SM Chapter 14

www.downloadslide.
net
Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition
CHAPTER 14
Performance Measurement
ASSIGNMENT CLASSIFICATION TABLE
Brief A B
Study Objectives Questions Exercises Exercises Problems Problems BYP
1. Understand the 1, 2, 3, 18 1, 2 1, 4 4A 2B, 4B

concept of sustainable
income and indicate
how discontinued items
are presented.
2. Explain and apply 4, 5, 6, 7, 3, 4, 5, 6 2, 4 1A, 3A 1B, 3B 1, 5

horizontal analysis. 10,
3. Explain and apply 5, 6, 7, 8, 5, 6, 7, 8 3, 4 2A, 3A 2B, 3B 1, 4

vertical analysis. 9, 10,
4. Identify and calculate 10, 11, 12, 9, 10 5, 6, 7, 13 5A, 6A, 7A, 5B, 6B, 7B, 2, 3, 4,
ratios that are used to 15 8A, 9A 8B, 9B 5, 7
analyze liquidity.
5. Identify and calculate 13, 14, 15 11 5, 8, 9, 13 5A, 6A, 7A, 5B, 6B, 7B, 2, 3, 4,
ratios that are used to 8A, 9A 8B, 9B 5, 7
analyze solvency.
6. Identify and calculate 15, 16, 17, 12, 13, 14 5, 10, 11, 4A, 5A, 6A, 4B, 5B, 6B, 2, 3, 4,
ratios that are used to 18, 19, 20 12, 13 7A, 8A, 9A 7B, 8B, 9B 5, 6, 7
analyze profitability.
7. Understand the 20, 21, 22, 14 9A 9B 3

limitations of financial 23
analysis.
Solutions Manual 14-1 Chapter 14

Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
www.downloadslide.net
ASSIGNMENT CHARACTERISTICS TABLE
Problem Difficulty Time

Number Description Level Allotted (min.)
1A Prepare horizontal analysis. Moderate 30-40
2A Prepare vertical analysis. Moderate 25-35
3A Interpret horizontal and vertical analysis. Moderate 20-30
4A Calculate and evaluate profitability ratios with Moderate 30-40

discontinued operations.
5A Calculate and evaluate ratios. Moderate 40-50
6A Calculate and evaluate ratios. Moderate 50-60
7A Evaluate ratios. Moderate 50-60
8A Evaluate liquidity, solvency, and profitability. Moderate 40-50
9A Discuss impact of accounting policies on financial Moderate 30-40

analysis.
1B Prepare horizontal analysis Moderate 30-40
2B Prepare vertical analysis, with discontinued Moderate 25-35

operations.
3B Interpret horizontal and vertical analysis. Moderate 20-30
4B Calculate and evaluate profitability ratios with Moderate 30-40

5B Calculate and evaluate ratios. Moderate 40-50
6B Calculate and evaluate ratios. Moderate 50-60
7B Evaluate ratios. Moderate 50-60
8B Evaluate liquidity, solvency, and profitability. Moderate 40-50
9B Discuss impact of accounting policies on financial Moderate 30-40

analysis.

ANSWERS TO QUESTIONS
1. Sustainable income is the level of income that is most likely to be maintained in the future.
It differs from profit by the amount of irregular or non-typical items (e.g., from non-recurring
or unusual revenues, expenses, gains, or losses) included. In other words, it is the amount
of profit that a company can expect to earn from its normal, recurring operations.
2. (a) Discontinued operations refers to disposal, or availability for sale, of an identifiable

component or segment of a business, which comprises a major line of business or
geographical area of operations.
(b) A component of an entity is a separate major line of business or major geographical

area of operations. It must be clearly distinguishable, operationally and financially, from the
rest of the company.
3. (a) Statement of financial position: If discontinued operations are being held for sale, the
assets held for sale are reported separately on the statement of financial position, and they
are valued and reported at the lower of their carrying amount and fair value, less costs to
sell. Any liabilities relating to the discontinued operations are also shown separately as
current liabilities.
(b) Income statement: The results from a company’s discontinued operations and the
gain (loss) on disposal are shown separately on the income statement after profit from
continuing operations. Note that the results from discontinued operations usually contains
two parts; the first being the operating results attributable to the discontinued component
and the second being the gain or loss (if any) on disposal of the component. The amounts
for the discontinued component are presented net of any income tax expense or savings. In
addition, earnings per share must be reported separately for continuing operations and for
4. (a) An answer cannot be calculated for the percentage change when there is no value in
a base year, because division by 0 is mathematically impossible. However, the absolute
dollar value of the change from the base year can be determined.
(b) An answer cannot be calculated for the percentage change when there is a negative
value in a base year and a positive value in the next year. However, the absolute dollar
value of the change from the base year can be determined.
5. Horizontal analysis (also called trend analysis) measures the dollar and percentage
increase or decrease of an item over a period of time. In this approach, the amount of the
item on one statement is compared with the amount of that same item on one or more
earlier statements. Horizontal analysis measures items across years (or periods).
Vertical analysis (also called common size analysis) expresses each item within a financial
statement in terms of a percent of a relevant total, usually the largest item within the same
statement. Vertical analysis measures items within the same year (or period).

Answers to Questions (Continued)
6. (a) Horizontal percentage of a base-period amount is accomplished by using a base

year for comparative purposes, which is assumed to be 100. The results of any
subsequent year are compared to the base year by dividing the results from the
year in question by the results from the base year. For example, assume that XYZ
Inc. reported profit of $200,000 and $220,000 for 2014 and 2015 respectively. If
2014 is assumed to be the base year, the percent of base period amount is
calculated as follows: $220,000 ÷ $200,000 = 110%, and expressed as a
percentage.
(b) Horizontal percentage change for a period is calculated by dividing the dollar
amount of the change between the specific year under analysis and the base year
by the base-year amount. In calculating the percentage change for a period, each
prior year is set as the base year in order to assess trends in changes between
years. In the above example discussed in (a), the horizontal percentage change for
a period would be 10% (110% – 100%).
(c) In vertical percentage of a base amount, each item in a financial statement is

expressed as a percentage of a base amount in the same financial statement,
providing analysis of data within the same year. The base amount commonly used
for the statement of financial position is total assets and the base amount
commonly used for the income statement is net sales or revenues. For example,
assume that XYZ Inc. reported merchandise inventory of $200,000 and total assets
of $5,000,000 for 2012. The percent of base amount is calculated as follows:
$200,000 ÷ $5,000,000 = 4%, and expressed as a percentage.
7. Trend analysis is made difficult when a limited amount of information is available to the
general public concerning a business. In the case of Facebook, the first fiscal period is
less than a full year. Horizontal analysis of 2012 and 2013 would not be useful since
apples would be compared to oranges. Vertical analysis may be less problematic.
8. (a) The base amount assigned a 100% value in a vertical analysis of a statement of
financial position is total assets.
(b) The base amount assigned a 100% value in a vertical analysis of an income
statement is net sales.
9. Yes. Companies competing in the same industry that are different sizes and in different
countries with different exchange rates can be compared. For instance, a company may
want to know whether its gross profit margin percentage is in line with that of its
competition. Vertical analysis uses percentages to place the results of both companies
side by side, which allows for a comparison despite differences such as size and
currency.


10. (a) Comparison of financial information can be made on an intracompany basis,
intercompany basis, and industry average basis (using predetermined norms).
• The intracompany basis compares an item or financial relationship within the
current year or with one or more prior periods, within the same company.
• The intercompany basis compares the same item or relationship with one or
more competing companies.
• The industry average basis compares an item or relationship with that of the
industry.
These three bases of comparison should be used together.
(b) Horizontal analysis is useful in detecting significant trends within a company and in
assessing the impact of economic changes that affect the industry. It is best used
in intracompany comparisons, although it can also be used to compare with one or
more competing companies. Vertical analysis is useful in detecting changes in
financial relationships between years, with competitors and between companies in
the same industry. It is best used in intercompany comparisons, although it can
also be used to compare the company’s data on an intracompany basis. Ratio
analysis is useful to evaluate the significance of financial data within the same
company across different years and to provide insight into a company's position
relative to other companies and to the industry. Ratio analysis can be used with all
three bases of comparisons—intracompany, intercompany and industry averages.
11. A high current ratio is usually a good indicator of a company’s liquidity. However, it
might be hiding liquidity problems with regard to inventory or accounts receivable. For
example, a high level of inventory will cause the current ratio to increase. Increases in
inventory can be because inventory is not selling and may be obsolete. Increases in the
current ratio will also occur if the company’s accounts receivable increase. An increase
in accounts receivable could indicate the company is having trouble collecting its
overdue accounts, which again would mean liquidity problems for the business.
12. A lower result is better in the case of the following liquidity ratios: average collection
period and days in inventory. The longer assets are held before they are converted to
cash, the longer the business needs to finance these assets.
13. A lower result is better in the case of the debt to total assets solvency ratio because
debt gives rise to servicing charges such as interest and also requires principal
repayments, which will have to be paid with the use of cash.
14. Tim Hortons’ has a lower debt to total assets ratio than the industry average. Even
though its times interest earned is lower than average, it is quite acceptable. As a
result, Tim Hortons’ solvency is probably better than other businesses in the same the
industry.


15. (a) Asset turnover
(b) Inventory turnover, days in inventory
(c) Return on common shareholders’ equity
(d) Times interest earned
(e) Current ratio, cash current debt coverage
16. The difference between CIBC’s return on assets of 0.8% and the return on common
shareholders’ equity of 21.8% means that the company must be using a substantial
amount of debt to finance their assets. This debt is likely in the form of customers’ bank
accounts, which are in turn lent out to others to earn a higher rate of interest than the
one paid to customers on their deposits.
17. The profit margin and the asset turnover ratio combine mathematically to equal the
return on assets ratio. To increase its return on assets, a company can increase its
profit margin or increase its asset turnover.
The return on common shareholders’ equity is affected by both the return on assets and
the debt to total assets ratio. To increase its return on common shareholders’ equity, a
company can increase its return on assets or increase its leverage (as measured by the
debt to total assets ratio). Leverage, however, should only be increased if the increased
interest expense on the increased level of debt can be covered by higher profits.
18. Lai’s profit margin has improved. When comparing the company’s profit margin before
considering irregular items, we see that the profit margin has improved from 5% to
6.5%. Discontinued operations are a nonrecurring item and should be excluded for
analysis purposes.
19. (a) To consider how investors view a company’s growth potential, investors would
focus primarily on the price-earnings ratio. If this ratio is high it means that the
market expects the company to grow rapidly.
(b) To consider income potential, this generally refers to the receiving dividends from
the company. Investors would focus on the payout ratio to determine the extent to
which the company pays dividends from the profits earned and consider the
dividend yield to measure the rate of return that a dividend gives the investor
relative to the share’s price.


20. (a) Yum Brands’ profitability has improved as its profit margin excluding other
comprehensive income increased from 10.6% to 11.8%.
(b) It is common practice to calculate profitability ratios using profit rather than
comprehensive income. Typically, items recorded in OCI are not largely significant
and may not be a reflection of the operations of a company. Sometimes they
consist of non-recurring items. Another reason for excluding OCI from ratios is
because companies reporting under ASPE do not use OCI so comparing a
profitability ratio of a public company based on comprehensive income with a
private company that reports only profit would not give a fair comparison.
Nonetheless, if a public company does have a significant amount of OCI, we
should strive to understand its impact on the company.
21. The factors that can limit the usefulness of financial analysis are the use of alternative
accounting policies, professional judgement, comprehensive income, diversification,
inflation, and economic factors. The use of different accounting policies can impact a
company’s results and, therefore, lessen comparability. The use of professional
judgement may introduce the possibility of bias and impacts the many estimates made
in preparing financial statements. Significant sources of comprehensive income should
be considered in assessing a company’s profitability, even though OCI is not typically
used in ratios. Many companies are diversified, which makes it difficult to compare them
since they cannot be classified to a single industry. Inflation is not considered in the
preparation of financial statements so assessment of growth rates and trends may not
be accurate if inflation is significant. Understanding the effect of the economy is also
important in correctly interpreting financial information.
22. Management must use professional judgement to choose the most appropriate
accounting policy and in preparing estimates. This can impact the financial statements
through bias (since management is often under pressure to meet company objectives)
and inaccuracies in the estimates.
23. The use of IFRS and ASPE consist of several areas where accounting policies are
different and where certain ratios are not available (e.g., price-earnings ratio for a
private company). This limits comparability between companies and for comparison of a
company’s results to industry averages.

SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 14-1
Profit from continuing operations before income tax ................................. $1,040,000

Less: Interest expense .......................................................... $125,000
Income tax expense ..................................................... 260,000 385,000
Sustainable income ................................................................................... $ 655,000
BRIEF EXERCISE 14-2
(a) 3 A realized gain on the sale of trading investments

(b) 1 Sales revenue
(c) 2 Salaries expense
(d) 1 Cost of goods sold
(e) 3 Dividend revenue
(f) 4 A loss from operations of a discontinued wholesale business
(g) 3 Interest expense
(h) 1 A write-down of obsolete inventory
(i) 4 A gain on the sale of assets of a discontinued wholesale business

BRIEF EXERCISE 14-3
(a) Horizontal percentage of a base-year amount
2015 2014 2013

Cash 200.0%5 233.3%1 100%
Accounts receivable 133.3%6 88.9%2 100%
Inventory 111.4%7 85.7%3 100%
Property, plant, and equipment 109.8%8 98.2%4 100%
— — —
Intangible assets
1 5
$175,000 $150,000
= 233.3% = 200.0%
$75,000 $75,000
2 6
$400,000 $600,000
= 88.9% = 133.3%
$450,000 $450,000
3 7
$600,000 $780,000
= 85.7% = 111.4%
$700,000 $700,000
4 8
$2,800,000 $3,130,000
= 98.2% = 109.8%
$2,850,000 $2,850,000

BRIEF EXERCISE 14-3 (Continued)
(b) Horizontal percentage change for each year
2015 2014 2013

Cash (14.3)%5 133.3%1 0%
Accounts receivable 50.0%6 (11.1)%2 0%
Inventory 30.0%7 (14.3)%3 0%
Property, plant, and equipment 11.8%8 (1.8)%4 0%
Intangible assets (10.0)%9 — —
1 6
($175,000 – $75,000) ($600,000 – $400,000)
= 133.3% = 50.0%
$75,000 $400,000
2 7
($400,000 – $450,000) ($780,000 – $600,000)
= (11.1)% = 30.0%
$450,000 $600,000
3 8
($600,000 – $700,000) ($3,130,000 – $2,800,000)
= (14.3)% = 11.8%
$700,000 $2,800,000
4 9
($2,800,000 – $2,850,000) ($90,000 – $100,000)
= (1.8)% = (10.0)%
$2,850,000 $100,000
5
($150,000 – $175,000)
= (14.3)%
$175,000

BRIEF EXERCISE 14-4
Comparing the percentages presented results in the following conclusions:
The profit for Coastal decreased in 2014 over 2013. Cost of goods sold and operating
expenses increased faster than net sales. In addition, income tax expense declined indicating
that profit from operations also declined, assuming no change in the income tax rate.
Profit in 2015 increased over 2014. Sales increased faster than did cost of goods sold and
operating expenses, which actually declined. Income tax expense increased indicating that
profit from operations also increased, assuming no change in the income tax rate.
BRIEF EXERCISE 14-5
Basis of Comparison Tool of Analysis

(a) Intracompany Horizontal
(b) Intercompany Vertical
(c) Intercompany Vertical
(d) Intracompany Horizontal

BRIEF EXERCISE 14-6
(a)
2015 2014 2013
Current assets 125% 96% 100%
Property, plant, and equipment 110% 98% 100%
Goodwill - - -
Total assets 117% 100% 100%
We did not calculate the change in goodwill as is it too large in 2014 and goodwill is not a
significant asset.
(b)
2015
Amount Percentage
Current assets $1,530,000 32.2%
Property, plant, and equipment 3,130,000 65.9%
Goodwill 90,000 1.9%
Total assets $4,750,000 100.0%
2014
Amount Percentage
Current assets $ 1,175,000 28.8%
Goodwill 100,000 2.5%
Total assets $ 4,075,000 100.0%
2013
Amount Percentage
Current assets $ 1,225,000 30.1%
Goodwill - 0.0%
Total assets $ 4,075,000 100.0%

BRIEF EXERCISE 14-7
2015 2014
Amount Percentage Amount Percentage
Net sales $1,914 100.0% $2,073 100.0%
Cost of goods sold 1,612 84.2% 1,674 80.8%
Gross profit 302 15.8% 399 19.2%
Operating expenses 218 11.4% 210 10.1%
Profit before income tax 84 4.4% 189 9.1%
Income tax expense 17 0.9% 38 1.8%
Profit $ 67 3.5% $ 151 7.3%
BRIEF EXERCISE 14-8
Profit as a percentage of sales for Waubon decreased in 2014 because cost of goods sold
and operating expenses increased. The decrease in income tax expense was too small to
offset the increase in the other expenses.
Profit as a percentage of sales increased in 2015 as both cost of goods sold and operating
expenses as a percentage of sales decreased. The increase in income tax expense was too
small to offset the decrease in other expenses.
For information, the calculated profit as a percentage of sales is:

2013 = 16% (100% – 60% – 20% – 4%)
2014 = 15.3% (100% – 60.5% – 20.4% – 3.8%)
2015 = 16.8% (100% – 59.4% – 19.6% – 4.2%).

BRIEF EXERCISE 14-9
(a) 2015 2014

1 2
Current ratio 2.1 : 1 1.8 : 1
3 4
Receivables turnover 8.0 times 8.9 times
5 6
Inventory turnover 4.5 times 5.0 times
1 4
$2,100,000 $6,240,000
= 2.1 :1 = 8.9 times
$1,000,000 ($750,000 + $650,000) ÷ 2
2 5
$2,000,000 $4,540,000
= 1.8 :1 = 4.5 times
$1,100,000 ($1,020,000 + $980,000) ÷ 2
3 6
$6,420,000 $4,550,000
= 8.0 times = 5.0 times
($850,000 + $750,000) ÷ 2 ($980,000 + $840,000) ÷ 2
(b)
The company’s current ratio has improved from 2014 to 2015. However, the receivables
turnover and inventory turnover have both deteriorated. Even though at first glance, the
company’s liquidity seems to have improved based on the improvement of the current ratio,
an examination of the liquidity of the major current assets, accounts receivable and inventory,
indicates that liquidity has deteriorated. The deterioration of the turnover of receivables and
inventory leads to an increase in these assets and increases the current ratio.
BRIEF EXERCISE 14-10
Holysh’s liquidity is probably deteriorating. The increase in the current ratio is likely caused by
the deteriorating turnover of receivables and inventory. This may mean that the company is
not collecting its accounts receivable on as timely a basis as in the past, or that some
balances may be uncollectible. The decrease in the inventory turnover ratio implies the
company is not selling its inventory as quickly as in the past or that it has too much inventory
on hand at year end, or has increasing amounts of obsolete inventory. Further investigation
into the cause for the slowdown in collections and inventory turnover will have to be made
before it is possible to assess the company’s liquidity.


Manulife’s solvency appears to have deteriorated slightly. The company’s reliance on debt
did not change in 2012 as evidenced by the very high but identical debt to total assets ratio.
There has been deterioration in the times interest earned ratio but offsetting this trend has
been a small increase in its free cash flow. Cash total debt coverage also stayed the same.
These changes are marginal however. The decrease in Manulife’s times interest earned ratio
was more significant, moving from a 1.0 times in 2011 to 0.8 times in 2012. The overall
conclusion is that Manulife’s solvency has deteriorated slightly.

(a) The Wolastoq’s profitability is deteriorating.
(b) Its return on common shareholders’ equity, return on assets and profit margin have all
deteriorated, whereas the debt to total assets, and asset turnover have remained the
same. Return on common shareholders’ equity is affected by return on assets and debt
to total assets. Since the return on assets has deteriorated while the debt to total asset
ratio has remained stable, the return on assets has driven the decline in return on
common shareholders’ equity.
Return on assets, in turn, is driven by profit margin and asset turnover. The decline in
profit margin has decreased the return on assets and consequently the decrease in the
return on common shareholders’ equity.

For growth, I would purchase the shares of Loblaws as the price-earnings ratio is higher,
suggesting investors are willing to pay more for the shares because the company has higher
prospects for growth and profits in the future. For income, I would purchase the shares of the
Bank of Montreal as the dividend yield is higher. It should be noted that if a company pays
out a larger portion of its profit as a dividend, less funds are available to invest in assets and
grow the size of the company so it is more likely that a company that pays out high dividends
will tend to have a lower price-earnings ratio.

(a)
(in U.S. $ 2012 2011 2010

millions)
With OCI:
Profit $1,868 $(1,690) $816
margin = 14.1% = (12.2%) = 6.2%
$13,278 $13,807 $13,070
Without
OCI:
Profit $2,123 $(1,392) $933
margin = 16.0% = (10.1%) = 7.1%
$13,278 $13,807 $13,070
(b)
Most financial ratios exclude total comprehensive income, or other comprehensive income,
from the analysis. Profitability ratios, including industry averages, generally use data from the
income statement and not from the statement of comprehensive income, which includes both
profit and other comprehensive income. In addition, there are no standard ratio formulas
incorporating comprehensive income. Consequently, the profit margin without other
comprehensive loss should be used in reliable financial analysis.

SOLUTIONS TO EXERCISES
EXERCISE 14-1
(a) (b)
Statement Classification
1. Realized gain on Sustainable Income Other revenue

the sale of long- Statement
term investments
2. A loss caused by Sustainable Income Other expenses

a labour strike Statement
3. Current assets of Irregular Statement of Current assets

a discontinued Financial
component of an Position
entity being held
for immediate and
probable sale
4. An operating loss Irregular Income Discontinued

from a Statement operations
discontinued
component of an
entity, held for
immediate and
probable sale
5. An impairment Sustainable Income Operating

loss on goodwill Statement expenses

EXERCISE 14-2
(a) DRESSAIRE INC.

Horizontal Analysis of Statement of Financial Position
(% of base-year amount)
2015 2014 2013
Current assets 120.0 80.0 100.0

Non-current assets 133.3 116.7 100.0
Current liabilities 107.7 138.5 100.0
Non-current liabilities 110.0 70.0 100.0
Common shares 150.0 115.0 100.0
Retained earnings 158.8 141.2 100.0

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Sixth Canadian Edition
EXERCISE 14-2 (Continued)

(b)
DRESSAIRE INC.
(% change between periods)
2015 Increase (Decrease) 2014 Increase (Decrease) 2013

Amount % Amount %
Assets
Current assets $12 $ 40,000 50.0% $ 80,000 $(20,000)) (20.0)% $100,

Non-current assets 0, 50,000 14.3% 350,000 50,000) 16.7 % 00
Total assets 0 $90,000 20.9% $430,000 $ 30,000) 7.5 % 0
0 300,000
0 $400,000
4
0
0,
0
0
0
$520,000

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Sixth Canadian Edition

(b) (Continued)
Liabilities and Shareholders’ Equity
iabilities
Current liabilities $ 70,000 $(20,000) (22.2)% $ 90,000 $ 25,000 38.5% $ 65,000
Non-current liabilities 165,000 60,000 57.1% 105,000 (45,000) (30.0%) 150,000
Total liabilities 235,000 40,000 20.5% 195,000 (20,000) (9.3%) 215,000
Shareholders’ equity
Common shares 150, 35,000 30.4% 115,000 15,000 15.0%
Retained earnings 0 15,000 12.5% 120,000 35,000 41.2% 10
Total shareholders’ 0 50,000 21.3% 235,000 50,000 27.0% 0,0
equity 0 00
Total liabilities and 135,000 $90,000 20.9% $430,000 ($30,000) 7.5% 85,000
shareholders’ equity 285,000 185,000
$520,000 $400,000

EXERCISE 14-3
FLEETWOOD CORPORATION
Vertical Analysis of Income Statement
2015 2014
Amount Percent Amount Percent
Sales $800,000 100.0% $600,000 100.0%
Gross profit 250,000 31.3% 225,000 37.5%
Operating expenses 175,000 21.9% 125,000 20.8%
Profit before
income tax 75,000 9.4% 100,000 16.7%
Income tax expense 15,000 1.9% 20,000 3.3%
Profit $60,000 7.5% $80,000 13.3%
Note: The percentages shown in the above table do not add perfectly because of rounding
discrepancies that occur from rounding the results to one decimal place.

EXERCISE 14-4
(a) POSTMEDIA NETWORK CANADA CORP.

Horizontal Analysis of Income Statement
Year Ended August 31
2012 2011 2010

Revenues 681.3 736.2 100.0
Operating expenses 593.1 613.5 100.0
Other expenses 231.5 275.6 100.0
Loss from continuing operations before
income tax 83.5 27.2 100.0
Income tax expense - - -
Loss from continuing operations 83.5 27.2 100.0
Income from discontinued operations,
net of income tax - - -
Loss 52.0 21.5 100.0
Because there was no income from discontinued operations in 2010, no percentage change is
calculated for 2011 and 2012 even though in those years, income from discontinued
operations was recorded.


(b)
POSTMEDIA NETWORK CANADA CORP.
2010
Amount Percent
Revenues $122,094 100.0%
Operating expenses 133,650 109.5%
Other expenses 33,062 27.1%
Loss from continuing operations before income tax (44,618) (36.5%)
Income tax expense 0 0.0%
Loss from continuing operations (44,618) (36.5%)
Income from discontinued operations, net of income tax 0 0.0%
Loss $(44,618) (36.5%)
2011
Amount Percent
Revenues $898,888 100.0%
Income from discontinued operations, net of income tax 2,565 0.3%
Loss $(9,589) (1.1%)
2012
Amount Percent
Revenues $831,877 100.0%
Income from discontinued operations, net of income tax 14,053 1.7%
Loss $(23,222) (2.8%)


(c) Comparing 2011 to 2010, we can use the horizontal analysis of part (a) which
demonstrates to us how extensive the increase in revenues was in 2011 over 2010. The
increase was more than 7 times the level of revenue of 2010. With the increase in
revenue came corresponding increases in expenses, with operating expenses coming in
at 6 times the level of 2010, and other expenses increasing to a lesser extent. Other
expenses also rose in 2011 but not by as much as revenues. We can see this effect
when we look at the vertical analysis for 2011 versus 2010. Notice how the operating
expenses and other expenses as a percentage of revenues fell in 2011. Because the
expenses did not rise as much as the revenues,the loss from continuing operations fell
a great deal in 2011 and represented only 1.4% of revenues in 2011 compared to
36.5% in 2010. In 2011, unlike 2010, there was income from discontinued operations
that lowered the overall loss for that year.
In 2012, both revenues and operating expenses fell but revenues fell by a greater extent
as evidenced by the fact that operating expenses in 2012 were 95.3% of revenues
compared to 91.2% in 2011 as we can see in the vertical analysis. Other expenses fell
in 2012 and represented only 9.2% of sales in that year compared to 10.1% in the prior
year. Despite this however, the loss from continuing operations in 2012 rose to 4.5% of
revenues compared to only 1.4% of revenues in 2011. Fortunately, in 2012, income
from discontinued operations grew but not by enough to prevent the overall loss for the
year from being more than twice the amount in 2011.

EXERCISE 14-5
(a) (b)
Asset turnover P B
Average collection period L W
Cash current debt coverage L B
Cash total debt coverage S B
Current ratio L B
Days in inventory L W
Debt to total assets S W
Dividend yield P B
Earnings per share P B
Free cash flow S B
Gross profit margin P B
Inventory turnover L B
Payout ratio P B
Price-earnings ratio P B
Profit margin P B
Receivables turnover L B
Return on assets P B
Return on common shareholders’ equity P B
Times interest earned S B
Working capital L B

EXERCISE 14-6
($ in millions)
(a) 2015 2014
Working capital
= $1,430 – $890 = $540 = $1,314 – $825 = $489
Current ratio
= 1.61:1 ($1,430 ÷ $890) = 1.59:1 ($1,314 ÷ $825)
Acid-test ratio
= 0.86:1 = 0.89:1
[($30 + $55 + $676) ÷ $890] [($91 + $60 + $586) ÷ $825]
Receivables turnover
($4,190 ÷ [($676 + $50) + ($586 + $45) ÷ 2]) ($3,940 ÷ [($586 + $45) + ($496 + $40)) ÷ 2])
Collection period
= 59 days (365 ÷ 6.2 times) = 54 days (365 ÷ 6.8 times)
Inventory turnover
($2,900 ÷ [($628 + $525) ÷ 2]) ($2,650 ÷ [($525 + $575) ÷ 2])
Days sales in inventory

= 73 days (365 ÷ 5.0 times) = 76 days (365 ÷ 4.8 times)
(b)
Working capital Better
Current ratio Better
Acid-test ratio Worse
Receivables turnover Worse
Collection period Worse
Inventory turnover Better
Days sales in inventory Better

EXERCISE 14-7
(a) The company’s collection of its accounts receivable has deteriorated over the past
several years as it is taking the company longer to collect receivables as evidenced by
the decrease in the accounts receivable turnover.
(b) The company is selling its inventory slower as the inventory turnover is declining.
(c) Overall, the company’s liquidity has deteriorated. The increase in the current ratio is
caused by the increase in inventory and receivables due to the slowdown in the
movement of these assets. Even though the company’s current ratio is higher, if the
underlying assets cannot be converted to cash to repay current liabilities, then liquidity
has deteriorated.
EXERCISE 14-8
(a)
2015
Debt to total $2,175
= = 55.9%
assets $3,890
Free cash = $850 – $400 = $450

flow
Interest ($405 + $15 + $175)

= = 39.7 times
coverage $15
2014
Debt to total $1,960
= = 53.0%
assets $3,700
Free cash = $580 – $300 = $280

flow
Interest ($375 + $25 + $150)

= = 22.0 times
coverage $25
(b) Debt to total assets Worse

Free cash flow Better
Interest coverage Better

EXERCISE 14-9
(a) The debt to total assets ratio has deteriorated over the last three years as the proportion
of total debt to total assets has increased.
(b) The increase in the times interest earned ratio indicates that it has improved over the
last three years. This means that the company’s profit before interest and taxes has
risen more than the increase in interest expense.
(c) The company’s solvency initially appears to be worsening as evidenced by its increased
reliance on debt. However, the company’s times interest earned and cash total debt
coverage ratios are improving, so the company appears to be able to handle this
increasing level of debt. Because of the impact of these latter two ratios, solvency has
not deteriorated.

EXERCISE 14-10
(a) ($ in thousands)
2015 2014
($500 -
Gross profit $375) ($400 - $290)
= 25.0% = 27.5%
margin
$500 $400
Profit $33.5 $30.0

margin = 6.7% = 7.5%
$500 $400
Asset $500 $400

= 1.60 = 1.46
turnover ($350 + $275) times ($275 + $274) times
2 2
Return on $33.5 $30.0

assets = 10.7% = 10.9%
($275 + $350) ($275 + $274)
2 2
Return on $33.5 $30.0

equity ($133.5 + = 28.7% = 40.0%
$100) ($100 + $50)
2 2
(b) Gross profit margin Worse

Profit margin Worse
Asset turnover Better
Return on assets Worse
Return on equity Worse
EXERCISE 14-11
Overall, BetaCom is more profitable. While Top’s gross profit margin is higher than BetaCom’s
and the industry, BetaCom’s profit margin, return on common shareholder’s equity and return
on assets are higher than Top’s. Both company’s ratios are better than the industry average
with the exception of BetaCom’s gross profit margin.

EXERCISE 14-12
(a) Return on assets is influenced by the profit margin and asset turnover. The main driver
of the company’s return on assets is its profit margin. This is because the profit margin
has decreased, whereas the asset turnover has remained constant.
(b) Return on common shareholders’ equity is influenced by return on assets and debt to
total assts. The return on assets ratio, more specifically the profit margin, was the
primary driver of the deterioration in the return on common shareholders’ equity ratio.
The profit margin has shown an increase from 2010 to 2011 and a substantial decrease
from 2011 to 2012. This same pattern is reflected in the return on common
shareholders’ equity. The debt to total assets ratio rose in 2011 and then remained
constant from 2011 to 2012 so it is less of an influence on return on common
shareholders’ equity.
EXERCISE 14-13
(a) Nyarboro is the more liquid of the two despite Rogers’s current ratio being higher than
that of Nyarboro and closer to the industry average. Nyarboro’s receivables and
inventory turnover ratios are substantially higher than Archers’, which essentially means
that it converts its receivables and inventory to cash much more quickly than does
Archers. Although more information would be helpful before concluding, Archers’ higher
current ratio could be the result of higher accounts receivable (possible collection
problem) and higher inventory (slow moving due to lower demand).
(b) It appears that Archers is the more solvent of the two. Because Nyarboro has a lower
debt to total assets ratio, which is indicative of greater solvency, one would expect it to
have a higher times interest earned ratio indicating a greater ability to meet its interest
commitments (because of the lower debt level) yet it is Archers that has a higher times
interest earned ratio despite having a higher level of debt.
(c) Archers is clearly the more profitable of the two, as all of its profitability ratios are
superior to those of Nyarboro and exceed the industry average.
(d) Investors seem to favour Nyarboro as indicated by the price-earnings ratio. This ratio is
higher than Archers’ although, not as high as the industry average. This finding is not
consistent with the assessment of solvency and profitability. Investors’ believe that
Nyarboro has the better prospects for future growth. Their assessment of a company’s
prospects is usually based on expectations of future results rather than an assessment
based on historical results. Because the price earnings ratio of Archers is lower, its
shares are relatively cheaper than Nyarboro’s shares, and because Archers has better
profitability, an investor may be more likely to buy shares in Archers.

SOLUTIONS TO PROBLEMS
PROBLEM 14-1A
(a)
CLUBLINK ENTERPRISES LIMITED
December 31
2012 2011 2010

Assets
Total assets 106.7 108.3 100.0

Liabilities
Total liabilities 103.2 103.7 100.0
Shareholders’ equity 117.0 121.7 100.0
Total liabilities and
shareholders’ equity 106.7 108.3 100.0

PROBLEM 14-1A (Continued)
(a) (Continued)
CLUBLINK ENTERPRISES LIMITED

Year Ended December 31
2012 2011 2010
Revenue 104.9 105.4 100.0

Profit from operations 107.5 98.4 100.0
Interest expense 95.8 98.2 100.0
Other NA 1,970.1 100.0
Profit before income tax 118.7 139.4 100.0
Income tax expense 106.0 142.6 100.0
Profit 122.9 138.4 100.0
The percentage change for other revenues and expenses in 2012 is not calculated
because the amount changed from a large expense to a small revenue amount.
(b) By expressing the amounts in the statements as a percentage of a base year amount,
we can see that in the statement of financial position the most substantial change was
the decline in current assets in 2012 and the increase in current liabilities and
shareholders’ equity in 2011. The latter arose due the large increase in retained
earnings arising from other revenues in 2011. The remaining elements on the statement
of financial position show increases in line with the increased volume of business
demonstrated on the income statement.
The most significant change on the income statement arose from the decrease in
revenue in 2012 likely due to the decline in the number of members as revealed in the
footnote to the income statement. The increase in operating expenses increased by
more than the increase in revenues in 2011, resulting in decreased profit from
operations. The large source of other revenues in 2011 was the main reason for the
increase in profits for 2011. The income tax expense decreased relative to profit before
income tax in 2012, possibly due to a decrease in tax rates.

PROBLEM 14-2A
(a)
BIG ROCK BREWERY
Vertical Analysis of Statement of Financial Position
December 31
(in thousands)
2012 2011 2010

$ % $ % $ %
Assets
Current assets 10,895 23.5 8,089 17.9 7,426 21.5
Non-current assets 35,409 76.5 37,081 82.1 27,035 78.5
Total assets 46,300 100.0 45,170 100.0 34,461 100.0

Liabilities
Current liabilities 6,318 13.6 5,575 12.3 4,322 12.5
Non-current liabilities 7,911 17.1 7,146 15.8 4,786 13.9
Total liabilities 14,229 30.7 12,721 28.2 9,108 26.4
Shareholders’ equity 32,071 69.3 32,449 71.8 25,353 73.6
shareholders’ equity 46,300 100.0 45,170 100.0 34,461 100.0
BIG ROCK BREWERY

(in thousands)
2012 2011 2010
$ % $ % $ %
Net sales 46,057 100.0 45,183 100.0 45,130 100.0
Cost of sales 21,149 45.9 21,385 47.3 19,418 43.0
Gross profit 24,908 54.1 23,798 52.7 25,712 57.0
Operating expenses 19,290 41.9 20,455 45.3 20,054 44.4
Profit from operations 5,618 12.2 3,343 7.4 5,658 12.5
Interest expense 93 0.2 141 0.3 147 0.3
Other income (204) (0.4) (288) (0.6) (327) (0.7)
Profit before income tax 5,729 12.4 3,490 7.7 5,838 12.9
Income tax expense (recovery) 1,594 3.5 957 2.1 (279) (0.6)
Profit 4,135 9.0 2,533 5.6 6,117 13.6

(b) The most significant change in Big Rock’s statement of financial position has been a
expansion of the business, which occurred in 2011 giving rise to non-current assets that
increased by over $10 million. This increase was financed partially from debt as seen in
the increase in non-current liabilities of $2.4 million and by a more substantial increase in
equity of $6.9 million. There probably was a large issuance of shares as the increase in
shareholders’ equity can only partially be explained by an increase in retained earnings
arising profit of $2.5 million. Consequently, most of the increase in shareholders’ equity
likely arose from share issuances that were used to finance the purchase of the non-
current assets.
The company’s gross profit decreased significantly in 2011 compared to 2010 but this
improved somewhat in the following year. The decrease in gross profit percentage was
counterbalanced somewhat in 2012 with a decline in operating expenses so that overall
there was an improvement in the profit margin percentage in 2012 compared to 2011.
(c) Big Rock has primarily financed its assets through equity, but as indicated by the
gradually increasing debt to total assets ratio of 26.4% in 2010, 28.2% in 2011, and
30.7% in 2012, the company is relying less on equity financing than it has in the past.

PROBLEM 14-3A
(a) Although the operating expenses have been increasing over the last four years, when
these are expressed as a percentage of revenues in the vertical analysis, it is clear that
their proportion as a percentage of revenue is smaller in 2015 than in 2012,
demonstrating that the company has a good control over the operating expenses.
(b) The change in profit before income tax, income tax expense and profit is the same
because the income tax rate has not changed. Therefore the absolute amount of the tax
expense will change in the same proportion as the change in profit before income taxes.
As demonstrated in the vertical analysis statement, when compared to revenues, the
absolute amount of income tax expense will change since other variables, such as
operating expenses, reduce revenues in different amounts and proportions each year.
(c) Although most expenses have grown in similar proportions to the increase in revenue,
this is not the case for interest expense. Interest expense is decreasing over the four
year period. This reduction is likely due to the reduction in interest rates charged and
the amount of the debt on the statement of financial position.
Although the horizontal analysis draws attention to a major increase in the other
revenues, that attention is later diminished when inspecting the vertical analysis income
statement. This statement reveals that in absolute terms, the amount of other revenue
involved is very small and so a major increase of 240% over a three year period turns
out to have a modest effect on the profit.
(d) Horizontal and vertical analysis of the statement of financial position, as well as the
financial statements themselves, can be useful in assessing this company’s
performance and financial position. In addition, ratio analysis would help complete the
picture. Comparisons of this company to other businesses in the industry, as well as
understanding any external economic or other factors, would also be useful.

PROBLEM 14-4A
($ in millions)
(a) Before Discontinued Operations
Ratio 2012 2011 2010 2009 2008

Profit margin $333 $395 $572 $512 $1,602
$6,430 $6,169 $5,411 $4,203 $6,576
= 5.2% = 6.4% = 10.6% = 12.2% =24.4%
Return on assets $333 $395 $572 $512 $1,602
$20,302 $19,493 $22,030 $22,528 $20,115
= 1.6% = 2.0% = 2.6% = 2.3% = 8.0%
Return on $333 $395 $572 $512 $1,602
common $8,589 $8,094 $8,218 $7,418 $6,374
shareholders’ = 3.9% = 4.9% = 7.0% = 6.9% = 25.1%
equity
After Discontinued Operations
Ratio 2012 2011 2010 2009 2008

Profit margin $333 $697 $1,197 $536 $1,715
$6,430 $6,169 $5,411 $4,203 $6,576
= 5.2% = 11.3% = 22.1% = 12.8% = 26.1%
Return on assets $333 $697 $1,197 $536 $1,715
$20,302 $19,858 $22,404 $22,528 $20,115
= 1.6% = 3.5% = 5.3% = 2.4% = 8.5%
Return on $333 $697 $1,197 $536 $1,715
common $8,589 $8,094 $8,218 $7,418 $6,374
shareholders’ = 3.9% = 8.6% = 14.6% = 7.2% = 26.9%
equity

(b) Nexen’s revenues declined sharply in 2009 but steadily arose afterwards. However,
despite this, profit margin before discontinued operations deteriorated gradually over the
five year period. Return on assets and return on equity improved slightly in 2010, but
showed significant declines in 2011 and 2012.
If we analyze profitability using profit after continuing operations, the pattern is similar – a
sharp decline in 2009, significant improvements in 2010, followed by declines in 2011 and
2012. All 3 ratios for 2010 and 2011 are much higher than those calculated without the
discontinued operations because the discontinued operations gave rise to higher profit
due to the disposal of the assets held by these operations.
(c) An analysis on profitability before discontinued operations is more relevant to investors as

it provides a better indication as to how the company will perform in future periods.

PROBLEM 14-5A
(a)
2015 2014
1. Current ratio $180,000 $150,000

= 2.1 :1 = 1.9 :1
$85,000 $80,000
2. Receivables $700,000 $450,000

turnover $60,000* + $49,500* $49,500* + $52,800*
� � � �
2 2
3. Inventory $450,000 $300,000

turnover $100,000 + $85,000 $85,000 + $64,000
� � � �
2 2
4. Debt to total $240,000 $165,000

assets = 32.7% = 28.0%
$735,000 $590,000
5. Times interest $100,000 $66,000

earned $10,000 $4,000
6. Cash total $102,000 $119,600

debt coverage �$240,000 + $165,000� �
$165,000 + $50,000
�
2 2
7. Gross profit $250,000 $150,000

= 35.7% = 33.3%
margin $700,000 $450,000
8. Profit margin $72,000 $49,600

= 10.3% = 11.0%
$700,000 $450,000
* 2. Receivables turnover—Gross accounts receivable:

2015: $55,000 + $5,000
2014: $45,000 + $4,500
2013: $48,000 + $4,800


(a) (Continued)
2015 2014
9. Asset $700,000 $450,000

turnover $735,000 + $590,000 $590,000 + $433,000
� � � �
2 2
10.Return on $72,000 $49,600

= 10.9% = 9.7%
assets $735,000 + $590,000 $590,000 + $433,000
� � � �
2 2
(b) 1. Current ratio Favourable

2. Receivables turnover Favourable
3. Inventory turnover Favourable
4. Debt to total assets Unfavourable
5. Times interest earned Unfavourable
6. Cash total debt coverage Unfavourable
7. Gross profit margin Favourable
8. Profit margin Unfavourable
9. Asset turnover Favourable
10. Return on assets Favourable
(c) Overall:
(1) Liquidity improved in 2014. The current ratio, the accounts receivable turnover and
inventory turnovers ratio were all favourable.
(2) Solvency deteriorated because the debt to total assets ratio, the times interest earned
ratio and cash total debt coverage trends were all unfavourable.
(3) Profitability improved because the gross profit margin ratio trend was favourable, as
were the asset turnover and return on assets ratios. On the other hand, the profit
margin ratio trend was unfavourable. Overall, the profitability improved as the profit
increased by a substantial amount in 2015.

PROBLEM 14-6A
(a) Liquidity
2015 2014
Working $319,000 – $185,000 = $134,000 $303,000 – $182,000 = $121,000

capital 1
$319,000 $303,000
Current ratio = 1.7 :1 = 1.7 :1
$185,000 $182,000
$96,000 $85,000
Cash current = 0.5 times = 0.5 times
1 $185,000 + $182,000 $182,000 + $180,000
debt coverage � � � �
2 2
$900,000 × 75% $840,000 × 75%

Receivables ($95,000 + $5,000 + $90,000 + $4,000) ($90,000 + $4,000 + $88,000 + $3,000)
� � � �
turnover 2 2
Average
365 365
collection = 52 days = 54 days
7.0 6.8
period
$600,000 $575,000
Inventory = 4.7 times = 4.8 times
$130,000 + $125,000 $125,000 + $115,000
turnover � � � �
2 2
Days in 365 365

= 78 days = 76 days
inventory 4.7 4.8
1
Current assets, 2015 = $70,000 + $95,000 + $130,000 + $24,000 = $319,000
Current assets, 2014 = $65,000 + $90,000 + $125,000 + $23,000 = $303,000
Current liabilities, 2015 = $45,000 + $30,000 + $110,000 = $185,000

(a) (Continued)
Solvency
2015 2014
Debt to total $385,000 $332,000

assets = 51.1 % = 51.2 %
$754,000 $648,000
Times interest $116,000 $105,000

earned = 3.9 times = 5.3 times
$30,000 $20,000
Cash total debt $96,000 $85,000

coverage $385,000 + $332,000 $332,000 + $371,000
� � � �
2 2
Free cash flow $96,000 – $125,000 – $8,000 $85,000 – $50,000 – $8,000

= $(37,000) = $27,000

(a) (Continued)
Profitability
2015 2014
$64,000 $65,000
Return on common $369,000 + $316,000 $316,000 + $259,000
� � � �
shareholders’ equity 2 2
= 18.7% = 22.6%
$64,000 $65,000
$754,000 + $648,000 $648,000 + $630,000
Return on assets � � � �
2 2
= 9.1% = 10.2%
$64,000 $65,000
Profit margin = 7.1 % = 7.7 %
$900,000 $840,000
$900,000 $840,000
$754,000 + $648,000 $648,000 + $630,000
Asset turnover � � � �
2 2
= 1.3 times =1.3 times
$300,000 $265,000
Gross profit margin = 33.3 % = 31.5 %
$900,000 $840,000
$64,000 $65,000
Earnings per share = $3.20 = $3.25
20,000 20,000
$8,000 $8,000
Payout = 12.5% = 12.3%
$64,000 $65,000

(b) 1. Working capital Favourable

2. Current ratio Unchanged
3. Cash current debt coverage Unchanged
4. Receivables turnover Favourable
5. Average collection period Favourable
6. Inventory turnover Unfavourable
7. Days in inventory Unfavourable
8. Debt to total assets Favourable
10. Cash total debt coverage Favourable
11. Free cash flow Unfavourable
12. Return on common shareholders’ equity Unfavourable
13. Return on assets Unfavourable
14. Profit margin Unfavourable
15. Asset turnover Unchanged
17. Earnings per share Unfavourable
18. Payout Favourable
(c) (1) Clack’s liquidity has not changed significantly. The current ratio has remained constant
while the receivables turnover ratio has improved slightly and the inventory turnover ratio
has deteriorated slightly.
(2) Overall, solvency has deteriorated slightly. While the debt to total assets and the cash
total debt coverage ratios have improved slightly, the times interest earnings and free
cash flow ratios have deteriorated.
(3) Clack’s profitability has declined as indicated by the decrease in the return on
common shareholders’ equity, return on assets, profit margin, and earnings per share
ratios. The asset turnover has remained constant. The gross profit margin and the payout
ratio have increased slightly.

PROBLEM 14-7A
(a)Accounts receivable management can be assessed by reviewing a company’s average

collection period, which indicates how long the company is taking to collect its accounts
receivable. Bureau Nouveau’s average collection period of 31 days is excellent when
compared to its credit terms of 30 days. As well, Bureau Nouveau’s average collection period
is better than Supplies Unlimited.
(b) A company’s ability to manage its inventory can be measured by the days in inventory
ratio. Currently Bureau Nouveau is taking 61 days to turn over its inventory, which can
also be expressed as approximately every 6 times per year (365 ÷ 61 days). When
compared to the days in inventory for Supplies Unlimited of 122 days it is clear that
Bureau Nouveau is turning over its inventory faster.
(c) Supplies Unlimited has a higher current ratio than Bureau Nouveau and this would
normally indicate a greater level of liquidity but in this case it probably does not as the
reason for the higher current ratio is likely due to higher accounts receivable because of a
longer collection period and higher inventory due to its higher days in inventory. If a
company is slower at collecting its accounts receivables and selling its inventory, it is less
liquid. Therefore, Bureau Nouveau is more liquid. Furthermore, Bureau Nouveau’s cash
current debt ratio is higher than that of Supplies Unlimited and this indicates greater
liquidity.
(d) Supplies Unlimited appears to be the more solvent of the two companies. Supplies
Unlimited has a lower debt to total assets ratio indicating that Supplies Unlimited has a
lower percentage of its assets financed by debt. As well, Supplies Unlimited has a higher
times interest earned ratio indicating that Supplies Unlimited has a better ability to service
its debt as interest payments become due.
(e) Supplies Unlimited likely has a higher gross profit margin because it sells a product that
has a higher price relative to its cost allowing it to earn a higher gross profit margin. It is
also possible to have a higher gross profit because the company can purchase inventory
at a lower cost. The profit margin incorporates all of the elements of the gross profit
margin in addition to operating expenses, other revenues and expenses and income tax.
If Supplies Unlimited, which has a higher gross profit margin also has a lower profit
margin, then it is most likely due to the fact that operating expenses, other expenses
and/or income tax expense are larger relative to sales for this company and this has
caused the profit margin to fall.
(f) Recall that the return on assets can be calculated by multiplying the profit margin by
asset turnover. Bureau Nouveau’s higher return on assets is almost equally due to its
higher profit margin and asset turnover ratios, which are both approximately 17%-18%
higher than those of Supplies Unlimited.


(g) If a company’s return on common shareholders’ equity is greater than its return on
assets, this excess arose from the advantage of leverage. The return on assets is 14.3%
while the return on common shareholders’ equity is 26.1%. The difference which is
slightly smaller than 14.3% arose because of that company’s use of debt. Therefore, the
return on assets is a larger contributing factor to the return on common shareholders’
equity than the use of debt.
(h) Bureau Nouveau may have a lower payout ratio than Supplies Unlimited because Bureau
Nouveau’s management has likely decided to retain profits in the business to finance
future growth.
(i) Market price per share

= Price-earnings ratio × Earnings per share
Bureau Nouveau’s market price per share = 29 × $3.50 = $101.50
Supplies Unlimited’s market price per share = 45 × $2.40 = $108.00
(j) The price-earnings ratio reflects investors’ assessment of the future prospects of a
company. As indicated by its higher price-earnings ratio, investors appear to believe that
Supplies Unlimited has the better possibility for growing its profits.

PROBLEM 14-8A
(a) Despite the fact that Mac’s has a higher current ratio, one may argue that Mac’s has
less liquidity compared to King’s or the industry average because of its lower
receivables and inventory turnovers. Each companies’ receivables turnover is lower
than the industry average. However, Mac’s inventory turnover is more in line with the
industry average, while King’s is well ahead of the industry average.
(b) Mac’s is more solvent than King’s. Although its debt to total assets ratio is higher than
King’s, which indicates more of its assets are financed by debt, Mac’s times interest
earned is much better than King’s and is also better than the industry average. King’s
times interest earned ratio is significantly lower than the industry average. This indicates
that Mac’s has a higher capacity to service its debt because its profit before income tax
and interest is much higher relative to its interest expense.
(c) Mac’s is the more profitable of the two companies. Mac’s has a significantly higher
gross profit margin and profit margin than King’s. Mac’s is better than industry average
while King’s is below industry average for the gross profit margin and profit margin.
Mac’s also has a better return on common shareholders’ equity and a higher return on
assets. While King’s has a slightly higher asset turnover, all other profitability ratios
indicate that Mac’s is more profitable than King’s and the industry.
(d) Investors seem to favour Mac’s as it has a slightly higher price-earnings ratio and
significantly higher dividend yield. King’s price-earnings ratio is lower than the industry
average, showing that investors on average favour other restaurants in the industry and
this is most likely due to King’s lower profitability. Because Mac’s is so much more
profitable than King’s and the industry average as shown by its very high return on
common shareholders’ equity, one would expect Mac’s to have a higher price-earnings
ratio. Although it is higher than King’s it is not higher than the industry average, which is
surprising. This would indicate that the market does not think that the growth prospects
of Mac’s are any better than those of the average company in the industry.

PROBLEM 14-9A
(a) and (b)

(a) Higher (b) Higher
(1) Current ratio Company A no impact
(2) Debt to total assets Company B Company A
(3) Profit margin Company A Company B
(c) Yes. The impact the different accounting policies and estimates will have on each
company’s profit and ratios must be considered so that the comparison is meaningful.
(d) An analyst must also consider professional judgement and diversification. Professional
judgement impacts estimates made by management as it prepares the financial
statements. The more diversified a company is, the harder it is to compare as it is
involved in many industries.

PROBLEM 14-1B
(a)
LULULEMON ATHLETICA INC.
January 31
2013 2012 2011

Assets
Total assets 210.5 147.1 100.0

Liabilities
Total liabilities 156.0 122.3 100.0
shareholders’ equity 210.5 147.1 100.0
LULULEMON ATHLETICA INC.

Year Ended January 31
2013 2012 2011
Net revenue 192.5 140.6 100.0

Cost of goods sold 191.8 136.2 100.0
Gross profit 193.1 144.2 100.0
Other income 161.0 63.1 100.0
Profit before income tax 208.0 157.7 100.0
Profit 222.0 151.1 100.0

PROBLEM 14-1B (Continued)
(b) The primary driver of the company’s profit appears to be the increase in revenues. In
2012, cost of goods sold increased at a slower rate than did revenues, which resulted in
an increase in gross profit. The other income which fell in 2012, increased in 2013 and
also contributed to higher profit in that year.
In the statement of financial position, total assets increased at a faster rate than did total
liabilities. This increase in assets was financed primarily by an increase in shareholders’
equity. Shareholders’ equity increased both from profit and what must have been an
increase in shares not counting the amount of dividends that must have been paid out
because shareholders’ equity increased more than by profit for 2012 and 2013. The
remaining elements on the statement of financial position show increases in line with
the increased volume of business demonstrated on the income statement.

PROBLEM 14-2B
(a) YELLOW MEDIA INC.
December 31
(in thousands)
2012 2011 2010
$ % $ % $ %
Assets
Current assets 369,361 21.0 350,559 6.9 443,370 4.8
Fixed assets 27,414 1.6 46,496 0.9 112,445 1.2
Intangible assets 1,312,148 74.7 1,658,051 32.8 2,123,776 22.8
Goodwill - - 2,967,847 58.8 6,508,984 70.0
Other assets 47,553 2.7 25,979 0.5 111,673 1.2
Total assets 1,756,476 100.0 5,048,932 100.0 9,300,248 100.0

Liabilities
Current liabilities 326,923 18.6 634,613 12.6 478,562 5.1
Non-current liabilities 1,143,393 65.1 2,329,292 46.1 2,871,617 30.9
Total liabilities 1,470,316 83.7 2,963,905 58.7 3,350,179 36.0
Shareholders’ equity 286,160 16.3 2,085,027 41.3 5,950,069 64.0
shareholders’ equity 1,756,476 100.0 5,048,932 100.0 9,300,248 100.0

(a) (Continued)
YELLOW MEDIA INC.
(in thousands)
2012 2011 2010
$ % $ % $ %
Revenues 1,107,715 100.0 1,328,866 100.0 1,679,860 100.0
Operating expenses 686,331 62.0 843,950 63.5 1,164,104 69.3
Goodwill impairment 3,267,847 295.0 2,900,000 218.2 - -
Profit (loss) from operations (2,846,463) (257.0) (2,415,084) (181.7) 515,756 30.7
Other revenues and expenses
Interest expense (146,265) (13.2) (130,582) (9.8) (144,796) (8.6)
Other 962,788 86.9 (75,307) (5.7) (36,398) (2.2)
Profit (loss) before income (2,029,940) (183.3) (2,620,973) (197.2) 334,562 19.9
tax
Income tax expense
(recovery) (75,935) (6.9) 87,149 6.6 60,527 3.6
Profit (loss) from continuing
operations (1,954,005) (176.4) (2,708,122) (203.8) 274,035 16.3
Discontinued business loss - - 120,877 9.1 - -
Profit (loss) (1,954,005) (176.4) (2,828,999) (212.9) 274,035 16.3
(b) Yellow Media performance and financial position are overshadowed by the devastating
effect of taking an impairment charge on goodwill of $2.9 billion in 2011 followed by a
complete balance write-off in 2012 of $3.3 billion. This charge coupled with declining
revenues caused devastating losses for 2011 and 2012 and consequently declining
shareholders’ equity to $0.3 billion by the end of 2012. Because goodwill represented
70% of the total assets at the end of 2010, the impairment of this asset caused this
company to shrink to a fraction of its former self. The only positive sign in 2012 is the
large other revenue of slightly under $1 billion. By the end of 2012 due to the dwindling
equity position, debt to total asset climbed to 83.7%. This is a level that will cause
concerns to shareholders and to creditors.
(c) As mentioned in part (b) above, Yellow Media had previously financed its assets primarily
through equity with an equity to total assets ratio of 64% but by the end of 2012, this ratio
had reduced to 16.3%.

PROBLEM 14-3B
(a) The horizontal and vertical analysis statements demonstrate that the company’s control
over cost of goods sold was steady in 2013 and 2014 but went somewhat out of control
in 2015, when costs of goods sold increased by 2.4% of revenue.
(b) Although the profit before income tax has remained constant as a percentage of each
year’s revenue over the last four years, the amounts have increased in absolute terms
each year, as shown in the horizontal analysis statement. This demonstrates that the
percentage increase in profit before income tax is increasing at about the same pace as
the percentage increase in revenue.
(c) Although most expenses have grown in similar proportions to the increase in revenue,
this is not the case for interest expense. Interest expense is decreasing over the four
year period. This reduction is likely due to the reduction in interest rates charged and
the amount of the debt on the statement of financial position. Operating expenses have
been growing at a faster rate than revenue.
Although the horizontal analysis draws attention to a major increase in the other
revenues, that attention is later diminished when inspecting the vertical analysis income
statement. That statement that reveals that in absolute terms, the amount of other
revenue involved is very small and so a major increase of 140% over a three year
period turns out to have a modest effect on the profit.
(d) The financial statements themselves, along with some ratio analysis, would also be
useful in assessing this company’s performance and financial position. Comparisons of
this company to other businesses in the industry, as well as understanding any external
economic or other factors, would also be useful.

PROBLEM 14-4B
(in USD millions)
(a) Before Discontinued Operations
Ratio 2013 2012 2011 2010 2009

Return on $4,535 $3,883 $3,338 $2,620 $2,312
common $17,837 $18,394 $19,141 $18,585 $17,746
shareholders’ = 25.4% = 21.1% = 17.4% = 14.1% = 13.0%
equity
Return on assets $4,535 $3,883 $3,338 $2,620 $2,312
$40,801 $40,321 $40,501 $41,020 $42,744
= 11.1% = 9.6% = 8.2% = 6.4% = 5.4%
Profit margin $4,535 $3,883 $3,338 $2,620 $2,312
$74,754 $70,395 $67,997 $66,176 $71,288
= 6.1% = 5.5% = 4.9% = 4.0% = 3.2%
After Discontinued Operations
Ratio 2013 2012 2011 2010 2009

Return on $4,535 $3,883 $3,338 $2,661 $2,260
common $17,837 $18,394 $19,141 $18,585 $17,746
shareholders’ = 25.4% = 21.1% = 17.4% = 14.3% = 12.7%
equity
Return on assets $4,535 $3,883 $3,338 $2,661 $2,260
$40,801 $40,321 $40,501 $41,020 $42,744
= 11.1% = 9.6% = 8.2% = 6.5% = 5.3%
Profit margin $4,535 $3,883 $3,338 $2,661 $2,260
$74,754 $70,395 $67,997 $66,176 $71,288
= 6.1% = 5.5% = 4.9% = 4.0% = 3.2%

(b) Home Depot’s profitability before and net of discontinued operations is very similar and is
gradually improving over the five year period. This is demonstrated in all three ratios. Net
sales have been increasing since 2010 and profits have been rising at a faster rate,
having doubled from 2009 to 2013. Consequently, all profitability ratios show significant
improvement because profits are rising at a faster rate than net sales. Cost control
explains this result. Average shareholders’ equity is actually declining in 2012 and 2013,
yielding a larger increase in the return on common shareholders’ equity than the other two
ratios. Similarly average total assets declined over the five year period, which helped
provide for a stronger increase in the return on assets.
(c) An analysis on profitability before discontinued operations is more relevant to investors as

it provides a better indication as to how the company will perform in future periods.

PROBLEM 14-5B
(a)
2015 2014
1 2
1. Current ratio $265,000 $194,000
= 4.2 :1 = 3.8 :1
$63,500 $51,000
2. Receivables $890,000 $800,000

turnover $83,650* + $52,750* $52,750* + $55,400*
� � � �
2 2
3. Inventory $490,000 $450,000

turnover $85,000 + $45,000 $45,000 + $50,000
� � � �
2 2
4. Debt to total $308,500 $116,000

assets = 32.1% = 18.9%
$960,000 $615,000
5. Times interest $134,000 $90,000

earned $27,750 $8,750
6. Cash total $107,500 $91,000

debt coverage �$308,500 + $116,000� �
$116,000 + $135,000
�
2 2
7. Gross profit $400,000 $350,000

= 44.9% = 43.8%
margin $890,000 $800,000
1. Current ratio:
1
Current assets 2015 = $30,000 + $80,000 + $85,000 + $70,000 = $265,000
2
Current assets 2014 = $24,000 + $50,000 + $45,000 + $75,000 = $194,000
2. Receivables turnover—Gross accounts receivable:

* 2015: $80,000 + $3,650 = $83,650
* 2014: $50,000 + $2,750 = $52,750
* 2013: $53,000 + $2,400 = $55,400


(a) (Continued)
2015 2014
8. Profit margin $85,000 $65,000

= 9.6% = 8.1%
$890,000 $800,000
9. Asset $890,000 $800,000

turnover $960,000 + $615,000 $615,000 + $540,000
� � � �
2 2
10.Return on $85,000 $65,000

= 10.8% = 11.3%
assets $960,000 + $615,000 $615,000 + $540,000
� � � �
2 2
(b) 1. Current ratio Favourable

2. Receivables turnover Unfavourable
6. Cash total debt coverage Unfavourable
8. Profit margin Favourable
9. Asset turnover Unfavourable
10. Return on assets Unfavourable

PROBLEM 14-6B
(a) Liquidity
2015 2014
Working $575,000 – $443,750 = $131,250 $460,000 – $265,000 = $195,000

capital 1
$575,000 $460,000
Current ratio = 1.3 :1 = 1.7 :1
$443,750 $265,000
$223,000 $135,500
1 $443,750 + $265,000 $265,000 + $250,000
2 2
$1,100,000 $950,000
Receivables ($100,000 + $10,000 + $87,000 + $5,000) ($87,000 + $5,000 + $80,000 + $3,000)
� � � �
turnover 2 2
Average
365 365
collection =33 days = 33 days
10.9 10.9
period
$650,000 $635,000
$400,000 + $300,000 $300,000 + $320,000
2 2
Days in 365 365

= 192 days = 183 days
inventory 1.9 2.0
1
Current assets, 2015 = $50,000 + $100,000 + $400,000 + $25,000 = $575,000
Current assets, 2014 = $42,000 + $87,000 + $300,000 + $31,000 = $460,000

(a) (Continued)
Solvency
2015 2014
Debt to total $643,750 $390,000

assets = 48.0 % = 39.6 %
$1,340,000 $985,000
Times interest $165,000 $100,000

earned = 5.5 times = 10.0 times
$30,000 $10,000
Cash total debt $223,000 $135,500

coverage $643,750 + $390,000 $390,000 + $543,500
� � � �
2 2
Free cash flow $223,000 – $92,000 – $4,000 $135,500 – $50,000 – $4,000

= $127,000 = $81,500

(a) (Continued)
Profitability
2015 2014
$101,250 $67,500
Return on common $696,250 + $595,000 $595,000 + $531,500
� � � �
= 15.7% = 12.0%
$101,250 $67,500
$1,340,000 + $985,000 $985,000 + $1,075,000
2 2
= 8.7% = 6.6%
$101,250 $67,500
$1,100,000 $950,000
$1,100,000 $950,000
$1,340,000 + $985,000 $985,000 + $1,075,000
2 2
$450,000 $315,000
Gross profit margin = 40.9 % = 33.2 %
$1,100,000 $950,000
$101,250 $67,500
Earnings per share = $1.01 = $0.68
100,000 100,000
$4,000 $4,000
Payout = 4.0% = 5.9%
$101,250 $67,500


(b) 1. Working capital Unfavourable
2. Current ratio Unfavourable
3. Cash current debt coverage Favourable
4. Receivables turnover Unchanged
5. Average collection period Unchanged
7. Days in inventory Unfavourable
10. Cash total debt coverage Favourable
11. Free cash flow Favourable
12. Return on common shareholders’ equity Favourable
13. Return on assets Favourable
14. Profit margin Favourable
15. Asset turnover Unchanged
17. Earnings per share Favourable
18. Payout Unfavourable
(c) (1) Track’s overall liquidity has declined in 2015. Its working capital and current ratio
have declined and it is taking longer to turnover its inventory. The receivables turnover
and average collection period have stayed the same. The cash current debt coverage is
the only liquidity ratio that has shown an improvement.
(2) Track’s overall solvency has deteriorated. This is evidenced by the increase in debt to
total assets ratio and the decrease in times interest earned. The cash total debt coverage
and free cash flow have improved.
(3) Track’s overall profitability has improved as evidenced by the increase in return on
common shareholders’ equity, return on assets, profit margin, gross profit margin, and
earnings per share. The decrease in payout ratio is due to Track’s increased profit. The
asset turnover ratio has remained constant.

PROBLEM 14-7B
(a) Accounts receivable management can be assessed by reviewing each company’s

receivables turnover ratio and average collection period. Flavour’s receivables turnover of
10.4 times yields an average collection period of 32 days (365 ÷ 10.4) days. This is
excellent when compared to its credit terms of 30 days. Refresh’s average collection
period of 37 days (365 ÷ 9.8) days is worse than that of Flavour.
(b) Flavour appears to be managing its inventories better than Refresh with days in inventory
of 37 (365 ÷ 9.9) versus 63 (365 ÷ 5.8). This is assessed by reviewing the inventory
turnover ratio and the average number of days in inventory.
(c) Refresh has a higher current ratio than Flavour likely because it is lower receivables and
inventory turnover as shown above. It is likely that the higher current ratio is therefore due
to higher accounts receivable and higher inventory and not due to higher cash or lower
current liabilities. In this case having a higher current ratio is unfavourable.
(d) Refresh appears to be the more solvent of the two companies. Refresh has a lower debt
to total assets ratio, indicating that Refresh has a lower percentage of its assets financed
by debt. As well, Refresh has a higher times interest earned ratio indicating that Refresh
has a better ability to service its debt as interest payments become due and a higher
cash total debt coverage indicating it has a better ability to pay its debts.
(e) Refresh could have a higher gross profit margin because it either sells its products at a
higher price or obtains these products at a lower cost. It would have a lower profit margin
because any advantage received from the higher gross profit margin was lost due to
higher operating expenses, interest expenses or tax expense, which caused the profit
margin to be lower for this company. Refresh may sell a product that is more expensive
and commands a higher gross profit margin. A clue to this is its significantly slower
inventory turnover. On the other hand, to achieve sales of high priced items, more
expenses have to be incurred in obtaining the sales, such as advertising, which then
leads to a lower profit margin.
(f) The asset turnover is the same for both companies. Therefore, Flavour’s higher return on
assets seems to be attributable to Flavour’s higher profit margin.
(g) If a company’s return on common shareholders’ equity is greater than its return on assets,
this excess arose from the advantage of leverage. The return on assets is only 10.2%
while the return on common shareholders’ equity is 29.8% The difference between the
two is much larger than 10.2% and arose because of that company’s use of debt.
Therefore, the use of debt is a greater contributing factor to the return on common
shareholders’ equity than the return on assets.

(h) Refresh may have a lower payout ratio than Flavour because Refresh’s management
may have decided to retain profits in the business to finance future growth.
(i) Market price per share
Refresh
= 14.3 × $0.98
= $14.01
Flavour
= 20.3 × $1.37
= $27.81
(j) The price-earnings ratio reflects investors’ assessment of the future prospects of a
company. As indicated by its higher price-earnings ratio, investors appear to believe that
Flavour has the better possibility for growing its profit in future.

PROBLEM 14-8B
(a) Best Tools appears to be more liquid. Although Snappy Tool’s current ratio is higher than
Best Tools’, its receivables turnover and inventory turnover are much lower than Best
Tools’. This indicates that some of the key current assets may not be as liquid and are
inflating the current ratio.
(b) By reviewing the debt to total assets ratio, we can see Snappy Tools has significantly
more debt than Best Tools relative to its assets and a level of double the industry
average. However, Snappy Tool has a higher times interest earned ratio which indicates it
has a better ability to service its debt as interest payments become due and appears to
be the more solvent of the two companies.
(c) Snappy Tool has a higher return on common shareholders’ equity, return on assets, profit
margin, and gross profit margin than Best Tools and the industry. Best Tools’ return on
common shareholders’ equity, return on assets, and profit margin ratios are lower than
the industry average. All of this indicates that Snappy Tool is the more profitable
company.
(d) Investors seem to favour Snappy Tools as it has the higher price-earnings ratio, large
payout ratio and much higher dividend yield. This is consistent with (c), as you would
expect investors to favour the more profitable company. Investors must be anticipating
better future profitability from Snappy Tools.

PROBLEM 14-9B
(a) and (b)
(a) Higher (b) Higher

(1) Current ratio No impact No impact
(2) Debt to total assets Company B Company A
(3) Profit margin Company A No impact
(c) Yes. The impact the different accounting policies will have on each company’s profit and
ratios must be considered. Otherwise, the comparison would not be as meaningful.
(d) An analyst must also consider the use of professional judgement by management in
determining the estimates it makes in preparation of the financial statements and
whether the company is involved in more than one industry, (that is, how diversified the
company is).

BYP 14-1 FINANCIAL REPORTING

(a)
SHOPPERS DRUG MART
(in U.S. thousands)
2012 2011 2010

Income statement
Sales 105.8 102.6 100.0
Cost of goods sold 105.2 102.1 100.0
Gross profit 106.7 103.4 100.0
Interest expense 95.0 106.1 100.0
Profit 102.8 103.7 100.0
2012 2011 2010
Statement of financial position


BYP 14-1 (Continued)
(b)
(1)
SHOPPERS DRUG MART
Year Ended December
(thousands)
2012 2011 2010

$ % $ % $ %
Sales 10,781,848 100.0 10,458,652 100.0 10,192,714 100.0
Cost of goods sold 6,609,229 61.3 6,416,208 61.3 6,283,634 61.6
Gross profit 4,172,619 38.7 4,042,444 38.7 3,909,080 38.4
Operating expenses 3,291,698 30.5 3,131,539 29.9 3,011,758 29.5
Profit from operations 880,921 8.2 910,905 8.7 897,322 8.8
Interest expense 57,595 0.5 64,038 0.6 60,633 0.6
Income tax expense 214,845 2.0 232,933 2.2 244,838 2.4
Profit 608,481 5.6 613,934 5.9 591,851 5.8
(2)
SHOPPERS DRUG MART
(thousands)
2012 2011 2010

$ % $ % $ %
Current assets 2,764,997 37.0 2,695,647 36.9 2,542,820 36.1
Non-current assets 4,708,724 63.0 4,604,663 63.1 4,501,377 63.9
Total Assets 7,473,721 100.0 7,300,310 100.0 7,044,197 100.0
Current liabilities 2,334,917 31.2 1,776,238 24.3 1,527,567 21.7
Non-current liabilities 815,477 10.9 1,256,242 17.2 1,413,995 20.1
Shareholders’ equity 4,323,327 57.8 4,267,830 58.5 4,102,635 58.2
Total Liab. & Equity 7,473,721 100.0 7,300,310 100.0 7,044,197 100.0

(c) The horizontal analysis of part (a) highlights disproportionate increases in operating
expense in 2012 and of current liabilities by the end of 2012. To some extent the vertical
analysis of part (b) echoes the highlights of part (a). Whereas gross profit ratio is
essentially holding to a constant, the profit margin is declining due to the increase of
operating expenses. Similarly, the increase in current liabilities to 31.2% of total assets is
demonstrated in the vertical analysis. In spite of this increase, Shoppers is enjoying
strong solvency with debt to equity proportions remaining close to a 40:60 split. On the
other hand, liquidity is being hurt by the increase in current liabilities.

BYP 14-2 COMPARATIVE ANALYSIS

(a) Liquidity ratios
Shoppers Drug Mart (millions) Jean Coutu (millions)
$2,765.0 $421.9
Current ratio = 1.2 :1 = 1.6 :1
$2,335.9 $265.3
$10,781.8 $2,468.0
Receivables = 22.4 times = 12.2 times
($469.7 + $493.3) ($199.6 + $206.5)
2 2
Average
365 365
collection = 16 days = 30 days
22.4 12.2
period
$6,609.2 $2,169.0
$2,148.5 + $2,042.3 $190.1 + $166.2
2 2
Days in 365 365

= 114 days = 30 days
inventory 3.2 12.2
$916.8 $223.8
$2,334.9 + $1,776.2 $265.3 + $408.7
2 2
Liquidity:
Comparing the ratios related to liquidity, Jean Coutu is more liquid than Shoppers with
the exception of receivables turnover. Its current ratio is excellent. While its receivables
turnover ratio is not as strong as Shoppers, its inventory turnover ratio is far superior, at
12.2 times (30 days).

(b) Solvency
Debt to total $3,150.4 $281.9

assets = 42.2 % = 20.2 %
$7,473.7 $1,392.7
Free cash flow $916.8 – $254.2 – $54.4 – $218.7 $223.8 – $20.9 – $16.1 – $60.8
= $389.5 = $126.0
Times interest $608.5 + $214.8 + $57.6 $558.4 + $78.9 + $2.0

earned $57.6 $2.0
= 15.3 times = 319.7 times
Cash total debt $916.8 $223.8

coverage $3,150.4 + $3,032.5 $281.9 + $423.6
� � � �
2 2
Solvency:
The higher a company’s percentage of debt to total assets is, the greater the risk that this
company may be unable to meet its maturing obligations. Shoppers’ debt to total assets
ratio of 42.2% is more than double that of Jean Coutu. However, it has sufficient profit
before income tax and interest expense to service this debt, as evidenced by its high
times interest earned ratio of 15.3. Jean Coutu’s debt to total assets is extremely low at
20.2% which means that it is primarily financed by equity. Its times interest earned ratio is
consequently extremely high. Although Shoppers has a larger free cash flow amount, this
is an absolute amount and not a ratio and so it is dependent on the size of the business.
Jean Coutu’s cash total debt coverage is twice that of Shoppers.


(c) Profitability ratios
$4,172.6 $2,468.0 – $2,169.0

Gross profit margin = 38.7 % = 12.1%
$10,781.8 $2,468.0
$608.5 $558.4
$10,781.8 $2,468.0
$10,781.8 $2,468.0
$7,473.7 + $7,300.3 $1,392.7 + $1,072.8
2 2
$608.5 $558.4
$7,473.7 + $7,300.3 $1,392.7 + $1,072.8
2 2
= 8.2% = 45.3%
$608.5 $558.4
Return on common $4,323.3 + $4,267.8 $1,110.8 + $649.2
� � � �
= 14.2% = 63.5%
Profitability:
Although Shoppers has a much stronger gross profit margin compared to Jean Coutu
based on their respective profit margins, we can see that Jean Coutu is more profitable
than Shoppers. The large difference in gross profit margin may be due to the product mix
of each company or the allocation of costs between cost of goods sold and operating
expenses. Nonetheless, Jean Coutu appears to control its operating expenses better.
This has allowed the company to have a much healthier profit margin compared to
Shoppers.
The return on assets ratio indicates that Shoppers is generating a much lower return than
Jean Coutu based on the amount of assets invested in the business. The asset turnover
measures how efficiently a company uses its assets to generate sales. Jean Coutu’s
asset turnover was higher than Shoppers.


(d) Other useful information would include the industry averages to determine each
company’s performance in relation to other companies in the same industry. In addition,
previous years financial results would show any trends that are affecting the company’s
performance. Other useful information contained in the annual report, but not the financial
statements, would indicate management’s assessment of financial performance,
discussion of economic conditions, and discussion of strategies that would indicate the
reasons behind some of the changes in the financial ratios.

BYP 14-3 COMPARING IFRS AND ASPE
(a) FLL is reporting under IFRS because it uses the Other Comprehensive Income account,
which is not used under ASPE. It also reversed an impairment loss and revalued
equipment to fair value, both of which are allowed only under IFRS. Lastly, the company
recorded a “provision”, which is term used only under IFRS. Since DLL has recorded
none of these items allowed under IFRS, it is logical to assume that it reports using
ASPE.
(b) Not all of the differences that are described relate to the use of IFRS and ASPE. The
choice of inventory cost methods is available under both sets of standards
(c) Current ratio: Due to the rising cost of inventory, FIFO will yield a higher value in
inventory and so FLL will have a higher current ratio than DLL.
Inventory turnover: Cost of goods sold will be lower under FIFO in times of rising prices
and ending inventory will be higher. Therefore, FLL will likely experience a lower
inventory turnover ratio.
Debt to total assets ratio: FLL will likely have a lower debt to total asset ratio because
the equipment value has been increased to fair value, and because of the reversal of
the impairment loss on some of the equipment has caused assets to increase.
Offsetting this increase in property, plant, and equipment may be the reduction of those
assets involved in the other comprehensive loss recorded during the year which might
not be triggered under ASPE.
Profit margin: FLL will have a higher profit margin because of its choice to use FIFO, as
explained in the inventory turnover ratio above. As well the reversal of the impairment
loss on some of the equipment will increase profit.
Asset turnover: FLL will have higher total assets as explained in the debt to total assets
ratio above. Consequently its asset turnover ratio will be lower than DLL.

BYP 14-4 CRITICAL THINKING
Company A is WestJet Airlines Ltd. – clues to its identity include:
• Discount airline would have a low gross profit

• Administrative costs would be minimal as most employees would work on the airplanes or
in maintenance – salaries for pilots, attendants, mechanics etc. would be included in cost of
goods sold
• WestJet has a December 31 year-end, which is right after the very busy Christmas travel
season so cash levels are very high
• Accounts receivable would be very low as most customers pay with credit cards
• Inventories would be minimal as products are not sold to customers except food on
airplanes, and there may be some spare parts inventory for planes and equipment
• Property, plant and equipment would be high as the company operates airplanes
• Current liabilities would be high because a large portion of this would be unearned revenue
as tickets are sold in advance
Company B is Blackberry Limited – clues to its identity include:
• The only company with research and development costs

• Products are not sold to consumers but retailers, and these types of sales are more likely to
be on credit so accounts receivable would be fairly high
• This is the company most likely to have intangible assets for the patents on its products
• High tech companies usually do not rely as much on bank financing as other companies
because they tend to have less tangible collateral, so we would expect to see lower levels
of non-current liabilities
Company C is Loblaw Companies Ltd. – clues to its identity include:
• The grocery industry is competitive so we would expect a lower gross profit margin and a
lower profit margin ratio
• Despite lower margins, such a company is less likely to be unprofitable given the
predictability of revenues and expenses and the constant demand for its products
• Selling costs should be a higher percentage of sales compared to other companies
because grocery stores advertise (so do furniture companies but they would have higher
gross profits).
• Inventory would be high but not the highest of the five companies as inventory turnover
would have to be high enough to prevent too much spoilage
• Because it has private labels, it should have some intangible assets


Company D is Canadian Natural Resources Limited – clues to its identity include:
• Oil prices are high this year so a high gross profit margin is expected along with a high
profit margin
• Depreciation is the largest expense because the business is so capital intensive – oil sands
plants are very expensive – this correlates with the large percentage of assets represented
by property, plant and equipment
• Due to the large proportion of non-current assets, one would expect to see a
correspondingly larger proportion of non-current liabilities compared to current liabilities
• Due to the riskiness of oil prices it is more likely for an oil and gas company to have lower
debt relative to liabilities than companies with more stable revenue streams like an airline
or grocery chain
Company E is Leon’s Furniture – clues to its identity include:
• Large selling expenses due to significant advertising that occurs in this industry
• This company should have a reasonably high level of inventory as its turnover would be
slower than the grocery chain
• Accounts receivable would be low as sales are made to individuals and any special sales
where payment is not needed for a certain period of time give rise to receivables that are
often sold to financial institutions
• A company that has operated for over 100 years, may be more likely to have a higher level
of retained earnings and equity and be less in need of bank financing than the other
companies and would not need as many non-current liabilities

BYP 14-5 ETHICS CASE
(a) The stakeholders in this case are:

Vern Fairly, president of Flex Industries
Anne Saint-Onge, vice-president of communications
You, as controller of Flex Industries
Shareholders of Flex Industries
Potential investors in Flex Industries
Any readers of the press release
(b) The president’s press release is deceptive and incomplete and to that extent his action is
unethical.
(c) As controller you should at least inform Anne Saint-Onge, the vice-president of
communications, about the biased content of the release. She should be aware that the
information she is about to release, while factually accurate, is deceptive and incomplete.
Both the controller and the vice-president of communications (if she agrees) have the
responsibility to inform the president of the bias of the about-to-be-released information.

BYP 14-6 “ALL ABOUT YOU” ACTIVITY
(a) The software company should have a higher price-earnings ratio because the market
expects this company to have opportunities to grow faster than a more established
company.
(b) More established companies like this bank tend to have stable profits and cash flows and
are not in the same growth phase that a newly public company would be in.
Consequently, such a company can distribute some of its cash flows to shareholders by
paying out a dividend. A newly public company typically obtains a listing on a stock
exchange to raise capital from investors to expand their operations and would therefore,
be using all available cash for expansion and would not want to diminish available cash
by returning any to shareholders through dividends.
(c) The software company has yet to reach its normal levels of activity and profitability so
one would expect such a company to have low profits (and perhaps even losses), which
in turn will make any ratio based on profitability, such as return on common shareholders’
equity or return on assets, lower than more established companies with a record of
profitability.
(d) A bank uses leverage (borrowed funds) extensively. Every savings account that a bank
has is a liability on the bank’s statement of financial position. Therefore, the debt that a
bank has is usually much larger than its equity. Normally, the bank will earn a higher
return on the borrowed money than it pays to its customers in interest. Because of this,
the return on common shareholders’ equity will be higher than the return on assets.

(e) There really is no “right” answer to this question. It really depends on how much risk an
investor is willing to undertake. The bank may provide a nice dividend and its share price
may rise in the future but not at a very fast rate because the ability of a bank to grow
rapidly is limited due to the large number of competing banks that exist. On the other
hand, if the software company makes a very good game and there exists a large demand
for that game, then the software company’s share price will rise dramatically. However,
there is a risk that the game may not be popular and the share price may then collapse.
Such a drop in share price may not occur for the bank’s shares given the steady demand
that exists for its services. So, if you feel comfortable with the risk implicit in buying the
software company’s shares and believe that their games will indeed be popular, buy
those shares. If you are more conservative and don’t mind earning a more modest profit
or incurring a modest rather than severe loss, you may want to buy the bank shares.
Your aversion to risk may also be a function of age. For example, a senior should
probably not invest extensively in software company’s shares because if the price falls
dramatically, that lost income can’t be replaced because the senior may be unable to
work. Furthermore, the senior may need dividend income to meet living expenses,
whereas a younger person can take on more risk with their investments because they
have alternative sources of income.

BYP 14-7 SERIAL CASE
(a) Biscuits is more liquid than Cookies Are for Us. Biscuits’ current ratio is higher and
matches the industry ratio. Its receivables turnover and inventory turnover are both
higher than those of Cookies Are for Us and the industry average. This indicates that
the Biscuits’ current ratio is strong, and that it is collecting its accounts receivable and
turning over its inventory more quickly than its competitor.
(b) It appears that Biscuits is the more solvent of the two companies. The two ratios provide
conflicting results. Cookies Are for Us has a lower debt to total assets ratio, which is
indicative of greater solvency. However, despite having a higher debt to total assets
ratio, Biscuits also has a higher times interest earned ratio. Biscuits’ times interest
earned ratio exceeds the industry average, which is also indicative of greater solvency.
Biscuits higher times interest earned ratio indicates that it can service its higher debt
load.
(c) Biscuits is clearly the more profitable of the two, as all of its profitability ratios are
superior to those of Cookies Are for Us. Biscuits’ return on common shareholders’
equity and gross profit margin ratios also exceed the industry average. However, its
profit margin and return on assets ratios are lower than the industry average.
(d) Investors favour Biscuits as indicated by their higher price-earnings ratio. Their P-E ratio
is also higher industry average. This could mean that Natalie and Daniel may have to
pay more to purchases shares of Biscuits.
(e) Natalie and Daniel should be aware that financial statements prepared under IFRS can
contain accounting policy choices and financial statement items (such as other
comprehensive income) that are different from those applied by companies using
ASPE. They should also inquire whether the industry averages are applicable given that
they likely relate only to publicly-traded competitors. In preparing their analysis, they
should also be aware of what items under IFRS will be subject to additional volatility and
how they will interpret the change in the trends for the ratios affected.

(f) Natalie and Daniel should consider some of the following factors related to making an
investment in Biscuits:
- their risk tolerance (can they tolerate the fluctuations inherent in share investments).
- their profile as investors (are they investing for growth or income).
- their goals for this investment (are they investing for short-term appreciation or long-
term growth).
- is this the right time to be purchasing the shares (are they currently overvalued by
other investors)?
- are they looking for dividend income or capital growth?
In addition, before concluding their analysis, Natalie and Daniel should obtain additional
information to supplement the ratio analysis. This could include detailed financial
statements, a horizontal and vertical analysis, as well as relevant non-financial
information. They likely already have a very good understanding of the business and the
economy from their involvement with Koebel’s Family Bakery.

COMPREHENSIVE CASE: CHAPTERS 13 – 14
(a)
MANUTECH LTD.
2015 2014
Amount Percent Amount Percent
Net sales $1,470,000 100.0% $1,100,000 100.0%
Gross profit 735,000 50.0% 445,000 40.5%
Operating expenses 313,500 21.3% 270,000 24.6%
Profit from operations 421,500 28.7% 175,000 15.9%
Interest expense 61,500 4.2% 53,600 4.9%
Profit before income tax 360,000 24.5% 121,400 11.0%
Income tax expense 90,000 6.1% 30,350 2.7%
Profit $ 270,000 18.4% $ 91,050 8.3%
As demonstrated in the vertical analysis above, the profit margin has increased as a
percentage of sales from 8.3% to 18.4%.
The most apparent explanation for the substantial increase in profit margin is the 9.5%
reduction in cost of goods sold as a percentage of sales. This may be a result of
Manutech’s investment in a customer relationship management system. It appears that the
use of this system has resulted in a recovery from the decline in sales of the past. The
system should be able to provide management with the necessary feedback on purchasing
trends and from repeat sales that have generated these positive results.

COMPREHENSIVE CASE: CHAPTERS 13 - 14(Continued)

(b)
Ratio Manutech Ltd. Industry
$292,000 2.0:1
Current ratio = 1.6:1
$185,000
Receivables $1,470,000 = 11.5 times

turnover ($150,000 + $105,000)
2
Average 365 = 32 days 28 days

collection period 11.5
Inventory $735,000
= 7.3 times
turnover ($112,000 + $90,000)
2
Days in 365 = 50 days 40 days

inventory 7.3
Compared to the industry average, Manutech has a low current ratio, and is slower than
the industry in collecting its accounts receivable and selling its inventory. Manutech is
less liquid than the industry average.

COMPREHENSIVE CASE: CHAPTERS 13-14 (Continued)

(c)
Debt to $815,000 50.0%

= 53.9%
total assets $1,512,000
Times interest $421,500 5.0 times

= 6.9 times
earned $61,500
Manutech slightly exceeds the industry average in the amount of assets financed by
debt but can cover its interest costs more comfortably than others in its industry.
(d)
Gross profit
$735,000 = 50.0% 44.5%
margin
$1,470,000
Profit margin $270,000 = 18.4% 15.1%

$1,470,000
Asset $1,470,000 = 1.0 times 0.8 times

turnover ($1,512,000 + $1,359,500)
2
Return on $270,000 = 18.8% 12.5%

assets ($1,512,000 + $1,359,500)
2
Compared to the industry averages, Manutech is stronger on all profitability ratios.

COMPREHENSIVE CASE: CHAPTERS 13-14 (Continued)
(e)
MANUTECH LTD.
Statement of Cash Flows—Partial
Year Ended December 31, 2015
Net cash provided by operating activities $355,500
Investing activities
Purchase of management system $(300,000)
Net cash used in investing activities (300,000)
Financing activities
Issue of bank loan $ 85,000
Repayment of mortgage payable (20,000)
Payment of dividends (170,000)
Net cash used in financing activities (105,000)
Net decrease in cash (49,500)

Cash, January 1 79,500
Cash, December 31 $ 30,000
As was explained in part (a), the major improvements in the profitability for Manutech
were achieved following the $300,000 investment in a customer relationship management
system. Although some of this investment seems to have been financed through a bank
loan, the remainder was obtained from operations. In addition to this, almost half of the
cash generated from operations was disbursed in dividends. The total amount of the
dividends is extremely high compared to profit. These two factors are the main reasons
why the cash position did not improve at the same pace as profit.

Legal Notice
Copyright
Copyright © 2014 by John Wiley & Sons Canada, Ltd. or related companies. All rights
reserved.
The data contained in these files are protected by copyright. This manual is furnished under
licence and may be used only in accordance with the terms of such licence.
The material provided herein may not be downloaded, reproduced, stored in a retrieval
system, modified, made available on a network, used to create derivative works, or transmitted
in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or
otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.
(MMXIII xi FI)


SM Chapter 14

Hochgeladen von

Dokumentinformationen

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

SM Chapter 14

Hochgeladen von

Copyright:

Verfügbare Formate

www.downloadslide.

ASSIGNMENT CLASSIFICATION TABLE

1. Understand the 1, 2, 3, 18 1, 2 1, 4 4A 2B, 4B

2. Explain and apply 4, 5, 6, 7, 3, 4, 5, 6 2, 4 1A, 3A 1B, 3B 1, 5

3. Explain and apply 5, 6, 7, 8, 5, 6, 7, 8 3, 4 2A, 3A 2B, 3B 1, 4

7. Understand the 20, 21, 22, 14 9A 9B 3

Solutions Manual 14-1 Chapter 14

ASSIGNMENT CHARACTERISTICS TABLE

Problem Difficulty Time

1A Prepare horizontal analysis. Moderate 30-40

2A Prepare vertical analysis. Moderate 25-35

3A Interpret horizontal and vertical analysis. Moderate 20-30

4A Calculate and evaluate profitability ratios with Moderate 30-40

5A Calculate and evaluate ratios. Moderate 40-50

6A Calculate and evaluate ratios. Moderate 50-60

7A Evaluate ratios. Moderate 50-60

8A Evaluate liquidity, solvency, and profitability. Moderate 40-50

9A Discuss impact of accounting policies on financial Moderate 30-40

1B Prepare horizontal analysis Moderate 30-40

2B Prepare vertical analysis, with discontinued Moderate 25-35

3B Interpret horizontal and vertical analysis. Moderate 20-30

4B Calculate and evaluate profitability ratios with Moderate 30-40

5B Calculate and evaluate ratios. Moderate 40-50

6B Calculate and evaluate ratios. Moderate 50-60

7B Evaluate ratios. Moderate 50-60

8B Evaluate liquidity, solvency, and profitability. Moderate 40-50

9B Discuss impact of accounting policies on financial Moderate 30-40

Solutions Manual 14-2 Chapter 14

2. (a) Discontinued operations refers to disposal, or availability for sale, of an identifiable

(b) A component of an entity is a separate major line of business or major geographical

Solutions Manual 14-3 Chapter 14

Answers to Questions (Continued)

6. (a) Horizontal percentage of a base-period amount is accomplished by using a base

(c) In vertical percentage of a base amount, each item in a financial statement is

Solutions Manual 14-4 Chapter 14

Answers to Questions (Continued)

Solutions Manual 14-5 Chapter 14

Answers to Questions (Continued)

Solutions Manual 14-6 Chapter 14

Answers to Questions (Continued)

Solutions Manual 14-7 Chapter 14

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 14-1

Profit from continuing operations before income tax ................................. $1,040,000

BRIEF EXERCISE 14-2

(a) 3 A realized gain on the sale of trading investments

Solutions Manual 14-8 Chapter 14

BRIEF EXERCISE 14-3

(a) Horizontal percentage of a base-year amount

2015 2014 2013

Solutions Manual 14-9 Chapter 14

BRIEF EXERCISE 14-3 (Continued)

(b) Horizontal percentage change for each year

2015 2014 2013

Solutions Manual 14-10 Chapter 14

BRIEF EXERCISE 14-4

Comparing the percentages presented results in the following conclusions:

BRIEF EXERCISE 14-5

Basis of Comparison Tool of Analysis

Solutions Manual 14-11 Chapter 14

BRIEF EXERCISE 14-6

Solutions Manual 14-12 Chapter 14

BRIEF EXERCISE 14-7

BRIEF EXERCISE 14-8