LESSON 2: FINANCIAL STATEMENT ANALYSIS

Learning Objectives:
At the end of the lesson, you should be able to:
1. identify the purpose of using financial statement analysis;
2. determine the three types of analysis being used by various users in
evaluating financial statements; and
3. solve accounting problems using horizontal analysis, vertical analysis
and financial ratios to be used in decision-making.

LET’S ENGAGE!
Financial statements were introduced to you when you took up Accounting
for Business Transactions. Your knowledge on this topic was refreshed in our
Lesson 1.
Could you identify the three (3) major financial statement user groups and
describe what each group hopes to learn from financial statement analysis?
User Group Things they wanted to know from financial statement analysis
1. _______ - _______________________________________________________________
_______________________________________________________________
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_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
2. _______ - _______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
3. _______ - _______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________
_______________________________________________________________

In this lesson, you will be identifying the different user groups of financial
statements and what do these user groups hope to see and understand from
the financial statement using the three (3) different methods in analyzing the
financial statements.
Aside from this, you will also be introduced to the three methods in
analyzing financial statements, namely; (1)Vertical Analysis (common-sized
financial statements); (2) Horizontal Analysis ( trend percentage and index
analysis); and (3) Financial Ratios.
 LET’S EXPLORE!
The objective of financial statement analysis is to determine the
extent of a firm’s success in attaining its financial goals, namely:
a. To earn maximum profit;
b. To maintain solvency; and
c. To attain stability

Financial statements user groups include the following:

a. Creditors – Creditors lend money to a company on either a short-
term or a long-term basis. Short-term creditors include trade
creditors and lending institutions. Long-term creditors include
lending institutions and corporate bondholders. All creditors want to
be assured of receiving prompt payments from the company when
the debt matures.
b. Equity investors – Equity investors are those who purchase an
ownership interest in a company. They want to determine if the
company will be able to distribute income or dividends in the future
and if the value of their investments will rise.
c. Management – Management analyzes the company’s financial
statements with a view toward further improving the operations of
the company thereby satisfying the expectations of the various
parties, both internal and external.

This different user groups might not be knowledgeable enough on the

different information presented on the financial statements. They needed to
identify the liquidity of the entity before they dive-in to investing with the
company. Information about liquidity deals with the ability of the firm to meet
its short-term obligations, while solvency talks about the ability of the entity to
meet its long-term obligations.

To be able to have first-hand information needed from the data presented

in the financial statements, decision-makers need to analyze the figures
presented on the face of the financial statements. Analyzing financial statement
entails detailed computation to be able to come up with analysis and evaluation
on the company’s status in the industry. To be able to deal with this, decision-
makers would need the three (3) identified financial statement analysis
commonly used in terms of this perspective, namely: (a) Horizontal analysis; (b)
Vertical Analysis; and (c) Financial Ratios.

.
LET’S TALK ABOUT IT!
Financial statement analysis is the process by which the relationships,
changes and trends are determined from data in financial statements and
related information to arrive at an evaluation and conclusion as to the causes of
changes and as to the soundness of the financial position and the results of
operations of an enterprise.

Analysis of a Business versus Analysis of Financial Statements

Analysis of a business is a broader evaluating activity focusing on the
strengths and weaknesses of an enterprise based on internal factors and
relating such to the problems and opportunities as perceived based on external
factors. Analysis of financial statements limits the evaluation to the data in the
financial statements and other related information.

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Methods and Techniques in Analysis
1. Horizontal or Trend Analysis – This is an analytical method by which
comparative statements are presented to show changes in each item as of
different dates or for different period as a means of determining improvement
or deterioration of the financial condition or results of operations of a business
enterprise.

a. Increase/Decrease Method – horizontal analysis method highlighting the

peso as well as the percentage increase or decrease of each item in the
comparative statements. The difference between the item amounts of the two
periods is calculated, and the percentage change from one period to the next is
computed using the earlier period as a base.

b. Trend Percentages or Index Numbers – emphasize changes that have

occurred from period to period and are useful in comparing data covering
several years. Trend percentages are calculated as follows:
 A base year is selected, and each item amount is assigned a weight of
100%.
 Then each item from the statements for the years after the base year is
expressed as a percentage of its base year amount. To determine these
percentages, the item amounts in the years after the base year are
divided by the amount of the item in the base year.

Illustration:
Suppose an analyst is interested in the trend in sales and net income for MP
Company for the past five (5) years. The following are MP’s sales revenue and
net income figures and trend percentages for 2015 to 2019.

MP Company
Income Statement
For the Years Ended December 31, 2015 to 2019
(In Thousands)

2015 2016 2017 2018 2019

Net sales 600.00 660.00 726.00 798.60 878.46
Cost of goods sold 420.00 441.00 463.05 486.20 510.51
Gross profit 180.00 219.00 262.95 312.40 367.95
Operating expenses
Selling expenses 12.00 13.80 15.87 18.25 20.99
General and administrative expenses 6.00 7.20 8.64 10.37 12.44
Total operating expenses 18.00 21.00 24.51 28.62 33.43
Operating income 162.00 198.00 238.44 283.78 334.52
Other income and expenses, net (deduct) (2.00) (1.80) (1.71) (1.62) (1.54)
Income before taxes 160.00 196.20 236.73 282.15 332.97
Less: Income tax 44.80 74.56 78.12 95.93 99.89
Net Income 115.20 121.64 158.61 186.22 233.08

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Income Statement Trend Percentages
2015 2016 2017 2018 2019
Net sales 100% 110.00% 121.00% 133.10% 146.41%
Cost of goods sold 100% 105.00% 110.25% 115.76% 121.55%
Gross profit 100% 121.67% 146.08% 173.55% 204.42%
Operating expenses
Selling expenses 100% 115.00% 132.25% 152.09% 174.90%
General and administrative expenses 100% 120.00% 144.00% 172.80% 207.36%
Operating income 100% 122.22% 147.19% 175.17% 206.49%
Other income and expenses, net (deduct) 100% 90.00% 85.50% 81.23% 77.16%
Income before taxes 100% 122.63% 147.96% 176.35% 208.11%
Less: Income tax 100% 166.42% 174.38% 214.14% 222.97%
Net Income 100% 105.59% 137.68% 161.65% 202.33%

Discussion: A base year (2015) is selected and represented as 100% and then
divide the data for each of the remaining year by the base-year data. The result
is an index of the changes occurring throughout the period.

Interpretation:
It will be observed that both sales and cost of sales showed upward trends
with sales increasing at a faster rate. These data reflect a favorable situation
from the point of view of managerial ability to control costs relative to change
on sales volume. This more desirable percentage may have been the result of
one or more factors such as favorable price-level changes, more effective
markup policies or greater efficiency in purchasing.
An unfavorable tendency is reflected by the fact that trend percentages
for selling, general and administrative expenses increased at a faster rate than
net sales. The company could have earned more profit if better and more
effective control over operating expenses instituted.

2. Vertical Analysis – This is a technique for evaluating financial statement

data by which relationships between different items in a single statement as of
a date or period are shown in percentages.

Common-size statements or 100% statements – are comparative

statements that give only the vertical percentages or ratios for the financial
data.
a. Balance Sheet – TOTAL ASSETS represent 100%. Other items on the
balance sheet are expressed as percentages of total assets by dividing
each item by the total assets.
b. Income Statement – NET SALES or NET OPERATING REVENUE is set
at 100%. Each item in the income statement is divided by net sales/net
operating revenue to express such items as percentages of net sales.

A common-size statement of financial position shows the percent of total

assets that has been invested in each type or kind of asset. These percentages
may be compared with those of a competitor or the industry to determine
whether or not the firm has over or underinvested in one or more of its assets.
This should however, be supplemented by turnover or other statistics before
final conclusion can be drawn.

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 The common-size income statement shows the amount or percentage of
the sales that has been absorbed by each individual cost or expense item and
the percentage that remains as net income.
Illustration:
A comparative income statement is given below for PM Company

PM Company
Income Statement
For the Years Ended December 31, 2015 to 2019
(In Peso)

2019 2018
Sales P5,000,000.00 P4,000,000.00
Less: Cost of goods sold 3,160,000.00 2,400,000.00
Gross profit 1,840,000.00 1,600,000.00
Selling expenses 900,000.00 700,000.00
Administrative expenses 680,000.00 584,000.00
Total expenses 1,580,000.00 1,284,000.00
Net operating income 260,000.00 316,000.00
Interest expense 70,000.00 40,000.00
Net income before taxes P190,000.00 P276,000.00
The president is concerned that net income is down in 2019 even through
sales have increased during the year. The president is also concerned that
administrative expenses have increased, since the company made a concerted
effort during 2019 to pare “fat” out of the organization.

Required:
a. Express each year’s income statement in common-size percentages.
b. Comment briefly on the changes between the two years.

Solution:
Requirement 1
PM Company
Income Statement
For the Years Ended December 31, 2015 to 2019
(In Peso)

2019 2018
Sales 100.00% 100.00%
Less: Cost of goods sold 63.20% 60.00%
Gross profit 36.80% 40.00%
Selling expenses 18.00% 17.50%
Administrative expenses 13.60% 14.60%
Total expenses 31.60% 32.10%
Net operating income 5.20% 7.90%
Interest expense 1.40% 1.00%
Net income before taxes 3.80% 6.90%

Requirement 2
The company’s major problem seems to be the increase in cost of goods sold,
which increased from 60.00% of sales in 2018 to 63.20% of sales in 2019. This

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suggests that the company is not passing the increases in costs of its products
on to its customers. As a result, cost of goods sold as a percentage of sales has
increased and gross margin has decreased. Selling expenses and interest
expense have both increased slightly during the year, which suggests that costs
generally are going up in the company. The only exception is the administrative
expenses, which have decreased from 14.6% of sales in 2018 to 13.6% of sales
in 2019. This probably is a result of the company’s efforts to reduce
administrative expenses during the year.

3. Financial Ratios - These are significant relationships between items in the

financial statements expressed in mathematical form. As indicators of
profitability, liquidity and stability, they are used to determine the possible
areas of weakness and strengths of an organization.

A. Indicators of Profitability
Significance

Indicates the amount of

1. Rate of Return on Sales = Net Income/Sales net income per peso sales
or the profitability based
on sales.

2. Rate of Return on Return on Sales x Indicates the profitability in

Total Assets = Asset Turnover the use of the total assets
or total capital, both
borrowed and invested.
Net Income
Average Total Assets

Net Sales Indicates the efficiency in

3. Asset Turnover =
Average Total the use of total resources.
Assets

4. Gross Profit Ratio = Gross Profit Indicates the gross margin

Net Sales per peso sales. Used in
determining the adequacy
of gross margin to cover
operating expenses and
provide desired profit.
COS + OPEX Indicates
Indicates what
whatportion
portionofof
5. Operating Ratio =I Net Sales net
net sales
salesisisabsorbed
absorbed byby
operating costs.
operating costs.

Indica
Net Income tes the profitability in the
6. Rate of Return
= Average Current use current assets.
Current Assets
Assets
Indicates the rate at
7. Current Asset = COS + OPEX which current assets are
Turnover Average Current being used and adequacy
Assets of current assets.

Rate of Return on
8. Rate of Return per = Current Assets Indicates the percentage
Current Asset of profit every time
Turnover current assets are used.
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Current Asset Turnover

9. Rate of Return on Net Income Indicates the profitability in

Working Capital = Average the use of working capital.
Working Capital

COS + OPEX Indicates the rate at which

10. Working Capital =
Average working capital is being used
Turnover
Working Capital and the adequacy of working
capital.

Rate of Return
11. Rate of Return per Indicates the percentage of
on Working
Working Capital = profit earned every time
Capital
Turnover working capital is used.
Working Capital
Turnover

Net Sales Indicates the rate at which

12. Invested Capital
= Average owners’ capital or the assets
Turnover
Owners’ Equity provided by owners are being
used.

Net Income Indicates the profitability in

13. Rate of Return on
Average the use of invested capital or
Owners’ Equity =
Owners’ Equity the amount of return per
or peso of owners’ equity.

Rate of Return
on Sales x
Invested Capital
Turnover

Net Income –
14. Earnings Preferred Indicates the amount of
Per share = Dividends returns on each share of
Ave. # of common stock and the
Common Shares ability to pay dividends.
Outstanding
Market Price per
15. Price Earnings Measures the relationship
= Share
Ratio between market price and
Earnings per
Share earnings on each share.

16. Capitalization Rate EPS Indicates the rate at which

Or Earnings/Price = Market Price per the stock market is
Ratio Share apparently capitalizing the
value of current earnings.
Dividends
17. Dividends per Shows the amount of
Declared
Share = distributed earnings
Common
per Shares
share.
Outstanding
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 18. Yield on Dividends per Share Shows the percentage of
Common Stock = Market value per distributed earnings based
Common Share on market value.

19. Payout Ratio = Dividends per Share Indicates the percentage of

EPS distributed earnings based on
earnings made per share.
20. Retained Indicates the probability of
Retained Earnings
Earnings to = dividend declaration.
Capital Stock
Capital Stock

21. Market Price Market Price per Indicates whether the stock
=
To Book Value Share is undervalued
Per Share Book Value per Share
or not.

B. Indicators of Liquidity or Short-term Solvency

Significance
Current Assets
1. Current Ratio = Indicates the ability to pay
Current Liabilities
current obligations.

2. Acid Test Ratio = Quick Assets

Indicates the ability to pay
Current Liabilities
current obligations from the
more liquid current assets.

3. Current Assets Current Assets Indicates the liquidity of the

To Total Assets = Total Assets total assets.

4. Ratio of Each Each Current Asset

Indicates the liquidity of the
Current Asset Item = Total Current Assets total current assets and the
To Total Current distribution thereof.
Assets

Indicates the number of times

5. Receivable Net Credit Sales average amount of receivables
=
Turnover Average Receivables is collected during the period
and the collected during the
period and the efficiency of
collection.
6. Number of Days’ 360 Days Indicates the average age of
Sales in Average = Receivable receivables or the number of
Receivables or Turnover days to collect average
Average Collection receivables.
Period

7.a. Merchandise Cost of Goods Indicates the number of times

Inventory Turn- = Sold average inventory was sold
over Finished Average Inventory during the period and
Goods Inventory over/under investment in
Turnover inventory.

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 Cost of Goods Indicates the number of times
7.b. Work in Process Manufactured average inventory was
Turnover =
Average Work in manufactured during the
Process Inventory period and over/under
investment in work in process
inventory.

Indicates the number of times

Raw Materials used average inventory was used
7.c. Raw Materials
= Average Raw and the sufficiency of raw
Turnover
Materials Inventory materials in stock.

360 Days Indicates the number of days

8. Number of Days’
= Inventory required to sell or consume
Supply in Inventory
Turnover average inventory.

Net Credit Indicates the number of times

9. Payable Turnover = Purchases the amount of cash and its
Average equivalent is used during the
Payables period.

Cost of Sales + OPEX

(excluding charges Indicates the number of times
10. Cash and the amount of average
Marketable
= not requiring current
assets) payables is being paid.
Securities Turnover Average Cash and
Marketable Securities

360 Days Indicates the

11. Number of Days’ Cash and Marketable Securities number of days’
operations covered = Turnover operations
by Cash and Or covered by cash
Marketable Securities Average Cash and Marketable and cash
Securities equivalents.
{(COS + OPEX (excluding charges not
requiring cash)/360 days}
C. Indicators of Stability or Long-Term Solvency

Total Liabilities Measures the proportion

1. Debt/Equity Ratio = Total Owners’ of borrowed capital to
Equity invested capital.

Total Owners’ Indicates the margin of

2. Equity/Debt
= Equity safety to creditors.
Ratio
Total Liabilities

Total Owners’
3. Proprietary Ratio Equity Indicates what portion of
or Equity Ratio = total assets is provided
Total Assets
by owners or
stockholders.

4. Debt Ratio Total Liabilities Indicates what portion of

= Total Assets total assets is provided
by creditors.

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 5. Fixed assets Fixed Assets Indicates the portion of
= Total Owners’ owners’ equity invested
to Owners’
Equity Equity in fixed assets.

6. Fixed assets = Fixed Assets Indicates over/under

to Total Assets Total Assets investment in property,
plant and equipment.
.
7. Fixed Assets Fixed Assets Indicates the portion of
to Long-Term =
Total Long-Term long-term debt secured
Liabilities Liabilities by fixed assets.

8. Plant Turnover = Net Sales Indicates the efficiency in

Average Fixed the use of fixed assets.
Assets (net)
9. Book Value Common Stock Equity Indicates the book value
=
per share Number of Common of net assets for every
Shares Outstanding outstanding share of
common stock.

10. Number of Times Income before Indicates the company’s

Interest is Earned = Interest and Taxes ability to pay fixed
Annual Interest interest charges.

11. Number of Net Income Indicates the ability to

=
Times Preferred Preferred meet annual preferred
Dividend Requirement Dividend stock dividend
Is Earned Requirement requirement.

Income before Tax Indicates the ability to

12. Number of
and Fixed Charges meet annual fixed
Times Fixed = (Rent expense charges.
Charges are
+Interest, etc.)
Earned

D. Operating Cycle
 An operating cycle for a manufacturing firm begins from the time raw
materials are acquired, through production, sale of finished goods, until
the time when receivables are collected or converted into cash which
may in turn be used again to acquire raw materials. The length of time
during which an operating cycle is completed may be calculated by
adding the average ages of or the number of days sales in receivables
and the three inventories – raw materials, work in process and finished
goods.
 In the case of merchandising firms, operating cycle is computed by
adding the average ages of receivables and merchandise inventory.

Limitations of Financial Statements Analysis

Financial statement analysis by means of horizontal, vertical and ratio
analysis has several inherent limitations. The analyst and user should bear them
in mind in evaluating the performance and status of a single enterprise or of
several enterprises compared to each other. Some of these limitations are:
1. The results of analytical procedures applied emphasize only certain trends
and changes in individual items and relationships. The reason behind the

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 trend or change is not provided. The analyst should investigate further to
answer the question, “why?”
2. Ratios and percentages are affected by any change in accounting procedures
the company may have adopted in the current period in relation to prior
periods. Erroneous conclusions may be drawn from the results of analysis
unless the user of the information is aware of such changes.
3. Conventional financial statements do not reflect the effects of changing price
levels. Misperceptions can result from the failure to account for the effects of
inflation or deflation.
4. Use of different accounting procedures by two or more companies will result
in ratios and percentages that are not comparable. Adjustments will have to
be made if an intelligent comparison is to be made regarding the
performance and status of two or more companies. Comparability assumes
the use of the same accounting principles and procedures.
5. Information reflected on financial statements is not exact and not final.
Estimates and judgment are applied by the accountant in measuring
operating results and financial position. Thus, the financial report is basically
a mixture of facts and opinions. It follows that analytical data are intrinsically
tentative in character and single measurements should not be given too
much weight and importance.
6. Financial statements, which are the basis of financial analysis are historical
reports. They merely provide a basis for predicting future events. Moreover,
they only include matters that are capable of quantification. Other vital
information such as industry changes, management changes, competitors’
actions, technological developments, government actions and union
activities are not provided by the traditional financial statements.

Interpretation
Financial statement analysis is just one tool or means of interpreting
intelligently financial data. It is a guide so that users of the financial data can
arrive at better decisions whether they are to invest, to lend, to keep the
investment or dispose of it. To arrive at some informed conclusions however,
the statement user must be able to interpret the results of financial analysis.
In other words, there should be a standard against which the result of
analysis could be compared. This standard may be summarized as follows:
1. Personal standards which are based on the analyst’s own experience and
observation;
2. Budgeted standards which come from the company’s goals and plans as
reflected on the budget;
3. Historical standards which refer to the company’s performance in the past;
and,
4. Rule of thumb standards which are general and obtained from other
companies’ financial standards, trade publication and published references.

Multiple-Choice. Answer the following multiple-choice problems by

writing the letter of your choice on the space provided.

1. When a balance sheet amount is related to an income statement amount in

computing a ratio:
A. The income statement amount should be converted to an average for
the year.
B. Comparison with industry ratios is not meaningful.
C. The balance sheet amount should be converted to an average for the
year.

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 D. The ratio loses its historical perspective because a beginning of the
year amount is combined with an end of the year amount.
Answer: _____
2. A major problem in comparing profitability measures among companies is
the
A. Lack of general agreement over which profitability.
B. Differences in the size of the companies.
C. Differences in the accounting methods used by the companies.
D. Differences in the dividend policies of the companies.
Answer: _____
3. In 2018, RRD Corporation’s net income was P800,000 and in 2019, it was
P200,000. What percentage increase in net income must RRD achieve in
2020 to offset the 2019 decline in net income?
A. 60%
B. 600%
C. 400%
D. 300%
Answer: _____
4. The following common size income statement are available for Gaea
Corporation for the two years ended December 2019, and 2018

2019 2018
Sales 100% 100%
Cost of sales 55% 70%
Gross profit on sales 45% 30%
Operating expenses 20% 18%
(including income tax
expense)
Net income 25% 12%
The trend percentages for sales are as follows:
2017 130%
2016 100%
What should be the trend percentage for gross profit on sales for 2019
A. 58.5%
B. 130%
C. 150%
D. 195%
Answer: _____
Please present your solution:

5. An income statement showing only component percentage is known as

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 A. Common pesos statement.
B. Condensed income statement.
C. Common-size income statement.
D. Comparative income statement.
Answer: _____

6. It refers to the practice of financing assets with borrowed capital. Its

extensive use may impact on the return on common stockholders’ equity to
be above or below the rate of return on total assets.
A. Discounting
B. Mortgage
C. Leverage
D. Arbitrage
Answer: _____

7. Securing of funds for investment at a fixed rate of return to fund suppliers to

enhance the well-being of common stockholders is known as:
A. Financial leverage
B. Fund management
C. Prudent borrowing
D. Financial arbitrage
Answer: _____

8. When compared to a debt-to-asset ratio, a debt-to-equity ratio would

A. be lower than the debt-to-asset ratio.
B. be higher than the debt-to-asset ratio.
C. be about the same like the debt-to-asset ratio.
D. have no relationship at all to the debt-to-asset ratio
Answer: _____
Questions 9 and 10 are based on the following data:
FRYVIE Corporation
Selected Financial Data
For the Year Ended December 31, 2019
Operating income P900,000
Interest expense 100,000
Income before income tax 800,000
Income tax expense 320,000
Net income 480,000
Preferred stock dividends 200,000
Net income available to common stockholders 280,000
Common stock dividends 120,000
Increase in retained earnings P160,000
9. The times interest earned ratio is
A. 2.8 to 1
B. 4.8 to 1
C. 8.0 to 1
D. 9.0 to 1
Answer: _____
Please present your solution:

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 10. The times preferred dividend earned ratio is
A. 1.4 to 1
B. 1.7 to 1
C. 2.4 to 1
D. 4.0 to 1
Answer: _____
Please present your solution:

Are you done? Now, you may check your own answers
from the suggested answers below.

1. D 6. B
2. D 7. A
3. B 8. D
4. A 9. C
5. B 10.C

Did you get the correct answers? If there are items where your
answer is incorrect, connect with our group messenger for us to
brainstorm and talk about it!

IT’S YOUR TURN!

Solve the following set of problems for in financial statement analysis.
Read and analyze each problem before coming up with your
computation. Maintain cleanliness in your paper.

Problem 1
Family Savings Mart and Dumalsin Merchandise disclose the following
data on their December 31, 2019 balance sheet (in thousands)
FSM DM
Debt P160,000 P640,000
Stockholders’ equity 640,000 160,000
Total liabilities and stockholders’ equity P800,000 P800,000
Earnings before interest and taxes P600,000 P600,000
Interest expense 15,000 60,000
Required: For each company, compute the following:
a. Debt ratio
b. Debt-equity ratio
c. Equity multiplier
d. Times interest earned
Present your answer in good form.

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Present the continuation of your solution below:

Problem 2
RJ Corporation and RR Company revealed the following information on
their published financial statements:
RJ Corp RR Company
Current assets P375,000 P125,000
Long-term investments 50,000 300,000
Property, plant and equipment 50,000 50,000
Intangible assets 15,000 15,000
Other assets 10,000 10,000
Total assets P500,000 P500,000
Required: For each company, determine the percentage component of each
asset over the total assets. Present your answer in good form.

Problem 3
The financial position of AV Company at the end of 2018 and 2019 is as
follows:

AV Company
Comparative Balance Sheet
As of December 31, 2018 and 2019
(in thousands)
Assets 2018
2019
Cash P3,000 P5,000
Accounts receivable 40,000 25,000
Inventory 27,000 30,000
Long-term investments 15,000 0
Land, buildings and equipment (net) 100,000 75,000
Intangible assets 10,000 10,000

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 Other assets 5,000 20,000
Total assets P200,000 P165,00
0
Liabilities
Current liabilities P30,000 P47,000
Long-term liabilities 88,000 74,000
Total liabilities 118,000 121,000
Stockholders’ Equity
8% Preferred stock 10,000 9,000
Common stock 54,000 42,000
Additional Paid-in capital 5,000 5,000
Retained earnings 13,000 (12,000)
Total stockholders’ equity 82,000 44,000
Total liabilities and stockholders’ equity P200,000 P165,00
0

Sales and cost of goods sold insignificantly change in 2019 in relation with
2018.

Required:
a. Prepare a comparative balance sheet showing peso and percentage
changes for 2019 as compared with 2018.
b. Prepare a common-size balance sheet as of December 31, 2018 and
2019.
The format is already given. Fill-up the Increase (Decrease ) column for your
answer.

a. Comparative balance sheet (horizontal analysis)

AV Company
Comparative Balance Sheet
As of December 31, 2018 and 2019
Increase
(in thousands)
(Decrease)
Assets 2019 2018 Peso
Percentag
e
Cash P3,000 P5,000 _______ _______
Accounts receivable 40,000 25,000 _______ _______
Inventory 27,000 30,000 _______ _______
Long-term investments 15,000 0 _______ _______
Land, buildings and 100,000 75,000 _______ _______
equipment (net)
Intangible assets 10,000 10,000 _______ _______
Other assets 5,000 20,000 _______ _______
Total assets P200,000 P165,00 _______ _______
0
Liabilities
Current liabilities P30,000 P47,000 _______ _______
Long-term liabilities 88,000 74,000 _______ _______
Total liabilities 118,000 121,000 _______ _______

63
 Stockholders’ Equity
8% Preferred stock 10,000 9,000 _______ _______
Common stock 54,000 42,000 _______ _______
Additional Paid-in capital 5,000 5,000 _______ _______
Retained earnings 13,000 (12,000) _______ _______
Total stockholders’ equity 82,000 44,000 _______ _______
Total liabilities and P200,000 P165,00 _______ _______
stockholders’ equity 0

b. Common-size balance sheet (vertical analysis)

AV Company
Comparative Balance Sheet
As of December 31, 2018 and 2019
(in thousands)
Assets 2019 2018
Cash ___________ ___________

Accounts receivable ___________ ___________

Inventory ___________ ___________

Long-term investments ___________ ___________

Land, buildings and equipment (net) ___________ ___________

Intangible assets ___________ ___________

Other assets

Total assets

Liabilities
Current liabilities ___________ ___________

Long-term liabilities ___________

Total liabilities

Stockholders’ Equity

8% Preferred stock ___________ ___________

Common stock ___________ ___________

Additional Paid-in capital ___________ ___________

Retained earnings ___________ ___________

Total stockholders’ equity ___________ ___________

Total liabilities and

stockholders’ equity

64
Problem 4
The following information presents the operating results of Angelika Company
for the year ended December 31, 2019 and 2018:

Angelika Company
Income Statement
As of December 31, 2018 and 2019
(in thousands)
2018
2019
Sales P453,200 P504,000
Sales returns 13,200 24,000
Net sales 440,000 480,000
Cost of goods sold 242,000 360,000
Gross profit 198,000 120,000
Selling and general expenses 118,800 96,000
Operating income 79200 24,000
Other expenses 30,800 33,600
Income (loss) before income tax 48,400 (9,600)
Income tax (refund) 14,520 (2,880)
Net income (loss) P33,880 P(6,720)

Required:
a. Prepare a comparative income statement showing the peso changes and
percentage changes for 2019 as compared with 2018.
b. Prepare a comparative income statement sowing a percentage analysis
of component revenue and expense items of net sales each year.
Note: Present your solution in good form. Follow the format presented on
Problem 3 but use the appropriate income statement format instead.

Present your solution on Requirement (a) below:

Continuation of your solution:

65
 Present your solution on Requirement (b) below:

Problem 5
Jill Corporation’s sales, current assets, and current liabilities have been reported
as follows over the last five years (amounts in thousands):
2019 2018 2017 2016 2015
Sales P10,800 P9,600 P9,200 P8,640 P8,000
Current assets 2,626 2,181 2,220 2,267 2,225
Current liabilities 475 450 350 325 250
Required: Express all the sales, current assets, and current liabilities on trend
index. Round your decimals up to 2 places.
a. Use 2015 as your base year.
b. Use 2019 as your base year.
Solution (a)

Solution (b)

Problem 6

66
 The following data were taken from the records of Vony Company and
Francis Company (in thousands)
Vony Company Francis
Company
Net sales P80,000 P10,000
Net income (loss) 3,000 600
Interest expense 600 300
Average total assets 12,000 2,000
Average total stockholders’ equity 4,000 900
Average common stockholders’ equity 6,000 500
Preferred stock dividends 200 20
Average no. of common shares 600 50
outstanding
Tax rate 40% 40%

The companies are independent business segments of their mother

company, JD Limited.
Required:
a. Determine the following for Vony Company and Francis Company for
purposes of segment evaluation:
1. Return on sales
2. Return on investment
3. Return on net stockholders’ equity
4. Return on common equity
5. Earnings per share

b. Calculate the return on assets assuming Vony Company and Francis

Company are not allied companies and are to be evaluated as completely
independent from each other.
Solution (a)

67
Solution (b)

Problem 6
Consider the following data for the year ended December 31, 2019.
Barako Co. Espresso Co.
Earnings per share P50 P200
Market price per common share 150 500
Dividend per common share 40 120
Dividend per preferred share 10 20
Total stockholders’ equity P10,000,000 P20,000,000
Common stock outstanding 1,000,000 4,000,000
Preferred stock outstanding, noncumulative 500,000 2,000,000
Preferred stock liquidation value P3 per share P2.50 per share

Required:
Calculate the following ratios for Barako Co and Espresso Co:
a. Price-earnings ratio
b. Dividend payout ratio
c. Dividend yield ratio
d. Book value per preferred share
e. Book value per common share
Present your solution in good form:

68
Problem 7
You have been asked by the Chief Financial Officer of Coffee Lover
Corporation to analyze its liquidity position in 2019. You have gathered the
following data from the records of the company and industry published reports
(in thousands):
Coffee Lover Industry Average
Corporation
Average cash P3,500 P2,000
Average trade receivables 8,000 10,000
Average inventory 6,500 7,000
Average trade payables 14,000 12,000
Net cash sales 20,000 25,000
Net credit sales 200,000 150,000
Cost of sales 130,000 112,000
Net credit purchases 140,000 96,000
The company uses a 360-day a year base. The credit terms offered to
customers are 2/10, n/40. Suppliers give credit terms of 3/20, n/40.

Required: For Coffee Lover Corporation and the industry, compute the following:
a. Receivable turnover
b. Collection period
c. Inventory turnover
d. Inventory days (Days to sell inventory)
e. Payable turnover
f. Payment period
g. Operating cycle
h. Net cash cycle
i. Net working capital
j. Working capital turnover
k. Current ratio
l. Acid-test (Quick-assets) ratio

Please present your solution below:

69
Continuation of your answers below:

Problem 8
The following ratios and other data pertain to the financial statements of
the No Forever Company for the year ended December 31, 2019.

Current ratio 1.75 to 1

Acid-test ratio 1.27 to 1
Working capital P33,000
Fixed assets to equity ratio 0.625 to 1
Inventory turnover (based on cost of closing 4X
inventory)
Gross profit percentage 40%
Earnings per share P0.50
Average age of outstanding accounts receivable
(based on calendar year of 365 days) 73 days
Share capital outstanding 20,000 no par
value shares
Earnings for the year as a percentage of share 25%
capital

70
 The company has no prepaid expenses, deferred, intangible assets or
long-term liabilities.
Required:

Required. Reconstruct in as much detail as possible the company’s balance

sheet and income statement for the year ended December 31, 2019, show
supporting computations in good form.

Answer:

71
Please present the continuation of your answer below:

72
Problem 9
Jenny Rod Inc. was founded by Rodie Yad to produce a specialized roller
skate he had designed for doing aerial tricks. Up to this point, Rodie has
financed the company from his own savings and from retained profits. However,
Rodie now faces a cash crisis. In the year just ended, an acute shortage of roller
bearings had developed just as the company was beginning production for the
Christmas season. Rodie had been assured by the suppliers that the roller
bearings would be delivered in time to make Christmas shipments, but the
suppliers had been unable to fully deliver on this promise. As a consequence,
Jenny Rod had large stocks of unfinished skates at the end of the year and had
been unable to fill all of the orders that had come in from retailer for the
Christmas season. Consequently, sales were below expectations for the year,
and Rodie does not have enough cash to pay his creditors.

Well before the accounts payable were to become due, Rodie visited a
local bank and inquired about obtaining a loan. The loan officer at the bank
assured Rodie that there should not be any problem getting a loan to pay off his
accounts payable – providing that on his most recent financial statements the
current ratio was above 2.0, the acid-test ratio was above 1.0, and net
operating income was at least four times the interest on the proposed loan.
Rodie promised to return later with a copy of his financial statements.

Rodie would like to apply for a P80,000 six-month loan bearing an interest
rate of 10% per year.
The unaudited financial reports of the company appear below:

JENNY ROD, INC.

Comparative Balance Sheet
As of December 31, 2018 and 2019
(in thousands)
Assets 2018
2019
Cash P70 P150
Accounts receivable 50 40
Inventory 160 100
Prepaid expenses 10 12
Total current assets 290 302
Plant and equipment 270 180
Total assets P560 P482
Liabilities and Equity
Current liabilities:
Accounts payable P154 P90
Accrued payables 10 10
Total current liabilities 164 100
Long-term liabilities - -
Total liabilities 164 100
Stockholders’ Equity
Ordinary shares and additional paid-in capital 100 100
Retained earnings 296 282
Total stockholders’ equity 396 382
Total liabilities and stockholders’ equity P560 P482

73
 JENNY ROD, INC.
Income Statement
For the period ended December 31, 2019
(in thousands)

Sales (all on account) P420

Cost of goods sold 290
Gross margin 130
Operating expenses:
Selling expenses 42
Administrative expenses 68
Total operating expenses 110
Net operating income 20
Interest expense -
Net income before taxes 20
Less income taxes (30%) 6
Net income P14

Required:
1. Based on the above unaudited financial statements and the statement
made by the loan officer, would the company qualify for the loan? Defend
your answer. Show necessary computations in good form.

2. Last year Rodie purchased and installed new, more efficient equipment to
replace an older plastic injection molding machine. Rodie had originally
planned to sell the old machine but found that it is still needed whenever
the plastic injection molding process is a bottleneck. When Rodie
discussed his cash flow problems with his brother-in-law, he suggested to
Rodie that the old machine be sold or at least reclassified as inventory on
the balance sheet since it could be readily sold. At present, the machine
is carried in the Property and Equipment account and could be sold for its
net book value of P45,000. The bank does not require audited financial
statements. What advice would you give to Rome concerning the
machine? Show necessary computations in good form.

Answer (1)

Answer (2)

74
75
LESSON 3: CASH FLOW ANALYSIS
Learning Objectives:
At the end of the lesson, you should be able to:
1. describe the nature and purpose of the statement of cash flows;
2. determine the content and form of the Statement of Cash Flows; and
3. compute for the net cash flow provided by operating, investing, and
financing activities using the direct method and the indirect method.

LET’S ENGAGE!
Philippine Accounting Standard (PAS) 7 provides information about cash
inflows and outflows during an accounting period as well as the net change in
cash flows from the operating, investing and financing activities in a manner
that reconciles the beginning and ending cash balances.
Undeniably, the statement of financial position and the income statement
are the most common financial documents available to external users.
Managers and those people directly involved in the operation of business who
make financial decisions may find their operations at a loss if they only have
these two documents on which to base their decisions for this day onwards.
With your knowledge on cash flows, compute for the total amount of cash
received from customers, total amount of cash paid to suppliers, cash paid for
operating expenses, and the net amount of cash provided by operating
activities using the information given below.
RJ Company
Income Statement
For the year ended December 31, 2019

Sales P20,700,000
Cost of goods sold
Inventory, January 1 P5,700,000
Purchases 13,200,000
Goods available for sale 18,900,000
Inventory, December 31 4,800,000 14,100,000
Gross income P6,600,000
Additional information:
a. Accounts receivable decreased P1,080,000 during the year.
b. Prepaid expenses increased P510,000 during the year.
c. Accounts payable to suppliers of merchandise decreased P825,000
during the year.
d. Accrued expenses payable decreased P300,000 during the year.
e. Administrative expenses include depreciation expense of
P180,000.
Computation on the total amount of cash received from customers:

Computation on the total amount of cash paid to suppliers:

76
Computation on the total amount of cash paid for operating expenses:

Computation on the net amount of cash provided by operating activities using

the direct method and indirect method:

Compare the net cash provided by operating activities using both methods
(direct and indirect).

The movement of cash is vital for business operation in relation to the first
axiom of financial management, which is “Cash – Not Profit is King.”

LET’S EXPLORE!
Cash flow is the difference between inflows (actual cash received) and
outflows (actual cash paid). When you have more cash coming in than going
out, you have positive cash flow. This is a good thing (The Business Doctor, n.d.)
Cash – Not Profit is King! Indeed, cash is the lifeblood of any business
entity. Many businesses fail due to a lack of cash than a lack of profit. You may
incur losses for the start up, but still you could be in the right track. Business
operations would still be up. However, ones cash run off, nothing to pay for bills,
no cash to pay employee salaries, cash is not enough to pay suppliers, then
business operations might totally stop.
Financial decision makers need to know when the company falls short on
cash to anticipate when the need to borrow cash arises for business continuity.
Tracking and measuring the flow of cash is an indispensable business
management tool that can help spot problems, so that right there and then,
correct them before they become big issues.

77
 Let’s present the solution on the scenario presented on the Let’s Engage
part.

Computation on the total amount of cash received from customers:

Accounts Receivable

Decrease in AR P 1,080,000 P21,780,000 Collection from

Sales 20,700,000
P21,780,00 P21,780,00

Computation on the total amount of cash paid to suppliers:

Accounts Payable
Decrease in AP 825,000 P15,000,000 Purchases ( COGS + dec. in
inventory,end)
Payment to suppliers 14,025,000

P15,000,00 P15,000,00
0 0

Computation on the total amount of cash paid for operating expenses:

Operating Expenses:
Selling expenses P1,350,000
Administrative expenses 2,100,000 P3,450,000
Less: Non-cash expenses
Depreciation 180,000
Add: Increase in Prepaid expenses 510,000
Decrease in Accrued expenses 300,000
payable
Cash payment for operating expenses P4,080,000

Computation on the net amount of cash provided by operating activities:

Direct Method
Cash receipts from customers P21,780,000
Cash payments to suppliers (14,025,000)
Cash payments for operating expenses (14,080,000)
Net cash provided by operating activities P3,675,000

Indirect Method
Net income P3,150,000
Add: Non-cash expenses 180,000
Decrease in accounts receivable 1,080,000
Decrease in inventory 900,000
Deduct:
Increase in prepaid expenses 510,000
Decrease in accounts payable 825,000
Decrease in accrued expenses payable 300,000
Net cash provided by operating activities P3,675,000

Compare the net cash provided by operating activities using both methods
(direct and indirect).

78
 The net cash provided by operating activities using both methods ended
up the same amount. Thus, whatever method to be used in preparing the
Statement of Cash Flows does not matter. The preparer may use either the
direct or indirect method in presenting the Cash Flow Statement. Both methods
are acceptable.

LET’S TALK ABOUT IT!

The statement of cash flows provides information about the company’s
sources and uses of cash. Business activities that increases cash are called cash
inflows (sources of cash) while activities that decreases cash are cash outflows
(uses of cash). Figure 2 presents the sources and uses of cash

SOURCES OF USES OF CASH

CASH
Operating Activities
Operating Activities  Payment of
 Collection of operating expenses
sales Revenue CASH Investing Activities
 Purchase of long-
Investing Activities term assets
 Sale of long-
term assets Financing Activities
 Retirement of long-
Financing Activities term debt
 Issuance of  Treasury stock
long-term debt purchases
or stock  Dividends

Figure 2. Sources and Uses of Cash

The statement provides additional information by classifying cash flows into

three categories: cash flows from operating activities, cash flows from investing
activities, and cash flows from financing activities.

 Operating activities are on-going, day-to-day, revenue-

generating activities of an organization. Typically, operating cash
flows involve increases or decreases in either current assets or
current liabilities. Cash inflows from operating activities come from
the collection of sales revenues. Cash outflows are caused by
payment for operating costs. The difference between the two
produces the net cash inflow (outflow) from operations.
 Investing activities are those activities that involve the
acquisition or sale of long-term assets. Long-term assets may be
productive assets (e.g. acquiring new equipment) or long-term
activities (e.g. acquiring stock in another company.)
 Financing activities are those activities that raise (provide) cash
from (to) creditors and owners. Although interest payments could
be seen as financing outflows, the statement includes these
payments in the operating section.

There are two methods in presenting the Statement of Cash Flows

a. Direct method
b. Indirect method

79
 The direct method shows each major class of gross cash receipts and gross
cash payments.

In the indirect method, profit or loss is adjusted for the effects of non-cash
items and changes in operating assets and liabilities
Figure 3 presents the Statement of Cash Flows under the Direct Method

Name of the Company

Statement of Cash Flows
For the Year Ended December 31, 20x1

Cash flows from operating activities

Cash receipts from customers Pxx
Cash receipts for rent income xx
Cash receipts for interest income xx
Cash paid to suppliers (xx)
Cash paid for insurance (xx)
Cash paid for other expenses (xx)
Cash generated from operations Pxx
Interest paid (xx)
Income taxes paid (xx)
Cash paid for the acquisition of held for trading securities (xx)
Net cash provided (used) from operating activities Pxx

Cash flows from investing activities

Cash receipt form sale of old building Pxx
Cash payment for acquisition of building (xx)
Net cash provided (used) from investing activities Pxx

Cash flows from financing activities

Cash proceeds from issuance of share capital Pxx
Cash payment for short-term loan (xx)
Cash payment for dividends (x)x
Net cash provided (used) from financing activities Pxx

Net increase (decrease) in cash and cash equivalents Pxx

Cash and cash equivalents, beginning xx
Cash and cash equivalents, end Pxx
Figure 3. Statement of Cash Flows – Direct Method

Figure 4 presents the Statement of Cash Flows using Indirect Method

Name of the Company

Statement of Cash Flows
For the Year Ended December 31, 20x1

Cash flows from operating activities

Profit before tax Pxx
Adjustments for: xx
Depreciation expense xx
Impairment loss on goodwill xx
Loss on sale of building xx

80
 Unrealized gain on held for trading securities xx
Interest income xx
Interest expense xx

Increase in accounts receivable (xx)

Increase in rent receivable (xx)
Decrease in inventory xx
Increase in prepaid insurance (xx)
Increase in accounts payable xx
Decrease in unearned rent (xx)
Increase in insurance payable xx
Interest received xx
Cash generated from operations Pxx
Interest paid (xx)
Income taxes paid (xx)
Cash paid for the acquisition of held for trading securities (xx)
Net cash provided (used) from operating activities Pxx

Cash flows from investing activities

Cash receipt form sale of old building Pxx
Cash payment for acquisition of building (xx)
Net cash provided (used) from investing activities xx

Cash flows from financing activities

Cash proceeds from issuance of share capital Pxx
Cash payment for short-term loan (xx)
Cash payment for dividends (xx)
Net cash provided (used) from financing activities (Pxx)

Net increase (decrease) in cash and cash equivalents Pxx

Cash and cash equivalents, beginning xx
Cash and cash equivalents, end Pxx
Figure 4. Statement of Cash Flows – Indirect Method

Note: (1) The “Cash and cash equivalents, end” will be extended in the
Statement of Financial Position as the first line item.

(2) Philippine Accounting Standard (PAS) 7 does not require any

particular method: Direct or Indirect. Both methods are applicable
and acceptable. However, PAS 7 encourages the use of direct
method because it provides information that may be useful in
estimating future cash flows which is not available under the
indirect method. In practice, however, the indirect method is more
commonly used because it is easier to apply.

Food for the Brain ^-^

Operating activities, investing activities, and financing activities provide
cash (cash inflows) and uses of cash (cash outflows). Operating activities are
day-to-day revenue generating activities. Investing activities involve the sale
and acquisition of long-term assets. Financing activities are associated with
cash flows involving creditors and investors.

Identification. Classify each activities presented below as to whether

they are “Sources” or “Uses” of cash.

81
 During the last 2 years of operation, Wuhan Company engaged in the
following activities:
1. Issuing long-term debt
2. Paying cash dividends
3. Reporting unprofitable operations
4. Issuing capital stock
5. Reducing long-term debt
6. Retiring capital stock
7. Selling long-term assets (e.g) plant, equipment, and securities)
8. Reporting profitable operations
9. Purchasing long-term assets
10. Paying interest

Required:
Classify each of these activities as belonging to the operating, investing,
or financing categories and identify them as sources or uses of cash.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Are you done? Now, you may check your own answer from the
suggested answers below.

1. Financing, source of cash

2. Financing, use of cash
3. Financing, use of cash
4. Financing, source of cash
5. Financing, use of cash
6. Financing, use of cash
7. Investing, source of cash
8. Operating, source of cash
9. Investing, use of cash
10.Operating, use of cash

Did you get the correct answers? If there are items where your
answer is incorrect, connect with our group messenger for us to
brainstorm and talk about it.

82
IT’S YOUR TURN!

A. Answer the following problems. Read and analyze the

each item carefully before answering. Present your
solutions in good form on the spaces provided. Maintain
cleanliness in your paper.

Problem 1
A comparative balance sheet and income statement for Rhyezel Company
follow:
Rhyezel Company
Comparative Balance Sheet
As of the Years Ended December 31, 2018 and 2019
(in thousands)
Assets 201 201
9 8
Cash P4 P11
Accounts receivable 310 230
Inventory 160 195
Prepaid expenses 8 6
Plant and equipment 500 420
Accumulated depreciation (85) (70)
Long-term investments 31 38
Total assets P298 P830

Liabilities and Shareholders’ Equity

Accounts payable P300 P225
Accrued liabilities 70 80
Bonds payable 195 170
Deferred income taxes 71 63
Ordinary shares 160 200
Retained earnings 132 92
Total liabilities and shareholders’ equity P298 P830

Rhyezel Company
Income Statement
For the Year Ended December 31, 2019
(in thousands)
Sales P750
Cost of goods sold 450
Gross margin 300
Selling and administrative expenses 223
Net operating income 77
Gain on sale of investments P5
Loss on sale of equipment 2 3
Income before taxes 80
Income taxes 24
Net income P56

83
 During 2019, the company sold some equipment for P18,000 that had cost
P30,000 and on which there was accumulated depreciation of P10,000. In
addition, the company sold long-term investments for P12,000 that had cost
P7,000 when purchased several years ago. Cash dividends totaling P16,000
were paid during 2019.

Required:
1. Using the indirect method, determine the net cash provided by operating
activities for 2019.
2. Using the information in (1) above, along with an analysis of the
remaining balance sheet accounts, prepare a statement of cash flows for
2019.

Please present your answer here:

84
Continuation of your solution below:

B. Identification. Before proceeding, read and analyze each item

carefully. Classify each business transactions as to which activities
(operating, investing, or financing) in the business operation do they
appear. Mark “X” as to the activities and √ as to whether they are
source or use of cash. Present your answers on the table provided
below. Maintain cleanliness in your paper.

Problem 2

Below are certain events that took place at Ray Josh Inc., last year:
1. Short-term investment securities were purchased.
2. Equipment was purchased.
3. Accounts payable increased.
4. Deferred taxes decreased.
5. Long-term bonds were issued.
6. Ordinary shares were sold.
7. Interest was paid to long-term creditors.
8. A long-term mortgage was entirely paid off.
9. A cash dividend was declared and paid.
10.Inventories decreased.
11.Accounts receivable increased
12.Depreciation charges totaled P200,000 for the year.

Required:
Place an (X) mark in the Operating, Investing, or Financing column and a
check mark (√) in the Source or Use column as appropriate.

Activities
Transactions Operating Investing Financing Source Use
1.
2.
3.
4.
5.
6.
7.

85
 8.
9.
10.

C. Multiple-Choice Test. Read and analyze each item carefully before

choosing the letter that corresponds to the best answer. Write the
letter of your choice on the space provided after each item.

Problem 3

1. Which of the following items is included in the adjustment of net income to

obtain cash flow from operating activities?
a. Depreciation expense for the period
b. The change in deferred taxes.
c. The amount by which equity income recognized exceeds cash received.
d. All of the above
Answer: _____

2. Which statement is true for gains and losses from capital asset sales?
a. They do not affect cash and are excluded from the statement of cash
flows.
b. They are included in cash flows from operating activities.
c. They are included in cash flows from investing activities.
d. They are included in cash flows from financing activities.
Answer: _____

3. Which of the following assets is included in the adjustment of net income to

obtain cash flow from operating activities?
a. Accounts receivable
b. Inventory
c. Prepaid expenses
d. All of the above
Answer: _____

4. Which of the following current liability accounts is included in the adjustment

of expenses to obtain cash flow from operating activities?
a. Accounts payable
b. Notes payable and current maturities of long-term debt.
c. Accrued liabilities.
d. Both (a) and (c)
Answer: _____

5. How is it possible for a firm to be profitable and still go bankrupt?

a. Earnings have increased more rapidly than sales.
b. The firm has positive net income but has failed to generate cash from
operations.
c. Net income has been adjusted for inflation.
d. Sales have not improved even though credit policies have been eased.
Answer: _____

6. Why has cash flow from operations become increasingly important as an

analytical tool?

86
 a. Inflation has distorted the meaningfulness of net income.
b. High interest rates can put the cost of borrowing to cover short-term
cash needs out of reach for many firms.
c. Firms may have uncollected accounts receivable and unsalable inventory
on the books.
d. All of the above.
Answer: _____

7. Which of the following statements is false?

a. A negative cash flow can occur in a year in which net income is positive.
b. An increase in accounts receivable represents accounts not yet collected
in cash.
c. An increase in accounts payable represents accounts not yet collected in
cash.
d. To obtain cash flow from operations, the reported net income must be
adjusted.
Answer: _____

8. Which of the following could lead to cash flow problems?

a. Obsolete inventory, accounts receivable of inferior quality, easing of
credit by suppliers.
b. Slow-moving inventory, accounts receivable of inferior quality, tightening
of credit by suppliers..
c. Obsolete inventory, increasing notes payable, easing of credit of
suppliers.
d. Obsolete inventory, improved quality of accounts receivable, easing of
credit by suppliers.
Answer: _____

Items 9-12 are based on the following data:

The following information is available for Bubble Guppy’s Jewelry and Gift Store:
Net income P5,000
Depreciation expense 2,500
Increase in deferred tax liabilities 500
Decrease in cash 3,000
Increase in marketable securities 1,000
Decrease in accounts receivable 2,000
Increase in inventories 9,000
Decrease in accounts payable 5,000
Increase in accrued liabilities 1,000
Increase in property and equipment 14,000
Increase in short-term notes payable 19,000
Decrease in long-term notes payable 4,000
Use the indirect method to answer the questions.

9. What is net cash flow from operating activities?

a. P(3,000)
b. P(1,000)
c. P5,000
d. P13,000
Answer: _____
Please present your solution below:

87
10.What is the net cash flow from investing activities?
a. P14,000
b. P(14,000)
c. P21,000
d. P(16,000)
Answer: _____
Please present your solution below:

11. What is the net cash flow from financing activities?

a. P15,000
b. P(15,000)
c. P17,000
d. P(14,000)
Answer: _____
Please present your solution below:

12. What is the net increase (decrease) in cash?

a. P(3,000)
b. P3,000
c. P2,000
d. P(2,000)
Answer: _____
Please present your solution below:

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REFERENCES

Cabrera, Ma. Elenita B., Cabrera, Gilbert Anthony B (2017). C.M. Recto Avenue,
Manila, Philippines: GIC Enterprises and Co., Inc.

ColdLegacy. (March 2018). Thinking Women PNG. Retrieved from

https://imgbin.com/png/L1ZdfdYT/thinking-woman-png

Hicks, Mark A. (n.d) Thinking Cap Clip Art. Retrieved from

https://www.pinterest.ph/pin/3619768888795291816/

Lady presenting. [image]. (n.d.). Retrieved from Shutterstock.com

Millan, Zeus Vernon G. (2018). Conceptual Framework & Accounting Standards.

Marcos Highway, Baguio City: Bandolin Enterprise.

Mowen, Maryanne M., Hansen Don R, and Dan L. Heitger (2015). Managerial
Accounting Fifth Edition. Pasig City, Philippines: Cengage Learning Asia
Pte Ltd. pp. 675 - 698

The Business Doctor (n.d). Cash – Not – Profit Really is King. Retrieved August
19, 2020 from www.businessdoctornj.com/cash-not-profit-really-is-king/

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