Learning Goal 30: Analyze Financial Statements
Learning Goal 30
a Earnings per share is also used directly for comparing profitability on a per-share basis.
c An airline would have a much greater investment in property, plant, and equipment assets
than an accounting firm. Therefore, the denominator in the fraction will be much bigger,
making the answer for turnover much smaller. A much bigger asset investment is needed
to create a dollar of revenue in an airline. An accounting firm and an airline are service
businesses and do not have merchandise inventory or cost of goods sold.
b First, this focuses blame on the old management. Second, future years’ results will now look
better when compared to the current large loss year in which the “big bath” was recorded.
c Both ratios relate to potential near-term cash flow and are also indicators of management
d If sales on account are overstated, the average balance of accounts receivable will also be
overstated. Also, these overstated receivables will remain uncollected. The denominator in
the ratio calculation will increase, which reduces the turnover and increases the days.
Assume correct amounts are: sales 100, beginning A/R 14, and ending A/R 10.
[100/(14 + 10)]/2 = 8.33. Now assume sales overstated by 20.
[120/(14 + 30)]/
2 = 5.45 (lower turnover). (
The gross profit ratio will also provide a clue as it begins to
increase above historical averages.)
b Changing from LIFO to FIFO in a period of rising prices reduces cost of goods sold, and the
numerator of the ratio becomes smaller. As well, the ending inventory becomes greater,
which increases the average inventory in the denominator. These changes decrease the
inventory turnover answer, although items are not actually being sold any slower. Be careful
when comparing companies using different inventory methods