Communicating and Interpreting Accounting Information ANSWERS TO QUESTIONS

Potter © McGraw-Hill Australia Pty Ltd 2009 Solutions to accompany Accounting in Context 5-1

Chapter 5 Communicating and Interpreting Accounting Information

ANSWERS TO QUESTIONS

1. The primary responsibility for the accuracy of the financial records and conformance

with Generally Accepted Accounting Principles (GAAP) and / or AASB Standards of the information in the financial statements rests with management, normally the CEO and CFO. Independent auditors or registered company auditors are responsible for conducting an examination of the statements in accordance with Generally Accepted Auditing Standards (for private companies) and AUASB Auditing Standards (for public companies), and based on that examination, attesting to the fairness of the financial presentations in accordance with GAAP and / or AASB Standards. Both management and the auditors assume a financial responsibility to users of the statements.

2. Financial analysts, who normally work for brokerage and investment banking

houses, mutual funds, and investment advisory services, gather extensive financial and non-financial information about a company, on which they base forecasts and stock purchase and sale recommendations.

Private investors include individuals who purchase shares in companies, often on the basis of recommendations from financial analysts. Institutional investors are managers of pension, mutual, endowment, and other funds that invest on behalf of others. They usually employ their own analysts who also rely on the information intermediaries such as financial analysts and information services. Companies do have incentives to consider when communicating with the above users. One example would be the desire to meet analysts’ expected earnings level.

3. Information services provide a wide variety of financial and non-financial information

to analysts and investors, often on-line or on CD-ROM. These services are normally the first source where important financial information such as half yearly or annual earnings announcements is available.

4. To be useful, information must be relevant; that is, it must be timely and have

predictive and/or feedback value. However, if the information is not reliable


(accurate, unbiased, and verifiable) it will not be relied upon, and thus will not be useful.

5. a. Statement of comprehensive income --Accrual basis required by GAAP. b. Statement of financial position--Accrual basis required by GAAP. c. Statement of cash flows--Cash basis required by GAAP. 6. The role of the Australian Securities and Investments Commission (ASIC) is to

protect investors and maintain the integrity of the financial markets. ASIC regulates Australian companies, financial markets, financial services organisations and professionals. It also reviews the activities of companies and individuals for compliance with the Corporations Act 2001 and accounting standards, investigates irregularities and punishes violators.

7. Public companies in Australia are required by ASIC to issue press releases and

annual reports. Press releases are written public news announcement normally distributed to major news services and are the first announcement of half-yearly or annual financial information. Annual reports are often elaborate reports including extensive discussions and colour photos. The financial section includes: (1) directors’ declaration as to the solvency of the company and the integrity of the financial reports; (2) directors’ report; (3) the four primary financial statements and associated notes and disclosures; (4) report of independent auditor. The non-financial section includes: (1) a letter to shareholders from the chairperson and CEO; (2) the company’s management philosophy, products, successes; (3) exciting prospects and challenges for the future. Publicly listed companies in Australia and other relevant entities are also required to report on a half-yearly basis. These reports typically include a short letter to shareholders, an audited statement of comprehensive income for the half year showing less detail compared to the annual report, and an audited statement of financial position dated at the end of the half year. Companies may also elect to provide Concise Financial Reports under the Corporations Act 2001 according to the minimum disclosure guidance under AASB 1039.

8. The four major subtotals or totals on the statement of comprehensive income are:

(a) Gross profit, which is net sales less cost of goods sold; interested users would include parties such as customers, competitors, management, regulators, suppliers, etc.

(b) Income from continuing operations, equals net sales less cost of goods sold and

other operating expenses; interested users would include parties such as competitors, creditors, management, shareholders, regulators, etc.8

(c) Profit before income tax; interested users would include parties such as

competitors, creditors, management, shareholders, regulators, etc. (d) Net profit; interested users would include parties such as customers, competitors,

suppliers, regulators, etc.


9. When a major component of a business is sold or abandoned, profit and loss from

that component, as well as any gain or loss on disposal, are included as discontinued operations. Discontinued operations are reported on the statement of comprehensive income separately because they are not useful in predicting the future profits of the company given their nonrecurring nature. They also aid the user in evaluating the profit performance of the business. Inclusion of such items in the continuing operational revenue and expense categories would lead the user to believe that they are normal and will recur often in the future, which would be misleading.

10. The six major classifications on the statement of financial position are: (a) current

assets, (b) non-current assets, (c) current liabilities, (d) non-current liabilities, (e) contributed capital and (f) retained earnings.

11. Property, plant, and equipment are reported on the statement of financial position.

Property, plant, and equipment are those assets held by the business not for resale but for use in operating the business, such as a delivery truck. (a) Property, plant, and equipment are reported at their acquisition cost which represents the amount of resources expended in acquiring them. (b) Over their period of use, they are "depreciated" because of being worn out (used up) or becoming obsolete in carrying out the function for which they were acquired. A portion of the cost of this effect is known as depreciation expense. A certain amount of depreciation is reported each period as an expense on the statement of comprehensive income and the total amount of depreciation on the asset from the date it was acquired up to the date of the financial statement is known as accumulated depreciation. (c) Cost minus accumulated depreciation equals net book value, as reported on the statement of financial position. Net book value (sometimes also called book value or carrying value) does not represent the current market value of the asset but rather the original cost of it less the amount of that cost that has been measured as depreciation expense for all of the periods since the asset was acquired.

12. The major classifications of shareholders’ equity are: (1) contributed capital, which

represents the shareholders' investments and (2) retained earnings, which represent the earnings of the company to date less any dividends paid to the owners. Contributed capital is often split between the account common stock (which consists of a nominal legal amount called par value) and paid-in capital.

13. The three major classifications on the Statement of Cash Flows are (a) cash from

operating activities, (b) cash from investing activities, and (c) cash from financing activities.

14. The three major categories of footnotes are: (1) descriptions of accounting rules

applied to the company’s statements, often called significant accounting policies (e.g., the depreciation method applied to property, plant, and equipment), (2) additional details about financial statement numbers (e.g., sales by geographic


region), and (3) relevant financial information not listed on the statements (e.g., the existence of a bank line of credit).

15. Return on equity (ROE) is a ratio measure defined as net income divided by

average shareholders’ equity. It measures how much the firm earned for each dollar of shareholders’ investment. A return on equity analysis provides an overall framework for evaluating company performance by breaking down ROE into its three determinants: net profit margin, asset turnover, and financial leverage. Together, these indicate why ROE differs from prior levels or that of competitors, and provide insights into strategies to improve ROE in future periods.

ANSWERS TO MULTIPLE CHOICE

1. c) 2. b) 3. d) 4. a) 5. c) 6. b) 7. c) 8. d) 9. d)


MINI-EXERCISES

M5-1.

Players Definitions

____C____ (1) CEO and CFO ____D____ (2) Independent auditor ____B____ (3) Users ____A____ (4) Financial analyst

A. Adviser who analyses financial and other economic information to form forecasts and stock recommendations.

B. Institutional and private investors and creditors (among others).

C. Chief executive officer and chief financial officer who have primary responsibility for the information presented in financial statements.

D. Independent organisation or individual who examines financial statements and attests to their fairness.

M5-2.

No. Title

____2_____ Annual report ____3_____ Earnings forecast ____1_____ Earnings press release Note: Many companies now issue the annual report and the earnings forecast at the same time. M5-3. Elements of Financial Statements Financial Statements B (1) Liabilities A. Statement of Comprehensive Income. C (2) Cash from operating activities B. Statement of Financial Position. A (3) Losses C. Statement of Cash Flows. B (4) Assets D. None of the above. A (5) Revenues C (6) Cash from financing activities A (7) Gains B (8) Owners' equity A (9) Expenses D (10) Assets personally owned by a shareholder


M5-4. Transaction Current

Assets Gross Profit Current

Liabilities a. + + NE b. NE NE + The effects of the transactions can be seen by making the related journal entries and using CA, CL, R, and E to denote current asset, current liability, revenue, and expense, respectively. a. Accounts receivable (+CA) ........................................ 110 Sales revenue (+R) ........................................... 100

GST Payable (+CL) ........................................... 10 Cost of goods sold (+E) ............................................... 60 Inventory (–CA) ............................................... 60

Note that Gross Profit increases (by $40) since it is defined as Sales (increased by $100) less Cost of Goods Sold (increased by only $60).

b. Advertising expense (+E) .......................................... 10 GST receivable (+CA)……………………………………. 1 Accounts payable (+CL) ................................. 11

Note that Advertising Expense is not included in Cost of Goods Sold and, hence, has no effect on Gross Profit.

M5-5.

Assets Liabilities Shareholders’ Equity

a.) Accounts Receivable +550

Inventory -360

GST Payable +50 Sales Revenue +500

Cost of Goods Sold -360

b.) Cash +90 000 Contributed Equity +90 000


M5-6. a. Accounts receivable (+A) ........................................................ 550 Sales revenue (+R, +SE) ............................................. 500

GST Payable (+ L) ....................................................... 50 Cost of goods sold (+E, –SE) ................................................. 360 Inventory (–A) .............................................................. 360 b. Cash (+A) ................................................................................ 90 000 Contributed equity ($9 10 000 shares) (+SE)............. 90 000 M5-7. Return on equity (ROE) = Net income = 85 = 85 = 0.11 Avg. shareholders’

equity (800+750)/2 775

Return on equity (ROE) measures how much the firm earned for each dollar of shareholders’ investment. The information given is not sufficient for deriving sales for the year.

EXERCISES

E5-1.


Players Definitions E (1) ASIC D (2) Independent

auditor H (3) Institutional

investor C (4) CEO and

CFO B (5) Lender A (6) Financial

analyst G (7) Private

investor F (8) Information

service

A. Adviser who analyses financial and other economic information to form forecasts and stock recommendations.

B. Financial institution or supplier who lends money to the company.

C. Chief Executive Officer and Chief Financial Officer who have primary responsibility for the information presented in financial statements.

D. Independent professional or organisation that examines financial statements and attests to their fairness.

E. Australian Securities and Investments Commission which regulates financial disclosure requirements.

F. A company that gathers, combines, and transmits (paper and electronic) financial and related information from various sources.

G. Individual who purchases shares in companies. H. Manager of pension, mutual, and endowment funds

that invest on the behalf of others.

E5-2. Information Release Definition

B (1) Annual report C (2) Half-yearly A (3) Press release D (4) Concise report

A. Written public news announcement that is normally distributed to major news services.

B. Report containing the four basic financial statements for the year, related notes, and often statements by management and auditors.

C. Report for a six-month period normally containing summary statement of comprehensive income and statement of financial position (audited).

D. Brief report prepared by public companies that may contain a discussion and analysis section.

E. Report providing a more detailed description of the business including product development and other current events.


E5-3. Information Item Report A (1) Summarised financial data for 5- or 10-year period. C (2) Announcement of annual earnings forecast. A, C (3) Announcement of a change in auditors. A (4) Discussion and explanation of results by

management. A, F (5) The four primary financial statements for the year. A, B (6) Notes accompanying financial statements. D (7) Detailed discussion of the company’s competition. A (8) Director’s declaration A* (9) A description of those responsible for the financial

statements. C (10) Initial announcement of hiring of new national sales

manager.

A. Annual Report B. Concise Report C. Press Release D. None of the above

* It is also possible to argue that a ‘description’ of those responsible for the preparation of financial statements is not provided in the annual report and that the answer should be ‘none of the above’. Those responsible are identified, by are not ‘described’ per se. E5-4.

No. Title 6 Current liabilities 7 Long-term liabilities 2 Long-term investments 4 Intangible assets 3 Property, plant, and equipment 1 Current assets 9 Retained earnings 8 Contributed capital 5 Other non-current assets


E5-5.

Apple Computer, Inc. Consolidated Balance Sheet September 29, Current Year

(in millions)

Assets

Current Assets Cash and cash equivalents $9 352 Short-term investments 6 034 Accounts receivable 1 637 Inventories 346 Other current assets 4 587

Total current assets 21 956 Non-current Assets

Property, plant and equipment, net 1 832 Intangible assets 337 Other non-current assets 1 222

Total assets $25 347

Liabilities and Stockholders' Equity Current liabilities

Accounts payable $4 970 Accrued expenses 4 329

Total current liabilities 9 299 Long-term liabilities

Non-current liabilities 1 516

Total liabilities 10 815 Stockholders' Equity

Contributed equity 5 368 Retained earnings 9 164

Total stockholders' equity

Total liabilities and stockholders' equity $25 347


E5-6. Req. 1.

Lance Inc. Consolidated Balance Sheet December 31, Current Year

(in millions)

Assets CURRENT ASSETS Cash and cash equivalents $ 5 504

Accounts receivable, net 61 690 Inventories 36 838 Prepaid expenses 6 300 Other current assets 15 360Total current assets 125 692 Property, plant and equipment, net 193 010 Other intangible assets, net 13 210 Other assets (non-current) 53 540TOTAL ASSETS $385 452Liabilities and Stockholders’ Equity CURRENT LIABILITIES Accounts payable $ 18 194 Accrued liabilities 42 280 Other current liabilities 12 978Total current liabilities 73 452 NONCURRENT LIABILITIES Long-term debt 50 000 Other long-term liabilities 39 600Total non-current liabilities 89 600 STOCKHOLDERS' EQUITY

Contributed equity 285 350 Retained earnings (62 950)Total stockholders' equity 222 400TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $385 452


E5-6. (continued) Req. 2. In each case, the term “net” means that the account is reported after the balance in the related contra account has been subtracted. "Accounts receivable, net" means that the allowance for doubtful accounts contra account has been subtracted. Goodwill, net and other intangible assets, net mean that the accumulated amortisation contra account has been subtracted. "Property, plant and equipment, net" means that the accumulated depreciation contra account has been subtracted. E5-7. Cash (+A) ................................................................... 111 000 000 Contributed capital (+SE) ........................................................ 111 000 000 E5-8. Req. 1. Beginning RE + Net income - Dividends = Ending RE Dividends = Beginning RE + Net profit - Ending RE Dividends = $838 500 000 + 450 000 000 – 1 094 600 000 = $193 900 000 Leighton paid $193.9 million dividends during the year, assuming there are no

other transactions affecting Retained Earnings during the period. Req. 2. If a share issue was made during the year the following accounts would be affected: Cash (+A) ....................................................... Contributed equity (+SE) ......................


E5-9. Terms Definitions E (1) Cost of goods sold F (2) Interest expense B (3) Discontinued

operations C (4) Service revenue K (5) Income tax expense J (6) Income from

continuing operations D (7) Net profit A (8) Gross profit G (9) EPS I (10) Operating expenses

A. Sales revenue – cost of goods sold. B. Item that is not expected to impact on future

performance. C. Sales of services for cash or on credit. D. Revenues + Gains - Expenses - Losses

including effects of discontinued operations, and cumulative effects of accounting changes (if any).

E. Amount of resources used to purchase or produce the goods that were sold during the reporting period.

F. Cost of money (borrowing) over time. G. Net profit divided by average shares

outstanding. H. Profit before unusual and infrequent items and

the related income tax. I. Total expenses directly related to operations. J. Profit before all income tax and before

discontinued operations and cumulative effects of accounting charges (if any).

K. None of the above.


E5-10. Case A Case B Case C Case D Case E Sales revenue $900 $700 $410 $1 190* $750* Cost of goods sold 400* 370 200* 500 310 Gross margin 500 330* 210* 690* 440 Operating expenses: Selling expense 200* 150 80 400 250 Administrative expense 100 90* 60 100 80 Total expenses 300* 240* 140* 500* 330* Profit before tax 200 90 70* 190 110* Income tax expense 30* 30 20 40 30 Net profit $170 $60* $50 $150* $80 *Amounts not given in the exercise. E5-11.

VANDIN COMPANY Statement of comprehensive income

For the Year Ended December 31, 2013 Computations in Order Sales revenue ................................ Given $70 000 Cost of goods sold.......................... (a) $70 000 - $24 500 45 500 Gross profit ..................................... Given 24 500 Operating expenses: Selling expense ............................ Given $8 000 Administrative expense ................ (c) $12 500 – $8 000 4 500 Total operating expenses ............... (b) $24 500 – $12 000 12 500 Pretax income ................................ Given 12 000 Income tax expense ................... (d) $12 000 x 30%* 3 600 Net profit ......................................... (e) $12 000 – $3 600 $ 8 400 Earnings per share ($8 400 3 000 shares*) $2.80 *Given


E5-12.

THAYER APPLIANCES PTY LTD Statement of Comprehensive Income

For the Year Ended December 31, 2015 Computations in Order Sales revenue ................................ Given $130 000 Cost of goods sold.......................... (a) $130 000 - $58 000 (given) 72 000 Gross profit ..................................... Given 58 000 Operating expenses: Administrative expense ............... Given $10 000 Selling expense ........................... Given 18 000 Total operating expenses ......... (b) $10 000 + $18 000 28 000 Income before income taxes .......... (c) $58 000 - $28 000 30 000 Income tax expense ................... (d) 25%* x $30 000 7 500 Net profit ......................................... (e) $30 000 - $7 500 $22 500 Earnings per share ($22 500 2 000 shares*) = $11.25 *Given


E5-13. Transaction Current


Liabilities a. +$5 399.9 +$1 852.5 NE b. +$25.6 NE +$25.6 c. NE NE NE The effects of the transactions can be seen by making the related journal entries and using CA, CL, R, and E to denote current asset, current liability, revenue, and expense, respectively. a. Accounts receivable (+CA) ........................................ 5 399.9 Sales revenue (+R) ........................................... 4 909.0

GST Payable (+CL) ........................................... 490.9 Cost of goods sold (+E) ............................................... 3 056.5 Inventory (–CA) ............................................... 3 056.5

Note that Gross Profit increases (by $1,852.5) since it is defined as Sales (increased by $4,909.0) less Cost of Goods Sold (increased by only $3,056.5).

b. Cash (+CA) ................................................................ 25.6 Notes payable (+CL) ....................................... 25.6 c. Depreciation expense (+E) ........................................ 9.2 Accumulated depreciation (Contra NCA) ........ 9.2

Note that Depreciation Expense is not included in Cost of Goods Sold and, hence, has no effect on Gross Profit.

E5-14. Transaction Current


Liabilities Cash Flow from

Operating Activitiesa. NE NE NE + 334.97 b. – 2.1 NE – 2.1 NE The effects of the transactions can be seen by making the related journal entries and using CA and CL to denote current asset and current liability, respectively. a. Cash (+CA) .................................................................. 334.97 Accounts receivable (–CA) ............................... 334.97 b. Notes payable (–CL) .................................................... 61.96 Cash (–CA) ....................................................... 61.96 Note that repayment of debt is a financing activity.


E5-15.

WHITEWALL COMPANY Statement of Cash Flows

For the Year Ended December 31, 2011 From Operating Activities Net profit .................................................................... $18 000 Increase in accounts receivable ................................. (10 000) Decrease in inventory ................................................ 2 000 Decrease in accounts payable ................................... (4 000) Cash flows from operating activities ....................... $ 6 000 From Investing Activities Purchased a new delivery truck .................................. (12 000) Purchased land ........................................................... (36 000) Cash flows from investing activities ........................ (48 000) From Financing Activities Borrowed cash on three-year note .............................. 25 000 Issued shares for cash ................................................ 22 000 Cash flows from financing activities ........................ 47 000 Net cash inflows for the year .............................. 5 000 Beginning cash balance .................................................... 36 000 Ending cash balance ......................................................... $ 41 000


E5-16. Req. 1.

Current Year

Prior Year

Net profit (given) Average Shareholders' Equity (given)

$1 030 = 0.24 $4 221

$477 = 0.14 $3 334

The increase in ROE from 0.14 in the prior year to 0.24 in the current year means that the firm earned $0.10 more for each $1 of stockholders’ investment. Req. 2.

ROE Analysis Current Year

Prior Year

Net Profit Net Sales

Net Profit Margin

$1 030 = 0.065 $15 854

$477 = 0.033 $14 455

x Net Sales Average Total Assets

Asset Turnover

$15 854 = 1.57 $10 123

$14 455 = 1.64 $8,793

x Average Total Assets Average Shareholders' Equity

Financial Leverage

$10 123 = 2.40 $4 221

$8 793 = 2.64 $3 334

Return on Equity 0.24 0.14

The increase in ROE is caused by the increase in net profit margin (from 0.033 in the prior year to 0.065 in the current year). This increase is offset partially by small declines in asset turnover and financial leverage.


E5-17. Req. 1.

Current Year

Prior Year

Net profit (given) Average Shareholders' Equity (given)

$33 563 = 0.24 $140 610

$46 797 = 0.31 $148 790

The decrease in ROE from 0.31 in the prior year to 0.24 in the current year means that the firm earned $0.07 less for each $1 of shareholders’ investment. Req. 2.

ROE Analysis Current Year

Prior Year

Net profit Net Sales

Net Profit Margin

$33 563 = 0.037 $917 378

$46 797 = 0.05 $946 219


Asset Turnover

$917 378 = 2.57 $357 023

$946 219 = 2.51 $377 136

x Average Total Assets Average Shareholders' Equity

Financial Leverage

$357 023 = 2.54 $140 610

$377 136 = 2.53 $148 790

Return on Equity 0.24 0.31

The decrease in ROE is caused by the decrease in profit margin (from 0.05 in the prior year to 0.037 in the current year). Req. 3. Security analysts would be more likely to decrease their estimates of share value on the basis of this change. The company decreased its earnings by $0.07 for each $1 of shareholders’ investment and, hence, decreased the corresponding value of that investment.


PROBLEMS

P5-1. (1) E; (2) K; (3) D; (4) H; (5) L; (6) V; (7) B; (8) P; (9) A; (10) Q; (11) T; (12) M; (13) C;

(14) F; (15) U; (16) H; (17) J; (18) I; (19) R; (20) N; (21) O. P5-2. G (1) Retained earnings B (11) Contributed equity L (2) Current liabilities ̀ Q (12) Liabilities D (3) Liquidity P (13) Fixed assets H (4) Contra-asset account C (14) Shareholders' equity N (5) Accumulated depreciation E (15) Current assets J (6) Intangible assets K (16) Assets A (7) Other assets O (17) Long-term liabilities I (8) Shares outstanding M (9) Normal operating cycle F (10) Written down value


P5-3. Req. 1

GOLD JEWELERS Statement of Financial Position

December 31, 2013

Assets Current Assets Cash ........................................................................... $ 42 000 Accounts receivable .................................................... 51 300 Prepaid insurance ....................................................... 800 Merchandise inventory ................................................ 110 000 Other Assets Used store equipment held for disposal ...................... 7 000 Total current assets ............................................ $211 100 Non-current assets: Long-Term Investments Investment in Z Pty Ltd ............................................... 26 000 Store equipment ................................................................ 48 000 Less accumulated depreciation .................................. 9 600 Store equipment (written down value) ............................... 38 400 Total assets ...................................................... $275 500

Liabilities Current Liabilities Accounts payable ....................................................... $ 42 000 Income taxes payable ................................................. 8 000 Total current liabilities ..................................... $ 50 000 Non-current Liabilities Note payable .............................................................. 29 000 Total liabilities .................................................. 79 000

Shareholders' Equity Contributed Equity Ordinary shares issued at $1.10 per share, ................ 110 000 Retained Earnings ............................................................. 86 500 Total shareholders' equity .................................. 196 500 Total liabilities and shareholders' equity ............. $275 500


P5-3. (continued) Req. 2 Store equipment $48 000 - $9 600 = $38 400 Acquisition cost less sum of all

depreciation expense to date. Written down value (sometimes called book value or carrying value) is the amount of cost reported on the statement of financial position less any contra accounts (offsets). In theory this is the amount of benefits from the asset that have yet to be used up. This should not be confused with the asset’s current value. P5-4. Req. 1

EL PASO PTY LTD Statement of Financial Position

December 31, 2009

Shareholders' Equity

Contributed capital: Opening balance …………………………………………… 80 000 Shares issued Ordinary shares, 1000 shares issued at $15 per share $15 000 Total contributed capital .............................................. 95 000 Retained earnings: Ending balance [$45 000 + $40 000 - (*7 000 shares x $3 = $21 000)] . 64 000 Total shareholders' equity ........................................... $159 000 *Since the number of shares outstanding at the beginning of the year is not given, an assumption is required. If an alternative amount of shares was assumed to have been issued, then the dividends and hence the retained earnings closing balance will change. Req. 2 Cash (1 000 shares x $15) (+A) .................................. 15 000 Contributed capital – ord. shares (1 000 shares) (+SE) 15 000


P5-5.

TOMMY HILFIGER CORPORATIONConsolidated Statement of Comprehensive Income

For Year Ended March 31, Current Year

In Thousands Except Per Share Amounts Net revenue $1 875 797Cost of goods sold 1 012 156

Gross profit 863 641

Depreciation and amortisation 76 307Other selling, general and administrative expenses 583 502

Total operating expenses $659 809

Operating income 203 832Interest expense 31 756Interest income 3 577

Profit before income taxes 175 653Income tax expense 37 445

Net profit $138 208 Earnings per share: Basic earnings per share $1.52Weighted average shares outstanding 90 692


P5-6. (a) JOSHUA SALES COMPANY Statement of Comprehensive Income For the Year Ended March 31, 2011 Sales revenue ................................................................... $90 000 Cost of goods sold ...................................................... 30 000 Gross profit ........................................................................ 60 000 Operating expenses: Operating expenses .................................................... 18 000 Depreciation expense ................................................. 5 500 Total operating expenses ....................................... 23 500 Income from continuing operations ................................... 36 500 Interest expense ......................................................... 2 500 Profit before income taxes ................................................ 34 000 Income tax expense ($34 000 x 30%) ......................... 10 200 Net profit ........................................................................... $23 800 There is insufficient information to Calculate EPS.


P5-6. (continued) (b) JOSHUA SALES COMPANY Statement of Financial Position March 31, 2011

Assets Current Assets: Cash ........................................................................... $53 000 Accounts receivable .................................................... 44 800 Office supplies inventory 300 Total current assets ................................................ $98 100 Noncurrent Assets: Automobiles (company cars) ....................... $30 000 Less accumulated depreciation ................ 10 000 20 000 Office equipment .......................................... 3 000 Less accumulated depreciation ................ 1 000 2 000 Total noncurrent assets .......................................... 22 000 Total assets ............................................................ $120 100

Liabilities Current Liabilities: Accounts payable ....................................................... $20 250 Income taxes payable ................................................. 10 200 Salaries and commissions payable ............................. 1 500 Total current liabilities ............................................. $31 950 Long-Term Liabilities: Note payable ............................................................... 30 000 Total liabilities ......................................................... 61 950

Shareholders' Equity Contributed capital: Ordinary shares .......................................................... 35 000 Retained earnings (beginning balance, $7 350 + net profit, $23 800 - dividends declared and paid, $8 000) ............. 23 150 Total shareholders' equity ........................................... 58 150 Total liabilities and shareholders' equity ................. $120 100


P5-7. Req. 1. a.* Accounts receivable (+CA) ...................................................... 550 Sales revenue (+R) ....................................................... 500 GST payable (+L)…………………………………………… 50 Cost of goods sold (+E) ........................................................... 475 Inventory (–CA) ............................................................. 475 *It should be assumed that transactions a and b are stated in GST excl. terms, since the related revenue and expense amounts are provided. b. Research and development expense (+E) .............................. 100 GST receivable (+A)……………………………………………….. 10 Cash (–CA) ................................................................... 110 c. Cash (+CA) .............................................................................. 200 Contributed equity (ordinary shares) (+SE) .................... 200 d. Retained Earnings (–SE) ......................................................... 90 Cash (–CA) ................................................................... 90 Req. 2. Assuming that next period Creative pays no dividends, does not issue or buy back shares, and earns the same profit as during the current period, Creative’s ROE will be lower than in the current period. Net profit increases shareholder’s equity. Hence, average shareholders’ equity (the denominator in the ROE ratio) will increase in the next period and ROE will decrease in the next period.


P5-8.

Adolf Coors Company Statement of Comprehensive Income

For the year ended December 31 (in thousands)

Net sales ............................................................ $1 550 788 Cost of goods sold ............................................ 1 035 544 Gross profit ...................................................... 515 244 Marketing, general and administrative ............... 429 573 Research and project development .................. 12 370 Operating income ........................................... 73 301 Other income (expense) Interest income ............................................... 255 Miscellaneous income - net ............................ 1 087 Interest expense ............................................. (16 014) Income from continuing operations before taxes and cumulative effects of changes in accounting 58 629 Income tax expense .......................................... 22 900 Income from continuing operations before cumulative effects of changes in accounting ... 35 729 Net loss from discontinued operations .............. (29 415) Cumulative effect of change in accounting for income tax ...................................................... 30 500 Cumulative effect of change in accounting for postretirement benefits (net of tax) .................. (38 800) Net profit (loss) .............................................. $ (1 986)


ALTERNATE PROBLEMS AP5-1. Req. 1

CARPET BAZAAR Statement of Financial Position

December 31, 2012

Assets Current Assets Cash ........................................................................... $ 35 000 Accounts receivable .................................................... 47 500 Prepaid insurance ....................................................... 1 300 Carpet inventory ......................................................... 118 000 Total current assets ............................................ $201 800 Long-Term Investments Investment in ABC Company ...................................... 32 000 Non-current assets Store equipment ......................................................... 51 000 Less accumulated depreciation .............................. 10 200 Total fixed assets ............................................... 40 800 Other Assets Used store equipment held for disposal ...................... 3 500 Total assets ........................................................ $278 100

Liabilities Current Liabilities Accounts payable ....................................................... $ 45 000 Income tax payable ..................................................... 6 000 Total current liabilities ......................................... $ 51 000 Long-Term Liabilities Note payable .............................................................. 26 000 Total liabilities ..................................................... 77 000

Shareholders' Equity Contributed Capital Ordinary shares (100 000 shares at $1.25 per share) 125 000 Retained Earnings ............................................................. 76 100 Total shareholders' equity .................................. 201 100 Total liabilities and shareholders' equity ............. $278 100


AP5-1. (continued) Req. 2 Store equipment $51 000 - $10 200 = $40 800 Acquisition cost less sum of all

depreciation expense to date. Written down value (sometimes called book value or carrying value) is the amount of cost reported on the Statement of financial position less any contra accounts (offsets). This represents the amount of the cost of the asset that has yet to be expensed. Req.3 Only 1 year’s information is provided here – so our ability to comment is limited. Some things to consider include: (i)The short term liquidity for the company looks good with current assets far exceeding current liabilities. This depends of course, on the quality of the debtors and inventory, but assuming they can be collected, the short term position for the company looks good. (ii) In the longer term, financial position looks equally solid, with assets far exceeding liabilities. It is relevant to seek further information to calculate the interest coverage (the company’s ability to meet interest commitments), but the evidence presented would suggest that this is probably fine. (iii) If anything, there may exist opportunity here for the company to borrow additional funds to enhance returns for shareholders. AP5-2. Req. 1

TORRINGTON LTD Statement of Financial Position

December 31, 2011

Shareholders' Equity Contributed equity (Ordinary shares) 11 000 shares (9 500 x $10 and 1 500 x 17) ...................................... $120 500 Retained earnings [$98 500 + $50 000 - (9 500 shares x $2 = $19 000)] .. 129 500 Total shareholders' equity ........................................... $250 000 Req. 2 Cash (1 500 shares x $17) (+A) .................................. 25 500 Contributed equity (1 500 shares) (+SE) .......... 25 500


AP5-3. (a) ACME SALES Statement of Comprehensive Income For the Year Ended August 31, 2010 Sales revenue ................................................................... $55 000 Cost of goods sold ...................................................... 17 000 Gross profit ........................................................................ 38 000 Expenses: Operating expenses .................................................... $10 000 Depreciation expense ................................................. 12 000 Total operating expenses ....................................... 22 000 Income from continuing operations ................................... 16 000 Interest expense ......................................................... 2 000 Profit before income tax ................................................... 14 000 Income tax expense ($14 000 x 30%) ......................... 4 200 Net profit ........................................................................... $ 9 800 Earnings per share ($9 800 10 000 shares) ................... $ .98


AP5-3. (continued)

(b) ACME SALES Statement of Financial Position August 31, 2010

Assets Current Assets: Cash ........................................................................... $26 000 Accounts receivable .................................................... 30 800 Supplies inventory....................................................... 1 300 Total current assets ................................................ $58 100 Noncurrent Assets: Service vehicles ........................................... $60 000 Less accumulated depreciation ................ 20 000 40 000 Equipment ...................................................... 14 000 Less accumulated depreciation .................... 4 000 10 000 Total noncurrent assets ....................................... 50 000 Total assets ........................................................... $108 100

Liabilities Current Liabilities: Accounts payable ....................................................... $16 700 Income tax payable ..................................................... 4 200 Payables ..................................................................... 1 100 Total current liabilities ......................................... $22 000 Non-current Liabilities: Note payable ............................................................... 34 000 Total liabilities....................................................... 56 000

Shareholders' Equity Contributed capital: (10 000 shares, issued at $4 per share) 40,000 Retained earnings (beginning balance, $4 300 + net profit, $9 800 - dividends declared and paid, $2 000) ............... 12 100 Total shareholders' equity ........................................... 52 100 Total liabilities and shareholders' equity ................. $108 100


AP5-4. Req. 1. (Assumed here that transactions were stated in GST exclusive terms) a. Cash (+CA) ................................................................................ 4 Interest income (+R) ..................................................... 4 b. Inventory (+CA) ....................................................................... 25 GST receivable (+CA)……………………………………………… 2.5 Accounts Payable (+CL) ............................................... 27.5 c. Advertising expense (+E) ........................................................ 9 GST receivable (+CA)……………………………………………… 0.9 Cash (–CA) ................................................................... 9.9 d. Cash (+CA) .............................................................................. 50 Contributed equity (Ordinary shares) (+SE) .................... 50 Req. 2. Assuming that next period Barnes & Noble pays no dividends, does not issue or buy back shares, but earns 20% more income as during the current period, Barnes & Noble’s ROE will increase over that earned in the current period. The answer, however, is not obvious. Net profit increases shareholder’s equity. Hence, average shareholders’ equity (the denominator in the ROE ratio) will increase in the next period. In this case, net profit is increasing at a slightly faster rate than average shareholder’s equity, causing ROE to be slightly higher in the next period. (However, if earnings had only increased by 10%, Barnes & Noble’s ROE would have decreased slightly. Students are encouraged to calculate ROE to verify this assertion.)


CASES AND PROJECTS FINANCIAL REPORTING AND ANALYSIS CASES CP5-1. 1. Note 13 states that prepayments and other deposits comprise “other current assets”. 2. The company disposed of $4 139 000 in property plant and equipment during 2007

and this information can be obtained from note 16. This is different from the $180 000 disclosed in the statement of cash flows, which represents only that PPE which was disposed in exchange for cash.

3. 9573/185288 = 5.2 per cent (note 19) 4. When the consolidated entity has transferred to the buyer the significant risks and

rewards of ownership of the goods. (See note 1). 5. Although they had positive cash flow from operations, a considerable amount of

cash was used for purchases of additional plat and equipment ($34 406 000), and to pay dividends. Some additional borrowings were received also. So, overall, the overall change in the company’s cash balance is the total of each of these factors.

6. The number of share options granted during the year was 1 095 000 (note 9). 7. ROE increased from fiscal 2006 to 2007. Since this ratio provides information about

the profitability of the company and the potential returns to owners, one might suspect that the news provided in the ROE calculation would, at least to some extent, be reflected in the share price. In pricing company shares however, many other things are taken into account, including macro economic factors and market conditions.

2007 2006

Net Profit_ Average Shareholders’ Equity

$41 376 _

$(118 802+83 657)/2

= 40.9%

$25 813 _

$(83 657+62 238)/2

= 35.4%


CP5-2. 1. The company presents the subtotals “total expenses”, “Profit before income tax” and

“profit attributable to members of Super Cheap Auto Group Limited”. 2. The cash flow statement indicates that operating activities provided $33 992 000 in

cash, while there was a net cash outflow for financing activities ($3 663 000). Thus, most of the investing activities were financed by operating activities.

3. The company’s largest asset (net) is “Property and Equipment” of $67 262 000

reported on the Statement of financial position.

4. BCF constituted 15.9 per cent of sales to external customers in 2007, while only 8.4 per cent in 2006 (note 4)

5. Motor vehicles are depreciated are the rate of 15% per year (note 1). 6. Computer equipment comprises (11543/67262) 17.2 per cent of net property, plant

and equipment. .


CP5-3. Req. 1. JB Hi Fi Super Cheap Auto

Net Profit _ Average Shareholders’ Equity

$41 376 _ $(118 802+83 657)/2

= 40.9%

$22 332 $(124 526+112 930)/2

= 18.8

JB Hi Fi provided the highest return to shareholders during the current year, although both companies reported higher returns than the industry average. . Req. 2.

ROE Analysis JB Hi Fi Super Cheap Auto

Net Profit Net Sales

41 376 = 3.23 1 281 837 22 322_ = 3.57 625 187


1 281 837 = 3.28

$(453 978+326 844)/2

625 187 = 2.14 (314 608 + 269 476)/2

x Average Total Assets Average Shareholders’ Equity

$(453 978+326 844)/2 = 3.86 $(118 802+83 657)/2

(314 608 + 269 476)/2 = 2.46$(124 526+112 930)/2

Return on Equity 40.9 18.8%

The higher ROE for JB is driven by a combination of its higher sales turnover and more debt, which has worked to drive up returns. Super Cheap has higher profit margin. Ownership of property, plant, and equipment decreases the total asset turnover ratio relative to rentals. The owned assets would be included in “average total assets” while rented assets would not be included—thus, for the same level of sales, asset turnover would be lower.


CP5-3. (continued) Req. 3. Industry Return on Equity (ROE) profit driver analysis: ROE = Net Profit Margin Asset Turnover Financial Leverage

ROE Analysis Industry Average

JB Hi Fi Super Cheap Auto

Net Profit Margin 2.45 3.23 3.57

Asset Turnover 3.17 3.28 2.14

Financial Leverage 2.16 3.86 2.46

Return on Equity 16.8* 40.9* 18.8*

*rounded Both focus companies have ROE higher than the industry average. This is being driven by their higher net profit margins and by the effective use of borrowings to drive up returns. JB’s asset turnover is very similar to the industry average, while Super Cheap’s is lower. Both companies are more highly levered than the industry average. CP5-4. Companies involved in alleged instances of fraudulent financial reporting are relatively small, with an average of less than $100 million in assets prior to the fraud. Top senior executives (specifically, the CEO or CFO) are frequently involved. Typical accounting fraud techniques include the overstatement of revenues (through early recording of legitimate revenues or the recording of fictitious revenues) and the overstatement of assets (by overstating the assets’ value or by recording fictitious assets). Possible motivations for introducing misstatements into the statement of comprehensive income near the end of the accounting period may include the need to meet contractual targets (such as debt covenant requirements or executive bonus targets) or the need to present a particular image of the company (for example, that of a healthy and growing company, in order to renew or obtain financing more easily).


CP5-5. 1. Gross margin on sales, $105 000. Computation: Sales revenue ......................................................... $275 000 Less: Cost of goods sold ........................................ 170 000 Gross margin on sales ............................................ $105 000 2. EPS, $1.00. Computation: Net income, $10 000 ($100 000 $10 = 10 000 shares) = $1.00 per share. 3. Profit before tax, $13 333. Computation (and proof): Profit before income tax [$10 000 (100% - 30% = 70%)] $14 286 (rounded) Proof: Income tax ($14 286 x 30%) ................................... 4 286 Net profit (given) ..................................................... $10 000 4. Average sales price per share of stock, $11.60. Computation: $116 000 ($100 000 $10 = 10 000 shares) = $11.60 per share. 5. Beginning balance, $70 000. Computation: (work backwards) Beginning balance (?) ($80 000 - $10 000) ............ $70 000 Add: 2008 net income (given) ................................. 10 000 Deduct: 2008 dividends (given) .............................. (None) Ending balance (given) ........................................... $80 000


CRITICAL THINKING CASES CP5-6. Strategy Change

Current Period ROE

Future Periods’

ROE

Explanation a. + – The decrease in R&D investments would lead to lower expense

in the current year, increasing current period’s income and ROE. However, when fewer products are brought to market in future periods, income and ROE will decrease.

b. – + The advertising expense would decrease income and ROE in the current year. Assuming that the movie earns a greater income in future periods because of the advertising, net income will increase, increasing ROE in future periods.

c. – + The issuance of additional shares increases average shareholders’ equity and, hence, decreases ROE in the current year. The proceeds are used only in future periods to purchase other high-tech companies—assuming those companies are profitable, their purchase would then increase income and ROE in future periods.

d. + + The repurchase of company shares decreases average shareholders’ equity and, hence, increases ROE in the current year. Equity will stay lower in future years thus maintaining a higher ROE result. This is assuming that the cash used to buy back the shares does not impede the ability of the company to generate future profits.

CP5-7. (It is assumed that the amount stated at transaction 3 is exclusive of GST since it refers to the amounts recognised as ‘revenue’.) The amounts at 6 and 7 are assumed to be inclusive of GST since they refer to the total amounts. Net Profit Assets Liabilities

Error 2010 2011 2010 2011 2010 2011 (1) O NE O O NE NE

$950 $950 $950 (2) O U NE NE U NE

500 $500 $500 (3) U O U NE U NE

600 600 660 60 (GST) (4) U O U NE NE NE

200 200 200 (5) O U NE NE U NE

900 900 900 (6) U NE U U U NE

273 300 300 27 (7) NE NE U NE U NE

8,000 8,000


CP5-7. (continued) Explanation of analysis if not corrected: (1) Given in problem (example). (2) Wage expense should be increased (debited) by $500 in 2010 because the wages

were incurred in that year. This increase in expense was not recorded; therefore, income for 2010 was overstated by $500. The wages were not paid when earned in 2010. Therefore, there is a 2010 liability of $500; thus, liabilities were understated at the end of 2010. In 2011 when the wages are recorded, wage expense will be overstated and income will be understated.

(3) Revenues were understated by $600 in 2010, which caused 2010 income to be

understated by $600. Also accounts receivable was understated because the amount of $660 (GST inclusive) will be collected in 2011; thus, assets were understated by $660 at the end of 2010. Also, if not corrected, the $600 of revenue would be recorded in 2011, which would cause 2011 revenues, and hence income, to be overstated.

(4) The $200 expense should be recorded as 2011 expense. It was recorded in 2010;

therefore, 2010 expense was overstated which would cause 2010 income to be understated. If not corrected, 2011 expense would be understated, which would cause 2011 income to be overstated by $200. Assets at the end of 2010 would be understated by $200 because prepaid expense (an asset) should be debited at the end of 2010 for this expenditure, because it was paid in advance.

(5) The $900 revenue should be recorded as revenue in 2011 because it was earned in

2011. Therefore, if not corrected, 2010 revenue and income would be overstated by $900. Also, 2011 revenue and income would be understated by $900 because that is the year that the $900 revenue was earned but was not recorded. At the end of 2010 liabilities would be understated by $900 because revenue collected in advance (a liability to render future performance to earn the revenue) should be credited for $900 at the end of 2010.

(6) This transaction should have been recorded as a credit to revenue ($273) and GST

clearing ($27) instead of a credit to accounts receivable. Therefore, revenue, and hence income, was understated as was liabilities. The credit to accounts receivable caused assets to be understated by $300 for each year. Accounts receivable will continue to be understated until a correction is made.

(7) This transaction should have been recorded in 2010 as a debit to Land and GST

clearing (8000 in total) and a credit to Liabilities, $8 000. Therefore, at the end of 2010 both assets and liabilities were understated by $8 000. The entry in 2011 corrected the accounts.


CP5-8. 1. The U.S. Attorney’s office has vigorously pursued criminal charges against four

executives at Ahold’s U.S. subsidiary. Two former top managers pleaded guilty to the fraud charges while the former chief financial officer and chief marketing officer pleaded not guilty. Dutch authorities also pursued charges against Dutch executives at Ahold. This provides clear indication of whom the regulators authorities should beheld responsible.

2. Regulators may choose not to impose monetary fines on the companies involved

where extensive cooperation is provided with the investigating authorities. This may be considered on a case by cases basis, and decided in light of the nature and extent of cooperation provided. For example, companies in the past have promptly attended to regulators’ requests for information, granted access to current employees, waived attorney-client privilege in its internal investigations, revised its internal control procedures to prevent further frauds, and fired employees found responsible for the frauds. Such instances send strong signals to other companies that there is a benefit to cooperating with regulatory investigations.

3. Bonuses tied to performance measures such as accounting earnings tend to align

the managers' interests with those of the shareholders. However, when companies face a significant downturn, and bonuses will not be awarded, some dishonest managers attempt to meet performance goals by falsifying accounting numbers.

FINANCIAL REPORTING AND ANALYSIS PROJECT CP5-9. The solutions to this case will depend on the company and/or accounting period selected for analysis.

Communicating and Interpreting Accounting Information ANSWERS TO QUESTIONS

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