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Picasso Company is a wholesale distributor of packaging equipment and supplies. The company’s sales have averaged about \(900,000 annually for the 3-year period 2015–2017. The firm’s total assets at the end of 2017 amounted to \)850,000.

The president of Picasso Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s operations for the past 3 years. This report will be presented to the board of directors at their next meeting.

In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios which can assist in the identification and interpretation of trends. At the request of the controller, the accounting staff has calculated the following ratios for the 3-year period 2015–2017.

2015

2016

2017

Current ratio

1.80

1.89

1.96

Acid-test (quick) ratio

1.04

0.99

0.87

Accounts receivable turnover

8.75

7.71

6.42

Inventory turnover

4.91

4.32

3.42

Debt to assets ratio

51.0%

46.0%

41.0%

Long-term debt to assets ratio

31.0%

27.0%

24.0%

Sales to fixed assets (fixed asset turnover)

1.58

1.69

1.79

Sales as a percent of 2015 sales

1.00

1.03

1.07

Gross margin percentage

36.0%

35.1%

34.6%

Net income to sales

6.9%

7.0%

7.2%

Return on assets

7.7%

7.7%

7.8%

Return on common stockholders’ equity

13.6%

13.1%

12.7%

In preparation of the report, the controller has decided first to examine the financial ratios independent of any other data to determine if the ratios themselves reveal any significant trends over the 3-year period.

Instructions

a) The current ratio is increasing while the acid-test (quick) ratio is decreasing. Using the ratios provided, identify and explain the contributing factor(s) for this apparently divergent trend.

Short Answer

Expert verified

Inventory turnover has decreased considerably during the previous three years, falling from 4.91 to 3.42.

Step by step solution

01

Meaning of Financial Statements

Financial management is the department interior and organization or trade that's concerned with cash flow, profitability, credits, costs, etc. in order to guarantee that the company has the resources essential to realize its trade targets and objectives.

02

Explaining the contributing factors for apparently divergent trend

The acid-test ratio is the current ratio with the subtraction of stock and prepaid costs(by and large inconsequential relative to stock) from current assets. Any disparity in drift between these two ratios would subsequently be subordinate to the inventory account.

Inventory turnover has declined strongly within the three-year period, from 4.91 to 3.42. Amid the same period, deals to settled resources have expanded, and total deals have expanded 7 percent.

The decline within the inventory turnover is subsequently not due to a decline in sales. The clear cause is that venture in stock has expanded at a quicker rate than deals, and this has accounted for the uniqueness between the acid-test and current ratios.

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Most popular questions from this chapter

An annual report of Crestwood Industries states, “The company and its subsidiaries have long-term leases expiring on various dates after December 31, 2017. Amounts payable under such commitments, without reduction for related rental income, are expected to average approximately \(5,711,000 annually for the next 3 years. Related rental income from certain subleases to others is estimated to average \)3,094,000 annually for the next 3 years.” What information is provided by this note?

Your firm has been engaged to examine the financial statements of Almaden Corporation for the year 2017. The bookkeeper who maintains the financial records has prepared all the unaudited financial statements for the corporation since its organization on January 2, 2012. The client provides you with the following information.

ALMADEN CORPORATION

BALANCE SHEET

DECEMBER 31, 2017

Asset

Liabilities

Current assets

\(1,881,100

Current liabilities

\) 962,400

Other assets

5,171,400

Long-term liabilities

1,439,500


Capital

4,650,600

\(7,052,500

\)7,052,500

An analysis of current assets discloses the following.

Cash (restricted in the amount of \(300,000 for plant expansion)

\)571,000

Investments in Land

185,000

Accounts receivable less allowance of \(30,000

480,000

Inventories (LIFO flow assumption)

645,100

\)1,881,100

Other assets include:

Prepaid expenses

\( 62,400

Plant and equipment less accumulated depreciation of \)1,430,000

4,130,000

The cash surrender value of life insurance policy

84,000

Unamortized bond discount

34,500

Notes receivable (short-term)

162,300

Goodwill

252,000

Land

446,200

\(5,171,400

Current liabilities include:

Accounts payable

\) 510,000

Notes payable (due 2020

157,400

Estimated income taxes payable

145,000

Premium on common stock

150,000

\( 962,400

Long-term liabilities include

Unearned revenue

\) 489,500

Dividends payable (cash

200,000

8% bonds payable (due May 1, 2022)

750,000

\(1,439,500

Capital includes:

Retained earnings

\)2,810,600

Common stock, par value \(10; authorized 200,000 shares, 184,000 shares issued

1,840,000

\)4,650,600

The supplementary information below is also provided.

  1. On May 1, 2017, the corporation issued at 95.4, \(750,000 of bonds to finance plant expansion. The long-term bond agreement provided for the annual payment of interest every May 1. The existing plant was pledged as security for the loan. Use the straight-line method for discount amortization.
  2. The bookkeeper made the following mistakes.
    1. In 2015, the ending inventory was overstated by \)183,000. The ending inventories for 2016 and 2017 were correctly computed.
    2. In 2017, accrued wages in the amount of \(225,000 were omitted from the balance sheet, and these expenses were not charged on the income statement.
    3. In 2017, a gain of \)175,000 (net of tax) on the sale of certain plant assets was credited directly to retained earnings.
  3. A major competitor has introduced a line of products that will compete directly with Almaden’s primary line, now being produced in a specially designed new plant. Because of manufacturing innovations, the competitor’s line will be of comparable quality but priced 50% below Almaden’s line. The competitor announced its new line on January 14, 2018. Almaden indicates that the company will meet the lower prices that are high enough to cover variable manufacturing and selling expenses but permit recovery of only a portion of fixed costs.
  4. You learned on January 28, 2018, prior to completion of the audit, of heavy damage because of a recent fire to one of Almaden’s two plants; the loss will not be reimbursed by insurance. The newspapers described the event in detail.

Instructions

Analyze the above information to prepare a corrected balance sheet for Almaden in accordance with proper accounting and reporting principles. Prepare a description of any notes that might need to be prepared. The books are closed and adjustments to income are to be made through retained earnings.

Where can authoritative IFRS be found related to the various disclosure issues discussed in the chapter?

(Disclosure of Estimates) Nancy Tercek, the financial vice president, and Margaret Lilly, the controller, of Romine Manufacturing Company are reviewing the financial ratios of the company for the years 2017 and 2018. The financial vice president notes that the profit margin on sales ratio has increased from 6% to 12%, a hefty gain for the 2-year period. Tercek is in the process of issuing a media release that emphasizes the efficiency of Romine Manufacturing in controlling cost. Margaret Lilly knows that the difference in ratios is due primarily to an earlier company decision to reduce the estimates of warranty and bad debt expense for 2018. The controller, not sure of her supervisor’s motives, hesitates to suggest to Tercek that the company’s improvement is unrelated to efficiency in controlling cost. To complicate matters, the media release is scheduled in a few days.

Instructions

  1. What stakeholders might be affected by Tercek’s media release?

(Dividend Policy Analysis) Matheny Inc. went public 3 years ago. The board of directors will be meeting shortly after the end of the year to decide on a dividend policy. In the past, growth has been financed primarily through the retention of earnings. A stock or a cash dividend has never been declared. Presented below is a brief financial summary of Matheny Inc.’s operations.

(\(000 omitted)

2018

2017

2016

2015

2014

Sales revenue

\)20,000

\(16,000

\)14,000

\(6,000

\)4,000

Net income

2,400

14,000

800

700

250

Average total assets

22,000

19,000

11,500

4,200

3,000

Current assets

8,000

6,000

3,000

1,200

1,000

Working capital

3,600

3,200

1,200

500

400

Common shares:

Number of shares

Outstanding (000)

Average market price

2,000

\(9

2,000

\)6

2,000

$4

20

-

20

-

Instructions

  1. Compute the return on assets, profit margin on sales, earnings per share, price-earnings ratio, and current ratio for each of the 5 years for Matheny Inc.
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