CHAPTER 1: OVERVIEW OF CORPORATE FINANCIAL REPORTING
PROBLEM SOLUTIONS
Assessing Your Recall
1.1 Financing Investing and Operating
The three major types of activities in which all companies engage are:
Financing refers to the activity of obtaining funds for the company to operate.
Two primary sources of funds are owners and creditors. Some typical
financing activities are: short and long term borrowing, repayment of debt,
dividend payments, and new issuance of share.
Investing refers to the activity of using funds generated by financing
activities to acquire assets that will generate profits in the future.
Investments include the purchase of property, plant ,and equipment, and the
purchase and sale of investments in other companies.
Operating activities are those activities which are associated with
developing, producing, marketing and selling the products and/or services of
the company. They are mainly concerned with the day to day activities of the
company.
1.2 The three major categories of items that appear in a typical balance sheet are:
Assets, Liabilities and Shareholders’ Equity.
Assets are those things that a company owns or has the rights to use and
which have probable future value. The company is able to perform its
activities and thereby generate profits with the help of its assets, therefore they
are income-earning. Assets may be current or noncurrent. Current assets will
be converted into cash with the next year or operating cycle. Examples include
inventories, cash, and accounts receivable. Noncurrent assets are those assets
whose benefits may be realized over a period longer than a year or operating
cycle. Examples include property, plant, and equipment, patents, trademarks,
etc.
Liabilities are the amounts that the company owes to others and which
require a probable future sacrifice of resources. Liabilities may be classified as
current and noncurrent. Current liabilities include notes payable due within
one year, accounts payable, accrued expenses and dividends payable.
Noncurrent liabilities include long-term debt, long-term warranties payable
and pension liabilities.
Shareholders’ Equity represents the wealth or the ownership interest of the
owners. Shareholders’ equity may also be defined as the difference between the
assets and liabilities of a company:
Shareholders’ Equity = Assets – Liabilities
1
There are two major Shareholders’ equity accounts: share capital and
retained earnings. Share capital represents the amount that investors
originally paid for the share that the company issued. Retained earnings
consist of the earnings of the company less the dividends paid.
1.3
The three main financial statements contained in all annual reports are: the
Income Statement, the Balance Sheet and the Statement of Cash Flows.
Income Statement: The income statement records the inflow of revenues
and the outflow of expenses over the year. As such, it measures the increase
(or decrease) in the shareholders’ wealth during the period. The statement
helps investors evaluate the performance of the company during the period
and it is useful in forecasting the future results of the company.
Balance Sheet: The balance sheet gives the financial status of the
company at a particular point in time. Since it divulges the details of assets,
liabilities and shareholders’ equity, it give the users of the information a fair
idea of the riskiness of the mix of asset and liabilities of the company.
Statement of Cash Flows: This statement measures the inflow and outflow
of cash during a specific period of time. It is very useful in measuring
performance of the company as well as in predicting future cash flows, since it
gives details about the inflow and outflow of cash broken down into operating,
investment and financing activities. It explains the change in cash between
the beginning and the end of the period.
1.4 Financial accounting is governed by a set of accounting guidelines. These
guidelines are referred to as Generally Accepted Accounting Principals (GAAP).
The Accounting Standards Board (AcSB) of the Canadian Institute of Chartered
Accountants (CICA) sets accounting and reporting standards for companies.
These guidelines have the force of law because they are recognized in both
federal and provincial statues that govern companies.
1.5 The objective of an auditor in his/her report to the shareholders is to inform
them whether the information furnished by the company is presented fairly and
whether the company has adhered to GAAP in preparing its financial
statements. An auditor may render different types of opinions depending upon
the situation. The different types of opinions are:
1. Unqualified or “Clean Opinion” – GAAP has been followed and the
information
reported is fair.
2. Qualified or Adverse Opinion – with exception of certain noted items, the
information is fair or GAAP has not been followed and information reported
does not reflect the true state of affairs of the company.
2
1.6 Shareholders – These users are interested in the performance of their
investment in the company. They will use the financial statements to evaluate
how well management is handling their investment.
Financial Institutions – These users are interested in evaluating the company
to decide whether to lend money to it. They will use the statements to evaluate
the risk that will be taken in making the loan.
Taxing Authorities – These users establish the rules for how taxable income
will be measured. They are interested in the fair measurement of the financial
position of the company so that the appropriate tax will be paid. Note however
that income taxes are not paid based on the financial statement’s net income;
rather, they are based on taxable income. In preparing the tax return, the
financial statement’s net income is the starting point and is then adjusted to
arrive at taxable income.
Financial Analysts – These users provide investment advice to their
customers. They are interested in evaluating the investment potential of
various companies. They will want to evaluate not only individual companies
but also make cross-company comparisons.
Credit Rating Agencies – These agencies evaluate companies as to their
credit risks. These ratings are then supplied to investors who want to make
investments in these companies, either through their common shares or through
their debt.
(Note: there are other users discussed in the chapter that would be
equally acceptable answers to this question.)
1.7
Three types of information that users should be able to learn from financial
statements are:
1. management’s ability to profitably manage the company.
2. the company’s investment in assets.
3. the company’s ability to repay debt.
4. the company’s compliance with regulations.
5. the financial health of the company.
(Note: This list could be expanded to include other types of
information.)
1.8
The major qualitative characteristics that accounting information should
possess are:
3
Understandability – The information must be understandable to a
reasonably well informed user.
Relevance – The information must be relevant for the decision under
consideration. Relevance consists of several sub-characteristics:
Timeliness – The information must be received on a timely basis in
order to make a difference in decision making.
Predictive Value and/or Feedback Value – The information, to be useful,
must provide the user with the ability to predict some future outcome or
to evaluate a past decision.
Reliability - The information must be reliable to be of use to a decision
maker. Reliability has four sub-characteristics:
Verifiability – The information must be capable of being verified or
reproduced by the user.
Neutrality – The information must not be produced in a biased way
relative to the effects it has on the entity being measured.
Representational Faithfulness – The information must represent what it
purports to represent.
Conservatism – Any estimates that are made in the financial statements
should err on the side of understating net assets and net income rather
than overstating them.
Comparability - The information produced by different companies must be
understood by users so that they can make comparisons across companies.
Companies are not required to use the same accounting methods. Therefore,
users must understand the impact of the various methods allowed under
GAAP.
1.9
The term “books” refers to the records (the accounting system) the company
keeps of the economic events that affect it. There are different types of books
that a company may keep. The first are the books that the company uses to
report to its shareholders. These books are prepared on the basis of GAAP and
are the substance of the financial statements that appear in the annual report.
A second set of books would be the tax books of the company. These books are
prepared based on the appropriate tax laws and GAAP is only relevant if the
tax laws require it.
4
APPLYING YOUR KNOWLEDGE
1.10
The business experiences of Raj Randhawa illustrate that accounting is
similar to a scorecard, because, like a scorecard that keeps track of past
events, accounting keeps track of past transactions. This enables users to
measure the company’s performance. For example, Raj describes how he
regularly checks the accounting system to receive feedback on past decisions
and receive input for his next business strategy.
Just as a scorecard keeps track of the score in a tennis game, companies
need a system to keep track of their historical transactions. Accounting
is this “scorecard system” that provides users with decision making
information. And while accounting is more complex than a simple
scorecard to record a game, practitioners have developed Generally
Accepted Accounting Principles (GAAP), that companies are required to
follow, in order to provide users with timely, reliable, and relevant
information. Thus, accounting and a scorecard have a lot in common.
Think about your own experience using a scorecard to record a past
event, like a golf game, and you will notice a lot of similarity between
the two. Both keep track of historical events in a fair and objective way,
and give users feedback on their performance.
1.11
Financing Transactions – Financing transactions would include borrowing
money, repayment of loans, issuance of shares, retirement of shares and
dividend payments.
Investing Transactions – Investing transactions would include purchase
and sale of new businesses, purchase and sale of marketable securities and
purchase and sale of capital assets (i.e. property, plant, and equipment).
Operating Transactions – Operating transactions include the purchase (for
a
manufacturer like Big Rock Brewery this would involve the transaction
involved in the manufacture of the inventory) and sale of inventory, repayment
for services such as salaries, utilities, etc., and the sale of services of the
company.
1.12
Hudson’s Bay Company
Examples of financing transactions
1. Share issuance to raise capital for store expansion
2. Increase in long-term debt to raise capital
Examples of investing transactions
1. Purchase of building for store expansion
2. Sale of delivery vehicles
5
Examples of operating transactions
1. Sale of clothes, watches and other consumer products
2. Payment of wages payable
1.13
a) While the historical cost is a much more reliable measure it measures only
one attribute about the land, its purchase price. While this cost would be
relevant to establish the amount of profit should the company sell the land it
would not be very relevant for much else. The current market value would be
quite relevant if the company were trying to decide whether to sell the land.
The selling price for a comparable site would therefore be relevant but may not
be a reliable measure of the fair value of the company’s land. While the site
that sold was “comparable” there will always be differences between various
sites of land that may make them noncomparable. If the company intends to
sell the land then the market value may be the most relevant value to report
on the balance sheet. On the other hand, if the company intends to use the
land to build a plant then the current market value of the land would not be
that relevant.
b) The market value would likely be most relevant to a banker since if the
company defaults on the loan the land would serve as collateral and the bank
would be able to recover the principal of its loan from its sale. The historical
cost would have little or no relevance.
1.14
An income statement presents the results of the operating activities of a
company for a period of time. A statement of cash flows reports the net cash
flows of a company for a period of time. An income statement presents mainly
the results of the operating activities while a statement of cash flows reports
cash flows relating to operating, investing and financing activities. An income
statement gives the net income (earnings/profits) of a company whereas a
statement of cash flows explains the inflow and outflow of cash for the period.
The income statement includes items which are not related to cash, such as
amortization. The statement of cash flows includes items only related to cash.
6
1.15
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
CA
CL
NI
CA
RE and/or SCF
NI
NCA
SC and/or SCF
CA and SCF
NCL
1.16
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
CL
NI
NCA and/or SCF
CL
CL and/or SCF
NI
NCA
NI
CA
CA
1.17
a)
b)
c)
d)
e)
f)
g)
h)
OA
FA
FA
IA
OA
IA
IA
FA
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
BS
BS
BS
IS
IS
N
IS
N
N
BS
1.18
7
1.19
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
BS
IS
BS
BS
N
IS
IS
BS
N
BS
8
1.20
Current Assets
Noncurrent
Assets
Total Assets
Current Liabilities
Noncurrent
Liabilities
Shareholders’
Equity
Total Liabilities &
Shareholders’
Equity
A
B
C
D
$100,000
$550,000
$230,000
$80,000
250,000
350,000
75,000
500,000
1,050,000
500,000
500,000
730,000
200,000
210,000
290,000
50,000
50,000
150,000
450,000
60,000
225,000
400,000
80,000
180,000
350,000
1,050,000
730,000
290,000
A
B
C
D
$40,000
18,000
$100,000
65,000
$450,000
400,000
$60,000
32,000
6,000
35,000
250,000
10,000
52,000
130,000
600,000
82,000
1.21
Retained Earnings
Dec. 31, Year 1
Net Income
Dividends declared
and paid
Retained Earnings
Dec 31, Year 2
9
1.22
a)
Hot Stuff Inc.
Income Statement
for the Month ended July 31, __
Sales
Cost of ingredients
Rent of the premises
Amount paid in wages
Telephone
Electricity and water
Gas and repairs on delivery
vehicle
Total Expenses
Net Income
b)
$18,730
$ 5,733
1,000
6,240
125
266
229
$ 13,593
$ 5,137
Other costs that Josephine might have incurred in July
that were not listed include:
1. Amortization of ovens, dough maker and other capital
assets
2. GST and Corporate taxes
3. Interest paid on any outstanding loans
10
1.23
a)
Call of the Wild, Ltd.
Income Statement
for the Month ended August 31, __
Sales
Supplies used
Wages
Telephone and electricity
Gas and repairs on vehicles
Advertising
Total expenses
Net income
$ 64,200
$ 10,674
21,120
574
1,300
5,780
39,448
$ 24,752
b) Other costs that Pavel might have incurred in August that were not
listed include:
1. Amortization of capital assets, like rafts and tents
2. GST and Corporate taxes
3. Interest paid on any outstanding loans
11
1.24
a)
Item
Inventory
Wages owed
Bank loan
Cash held in bank
Cost of ovens
Prepaid rent
Common shares
Retained Earnings
Classification
Asset
Liability
Liability
Asset
Asset
Asset
Shareholders’ equity
Shareholders’ equity
b)
Hot Stuff Inc.
Balance Sheet
July 31, __
Cash
Inventory
Prepaid rent
Ovens
Total Assets
$ 10,361
4,277
1,000
21,695
$ 37,333
Wages owed
Bank loan
Common Shares
Retained Earnings
Total Shareholders’
Equity and Liabilities
$ 1,650
10,000
15,000
10,683
$37,333
c) It is unlikely that Josephine will have an account called ‘accounts receivable’
since most of her sales will be on a cash basis. If customers purchased pizza
on credit then Josephine would have an accounts receivable section on her
balance sheet that would represent the amount that she is owed from her
customers. However, pizza businesses sell products that are relatively cheap,
and thus most customers, if not all, will have enough funds to pay for their
purchase in their wallet. Therefore, it is unlikely that Josephine will have an
account called ‘accounts receivable.’
12
1.25
a)
Item
Bank loan
Supplies on hand
Cash in bank
Common shares
Tents, rafts, etc.
Retained earnings
Vehicles
Amount paid for trips
to be taken in September
Classification
Liability
Asset
Asset
Shareholders’ equity
Asset
Shareholders’ equity
Asset
Liability
b)
Call of the Wild, Ltd.
Balance Sheet
August 31, __ __
Cash
Supplies on hand
Vehicles
Tents, rafts, etc.
$18,450
4,220
32,400
15,590
$70,660
Amounts paid for
trips in September
Bank loan
Common shares
Retained Earnings
$18,470
15,000
10,000
27,190
$70,660
13
1.26
c)
Pavel Bains does have some inventory, in the form of ‘supplies on
hand’ that will be used for future outdoor adventures. However,
in the more traditional sense, ‘supplies on hand’ is not really
inventory. Inventory refers to products that have been purchased
for resale to customers. Pavel’s business does not have any
products, but instead it provides a service, a guided adventure.
Thus, the real product is not inventory since it is a service that is
consumed by giving the customer a thrilling, exciting experience.
In this sense, Pavel does not have any inventory.
d)
It is unlikely that Pavel will have an account called ‘accounts
receivable’ since most of his customers will pay in cash or by
credit card. Similar to the pizza business, Pavel’s business does
not produce a product for which customers would be given credit.
Pavel would want his customers to pay in advance of providing
the service. Unlike a car dealership where the company can
repossess the car if the customer does not pay, it would not be
possible for Pavel to repossess an adventure trip once it is
complete. Thus, Pavel’s business is not likely to have an
‘accounts receivable’ account.
COMPANY
Petromet Resources Ltd.
Assets
Oil, and gas reserves
Exploration equipment
Liabilities
Long-tem debt
Fletcher Challenge Canada Ltd.
Assets
Land
Accounts receivable
Liabilities
Environmental Liabilities for restoring deforested land
Sask Tel
Assets
Telephone equipment
Receivables from customers
Receivables from leased equipment
Liabilities
Advance billings & customer deposits
14
Long-term debt
Accounts Payable
15
Sun Life
Assets
Investments
Loans to policyholders
Premiums due
Liabilities
Loss reserves
Commissions payable
Contract claims payable
Bombardier Inc.
Assets
Construction in process
Manufacturing equipment
Liabilities
Interest payable
Scotiabank
Assets
Securities investments
Mortgage loans
Liabilities
Deposits
1.27
COMPANY
Petromet Resource Ltd..
Income Statement
Amortization of capitalized exploration costs
Revenue on sale of gas and oil
Fletcher Challenge
Income Statement
Amortization of mill equipment
Interest expense
Sask Tel
Income Statement
Revenue from local and long distance services
Amortization of telephone equipment
Maintenance expense
16
Sun Life
Income Statement
Premiums
Investment income
Claim costs
Bombardier Inc.
Income Statement
Interest expense on loans needed to finance projects
Revenue from sale of equipment
Cost of goods sold
Scotia Bank
Income Statement
Interest revenue
Interest expense on deposits
Wage expenses
1.28
COMPANY
Petromet Resource Ltd.
Statement of Cash Flow
Investment in gas properties
Issuance of long-term debt
Fletcher Challenge
Statement of Cash Flow
Investments in land
Proceeds from sale of mill equipment
Sask Tel
Statement of Cash Flow
Investment in phone equipment
Payment of dividends to provincial government
Increase in investments
Sun Life
Statement of Cash Flow
Dividends paid
Loans repaid
Claims paid
17
Bombardier Inc.
Statement of Cash Flow
Debt issuance
Common shares issued
Purchase of equipment
Scotia Bank
Statement of Cash Flow
Purchase of securities
Debt issuance
18
Management Perspective Problems
1.29
To: Helmut Schmidt, CEO
From: A. Accountant, Manager Financial Reporting
Re: Canadian Reporting Bases
Unlike the accounting standards in Germany, Canada has different sets of
standards for tax and financial statement reporting. Financial statement
reporting standards are set under the jurisdiction of the Canadian Institute
of Chartered Accountants (CICA) which sets reporting standards for
companies that are publicly traded. The CICA has developed a conceptual
framework in which it defines components of the financial statements. This
conceptual framework is then used to justify the development of new
standards. The reporting for tax purposes is under the jurisdiction of
Revenue Canada and the tax laws passed by Parliament. The setting of
standards for this purpose are dictated by the needs and objectives of the
government as reflected in parliament. While the accounting standards
adopted by Revenue Canada do follow similar principles to those developed
by the CICA there are several very significant differences. There is no
requirement that the tax rules follow the principles set forth in the CICA
Handbook.
1.30
Accounting for inventory at its current market price rather than at its
historical cost would be more relevant for users in that it would help them to
better predict the future cash flows generated from the sale of that inventory
(predictive value). At the same time, accounting for inventory at its current
market price would be less reliable, because market value tends to fluctuate,
and is thus less verifiable than historical cost. Due to the potential
uncertainty in determining market value, the principle of conservatism also
applies, suggesting the use of historical cost.
1.31
Selling price of each model of laptop computer
Cost of each model of laptop computer
Selling price of assembly services
Cost of assembly services
Salaries and wages paid to employees
Information on customers, such as name, model purchased, and account
balance
Information on suppliers such as time to delivery and payment policy
An accounting software package could reliably keep track of the above
information, as well as other relevant information for running the business.
1.32
a) A bank loan officer would request that financial statements be
prepared according to GAAP because GAAP has established guidelines
19
for the preparation of financial statements which would provide some
assurance to the loan officer that the reporting followed some basic
format. Furthermore, statements prepared according to GAAP are
intended to satisfy qualitative criteria such as relevance, reliability,
understandability, and comparability.
b) You could convince the loan officer that the statements were
prepared according to GAAP through appointing an auditor to express
an opinion on the financial statements.
1.33
Stock exchanges require companies to have audited financial statements so
that investors can be assured that the financial statements of the companies
are presented fairly in conformity to accounting guidelines. This sets a
standard that leads to efficient processing of the information by all
participants in the stock exchange.
1.34
Funds can be raised from several sources but the two primary sources are
from lenders and shareholders. The advantage of borrowing from a lender is
that your friend would retain complete ownership of the business and would
not be required to share the decision-making and the profit of the company
with anyone else. Bringing in another shareholder would obviously result in
the dilution of control over the company and would also mean giving up some
share of the future profits. The disadvantage of borrowing from a lender is
that the loan contracts will require repayment of the amount on a set
schedule. This increases the risk to the company that it will not be able to
make payments on a timely basis. There could be significant consequences
to not making payments including losing ownership of the business. A new
shareholder would not have this same type of contractual arrangement and
would be at risk in the same way as your friend. However, the new
shareholder would probably expect a higher return from her/his investment
than would a lender. Therefore, your friend would be giving up more
potential profit to a new shareholder than a lender. There are also tax
incentives for borrowing in that from a corporate point of view the interest
payments on a loan is deductible for tax purposes. Payments to shareholders
(such as dividends) are not tax deductible.
1.35
As an external user of financial statements, management forecasts of future
expectations would be relevant in predicting the future cash flows of the
company and making investment decisions. For example, such forecasts
could bring up relevant issues that concern future operations, but had no
impact on the historical financial statements. However, the information
may not be reliable, since management forecasts cannot be verified, and are
not free from bias. For example, in issuing financial statements and
forecasting future net income, management is often attempting to attract
additional capital or maximize the share price.
20
1.36
The partnership should treat the payment as a distribution of profits, rather
than as an expense of doing business. There is no impact on the distribution
of profits to the partners, so long as the salary is paid first, before dividing
up the remainder.
21
Reading and Interpreting Published Financial Statements
1.37
Big Rock did not declare any dividends in 1999. We can prove this by
noting that the change in retained earnings, a decrease of $928,023
(5,975,448 – 6,903,471), equaled the net loss for 1999 of $556,745 and
the redemption of common shares of $371,278. If dividends were
declared, retained earnings would have been lower than $5,975,448
since dividends decrease the retained earnings account.
1.38
Figures from Big Rock Consolidated Balance Sheets
Total Assets
$29,165,835 =
$29,165,835 =
1.39
=
Total Liabilities + Shareholders’
Equity
$12,718,178 + $16,447,657
$29,165,835
All figures in Canadian $
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
$26,466,241 -- net of government taxes and commissions,
revenue is $16,644,881
$7,691,231
$661,640 = $647,317 + $14,323
($228,500) = ($268,500) + $40,000 (the $40,000 represents a tax
recovery because of the loss during the year)
$288,981
$2,050,703
$1,049,753
$5,975,448
$9,000,000
$2,113,702
($294,898)
$546,994
$318,616
($1,524,000)
22
1.40
Big Rock’s two largest sources of cash in 1999 were:
1. Cash from operations
2. Proceeds on disposal of capital assets
$2,113,702
$755,000
Big Rock’s two largest uses of cash in 1999 were:
1. Repayment of long-term debt
2. Share repurchase
1.41
($1,524,000)
($726,981)
Two reasons why Big Rock’s income was $288,981 in 1998, yet cash flow
from operations was $1,665,863 are:
1. Amortization, a non-cash expense, was $1,103,976 in 1998, which
decreases income but does not decrease operating cash flow.
2. Timing differences between tax expense and cash tax payable
resulted in an increase in the deferred income tax account by $972,000.
This amount was added back to net income to get operating cash flow,
since cash taxes were less than tax expense.
1.42
The reasons why 1999 sales were approximately $1,000,000 higher than
they were in 1998, yet net income in 1999 was approximately $800,000
lower than in 1998, are:
1. Selling, general and administrative expenses increased by
$2,191,360 from the 1998 amount of $5,525,157
2. Big Rock incurred a loss on the sale of its capital assets of $228,577
3. Interest expense decreased from $841,565 to $661,640.
1.43
All figures in thousands of dollars
The amount of dividends declared by AT Plastics Inc. in 1998 was $3,086.
This amount is located on the Consolidated Statements of Operations and
Retained Earnings.
23
1.44
Total Assets
$505,621
$505,621
1.45
=
=
=
Total Liabilities
$317,913
$505,621
+
+
Shareholders’
Equity
$187,708
Net working capital equals current assets less current liabilities:
1998
Current Assets (thousands of dollars)
Cash and short-term investments
Accounts Receivable
Inventory
Prepaids
$4,292
32,028
46,877
1,113
Total Current Assets
84,310
Less Current Liabilities (thousands of dollars)
Accounts Payable
Current portion of long-term debt
Total Current Liabilities
NET WORKING CAPITAL
$41,384
12,555
53,939
$30,371
24
1.46
Figures in thousands of dollars:
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
k)
l)
m)
1.47
$229,976
$194,170
$5,858
$8,368 = $2,264 + $6,104
$10,768
$46,877
$30,362
$33,771
$149,362
$39,129
($140,457)
$100,433
($148,903)
In All figures in thousands of dollars
This question can be answered from two sources. First the balance
sheet. In 1998, the total liabilities were $317,913 and the total
shareholders’ equity was $187,708. Because the liabilities are greater
than the shareholders’ equity, creditors are providing more resources to
AT Plastics Inc. A second place where this answer can be observed is on
the statement of changes in financial position. In 1998 senior
debentures were issued in the amount of $100,433 and long-term debt
was repaid in the amount of $8,641. $24,949 in common shares were
issued. Thus, in 1998, AT Plastics Inc. has increased its reliance on
debt financing.
.
25
1.48
1.49
All figures in thousands of dollars
The two largest sources of cash:
1. Senior debentures issued
2. Cash from Operations
$100,433
$39,129
The two largest uses of cash:
1. Purchase of fixed assets
2. Long-term debt repaid
($140,457)
($8,641)
All figures in thousands of dollars
The reason for the difference between cash flow from operations and net
income can be found on the statement of changes in financial position.
1.The total depreciation and amortization charged by AT Plastics Inc.
against income was $9,680. This is a non-cash expense and therefore
you can see that the accountant has added it back to the operating
section of the statement of cash flows.
2. Deferred income taxes, and amortization of exchange on long-term
debt, represent non-cash items, and were, therefore, added back. Note
that the deferred income tax amount of $6,104 also appears on the
statement of operations. Although it forms part of the income tax
expense, it is not due to Revenue Canada yet, and is thus excluded from
current income taxes.
3. The last item that accounts for the difference is the “change in noncash working capital and other liabilities” of $11,145. This amount
represents the changes in the current assets and current liabilities that
represent operating activities. For example, the accounts receivable
increased from $31,809 in 1997 to $32,028 in 1998. This increase of
$219 means that a larger amount was owed to the company by
customers at the end of 1998 than was owed at the end of 1997. In
other words, the company collected less cash from customers than the
sales amount of $229,976 that is included in the income statement. The
other current accounts that would affect this balance would be the
changes in inventory, prepaids, and accounts payable. See if you can
work through the changes in these accounts and arrive at the $11,145
net change in working capital.
26
1.50
Average market value for the fourth quarter:
($11.00 + $8.05)/2 = $9.525
Number of shares outstanding:
17,760,916
Average Market Value of Shares:
$9.525 x 17,760,916 = $169,172,724.90
Value of Shareholders’ Equity on the Balance Sheet:
$187,708,000
The market value of the shares depends on various factors. The discrepancy
between the balance sheet value (book value) and the market value of the
shareholders’ equity can be attributed to any of the following reasons:
1.
2.
3.
4.
The market may have concerns about the future profitability at AT
Plastics.
The market may have concerns about the plastics industry as a
whole.
The market may have some concerns about the level of debt carried
by AT Plastics and its ability to repay it.
The market may view AT Plastics’s earnings as low relative to
other companies in the plastics industry.
Other answers are possible.
27
1.51
May 1st for 1998 and May 2nd for 1997.
1.52
a.
b.
c
d.
e
f.
g.
h.
i.
j.
k.
l.
m.
n.
Figures in thousands of dollars
$40,672
$13,956
$707
$3,012
$3,748
$5,512
$4,988
$25,821
$5,970 = $128 + $5,842
$6,048
$10,357
-0$395
($11,125)
1.53 Figures in $ thousands
This question can be answered from two sources. First the balance sheet. In
1998, the total liabilities were $13,710 and the total shareholders’ equity was
$47,041. Because the liabilities are less than the shareholders’ equity,
shareholders are providing most of the resources to Mosaid Technologies Inc.
A second place where this answer can be observed is on the statement of
changes in financial position. In 1998 common shares were issued in the
amount of $395 and aside from a $30 mortgage repayment Mosaid
Technologies Inc. issued $6,000 worth of mortgages. Thus, in 1998, Mosaid
Technologies Inc. relied more heavily on debt financing, but its capital
structure remains more heavily reliant on equity financing.
28
1.54
The two largest sources of cash:
1. Cash from operations
2. Issue of shares
The two largest uses of cash:
1. Acquisition of capital assets
2. Long-term investments
1.55
$ 4,748
$ 876
($5,366)
($2,570)
The reasons cash flow from operations exceeded net income in 1998 is that
the amount of non-cash charges to net income exceeded the amount of noncash additions to net income. In 1998, the summation of all the non-cash
charges included the following items: amortization, loss on disposal of capital
assets, non-controlling interest and the change in non-cash working capital
items. The total was $5,145 (3,301+206+337+1,301). The summation of all
the non-cash additions to net income included the following items: gain on
long-term investment and deferred income taxes. The total was $4,308
(4,103+205). You subtract non-cash additions to net income, because they
increase net income but do not increase cash from operations. The reverse
holds for non-cash charges to net income – they decrease net income, but
have no affect on cash from operations. Therefore, the reason cash flow from
operations exceeded net income is that the non-cash charges to net income
exceeded the non-cash additions to net income by $837, which equals the
difference between net income and cash from operations.
1.56
The three assets and liabilities which experienced the largest dollar
changes from 1997 to 1998 are:
Asset
Change
(thousands)
Capital Assets
$7,153
Long-term
investment
$4,102
Accounts
receivable ($1,761)
Liabilities
Mortgage payable
Income tax
payable
Deferred income
tax
Change
(thousands)
$5,970
$768
($205)
29
1.57
Figures in thousands of dollars
Total Liabilities
Shareholders’ Equity
Total Assets
Ratio of Debt to Assets
Ratio of Equity to Assets
1998
$13,710
$47,041
$60,751
1998
22.57%
77.43%
1997
$7,021
$41,435
$48,456
Change
$ 6,689
$ 5,606
$12,295
1997
14.49%
85.51%
As seen from the above table, Mosaid Technologies has changed its sources
of financing to a small extent, relying a bit more on debt financing
(+8.08%) to 22.57% from 14.49%. This increase in debt financing is due to
the issue of a mortgage in 1998 of $6,000. However, Mosaid Technologies,
is still relying on equity financing as its primary means to fund its
business. 77.43% of its capital structure is financed by equity.
1.58
1.59
September 26th, 1998
Figures in millions of dollars
a. $3,653.0
b. $3,483.1
c.
$3.0
d. $41.9
e. $65.4
f.
$164.8
g. $11.3
h. $183.6
i.
$97.3 = $94.6 + $2.7
j.
$121.2
k. ($80.5)
l.
$10.4
m. ($53.8)
30
1.60
Figures in $ millions
This question can be answered from two sources. First the balance
sheet. In 1998, the total liabilities were $444.9 and the total
shareholders’ equity was $342.6. Because the liabilities are greater
than the shareholders’ equity, creditors are providing most of the
resources to Métro-Richelieu Inc. A second place where this answer can
be observed is on the statement of changes in financial position. In
1998, long-term debt was issued in the amount of $3.6, but $48.8 of
long-term debt was repaid. Additional financing activities include an
issuance of capital stock in the amount of $3.0 and a redemption of
subordinate shares in the amount of $10.5. Thus, overall, MétroRichelieu Inc. has decreased its reliance on debt financing through a net
decrease in long-term debt of $45.2. As a result of earning a net income
of $65.4 in 1998, retained earnings, and thus total shareholders’ equity
increased. As a percentage of total assets, shareholders’ equity accounts
for 43.5% and total liabilities accounts for 56.5%. While balanced
equally, Métro-Richelieu Inc. slightly favours financing from creditors
rather than shareholders.
1.61
1.62
Figures in millions of dollars
The three largest sources of cash:
1. Cash from operations
2. Disposal of investment
3. Increase in long-term debt
$121.2
$13.2
$3.6
The three largest uses of cash:
1. Net acquisitions of capital assets
2. Repayment of long-term debt
3. Redemption of subordinate shares
($80.5)
($48.8)
($10.5)
Figures in millions of dollars
Retained earnings, September 27, 1997
Add: Net earnings
Deduct: Dividends
Deduct: Share redemption premium
Deduct: Stock option settle in cash
Retained earnings, September 26, 1998
$138.5
65.4
(10.4)
(8.8)
(1.1)
$183.6
31
1.63
Figures in millions of dollars
The major reasons for the significant decline in cash can be found on the
statement of changes in financial position. Although operations resulted in a
cash inflow of $121.2, investing and financing activities account for a total
cash outflow of $125.3, and dividends resulted in a further cash outflow of
$10.4. Within investing activities, the acquisition of capital assets is the
most significant component, requiring an outflow of $80.5. The acquisition of
these assets was not financed through issuing additional debt or shares,
since neither of these items appears as a significant source of cash under
financing activities. In fact, $48.8 of long-term debt was repaid, causing a
further decline in cash. In 1998, Métro-Richelieu relied on its operating cash
flow to finance its investing activities and repayment of long-term debt.
Thus, Métro-Richelieu has experienced a decrease in cash, since operating
cash flow was below the sum of the cash used for financing and investing
activities, and for the payment of dividends.
1.64
Figures in millions of DM
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
124,050
98,943
618
3,982
8,042
13,602
9,027
26,508
2,577
20,656
5,833
15.59 (basic earnings per share amount)
1.65
This question can be answered by analyzing Daimler Benz’s consolidated
balance sheets. In 1997, the total liabilities (total liabilities = liabilities +
accrued liabilities + minority interest + deferred taxes + deferred income)
was $102,014 million DM and the total shareholders’ equity was $35,085
million DM. Because the liabilities are greater than the shareholders’
equity, Daimler Benz is primarily financing its business from creditors. As a
percentage of total assets, 25.6% is financed by shareholders’ equity and
74.4% is financed by creditors.
1.66
Daimler Benz’s fiscal year end is December 31, 1997
32
1.67
The major differences between Daimler Benz’s consolidated balance
sheets and the consolidated balance sheets that we have seen for North
American companies are:
1. In Daimler Benz’s balance sheet, long term, non-current assets, are
listed above current assets. Most companies in North American list
current assets above non-current assets, and in order of liquidity.
2. In Daimler Benz’s balance sheet, shareholders’ equity is listed above
liabilities. The balance sheets we have seen for North American
companies list the liabilities above shareholders equity. Further, the
liabilities are broken down into current liabilities and non-current
liabilities where the former is listed above the latter.
3. Prepaid expense in Daimler Benz’s balance sheet is not grouped
under the heading of current assets, but rather listed separately. In the
balance sheets of most North American companies, prepaid expense is
grouped with current assets.
4. In Daimler Benz’s balance sheet, deferred taxes are shown as both a
liability and an asset. This may imply that German firms use a
different accounting method to present deferred income taxes than
North American firms. Most North American firms show only one
deferred income tax account – as an asset or a liability depending on
whether the tax expense was above or below cash taxes payable to
Revenue Canada.
Beyond the Book
1.68
No answer required.
1.69
Answers to this question will be dependent on the company selected.
1.70
Answers to this question will be dependent on the company selected.
Critical Thinking Questions
1.71
a) Some of the differences that could be included are: 1) life insurance
companies, banks, trust companies and securities dealers sell services as
opposed to physical products; 2) many of the services that are sold by these
companies require long-term commitments by the companies as opposed to
selling a product and completing the customer contact; 3) the long-term
commitment to customers means that the service that has been sold can
change in value which commits the company to varying obligations over
time; 4) some of these companies (i.e. banks) are subject to government
33
regulations. Most retail companies are subject only to the corporate
legislation under which they are incorporated. Other answers are possible.
b) Reasons why the accounting guidelines might be different are: a) the
government regulations might require that items are measured, recorded,
and reported in a manner different from GAAP; 2) the long-term commitment
to customers means that the liability (long-term obligation) may change in
value over time. Currently under GAAP the value of liabilities is often fixed
and not changed. 3) the long-term commitments also mean that it might be
more difficult to determine when an item has been sold and when revenue
can be recognized; 4) it is more difficult to measure the cost of a service than
it is to measure the cost of a product. Other answers are possible.
c) Why accounting guidelines should be identical: 1) user would find it
easier to understand the financial information across various industries if
they all used the same guidelines; 2) it would be easier to compare companies
in different industries if they all used the same guidelines; 3) there would be
fewer guidelines to know, and therefore, it should be much easier to maintain
accounting records and prepare financial statements. Other answers are
possible.
d) Why accounting guidelines should not be identical: 1) industries often
have distinct characteristics that should be measured and reported in a
specific way so that the financial position of the companies can be
realistically represented; 2) if all industries had to use the same guidelines,
the financial results of some companies may be misstated; 3) some items
within some industries may be measured inappropriately or may not be
measured at all, if guidelines were identical. Other answers are possible.
34