Download Chapter 2: A Further Look at Financial Statements

Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
CHAPTER 2
A Further Look at Financial Statements
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives
Questions
Brief
Exercises
Exercises
A
Problems
B
Problems
1. Describe the basic
objective of financial
reporting, and the
qualitative
characteristics of
accounting information.
1, 2, 3
1, 2,
1A
1B
2. Identify the two
constraints in
accounting.
4, 5
3
2A
2B
3. Identify the sections of a
classified balance sheet.
6, 7, 8, 9
4, 5
1, 2, 3, 4,
5
3A, 4A, 5A, 3B, 4B, 5B,
6A
6B
4. Identify and calculate
ratios for analysing a
company's profitability.
10, 12, 13,
14, 15, 16
6
6
7A, 8A, 9A, 7B, 8B, 9B,
10A
10B
5. Explain the relationship
between a statement of
retained earnings, a
statement of earnings,
and a balance sheet.
11
7
5
5A, 6A
6. Identify and calculate
ratios for analysing a
company's liquidity and
solvency.
12, 13, 14,
15, 16
8
7, 8
7A, 8A, 9A. 7B, 8B, 9B,
10A
10B
Solutions Manual
2-1
5B, 6B
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number
Description
Difficulty
Level
Time
Allotted (min.)
1A
Comment on objective and qualitative
characteristics of financial reporting.
Moderate
20-30
2A
Comment on the constraints of accounting.
Moderate
10-20
3A
Classify accounts.
Simple
10-20
4A
Prepare classified balance sheet.
Moderate
10-20
5A
Prepare financial statements.
Moderate
20-30
6A
Prepare financial statements and discuss
relationships.
Moderate
20-30
7A
Calculate ratios and comment on profitability,
liquidity, and solvency.
Moderate
20-30
8A
Calculate profitability, liquidity, and solvency ratios.
Simple
10-20
9A
Calculate profitability, liquidity, and solvency ratios
and discuss results.
Moderate
15-25
10A
Calculate profitability, liquidity, and solvency ratios
and discuss results.
Moderate
15-25
1B
Comment on the objective and qualitative
characteristics of accounting information.
Moderate
20-30
2B
Comment on the constraints of accounting.
Moderate
10-20
3B
Classify accounts.
Simple
10-20
4B
Prepare classified balance sheet
Moderate
10-20
5B
Prepare financial statements.
Moderate
20-30
6B
Prepare financial statements and discuss
relationships
Moderate
20-30
7B
Calculate ratios and comment on profitability,
liquidity, and solvency.
Moderate
20-30
Solutions Manual
2-2
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
Description
Difficulty
Level
Time
Allotted (min.)
8B
Calculate profitability, liquidity, and solvency ratios.
Simple
10-20
9B
Calculate profitability, liquidity, and solvency ratios
and discuss results.
Moderate
15-25
10B
Calculate profitability, liquidity, and solvency ratios
and discuss results.
Moderate
15-25
Problem
Number
Solutions Manual
2-3
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
ANSWERS TO QUESTIONS
1.
(a)
(b)
(c)
Generally accepted accounting principles (GAAP) are a set of rules and practices,
having substantial support, that are recognized as a general guide for financial
reporting purposes.
The primary objective of financial reporting is to provide information useful for
decision-making.
The qualitative characteristics are (1) understandability, (2) relevance,
(3) reliability, and (4) comparability.
2.
Erhardt is correct. Consistency means using the same accounting principles and
accounting methods from period to period within a company. Without consistency in the
application of accounting principles, it is difficult to determine whether a company is
better off, worse off, or in the same position from period to period. When a change is
made in accounting principles or methods a company is required to disclose information
about the change.
3.
Comparability results when different companies use the same accounting principles.
Consistency means using the same accounting principles and methods from year to year
within the same company.
4.
The two constraints are cost-benefit and materiality. The cost-benefit constraint means
that information will be presented only when the benefit associated with it exceeds the
cost of producing it. The materiality constraint means that an item may be so small that
failure to follow generally accepted accounting principles will not influence the decision of
a reasonably prudent investor or creditor.
5.
The accountant is correct in saying that the rounded financial figures provide useful
information to external users for decision making. This is supported by the concept of
materiality. When investors are making decisions they are not concerned with immaterial
dollar values or cents. In fact, presenting rounded information may make it easier for
investors to focus on the ‘big picture’.
6.
Current assets are cash and other resources that are reasonably expected to be realized
in cash or sold or consumed in the business within one year of the balance sheet date or
the company's operating cycle, whichever is longer. Current assets are listed in the order
of liquidity. That is, in the order in which they are expected to be converted into cash.
7.
Long-term investments are generally investments in debt and equity of other
corporations that are normally held for many years. They also include investments in
long-term assets such as land and buildings that are not currently being used in the
organization’s operating activities. Intangible assets are assets that do not have any
physical substance and yet add value to the company. Intangible assets include items
such as trademarks, copyrights and goodwill.
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2-4
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
Questions (Continued)
8.
The major differences between current liabilities and long-term liabilities are:
Difference
Source of
payment.
Current Liabilities
Existing current assets or
other current liabilities.
Long-term Liabilities
Other than existing
current assets or creating
current liabilities.
Time of expected
payment.
Within one year or the
operating cycle.
Beyond one year or the
operating cycle.
Nature of items.
Debts pertaining to the
operating cycle and other
short-term debts.
Mortgages, bonds and
other long-term liabilities.
9.
The two parts of shareholders' equity and the purpose of each are: (1) Share capital is
used to record investments of assets in the business by the owners (shareholders). If
there is only one class of shares it is known as common shares. (2) Retained earnings
is used to record net earnings retained in the business.
10.
Amod is correct. A single ratio by itself may not be very meaningful and is best
interpreted by comparison with (1) past ratios of the same enterprise, (2) ratios of other
enterprises, or (3) industry norms or predetermined standards. In addition, other ratios of
the enterprise are necessary to determine overall financial well being.
11.
The statement of retained earnings is interrelated with both the statement of earnings
and the balance sheet. The statement of earnings reports the net earnings for the
period. This figure is then used in the statement of retained earnings, along with
dividends to calculate the amount of retained earnings at the end of the period. The
retained earnings figure is used in the balance sheet to complete the accounting
equation.
12.
(a)
(b)
13.
(a)
(b)
(c)
Solutions Manual
Tia is not correct. There are three characteristics: liquidity, profitability, and
solvency.
The three parties are not primarily interested in the same characteristics of a
company. Short-term creditors are primarily interested in the liquidity of the
enterprise. In contrast, long-term creditors and shareholders are primarily
interested in the profitability and solvency of the company.
Liquidity ratios: Working capital, current ratio, and cash current debt coverage.
Solvency ratios: Debt to total assets and cash total debt coverage.
Profitability ratios: Earning per share and price-earnings ratio.
2-5
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
Questions (Continued)
14.
(a)
(b)
(c)
15.
(a)
(b)
(c)
(d)
16.
(a)
(b)
(c)
Solutions Manual
Liquidity ratios measure the short-term ability of the enterprise to pay its maturing
obligations and to meet unexpected needs for cash.
Profitability ratios measure the earnings or operating success of an enterprise for
a given period of time.
Solvency ratios measure the company's ability to survive over a long period of
time.
An increase in earnings per share usually signals good new for the company
because higher EPS will generally indicate to investors that the company is
providing them with a higher return on their investment. This will cause the
company’s shares to become more attractive and hopefully increase in price.
An increase in the current ratio usually signals good news because the company
improved its ability to meet maturing short-term obligations. It can also mean that
some of the components of the current ratio (e.g. Accounts receivable, inventory)
are slow moving. Further investigation is usually necessary to ensure that this is
not the case.
The increase in the debt to total assets ratio is bad news because it means that
the company has increased its obligations to creditors and has lowered its equity
"buffer."
A decrease in the cash current debt coverage ratio usually signals bad news for
the company because it means the company has been able to generate less cash
to meet its short-term obligations.
The debt to total assets ratio and cash total debt coverage ratio which indicate the
company's ability to repay the face value of the debt at maturity and periodic
interest payments.
The current ratio, working capital, and cash current debt coverage, which indicate
a company's liquidity and short-term debt-paying ability.
The earnings per share ratio and the price-earnings ratio. The earnings per share
measures the net earnings earned on each common share and the price-earnings
ratio measures the relationship between the market price per share and the
earnings per share.
2-6
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 2-1
(a)
(b)
(c)
(d)
(e)
(f)
General business and economic conditions
Predictive value
Feedback value
Verifiable
Conservative
Different companies use similar accounting principles
BRIEF EXERCISE 2-2
(a)
(b)
(c)
(d)
1.
2.
3.
4.
Predictive value.
Neutral.
Verifiable.
Timely
BRIEF EXERCISE 2-3
(a) Cost-Benefit.
(b) Materiality.
(c) Materiality.
BRIEF EXERCISE 2-4
CL
CA
PPE
PPE
CA
IA
Accounts payable
Accounts receivable
Accumulated amortization
Building
Cash
Goodwill
Solutions Manual
CL
LT I
PPE
CA
IA
CA
2-7
Income tax payable
Investment in long-term bonds
Land
Merchandise inventory
Patent
Supplies
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BRIEF EXERCISE 2-5
SWANN LIMITED
Balance Sheet (Partial)
Current assets
Cash
Short-term investments
Accounts receivable
Supplies
Prepaid insurance
Total current assets
$18,400
8,200
16,500
5,200
3,600
$51,900
BRIEF EXERCISE 2-6
(a)
2002
2001
Earnings per share:
Earnings per share:
$38,520
= $1.93 per share
19,956 shares
$36,323
= $1.82 per share
19,926 shares
Price-earnings ratio:
Price-earnings ratio:
$30.88
= 16 times
$1.93
$23.00
= 12.6 times
$1.82
(b)
Given that the number of common shares outstanding increased during the year, the increase
in earnings per share would indicate that profitability has improved in 2002. As well, investors
appear to have more confidence in Leon’s earnings as indicated by the increase in the priceearnings ratio in 2002.
Solutions Manual
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Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BRIEF EXERCISE 2-7
Share Capital
a.
b.
c.
d.
e.
Issued common shares
Paid a cash dividend
Reported net earnings
Paid cash to creditors
Issued preferred shares
Retained Earnings
+
NE
NE
NE
+
NE
+
NE
NE
BRIEF EXERCISE 2-8
(a) Current ratio
$252,787
= 0.86:1
$293,625
(b) Debt to total assets
$376,002
= 85.5%
$439,832
(c) Cash current debt coverage
$(2,574)
= (0.009) times
 $293,625  $240,819 


2


SOLUTIONS TO EXERCISES
EXERCISE 2-1
CL
Accounts payable and
accrued liabilities
CA
Accounts receivable
PPE Accumulated amortization
PPE Buildings
CA
Cash and temporary investments
CL
Dividends payable
IA
Goodwill
Solutions Manual
CA
LTI
PPE
LTL
CA
PPE
SC
CA
2-9
Inventories
Investments
Land
Long-term debt
Materials and supplies
Office equipment and furniture
Preferred shares
Prepaid expenses and other
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
CA
Financial Accounting, Second Canadian Edition
Income taxes receivable
EXERCISE 2-2
JUMBO ENTERTAINMENT INC.
Balance Sheet
February 28, 2003
Assets
Current assets
Cash and short-term investments
Accounts and current notes receivable
Inventory
Prepaid expenses
Total current assets
Property, plant and equipment
DVD and video rental library
Capital assets
$1,001,640
Less: Accumulated amortization
429,241
Total property, plant, and equipment
Intangible assets
Trademarks, franchise licences and goodwill
Total assets
Solutions Manual
2-10
$ 878,012
415,373
1,231,307
47,396
2,572,088
$166,994
572,399
739,393
3,789,744
$7,101,225
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
EXERCISE 2-3
(a) Net earnings
Retained earnings
=
=
=
Revenues – expenses
$18,180 – 780 – 5,360 – 2,600
$9,440
=
=
=
Beginning retained earnings + net earnings – dividends
$40,000 + 9,440 – 0
$49,440
(b)
SUMMIT’S BOWLING ALLEY LTD.
Balance Sheet
December 31, 2004
Assets
Current assets
Cash
Accounts receivable
Prepaid insurance
Total current assets
Property, plant and equipment
Land
Building
$105,800
Less: Accumulated
amortization
45,600
Equipment
$82,400
Less: Accumulated
amortization
18,720
Total property, plant and
equipment
Total assets
$20,840
14,520
4,680
$ 40,040
$61,200
60,200
63,680
185,080
$225,120
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable
Interest payable
Current portion of long-term debt
Total current liabilities
Mortgage payable
Total liabilities
Shareholders' equity
Common shares
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders' equity
Solutions Manual
2-11
$ 12,480
3,600
13,600
$ 29,680
80,000
109,680
66,000
0
49,440
115,440
$225,120
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
EXERCISE 2-4
THE JEAN COUTU GROUP (PJC) INC.
Balance Sheet
May 31, 2002
Assets
Current assets
Accounts receivable
Inventories
Prepaid expenses
Other current assets
Total current assets
Investments
Property, plant and equipment
Less: Accumulated amortization
Total property, plant and equipment
Intangible assets
Less: Accumulated amortization
Other assets
Total assets
$231,142
515,483
8,493
23,323
$ 778,441
236,679
$572,712
157,217
415,495
$265,743
60,479
205,264
25,726
$1,661,605
Liabilities and Shareholders' Equity
Current liabilities
Bank overdraft and bank loans
Accounts payable
Income taxes payable
Current portion of long-term debt
Total current liabilities
Long-term debt
Other long-term debt
Total liabilities
Shareholders' equity
Capital stock
Other shareholders’ equity
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders' equity
Solutions Manual
2-12
$ 46,360
296,044
10,106
32,618
$ 385,128
324,083
6,335
715,546
$203,763
20,711
721,585
946,059
$1,661,605
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
EXERCISE 2-5
(a)
BATRA CORPORATION
Statement of Earnings
Year Ended July 31, 2004
Revenues
Commission revenue
Rent revenue
Total revenues
Expenses
Salaries expense
Rent expense
Utilities expense
Amortization expense
Total expenses
Earnings before income taxes
Income tax expense
Net earnings
$73,100
18,300
91,400
48,700
10,800
4,900
3,975
68,375
23,025
8,000
$15,025
BATRA CORPORATION
Statement of Retained Earnings
Year Ended July 31, 2004
Retained earnings, August 1, 2003
Add: Net earnings
$25,200
15,025
40,225
4,000
Less: Dividends
Retained earnings, July 31, 2004 $36,225
EXERCISE 2-5 (Continued)
(b)
BATRA CORPORATION
Balance Sheet
July 31, 2004
Assets
Current assets
Cash
Short-term investments
Accounts receivable
Solutions Manual
$12,795
20,000
18,780
2-13
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
Supplies
Total current assets
Property, plant and equipment
Equipment
Less: Accumulated amortization
Total property, plant and equipment
Total assets
1,500
$53,075
$19,875
7,950
11,925
$65,000
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable
Long-term note payable
Total liabilities
Shareholders' equity
Common shares
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders' equity
Solutions Manual
2-14
$ 6,220
2,555
8,775
$20,000
36,225
56,225
$65,000
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
EXERCISE 2-6
(a) and (b)
2004
2003
Earnings per share:
Earnings per share:
$58,500 - $2,000
= $0.84 per share
67,000 shares
$81,000 - $2,000
= $1.15 per share
69,000 shares
Price-earnings ratio:
Price-earnings ratio:
$10.00
= 11.9 times
$0.84
$9.00
= 7.8 times
$1.15
(c)
The company was less profitable in 2004 than in 2003 as evidenced by its lower earnings
and earnings per share. However, given the increase in the price-earnings ratio, investors
still seemed to have a positive opinion about the future earnings prospects of the
company despite the decline in the earnings per share.
(d)
A potential investor may be more concerned about he decline in earnings per share and
wonder if the higher price-earnings ratio might mean that the share price is to high and
likely to fall in the near future.
Solutions Manual
2-15
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
EXERCISE 2-7
(a)
2003
Working capital
Current ratio
2002
$30,483  $32,617
 $(2,134)
$27,878  $27,282
$30,483
= 0.93:1
$32,617
$27,878
= 1.02:1
$27,282
 $596
(b) The decline in the working capital and current ratio indicate that Wal-Mart’s liquidity
deteriorated in 2003.
(c) For 2002, Wal-Mart’s current ratio is lower than the current ratio of both Sears and The
Bay. Wal-Mart’s current ratio is also lower than the industry average. This would indicate
that Wal-Mart is less liquid than Sears, The Bay and the industry as a whole.
Solutions Manual
2-16
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
EXERCISE 2-8
(a)
(b)
Debt to total assets =
Total debt
Total assets
2002 
$564,821
 34%
$1,656,248
2001 
$466,017
 30.4%
$1,532,557
Cash current debt coverage =
Cash provided from operating activities
Average current liabilities
$117,716
= 0.24 times
 $551,540  $437,946 


2


Cash total debt coverage =
Cash provided from operating activities
Average total liabilities
$117,716
= 0.23 times
 $564,821  $466,017 


2


(c) The Carnival’s solvency, a measure of its ability to survive over the long-term, has
deteriorated in 2002 versus 2001. Its debt to total assets ratio increased from 30.4% in
2001 to 34% in 2002. This means that in 2002, 34% of its assets were financed through
debt compared to 30.4% in 2001.
(d) In 2002, Carnival generated sufficient cash from its operating activities ($117,716) to
provide for the full amount of cash used in investing activities in the year ($107,393). Had
there been a deficiency, the deficiency could have been provided for out of cash the
organization had on hand at the beginning of the year. Alternatively, any deficiency could
have been covered through financing activities such as issuing debt.
Solutions Manual
2-17
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
SOLUTIONS TO PROBLEMS
PROBLEM 2-1A
(a) Generally accepted accounting principles are the accounting rules that have
substantial authoritative support and are recognized as a general guide for
financial reporting in Canada. In Canada, the primary responsibility for the
development of the generally accepted accounting principles rests with the
Canadian Institute of Chartered Accountants and is codified in the CICA
Handbook.
(b) Financial reporting is the term used to describe all of the financial information
presented by a company – both in its financial statements and in additional
disclosures in the annual report. The basic objective of financial reporting is to
communicate information that is useful to investors, creditors and others in
making investment and lending decisions and in assessing management
performance.
(c) In order for information provided in financial statements to be useful, it must
be understood by the users. Many investors may not understand detailed
scientific findings. While scientific findings, knowledgeable employees and
good customer relationships are important to business, these are nonfinancial performance measures. As such, they are not part of the financial
report. The information is relevant to users, but may not necessarily be
capable of being reliably measured. The fourth qualitative characteristic,
comparability, is not specifically addressed here.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
PROBLEM 2-2A
(a) Sears may feel that reporting its cost of merchandise sold separately in its
financial statements may provide its competitors with useful information. The
lack of disclosure in this area makes it more difficult for users of the financial
statements to evaluate the company’s performance.
(b) The two constraints in accounting are:
1. the cost-benefit constraint, which ensures that the value of the information
exceeds the cost of providing it; and
2. materiality relates to a financial statement item’s impact on a company’s
overall financial condition and operations.
Neither of these constraints likely impact Sears’ reporting policy with respect
to cost of goods sold. Sears may round its financial statements to the nearest
thousand dollars based on the materiality constraint.
Sears could hire more security guards, put in more security monitors, count
inventory daily, etc. as ways to monitor and control inventory theft. While they
do some of these, at some point the cost exceeds the benefit.
PROBLEM 2-3A
Account
Financial Statement Classification
Accounts payable
Balance Sheet: current liabilities
Accounts receivable
Balance Sheet: current assets
Accum. amortization, building
Balance Sheet: property, plant and
equipment
Balance Sheet: property, plant and
equipment
Statement of Earnings: expense
Accum. amortization, equipment
Amortization expense
Building
Cash
Solutions Manual
Balance Sheet: property, plant and
equipment
Balance Sheet: current assets
2-19
Chapter 2
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
Common shares
Balance Sheet: shareholders' equity
Cost of goods sold
Statement of Earnings: expense
Current portion of long-term debt
Balance Sheet: current liabilities
Dividends
Statement of Retained Earnings
Equipment
Income tax expense
Balance Sheet: property, plant and
equipment
Statement of Earnings: expense
Income taxes payable
Balance Sheet: current liabilities
Interest expense
Statement of Earnings: expense
Inventories
Balance Sheet: current assets
Land
Long-term debt
Balance Sheet: property, plant and
equipment
Balance Sheet: long-term liability
Prepaid expenses
Balance Sheet: current assets
Retained earnings, beginning of year Statement of Retained Earnings
Sales
Statement of Earnings: revenue
Selling expenses
Statement of Earnings: expense
Short-term investments
Balance Sheet: current assets
Wages payable
Balance Sheet: current liabilities
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Financial Accounting, Second Canadian Edition
PROBLEM 2-4A
INTRAWEST CORPORATION
Balance Sheet
June 30, 2002
(thousands)
Assets
Current assets
Cash and cash equivalents
$ 76,689
Amounts receivable
109,948
Other current assets
495,170
Total current assets
$ 681,807
Investment properties
468,218
Property, plant and equipment
Ski and resort operations
$1,125,603
Less: Accumulated amortization,
Ski and resort operation
283,762
Total property, plant and equipment
841,841
Goodwill
15,985
Other noncurrent assets
159,066
Total assets
$2,166,917
Liabilities and Shareholders' Equity
Current liabilities
Bank and other indebtedness,
current portion
$282,047
Amounts payable
195,254
Other current liabilities
99,484
Total current liabilities
$ 576,785
Long-term liabilities
Long-term liabilities
$138,991
Bank and other indebtedness,
noncurrent portion
773,872
Total long-term liabilities
912,863
Total liabilities
1,489,648
Shareholders' equity
Capital stock
$466,899
Retained earnings
210,370
Total shareholders’ equity
677,269
Total liabilities and shareholders' equity
$2,166,917
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Financial Accounting, Second Canadian Edition
PROBLEM 2-5A
(a)
BEAULIEU LIMITED
Statement of Earnings
Year Ended December 31, 2004
Service revenue
Expenses
Repair expense
Salaries expense
Rent expense
Utilities expense
Insurance expense
Amortization expense
Total expenses
Earnings before income taxes
Income tax expense
Net earnings
$82,000
3,200
36,000
18,000
3,700
1,200
7,000
69,100
12,900
6,500
$ 6,400
BEAULIEU LIMITED
Statement of Retained Earnings
Year Ended December 31, 2004
Retained earnings, January 1
Add: Net earnings
Less: Dividends
Retained earnings, December 31
$14,000
6,400
20,400
2,200
$18,200
PROBLEM 2-5A (Continued)
(b)
BEAULIEU CORPORATION
Balance Sheet
December 31, 2004
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Assets
Current assets
Cash
$ 8,200
Temporary investments
15,400
Accounts receivable
7,500
Prepaid insurance
1,800
Total current assets
Property, plant and equipment
Equipment
$32,000
Less: Accumulated amortization
10,500
Total property, plant and equipment
Total assets
$32,900
21,500
$54,400
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable
$12,000
Salaries payable
3,000
Income taxes payable
1,200
Total current liabilities
$16,200
Shareholders' equity
Common shares
$20,000
Retained earnings
18,200
Total shareholders’ equity
38,200
Total liabilities and shareholders' equity
$54,400
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Financial Accounting, Second Canadian Edition
PROBLEM 2-6A
(a)
COMMERCE CRUSADERS INC.
Statement of Earnings
Year Ended April 30, 2004
Sales
Expenses
Cost of goods sold
Operating expense
Wages expense
Amortization expense
Interest expense
Total expenses
Earnings before income tax
Income tax expense
Net earnings
$34,000
9,900
4,400
7,000
4,000
4,000
29,300
4,700
1,350
$ 3,350
COMMERCE CRUSADERS INC.
Statement of Retained Earnings
Year Ended April 30, 2004
Retained earnings, May 1
Add: Net earnings
$10,150
3,350
13,500
3,250
$10,250
Less: Dividends
Retained earnings, April 30
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Financial Accounting, Second Canadian Edition
PROBLEM 2-6A (Continued)
(b)
COMMERCE CRUSADERS INC.
Balance Sheet
April 30, 2004
Assets
Current assets
Cash
$ 5,700
Short-term investments
12,000
Accounts receivable
8,100
Inventories
9,670
Prepaid expenses
120
Total current assets
Property, plant and equipment
Land
Building
$15,370
Less accumulated amortization, building
1,500
Equipment
$12,200
Less accumulated amortization, equipment
5,000
Total property, plant and equipment
Total assets
Solutions Manual
2-25
$35,590
14,000
13,870
7,200
35,070
$70,660
Chapter 2
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Financial Accounting, Second Canadian Edition
PROBLEM 2-6A (Continued)
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable
Wages payable
Income taxes payable
Current portion of long-term debt
Total current liabilities
Long-term liabilities
Notes payable
Total liabilities
Shareholders' equity
Common shares
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders' equity
$8,340
2,220
1,350
4,500
$16,410
35,000
51,410
$ 9,000
10,250
19,250
$70,660
(c) The statement of earnings reports the net earnings for the period. This figure is
then used in the statement of retained earnings, along with dividends to
calculate the amount of retained earnings at the end of the period. The
retained earnings figure is used in the balance sheet to complete the
accounting equation.
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Financial Accounting, Second Canadian Edition
PROBLEM 2-7A
(a) Earnings per share:
Net earnings - Preferred dividends
Average number of common shares
Belliveau
Shields
$36,000
 $0.18 per share
200,000 shares
$173,000
= $0.43 per share
400,000 shares
Shields Corp. appears to be more profitable than Belliveau as it has higher
earnings per share.
Price-earnings Ratio:
Market price per share
Earnings per share
Belliveau
Shields
$7.00
= 16.28 times
$0.43
$2.50
 13.89 times
$0.18
Investors appear to have more confidence in the earnings and profitability of
Shields Corp. since the company has a higher price-earnings ratio than
Belliveau Corp.
(b) Current Ratio:
Current assets
Current liabilities
Belliveau
Shields
$130,000
 2.2 : 1
$60,000
$700,000
 2.8 : 1
$250,000
Shields’ 2004 current ratio of 2.8:1 is higher than Belliveau’s current ratio of
2.2:1, which suggests that Shields is slightly more liquid than Belliveau.
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Financial Accounting, Second Canadian Edition
PROBLEM 2-7A (Continued)
(b) (Continued)
Cash current debt coverage ratio:
Cash provided from operating activities
Average current liabilitie s
Belliveau
$20,000
= 0.4 times
 $60,000  $52,000


2
Shields
$185,000
= 0.7 times
 $250,000  $275,000


2
Shields’ ratio of 0.7 times versus Belliveau’s measure of 0.4 times suggests
that Shields is the more liquid of the two companies.
(c) Debt to total assets:
Total debt
Total assets
Belliveau
$110,000
 25.3%
$435,000a
Shields
$450,000
 30%
$1,500,000b
Belliveau appears to be more solvent. Belliveau’s 2004 debt to total assets
ratio of 25.3% is lower than Shields’ ratio of 30%. The lower the percentage of
debt to total assets, the lower the risk that a company may be unable to pay
its debts as they come due.
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Financial Accounting, Second Canadian Edition
PROBLEM 2-7A (Continued)
(c) (Continued)
Cash total debt coverage ratio:
Cash provided from operating activities
Average total liabilitie s
Belliveau
$20,000
 $110,000  $120,000c 


2


= 0.2 times
Shields
$185,000
 $450,000  $425,000d 


2


= 0.4 times
Shields’ cash total debt coverage ratio of 0.4 times suggests that Shields is
more solvent than Belliveau, which has a ratio of 0.2 times.
a
Total liabilities: $110,000 ($60,000 + $50,000) is Belliveau’s 2004 total
liabilities.
Total assets: $435,000 ($130,000 + $305,000) is Belliveau’s 2004 total
assets.
b
Total liabilities: $450,000 ($250,000 + $200,000) is Shields’ 2004 total
liabilities.
Total assets: $1,500,000 ($700,000 + $800,000) is Shields’ 2004 total assets.
c
Total liabilities: $120,000 ($52,000 + $68,000) is Belliveau’s 2003 total
liabilities.
d
Total liabilities: $425,000 ($275,000 + $150,000) is Shields’ 2003 total
liabilities.
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Financial Accounting, Second Canadian Edition
PROBLEM 2-8A
(a) Current ratio =
$246,500
= 1.55:1
$159,500
(c) Cash current debt coverage =
(d) Debt to total assets =
$55,600
= 0.35 times
 $159,500  $156,000


2


$291,500
= 35.9%
$811,800
(e) Cash total debt coverage =
$55,600
= 0.20 times
 $291,500  $276,000


2


(f) Earnings per share =
$82,900
= $11.84
7,000 shares
(g) Price-earnings ratio =
$34.00
= 2.9 times
$11.84
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Financial Accounting, Second Canadian Edition
PROBLEM 2-9A
(a)
2004
1.
2.
3.
4.
5.
2003
Earnings per share:
Earnings per share:
$46,000
= $0.60 per share
76,000 shares
$163,000
= $3.26 per share
50,000 shares
Price-earnings ratio:
Price-earnings ratio:
$4.00
= 6.6 times
$0.60
$6.00
= 1.8 times
$3.26
Working capital:
Working capital:
($50,000  $90,000  $80,000)
 $98,000  $122,000
($24,000  $65,000  $75,000)
 $75,000  $89,000
Current ratio:
Current ratio:
$220,000
= 2.24:1
$98,000
$164,000
= 2.19:1
$75,000
Debt to total assets:
Debt to total assets:
$98,000 $105,000
= 23.6%
$860,000
$75,000  $75,000
= 22.9%
$654,000
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Financial Accounting, Second Canadian Edition
PROBLEM 2-9A (Continued)
(b) The underlying profitability of the corporation has declined as indicated by the
decline in earnings and earnings per share. However, the decline in earnings
per share can also be attributed to some extent to the increase in the average
number of common shares from 50,000 in 2003 to 76,000 in 2004. It seems
investors still have confidence in the earnings of the company as the priceearnings ratio has improved despite the decline in profitability. However, the
increase in the P/E ratio may just be indicative of the fact that the shares are
overvalued and may decline in the future.
Despite the decline in earnings, the company’s liquidity position improved in
2004. Working capital increased by $33,000 ($122,000 - $89,000) and the
working capital ratio increased from 2.19:1 to 2.24:1. This means the
company now has more current assets on hand to repay its currently maturing
obligations.
Finally, Giasson Corporation’s solvency also appears to have remained fairly
constant in 2004, as total assets are financed only 23.6% by debt in 2004
versus 22.9% in 2003.
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Financial Accounting, Second Canadian Edition
PROBLEM 2-10A
(a) ($ in millions)
Abitibi
Working
Capital
Tembec
$1,640 - $1,415  $225
$1,273.5- $504.1 $769.4
$1,640
= 1.16:1
$1,415
$1,273.5
= 2.52:1
$ 504.1
Debt to
Total
Assets
$8,442
= 72.1%
$11,707
$2,771.2
= 67%
$4,138.8
Cash total
debt
coverage
$1,037
= 0.125 times
$8,301
$173.6
= 0.08 times
$2,303.8
$289
= $0.66 per share
440 shares
$77.9
= $0.95 per share
82 shares
$11.63
= 17.6 times
$0.66
$10.10
= 10.6 times
$0.95
Current
Ratio
Earnings
per share
Price earnings
ratio
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Financial Accounting, Second Canadian Edition
PROBLEM 2-10A (Continued)
(b) (Continued)
Liquidity
With a current ratio of 1.16 Abitibi appears to be less liquid then both Tembec
and the industry. Tembec’s current ratio of 2.52:1 is better than the industry
average of 1.23:1. Overall, Tembec is more liquid than both Abitibi and the
industry.
Profitability
Tembec is more profitable than Abitibi in that it has higher earnings per share.
Also, both companies have higher earnings per share than the industry.
However, investors appear to have more confidence in the earnings of Abitibi
as evidenced by Abitibi’s price-earnings ratio. However, a high price-earnings
ratio may indicate that Abitibi’s shares are overpriced. Both companies have
a lower price-earnings ratio than the industry.
Solvency
When looking at the debt to total asset ratio, Tembec appears to be more
solvent than Abitibi as less of Tembec’s assets are financed by debt.
However, Abitibi seems to be able to generate more cash form operations that
can be used to repay their liabilities as evidenced by Abitibi’s higher cash total
debt coverage ratio.
PROBLEM 2-1B
(a) The primary objective of financial reporting is to provide information for
decision making. In reporting the financial results of the company the financial
statements meet some of the investor’s need. There is other information that
investors need that is not part of the financial reporting package such as plans
for future growth and the experience of the management team.
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(b) Investors buy Net Nanny’s shares despite the losses because they expect the
company to do well in the long-term. This does not mean that the information
in the financial statements is not reliable or relevant. It does confirm that there
is additional information, not contained in a company’s financial statements,
that investors use when making investment decisions.
(c) The change in reporting currency will make the information easier for some
investors to use. It will be easier to compare Net Nanny’s results to similar US
companies. It will be necessary for Net Nanny to restate its previous years
statements for comparability.
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Financial Accounting, Second Canadian Edition
PROBLEM 2-2B
The two constraints in accounting are:
1. the cost-benefit constraint, which ensures that the value of the information
exceeds the cost of providing it; and
2. materiality relates to a financial statement item’s impact on a company’s
overall financial condition and operations.
The Empire Company Limited has almost ten billion dollars in revenue. The type
of information that Ryan is looking for, such as sales and cost data by various
categories, is generally not disclosed in external financial statements. It would be
prohibitively expensive to present such information to external users, and have it
verified by external auditors. The company quite likely has internal reports with
data on various ticket and concession sales. However, the information used by
management is not always material to external users. As well, companies like to
guard against disclosure of information if doing so would weaken their competitive
position.
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Financial Accounting, Second Canadian Edition
PROBLEM 2-3B
Account
Balance Sheet Category
Accounts payable and accrued liabilities
Accounts receivable
Buildings
Cash and cash equivalents
Common shares
Customers’ deposits
Dividends payable
Future income tax liabilities
Current liabilities
Current assets
Property, plant and equipment
Current assets
Shareholders’ equity
Current liabilities
Current liabilities
Current liabilities or long-term
liabilities
Current assets
Current assets
Property, plant and equipment
Property, plant and equipment
Long-term liabilities
Current assets
Shareholders’ equity
Property, plant and equipment
Income taxes recoverable
Inventory
Land
Leasehold improvements
Long-term liabilities
Marketable securities
Retained earnings
Vehicles
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Financial Accounting, Second Canadian Edition
PROBLEM 2-4B
YAHOO! INC.
Balance Sheet
December 31, 2002
Assets
Current assets
Cash and cash equivalents
Short-term investments
Accounts receivable
Prepaid expenses and
other current assets
Total current assets
Long-term investments
Property and equipment, net
Intangible assets, net
Goodwill
Other assets
Total assets
$310,972
463,204
113,612
82,216
$ 970,004
763,408
371,272
96,252
415,225
174,020
$2,790,181
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable
$ 18,738
Deferred revenue—current
135,501
Accrued expenses and
other current liabilities
257,575
Total current liabilities
$ 411,814
Other liabilities
116,097
Total liabilities
527,911
Shareholders’ equity
Common stock
$2,270,845
Other shareholders’ equity
(1,082)
Deficit
(7,493)
Total shareholders’ equity
2,262,270
Total liabilities and shareholders’ equity
$ 2,790,181
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Financial Accounting, Second Canadian Edition
PROBLEM 2-5B
(a)
MBONG CORPORATION
Statement of Earnings
Year Ended December 31, 2004
Service revenue
Expenses
Repair expense
Salaries expense
Rent expense
Utilities expense
Insurance expense
Amortization expense
Supplies expense
Total expenses
Earnings before income taxes
Income tax expense
Net earnings
$65,000
1,800
35,000
12,000
1,700
2,200
2,600
700
56,000
9,000
3,000
$ 6,000
MBONG CORPORATION
Statement of Retained Earnings
Year Ended December 31, 2004
Retained earnings, January 1
Add: Net earnings
Less, Dividends
Retained earnings, December 31
$16,000
6,000
22,000
2,000
$20,000
PROBLEM 2-5B (Continued)
(b)
MBONG CORPORATION
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Financial Accounting, Second Canadian Edition
Balance Sheet
December 31, 2004
Assets
Current assets
Cash
$13,600
Accounts receivable
13,500
Supplies
1,000
Prepaid insurance
3,500
Total current assets
Investments
Property, plant and equipment
Equipment
$13,000
Less: Accumulated amortization
5,600
Total property, plant and equipment
Total assets
$31,600
22,300
7,400
$61,300
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable
$13,300
Salaries payable
3,000
Total current liabilities
$16,300
Note payable
5,000
Total liabilities
21,300
Shareholders' equity
Common shares
$20,000
Retained earnings
20,000
Total shareholders’ equity
40,000
Total liabilities and shareholders' equity
$61,300
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Financial Accounting, Second Canadian Edition
PROBLEM 2-6B
(a)
CHEUNG CORPORATION
Statement of Earnings
Year Ended April 30, 2004
Fee revenue
Expenses
Salaries expense
Rent expense
Interest expense
Amortization expense
Total expenses
Earnings before income taxes
Income tax expense
Net earnings
$32,590
6,840
6,000
342
4,610
17,792
14,798
4,500
$10,298
CHEUNG CORPORATION
Statement of Retained Earnings
Year Ended April 30, 2004
Retained earnings, May 1, 2003
Add: Net earnings
Less: Dividends
Retained earnings, April 30, 2004
$13,960
10,298
24,258
3,650
$20,608
PROBLEM 2-6B (Continued)
(b)
CHEUNG CORPORATION
Balance Sheet
April 30, 2004
Assets
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Current assets
Cash
$20,263
Short-term investments
11,000
Accounts receivable
7,840
Prepaid rent
500
Total current assets
Property, plant and equipment
Equipment
$23,050
Less: Accumulated amortization
9,220
Total property, plant and equipment
Total assets
$39,603
13,830
$53,433
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable
$5,972
Interest payable
28
Income taxes payable
1,125
Total current liabilities
$ 7,125
Notes payable
5,700
Total liabilities
12,825
Shareholders' equity
Common shares
$20,000
Retained earnings
20,608
Total shareholders’ equity
40,608
Total liabilities and shareholders' equity
$53,433
(c) The statement of earnings reports the net earnings for the period. This figure
is then used in the statement of retained earnings, along with dividends to
calculate the amount of retained earnings at the end of the period. The
retained earnings figure is used in the balance sheet to complete the
accounting equation.
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Financial Accounting, Second Canadian Edition
PROBLEM 2-7B
(a) Earnings per share:
Net earnings - Preferred dividends
Average number of common shares
Chen
Cassie
$311,630
=$3.12 per share
100,000shares
$113,040
= $2.26 per share
50,000 shares
Chen Corporation appears to be more profitable than Cassie as it has higher
earnings per share.
Price-Earnings Ratio:
Market price per share
Earnings per share
Chen
Cassie
$25.00
 8.0 times
$3.12
$14.00
= 6.2 times
$2.26
Investors appear to have more confidence in the earnings and profitability of
Chen Corporation since the company has a higher price-earnings ratio than
Cassie Corporation.
(b) Working Capital:
Current assets – current liabilities
Chen
Cassie
$425,975 $66,325  $359,650
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$190,336 $35,458  $154,878
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Financial Accounting, Second Canadian Edition
PROBLEM 2-7B (Continued)
(b) (Continued)
Current Ratio:
Current assets
Current liabilities
Chen
Cassie
$190,336
 5.4 : 1
$35,458
$425,975
 6.4 : 1
$66,325
Chen’s 2004 current ratio of 6.4:1 is higher than Cassie’s current ratio of
5.4:1, which suggests that Chen is slightly more liquid than Cassie.
Cash current debt coverage ratio:
Cash provided from operating activities
Average current liabilitie s
Chen
Cassie
$162,594
$24,211
= 2.3
= 0.7
 $35,458  $30,281
 $66,325 $75,815




2
2
Chen’s cash current debt coverage ratio of 2.3 times is 3 times that of Cassie,
showing that Chen is more liquid.
(c)
Debt to total assets:
Total liabilitie s
Total assets
Chen
Cassie
$65,078
 19.7%
$330,064b
$174,825
 18.5%
$947,285a
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
PROBLEM 2-7B (Continued)
(c) (Continued)
Chen appears to be slightly more solvent. Chen’s 2004 debt to total assets
ratio of 18.5% is lower than Cassie’s ratio of 19.7%. The lower the percentage
of debt to total assets, the lower the risk that a company may be unable to pay
its debts as they come due.
Cash total debt coverage ratio:
Cash provided from operating activities
Average total liabilitie s
Chen
$162,594
= 0.95
 $174,825 $165,815c 


2


Cassie
$24,211
= 0.4
 $65,078  $55,281d 


2


Chen’s cash total debt coverage ratio of 0.95 times also suggests that Chen is
more solvent than Cassie, which has a ratio of 0.4 times.
a
Total liabilities: $174,825 ($66,325 + $108,500) is Chen’s 2004 total liabilities.
Total assets: $947,285 ($425,975 + $521,310) is Chen’s 2004 total assets.
b
Total liabilities: $65,078 ($35,458 + $29,620) is Cassie’s 2004 total liabilities.
Total assets: $330,064 ($190,336 + $139,728) is Cassie’s 2004 total assets.
c
Total liabilities: $165,815 ($75,815 + $90,000) is Chen’s 2003 total liabilities.
d
Total liabilities: $55,281 ($30,281 + $25,000) is Cassie’s 2003 total liabilities.
PROBLEM 2-8B
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(a) Working capital = $444,900 $142,500 $302,400
(b) Current ratio =
$444,900
= 3.1:1
$142,500
(c) Cash current debt coverage =
(d) Debt to total assets =
$74,900
= 0.60 times
 $142,500  $107,400


2


$452,500
= 42.3%
$1,070,200
(e) Cash total debt coverage =
$74,900
= 0.20 times
 $452,500  $307,400


2


(f) Earnings per share =
$122,300
= $2.45
50,000 shares
(g) Price-earnings ratio =
$7.00
= 2.9 times
$2.45
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
PROBLEM 2-9B
(a)
2004
1.
2.
3.
4.
5.
2003
Earnings per share:
Earnings per share:
$94,000
= $1.15 per share
82,000 shares
$52,000
= $0.65 per share
80,000 shares
Price-earnings ratio:
Price-earnings ratio:
$66.00
= 57.4 times
$1.15
$44.00
= 67.7 times
$0.65
Working capital:
Working capital:
$(25,000  $70,000  $90,000)
$(20,000  $65,000  $70,000)
- $75,000  $110,000
- $80,000  $75,000
Current ratio:
Current ratio:
$185,000
= 2.46:1
$75,000
$155,000
= 1.94:1
$80,000
Debt to total assets:
Debt to total assets:
$75,000 $86,000
= 21.2%
$760,000
$80,000 $110,000
= 27.7%
$685,000
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
PROBLEM 2-9B (Continued)
(b) The underlying profitability of the corporation has improved as evidenced by
the improvement in earnings and earnings per share. However, it seems
investors have less confidence in the future earnings of the company as the
price-earnings ratio has declined despite the increase in profitability.
The company’s liquidity position improved in 2004. Working capital increased
by $35,000 ($110,000 - $75,000) and the current ratio increased from 1:94:1
to 2.46:1. This means the company now has more current assets on hand to
repay its currently maturing obligations.
Finally, Pitka Corporation’s solvency also appears to have improved in 2004,
as total assets are financed only 21.2% by debt in 2004 versus 27.7% in 2003.
The lower the percentage of debt to total assets, the lower the risk that a
company may be unable to pay its debts as they come due.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
PROBLEM 2-10B
(a) ($ in thousands)
Big Rock
Working
capital
Current
ratio
Debt to
total
assets
Cash
current
debt
coverage
Cash total
debt
coverage
Earnings
per share
Price
earnings
ratio
Solutions Manual
Sleeman
$6,492.3- $5,357.9  $1,134.4 $44,511- $46,315 $1,804
$6,492.3
= 1.21:1
$5,357.9
$44,511
= 0.96:1
$46,315
$11,276.6
= 34.1%
$33,060.7
$124,554
= 63%
$197,642
$2,580.5
= 0.52 times
$4,916.8
$18,984
= 0.44 times
$43,044.5
$2,580.5
= 0.22 times
$11,792.3
$18,984
= 0.15 times
$122,089.5
$1,217.8
5,167.7 shares
$9,765
15,223 shares
= $0.24 per share
= $0.64 per share
$5.50
= 22.9 times
$0.24
$9.73
= 15.2 times
$0.64
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Financial Accounting, Second Canadian Edition
PROBLEM 2-10B (Continued)
(b) Liquidity
With a current ratio of 1.21 Big Rock appears to be more liquid than both
Sleeman and the industry. Sleeman’s current ratio of 0.96 is even less than
the industry average of 1.18:1. As well, Big Rock has been able to generate
more cash to repay it current liabilities as indicated by Big Rock’s higher cash
current debt coverage ratio. Overall, it appears that Big Rock is more liquid
than both Sleeman and the industry.
Profitability
Sleeman is more profitable than Big Rock in that it has a higher earnings per
share. However, investors appear to have more confidence in the earnings of
Big Rock as evidenced by Big Rock’s higher price-earnings ratio. Both
companies have higher earnings per share than the industry. However, both
companies have a much lower price-earnings ratio than the industry.
Solvency
Big Rock appears more solvent than Sleeman. It betters Sleeman in the debt
to total assets ratio and in the cash total debt coverage ratio.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-1 FINANCIAL REPORTING PROBLEM
(a) Total current assets were $3,526,000,000 at December 28, 2002, and $3,086,000,000 at
December 29, 2001.
(b) Current assets are properly listed in the order of liquidity. As you will learn in a later chapter,
inventories are considered to be less liquid than receivables. They are listed below
receivables and before prepaid expenses.
(c) The asset classifications are similar to the text: current assets, followed by non-current
assets such as fixed assets, goodwill, future income taxes and other assets.
(c) Total current liabilities were $3,154,000,000 at December 28, 2002, and $2,796,000,000 at
December 29, 2001.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-2 COMPARATIVE ANALYSIS PROBLEM
(a)
Loblaw (millions)
Sobeys (millions)
1. Working capital
$3,526 - $3,154  $372
$1,094 - $1,180.5  $86.1
2. Current ratio
$3,526
 1.12 :1
$1,094.4
 63%
$1,755.7
$3,154
3. Debt to total
assets
4. Earnings per
share
$6,986
$11,110
$728
276.2 shares
5. Price-earnings
ratio
$1,180.5
$3,192.5
 0.93 : 1
 55%
$179.0
 $2.64
65.9 shares
$36.75
$54.00
= 20.5 times
$2.64
$2.72
 $2.72
= 13.5 times
(b) Sobeys has a negative working capital and a current ratio of less than one. Loblaw has a
positive working capital and a current ratio which indicates the company has sufficient
assets to cover its current liabilities. Using these ratios it appears that Sobeys is in worse
condition based on relative liquidity.
Based on the debt to total assets ratio it appears that Loblaw is less solvent than Sobeys.
Because Sobeys’ debt to total assets ratio is lower than Loblaw’s, Sobeys would be
considered better able to pay its debts as they come due.
Based on earnings per share Sobeys appears to be more profitable than Loblaw. Sobeys
has been able to generate $2.72 in earnings for each common share while Loblaw has
only generated $2.64. However, as indicated by the higher price earnings ratio, investors
appear to have more confidence in Loblaw’s earnings and relatively seem to be willing to
pay more for Loblaw’s shares.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-3 RESEARCH CASE
The students' answers depend on the company and article selected.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-4 INTERPRETING FINANCIAL STATEMENTS
(a) The percentage increase in The Gap’s total assets during this period is calculated as:
$9,902 – $3,964
= 150%
$3,964
The average increase per year can be approximated as:
150%
= 37.5% per year
4 years
(b) The Gap’s working capital increased significantly during this period, while
its current ratio also improved. The improvement in the current ratio would suggest that
The Gap’s liquidity improved. The current ratio is a better measure of liquidity because it
provides a relative measure; that is, current assets compared to current liabilities. Working
capital only tells us the net amount of current assets and current liabilities. It is hard to say
whether a given amount of working capital is adequate or inadequate without knowing the
size of the company. Another problem with interpreting The Gap’s working capital is that it
fluctuated considerably during the period. The Gap’s current ratio may have improved
because the clothing chain expanded rapidly during this period. With expansion comes the
need to carry additional inventories which is a significant component of current assets.
(c) The debt to total assets ratio suggests that The Gap’s solvency declined during the period,
as the percentage of debt used to finance its assets increased. However, this could be
due to the additional funds required to finance the company’s growth over the past several
years.
(d) The company’s earnings per share have decreased over the past several years. The
average earnings per share from 1998 to 2002 was:
[$0.55  $(0.01)  $1.03  $1.32  $0.95]
 $0.77
5
On the average, earnings per share has declined which might cause some investors to
have concerns about the company’s future prospects. However, investors would need
information concerning the change in the number of common shares outstanding to fully
assess the earnings per share, as the decline in EPS could be related to increases in the
number of shares rather than decreases in profitability.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-5 A GLOBAL FOCUS
(a) By switching to US reporting standards, a company’s statements would be more relevant
to the company’s US investors (present and potential). This may make it easier for them to
raise funds in the US, a much larger capital base than Canada. It will make it easier for US
investors to understand the statements because they will use standards that they are
familiar with and it will be easier for them to make comparisons with US companies. Many
non-US companies use US standards. The disadvantages associated with such a change
include making it more difficult for Canadian investors to understand the statements and
make comparisons to company’s using Canadian standards. It will also increase the
financial reporting costs—the company will be required to reconcile the statement prepared
using the different standards. The impact of the switch on a company’s net earnings could
be either an advantage or disadvantage depending on the individual circumstance of the
company.
(b) The use of country specific accounting policies may hinder my comparison. When different
standards are used the impact on reported earnings and financial performance can be
significant. In order to compare apples and apples, a conversion of one of the sets of
statements may be required. This may require significant time and expertise. Many
Canadian companies include a reconciliation to US GAAP in their financial statements to
help with this.
(c) Comparison of Canadian companies that use different accounting policies would be difficult
as the use of different policies can have a significant impact on reported earnings and
financial performance.
(d) There is no significant distinction between comparing statements prepared in different
countries and statements prepared in the same country using different accounting policies.
In either case the policies will have to be reconciled in order to make valid comparisons.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-6 FINANCIAL ANALYSIS ON THE WEB
Due to the frequency of change with regard to information available on the World Wide Web,
the Accounting on the Web cases are updated as required. Their suggested solutions are also
updated whenever necessary, and can be found in the Instructor Resources section of our
homepage (www.wiley.com/canada/kimmel
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-7 COLLABORATIVE LEARNING ACTIVITY
The current ratio increase is a favourable indication as to liquidity, but alone tells little about the
prospects of the client. From this ratio change alone, it is impossible to know the amount and
direction of the changes in individual accounts, total current assets, and total current liabilities.
Also unknown are the reasons for the changes.
The working capital increase is also a favourable indication as to liquidity, but again the amount
and direction of the changes in individual current assets and current liabilities cannot be
determined from this measure.
The decrease in the debt to total assets ratio is a favourable indicator for solvency and goingconcern prospects. The lower the percentage of debt to total assets, the lower the risk that a
company may be unable to pay its debts as they come due. A decline in the debt to total assets
ratio is also a positive sign regarding going-concern potential.
The increase in net earnings is a favourable indicator for both solvency and profitability
prospects although much depends on the quality of receivables generated from sales and how
quickly they can be converted into cash. Indirectly, the improved income picture may have a
favourable impact on solvency and going concern potential by enabling the client to borrow
currently to meet cash requirements.
The earnings per share increase is a favourable indicator for profitability. The fact that the EPS
more than doubled during the year indicates a significant increase in net earnings and provides
a favorable sign regarding going concern potential. However, investors should check to ensure
that the increase in earnings per share was not due to a major decrease in the average number
of common shares outstanding
The increase in price-earnings ratio indicates that investors have confidence in the earnings of
the company and are willing to pay a premium for the shares. However, investors may be
cautious about buying if the P/E ratio is too high as it may indicate that the company’s shares
are overpriced.
Overall, Soukup’s liquidity, solvency, and profitability do appear to be improving. Its liquidity has
improved, although further investigation is warranted into receivables and inventory turnovers
before concluding on this matter. The company’s solvency has improved, with the decline in the
debt to total assets ratio. The company’s profitability has also improved.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-8 COMMUNICATION ACTIVITY
To:
S.B. Barrett
From:
Accounting Major
Subject:
Financial Statement Analysis
Ratios can be classified into three types, which measure three different aspects of a company's
financial health:
(a) Liquidity ratios—These measure a company's ability to pay its current obligations.
Examples of liquidity ratios include the current ratio (current assets/current liabilities) and
the cash current debt coverage ratio (cash provided by operating activities/average current
liabilities).
(b) Solvency ratios—These measure a company's ability to pay its long-term obligations and
survive over the long-term.
Examples of solvency ratios include the total debt and total assets ratio (total liabilities/total
assets) and the cash total debt coverage ratio (cash provided by operating
activities/average total liabilities).
(c) Profitability ratios—These measure the ability of the company to generate a profit.
Examples of profitability ratios include the earnings per share (net earnings - preferred
dividends) ÷ (average number of common shares outstanding) and the price-earnings ratio
(market price per common share ÷ earnings per share).
There are three bases for comparing a company's results:
(a) Intracompany—This basis compares an item or financial relationship within a company in
the current year with the same item or relationship in one or more prior years.
(b) Industry averages—This basis compares an item or financial relationship of a company
with industry averages (or norms).
(c) Intercompany—This basis compares an item or financial relationship of one company with
the same item or relationship in one or more competing companies.
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Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
BYP 2-9 ETHICS CASE
(a) The stakeholders in this case are:
Kathy Johnston, controller.
Redondo’s vice-president.
Users of the company's financial statements.
(b) The ethical consideration in the situation is whether or not the early implementation of the
new standard would affect the decisions of the users of the financial statements. Because
early adoption is only suggested and not required, the vice-president is fully within his
rights to delay implementation of the standard. However, it is ethically preferable to
disclose the most financially relevant information to the users of the financial statements so
that they can make informed decisions.
(c) As controller, by supporting early implementation Kathy could gain the trust and respect of
the board of directors and the shareholders in general. The users of the company’s
financial statements will be affected by the decision against early implementation as their
decision-making may be influenced by the presentation of the company’s financial results
using the old standards.
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Financial Accounting, Second Canadian Edition
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