Chapter 14 - Summary LO 1 Explain the uses of dollar and percentage changes, trend percentages, component
percentages, and ratios. An important aspect of financial statement analysis is determining relevant
relationships among specific items of information. Companies typically present
financial information for more than one time period, which permits users of
the information to make comparisons that help them understand changes over time.
Dollar and percentage changes and trend percentages are tools for comparing
information from successive time periods. Component percentages and ratios,
on the other hand, are tools for establishing relationships and making comparisons
within an accounting period. Both types of comparisons are important in understanding
an enterprise's financial position, results of operations, and cash flows. LO 2 Discuss the quality of a company's earnings, assets, and working capital. Assessing the quality of information is an important aspect of financial statement
analysis. Enterprises have significant latitude in the selection of financial
reporting methods within generally accepted accounting principles. Assessing
the quality of a company's earnings, assets, and working capital is done by
evaluating the accounting methods selected for use in preparing financial statements.
Management's choice of accounting principles and methods that are in the best
long-term interests of the company, even though they may currently result in
lower net income or lower total assets or working capital, leads to a conclusion
of high quality in reported accounting information. LO 3 Explain the nature and purpose of classifications in financial statements. In classified financial statements, items with certain common characteristics
are placed together in a group, or classification. The purpose of these classifications
is to develop subtotals that will assist users in analyzing the financial statements. LO 4 Prepare a classified balance sheet and compute widely used measures of liquidity
and credit risk. In a classified balance sheet, assets are subdivided into the categories of
current assets, plant and equipment, and other assets. Liabilities are classified
either as current or long term. The liquidity measures derived from the balance sheet are as follows: Working capital. Current assets minus current liabilities. Current ratio. Current assets divided by current liabilities. Quick ratio. Quick assets divided by current liabilities. A measure of long-term credit risk is the debt ratio, which is total liabilities
expressed as a percentage of (divided by) total assets. LO 5 Prepare a multiple-step and a single-step income statement and compute widely
used measures of profitability. In a multiple-step income statement, the cost of goods sold is deducted from
net sales to provide the subtotal, gross profit. Operating expenses then are
deducted to arrive at income from operations. As a final step, nonoperating
items are added together and subtracted from income from operations to arrive
at net income. In a single-step income statement, all revenue items are listed
first, and then all expenses are combined and deducted from total revenue. The profitability measures discussed in this chapter are as follows: Percentage change. The dollar amount of change in a financial statement item
from one period to the next, expressed as a percentage of (divided by) the item
value in the earlier of the two periods being compared. Gross profit rate. Dollar amount of gross profit divided by net sales. A measure
of the profitability of a company's products. Net income as a percentage of sales. Net income divided by net sales. A measure
of management's ability to control expenses. Earnings per share. In the simplest case, net income divided by shares of capital
stock outstanding. Indicates the earnings applicable to each share of stock. Price-earnings ratio. Market price of the stock, divided by earnings per share.
A measure of investors' expectations regarding future profitability. Return on assets. Operating income divided by average total assets. Measures
the return generated by assets, regardless of how the assets are financed. Return on equity. Net income divided by average total equity. Indicates the
rate of return earned on owners' equity. LO 6 Put a company's net income into perspective by relating it to sales, assets,
and stockholders' equity. Financial accounting information is most useful if viewed in comparison with
other relevant information. Net income is an important measure of the financial
success of an enterprise. To make the amount of net income even more useful
than if it were viewed simply in isolation, it is often compared with the sales
from which net income results, the assets used to generate the income, and the
amount of stockholders' equity invested by owners to earn the net income. LO 7 Compute the ratios widely used in financial statement analysis and explain
the significance of each. Ratios are simply mathematical calculations that compare one financial statement
item with another financial statement item. The two items may come from the
same financial statement, such as the current ratio, which compares the amount
of current assets with the amount of current liabilities, both of which appear
in the statement of financial position (balance sheet). On the other hand, the
items may come from two different financial statements, such as the return on
stockholders' equity, which compares net income from the income statement with
the amount of stockholders' equity from the statement of financial position
(balance sheet). Accountants and financial analysts have developed many ratios
that place information from a company's financial statements in a context to
permit better understanding to support decision making. LO 8 Analyze financial statements from the viewpoints of common stockholders, creditors,
and others. Different groups of users of financial statements are interested in different
aspects of a company's financial activities. Short-term creditors are interested
primarily in the company's ability to make cash payments in the short term;
they focus their attention on operating cash flows and current assets and liabilities.
Long-term creditors, on the other hand, are more interested in the company's
long-term ability to pay interest and principal and would not limit their analysis
to the company's ability to make cash payments in the immediate future. The
focus of common stockholders can vary from one investor to another, but generally
stockholders are interested in the company's ability to pay dividends and increase
the market value of the stock of the company. Each group may focus on different
information in the financial statements to meet its unique objectives. This chapter completes our study of financial accounting - providing
information for external users (primarily investors and creditors) to support
investment, credit, and other decisions. We have focused attention exclusively
on business and accounting in the United States. In Chapter 15 we introduce
the subject of international business and accounting, after which we turn our
attention to the subject of management accounting for the remainder of the textbook. | 
2002 McGraw-Hill Higher Education