Accounting Principles 7th Canadian Edition Volume 2 Solution

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Accounting Principles 7th Canadian Edition Volume 2 Solution

 

Sample Chapter Below:

 

 

CHAPTER 18

 

 

Financial Statement Analysis

 

 

ASSIGNMENT CLASSIFICATION TABLE

 

Learning Objectives Questions Brief Exercises Exercises Problems Set A Problems Set B
1.    Identify the need for, and tools of, financial analysis.

 

1, 2, 3 1, 2 15 2, 5, 7 2, 5, 7
2.    Explain and apply horizontal analysis.

 

4 3, 4, 5 1, 2, 4 1, 3 1, 3
3.    Explain and apply vertical analysis.

 

5, 6, 7 6, 7 3, 4, 5 2, 3 2, 3
4.    Identify and use ratios to analyze liquidity.

 

8, 9, 10, 11, 17 8, 9, 10, 11, 19, 20, 21, 22 6, 7, 8, 9, 15, 16, 17, 18 4, 5, 6, 7, 8, 9, 10, 11 4, 5, 6, 7, 8, 9, 10, 11
5.    Identify and use ratios to analyze solvency.

 

12, 13, 14, 17 12, 13, 14, 19, 20 10, 11, 15, 16, 17, 18 4, 5, 6, 7, 8, 9, 10, 11 4, 5, 6, 7, 8, 9, 10, 11
6.    Identify and use ratios to analyze profitability.

 

15, 16, 17 15, 16, 17, 18, 19, 20, 21 12, 13, 14, 15, 16, 17, 18, 19 2, 4, 5, 6, 7, 8, 9, 10, 11 2, 4, 5, 6, 7, 8, 9, 10, 11
7.    Recognize the limitations of financial statement analysis.

 

18, 19, 20 22 19 1, 3, 8 1, 3, 8

 

ASSIGNMENT CHARACTERISTICS TABLE

 

Problem Number  

Description

Difficulty Level Time

Allotted (min.)

 

1A Prepare horizontal analysis and identify changes. Moderate 25-35

 

2A Prepare vertical analysis, calculate profitability ratios, and compare.

 

Moderate 45-55

 

3A Interpret horizontal and vertical analysis. Moderate 25-30

 

4A Calculate ratios. Moderate 45-55

 

5A Calculate and evaluate ratios. Moderate 45-55

 

6A Calculate ratios. Moderate 45-55

 

7A Calculate and evaluate ratios. Moderate 50-60

 

8A Calculate and evaluate ratios. Moderate 50-60

 

9A Evaluate ratios. Moderate 25-35

 

10A Evaluate ratios.

 

Simple 20-25
11A Calculate missing information. Complex 25-35

 

1B Prepare horizontal analysis and identify changes. Moderate 25-35

 

2B Prepare vertical analysis, calculate profitability ratios, and compare.

 

Moderate 45-55

 

3B Interpret horizontal and vertical analysis. Moderate 25-30

 

4B Calculate ratios. Moderate 45-55

 

5B Calculate and evaluate ratios. Moderate 45-55

 

6B Calculate ratios. Moderate 45-55

 

7B Calculate and evaluate ratios. Moderate 50-60

 

8B Calculate and evaluate ratios. Moderate 50-60

 

9B Evaluate ratios. Moderate 25-35

 

10B Evaluate ratios. Simple

 

20-25
11B Calculate missing information. Complex 25-35

 

BLOOM’S TAXONOMY TABLE

 

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Material

 

Learning Objectives Knowledge Comprehension Application Analysis Synthesis Evaluation
1.     Identify the need for, and tools of, financial analysis. Q18-1

BE18-1

 

Q18-2

Q18-3

BE18-2

E18-15

P18-2A

P18-2B

P18-5A

P18-7A

P18-5B

P18-7B

2.     Explain and apply horizontal analysis. Q18-4

 

Q18-5

 

BE18-3

BE18-4

BE18-5

E18-1

E18-2

E18-4

P18-1A

P18-3A

 

P18-1B

P18-3B

 

 

3.     Explain and apply vertical analysis. Q18-6

 

Q18-5

Q18-7

BE18-6

BE18-7

E18-3

P18-2A

P18-2B

E18-4

E18-5

 

P18-3A

P18-3B

4.     Identify and use ratios to analyze liquidity. Q18-8

Q18-10

BE18-16

BE18-19

 

Q18-11

Q18-17

BE18-8

BE18-20

BE18-21

E18-14

 

BE18-10

BE18-11

E18-7

E18-17

P18-4A

P18-6A

P18-4B

P18-6B

Q18-9

BE18-22

E18-6

E18-8

E18-9

E18-15

E18-16

E18-18

P18-5A

P18-7A

 

P18-8A

P18-9A

P18-10A

P18-11A

P18-5B

P18-7B

P18-8B

P18-9B

P18-10B

P18-11B

 

5.     Identify and use ratios to analyze solvency. Q18-12

BE18-19

 

Q18-13

Q18-14

Q18-17

BE18-12

BE18-20

E18-14

 

BE18-13

E18-10

E18-17

P18-4A

P18-6A

P18-4B

P18-6B

 

 

BE18-14

E18-11

E18-16

E18-18

P18-5A

P18-7A

P18-8A

P18-9A

 

P18-10A

P18-11A

P18-5B

P18-7B

P18-8B

P18-9B

P18-10B

P18-11B

 

6.     Identify and use ratios to analyze profitability. Q18-15

Q18-16

BE18-19

 

Q18-17

Q18-19

BE18-15

BE18-20

BE18-21

 

BE18-16

BE18-17

E18-12

E18-13

E18-17

P18-2A

P18-4A

P18-6A

P18-4B

P18-6B

 

 

Q18-17

Q18-18

BE18-18

E18-14

E18-16

E18-18

E18-19

P18-3A

P18-5A

P18-7A

P18-8A

P18-9A

P18-10A

P18-11A

P18-3B

P18-5B

P18-7B

P18-8B

P18-9B

P18-10B

P18-11B

 

7.     Recognize the limitations of financial statement analysis.

 

Q18-18

Q18-20

Q18-19

BE18-22

E18-19

P18-1A

P18-3A

P18-8A

P18-1B

P18-3B

P18-8B

 

Broadening Your Perspective BYP18-4 BYP18-5 BYP18-1

BYP18-2

BYP18-3

BYP18-6

ANSWERS TO QUESTIONS

 

  1. Short-term creditors and long-term creditors are interested in short-term liquidity and long-term solvency of a company. They look at the ability of the lender to pay obligations when they become due. On the other hand, the primary focus of shareholders is the company’s profitability to assess the likelihood of dividends and growth potential of the share price.

 

  1. (a) An intracompany basis of comparison compares the same item with prior periods, or with other financial items in the same period, for one company. A store may compare this year’s sales to last year’s sales, for example.

 

(b)   An intercompany basis of comparison compares the same item with one or more other company’s financial statements. A store may compare its current year’s sales with another company’s sales for the same period, for example. The intercompany basis of comparison can provide insight into a company’s competitive position in relation to other companies.

 

  1. The three common tools used in analysis are: horizontal analysis, vertical analysis, and ratio analysis. Horizontal analysis is used mainly in intracompany comparisons. Vertical analysis is used in both intra- and intercompany comparisons. Ratio analysis can be used in both types of comparisons.

 

  1. The percentage change for a base year is the amount for the period in question divided by the base-year amount, and the result is multiplied by 100 to express the answer as a percentage.

 

For the calculation of the percentage change for a period, the previous period amount is subtracted from the current period amount. The result is divided by the amount from the previous period and then multiplied by 100 to express the answer as a percentage.

 

  1. Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or decrease of an item over a period of time. In this approach, the amount of the item on one financial statement is compared with the amount of that same item on one or more earlier financial statements.

 

Vertical analysis (also called common size analysis) expresses each item within a financial statement in terms of a percent of a relevant total or other common basis within the same statement, for the same time period.

 

Horizontal and vertical analysis differ in that horizontal analysis compares data across more than one year, while vertical analysis compares data within the same year. Horizontal and vertical analyses are similar in that they both use percentages to demonstrate numerical relationships.

QUESTIONS (Continued)

 

  1. (a) On a balance sheet, total assets and total liabilities plus shareholders’ equity are both assigned a value of 100%.

 

(b)   On an income statement, the figure for net sales or revenue is assigned a value of 100%.

 

  1. Yes, it can. By converting the accounting numbers to percentages, companies of vastly different sizes can be more readily compared.

 

  1. (a) Liquidity ratios measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash.

(b)   Short-term creditors such as suppliers would be the type of users who would be most interested in liquidity ratios.

 

  1. A high current ratio might be hiding liquidity problems with regards to inventory or accounts receivable. For example, a high level of inventory will cause the current ratio to increase. Increases in inventory can be due to the fact that inventory is not selling and may be obsolete. Increases in the current ratio will also occur if the company’s accounts receivable increase. An increase in accounts receivable could indicate the company is having trouble collecting its overdue accounts, which again would mean liquidity problems for the business.

 

  1. The difference between the current ratio and acid-test ratio is that the current ratio includes inventory, prepayments, and supplies in the assets for the numerator, while the acid-test ratio does not.

 

  1. From the list of liquidity ratios given in the textbook, three ratios provide a calculation where a lower result is considered a better result. The three ratios include the collection period, days sales in inventory, and the operating cycle. The operating cycle adds the number of days for the collection period and the number of days sales in inventory. The fewer the number of days in the cycle, the better off the business can be from the point of view of liquidity.

 

  1. (a) Solvency ratios measure the ability of the company to survive over a long period of time and be able to pay off all of its debt.

(b)   Long-term lenders such as banks, mortgage companies, and leasing companies would be the most interested users of solvency ratios.

 

  1. Wong’s solvency is better than that of its competitor. It is carrying a slightly lower percentage of debt than its competitor (37% versus 39%) and has a higher interest coverage ratio (3 versus 2.5).

 

 

 

QUESTIONS (Continued)

 

  1. One of the solvency ratios, the debt to total assets ratio, generates a percentage which, when the result is low, it is interpreted as a desired result. Since fewer of the business’ assets are financed with debt and instead financed with equity, the business is not burdened to service the debt and meet the deadlines for repayments on large amounts of debt.

 

  1. (a) Profitability ratios measure the profit or operating success of a company for a specific period of time.

(b)   Shareholders and potential investors would be most interested in profitability ratios.

 

  1. Investors have a higher expectation of future earnings from Microsoft than from General Motors. Investors favour Microsoft, which has a higher earnings multiple in its price-earnings ratio.

 

  1. (a) Asset turnover

(b)   Acid-test ratio

(c)   Operating cycle

(d)   Return on equity

(e)   Interest coverage

 

  1. 1. Alternative accounting policies. Differences in accounting policies can make intercompany comparisons difficult and misleading.

 

  1. Other comprehensive income. Other comprehensive income, if significant, should not be ignored in financial analysis yet few, if any, ratios include it.

 

  1. Quality of information. The information used for financial analysis is only good if it is of high quality— relevant, transparent, and easily understood.

 

  1. Economic factors. It is important to understand the impact of the economy on the financial results and to separate, where possible, changes resulting from general economic conditions and those resulting from management influences.

 

  1. McCain Foods has chosen to adopt IFRS, although this adoption was not mandatory. McCain Foods’ management likely wishes to report financial results which have been prepared using the accounting policies that are consistent with its global competitors. Cavendish, on the other hand, might not perceive any additional benefit in adopting IFRS and so it chooses to follows ASPE as do the vast majority of private companies. Certain accounting policies differ under ASPE and IFRS, which may lead to distortions for comparative purposes.

 

QUESTIONS (Continued)

 

  1. Other comprehensive income is the gains and losses that are not included in profit, but still affect shareholders’ equity. Other comprehensive income is added to profit to determine comprehensive income. Most financial analysis ratios exclude other comprehensive income. For example, profitability ratios generally use data from the income statement and not the statement of comprehensive income. In fact, there are no standard ratio formulas incorporating comprehensive income. In cases where other comprehensive income is significant, and depending on the source of the income, some analysts will adjust profitability ratios to incorporate the effect of total comprehensive income.

 

SOLUTIONS TO BRIEF EXERCISES

 

BRIEF EXERCISE 18-1

 

  1. Intracompany (e)
  2. Intercompany (c)
  3. Horizontal analysis (d)
  4. Vertical analysis (b)
  5. Ratio analysis (a)

 

 

BRIEF EXERCISE 18-2

Basis of Tool of
Comparison Analysis
(a) Analysis of a company’s dividend history intracompany horizontal
(b) Comparison of different-sized companies intercompany vertical
(c) Comparison of gross profit to net sales among competitors intercompany vertical
(d) Calculation of a company’s sales growth over time intracompany horizontal

 

BRIEF EXERCISE 18-3

 

  2017   2016   2015   2014
Cash 120%   225%   150%   100%
Accounts receivable 179%   151%   131%   100%
Inventory 154%   148%   122%   100%
Prepaid expenses 100%   0%   45%   100%
Total current assets 157%   146%   122%   100%

 

BRIEF EXERCISE 18-4

 

  2017   2016   2015
Cash (47%)   50%   50%
Accounts receivable 18%   15%   31%
Inventory 4%   22%   22%
Prepaid expenses n/a   (100%)   (55%)
Total current assets 8% 19%   22%

 

 

BRIEF EXERCISE 18-5

 

2017 2016 Change as a %
(a) Net Income $450,000 $500,000        $(50,000) -10%
2018 2017 Change as a %
(b) Net Income $522,000 $450,000 $72,000 16%

 

 

(c)   The change was a decrease in 2017 and an increase in 2018.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BRIEF EXERCISE 18-6

 

2017
Amount Percentage
Current assets $1,530,000 32.8%
Property, plant, and equipment 3,130,000 67.0%
Goodwill        10,000 0.2%
Total assets $4,670,000 100.0%

 

 

2016
Amount Percentage
Current assets $1,175,000 28.9%
Property, plant, and equipment 2,800,000 68.9%
Goodwill 90,000 2.2%
Total assets $4,065,000 100.0%

 

2015
Amount Percentage
Current assets  $1,225,000 30.1%
Property, plant, and equipment 2,850,000 69.9%
Goodwill                  –   0.0%
Total assets  $4,075,000 100.0%

 

 

 

 

 

 

 

 

 

 

 

 

BRIEF EXERCISE 18-7

Income Statement  
Amount   Percent  
Net sales $1,934   100.0%  
Cost of goods sold 1,612   83.4%  
Gross profit 322   16.6%  
Operating expenses 218   11.3%  
Profit before income tax 104   5.4%  
Income tax expense 31   1.6%  
Profit $    73   3.8%  

 

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

 

BRIEF EXERCISE 18-8

 

(a)    Deterioration: A decrease in the receivables turnover would be viewed as deterioration. It is taking longer to collect the accounts receivable.

 

(b)    Improvement: A decrease in the collection period would be viewed as an improvement. It takes fewer days to collect accounts receivable.

 

(c)    Deterioration: The increase in the days sales in inventory would be viewed as deterioration. It is taking the company longer to sell the inventory and consequently there is a greater chance of inventory obsolescence, delays in obtaining cash inflows, and higher carrying costs.

 

(d)    Improvement: An increase in the inventory turnover would be viewed as an improvement. It takes fewer days to sell inventory.

 

(e)    Deterioration: A decrease in the acid-test ratio would be viewed as deterioration because the company has fewer liquid assets to pay off liabilities in the very near future.

 

(f)     Deterioration: An increase in the operating cycle would be viewed as deterioration because it is taking longer for the business to purchase inventory, sell it on account, and collect the cash.

BRIEF EXERCISE 18-9

(a)

1. Current ratio =  $40,918,000     = 2.2  
 $18,644,000    
                 
2. Acid-test ratio = $8,041,000 + $4,947,000 + $6,545,000 = 1.05  
$18,644,000  
                 

(b)    Underwood’s current ratio is a little more than the recommended 2:1. Given the steep decline in the acid-test ratio, it appears a large portion of its liquidity is tied up in inventory. If they have an issue with slow moving inventory, the acid-test ratio indicates they may run into liquidity issues.

 

 

BRIEF EXERCISE 18-10

(a) 

2017

                 
(1) Receivables turnover = $3,960,000 = 7.4 times
[($550,000 + $520,000) ÷ 2]
               
(2) Collection period =        365 ÷ 7.4 = 49.3 days
           

 

2016

                 
(1) Receivables turnover = $3,100,000 = 6.2 times
[($520,000 + $480,000) ÷ 2]
               
(2) Collection period =        365 ÷ 6.2 = 58.9 days
           

 

(b)   The management of accounts receivable has improved substantially by decreasing the collection period by almost ten days.

BRIEF EXERCISE 18-11

 

(a)

                                                             2017                2016

Beginning Inventory                    $940,000        $860,000

Purchases                                     4,340,000       4,661,000

Ending Inventory                       (1,020,000)        (940,000)

Cost of Goods Sold                  $4,260,000     $4,581,000

                                                                         

 

  2017
(1) Inventory turnover = $4,260,000 =   4.3 times
($940,000 + $1,020,000)÷2
                 
(2) Days sales in inventory =            365 ÷ 4.3 =   85 days
             
                 
  2016
(1) Inventory turnover = $4,581,000 =   5.1 times
  ($860,000 + $940,000) ÷ 2
                 
(2) Days sales in inventory =            365 ÷ 5.1 =   72 days
             
                 

 

(b)     The management of inventory is deteriorating as days sales in inventory has increased by almost two weeks.

 

 

 

 

 

 

 

 

BRIEF EXERCISE 18-12

 

(a)    Improvement: The decrease in debt to total assets would be viewed as an improvement because it means that the company has reduced its obligations to creditors and has raised its equity “buffer.”

 

(b)    Deterioration: A decrease in interest coverage would be viewed as deterioration because it means that the company’s ability to meet interest payments as they come due has weakened.

 

(c)    Improvement: An increase in free cash flow would be viewed as an improvement because it means that the company has more flexibility in using cash for capital expenditures.

 

(d)    Improvements: A decrease in debt to total assets combined with an increase in interest coverage would be viewed as improvements because the company has reduced its obligations to creditors, has raised its equity “buffer,” and the company’s ability to meet interest payments as they come due has strengthened.

 

 

BRIEF EXERCISE 18-13

 

($ in thousands)

 

(a) Debt to total assets = $960,358   = 56.5%  
$1,700,838    
               
(b) Interest coverage = $422,561* = 21.2 times
$19,956
  *$422,561 = $295,410 + $19,956 + $107,195  

 

(c)  Free cash flow = $355,872 – $84,244 = $271,628

BRIEF EXERCISE 18-14

 

(a)    The debt to total assets ratio for Culleye Corporation has deteriorated, because there is proportionately more debt compared to total assets than there was in 2016.

 

        Culleye’s interest coverage ratio has improved. The business can pay its interest expense more times in 2017 than it could in 2016.

 

(b)    While interest coverage is important, it is a reflection of a single year’s performance. On the other hand, debt, especially non-current debt carries over from year to year. The improvement in the interest coverage ratio is overshadowed by the deterioration in the debt to total assets ratio. Consequently, the overall solvency of Culleye has deteriorated in 2017.

 

 

BRIEF EXERCISE 18-15

 

(a)    Improvement: An increase in the gross profit margin would be viewed as an improvement because it means that a greater percentage of net sales is going towards profit.

 

(b)    Deterioration: A decrease in asset turnover would be viewed as deterioration because it means the company has become less efficient at using its assets to generate sales.

 

(c)    Improvement: An increase in the return on equity would be viewed as an improvement because it means more profit was generated per dollar of equity investment.

 

(d)    Deterioration: A decrease in earnings per share would be viewed as deterioration because the profit for each share is a smaller amount.

 

(e)    Deterioration: A decrease in profit margin would be viewed as deterioration because there is less profit as a percentage of net sales compared to the previous year.

BRIEF EXERCISE 18-16

 

($ in millions)

(a)

2014

(1)   Gross profit            margin = $42,611 – $32,063

$42,611

= 24.8%

 

(2) Profit       margin = $53   = 0.12%  
   $42,611    
2013                
(1)   Gross profit            margin = $32,371 – $24,701

$32,371

= 23.7%

 

(2) Profit

Margin

= $627   = 1.9%  
       $32,371        

 

(b)     While gross profit improved slightly, the profit margin decreased to close to nil. The 2014 performance indicates that operating costs appeared to have increased.

 

 

BRIEF EXERCISE 18-17

 

           
(a) Asset turnover = $750,000   =  1.4 times
$550,000*  
               
(b) Return on assets = $60,000   = 10.9%
$550,000  
(c) Return on equity = $60,000   = 15.8%
$380,000**  
           

*Average total assets ($600,000 + $500,000) ÷ 2 =$550,000

**Average shareholders’ equity ($450,000 + $310,000) ÷ 2 = $380,000

 

BRIEF EXERCISE 18-18

 

Ignoring all other factors, if an investor wants to purchase shares for growth, Apple would be the better choice of the two as indicated by the higher price-earnings ratio. Although Apple pays out a lower percentage of profits as dividends, it is viewed to have more future earnings potential than Chevron since Apple has a higher price-earnings ratio. If instead, the investor is looking for income, Chevron, an oil company, would be a better choice since it pays close to 40% of its profits as dividends. In addition, Chevron is considered a less risky investment as it has a lower price-earnings ratio.

 

 

BRIEF EXERCISE 18-19

  (a) (b)
Ratio Classification Direction
  Acid-test L Higher
  Asset turnover P Higher
  Collection period L Lower
  Debt to total assets S Lower
  Gross profit margin P Higher
  Interest coverage S Higher
  Inventory turnover L Higher
  Operating cycle L Lower
  Profit margin P Higher
  Return on equity P Higher

 

 

BRIEF EXERCISE 18-20

 

  • Asset turnover
  • Acid-test ratio
  • Operating cycle
  • Return on equity
  • Interest coverage

 

 

BRIEF EXERCISE 18-21

(a)

2017 Average accounts receivable =  $1,090 + $965 = $1,027.50
2
2016 Average accounts receivable =  $965 + $880 =  $922.50
2
2017 Average total assets =  $27,510 + $26,760 = $27,135.00
2
2016 Average total assets =  $26,760 + $23,815 = $25,287.50
2
2017 Average shareholders’ equity =  $12,830 + $12,575 =  $12,702.50
2
2016 Average shareholders’ equity =  $12,575 + $10,930 =  $11,752.50
2

 

(b)    The averages calculated in part (a) could be used in the following ratios:

  1. Receivables turnover
  2. Asset turnover
  3. Return on assets
  4. Return on equity

 

(c)    Averages are used in certain ratio calculations. When a figure from the income statement is compared with a figure from the balance sheet in a ratio, the balance sheet figure is averaged by adding together the beginning and ending balances and dividing them by 2. That is because income statement figures cover a period of time (i.e., a year) and balance sheet figures are at a point in time—in this case, the beginning and the end of the year. Comparisons of end-of-period figures with end-of-period figures, or period figures with period figures, do not require averaging.

BRIEF EXERCISE 18-22

 

(a)

Stirling Corporation
Inventory turnover = $200,000 =   20 times
$10,000
               
Bute Inc.
Inventory turnover = $180,000 =   15 times
$12,000
               

 

(b)    In times of falling prices, FIFO will result in a higher cost of goods sold than if the average cost formula were used. As well, the ending inventory under FIFO will be based on the newest inventory purchased at the lower price. This could result in the inventory turnover ratio being higher simply because of the choice of the FIFO cost formula, all other factors being equal. Without converting the inventory turnover ratio to the same cost formula, or fully understanding the effects of the different cost formulas on this ratio, a true comparison of inventory turnover could be difficult.

 

SOLUTIONS TO EXERCISES

 

 

EXERCISE 18-1

 

DRESSAIRE INC.

Balance Sheet

 

2017   2016   2015
Current assets $120,000   $  80,000   $100,000
Non-current assets 400,000   350,000   300,000
Current liabilities 90,000   70,000   65,000
Non-current liabilities 145,000   125,000   150,000
Common shares 150,000   115,000   100,000
Retained earnings 135,000   120,000   85,000
(a) 2017   2016   2015
Current assets 120%   80%   100%
Non-current assets 133%   117%   100%
Current liabilities 138%   108%   100%
Non-current liabilities 97%   83%   100%
Common shares 150%   115%   100%
Retained earnings 159%   141%   100%
(b) 2017   2016
Current assets 50%   (20%)
Non-current assets 14%   17%
Current liabilities  29%   8%
Non-current liabilities 16%   (17%)
Common shares 30%   15%
Retained earnings 13%   41%

 

 

EXERCISE 18-2

Net sales increased by 10% in 2016 but then fell back within 1% of the level of net sales of 2015. Cost of goods sold had essentially the same trend as net sales over the three-year period. Operating expenses grew by a larger percentage in 2016 than sales but declined in 2017 below the 2015 level. This means that operating expenses were brought under control in 2017, compared to sales, as they should not rise at a faster rate than sales. As a result, profit from operations (sales less cost of goods sold less operating expenses) also increased over the three-year period.

Income tax expense increased faster than sales over the total of the three years. However, many factors can affect income tax that are beyond the control of the company and it is hard to draw any further interpretations from this change. Given that profit from operations has grown, we can conclude that profit likely increased as well, despite the increase in income tax expense, which is a fraction of income before income tax.

 

It may help to make up numbers to better understand the direction of the changes over the three years. One possible set of hypothetical numbers follows. Note that the percentages are taken from the text; the subtotals and 2016 and 2017 numbers are calculated based on the hypothetical numbers from 2015 and the percentages.

 

  2017   2016   2015
Net sales 101% $2,020   110% $2,200   100% $2,000
Cost of goods sold 100%  1,200   111%  1,332   100%  1,200
Gross profit   820     868     800
Operating expenses 99%     495   112%    560   100%    500
Profit from operations and before income tax   325     308     300
Income tax expense 106%       48   105%      47   100%      45
Profit   $  277     $  261     $  255

It would be possible to show that profit could go down, but it would take assumptions like extremely high tax rates and low operating costs to arrive at such a result.

EXERCISE 18-3

 

FLEETWOOD CORPORATION

Income Statement

Year Ended December 31

2017   2016
Amount   Percent   Amount   Percent
Sales $800,000   100.0%   $600,000   100.0%
Cost of goods sold 550,000   68.8%   375,000   62.5%
Gross profit 250,000   31.3%   225,000   37.5%
Operating expenses 175,000   21.9%   125,000   20.8%
Profit before    
   income tax 75,000   9.4%   100,000   16.7%
Income tax expense 18,750   2.3%   25,000   4.2%
Profit $ 56,250   7.0%   $ 75,000   12.5%

 

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

EXERCISE 18-4

 

(a)

BLACKBERRY LIMITED

Balance Sheet

February 28, 2015 and March 1, 2014

(in U.S. millions)

Increase (Decrease)
2015 2014 Amount Percent
Assets
Current assets $4,167 $4,848 $(681) -14.0%
Non-current assets    2,382     2,704     (322) -11.9%
Total assets  $6,549  $7,552 $(1,003) -13.3%
Liabilities and
Shareholders’ Equity
Current liabilities $1,363  $2,268 $ (905) -39.9%
Non-current liabilities 1,755 1,659       96 5.8%
Total liabilities 3,118 3,927     (809) -20.6%
Shareholders’ equity 3,431 3,625   (194) -5.4%
Total liabilities and
shareholders’ equity $6,549 $7,552 $(1,003) -13.3%

 

 

EXERCISE 18-4 (Continued)

 

(b)

BLACKBERRY LIMITED

Balance Sheet

February 28, 2015 and March 1, 2014

(in U.S. millions)

 

2015 2014
Assets Amount Percent Amount Percent
Current assets $4,167 63.6% $4,848 64.2%
Non-current assets    2,382 36.4%     2,704 35.8%
Total assets  $6,549 100.0%  $7,552 100.0%
Liabilities and
Shareholders’ Equity
Current liabilities $1,363 20.8%  $2,268 30.0%
Non-current liabilities 1,755 26.8% 1,659 22.0%
Total liabilities 3,118 47.6% 3,927 52.0%
Shareholders’ equity 3,431 52.4% 3,625 48.0%
Total liabilities and
shareholders’ equity $6,549 100.0% $7,552 100.0%

 

 

(c)    The two most significant changes from 2014 to 2015 include

        the proportion of the business that is financed with debt compared to equity, and the decrease in current liabilities. While debt made up 52% of the financing in 2014, the percentage declined to 47.6% in 2015. The decline in current liabilities makes up most of the total decline in liabilities and shareholders’ equity.

        There were corresponding large decreases in current assets in 2015, but the liquidity of the business remained in a strong position.

 

EXERCISE 18-5

 

If we make the assumption that there are no other factors impacting the income statement than those stated in the data provided, then we can determine the vertical percentage of profit for each year as follows:

 

2017: 100.0% – 59.4% – 19.6% – 4.2% = 16.8%

2016: 100.0% – 60.5% – 20.4% – 3.8% = 15.3%

2015: 100.0% – 60.0% – 20.0% – 4.0% = 16.0%

 

It would appear that profit declined as a percentage of net sales between 2015 and 2016, and increased from 2016 to 2017.

EXERCISE 18-6

(a)

(1) and (2)

2017
Receivables turnover = $6,420,000 =   8.0 times
($850,000 + $750,000) ÷ 2
               
Collection period =            365 ÷ 8.0 =   46 days
           
               
2016
Receivables turnover = $6,240,000 =   8.9 times
($750,000 + $650,000) ÷ 2
               
Collection period =            365 ÷ 8.9 =   41 days

 

(3) and (4)

 

2017
Inventory turnover = $4,540,000 =   4.5 times
($1,020,000 + $980,000)÷2
               
Days sales in inventory =            365 ÷ 4.5 =   81 days
           
               
2016
Inventory turnover = $4,550,000 =   5.0 times
($980,000 + $840,000) ÷ 2
               
Days sales in inventory =            365 ÷ 5.0 =   73 days
           
               

(5)   Operating cycle = Days sales in inventory + Collection period

        2017: 127 days = 81 days + 46 days

        2016: 114 days = 73 days + 41 days

EXERCISE 18-6 (Continued)

 

(b)   Management should be concerned with the fact that inventory is moving more slowly in 2017 than it did in 2016, by an extra 8 (81 – 73) days. As for receivables turnover, it is taking an extra 5 (46 – 41) days to collect accounts. Taken together, the company’s operating cycle has increased (deteriorated) by 13 (127 – 114) days in 2017.

 

        The decrease in the receivables turnover ratio could be caused by taking on bad credit risks or because less attention is being paid to collecting accounts. The decrease in inventory turnover may be because of poor pricing decisions or because the company has obsolete inventory. Or the company may have decided to increase the amount of inventory that is kept on hand. Management needs to review and address each of these.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EXERCISE 18-7

 

($ in millions)

(a)               2017                                                          2016

 

Current ratio                                      

= 1.30:1 ($2,465 ¸ $1,890)                 = 1.59:1 ($1,314 ¸ $825)

 

Acid-test ratio

= 0.81:1                                                = 0.89:1

   [($795 + $55 + $676) ¸ $1,890]      [($91 + $60 + $586) ¸ $825]

 

Receivables turnover

= 13.1 times                                         = 7.3 times

   ($8,258 ¸ [($676 + $586) ÷ 2])        ($3,940 ¸ [($586 + $496) ÷ 2])

 

Collection period

= 28 days (365 ÷ 13.1 times)            = 50 days (365 ÷ 7.3 times)

 

Inventory turnover

= 7.5 times                                           = 4.8 times

   ($5,328 ¸ [($898 + $525) ÷ 2])        ($2,650 ¸ [($525 + $575) ÷ 2])

 

Days sales in inventory

= 49 days (365 ÷ 7.5 times)               = 76 days (365 ÷ 4.8 times)

 

Operating cycle

= 77 days (49 + 28)                             = 126 days (76 + 50)

 

 

(b)

  1. Current ratio Worse                
  2. Acid-test ratio Worse
  3. Receivables turnover Better
  4. Collection period Better
  5. Inventory turnover Better
  6. Days sales in inventory Better
  7. Operating cycle Better

EXERCISE 18-8

 

(a)    The company’s collection of its accounts receivable has deteriorated over the past three years. It is taking the company longer to collect its outstanding receivables as evidenced by the decrease in the receivables turnover.

 

(b)    The company is selling its inventory more slowly since the inventory turnover is declining.

 

(c)    Overall, the company’s liquidity has deteriorated. The increase in the current ratio is most likely caused by the increase in inventory and receivables due to the slowdown in the movement of these assets. The acid-test ratio is also likely inflated because of the slow moving receivables. In total, the increase in the operating cycle indicates deteriorating liquidity.

EXERCISE 18-9

 

From an overall perspective, Hakim’s liquidity is deteriorating. Although the current and acid-test ratios are improving in the current year over the previous year, the drop in both the receivable and inventory turnovers is more worrisome. Slow moving inventory and slow collections will ultimately hurt the business’ ability to meet its current obligations in the future.

EXERCISE 18-10

(a)

 

2017
Debt to total assets = $2,177 = 56.0%
$3,886
Free cash flow = $925 $475 =     $450
Interest coverage = ($406 + $27 + $174) =      22.5 times
$27
2016
Debt to total assets = $1,959 = 52.8%
$3,708
Free cash flow =        $580  –       $300 =      $280
Interest coverage = ($375 + $17 + $152) =      32.0 times
$17

 

(b)    Debt to total assets              Worse

        Free cash flow                      Better

        Interest coverage                 Worse

EXERCISE 18-11

 

(a)     The debt to total assets has gradually improved over the past three years.

 

(b)     The interest coverage has deteriorated over the past three years.

 

(c)     The company’s solvency initially appears to be improving as evidenced by its decreased reliance on debt. However, its interest coverage ratio is dropping significantly in spite of the reduced reliance on debt. This is likely caused by decreasing profits. Overall, its solvency appears to be relatively stable given the differing directions of the company’s debt to total assets and interest coverage ratios.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EXERCISE 18-12

 

 ($ in thousands)

 

    2017
(a) Gross profit margin        
  $750 – $480 = 36.0%
  $750
       
     
(b) Profit margin   $60 = 8.0%
    $750
           
     
(c) Asset $750 = 1.4 times
turnover ($600 + $500)
  2
           
           
(d) Return on assets $60 = 10.9%
  ($600 + $500)
    2    
           
(e) Return on shareholders’ equity $60 = 15.8%
  ($450 + $310)
    2    

EXERCISE 18-13

 

(a) ($ in thousands)

 

  2017 2016
Gross profit margin                
  $500 – $375 = 25.0%   $400 – $290 = 27.5%
  $500   $400
               
       
Profit margin   $33.5 = 6.7%   $30.0 = 7.5%
  $500   $400
                 
       
Asset $500 = 1.6 times $400 = 1.5 times
turnover ($350 + $275) ($275 + $274.467)
  2 2
                 
                 
Return on assets $33.5 = 10.7% $30.0 = 10.9%
($275 + $350) ($275 + $274.467)
  2     2    
                 
Return on equity $33.5 = 28.7% $30.0 = 40.0%
($133.5 + $100) ($100 + $50)
  2     2    

 

                                                       

(b)    Gross profit margin             Worse

Profit margin                        Worse

Asset turnover                     Better

Return on assets                 Worse

Return on equity                  Worse

EXERCISE 18-14

 

(a)     Potash Corporation of Saskatchewan Inc. (Potash) is far more profitable than Agrium Inc. (Agrium). Its profit margin of 21.6% is significantly higher than that of Agrium’s, at 4.5%. On the other hand, Potash’s return on equity is lower at 8.3% compared to that of Agrium at 10.7%. This inconsistency is likely due to varying capital structures of the two fertilizer companies. Note that earnings per share are not comparable between companies because of differing capital structures.

 

(b)     Investors favour Potash, but not by a large margin. Potash has a higher price-earnings ratio of 22.4 times earnings compared to Agrium’s 20.0 times. Potash’s higher profitability picture in the current period leads investors to believe it has a better opportunity for future profitability than Agrium.

 

(c)     Investors would purchase shares in Potash for dividend income. The payout ratio is higher with Potash.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EXERCISE 18-15

 

                                                                   (a)                       (b)

 

 

Ratio

 

 

Classification

Long compared to Circular
Acid-test ratio L B
Asset turnover P B
Current ratio L W
Debt to total assets S B
Gross profit margin P B
Interest coverage S B
Inventory turnover L B
Operating cycle L B
Profit margin P B
Receivables turnover L B
Return on assets P B
Return on equity P W

 

(c)     The comparison that was done in part (b) was an intercompany comparison.

 

EXERCISE 18-16

 

($ in thousands except for share price)

 

(a) (b)            
1. Asset turnover P = $1,234,716 = .77 times
($1,609,416 + $1,591,378) ÷ 2
                 
2. Current ratio L = $151,909     = 0.45
$335,930    
                 
3. Debt to total assets S = $877,567   = 54.5%
$1,609,416  
                 
4. Earnings per share P = $76,271   =  $1.21
62,973  
                 
5. Free cash flow S =  $180,258  $106,712 = $73,546
             
                 
6. Interest coverage S = $76,271 + $21,948 + $21,144 = 5.4 times
$21,948
                 
7. Price- earnings ratio P = $44.83     = 37 times
 $1.21    
                 
8. Profit       margin P = $76,271   = 6.2%
 $1,234,716  
                 
9. Return on assets P = $76,271 = 4.8%
($1,609,416 + $1,591,378) ÷ 2
10. Return on equity P = $76,271 = 10.3%
($731,849 + $748,272) ÷ 2

 EXERCISE 18-17

 
(a) Current ratio =  $35,500*     = 3.4  
 $10,370    
  *$ 5,300 + $21,200 + $9,000 = $35,500      
                 
(b) Acid-test ratio = $ 5,300 + $21,200 = 2.6  
$10,370  
                 
(c) Receivables turnover = $120,000 = 5.4 Times
($21,200 + $23,400) ÷ 2
               
(d) Collection period = 365 ÷ 5.4 = 68 Days
           
               
(e) Inventory turnover = $70,000 = 8.8 Times
($9,000 + $7,000) ÷ 2
               
(f) Days sales in inventory = 365 ÷ 8.8 = 41 Days
           
                 
(g) Profit       margin = $14,000   = 11.7%
$120,000  
               
(h) Asset turnover = $120,000 = 1.0 times
($110,500 + $120,100) ÷ 2
               
(i) Return on assets = $14,000 = 12.1%
($110,500 + $120,100) ÷ 2
(j) Return on equity = $14,000 = 14.8%
($100,130* + $89,000**) ÷ 2
           
(k) Debt to total assets = $10,370   = 9.4%
$110,500  

      *($75,000 + $25,130) = $100,130   **($69,000 + $20,000) = $89,000

EXERCISE 18-18

 

(a)     Receivables turnover is calculated as net sales ÷ average accounts receivable. Net credit sales of $1,950,000 ÷ 13 = accounts receivable of $150,000.

 

(b)     Inventory turnover is calculated as cost of goods sold ÷ average inventory. So cost of goods sold of $1,267,500 ÷ 6.5 = $195,000. Or total current assets of $365,000 – cash of $20,000 – accounts receivable of $150,000 = inventory of $195,000.

 

(c)     Current assets of $365,000 + non-current assets of $435,000 = total assets of $800,000.

 

(d)     Current ratio is current assets ÷ current liabilities = 2:1. So current assets of $365,000 ÷ 2 = current liabilities $182,500.

 

(f)      Debt to total assets ratio = 70% so total assets of $800,000 × 70% = $560,000.

 

(e)     Non-current liabilities = total liabilities of $560,000 less current liabilities of $182,500 = $377,500.

 

(h)     Total liabilities and shareholders’ equity = total assets of $800,000.

 

(g)     Shareholders’ equity = Total liabilities and shareholders’ equity of $800,000 – total liabilities (f) above of $560,000 = $240,000.

EXERCISE 18-18 (Continued)

 

Summary of results:

MAIN RIVER CORP.

Balance Sheet

December 31, 2017

 

Assets

 
Current assets  
   Cash $  20,000
   Accounts receivable 150,000
   Inventory  195,000
      Total current assets 365,000
Non-current assets  435,000
      Total assets $800,000
   
Liabilities and Shareholders’ Equity  
Current liabilities $182,500
Non-current liabilities  377,500
   Total liabilities 560,000
Shareholders’ equity   240,000
   Total liabilities and shareholders’ equity $800,000

 

 

EXERCISE 18-19

 

Most financial analysis ratios exclude other comprehensive income. There are no standard ratio formulas incorporating comprehensive income. Nevertheless, other comprehensive income (loss) should not be ignored in assessing the profitability performance of a company.

 

If we analyze the change in the profit, we can see that over the three-year period it has declined, although it has seen a small increase in 2017. If, however, we analyze the change in the total comprehensive income, we see a significant increase in 2016, compared to a significant decrease in profit in 2015. Total comprehensive income declined significantly in 2017 while profit increased slightly.

 

By its nature, other comprehensive income is often volatile. Consequently, further analysis as to the sources of comprehensive income and reasons for the changes between years would be worthwhile.

 

 


 

SOLUTIONS TO PROBLEMS

 

PROBLEM 18-1A

 

(a)

WESTJET AIRLINES LTD.

Income Statement

Horizontal Analysis

Year Ended December 31

  2014 2013   2012   2011
Revenue 129%   119%   112%   100%
Operating expenses 124%   116%   108%   100%
Profit from operations 185%   155%   146%   100%
Other expenses 173%   55%   71%   100%
Profit before income taxes 188%   179%   163%   100%
Income tax expense 180%   175%   166%   100%
Profit 191%   181%   162%   100%

 

WESTJET AIRLINES LTD.

Balance Sheet

Horizontal Analysis

December 31

  2014 2013   2012   2011
Assets              
Current assets 121%   107%   115%   100%
Non-current assets 142%   128%   103%   100%
     Total assets 134%   119%   108%   100%
Liabilities & Shareholders’ Equity          
Current liabilities 142%   149%   126%   100%
Non-current liabilities 132%   99%   94%   100%
     Total liabilities 136%   121%   108%   100%
Shareholders’ equity 130%   116%   107%   100%
     Total liabilities and              
     shareholders’ equity 134% 119% 108% 100%

PROBLEM 18-1A (Continued)

 

(b)   In a horizontal analysis of the income statement over the past four years, WestJet’s 29% increase in revenue has translated into an even greater percentage increase in profit. Although the 73% increase in other expenses is large, the increase is modest considering the absolute amounts involved each year.

 

        In a horizontal analysis of the balance sheet, current assets have increased 21%, but were outpaced by the 42% increase in current liabilities over the same period. There would have been large distributions of dividends in the period because the percentage increase in profit is far greater than the percentage increase in shareholders’ equity (the absolute numbers for shareholders’ equity far exceed the profit of course).

 

(c)   Similar to a horizontal analysis of the base-year amount, a horizontal analysis of the percentage change for each year is limited to condensed information available on the financial statements. While these percentages can show a number of meaningful facts and indicators, the detailed composition of each category and the interrelationship between these various percentages would also be of importance. Trend analysis is the most useful.

 

 

Taking It Further:

 

The horizontal analysis for fiscal years prior to those provided in part (a) above would be interpreted with additional information and disclosure. This additional information would have been provided in the notes to the financial statements concerning the impact the implementation of IFRS had on financial statement elements. Without this in hand, the user of the analysis risked drawing conclusions from information that had not been prepared using consistent accounting practices and standards, which could in turn lead to faulty conclusions.

 


PROBLEM 18-2A

 

(a)                                  CHEN INC. AND CHUAN LTD.

Income Statements

Year Ended December 31, 2017

 

Chen   Chuan
Amount   Percent   Amount   Percent
Net sales $1,849,035   100.0%   $539,038   100.0%
Cost of goods sold 1,060,490   57.4%   338,006   62.7%
Gross profit 788,545   42.6%   201,032   37.3%
Operating expenses 502,275   27.2%   89,000   16.5%
Profit from   operations 286,270   15.5%   112,032   20.8%
Interest expense 6,800   0.4%   1,252   0.2%
Profit before    
   income tax 279,470   15.1%   110,780   20.6%
Income tax expense 83,841   4.5%   27,695   5.1%
Profit $  195,629   10.6%   $  83,085   15.4%

 

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

 

 

(b)   Gross Profit Margin: Gross profit ÷ Net sales

 

Chen                                            Chuan

= $788,545 ÷ $1,849,035           = $201,032 ÷ $539,038

= 42.6%                                        = 37.3%

 

      Profit Margin: Profit ÷ Net sales

 

Chen                                            Chuan

= $195,629 ÷ $1,849,035           = $83,085 ÷ $539,038

= 10.6%                                        = 15.4%

PROBLEM 18-2A (Continued)

 

(b) (Continued)

 

Asset Turnover: Net sales ÷ Average total assets

 

        Chen                                            Chuan

        Asset turnover                           Asset turnover

        = $1,849,035 ÷ $894,750           = $539,038 ÷ $251,313

        = 2.1 times                                  = 2.1 times

 

        Return on Assets: Profit ÷ Average total assets

 

Chen                                            Chuan

= $195,629 ÷ $894,750              = $83,085 ÷ $251,313

= 21.9%                                        = 33.1%

 

        Return on Equity:

        Profit ÷ Average shareholders’ equity

 

Chen                                            Chuan

Return on Equity                       Return on Equity

= $195,629 ÷ $724,430              = $83,085 ÷ $186,238

= 27.0%                                        = 44.6%

 

(c)    Chuan is the more profitable company. Although Chen has a higher gross profit margin, Chuan has a better profit margin, which means it can generate more profit per dollar of sales. Chuan’s assets are returning more even though the asset turnover is the same as Chen’s. Finally Chuan’s investors are enjoying a much better return on their investment.

 

(d)    The analysis in (c) is an intercompany comparison, which involves comparing ratios for different companies.

 

PROBLEM 18-2A (Continued)

 

 

Taking It Further:

 

Ratio analysis helps us compare companies of differing sizes. However, we should be able to see Chen enjoying some economies of scale being the larger business of the two. This does not appear to be the case. The operating expenses as a percentage of sales are much higher in the case of Chen. On the other hand, being a larger company helps it obtain lower prices for the goods that are sold, as is demonstrated by its gross profit margin percentage.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PROBLEM 18-3A

 

(a)     The horizontal and vertical analysis statements demonstrate that the company’s control over its cost of goods sold was relatively steady in 2015 and 2016. However, cost of goods sold increased significantly as a percentage of net sales in 2017, and is increasing faster than net sales. Operating expenses also increased, and at a faster pace than that exhibited by cost of goods sold. The trend of increasing costs faster than increasing sales is worrisome.

 

(b)     Interest expense has reduced substantially over the four-year period. This reduction is likely due to the reduction in interest rates charged and the amount of the debt on the balance sheet.

 

Although the horizontal analysis draws attention to a major increase in the other revenues, that attention is later diminished when inspecting the vertical analysis income statement. That statement reveals that in absolute terms, the amount of other revenue involved is very small and so a major increase of 140% over the four-year period turns out to have a modest effect on the profit.

 

(c)     Horizontal and vertical analysis of the balance sheet, as well as the financial statements themselves, would also be useful in assessing the company’s performance and financial position. In addition, ratio analysis would help complete the picture. Finally, understanding any external economic or other factors that may be affecting costs would also be useful.

PROBLEM 18-3A (Continued)

 

 

Taking It Further:

 

(a)   Percentage of base-period amount: The amount for the period in question is divided by the base-year amount, and the result is multiplied by 100 to express the answer as a percentage. If an item has no value in a base year and a value in the next year, no percentage change can be calculated.

 

(b)   Percentage change for a period: The amount from the previous period is subtracted from the current period amount. The result is divided by the amount from the previous period and then multiplied by 100 to express the answer as a percentage. If a negative amount appears in the base and there is a positive amount the following year, or vice versa, no percentage change can be calculated.


PROBLEM 18-4A

(a)

2017 2016 *
                     
1. Gross profit margin = $886,750   = 43.1%   $807,000   = 44.4%  D
 $2,055,750     $1,818,500    
         
2. Profit       margin = $251,475   = 12.2%   $203,000   = 11.2%  I
 $2,055,750     $1,818,500      
           
3. Earnings per share = $251,475 =  $ 4.41   $203,000 =  $  3.69 I
  57,000 55,000
           
4. Receivables turnover = $2,055,750 = 14.2 times $1,818,500 =  17.3 times D
  $181,600 + $107,800 $107,800 + $102,800
  2   2  
  Collection period =        
5. 365 ÷ 14.2 = 25.7 days 365 ÷ 17.3 = 21.1 days D
         
6. Inventory turnover = $1,169,000 =             6.7 times $1,011,500 =  8.1 times D
  $216,800 + $133,000 $133,000 + $115,500
  2   2  

 

 

 

PROBLEM 18-4A (Continued)

 

    2017     2016   *
Days sales in inventory =
7. 365 ÷ 6.7 = 54.5 days 365 ÷ 8.1 = 45.1 days D
 
8. Return on shareholders’ equity = $251,475 = 42.4% $203,000 = 39.3% I
  $618,175 + $566,700 $566,700 + $465,400
  2 2
           
9. Return on assets = $251,475 = 23.9% $203,000 = 22.3% I
  $1,136,350 + $970,200 $970,200 + $852,800
  2   2  
         
10. Current ratio =  $ 485,650 = 1.48  $     369,900 = 1.77 D
 $ 328,175  $     208,500
       
11. Acid-test ratio = $485,650 – $216,800 = 0.82   $369,900 – $133,000 = 1.14 D
$328,175   $208,500
         
12. Asset turnover = $2,055,750 = 1.95 times $1,818,500 =  2.00 times D
$1,136,350 + $970,200 $970,200 + $852,800
  2   2  
         
13. Debt to total assets =         $518,175 = 45.6% $403,500 = 41.6% D
     $1,136,350 $970,200

* (b) D denotes deterioration, while I denotes improvement


PROBLEM 18-4A (Continued)

 

 

Taking It Further:

 

As calculated in ratio no. 5, the collection period for Pristine Interiors is 25.7 days in 2017.  Ratio No. 7. shows the business has days sales in inventory of 54.5 days in 2017. Combined (25.7 + 54.5) is 80.2 days for the operating cycle. This result is worse than the 75-day operating cycle of the nearest competitor. On the surface, this ratio would indicate that Pristine has a liquidity problem. An investigation into such policies as the terms provided to customers may explain the worse performance.


PROBLEM 18-5A

(a)

2017 2016
             
1. Profit       margin = $45,000 = 6.4% $30,000 = 4.6%
$700,000 $650,000
       
2. Asset turnover = $700,000 =     1.13 times $650,000 =  1.15 times
$640,000 + $600,000 $600,000 + $533,000
2   2  
       
3. Earnings per share = $45,000 =   $1.41 $30,000 = $0.97
32,000 31,000
     
4. Price- earnings ratio = $8.00 = 5.67 times $5.00 =  5.15 times
$1.41 $0.97
       
5. Payout ratio = *$25,000 ÷ $45,000 = 55.6% **$18,000 ÷ $30,000 = 60.0%
       
6. Debt to total assets = $155,000 = 24.2% $165,000 = 27.5%
$640,000 $600,000
       
7. Gross profit margin = $280,000 = 40.0% $250,000 = 38.5%
$700,000 $ 650,000
                       

 

PROBLEM 18-5A (Continued)

 

(a)   (Continued)

 

The amount of dividends paid were calculated from the statement of income and the retained earnings balances on the balance sheet:

 

Retained Earnings Dec. 31, 2016                        $125,000

Add Net income for 2017                                           45,000

170,000

Less Retained Earnings Dec. 31, 2017                145,000

Dividends declared and paid in 2017                  *$25,000

Retained Earnings Dec. 31, 2015                        $113,000

Add Net income for 2016                                           30,000

143,000

Less Retained Earnings Dec. 31, 2016                125,000

Dividends declared and paid in 2016                **$18,000

 

(b)     Based on the results of the comparative ratio analysis for Landwehr Corporation, we can see that profitability has improved based on the gross profit margin, the profit margin, and the earnings per share ratios.  By the end of 2017 the financial position of the company has improved in that there is less debt compared to total assets. In spite of the fact that the dividend payout has reduced slightly as a percentage of net income, shareholders have bid up the market price of the shares, making the price-earnings ratio increase. The price-earnings ratio remains modest.

 

 

Taking It Further:

 

Julie is correct. Profitability is only one area of concern when managing the success and well-being of a business. Liquidity
and solvency issues are also important. By using the three common tools of financial analysis: horizontal analysis, vertical analysis, and ratio analysis, Roberto Landwehr will get a better understanding of the business’ performance and will be able
to detect areas that need his further attention.

 

PROBLEM 18-6A

 

 

Liquidity Ratios

             
1. Current ratio =  $318,900     = 1.5  
 $208,500    
                 
2. Acid-test ratio = $68,100 + $107,800 = 0.8  
$208,500  
                 
3. Receivables turnover = $1,948,500 = 17.6 times
($113,200* + $107,900**)÷2
  * $113,200 = $107,800 + $5,400      
  ** $107,900 = $102,800 + $5,100      
             
4. Collection period = 365 ÷ 17.6 = 21 days
             
5. Inventory turnover = $1,025,500 = 7.9 times
($143,000 + $115,500) ÷ 2
               
6. Days sales in inventory = 365 ÷ 7.9 = 46 days
           
               
7. Operating cycle   46 days + 21 days = 67 days

 

PROBLEM 18-6A (Continued)

 

Solvency Ratios            
8. Debt to total assets = $312,500   = 31.3%  
$998,200    
               
9. Interest coverage = $407,000* =  14.5 times
$28,000
  * $407,000 = $265,300 + $113,700 + $28,000      
                 
10. Free cash    flow =  $ 316,200  $161,300 =  $154,900
             

 

 

Profitability Ratios            
11. Gross profit margin = $923,000   = 47.4%  
$1,948,500    
               
12. Profit       margin = $265,300   = 13.6%  
 $1,948,500    
               
13. Asset turnover = $1,948,500 =  2.1 times
($998,200 + $852,800) ÷ 2
             
14. Return on   $265,300      
  assets = ($998,200 + $852,800) ÷ 2 = 28.7%  

 

PROBLEM 18-6A (Continued)

 

Profitability Ratios (Continued)

 

15. Return on

shareholders’ equity

= $265,300 = 46.1%
($685,700 + $465,400) ÷ 2
           
16. Earnings per share = $265,300 = $4.57
[60,000 − (4,000 ÷ 2)]
                 
17. Payout ratio =  $5,000 ÷ $265,300 = 1.9%  

 

 

Taking It Further:

 

The Cable Company’s liquidity appears to be strong mainly because of the high receivables and inventory turnover ratios. Its operating cycle of 67 days is likely reasonable, depending on what the norm is among its competitors.

 

With respect to solvency, since a significant percentage of its assets are financed with equity, the debt to total assets and interest coverage ratios are strong.

 

Finally, profitability also appears to be very good mainly because of the high gross profit margin and return on equity ratios. Industry averages would be useful to confirm this assessment, as would comparative ratios for The Cable Company for prior years.

 

 

 

PROBLEM 18-7A

 

(a) and (b)                                                                                                                                  (b)

Liquidity Ratios 2017 2016 Chan-ge
                         
1. Current ratio =  $364,000*     = 1.9 $343,000**     =  1.9 NC
 $187,000      $182,000    
                             
2. Acid-test ratio = $209,000* = 1.1   $195,000* =  1.1 NC
$187,000   $182,000
      * $209,000 = $95,000 + $114,000 

 

*$195,000 =  $85,000 + $110,000

 

3. Receivables turnover = $675,000*** = 5.8 times $630,000*** = 5.6 times F
($118,000* + $115,000**)÷2 ($115,000* + $111,000**)÷2
    *$118,000 = $114,000 + $4,000   *115,000 = $110,000 + $5,000
    **$115,000 = $110,000 + $5,000   **$111,000 = $108,000 + $3,000
                           
4. Collection period = 365 ÷ 5.8 = 63 days 365 ÷ 5.6 = 65 days F
                       

 

*$754,000 – $390,000

**$648,000 – $305,000

***Net Credit Sales 2017= $900,000 x .75 = $675,000

***Net Credit Sales 2016= $840,000 x .75= $630,000

PROBLEM 18-7A (Continued)

 

(a) and (b) (Continued)

                                                                                                                                                 (b)

Liquidity Ratios (Continued) 2017 2016 Chan-ge
5. Inventory turnover = $625,000 = 4.9 times $575,000 = 5.2 times U
($130,000 + $125,000) ÷ 2 ($125,000 + $97,000) ÷ 2
                           
6. Days sales in inventory = 365 ÷ 4.9 = 74 days 365 ÷ 5.2 = 70 days U

 

                           
7. Operating cycle = 74 days + 63 days = 137 days 70 days + 65 days = 135 days U

 

PROBLEM 18-7A (Continued)

 

(a) and (b) (Continued)

                                                                                                                                                 (b)

  2017 2016 Chan-ge
Solvency Ratios                        
8. Debt to total assets = $377,000   = 50.0% $332,000   = 51.2% F
$754,000   $648,000  
                           
9. Interest coverage = $111,000* = 3.2 times $105,000* = 5.3 times U
$35,000 $20,000
       *$111,000 = $57,250 + $35,000 + $18,750

 

 *$105,000 = $65,000 + $20,000 + $20,000

 

10. Free cash   flow =  $103,500  $115,500 = $(12,000)  $129,000 $35,000 = $94,000 U

 

PROBLEM 18-7A (Continued)

 

(a) and (b) (Continued)

                                                                                                                                                 (b)

  2017 2016 Chan-ge
Profitability Ratios                  
11. Gross profit margin = $275,000   = 30.6% $265,000   = 31.5% U
$900,000   $840,000  
                           
12. Profit       margin = $57,250   = 6.4% $65,000   = 7.7% U
$900,000    $840,000  
                           
13. Asset turnover = $900,000 = 1.3 times $840,000 = 1.3 times NC
($754,000 + $648,000) ÷ 2 ($648,000 + $630,000) ÷ 2
                             
14. Return on assets = $57,250 = 8.2% $65,000 = 10.2% U
($754,000 + $648,000) ÷ 2 ($648,000 + $630,000) ÷ 2
15. Return on equity = $57,250 = 16.5% $65,000 = 22.6% U
($377,000 + $316,000) ÷ 2

 

($316,000 + $259,000) ÷ 2

PROBLEM 18-7A (Continued)

 

(a) and (b) (Continued)

                                                                                                                                                 (b)

Profitability Ratios (Continued) 2017 2016 Chan-ge
16. Earnings per share = $57,250     = $2.86 $65,000     = $3.25 U
 20,000     20,000    
17. Payout ratio =  $3,000 ÷  $57,250 = 5.2%  $8,000 ÷ $65,000 = 12.3% U
                           


PROBLEM 18-7A (Continued)

 

(c)

 

(1) Liquidity: Stayed essentially the same

The overall liquidity of Click and Clack is slightly better with respect to the receivables turnover, but worse for inventory turnover than the previous year, but the changes are small.

 

(2) Solvency: Deteriorated

Although the debt to total assets ratio improved slightly, the interest coverage ratio worsened. A large amount of cash was used in investing activities during 2017 which in turn increased the debt and corresponding interest charges. Free cash consequently turned negative and the interest coverage ratio has deteriorated.

 

(3) Profitability: Deteriorated

Profitability has decreased slightly. Profit was mostly affected by the large increase in interest charges. This explains why the gross profit margin decreased slightly but the return on equity decreased dramatically. The return on assets declined correspondingly.

 

 

Taking It Further:

 

The problem is employing intracompany comparison. It is hard to say which is more useful—intercompany or intracompany comparisons—as both provide valuable information. When two companies in the same industry are compared, then intercompany comparisons can be very useful. A business might obtain feedback that they are doing well from an intracompany analysis, but may not be doing as well on an intercompany comparison, possibly failing to keep pace with pricing increases or cost control opportunities that the company’s competitors are taking advantage of.


PROBLEM 18-8A

 

(a) ($ in thousands)

 

Liquidity Ratios Big Rock Brewery Inc. Brick Brewing Co. Ltd.
1. Current ratio = $9,680 = 2.0 $10,838 = 1.7
$4,958 $6,335
                             
2. Receivables turnover = $36,755 = 26 times $36,333 = 5.9 times
$1,413 $6,179
                           
  Collection period =        365 ÷ 26 = 14.0 days    365 ÷ 5.9 = 61.9 days
                       
                             
3. Inventory turnover = $18,930 = 5.6 times $26,136 = 7.1 times
$3,398 $3,676
                           
  Days sales in inventory = 365 ÷ 5.6 = 65.2 days    365 ÷ 7.1 = 51.4 days
                       
                             
4. Operating cycle = 65.2 + 14.0 = 79.2 days 51.4 + 61.9 = 113.3 days

 

 

 

PROBLEM 18-8A (Continued)

 

(a)  (Continued)

Solvency Ratios Big Rock Brewery Inc. Brick Brewing Co. Ltd.
5. Debt to total assets =  $9,724   = 20.2%  $10,552   = 23.5%
 $48,167    $44,934  
                           
6. Interest coverage =  N/A no interest expense     $1,395 + $535 +$627 = 4.8 times
      $535  
Profitability Ratios                        
7. Gross profit margin = $17,825   = 48.5 % $10,197   = 28.1%
$36,755   $36,333  
                           
8. Profit       margin = $624   = 1.7% $1,395   = 3.8%
$36,755   $36,333  
                           
9. Asset turnover = $36,755   =  0.8 times $36,333   =  0.8 times
$45,412   $45,651  
                             
10. Return on assets = $624   = 1.4% $1,395   = 3.1%
$45,412   $45,651  
11. Return on equity = $624   = 1.8% $1,395   = 4.2%
$34,200   $33,447  
                           

 


PROBLEM 18-8A (Continued)

 

(b)     Liquidity:

          When looking at the liquidity ratios, one can conclude that Big Rock is more liquid than Brick. Where there is a larger discrepancy in the performance is in the collection of accounts receivable. It is taking Brick more than four times as much time to collect accounts receivable compared to Big Rock. Big Rock has also outpaced Brick for its inventory turnover.

 

Solvency:

The debt to total assets ratio is similar between Big Rock and Brick. Where Big Rock is noticeably better, is in its absence of any interest expense.

 

Profitability:

In spite of a much better gross profit margin, Big Rock realizes very little profit. Brick is more profitable and has a better return on assets and return on equity although the ratios are an indication of poor overall profitability  performance.

 

 

Taking It Further:

 

Most financial analysis ratios exclude other comprehensive income. There are no standard ratio formulas incorporating comprehensive income. Nevertheless, other comprehensive income (loss) should not be ignored in assessing the profitability of a company. Key profitability ratios should be recalculated including other comprehensive income if it is significant and depending on its composition.

 

 

 

 

 

 

 

PROBLEM 18-9A

 

(a)   Fournitures Ltée’s accounts receivable management can be assessed by reviewing the company’s receivables turnover, which indicates how often the company is “turning” over its receivables; that is, how long the company is taking to collect its accounts receivable. Fournitures Ltée’s receivables turnover of 11.8 times can also be expressed as an average collection period of 31 days (365 ÷ 11.8). This receivables turnover is reasonable when compared to its credit terms of 30 days. This can be compared to Supplies Unlimited’s average collection period of 40.1 days (365 ÷ 9.1), which indicates collections for Supplies Unlimited are taking longer than the 30-day credit terms. As well, Fournitures Ltée’s receivables turnover is better than Supplies Unlimited, indicating that Fournitures Ltée’s management is doing a better job at controlling the collection of the company’s receivables.

 

(b)   Fournitures Ltée’s ability to manage its inventory can be measured by the inventory turnover ratio. Currently Fournitures Ltée is turning over its inventory 6 times per year which can also be expressed as approximately every 61 days (365 ÷ 6 times). Supplies Unlimited is turning over its inventory 3.1 times per year or approximately every 118  days (365 ÷ 3.1 times).  It appears that Fournitures Ltée is turning over its inventory much faster than its competitor.

 

(c)   Supplies Unlimited’s current ratio could be higher than Fournitures Ltée’s because of its slower accounts receivable and inventory turnovers. It could also have a higher level of prepaid expenses or similar type of current assets.

 

PROBLEM 18-9A (Continued)

 

(d)   Fournitures Ltée is the less solvent company of the two companies as it has a higher proportion of assets financed with debt, as demonstrated by its debt to total asset ratio of 35% (compared to Supplies Unlimited’s debt to total assets ratio of 30.3%). This percentage is still very good in general. The other ratio that pinpoints solvency is the interest coverage ratio. In this case, since Fournitures Ltée has proportionately more debt, it is not surprising to note that it has a lower interest coverage ratio.

 

(e)   Fournitures Ltée’s lower gross profit margin may be attributable to a number of factors:

  • The company may be selling its products at a lower price hoping to increase its sales volume and hence profit.
  • The company may be paying more for the cost of its inventory than the competition. This may occur if, for example, Fournitures Ltée is not able to purchase inventory in the same quantity for the same price as its competition.
  • Fournitures Ltée might not be able to take advantage of reduced costs from bulk purchases because it has overextended its credit and is unable to obtain additional debt financing.

 

Fournitures’ higher profit margin could be the result of lower operating expenses or more other income than Supplies Unlimited.

 

(f)    The price-earnings ratio reflects investors’ assessment of the future prospects of a company. As indicated by the higher price-earnings ratio, investors appear to believe that Fournitures Ltée has the better possibility for growing its profit.

 


PROBLEM 18-9A (Continued)

 

Taking It Further:

 

Financial leverage is said to be positive if a company is able to earn a higher return on equity by using borrowed money in its operations than it has to pay on the borrowed money. A quick measure of leverage is calculated by comparing the amount the percentage of return on equity exceeds return on assets. Fournitures Ltée’s return on equity exceeds its return on assets by a 5.2% return while Supplies Unlimited has an excess of 3.5% return.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PROBLEM 18-10A

 

(a)   DavidsTea is more liquid, with a much better current ratio than that of Starbucks. On the other hand, DavidsTea  turns over inventory more slowly than Starbucks. The operating cycles of the two companies are similar in total.

 

(b)   The debt to total assets of 100% for DavidsTea means there is no equity. On the other hand Starbucks has about half of its assets financed with debt and half with equity. Starbucks is also able to cover its interest 50 times.  Starbucks has excellent solvency when compared to DavidsTea.

 

(c)   Although the gross profit of the two companies is similar, the profit margin percentage for Starbucks is almost three times that of DavidsTea. Similarly the return on assets is much stronger with Starbucks. Overall profitability is better with Starbucks. The only ratio that is not in support of Starbucks’s superior profitability is its asset turnover.

 

 

Taking It Further:

 

Based only on its higher price-earnings ratio, investors favour DavidsTea over Starbucks. This is inconsistent with Starbucks’s superior profitability. The price-earnings ratio of DavidsTea is more a reflection on its low profit (earnings, in the price-earnings ratio) than it is about good financial performance.

 

 

 

 

 

 

 

 


PROBLEM 18-11A

 

(a)    Gross profit margin is 40% so gross profit of $500,000 (c) ÷ 40% = net sales of $1,250,000.

 

(b)    Net sales of $1,250,000 less gross profit of $500,000 = cost of goods sold of $750,000.

 

(c)    Profit from operations of $166,250 plus operating expenses of $333,750 = gross profit of $500,000.

 

(d)    Profit before income taxes $155,750 plus interest expense $10,500 = profit from operations of $166,250.

 

(e)    Income tax rate is 20%. Profit after income tax is $124,600 so profit before income tax $124,600 ÷ .8 (100% – 20%) = $155,750.

 

(f)     Income tax is profit before income taxes of (e) $155,750 × 20% = $31,150 or profit after income tax is $124,600 × .25 = $31,150, or more simply profit before income taxes of (e) $155,750 less profit of $124,600 given = $31,150.

 

 

Summary of results:

SCHWENKE CORPORATION

Income Statement

Year Ended December 31, 2017

 

Net sales

 

$1,250,000

Cost of goods sold     750,000
Gross profit 500,000
Operating expenses     333,750
Profit from operations 166,250
Interest expense       10,500
Profit before income taxes 155,750
Income tax expense       31,150
Profit $  124,600

PROBLEM 18-11A (Continued)

 

(g)    Current assets of $190,000 less cash of $7,500 less inventory of $93,750 = accounts receivable of $88,750.

 

(h)    Inventory turnover is 8 times and so cost of goods sold of $750,000 ÷ 8 = inventory of $93,750.

 

(i)     Current ratio is 3:1 so current liabilities of $63,333 × 3 = current assets of $190,000(rounded).

 

(j)     Total assets of $833,333 less current assets of $190,000 = property, plant, and equipment of $643,333.

 

(k)    Asset turnover is 1.5 times so net sales of $1,250,000 ÷ 1.5 = total assets and (n) total liabilities and shareholders’ equity of $833,333.

 

(l)     Total liabilities of $183,333 less non-current liabilities of $120,000 = current liabilities of $63,333.

 

(m) Total liabilities and shareholders’ equity of $833,333 less shareholders’ equity of $650,000 = total liabilities of $183,333.

 

 

 

 

PROBLEM 18-11A (Continued)

 

Summary of results:

SCHWENKE CORPORATION

Balance Sheet

December 31, 2017

 

Assets

 
Current assets  
   Cash $    7,500
   Accounts receivable 88,750
   Inventory     93,750
      Total current assets 190,000
Property, plant, and equipment   643,333
      Total assets $833,333
Liabilities  
Current liabilities $  63,333
Non-current liabilities   120,000
   Total liabilities 183,333
Shareholders’ Equity  
Common shares 250,000
Retained earnings   400,000
   Total shareholders’ equity   650,000
   Total liabilities and shareholders’ equity $833,333

 

 

Taking it Further:

 

Because of the large number of figures that are omitted at the beginning of each of the financial statements, it is necessary to work backwards, using totals and sub-totals along with the ratios given.

 

 

 

 

 

 

 

PROBLEM 18-1B

 

(a)

LULULEMON ATHLETICA INC.

Income Statement

Year Ended December 31

 

  2015 2014   2013   2012
Revenue 180%   159%   137%   100%
Operating expenses 205%   174%   141%   100%
Profit from operations 161%   148%   134%   100%
Other expenses 190%   159%   137%   100%
Profit before income taxes 132%   137%   131%   100%
Income tax expense 137%   111%   105%   100%
Profit 129%   151%   146%   100%

 

LULULEMON ATHLETICA INC.

Balance Sheet

Horizontal Analysis

       

  Feb. 1 Feb. 2   Feb. 3   Jan. 29
  2015 2014   2013   2012
Assets              
Current assets 180%   179%   149%   100%
Non-current assets 166%   148%   127%   100%
Total assets 176%   170%   143%   100%
Liabilities and Shareholders’ Equity        
Liabilities            
Current liabilities 155%   113%   129%   100%
Non-current liabilities 188%   156%   124%   100%
Total liabilities 162%   121%   128%   100%
   Shareholders’ equity 179%   181%   146%   100%
Total liabilities and equity 176% 170% 143% 100%

 

 

 

PROBLEM 18-1B (Continued)

 

(b)    lululemon athletica has seen some significant revenue growth over the four-year period. The increase in operating expenses, grouped with cost of goods sold, has outpaced the increase in revenue. Revenue increased 80% but operating expenses doubled in the period. This is not a positive trend and costs and pricing may need to be carefully reviewed. Further analysis to determine the composition of this increase (what is cost of goods sold and other operating expenses) would be helpful.

 

        Other expenses is not a significant dollar amount and by its nature can be expected to vary over the years. Income tax expense increased dramatically in 2015, causing a larger decline in profit in that year

 

        The horizontal analysis of the balance sheet adds additional insight into lululemon’s financial performance and position. Current assets have increased at the exact same rate as revenues. The shareholders’ equity increase generally has exceeded the trend of profit.  Coinciding with the decrease in profit is the increase in non-current liabilities, in 2015.

 

        The increase in assets over the period is similar to the increase in liabilities and does not raise a liquidity or solvency concern. Non-current liabilities are small in comparison to non-current assets, which enhances lululemon’s financial flexibility.

 

        Shareholders’ equity experienced a decrease in 2015,  likely from the repurchase of shares.

 

 

 

 

 

 

PROBLEM 18-1B (Continued)

 

(c)    Similar to a horizontal analysis of the base-year amount, a horizontal analysis of the percentage change for each year is limited to condensed information available on the financial statements. While these percentages can show a number of meaningful facts and indicators, the detailed composition of each category and the interrelationship between these various percentages would also be of importance. Trend analysis is the most useful.

 

 

Taking It Further:

 

Because operating expenses are growing faster than the revenues, lululemon should examine both expenses and revenue to turn this trend around. For example, it should review the items included in the operating costs  and determine where they may be able to reduce costs. Alternatively, lululemon could look at ways to increase their revenues or at increasing prices as a means to improve the revenue figure.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PROBLEM 18-2B

 

(a)                                    Income Statement

Year Ended June 30, 2017

Manitou   Muskoka
Amount   Percent   Amount   Percent
Net sales $360,000   100.0%   $1,400,000   100.0%
Cost of goods sold 200,000   55.6%   720,000   51.4%
Gross profit 160,000   44.4%   680,000   48.6%
Operating expenses 60,000   16.7%   272,000   19.4%
Profit from operations 100,000   27.8%   408,000   29.1%
Rental income 12,000   3.3%   24,000   1.7%
Profit before    
   income tax 112,000   31.1%   432,000   30.9%
Income tax expense 22,400   6.2%   95,040   6.8%
Profit $  89,600   24.9%   $  336,960   24.1%

 

Note: The percentages shown in the above table do not add perfectly because of rounding discrepancies that occur from rounding the results to one decimal place.

 

(b)

Gross Profit Margin as indicated above: Gross profit ÷ Net sales

 

Manitou                                           Muskoka

= $160,000 ÷ $360,000                  = $680,000 ÷ $1,400,000

= 44.4%                                           = 48.6%

 

Profit Margin: Profit ÷ Net sales

 

Manitou                                           Muskoka

= $89,600 ÷ $360,000                    = $336,960 ÷ $1,400,000

= 24.9%                                           = 24.1%

PROBLEM 18-2B (Continued)

 

(b) (Continued)

 

Asset Turnover: Net sales ÷ Average total assets

 

Manitou:                                          Muskoka

Asset Turnover                             Asset Turnover

$360,000 ÷ $457,500                     $1,400,000 ÷ $1,725,000

= 0.8 times                                      = 0.8 times

 

Return on Assets: Profit ÷ Average total assets

 

Manitou:                                          Muskoka

$89,600 ÷ $457,500                       $336,960 ÷ $1,725,000

= 19.6%                                           = 19.5%

 

Return on Equity: Profit ÷ Average shareholders’ equity

 

Manitou:                                          Muskoka

Return on Equity                           Return on Equity

$89,600 ÷ $204,800                       $336,960 ÷ $743,480

= 43.8%                                           = 45.3%

 

(c)    Muskoka is slightly more profitable. Muskoka has a better gross profit margin, but a slightly lower profit margin than does Manitou. Manitou has lower operating expenses, compared to Muskoka. Muskoka’s return on equity is also slightly better. Its asset turnover is the same and its return on assets slightly lower than that of Manitou.

 

(d)    The comparison in (c) above is an intercompany comparison, which involves comparing ratios for different companies.

 

PROBLEM 18-2B (Continued)

 

 

Taking It Further:

 

Ratio analysis helps us compare companies of differing sizes. However, we should be able to see Muskoka enjoying some economies of scale being the larger business of the two. This does not appear to be the case. The operating expenses as a percentage of sales are higher in the case of Muskoka compared to Manitou. On the other hand, Muskoka has better buying power and can obtain lower prices for the goods that it purchases, as is demonstrated by its gross profit percentage.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 PROBLEM 18-3B

 

(a)     Although the operating expenses have been increasing over the past four years, when these are expressed as a percentage of revenues in the vertical analysis, it is clear that in spite of the fact that the absolute amounts are greater over time, their proportion as a percentage of revenue is smaller, demonstrating that the company has control over the operating expenses.

 

(b)     Interest expense is decreasing over the four-year period. This reduction is likely due to the reduction in interest rates charged and the amount of the debt on the balance sheet.

 

Although the horizontal analysis draws attention to a major increase in the other revenues, that attention is later diminished when inspecting the vertical analysis income statement. That statement reveals that in absolute terms, the amount of other revenue involved is very small and so an increase of 240% over a four-year period turns out to have a modest effect on the profit.

 

(c)     Horizontal and vertical analysis of the balance sheet, as well as the financial statements themselves, would be useful in assessing the company’s performance and financial position. In addition, ratio analysis would help complete the picture. Finally, understanding any external economic or other factors would also be useful.

 

PROBLEM 18-3B (Continued)

 

 

Taking It Further:

 

For a new public company, historical financial information is not as readily available to perform meaningful analysis. Although some historical financial information would be found in the prospectus, it would not be useful in assessing comparisons under the new capital structure which includes all of the cash financing obtained from the initial public offering. Consequently, meaningful horizontal or vertical analysis cannot be prepared for its first full year of operations.

 


PROBLEM 18-4B

(a)

2017 2016 *
                     
a Gross profit margin = $1,033,750   = 48.0%   $818,000   = 44.7%  I
 $2,153,650     $1,828,500    
         
b Profit       margin = $203,085   = 9.4%   $199,000   = 10.9%  D
 $2,153,650     $1,828,500      
           
c Earnings per share = $203,085 =  $ 3.56   $199,000 =  $  3.49 I
  57,000 57,000
           
d

 

Receivables turnover = $2,153,650 = 16.23 times $1,828,500 = 16.21 times I
$142,600 + $122,800 $122,800 + $102,800
  2   2  
  Collection period =        
e 365 ÷ 16.23 = 22.5 days 365 ÷ 16.21 = 22.5 days NC
         
f Inventory turnover = $1,119,900 = 7.91 times $1,010,500 =  8.84 times D
  $170,000 + $113,000 $113,000 + $115,500
  2   2  

 

*  D denotes deterioration, while I denotes improvement, NC denotes no change

 

 

PROBLEM 18-4B (Continued)

    2017     2016   *
Days sales in inventory =
g 365 ÷ 7.91 = 46 days 365 ÷ 8.84 = 41 days D
 
h

 

 

Return on common shareholders’ equity = $203,085 = 34.8% $199,000 = 38.9% D
$609,700 + $556,700 $556,700 + $465,400
2 2
           
i Return on assets = $203,085 = 20.2% $199,000 = 21.8% D
  $1,040,950 + $970,200 $970,200 + $852,800
  2   2  
         
j Current ratio =  $ 435,650 = 2.06  $     364,900 = 1.79 I
 $211,250  $     203,500
       
k Acid-test ratio = $435,650 – $170,000 = 1.26   $364,900 – $113,000 = 1.24 I
$211,250   $203,500
         
l Asset turnover = $2,153,650 = 2.14 times $1,828,500 =  2.01 times I
$1,040,950 + $970,200 $970,200 + $852,800
  2   2  
         
m Debt to total assets =         $431,250 = 41.4% $413,500 = 42.6% I
     $1,040,950 $970,200


PROBLEM 18-4B (Continued)

 

 

Taking It Further:

 

As calculated in ratio no. 5, the collection period for Andy’s Art Company is 22.5 days in 2017.  Ratio No. 7. shows the business has days sales in inventory of 46 days in 2017. Combined (22.5 + 46) is 68.5 days for the operating cycle. This result is worse than the 60-day operating cycle of the nearest competitor. On the surface, this ratio would indicate that Andy’s Art Company has a liquidity problem. An investigation into such policies as the terms provided to customers may explain the worse performance.


PROBLEM 18-5B

(a)

2017 2016
             
1. Gross profit       margin = $290,000 = 40.8% $260,000 = 39.4%
$710,000 $660,000
       
2. Asset turnover = $710,000 =     1.15 times $660,000 =  1.17 times
$640,000 + $600,000 $600,000 + $533,000
2   2  
       
3. Earnings per share = $55,000 =   $1.72 $40,000 = $1.29
32,000 31,000
     
4. Price- earnings ratio = $8.00 = 4.65 times $5.00 =  3.88 times
$1.72 $1.29
       
5. Payout ratio = *$35,000 ÷ $55,000 = 63.6% **$28,000 ÷ $40,000 = 70.0%
       
6. Debt to total assets = $145,000 = 22.7% $165,000 = 27.5%
$640,000 $600,000
       
7. Profit margin = $55,000 =

 

7.7% $40,000 = 6.1%
$710,000 $ 660,000
                       


PROBLEM 18-5B (Continued)

 

(a) (Continued)

 

The amount of dividends paid were calculated from the statement of income and the retained earnings balances on the balance sheet:

 

Retained Earnings Dec. 31, 2016                        $125,000

Add Net income for 2017                                           55,000

180,000

Less Retained Earnings Dec. 31, 2017                145,000

Dividends declared and paid in 2017                  *$35,000

Retained Earnings Dec. 31, 2015                        $113,000

Add Net income for 2016                                           40,000

153,000

Less Retained Earnings Dec. 31, 2016                125,000

Dividends declared and paid in 2016                **$28,000

(b)     Based on the results of the comparative ratio analysis for Lauer Corporation, we can see that profitability has improved based on the gross profit margin, the profit margin, and the earnings per share ratios.  By the end of 2017 the financial position of the company has improved in that there is less debt compared to total assets. In spite of the fact that the dividend payout has reduced as a percentage of net income, shareholders have bid up the market price of the shares, making the price-earnings ratio increase. The price-earnings ratio remains modest.

 

Taking It Further:

 

Brittany is correct. Profitability is only one area of concern when managing the success and well-being of a business. Liquidity and solvency issues are also important. By using the three common tools of financial analysis: horizontal analysis, vertical analysis, and ratio analysis, Mr. Lauer will get a better understanding of the business’ performance and will be able to detect areas that need his further attention.

 

PROBLEM 18-6B
 

Liquidity Ratios

             
                 
1. Current ratio =  $250,500     = 1.4  
 $180,150    
                 
2. Acid-test ratio = $154,100* = 0.9  
$180,150  
  *$154,100 = $49,380 + $104,720  
                 
3. Receivables turnover = $790,000 = 7.6 times
($110,220* + $98,300**)÷2
* $110,220 = $104,720 + $5,500  
** $98,300 = $93,800 + $4,500  
               
4. Collection period = 365 ÷ 7.6 = 48 days
           
               
5. Inventory turnover = $540,000 = 6.3 times
($96,400 + $74,000) ÷ 2
               
6. Days sales in inventory = 365 ÷ 6.3 = 58 days
           
                 
7. Operating cycle = 58 + 48 = 106 days

PROBLEM 18-6B (Continued)

 

Solvency Ratios            
8. Debt to total assets = $270,150   = 37.7%
$715,800  
             
9. Interest coverage = $73,270 + $12,930 + $3,200 = 27.9 times
$3,200
               
10. Free cash    flow =  $116,780  $51,660 =  $65,120
           

 

 

Profitability Ratios          
11. Gross profit margin = $250,000   = 31.6%
$790,000  
             
12. Profit       margin = $73,270   = 9.3%
$790,000  
             
13. Asset turnover = $790,000 = 1.1 times
($715,800 + $672,000) ÷ 2
               
14. Return on assets = $73,270 = 10.6%
($715,800 + $672,000) ÷ 2
15. Return on equity = $73,270 = 17.4%
($445,650 + $396,000) ÷ 2

 

PROBLEM 18-6B (Continued)

 

Profitability Ratios (Continued)

           
16. Earnings per share = $73,270     = $4.88
15,000    
17 Payout ratio =  $23,620 ÷  $73,270 = 32.2%

 

 

Taking It Further:

 

The Rose Packing’s liquidity appears to be a bit weak, based primarily on its collection period of 48 days. However, it is hard to assess its collection period without knowing the company’s credit terms. Its inventory turnover ratio may be reasonable, depending on what the norm is among its competitors and the packing industry.

 

With respect to solvency, since a significant percentage of its assets are financed with equity, the debt to total assets and interest coverage ratios are strong.

 

Finally, profitability also appears to be reasonable based on ratios. Industry averages would be useful to confirm this assessment, as would comparative ratios for the company for prior years.

 

 


PROBLEM 18-7B
  • and (b)

 

Liquidity Ratios 2017 2016 Chan-ge
                           
                             
1. Current ratio =  $415,000     = 1.2    $360,000     = 1.1   F
 $337,750      $315,000    
                             
2. Acid-test ratio = $50,000 + $100,000 = 0.4   $42,000 + $87,000 = 0.4   NC
$337,750   $315,000  
                             
3. Receivables turnover = $1,000,000 = 10.2 times $940,000 = 11.0 times U
($105,000* + $91,000**)÷2 ($91,000* + $80,000**)÷2)
    * $105,000 = $100,000 + $5,000

** $91,000 = $87,000 + $4,000

* $91,000 = $87,000 + $4,000

** $80,000 = $77,000 + $3,000

                           
4. Collection period = 365 ÷ 10.2 = 36 days 365 ÷ 11.0 = 33 days U
                       

PROBLEM 18-7B (Continued)

Liquidity Ratios (Continued)

 

2017 2016 Chan-ge
5. Inventory turnover = $650,000 = 3.0 times $635,000 = 3.6 times U
($240,000 + $200,000) ÷ 2 ($200,000 + $150,000) ÷ 2
                           
6. Days sales in inventory = 365 ÷ 3.0 = 122 days 365 ÷ 3.6 = 101 days U
                       
                           
7. Operating cycle = 122 + 36 = 158 days 101 + 33 = 134 days U

PROBLEM 18-7B (Continued)

Solvency Ratios

 

2017 2016 Chan-ge
8. Debt to total assets =  $437,750   = 35.3% $415,000   = 36.6%

 

F
$1,240,000   $1,135,000  
                           
9. Interest coverage = $150,000* = 4.3 times $125,000* = 3.6 times F
$35,000 $35,000
       *$150,000 = $97,750 + $17,250 + $35,000

 

 *$125,000 = $76,500 + $13,500 + $35,000

 

10. Free cash    flow =  $133,500  $110,000 = $23,500  $180,500 $56,000 = $124,500 U
                         

 

 

PROBLEM 18-7B (Continued)

 

Profitability Ratios

 

      2017 2016 Chan-ge
11. Gross profit margin = $350,000   = 35.0%

 

$305,000   = 32.4%

 

F
$1,000,000   $940,000  
                           
12. Profit       margin = $97,750   = 9.8% $76,500   = 8.1% F
$1,000,000   $940,000  
                           
13. Asset turnover = $1,000,000 = 0.8 times

 

$940,000 = 0.9 times   U
($1,240,000 + $1,135,000)÷2 ($1,135,000 + $1,075,000)÷2
                             
14. Return on assets = $97,750 = 8.2% $76,500 = 6.9% F
($1,240,000 + $1,135,000)÷2 ($1,135,000 + $1,075,000)÷2
                     

 

PROBLEM 18-7B (Continued)

 

Profitability Ratios (Continued)

 

2017 2016 Chan-ge
15. Return on equity = $97,750 = 12.8%

 

$76,500 = 11.1%

 

F
($802,250 + $720,000) ÷ 2 ($720,000 + $659,000) ÷ 2
16. Earnings per share = $97,750 = $0.98 $76,500 = $0.77 F
100,000  100,000
17. Payout ratio = $15,500 ÷ $97,750 = 15.9%  $15,500 ÷ $76,500 = 20.3% U
                           

 

 


PROBLEM 18-7B (Continued)

 

(c)

(1)   Liquidity: Deteriorated

Track’s overall liquidity has deteriorated in 2017 compared to 2016 in spite of a modest improvement in the current ratio. Both the receivables and inventory turnover ratios have deteriorated and consequently the operating cycle worsened by 24 days.

 

(2)   Solvency: Improved

The debt to total assets ratio improved slightly. The interest coverage ratio improved even more so; consequently, overall solvency improved. A larger amount of cash was used in investing activities during 2017 compared to 2016 which resulted in a large decrease in free cash flow.

 

(3)   Profitability: Improved

Profitability, with the exception of the asset turnover ratio which decreased slightly, has improved overall.

 

 

Taking It Further:

 

The problem is employing intracompany comparison. It is hard to say which is more useful—intercompany or intracompany comparisons—as both provide valuable information. When two companies in the same industry are compared, then intercompany comparisons can be very useful. A business might obtain feedback that they are doing well from an intracompany analysis, but may not be doing as well on an intercompany comparison, possibly failing to keep pace with pricing increases or cost control opportunities that the company’s competitors are taking advantage of.

 


PROBLEM 18-8B

 

(a)   ($ in millions)

 

Liquidity Ratios Hudson’s Bay Nordstrom
                         
1. Current ratio = $2,829 = 1.32 $5,224 = 1.87
$2,144 $2,800
                             
2. Receivables turnover = $8,169 = 29.1 times $13,506 = 6.0 times
$281 $2,242
                           
  Collection period = 365 ÷ 29.1 = 13 days 365 ÷ 6.0 = 61 days
                       
                             
3. Inventory turnover = $4,893 = 2.2 times $8,406 = 5.2 times
$2,199 $1,632
                           
  Days sales in inventory = 365 ÷ 2.2 = 166 days 365 ÷ 5.2 = 70 days
                       
                             
4. Operating cycle = 13 + 166 = 179 days 61 + 70 = 131 days

 

PROBLEM 18-8B (Continued)

(a) (Continued)

 

Solvency Ratios Hudson’s Bay Nordstrom
                     
5. Debt to   $6,580   = 72.5% $6,805   = 73.6%
total assets = $9,072   $9,245  
                             
6. Interest

coverage

= $238 + $262 – $19          =   1.8 times $720 + $138+$465 = 9.6 times
    $262     $138          
                         
Profitability Ratios:                        
7. Gross profit = $3,276     = 40.1%   $5,100     = 37.8%  
  margin   $8,169           $13,506          
                             
8. Profit       margin = $238   = 2.9% $720   = 5.3%
$8,169    $13,506  
                           
9. Asset turnover = $8,169   = 1.0 times $13,506   = 1.5 times
 $8,507    $8,910  
                             
10. Return on assets = $238   = 2.8% $720   = 8.1%
 $8,507    $8,910  
11. Return on equity = $238   = 10.5% $720   = 31.9%
 $2,268    $2,260  


PROBLEM 18-8B (Continued)

 

(b) Liquidity: Nordstrom is the better performer.

Nordstrom has a much stronger current ratio than Hudson’s Bay. Hudson’s Bay collects its receivables more quickly than Nordstrom, likely because most of their sales are cash or bank credit cards. Nordstrom’s inventory turnover is more than double that of Hudson’s Bay.

 

Solvency: Nordstrom is the better performer.

Although the source of financing from debt as a percentage of assets is similar between the two companies, Nordstrom is in a far better position to pay its interest.

     

      Profitability: Nordstrom is the better performer.

      Although Hudson’s Bay has a higher gross profit margin, it is not translating into a higher profit margin. Both the return on assets and return on equity for Hudson’s Bay are a fraction of the Nordstrom returns.

 

 

Taking It Further:

 

Most financial analysis ratios exclude other comprehensive income. There are no standard ratio formulas incorporating comprehensive income. Nevertheless, other comprehensive income (loss) should not be ignored in assessing the profitability of a company. Key profitability ratios should be recalculated including other comprehensive income if it is significant and depending on its composition.

 

 

 

 

 

 

 

 

 

PROBLEM 18-9B

 

(a)   Accounts receivable management can be assessed by reviewing each company’s receivables turnover ratio and average collection period. Refresh’s average collection period of 35 days (365 ÷ 10.4) days is reasonable when compared to its credit terms of 30 days. Flavour’s average collection period of 37 days (365 ÷ 9.8) days is marginally worse than that of Refresh.

 

(b)   Each company’s ability to manage its inventory can be measured by the inventory turnover ratio. Currently Refresh is turning over its inventory 5.8 times per year, which can also be expressed as days in inventory of approximately 63 days (365 ÷ 5.8 times). When compared to the turnover of 9.9 or 37 days (365 ÷ 5.8 times) times for Flavour, it appears that Refresh is turning over its inventory at a much slower rate than its competitor.

 

(c)   Refresh’s current ratio could be higher than Flavour’s because of its slower inventory turnover. It could also have a higher level of prepaid expenses or similar type of current assets.

 

(d)   Refresh is the more solvent of the two companies. Refresh has a much lower debt to total assets ratio, indicating that Refresh has a lower percentage of its assets financed by debt. As well, Refresh has a higher interest coverage ratio indicating that Refresh has a better ability to service its debt as interest payments become due.

PROBLEM 18-9B (Continued)

 

(e)   Refresh’s higher gross profit margin may be attributable to a number of factors:

  • The company may be selling its products at a higher price.
  • The company may be paying less for the cost of its inventory than the competition. This may occur if, for example, Refresh is able to purchase inventory in large volumes and receives purchase discounts.
  • Flavour might not be able to take advantage of reduced costs from bulk purchases because it has overextended its credit and is unable to obtain additional debt financing.

Refresh’s lower profit margin is most likely the result of higher operating expenses or less other income.

 

(f)    The price-earnings ratio reflects investors’ assessment of the future prospects of a company. As indicated by the higher price-earnings ratio, investors appear to believe that Refresh has the better possibility for growing its profit.

 

 

Taking It Further:

 

Financial leverage is said to be positive if a company is able to earn a higher return on equity by using borrowed money in its operations than it has to pay on the borrowed money. A quick measure of leverage is calculated by comparing the amount the percentage of return on equity exceeds return on assets. Flavour Corp’s return on equity exceeds its return on assets by an excellent 19.7% return while Refresh Ltd. has an excess of 14.5% return.

 

 

 

 

 

 

 

PROBLEM 18-10B

 

(a)    Both Rogers and Shaw seem to have extremely low current ratios. This should not be considered alarming as there are likely large customer deposits as current liabilities which will be used for payments on account. When compared to each other, Shaw has the better liquidity as evidenced by all three liquidity ratios. A detailed composition of the current assets and current liabilities of each company would help confirm this initial assessment.

 

(b)    As for solvency, Shaw is again the better performer of the two companies. Shaw has less debt compared to total assets and also has a much better ability to cover its interest.

 

(c)    Likely due to the different capital structures of the two companies, the conclusions concerning profitability have mixed results. From the profit margin, Shaw’s performance is far stronger than Rogers. Asset turnover is similar between companies, but where opposite trends are revealed is in the return on assets and equity. Rogers has lower equity as a percentage of total assets and the return on equity is considerably stronger than that of Shaw and that of its own return on assets. A detailed composition of the equity of each company would help confirm this initial assessment

 

 

Taking It Further:

 

Investors seem to favour Rogers as it has a higher price-earnings ratio. This is consistent with (c) as investors would likely favour a company with a better return on equity.

 

 

 

 


PROBLEM 18-11B

 

(a)    Cost of goods sold is net sales of $11,000,000 less gross profit of $4,400,000 = $6,600,000 or 60% of net sales.

 

(b)    Gross profit is 40% of net sales of $11,000,000 or $4,400,000.

 

(c)    Gross profit of $4,400,000 less operating expenses of $1,600,000 equals profit from operations of $2,800,000.

 

(d)    Profit from operations of $2,800,000 less profit before income taxes of $2,357,000 equals interest expense of $443,000.

 

(e)    Profit of $1,650,000 plus income tax expense of $707,000 equals profit before income taxes of $2,357,000.

 

(f)     Profit margin is 15% of sales. Net sales × 15% equals profit of $1,650,000.

 

Summary of results:

 

VIEUX CORPORATION

Income Statement

Year ended December 31, 2017

 

Net sales

 

$11,000,000

Cost of goods sold    6,600,000
Gross profit 4,400,000
Operating expenses    1,600,000
Profit from operations 2,800,000
Interest expense       443,000
Profit before income taxes 2,357,000
Income tax expense       707,000
Profit $ 1,650,000

 

PROBLEM 18-11B (Continued)

 

(g)    Total current assets of $2,650,000 less accounts receivable (h) of $1,100,000 and inventory (i) of $825,000 equals cash of $725,000.

 

(h)    Receivables turnover is 10 times and so net sales of $11,000,000 ÷ 10 = accounts receivable of $1,100,000.

 

(i)     Inventory turnover is 8 times and so cost of goods sold of $6,600,000 ÷ 8 = inventory of $825,000.

 

(j)     Total assets of $7,500,000 less property, plant, and equipment of $4,420,000 and long-term investments of $430,000 equal current assets of $2,650,000.

 

(k)    Return on assets is 22% so profit of $1,650,000 ÷ 22% equals total assets of $7,500,000.

 

(l)     Current ratio is 2:1 and so current assets (g) of $2,650,000 ÷ 2 equals current liabilities of $1,325,000.

 

(m)   Total liabilities of $4,100,000 less current liabilities (l) of $1,325,000 equals non-current liabilities of $2,775,000.

 

(n)    Total liabilities and shareholders’ equity of $7,500,000 less shareholders’ equity of $3,400,000 equals total liabilities of $4,100,000.

 

(o)    Total liabilities and shareholders’ equity is equal to total assets of $7,500,000.

 

 

PROBLEM 18-11B (Continued)

 

Summary of results:

 

VIEUX CORPORATION

Balance Sheet

December 31, 2017

 

Assets

 
Current assets  
   Cash $  725,000
   Accounts receivable 1,100,000
   Inventory     825,000
      Total current assets 2,650,000
Long-term investments 430,000
Property, plant, and equipment   4,420,000
   Total assets $7,500,000
Liabilities  
Current liabilities $1,325,000
Non-current liabilities   2,775,000
   Total liabilities   4,100,000
Shareholders’ Equity  
Common shares 1,500,000
Retained earnings   1,900,000
   Total shareholders’ equity   3,400,000
   Total liabilities and shareholders’ equity $7,500,000

 

 

Taking It Further:

 

Because of the large number of figures that are omitted at the beginning of each of the financial statements, it is necessary to work backwards, using totals and sub-totals along with the ratios given.

 

 

 

 


BYP18-1 FINANCIAL REPORTING PROBLEM

 

(a)

CORUS ENTERTAINMENT INC.
Consolidated Statement of Financial Position
(in thousands)
  August 31, 2014 August 31, 2013
Amount Percentage Amount Percentage
Current
Cash and cash equivalents        $11,585 0.4%     $81,266 3.7%
Accounts receivable        183,009 6.6%     164,302 7.6%
Promissory notes receivable       47,759 2.2%
Income taxes recoverable            9,768 0.4%             351 0.0%
Prepaid expenses and other          13,032 0.5%       16,392 0.8%
Total current assets        217,394 7.8%     310,070 14.3%
Other assets and investments          76,674 2.8%     210,470 9.7%
Property, plant and equipment        143,618 5.2%     151,192 7.0%
Program and film rights        330,437 11.9%     232,587 10.7%
Film investments          63,455 2.3%       62,274 2.9%
Broadcast licenses        979,984 35.2%     515,036 23.8%
Goodwill        934,859 33.6%     646,045 29.8%
Deferred tax assets          38,161 1.4%       39,463 1.8%
Total assets   $2,784,582 100.0% $2,167,137 100.0%

 

 

BYP18-1 (Continued)

(a)  (Continued)                                 

CORUS ENTERTAINMENT INC.

Consolidated Statement of Financial Position
(in thousands)
  August 31, 2014 August 31, 2013
Amount Percentage Amount Percentage
LIABILITIES
Current
Accounts payable and accrued liabilities    $170,411 6.1% $164,443 7.6%
Provisions         5,314 0.2%       3,941 0.2%
Total current liabilities      175,725 6.3%   168,384 7.8%
Long-term debt      874,251 31.4%   538,966 24.9%
Other long-term liabilities      171,793 6.2%     93,241 4.3%
Deferred tax liabilities      252,687 9.1%   145,713 6.7%
Total liabilities   1,474,456 53.0%   946,304 43.7%
SHAREHOLDERS’ EQUITY
Share capital      967,330 34.7%   937,183 43.2%
Contributed surplus          8,385 0.3%        7,221 0.3%
Retained earnings      313,361 11.3%   256,517 11.8%
Accumulated other comprehensive income          3,767 0.1%        1,653 0.1%
Equity – Non-controlling interest 17,283 0.6%     18,259 0.8%
Total shareholders’ equity 1,310,126 47.0% 1,220,833 56.3%
Total liabilities and shareholders’ equity $2,784,582 100.0% 2,167,137 100.0%

BYP18-1 (Continued)

BYP18-1 (Continued)

(a) (Continued)

 

CORUS ENTERTAINMENT INC.
Consolidated Statements of Income
Years Ended August 31
(in thousands)
2014 2013
Amount Percentage Amount Percentage
Revenues        $833,016 100.0%     $751,536 100.0%
Direct cost of sales, general

  and administrative expenses

       543,378 65.2%     500,562 66.6%
Depreciation and amortization        24,068 2.9%     26,812 3.6%
Interest expense and debt financing       48,320 5.8%    69,828 9.3%
Broadcast license and goodwill impairment       83,000 10.0%       5,734 0.8%
Business acquisition,

    integration and restructuring costs

         46,792 5.6%          7,343 1.0%
Gains, losses and other expenses   (122,144) -14.7%   (58,954) -7.8%
Income before income taxes     209,602 25.2%   200,211 26.6%
Income tax expense       53,433 6.4%     34,462 4.6%
Net income $156,169 18.7% $165,749 22.1%

 

 


BYP18-1 (Continued)

(b)   The focus of interest on the Corus statement of financial position is not on current assets or liabilities as they make up a very small portion of the totals. Liquidity is not an issue of concern. Rather the attention should be given to the large portion of the assets made up of broadcast licenses and goodwill, which together make up 68.8% of total assets in 2014. In the previous year, these assets made up 53.6% of the total assets. The large increase is explained by an acquisition during 2014 which generated a gain on acquisition close in amount to the size of the net income. Long-term debt increased 62% from the acquisition, while share capital increased modestly.

Solvency would not appear to an issue in spite of total liabilities representing 53% of total assets in 2014, up from 43.7% in 2013, due to the acquisition.

 

On the income statement, as mentioned earlier, the unusual gain from acquisition sustained the profitability of Corus to its prior year level.  The major charges representing 10% of total revenues came from broadcast license and goodwill impairment. Business acquisition, integration and restructuring costs were also incurred that are unusual and likely not recurring in the future.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BYP18-2 INTERPRETING FINANCIAL STATEMENTS

 

(a)   In terms of liquidity, both companies have low current ratios and identical acid-test ratios. CN’s receivables turnover is higher than those of CP and so overall, CN’s liquidity is slightly better than CP’s.

 

(b)   CN has less free cash flow than CP but both have enough to maintain financial flexibility. Since CP has more debt to total assets, this explains in part why it is worse off concerning its ability to pay its interest costs.

 

(c)   CN is more profitable. All of its ratios are better than those of CP, except the asset turnover which is the same.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


BYP18-3 COLLABORATIVE LEARNING ACTIVITY

 

All of the material supplementing the collaborative learning activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BYP18-4 COMMUNICATION ACTIVITY

 

Memorandum

 

Re: Limitations of financial statement analysis

 

In evaluating the financial performance of a company, it is important to understand the limitations of financial statement analysis. I have identified the following questions to raise at the audit committee:

 

  • Alternative accounting policies: What significant judgements and estimates were required in the choice of IFRS policies by EasyMix? Which key accounting policies have changed in the transition from ASPE to IFRS? Has the effect of the recent implementation to IFRS been adequately explained in the MD&A and notes to the financial statements? How do the policies of this company compare to those used by its key competitors in the cement industry?

 

  • Comparability of data: What efforts have been made to explain the impact of the transition from ASPE to IFRS in the ratios reported to the audit committee and the board? Has there been any impact on the calculation or choice of ratios used to meet debt covenants, in particular?

 

  • Economic factors: How have the changing prices of commodities and foreign exchange affected this industry? Has the decrease in demand for the construction industry affected this company significantly, and if so, how?

 

Risk assessment: Have all business risks been properly assessed and disclosed?

 

 

 

 

BYP18-5 “ALL ABOUT YOU” ACTIVITY

 

  • When evaluating the financial statement ratios, a reading of the Management’s Discussion and Analysis (MD&A) will provide some key information for interpreting trends and explaining possible anomalies in the ratio performance for the period. MD&A gives context to the financial information in order to draw more informed conclusions.

 

        The purpose of the MD&A of Canadian Tire’s is to provide a description of the economic, financial, and other factors behind the business, usually broken down by its main products, services, or departments. It provides management’s perspective on such topics as the company’s past plans, current performance, and future goals.

 

        This section of the annual report is not audited, and is prepared from the point of view of management. It is not intended to be used in isolation.

 

  • The quoted closing price for CTC.a on the TSX Composite Index was as follows at the given dates:

         January 2, 2015                           $122.22

         December 27, 2013                       $99.84

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BYP18-5 (Continued)

 

(c)
2014

1. Current Ratio =  $  8,510.2 = 1.9
 $  4,578.8
2. Inventory turnover = $8,416.9 = 5.4 times
$1,623.8 + $1,481.0
2
3. Debt to total assets = $8,922.4 = 61.3%
$14,553.2
4. Interest coverage = $639.3 + $108.9 + $238.9 = 9.1 times
$108.9
5. Gross profit margin = $4,046.0 = 32.5%
 $12,462.9
6. Profit       margin = $639.3 = 5.1%
$12,462.9
7. Return on assets = $639.3 = 4.5%
$14,553.2 + $13,630.0
2
8. Return on equity = $639.3 = 11.5%
$5,630.8 + $5,449.9
2
9. Price-earnings ratio = $122.22 = 16.0 times
$7.65
10. Payout ratio =     $154.1 ÷       $604.0 = 25.5%

BYP18-5 (Continued)         

 

(c) (Continued) 

2013

1. Current ratio =  $  7,977.8 = 1.8
 $  4,322.1
2. Inventory turnover = $8,063.3 = 5.4 times
$1,481.0 + $1,503.3
2
3. Debt to total assets = $8,180.1 = 60.0%
$13,630.0
4. Interest coverage = $564.4 + $105.8 + $220.2 = 8.4 times
$105.8
5. Gross profit margin = $3,722.3 = 31.6%
 $  11,785.6
6. Profit       margin = $564.4 = 4.8%
$11,785.6
7. Return on assets = $564.4 = 4.2%
$13,630.0 + $13,228.6
2
8. Return on equity = $564.4 = 11.1%
$5,449.9 + $4,764.3
2
9. Price-earnings ratio = $99.84 = 14.3 times
$6.96
10. Payout ratio =     $119.6 ÷       $561.2 = 21.3%

 

BYP18-5 (Continued)

 

(c)  (Continued)

 

 

  Ratio 2014 2013 Comparison
1. Current ratio 1.9:1 1.8:1 Better
2. Inventory turnover 5.4 times 5.4 times Same
3. Debt to total assets 61.3% 60.0% Worse
4. Interest coverage 9.1 times 8.4 times Better
5. Gross profit margin 32.5% 31.6% Better
6. Profit margin 5.1% 4.8% Better
7. Return on assets 4.5% 4.2% Better
8. Return on equity 11.5% 11.1% Better
9. Price-earnings ratio 16.0 times 14.3 times Better
10. Payout ratio 25.5% 21.3% Better

 

 

(d)     The five-year stock chart showing the closing price of the CTC.a stock performance over the past five years demonstrates a fairly smooth climb in the stock price over that period, with few noticeable declines.

 

(e)     Ratios and stock performance show positive trends.

 

(f)      Both tools are helpful in assessing some financial considerations in an investment choice. The history of the business and the means that it has taken to grow its operations would be a major factor in explaining it increased earnings and profits. Mark’s Workwear and Forzani acquisitions of the recent past explain much of the growth of the business.

 

(g)     Message boards may alert a potential investor to some information that could not be found in the annual report. An investor would be well advised to do their own research as well as read analysts’ reports on the current status of the business. Analysts follow the company carefully and provide ratings and recommendations as well as expectations of the performance of the stock in the future.

BYP18-6 Santé Smoothie Saga

 

(a)    Santé Smoothies & Sweets Ltd. is far more liquid than the public company Okanagan Fruit & Vegetable Corp. Of course, its current ratio is very high, consistent with the excess cash it has on hand. Its receivables turnover is much higher than Okanagan Fruit & Vegetable Corp.; however, it is unlikely that Sante’s has as many receivables as the larger, public company. Its inventory turnover is much lower, but it likely only produces what it can sell most days. A larger bakery would be expected to have more inventory to meet its larger distribution requirements.

 

(b)    Both companies have good debt to total asset ratios, and correspondingly strong times interest earned ratios. Overall,  Santé Smoothies & Sweets Ltd. Ltd. remains in the better solvency position.

 

(c)    From a profitability point of view, Santé Smoothies & Sweets Ltd.’s performance is far better than that of Okanagan Fruit & Vegetable Corp. Santé’s gross profit margin, profit margin, return on common shareholders’ equity, and return on assets ratios are multiples of those experienced by Okanagan. Again, this is not unusual as Santé’s business model is quite different than that of Okanagan. It can adjust its pricing as more of a specialty baker and is likely also doing less volume. Its families’ salaries and other expenses also might not be reflective of those of a much larger, public company such as Okanagan Fruit & Vegetable Corp.

 

 

 

 

 

 

 

 

 

 

 

 

BYP18-6 (Continued)

 

(d)    Compared to 2017, Okanagan Fruit & Vegetable Corp.’s ratios in 2018 are generally worsening. All three liquidity ratios have declined.

 

The debt to total assets ratio has deteriorated slightly, but the times interest earned ratio has improved significantly, leading to an overall improvement in solvency.

 

As for profitability, all profitability ratios are declining, with the exception of the dividend payout ratio and the price earnings ratio. Investors may be bidding up the market value of Okanagan Fruit & Vegetable Corp.’s common shares because of the increase in the dividend payout ratio.

 

(e)    Overall, Santé’s is stronger than Okanagan in liquidity, solvency, and profitability. This is likely because of differences in the size and flexibility of the company’s business model as outlined in parts (a) and (c).

 

(f)     Because of market volatility, it is possible that the market price of the Okanagan Fruit & Vegetable Corp. common shares could decline at a time when Santé’s needs the cash for operations and is forced to sell the investment at a loss. Consequently, considering an equity investment by investing in the shares of another company for a short-term return may not be the most appropriate option. To maintain liquidity and reduce its risk, Santé’s should instead consider investing in a debt (fixed income) investment to ensure that they don’t experience a loss on their investment.

 

 


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MMXVI ii F1