Friedlan4e SM Ch12

CHAPTER 12
Analyzing and Interpreting Financial Statements

QUESTIONS
Q12-1
From an entities perspective its not possible to identify the most important stakeholder; it
depends on the entitys circumstances. For example, a company needing equity capital would
consider prospective shareholders most important. A company with few external stakeholders
might focus on tax minimization. From the stakeholders perspective they would consider
themselves the most important as they rely of the financial statements to form their financial
decision i.e. whether to invest or lend.
Q12-2
Net Income is a measure of the extent to which economic benefits exceed economic costs. Under
IFRS and ASPE it measures how much better off an entitys owners are. Economic benefits are
defined as revenues and economic sacrifices as expenses. Measurement of revenues and
expenses depend on the definitions provided by the accounting standards. Under IFRS (and to a
lesser extent under ASPE) net income reflects unrealized gains and losses as well as realized
ones. Measuring net income (and revenue and expenses) requires judgement to determine when
and how much revenue and expenses belongs in a particular period and estimates of uncertain
future amounts.
Q12-3
Eliminating choice from accounting standards would solve some problems but create different
ones. By eliminating choice a stakeholder could be confident about how an entity was doing its
accounting; everyone would recognize revenue at the same point and depreciate its assets the
same way. However, eliminating choice would result in accounting for all transaction of a certain
type even if the circumstances of those transactions were different (selling merchandise to
customers who had a high probability of paying versus ones that were high risk of not paying). If
managers could be relied on to do the right thing (not behave self-interestedly) then unlimited
choice would make sense as they would always choose the accounting method that best reflected
the economic circumstances of the transaction.
Q12-4
Permanent earnings are expected to be repeated in the future, while transitory earning arent. For
example, sales may increase temporarily when a competitor is shut down by a strike. If you
expect that most of those customers will resume purchasing from the competitor when the strike
is over, those earnings are transitory. The distinction is extremely important if you want to
predict future profits and assess the value of the company.
John Friedlan, Financial Accounting: A Critical Approach, 4th edition

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Copyright 2013 McGraw-Hill Ryerson Ltd.
Q12-5
One of the major concerns would be that the companies may have chosen different accounting
policies. Even if they use the same policies, they may implement the policies in different ways
and may use different estimates, such as the useful lives of store fixtures. For that reason, the net
income for the current period wouldnt be comparable. Financial statements provide descriptions
and accounting policies and significant estimates, but these are often very vague and the
information needed to adjust financial statements to be more comparable isnt disclosed. There
might also be differences in the nature of the businesses that make them not perfectly
comparable. These differences could be the actual business activities of the entity, how each runs
its business, the markets it operates in, the risks it takes, and so on. Information about these can
be found in the popular media, research reports, and the management discussion and analysis, to
name a few.
Q12-6
Information is power. Understanding an entity makes the financial statements more informative.
There are many items of information that could assist the reader to better understand the
financial statements or to assess the risk faced by the company or its future prospects. For
example, if you know that a major contract has been cancelled or that one customer represents
75% of the companys sales and receivables, your beliefs about the prospects of the firm could
change significantly. In particular, if you are an equity investor in a publicly traded company, you
cant afford to be unaware of information that is broadly known to other investors. In general,
more and better information leads to better, more informed decisions. The main constraint
against gathering additional information is the cost (time and money), in other words gathering
information must be assessed in a cost-benefit context.
Q12-7
Its not advisable to lend money based solely on the financial statements because the are many
aspects of the decision that arent reflect in the statements. Lenders are concerned with being
paid back, which is a future oriented decision. Lenders must take into consider the future
prospects of an entity, many of which wont be reflected in the financial statements (which are
transactions based). Also consideration of factors such as the quality and integrity of
management should be considered.

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Q12-8
(More about each of these caveats can be found in the in the section called Some Limitations
and Caveats about Financial Statements and Financial Statement Analysis.)
Since IFRS financial statements are historical, their predictive value is limited when the
future will differ from the past.
IFRS financial statements are prepared by managers, who understand the entity better than
others, but who also have an interest in biasing the financial statements to serve their selfinterest.
IFRS financial statements arent comprehensive, since the firm may have assets and
liabilities that arent represented.
IFRS financial statements are affected by accounting policy choices and estimates.
The comparability of IFRS financial statements is often difficult since the information
needed to eliminate differences among companies is rarely available.
IFRS financial statements arent the only source of relevant information. Other sources of
information are available and should be consulted.
IFRS financial statements dont necessarily provide explanations for problems that are
identified. Analysis of accounting information and other sources of information are needed to
get to the root of the problem.
Q12-9
The problem for users is that because managers make the accounting choices, they can choose
methods that suit their interests or the interests that are most important to them. The choices that
managers make are rarely transparent, with the result that it isnt possible to assess what biases
are present. On the other hand, choice provides managers with the ability to choose the most
appropriate way to accounting for a transaction.
For example, managers can choose to expense or capitalize certain expenditures, the useful lives
or residual values of long-lived assets, and when to recognize revenue. They choose inventory
valuation methods, depreciation methods, and make estimates like uncollectible amounts and
obsolete inventory. (Many other examples can be offered.)
Q12-10
In one sense, more liquidity is better since the ability of the entity to meet its obligations as they
become due is essential to survival. However, if liquidity is attained by holding excessive
amounts of cash or temporary investments, the company may be earning a low return on those
assets (because cash in a non-productive asset) and the wealth of the shareholders may be
reduced.

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Q12-11
The current ratio includes assets such as inventory or prepaid expenses that may not be quickly
converted into cash and therefore arent available to pay suppliers and employees in the next few
weeks. The quick ratio is therefore a better indicator since it doesnt include these items.
Q12-12
A prospective equity investor would want to be able to separate permanent from transitory
earnings to estimate the profitability of the company so he could determine the price he would be
willing to pay for the shares. Transitory earnings dont recur so its important for the prospective
investor to separate them out so that they can get a sense of what future earnings will be.
Q12-13
Earnings quality is the usefulness of current earnings for predicting future earnings. When
earnings are high in quality, there is a close relationship between current earnings and future
earnings. When earnings quality is low the correlation between current and future earnings is
low.
Q12-14
a.
Earnings quality is reduced since the current period will be less predictive of future
earnings. The advertising expense has been increased for one period only after which
time the expense will be reduced.
b.
To a degree, earnings quality is sacrificed, since the expense matched against revenues
differs between past and future periods. If the change in estimate results in a better
relationship between expenses and revenue earnings quality will ultimately be improved.
c.
Earnings quality at the transition is reduced, but earnings quality in the future could be
considered to be improved since the costs matched against revenues are more reflective
of the current costs of the resources used.
Q12-15
Common size financial statements express amounts in a years financial statements as a
percentage of another element of the same years statements (for example, the income statement
for 2017 would restate all the amounts in the statement as a proportion of 2017 revenue). These
statements help the users to see at a glance the proportions of each component of the statements.
Common size financial statements eliminate the effect of size and make it easier (in some
respects) to make comparisons over time and among entities. For example, one can readily see
that inventory has increased as a portion of total assets or how certain expenses have changed
relative to sales.

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Q12-16
Trend financial statements show the proportional change in each account relative to a base year.
The user is helped by being able to compare changes in various accounts. For example, the user
could see at a glance that inventory has increased by 25% over three years while sales have only
increased by 10%.
Q12-17
Liquidity is the availability of cash and near-cash resources, which are necessary for meeting
payments as they come due. Since the primary concern of a supplier is whether the customer will
pay for purchases, an assessment of the ability to pay bills is very relevant.
Q12-18
Accounts receivable turnover provides information about how long it takes for a company to
collect amounts owing to it. The higher the turnover the more quickly cash is being collected and
the more liquid the entity is. Inventory turnover measures how fast inventory is selling, the
higher the turnover the more quickly inventory is being sold and the less time cash is tied up in
inventory. With less cash invested in inventory the more liquidity the entity will have (the entity
will have cash instead of inventory). It should be noted that management may make choices and
estimates that affect these turnover ratios. For example, increasing allowance for doubtful
account will increase accounts receivable turnover and writing off inventory will increase
inventory turnover.
Q12-19
Financial statement information is a window, but only one window, on an organization. Without
considering other sources of information, a more complete view of the entity isnt obtained. Also,
the information that is provided in financial statements is designed for a broad group of users,
not a particular user or every user. The bank will likely want to know if a large percentage of
accounts receivable is owed by one customer, as the creditworthiness of that customer will affect
the risk that some of the receivables wont be collected. A supplier might want to know how
prompt the company is in paying its bills and could obtain that information by asking the
company for credit references, by talking to the companys bank or by purchasing a credit report
from one of the companies providing such information. Also, IFRS/ASPE statements have
limiting assumptions. For example, IFRS/ASPE statements tell what happened; they arent
intended to be predictions of the future. Generally, future-oriented information isnt provided in
financial statements. Also, financial statements dont provide detailed information about
management or strategy. Other useful sources of information include the media, press releases
issued by the company, the MD&A, reports by analysts, reports by credit agencies, among
others.

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Q12-20
A covenant is a restriction that imposes limits on the actions of an entity. For example, covenants
could restrict payment of dividends, limit the sale or purchase of capital assets, or require certain
levels of financial ratios. They are often included in lending agreements to provide lenders with
assurance that certain actions wont be taken that increase the risk of the loan. Generally, since
the covenants reduce the risk of the loan, a lower interest rate will be required than would be the
case without the covenants. Many covenants involve agreements to maintain certain
relationships, which are measured and reported on the financial statements. The financial
statements then serve as a basis for assessing whether those covenants, such as the debt to equity
ratio, have been respected. Covenants are often stated in accounting terms because financial
statements must be prepared by entities, they are prepared on a standard basis, and they can be
check through an audit of the financial statements.
Q12-21
Covenants on a borrower mitigates risks of default by the borrower. As a result when a borrower
agrees to covenants and abides by them I would be more likely to offer a loan and a lower
interest rate because the risk is lower.
Q12-22
Creditors want to know whether the company has the ability to pay, which is a concern with
liquidity, what will occur if the payments arent made, which is a concern about the availability
and value of security, and that the borrower adheres to lending agreements by complying with
covenants. Many sources of information are available to the user about liquidity, including the
current assets and current liabilities, and cash flow from operations. A schedule of expected cash
receipts and disbursements would also be very helpful. Information about the assets available to
the lender and their liquidation value would be important information about the security
available. Details about receivables, inventory, and plant, property, and equipment are the
primary items that the company could provide. For plant, property, and equipment it would be
useful to know their market values. It would also be important for a lender to know whether and
which assets have been pledged to other creditors. Information could be obtained from the entity
itself, people who value property (to obtain market values of capital assets) and credit agencies
that could provide information about how reliable the entity has been about meeting its
obligations. Lastly by requesting audited financial statements the lender may rely on ratio
calculations to ensure covenants arent in breach.
Q12-23
Long-term creditors have a longer time horizon than short-term creditors. For example, a lender
might finance a piece of machinery with equal monthly payments over ten years while a supplier
of inventory expects payment within 30 days after delivery. The inventory supplier doesnt need
to believe that the company will still be in business ten years from now but the term lender who
financed the equipment needs significant assurance that the company will be able to make the
payments for the duration of the loan. Short-term creditors are primarily interested in liquidity
and collateral while long-term lenders are also interested in solvency.

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Q12-24
Any information that is relevant to any other user of financial statements is also relevant to
equity investors, since any change in the way that other users view the prospects of the firm
affects the interests of the owner. For example, if the bank views the company as less
creditworthy, the company will find it more difficult to obtain needed financing and will pay
higher interest rates. The increased riskiness of the firm will have economic consequences for the
shareholders (more interest means less profit). Additionally, since the share price of a publicly
traded company quickly adjusts to reflect all publicly available information, the equity investor
who lacks some of that information will be misled in making decisions about the value of the
firm.
Q12-25
a.
Information about the competitive position of the firm is relevant to the long-term
riskiness of the loan. For example, one cant assess the ability of Rogers to make interest
payments on a 20-year loan without assessing the competitiveness of its products. This
information wouldnt be available from the financial statements, although its often
available in the management discussion and analysis that is provided in the annual reports
of public companies.
b.
Information about risks faced by the entity is extremely relevant to long-term lenders.
Risks have implications for the long-term viability of the entity. For example, if a bank is
primarily lending to a particular industry or geographic area, the loans are generally
riskier than if they were more diversified. The information may be included in the
segmented information in the financial statements and is often included in the
management discussion and analysis. In general, the MD&A provides information about
the risks an entity faces.
c.
Uncertainties about supplies could be of concern, particularly in some industries, where

supply is uncertain and prices can vary significantly. This information isnt included in
the financial statements but often discussed in the management discussion and analysis.
d.
The regulatory environment affects the risk and is particularly of concern in some
industries. Regulation of rates in utility markets can make the loan less risky. This
information is publicly available in many industries but isnt addressed in the financial
statements.

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Q12-26
a.
The quality and experience of the management is of significant value to investors who are
trying to predict the success of the firm. The current performance of management also has
predictive value and is the basis for compensation and staffing decisions by the board of
directors. The financial statements can provide useful information on current performance
of management but financial statements and other parts of the annual report tend to
provide limited information about quality and experience. Other documents such as the
prospectus and other filings such as those required by securities regulators do require
certain specific information. Management is crucial for the success of an entity and
knowing about the managers skills and abilities, successes and failures, and experience
can be very important. Information about the managers isnt explicitly reported in the
financial statements.
b.
Investors want to assess the likely success of the companys strategy for making money.
Generally such information is included explicitly or implicitly in the MD&A and other
portions of the annual report other than the financial statements. Strategy is future
oriented and financial statements will report only the outcome of past strategies.
c.
Equity investors want to predict the future profits of the firm and will benefit from
information on the competitive environment. Generally, this information is provided in
the annual report of a public company but not in the financial statements. For publicly
traded companies, assessments can often be obtained from analysts. The impact of
competition will be reflected in the financial statements but the specifics of the effect of
changes wont be explicitly addressed.
d.
Information on lines of business helps equity investors to assess where the company is
earning profits and assists them in predicting future performance. The information will be
provided by public companies in segmented information but private companies arent
required to provide segment information.
Q12-27
The MD&A section of the annual report provides managements views on past results, current
position, and future prospects of the firm. The MD&A is intended to provide readers with a view
of the entity through the eyes of management. Shareholders of private companies often have
direct access to management and can thus obtain direct information whereas shareholders in
public companies must depend on the information that management provides publicly.

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Q12-28
Management has access to a great deal of information about such matters as impending large
sales and the plans for the future that independent analysts dont have. Management is also
closest to the goings on of an entity and will therefore be most informed parties the entity. Its
unlikely that anyone could be better informed about an entity than its management. Management
information can be extremely valuable but it has strong incentives to withhold or bias
information. The views of independent analysts are generally more objective and reflect a
broader perspective but lack access to certain information that management may possess. It
should be noted while independent analyst is more objective they may also have biases to put
companies in a positive light to sell more shares or to lure future clients hence they may take a
more optimistic approach in delivering information.
Q12-29
The main factors that make earnings management possible are accrual accounting and periodic
reporting. When financial statements are prepared, revenues and expenses are recorded even
though there is often uncertainty about the actual future amounts. The requirement for periodic
financial statements means that revenues and expenses have to be allocated to particular periods.
The flexibility exists because of uncertainty about future outcomes such as the life of assets, how
assets are used, the amount of receivables that will be collected, and so on.The flexibility
available to management permits them to adjust earnings and other financial statement numbers
to achieve their reporting objectives.
Q12-30
The return on assets measures the performance of the entity without the impact of how the assets
were financed, while the return on equity relates the performance to the investment of the owners
(at book value). Both are useful. The return on assets assesses managements performance in
stewardship over the assets by showing the return earned on the total asset base, regardless of
whether the assets were financed by debt or equity. The return on equity shows the impact of use
of debt and equity on the wealth of the owners. It shows the return the common equity holders
earned on their investment. It isnt possible to state that one is better than the other. Each is
appropriate depending on the needs of the user.
Q12-31
Ratios have no meaning in absolute terms. One cant say that a particular ratio is good or bad
without knowing what the benchmarks are. Benchmarks can vary from industry to industry, from
market to market, from ownership structure to ownership structure and so on. Comparisons can
be made with other similar entities, to the entity in question itself over time, and to industry
benchmarks.
Q12-32
Different decisions require different information and without knowing what decision is being
made it isnt possible to provide an appropriate analysis. For example, the analysis that is
appropriate for creditors differs from that for equity investors. Long-term creditors have different
information needs than short-term creditors. Short-term creditors have short-term liquidity needs
whereas equity investors are concerned about the ability of the entity to produce cash flow and
profit over a longer horizon.
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EXERCISES
E12-1.
a.
The warehouse is on the shore of a river that overflows its banks periodically. This means
the cost occurs with some regularity so its permanent but not necessarily annual. So
there is information for predictive purposes in the previous cost of flood damage.
b.
Sales of equipment occur regularly in the course of business as an entity purchases and
replaces equipment. A lot depends on the size of the fleet. If the fleet is large and
replacements occur with some regularity then this is a permanent item. If replacements
are infrequent this could be classified as more of a transitory event.
c.
Write-downs of inventory that are on cyclical selling cycles are permanent since its part
of being in a seasonal business.
d.
If the significant price increase carries to future periods then its a permanent event
however if prices are expected to stabilize there after its transitory. This will depend on
the volatility of the markets.
E12-2.
a.
Payments to settle lawsuits are probably infrequent and transitory.
b.
(although they could be regular occurrences in some industries).
c.
Donations to charities if done every year may be considered as permanent, however if

this is a one time donation then it would be transitory.
d.
The revenues and expenses are transitory since the operations wont continue in the
future.
e.
Depending on the market and industry the drop in price maybe be either permanent or
transitory.

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E12-3.
a.
A strike that prevents a company from production for half a year wouldnt be reflective of
future periods, therefore the financial statements produced in that year wont be a good
indication of future periods.
b.
With the new drug expected to reach the market in the future financial performance
should improve. IFRS statements wouldnt capture the sales that will be generated in
future in the current year (no impact until actual sales occur) so the statements would
provide little insight into the future performance of the company.
c.
The income of the new restaurant isnt predictable from the historical financial statements
because the activities of the restaurant are new. Some insight maybe gained from the past
two quarters however it may not be representative of the rest of the year and years
moving forward.
d.
Future earnings would be difficult because the company is opening stores in a new region
so its difficult to determine whether they will be successful (amount of sales, operating
costs, profitability) will be uncertain.

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E12-4
Revenue
Cost of sales
Gross margin
Other expenses
Goglin Ltd.
Common size Income Statements
For the years ended December 31,
2016
2015
1.00
1.00
0.51
0.48
0.49
0.52
0.36
0.41
Net income
0.12
0.11
2014
1.00
0.46
0.54
0.46
0.08
Goglin Ltd.
Trend Income Statements
201
201
201
6
5
4
Revenue
1.92 1.46 1.00
Cost of sales
2.13 1.52 1.00
Gross margin
1.74 1.41 1.00
Other expenses
1.52
1.30
1.00
Net income
3.10
2.10
1.00
The performance of the company over the three-year period is fairly good. Revenues have almost
doubled and net income has more than tripled, but gross margin has decreased by five percentage
points while profit margin has increased by 4.7 percentage points. Other expenses has decreased
by 5% year over year as a result of management taking action to offset the increase cost of sales
resulting in an improving net income. Based on this perspective, the company appears to have
controlled their period costs well however the increase in cost of sales may be a result of price
reduction to boost sales and overall profits
From the trend financial statements, we see that cost of sales is increasing faster than sales and,
as a result, the gross margin has decreased over the three year period. Other expenses on the
other hand are growing slower than revenues. The overall effect is that net income has tripled
over the three years while sales have only doubled. This indicates that the company has managed
its costs effectively. The major reason that net income has increased faster than revenues is that
other expenses have increased at a slower rate than sales.

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E12-5.
a.
Fairplay Inc.
Common-size Balance Sheets
As of December 31
2018
0.023
0.136
0.153
0.031
0.343
2017
0.037
0.143
0.141
0.034
0.355
2016
0.035
0.124
0.159
0.028
0.346
Capital assets (net)

Total assets
0.657
1.000
0.645
1.000
0.654
1.000
Bank loans
Accounts payable and accrued liabilities
Total current liabilities
0.125
0.118
0.243
0.084
0.126
0.210
0.081
0.134
0.215
Long-term liabilities
Common shares
Retained earnings
Total liabilities and shareholders equity
0.180
0.322
0.255
1.000
0.191
0.384
0.215
1.000
0.177
0.442
0.166
1.000
Cash
Accounts receivable
Inventory
Other current assets
Total current assets

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Fairplay Inc.
Common-size Income Statements
For the year ended December 31
2018
2017
Revenue
1.000
1.000
Cost of sales
0.473
0.475
Gross margin
0.527
0.525
Selling, general & admin.
0.242
0.240
Depreciation
0.058
0.058
Other expenses
0.122
0.122
Interest expense
0.029
0.025
Income before taxes
0.077
0.080
Income tax expense
0.017
0.021
Net income
0.060
0.059
2016
1.000
0.488
0.512
0.256
0.053
0.112
0.019
0.072
0.019
0.053
*Columns may not add due to rounding.

b.
The performance of the company over the three year period is generally favourable and stable.
Most of the components of the income statement have varied within a very narrow range. Cost of
goods sold is a decreasing percentage, so gross margin has increased in each year, which
indicates that the value provided by the companys products and services is recognized
favourably by its customers. The selling, general and administrative expenses are slightly
decreasing and depreciation increased, which is the result of increased investment in capital
assets. Interest expense is increasing, partly due to an increase in long-term liabilities to finance
the capital acquisitions and possibly higher interest rates. Overall, the company is benefiting
from improved gross margins which are partially offset by increased depreciation and interest
cost. Net income has increased as a proportion of sales over the three-year period. Based on this
perspective, the company appears to have a steady and viable future.
The liquidity of the company may be of some concern. The current assets in total are a fairly
constant percentage of total assets and the composition of the current assets varies slightly and
no specific trend is obvious. However, current liabilities have increased, in particular the bank
loan (although payables have decreased). The percentage of assets financed by equity has
decreased slightly from about 60% in 2016 and 2017 to 58% in 2018. The difference isnt in
itself dramatic but there is a limit to how fast the company can grow by adding debt.

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c.
The common size statements eliminate the effect of size on financial statement numbers. With
the actual statements, its difficult to see the proportional impact of changes in the accounts in the
financial statements. Changes in magnitude can be related to growth or to a proportional increase
or decrease relative to some benchmark amount.
d.
Without the original financial statements, we cant whether the changes shown in the common
size statements pertain to large or small numbers and a great deal of perspective is lost. A 10%
change in a very small amount isnt very meaningful whereas a 10% change in a large amount
will be very significant. You also cant see the magnitude of different accounts. Significant
proportional changes in accounts might be identified from the common size statements but the
actual amounts in the accounts may be small and immaterial. The common size statements
should be examined in conjunction with the original statements.

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E12-6.
a. 2016 as base year.
Fairplay Inc.
Trend Balance Sheets
As of December 31
2018 2017 2016
Cash
Accounts receivable
Inventory
0.900
1.503
1.317
1.500
1.356

Total Assets
1.378 1.135 1.000

1.370 1.150 1.000
Bank loans
2.100 1.191 1.000

1.208 1.079 1.000
1.544 1.121 1.000
Long-term liabilities
1.400 1.240 1.000
Common shares
Retained earnings
Total liabilities & shareholders equity
1.000 1.000 1.000

2.099 1.489 1.000
1.370 1.150 1.000

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1.200
1.326
1.022
1.375
1.178
1.000
1.000
1.000
1.000
1.000
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Fairplay Inc.
Trend Income Statements
For the year ended December 31
Revenue
Cost of sales
Gross margin
Selling, general & admin.
Depreciation
Other expenses
Interest expense
Income before taxes
Income tax expense
Net income
2018
1.210
1.172
1.246
1.145
1.304
1.318
1.875
1.288
1.098
1.354
2017
1.120
1.090
1.149
1.050
1.217
1.220
1.500
1.246
1.250
1.245
2016
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
b.
From the trend financial statements, we see that cost of sales is increasing more slowly than sales
and, as a result, the gross margin has increased over the three year period. Also, selling, general
and administrative expenses are growing slightly more slowly than revenues but interest
expense, depreciation and other expenses are growing more rapidly. The overall effect is that net
income has increased over 35% over the three years while sales have increased 21%. This
indicates that the company has managed its costs effectively. The major reason that net income
has increased faster than revenues is that cost of goods sold and selling, general, and
administrative expenses have increased at a slower rate than sales.
On the trend balance sheets, we see that liabilities are increasing faster than assets. In particular,
bank loans have more than doubled and long-term debt has increased by 40 percent. However,
capital assets (which are often financed by long-term debt) have increased at about the same rate
as long-term debt. Bank loans are often used to finance current assets but current assets have
increased at a much slower rate than bank loans. Also, inventory has increased significantly
faster than cost of sales (you would expect them to grow at about the same rate) and accounts
receivable have grown much faster than sales, which is a cause for concern because this indicates
difficulty collecting receivables (or perhaps a relaxing of credit terms to boost sales).
c.
These financial statements enable us to see the trends in various accounts without the absolute
size of the numbers obscuring the changes. The trend statements also make it possible to
compare changes in the individual accounts over time. Its more difficult to infer changes from
the original statements.

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Page 1-17
d.
Without the original financial statements, the trends have little explanatory power. When we try
to rely on the trend statements alone to understand what is happening, we can easily form
nonsensical beliefs. So while eliminating absolute size from the statements makes trends and
changes clearer, without perspective on the significance of each of the numbers, the ability to
draw conclusions is impaired. For example, from the trend statements alone, one could become
very concerned about a large percentage increase when the absolute dollar amount makes the
concern unimportant.

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Page 1-18
E12-7.
a.
i.
ii.
iii.
iv.
v.
vi.
vii
viii
ix.
Current ratio
Quick ratio
Accounts receivable turnover ratio
Average collection period
Inventory turnover
Average days inventory
Accounts payable turnover
Average payment period
Cash lag
2018
1.410
0.654
10.508
34.737
4.676
78.061
5.968
61.158
51.639
2017
1.687
0.854
11.833
30.846
5.031
72.554
5.820
62.712
40.688
b.
Report to the management:
We are concerned with Fairplays ability to meet its financial obligations as they come due. Our
time horizon is relatively short term since we should expect to be paid between 30 and 90 days
depending on the credit terms so our main concern is Fairplays short term and ongoing liquidity.
From my analysis Fairplays liquidity position has deteriorated slightly in the last year, with both
the current and quick ratios decreasing from 2017 to 2018. However, neither ratio appears to be
unreasonably low (although examination of industry benchmarks would be appropriate). The
company is collecting its receivables less quickly and its inventory turnover is decreasing. The
time Fairplay takes to pay its supplier has decreased slightly. Its difficult to assess these ratios
without knowing the industry and the specific terms offered and received by Fairplay. If Fairplay
offers 30 days credit to its customers then it is very effective collecting, even if the collection
period has increased by about four days. If customers are required to pay in less than 30 days
then a different conclusion may be necessary .If the payment period is 60 days then the company
is meeting its obligation on time. If the average payment period is 30 or 45 days then payment is
a problem. More information is needed on the terms. Looking at the actual financial statement
numbers raises some additional concerns. Cash is at the lowest level in three years and bank
loans have increased significantly. If the bank loans are demand loans (and therefore must be
classified as current) but the bank has no intention of collecting in the short term then my
assessment of liquidity improves. If the loans are coming due in the short term I am more
concerned.
Based on this analysis I think we are justified to offer Fairplay credit terms. We may want to
limit the amount of credit until we are more comfortable that the companys liquidity position is
stable.

Solutions Manual
Page 1-19
E12-8.
Current Ratio
Quick Ratio
2.35
1.54
Based on the liquidity ratios Atluck is in a positive liquidity position with current and quick
assets exceeding current liabilities. This translates to the company being able to meet its current
obligations. Also cash on hand exceeds the amount of credit being requested ($10,000). Further
information would be required regarding the collectability of receivables and the saleability of
inventory. However, based on the ratios plus the amount of cash credit of up to $10,000 would be
reasonable.
E12-9
a.
Revenue
Cost of sales
Gross margin
SG&A expenses
Depreciation expense
Interest expense
Non-Recurring Expense
Income before income
taxes
Income tax expense
Net income
Kronau Corp.
Common size income statements
For the years ended March 31
2017
2016
2015
$2,875,00
100.00 $2,612,50
100.00 $2,425,00
100.00
0
%
0
%
0
%
1,575,000 54.78% 1,375,000 52.63% 1,280,500 52.80%
1,300,000 45.22% 1,237,500 47.37% 1,144,500 47.20%
675,000 23.48%
575,000 22.01%
555,500 22.91%
129,000
4.49%
105,000
4.02%
95,000
3.92%
150,000
5.22%
137,500
5.26%
130,000
5.36%
250,000
8.70% 96,000
18,000
$78,000
3.34%
0.63%
2.71%

Solutions Manual
420,000
80,000
$340,000
16.08%
3.06%
13.01%
364,000
75,000
$289,000
15.01%
3.09%
11.92%
Page 1-20
Revenue
Cost of sales
Gross margin
SG&A expenses
Interest expense
Non-recurring expense
Income before income
taxes
Income tax expense
Net income
Kronau Corp.
Trend income statements
For the years ended March 31
2017
2016
$2,875,000 1.19
$2,612,500
1,575,000 1.23
1,375,000
1,300,000 1.14
1,237,500
675,000 1.22
575,000
129,000 1.36
105,000
150,000 1.15
137,500
250,000 96,000
18,000
$78,000
0.26
0.24
0.27
420,000
80,000
$340,000
1.08
1.07
1.08
1.04
1.11
1.06
1.15
1.07
1.18
2015
$2,425,000
1,280,500
1,144,500
555,500
95,000
130,000
364,000
75,000
$289,000
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
b.
Kronau Corp. has generally performed reasonably well over the three-year period with the
exception of a transitory expense item in 2017 leading to an abnormal drop in net income, which
significantly decreased the profit margin. Gross margin has increased over the three-year period,
although we cant tell how that compares to other firms in the industry. From the common-sized
financial statements, we observe that the cost of sales was approximately constant in 2015 and
2016, but increased as a percentage of sales by almost 2% in 2017, which suggests that the
company has experienced cost increases that it hasnt been able to pass on to customers. As a
result the gross margin percentage decreased in 2017. Selling, general and administrative costs as
a percentage of sales have increased by 1.5 percentage points in 2017, suggesting that
management hasnt been effective in controlling costs. Depreciation expense as a percentage of
sales has increased slightly. As a percentage of sales interest expense has been decreasing very
gradually although the actual amount of interest has been increasing, which could be due to
increased debt or higher interest rates. The downturn in net income in 2017 is due to the the nonrecurring expense and the impact should be interpreted carefully since ongoing costs have also
increased on a proportional basis over the three years for almost all accounts (except interest and
taxes in the year of the non-recurring expense). The trend statements show that many expenses
have increased at rates faster than sales, suggesting that costs arent being well controlled. The
non-recurring item needs to be investigated but since its transitory it shouldnt used to make
future predictions.
Without more details, it isnt possible to arrive at a definite conclusion about the performance of
the company. However, all the trends are consistent with a company that is growing and
expanding capacity for future growth. The increased selling, general and administrative costs
could reflect the costs of hiring additional sales representatives to generate the additional sales,
perhaps with the expectation that sales will increase while these costs remain constant in future.
On the other hand, the increased general and administrative costs are consistent with a company
that has previously been operated efficiently with careful control of costs but where the managers
are now indulging themselves with more luxurious offices, support staff and more expensive
Solutions Manual
Page 1-21
company-owned automobiles. Another interpretation is that, with the growth of the company (as
reflected by the increase in sales), there has been a decrease in efficiency and control over costs
because the managers are more distant from the actions of certain employees. Which of these
scenarios is more accurate can be determined by a visit to the firm and an interview with the
owners at which point an explanation to the $250,000 expense would be required also.
c.
Its very difficult to assess the performance of the company without removing the non-recurring
expense from the analysis (presuming that this item is really transitory). With the inclusion of
that amount in the analysis, the year-to-year comparisons arent meaningful nor are predictions
of future profitability appropriate. Fortunately, the adjustment is easy to perform. Without the
non-recurring expense, the trend analysis would show a decrease in income before income taxes
from 2016 to 2017 of about 10% rather than a 80% decrease. Similarly, the common size
statements show that income before taxes and unusual items was 12% of sales in 2017, which is
still significantly lower than in the previous two years.
Note: Other unusual events may not be isolated. For example, the reduced gross margin in
2017 could have been caused by an unwise purchasing decision that required a significant
segment of the inventory being sold at much lower prices than expected.
E12-10.
a., b.
Beginning accounts payable
Ending accounts payable
Average accounts payable
2015
$1,535,630
1,919,538
1,727,584
2016
$1,919,538
2,132,820
2,026,179
2017
$2,132,820
2,509,200
2,321,010
Cost of Sales
Beginning Inventory
Ending Inventory
Purchases
A/P Turnover ratio
9,623,028
2,272,732
2,898,502
10,248,798
5.93
61.5
10,416,692
2,898,502
3,156,574
10,674,764
5.27
69.3
10,112,076
3,156,574
3,261,960
10,217,462
4.40
82.9
c.
The accounts payable turnover ratio is decreasing and the average payment period is increasing.
This indicates that the company is taking more time to pay its suppliers.
d.
There are many possible explanations: changing credit terms from major suppliers, cash flow
problems that make it difficult to meet its obligations so the company is trying to stretch its
payables, or changes in suppliers or the composition of suppliers.

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Page 1-22
E12-11.
Note: the following answers assume that the event occurs on the day before the end of the period
for which the financial statements are prepared. Also, its necessary in some cases to make
assumptions. Students should recognize and make their assumptions explicit and those who do so
should be rewarded.
Quick Ratio
Ratio before the

transactions/ economic
events
a.
Early retirement of
long-term debt
(classified as longterm when retired)
for cash at a loss
b.
Accrual of a warranty
liability
c.
Declaration of a cash
dividend
d.
Sale of common
shares for cash
e.
Arrangement of a
capital lease
(quick
assets/current
liabilities)
Inventory
Turnover
(cost of
sales/average
inventory)
0.85
3.5
Return on Assets
(net income +
after tax interest
exp/average total
assets)
12%
Profit margin
%
(net income
/sales)
8%
Debt/
Equity
1.5:1
Decrease
No Change
Increase
Decrease
Decrease
Decrease
No Change
Decrease
Decrease
Increase
Decrease
No Change
No Change
No Change
Increase
Increase
No Change
Decrease
No Change
Decrease
No Change
No Change
Decrease
No Change
Increase
a. Cash (-) , Long Term Liabilities (-), Equity (-)

b. Expense(+), Current Liabilities (+)
c. Current Liability (+) , Equity (-)
d. Cash (+), Equity (+)
e. Capital asset (+), Non-current liability (+), Current liability (+)

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E12-12.
Note: the following answers assume that the event occurs on the day before the end of the period
for which the financial statements are prepared. Also, its necessary in some cases to make
assumptions. Students should recognize and make their assumptions explicit and those who do so
should be rewarded.
Interest
coverage
Receivables
turnover
Price to earnings
Return on equity
Dividend yield
(cash from
operations
interest paid /
interest paid)
(credit sales/ avg.

A/R)
(market
price/EPS)
(net income
preferred
dividends/average
total equity)
(Cash
dividends
declared/share
price)
4.12
4.75
22.7
12%
3.10%
No effect
No effect
Increase (share price

will increase)
No effect
Decrease
(share price
will increase)
b. Writedown of impaired
property, plant, and
equipment
Decrease
No effect
No effect (assumes
no effect on share
price)
Decrease
No effect
c. 2 for 1 stock split
No effect
No effect
No effect (assumes
share price and eps
decrease by 50%)
No effect
No effect
d. Payment of an amount
owing to a supplier
No effect
No effect
No effect
No effect
No effect
e. Credit sale of
merchandise to a
customer
Increase
Decrease
Decrease (assumes
no effect on share
price)
Increase
No effect
Ratio before the

events
a. Unexpected
announcement by a public
company of a new longterm contract with a new
customer. Contract goes
into effect next year.
a. Assumption - Executory Contract. Assume that none of b. through e.

have an effect on share price. Assume announcement in a. increases
share price in anticipation of higher future profits. Different
assumptions are possible.
b. Property, plant and equipment (-) \, Net income (-)
c. No effect
d. Accounts payable (-), Cash (-)
e. Accounts receivable (+), Sales(+); Inventory (-), Cost of goods sold
(+) Assume sales was for a profit

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Page 1-24
E12-13.
Its necessary in some cases to make assumptions. Students should recognize and make their
assumptions explicit and those who do so should be rewarded.
Current
Average
payables
payment period
Return on
Assets
Gross margin
%
Ratio
( 365 /
(sales cost of
sales / sales)
(current assets /
current
liabilities)
(purchases/aver
age a/p) )
(net income +
after tax interest
exp/average
total assets)
* Assume all
effect on
average asset =
1/2
1.3
38
12.50%
48%
$1.75
Decrease
Increase
Decrease
No effect
Decrease
b. Writedown of inventory
to net realizable value.
Amount included in cost of
goods sold
Decrease
No effect
Decrease
Decrease
Decrease
c. Payment of a previously
declared dividend
Increase
No effect
Increase
No effect
No effect
d. Purchase of land in
exchange for a long-term
note payable
No Effect
No effect
Decrease
No effect
No effect
e. Repurchase of common
shares for cash
Decrease
No effect
Increase
No effect
Increase
Ratio before the

events
a. Accrual of wages owed to
employees at the end of a
period. Amount included in
accounts payable
EPS
a. Expense(+), A/P(+)
b. COGS(+), Inventory (-)
c. Dividend payable(-), Cash (-)
d. Long Term Asset (+) , Long Term Liability(+)
e. Equity (-), Cash (-)

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Page 1-25
E12-14
a.
Dyce Auto Parts Ltd.
Summarized income statements for the years ended December 31,
(000)
Revenues
Cost of goods sold
Gross margin
All other expenses
Net income
Gross Margin %
Profit margin %
2017
7,448
6,466
982
681
301
2016
5,945
5,373
572
740
(168)
2015
7,588
6,716
872
849
23
2014
$8,399
7,281
1,118
904
214
2013
$8,226
7,216
1,010
830
180
2012
$8,287
7,205
1,082
850
232
2011
$8,061
6,907
1,154
884
270
13.18%
4.04%
9.62%
-2.83%
11.49%
0.30%
13.31%
2.55%
12.28%
2.19%
13.06%
2.80%
14.32%
3.35%
b.
Dyce auto parts has shown variable gross margin over the seven year period while profit margin is at its highest level in the period
being examined. Sales also showed a recovery in 2017 after a big drop in 2016. 2017 was a big recovery year for the company. While
sales are lower than in any year other than 2016 net income is at its highest in the period. The higher gross margin in 2017 contributed
to the high profit in 2017 but cost control in other expenses also played a role with all other expenses at their lowest level both in
absolute amount and as a percentage of revenues. The auto industry has struggled in the period shown and this may have contributed
to the deteriorated performance in the period.

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E12-15.
a.
Beginning accounts receivable
Ending accounts receivable
Average accounts receivable
Sales
% credit sales
Credit sales
accounts receivable turnover
Collection period
2016
$67,500
75,000
71,250
950,000
60%
570,000
8.00
45.63
2017
$75,000
85,000
80,000
1,006,250
66%
664,125
8.30
43.97
2018
$85,000
93,750
89,375
1,093,750
75%
820,313
9.18
39.77
b.
The company appears to be improving its management of its accounts receivable fairly
well as they are, on average, collected more promptly each year.
c.
Possible explanations include a) Oungre doesnt follow up with customers on a regular

basis; b) its inevitable that some customers dont pay or pay late; c) some customers may
receive more time to pay. Possible ways to accelerate collection are to be proactive with
customers to ensure they pay on time; offer a discount for early payment; decline credit
terms for customers who pay slowly; and tighten credit granting standards (so only very
low risk customers receive credit). The problem is that in a competitive market such as
printing services, all of the above actions are likely to reduce the profitability of the
company.
d.
If the collection period was calculated based on total sales and not credit sales, the
companys receivables turnover would be higher, which could be confusing. Without
knowing the proportion of cash sales accounts receivable turnover would change because
of the mix of cash and non-cash business, not because of changes in the management of
receivables.

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Page 1-27
E12-16
a.
Beginning Inventory
Ending Inventory
Average Inventory
Cost of Sales
Inventory turnover
Average days in inventory
2015
$48,750
54,750
51,750
3,150,000
60.87
6.00
2016
$54,750
60,750
57,750
3,622,500
62.73
5.82
2017
$60,750
97,500
79,125
3,441,375
43.49
8.39
b.
The company appears to have manged its inventory fairly well in 2015 and 2016.We
would expect a high turnover of inventory in the produce business since the merchandise
is perishable. Its difficult to determine exactly what occurred in 2017 but cost of sales
decreased in 2017 while ending inventory increased by more than 60 percent. Clearly we
need to know why ending inventory increased and why cost of sales decreased to
appropriately interpret the 2017 performance. Its a strange situation because higher
inventory suggests expansion or overbuying, but in this type of business, the purchasing
cycle is very short because of the nature of inventory, so excessive overbuying should not
occur. Industry benchmarks would be useful to see what is normal in this business as
would be sales and other financial statement information.
c.
Many explanations are possible. Students should try to generate many explanations and
then try to rank them in credibility for the circumstances that are given in the question.
One probable cause is that the company has made specific recent inventory purchases
that it has been unable to sell to retailers. Some produce such as carrots and potatoes can
be stored for a significant length of time, so this may not signify a crisis. Otherwise the
inventory may need to be written down if its value is deteriorating. Perhaps the company
is caught with binding commitments to accept regular deliveries from its suppliers but
has lost a major customer. Another potential cause is that the year-end happened on a day
when a $60,000 special order was waiting two or three days until the customer was ready
to receive the shipment. In that case, a year-end a week earlier or later would have
provided a very different impression.
Note: For most companies, the quantity of inventory on hand at a balance sheet date is
somewhat representative of the average inventory for the year. However, Zawales
inventory likely fluctuates significantly each day. A user of financial statements,
particularly a banker, would be better served with an average based on monthly rather
than annual counts. Monthly counts would also reduce the incentive to mislead the users
of the financial statements by allowing inventory to run down at the end of the year. Any
company with very high turnover would find it very easy to reduce purchases as the yearend nears to ensure that the inventory count is low and the turnover appears high. In
contrast, a jewellery store or a hardware store would find it much more difficult to
achieve the same result.
d.
The additional inventory at year-end, if its to be held for more than a few days, will
require financing and have significant negative cash flow implications for the company.

Solutions Manual
Page 1-28
The overall implications of the observations from (a) and (b) really depend on whether
they represent a situation that will persist. It seems unlikely that a 60% increase in
inventory from the beginning to the end of 2017 reflects a deliberate decision to increase
inventory when sales arent increasing. Excess produce in good condition can easily be
sold in wholesale markets at some price, so the situation isnt really cause for grave
concern. On the other hand, if the inventory cant be moved in good time it will have to
be written off, which will reduce net income.
E12-17.
a.
Beginning payables
Ending payables
Average payables
Credit purchases
Payables turnover
2015
2016
2017
$67,200
72,800
70,000
448,000
6.40
57
$72,800
85,400
79,100
462,000
5.84
62.5
$85,400
100,800
93,100
455,000
4.89
74.7
b.
The company has been paying more slowly on average each year for the last three years,
which isnt good news if we are hoping that the company will pay us promptly in 60
days. It would be very helpful to know whether any of the companys suppliers have
changed the credit terms in the last two years. Its possible that competitive pressures
have motivated a new supplier to offer 90-day terms to obtain Guisachans business. On
the other hand, there is likely only one supplier for a particular book, so that explanation
doesnt seem plausible in this case. More likely is that Guisachan is suffering from cash
flow problems and is simply unable to pay promptly. Bank financing may be difficult to
obtain in adequate amounts, so effectively the business is financed by its suppliers. If the
company is doing well and pays all its bills, even if it does so slowly, I may be willing to
extend the credit. Additional information that would be useful would be credit reports on
Guisachans payment history as well as a complete set of financial statements and cash
forecasts.
c.
An increase in accounts payable represents a source of cash, which would appear

favourable on the statement of cash flows (because CFO would increase). However, as a
supplier, I would prefer to see cash come from sources such as selling merchandise. The
problem is that payables are increasing when sales arent (purchases are relatively stable).
To obtain additional cash inflows in future years, the company will need to extend the
average payment period even further, which is likely to be resisted by suppliers. Suppliers
are often willing to assist a new business, a growing business, or a business that is
experiencing temporary difficulties. However, they expect to see the company decrease
its reliance on supplier financing as the company becomes established. Unfortunately,
small bookstores tend to struggle financially for long periods of time. Eventually
suppliers may decide to not offer additional credit.

Solutions Manual
Page 1-29
E12-18.
a.
Basic EPS = ($11,879,500- $500,000)/100,000,000 = $0.114each common share
earned $0.11 after deducting the preferred dividend.
b.
P/E ratio = $5.75/0.11 = 50.53 to 1 the market is paying $50.53 for each dollar of
accounting earnings available to common shareholders.
c.
Dividend payout ratio = (100,000,000 x $0.08)/(11,879,500 -500,000)= 70.3% - 70.3% of

earnings is being paid out in common dividends.
d.
Dividend yield = $0.08/$5.75 = 1.4% - each common share yielded 1.4% return from
dividends.
E12-19.
a.
i. Basic EPS = (-$37,500,000 - $5,000,000)/24,000,000 = -$1.77each common share
lost $1.77 after deducting the preferred dividend.
ii. P/E ratio = $6.75/-$1.77 = -3.81 to 1This ratio isnt meaningful when the entity is
losing money. The market is pricing the company and factors other than the current
years earnings alone. Otherwise the company would have a negative share price.
iii. Dividend payout ratio = ($0.05 x 24,000,000 x 4)/-37,500,000 = -12.8%this means
that a dividend was paid when the company incurred a loss. The interpretation is
otherwise not meaningful.
iv. Dividend yield = ($0.05 X4)/$6.75 = 2.96% - each common share yielded 2.96%
return
b.
A dividend requires cash, not earnings. A loss in a period doesnt preclude the payment of
a dividend, although losses over a number of periods could impair the ability of an entity
to pay cash dividends since there is a correlation between cash flow and net income,
especially over longer periods of time.
c.
The value of a stock represents the future cash flows that will be realized by the
shareholders. A loss in a given year doesnt mean that future earnings and future cash
flows will be negative. Clearly, in this case, the markets expectations about the future
performance of the company are based on more than the current years earnings. The
dividend yield is positive because it doesnt take into account profits earned by the
company but rather the dividends declared. Therefore dividend yield would never be
negative and at worst would be zero meaning no dividends was paid.

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Page 1-30
E12-20.
a.
The debt-to-equity ratio is 1.78:1.
b.
The company could have liabilities of $60,000 more than it has outstanding and still
maintain the 2:1 covenant.
c.
The company could have reduced equity by paying a dividend of $30,000 without
breaching their debt covenant.
d.
The dividend would reduce shareholders equity by $25,000 to $250,000. It would

increase liabilities by $25,000 to $515,000 and increase the debt/equity ratio to 2.06:1,
which would put Husavick in violation of the covenant. If the divide was paid before the
year end the covenant woulnt be breached.
E12-21.
a.
2017
i. gross margin
percentage
ii. profit margin
percentage
iii. earnings per share
iv. working capital
v. current ratio
vi. quick ratio
vii. debt-to-equity ratio
viii. interest coverage
ratio
ix. dividend payout ratio
2016
36.49%
36.90%
3.02%
$0.67
$9,587,00
0
1.33
0.26
1.01
8.46%
$1.86
$15,254,00
0
1.63
0.32
0.94
4.14
73.20%
8.33
26.22%
b.
i. asset turnover
ii. return on equity
iii. return on assets
iv. inventory turnover ratio
v. average days inventory
vi. accounts receivable turnover
vii. average collection period of
AR
viii. accounts payable turnover
ratio
ix. average payment period for AP
x. cash lag
1.04
0.062
0.041 or 0.031 (depending on method used)
1.79
203.93
11.35

Solutions Manual
32.15
7.133
51.17
184.91
Page 1-31

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Page 1-32
c.
The most significant effect of the unusual items is on those calculations that directly
include net income, most specifically the profit margin, EPS, return on assets and equity.
The profit margin for 2016 is 8.46% if the unusual item is included but 4.96% if its
excluded (the revised percentage is calculated after tax. If the unusual item is subtracted
without considering the tax effect the revised profit margin percentage is 3.01%). The
impact on 2017 is much smaller but is about half a percent higher when the unusual item
is included. Similar impact occurs on return on assets and equity. Since by definition the
item wont likely recur, it would be misleading to compare 2016 and 2017 with the
unusual items included, although it is relevant when considering how Hurstwood
performed (as opposed to for predictive purposes). Unusual items are transitory in nature
because they should not recur with any regularity. That said, some companies use unusual
items to try and manage their earnings so that users will discount the future impact of
certain expenses. There is evidence that some companies report unusual items quite
regularly. Indeed, Hurstwood has unusual items reported in both years shown.
d.
As a wine producer and distributor, we would expect the company to have large amounts
of inventory and a very slow inventory turnover. In fact, if all of the current liabilities
were to come due in the first few weeks following the balance sheet date, its very
unlikely that the payments could be made without accepting distress prices for the wine
inventory. More realistically, the receivables arent sufficient to cover the accounts
payable. Presumably the bank indebtedness is a line of credit which the company can
access to meet those obligations. In summary, the company isnt very liquid in terms of
its ability to meet its obligations by turning its current assets quickly into cash, even
though total current assets exceed current liabilities. Companies of this sort with slow
inventory turnover require access to bank loans secured by inventory and receivables.
Assuming that the company is established, the bank is likely to view the wine as fairly
good collateral.

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Page 1-33
E12-22.
a, b.
2017
2016
2015
2014
$1,309,440
$1,223,776
$1,165,500
$1,050,000
Net income
156,306
151,398
144,290
136,750
Total liabilities (at year-end)
346,274
326,674
294,300
272,500
250,000
Shareholders equity (at yearend)
381,680
325,376
273,976
229,688
192,938
58,500
51,000
42,500
61,500
18%
18%
18%
18%
Sales
Interest expense
Tax rate
Average total assets

$690,002
$610,163
$535,232
Asset turnover ratio
1.90
2.01
2.18
After tax interest expense
$47,970
$41,820
$34,850
Profit margin percentage
(adjusted for interest)
0.156
0.158
0.154
0.1
0.1
0.1
(net income/sales)
19
24
24
Return on assets
0.296
0.317
0.335
Average equity
$353,528
$299,676
$251,832
Return on equity
0.442
0.505
0.573
*ROE = Net income preferred dividends / average shareholders' equity)
c.
2013
$
$472,563
2.22
$50,430
0.178
0.1
30
0.396
$211,313
0.647
Unwins net income has steadily increased over the four-year interval but the profit
margin has declined since 2015, meaning the company is earning less per dollar of sales.
The asset turnover ratio has also decreased, meaning that sales have increased more
slowly than total assets and assets are being used less efficiently to produce sales.
Possible explanations include large capital investments that will benefit future years, a
substantial accumulation of inventory and receivables or capital assets not being used
efficiently. There could also be assets that are obsolete, ones that are inefficient, or
excessive amounts of certain assets. The interpretation would differ significantly
depending on the actual causes, which would be evident with complete financial
statements. ROA and ROE both show declining performance, decreasing across the four
years.

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Page 1-34
E12-23
a, b.
2018
Sales
Net income
Total liabilities (at year end)
Shareholders equity (at year
end)

Asset turnover ratio
Return on assets
Average equity
Return on equity
c.
2017
2016
2015
$957,264
$854,700
$763,125
$687,500
33,504
159,535
318,623
32,479
151,938
285,119
30,525
144,703
252,641
28,875
137,813
222,116
$457,608
2.09
0.03
7.32%
$301,871
11.10%
$417,201
2.05
0.04
7.78%
$268,880
12.08%
$378,637
2.02
0.04
8.06%
$237,379
12.86%
$342,210
2.01
0.04
8.44%
$207,679
13.90%
2014
131,250
193,241
The net income of the company has steadily increased over the four-year interval and the
asset turnover has increased marginally. However, profit margins have decreased,
suggesting either that cost of sales or some other expenses have increased relative to
sales. This means that, while the company is using its assets slightly more efficiently, its
profitability is declining. As a result, ROA and ROE have declined over the period. The
increased use of debt would suggest higher interest costs is contributing to the decreased
profitability. Note that the definition used for ROA in this chapter is different from that
used in the chapter where the numerator is net income plus the after tax cost of interest.
This was done to simplify the exercise.
E12-24.
The information suggests that Business A is in a better liquidity position then Business B. At first
glance the Bs current ratio of 1.75 suggests a strong liquidity position, but the low quick ratio of
0.38 (compared with 0.75 for A) indicates that B has more less liquid assets, such as inventory. A
has fewer current assets relative to current liabilities than B but more of its current assets are
highly liquidcash, investments, and receivables. Its not surprising that both businesses have
quick ratios below 1 because as retailers they have to carry a lot of inventory. An important
question is, what is the nature of Bs inventory? An inventory thats easy to sell would be less of
liquidity concern than inventory thats hard to sell. The inventory turnover ratio indicates that B
turns its inventory over 2.6 times per year or in 140 days, meaning that it takes B on average 140
days to sell inventory and convert it to cash (assuming it doesnt offer its own credit). In contrast,
A holds its inventory on average for 118 days, which means it gets its cash 22 days sooner than
B. Finally, A pays its payable much faster than B, on average paying its bills in 80 days, versus
100 days for B. This suggest that A has is able to meet its obligations on a more timely basis than
B (although difference in the payable period could be due to many factors).

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Page 1-35
E12-25
Business A has a gross margin of 40%, which means that for every dollar of sales it has its able
to generate $0.40 per dollar of sales to cover costs other than the cost of inventory and provide
profit to its shareholders/owners. This is more than what B generates. The higher margin could
be the result of A facing less competition or providing better service to its customers. However,
B has a higher profit margin and a higher return on assets than A. The higher profit margin
means there is more profit per dollar of sales available to the owners of B than to the owners of
A. This means that costs other than the cost of goods sold are greater for A than for B. For
example, A may have higher rent, advertising, or wages and salaries. The higher return on assets
means that B is able to generate more income per dollar invested in assets than A. This means
that B can generate a certain amount of income with less investment in assets by the company.

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Page 1-36
PROBLEMS
P12-1
Kynocks Inc.
Balance Sheets
As of December 31,
2017
2016
Cash
$75,000
$110,000
Accounts
receivable
Inventory
125,000
105,000
300,000
248,000
Capital assets
(net)
Total assets:
930,000
146,000
$1,430,000
$609,000
$225,000
$184,000
13
9
380,000
100,000
10
75,000
75,000
750,000
250,000
7
4
$1,430,000
$609,000
Accounts
payable
Long-term
debt
Capital stock
Retained
earnings
Total liabilities and
shareholders equity:
12
11
8
13
Kynocks Inc.
Income Statement
For the Year Ended December 31, 2017
Revenue
Cost of sales
Gross margin
Selling, general, and
administrative expenses
Interest
expense
Income before
taxes
Income tax
expense
Net income
Number of common shares outstanding
during 2017
$2,500,000
1
1,500,000 Given
$1,000,000
1
$249,000
6
$121,000
$630,000
$130,000
$500,000
1,250,000

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Page 1-37
Steps to solve this question. (Note that there are different ways that the missing values can be determined.)
1
Revenue = Cost of sales/(1 gross margin percentage)

= $1,500,000/(1-.40)
=
$2,500,000
Gross Margin = Sales - Cost of Sales

=
2
$1,000,000
Net income = Revenue x profit margin = $2,500,000 x .20

=
$500,000
Income before taxes = Net income/(1 tax rate) = $546,000/(1 .2063)

=
$629,961
=$630,000
Income tax expense = Income before taxes Net income = $630,000 $500,000
=
4
$130,000
Retained Earnings = Opening Retained Earnings +Net Income - Dividends = $250,000+ $500,000 - 0
=
$750,000
Interest coverage ratio = 6.2085

6.2085
= (Net income + interest expense + income tax expense)/interest expense
6.2085
= (500,000 + interest expense + 130,000)/interest expense
Interest Expense =
6
=$121,000
Selling, general and administrative = Gross margin Income before taxes Interest Expense
=
$120,956
$249,000
Number of shares outstanding

= Net income/EPS = $500,000/$0.40
1,250,000
Inventory Turnover Ratio = Cost of Sales / Average Inventory

5.474 = ($1,500,000/((Ending inventory + $248,000)/2))
$3,000,000/5.474 = (Ending inventory + $248,000)
$548,045 = (Ending inventory + $248,000)
Ending inventory = $300,045

Solutions Manual
=$300,000
Page 1-38
Accounts payable turnover = Credit Purchases/Average Accounts payable

7.589 = (Credit purchases/Average accounts payable)
Credit purchases = COGS Beginning inventory + Ending inventory
Credit purchases =
Average accounts payable = $1,552,000/7.589
Average accounts payable =
Ending accounts payable =
10
Total equity =
Debt/equity = 0.733 = Liabilities/$825,000 = $604,725
Longterm debt = $605,000 $225,000= $380,000.
(Account payable = $225,000from 9.)
11
Accounts receivable turnover = Credit Sales/Average A/R

21.739=($2,500,000/Average accounts receivable)
Average accounts receivable = $2,500,000/21.739
Average accounts receivable = $115,000
Ending accounts receivable = $125,001
$204,512
$225,024
=$225,000
$825,000
=125,000
12
Current assets = 2.222 X $225,000 (accounts payable) = $500,000

Cash = $500,000 $300,000 125,000 = $75,000.
13
Total assets = Total liabilities + Shareholders equity = $1,430,000

Capital assets = $1,430,000 $75,000-$125,000 - $300,000 = $930,000

Solutions Manual
$1,552,000
Page 1-39
P12-2
Voligny Inc.
Balance Sheets
As of December 31,
Cash
2017
$35,000
2016
$25,000
11
Accounts receivable
140,000
125,000
Inventory
220,000
185,000
937,000
925,000
12
$1,332,000
$1,260,000
12
Accounts payable
$92,000
$70,000
Long-term debt
400,000
450,000
Common shares
200,000
200,000
10
Retained earnings
640,000
540,000
$1,332,000
$1,260,000
Total Assets
Total Liabilities and

Shareholders Equity
Voligny Inc.
Income Statement
For the Year Ended December 31, 2017
Revenue
Cost of sales
Gross margin
Selling general and
$1,000,000
$550,000
$450,000
$293,000
1
1
1
6
Income before taxes
$125,000
5
2
Income tax expense
$25,000
Net income
$100,000
Interest expense
$32,000

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Page 1-40
Steps to solve this question. (Note that there are different ways that the missing values can be determined.)
Net income = $100,000 = Revenue x profit margin = Revenue x .10

=
$1,000,000 =Revenue
Gross Margin = Revenue x gross margin percentage

= $1,000,000 x .45
$450,000
Cost of Sales = Sales - Gross Margin

=
$550,000
Income before taxes = Net income/(1 tax rate) = $100,000/(1 .20)

=
$125,000
Income tax expense = Income before taxes Net income = $125,000 $100,000
=
$25,000
Retained Earnings = Opening Retained Earnings +Net Income - Dividends = $540,000+ $100,000 - 0
=
$640,000
Number of shares outstanding

= Net income/EPS = $100,000/0.75
133,333
Interest coverage ratio = 4.906

4.906 = (Net income + interest expense + income tax expense)/interest expense
4.906 = ($100,000 + interest expense + $25,000)/interest expense

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Page 1-41
Interest Expense =
$32,002
Selling, general and administrative = Gross margin Income before taxes Interest Expense
=
$293,000
Inventory Turnover Ratio = Cost of Sales / Average Inventory

2.716 = ($550,000/((Ending inventory + $185,000)/2))
$1,100,000/2.716 = (Ending inventory + $185,000)
$405,007 = (Ending inventory + $185,000)
Ending inventory = $220,007
=$220,000
Accounts payable turnover = Credit Purchases/Average Accounts payable

7.222 = (Credit purchases/Average accounts payable)
Credit purchases = COGS Beginning inventory + Ending inventory
Credit purchases =
Average accounts payable = $585,000/7.222
Average accounts payable =
Ending accounts payable =
10
=$32,000
Total equity =
Debt/equity = 0.586 = Liabilities/$840,000 = $492,240
Longterm debt = $492,000 $92,000= $400,000.
(Account payable = $92,000from 8.)
$81,002
$92,004
=$92,000
$840,000
Accounts receivable turnover = Credit Sales/Average A/R

7.547=($1,000,000/Average accounts receivable)
Average accounts receivable = $1,000,000/7.547
Average accounts receivable = $132,503
Ending accounts receivable = $140,006
=140,000
11
Current assets = 4.293 x $92,000 (accounts payable) = $394,956

Cash = $395,000 $140,000 220,000 = $35,000.
12
Total assets = Total liabilities + Shareholders equity = $1,332,000

Capital assets = $1,332,000 $35,000-$140,000 - $220,000 = $937,000

Solutions Manual
$585,000
Page 1-42
P12-3
The answers below are generalizations. The current ratio can be affected by short-term
borrowing arrangements and available lines of credit. This problem is good for discussion
purposes to help students think about the nature of different types of businesses.
a.
Rogers manages to operate successfully with a current ratio consistently below one. It
has reliable cash flows from its cable and wireless operations as well as available lines of
credit so it does not have to maintain large amounts of cash to meet obligations. It has
low inventories (its a service business) though it does have significant receivables.
b.
Airlines, like other service businesses will tend to have lower current ratios because
they dont have inventory. However, there will be significant payables for operating costs
that are not offset by current assets. Airlines often have a lot of cash available, which
increases the current ratio. Since many/most customer transactions are for cash (credit
card), accounts receivable will be also be low, tending to reduce the current ratio. The
level of current ratio will be affected by what the airline does with its cash.
c.
A furniture retailer would likely have a high current ratio because of the large amount
of inventory it would have. Some of the inventory would have been already paid for so
payables would be lower than inventory. On the other hand many furniture retailers wont
have much accounts receivable since most purchases are for cash or on major credit cards
(although the bigger chains do offer financing).
d.
Software developers should have lower current ratios because they dont have
inventory. They will still have significant payables that are not offset against current
assets (e.g. they have software development costs that are generally expensed as
incurred). However, software companies often have a lot of cash (if theyre stable), which
will result in an increased current ratio. Software developers will have accounts
receivable since sales to customers will usually be on credit.
e.
Real estate developers would have low current ratios because they will tend to have
few current assets. Most current assets would be receivables and cash whereas there will
be accounts payable for current operating costs, taxes payable, and short-term operating
loans.
f.
Car manufacturers will have high inventory and high accounts receivable, which will
lead to a higher current ratio. They will have high amounts of payables as well because of
their inventory, but there will also be other significant operating costs that will be
financed in the short term through payables.

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Page 1-43
P12-4.
a.
Chortitz Ltd.
Income Statements
For the Years Ended June 30,
Revenues
Cost of revenues:
License & Networking
Customer Support
Service
Total cost of revenues
Operating expenses:
Research and development
Sales and marketing
General and administrative
Depreciation
Total operating expenses
Income (loss) from operations
Interest expense
Income before income taxes
Provision for (recovery of) income taxes
Net income for the year
2017
$243,704
2016
$186,360
2015
$152,686
9,698
12,592
41,192
63,482
180,222
4,430
9,456
37,950
51,836
134,524
3,002
5,200
24,510
32,712
119,974
29,385
84,674
21,766
10,356
21,285
70,832
32,722
9,172
15,934
60,128
9,770
8,450
146,181
34,041
134,011
513
94,282
25,692
2,010
1,530
996
32,031
(1017)
24,696
4,230
(1,708)
3,990
$27,801
$691
$20,706
Research and development assets

2014
$8,816
15,812
-9,679
14,949
2013
2017
2016
2015
2014
Research and development assets on June 30,
$36,501
$25,772
$17,781
$14,949
Extracts from the balance sheet

Current assets
Total assets
Current liabilities
Non-current liabilities
Shareholders equity
$95,906
246,933
64,308
23,100
159,525
$103,126
216,644
66,440
18,480
131,724
$82,204
187,875
44,466
12,376
131,033
$69,630
156,127
37,138
8,662
110,327
Opening balance
Additions
Amortization
Ending balance
2017
$25,772
40,114
-29,385
36,501
2016
$17,781
29,276
-21,285
25,772
2015
$14,949
18,766
-15,934
17,781

Solutions Manual
$
13,224
-4,408
8,816
Page 1-44
b.
Profit margin
Interest coverage ratio
EPS
Debt-to-equity ratio
ROA(adjusted for after tax cost of
interest)
(tax rate based on actual tax
expense)
ROA (not adjusted for after tax cost
of interest)
ROE
Expense Research and

Development
2017
2016
2015
0.070
-0.039
0.117
11.598
-4.888
22.952
0.426
-0.163
0.427
0.710
0.801
0.502
Capitalize and Amortize

Research and Development
2017
2016
2015
0.114
0.004
0.136
16.936
0.335
25.795
0.694
0.015
0.495
0.548
0.645
0.434
9.3%
-3.4%
12.0%
12.7%
-0.2%
12.5%
8.5%
14.9%
-4.0%
-6.7%
11.5%
17.1%
12.0%
19.1%
0.3%
0.5%
12.0%
17.2%
c.
When research and development is capitalized and amortized, Chortitzs performance and
solvency appears better. Of course, the actual performance and solvency of the company arent
affected by the numbers since the numbers are representations of the actual but unobservable
economic situation. Because Chortitz is expanding its R&D investments, expenses are lower and
income, assets, and shareholders equity higher when the costs are capitalized. Because the total
costs have to be the same under both methods, eventually the expensing method will yield higher
income than the capitalizing approach. The results in part b. of the question show that all
indicators are better under the capitalize approach. The IFRS treatment of R&D is controversial.
The outcome of R&D expenditures can be very uncertain, which is an important reason for the
IFRS requirement that these costs (research in particular) be expensed as incurred. Given the
tendency for managers to manage earnings, there is added credibility to the approach since the
uncertainty makes the judgment of the managers more important. On the other hand, R&D is
clearly a valuable resource to a company. Otherwise, companies would not invest in it. Requiring
that R&D costs be expensed, however, still provides no information about the prospects for the
R&D.
Users would find it useful if managers had to assess the future benefits associated with research
and development expenditures since such an evaluation would give some information about cash
flows that would be generated by the expenditures in the future.

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Page 1-45
P12-5.
a. and b.
2017
Sales
Net income
Interest expense
Income tax rate
After-tax interest cost
$875,000
487,500
50,000
15,000
0.20
12,000
Note: The book uses two different measures of profit margin in this chapter. The solution
is provided using both. With the first considering the after tax cost of interest.
Profit margin = ($50,000 + $12,000)/$875,000 = 7.09 %
Or Profit margin = $50,000/$875,000 = 5.71 %
Asset turnover = $875,000/$487,500= 1.79
Return on assets = [$50,000+ $15,000( 1-.2)]/$487,500 = 0.127
b.
If average assets increase by 10% to $536,250, and sales increase 12% to $980,000 the
asset turnover ratio required would be 1.83 (assuming the profit margin stays the same)
(ROA/profit margin = 20%/7.09. will be 2.82.
The profit margin required to achieve the presidents objectives (assuming asset turnover
of 1.83 ($980,000/$536,250) would be 10.9%, (0.20 = 1.83 x profit margin)
With a profit margin of 10.9% net income would have to be $94,820.
(($875,000*1.12)*10.9% - $12,000)
c.
The targets that she has set require an increase in sales of 12% while increasing the profit
margin by 3.84 percentage points to 10.9% or asset turnover to 2.82, an increase of 57%,
seems a difficult challenge. To increase profit margin the company would have to be able
to raise its prices or increase sales(to increase gross margin) and decrease expenses by a
significant amount. To increase asset turnover it would have to reduce assets (not increase
them).

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Page 1-46
P12-6
a, b.
2017
Proposed
Sales units
Selling Price
Cost per unit
Sales
Cost of Sales
Gross Margin
Other Expenses
Net Income
500,000
$20.00
$12.50
$10,000,000
6,250,000
3,750,000
3,550,000
$ 200,000
590,000
$19.00
$12.50
$11,210,000
7,375,000
3,835,000
3,550,000
$ 285,000
Gross Margin %
Profit Margin %
37.50%
2.00%
34.21%
2.54%
c.
The company made more money despite a lower gross margin First, it would be able to
keep its other expenses the same with the higher volume of sales and it would be able to
generate more gross margin (despite the lower gross margin percentage) because of the
higher volume. This combination would result in an overall improvement in profit
margin.
d.
If the assumptions are accurate then Vita should undertake the strategy because it would
result in an overall increase in profits for the company. The drawbacks would be the
accuracy of the predictions in terms of consumers willing to buy with the $1 decrease in
price. Another drawback is whether or not the company can sustain the increased sales
with current staffing levels. If they are able to support the increase then the question
maybe if the current infrastructure is too over staffed and therefore may focus on cost
cutting internally rather than reducing selling price. There are a variety of other
drawbacks such as production capacity, consumer acceptance of new pricing or others
that may hinder achievement of the target.

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Page 1-47
P12-7
2017
$65,000
375,000
610,000
2,839,730
1,535,517
Proposed
$176,340
326,763
546,896
2,839,730
1,535,517
Inventory Turnover
Days in inventory
2.517
145.0
2.808
130
Receivables Turnover
Collection period days
7.573
48.2
8.690
42
Cash
Average Receivables
Average Inventory
Revenue
Cost of Sales
Assuming all inventory is paid with cash and all other accounts remain unaffected the companys
cash position would improve by $111,340 if it reduced inventory holding period and receivables
collection period.
Some methods management can use to achieve these targets include offering discounts for early
payment of receivables (penalties for late payment may also be enforced), be more active in
pursuing overdue receivables, and tightening credit requirements (although this might decrease
sales). The inventory holding period could be shortened by eliminating unprofitable products and
discounting slow moving items.

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Page 1-48
P12-8
a. to c.
Accounts receivable
Inventory
Accounts payable
Revenue
Cost of sales
Gross margin %
2015
$300,000
200,000
150,000
2,000,000
1,100,000
45.0%
Accounts receivable turnover

Inventory turnover
Days inventory on hand
Purchases
Cash lag
2016
$315,000
210,000
157,500
2,100,000
1,155,000
45.0%
2017
$330,750
220,500
165,376
2,310,000
1,282,050
44.5%
2018
$347,288
231,526
173,644
2,541,000
1,423,076
44.0%
6.829
53.45
5.634
64.78
$1,165,000
7.577
48.17
70.1
7.154
51.02
5.956
61.28
$1,292,550
8.006
45.59
66.7
7.495
48.70
6.296
57.97
$1,434,102
8.460
43.14
63.5
d.
Everells business has been improving over the four years. Sales have grown steadily
although the gross margin percentage has decreased slightly, by 1%. From the
information provided, its not possible to tell how other costs have been managed and the
overall profitability of the enterprise. Inventory and receivables have been well managed
over the period. While sales have grown by about 27%, receivables and inventory have
grown by less than 16%. This demonstrates good liquidity management. Over the three
year period, the collection period has decreased by almost five days and the days
inventory on hand has decreased by almost seven days. Everell has also paid its suppliers
more quickly. Hopefully this has resulted in the company being able to take advantage of
discounts for prompt payment. As a result, the cash lag has decreased by seven days from
70.1 days to 63.5 days. The implication is that Everell will have more cash available to
meet its needs.
e.
The improvements in the presented results suggest good management. The reduction in
the collection period for receivables could be due to more aggressive collection
techniques, changes in credit terms that either reward customers for more prompt
payments or provide for penalties for late payment, or elimination of poorer credit risks.
The reduction in the number of days inventory on hand reflects improved inventory
control procedures. It could also indicate streamlining of the inventory on hand so less
obsolete inventory lines are kept on hand. The increase in the speed in which payables are
made could indicate that the company is taking advantage of more prompt payment
discounts or is meeting supplier deadlines for payment because of cash flow
improvements.

Solutions Manual
Page 1-49
f.
Its not possible to come to a conclusion as to whether a line of credit should be offered to
Everell based on the information given. However, the information provided is positive.
Other than the decline in the gross margin percentage, the company has improved its
liquidity and management of liquidity over the last three years. That said, there is a lot
more to know before a decision could be reached.

Solutions Manual
Page 1-50
P12-9.
a. to c.
2014
2015
2016
Accounts receivable
Inventory
Accounts payable
$2,868,750
5,625,000
725,000
$3,098,250
5,850,000
738,920
$3,253,163
6,142,500
760,351
Revenue
22,500,000
23,625,000
23,152,500
2017
$3,415,82
2
5,835,375
707,883
21,994,87
5
9,000,000
9,402,750
9,168,622
8,666,640
7.919
46.094
1.639
222.721
9,627,750
13.153
27.750
241.1
7.291
50.065
1.529
238.709
9,461,122
12.621
28.920
259.9
6.596
55.335
1.447
252.227
8,359,515
11.387
32.054
275.5
Cost of sales
Accounts receivable turnover

Inventory turnover
Days inventory on hand
Purchases
Cash lag (number of days)
d.
The companys liquidity has been deteriorating over the last three years. The average
collection period has increased by over nine days since 2016 and the holding period for
inventory has increased by 30 days. The long collection period suggests that customers
arent paying promptly? It will be useful to know if they are collecting interest. The time
Everell is taking to pays its bills has increased by over four days. While the company
appears to be paying in good time, the information suggests that itsnt taking advantage
of discounts for prompt payment. These should be taken if possible. The net effect is that
the cash lag has increased significantly over the three years. The company will be
incurring high carrying costs for its inventory and receivables since they are self-financed
for such a long time. This all suggests a decline in liquidity as the company takes longer
to collect from customers and holds its inventory longer while paying its bills in the same
length of time. Its recommended that the company take steps to improve their cash
reserve, line of credit, or other inflow of cash, as the path the company is on is a
dangerous one for liquidity.
Sales have declined from 2014 through 2017 while accounts receivable and inventory
have increased. This indicates that management have not been diligent in collecting
receivables and controlling inventory levels. It also raises the possibility that the
collectability of some of the receivables is in doubt and that inventory may be obsolete.
This situation may also suggest poor management and planning if there has been a
change in the market and economic conditions faced by the company. The increasing
inventory coupled with the declining sales suggests management was expecting growth
but did not get it. Inventory was reduced in 2017 but even so sales declined more quickly
than inventory. Is management still being too optimistic? The steady increase in
receivables suggests management is extending credit terms to maintain business or is just

Solutions Manual
Page 1-51
doing a poor job getting customers to pay. The entire situation is suggestive of a weak
business environment.
Over all the company may not be enforcing their interest penalties resulting in late
payments. Also the company should take on a more rigorous credit check to extend credit
to those that are worthy. Inventory that is moving slow should be written-off or sold at a
discount to help improve the companys cash position. As for payables if payment is not
made within the 10 days then the company should stretch their payables as long as
possible or negotiate better terms with their existing vender. The objective is to reduce the
growing cash lag the company is currently experiencing as a result of their
mismanagement of these accounts.
e.
As a banker, I would be concerned with the management of receivables and inventory. On

the other hand, the company is able to pay its suppliers. If the bank was to provide a line
of credit, it should be linked to receivables and, to a minor degree, inventory. There may
be significant obsolete inventory (we need to know more about the business) so accepting
the inventory as collateral may be risky. A loan secured by receivables would be
reasonable, though we would need to have an aging schedule so that we lend only against
receivables with a significant probability of collection. Of course, we need to find out
whether the receivables have been pledged to other creditors. Without knowing the
balance in cash and having access to a statement of cash flows, its difficult to assess the
ability of the company to meet its financial obligations in the future.

Solutions Manual
Page 1-52
P12-10
a.
Income before int. and taxes

Interest expense
Income before taxes
Income tax expense
Net income (loss)
Dividends paid
Total assets
Shareholders' equity
Tax rate
Average Total Assets
ROA
(Net income + interest (1tax)/average assets)
Average Common Shareholders'
Equity
ROE
Company A
2017
2018
$22,400
$2,400
$22,400
$2,400
4,928
528
$17,472
$1,872
$8,000
$4,368
Company B
2017
2018
$22,400
$2,400
2,400
2,400
20,000
0
4,400
0
$15,600
$0
$6,128
$2,496
Company C
2017
2018
$22,400
$2,400
5,600
5,600
16,800
(3,200)
3,696
(704)
$13,104
$(2,496)
$3,632
$0
$89,472
89,472
0.22
$86,976
86,976
0.22
$89,472
65,472
0.22
$86,976
62,976
0.22
$89,472
33,472
0.22
$86,976
30,976
0.22
84,736
88,224
84,736
88,224
84,736
88,224
0.206
0.021
0.206
0.021
0.206
0.021
84,736
0.206
88,224
0.021
60,736
0.257
64,224
0
28,736
0.456
32,224
-0.077
b.
The ROA of the three companies is exactly the same when the effects of the different
financing are eliminated. Each had a profitable 2017 but a much less profitable 2018. The
key difference is that the results across the three companies for ROE wont be the same.
The effect of the financing is that the companies with more debt perform better than the
company with no debt when profitability is high and worse when profitability is low. If
the debt costs more than the return earned on the borrowed funds, ROE is better with less
debt. If the borrowed funds generate a return larger than the cost of the debt, the more
debt the entity has the better the ROE.
c.
The interest rate that companies B and C are paying on their debt is 10%. In 2017, the
return on assets is more than twice the rate of interest but in 2018, its only 2%. In
general, when the return on assets is greater than the after-tax interest cost, net income is
increased by the use of more debt. When the ROA is less than the after-tax interest cost,
net income is decreased by debt. ROE is similarly affected. The idea of leverage is that
by financing with debt the owners get a chance to increase the returns they earn on their
investments. The downside is that leverage increases the owners losses if performance is
poor.
d.
There is no way to determine which company is the best investment with this information
as it would depend if the investment was in debt or equity and the associated risks. The
variances in performance are a result of the use of different debt and equity structures.
The companies have the same level of assets and the same income before interest and
taxes. A chance will depend on the investors willingness to accept risk.

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Page 1-53
P12-11.
a.
EPS
Dividend per share
Market price per share
2017
$0.98
$ 1.00
$ 11.10
2016
$1.45
$ 1.00
$ 18.50
2015
$2.25
$ 1.00
$ 24.25
2014
$2.45
$ 1.00
$ 27.55
1.02
0.090
0.69
0.054
0.44
0.041
0.41
0.036
Dividend Payout Ratio *

Dividend Yield
Dividend Payout ratio = Dividends per share EPS
b.
Dear friend,
Based on the information you have tracked and the information you provided I would
caution you on investing in the company. The market price per share is a reflection of the
companys future earning potential. As you can see the market price has steadily declined
year over year, translating to a company that has a less and less optimistic outlook. This is
reflected in the companies diminishing EPS year over year which represents the return
per share. To maintain the perception of performing well the company has continued to
pay the same dividends year over year. Over the four years the payout ratio has increased
and in 2017 more was paid out than earned. This means that funds are not being held
back to reinvest in the companys growth. This situation isnt sustainable because the
company has to generate cash to pay the dividend and ultimately earnings corresponds
with cash.
The dividend yield has also increased as a result of the falling market price per share.
While high dividend payout and a high dividend yield appear to be favourable to the
equity investor, the factors causing these increases may not be sustainable in the future.
As a result I would not recommend you purchase any additional shares in this company
on the basis of a consistent dividend payout. However, it might be a good time to invest
in the company. Perhaps if you look closely you will decide that the future looks better
for the company. But based on the information provided this company looks risky.
c.
Additional information that would help assess the situation is the companys set of
financial statements along with the MD&A on the future prospects of the company. Its
clear that the company isnt performing well. However the key questions are about the
future. Information about the companys industry, economic forecasts and the impact of
economic factors on the company and industry, and the competitive environment would
be examples of information that would be relevant.

Solutions Manual
Page 1-54
P12-12.
a.
Fodhia Inc.
Balance Sheets
As of December 31,
Operating Lease
2017
2016
Cash
Accounts receivable
Inventory
Other non-current assets
Capital Lease
2017
2016
$159,000
$206,250
$159,000
$206,250
521,250
456,000
521,250
456,000
1,368,750
1,160,250
1,368,750
1,160,250
2,171,250
1,989,000
2,487,500
1,989,000
281,250
281,250
$4,817,75
0
331,500
$4,143,000
Total assets
$4,501,500
331,500
$4,143,00
0
Current liabilities
Long term debt
Capital stock
(750 ,000 shares outstanding)
Retained earnings
$1,296,000
$1,367,25
0
$1,319,92
5
$1,367,250
742,500
712,500
1,041,825
712,500
900,000
900,000
900,000
900,000
1,563,000
$4,501,500
1,556,000
$4,817,75
0
1,163,250
Total liabilities and owners' equity
1,163,250
$4,143,00
0
$4,143,000
Fodhia Inc.
Income Statements
Operating Lease
2017
2016
Revenue
Cost of sales
Selling, general, and
Lease expense for equipment
Interest expense
Income tax expense
Net income
Capital Lease
2017
2016
$12,937,500
$10,875,000
$12,937,500
$10,875,000
7,163,250
5,997,000
7,163,250
5,997,000
4,884,000
4,162,500
4,884,000
4,162,500
232,500
206,250
261,250
206,250
56,250
69,000
64,500
103,500
64,500
132,750
111,000
132,750
111,000
$399,750
$333,750
$392,750
$333,750

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Page 1-55
b.
Return on assets
Return on equity
Profit margin ratio
Current ratio
Asset turnover
Earnings per share
Operating lease
(2017)
0.828
10.455%
Capital lease
(2017)
0.962
10.495%
17.664%
3.090%
1.581
2.993
0.533
8.717
17.244%
3.246%
1.552
2.888
0.524
6.077

Solutions Manual
Page 1-56
c.
Financial ratios are functions of the measurements that go into the calculation of the
ratios. For Fodhia Inc., regardless of whether the leases are accounted for as capital or
operating leases, the underlying economic activity is the same. However, the
representation of that activity can have a significant impact on the financial statements.
The ratios differ under the two methods of accounting for the leases because of the
impact the different accounting has on assets, liabilities, and expenses. With a capital
lease, the leased assets are included in capital assets and a liability is reported
representing the amount owing to the lessor. As a result, there would be more assets and
more liabilities when the leases are accounted for as capital leases. Under an operating
lease, the amount expensed for the period is the amount paid or owing for use of the
leased assets. With a capital lease, the expense is the interest expense related to the lease
liability and the amortization of the capital assets. Over the life of the lease and the assets,
the amount expensed will be the same regardless of how the leases are accounted for, but
the timing of the expenses will differ under the two accounting methods.
Strictly speaking, users should not be affected by the different accounting method that is
used since it should be possible for them to make adjustments for the accounting
differences. Adjustments are possible especially given the disclosure that is provided
regarding the treatment of leases. That said, some users perceptions of the company may
be affected. How efficient one believes capital markets to be will have an impact on how
one believes the markets would be affected. There would be more direct impact if there
are economic consequences that follow from the differences. If payments or other wealth
transfer differences occur as a result of the different measures (for example, impact on a
covenant related to the debt-equity ratio), the impact might be significant.
Again, the underlying economic activity is not affected by how the accounting is done,
just the representation of that activity. Therefore it can sometimes be difficult to argue
that one measure is definitively better than another. In this case, however, a strong
argument can be made in favour of the measures provided by the capital lease approach.
The reason is that a lease is a financing arrangement. Treating leases as operating leases
results in off-balance sheet financing and, as a result, liabilities are understated. Operating
lease accounting doesnt reflect the assets that are at the entitys disposal, although
depending on the user information about assets that arent owned by the entity may not be
useful for the user (for example a lender looking for collateral). If one accepts that capital
lease accounting provides a better indication of the obligations and resources of the
entity, the capital lease measures should be seen as better measures of the categories
indicated. However, counter arguments can be made.

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P12-13.
a. and b.
Financial statements with write-down in 2014
(amounts in thousands)
2013
Revenue
Operating expenses
Interest expense
Income before write-down of assets
Write-down
Income before tax
Income tax expense
Net income
Total assets as reported
Adjustment (cumulative)
Adjusted total assets
$74,000
Shareholders equity as reported

Adjusted shareholders' equity
Average shareholders' equity
$50,000
Profit margin
Return on assets (net income + after tax interest)/average assets)
Return on shareholders' equity

Solutions Manual
2014
2015
2016
2017
$61,000
$56,000
$62,000
$66,000
24,000
22,000
26,000
29,000
14,000
14,400
14,800
15,600
2,400
2,400
2,400
2,400
20,600
17,200
18,800
19,000
20,000
600
17,200
18,800
19,000
5,150
4,300
4,700
4,750
$(4,550)
$12,900
$14,100
$14,250
$69,450
$82,350
$96,450
$110,700
20,000
20,000
20,000
20,000
$49,450
$62,350
$76,450
$90,700
$61,725
$55,900
$69,400
$83,575
$45,450
$58,350
$72,450
$86,700
20,000
20,000
20,000
20,000
$25,450
$38,350
$52,450
$66,700
$37,725
$31,900
$45,400
$59,575
-7.5%
23.0%
22.7%
21.6%
-4.46%
-12.1%
26.30%
40.4%
22.91%
31.1%
19.20%
23.9%
Page 1-58
a. and b (contd.)
Financial statements without write-down in 2014
(amounts in thousands)
2013
2014
$61,000
24,000
18,000
2,400
16,600
5,150
$11,450
2015
$56,000
22,000
18,400
2,400
13,200
4,300
$8,900
2016
$62,000
26,000
18,800
2,400
14,800
4,700
$10,100
2017
$66,000
29,000
19,600
2,400
15,000
4,750
$10,250
$69,450
4,000
$65,450
$69,725
$82,350
8,000
$74,350
$69,900
$96,450
12,000
$84,450
$79,400
$110,700
16,000
$94,700
$89,575
$45,450
4,000
$41,450
$45,725
$58,350
8,000
$50,350
$45,900
$72,450
12,000
$60,450
$55,400
$86,700
16,000
$70,700
$65,575
Profit margin
18.8%
15.9%
16.3%
15.5%

Return on shareholders equity
19.0%
25.0%
15.3%
19.4%
15.0%
18.2%
13.5%
15.6%
Revenue
Operating expenses
Interest expense
Income before tax
Income tax expense
Net income
Total assets as reported

Adjusted total assets
Shareholders equity as reported
Adjusted shareholders' equity
Average shareholders equity

Solutions Manual
$74,00
0
50,000
Page 1-59
Summary
Ratios with the write-down in 2014
Profit margin
Ratios without the write-down in 2014
Profit margin
-7.5% 23.0%
-4.46% 26.30%
-12.1% 40.4%
18.8%
19.0%
25.0%
15.9%
15.3%
19.4%
22.7%
22.91%
31.1%
21.6%
19.20%
23.9%
16.3%
15.0%
18.2%
15.5%
13.5%
15.6%
c.
The write-down is transitory earnings (loss) since it wont continue into the future. However, as a result of the write-down, the
depreciation expense will be $4,000,000 lower than it would have been had the write-down not occurred. Recognize that the
transitory unusual expense gives rise to a permanent impact in later years by way of reduced depreciation expense.
d.
Its very likely that I would evaluate the company differently if the assets were written down than I would if they were not.
This is because I wouldnt be aware that there had been any deterioration in the value of the assets if no write-down was made.
On the other hand, when the assets are written down I learn about the loss of wealth that results from the decreased utility of
the assets. I would view the loss as transitory but the earnings in the following years are larger with the write-down.
Unfortunately, if I obtain the financial statements in 2016 or later, I wont know that the write-down had occurred and will
respond to the financial statements quite differently, given the higher earnings resulting from the lower depreciation expense.
While the write-off would be considered transitory, the effect of lower depreciation in subsequent years becomes part of
permanent earnings unless users adjust for the effect.

Solutions Manual
Page 1-60
P12-14.
a.
Actual 2017
$5,100,000
Sales
Cost of sales
2,295,000
Gross margin
2,805,000
Expenses:
Salaries and wages
1,101,600
Depreciation
Selling and admin
394,800
580,000
Interest
Other
Unusual items (revenue)
200,000
130,000
400,000
Income before taxes

Income tax expense
798,600
239,580
Net income
$559,020
Forecast 2018
Explanation
$4,922,000 Sales increase by 7% after removing
the one-time sale of $500,000 to the
foreign government
2,177,640 Inventory costs increase by 8% after
removing the cost of sales associated
with the one-time sale to the foreign
government ($500,000* .4) and
reducing the inventory write down
by $78,666 (normal write down
assumed to be about $39,333).
2,744,360
1,132,445 4% increase on 70% of salaries and

wages
406,644 3% increase
490,000 2% decrease after removing the
$80,000 payment to the former
CEO. Its assumed that this amount
will not recur.
200,000 No change expected
136,500 5% increase
0 Not expected to recur
378,771
113,631 Tax rate assumed to be 30%
$265,140
b.
The results for 2017 exaggerate the profitability of the firm on an ongoing basis,
particularly due to the one-time sale and the gain on a lawsuit. Without consideration of
these two factors, 2018 will appear to be much less successful but it will be a better year
if the assumptions that we have been given turn out to be accurate.
c.
Forecasting the future performance of an enterprise can be difficult since there can be
many unforeseen factors, from strikes to competitive actions to loss of major customers.
In addition, IFRS/ASPE financial statements can distort the predictive value of the
current years financial statements when write-downs occur. IFRS/ASPE reports what
happened and the past is not necessarily a good indicator of what will happen. Also,
under IFRS/ASPE, many of the accounting choices allocate revenues and expenses to
periods and those allocations are a function of management decisions. Different decisions
will result in different measurements. Its not always clear or known what events or
amounts are transitory. For example, the existence of the $500,000 one-time contract
would probably not be disclosed.

Solutions Manual
Page 1-61
P12-15
High Fashion Ltd.
Common Size Balance Sheets
as of December 31,
201
7
2016
2015
2014
Cash
0.05
0.08
0.23
0.35
Inventory
0.40
0.41
0.41
0.37
0.05
0.06
0.06
0.03
0.51
0.55
0.70
0.75
Capital assets
0.73
0.23
0.65
0.20
0.45
0.16
0.35
0.11
1.00
1.00
1.00
1.00
Bank loan
0.07
0.07
0.06
0.02
Accounts payable
0.24
0.24
0.24
0.21
Other payables
0.01
0.04
0.08
0.11
Current portion of long-term debt
0.06
0.02
0.02
0.02
0.38
0.37
0.40
0.37
Long-term debt
0.10
0.19
0.25
0.31
Common shares
0.22
0.22
0.21
0.24
Retained earnings
0.31
0.22
0.15
0.08
1.00
1.00
1.00
1.00
Assets
Accumulated depreciation
Liabilities and Shareholders equity
High Fashion Ltd.

Common Size Income Statements
as of December 31,
2017
2016
2015
2014
Revenue
1.00
1.00
1.00
1.00
Cost of sales
0.54
0.53
0.53
0.52
Gross margin
Selling, general, and administrative
costs
0.46
0.47
0.47
0.48
0.34
0.36
0.37
0.39
Interest expense
0.01
0.01
0.01
0.01
Other expenses
0.02
0.03
0.04
0.06
Income before taxes
0.10
0.07
0.05
0.02
Income taxes
0.02
0.01
0.01
0.00
Net income
0.08
0.06
0.04
0.02

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Page 1-62
2017
2016
2015
Return on Assets
Return on Equity
0.16
0.293
0.12
0.26
0.10
0.24
Current Ratio
Quick Ratio
Inventory Turnover
Average days of Inv.
A/P turnover
Average Payment Period
1.346
0.13
2.351
155.3
4.244
86.01
1.48
0.23
2.44
150
4.43
82.4
1.77
0.58
2.66
137
4.99
73.1
From the analysis the company is sustaining stable growth over the four year period with
associated expenses reflective of the growth the company is experiencing. Both return on assets
and return on equity has improved year over year as has the profit margin. Sales have increased
by about 66% over the period. The gross margin percentage has decreased (from 48% to 46.3%)
but this may have contributed to the growth of the company by improving competitiveness.
Other expenses have not grown as quickly sales so the company has been exercising reasonable
cost control. This growth and improvement has been achieved with the company reducing its
long-term debt, which is offset by increases in bank borrowing. The bank borrowing is more
expensive than the long-term debt because the interest expense has increased in 2017.
The concern is with the companys liquidity. There are number of warning signs. First, the
amount of cash the company has is very low. High Fashion has been borrowing to meet its cash
needs. It is not known whether the company has a line of credit or it arranges loans on an as
needed basis. The availability of a line of credit means a bit more certainty on the availability of
liquidity. In addition, inventory turnover has decreased over the last two years and more time is
being taken to pay bills. The companys growth may have created problems with inventory
management, and this is an area that should be examined for improvement.

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Page 1-63
P12-16.
Bonanza Inc.
Common Size Income Statements
For the Years Ended July 31,
2017
2016
2015
Sales
1.00
1.00
1.00
Cost of sales
Selling, general, and administrative expenses
Amortization
Research and development
Gain on sale of investment
Income tax expense
Net Income
0.56
0.56
0.55
0.35
0.34
0.33
0.06
0.05
0.05
0.02
0.04
0.06
0.03
0.00
0.00
0.01
0.00
0.00
0.03
0.01
0.00
2017
2016
2015
2014
Cash
Receivables
Inventory
Prepaid expenses
0.004
0.212
0.243
0.039
0.023
0.185
0.180
0.024
0.005
0.169
0.171
0.076
0.052
0.187
0.213
0.019
Current assets
Capital assets (net of depreciation)
Investment, at cost
0.499
0.501
0.000
1.000
0.096
0.270
0.367
0.135
0.386
0.112
1.000
0.412
0.524
0.064
1.000
0.079
0.264
0.343
0.150
0.429
0.077
1.000
0.422
0.508
0.071
1.000
0.044
0.254
0.298
0.165
0.470
0.067
1.000
0.471
0.529
0.000
1.000
0.000
0.271
0.271
0.000
0.645
0.084
1.000
Bonanza Inc.
Common Size Balance Sheets
As of July 31,
Bank loans
Current liabilities
Long-term debt
Capital stock
Retained earnings

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Page 1-64
Bonanza Inc.
Cash Flow Statements
For the Years Ended July 31
2017
Net income
$111,948
Add: depreciation expense
220,000
Less: Gain on sale of investments
(126,000)
Adjustments for changes in non-cash working capital
accounts:
Accounts receivable
(120,000)
Inventory
(210,000)
Prepaids
(46,000)
Accounts payable
84,000
Cash from operations
($86,052)
Investing
Investment in capital assets
Sale of investment
2016
$36,144
204,000
2015
$13,066
196,000
(70,000)
(56,000)
106,000
76,000
296,144
(70,000)
(34,000)
(132,000)
120,000
93,066
(298,000)
276,000
(22,000)
(344,000)
(344,000)
(456,000)
(150,000)
(606,000)
66,000
66,000
90,000
90,000
350,000
94,000
444,000
(42,052)
53,210
$11,158
42,144
11,066
$53,210
(68,934)
80,000
$11,066
Financing
Issue of long-term debt
Bank loans
Cash generated during the year

Cash at the beginning of the year
Cash at the end of the year

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Page 1-65
Current ratio
Quick ratio
Inventory turnover
Days inventory
Accounts receivable
turnover
Days to collect
receivables
Accounts payable
turnover
Days to pay payables
Cash lag
Profit margin
Gross margin
2017
1.361
0.591
1.007
3.958
92.219
2016
1.199
0.604
0.975
5.611
65.048
2015
1.415
0.585
0.861
6.196
58.905
7.559
10.034
12.073
48.286
36.378
30.233
3.477
104.972
35.533
2.200
0.030
0.439
3.902
93.531
7.895
1.413
0.009
0.445
4.550
80.214
8.924
1.314
2014
1.738
0.881
0.372
0.003
0.452
Report on Bonanza Inc.s Liquidity

The liquidity of Bonanza has deteriorated over the last four years. The current ratio has fallen
from 1.74 in 2014 to 1.36 in 2017. Of more concern is there is very little cash and receivables
and inventory have almost doubled while sales have fallen. Not only does this cause cash flow
problems because cash is tied up in inventory and receivables, but it also raises concerns about
possible obsolete inventory and the collectability of receivables. The company has used up
almost all of its line of credit and has increased its accounts payable. The company is holding on
to its inventory much longer and taking much longer to collect its receivables.
The companys solvency is also a concern, since total debt has more than tripled while sales are
falling, raising serious questions about the management of the company. The debt to equity ratio
has risen from 0.37 to 1.01. The cash flow statement shown above indicates that the company
had negative cash from operations in 2017, generated mainly by the increases in the current
operating asset accounts. Of additional concern is the fact that the $350,000 long-term debt is
due to be repaid in early 2019, which could put the company into serious jeopardy.
I would be very hesitant to lend the company additional funds without a clear understanding of
how the investment would affect revenues and costs. Without the gain on the sale of investment,
the company would have incurred a loss. The best year, 2016, resulted in a profit margin of
approximately 1%. Another bothersome issue is the fact that the firm has cut R&D by about 2/3
over the three years. Cutting back on R&D is a short-term measure that may jeopardize the
companys market position in the future.

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Page 1-66
I would want to see an aging of accounts receivable and a report on the inventory. The company
needs to turn its receivables and inventory into cash as soon as possible and reduce its accounts
payable and line of credit. A projected statement of cash flows would also indicate the cash flow
from operations, which has been negative for the last year. The company also needs to look at
selling, general and administrative expenses that have held steady while sales have fallen.
In conclusion, the company has not been well managed in recent years and has not performed
well. More cash would only be a temporary solution at best.

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Page 1-67
P12-17.
Report on Bonanza Inc.
I would be very hesitant in making an equity investment in Bonanza Inc. based on the financial
information we have received. The companys sales have declined over the last few years and the
only reason that profits are higher in 2017 is that the company recorded a gain on the sale of an
investment and reduced its R&D by $86,000. If R&D had not been reduced by$74,000 in 2016
Bonanza would have suffered a loss as well. Without these events, profitability would have
shown a downward trend, not an increase. The gross margin decreased slightly over the three
years suggesting the company cannot maintain its competitive position or its costs. A possible
explanation is that the merchandise has become less attractive than competitors as a result of the
R&D cutbacks. In any event, the company is not very profitable, with a profit margin of only 1%
in 2016, which is the best year once one-time gains have been eliminated.
The company has not been well managed, as evidenced by the increasing debt, inventory and
receivables. I would have serious concerns about the valuation of the inventory and receivables.
There may very well be items that should be written down. The increasing payables may also
cause supplier relationships to suffer as well as an indication of cash flow problems. The
company is also facing some serious liquidity problems. With a major debt repayment coming in
less than two years and negative cash from operations in 2017 (see cash flow statement provided
in P12-16) our investment may simply ensure the short-term survival of the company.
There is no evidence that the company has significant growth prospects. The impression that is
provided by the financial statements is that the company is looking for equity not because it has
positive prospects but because its in a cash crunch and has virtually exhausted its line of credit.
The basic question in my mind is whether the company could become profitable if quick and
drastic changes were made. I expect that the companys management would expect us to come in
with less than 50% of the ownership, which suggests that we would have a difficult time
persuading the president to take the necessary actions to turn the company around. While its
possible that the cash problems could be solved by our investment and better management of
current assets, the problem of the deteriorating product competitiveness would take longer to
resolve.
Further information is required about conditions in this industry, markets for products,
competition, and more detailed information about Bonanza so that we can assess whether an
infusion of capital will be helpful. It could be that a change in management would go a long way
to improving the companys prospects since, as discussed above, it does not appear to have been
well managed.
In summary, I do not see any evidence that this investment is likely to increase in value to a
sufficient degree that we can expect to sell it at a profit unless we could obtain a large share of
ownership for a modest investment. Since a small investment would have no appeal to
management, that option is not likely viable. A change of management is possibly necessary and
we would not be able to bring that about with less than 50% of the shares. I recommend that we
look elsewhere for investment opportunities.

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Page 1-68
P12-18
Note: There are many possible ways and points that students can approach this problem from. This is a sample of how it might
be done. Evaluation of student performance on this question should consider how a student tackled the problem and how
he/she selected tools to do the analysis.
To: Manager of Investment Fund
Re: Investment opportunity with Bold!
As per your request, I have completed a preliminary analysis regarding the financial condition of Bold! Over the course of the last
seven years Bold! has produced erratic results. Revenues are 10% below the highest point in 2011 and at their lowest point in 2015
revenues were 18% below the high. On the positive side revenues have increased for the last two years. In 2017 Bold! enjoyed its
highest profits over the seven year period. Between 2013 and 2015 the company suffered losses and in 2016 it had only a small profit.
Gross margin has slipped significantly in 2017 to its lowest level in the period, which could indicate increasing costs or a lack of
control over costs or it may indicate that there is increased competition (resulting in decreased prices)..
Bold!s cash position is relatively strong (compared with other years provided) and inventory turnover is at a high point. (Accounts
receivable are not meaningful because credit sales are a small part of the companys business.) The company appears to be paying is
bills in good time, with the accounts payable turnover ratio relatively high. These results suggest a reasonable liquidity position.
I would recommend an investigation of Bold!s cash flow position and an examination of the strength of the market and its customers
before pursuing an investment in Bold! at this time. The company has not shown much stability over the course of the past seven years
and net income has suffered on several occasions. Frankly, I have some doubts about the reliability of the accounting information itself
or with the ability of management given the strange changes in the reported amounts.

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Page 1-69
Financial Analysis of Bold!.

Periods ended:
Operating revenue
General and administrative expenses
Cost of sales
Net income
Cash and equivalents
Inventories
Accounts receivable
2017
2016
2015
2014
2013
2012
2011
$000s
$000s
$000s
$000s
$000s
$000s
$000s
$65,420 $63,240 $59,340 $66,540 $71,246 $70,195 $71,991
28,971
27,911
28,696
27,868
29,776
28,558 25,678
34,946
31,826
30,781
33,145
36,024
35,515 36,839
5,157
661
-2,201
-74
-2,839
2,158
4,290
7,953
8,232
4,733
8,477
9,200
2,902
1,511
10,962
11,424
12,939
11,612
11,966
14,812 15,465
302
290
161
238
254
240
194
3,938
3,755
4,283
3,268
3,770
4,224
4,189

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Page 1-70
2017
3.1221
2016
2.6127
2015
2.5075
2014
2.8115
2013
2.6906
2012
2.3460
116.91
139.70
145.56
129.82
135.66
155.58
221.01
280.44
297.44
270.49
288.45
323.48
296.00
225.50
199.50
246.00
247.00
217.00
1.65
1.30
1.23
1.35
1.27
1.13
Purchases
Average A/P
A/P turnover ratio
34,484
3,846.50
8.965
40.714
30,311
4,019.00
7.542
48.396
32,108
3,775.50
8.504
42.919
32,791
3,519.00
9.318
39.170
33,178
3,997.00
8.301
43.972
34,862
4,206.50
8.288
44.041
Profit margin ratio

Gross margin percentage
0.079
0.466
0.010
0.497
(0.037)
0.481
(0.001)
0.502
(0.040)
0.494
0.031
0.494
0.060
0.488
0.534
0.503
0.519
0.498
0.506
0.506
0.512
0.443
0.079
0.441
0.010
0.484
(0.037)
0.419
(0.001)
0.418
(0.040)
0.407
0.031
0.357
0.060
0.709
1.557
0.940
0.739
1.495
0.896
0.837
0.830
1.022
0.751
1.227
0.780
0.774
1.309
0.900
0.958
1.237
1.008
1.000
1.000
1.000
Inventory turnover ratio

Average number of days
inventory on hand
Accounts receivable
turnover ratio
Average accounts
receivable
Average collection
period of accounts
receivable
Vertical Analysis
Cost of sales
General and
Net Income
Horizontal Analysis
(2011) base year)
Inventories
Accounts Receivable
Accounts payable and

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Page 1-71
accrued liabilities
Operating revenue
General and
Cost of sales
Net Income
0.909
0.878
0.824
0.924
0.990
0.975
1.000
1.128
0.949
1.202
1.087
0.864
0.154
1.118
0.836
(0.513)
1.085
0.900
(0.017)
1.160
0.978
(0.662)
1.112
0.964
0.503
1.000
1.000
1.000

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Page 1-72
USING FINANCIAL STATEMENTS

FS12-1.
Balance Sheet
Assets
Current Assets
Cash
Trade and other receivables
Other financial assets
Current tax assets
Inventory
Prepaid expenses
Total Current assets
Non Current Assets
Other financial assets
Property, plant and equipment
Non-current assets held for sale
Goodwill
Intangible assets
Other non-current assets
Deferred tax assets
Total assets
Common Size
As at December ,
2011 2010 2009
Trend
As at December,
2011 2010 2009
0.00
6
0.13
3
0.00
1
0.00
3
0.30
2
0.00
7
0.45
2
0.02
6
0.10
3
0.00
1
0.00
0
0.31
0
0.00
6
0.44
5
0.08
8
0.09
2
0.00
1
0.00
1
0.26
8
0.00
7
0.45
7
0.07
2
1.49
1
0.55
5
3.12
6
1.15
8
1.15
0
1.01
7
0.31
6
1.20
8
0.84
9
0.00
0
1.24
8
0.99
1
1.05
2
1.00
0
1.00
0
1.00
0
1.00
0
1.00
0
1.00
0
1.00
0
0.00
5
0.31
4
0.00
4
0.15
4
0.04
6
0.00
2
0.02
3
1.00
0
0.00
3
0.30
3
0.00
6
0.18
1
0.04
4
0.00
1
0.01
7
1.00
0
0.00
4
0.30
6
0.00
4
0.16
8
0.03
9
0.00
2
0.01
9
1.00
0
1.22
5
1.05
6
0.94
4
0.93
7
1.19
6
1.23
4
1.25
9
1.02
8
0.86
7
1.06
9
1.48
7
1.16
1
1.20
8
0.73
6
0.94
1
1.08
0
1.00
0
1.00
0
1.00
0
1.00
0
1.00
0
1.00
0
1.00
0
1.00
0
0.00
2
0.17
5
0.00
1
0.00
1
0.15
5
0.00
3
0.00
2
0.15
2
0.00
0
0.84
0
1.19
1
0.37
3
1.10
8
1.00
0
1.00
0
N/A
N/A
N/A
Liabilities
Current Liabilities
Bank loans
Trade and other payables
Dividends payable

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Current tax liabilities

Derivative financial instruments
Provisions
Instalments on long-term debt
Current liabilities
Long-term debt
Other non-current liabilities
Provisions
Deferred tax liabilities
Total liabilities
0.00
0
0.00
0
0.00
2
0.00
7
0.18
8
0.00
1
0.00
1
0.00
2
0.00
7
0.17
0
0.00
0
0.00
0
0.00
3
0.00
4
0.16
0
N/A
0.89
0
0.99
2
2.02
7
1.20
8
N/A
2.13
0
0.66
1
2.11
6
1.14
6
N/A
1.00
0
1.00
0
1.00
0
1.00
0
0.08
3
0.01
2
0.00
1
0.01
2
0.29
7
0.15
2
0.01
0
0.00
2
0.01
2
0.34
6
0.15
9
0.01
0
0.00
4
0.01
0
0.34
4
0.53
9
1.20
8
0.33
5
1.18
2
0.88
7
1.03
2
1.09
8
0.42
2
1.23
8
1.08
6
1.00
0
1.00
0
1.00
0
1.00
0
1.00
0
0.28
5
0.40
1
0.00
4
0.00
0
0.69
1
0.01
3
0.70
3
1.00
0
0.21
7
0.42
2
0.00
4
0.00
0
0.64
2
0.01
2
0.65
4
1.00
0
0.22
3
0.41
6
0.00
5
0.00
0
0.64
4
0.01
2
0.65
6
1.00
0
1.31
4
0.99
2
0.86
7
1.04
8
1.09
6
0.84
8
1.00
0
1.00
0
1.00
0
N/A
1.10
2
1.08
4
1.10
2
1.02
8
N/A
1.07
7
1.09
3
1.07
7
1.08
0
N/A
1.00
0
1.00
0
1.00
0
1.00
0
Shareholders Equity
Share capital
Retained earnings
Contributed surplus
Accumulated other comprehensive
income
Total equity owners of RONA Inc.
Non-controlling interests
Total equity
Total liabilities and equity
Income Statement
Revenues
Cost of sales
Gross profit
SG&A
Common Size
Year Ended
2011
2010
1.000
1.000
(0.719) (0.715)
0.281
0.285
(0.253) (0.243)

Solutions Manual
Trend
Year Ended
2011
2010
0.997
1.000
1.002
1.000
0.984
1.000
1.036
1.000
Page 1-74
Net gains on disposal of assets

Other income
Goodwill impairment
Other charges
Operating profit (loss)
0.000
0.004
(0.024)
(0.015)
(0.007)
0.001
0.004
0.000
0.000
0.046
0.346
1.011
N/A
N/A
(0.141)
1.000
1.000
N/A
N/A
1.000
Finance income
Finance costs
Income (loss) before Income Taxes
0.001
(0.007)
(0.013)
0.001
(0.005)
0.042
1.198
1.443
(0.299)
1.000
1.000
1.000
Income tax expense

Net income (loss)
(0.003)
(0.016)
(0.013)
0.030
0.228
(0.524)
1.000
1.000
Observations:
RONAs balance sheet has remained remarkably stable from the common size analysis
over the three year period
Cash has decline significantly, from almost 9% of total assets to less than 1% on a
common size basis. The trend statement shows cash in 2011 at 7% of 2009 levels.
Long-term debt as a proportion of total assets has declined over the three years. The trend
data shows an increase in absolute amount relative to 2009 in 2010 and then a significant
decline in 2011.
Trade and accounts receivable have grown significantly as a proportion of total assets
(common size) and relative to 2009 (trend). The growth in receivables is a concern
especially because sales actually decreased from 2010 to 2011.
Inventory has grown as a proportion of total assets over the three years by over 15%
which is an improvement for 2010 level which increased by almost 25% from 2009. The
question however is why the major changes in inventory despite fairly stagnant revenues
over 2010 and 2011?
Cost of sales increased as a proportion of sales by one percentage point and increased
relative to 2010. However, sales decreased in 2011 relative to 2010. This indicates higher
costs in 2011.
FS12-2.
Use COGS = Beginning Inventory + Purchases Ending Inventory to calculate purchases.
a. current ratio
b. quick ratio
c. accounts receivable turnover ratio
d. average collection period of accounts receivable
e. inventory turnover ratio
f. average number of days inventory on hand
g. accounts payable turnover ratio
h. average payment period for accounts payable
2011
2.41
0.74
14.34
25.45
3.96
92.21
7.20
50.71

Solutions Manual
2010
2.62
0.76
17.59
20.75
4.23
86.35
8.40
43.47
Page 1-75
RONAs liquidity position has remained relatively stable over the two years. The current and
quick ratios have both decreased slightly. The current ratio is high but the cash balance is low
and accounts receivable have increased much faster than sales, which may indicate a problem
with the receivables. The quick ratio is low but this is reasonable for a retail business that has
most of its current assets invested in inventory. Ronas collection period for receivables has
increased by five days since last year, which means cash is being collected from customers less
quickly. However, this result may be misleading because retail sales will not be on credit (except
for a major credit card) so the receivables are likely related to wholesales sales. This is change
that should be investigated by getting more details into the breakdown of revenues by customer
base. With receivables being 20 times that of cash on hand this needs makes the receivable very
important in determining liquidity. Inventory is being held for 6 days longer than last year. Since
inventory represents a large investment, this could represent a negative trend as inventory is
taking longer to turn into cash flow. Rona has also increased the time it takes (by a small
amount) to pay its payables. Further investigation is required to find the reason whether its
intentional or simply a change in the composition of the payables. The cash flow statement
shows that the company generates good cash flow from operations, which is an important source
of an entitys liquidity.

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Page 1-76
FS12-3.
a. gross margin
b. profit margin
c. return on assets
(net income + finance costs * (1 tax rate)/average total assets)
d. return on equity
(Net Income + preferred dividends/Average Shareholders' Equity)
2011
2010
0.281
-0.016
0.285
0.030
-0.017
0.057
-0.036
0.077
Its difficult to assess an entitys performance based on two years data, so by necessity this
analysis is limited. Based on the data available RONAs performance has deteriorated in 2011
versus 2010 because it operated at a loss. Gross margin percentage decreased slightly in 2011,
meaning that the company has been able to maintain its margin on the goods it sold. All other
measures have deteriorated in 2011 as a result of the net loss, despite the reduction in average
assets. Because gross margin was unchanged its worth noting that costs other than product costs
have increased disproportionally, in RONAs case it was due to elevated SG&A and impairment
losses.
FS12-4.
a. debt-to-equity ratio
b. interest coverage ratio (earnings based)
c. interest coverage ratio (cash based)
2011
2010
0.42
-0.75
8.84
0.53
9.46
5.96
RONAs debt-to-equity ratio has decreased by 9% from 2010 to 2011. This is due to the
reduction in long term debt and is a sign that the company is not very risky since the company is
primarily financed by equity. Interest coverage ratio using the earnings base was not a good ratio
for comparison because of the net loss in 2011 however the cash based approach paints a
different picture. RONAs cash flow from operations actually improved over the two years hence
the cash based approach is a better way of comparing the companys ability to meet its interest
obligations. Overall the company is replacing debt with the issuance of more preferred shares
which in substance is similar to debt despite being considered as equity.

Solutions Manual
Page 1-77
FS12-5.
RONAs gross margin for 2011 and 2010 was 0.281 and 0.285 respectively.
Revenue
Gross Profit
As
reported
adjusted
Before Tax
Net Income
As
reported
adjusted
2011( Gross margin =0.281)
4,804,584
1,349,283
1,367,550
(60,910)
(42,643)
2010( Gross margin =0.285)
4,819,589
1,371,821
1,353,497
203,538
185,214
Since gross margin slightly declined from 2010 to 2011 the result would have been a lower loss
in 2011 if 2010s gross margin was the same. On the other hand if 2010s gross margin was the
same as 2011s then net income would have been lower. (Note: Responses may vary slightly due
to rounding.)
FS12-6.
Yes RONA does have off-balance sheet liabilities in the form of commitments that are not
reflected on the balance sheet. These items include operating leases and a constructive obligation
to support the Olympics and Paralympics. Since these items are not reflected on the balance
sheet the debt-to-equity ratio doesnt fully reflect RONAs obligations. A comparison of
capitalizing the lease amounts results in the following changes to the debt-to-equity ratio. Note
that since some of the leases are sublet to their franchises, the difference will be taken between
payments and receivables when performing the present value calculations. Its assumed in the
analysis that the payments between years 1 and 5 are spread evenly over the four years and the
payments over five years are evenly spread from 2017 to 2030.
Annual Payments less receivables

Years of payment terms
Rate
PV of payments
Total amount to Capitalize
debt-to-equity ratio
2012
$130,957
1
(1 year)
15%
$113,876
$472,153
up to 2016
$437,650
2-5
(4 years)
15%
$271,626
Before
2011
After
2011
0.42
0.66*
up to 2030
$426,241
6-19
(14 years)
15%
$86,651
Adjusted debt-to-equity calculation: ($824, 754 + $472, 153)/$1,955,624 = 0.66

The debt-to-equity ratio increased by about 57% as liabilities increased by 57%. Through off
balance sheet financing RONA is able to present its financial statements in a better light than

Solutions Manual
Page 1-78
with through finance leases. Therefore users must be aware of these items that are not presented
in the financial statements but rather in the details of the notes disclosure.
FS12-7.
RONAs ending cash balance on December 31, 2011 was $58,428 lower than one year earlier,
this despite that CFO was almost $92,000 higher in 2011. In 2011 RONA had a net outflow of
cash from investing activities (mainly acquisitions of other businesses, property, plant, and
equipment, and intangibles) of $146,833 and a net outflow from financing activities (mainly
repurchase of debentures and common shares and repayment of long-term debt, offset by new
long-term debt and proceeds from issuing preferred shares) of $141,840.
RONAs cash from operations is greater than net income because cash from operations is
comprised of cash items associated with operating activities, whereas net income is a
combination of cash and non-cash items (for example, depreciation and gains and losses are noncash items that impact net income but are not part of cash from operations). In the case of
RONAs 2011 CFO two major expenses that were non-cash that were added back to net income
included $149,736 for depreciation and amortization and goodwill impairment of $117,000.
It should be mentioned that the write-off and restructuring may imply impairments of future cash
flows, so CFO may decrease in future because the future benefit associated with the impairment
of assets has decreased.
FS12-8.
There are two aspects to RONAs poorer performance in 2011: one-time events and deteriorating
operational performance. In 2011 RONA reported $181,343 in one-time costs related to
restructuring (goodwill impairment-$117,000; Restructuring costs and impairment-$71,343). In the
absence of these items RONA would have reported a profit (ignoring taxes) of $113,570. In
addition, from note 5.1 operating profit before goodwill impairment and restricting costs was
$66,305 lower in 2011 (due a decrease in sales, decrease in gross margin percentage and increase
in selling, general, and administrative costs. In addition, finance costs increased in 2011. In
summary:
Net income as reported

Goodwill impairment
Restructuring costs and impairment
Total
Decrease in operating profit before restructuring and impairment
Adjusted profit

Solutions Manual
Change
($74,733)
117,000
71,343
113,610
66,305
$179,915
Page 1-79
FS12-9.
Instructors can tailor this question depending on how in-depth they wish students to go. The
analysis can range from a cursory discussion of some basic ratios to an in-depth analysis that
includes consideration of economic and market conditions in concert with independent research.
A problem with making this analysis too broad is that students will not be able to recreate
economic conditions at the time of the financial statements. It will be necessary to use the 2011
financial data and later market and economic information to carry out the analysis. This is
certainly doable, but it will lack some realism. An alternative approach would be for instructors
to choose another entity for purposes of this exercise (or use a more current version of RONAs
financial statements). This will serve the same purpose and will allow students to use more
current financial information as a starting point.
In carrying out this analysis, students should examine the financial information provided. The
beginning of the report should lay out the decision being made and the decision criteria. A
framework is crucial for this type of assessment. Without laying out the terms of reference of the
task, its not possible to make an assessment. Its crucial that students be aware of this need. If a
framework is not laid out, the analysis tends to be a dump of financial ratios with little
interpretation, context or analysis.
The following report focuses on the data provided. More comprehensive answers are possible:
To the manager of the credit department,
As a supplier, I am concerned with RONAs ability to meet its payments for inventory purchased.
The risk we face is that at some point in time RONA will face financial distress and will not be
able to pay. If we are a major supplier, this could represent a significant amount of money for us.
Also, it could be several months before we become aware of the problem. Our relationship with
RONA will be an ongoing one so our assessment cannot be solely short term. We must assess
whether RONA will be a reliable debtor over the years. We must determine whether we will offer
credit to the company, how much credit we will offer, and on what terms. Its difficult to provide
a complete analysis based on the information provided. Further research of market conditions,
the competitive environment, credit history, and so on is required.
RONAs immediate liquidity situation is solid. As of December 25, 2011 the company had
significant cash on hand (over $17 million, although this is $57 million less than a year earlier,
but more importantly its over $200 million less than 2009) and the current ratio is 2.41,
indicating that there is $2.41 of current assets for each $1 of current liabilities. However, most of
the current assets are in the form of inventory that, if its not fully saleable, could introduce
liquidity problems. The quick ratio of 0.76 bears this out. A low quick ratio is common in retail
businesses because there has to be a lot of money tied up in inventory. Both of these ratios have
been steady over the last two years and this is a positive indicator. A longer time series would be
even more helpful. RONA has delivered significant positive cash from operations over the last
two years. CFO is a crucial factor in liquidity so I have some confidence that the company can
meet its obligations. However, some sensitivity analysis is required to determine the effect on
CFO of a contraction in sales.

Solutions Manual
Page 1-80
RONAs debt-to-equity ratio has decreased since last year, from 0.42 to 0.53, which is an
improvement however the increased in equity was through the issuance of new preferred shares
which in substance is similar to debt. The company has paid off over $200 million in long-term
debt in 2011, which is a sign that the company is less risky than previous years. I have calculated
turnover ratios for receivables, inventory, and payables. The payment time for payables has
increased, but seems to be long (50.71 days), but we need information on the companys credit
terms to correctly interpret this. This result may be due to the need to the need to estimate
purchases and on using total accounts payable, which includes more than just inventory
purchases. The increase in days to pay payables can be viewed as a concern as their supplier.
Also, the inventory turnover ratio has decreased, which means that its taking longer for RONA
(about 92 days) to sell inventory. This also reduces liquidity. RONAs cash from operations is
good and has improved in 2011.
More information is needed about RONA before I can come to a definite conclusion. Based on
the information available, RONA seems a reasonable risk. However, we should obtain a credit
report, a longer time series of financial statements, and more information about the company and
its business.

Solutions Manual
Page 1-81
FS12-10.
includes consideration of economic and market conditions in concert with independent research.
A problem with making this analysis too broad is that students will not be able to recreate
economic conditions at the time of the financial statements. It will be necessary to use the 2011
financial data and later market and economic information to carry out the analysis. This is
certainly doable, but it will lack some realism. An alternative approach would be for instructors
to choose another entity or a more recent set of RONAs financial statements for purposes of this
exercise. This will serve the same purpose and will allow students to use more current financial
information as a starting point.
Since equity investors need to know everything, responses to this question can build on the
answer to FS12-9, which considers liquidity and solvency. The equity investor will want to get
an idea of the future performance of the entity so as to ultimately estimate RONAs future stock
price. Students should look at the performance indicators such as gross margin, profit margin,
and ROI. Again additional information is necessary to do a comprehensive analysis. It would be
necessary to study RONAs business, its markets, the competition, and so on. Analysis of similar
companies would also be appropriate. Whether this depth of analysis is required depends on the
terms of reference provided by the instructor. This could be a major project or simply involve the
calculation of basic ratios with a discussion. The responses to FS12-1 to FS12-6 will provide
appropriate discussion of these ratios.

Solutions Manual
Page 1-82
FS12-11.
includes consideration of economic and market conditions in concert with the independent
research. A problem with making this analysis too broad is that students will not be able to
recreate economic conditions at the time of the financial statements. It will be necessary to use
the 2011 financial data and later market and economic information to carry out the analysis. This
is certainly doable, but it will lack some realism. By selecting another comparable entity with a
more recent set of RONAs financial statements, this would make the exercise more meaningful.
This will serve the same purpose and will allow students to use more current financial
information as a starting point.
The responses to this question can build on the answer to FS12-9, which considers liquidity and
solvency. Students should look at the performance indicators such as gross margin, profit margin,
and ROI. Again additional information is necessary to do a comprehensive analysis. This
question is more comprehensive and combines analysis from both FS12-9 and FS12-10. Whether
this depth of analysis is required depends on the terms of reference provided by the instructor.
This could be a major project or simply involve the calculation of basic ratios with a discussion.
The responses to FS12-1 to FS12-6 will provide appropriate discussion of these ratios.
RONA is the largest Canadian distributor and retailer of hardware, home renovation and
gardening products. Its major competitors include: Lowes, Canadian Tire, Home Depot, Home
Hardware and local small businesses in this space. Along with being Canadian based RONA
differentiates themselves from their large peers by offering the same customer service found at
smaller, local establishments in combination with the large purchasing power and economies of
scale. Home Depot and Lowes are US public companies and Canadian Tire trades on the TSX in
Canada.

Solutions Manual
Page 1-83

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CHAPTER 12

Analyzing and Interpreting Financial Statements

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Uncertainties about supplies could be of concern, particularly in some industries, where

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Donations to charities if done every year may be considered as permanent, however if

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Capital assets (net)

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

*Columns may not add due to rounding.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Capital assets (net)

1.378 1.135 1.000

2.100 1.191 1.000

1.400 1.240 1.000

1.000 1.000 1.000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Ratio before the

a. Cash (-) , Long Term Liabilities (-), Equity (-)

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

(credit sales/ avg.

Increase (share price

c. 2 for 1 stock split

Ratio before the

a. Assumption - Executory Contract. Assume that none of b. through e.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Ratio before the

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Possible explanations include a) Oungre doesnt follow up with customers on a regular

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

An increase in accounts payable represents a source of cash, which would appear

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Dividend payout ratio = (100,000,000 x $0.08)/(11,879,500 -500,000)= 70.3% - 70.3% of

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

The dividend would reduce shareholders equity by $25,000 to $250,000. It would

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Total liabilities (at year-end)

Shareholders equity (at yearend)

Average total assets

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Average total assets

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Revenue = Cost of sales/(1 gross margin percentage)

Gross Margin = Sales - Cost of Sales