Chapter13_hw_solutions

Chapter13_hw_solutions - ANSWERS TO QUESTIONS 1 Sustainable...

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ANSWERS TO QUESTIONS 1. Sustainable income is defined as the most likely level of income to be obtained in the future. It is the amount of regular income that a company can expect to earn from its normal operations. In order to distinguish a company’s net income from its sustainable income, irregular items, such as a once-in-a lifetime gain or discontinued operations, are reported separately on the income statement. 2. Items (a), (d), and (g) are extraordinary items; item (h) is debatable. 3. This would not be considered a favorable trend for McDonell Inc. The relevant earnings per share figures are the $3.26 in 2009 and the $2.99 in 2010. These figures indicate that, unless there was a sale of common stock, the earnings from the continuing operations of the company decreased during 2010. This should give the company’s management some concern because they will not always be able to count on revenue or gains from irregular items. 4. Companies report a change from FIFO to average cost pricing for inventory retroactively. That is, they report both the current period and any previous periods reported on the face of the statement using the new principle. As a result, the same principle applies in all periods. This treatment improves the ability to compare results across years. 5. Tootsie Roll reported “Other comprehensive earnings” of $810,000 in 2007. “Comprehensive earnings” exceeded “Net earnings” by 1.6% [($52,435 – $51,625) ÷ $51,625] 6. (a) Andrea is not correct. There are three characteristics: liquidity, profitability, and solvency. (b) The three parties are not primarily interested in the same characteristics of a company. Short- term creditors are primarily interested in the liquidity of the enterprise. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company. 7. (a) Comparison of financial information can be made on an intracompany basis, an inter- company basis, and an industry average basis. 1. An intracompany basis compares the same item with prior periods, or with other financial items in the same period. 2. An intercompany basis compares the same item with other companies’ published reports. 3. The industry average compares the item with the industry average as compiled by Dun & Bradstreet or by trade associations. (b) The intracompany basis of comparison is useful in detecting changes in financial relationships and significant trends within a company.
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The intercompany basis of comparison provides insight into a company’s competitive position. The industry average basis provides information about a company’s relative performance within the industry. 8. Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or decrease of an item over a period of time. In this approach, the amount of the item on one statement is compared with the amount of that same item on one or more earlier statements. Vertical analysis, also called common-size analysis, expresses each item within a financial statement as a percent of a relevant base amount.
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