Graded Homework

Bus1130
–Accounting Fundamentals

Unit
#3 – Financial Statement Analysis

Remember that purpose of accounting is to
track the assets of an entity and the claims to those assets [accomplished by
“A =
L + OE”] a main goal of accounting is to provide
information that is beneficial to the users (e.g. management, investors,
creditors, governmental agencies) of the financial statements.

Many times the users will use ratios
to analyze the data on the financial statements and in many cases they are
evaluating how a company is doing in different “areas”, and thus commonly used
ratios are separated into different categories (e.g. liquidity and
profitability) as shown in the list of ratios given below (mostly taken from
the Bus1125 textbook)

Summary
of Financial Ratios

Liquidity Ratios

·
1. Current ratio = current assets/current liabilities

·
2. quick ratio = (cash + short-term investments +
receivables)/current liabilities

·
3. Operating cash flow ratio = cash flows from operating
activities/current liabilities

Debt Management Ratios (capital structure ratios)

·
4. Times interest earned = operating income/interest expense

·
5. Long-term debt to equity ratio = long-term debt (including
current portion)/total equity

·
6. Debt-to-equity ratio = total liabilities/total equity

·
7. Long-term debt to total assets ratio = long-term debt
(including current portion)/total assets

·
8. Debt-to-assets ratio = total liabilities/total assets

Asset Efficiency Ratios

·
9. Accounts receivable turnover ratio = net credit sales (or
net sales)/average accounts receivable

10. Days
in A/R (days to collect) = 365/accounts receivable turnover ratio

·
11. Inventory turnover ratio = cost of goods sold/average inventory

·
12. Days in inventory (days to sell) = 365/inventory turnover
ratio

·
13. Asset turnover ratio = net sales/average total assets

Profitability
Ratios

·
14. Gross profit percentage = gross
profit/net sales

·
15. Operating margin percentage = income from
operations/net sales

·
16. Net profit margin percentage = net
income/net sales

·
17. Return on assets = {net income +
[interest expense * (1 – tax rate)]}/average total assets
[or just use = net income/average total assets]

·
18. Return on equity = net income/average
equity

Stockholder Ratios

·
19. Earnings per Share (EPS) Ratio = (net income
– preferred dividends)/average number
of common shares outstanding

·
20. Return on common equity = net
income/average common equity

·
21. Dividend yield ratio = dividends per
common share/current stock price

·
22. Dividend payout ratio = common dividends/net
income

·
23. Stock repurchase payout ratio = common
stock repurchases/net income

·
24. Total payout ratio = (common dividends +
common stock repurchases)/net income

·
25. Market cap = number of shares outstanding
* current stock price

·
26. P/E (price-earnings) ratio = current
stock price/most recent EPS

I. Using
ratios

In
addition to the ratios included in the categories given above, investors
generally are also very interested in
cash flow information [remember the financial statements are prepared on an accrual basis, which may not
be directly correlated to the generation of cash;
and you should also remember that though a company may have significantly increased its cash (per the balance sheet),
it is the generation of “cash from operating activities” (per the statement of cash flows) that is
required in the long-run for all companies
(if they are to continue in existence)].

• One ratio
  that does consider cash flow is the “quality
  of income” ratio = net cash from operations/net income, which does
  provide some information about the generation of cash from operations, but
  many times “simple” items such as percentage change from year-to-year
  [i.e. horizontal analysis] will also be used to assess cash flows.

• Note: the ratios given in the table above are
  just commonly used ratios, and users of the financial statements may
  develop his/her own ratios to help them understand the financial position
  of a company. You should also
  realize that certain ratios might be more relevant to analysis of
  companies in certain industries than companies in other industries.

• There
  will be times in other classes (e.g. Strategic Management at 4-year
  colleges) in which you will be asked to do a financial statement analysis
  of a company, or a comparison between two or more companies. My suggestion is that you try not to use
  too many ratios (unless instructed to do otherwise), but rather become
  comfortable with one or two ratios in each of the categories and
  understand and be able to discuss them meaningfully (i.e. what is most
  important is the quality of the analysis and not the quantity).

o
As you should have been doing
throughout this class, and all of your classes, and in real-life, after you
calculate an amount (or ratio), do a quick check for reasonableness [e.g. do not
submit a trial balance in which the “supplies” account has a credit balance on
it (as “supplies” is an asset, which has a normal debit balance)]. There was a situation in a class where there
was an error in the formula in the textbook related to “days in inventory”
(also called “days to sell” as indicated under #12.” in the table above) and
students reported (and lost points for it) a calculated number of “.2 days”, as it just doesn’t make
logically sense that it would only take a company on average two-tenths of a
day to sell its inventory!

Another example, if you grab a candy bar
to buy in a store, and the clerk scans it, and
says “that will be $5”, I doubt if any of you will just say “well the cash resister is showing $5, so it must be
correct” and then pay the $5. I hope all
of you would ask (investigate)
how the price could be $5. Maybe you
would find that the candy bar was made
of very high quality Swiss chocolate, and that $5 was the correct price, or maybe you would discover that the
selling price was entered incorrectly
into the system at $5.00 when it should have been entered at $.50.

§ A little logical thinking can go a long way in both the classroom
(saving you points) and in real-life (saving you money)!

II. What
investors (potential investors) look at

There
are two main means of generating a profit when purchasing stock as an
investment, one being an
appreciation in stock price (i.e. sell at a higher price then what you had paid) and the second is the receipt of
dividends. More conservative investors
will be more apt to buy stock in
companies which pay a dividend versus stock in companies that are reinvesting its profits back into
the business to grow the company (these are called “growth stocks”). Dividend
paying stocks not only generate a current income stream (i.e. the dividend) but the dividend
generally also provides a floor to a company’s stock price when there is a significant downturn in
the overall market. Generally a
company’s stock price will get
punished if the company reduces its dividend.

The
two main ratios used to help evaluate a company’s dividend policy are:

(21). The dividend
yield ratio = annual dividend/current stock
price [This ratio indicates what percent the annual
dividend is relative to the current market price of the stock. The larger the number isn’t necessarily
better, as mature stocks will pay
a higher dividend than will growth stocks, or the stock is undervalued in the market, which
would make the dividend yield larger.], and

(22). The dividend
payout ratio = annual dividend per share/basic EPS [This
ratio indicates what percent
of net income is being paid out as a dividend.
Again, the larger
the number isn’t necessarily better. One
would expect a “mature stock” to pay
out a larger percent of its net income in a dividend than would a “growth stock”. Generally companies want to increase, or at
least maintain the amount of a
dividend so if net income went down next year, its “dividend payout ratio” would increase, but
that is not a good thing (since net income declined).]

Note: Abbott Labs, which split up into two separate
companies in early 2013 had increased its dividend for 40
consecutive years, and in 2012 had a dividend yield of 3.5% with a dividend payout ratio of 68%. At about that time the yield on a 10-year US Treasury
Bill was only 2.04% and thus a “favorite” investment for many people,
since bond yields were historically low, was to buy high quality, multinational
companies which paid a good dividend and which also have a good chance at stock price
appreciation [such as Abbot and McDonalds and Nike]

·
The ratios given above will
provide information as to the financial “fundamentals” of the company, but
remember that investors are mainly concerned with a “return on their
investment”, which will occur through either receipt of dividends and/or
appreciation in stock price. Even though
the financial fundamentals are solid for a company, at least in the short-run a
positive return on investment may not
occur [though in the long-run investments in companies with sound fundamentals
should prove fruitful].

III. Assignment
Requirements

The
financial statements from Kohl’s Corporation 2012 Annual Report (for the
fiscal- year ended February 2, 2013)
will be the base for the majority of the questions. I have extracted
the four financial statements, the auditor’s report, and some of the Notes from
its 10-K filing and you can find
this Word doc in Content in D2L (you may print out this document is you desire to work off of a hard copy).

·
You will also be asked to do
some comparisons between Kohl’s and Home Depot.
Both companies are retailers, thus doing cross-sectional ratio analysis
should be at least somewhat appropriate (i.e. some product lines are similar, though
most are somewhat different). You are
also given some other questions about the audit report and the “notes” to the
financial statements

The following is known with respect to Home Depot for fiscal 2012 (or
at its fiscal 2012 year-end, February 3,
2013 => basically the same fiscal year-end as Kohl’s)

Home
Depot’s closing stock price at February 3, 2013 =
$67.30

dividend yield ratio = 1.7%

dividend payout ratio = 38.3%

Current ratio = 1.3

Debt-to-asset ratio = 56.7%

Gross profit % = 34.6%

Net profit margin = 6.1%

Days to sell (days in inventory) = 78 days

Kohl’s closing stock price at January 28, 2012 = $46.38

Kohl’s closing stock price at February 2,
2013= $49.85

Kohl’s fiscal 2012 dividend = $1.28/share
[Kohl’s paid it first dividend ever in the 1^st quarter of fiscal
2011 at $.25 per share and increased the quarterly dividend to $.32 in the
first quarter of fiscal 2012 (and then to $.35 per share per quarter in the
first quarter of fiscal 2013)

Required

Select the most appropriate answer to each
of the 19 following questions. Submit
your answers to CengageNow under Unit #3 – Financial Statement Analysis. Please read the post-submission feedback when
given as you will be tested on this material on the Final Exam.

1. Which
one of the following items did the “independent registered public accounting firm” (i.e. the auditor’s) find problems
with when performing its audit of Kohl’s?

A. there was a material misstatement in the
financial statements

B. certain amounts in the financial
statements were prepared on a basis other than GAAP

C. Kohl’s system of internal controls

D. none of the above, as everything was
fine

2. Kohl’s
stock symbol is “KSS” (i.e. three letters), therefore it is likely that Kohl’s
stock is listed on which one of the
following exchanges? [note: if you so
desire go to the Yahoo, Google, or
similar financial page and enter the symbol “KSS” in the “stock quote” dialog box and press enter to
find out what exchange Kohl’s stock is listed on. This
topic was also covered in the Unit #1 Notes.]

A. New York Stock Exchange

B. NASDAQ

C. one of the “over-the-counter” exchanges

D. the Chicago Board of Trade (CBOT)

3. Compute
Kohl’s “dividend yield” ratio as of February 2, 2013 (i.e. at the last day of
fiscal 2012).

A. 2.2% B. .06% C. 2.6% D. 22.0%

4. What
happened to Kohl’s dividend yield from January 28, 2012 (the last day of fiscal
2011) to February 2, 2013 (the last
day of fiscal 2012)?

A. it increased

B. it declined

C. it basically remained constant

D. the effect cannot be determined from the
information given

5. How
should/would the change in the dividend yield ratio from January 28, 2012 (the
last day of fiscal 2011) to
February 2, 2013 (the last day of fiscal 2012) generally be viewed by investors?

A. positively

B. negatively

6. Calculate
Kohl’s dividend payout ratio for fiscal 2012 (i.e. for the year ended
February 2, 2013). Use the Net
Income listed in the middle of the incomestatement.

A. 2.6% B. 30.5% C. 23.1% D. 29.6%

7. Which
one of the following is correct (true) with respect to Kohl’s dividend?

A. Cash dividends of $300,0000,000 paid to
investors in 2012 were included under “Cash Flows from Investing
Activities” on the Statement of Cash Flows

B. Cash Dividends paid reduces the Common
Stock account on the Statement of Shareholders’ Equity.

C. The total amount of dividends paid increased
from 2011 to 2012.

D. The ending balance in the retained
earnings account must have decreased from January 28, 2012 (the last day of
fiscal 2011) to February 2, 2013 (the last day of fiscal 2012) because dividends where paid.

8. Which one of the
following is correct with respect to Kohl’s .vs. Home Depot for fiscal 2012?
You are saying the Kohl’s is better or worse then Home Depot on these two
percentages.

	Kohl’s .vs. Home Depot Gross profit margin %	Kohl’s .vs. Home Depot Net profit margin %
A.	Better	Worse
B	Worse	Better
C.	Worse	Worse
D.	Better	Better

9. Which one of the
following would cause a company (Company A) to have a lower gross profit margin
% but a larger net profit margin % than another (second) company (Company B)?
Answer this from Kohl’s income statement. Remember what is included in net
income.

A. Company A had a lower % for operating
expenses than did Company B

B. Company B had significant “non-operating
expenses” or a loss which was not present for Company A.

C. Company A had significant “non-operating
income” or a gain which was not present for Company B.

D. A, B and C are correct

10. Which
one of the following is correct with respect to Kohl’s .vs. Home Depot at
fiscal year-end 2012 (i.e. at
February 2, 2013)?

	Kohl’s .vs. Home Depot Current ratio	Kohl’s .vs. Home Depot Debt-to-asset ratio
A.	Better	Worse
B	Worse	Better
C.	Better	Better
D.	Worse	Worse

11. Refer to the
comparative balance sheets for Kohl’s.
Which one of the following is the “simplified” adjusting journal entry
(AJE) that could have been made for the change in the accrued liabilities
balance?

	Debit		Credit
A.	Cash	161
			Accrued Liabilities	161
B.	A/P	161
			Accrued Liabilities	161
C.	Accrued Liabilities	161
			Cash	161
D.	Expenses	161
			Accrued Liabilities	161

12. What
effect did the AJE that was made for question #11 with respect to the increase
in current liabilities have on the
current ratio of Kohl’s at its February 2, 2013 (fiscal 2012) year-end?
(Round to three decimal places before comparing the ratios.)

A. improved it

B. made it worse

C. left it unchanged

D. not enough information is given to
determine the effect

13. How
would the change in cash from January 28, 2012 to February 2, 2013 generally be
viewed? [careful! => refer to the
statement of cash flows]

A. favorably B. unfavorably

14. What impact did
Kohl’s buyback of 27 million shares of its own common stock (i.e. treasury
stock) for $1,269 (per the statement of shareholders’ equity) in fiscal 2012
have on the following? Because the income decreased, it is hard to determine if
the purchase of treasury stock had an effect on the income. Assume that the net
income is the same for both years; everything else is constant except that
treasury stock was purchased.

	EPS	Return on Equity
A.	Improved	Worsened
B	Worsened	Improved
C.	Improved	Improved
D.	Worsened	Worsened

Following is a “Note” to the financial
statements taken from the Kohl’s 2012 Annual Report:

Accrued Liabilities

Accrued liabilities consist of the following:

	Feb 2, 2013		Jan 28, 2012
	(In Millions)
Various liabilities to customers	$	275			$	302
Payroll and related fringe benefits	101			202
Sales, property and use taxes	153			166
Accrued construction costs	65			105
Credit card liabilities	120			79
Other	272			293
	$	986			$	1,147

The
various liabilities to customers include gift cards and merchandise return
cards that have been issued but not presented for redemption.

We have corrected the presentation of $17
million of deferred revenues that were previously recorded as a reduction to
merchandise inventory as of January 28, 2012.

15. Which
one of the following best describes the main purpose of this “Note”?

A. To provide detail for a “condensed” amount
presented on the face of the financial
statements.

B. To provide additional information about
items/amounts presented on the financial statements.

C. To provide information about items not
directly included in the financial statements.

D. All of these describe the purpose of
this Note.

16. Which
one of the following statements is correct (true)?

A. The financial statements were prepared
without using any estimates.

B. Property and equipment, net of 8,872 on
the Feb. 2, 2013 balance sheet includes Land of 7,575.

C. Kohl’s uses the “LIFO” (last-in,
first-out” cost flow method to value its inventories.

D. Revenue from gift card sales is
recognized when the gift cards are redeemed.

17. Ratios are not GAAP,
and anybody can develop a ratio to use in helping to evaluate information. But ratios that are developed (used) should
logically make sense and be appropriate from a mathematical stand-point. Ignore
the apples and oranges if they are confusing.

The
asset efficiency ratios given above include the following:

(9). Accounts receivable turnover ratio =
net credit sales (or net sales)/average
accounts
receivable

(11). Inventory
turnover ratio = cost of goods sold/average
inventory

Which
one of the following statements is false
(incorrect) with respect to the two ratios given
above (think logically)?

A. sales, and thus cost of goods sold (i.e.
the numerators of the ratios) occur throughout the period and thus
average inventory [= (beg. inventory + ending inventory)/2] is used in the
denominator of these ratios (rather than just ending inventory) in order to divide “apples by
apples” [instead of dividing apples by an orange]

B. Cost of goods sold is used in the
numerator of the inventory turnover ratio rather than using net sales (as is true for the
A/R turnover ratio) because inventory is a cost
based number (rather than a selling price based number) [and “apples” should be divided by “apples”].

C. If all sales for a company were made on
credit then the accounts receivable turnover ratio must equal the
inventory turnover ratio.

D. If credit terms to customer are reduced
from n/60 to 2/10, n/30 the accounts receivable turnover ratio should
increase.

18. Inventory
(and thus COGS) is the greatest cost for retailers and thus effective management of inventory is critical to the
success of these entities (which of course means
significant analysis of these amounts occurs).
Compute the approximate “days to sell”
(days in inventory) for Kohl’s for fiscal 2012.

A. 103 days B. 96 days C. 66 days D. 111 days

19. For
fiscal 2012 who had the better “days to sell” (i.e. days in inventory”) ratio?
(2 points)

A. Kohl’s B. Home Depot