www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition CHAPTER 13 Statement of Cash Flows ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Describe the purpose and content of the statement of cash flows 1, 2, 3, 4, Prepare the operating activities section of a statement of cash flows using one of two approaches: 6, 7, 8, 14, 16, 17 Brief Exercises Exercises A Problems B Problems 1, 2, 1, 1A 1B 1, 3, 3, 13 11A 11B 1, BYP (a) the indirect method or 9, 10, 11 3, 4, 4, 5, 8, 9, 12 2A, 3A, 2B, 3B, 6A, 7A, 8A 6B, 7B, 8B (b) the direct method 12, 13, 15 6, 7, 8, 9, 10 6, 7, 10, 12 2A, 3A, 6A, 7A 2B, 3B, 6B, 7B Prepare the investing activities section of a statement of cash flows 14, 15, 17 11, 12 8, 9, 11, 12, 13 4A, 6A, 7A, 8A, 11A 4B, 6B, 7B, 8B, 11B 1, Prepare the financing activities section of a statement of cash flows 15, 16, 17 13, 14 8, 9, 11, 12, 13 5A, 6A, 7A, 8A, 11A 5B, 6B, 7B, 8B, 11B 1, Complete the statement of cash flows 18 8, 9, 12 6A, 7A, 8A, 11A 6B, 7B, 8B, 11B 1, 6, Use the statement of cash flows to evaluate a company’s liquidity and solvency 19, 20, 21, 22, 23 8, 9, 13, 14 9A, 10A 9B, 10B 2, 3, 4, 15, 16, 17 Solutions Manual 13-1 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) Simple 20-30 1A Classify activities 2A Prepare operating activities section—indirect and direct methods Moderate 30-40 3A Prepare operating activities section—indirect and direct methods—and discuss methods Moderate 30-40 4A Calculate and classify cash flows for property, plant, and equipment Moderate 20-30 5A Calculate and classify cash flows for shareholders’ equity Moderate 20-30 6A Prepare statement of cash flows—indirect and direct methods Moderate 30-40 7A Prepare statement of cash flows—indirect and direct methods Moderate 50-60 8A Prepare statement of cash flows (indirect method) and answer questions Complex 40-50 9A Calculate and evaluate liquidity and solvency Moderate 20-30 10A Evaluate liquidity and solvency Moderate 20-30 11A Compare cash flows for three companies Moderate 20-30 1B Classify activities Simple 20-30 2B Prepare operating activities section—indirect and direct methods Moderate 40-50 3B Prepare operating activities section—indirect and direct methods—and discuss methods Moderate 50-60 4B Calculate and classify cash flows for property, plant, and equipment Moderate 20-30 5B Calculate and classify cash flows for shareholders’ equity Moderate 30-40 Solutions Manual 13-2 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number Description Difficulty Level Time Allotted (min.) 6B Prepare statement of cash flows—indirect and direct methods Moderate 30-40 7B Prepare statement of cash flows—indirect and direct methods Moderate 50-60 8B Prepare statement of cash flows (indirect method) and answer questions Complex 40-50 9B Calculate and evaluate liquidity and solvency Moderate 20-30 10B Evaluate liquidity and solvency Moderate 20-30 11B Compare cash flows for three companies Moderate 20-30 Solutions Manual 13-3 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ANSWERS TO QUESTIONS The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activities of a company during a period, in a format that reconciles the beginning and ending cash balances The statement of cash flows is useful because it helps investors, lenders and other creditors, as well as other users, assess the following aspects of a company’s financial position: • the reasons for the difference between profit and cash provided (used) by operating activities • the cash investing and financing transactions during a period • the company’s ability to generate future cash flows Cash equivalents are short-term, highly-liquid investments that are readily convertible to known amounts of cash Generally, only debt investments with original maturities of three months or less qualify under this definition Bank overdrafts that are repayable on demand are also included (deducted from) cash equivalents The statement of cash flows may be prepared using cash, or cash and cash equivalents as its base If the latter, cash equivalents must be clearly defined Operating activities include the cash flow activities arising from a company’s principal revenue-producing activities and all other activities that are not investing or financing activities Investing activities are those arising from the acquisition and disposal of non-current assets Financing activities include those resulting in changes in the size and composition of the equity and borrowings of a company Companies following ASPE classify interest paid, interest revenue, and dividend revenue, as part of operating activities because they are disclosed on the income statement as part of profit Dividend payments are classified as financing activities This is the most common practice for both publicly traded and private companies Companies following IFRS may classify interest and dividend revenue as either investing activities or operating activities; and interest and dividend payments as either financing activities or operating activities Companies select where these payments and receipts will be presented and must apply the presentation consistently Examples of noncash transactions include the issue of shares or a mortgage to purchase property, plant, and equipment In both cases, cash is not involved Noncash transactions should be reported in the notes to the financial statements and crossreferenced to the statement of cash flows, but not reported as investing and financing activities in the body of the statement of cash flows Solutions Manual 13-4 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) (a) and (b) (1) The adjusted trial balance is not required to prepare the statement of cash flows because it does not provide necessary data (2) A comparative statement of financial position is required to obtain the changes in individual asset, liability, and equity balances Changes in the noncash working capital (current) accounts may affect the operating activities, changes in short-term investment and long-lived asset accounts may affect the investing activities, and changes in non-current liability and equity accounts may affect the financing activities reported in the statement of cash flows (3) The income statement is required to obtain the elements of operating activities, which will be converted from the accrual basis to the cash basis The income statement is also required to identify noncash revenues and expenses such as depreciation and amortization expenses and accounting gains and losses (4) The statement of comprehensive income is needed to reconcile certain fair-valued assets (e.g., revaluation of the fair value of land) and equity (e.g., accumulated other comprehensive income) accounts appearing in the statement of financial position However, changes in comprehensive income not affect cash and are not reported on the statement of cash flows (5) The statement of changes in equity will provide details of the changes in the share capital and retained earnings accounts From these, the cash effects of financing transactions with shareholders, such as the issue or reacquisition of shares and/or payment of dividends, can be determined and reported as financing activities on the statement of cash flows Although the approaches and format are different, both the direct and indirect methods will produce the same net cash provided by operating activities A number of factors could have caused net cash provided by operating activities to exceed profit These include (1) a high amount of collections of unearned revenue; (2) large amounts of depreciation or amortization; and (3) accounting losses These are non-cash items deducted in arriving at profit so they are now added back to profit when determining net cash flow provided by operating activities thereby making it higher than profit Solutions Manual 13-5 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) The indirect method involves converting accrual-based profit to net cash provided by operating activities This is done by starting with accrual-based profit from the income statement and adding or subtracting noncash items included in profit Examples of adjustments include adding back noncash expenses, such as depreciation, and removing any noncash gains or losses from profit Then changes in the balances of noncash current asset and current liability accounts from one period to the next are added or subtracted 10 Under the indirect method, depreciation and amortization expense is added back to profit to reconcile profit to net cash provided by operating activities because depreciation and amortization are expenses that have reduced profit, but not result in the use of cash Adding them back cancels the expenses reported in the income statement, as accrual profit is the starting point under the indirect method Example: Profit before depreciation $5,000 Less: Depreciation expense (1,000) Profit 4,000 Add: Depreciation expense 1,000 Cash provided by operating activities $5,000 11 Under the indirect method, a gain on disposal of equipment is deducted from profit to reconcile profit to net cash provided by operating activities A gain is the difference between the cash proceeds received when the asset is sold and the carrying amount of the asset This gain is not a cash receipt or payment Therefore, the noncash gain, which was included in profit, must be deducted from profit on the statement of cash flows to convert profit to net cash provided by operating activities The total cash proceeds received when the asset is disposed would be reported in the statement of cash flows as an investing activity 12 Net cash provided by operating activities under the direct method is the difference between cash revenues and cash expenses The direct method adjusts the accrualbased revenues and expenses directly to reflect the cash-based revenues and expenses, which combine to equal "net cash provided by operating activities." 13 Depreciation and amortization expenses are not listed in the direct method operating activities section because they are not cash flow items—they not affect cash Recall the journal entry to record depreciation: debit Depreciation Expense and credit Accumulated Depreciation The entry to record amortization is similar As you can see, there is no cash involved in this journal entry This is different from the indirect method, which uses profit as its starting point and must add back depreciation and amortization as noncash items included in the determination of profit Solutions Manual 13-6 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) 14 When a business invests money, it does so outside of its main revenue-generating operations It might have excess cash, which it wants to put to use in producing some interest or dividend revenue Since the intention is to earn a return on its investment, the buying and selling of investments is generally reported as investing activities in the statement of cash flows The exception occurs when the investments are held for trading purposes, in which case they are treated similar to inventory acquired for resale These types of investments are reported as operating activities 15 The gain on disposal of equipment and the loss on the sale of land would not appear on the statement of cash flows prepared using the direct method because these are not cash flow items However, the gross proceeds received when the assets are sold would be reported in the statement of cash flows as investing activities 16 Short-term loans payable issued for trade purposes (e.g., instead of an accounts payable) are classified as operating activities However, short-term loans payable that are issued for borrowing purposes rather than for trade not relate to operating activities The issue or repayment of such short-term loans payable are consequently classified as financing activities 17 A growing company would report low or negative cash flows from operating activities if it just commenced its operations Later, as its sales grow, the cash from operating activities will become positive The company would also usually show cash used in investing activities as it invests in its productive capacity At this stage, the company will also usually show cash inflows in financing activities to finance the purchase of productive assets and to cover the shortfall from operating activities 18 The statement of cash flows is prepared from detailed information about the changes in account balances that occurred between two periods of time, as shown on the other financial statements Unlike the other financial statements, it is not prepared from an adjusted trial balance In particular, the information to prepare the statement of cash flows comes from a comparative statement of financial position, the income statement, the statement of changes in equity, and additional information 19 (a) The cash current debt coverage ratio is a cash-based ratio that measures liquidity Liquidity can also be measured using the current ratio (accrual-based) (b) Solvency can be measured by the cash total debt coverage ratio (cash-based) Solvency can also be measured using the debt to total assets ratio (accrualbased) Free cash flow is also a cash-based solvency measure, but there is not accrual-based counterpart to this measure Solutions Manual 13-7 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) 20 Leon’s cash current debt coverage was probably lower than its current ratio because its net cash flows provided by operating activities was significantly lower than its current assets and/or because the company’s average current liabilities for the year were higher than its current liabilities on the statement of financial position date Cash flows from operating activities could have been lower than current assets because of receivables, inventory, or prepaids which are included in current assets but not increase cash 21 It is difficult to draw conclusions about the relative solvency of these companies, given the limited information provided For instance, one would want to know the composition of the cash provided by operating activities and the debt of each of the companies In addition to this, the times interest earned ratio for each company would prove helpful Based on the information provided, Rogers reports a higher debt to total assets ratio than Shaw, which indicates a worse solvency However, Rogers also shows a higher debt coverage ratio than Shaw and this ratio indicates a better solvency as Rogers seems more able to pay its interest Consequently, Rogers would be considered more solvent 22 Creditors may be concerned about the company’s ability to repay its obligations over the long-term The company’s declining cash total debt coverage ratio indicates either a decline in cash from operating activities, an increasing dependence on borrowed funds, or both Creditors may be reluctant to grant loans to the company if these trends persist The lack of cash flows from operating activities may be of concern to investors for several reasons First, the decrease in cash flows may have an adverse effect on the company’s share price In addition, some investors may be concerned that the company will not generate enough cash to pay dividends in the future This concern is supported by the declining free cash flow, which also indicates the company is generating less cash from operating activities to pay future dividends and to expand the business 23 If net capital expenditures and dividends paid exceed cash provided by operating activities, then free cash flow will be negative Solutions Manual 13-8 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 (a) (b) (c) (d) (e) – – NE + – (f) (g) (h) (i) (j) + NE – – NE BRIEF EXERCISE 13-2 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) F O if reporting under ASPE but if reporting under IFRS a choice exists between showing this as an operating or financing activity NC – an exchange of land (investing activity) for shares (financing activity) that does not involve cash F O O Not a cash activity – a reduction of retained earnings and an increase in dividends payable F if reporting under ASPE but if reporting under IFRS a choice exists between showing this as a financing or operating activity O Not a cash activity – a cost allocation BRIEF EXERCISE 13-3 (a) F O I F F O (b) Mega Brands uses the indirect method as indicated by the changes in noncash operating working capital items and the depreciation expense Solutions Manual 13-9 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BRIEF EXERCISE 13-4 (a) (b) (c) (d) (e) (f) (g) (h) (i) + – + + – – + – + BRIEF EXERCISE 13-5 DUPIGNE CORPORATION Statement of Cash Flows (Partial)—Indirect Method Year Ended March 31, 2015 Operating activities Profit Adjustments to reconcile profit to net cash provided (used) by operating activities Depreciation expense Loss on disposal of land Accounts receivable increase Merchandise inventory increase Prepaid expenses increase Accounts payable decrease Interest payable decrease Income tax payable increase Net cash provided by operating activities $275,000 $60,000 15,000 (20,000) (5,000) (2,000) (5,000) (2,500) 5,000 45,500 $320,500 Solutions Manual 13-10 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 13-8B (Continued) Calculations: (1) Transactions involving Buildings: Buildings Dec 31, 2014 Purchases Dec 31, 2015 263,000 304,000 477,000 Disposal 90,000 Accumulated Depreciation—Buildings Disposal (derived) 78,000 Dec 31, 2014 Depreciation Dec 31, 2015 100,000 45,000 67,000 Cost of building sold (derived) Accumulated depreciation Net carrying amount (derived) Add: Gain on disposal Cash proceeds from disposal $90,000 78,000 12,000 28,000 $40,000 Cash Accumulated Depreciation—Buildings Gain on Disposal Buildings 40,000 78,000 28,000 90,000 (2) Transactions involving Equipment: Equipment Dec 31, 2014 Purchases Dec 31, 2015 40,000 125,000 135,000 Disposal 30,000 Accumulated Depreciation—Equipment Disposal 21,000 Dec 31, 2014 Depreciation Dec 31, 2015 10,000 29,000 18,000 Cost of equipment sold (derived) Accumulated depreciation Net carrying amount Less: Loss on disposal Cash proceeds from disposal $30,000 21,000 9,000 5,000 $ 4,000 Cash Accumulated Depreciation—Equipment Loss on Disposal Equipment 4,000 21,000 5,000 30,000 Solutions Manual 13-70 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 13-8B (Continued) (3) Total depreciation recorded during the year: For buildings: For equipment: Total depreciation expense for the year: $45,000 29,000 $74,000 (4) Transactions involving Retained Earnings: Retained Earnings Dividends (derived) 33,000 Dec 31, 2014 Profit Dec 31, 2015 30,000 53,000 50,000 (5) Transactions involving Bank Loan Payable: Bank loan balance Dec 31, 2014: Current portion $ 20,000 Non-current portion 212,000 Total $232,000 Bank loan balance Dec 31, 2015: Current portion $ 26,000 Non-current portion 520,000 Total $546,000 Net increase during the year ($546,000 − $232,000) $314,000 Additions to the bank loans during the year (given) 350,000 Repayments made on bank loans during the year $ 36,000 (b) Anderson Ltd did not manage its noncash working capital efficiently It increased its accounts receivable and merchandise inventory while at the same time decreasing its accounts payable Taken together this shows a bad trend and possible issues with overstocking or slowing sales (c) The purchase of the building was financed primarily through the use of bank loans, which are now at a fairly high level The required repayments to the bank loan this year were $36,000 and this may rise in the future because of the additional debt incurred this year To pay for this, the company has only generated $40,000 from operating activities The bank will be concerned about this Furthermore, the bank will notice that dividends paid were over 80% of the cash from operating activities and the bank may ask for dividends to be reduced Solutions Manual 13-71 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 13-9B (a) (USD millions) Google Yahoo! Cash current debt coverage $16,619 ÷ $11,625 = 1.4 times $(281.6) ÷ $1,248.8 = N/A as negative Cash total debt coverage $16,619 ÷ $18,256 = 0.9 times $(281.6) ÷ $2,349.5 = N/A as negative Free cash flow $16,619 – $3,273 – $0 = $13,346 $(281.6) – $505.5 – $0 = $(787.1) (b) Google is significantly more liquid than Yahoo! as evidenced by its cash current debt coverage ratio Google is able to generate significantly more cash to meet all of its currently maturing liabilities Google is also more solvent than Yahoo! Google has a higher cash total debt coverage ratio than Yahoo!, which indicates that Google is the more solvent of the two companies Only Google has positive free cash flows Google is both more liquid and more solvent than Yahoo! Solutions Manual 13-72 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 13-10B (a) Barrington is definitely the more liquid of the two companies The company has more current assets to repay its currently maturing liabilities as evidenced by its higher current ratio Also, Barrington is turning its receivables into cash every 60 days (365 ÷ times), which is quicker than Ste-Croix who is currently taking over 90 days on the average to collect its receivables As well, Barrington is moving its inventory faster than Ste-Croix, which again, indicates Barrington is more liquid Finally, Barrington’s cash current debt coverage is higher than Ste-Croix’s This indicates that Barrington is generating more cash from operating activities that can be used to repay current obligations (b) Barrington has a much higher percentage of debt to total assets than Ste-Croix, which would indicate that the company is the less solvent of the two However, Barrington is generating more cash to use for the repayment of long-term debt as can be seen by examining the cash total debt coverage ratios of the two companies Finally, the times interest earned ratio indicates that Barrington’s profit when compared to its required interest payments (the company’s times interest earned ratio is times) is higher than the same ratio for Ste-Croix Therefore, although Barrington carries more debt relative to total assets than Ste-Croix, Barrington seems to be in a better position than SteCroix to meet its obligations regarding repayment of principal and interest Solutions Manual 13-73 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 13-11B (a) All three companies generated cash from operating activities and used cash in investing and financing activities, with the exception that Burger King which generated cash from investing activities All three companies produced more cash from operating activities than profit with Wendy’s showing the largest proportion of cash from operating activities to profit McDonald’s showed no increase in cash and cash equivalents while Burger King showed a 19.1% increase in cash and cash equivalents, whereas Wendy’s showed a net decrease in cash and cash equivalents ($ in USD millions) Profit Net cash provided by operating activities Net cash provided by operating activities in excess of profit Net cash provided by operating activities as a % of profit % increase in cash from prior year (b) McDonald’s $5,464.8 $6,966.1 Burger King $117.7 $224.4 Wendy’s $9.5 $190.4 $1,501.3 $106.7 $180.9 127.5% 190.7% 2,004.2% 0% 19.1% (4.6)% Burger King is in the strongest position It shows the highest percentage increase in cash during the year Because we need to ignore the comparisons to profit for Wendy’s due to the extremely small profit, Burger King has the highest proportion of net cash provided by operating activities to profit Despite McDonald’s far larger profit and cash amounts, proportionately, Burger King appears to be the stronger of the two from a “cash generated by operating activities” perspective More information in terms of past trends would be helpful to properly compare the two Solutions Manual 13-74 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-1 FINANCIAL REPORTING (a) Shoppers Drug Mart uses the indirect method of calculating operating activities (b) Shoppers generated cash from operating activities in the amount of $916,816,000 in 2012 and $973,838,000 in 2011 (c) The most significant investing activity for Shoppers is cash used in the acquisition and development of property and equipment in the amount of $254,259,000 For financing activities, Shoppers did a refinancing of debt by issuing one quarter of a billion dollars of commercial paper and repaying long-term debt of the same amount (d) Cash decreased in 2012 by $14,037,000 and increased in 2011 in the amount of $54,212,000 (e) Shoppers grew from acquiring property and equipment, and from developing property with a cost that was approximately one quarter of a billion dollars in total It also spent considerable amounts of cash buying other businesses (f) Shoppers used the cash generated from operating activities to repurchase its own shares and to pay dividends These payments were also made in similar amounts in 2011 Solutions Manual 13-75 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-2 COMPARATIVE ANALYSIS (a) Ratio Cash current debt coverage Current ratio Cash total debt coverage Debt to total assets Times interest earned Free cash flow Shoppers (in thousands $) Jean Coutu (in millions $) $916,816 = 0.4 times ($2,334,917 + $1,776,238) ÷ $223.8 = 0.7 times ($265.2 + $408.7) ÷ $2,764,997 = 1.2 :1 $2,334,917 $421.9 = 1.6 :1 $265.2 $916,816 = 0.3 times ($3,150,394 + $3,032,480) ÷ $223.8 = 0.6 times ($281.9 + $423.6) ÷ $3,150,394 = 42.2% $7,473,721 $281.9 = 20.2% $1,392.7 $608,481 + $57,595 + $214,845 $558.4 + $2.0 + $78.9 = 15.3 times = 319.7 times $57,595 $2.0 $916,816 – $395,074 – $218,732 = $303,010 $223.8 – $66.0 – $60.8 = $97.0 (b) From all measures arrived at in part (a), we can conclude that Jean Coutu enjoys far better liquidity and solvency than Shoppers While Shoppers demonstrates good ratios, for debt to total assets and times interest earned, the corresponding ratios are far superior with Jean Coutu (c) In order to conclude which company is more committed to growth, we would look at the investing activities of the statement of cash flows While Jean Coutu has a net cash position in investing activities from selling Rite Aid, Shoppers incurred a large cash outflow from purchasing investments in businesses and developing properties for new store locations Shoppers is, therefore, the company most committed to growth In order to conclude which company is more committed to paying down debt, we would look at the financing activities the statement of cash flows Shoppers’ financing activities consisted primarily of cash payments to buy back common shares and pay dividends On the other hand, Jean Coutu appears to have used the proceeds from the sale of Rite Aid to pay down its revolving credit facility This explains in part why the debt to total asset and times interest earned ratios are more favourable with Jean Coutu Jean Coutu is more committed to paying down debt Looking at the proportion of cash obtained from operating activities paid out in dividends, Shoppers percentage payout is slightly lower than that of Jean Coutu Shoppers’ is 23.9% ($218,732 ÷ $916,816) while Jean Coutu’s is 27.1% ($60.8 ÷ $223.8) Solutions Manual 13-76 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-3 COMPARING IFRS AND ASPE (a) Companies following ASPE classify interest paid, interest revenue, and dividend revenue, as part of operating activities because they are disclosed on the income statement as part of profit Dividend payments are classified as financing activities This is the most common practice for both publicly traded and private companies Companies following IFRS may classify interest and dividend revenue as either investing activities or operating activities; and interest and dividend payments as either financing activities or operating activities In order to present the strongest (largest) performance for cash obtained from operating activities, Discount Ltd.’s management probably chose to classify interest and dividend revenue as operating activities as these can only be positive cash flows and likely would have chosen to classify interest and dividend payments under financing activities as these can only be negative cash flows (b) Increasing the cash flows from operating activities by using the classification choices described in part (a) will cause Discount Ltd to have a higher (better) cash debt coverage and higher (better) cash total debt coverage since, in both ratios, the numerator will be larger The choice will also provide for a larger (better) free cash flow ratio as the amount of cash flow from operating activities will be larger, leaving more cash remaining after covering capital expenditures and dividend payments Solutions Manual 13-77 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-4 CRITICAL THINKING CASE Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS (a) During 2014, the purchase of property, plant, and equipment in the amount of $2 billion dollars was financed differently by the three companies While some of the financing came from using cash generated from operations, A Limited chose to finance the balance needed with a blend of debt and equity financing that was similar in amount B Limited chose to use only equity and C Limited financed with mostly debt For 2015, expansion continued at an even greater pace for A Limited, which spent $2,350 million on property, plant, and equipment, while B and C acquired far less of these assets A Limited financed this higher level of expenditures by using net cash from operating activities and by issuing more common shares Because the majority of the investments in 2014 made by C Limited were financed with debt, even though C Limited was able to pay down some of this debt in 2015 and reduce it to a lower amount than the debt held by A Limited, relative to its assets, of the three companies, C Limited still has the greatest percentage of its assets financed with debt as the other two companies have used equity more extensively than C Limited (b) Because A Limited financed expansion in 2015 using mostly equity, and it grew its operations in that year through expansion, it generated the most cash from operations The cash total debt coverage is determined by taking cash from operating activities and dividing it by average total liabilities Even though A Limited has the highest cash flow from operations, B Limited has very little debt and because of this, is likely the company that would have the highest cash to total debt ratio (c) C Limited is the only company that had a decrease in the net cash from its operating activities in 2015 This happened because too much cash was tied up in accounts receivable and inventory The increases in these current assets, particularly during 2015, caused a large reduction of cash that could have been used instead to reduce the high levels of debt (d) C Limited likely did not have a choice to pay down its bank loans in 2015 It was forced to so by the bank C Limited had poor performance in managing accounts receivable and inventory that in turn caused a shortage of cash needed to satisfy the bank’s concerns with regard to its liquidity and solvency C Limited resorted to the desperate measure of selling off some its non-current assets at a loss of $70 million to raise the cash needed to pay down the bank loans Solutions Manual 13-78 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-4 (Continued) (e) As a shareholder interested in dividends and not in growth in the value of my investment, I would consider investing in B Limited The amount of dividends paid by B Limited in 2015 was $120 million, which is 10% of the total value of shares issued This percentage is lower for the other two companies so shareholders in B Limited are receiving the largest dividend relative to the amount invested (f) A Limited is the company most committed to growth as demonstrated by the large investment in property, plant and equipment that continued into 2015 So long as shareholders feel that the cash spent provides for growth in the market value of the common shares issued, the pace of expansion is not excessive since it was financed with equity, which will not cause a reduction in cash flow due to interest payments (g) C Limited has the highest free cash flow Net cash provided by operating activities Purchases of property, plant, and equipment Dividends paid Free cash flow (h) A Limited $1,030 (2,350) (100) $(1,420) B Limited $980 (830) (120) $30 C Limited $820 (430) (5 ) $385 If I was interested in owning the shares of one of these companies, I would likely not invest in C Limited due to the build up of inventory and accounts receivable shown in the operating activities section of the statement of cash flows I would also be concerned about a management team that raised funds in 2014 to buy non-current assets, and then sold some of them in 2015 at a loss As an investor I would like the fact that A Limited is growing, but I would like to know at what point the expansion occurred in 2015 If it occurred early in the year, one would expect, given the larger asset base of this company, that profit would be higher On the other hand if the expansion occurred very late in 2015, the extra asset base could trigger much higher amounts of profit next year compared to 2015 On the other hand B Limited seems to be conservatively financed with little debt, so it has the potential to expand very easily in the future So before making a decision, I would need more information about the success of A Limited’s 2015 expansion before buying their shares On the other hand, B Limited is probably the safest company to lend money to, given its low level of debt and its reasonably high operating cash flows Solutions Manual 13-79 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-5 ETHICS CASE (a) A company’s dividend policy should be based on several factors other than the requirement to pay the “usual” dividend Some of these factors include: • Legal requirements such as the Business Corporations Acts for the jurisdiction in which the company is incorporated For example, the Canada Business Corporations Act specifies certain requirements that must be met in order for companies to be able to pay dividends; these requirements include solvency and a positive (credit) balance in Retained Earnings • Creditor or other contractual requirements: some creditor loan agreements can specify financial ratios that must be maintained or limit the amounts of dividends that can be paid out to shareholders • The company’s short-term and long-term budgets and goals The payment of dividends uses the company’s cash, and management has to ensure that sufficient cash remains to operate the business and meet its short-term and longterm goals, such as property, plant, and equipment purchases, expansion, debt repayment, etc (b) The stakeholders in this situation are: Phil Monat, president and CEO of Onwards and Upwards Corporation Leland Yee, controller The board of directors The shareholders of Onwards and Upwards Corporation (c) The president’s statement, “We must get that amount above $1 million,” puts undue pressure on the controller This statement along with his statement, “I know you won’t let me down Leland,” encourages Leland to something unethical Controller Leland Yee’s reclassification (intentional misclassification) of cash payments from interest as an operating activity to a financing activity is inappropriate and unethical Although companies reporting under IFRS have the choice to show interest payments under either operating or financing activities, the presentation must be consistent from year to year (d) Yes Under IFRS, it is permissible to show interest paid as a financing rather than an operating cash payment but just like the dividend payment discussed above, such a change should be consistent from year to year Companies reporting under ASPE must classify interest paid as part of operating activities and not have the choice to show these payments as part of financing activities Solutions Manual 13-80 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-6 “ALL ABOUT YOU” ACTIVITY (a) Statement of Cash Flows—Direct Method Year Ended (date) Operating activities Cash receipts from salary Cash payments For rent and utilities For interest For car expenses For food, entertainment and recreation Net cash provided by operating activities Investing activities Purchase of car Purchase of investments Purchase of computer Disposal of computer Disposal of motorcycle Net cash used in investing activities Financing activities Increase in credit card debt ($2,500 – $1,000) Decrease in line of credit ($2,500 – $1,200) Car loan obtained Repayment of student loan ($15,000 – $10,000) Net cash provided by financing activities Net increase in cash Cash, beginning of year Cash, end of year (b) $45,000 $(16,600) (1,400) (4,800) (6,000) (28,800 ) 16,200 $(20,000 ) (5,500) (1,500) 100 1,000 (25,900) $ 1,500 (1,300) 15,000 (5,000) 10,200 500 500 $ 1,000 Depending on the level of security for the large investment made during the year, your friend should likely consider the benefits of eliminating some interest expenses by reducing debt that carries a higher interest rate than the yield obtained from the investment Solutions Manual 13-81 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-7 SERIAL CASE (a) Koebel’s Family Bakery Biscuits ($ in thousands) Coffee Beans ($ in thousands) Cash current debt coverage ratio $235,279 $31,121 = 7.6 times $6,821 $16,233 = 0.4 times $1,594 $3,759 = 0.4 times Cash total debt coverage ratio $235,279 $81,551 = 2.9 times $6,821 $27,758.5 = 0.2 times $1,594 $8,879 = 0.2 times Free cash flow $235,279 – $144,000 – $120,000 = $(28,721) $6,821 – $3,414 – $580 = $2,827 $1,594 – $1,448 – $0 = $146 (b) Koebel is able to generate a significant amount of cash from its operating activities—in excess of its profit It uses cash for both its investing activities and financing activities The use of cash in investing activities indicates that Koebel is investing in its plant and equipment, which is a good sign for future growth Its use of cash in financing activities indicates that they are either repaying more debt than they are raising (through debt or equity) or are using cash for dividends From the additional information, we can determine that a $120,000 dividend was paid, which exceeded the amount that Daniel contributed in equity ($107,500) See Chapter 11 Biscuits is also generating a significant amount of cash from its operating activities—far in excess of its profit It is also using cash in both its investing and financing activities From this, it appears to be at the maturity stage of its corporate life cycle Coffee Beans’ cash flows tell a bit of a different story Although it is also generating a significant amount of cash from its operating activities in excess of its profit, it is insufficient to cover the investing and financing activities It does not pay a dividend so most of its cash used for financing activities is likely repaying debt on its capital expenditures All of this has resulted in a net decrease in cash during the year, leaving the company with a low ending cash balance Solutions Manual 13-82 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 13-7 (Continued) (c) As we saw above, Koebel is generating positive cash from its operating activities While its free cash flow is negative (because of its investment in capital expenditures and relatively large dividend), it has little debt and is able to pay a generous dividend from its operating activities Its cash current debt coverage and cash total debt coverage ratios indicate that the cash provided from its operating activities is more than sufficient to pay the current and total liabilities Overall, the company appears to report strong profit and cash flow, which are likely two of the financial reasons Biscuits and Coffee Beans are interested in acquiring Koebel, in addition to strategic reasons discussed in the past (d) The Koebels will likely favour Biscuits over Coffee Beans Biscuits appears to have a stronger financial position than Coffee Beans It has more cash available to pay for its investment in Koebel’s Family Bakery Coffee Beans, on the other hand, does not pay a dividend and has decreased its overall cash position during 2016 Even though its cash current debt coverage and cash total debt coverage ratios are similar to those of Biscuits, its free cash flow is significantly less Other issues the Koebels should consider before finalizing their decision could include: • • • • Determining what percentage of ownership Natalie and Daniel will have going forward How will Natalie and Daniel feel about the change in control? Will they be paid in cash for the purchase of their shares or will they be asked to take back a note or preferred shares in partial payment? What are the income tax consequences of this sale? Solutions Manual 13-83 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition 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) Solutions Manual 13-84 Chapter 13 Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 (a)... this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition SOLUTIONS TO EXERCISES EXERCISE 13-1 (a) Cash Effect... transmission of this page is strictly prohibited www.downloadslide.net Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ANSWERS TO QUESTIONS The statement