1) Identify your company’s basic and diluted earnings per share for the recent period. Has the EPS improved or declined from the prior periods? What is driving the difference between the basic and diluted EPS calculations?
2) Identify the different segments of your company. How is this information useful to prospective investors?
3) Compute gross profit percentage for each quarter for the two most recent fiscal years. Is the gross profit percentage in the fourth quarter substantially different from other quarters?
Freida White has $200,000 that she plans to invest in growth stocks. She has narrowed her choices to two companies in the same industry. Brown Inc. and Zepada Inc. Each company has a documented history of growth and an established, strong position within the industry. Last year, each company reported net income of $10 million and a return on owners’ investment of 17%; however, Brown reported EPS of $1.32, and Zepada reported EPS of $2.75.
Freida requests that you explain why the EPS differs when other measures of activity and profitability are similar. What factors contribute to and limit the comparability of these data?
Concepts for Analysis
CA24.2 (LO 1, 2) (Disclosures Required in Various Situations) Ace Inc. produces electronic components for sale to manufacturers of radios, television sets, and digital sound systems. In connection with her examination of Ace’s financial statements for the year ended December 31, 2021, Gloria Rodd, CPA, completed field work 2 weeks ago. Ms. Rodd now is evaluating the significance of the following items prior to preparing her auditor’s report. Except as noted, none of these items have been disclosed in the financial statements or notes.
Item 1: A 10-year loan agreement, which the company entered into 3 years ago, provides that dividend payments may not exceed net income earned after taxes subsequent to the date of the agreement. The balance of retained earnings at the date of the loan agreement was $420,000. From that date through December 31, 2021, net income after taxes has totaled $570,000 and cash dividends have totaled $320,000. On the basis of these data, the staff auditor assigned to this review concluded that there was no retained earnings restriction at December 31, 2021.
Item 2: Recently Ace interrupted its policy of paying cash dividends quarterly to its stockholders. Dividends were paid regularly through 2020, discontinued for all of 2021 to finance purchase of equipment for the company’s new plant, and resumed in the first quarter of 2022. In the annual report, dividend policy is to be discussed in the president’s letter to stockholders.
Item 3: A major electronics firm has introduced a line of products that will compete directly with Ace’s primary line, now being produced in the specially designed new plant. Because of manufacturing innovations, the competitor’s line will be of comparable quality but priced 50% below Ace’s line. The competitor announced its new line during the week following completion of field work. Ms. Rodd read the announcement in the newspaper and discussed the situation by telephone with Ace executives. Ace will meet the lower prices that are high enough to cover variable manufacturing and selling expenses but will permit recovery of only a portion of fixed costs.
Item 4: The company’s new manufacturing plant building, which cost $2,400,000 and has an estimated life of 25 years, is leased from Wichita National Bank at an annual rental of $600,000. The company is obligated to pay property taxes, insurance, and maintenance. At the conclusion of its 10-year noncancelable lease, the company has the option of purchasing the property for $1. In Ace’s income statement, the rental payment is reported on a separate line.
For each of the above items, discuss any additional disclosures in the financial statements and notes that the auditor should recommend to her client. (The cumulative effect of the four items should not be considered.)