Q25PGB - Horngren'S Financial And Managerial Accounting

Question

Consider the data for Klein Department Stores presented in Problem P15-24A.

Requirements

1. Prepare a common-size income statement and balance sheet for Klein. The first column of each statement should present Klein’s common-size statement, and the second column, the industry averages.

2. For the profitability analysis, compute Klein’s

1. gross profit percentage and
2. profit margin ratio. Compare these figures with the industry averages. Is Klein’s profit performance better or worse than the industry average?

3. For the analysis of financial position, compute Klein’s 

1. current ratio and
2. debt to equity ratio. Compare these ratios with the industry averages.

Assume the current ratio industry average is 1.47, and the debt-to-equity industry average is 1.83. Is Klein’s financial position better or worse than the industry averages?

Step-by-Step Solution

Answer

(1) Common size statements are prepared in Step 1 and 2. 

(2) (a) Gross profit percentage equals 32.6%

(b) Profit margin ratio equals 11.3%. Gross profit percentage and profit margin ratios are lower than the given industry average. Hence, Store performance is worst.

(3) (a) Current ratio equals 1.46,

(b) Debt to equity ratio equals 2.18.

The performance of the K D Stores is worst. Hence, it is high risk position compared to the given industry average rate of debt to equity

 

Step1: Common size income statement

 Common size income statement:

 

Klein Department Stores
Income Statement
Year Ended December 31, 2018
	K D S Inc.	Percentage	Industry Average
Net Sales Revenue	$778000	100%	100.00%
Less: Cost of Goods Sold	524372	67.4	65.80%
Gross Profit	253628	32.6	34.20%
Operating expenses	159490	20.5	19.70%
Operating income	94138	12.1	14.50%
Other expenses	6224	0.8	0.40%
Net income	87914	11.3	14.10%

Step2:Common size Balance sheet

In vertical analysis the base amount (100%) is total assets. The base amount is also equal for total liabilities and stockholder’s equity.

Klein Department Stores
Balance Sheet
Year Ended December 31, 2018
	K D S Inc.	Percentage	Industry Average
Current Assets	$339000	67.8	70.90%
Property plant & equipment net	130000	26	23.6
Intangible Asset, net	7000	1.4	0.8
Other assets	24000	4.8	4.7
Total Assets	500000	100	100.00%
Current Liabilities	232000	46.4	48.10%
Long Term Liabilities	111000	22.2	16.60%
Total Liabilities	343000	68.6	64.70%
Stock holders’ equity	157000	31.4	35.30%
Total liabilities &stockholder’s equity	500000	100.00%	100.00%

Step3:Calculation of gross profit percentage:

 $\begin{array}{rcl}\mathbf{Grossprofit}\mathbf{\%}& \mathbf{=}& \frac{\mathbf{Grossprofit}}{\mathbf{netsalesrevenue}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{253628}}{\mathbf{\$}\mathbf{778000}}\\ \mathbf{ }& \mathbf{=}& \mathbf{32}\mathbf{.}\mathbf{6}\mathbf{\%}\end{array}$

Hence, Gross profit percentage is 32.6%.

Step 4: Profit Margin Ratio Calculation

Calculate profit margin ratio

 $\begin{array}{rcl}\mathbf{Profitmarginratio}& \mathbf{=}& \frac{\mathbf{Netprofit}}{\mathbf{netsalesrevenue}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{87914}}{\mathbf{\$}\mathbf{778000}}\\ & \mathbf{=}& \mathbf{11}\mathbf{.}\mathbf{3}\mathbf{\%}\end{array}$

Step5: Calculation of current assets and Debt to equity Ratio

 $\begin{array}{rcl}\mathbf{Currentratio}& \mathbf{=}& \frac{\mathbf{Currentassets}}{\mathbf{CurrentLiabilities}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{339000}}{\mathbf{\$}\mathbf{232000}}\\ & \mathbf{=}& \mathbf{1}\mathbf{.}\mathbf{46}\end{array}$

Hence Current ratio is 1.46

 $\begin{array}{rcl}\mathbf{Debttoequityratio}& \mathbf{=}& \mathbf{ }\frac{\mathbf{TotalLiabilities}}{\mathbf{TotalEquity}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{343000}}{\mathbf{\$}\mathbf{157000}}\\ & \mathbf{=}& \mathbf{2}\mathbf{.}\mathbf{18}\end{array}$

Hence, debt-equity ratio is 2.18.