Charles Crutchfield, manager of manufacturing operations at Morgan Manufacturing, was evaluating the performance of the company. Given his position, he was primarily interested in the health of the operating aspects of the business. At Morgan, the gross margin percentage was considered to be a key measure of operating performance; other measures considered to provide essential information on the health of business operations were pretax return on sales and pretax return on assets. Crutchfield considered the after-tax versions of these measures less relevant for his purposes because they combined information reflecting the health of operations with information reflecting the effectiveness of the tax accounting department, which was not under his control.
EXHIBIT 1
Morgan Manufacturing Financial Statements ($ millions)

EXHIBIT 2
Westwood, Inc., Financial Statements ($ millions)

Questions
1. What are Westwood's gross margin percentage, pre-tax return on sales (pre-tax income ÷ sales), and pre-tax return on assets (pre-tax income ÷ total assets)?
2. Which accounts that appear on the income statement or balance sheet and the various financial ratios and measurements incorporating these accounts are affected by the differing choices of inventory accounting method? Explain how the choice of different inventory accounting methods affects one's ability to directly compare the results of these two companies.
3. Using the information available in the exhibits, make the necessary adjustments to the 2010 results so that you can better compare the performance of the two companies on the three key measures.
4. Which of the two companies do you believe is performing better? Why?

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Income Statement, for the year ended December 31 Sales Cost of goods sold Gross margin Selling, general, and administrative expenses Income before taxes Income tax expense 2009 $1,500 810 690 450 240 96 2010 $2,000 1,110 890 600 290 116 5 144 174 Net income Balance Sheet, as of December 31 Cash Accounts receivable Inventory Plant, property, and equipment (net) 2009 2010 s 100 250 120 1,385 $1,855 5 250 500 400 705 s 140 350 100 1,580 $2,170 Total assets Current liabilities Long-term liabilities Common stock Retained earnings 5 325 675 400 770 $2,170 $70 Total liabilities and owners' equity 51.835 2120 LIFO reserve $10 Income Statement, for the year ended December 31 Sales Cost of goods sold Gross margin Selling, general, and administrative expenses Income before taxes Income tax expense 2009 2010 $2,000 1,100 900 600 300 120 5 180 $1,500 700 450 250 100 Net income S 150 Balance Sheet, as of December 31 Cash Accounts receivable 2009 2010 5 100 250 140 1,385 $1,875 5 250 500 400 725 s 140 350 170 1,580 $2,240 5 330 675 400 835 $2,240 Plant, property, and equipment (net) Total assets Current liabilities Long-term liabilities Common stock Retained earnings Total Babilities and owners' equity S1875 1220