Financial Statement Analysis: Assignment Classification Table

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition
CHAPTER 18
Financial Statement Analysis
ASSIGNMENT CLASSIFICATION TABLE

Brief Problems Problems
Study Objectives Questions Exercises Exercises Set A Set B
1. Explain and apply 1, 2, 3, 4, 1, 2 3 1, 3, 4 1 1
horizontal analysis. 5
2. Explain and apply 4, 5, 6, 7 3, 4, 5 2, 3, 4 2 2

vertical analysis.
3. Identify and use ratios 8, 9, 10, 6, 7, 8, 9, 5, 6, 7, 8, 2, 3, 4, 5, 2, 3, 4, 5,

to analyze a 11, 12, 13, 10, 11 9, 10, 11 6, 7, 8, 9 6, 7, 8, 9
companys liquidity, 14, 15, 16
profitability, and
solvency.
4. Recognize and 17, 18, 19, 12, 13, 12, 13 9, 10 9, 10

illustrate the limitations 20, 21, 22 14
of financial statement
analysis.
Solutions Manual 18-1 Chapter 18

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strictly prohibited.
ASSIGNMENT CHARACTERISTICS TABLE

Problem Difficulty Time
Number Description Level Allotted (min.)
1A Prepare horizontal analysis and comment. Simple 60-70
2A Prepare vertical analysis, calculate profitability Moderate 50-60

ratios, and comment.
3A Calculate ratios. Moderate 35-40
4A Calculate and evaluate ratios for two years. Moderate 70-80
5A Calculate and evaluate ratios for two companies. Moderate 45-55
6A Analyze ratios. Moderate 25-35
7A Analyze ratios. Moderate 15-20
8A Determine impact of transactions on ratios. Complex 20-25
9A Calculate and evaluate profitability ratios with Moderate 55-65

discontinued operations.
10A Prepare income statement and statement of Moderate 25-35

retained earnings, with irregular items.
1B Prepare horizontal analysis and comment. Simple 60-70
2B Prepare vertical analysis, calculate profitability Moderate 50-60

ratios, and comment.
3B Calculate ratios. Moderate 35-40
4B Calculate and evaluate ratios for two years. Moderate 70-80
5B Calculate and evaluate ratios for two companies. Moderate 45-55
6B Analyze ratios. Moderate 25-35
7B Analyze ratios. Moderate 15-20
8B Determine impact of transactions on ratios. Complex 20-25
9B Calculate and evaluate profitability ratios with Moderate 55-65

discontinued operations.
10B Prepare income statement and statement of Moderate 25-35

retained earnings, with irregular items.

BLOOMS TAXONOMY TABLE

Correlation Chart between Blooms Taxonomy, Study Objectives and End-of-
Chapter Material
Study Objectives Knowledge Comprehension Application Analysis Synthesis Evaluation

1. Explain and Q18-2 Q18-1 BE18-1
apply Q18-3 BE18-2
horizontal Q18-4 BE18-3
analysis. Q18-5 E18-1
E18-3
E18-4
P18-1A
P18-1B
2. Explain and Q18-6 Q18-4 BE18-3 P18-2A

apply vertical Q18-5 BE18-4 P18-2B
analysis. Q18-7 BE18-5
E18-2
E18-3
E18-4
3. Identify and Q18-8 Q18-9 BE18-7 Q18-10 P18-4A

use ratios to Q18-12 BE18-10 Q18-11 P18-5A
analyze a Q18-14 BE18-11 Q18-13 P18-6A
companys BE18-6 E18-10 Q18-15 P18-7A
liquidity, E18-5 P18-3A Q18-16 P18-8A
profitability, P18-9A BE18-8 P18-2B
and P18-3B BE18-9 P18-4B
solvency. P18-9B E18-6 P18-5B
E18-7 P18-6B
E18-8 P18-7B
E18-9 P18-8B
E18-11
P18-2A
4. Recognize Q18-17 Q18-19

and illustrate Q18-18 BE18-13
the Q18-20 BE18-14
limitations of Q18-21 E18-12
financial Q18-22 E18-13
statement BE18-12 P18-9A
analysis. P18-10A
P18-9B
P18-10B
Broadening Your BYP18-1 BYP18-2
Perspective Continuing BYP18-3
Cookie BYP18-4
Chronicle BYP18-5

ANSWERS TO QUESTIONS
1. (a) Comparison of financial information can be made on an intracompany
basis, an intercompany basis, and an industry average basis.
(1) An intracompany basis compares the same item with prior

periods, or with other financial items in the same period, for one
company. A store may compare this years sales to last years
sales, for example.
(2) An intercompany basis compares the same item with one or more
other companys financial statements. The intercompany basis of
comparison provides insight into a company's competitive
position in relation to other companies.
(3) The industry average basis compares an item with the average of
that item for the industry. For example, a department store may
compare its sales per square foot of floor space with the average
sales per square foot of floor space for department stores.
(b) The intracompany basis of comparison is useful in detecting changes

in financial relationships and significant trends within a company. The
intercompany basis of comparison provides insight into a company's
competitive position in relation to other companies. The industry
average basis provides information as to a company's relative position
within the industry.
The use of all three comparisons, when combined with economic and
non-financial measures provides the investor with an in-depth
analysis of the investment potential of the company.
2. Percentage of base period amount: The amount for the period in question
is divided by the base-year amount, and the result is multiplied by 100 to
express the answer as a percentage.
Percentage change for a period: The amount from the previous period is
subtracted from the current period amount. The result is divided by the
amount from the previous period and then multiplied by 100 to express
the answer as a percentage.
3. (a) An answer cannot be calculated when there is no value in a base

year, because division by 0 is mathematically impossible.
(b) An answer cannot be calculated when there is a negative value in a

base year and a positive value in the next year.

QUESTIONS (Continued)
4. 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.
Vertical analysis expresses each item within a financial statement in terms

of a percent of a relevant total or other common basis within the same
statement, for the same time period.
5. A comparison of the first quarter in 2006 after Tim Hortons became a

public company to the first quarter in 2005 when Tim Hortons was part of
Wendys International would be of limited value. A vertical analysis of the
income statement and balance sheet might be useful to determine the
companys performance since it separated from Wendys. However, any
horizontal analysis would not be comparable with the prior period(s).
6. (a) On a balance sheet, total assets and total liabilities and shareholders
equity are assigned a value of 100%.
(b) On an income statement, net sales is assigned a value of 100%.
7. Yes, it can. By converting the accounting numbers to percentages,

companies of vastly different sizes with different currencies can be
compared.
8. (a) Liquidity ratios measure the short-term ability of a company to pay its
maturing obligations and to meet it unexpected needs for cash.
(b) Profitability ratios measure the income or operating success of a

company for a specific period of time.
(c) Solvency ratios measure the ability of the company to survive over a
long period of time.
9. (a) Asset turnover

(b) Inventory turnover or days sales in inventory
(c) Return on shareholders' equity
(d) Interest coverage
(e) Current ratio

10. A high current ratio does not always mean that a company is liquid. A high
current ratio might be hiding liquidity problems with regards to inventory or
accounts receivable. For example, a high level of inventory will cause the
current ratio to increase. Increases in inventory can be due to the fact that
inventory is not selling and may be obsolete. Increases in the current ratio
will also occur if the companys 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.
11. Aubut Corporation is collecting its receivables much more slowly than the
industry average. Aubut collects its receivables, on average, every 81
days (365 4.5), compared to the industry average of 56 days (365
6.5). This could indicate that Aubut is not using the same credit checks or
collection policies as the rest of the industry.
However, a slower receivables turnover than the industry does not always
indicate a problem. The receivables turnover ratio can be misleading in
that some companies encourage credit and revolving charge sales and
slow collections, in order to earn a healthy return on the outstanding
receivables in the form of high rates of interest.
12. Wongs solvency is better than that of the industry. It is carrying a slightly
lower percentage of debt than the industry (37% versus 39%) and has a
higher interest coverage ratio (3 versus 2.5).
13. The companys free cash low may have fallen because it used the cash
for capital expenditures. A company that has a lower free cash flow has
less cash available for expansion and other expenditures and therefore, is
often considered to be less solvent.
14. Yes, Saputo has made effective use of leverage. Saputo earned a higher
return using borrowed money (12%) than it paid on the borrowed money.
This enabled Saputo to use money supplied by creditors to increase the
return to the shareholders (19%).

15. An investor interested in growth would want to invest in a company with a

high price-earnings ratio and a low dividend payout. The high price-
earnings ratio indicates that investors expect this companys earnings to
grow and are willing to pay for this anticipated future growth. A low payout
ratio generally indicates that the company has growth opportunities and is
choosing to reinvest earnings to finance this future growth rather than
paying earnings out as dividends.
An investor interested in shares with income potential would likely choose

a company that pays out its earnings as dividends and therefore has a
higher dividend payout ratio.
16. No, the president should not be overly concerned about the decrease in
the ratios. They declined because of the price decrease. Since net income
has risen, the increase in sales quantity is more than making up for the
unit price decrease. The company is making fewer dollars profit for each
item sold, but is selling sufficiently more items to increase its net income.
However, this practice may not be sustainable in the long-term,

particularly if higher sales in the current period will end up reducing sales
in a future period. In addition, operating expenses may increase because
of the additional sales so the president should continue to closely watch
both cost of goods sold and operating expenses in relation to sales.
17. 1. Use of estimates which may be inaccurate. To the extent that these
estimates may be inaccurate or biased, the financial ratios and
percentages are inaccurate or biased as well.
2. Use of cost which is not adjusted for price-level changes. Failing to

adjust for the effect of general price level changes may lead to
inaccurate conclusions about information such as the companys rate
of growth.
3. Use of alternative accounting methods. Differences in accounting

principles make intercompany comparisons difficult and often
misleading.
4. Quality of earnings. Management may try to manipulate income by

choosing estimates and accounting policies to manage income.
(Note: Question 17 continues on the next page)

17. (Continued)
5. Earning power and irregular items. Financial statements often include

non-recurring items that are not typical of normal business operations.
If such items are not presented separately on the income statement,
investors may make false assumptions concerning a companys
ongoing earning potential.
6. Diversification of firms. Today, many firms are so diversified that

intercompany comparisons or the use of industry statistics becomes
impossible, as these companies cannot be classified into one
industry.
18. If management wanted to increase income, it could decrease the

amortization expense by increasing the estimated useful life of the asset.
Management of income through, for example, the changing of accounting

estimates may lead to reported income that is confusing and misleading to
users. For example, if a company changes its estimate of an assets
useful life, amortization expense will change. The clarity and
thoroughness of the income may be reduced which would lead to a lower
quality of earnings.
Note to the instructor: Other accounting estimates might include residual

value, bad debts, and warranties, amongst others.
19. (a) The use of FIFO in periods of rising prices causes cost of goods sold
to be lower and income to be higher.
(b) Reducing the machinerys life from five years to three years causes a
higher amortization expense per year, which reduces net income.
(c) Declining-balance amortization is higher than straight-line

amortization in the early years of an assets life, but becomes lower in
the later years. Therefore, if straight-line amortization is used, net
income will be higher initially but will be lower in later years.
20. Lais profit margin has improved. When comparing the companys profit
margin before considering atypical items, we see that the profit margin
has improved from 5% to 8%. Discontinued operations are a nonrecurring
item and should be excluded for analysis purposes.

21. The concept of earning power is defined as net income adjusted for
irregular or non-typical items. It is the amount of income that a company
can expect to earn from its normal operations. In order to distinguish a
companys net income from its earning power, irregular items, such as
discontinued operations and extraordinary items, are reported separately
on the income statement. Investors trying to get a picture of the
companys future growth potential should not include these items in their
analysis of future earnings potential because they are not expected to
occur on an ongoing basis.
22. Discontinued operations refer to the disposal of an identifiable reporting or

operating segment of the business. It is important to report discontinued
operations separately because they represent atypical items. Investors
trying to get a picture of the companys future growth potential should not
include this item in their analysis of future earnings potential because it is
not expected to occur on an ongoing basis.

SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 18-1
Increase (Decrease)
c d
a b Amount Percentage
2008 2007 (a - b) (c b)
Cash $ 24 $ 45 ($21) (46.7)%
Accounts receivable 268 257 11 4.3%
Inventory 499 481 18 3.7%
Prepaid expenses 22 0 22 n/a
Property, plant, and 3,216 3,246 (30) (0.9)%
equipment
Intangible assets 532 532 0 0.0%
Total assets $4,561 $4,561 0 0.0%
BRIEF EXERCISE 18-2
Comparing the percentages presented results in the following

conclusions: The net income for Tilden Ltd. decreased in 2008
because of the combination of a decrease in sales and an
increase in both cost of goods sold and operating expenses.
However, the reverse was true in 2007 as sales increased, while
both cost of goods sold and expenses decreased. This resulted
in an increase in net income.

BRIEF EXERCISE 18-3
Horizontal Analysis
Increase (Decrease)
Dec. 31, 2008 Dec. 31, 2007 Amount Percentage
Cash $150,000 $175,000 $(25,000) (14.3)%1
Accounts
receivable 600,000 400,000 200,000 50.0%2
Inventory 780,000 600,000 180,000 30.0%3
Noncurrent
assets 3,130,000 2,800,000 330,000 11.8%4
$(25,000) $200,000
1
(14.3)% 2
50%
$175,000 $400,000
$180,000 $330,000
3
30% 4
= 11.8%
$600,000 $2,800,000
Vertical Analysis
Dec. 31, 2008 Dec. 31, 2007

Amount Percentage Amount Percentage
Cash $ 150,000 3.2% $ 175,000 4.4%
Accounts
receivable 600,000 12.9% 400,000 10.1%
Inventory 780,000 16.7% 600,000 15.1%
Noncurrent
assets 3,130,000 67.2% 2,800,000 70.4%
Total assets $4,660,000 100.0% $3,975,000 100.0%
2008 Calculations: 2007 Calculations

$150,000 $4,660,000 = 3.2% $175,000 $3,975,000 = 4.4%
$600,000 $4,660,000 = 12.9% $400,000 $3,975,000 = 10.1%
$780,000 $4,660,000 = 16.7% $600,000 $3,975,000 = 15.1%
$3,130,000 $4,660,000 = 67.2% $2,800,000 $3,975,000 = 70.4%

BRIEF EXERCISE 18-4
2008 2007
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%
Income before
income tax 84 4.4% 189 9.1%
Income tax expense 30 1.6% 68 3.3%
Net income $ 54 2.8% $ 121 5.8%
BRIEF EXERCISE 18-5
2008 2007 2006

Sales 100% 100% 100%
Cost of goods sold 59% 62% 64%
Operating expenses 25% 27% 28%
Income tax expense 3% 2% 2%
Net income 13% 9% 6%
Net income as a percentage of sales for Waubons increased

over the three-year period, because cost of goods sold and
operating expenses both decreased as a percentage of sales
every year.

BRIEF EXERCISE 18-6
(a) Deterioration: A decrease in the receivables turnover would

be viewed as deterioration. It is taking longer to collect the
accounts.
(b) Deterioration: The increase in the days sales in inventory

turnover would be viewed as deterioration. It is taking the
company longer to sell the inventory and consequently
there is a greater chance of inventory obsolescence, and
higher carrying costs.
(c) Improvement: The decrease in debt to total assets would

be viewed as an improvement because it means that the
company has reduced its obligations to creditors and has
raised its equity "buffer." However, the lower leverage will
not be to the advantage of the shareholders if operations
are sufficiently profitable.
(d) Deterioration: A decrease in interest coverage would be

viewed as deterioration because it means that the
company's ability to meet interest payments as they come
due has weakened.
(e) Improvement: An increase in the gross profit margin would

be viewed as an improvement because it means that a
greater percentage of net sales is going towards income.
(f) Deterioration: A decrease in asset turnover would be

viewed as deterioration because it means the company has
become less efficient at using its assets to generate sales.
(g) Improvement: An increase in the return on equity would be

viewed as an improvement because it means more net
income was generated per dollar of equity investment.

BRIEF EXERCISE 18-6 (Continued)
(h) Improvement: An increase in the payout ratio would

normally be viewed as an improvement. However, some
shareholders may view this as a deterioration if they prefer
that the company retain its earnings to fuel growth.
BRIEF EXERCISE 18-7
Holyshs liquidity is deteriorating even though its current ratio is

higher. The receivables are being collected more slowly, and it
is taking longer to sell the inventory. These less-liquid assets
are a higher proportion of the current assets than last year.
BRIEF EXERCISE 18-8
2005 2004
(a) Receivables turnover
Net credit sales

Average net receivables
$6,462,581 $6,364,983
= =
($247,014 + $292,462) ? ($292,462 + $242,306) ?
= 24.0 times = 23.8 times
(b) Collection period

365 days
Receivables turnover
365 days 365 days
= =
24.0 23.8
= 15.2 days = 15.3 days
Management should be pleased with the effectiveness of its

credit and collection policies. The collection period of 15.2 days
is well within the 30 days allowed in the credit terms.

BRIEF EXERCISE 18-9
Cost of goods sold

(a) Inventory turnover
Average inventory
2008 2007
$4,540,000 $4,550,000
$960,000 $1,020,000 $840,000 + $960,000
2 2
= 4.6 times
= 5.1 times
(b) Days sales in inventory
365 365
79.3 days 71.6 days
4.6 5.1
Management should be concerned with the fact that

inventory is moving more slowly in 2008 than it did in 2007.
The decrease in the turnover ratio could be because of
poor pricing decisions or because the company has
obsolete inventory, for example.
BRIEF EXERCISE 18-10
($ in thousands)
(a) Debt to total $1,872,374

= 42.8%
assets $4,375,383
(b) Interest $364,494 + $48,649 + $186,102

= 12.3 times
coverage $48,649
(c) Free cash flow $450,575 - $274,182 = $176,393

(US$ in millions)
Net sales
(a) Asset turnover =
Average total assets
$16,078.1
=
$7,071.1 + $7,676.1
2
= 2.2 times
Net income
(b) Profit margin =
Net sales
$834.4
=
$16,078.1
= 5.2%
(a) 4
(b) 1
(c) 6
(d) 2
(e) 1
(f) 3
(g) 5
(h) 2
(i) 6
(j) 5

(a) Income tax on continuing operations

= $500,000 X 25% = $125,000
(b) Tax savings on loss from operations

of discontinued operations
= ($154,000) X 25% = ($38,500)
Tax on gain on sale of
discontinued operations
= $60,000 X 25% = 15,000 ($23,500)
(c)
LIMA CORPORATION
Income Statement (Partial)
For the Current Year
Income before income tax ......................................... $500,000

Income tax expense ................................................... 125,000
Income from continuing operations ......................... 375,000
Discontinued operations
Loss from operations of discontinued
operations, net of $38,500
income tax savings.............................. ($115,500)
Gain on disposal of discontinued
operations, net of $15,000 income tax 45,000 (70,500)
Net income .................................................................. $304,500

OSBORN CORPORATION
Year Ended December 31, 2008
Income before income tax ........................................... $950,000

Income tax expense ($950,000 X 25%) ....................... 237,500
Income from continuing operations ........................... 712,500
Loss from operations of Mexico facility,
net of $75,000 ($300,000 X 25%)
income tax savings ................................. $225,000
Loss on disposal of Mexico facility, net of
$40,000 ($160,000 X 25%) income
tax savings ............................................... 120,000 (345,000)
Net income ......................................................................... $367,500

SOLUTIONS TO EXERCISES
EXERCISE 18-1
DRESSAIRE INC.
2008 2007 2006

Current assets $120,000 $ 80,000 $100,000
Noncurrent assets 400,000 350,000 300,000
Current liabilities 90,000 70,000 100,000
Noncurrent liabilities 145,000 95,000 100,000
Shareholders' equity 285,000 265,000 200,000
(a)
2008 2007 2006
Current assets 120% 80% 100%
Noncurrent assets 133% 117% 100%
Current liabilities 90% 70% 100%
Noncurrent liabilities 145% 95% 100%
Shareholders' equity 143% 133% 100%
(b)
2008 2007
Current assets 50% (20%)
Noncurrent assets 14% 17%
Current liabilities 29% (30%)
Noncurrent liabilities 53% (5%)
Shareholders' equity 8% 33%

EXERCISE 18-2
FLEETWOOD CORPORATION
Income Statement
Year Ended December 31
2008 2007
Amount Percent Amount Percent
Sales $800,000 100.0% $600,000 100.0%
Gross profit 300,000 37.5% 210,000 35.0%
Operating expenses 200,000 25.0% 156,000 26.0%
Income before
income tax 100,000 12.5% 54,000 9.0%
Income tax expense 25,000 3.1% 13,500 2.2%
Net income $ 75,000 9.4% $ 40,500 6.8%

EXERCISE 18-3
(a)
OLYMPIC CORPORATION
Income Statement
Increase or (Decrease)
2008 2007 Amount Percentage
Net sales $600,000 $550,000 $50,000 9.1%
Cost of goods sold 460,000 400,000 60,000 15.0%
Gross profit 140,000 150,000 (10,000) (6.7%)
Operating expenses 55,000 50,000 5,000 10.0%
Income before
income tax 85,000 100,000 (15,000) (15.0%)
Income tax 34,000 40,000 (6,000) (15.0%)
Net income $ 51,000 $ 60,000 $ (9,000) (15.0%)
(b)
OLYMPIC CORPORATION
Income Statement
2008 2007
Net sales $600,000 100.0% $550,000 100.0%
Cost of goods
sold 460,000 76.7% 400,000 72.7%
Gross profit 140,000 23.3% 150,000 27.3%
Operating
expenses 55,000 9.1% 50,000 9.1%
Income before
income tax 85,000 14.2% 100,000 18.2%
Income tax 34,000 5.7% 40,000 7.3%
Net income $ 51,000 8.5% $ 60,000 10.9%

EXERCISE 18-4
(a)
MOUNTAIN EQUIPMENT CO-OPERATIVE
Balance Sheet
December 31
(in thousands)
Increase (Decrease)
2005 2004 Amount Percent
Assets
Current assets $ 69,237 $58,150 $11,087 19.1%
Property, plant,
and equipment 37,587 39,225 (1,638) (4.2%)
Deferred store
opening costs 0 296 (296) (100.0%)
Total assets $106,824 $97,671 $ 9,153 9.4%
Liabilities and
Members' Equity
Current liabilities $ 21,271 $18,873 $2,398 12.7%
Long-term liabilities 641 4,113 (3,472) (84.4%)
Total liabilities 21,912 22,986 (1,074) (4.7%)
Members' Equity 84,912 74,685 10,227 13.7%
Total liabilities
and members'
equity $106,824 $97,671 $ 9,153 9.4%

EXERCISE 18-4 (Continued)
(b)
MOUNTAIN EQUIPMENT CO-OPERATIVE
Balance Sheet
December 31
(in thousands)
2005 2004
Current assets $ 69,237 64.8% $58,150 59.5%
Property, plant,
and equipment 37,587 35.2% 39,225 40.2%
Deferred site
operating costs 0 0.0% 296 0.3%
Total assets $106,824 100.0% $97,671 100.0%
Liabilities and
Members' Equity
Current liabilities $ 21,271 19.9% $18,873 19.3%
Long-term liabilities 641 0.6% 4,113 4.2%
Total liabilities 21,912 20.5% 22,986 23.5%

Members' Equity 84,912 79.5% 74,685 76.5%
Total liabilities
and members'
equity $106,824 100.0% $97,671 100.0%
(c) During 2005, the percentage of current assets increased

and the percentage of property, plant and equipment
decreased compared to 2004. Also, debt to total assets
decreased indicating that, compared to 2004, Mountain
Equipment Co-op is financing its assets more with equity
than debt.

EXERCISE 18-5
Ratio Classification
Asset turnover P
Collection period L
Current ratio L
Days sales in inventory L
Debt to total assets S
Earnings per share P
Free cash flow S
Gross profit margin P
Interest coverage S
Inventory turnover L
Payout ratio P
Price-earnings ratio P
Profit margin P
Receivables turnover L
Return on assets P
Return on equity P

EXERCISE 18-6
($ in millions)
(a) Working capital

= $1,395 - $710 = $685
Current ratio
= 1.96:1 ($1,395 $710)
= 6.2 times ($3,894 [($676 + $586) 2])
Collection period
= 58.9 days (365 6.2 times)
Inventory turnover
= 4.3 times ($2,600 [($628 + $586) 2])
Days sale in inventory

= 84.9 days (365 4.3 times)

(b)
Canadian Industry
Ratio Nordstar Tire Average
Working capital $685 $160 N/A
Current ratio 1.96:1 1.6:1 2.1:1
Receivables turnover 6.2x 15.2x 66.1x
Collection period 58.9 days 24 days 6 days
Inventory turnover 4.3x 9.6x 6.8x
Days sales in inventory 84.9 days 38 days 54 days
Nordstar is less liquid than Canadian Tire and the industry.

One must be cautious in interpreting Nordstars current
ratio. It is artificially high because the company is having
problems in its receivables collection and inventory
turnover. The collection period is significantly is higher
than Canadian Tire, and more importantly, the industry in
general. The inventory turnover is also well below the
industry average. Nordstar needs to focus its efforts on
increasing its turnover of receivables and inventory.

EXERCISE 18-7
(a) The companys collection of its accounts receivables has

deteriorated over the past three years. It is taking the
company longer to collect its outstanding 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 companys 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 companys
current ratio is higher, if the underlying assets cannot be
converted to cash to repay current liabilities, then liquidity
has deteriorated.
EXERCISE 18-8
(a) The debt to total assets has weakened over the past three
years.
(b) The interest coverage has improved over the past three
years.
(c) The companys solvency initially appears to be worsening

as evidenced by its increased reliance on debt. However,
its interest coverage ratio is improving, so the company
appears to be able to handle this increasing level of debt. I
would conclude that the solvency is not really worse.

EXERCISE 18-9
(a) Petro-Canada is more profitable. Its earnings per share

and profit margin are both higher than Imperial Oils.
(b) Investors favour Imperial Oil. It has a higher price-earnings

ratio.
(c) Investors would purchase shares in Imperial Oil and Petro-

Canada primarily for growth reasons. The payout ratio is
not overly large, so shareholders would expect to
purchase shares for future profitable resale while still
earning a reasonable dividend, but not primarily for the
dividend income.

EXERCISE 18-10
($ in thousands)
(a) Asset turnover (P)

$849,616
= 2.2 times
$391,103 + $393,085
2
$275,447
(b) Debt to total assets (S) = 70.4%
$391,103
$25,337
(c) Earnings per share (P) = $1.05
24,134
(d) Free cash flow (S) $67,106 - $17,407 = $49,699
(e) Interest coverage (S)
$25,337 + $3,917 + $360

= 7.6 times
$3,917
$14.10
(f) Price-earnings ratio (P) = 13.43 times
$1.05
$25,337
(g) Profit margin (P) = 2.98%
$849,616
$25,337
(h) Return on assets (P) = 6.5%
$391,103 + $393,085
2
$25,337
(i) Return on equity (P) = 24.8%
$115,656 + $88,868
2

Note: (L) stands for liquidity ratio, (P) for profitability ratio, and
(S) for solvency ratio.

EXERCISE 18-11
(a) Suncor is more liquid. It has a higher current ratio, and

although that may be partially due to its level of
receivables, Suncors receivable turnover is well above the
industry average. Husky has only $0.60 of current assets
for every $1 of current liabilities.
(b) Husky is more solvent. It has a lower proportion of debt

and covers its interest cost more times.
(c) Husky is more profitable. It has a higher profit margin and

a higher return on assets than Suncor.
(d) Investors favour Suncor. Its shares are trading at 26.9

times its EPS. This is not consistent with the findings in (b)
and (c). Share price is often based, to a large extent, upon
expectations about future earnings. It seems as though
investors see a brighter future for Suncor.

EXERCISE 18-12
(a)
DAVIS LTD.
Income from continuing operations ................................. $270,000

Gain from operations of division, net of
$33,000 income taxes ................................... $77,000
Loss from disposal of division, net of
$21,000 income tax savings ......................... (49,000) 28,000
Net income ........................................................................ $298,000
(b) The net-of-tax effect of the cumulative change in

accounting principle (item 2) would be presented in the
Statement of Retained Earnings as an adjustment to
opening retained earnings.

EXERCISE 18-13
PETRIE LTD.
Income Statement
Year Ended May 31, 2008
Sales................................................................... $1,000,000
Cost of goods sold ........................................... 400,000
Gross profit ....................................................... 600,000
Operating expenses ......................................... 300,000
Operating income ............................................. 300,000
Other revenue
Investment revenue ..................................... $20,000
Other expenses
Loss on sale of available-for-sale
securities .................................................. (10,000)
Interest expense ........................................... (50,000) (40,000)
Income before income tax ............................... 260,000
Income tax expense ($260,000 X 25%) ........... 65,000
Income from continuing operations ............... 195,000
Loss on operations of division, net of
$10,000 income tax savings ...................... $(30,000)
Gain on disposal of division, net of
$25,000 income tax savings ...................... 75,000 45,000
Net income ........................................................ $ 240,000

SOLUTIONS TO PROBLEMS
PROBLEM 18-1A
(a)
2005 2004 2003 2002 2001
Operating revenues 290.3% 220.1% 179.7% 142.1% 100.0%
Operating expenses 307.8% 246.2% 177.2% 141.8% 100.0%
Interest expense 2187.1% 1727.8% 929.8% 176.1% 100.0%
Income tax expense 132.7% 5.7% 174.8% 147.4% 100.0%
Net income (loss) 65.4% (46.8%) 164.9% 141.1% 100.0%
Current assets 372.8% 227.5% 322.9% 166.8% 100.0%

Total assets 562.5% 477.2% 375.4% 199.3% 100.0%
Current liabilities 396.3% 320.2% 250.4% 184.1% 100.0%
Total liabilities 898.5% 749.7% 521.8% 249.5% 100.0%
Share capital 376.5% 319.1% 290.9% 163.7% 100.0%
Retained earnings 218.0% 192.0% 221.5% 156.0% 100.0%
Calculations: Current value base year value X 100
(b) Noncurrent assets and noncurrent liabilities are primarily

responsible for changes in WestJets financial position.
They have grown much faster than current assets and
current liabilities. Operating expenses have been growing
faster than operating revenues. That, combined with a
massive increase in interest expense, has caused net
income to decline during the five-year period.
(c) WestJet has been increasingly relying on long-term debt to

finance its operations. Total liabilities are up 898.5% while
current liabilities are only up 396.3%. Total shareholders
equity is up about 310% [($486,706 + $201,447) ($129,268 +
$92,412) X 100].

PROBLEM 18-2A
(a)
Income Statement
Manitou Ltd. Muskoka Ltd.

Dollars Percent Dollars Percent
Net sales $350,000 100.0% $1,400,000 100.0%
Gross profit 150,000 42.9% 680,000 48.6%
Operating expenses 50,000 14.3% 272,000 19.4%
Income from
operations 100,000 28.6% 408,000 29.2%
Interest expense 3,000 0.9% 10,000 0.7%
Income before
income taxes 97,000 27.7% 398,000 28.5%
Income tax expense 23,000 6.6% 100,000 7.2%
Net income $ 74,000 21.1% $ 298,000 21.3%

PROBLEM 18-2A (Continued)
(b)
Gross Profit Margin: Gross profit margin Net sales
Manitou Muskoka
= $150,000 $350,000 = $680,000 $1,400,000
= 42.9% = 48.6%
Profit Margin: Net income Net sales
Manitou Muskoka
= $74,000 $350,000 = $298,000 $1,400,000
= 21.1% = 21.3%
Return on Assets: Net income Average total assets
Manitou: Muskoka
$74,000 $457,500 $298,000 $1,625,000
= 16.2% = 18.3%
Asset Turnover: Net sales Average total assets
Manitou: Muskoka
$350,000 $457,500 $1,400,000 $1,625,000
Return on Equity: Net income Average shareholders equity
Manitou: Muskoka
$74,000 $392,500 $298,000 $1,112,500
= 18.9% = 26.8%
(c) Muskoka appears to be more profitable. All of its ratios are

better than Manitous, although the profit margins are
almost the same. Muskokas return on equity is
significantly higher than Manitous.

PROBLEM 18-3A
Working capital $250,500 $190,150 = $60,350
$250,500
Current ratio = 1.3:1
$190,150
$540,000
Inventory turnover = 7.2 times
$86,400 + $64,000
2
Days sales in inventory 365 days 7.2 = 50.7 days
$780,000
= 7.1 times
$116,200 + $5,500 + $93,800 + $4,500
2
Collection period 365 days 7.1 = 51.4 days
$240,000
Gross profit margin = 30.8%
$780,000
$59,650
Profit margin = 7.6%
$780,000
$780,000
Asset turnover = 1.1 times
$715,800 + $672,000
2

$59,650
Return on assets = 8.6%
($715,800 + $672,000) ?
$59,650
Return on equity = 14.2%
$445,650 + $396,000
2
$59,650
Earnings per share = $3.98
15,000
$1,800
Payout ratio = 3.0%
$59,650
$270,150
Debt to total assets = 37.7%
$715,800
$59,650 +$9,920 + $26,550

Interest coverage = 9.7 times
$9,920
Free cash flow $89,000 - $53,500 = $35,500

PROBLEM 18-4A
(a) 2008 2007
Working capital
$515,000 - $337,750 = $460,000 - $315,000 =
$177,250 $145,000
Current ratio
$515,000 $460,000
= 1.5:1 = 1.5:1
$337,750 $315,000
Inventory turnover
$650,000 $635,000
$340,000 + $300,000 $300,000 + $350,000
2 2
Days sales in inventory

365 2.0 = 182.5 days 365 2.0 = 182.5 days
$1,000,000 $940,000
$105,000 + $91,000 $91,000 + $83,000
2 2
Collection period
365 10.2 = 35.8 days 365 10.8 = 33.8 days
Debt to total assets

$537,750 $515,000
= 40.1% = 41.7%
$1,340,000 $1,235,000

(a) (Continued)
Interest coverage
$145,000 $120,000
$30,000 $30,000
Free cash flow

$92,000 - $80,000 = $12,000 $65,000 - $50,000 = $15,000
Profit margin
$86,250 $67,500
= 8.6% = 7.2%
$1,000,000 $940,000
Gross profit margin

$350,000 $305,000
= 35.0% = 32.4%
$1,000,000 $940,000
Asset turnover
$1,000,000 $940,000
$1,340,000 + $1,235,000 $1,235,000 + $1,175,000
2 2
Return on assets
$86,250 $67,500
$1,340,000 + $1,235,000 $1,235,000 + $1,175,000
2 2
= 6.7% = 5.6%

(a) (Continued)
Return on equity
$86,250 $67,500
$802,250 + $720,000 $720,000 + $656,600
2 2
= 11.3% = 9.8%
Earnings per share

$86,250 $67,500
= $0.86 = $0.68
100,000 100,000
Payout
$4,000 $4,000
= 4.6% = 5.9%
$86,250 $67,500
(b) Star Tracks liquidity has deteriorated. Two-thirds of its

current assets are inventory, which is only turning over
twice a year. Solvency is largely unchanged although the
interest coverage is better in 2008. Almost of all of the
profitability ratios are improved in 2008.

PROBLEM 18-5A
($ in thousands)
Liquidity
The Brick Leons Industry
$284,373 $189,690
Current = 1.0:1 = 1.9:1 1.2:1
ratio $278,213 $99,579
Receivables $1,214,405 $547,744

turnover 8.3 times
$45,862 $19,234
Inventory $739,505 $323,629

turnover 4.9 times
$181,266 $71,962
Overall, Leons liquidity is better than the Bricks and better

than the industry average.
Solvency
Debt to total $445,511 $121,264

assets $923,900 $381,702 40.1%
= 48.2% = 31.8%
Interest $34,697 + $1,087

2.0 times
coverage $5,233 n/a
= 6.8 times

Based solely on the debt to total assets ratio since the interest
coverage ratio is not available for Leons, Leons is more
solvent than The Brick. The Brick has a higher portion of debt
than the industry average.
Profitability
$32,004 $48,964
Profit 1.6%
margin $1,214,405 $547,744
= 2.6% = 8.9%
$1,214,405 $547,744
Asset 0.6 times
turnover $892,200 $376,316
$32,004 $48,964
Return on 0.8%
$892,200 $376,613
assets
= 3.6% = 13.0%
Return on $32,004 $48,964

2.3%
equity $494,890 $255,152
= 6.5% = 19.2%
Leons is more profitable than The Brick, and The Brick is more
profitable than the industry average.

PROBLEM 18-6A
(a) Accounts receivable management can be assessed by

reviewing each companys receivables turnover ratio and
average collection period. Refreshs average collection
period of 32 days (365 11.4) days is reasonable when
compared to its credit terms of 30 days. Flavours average
collection period of 37 days (365 9.8) days is worse than
that of Refresh, but still better than the average firm in the
industry (365 9.3 = 39 days).
(b) Each companys ability to manage its inventory can be

measured by the inventory turnover ratio. Currently Refresh
is turning over its inventory 5.8 times per year, which can
also be expressed as days in inventory of approximately 63
days (365 5.8 times). When compared to the turnover for
Flavour and the industry average, it appears that Refresh is
turning over its inventory at a slower rate than the
competition.
(c) 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.
(d) Refreshs higher gross profit margin may be attributable to

a number of factors:
The company may be selling its products at a higher
price.
The company may be paying less for its inventory than
the competition. This may occur if, for example, Refresh
is able to purchase inventory in large volumes and
receives purchase discounts.

(e) The asset turnover is the same for both companies.

Therefore, Refreshs higher return on assets seems to be
attributable to Refreshs higher profit margin.
(f) Market price per share
Refresh
= Price earnings ratio x Earnings per share
= 50.3 x $0.98
= $49.29
Flavour
= Price earnings ratio x Earnings per share
=24.3 x $1.37
= $33.29
(g) 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
Refresh has the better possibility for growing its earnings
and dividends.

PROBLEM 18-7A
(a) It is difficult to say which company is more liquid. Snap-on

has a higher current ratio and turns its inventory over more
quickly than Black and Decker, but collects its receivables
more slowly.
(b) Snap-on is more solvent. Snap-on has significantly less

debt than Black and Decker and is more in line with the
industry average. However, both companies are able to
cover their interest better than the industry average.
(c) Both companies appear to be profitable. Snap-on has a

higher gross margin than Black and Decker but Black and
Decker has a higher profit margin, earns a higher return on
assets, and offers a much better return on equity. All of this
would indicate that Black and Decker is the more profitable
company.
(d) Investors seem to favour Snap-on as it has the higher

price-earnings ratio. This is consistent with (b) as investors
would likely favour a company with a better solvency
position. However, this is not consistent with (c), as you
would expect investors to favour the more and profitable
company. Investors must be anticipating better future
profitability from Snap-on.

PROBLEM 18-8A
(a)
Debt
to Free
Receivables Profit Earnings Total Cash
Turnover Margin per Share Assets Flow
Transaction (10X) (10%) ($2) (40%) ($25,000)
1. Issues
common NE NE D D NE
shares
2. Collects an
account I NE NE NE I
receivable
3. Issues a
mortgage
NE D NE I NE
note
payable
4. Sells
equipment NE D D I I
at a loss
5. Share price
increases
from $10
NE NE NE NE NE
per share to
$12 per
share
(b) A change in the profit margin ratio or the earnings per

share would have no impact on the above changes.

PROBLEM 18-9A
(a) Before Discontinued Operations

2005 2004 2003
Profit margin $700 $710 $507

$3,932 $2,944 $2,632
= 17.8% = 24.1% = 19.3%
Asset turnover $3,932 $2,944 $2,632
$13,486 $10,050 $7,191
= 0.3 times = 0.3 times = 0.4 times
Return on assets $700 $710 $507
$13,486 $10,050 $7,191
= 5.2% = 7.1% = 7.1%
Return on equity $700 $710 $507
$3,438 $2,471 $1,832
= 20.4% = 28.7% = 27.7%
After Discontinued Operations

2005 2004 2003
Profit margin $1,152 $793 $578

$3,932 $2,944 $2,632
= 29.3% = 26.9% = 22.0%
Asset turnover $3,932 $2,944 $2,632
$13,486 $10,050 $7,191
Return on assets $1,152 $793 $578
$13,486 $10,050 $7,191
= 8.5% = 7.9% = 8.0%
Return on equity $1,152 $793 $578
$3,438 $2,471 $1,832
= 33.5% = 32.1% = 31.6%

(b) Overall, profitability is declining when calculated before

discontinued operations and increasing when calculated
after discontinued operations. Return on equity is the most
graphic example.
(c) Investors are interested in the future. Analysis based on

continuing operations is therefore more relevant to them.

PROBLEM 18-10A
(a)
ZURICH CORPORATION
Income Statement
Net sales ............................................................................ $1,700,000

Cost of goods sold ........................................................... 01,100,000
Gross profit ....................................................................... 600,000
Operating expenses ......................................................... 260,000
Income from operations ................................................... 340,000
Other revenues ................................................. $20,000
Other expenses ................................................. 0 8,000 0 (12,000
Income before income tax ............................................... 352,000
Income tax expense ($352,000 X 25%) ........................... 88,000
Income from continuing operations ............................... 264,000
Gain from operations of discontinued division,
net of $5,000 income tax expense .............. $15,000
Loss on sale of discontinued division,
net of $17,500 income tax saving ............... (52,500) (37,500)
Net income ........................................................................ $ 226,500
Earnings per share:

Continuing operations ................................. $2.64
Discontinued operations ............................. (0.38)
Net income .................................................... $2.26

(b)
ZURICH CORPORATION
Statement of Retained Earnings
Balance, January 1 as originally reported .......... $ 940,000

Add: Cumulative effect of change in amortization
method, net of $15,000 income tax .................... 45,000
Balance, January 1 as adjusted ........................... 985,000
Add: Net income .................................................... 226,500
1,211,500
Less: Cash dividends ............................................ 25,000
Retained earnings, December 31 ......................... $1,186,500

PROBLEM 18-1B
(a)
BIG ROCK BREWERY INCOME TRUST
Income Statement Horizontal Analysis
Year ended December 31
2005 2004 2003
(12 months) (12 months) (9 months)
Revenues 142.3% 136.1% 100.0%
Cost of sales 148.1% 133.0% 100.0%
Gross profit 139.0% 137.8% 100.0%
Operating expenses 137.7% 136.4% 100.0%
Income before income taxes 142.2% 141.3% 100.0%
Income tax expense 126.4% 104.2% 100.0%
Net income 145.3% 148.5% 100.0%
BIG ROCK BREWERY INCOME TRUST

Balance Sheet Horizontal Analysis
December 31
2005 2004 2003
Assets
Current assets 127.6% 99.4% 100.0%
Noncurrent assets 94.2% 100.6% 100.0%
Total assets 102.4% 100.3% 100.0%
Liabilities & Unitholders Equity

Current liabilities 78.6% 81.0% 100.0%
Noncurrent liabilities 87.9% 80.7% 100.0%
Total liabilities 84.6% 80.8% 100.0%
Unitholders' equity 111.8% 110.6% 100.0%
Total liabilities & equity 102.4% 100.3% 100.0%

PROBLEM 18-1B (Continued)
(b) One would expect to see about a 33% increase for all
income statement items between 2003 and 2004 due to the
different time frames. That seems to be the case for
everything except income tax, which was largely
unchanged. Cost of sales rose faster than sales in 2005,
which led to a lower net income.
On the balance sheet, current assets have increased

significantly while current liabilities have decreased. This
should mean the companys liquidity is improved.
(c) The different time frames should not impact the balance
sheet analysis. The income statement analysis must
consider the time frame in order to be meaningful. One can
compare 2004 and 2005 without any problems, but the
comparison with 2003 data is not very meaningful.

PROBLEM 18-2B
(a)
CHEN AND CHUAN COMPANIES
Income Statements
Chen Inc. Chuan Ltd.

Dollars Percent Dollars Percent
Net sales $1,849,035 100.0% $539,038 100.0%
Cost of goods
sold 1,080,490 58.4% 338,006 62.7%
Gross profit 768,545 41.6% 201,032 37.3%
Operating
expenses 502,275 27.2% 79,000 14.7%
Income from
operations 266,270 14.4% 122,032 22.6%
Interest expense 6,800 0.4% 1,252 0.2%
Income before
income tax 259,470 14.0% 120,780 22.4%
Income tax
expense 103,800 5.6% 48,300 9.0%
Net income $ 155,670 8.4% $ 72,480 13.4%
(b) Gross Profit Margin: Gross profit margin Net sales
Chen Chuan
= $768,545 $1,849,035 = $201,032 $539,038
= 41.6% = 37.3%
Profit Margin: Net income Net sales
Chen Chuan
= $155,670 $1,849,035 = $72,480 $539,038
= 8.4% = 13.4%

(b) (Continued)
Asset Turnover: Net sales Average total assets
Chen Chuans
= $1,849,035 $894,750 = $539,038 $251,313
Return on Assets: Net income Average total assets
Chen Chuan
= $155,670 $894,750 = $72,480 $251,313
= 17.4% = 28.9%
Return on Equity:
Net income Average shareholders equity
Chen Chuan
= $155,670 $724,430 = $72,480 $186,238
= 21.5% = 38.9%
(c) Chuan seems to be a much more profitable company.

Although Chen has a higher gross profit margin, Chuan
has a better profit margin, which means it can generate
more net income per dollar of sales. Chuans assets are
returning more even though the asset turnover is the same
as Chens. Finally Chuans shareholders are enjoying a
much better return on their investment.

PROBLEM 18-3B
Working capital $310,900 - $208,500 = $102,400
$310,900
Current ratio = 1.5:1
$208,500
$1,005,500
Inventory turnover = 7.8 times
$143,000 $115,500
2
Days sales in inventory 365 days 7.8 = 46.8 days
$1,918,500
= 17.4 times
$107,800 + $5,400 + $102,800 + $5,100
2
Collection period 365 days 17.4 = 21.0 days
$913,000
Gross profit margin = 47.6%
$1,918,500
$265,300
Profit margin = 13.8%
$1,918,500
$1,918,500
Asset turnover = 2.1 times
$990,200 $852,800
2

$265,300
Return on assets = 28.8%
($990,200 $852,800) 2
$265,300
Return on equity = 45.7%
$695,700 + $465,400
2
$265,300
Earnings per share = $4.57
4,000
60,000 -
2
$294,500
Debt to total assets = 29.7%
$990,200
$265,300 $28,000 $113,700

Interest coverage
$28,000
= 14.54 times
Free cash flow = $313,900 - $161,000

= $152,900

PROBLEM 18-4B
Liquidity
2008 2007
$364,000 - $185,000 $343,000 - $182,000

Working capital = $179,000 = $161,000
$364,000 $343,000
Current ratio = 2.0:1 = 1.9:1
$185,000 $182,000
$900,000 x 75% $840,000 x 75%

Receivables
$96,500 $92,500
Turnover*
* Average gross receivables for 2008

= ($94,000 + $5,000 + $90,000 + $4,000) 2
Average gross receivables for 2007

= ($90,000 + $4,000 + $88,000 + $3,000) 2
365 days 7.0 365 days 6.8

Collection period
= 52.1 days = 53.7 days
$620,000 $575,000
Inventory
$127,500 $120,000
turnover
Days sales in 365 days 4.9 365 days 4.8

inventory = 74 days = 76 days

Profitability
2008 2007
$280,000 = 31.1% $265,000 = 31.5%

Gross profit
$900,000 $840,000
$56,000 $55,000
Profit margin = 6.2% = 6.5%
$900,000 $840,000
$900,000 $840,000
$754,000 + $648,000 $648,000 $630,000
Asset turnover
2 2
$56,000 $55,000
$754,000 +$648,000 $648,000 $630,000
Return on assets
2 2
= 8.0% = 8.6%
$56,000 $55,000
$369,000 + $316,000 $316,000 + $269,000
Return on equity
2 2
= 16.4% = 18.8%
$56,000 $55,000
EPS = $2.80 = $2.75
20,000 20,000
$8,000 $8,000
Payout ratio = 14.3% = 14.5%
$56,000 $55,000

Solvency
2008 2007
Debt to total $385,000 $332,000

= 51.1% = 51.2%
assets $754,000 $648,000
$116,000 $105,000
Interest coverage $30,000 $20,000
$68,000 - $120,000 $60,000 - $50,000

Free cash flow = ($52,000) = $10,000
(b) An overall increase in short-term liquidity has occurred. All

measures have improved.
Profitability, with the exception of EPS, has decreased

slightly.
Free cash flow and the interest coverage ratios have

deteriorated. The debt to total assets ratio is largely
unchanged.

PROBLEM 18-5B
(a) ($ in millions)
Liquidity
Domtar Cascades Industry
$1,157 $1,125
Current = 1.6:1 = 1.9:1 1.5:1
ratio $703 $595
Receivables $4,996 $3,460

turnover 7.9 times
$260 $536
Collection 365 19.2 365 6.5

period 46 days
= 19.0 days = 56.2 days
Inventory $4,333 $2,890

turnover 5.7 times
$719 $548
Days sales 365 6.0 365 5.3

64 days
in inventory = 60.8 days = 68.9 days
Solvency
Debt to total $3,583 $2,149

assets $5,192 $3,046 88.0%
= 69.0% = 70.6%

Profitability
$633 $570
Gross profit 24.7%
margin $4,966 $3,460
= 12.7% = 16.5%
$(388) $(97)
Profit (1.3)%
margin $4,966 $3,460
= (7.8)% = (2.8)%
$4,996 $3,460
Asset 0.9 times
turnover $5,436 $3,095
$(388) $(97)
Return on (1.0)%
$5,436 $3,095
assets
= (7.1)% = (3.1)%
Return on $(388) $(97)

(19.6)%
equity $1,828 $978
= (21.2)% = (9.9)%

(b) Overall, Domtars liquidity is better than the Cascades and

better than the industry average. Especially noteworthy is
its receivables turnover, which is much better than average.
Cascades liquidity is about average for the industry.
Both companies are more solvent than the industry

average.
Both companies are less profitable than the industry

average, but Domtar is worse than Cascades.
(c) Yes, a negative percentage return is meaningful.

PROBLEM 18-6B
(a) Paperclips accounts receivable management can be

assessed by reviewing the companys receivables turnover,
which indicates how often the company is turning over its
receivables; that is, how long the company is taking to
collect its accounts receivable. Paperclips receivables
turnover of 11.8 times can also be expressed as an average
collection period of 30.9 days (365 11.8). This receivables
turnover is excellent when compared to its credit terms of
30 days. As well, Paperclips receivables turnover is better
than Stapler and the industry average indicating Paperclips
management is doing a better job at controlling the
collection of the companys receivables.
(b) Paperclips ability to manage its inventory can be measured

by the inventory turnover ratio. Currently Paperclip is
turning over its inventory 7 times per year which can also
be expressed as approximately every 52 days (365 7
times). When compared to the turnover for Stapler and the
industry average it appears that Paperclip is turning over its
inventory faster than the competition.
(c) Stapler appears to be the more solvent of the two

companies. Stapler has a lower debt to total assets ratio
indicating that Stapler has a lower percentage of its assets
financed by debt. As well, Stapler has a higher times
interest earned ratio indicating that Stapler has a better
ability to service its debt as interest payments become due.
When looking at the debt to total assets, Paperclip appears
to be on a par with the average company in the industry.
However, when assessing Paperclips ability to service its
debt (as indicated by the times interest earned ratio) it can
be seen that Paperclip is not as solvent as the average firm
in the industry.

(d) Paperclips lower gross margin may be attributable to a

number of factors:
The company may be selling its products at a lower
price hoping to increase it sales volume and hence
profit.
The company may be paying more for its inventory than
the competition. This may occur if, for example,
Paperclip is not able to purchase inventory in the same
quantity for the same price as its competition.
(e) Paperclip may have a lower payout ratio than Stapler and
the industry average due to the fact that Paperclips
management may have decided to retain profits in the
business to finance future growth.
(f) Paperclip market price per share

= Price earnings ratio X Earnings per share
= 29 X $3.50 = $101.50
Stapler market price per share

= Price earnings ratio X Earnings per share
= 45 X $0.40 = $18.00
(g) 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
Stapler has the better possibility for growing its earnings
and dividends.

PROBLEM 18-7B
(a) It appears that Agrium is more liquid. Although its

receivables and inventory turn over a bit slower than
Potashs, its current ratio is far better.
(b) Potash is more solvent, but both companies are covering

their interest adequately.
(c) Overall, Potash is more profitable. It has a higher profit

margin and its EPS is more than double that of Agrium.
Gross profit margin, return on assets and return on equity
are similar for the two companies.
(d) Based on its higher price-earnings ratio, investors favour

Potash over Agrium. This is consistent with its superior
solvency and profitability.

PROBLEM 18-8B
(a)
Debt to
Current Inventory Total Asset Profit
Ratio Turnover Assets Turnover Margin
Transaction (1.5:1) (10X) (40%) (2X) (10%)
1. Paid an account
I NE D I NE
payable.
2. Collects an
account NE NE NE NE NE
receivable.
3. Buys a held-to-
maturity D NE NE NE NE
investment.
4. Sells
merchandise for I I D I I
cash at a profit.
5. Buys equipment
D NE NE NE NE
with cash.
(b) 1. The current ratio would now decrease.

2. There would still be no effect.
3. The current ratio would still decrease.
4. The current ratio would still improve.
5. The current ratio would still decrease.

PROBLEM 18-9B
(a)
Before Discontinued Operations
2005 2004 2003

$20,320 $24,948 $13,850
= 0.8% = 1.0% = 1.9%
Asset turnover $20,320 $24,948 $13,850
$29,990 $32,644 $24,854
$29,990 $32,644 $24,854
= 0.5% = 0.7% = 1.1%
$10,025 $10,342 $9,124
= 1.5% = 2.3% = 2.9%
After Discontinued Operations

2005 2004 2003

$20,320 $24,948 $13,850
= 0.6% = 1.0% = 0.7%
Asset turnover $20,320 $24,948 $13,850
$29,990 $32,644 $24,854
$29,990 $32,644 $24,854
= 0.4% = 0.8% = 0.4%
$10,025 $10,342 $9,124
= 1.3% = 2.5% = 1.1%

(b) Overall, profitability is declining when calculated before

discontinued operations. Profitability increases, then
declines when calculated after discontinued operations.
Return on equity is the most graphic example. Data for
2003 varies the most before and after discontinued
operations.
(c) Investors are interested in the future. Analysis based on

continuing operations is therefore more relevant to them.

PROBLEM 18-10B
HYPERCHIP CORPORATION
Income Statement
Year Ended November 30, 2008
Net sales ............................................................................ $1,500,000

Cost of goods sold ........................................................... 0 ,800,000
Gross profit ....................................................................... 700,000
Operating expenses ......................................................... 240,000
Income from operations ................................................... 460,000
Other revenues ................................................. $40,000
Other expenses ................................................. 030,000 , 010,000
Income before income tax ............................................... 470,000
Income tax expense ($470,000 X 30%) ........................... 0 ,141,000
Income from continuing operations ............................... 329,000
Loss from operations of ceramics division,
net of $45,000 income tax saving ............... $105,000
Loss on sale of ceramics division,
net of $21,000 income tax saving ............... 0 49,000 154,000
Net income ........................................................................ $ 175,000
Earnings per share:

Continuing operations ................................. $1.40
Discontinued operations ............................. (0.66)
Net income .................................................... $0.74

(b)
HYPERCHIP CORPORATION
Statement of Retained Earnings
Year Ended November 30, 2008
Balance, December 1 as originally reported ........... $1,225,000

Less: Cumulative effect of change in amortization
method, net of $9,000 income tax saving ............. 21,000
Balance, December 1 as adjusted ........................... 1,204,000
Add: Net income ........................................................ 175,000
1,379,000
Less: Cash dividends ................................................ 30,000
Retained earnings, November 30 ............................. $1,349,000

CONTINUING COOKIE CHRONICLE
(a) 1. Current ratio
$56,741
= 1.9:1
$30,411
2. Receivables turnover
$462,500
= 142.3 times
$3,250
3. Inventory turnover
$231,250
= 12.9 times
$17,897
4. Debt to total assets

$34,911
= 24.3%
$143,591
5. Interest coverage
$92,913
= 225 times
$413
6. Gross profit margin

$231,250
= 50.0%
$462,500
7. Profit margin
$74,000
= 16.0%
$462,500

CONTINUING COOKIE CHRONICLE (Continued)
(a) (Continued)
8. Asset turnover
$462,500
= 3.2 times
$143,591
9. Return on assets
$74,000
= 51.5%
$143,591
10. Return on equity

$74,000
= 68.1%
$108,680
(b) The company had a very good year. It was very profitable
and has a healthy balance sheet. The company is carrying
very little debt and can cover the interest charges easily.
There are no liquidity or solvency problems
(c) The bank should have no qualms about lending money to

the company. The new debt ratio would still be reasonably
low [($34,911 + $20,000) ($143,591 + $20,000) = 33.6%].
Even if there were no increases in revenue, operating
income would still be more than adequate to cover the
additional interest expense. The company is very profitable
and is an acceptable credit risk for the bank.
(d) Instead of bank financing, Cookies & Coffee Creations

could lease the equipment. Cookie & Coffee Creations
could also consider equity financing.

BYP 18-1 FINANCIAL REPORTING PROBLEM
(a)
THE FORZANI GROUP LTD.
Consolidated Balance Sheets
(in thousands)
2006 2005
ASSETS
Current
Cash $ 19,266 74.0% $ 26,018 100.0%
Accounts receivable 68,927 117.7% 58,576 100.0%
Inventory 278,002 99.8% 278,631 100.0%
Prepaid expenses 2,647 87.6% 3,022 100.0%
368,842 100.7% 366,247 100.0%
Capital assets 193,594 107.7% 179,702 100.0%
Goodwill and other
intangibles 75,805 143.6% 52,790 100.0%
Other assets 10,080 107.1% 9,415 100.0%
Future income tax asset 4,885 - - -
$653,206 107.4% $608,154 100.0%
LIABILITIES
Current
Accounts payable and
accrued liabilities $244,293 102.5% $238,239 100.0%
Current portion of long-
term debt 5,135 325.0% 1,580 100.0%
249,428 104.0% 239,819 100.0%
Long-term debt 58,805 146.0% 40,278 100.0%
Deferred lease
inducements 62,883 100.4% 62,613 100.0%
Deferred rent liability 3,810 172.2% 2,213 100.0%
Future income tax liability - 0.0% 384 100.0%
374,926 108.6% 345,307 100.0%

BYP 18-1 (Continued)
(a) Continued

(in thousands)
SHAREHOLDERS EQUITY
Share capital 138,131 100.2% 137,811 100.0%
Contributed surplus 4,271 146.5% 2,915 100.0%
Retained earnings 135,878 111.3% 122,121 100.0%
278,280 105.9% 262,847 100.0%
$653,206 107.4% $608,154 100.0%

(a) (Continued)

Consolidated Statements of Operations
Years Ended January 29 and January 30
(in thousands)
2006 2005
Revenue
119.1 100.0
Retail $ 856,149 % $718,820 %
102.6 100.0
Wholesale 273,255 % 266,234 %
1,129,404 114.7% 985,054 100.0%
Cost of sales 746,313 114.6% 651,158 100.0%
Gross margin 383,091 114.7% 333,896 100.0%
Operating and admin.
expenses
118.0 100.0
Store operating 225,218 % 190,891 %
General and 133.3 100.0
administrative 88,720 % 66,536 %
313,938 122.0% 257,427 100.0%
Operating earnings 69,153 90.4% 76,469 100.0%
Amortization 41,343 115.2% 35,885 100.0%
Interest 6,145 138.2% 4,447 100.0%
Loss on write-down of
investments - 0.0% 2,208 100.0%
47,488 111.6% 42,540 100.0%
Earnings before income
taxes 21,665 63.9% 33,929 100.0%
Provision for income
taxes
Current 8,784 86.1% 10,207 100.0

%
100.0
Future -876 - 2,177 %
7,908 63.9% 12,384 100.0%
Net earnings $ 13,757 63.9% $ 21,545 100.0%
(b)
(in thousands)
2006 2005
ASSETS
Current
Cash $ 19,266 2.9% $ 26,018 4.3%
Accounts receivable 68,927 10.6% 58,576 9.6%
Inventory 278,002 42.6% 278,631 45.8%
Prepaid expenses 2,647 0.4% 3,022 0.5%

368,842 56.5% 366,247 60.2%
Capital assets 193,594 29.7% 179,702 29.5%
Goodwill and other
intangibles 75,805 11.6% 52,790 8.7%
Other assets 10,080 1.5% 9,415 1.6%
Future income tax asset 4,885 0.7% - 0.0%
$653,206 100.0% $608,154 100.0%
LIABILITIES
Current
Accounts payable and $244,293 37.4% $238,239 39.2%
accrued liabilities
Current portion of
long-term debt 5,135 0.8% 1,580 0.2%
249,428 38.2% 239,819 39.4%
Long-term debt 58,805 9.0% 40,278 6.6%

Deferred lease
inducements 62,883 9.6% 62,613 10.3%
Deferred rent liability 3,810 0.6% 2,213 0.4%
Future income tax liability - 0.0% 384 0.1%
374,926 57.4% 345,307 56.8%

(b)
(in thousands)
SHAREHOLDERS EQUITY
Share capital 138,131 21.1% 137,811 22.6%
Contributed surplus 4,271 0.7% 2,915 0.5%
Retained earnings 135,878 20.8% 122,121 20.1%
278,280 42.6% 262,847 43.2%
$653,206 100.0% $608,154 100.0%

(b) (Continued)

Consolidated Statements of Operations
Years Ended January 29 and January 30
(in thousands)
2006 2005
Revenue
Retail $ 856,149 75.8% $ 718,820 73.0%
Wholesale 273,255 24.2% 266,234 27.0%

1,129,404 100.0% 985,054 100.0%
Cost of sales 746,313 66.1% 651,158 66.1%
Gross margin 383,091 33.9% 333,896 33.9%
Operating and admin. expenses
Store operating 225,218 19.9% 190,891 19.4%
General and
administrative 88,720 7.9% 66,536 6.7%
313,938 27.8% 257,427 26.1%
Operating earnings 69,153 6.1% 76,469 7.8%
Amortization 41,343 3.7% 35,885 3.6%
Interest 6,145 0.5% 4,447 0.5%
Loss on write-down of
investments - 0.0% 2,208 0.2%
47,488 4.2% 42,540 4.3%
Earnings before income
taxes 21,665 1.9% 33,929 3.5%
Provision for income taxes
Current 8,784 0.8% 10,207 1.1%
Future -876 -0.1% 2,177 0.2%
7,908 0.7% 12,384 1.3%
Net earnings $ 13,757 1.2% $ 21,545 2.2%


(c) Horizontal analysis
On the balance sheet, the proportion of cash decreased,

and the proportion of accounts receivables increased.
Goodwill and other intangibles are up 44% over the
previous year. The current portion of long-term debt is up
over three times the previous year.
On the income statement, retail revenue is up 19% while

wholesale revenue is up only 3%. General and
administrative expenses rose faster than revenue (33%
versus 19%). Interest costs increased 38%. These factors
combined to bring net income down by about 36%.
Vertical analysis
No significant changes were apparent.

BYP 18-2 INTERPRETING FINANCIAL STATEMENTS
(a) In terms of liquidity, both companies have cause for

concern. Both have low current ratios relative to the
industry although CPs current ratio is slightly better than
CNs. The receivable turnover for both companies is much
slower than the industry average.
(b) CN is more solvent than CP, but neither company is

covering their interest costs as well as the industry
average, in spite of having close to the average portion of
debt. CNs free cash flow is vastly superior to CPs.
(c) CN appears to be more profitable. Almost all of its ratios are

better than average and better than those of CP. CNs profit
margin is far superior.

BYP 18-3 COLLABORATIVE LEARNING ACTIVITY
All of the material supplementing the collaborative learning

activity, including a suggested solution, can be found in the
Collaborative Learning section of the Instructor Resource site
accompanying this textbook.

BYP 18-4 COMMUNICATION ACTIVITY
Memorandum
To: Self
Re: Limitations of financial statements.
In evaluating the financial performance of an entity it is

important to understand the limitations of financial statements.
To address this issue, I should inquire of the audit committee

some of the following questions:
1. To what extent is inflation an issue for the company.
2. What estimates have been used in preparing the financial

statements? How reliable are these estimates?
3. What accounting policies are being used? Have any of

these policies changed during the year? How do the
policies of this company compare to those used by similar
companies?
4. How diversified is this company? Are there competitors

that are similar enough for comparisons to be made?
5. How would you describe the quality of earnings reported

by the company? Has management been pressured to
increase earnings? Are there any bonus plans or stock
option plans, which would lead management to manipulate
earnings?

BYP 18-5 ETHICS CASE
(a) The stakeholders in this case are:

Sabra Surkis, president of Surkis Industries
Carol Dunn, public relations director
You, as controller of Surkis Industries
Shareholders and creditors of Surkis Industries
Potential creditors and investors in Surkis Industries
Any other 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 Carol, the public

relations director, 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 public relations
director (if she agrees) have the responsibility to inform the
president of the bias of the about-to-be-released
information.

Legal Notice
Copyright
Copyright 2009 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.


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Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Third Canadian Edition

Financial Statement Analysis

ASSIGNMENT CLASSIFICATION TABLE

2. Explain and apply 4, 5, 6, 7 3, 4, 5 2, 3, 4 2 2

3. Identify and use ratios 8, 9, 10, 6, 7, 8, 9, 5, 6, 7, 8, 2, 3, 4, 5, 2, 3, 4, 5,

4. Recognize and 17, 18, 19, 12, 13, 12, 13 9, 10 9, 10

Solutions Manual 18-1 Chapter 18

ASSIGNMENT CHARACTERISTICS TABLE

1A Prepare horizontal analysis and comment. Simple 60-70

2A Prepare vertical analysis, calculate profitability Moderate 50-60

3A Calculate ratios. Moderate 35-40

4A Calculate and evaluate ratios for two years. Moderate 70-80

5A Calculate and evaluate ratios for two companies. Moderate 45-55

6A Analyze ratios. Moderate 25-35

7A Analyze ratios. Moderate 15-20

8A Determine impact of transactions on ratios. Complex 20-25

9A Calculate and evaluate profitability ratios with Moderate 55-65

10A Prepare income statement and statement of Moderate 25-35

1B Prepare horizontal analysis and comment. Simple 60-70

2B Prepare vertical analysis, calculate profitability Moderate 50-60

3B Calculate ratios. Moderate 35-40

4B Calculate and evaluate ratios for two years. Moderate 70-80

5B Calculate and evaluate ratios for two companies. Moderate 45-55

6B Analyze ratios. Moderate 25-35

7B Analyze ratios. Moderate 15-20

8B Determine impact of transactions on ratios. Complex 20-25

9B Calculate and evaluate profitability ratios with Moderate 55-65

10B Prepare income statement and statement of Moderate 25-35

Solutions Manual 18-2 Chapter 18

BLOOMS TAXONOMY TABLE

Study Objectives Knowledge Comprehension Application Analysis Synthesis Evaluation

2. Explain and Q18-6 Q18-4 BE18-3 P18-2A

3. Identify and Q18-8 Q18-9 BE18-7 Q18-10 P18-4A

4. Recognize Q18-17 Q18-19

Solutions Manual 18-3 Chapter 18

(1) An intracompany basis compares the same item with prior

(b) The intracompany basis of comparison is useful in detecting changes

3. (a) An answer cannot be calculated when there is no value in a base

(b) An answer cannot be calculated when there is a negative value in a

Solutions Manual 18-4 Chapter 18

Vertical analysis expresses each item within a financial statement in terms

5. A comparison of the first quarter in 2006 after Tim Hortons became a

(b) On an income statement, net sales is assigned a value of 100%.

7. Yes, it can. By converting the accounting numbers to percentages,

(b) Profitability ratios measure the income or operating success of a

9. (a) Asset turnover

Solutions Manual 18-5 Chapter 18

Solutions Manual 18-6 Chapter 18

15. An investor interested in growth would want to invest in a company with a

An investor interested in shares with income potential would likely choose

However, this practice may not be sustainable in the long-term,

2. Use of cost which is not adjusted for price-level changes. Failing to

3. Use of alternative accounting methods. Differences in accounting

4. Quality of earnings. Management may try to manipulate income by

(Note: Question 17 continues on the next page)

Solutions Manual 18-7 Chapter 18

5. Earning power and irregular items. Financial statements often include

6. Diversification of firms. Today, many firms are so diversified that

18. If management wanted to increase income, it could decrease the

Management of income through, for example, the changing of accounting

Note to the instructor: Other accounting estimates might include residual

(c) Declining-balance amortization is higher than straight-line

Solutions Manual 18-8 Chapter 18