was higher than Precision Castpartsâ?? current market price, in the past couple of years the stock had traded for as much as $275 per share. One of the companyâ??s
major customer bases is the gas and oil industry. Gas and oil prices were depressed in August 2015, which made the
stock market cautious about Precision Castpartsâ?? stock. However, Mr. Buffett, Berkshireâ??s CEO, believed the company
was a good long-term investment and that the current low price presented a good buying opportunity.
Microsoft wanted to acquire Nokiaâ??s cell phone business to try to increase the use of Microsoftâ??s Windows operating
system for mobile phones, a segment where Apple and Android dominated. By owning both the hardware and software
aspect of the phone, Microsoft predicted its profit would increase from less than $10 per phone to $40.
How do companies decide what another company is worth? Valuing a potential investment is the result of extensive
financial analysis, as discussed in this chapter, along with capital budgeting techniques, which were discussed in
G
A
­Predicting the future is imperfect, no matter how well trained the forecaster might be.
T
How good were the decisions of Berkshire Hathaway and Microsoft? It is too early to say for the purchase of
E
Precision Castparts, but since Mr. Buffett bought Berkshire Hathaway in 1965, the companyâ??s return has been double
S
that of the S&P 500 index. As for Microsoftâ??s purchase of Nokia, things did not turn out well. In July 2015, just two
,
Chapter 10. As you have seen in these chapters, such decision making is based on estimates about future events.
years after its acquisition, Microsoft announced it was writing down $7.6 billion of its Nokia investment, and eliminat-
ing 7,800 jobs.
D
E
Would you prefer to take the trip with a map or without? Obviously you would prefer to have a map or GPS, even though
A
you know neither device is perfect. Financial analysis can be of great benefit when making business decisions, but there
N
are always uncertainties about future events that mathematics cannot eliminate.
D
Sources: Companiesâ?? documents, The Wall Street Journal, and Reuters.
R
A
Does this mean that financial analysis is useless? No. Assume you were planning to drive across the United States.
1 use either of two basic approaches:
When comparing more than two periods, analysts
(1) choosing one base year from which to calculate all
1 increases or decreases or (2) calculating
each periodâ??s percentage change from the preceding figure. To illustrate, assume Milavecâ??s
2
sales for 2015 through 2018 are as follows:
2018
Sales
Increase over 2015 sales
Increase over preceding year
$900,000
50.0%
12.5%
3
T
2017
S$800,000
33.3%
6.7%
2016
2015
$750,000
25.0%
25.0%
$600,000
â??
â??
Analysis discloses that Milavecâ??s 2018 sales represented a 50 percent increase over 2015
sales, and a large increase (25 percent) occurred in 2016. From 2016 to 2017, sales increased
only 6.7 percent but in the following year, sales increased much more (12.5 percent).
595
596
Chapter 13
Vertical Analysis
Vertical analysis uses percentages to compare individual components of financial statements to a key statement figure. Horizontal analysis compares items over many time periods; vertical analysis compares many items within the same time period.
Vertical Analysis of the Income Statement
Vertical analysis of an income statement (also called a common size income statement) involves converting each income statement component to a percentage of sales. Although
vertical analysis suggests examining only one period, it is useful to compare common size
income statements for several years. Exhibit 13.4 presents Milavecâ??s income statements,
along with vertical percentages, for 2018 and 2017. This analysis discloses that cost of
goods sold increased significantly as a percentage of sales. Operating expenses and income
taxes, however, decreased in relation to sales. Each of these observations indicates a need for
more analysis regarding possible trends for future profits.
EXHIBIT 13.4
MILAVEC COMPANY
G Analysis of Comparative Income Statements
Vertical
A
2018
2017
T
Percentage* Percentage*
of Sales
Amount
of Sales
E Amount
Sales
100.0%
$800,000
100.0%
S $900,000
Cost of goods sold
610,000
67.8
480,000
60.0
, 290,000
Gross margin
32.2
320,000
40.0
Operating expenses
Income before taxes
Income taxes
Net income
248,000
42,000
17,000
$ 25,000
27.6
4.7
1.9
2.8%
280,000
40,000
18,000
$ 22,000
35.0
5.0
2.3
2.8%
D
E
*Percentages may not add exactly due to rounding.
A
N
Vertical Analysis of the
DBalance Sheet
Vertical analysis of the balance sheet involves converting each balance sheet component to
R The vertical analysis of Milavecâ??s balance sheets in Exhibit 13.5
a percentage of total assets.
discloses few large percentage
changes from the preceding year. Even small individual
A
percentage changes, however, may represent substantial dollar increases. For example, inventory constituted 9.5 percent of total assets in 2017 and 13.8 percent in 2018. While this
appears to be a small increase,
1 it actually represents a 62.8 percent increase in the inventory
account balance [($70,000 â?? $43,000) ÷ $43,000] from 2017 to 2018. Careful analysis re1
quires considering changes in both percentages and absolute amounts.
2
3
RATIO ANALYSIS
T
Ratio analysis involves S
studying various relationships between different items reported in a
set of financial statements. For example, net earnings (net income) reported on the income
statement may be compared to total assets reported on the balance sheet. Analysts calculate
many different ratios for a wide variety of purposes. The remainder of this chapter is devoted
to discussing some of the more commonly used ratios.
Objectives of Ratio Analysis
As suggested earlier, various users approach financial statement analysis with many
­different objectives. Creditors are interested in whether a company will be able to repay its
Financial Statement Analysis
597
EXHIBIT 13.5
MILAVEC COMPANY
Vertical Analysis of Comparative Balance Sheets
Percentage* Percentage*
2018
of Total
2017
of Total
Assets
Cash
$ 20,000
3.9%
Marketable securities
20,000
3.9
Notes receivable
4,000
0.8
Accounts receivable
50,000
9.8
Merchandise inventory
70,000
13.8
Prepaid expenses
4,000
0.8
Total current assets
168,000
33.1
Property, plant, and equipment
340,000
66.9
Total assets
$508,000
100.0%
Liabilities and Stockholdersâ?? Equity
Accounts payable
$ 40,000
7.9%
G0.4
Salaries payable
2,000
Taxes payable
4,000
A 0.8
Total current liabilities
46,000
9.1
T19.7
Bonds payable, 8%
100,000
Total liabilities
146,000
E28.8
Preferred stock 6%, $100 par
50,000
9.8
S29.5
Common stock, $10 par
150,000
Retained earnings
162,000
, 31.9
Total stockholdersâ?? equity
362,000
71.2
Total liabilities and
stockholdersâ?? equity
$508,000
100.0%
D
$ 17,000
22,000
3,000
56,000
43,000
4,000
145,000
310,000
$455,000
3.7%
4 …
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