Financial Accounting: An Integrated Statements Approach, 2nd Edition

Sage Software Company has provided the following comparative information:

2008 2007 2006 2005 2004

Net income $1,200,000 $ 800,000 $ 600,000 $ 400,000 $ 300,000

Interest expense 200,000 170,000 150,000 120,000 100,000

Income tax expense 360,000 240,000 180,000 120,000 90,000

Total assets (ending balance) 6,000,000 4,500,000 3,500,000 2,600,000 2,000,000

Total stockholders’ equity

(ending balance) 4,000,000 2,800,000 2,000,000 1,400,000 1,000,000

Average total assets 5,250,000 4,000,000 3,050,000 2,300,000 1,800,000

Average stockholders’ equity 3,400,000 2,400,000 1,700,000 1,200,000 900,000

You have been asked to evaluate the historical performance of the company over the last five

years.

Selected industry ratios have remained relatively steady at the following levels for the last

five years:

2004–200 8

Rate earned on total assets 15%

Rate earned on stockholders’ equity 25%

Number of times interest charges earned 3.0

Ratio of liabilities to stockholders’ equity 1.5

Instructions

1. Prepare four line graphs with the ratio on the vertical axis and the years on the horizontal
   axis for the following four ratios (rounded to two decimal places):
   a. Rate earned on total assets
   b. Rate earned on stockholders’ equity
   c. Number of times interest charges earned
   d. Ratio of liabilities to stockholders’ equity
   Display both the company ratio and the industry benchmark on each graph. That is, each
   graph should have two lines.


2. Prepare an analysis of the graphs in (1).

For 2007, Pet Care, Inc., reported its most significant increase in net income in years. At the end

of the year, Jeff Newton, the president, is presented with the condensed comparative income

statement on the following page.

Instructions

1. Prepare a comparative income statement with horizontal analysis for the two-year period,
   using 2006 as the base year. Round to two decimal places.


2. To the extent the data permit, comment on the significant relationships revealed by the hor-
   izontal analysis prepared in (1).

674 Chapter 14 Financial Statement Analysis

Problem 14-5A

Profitability and leverage

trend analysis

Goals2, 3

ALTERNATIVE ACCOUNTING APPLICATION PROBLEMS

Alternate Problem

14-1B

Horizontal analysis for income

statement

Goal 1

1. Net sales, 25% increase