2.0Problem 9-1
Pines Inc reported the following operating results for two consecutive years.
2018
Sales
Cost of Goods Sold
Gross Margin
Operating Expenses
Income Before Taxes
Income Taxes
Net Income
Amount
2,000,000
1,450,000
550,000
290,000
260,000
72,800
187,200
2019
Sales
Cost of Goods Sold
Gross Margin
Operating Expenses
Income Before Taxes
Income Taxes
Net Income
Amount
2,500,000
1,700,000
800,000
350,000
450,000
144,000
306,000
REQUIRED
Express each income statement component for each of the two years as a percent of sales.
in a single chart.
Problem 9-2
Balance sheet data for Spring Training Inc. is presented below :
Current assets
Long-term assets (net)
Total assets
Current liabilities
Long-term liabilities
Total liabilities
Total stockholders’ equity
Total liabilities and stockholders’ equity
1,000,000
2,000,000
3,000,000
500,000
1,300,000
1,800,000
1,200,000
3,000,000
REQUIRED
Compute the following:
1
2
3
4
Debt to Equity Ratio
Debt to Assets Ratio
Working Capital
Current Ratio
Express the formula and show numbers in the formulas to receive full credit.
Two decimals for ratios and whole percentages are acceptable for reporting.
Problem 9-3
Compute the specified ratios using Syracuse Inc’s balance sheet at December 31, 2018.
Assets
Cash
Marketable securities
Accounts receivable
Inventory
Property and equipment
Accumulated depreciation
Total assets
Liabilities & Shareholders’ Equity
Accounts payable
Current notes payable
Long Term Liabilities
Mortgage payable
Bonds payable
Common stock
Retained earnings
Total liabilities and stockholders’ equity
20,000
40,000
14,000
11,000
200,000
(25,000)
260,000
12,000
10,000
18,000
50,000
130,000
40,000
260,000
The average number of common stock shares outstanding during 2018 was
Net Income for the year was:
30,000
REQUIRED
Compute each of the following:
1
2
3
4
Earnings per share
Quick (acid-test) ratio
Current ratio
Debt to equity ratio
15,000 shares
5 Return on investment
6 Return on equity
Express the formula and show numbers in the formulas to receive full credit.
Two decimals for ratios and whole percentages are acceptable for reporting.
Problem 9-4
Barker Company’s income statement information follows.
2018
800,000
180,000
129,600
20,000
600,000
Net sales
Income before interest and taxes
Net income after taxes
Interest expense
Stockholders’ equity, December 31
The average number of shares outstanding was
2017
640,000
170,000
122,400
18,000
500,000
20,000 for 2018
19,000 for 2017
REQUIRED
Compute the following ratios for Barker for 2018 and 2017.
1 Net margin.
2 Earnings per share based on the average number of shares outstanding.
3 Price-earnings ratios for 2018 and 2017.
Share price below.
2018 $
50
per share
2017 $
42
per share
4 Times interest earned.
5 Return on average equity.
Express the formula and show numbers in the formulas to receive full credit.
Two decimals for ratios and whole percentages are acceptable for reporting.
Problem 9-5
Revenues
Total revenues
Expenses
Cost of goods sold
Selling expenses
General and administrative expenses
Interest expense
Income tax expense
Total expenses
Earnings from continuing operations
before extraordinary items
Extraordinary gain (net of income tax)
Net income
Assets
Current assets
Cash
Marketable securities
Accounts receivable
Inventories
Prepaid items
Total current assets
Plant and equipment (net)
Intangibles
Total assets
Liabilities and Stockholders’ Equity
Liabilities
Current liabilities
Accounts payable
Other
Total current liabilities
Bonds payable
Total liabilities
Stockholders’ equity
Common stock
shares
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
2018
399,000
2017
485,000
242,000
46,000
12,000
9,000
39,000
348,000
220,000
42,000
24,000
9,000
36,000
331,000
51,000
4,000
55,000
154,000
0
154,000
9,600
2,400
84,000
240,000
7,200
343,200
252,000
48,000
643,200
19,200
2,400
76,800
230,400
4,800
333,600
252,000
0
585,600
96,000
40,800
136,800
158,400
295,200
129,600
36,000
165,600
160,800
326,400
276,000
276,000
72,000
348,000
643,200
(16,800)
259,200
585,600
75,000
REQUIRED
Calculate the following ratios for 2018 and 2017. When data limitations prohibit computing averages,
2016
2,000,000
use year-end balances or figures in your calculations.
1 Net margin
2 Earnings per share
3 Price-earnings ratio
12/31/2017 Share Price
12/31/2018 Share Price
$
$
75.00
85.00
4 Return on equity
5 Return on investment
Express the formula and show numbers in the formulas to receive full credit.
Two decimals for ratios and whole percentages are acceptable for reporting.
Problem 10-1
A review of the accounting records of St Archer Incorporated indicated that the company
incurred the following payroll costs during the month of February.
1.
2.
3.
4.
5.
6.
7.
8.
9.
Salary of the company president
Salary of the vice president of manufacturing
Salary of the chief financial officer
Salary of the vice president of marketing
Salaries of middle managers (department heads,
production supervisors) in manufacturing plant
Wages of production workers
Salaries of administrative secretaries
Salaries of engineers and other personnel
responsible for maintaining production equipment
Commissions paid to sales staff
$
$
$
$
89,600
44,800
52,640
43,680
$
$
$
548,800
2,626,400
313,600
$
$
498,400
705,600
REQUIRED
1. What amount of payroll cost would be classified as general, selling, and administrative expense?
2. Assuming that St Archer made
9,000
units of product in the month
Assuming that St Archer sold only
7,200
units of product made in the month
of August, determine the amount of payroll cost that would be included in cost of goods sold.
Also, assume there was no beginning inventory at the beginning of February.
Problem 10-2
Ashton Company makes eBook readers. The company had the following amounts at the
beginning of 2016:
Cash
Raw Materials Inventory
Work in Process Inventory
Finished Goods Inventory
Common Stock
Retained Earnings
$
$
$
$
$
$
1,380,000
106,000
40,000
90,000
1,212,000
404,000
1. Paid
$
50,000 of research and development costs.
2. Paid
$
114,000 for raw materials that will be used to make eBook readers.
3. Placed
$
200,000 of the raw materials cost into the process of manufacturing eBook readers.
4. Paid
$
150,000 for salaries of selling and administrative employees.
5. Paid
$
240,000 for wages of production workers.
6. Paid
$
216,000 to purchase equipment used in selling and administrative offices.
7. Recognized depreciation on the office equipment. The equipment was acquired on January, 1,
2016. It has a
$
20,000
salvage value and a
10
year life
8. Paid
$
500,000 cash to purchase manufacturing equipment.
9. Recognized depreciation on the manufacturing equipment. The equipment was acquired on Jan 1,
2016. It has a
$0
salvage value and a
5
year life
10. Paid
$
110,000 for rent and utility costs on the manufacturing facility.
11. Paid
$
20,000 for inventory holding expenses for completed eBook readers (rental of
warehouse space, salaries of warehouse personnel, and other general storage cost, this is not cost of goods).
12. Completed and transferred eBook readers that had total cost of
$600,000 from work in process
inventory to finished goods.
13. Sold
2,000 eBook readers for
$1,000,000 cash
14. It cost Ashton
$550,000 to make the eBook readers sold in Event 13.
REQUIRED
a. Show how these events affect the balance sheet, income statement, and statement of cash
flows by recording them in a horizontal financial statements model.
Hint : there are six asset accounts – you will need to adjust the template given and include more asset accounts.
b. Explain why Ashton’s recognition of cost of goods sold had no impact on cash flow.
c. Prepare a schedule of cost of goods manufactured and sold, a formal income statement, and
a balance sheet for the year. On the Balance sheet, split out the 3 different inventory accounts.
d. Distinguish between the product costs and the upstream costs that Ashton incurred.
2.0
Problem 11-1
Greek Week Inc makes and sells sweatshirts for college students. The company normally
produces and sells between
10,000
and
20,000
per year
The following cost data applies to various activity levels
Number of Sweatshirts
Total Costs Incurred
Fixed
Variable
Total Costs
Cost per Unit
Fixed
Variable
Total Cost per Sweatshirt
10,000
13,000
16,000
20,000
$68,000
$50,000
$118,000
$6.80
$5.00
$11.80
REQUIRED
1. Complete the schedule above by filling in the missing $ amounts for the 4 different levels of activity
shown in the first row of the table. Round all cost per unit figures to the nearest whole penny
2. Explain why the total cost per sweatshirt decreases as the number of sweatshirts increases.
Problem 11-2
The following income statement was drawn from the records of Phisig Incorporated, a manufacturing business.
Sales
Cost of Goods Sold
Gross Margin
Sales Commissions
Administrative salaries expense
Advertising Expense
Depreciation Expense
Shipping and Handling
Net Income
1,400,000
(680,000)
720,000
(100,000)
(150,000)
(80,000)
(160,000)
(130,000)
100,000
REQUIRED
1. Reconstruct the income statement using the contribution margin format. Assume COGS is variable and Advertising fixed.
Don’t forget to categorize all of the other expenses into fixed and variable (sales commissions, admin salaries, depreciation and shipping & handling)
2. Calculate the magnitude of operating leverage.
3. Use the measure of operating leverage to determine the amount of net income Phisig will earn if sales increase by
17
percent
Problem 11-3
Frank Company incurs annual fixed costs of
Variable costs for Frank product are
Sales price for Frank product are
Frank desires to earn an annual profit of
$
$
$
$128,000 .
500.00 per unit
580.00 per unit
110,000
REQUIRED
Determine the sales volume in dollars and units required to earn the desired profit.
You may use either the equation method or contribution margin method.
Problem 11-4
NYM Manufacturing Company makes a product.
Selling Price per unit
Variable manufacturing cost per unit
Variable selling expense per unit (sales commissions)
Annual Fixed Manufacturing Costs
Annual Fixed Selling and Admin Costs
$
$
$
$
$
150
80
25
40,000
60,000
REQUIRED
Determine the break-even point in units and dollars using the following approaches.
1 Equation method.
2 Contribution margin per unit.
3 Contribution margin ratio.
4 Confirm your results by preparing a contribution margin income statement for the breakeven sales volume.
MGT 45: Principles of Accounting
Tuesday and Thursday
2PM -320PM
330PM-450PM
Rady School of Mgt, Room 1N108
Professor: Joe Pecore
Spring 2019
http://www.bloomberg.com/live
https://markets.wsj.com/
Agenda 5/9/19
•
Announcements
•
Earnings Season
•
Lecture
–
Chapter 9
1-2
Announcements
1.
We will have a makeup class next Friday 5/17 at 1230 in Wells Fargo
Hall. Remember, there are no classes on 5/28 and 5/30.
2.
HW3 which covers Chapters 9-11 is posted.
3.
HW3 is due Tuesday 5/21 at the beginning of class.
1-3
Earnings Season
http://www.cnbc.com/earnings-calendar/
1-4
Chapter 9
Financial Statement Analysis Key Analytical Skill!
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-5
Chapter 9
Learning Objectives
1.
Differentiate between horizontal and vertical analysis.
2.
Explain ratio analysis.
3.
Calculate ratios for assessing a company’s liquidity.
4.
Calculate ratios for assessing a company’s solvency.
5.
Calculate ratios for assessing company management’s
effectiveness.
6.
Calculate ratios for assessing a company’s position in the
stock market.
7.
Review key ratios
8.
Explain the limitations of financial statement analysis.
1-6
Learning Objective 1
Differentiate between horizontal and
vertical analysis.
1-7
Horizontal Analysis
Horizontal analysis (or trend analysis) refers to
studying the behavior of individual financial
statement items over several accounting periods.
Absolute
Amounts
Percentage
Analysis
1-8
Milavec Company Horizontal Analysis
1-9
AAPL Income Statement Horizontal Analysis
(In millions, except number of shares which are reflected in thousands and per share amounts )
2018
2017
18 vs 17
2016
17 vs 16
$ 265,595
163,756
101,839
$ 229,234
141,048
88,186
16%
16%
15%
$ 215,639
131,376
84,263
6%
7%
5%
For three years ended 9/29/18
Net sales
Cost of sales
Gross margin
Operating expenses:
Research and development
Selling, general and administrative
Total operating expenses
Operating income
Other income and expense
Income before provision for income taxes
Provision for income taxes
Net income
$
Earnings per common share:
Basic
Diluted
$
$
Shares used in computing earnings per share:
Basic
Diluted
14,236
16,705
30,941
70,898
2,005
72,903
13,372
59,531 $
12.01
11.91
4,955,377
5,000,109
$
$
11,581
15,261
26,842
61,344
2,745
64,089
15,738
48,351
23%
9%
15%
16%
-27%
14%
-15%
23% $
10,045
14,194
24,239
60,024
1,348
61,372
15,685
45,687
15%
8%
11%
2%
104%
4%
0%
6%
9.27
9.21
30% $
29% $
8.35
8.31
11%
11%
5,471,820
5,500,281
-5%
-5%
5,217,242
5,251,692
-5%
-5%
1-10
Milavec Company Trend Analysis
Can compare to different base years
Trend Growth
=
Percentage (%)
((
Current Year Amount
) – 1)*100
Base Year Amount
1-11
AAPL Trend Analysis
(In millions)
For three years ended 9/29/18
Net sales
% increase above 2016
% increase above prior year
Trend Growth
=
Percentage (%)
((
2018
2017
2016
$ 265,595 $ 229,234 $ 215,639
23%
6%
16%
6%
Current Year Amount
) – 1)*100
Base Year Amount
1-12
AAPL Trend Analysis
a picture is worth a 1,000 words
Net sales (in $millions)
300000
250000
$ millions
200000
150000
100000
50000
0
1
Series2 $65,225
Series1
2010
2
3
4
5
6
7
8
9
$108,249 $156,508 $170,910 $182,795 $233,715 $215,639 $229,234 $265,595
2011
2012
2013
2014
2015
2016
2017
2018
1-13
Vertical Analysis
•Vertical analysis uses percentages to compare individual
components of financial statements to a key statement
figure.
•Vertical analysis compares within the same period
•A common-size financial statement is a vertical analysis in
which each financial statement item is expressed as a
percentage of a given measure.
1-14
Vertical Analysis of Income Statement
•In Income Statements, all items are usually expressed as a
percentage of sales.
1-15
Milavec Company Vertical Analysis
1-16
AAPL Income Statement Vertical Analysis
(In millions, except number of shares which are reflected in thousands and per share amounts)
For three years ended 9/29/18
Net sales
Cost of sales
Gross margin
Operating expenses:
Research and development
Selling, general and administrative
Total operating expenses
Operating income
Other income and expense
Income before provision for income taxes
Provision for income taxes
Net income
2018
$ 265,595
163,756
101,839
14,236
16,705
30,941
70,898
2005
72,903
13,372
$ 59,531
% sales
2017
100% $ 229,234
62%
141,048
38%
88,186
5%
6%
12%
27%
1%
27%
5%
22% $
11,581
15,261
26,842
61,344
2745
64,089
15,738
48,351
% sales
2016
% sales
100% $ 215,639
62%
131,376
38%
84,263
100%
61%
39%
5%
7%
12%
27%
1%
28%
7%
21% $
10,045
14,194
24,239
60,024
1348
61,372
15,685
45,687
5%
7%
11%
28%
1%
28%
7%
21%
1-17
Vertical Analysis of Balance Sheet
•For balance sheets, all items are usually expressed as a
percentage of total assets.
1-18
Milavec Company Vertical Analysis
1-19
AAPL Balance Sheet Vertical Analysis
(In millions, except number of shares which are reflected in thousands)
9/30/2018
ASSETS:
Current assets:
Cash and cash equivalents
Short-term marketable securities
Accounts receivable
Inventories
Deferred tax assets
Vendor non-trade receivables
Other current assets
Total current assets
Long-term marketable securities
Property, plant and equipment, net
Goodwill
Acquired intangible assets, net
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Current liabilities:
Accounts payable
Accrued expenses
Deferred revenue
Commercial Paper
Current portion of long term debt
Total current liabilities
Deferred revenue – non-current
Long Term Debt
Other non-current liabilities
Total liabilities
Commitments and contingencies
Shareholders’ equity:
Common stock
Retained earnings
Accumulated other comprehensive income/(loss)
Total shareholders’ equity
Total liabilities and shareholders’ equity
% Total
9/30/2017
% Total
9/24/2016
% Total
$ 25,913
40,388
23,186
3,956
0
25,809
12,087
131,339
170,799
41,304
0
22,283
$ 365,725
7% $ 20,289
11%
53,892
6%
17,874
1%
4,855
0%
0
7%
17,799
3%
13,936
36%
128,645
47%
194,714
11%
33,783
0%
5,717
0%
2,298
6%
10,162
100% $ 375,319
5% $ 20,484
14%
46,671
5%
15,754
1%
2,132
0%
0
5%
13,545
4%
8,283
34%
106,869
52%
170,430
9%
27,010
2%
5,414
1%
3,206
3%
8,757
100% $ 321,686
6%
15%
5%
1%
0%
4%
3%
33%
53%
8%
2%
1%
3%
100%
$ 55,888
32,687
7,543
11,964
8,784
116,866
2,797
93,735
45,180
258,578
15% $ 49,049
9%
25,744
2%
7,548
3%
11,977
2%
6,496
32%
100,814
1%
2,836
26%
97,207
12%
40,415
71%
241,272
13% $ 37,294
7%
22,027
2%
8,080
3%
8,105
2%
3,500
27%
79,006
1%
2,930
26%
75,427
11%
36,074
64%
193,437
12%
7%
3%
3%
1%
25%
1%
23%
11%
60%
40,201
70,400
-3,454
107,147
$ 365,725
11%
35,867
19%
98,330
-1%
-150
29%
134,047
100% $ 375,319
10%
31,251
26%
96,364
0%
634
36%
128,249
100% $ 321,686
10%
30%
0%
40%
100%
1-20
Horizontal and Vertical Analysis
Closing Thoughts
•Expressing analyses in %s really help management
understand the results and hone in on problems or
enhance performance
1-21
Learning Objective 2
Explain ratio analysis.
1-22
Ratio Analysis
•Ratio analysis involves studying various relationships
between different items reported in a set of financial
statements.
•Allows us to analyze the financials of one for different time
periods and compare to financials of other companies
1-23
Ratios to be Covered
Liquidity
1.
Working Capital
2.
Current Ratio
3.
Quick Ratio
4.
Accounts Receivable
Ratios
5.
Inventory Ratios
Solvency
Profitability/Management
Effectiveness
9.
Net Margin (or Return on
Sales)
10. Asset Turnover Ratio
11. Return on Investment
12. Return on Equity
Stock Market
6.
Debt to Assets Ratio
13. Earnings Per Share
7.
Debt to Equity Ratio
14. Price-Earnings (P/E) Ratio
8.
Number of Times
Interest Earned
15. Dividend Yield
1-24
Learning Objective 3
Calculate ratios for assessing a
company’s liquidity.
1-25
Liquidity Ratios
Liquidity measures and ratios indicate a company’s ability to
pay short-term debts. Can they cover their current
obligations?
They focus on current assets and current liabilities:
1. Working Capital
2. Current Ratio
3. Quick Ratio
4. Accounts Receivable Ratios
5. Inventory Ratios
1-26
Working Capital
• The amount of current assets greater than current
liabilities is known as working capital.
• Working capital measures the excess resources the
company will have available for operations, at a point in
time.
• Think of working capital as the cushion against short-term
debt-paying challenges.
1-27
CONSOLIDATED BALANCE SHEETS
(In millions, except number of shares which are reflected in thousands)
9/29/2018
AAPL
Balance
sheet
Fiscal Year ending
9/30/2017
9/24/2016
ASSETS:
Current assets:
Cash and cash equivalents
25,913
40,388
20,289
53,892
20,484
46,671
23,186
3,956
17,874
4,855
15,754
2,132
25,809
17,799
13,545
12,087
13,936
8,283
131,339
128,645
106,869
170,799
41,304
194,714
33,783
5,717
170,430
27,010
5,414
22,283
2,298
10,162
3,206
8,757
365,725
375,319
321,686
55,888
32,687
7,543
11,964
8,784
49,049
25,744
7,548
11,977
6,496
37,294
22,027
8,080
8,105
3,500
Total current liabilities
116,866
100,814
79,006
Deferred revenue – non-current
Long Term Debt
Other non-current liabilities
2,797
93,735
45,180
2,836
97,207
40,415
2,930
75,427
36,074
258,578
241,272
193,437
40,201
70,400
(3,454)
35,867
98,330
(150)
31,251
96,364
634
Total shareholders’ equity
107,147
134,047
128,249
Total liabilities and shareholders’ equity
365,725
375,319
321,686
Short-term marketable securities
Accounts receivable
Inventories
Deferred tax assets
Vendor non-trade receivables
Other current assets
Total current assets
Long-term marketable securities
Property, plant and equipment, net
Goodwill
Acquired intangible assets, net
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Current liabilities:
Accounts payable
Accrued expenses
Deferred revenue
Commercial Paper
Current Portion of Long Term Debt
Total liabilities
Shareholders’ equity:
Common stock and additional paid-in capital, $0.00001 par value; 12,600,000
shares authorized; 4,754,986 and 5,126,201 shares issued and outstanding,
respectively
Retained
earnings
Accumulated other comprehensive income/(loss)
1-28
AAPL Liquidity Ratios
Working Capital
Working Capital
($M)
Current Assets
Current Liabilities
Working Capital
2018
131,339
116,866
14,473
2017
128,645
100,814
27,831
2016
106,869
79,006
27,863
1-29
Current Ratio
Current
Ratio
=
Current Assets
Current Liabilities
• The current ratio measures a company’s short-term
debt/obligation paying ability.
• For every dollar of short term liabilities or obligations, what is the
level of short term asset coverage?
• A declining ratio may be a sign of deteriorating financial condition,
or it might result from eliminating obsolete inventories.
1-30
Current Ratio
1-31
AAPL Liquidity Ratios
Current Ratio
Current Ratio
($M)
Current Assets
Current Liabilities
Current Ratio
2018
131,339
116,866
1.12
2017
128,645
100,814
1.28
2016
106,869
79,006
1.35
1-32
Quick (Acid-Test) Ratio
Acid-Test
=
Ratio
Quick Assets
Current Liabilities
• Quick assets include Cash, Current Marketable
Securities, and Accounts Receivable. Excludes
inventory.
• This ratio measures a company’s ability to meet
obligations without having to liquidate or sell
inventory.
1-33
Quick (Acid-Test) Ratio
Milavec
1-34
AAPL Liquidity Ratios
Quick Ratios
Quick Ratio without Long Term Marketable Securities
($M)
Quick Assets
Current Liabilities
Quick Ratio
2018
127,383
116,866
1.09
2017
123,790
100,814
1.23
2016
104,737
79,006
1.33
Quick Ratio with Long Term Marketable Securities
($M)
Quick Assets
Current Liabilities
Quick Ratio
2018
298,182
116,866
2.55
2017
318,504
100,814
3.16
2016
275,167
79,006
3.48
1-35
Accounts Receivable Turnover
Accounts
Receivable
Turnover
=
Net Credit Sales
Average Accounts Receivable
• This ratio measures how many times a company converts
(collects) its receivables into cash each year on average.
1-36
Average Days to Collect Receivables
Also called Days Sales Outstanding (DSO)
Average
365 Days
Collection = Accounts Receivable Turnover
Period
Average
Collection =
Period
365 Days
16.98 Times
= 21 days
• This ratio measures, how many days it takes to collect
the average amount of accounts receivable based on
a year.
1-37
AAPL Liquidity Ratios
Accounts Receivable Ratios
Accounts Receivable Turnover
($M)
Sales
Accounts Receivable
Average Accounts Receivable
Accounts Receivable Turnover
2018
265,595
23,186
20,530
12.9
2017
229,234
17,874
16,814
13.6
2016
215,639
15,754
16,302
13.2
Average Days to Collect Receivables
Days in Year
A/R Turnover
Average Collection Period
365
12.9
28.2
365
13.6
26.8
365
13.2
27.6
1-38
Inventory Turnover
Inventory
Turnover
=
Cost of Goods Sold
Average Inventory
• This ratio measures how many times a company’s average inventory
has been sold and replaced during the year.
1-39
Average Days to Sell Inventory
Average
Sale Period
Average
=
Sale Period
=
365 Days
Inventory Turnover
365 Days
10.80 Times
= 34 days
• This ratio measures how many days, on average, it
takes to sell the inventory.
• In theory, inventory was sold and replenished every
34 days
1-40
AAPL Liquidity Ratios
Inventory Ratios
Inventory Turnover
($M)
Cost of Goods Sold
Inventory
Average Inventory
Inventory Turnover
2018
163,756
3,956
4,406
37.2
2017
141,048
4,855
3,494
40.4
2016
131,376
2,132
2,241
58.6
Average Days to Sell Inventory
Days in Year
Inventory Turnover
Average Sale Period (days)
365
37.2
9.8
365
40.4
9.0
365
58.6
6.2
1-41
Learning Objective 4
Calculate ratios for assessing a
company’s solvency.
1-42
Solvency Ratios
Solvency ratios are used to analyze a company’s long-term
debt-paying ability, obligation-paying ability and its capital
structure.
Essentially, how are assets funded?
1. Debt to Assets Ratio
2. Debt to Equity Ratio
3. Number of Times Interest Earned
1-43
Debt to Assets Ratio
Debt to
Assets =
Ratio
•
Total Liabilities
Total Assets
This ratio measures the percentage of a company’s
assets that are financed by debt.
1-44
AAPL Solvency Ratios
Debt to Assets Ratio
Debt to Asset Ratio
($M)
Total Liabilities
Total Assets
Debt to Asset Ratio
2018
258,578
365,725
0.71
2017
241,272
375,319
0.64
2016
193,437
321,686
0.60
1-45
Debt to Equity Ratio
Debt to
Total Liabilities
Equity =
Stockholders’ Equity
Ratio
•
This ratio compares creditor funding to owner funding.
Stockholders like a lot of
debt if the company can
take advantage of
positive financial
leverage. Less dilution
Creditors prefer less
debt and more equity
because equity
represents a buffer of
protection.
1-46
Debt to Equity Ratio
Debt to
Total Liabilities
Equity =
Stockholders’ Equity
Ratio
•
This ratio compares creditor funding to owner funding.
1-47
AAPL Solvency Ratios
Debt to Equity Ratio
Debt to Equity Ratio
($M)
Total Liabilities
Total Shareholders Equity
Debt to Equity Ratio
2016
258,578
107,147
2.41
2017
241,272
134,047
1.80
2016
193,437
128,249
1.51
Current Ratio
($M)
Current Assets
Current Liabilities
Current Ratio
2018
131,339
116,866
1.12
2017
128,645
100,814
1.28
2016
106,869
79,006
1.35
1-48
Number of Times Interest Earned Ratio
Times
Interest =
Earned
•
•
Earnings before Interest Expense
and Income Taxes
Interest Expense
Essentially Operating Income/Interest Expense.
This is the most common measure of a company’s ability to
provide protection for its long-term creditors.
1-49
Learning Objective 5
Calculate ratios for assessing company
management’s effectiveness.
Profitability Ratios/Management Effectiveness
Profitability ratios measure a company’s ability to
generate sales and earnings. These are also
known as management effectiveness ratios.
1. Net Margin (or Return on Sales)
2. Asset Turnover Ratio
3. Return on Investment
4. Return on Equity
1-51
Net Margin
Net
=
Margin
Net Income
Net Sales
This measure describes the percent remaining of
each sales dollar after subtracting all expenses
including cost of goods sold, operating expenses,
taxes and all other expenses.
1-52
AAPL Profitability Ratios
Net Margin (return on sales)
Net Margin
($M)
Net Income
Net Sales
Net Margin
2018
59,531
265,595
22.4%
2017
48,351
229,234
21.1%
2016
45,687
215,639
21.2%
1-53
Asset Turnover Ratio
Asset
Turnover
=
Net Sales
Average Total Assets
•This ratio measures how many sales dollars were
generated for each dollar of assets invested.
1-54
AAPL Profitability Ratios
Asset Turnover Ratio
Asset Turnover Ratio
($M)
Net Sales
Total Assets
Average Assets
Asset Turnover Ratio
2018
265,595
365,725
370,522
72%
2017
229,234
375,319
348,503
66%
2016
215,639
321,686
306,083
70%
1-55
Return on Investment (ROI)
Return on
Net Income
=
Investment
Average Total Assets
•
This is the ratio of net income to the amount
invested (average total assets).
For Milavec, ROI was as follows:
1-56
AAPL Profitability Ratios
Return on Investment
Return on Investment
($M)
Net Income
Total Assets
Average Assets
Return on Investment
2018
59,531
365,725
370,522
16%
2017
48,351
375,319
348,503
14%
2016
45,687
321,686
306,083
15%
1-57
Return on Equity
Return on =
Equity
•
Net Income
Average Total Stockholders’
Equity
This measure is often used to measure the profitability
of the stockholders’ investment.
1-58
AAPL Profitability Ratios
Return on Equity
Return on Equity
($M)
Net Income
Total Shareholders’ Equity
Average Shareholders’ Equity
Return on Equity
2018
59,531
107,147
120,597
49%
2017
48,351
134,047
131,148
37%
2016
45,687
128,249
123,802
37%
1-59
Profitability Ratios/Management Effectiveness
Profitability ratios measure a company’s ability to
generate sales and earnings. These are also
known as management effectiveness ratios.
1. Net Margin (or Return on Sales)
2. Asset Turnover Ratio
3. Return on Investment
4. Return on Equity
1-60
Learning Objective 6
Calculate ratios for assessing a
company’s position in the stock
market.
1-61
Stock Market Ratios
Stock market ratios analyze the earnings and
dividends of a company.
1. Earnings Per Share
2. Price-Earnings (PE) Ratio
3. Dividend Yield
1-62
Earnings Per Share
Earnings
Net Earnings Available for Common Stock
=
per
Average Number of Outstanding Common
Share
Shares
Simply put….
Earnings
=
per
Share
Net Income
Outstanding Shares
1-63
AAPL Stock Market Ratios
EPS
Earnings per Share
Net Income ($M)
Shares Outstanding (M)
Earnings per Share
$
2018
59,531
5,000
11.91 $
2017
48,351
5,252
9.21 $
2016
45,687
5,500
8.31
1-64
Price-Earnings Ratio
Price-Earnings
Ratio
=
Market Price Per Share
Earnings Per Share
•This ratio compares the market price for a share of the
company’s stock to the earnings of a company.
•Answers question – how much will investors be willing
to pay for a $ of earnings?
•Sometimes can be an indicator of whether a stock is
expensive or cheap in its industry
http://www.multpl.com/
1-65
AAPL Stock Market Ratios
P/E
Price to Earnings Ratio (P/E)
Stock Price
Earnings per Share
Price to Earnings Ratio (P/E)
$
$
2018
170 $
11.91 $
14.3
2017
160 $
9.21 $
17.4
2016
130
8.31
15.7
1-66
Dividend Yield
Dividend
Yield
=
Dividends Per Share
Market Price Per Share
•This ratio identifies the return, in terms of cash
dividends, on the current market price of the stock.
•It answers the question, how much dividend will I
receive per dollar of share price?
•Nowadays, dividend paying companies have a yield
comparable than banks (savings accounts and CDs)
1-67
AAPL Stock Market Ratios
Dividend Yield
Dividend Yield
Annual Dividend
Stock Price
Dividend Yield
$
$
2018
2.82 $
170 $
1.7%
2017
2.40 $
160 $
1.5%
2016
2.18
130
1.7%
1-68
Learning Objective 7
Review key ratios.
1-69
Ratios Covered
Liquidity
Profitability
1.
Working Capital
2.
Current Ratio
3.
Quick Ratio
10. Asset Turnover Ratio
4.
Accounts Receivable
Ratios
11. Return on Investment
5.
9.
Net Margin (or Return on
Sales)
12. Return on Equity
Inventory Ratios
Solvency
Stock Market
6.
Debt to Assets Ratio
13. Earnings Per Share
7.
Debt to Equity Ratio
14. Price-Earnings (P/E) Ratio
8.
Number of Times
Interest Earned
15. Dividend Yield
1-70
Ratios Covered
Liquidity
Profitability
1.
Working Capital
2.
Current Ratio
3.
Quick Ratio
10. Asset Turnover Ratio
4.
Accounts Receivable
Ratios
11. Return on Investment
5.
9.
Net Margin (or Return on
Sales)
12. Return on Equity
Inventory Ratios
Solvency
Stock Market
6.
Debt to Assets Ratio
13. Earnings Per Share
7.
Debt to Equity Ratio
14. Price-Earnings (P/E) Ratio
8.
Number of Times
Interest Earned
15. Dividend Yield
1-71
Yahoo Finance – AAPL Financial information
http://finance.yahoo.com/q?s=AAPL
AAPL Recent Earnings Release
https://www.apple.com/newsroom/2019/01/apple
-reports-first-quarter-results/
1-72
Exhibit 9-6
All Ratios covered in Chapter 9
1-73
Learning Objective 8
Explain the limitations of financial
statement analysis.
1-74
Limitations of Financial Statement
Analysis
Different Industries
Changing
Economic
Environment
Accounting
Principles
Need to understand the business!!
1-75
Chapter 9
Chapter Summary – We learned about…
1.
Horizontal and vertical analysis.
2.
Ratio analysis.
3.
Calculating ratios for assessing a company’s liquidity.
4.
Calculating ratios for assessing a company’s solvency.
5.
Calculating ratios for assessing company management’s
effectiveness.
6.
Calculating ratios for assessing a company’s position in the
stock market.
7.
Key Ratios
8.
The limitations of financial statement analysis.
1-76
MGT 45: Principles of Accounting
Tuesday and Thursday
2PM -320PM
330PM-450PM
Rady School of Mgt, Room 1N108
Professor: Joe Pecore
Spring 2019
http://www.bloomberg.com/live
https://markets.wsj.com/
Agenda 5/14/19
•
Business News of the Day
https://markets.wsj.com/
•
Announcements
•
Lecture
–
Chapter 10
1-2
Announcements
1.
We will have a makeup class next Friday 5/17 at 1230 in Wells Fargo
Hall. Remember, there are no classes on 5/28 and 5/30.
2.
HW3 which covers Chapters 9-11 is posted.
3.
HW3 is due Tuesday 5/21 at the beginning of class.
4.
Midterm Average = 88
1-3
Recap on Stock Market Ratios
Company NYM
1-4
Chapter 10
Introduction to Managerial
Accounting…its all about costs
and what you can control inside
the company
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-5
Chapter 10
Learning Objectives
1.
Distinguish between managerial and financial accounting.
2.
Identify the cost components of a product made by a
manufacturing company: the cost of materials, labor, and
overhead.
3.
Explain the impact on financial statements of product costs
versus general, selling, and administrative costs.
4.
Prepare a schedule of cost of goods manufactured and cost
of goods sold.
5.
Distinguish product costs from upstream and downstream
costs.
6.
Explain how product costing differs in service, merchandising
and manufacturing companies.
1-6
Learning Objective 1
Distinguish between managerial and
financial accounting.
1-7
Managerial vs. Financial Accounting
• Managerial Accounting is internally focused and can relate to
the future, present or past and is not regulated externally. Its
about optimizing limited resources. Think of organizations on
campus. Inside the company.
• Financial accounting is externally focused, mainly for
investors, based on historical information, extensively
regulated and is generally consistent for companies within a
given industry. Outside the company.
1-8
Managerial Accounting – Key Points from
Supplemental Reading
• Managerial or Cost Accounting is the branch of accounting
that deals exclusively with the cost of making or buying a
product or service that a company sells and delivers to its
customers or clients.
• Managerial or Cost Accounting is essentially internal
management reporting and is designed to assist those who
run the company not the investors. For decision makers
inside the walls of the company.
• Managerial or Cost Accounting is more complex in a
manufacturing company, especially international company
with many products (e.g. Ford)
1-9
Managerial Accounting – Key Points from
Supplemental Reading
• Underlying the whole idea of managerial accounting is the
need for every business selling products to protect and grow
its gross margin/profit while maintaining the quality of its
product(s) or service(s) at acceptable levels.
– Agouron example.
• Every company needs to understand its gross margin or profit
from operations. It’s the engine of profit.
• Gross margin pays for all other costs of running company and
net profit
• In the end – know your costs of the goods produced and sold!
1-10
Managerial Versus Financial Accounting Information
1-11
Product Costing and Pricing are related
Product
Costing
Cost Plus
Pricing
Managers need to
know the cost of
their products and
services for many
reasons. Pricing
being one…
A common
business
practice.
A business should know its costs to price effectively
1-12
Learning Objective 2
Identify the cost components of a product made
by a manufacturing company: the cost of
materials, labor, and overhead.
1-13
Product Costing and the Income Statement
Point out Income Statement categories
1-14
Elements of
Financial
Statements
INCOME STATEMENT
(In millions, except number of shares which are reflected in thousands and per share amounts)
For Fiscal Year ending
Sept 29, 2018
Sept 30, 2017
Sept 24, 2016
265,595
163,756
229,234
141,048
215,639
131,376
101,839
88,186
84,263
Selling, general and administrative
14,236
16,705
11,581
15,261
10,045
14,194
Total operating expenses
30,941
26,842
24,239
Operating income
Other income/(expense), net
70,898
2,005
61,344
2,745
60,024
1,348
Income before provision for income taxes
Provision for income taxes
72,903
13,372
64,089
15,738
61,372
15,685
Net income
59,531
48,351
45,687
Basic
12.01
9.27
8.35
Diluted
11.91
9.21
8.31
4,955,377
5,217,242
5,471,820
5,000,109
5,251,692
5,500,281
Net sales
Cost of sales
AAPL –
Income
Statement
Gross margin
Operating expenses:
Research and development
Earnings per share:
Shares used in computing earnings per share:
Basic
Diluted
1-15
Costs Can Be either Product or Period Costs
When incurred, costs become an asset or expense
Elements of
Product
Cost
Asset
COGS
Used to produce revenue
(e.g. production worker wages)
Expense
Period Cost
Cost of doing business unrelated
directly to revenue. (Office rent)
1-16
Product Cost Accounting
Elements of
Product
Cost
Asset
COGS
• Product Costs are treated differently than period costs in
accounting
• Product Costs start on the Balance Sheet as inventory
• Product costs are released to Cost of Goods when a sale is
made
‐ This follows the matching principle
1-17
Main categories of Product Costs in Manufacturing
Companies – The Big 3
Materials
Labor
Overhead
1-18
Factory Examples
who has been to a factory before?
Tesla Factory
https://www.youtube.com/watch
?v=hOXaBto7giY
Thornton Chocolate Factory
https://www.youtube.com/watch
?v=XNXWr5tg6ho
Lindt Chocolate Bunnies
https://www.youtube.com/watch
?v=9uuVuQKPdeU
1-19
Learning Objective 3
Explain the effects of the 3 different manufacturing
costs on financial statements for product costs
versus selling, general and administrative costs.
1-20
Transforming or Converting Cash into
Finished Goods – Tabor Manufacturing
1-21
Cost Classification for Tabor Manufacturing
Inventory/Cost of Goods/Selling & Admin
4 tables made and ready for sale
3 tables sold
1 table left in inventory
e.g. IT, Legal, Finance
(not a function of sales)
1-22
Main categories of Product Costs in Manufacturing
Companies – The Big 3
Materials
Labor
Overhead
1-23
Big 3 Manufacturing Costs – Elements
1. Materials
– Basic resources or parts. Also known as raw materials
2. Labor
– Cost of wages paid to workers with direct contact with
product and can be traced to product
3. Overhead
– Costs that can not be traced to specific products. Also
known as indirect costs. Depreciation, Utilities, Rent,
Taxes, Supervisory salaries, etc…
1-24
Big 3 Manufacturing Costs – Elements
1. Materials
– Basic resources or parts. Also known as raw materials
– For chocolate – eggs, flour, water, cocoa beans
2. Labor
– Cost of wages paid to workers with direct contact with
product and can be traced to product
– For chocolate – baker’s time
3. Overhead
– Costs that can not be traced to specific products. Also
known as indirect costs. Depreciation, Rent, Taxes,
Supervisory salaries, etc…
– For chocolate – use of oven and facilities
1-25
Raw Material Costs –
Balance Sheet to Income Statement
Cost of
Goods
Sold –
InventoryRaw
Materials
purchase
Balance
Sheet
Sale/
use
Income
Statement
1-26
Labor Costs
Production costs flow through Balance sheet and
period expenses do not
1-27
Overhead Costs
2 types of Depreciation
Production costs flow through Balance sheet and
period expenses do not
1-28
Big 3 Manufacturing Costs – flow of costs
from Balance Sheet to Income Statement
Cost of
Goods
Sold –
InventoryRaw
Materials
purchase
Labor &
Overhead
Balance
Sheet
Sale/
use
Income
Statement
usage
1-29
Patillo Company will..
• start their manufacturing business
• incur costs for manufacturing products
• incur costs to run business
• Sell inventory
1-30
Patillo Manufacturing Company
Transactions
Patillo Manufacturing Company experienced the following transactions:
Event 1
Event 2
Event 3
Event 4
Event 5
Event 6
Event 7
Event 8
Event 9
Event 10
Acquired additional $15,000 cash by issuing common stock.
Paid $2,000 for the materials that were used to make its products. All
products started were completed during the period.
Paid $1,200 for salaries of selling and administrative employees.
Paid $3,000 for wages of production workers.
Paid $2,800 for furniture used in selling and administrative offices.
Recognized depreciation on office furniture purchased in Event 5.
The furniture acquired on January 1 had a $400 estimated salvage value
and a four-year useful life. The annual depreciation charge is $600
[($2,800 – $400)/4].
Paid $4,500 for manufacturing equipment.
Recognized depreciation on equipment purchased in Event 7.
The equipment acquired on January 1 had a $1,500 estimated salvage value
and a three-year useful life. The annual depreciation charge is $1,000
[($4,500 – $1,500)/3].
Sold inventory to customers for $7,500 cash.
The inventory sold in Event 9 cost $4,000 to make.
1-31
Effect on Financial Statements
1-32
Effect on Financial Statements
1-33
Total Product Cost
1-34
Patillo Manufacturing Company
Transactions
Patillo Manufacturing Company experienced the following transactions:
Event 1
Event 2
Event 3
Event 4
Event 5
Event 6
Event 7
Event 8
Event 9
Event 10
Acquired additional $15,000 cash by issuing common stock.
Paid $2,000 for the materials that were used to make its products. All
products started were completed during the period.
Paid $1,200 for salaries of selling and administrative employees.
Paid $3,000 for wages of production workers.
Paid $2,800 for furniture used in selling and administrative offices.
Recognized depreciation on office furniture purchased in Event 5.
The furniture acquired on January 1 had a $400 estimated salvage value
and a four-year useful life. The annual depreciation charge is $600
[($2,800 – $400)/4].
Paid $4,500 for manufacturing equipment.
Recognized depreciation on equipment purchased in Event 7.
The equipment acquired on January 1 had a $1,500 estimated salvage value
and a three-year useful life. The annual depreciation charge is $1,000
[($4,500 – $1,500)/3].
Sold inventory to customers for $7,500 cash.
The inventory sold in Event 9 cost $4,000 to make.
Effect on Financial Statements
1-36
Total Product Cost
1-37
Patillo’s Financial Statements
Company
started 1/1/12
9,000
Effect on Financial Statements
1-39
Patillo Manufacturing Company
Transactions
Patillo Manufacturing Company experienced the following transactions:
Event 1
Event 2
Event 3
Event 4
Event 5
Event 6
Event 7
Event 8
Event 9
Event 10
Acquired additional $15,000 cash by issuing common stock.
Paid $2,000 for the materials that were used to make its products. All
products started were completed during the period.
Paid $1,200 for salaries of selling and administrative employees.
Paid $3,000 for wages of production workers.
Paid $2,800 for furniture used in selling and administrative offices.
Recognized depreciation on office furniture purchased in Event 5.
The furniture acquired on January 1 had a $400 estimated salvage value
and a four-year useful life. The annual depreciation charge is $600
[($2,800 – $400)/4].
Paid $4,500 for manufacturing equipment.
Recognized depreciation on equipment purchased in Event 7.
The equipment acquired on January 1 had a $1,500 estimated salvage value
and a three-year useful life. The annual depreciation charge is $1,000
[($4,500 – $1,500)/3].
Sold inventory to customers for $7,500 cash.
The inventory sold in Event 9 cost $4,000 to make.
1-40
Patillo’s Financial Statements
Company
started 1/1/12
9,000
1-41
Overhead Costs
2 types of Depreciation
Production costs flow through Balance sheet and
period expenses do not
1-42
Overhead Costs: Also known as Indirect
costs or Shared.
Indirect Costs
Depreciation
Supervisor’s
Salary
Shared costs
are usually
pooled and
allocated to
products. Hard
to pinpoint
specific usage
between
products
Utilities
1-43
Indirect Cost Allocation of Utilities
spreading $120 of utilities to different products
1-44
Learning Objective 4
Prepare schedules for cost of goods
manufactured and cost of goods sold.
1-45
Manufacturing Costs – Inventory Accounts
Usually accumulated in three distinct inventory accounts to reflect
the steps in the production process. Whatever is left in the account is
reported at period end on the Balance Sheet.
Think cake manufacturing
1.
Raw Material
– Eggs, flour, water
2.
Work-in-Process
– Not saleable – Batter, unfrosted cakes, unpackaged cakes
– When product is finished – transferred to Finished Goods. This
is the cost of goods manufactured
3.
Finished Goods
– Packaged cakes ready for sale
– If sold, cost transferred to Cost of Goods Sold
1-46
The Flow of Manufacturing Costs Through
the Accounting Records
Dotted arrows – stay
Solid arrows – go
1-47
Cost of Goods Manufactured and
Cost of Goods Sold
•
Helps us understand flow of materials and conversion of resources (labor and
overhead) through production process by examining each inventory account.
Calculation of each inventory account value.
•
RM->WIP->FG->COGS is a Key Sequence!
•
Flow of Work in Process to Finished Goods is Cost of Goods Manufactured. In
other words, what was transferred to Finished Goods?
•
Flow of Finished Goods to Cost of Goods Sold goes to income statement and is
matched with associated revenue. In other words, what was transferred to the
income statement from inventory?
•
Inventory Formula – VERY IMPORTANT
Beginning Inventory + Transfers in = Transfers out + Ending Inventory
This applies to each inventory account – RM, WIP and FG
1-48
Total Product Cost
Assume starting with zero inventory
1-49
Schedule of Cost of Goods Manufactured &
Sold
•Cost of Goods
Manufactured is the
amount that is
transferred to Finished
Goods.
•Cost of Goods sold is
amount transferred to
income statement to
match sales
1-50
Learning Objective 5
Distinguish product costs from upstream
and downstream costs.
1-51
Upstream and Downstream Costs
Upstream
Costs
Downstream
Costs
Costs occur before the
manufacturing process
begins.
Costs occur after the
manufacturing process
begins.
1-52
Learning Objective 6
Explain how product costing differs in
service, merchandising and manufacturing
companies.
1-53
Costing for products or services and accounting
differences between service, merchandising and
manufacturing companies
Service
Company
(No inventories)
Labor
and
Overhead
Merchandising
Company
(No conversion, has
inventory)
Labor
and
Overhead
Manufacturing
Company
(Most complicated)
Labor
and
Overhead
Period
Cost or
OpEx
Period
Cost or
OpEx
Product
Cost or
COGS
1-54
Chapter 10
Exercise 10-13
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-55
Chapter 10
Exercise 10-13 answer
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-56
Chapter 10
Exercise 10-13 answer
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-57
Review
1. For a manufacturing company there are 3 main costs
2. In a manufacturing and merchandizing company, product
costs start on the balance sheet and are released to the
income statement when there is a sale
3. 3 types of inventory accounts
4. Inventory formula
5. Depreciation and Overhead
Chapter 10
Chapter Summary – We learned about…
1.
Difference between managerial and financial accounting.
2.
Identification of the cost components of a product made by a
manufacturing company: the cost of materials, labor, and
overhead.
3.
The effects on financial statements of product costs versus
general, selling, and administrative costs.
4.
Preparing a schedule of cost of goods manufactured and sold.
5.
Distinguishing product costs from upstream and downstream
costs.
6.
How product costing differs in service, merchandising and
manufacturing companies.
1-59
Chapter 10
Exercise 10-14
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-60
Chapter 10 – Exercise 10-14 answer
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-61
MGT 45: Principles of Accounting
Tuesday and Thursday
2PM -320PM
330PM-450PM
Rady School of Mgt, Room 1N108
Professor: Joe Pecore
Spring 2019
http://www.bloomberg.com/live
https://markets.wsj.com/
Agenda 5/16/19
•
Business News of the Day
https://markets.wsj.com/
•
Announcements
•
Lecture
–
Chapter 11
1-2
Announcements
1.
We will have a makeup class this Friday 5/17 at 1230 in Wells Fargo
Hall. Remember, there are no classes on 5/28 and 5/30.
2.
HW3 which covers Chapters 9-11 is posted.
3.
HW3 is due Tuesday 5/21 at the beginning of class.
1-3
Review – Chapter 10
1. For a manufacturing company there are 3 main costs
2. In a manufacturing and merchandizing company, product
costs start on the balance sheet and are released to the
income statement when there is a sale
3. In a manufacturing company, there are 3 types of inventory
accounts – know the flow through the accounts
–
RM -> WIP -> FG -> COGS
4. Inventory formula
5. Depreciation and Overhead
Chapter 11
Cost-Volume-Profit Analysis,
Operating Leverage & Breakeven
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-5
Cost-Volume-Profit Analysis (CVP) is about…
•
Understanding the profit drivers in a merchandise or
manufacturing company through the relationship of
costs, volume and revenue
•
Understanding cost behavior and categorizing costs –
variable and fixed
•
This very valuable analytical tool will give us the ability
to understand and predict the behavior of the engine of
profit in a company.
•
Getting to the core of profit generation in a business
1-6
Chapter 11
Learning Objectives
1.
Identify and describe fixed, variable, and mixed cost
behavior.
2.
Calculate a contribution margin and generate a
contribution margin statement.
3.
Demonstrate the effects of operating leverage on
profitability.
4.
Calculate the magnitude of operating leverage.
5.
Calculate the break-even point.
6.
Calculate the sales volume required to attain a target
profit.
7.
Calculate the margin of safety in units, dollars, and
percentage.
1-7
Learning Objective 1
Identify and describe fixed, variable,
and mixed cost behavior.
1-8
Fixed Cost Behavior
When Activity
Increases
Total fixed costs
Fixed cost per unit
Remains
Constant
Decreases
When Activity
Decreases
Remains
Constant
Increases
Bike example $1,000 fixed costs for 100 or 50 bikes
Numerator the same, denominator changes
1-9
Cost Behavior – Total Fixed Costs
Monthly Basic
Telephone Bill
Assume your monthly basic telephone bill
is fixed and does not change when you make
more local calls.
Total Fixed Cost
Number of Local Calls
1-10
Cost Behavior – Unit Fixed Costs
Monthly Basic Telephone
Bill per Local Call
The fixed cost per local call decreases
as more local calls are made.
Number of Local Calls
1-11
Variable Cost Behavior
When Activity
Increases
When Activity
Decreases
Total variable cost
Increases
Proportionately
Decreases
Proportionately
Variable cost per unit
Remains
constant
Remains
constant
Bike example $20 per seat for 100 or 50 bikes
Numerator and Denominator move proportionally
1-12
Cost Behavior – Total Variable Costs
Total Long Distance
Telephone Bill
On some plans, your total long distance telephone bill is
based on how many minutes you talk and the rate per
minute. Pay as you go.
Minutes Talked
1-13
Cost Behavior – Unit Variable Costs
Per Minute
Telephone Charge
The cost per minute talked is constant.
For example, 10 cents per minute.
Variable Cost Per Unit
Minutes Talked
1-14
Cost Behavior Summarized
(think of phone bill examples)
When activity level changes . . .
Total Cost
Cost Per Unit
Fixed Costs
Remains
Constant
Changes
Inversely
Variable Costs
Changes in
Direct Proportion
Remains
Constant
1-15
Mixed Costs
•Some costs have both fixed and variable
components.
•These costs are known as mixed costs or
semivariable costs.
1-16
Mixed Costs
• Star Productions gives a backstage party for VIPs to meet
the band.
• You are tasked with projecting the cost of the party
• The total cost of this party is a mixed cost with these
components:
▪ Rental of room is fixed
▪ Refreshments are variable
1-17
Mixed Costs
Assuming a room rental fee of $1,000 and refreshments costs of
$20 per person, the total mixed cost at any volume of activity
can be computed as follows:
Total cost = Fixed cost + (Variable cost per party guest X
Number of guests)
If 60 people attend the backstage party the total mixed cost is:
Total cost = $1,000 + ($20 X 60) = $2,200
If 90 people attend the backstage party the total mixed cost is:
Total cost = $1,000 + ($20 X 90) = $2,800
1-18
Some Examples of Mixed Costs- each item has a
MIX of fixed and variable costs
Is the cost of UCSD mixed?
1-19
Cost-Volume-Profit Analysis
•
You are in charge of booking a band for the Spring
Music festival.
•
You are thinking of spending $48,000 for the band. This
is your only expense.
•
You need to breakeven or better, meaning bringing in
revenue equal to or greater than $48,000.
•
How would you price tickets?
1-20
Fixed Costs and Ticket Pricing Decision
Fixed costs are the same for each level of
sales.
The question becomes how many tickets will
we sell and what will be the cost per ticket to
then determine a sensible price?
Last time there was a similar event, 3,000
people attended
1-21
Fixed Costs and Ticket Decision
Consider the following
event example where the
band will be paid $48,000
regardless of the
number of tickets sold.
Fixed costs are the same for each level of sales. To
cover the fixed costs, the price of the tickets should be
lower at a higher volume and higher at a lower volume
Number of tickets sold
2,700
3,000
3,300
Total cost of band
$ 48,000
$ 48,000
$ 48,000
Cost per ticket sold
$
$
$
17.78
16.00
14.55
$48,000 ÷ 3,000 Tickets = $16.00 per Ticket
1-22
Fixed Costs and Ticket Pricing Decision
Number of tickets sold
2,700
3,000
3,300
Total cost of band
$ 48,000
$ 48,000
$ 48,000
Cost per ticket sold
$
$
$
17.78
16.00
14.55
$48,000 ÷ 3,000 Tickets = $16.00 per Ticket
Knowing how costs behave relative to the level of business
activity enables managers to more effectively plan and control
costs and maximize profit.
The two big questions are :
• how many tickets do they think they can sell?
• how much profit do they want to make?
‐ Based on number of projected tickets, price should reflect
profit per ticket they want to generate.
1-23
Learning Objective 2
Calculating contribution margin and
generating a contribution margin
statement.
1-24
Contribution Margin =
Revenue – Variable Costs
•To calculate, costs must be separated into variable and fixed
•The contribution margin is the amount of revenue remaining
after subtracting all variable costs
•This remaining amount will cover fixed costs and profits.
•Contribution margin is also known as variable profit from
sales
1-25
Contribution Margin Statement
2,000 units
Sales Revenue
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Net Income
Total
$ 100,000
60,000
$ 40,000
30,000
$ 10,000
Unit
$ 50
30
$ 20
The contribution margin format emphasizes cost behavior.
It separates variable and fixed costs.
Contribution margin covers fixed costs and funds net income.
1-26
Contribution Margin
• If we sold 2,001 units, or 1 more, how much
incremental profit would be generated?
• If we sold 1,999 units or 1 less, how much less profit
would be generated?
• Fixed costs don’t change….
1-27
Examples of Income and Contribution Margin
Statements – Company X42
Income Statement and Contribution Margin
Assumptions
Units
Price per Unit
COGS per unit
Opex
$
$
$
100
100
45
2,500
These operating parameters generate
$3,000 of Operating Income
Income Statement
Contribution Margin
Revenue
$
10,000
COGS
$
$
$
4,500
4,000
500
Gross Margin
$
5,500
Operating Expenses
Variable
Fixed
$
$
$
Operating Income
$
Variable
Fixed
Revenue
$ 10,000
Variable Costs
COGS
OpEx
$ 5,000
$ 4,000
$ 1,000
Contribution Margin
$ 5,000
2,500
1,000
1,500
Fixed Expenses
COGS
OpEx
$ 2,000
$
500
$ 1,500
3,000
Operating Income
$ 3,000
Gross
Margin % =
55%
Contribution
Margin % =
50%
1-28
Examples of Income and Contribution Margin
Statements – Company X42
Income Statement and Contribution Margin
Assumptions
Units
Price per Unit
COGS per unit
Opex
$
$
$
100
100
45
2,500
These operating parameters generate
$3,000 of Operating Income
Income Statement
Contribution Margin
Revenue
$
10,000
COGS
$
$
$
4,500
4,000
500
Gross Margin
$
5,500
Operating Expenses
Variable
Fixed
$
$
$
Operating Income
$
Variable
Fixed
Revenue
$ 10,000
Variable Costs
COGS
OpEx
$ 5,000
$ 4,000
$ 1,000
Contribution Margin
$ 5,000
2,500
1,000
1,500
Fixed Expenses
COGS
OpEx
$ 2,000
$
500
$ 1,500
3,000
Operating Income
$ 3,000
Gross
Margin % =
55%
Contribution
Margin % =
50%
1-29
Examples of Income and Contribution Margin
Statements – increase in volume
Income Statement and Contribution Margin
Assumptions
Units
Price per Unit
COGS per unit
Opex
$
$
$
What is the impact of a 10%
increase in sales volume?
100
100
45
2,500
Income Statement
+10% volume
Revenue
$
10,000
$
11,000
COGS
$
$
$
4,500
4,000
500
$
$
$
Gross Margin
$
5,500
Operating Expenses
Variable
Fixed
$
$
$
Operating Income
$
Variable
Fixed
Contribution Margin
+10% volume
Revenue
$ 10,000
$
11,000
4,900
4,400
500
Variable Costs
COGS
OpEx
$ 5,000
$ 4,000
$ 1,000
$
$
$
5,500
4,400
1,100
$
6,100
Contribution Margin
$ 5,000
$
5,500
2,500
1,000
1,500
$
$
$
2,600
1,100
1,500
Fixed Expenses
COGS
OpEx
$ 2,000
$
500
$ 1,500
$
$
$
2,000
500
1,500
3,000
$
3,500
Operating Income
$ 3,000
$
3,500
1-30
Examples of Income and Contribution Margin
Statements – decrease in volume
Income Statement and Contribution Margin
Assumptions
Units
Price per Unit
COGS per unit
Opex
$
$
$
What is the impact of a 10%
decrease in sales volume?
100
100
45
2,500
Income Statement
-10% volume
Contribution Margin
-10% volume
Revenue
$
10,000
$
9,000
Revenue
$ 10,000
$
9,000
COGS
$
$
$
4,500
4,000
500
$
$
$
4,100
3,600
500
Variable Costs
COGS
OpEx
$ 5,000
$ 4,000
$ 1,000
$
$
$
4,500
3,600
900
Gross Margin
$
5,500
$
4,900
Contribution Margin
$ 5,000
$
4,500
Operating Expenses
Variable
Fixed
$
$
$
2,500
1,000
1,500
$
$
$
2,400
900
1,500
Fixed Expenses
COGS
OpEx
$ 2,000
$
500
$ 1,500
$
$
$
2,000
500
1,500
Operating Income
$
3,000
$
2,500
Operating Income
$ 3,000
$
2,500
Variable
Fixed
1-31
Contribution Margin Analysis
• How do the contribution margin and gross margin
compare?
CM=Rev-Variable Costs and GM = Rev-COGS
• What is the unit contribution?
Total Contribution Margin/units. A measure of how much
contribution margin per unit sold the company brings in.
• What is the contribution margin ratio?
Total CM/Revenue or Unit CM/Unit Price. A percentage that
indicates how much contribution margin per revenue dollar the
company brings in.
1-32
Contribution Margin Analysis
• What happens when there is a volume change?
– What is the impact on contribution margin?
Proportional to volume
– What is the impact on operating income?
Equal to contribution margin difference
1-33
Learning Objective 3
Demonstrate the effects of operating
leverage on profitability.
1-34
Operating Leverage
• Relationship of % change in sales to % change in operating income
• Operating leverage is greatest in companies that have a high
proportion of fixed costs in relation to variable costs. High flow
through of incremental revenue to bottom line
• An indicator of the extent to which fixed costs are being used in an
organization.
Small
percentage
change in
revenue
Dramatic
percentage
change in
profitability
Fixed Costs
1-35
Operating Leverage
• What happened to income in our prior examples when
sales changed by + and – 10%?
• Income grew and shrank by 17% because of leverage –
a 10% change in sales resulted in a disproportionate
amount increased or decreased income
• Income grew from $3,000 to $3,500 when sales
increased 10%
• Income shrank from $3,000 to $2,500 when sales
decreased 10%.
1-36
Disney Second Quarter earnings announcement
http://www.cnbc.com/id/15906175
Walt Disney posted mixed quarterly results Thursday, and its
chief executive touted the health of its television business
after setting off concerns about the segment earlier this year.
The media giant reported adjusted earnings of $1.20 per
share on $13.51 billion in sales for its fiscal fourth quarter,
which marked increases of 35 and 9 percent, respectively,
from the previous year.
1-37
Operating Leverage
• Relationship of % change in sales to % change in operating income
• Operating leverage is greatest in companies that have a high
proportion of fixed costs in relation to variable costs. High flow
through of incremental revenue to bottom line
• An indicator of the extent to which fixed costs are being used in an
organization.
Small
percentage
change in
revenue
Dramatic
percentage
change in
profitability
Fixed Costs
Consider the following
concert example where
all costs are fixed.
1-38
Operating Leverage
with 100% fixed cost structure
(Assume: Price = $18/ ticket)
When all costs are fixed, every
additional sales dollar contributes
one dollar to profit.
10% Revenue
Increase
90%
Profit Increase
Disproportionate
1-39
Percentage Change
Percentage Change is Calculated Using:
(Alternative Measure – Base ) / Base
Change in number of tickets sold:
(3,300 – 3,000)/ 3,000 = 10% increase
Change in Profit:
($11,400 – $6,000 )/ $6,000 = 90% increase
1-40
Operating Leverage
with 100% fixed cost structure
10% Revenue
Decrease
When all costs are fixed, every
additional sales dollar contributes
one dollar to profit.
90%
Profit Decrease
Disproportionate
1-41
Risk and Reward Assessment- Balancing
fixed and variable in the cost structure
Risk refers to the possibility that
costs may exceed benefits.
Risk may be reduced by
converting fixed costs
into variable costs.
1-42
Risk and Reward Assessment
Balancing fixed and variable in the cost structure
How much money does the company lose if
zero tickets are sold and costs are 100%
fixed?
$48,000
Risk may be reduced by
converting fixed costs
into variable costs.
Let’s see what happens to the concert
example if the band receives $16 per
ticket instead of $48,000.
1-43
Variable Cost Behavior
100% Variable cost structure
Paying Band $16 per ticket
• The total variable cost increases in direct proportion to
the number of tickets sold
•Variable unit cost per ticket remains at $16 regardless of
the number of tickets sold.
• Band will get paid a variable amount based on ticket
sales or $16 per ticket
1-44
Variable Cost Behavior
When Activity
Increases
When Activity
Decreases
Total variable cost
Increases
Proportionately
Decreases
Proportionately
Variable cost per unit
Remains
constant
Remains
constant
Paying Band $16 per ticket
1-45
Operating Leverage
with 100% variable cost structure
Risk shifted to Band, not Promotion Company
10% Revenue
Increase
Shifting the cost structure from fixed to
variable not only reduces risk but also
the potential for profits.
10%
Profit Increase
Proportional
No operating leverage
Operating Leverage
with 100% fixed cost structure
(Assume: $18/ ticket)
When all costs are fixed, every
additional sales dollar contributes
one dollar to profit.
10% Revenue
Increase
90%
Profit Increase
Disproportionate
1-47
Learning Objective 4
Calculate the magnitude of operating
leverage.
1-48
Measuring Operating Leverage Using
Contribution Margin
Magnitude of Operating
Leverage
Contribution margin
=
Net income
Can one derive this measure from the
Financial Statements?
1-49
Measuring Operating Leverage Using Contribution
Margin- The Hammer Company
Operating
Leverage
(CM) $20,000
=
= 4
(NI) $5,000
A measure of how a percentage change in sales will
effect profits. Leverage Factor. For every 1% change
in sales, net income will change 4%
1-50
Measuring Operating Leverage Using
Contribution Margin
A 10 percent increase in sales results in
a 40 percent increase in net income.
(Fixed Expenses did not change.)
(10% × 4 = 40 %)
1-51
Operating Leverage Examples
using the income statement
AAPL
2011
2010 Difference
Revenue
$
108.2 $
65.2
COGS
$
64.4 $
39.5
Gross Margin
$
43.8 $
25.7
Operating Expenses $
10.0 $
7.3
Operating Income
33.8 $
18.4
$
2011
$
11.7 $
10.7
COGS
$
4.9 $
4.5
Gross Margin
$
6.8 $
6.2
Operating Expenses $
5.3 $
5.0
Operating Income
1.5 $
1.2
2011
84%
9%
Starbucks
25%
RIMM
2010 Difference
Revenue
$
18.4 $
19.9
COGS
$
11.9 $
11.1
Gross Margin
$
6.5 $
8.8
Operating Expenses $
5.1 $
4.2
Operating Income
1.4 $
4.6
$
Apple
SBUX
2010 Difference
Revenue
$
66%
-8%
-70%
Research in Motion
(Blackberry)
1-52
Learning Objective 5
Calculate the break-even point.
1-53
Break-even Point
• Sales achieved that exactly cover all costs, both variable and
fixed.
• The level of sales at which there is no profit or loss.
• Computed using the equation method (derived from the
income statement) or the contribution margin per unit
method.
• Can be expressed in terms of $ or units.
1-54
Calculating the Breakeven point
Bright Day produces one product called Delatine.
The company uses a cost-plus-pricing strategy; it sets prices
at cost plus a markup of 50% of cost.
Delatine costs $24 per bottle to manufacture (all variable
costs), so a bottle sells for $36 ($24 + [50% × $24]).
Price = $36/unit and Variable Cost = $24/unit
Given fixed costs of $60,000 in the company, how many
units need to be sold to break even?
1-55
Calculating the Breakeven point
Given fixed costs of $60,000 in the company, how many
units need to be sold to break even?
• Remember – the contribution margin covers the fixed
costs and profit.
• At breakeven, there is no profit.
• Therefore, how many units will it take to cover the
$60,000 fixed costs?
1-56
Calculating the Breakeven point by the
Equation Method
Begin by expressing the contribution margin statement as:
Sales – Variable Cost – Fixed Costs = Profit
Compute break-even point:
$36 = Sales price per unit
$24 = Variable cost per unit
$60,000 = Fixed costs
Sales price or unit
cost multiplied by
sales units (N)
Sales – Variable Cost – Fixed Costs = Profit
$36N –
$24N
–
$60,000 =
$0
$12N = $60,000
N = $60,000 / $12
N = 5,000 Units – results in no profit or loss and
$180,000 in sales
N = Number of units
1-57
Calculating the Breakeven point by using
the Contribution Margin per Unit Method
Finding break-even point begins with the contribution margin
per bottle:
Sales revenue per bottle
Variable cost per bottle
Contribution margin per bottle
$ 36
24
$ 12
1-58
Contribution Margin per Unit Method:
Break-even Point in Units
•The break-even point is the point where total revenue equals total costs
(both variable and fixed).
•Advertising costs are the fixed costs of the company. For Bright Day, the
cost of advertising are estimated to be $60,000.
•We use the following formula to determine the break-even point in units.
•In other words, how many units do I have to sell to cover fixed costs?
Break-even
=
volume in units
=
Fixed costs
Contribution margin per unit
$60,000
= 5,000 units
$12
1-59
Contribution Margin per Unit Method:
Break-even Point in Sales Dollars – Proof
For Delatine, the break-even point in sales dollars is
$180,000 or (5,000 bottles × $36 selling price).
Sales Revenue (5,000 units x $36)
Total Variable Expenses (5,000 units x $24)
$ 180,000
(120,000)
Total Contribution Margin (5,000 units x $12)
Fixed Expenses
60,000
(60,000)
Net Income
$
0
1-60
Learning Objective 6
Calculate the sales volume required
to attain a target profit.
1-61
Equation Method Sales Volume to Achieve
Desired (Target) Profit of $40,000
Bright Day’s profit is determined as follows:
$36 = Sales price per unit
$24 = Variable cost per unit
$60,000 = Fixed costs
$40,000 = Desired profit
Sales – Variable Cost – Fixed Costs = Profit
$36N –
$24N
–
$60,000 =
$40,000
$12N = $60,000 + $40,000
N = $100,000 / $12
N = 8,333 Units provide a $40,000 Profit and
$300,000 in sales
N = Number of units
1-62
Contribution Margin per Unit
Sales Volume or units needed to Achieve
Target Profit
Bright Day’s president wants the advertising campaign to
produce profits of $40,000 for the company.
“Break-even”
Fixed costs + Desired profit
volume in units = Contribution margin per unit
=
$60,000 + $40,000
$12
= 8,333.33 units
1-63
Reaching a Target Profit Level – Proof
At $36 per unit selling price, the sales dollars are
equal to $300,000, as shown below:
Units sold
Revenue @ $36
Variable Expenses @ $24
Contribution Margin @$12
Fixed Expenses
Net Income
Income
8,333.33
$ 300,000
(200,000)
100,000
(60,000)
$ 40,000
1-64
Learning Objective 7
Calculate the margin of safety in units,
dollars and percentage.
1-65
Calculating the Margin of Safety
•The margin of safety measures the cushion between
budgeted/estimated/planned sales and the break-even
point.
•It quantifies the amount by which actual sales can fall
short of expectations before the company will begin to
incur losses.
•Can be expressed in units, $ or %
1-66
Calculating the Margin of Safety
Budgeted sales
Break-even sales
Margin of safety
In Units
8,333
(5,000)
3,333
In Dollars
$ 299,988
(180,000)
$ 119,988
Margin of
Budgeted sales – Break-even sales
=
Safety %
Budgeted sales
Margin of = $299,988 – $180,000 X 100 = 40%
Safety %
$299,988
1-67
Chapter 11
Chapter Summary – We learned about…
1.Identification of fixed, variable, and mixed cost behavior.
2.Calculating a contribution margin and generating a
contribution margin statement
3.The effects of operating leverage on profitability.
4.Calculating the magnitude of operating leverage.
5.Calculating the break-even point.
6.Calculating the sales volume required to attain a target profit.
7.Calculating the margin of safety in units, dollars, and
percentage.
1-68
Chapter 10
Exercise 10-14
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-69
Chapter 10 – Exercise 10-14 answer
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
1-70
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