1. Warren Reeve Duchac Financial and Managerial Accounting 13e Financial Statement Analysis 15 C H A P T E R human/iStock/360/Getty Images

2. Learning Objectives LO1: Describe basic financial statement analytical methods. LO2: Use financial statement analysis to assess the solvency of a business. LO3: Use financial statement analysis to assess the profitability of a business. LO4: Describe the contents of corporate annual reports. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

3. Basic Analytical Methods Users analyze a company’s financial statements using a variety of analytical methods. Three such methods are: o Horizontal analysis o Vertical analysis o Common-sized statements ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

4. Horizontal Analysis (slide 1 of 2) The analysis of increases and decreases in the amount and percentage of comparative financial statement items is called horizontal analysis. o Each item on the most recent statement is compared with the same item on one or more earlier statements in terms of the following:  Amount of increase or decrease  Percent of increase or decrease ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

5. Horizontal Analysis (slide 2 of 2) When comparing statements, the earlier statement is normally used as the base year for computing increases and decreases. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6. Comparative Balance Sheet— Horizontal Analysis ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

7. Comparative Schedule of Current Assets— Horizontal Analysis ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8. Comparative Income Statement— Horizontal Analysis ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

9. Comparative Retained Earnings Statement— Horizontal Analysis ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. = 24.0%

10. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Based on this information, what is the amount and percentage of increase or decrease that would be shown on a balance sheet with horizontal analysis? Horizontal Analysis The comparative cash and accounts receivable balances for a company follow:

11. Vertical Analysis (slide 1 of 3) The percentage analysis of the relationship of each component in a financial statement to a total within the statement is called vertical analysis. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

12. Vertical Analysis (slide 2 of 3) In a vertical analysis of the balance sheet, the percentages are computed as follows: o Each asset item is stated as a percent of the total assets. o Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

13. Comparative Balance Sheet— Vertical Analysis ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

14. Vertical Analysis (slide 3 of 3) In a vertical analysis of the income statement, each item is stated as a percent of sales. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

15. Comparative Income Statement— Vertical Analysis ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

16. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Prepare a vertical analysis of the income statement for Lee Corporation. Vertical Analysis Income statement information for Lee Corporation follows:

17. Common-Sized Statements In a common-sized statement, all items are expressed as percentages, with no dollar amounts shown. Common-sized statements are useful for comparing one company with another or comparing a company with industry averages. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

18. Common-Sized Income Statements ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

19. Liquidity and Solvency Analysis (slide 1 of 2) All users of financial statements are interested in the ability of a company to do the following: o Maintain liquidity and solvency o Earn income, called profitability ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

20. Liquidity and Solvency Analysis (slide 2 of 2) The ability of a company to convert assets into cash is called liquidity, while the ability of a company to pay its debts is called solvency. Liquidity, solvency, and profitability are interrelated. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

21. Liquidity and Solvency Analysis (slide 3 of 3) Liquidity and solvency are normally assessed using the following: o Current position analysis  Working capital  Current ratio  Quick ratio o Accounts Receivable analysis  Accounts receivable turnover  Number of days’ sales in receivables o Inventory analysis  Inventory turnover  Number of days’ sales in inventory o The ratio of fixed assets to long-term liabilities o The ratio of liabilities to stockholders’ equity o The number of times interest charges are earned ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

22. Current Position Analysis A company’s ability to pay its current liabilities is called current position analysis. Current position analysis is a solvency measure of special interest to short-term creditors and includes the computation and analysis of the following: o Working Capital o Current ratio o Quick ratio ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

23. Current Position Analysis: Working Capital (slide 1 of 3) A company’s working capital is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Working Capital = Current Assets – Current Liabilities

24. Current Position Analysis: Working Capital (slide 2 of 3) The working capital for Lincoln Company for 2016 and 2015 is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

25. Current Position Analysis: Working Capital (slide 3 of 3) Working capital is used to evaluate a company’s ability to pay current liabilities. A company’s working capital is often monitored monthly, quarterly, or yearly by creditors and other debtors. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

26. Current Position Analysis: Current Ratio (slide 1 of 3) The current ratio is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Current Ratio = Current Assets Current Liabilities

27. Current Position Analysis: Current Ratio (slide 2 of 3) The current ratio for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

28. Current Position Analysis: Current Ratio (slide 3 of 3) The current ratio is a more reliable indicator of a company’s ability to pay its current liabilities than is working capital. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

29. Current Position Analysis: Quick Ratio (slide 1 of 2) A ratio that measures the “instant” debt-paying ability of a company is the quick ratio, sometimes called the acid-test ratio. The quick ratio is computed as follows: o Quick assets are cash and other current assets that can be easily converted to cash.  Quick assets include cash, temporary investments, and receivables but exclude inventories and prepaid assets. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Quick Ratio = Quick Assets Current Liabilities

30. Current Position Analysis: Quick Ratio (slide 2 of 2) The quick ratio for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

31. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determine (a) the current ratio and (b) the quick ratio. Current Position Analysis The following items are reported on a company’s balance sheet:

32. Accounts Receivable Analysis (slide 1 of 2) A company’s ability to collect its accounts receivable is called accounts receivable analysis. Accounts receivable analysis includes: o Accounts receivable turnover o Number of days’ sales in receivables ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

33. Accounts Receivable Analysis (slide 2 of 2) Quick collection of accounts receivable does the following: o Improves a company’s liquidity o Reduces the risk of uncollectible accounts o Provides cash to improve or expand operations ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

34. Accounts Receivable Analysis: Accounts Receivable Turnover (slide 1 of 2) The accounts receivable turnover is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Accounts Receivable Turnover = Sales Average Accounts Receivable

35. Accounts Receivable Analysis: Accounts Receivable Turnover (slide 2 of 2) The accounts receivable turnover for Lincoln Company for 2016 and 2015 is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

36. Accounts Receivable Analysis: Number of Days’ Sales in Receivables (slide 1 of 3) The number of days’ sales in receivables is computed as follows: where ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Number of Days’ Sales in Receivables Average Accounts Receivable Average Daily Sales = Sales 365 Days =

37. Accounts Receivable Analysis: Number of Days’ Sales in Receivables (slide 2 of 3) The number of days’ sales in receivables for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

38. Accounts Receivable Analysis: Number of Days’ Sales in Receivables (slide 3 of 3) The number of days’ sales in receivables is an estimate of the time (in days) that the accounts receivable have been outstanding. The number of days’ sales in receivables is often compared with a company’s credit terms to evaluate the efficiency of the collection of receivables. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

39. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determine (a) the accounts receivable turnover and (b) the number of days’ sales in receivables. Round to one decimal place. Accounts Receivable Analysis A company reports the following:

40. Inventory Analysis (slide 1 of 2) A company’s ability to manage its inventory effectively is evaluated using inventory analysis. Inventory analysis includes the computation and analysis of the following: o Inventory turnover o Number of days’ sales in inventory ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

41. Inventory Analysis (slide 2 of 2) Excess inventory does the following: o Decreases liquidity by tying up funds (cash) in inventory o Increases insurance expense, property taxes, storage costs and other related expenses o Increases the risk of losses because of price declines or obsolescence of the inventory ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

42. Inventory Analysis: Inventory Turnover (slide 1 of 2) The inventory turnover is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Inventory Turnover = Cost of Merchandise Sold Average Inventory

43. Inventory Analysis: Inventory Turnover (slide 2 of 2) The inventory turnover for Lincoln Company for 2016 and 2015 is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

44. Inventory Analysis: Number of Days’ Sales in Inventory (slide 1 of 3) The number of days’ sales in inventory is computed as follows: where ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Number of Days’ Sales in Inventory Average Inventory Average Daily Cost of Goods Sold = Sales 365 Days =

45. Inventory Analysis: Number of Days’ Sales in Inventory (slide 2 of 3) The number of days’ sales in inventory for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

46. Inventory Analysis: Number of Days’ Sales in Inventory (slide 3 of 3) The number of days’ sales in inventory is a rough estimate of the length of time it takes to purchase, sell, and replace the inventory. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

47. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determine (a) the inventory turnover and (b) the number of days’ sales in inventory. Round to one decimal place. Inventory Analysis A company reports the following:

48. Ratio of Fixed Assets to Long-Term Liabilities (slide 1 of 2) The ratio of fixed assets to long-term liabilities provides a measure of whether noteholders or bondholders will be paid. Because fixed assets are often pledged as security for long-term notes and bonds, it is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Ratio of Fixed Assets to Long-Term Liabilities Fixed Assets (net) Long-Term Liabilities =

49. Ratio of Fixed Assets to Long-Term Liabilities (slide 2 of 2) The ratio of fixed assets to long-term liabilities for Lincoln Company is computed as follows : ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

50. Ratio of Liabilities to Stockholders’ Equity (slide 1 of 2) The ratio of liabilities to stockholders’ equity measures how much of the company is financed by debt (creditors) and equity (owners). It indicates the margin of safety for creditors. The ratio of liabilities to stockholders’ equity is computed as: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Ratio of Liabilities to Stockholders’ Equity Total Liabilities Total Stockholders’ Equity =

51. Ratio of Liabilities to Stockholders’ Equity (slide 2 of 2) The ratio of liabilities to stockholders’ equity for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

52. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determine the company’s (a) ratio of fixed assets to long-term liabilities and (b) ratio of liabilities to total stockholders’ equity. Long-Term Solvency Analysis The following information was taken from Acme Company’s balance sheet:

53. Number of Times Interest Charges Are Earned (slide 1 of 3) The number of times interest charges are earned, sometimes called the fixed charge coverage ratio, measures the risk that interest payments will not be made if earnings decrease. The number of times interest charges are earned is computed as follows: The higher the ratio the more likely interest payments will be paid if earnings decrease. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Number of Times Interest Charges Are Earned Income Before Income Tax + Interest Expense Interest Expense =

54. Number of Times Interest Charges Are Earned (slide 2 of 3) The number of times interest charges are earned for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

55. Number of Times Interest Charges Are Earned (slide 3 of 3) The number of times interest charges are earned can be adapted for use with dividends on preferred stock. The number of times preferred dividends are earned is computed as follows: The higher the ratio, the more likely preferred dividend payments will be paid if earnings decrease. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Number of Times Preferred Dividends Are Earned Net Income Preferred Dividends =

56. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determine the number of times interest charges are earned. Times Interest Charges Are Earned A company reports the following:

57. Profitability Analysis (slide 1 of 2) Profitability analysis focuses on the ability of a company to earn profits. o This ability is reflected in the company’s operating results, as reported in its income statement. o This ability also depends on the assets the company has available for use in its operations, as reported in its balance sheet. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

58. Profitability Analysis (slide 2 of 2) Common profitability analyses include the following: o Ratio of sales to assets o Rate earned on total assets o Rate earned on stockholders’ equity o Rate earned on common stockholders’ equity o Earnings per share on common stock o Price-earnings ratio o Dividends per share o Dividend yield ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

59. Ratio of Sales to Assets (slide 1 of 2) The ratio of sales to assets measures how effectively a company uses its assets. The ratio of sales to assets is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Ratio of Sales to Assets = Sales Average Total Assets (excluding long-term investments)

60. Ratio of Sales to Assets (slide 2 of 2) The ratio of sales to assets for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

61. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determine the ratio of sales to assets. Sales to Assets A company reports the following:

62. Rate Earned on Total Assets (slide 1 of 3) The rate earned on total assets measures the profitability of total assets, without considering how the assets are financed. o In other words, this rate is not affected by the portion of assets financed by creditors or stockholders. The rate earned on total assets is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rate Earned on Total Assets Net Income + Interest Expense Average Total Assets =

63. Rate Earned on Total Assets (slide 2 of 3) The rate earned on total assets by Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

64. Rate Earned on Total Assets (slide 3 of 3) The rate earned on operating assets is sometimes computed when there are large amounts of nonoperating income and expense. The rate earned on operating assets is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rate Earned on Operating Assets Income from Operations Average Operating Assets =

65. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determine the rate earned on total assets. Rate Earned on Total Assets A company reports the following income statement and balance sheet information for the current year:

66. Rate Earned on Stockholders’ Equity (slide 1 of 4) The rate earned on stockholders’ equity measures the rate of income earned on the amount invested by the stockholders. The rate earned on stockholders’ equity is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rate Earned on Stockholders’ Equity Net Income Average Total Stockholders’ Equity =

67. Rate Earned on Stockholders’ Equity (slide 2 of 4) The rate earned on stockholders’ equity for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

68. Rate Earned on Stockholders’ Equity (slide 3 of 4) The rate earned on stockholders’ equity is normally higher than the rate earned on total assets. o This is because of the effect of leverage.  Leverage involves using debt to increase the return on an investment. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

69. Rate Earned on Stockholders’ Equity (slide 4 of 4) For Lincoln Company, the effect of leverage for 2016 and 2015 is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

70. Effect of Leverage ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

71. Rate Earned on Common Stockholders’ Equity (slide 1 of 3) The rate earned on stockholders’ equity measures the rate of profits earned on the amount invested by the stockholders. The rate earned on stockholders’ equity is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Rate Earned on Common Stockholders’ Equity Net Income – Preferred Dividends Average Common Stockholders’ Equity =

72. Rate Earned on Common Stockholders’ Equity (slide 2 of 3) The rate earned on common stockholders’ equity for Lincoln is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

73. Rate Earned on Common Stockholders’ Equity (slide 3 of 3) Lincoln’s rate earned on common stockholders’ equity differs from the rates earned on total assets and stockholders’ equity because of leverage. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

74. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Determine (a) the rate earned on stockholders’ equity and (b) the rate earned on common stockholders’ equity. Common Stockholders’ Profitability Analysis A company reports the following:

75. Earnings per Share on Common Stock (slide 1 of 3) Earnings per share (EPS) on common stock measures the share of profits that are earned by a share of common stock. Earnings per share must be reported in the income statement. EPS on common stock is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Earnings per Share (EPS) on Common Stock Net Income – Preferred Dividends Average Number of Common Shares Outstanding =

76. Earnings per Share on Common Stock (slide 2 of 3) The earnings per share (EPS) of common stock for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

77. Earnings per Share on Common Stock (slide 3 of 3) Many corporations have complex capital structures with various types of equity securities outstanding, such as convertible preferred stock, stock options, and stock warrants. In such cases, the possible effects of such securities on the shares of common stock outstanding are reported separately as earnings per common share assuming dilution or diluted earnings per share. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

78. Price-Earnings Ratio (slide 1 of 2) The price-earnings (P/E) ratio on common stock measures a company’s future earnings prospects. The price-earnings ratio is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Price-Earnings (P/E) Ratio Market Price per Share of Common Stock Earnings per Share on Common Stock =

79. Price-Earnings Ratio (slide 2 of 2) The price-earnings (P/E) ratio for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

80. Example Exercise ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. a.Determine the company’s earnings per share on common stock. b.Determine the company’s price-earnings ratio. Round to one decimal place. Earnings per Share and Price-Earnings Ratio A company reports the following:

81. Dividends per Share (slide 1 of 3) Dividends per share measures the extent to which earnings are being distributed to common shareholders. Dividends per share is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Dividend per Share = Dividends on Common Stock Shares of Common Stock Outstanding

82. Dividends per Share (slide 2 of 3) The dividends per share for Lincoln Company are computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

83. Dividends per Share (slide 3 of 3) Comparing dividends per share and earnings per share indicates the extent to which earnings are being retained for use in operations. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

84. Dividends and Earnings per Share of Common Stock ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

85. Dividend Yield (slide 1 of 2) The dividend yield on common stock measures the rate of return to common stockholders from cash dividends. It is of special interest to investors whose objective is to earn revenue (dividends) from their investment. The dividend yield is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Dividend Yield = Dividends per Share of Common Stock Market Price per Share of Common Stock

86. Dividend Yield (slide 2 of 2) The dividend yield for Lincoln Company is computed as follows: ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

87. Summary of Analytical Measures (slide 1 of 2) ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

88. Summary of Analytical Measures (slide 2 of 2) ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

89. Corporate Annual Reports In addition to the financial statements and the accompanying notes, corporate annual reports normally include the following sections: o Management discussion and analysis o Report on internal control o Report on fairness of the financial statements ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

90. Management Discussion and Analysis Management’s Discussion and Analysis (MD&A) is required in annual reports filed with the Securities and Exchange Commission. It includes management’s analysis of current operations and its plans for the future. Typical items included in the MD&A are: o Management’s analysis and explanations of any significant changes between the current and prior years’ financial statements. o Important accounting principles or policies that could affect interpretation of the financial statements, including the effect of changes in accounting principles or the adoption of new accounting principles. o Management’s assessment of the company’s liquidity and the availability of capital to the company. o Significant risk exposures that might affect the company. o Any “off-balance-sheet” arrangements such as leases not included directly in the financial statements. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

91. Report on Internal Control (slide 1 of 2) The Sarbanes-Oxley Act of 2002 requires a report by management. o The report states management’s responsibility for establishing and maintaining internal control. o In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

92. Report on Internal Control (slide 2 of 2) Sarbanes-Oxley also requires a public accounting firm to verify management’s conclusions on internal control. o Thus, two reports on internal control, one by management and one by a public accounting firm, are included in the annual report. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

93. Report on Fairness of the Financial Statements All publicly held corporations are required to have an independent audit (examination) of their financial statements. The Certified Public Accounting (CPA) firm that conducts the audit renders an opinion, called the Report of Independent Registered Public Accounting Firm, on the fairness of the statements. o An opinion stating that the financial statements present fairly the financial position, results of operations, and cash flows of the company is said to be an unqualified opinion, sometimes called a clean opinion. o Any report other than an unqualified opinion raises a “red flag” for financial statement users and requires further investigation as to its cause. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

94. Appendix: Unusual Items on the Income Statement Generally accepted accounting principles require that unusual items be reported separately on the income statement. o This is because such items do not occur frequently and are typically unrelated to current operations. Unusual items on the income statement are classified as one of the following: o Affecting the current period income statement o Affecting a prior period income statement ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

95. Appendix: Unusual Items Affecting the Current Period’s Income Statement Unusual items affecting the current period’s income statement include the following: o Discontinued operations o Extraordinary items ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

96. Appendix: Unusual Items Affecting the Current Period’s Income Statement—Discontinued Operations A company may discontinue a component of its operations by selling or abandoning the component’s operations. o If the discontinued component is (1) the result of a strategic shift and (2) has a major effect on the entity’s operations and financial results, any gain or loss on discontinued operations is reported on the income statement as a Gain (or loss) from discontinued operations. o A note to the financial statements should describe the operations sold, including the date operations were discontinued, and details about the assets, liabilities, income, and expenses of the discontinued component. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

97. Appendix: Unusual Items Affecting the Current Period’s Income Statement—Extraordinary Items An extraordinary item is defined as an event or transaction with both of the following characteristics: o Unusual in nature o Infrequent in occurrence Examples include the following: o Gains and losses from natural disasters such as floods, earthquakes, and fires provided that they occur infrequently o Gains or losses from land or buildings taken (condemned) for public use Any gain or loss from extraordinary items is reported on the income statement as Gain (or loss) from extraordinary item. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

98. Unusual Items in the Income Statement ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

99. Appendix: Unusual Items Affecting the Current Period’s Income Statement—Reporting Earnings per Share Earnings per common share should be prepared separately in the notes to the financial statements for discontinued operations and extraordinary items. ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

100. Income Statement with Earnings per Share ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

101. Appendix: Unusual Items Affecting the Prior Period’s Income Statement An unusual item may occur that affects a prior period’s income statement. o Two such items are as follows:  Errors in applying generally accepted accounting principles  Changes from one generally accepted accounting principle to another ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.