Horngren Accounting chapter 13
...The debt-to-equity ratio would probably be higher for the airlines, because most airlines borrow heavily (or incur capital leases) for their aircraft. The current ratio would be lower for the airline because it has no inventory. Inventory turnover is not relevant for an airline because there is no inventory. Service industries differ from retailers and manufacturers in certain characteristics and this is one. 13-11 (continued) Average collection period is generally not an important number for either industry because neither of these industries is likely to have a significant level of receivables. To the extent they exist, they are likely to be bankcard charges with high turnovers for "credit" sales. Return on equity will typically be stable for a grocery store. For an airline it is frequently negative and highly variable from year to year, because earnings are also variable and often negative. 13-12 Three comparisons are: 1) time-series comparisons, 2) comparison with bench marks (or rules of thumb), and 3) cross-sectional comparisons. Some students may also mention comparisons to plan or budget. 13-13 The instruction is not obvious. If the president wished to borrow money, the intention might be to increase the current ratio to appear more attractive to lenders. If the intention was to better utilize assets, the goal might be more rapid inventory turnover and faster account receivable collection which implies a lower current ratio. 13-14 Working capital is current assets less current liabilities. For a growing firm the ratio could decrease while the difference increases. To have an expectation, you would need to know something about the economic environment and management's intention. For a company that is not growing quickly, working capital probably decreased. 13-15 Some ways would be to be more stringent in granting credit, to increase the interest charges on continuing balances, to place overdue bills with collection agencies more quickly, and to write off bad debts more rapidly. The risk in each of these steps is fewer credit sales and less loyal customers. 13-16 Operating management is concerned with the day-to-day activities that generate revenues and expenses. Financial management is concerned with where the company gets cash and how it uses that cash to its benefit. 13-17 The operating income percentage of sales is multiplied by the total asset turnover to compute the pretax operating return on total assets. 13-18 No. Trading on equity means borrowing money at a certain interest rate (or obtaining funds from preferred stockholders at a certain dividend rate) and using the money to earn more than that rate. 13-19 Borrowing is a two-edged sword because, while borrowed money can bring high returns to holders of common stock when applied properly, it can be very costly if the returns from the use of borrowed money do not cover its cost. 13-20 Typically, companies with heavy debt in relation to ownership capital are in greater danger of suffering net losses or even insolvency when business conditions sour. Why? Because revenues and many expenses decline, but interest expense and maturity dates do not change. 13-21 Interest expense is deductible for income tax purposes. In contrast, dividends on preferred stock are not deductible. Therefore, from the common stockholders' point of view, after-tax cost of debt is generally less than the cost of preferred stock financing. 13-22 No. A rule-of-thumb is that income before interest and taxes should be at least five times greater than interest even in the poorest year in a span of seven to ten years. 13-23 The possibility of conversion of preferred stock or bonds into common stock or the issue of common stock at less than market prices, for example, for the exercise of stock options, can potentially cause dilution in earnings per share. 13-24 Special items are large and somewhat unusual items that are reported separately on the income statement. However, they are included in income from continuing operations. In contrast, extraordinary items, which need to be both unusual and infrequent, are reported net-of-tax after income from continuing operations. 13-25 Yes. Because discontinued operations will not continue to affect income in the future, it helps predict future income if they are reported separately. Then analysts can project only the revenues and costs that are expected to continue into the future. 13-26 The primary concerns in...