What does the use of the direct method reveal about a company that the indirect method does not?

accounting to managers 2

 

15.

 

Ratio Analysis: Decision FocusLO1, 2, 4, 5, 6

 

Avantronics is a manufacturer of electronic components and accessories that has total assets of $20,000,000. Selected financial ratios for Avantronics and the industry averages for firms of similar size are as follows:

 

  Avantronics Industry Average
  Year 1 Year 2 Year 3
Current ratio 2.09 2.27 2.51 2.24
Quick ratio 1.15 1.12 1.19 1.22
Inventory turnover 2.40 2.18 2.02 3.50
Profit margin 0.14 0.15 0.17 0.11
Debt-to-equity ratio 0.24 0.37 0.44 0.35

 

Avantronics is being reviewed by several entities whose interests vary, and the company’s financial ratios are a part of the data being considered. Each of the following parties must recommend an action based on its evaluation of Avantronics’s financial position:

 

MidCoastal Bank. The bank is processing Avantronics’s application for a new five-year term note. MidCoastal has been the banker for Avantronics for several years but must reevaluate the company’s financial position for each major transaction.

 

Ozawa Company. Ozawa is a new supplier to Avantronics and must decide on the appropriate credit terms to extend to the company.

 

Drucker & Denon. A brokerage firm specializing in the stock of electronics firms that are sold over the counter, Drucker & Denon must decide whether it will include Avantronics in a new fund being established for sale to Drucker & Denon’s clients.

 

Working Capital Management Committee. This is a committee of Avantronics’s management personnel chaired by the chief operating officer. The committee is responsible for periodically reviewing the company’s working-capital position, comparing actual data against budgets, and recommending changes in strategy as needed.

 

Required

 

  • Describe the analytical use of each of the five ratios presented in the chart.

 

  • For each of the four entities described, identify the financial ratios, from those ratios presented, that would be most valuable as a basis for its decision regarding Avantronics.

 

  • Discuss what the financial ratios presented in the question reveal about Avantronics. Support your answer by citing specific ratio levels and trends, as well as the interrelationships among these ratios.

 

 

 

 

  • Horizontal AnalysisLO2

 

  • Following are the income statements for Martha’s Miscellaneous for Year 1 and Year 2:

 

Martha’s Miscellaneous Comparative Statements of Income and Retained Earnings
      $ %
  Year 2 Year 1 Change Change
Sales revenue $700,000 $650,000    
Cost of goods sold   500,000   455,000    
Gross profit  $200,000  $195,000    
Payroll expense $ 50,000 $ 42,250    
Insurance expense   30,000   29,000    
Rent expense   18,000   18,000    
Depreciation    35,000    15,000    
Total expenses  $133,000  $104,250    
Operating income $ 67,000 $ 90,750    
Interest expense    (7,000)    (5,000)    
Gain on vehicle sale   25,000    
Loss on sale of securities   (25,000)    
Interest revenue    75,000    50,000    
Net income before interest and taxes $135,000 $135,750    
Income taxes    40,000    40,250    
Net income $ 95,000 $ 95,500    
Dividends    38,000    38,000    
Total retained earnings $ 57,000 $ 57,500    
Retained earnings, 1/1  193,500  136,000    
Retained earnings, 12/31  $250,500  $193,500    

 

  • Required

 

  • Complete the comparative income statement by computing dollar change ($ change) and percentage change (% change).

 

 

 

18.

 

Comprehensive Ratio AnalysisLO4, 5, 6

 

The 2012 financial statements for the Griffin Company are as follows:

 

Griffin Company Statement of Financial Position
  12/31/12 12/31/11
Assets    
Cash $ 40,000 $ 10,000
Accounts receivable   30,000   55,000
Inventory  110,000   70,000
Property, plant, and equipment  250,000  257,000
Total assets $430,000 $392,000
Liabilities and Stockholders’ Equity    
Current liabilities $ 60,000 $ 50,000
5% mortgage payable  120,000  162,000
Common stock (30,000 shares)  150,000  150,000
Retained earnings  100,000   30,000
Total liabilities and stockholders’ equity $430,000 $392,000
Griffin Company Income Statement For the Year Ended December 31, 2012
Sales on account $420,000
Less expenses:  
Cost of goods sold $214,000
Salary expense 50,000
Depreciation expense 7,000
Interest expense    9,000
Total expenses $280,000
Income before taxes $140,000
Income tax expense (50%) 70,000
Net income $ 70,000

 

Required

 

Compute the following ratios for the Griffin Company for the year ending December 31, 2012:

 

  • Profit margin ratio (before interest and taxes)

 

  • Total asset turnover

 

  • Rate of return on total assets

 

  • Rate of return on common stockholders’ equity

 

  • Earnings per share of stock

 

  • Inventory turnover

 

  • Current ratio

 

  • Quick ratio

 

  • Accounts receivable turnover

 

  • Debt-to-equity ratio

 

  • Times interest earned

 

 

 

 

 

14.

 

Adjustments to Income via the Indirect Method: Operating ActivitesLO1, 2, 3

 

The following account balances are for the noncash current assets and current liabilities of Wynn Bicycle Company at the end of 2011 and 2012.

 

    December 31  
  2011 2012
Accounts receivable $ 4,000 $ 6,000
Inventory  30,000  20,000
Office supplies   5,000   8,000
Accounts payable  10,000   7,000
Salaries and wages payable   2,500   4,000
Interest payable   1,500   2,500
Income taxes payable   5,500   2,500

 

In addition, the income statement for 2012 is as follows:

 

Sales revenue $110,000
Cost of goods sold   85,000
Gross profit $ 25,000
General and administrative expense $  9,000
Depreciation expense    2,000
Income before interest and taxes $ 14,000
Interest expense    2,000
Income before tax $ 12,000
Income tax expense    4,800
Net income $  7,200

 

Required

 

  • Prepare the operating activities section of the statement of cash flows, using the indirect method.

 

  • What does the use of the direct method reveal about a company that the indirect method does not?

 

 

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