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financial statement analysis

The Analysis And Use Of Financial Statements 3rd Edition Gerald I. White, Ashwinpaul C. Sondhi, Haim D. Fried - Solutions

7. [Capitalization versus expensing] Norsk Hydro [NHY). a multinational energy company, produces its financial statements in accordance with Norwegian GAAP but reconciles net income and shareholders' equity to U.S. GAAP. The reconciliation states that three major differences between Norwegian GAAP
b. Calculate the effect of that accounting choice on the follow- ing reported amounts for fiscal year 2000: (i) Net income (ii) Shareholders' equity (i) Return on assets (Assume a 35% tax rate.) 6. [Brand names] "Buildings age and become dilapidated. Ma- chines wear out. Cars rust. But what lives
5. Capitalization versus expensing] American Woodmark [AMWD] is a manufacturer of kitchen cabinets and similar items. Its fiscal year 2000 annual report contains the following footnote under Significant Accounting Policies: Promotional Displays. The Company's investment in promotional displays is
4. [Capitalization of computer software expenditures] Erics- son [ERICA]. a multinational producer of wireless telephone equipment, produces its financial statements in accordance with Swedish GAAP but reconciles net income and sharehold- ers equity to U.S. GAAP. Swedish GAAP does not permit the
3. [Capitalization of computer software; CFA adapted]a. Discuss the conditions, under U.S. GAAP, under which com- puter software development costs may be capitalized, before and after a product is proven economically feasible.b. How would your answer differ for IASB (IAAP?
2. [Capitalization as property, plant, and equipment; CFA adapted]a. Discuss, for each of the following, the conditions (under U.S. CIAAP) under which they may be included in the carrying amount of property, plant, and equipment: (i) Interest cost during the period of construction (ii) Cost of
1. [Capitalization of interest] The following data were obtained from the annual reports of Chevron, a multinational oil company (all data in Smillions): 1995 1996 1997 1998 1999 Interest expense S 401 5 364 $ 312 $ 405 $ 472 Pretax income 1,789 4,740 5.502 1.834 3,648 Net income 930 2,607 3.256
9. Discu•s the valuatton implications of expendimres that m~y be either capitalized or expensed.
8. Adjust reported financial statements for differences in capitalint1on policy.
7. Consider the accounting for industries wtth unusual capitalization practices and the effects of aecountmg choices on reported financ1al data.
6. Examine the financial statement effects of revaluation of long-term assets.
s. De;cnbe the two methods of accounting for oil and gas exploration and show their effects on the level and trend of reported income, cash flows, assets. and equity.
4. Shcm how capttal inti on of expendi turcs tOr t..:8earch and development and computer sotlware affects financial statements and how to restate to achteve compar~btltty wllh firms that expense such expendirnres.
J. Review the circumstances under which tntang1blc as:.e\8 are capitalized.
2. F.xplam the rule~ gvvcrning the capnalization of interest and the effects of such capnalization on financtal statements.
1. D1scuss the effe
24. [Effect of inventory methods on contracts] The Sechne Company has entered into a number of agreements in the past year. These agreements contain provisions that depend on the firm's reported financial statements: (i) Management compensation plan. Bonuses are based on a weighted average of
23. [Measuring operating performance in service economy] The inventory turnover ratio measures one aspect of a finn's operal- ing efficiency. For companies that do not have significant inven- tories (ie., service industries). this measure cannot be used. In some cases, even for firms that maintain
22. [Inventory costing for pricing purposes] The following para- graph was taken from the "Message to Stockholders" section of the Driver-Harris 1980 Annual Report. We would like to call your attention to a major effect caused by inflation Our results are significantly affected by the use of LIFO
21. [Effect of LIFO liquidations on gross margins] The follow- ing data were obtained from annual reports of Stride-Rite [SRR]. a shoe manufacturer and retailer Years Finded December 31 (in Sthousands) Sales COGS Gross profit LIFO liquidation (net of tax) 1997 1998 1999 $515.728 $539.413 5.572.696
20. [Decline in LIFO reserve] The following footnote appeared in the annual report of A. T. Cross [ATX], a pen manufacturer: Note B-Inventories Domestic writing instrument inventories, approximating $13.404.000 and $5,695,000 at December 30, 2000 and January 1, 2000, respectively, are priced at the
c. Explain how it is possible for a LIFO liquidation to decrease income as in 1998.d. Excluding the effects of the LIFO liquidation, compute COGS for 1998 and 1999 using (i) The company's current accounting method (ii) The FIFO methode. State and justify which of the following measures of COGS is
b. Compute the company's 1998 and 1999 COGS using the FIFO method
18. Adjusting for alternative accounting methods: effects of Irquidation] The Noland Company [NOLD] reported the follow- ing operating results: Years Ended December 31 in (Sthousands) Sales COGS Gross margin 1997 1998 1999 $464,965 $465,479 $482,830 371.212 372,033 385,892 $ 93,753 $ 93,446 $
17. [Adjusting for LIFO liquidations] The Jofen Company uses the LIFO inventory method In 20X3. anticipating a downturn in demand, the company decides not to replenish inventory levels at year-end. The resulting LIFO liquidation increases pretax in- come by $300,000 Ending inventory on December 31,
16. Inventory turnover ratio] General Electric [GE] reported that its inventory turnover ratio increased from 8.3 times in 1999 to 8.5 times in 2000. The following data appear in GE's annual report: Years Ended December 31 (in $millions) 1998 1999 2000 Sales of goods Sales of services $43,749
15. [Estimating company-specific inflation rates] Paper and pa- perboard products account for 90% of Westvaco's business; the other 10% is devoted to (specialty) chemical products. Producer price mdex data relevant to these segments are presented below. Producer Price Indices (1982 = 100) Pulp.
d. Discuss briefly whether the assumption made in part b is a reasonable one 7
c. Explain the usefulness of the adjusted data in part b.
b. Assume that all of Westvaco's inventories faced the same in- flation rate Adjust Westvaco's cost of sales to 100% LIFO and compute adjusted 2000 gross profit and net income.
14. Inflation rate and adjusting FIFO to LIFO]a. Using the data provided and the adjustment method described in the chapter, calculate the rate of price change experienced by Westvaco in 2000.
13. [LIFO versus FIFO and effect on ratios]a. Calculate Westvaco's inventory turnover, gross profit mar- gin, and ROE for 2000 based on reported data.b. Recompute the ratios in part a assuming Westvaco had used FIFO for all of its inventories.c. Describe the impact of the LIFO method on Westvaco's
12. [IIFO versus FIFO; effect on inventory turnover ratio and cost of sales, adjusting turnover ratio] Sears uses the LIFO method to value its merchandise inventories. The following data (in millions) were obtained from the company's annual reports: Calendar Year Fiscal Year 1997 1998 1999 January
e. Compare the company's 2000 inventory turnover to turnover in 1998 and 1999 based on: (i) Reported data (ii) FIFO data (iii) Current cost data
d. Discuss the effects of price changes on the company's re- ported profitability
c. Redo part a on the FIFO basis. State which measure of prof- itability more accurately reflects the real profitability of Sunoco for that period. Justify your choice.
b. Compute the price-level change of oil products in 2000 Compare that change to the 1998 and 1999 price-level changes
11. [Extension of Sunoco, FIFO vs. LIFO and effect on ratios] In its 2000 annual report, Sunoco reported a carrying value of $381 million for its crude oil and refined products inventories. The LIFO reserve at the 2000 year-end was $873 million Sales and cost of sales data for 1998-2000 follow:a.
b. Calculate the company's inventory turnover ratio on both a FIFO and LIFO basis.c. Calculate Zeta's return on equity on a FIFO basis. (Remem- ber to adjust both the numerator and denominator)d. Discuss the usefulness of the adjustments made n partsa, b. and c to a financial analyste. Describe
10. [LIFO versus FIFO; effect on ratios; adjusting ratios; CFA adapted The Zeta Corp. uses LIFO inventory accounting. The footnotes to the 20X4 financial statements contain the following data as of December 31 20X3 20X4 Raw materials $392.675 $369,725 Finished products 401,325 377,075 Inventory on
9. [LIFO versus FIFO; effect on ratios; adjusting ratios]a. Using only reported financial data, compute each of the fol- lowing ratios for both Zenab and Faybech. (i) Current ratio (20X1 and 20X2) (ii) Inventory turnover (20X2) (iii) Gross profit margin (20X2) (iv) Pretax profit margin (EBT to
7. [Declining costs: LOCM] Prices for the ZB Company's prod- ucts are talking due to lower production costs On September 30, 20X2, the company had the following inventory balance 100 units a $44 $4.400 Fourth-quarter purchases were 200 units a $43 5 8.600 300 unus a $40 S12,000 Fourth-quarter sales
5. [Inventory methods; basic relationships; impact on turnover ratio] The Renemax Company begins operations on December 31, 20X0, with $500 of inventory, enough for one month's (Jan- uary 20X1) sales. During 20X1, the company maintains its in- ventory at one month's sales. Monthly sales (in units)
b. Compute COGS and ending inventory under both the LIFO and FIFO methods.
4. [Inventory costing, basic relationships] During its first year of operations, Metro Retailers made the following inventory pur- chases: February 1 1,000 units ( $2 each April | August 2,800 units (a $3 each 1,000 units For the year, 11 reported COGS of $10,500 and ending inventory of $3,500
b. Assume that Mogul liquidates its entire inventory at year- end Discuss how the answers to part a would differ.
3. [FIFO and LIFO--basic relationships] The Mogul Com- pany, expecting that decreases in oil prices are only temporary. increases its monthly purchases as the price of oil decreases Mogul's monthly oil purchases follow Penod Quantity (bbl) Price/Barrel First quarter January 100,000 $25 February
2. [Effect of inventory methods on financial statements; CHA adapted] Compare the effect of the use of the LIFO inventory method with use of the FIFO method on cach of the follow- ing. assuming rising prices and stable inventory quantities: (i) Gross profit margin (ii) Net income (iii) Cash from
1. [Allocation of purchase costs under different inventory methods; (FA adapted] Assume the following: Quarter Units Purchased Per Unit Cost Dollar Purchases Unit Sales | 200 $22 $ 4,400 200 II 300 24 7,200 200 111 300 26 7,800 200 IV 200 1,000 28 5,600 200 $25,000 800 Year Inventory at beginning
1. Why do some firms continue to use FIFO? 2. Are firms that use LIFO perceived as being "better off" by the market despite lower reported carnings?
11. Discuss the inventory methods used outside the United States.
10. Describe what research tells us about why firms choose to adopt (or not to adopt) the LIFO method.
9. Discuss the motivation for adoption of the LIFO method and show the financial statement effects of that adoption.
8. Compare the two different signals transmitted by a decline in the LIFO reserve.
7. Adjust reported financial results to remove distor- tions caused by price changes.
6. Adjust the financial data of companies using differ- ent accounting methods to achieve comparability.
5. Contrast the effect of different inventory methods on financial ratios.
4. Show how price increases and decreases af- fect reported income under different accounting methods.
3. Describe the cash flow and working capital effects of the choice of inventory method.
2. Compare the usefulness of inventory and cost of goods sold data provided by these different account- ing methods.
1. Define and illustrate the alternative accounting methods used by companies to account for product inventory: LIFO, FIFO, and average cost.
d. Discuss why, in the case of Dell, it is particularly difficult to determine the cause of the market reaction.c. Most research studies would test for the market reaction to an announcement coming after the close of the market on the basis of the market reaction of the following day. In the case
c. The news items for Amgen and Dell imply that the price change was a reaction to the news reported. Although the same argument can be made in the case of Deere, the article does not do so. State and justify for which of these three com- panies there is the strongest argument that the market
Discuss whether this question could be asked with respect to the price change of Dell's shares in the last month.
9. [News releases, market reaction, and abnormal returns] Ex- hibit 5P-1 contains information as to. Closing prices and news items/releases of three companies The performance of various market indices on February 24. 1993a. Ignoring the news items. state and justify which of the three stocks you
Evaluate the argument made in the Newsweek article in the com- text of the accounting theories discussed in the chapter. Consid- eration should be given to the following points Whether the article is consistent with the effic ent market and/or positive theory views of accounting The possibility
8. [Mandated accounting changes, economic consequences; market reaction] Newsweek (January 11, 1993. p. 59) reported that a survey found that two-thirds of major corporations have curtailed retiree health plans or intend to in 1993 The article attributes the curta Iment of such bencfits to a change
7. [Implications for analysis] WSF Investment Services has a policy of completing a "company profile" for each new company whose financial statements it intends to analyze. You have been hired by WSF as an instructor in their training program. For each item on the checklist, explain to a trainee
6. [Monvation for income manipulation) A Business Week (February 14, 1994, pp. 78-92) article entitled, "Did Pfizer Doc- tor Its Numbers," suggests that for the 1993 fiscal year, Pfizer, a pharmaceutical and chemical company, "managed down the numbers." Specifically, the article contends that: the
5. [Accounting standard setting] Describe how the proponents of the three approaches to accounting theory would respond to the following statements "Generally accepted accounting principles are anything but principled. How could they be? They are a product of a political process."
c. Can you think of any (mandated) accounting standards that may have had pervasive effects across many sectors of the economy?
b. What does this imply about the nature of conclusions that can be drawn from certain market studies?
4. [Implications of adjusting for general market conditions] Assume that new information arrived affecting all aspects of the economya. Under standard research procedures, using a model such as the capital asset pricing model to test for market reaction, what would the results show?
c. Given the empirical evidence to date, discuss the possible roles for investment managers
b. Assuming the EMH holds, discuss two major roles or respon- sibilities of portfolio managers in an efficient market.
3. [Efficient market hypothesis, CFA adapted] The efficient market hypothesis (EMH) exists in three forms weak, semistrong, and strong.a. Briefly discuss the implications of each of these forms for in- vestment policy as it applies to: (i) Technical analysis (e.g.. charting) (ii) Fundamental
d. Ingberman and Sorter, in their paper. "The Role of Financial Statements in an Efficient Market," Journal of Accounting, Auditing and Finance (Fall 1978), pp. 58-62, suggest that financial statements are seldom the place in which sig- nificant firm-related events are initially reported. In-
c. Discuss the implication of your replies to parts A and B on the factors that must be considered when evaluating the use- fulness of financial reporting systems.
b. State under which system the second report would show more information content. Justify your choice.
2. [Predictability, surprises, and information content] Suppose it were possible to evaluate the effects on stock prices of two in- formation systems: Alpha and Gamma. Each produces two ac- counting reports. The second report of each system will be identical. Information system Alpha allows you to
1. [Approaches to accounting standard setting] In Chapter 1 we discuss neutrality, one of the qualitative characteristics of ac- counting information: Neutrality is concerned with whether financial statement data are biased. FASB proposals are frequently the object of complaints that companies will
1. [Cash flows: CFA adapted] Cash flow data of Palomba Pizza Stores for the year ended December 31. 2000 follow: Cash payment of dividends $(35,000) Acquisition of Naples' Pizza (14.000) Cash payments for interest (10,000) Cash payments for salaries (45.000) Sale of equipment 38.000 Retirement of
b. Discuss, from an analyst's viewpoint, the purpose of classify- ing cash flows into the three categories used in part a.
c. Discuss whether any of the cash flows should be classified differently.
d. Discuss the significance of the change in cash duning 2000 as an indicator of Palomba's performance.e. Calculate Palomba's free cash flow.f. In your calculation of free cash flow, justify your treatment of cash payments for interest and cash paid for acquisitions.
2. [Revenue and expense recognition cash flow analysis] The Stengel Company showed the following pattem of sales, bad debt expense, and net receivables for 1997 through 2001 (in $ millions): 1997 1998 1999 2000 2001 Sales $140 $150 $165 $175 $195 Bad debt expense 7 7 8 10 10 Net receivables* 40 50
3. [Cash flow: transactional analysis; CFAC adapted] The fol- lowing financial statements are from the 2001 Annual Report of the Niagara Company: Income Statement for Year Ended December 31, 2001 Sales Cost of goods sold Depreciation expense Sales and general expense Interest expense Income tax
5. [Preparation of cash flow statement-direct and indirect methods; CFA adapted] The balance sheet and income state- ment for the Green Company are presented in Exhibit 3P-2.a. Based on the financial statements provided, prepare a state- ment of cash flows for 2001 using the (1) Indirect method
6. [Extension of Box 3-2; cash flow; conversion of indirect to direct method] Exhibit 3P-3 contains financial statement data for A. M. Castle, a steel wholesaler. The statement of cash flows is prepared using the indirect method.a. Using the data in Exhibit 3P-3, prepare a direct method state- ment
Discuss how the cash flow statements in Box 3-2 and your answer to part a would have helped an analyst to forecast the dividend reductions.
7. [Differences between U.S. GAAP and Swedish GAAP-statement of cash flows] Hol- men's consolidated cash flow statements are based on Swedish accounting standards.a. Identify and discuss the major differences between the Swedish GAAP cash flow statement and the U.S. GAAP re- quirements (SFAS 95)
b. Convert Holmen's Swedish GAAP cash flow statement to a U.S. GAAP-based cash flow statement using Westvaco's statement of cash flows as a guide for the format.
c. Identify and discuss two significant advantages and two dis- advantages of the Swedish GAAP approach to cash flow statements. Your answers should discuss the usefulness of the data provided for financial analysis.
8. [Differences between U.S. GAAP and Interna- tional Accounting Standards-statement of cash flows] Roche provides cash flow statements based on International Accounting Standards.a. Identify and discuss the major differences between the Inter- national Accounting Standards cash flow statement and
c. Identify and discuss at least one significant advantage and one disadvantage of the International Accounting Standards approach to cash flow statements.
9. [Income statement and cash flow analysis, courtesy of Profes- sor I. Krinsky] The income statement and statement of cash flows of the Radloc Company are presented in Exhibit 3P-4. This is a merchandising company that has been expanding rapidly.
Assume that you are the credit manager of a bank and the company ap- proached you for a loan in the first quarter of 1995. State whether you would grant the company a loan and justify your answer. As part of your analysis, you should: (1) Compute (to the extent possible) a direct cash flow
(lii) Examine trends in income, CFO, and free cash flow. 10. [Cash flows; free cash flows; effect of acquisitions: CFA adapted] In October 1988, Philip Morris announced an unso- licited cash tender offer for all the 124 million outstanding
14. [Conversion of indirect to direct method cash flow state- ments; analysis of income and cash flow data; implications for valuation] Exhibit 3P-6 contains financial data for the Hamp- shire Company for 2000 and 2001. The following additional in- formation is provided: Hampshire is not subject to
b. Prepare income statements for 2000 and 2001 excluding the effects of nonrecurring items

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