Chapter 1

Financial Statements and Business Decisions

Revised: August 5, 2022

E1–5
SYSCO CORPORATION
Statement of Earnings
For the Year Ended June 30, Current Year
(in millions of U.S. dollars)
Revenues:
Sales $51,298
Other revenues 27
Total revenues $51,325
Expenses:
Cost of sales 41,941
Selling, general, and
administration expenses 7,919
Interest expense 880
Total expenses 50,740
Earnings before income taxes 585
Income tax expense 61
Net earnings $ 524

E1–6
CORUS ENTERTAINMENT INC.
Statement of Earnings
For the Year Ended August 31, Current Year
(in thousands)
Revenues ($1,280,150 + $263,333) $1,543,483
Cost of sales 540,386
Depreciation expense 152,255
General and administrative expenses 478,479
Other expenses and losses 4,952
Interest expense 104,078
Total expenses excluding income taxes 1,280,150
Earnings before income tax 263,333
Income tax expense 68,760
Net earnings $ 194,573

E1–7
HOME REALTY INC.

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-1
 Statement of Earnings
For the Year Ended December 31, Current Year

Revenue:
Commissions ($150,000 + $16,000) $166,000
Rental service fees 15,000
Total revenues $181,000
Expenses:
Salaries 62,000
Commissions 35,000
Payroll taxes 2,500
Rent ($2,200 + $200) 2,400
Utilities 1,600
Promotion and advertising 8,000
Miscellaneous 500
Total expenses (excluding income taxes) 112,000
Earnings before income taxes 69,000
Income tax expense 18,500
Net earnings $ 50,500

E1–8
A Net Earnings = $91,700 – $76,940 = $14,760;
Shareholders’ Equity = $140,200 – $69,000 = $71,200.
B Total Revenues = $74,240 + $14,740 = $88,980;
Total Liabilities = $107,880 – $79,010 = $28,870.
C Net Earnings (Loss) = $69,260 – $76,430 = $(7,170);
Shareholders’ Equity = $97,850 – $69,850 = $28,000.
D Total Expenses = $58,680 – $21,770 = $36,910;
Total Assets = $17,890 + $78,680 = $96,570.
E Net Earnings = $84,840 – $78,720 = $6,120;
Total Assets = $25,520 + $79,580 = $105,100.
Company B is a profitable company whereas Company C is not. In addition, Company C’s
liabilities are relatively much higher than those of Company B. Consequently, lending money to
Company C is riskier than lending money to Company B, which appears to have a better
capacity to repay the loan over time.

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-2
E1–9
DUCHARME CORPORATION
Statement of Earnings
For the Month of January, Current Year

Total revenues $299,000

Less: Total expenses (excluding income taxes) 189,000
Earnings before income taxes 110,000
Less: Income tax expense 34,500
Net earnings $ 75,500
DUCHARME CORPORATION
Statement of Financial Position
As at January 31, Current Year

Assets
Cash $ 65,150
Receivables from customers 34,500
Merchandise inventory 96,600
Total assets $196,250
Liabilities and Shareholders’ Equity
Liabilities
Payables to suppliers $ 26,450
Income taxes payable 34,500
Total liabilities 60,950
Shareholders’ equity
Contributed capital (2,600 shares issued) 59,800
Retained earnings 75,500
Total liabilities and shareholders’ equity $196,250

E1-10

Retained earnings, January 1, 2023 $ –

Net earnings for 2023 31,000
Dividends for 2023 (14,200)
Retained earnings, December 31, 2023 16,800
Net earnings for 2024 42,000
Dividends for 2024 (18,700)
Retained earnings, December 31, 2024 $ 40,100

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-3
E1–12

(O) (1) Cash paid to suppliers

O (2) Cash received from customers
(F)* (3) Dividends paid
F (4) Issuance of share capital
(O)** (5) Interest paid
I (6) Proceeds from disposal of investment
(I) (7) Purchases of property, plant, and equipment
(F) (8) Repurchase of share capital

*Dividends paid in cash are normally subtracted in the financing section of the statement of
cash flows, but IFRS allows companies to report dividends paid in the operating section as
well. This issue is covered in Chapter 11.

**Interest paid can also be subtracted in the financing section of the statement of cash flows,
which is permitted under IFRS. This issue is covered in Chapter 11.

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-4
PROBLEMS
(Note to the instructor: Most students find the Problems in this chapter to be quite challenging.)

P1–1

Req. 1
NUCLEAR COMPANY
Statement of Earnings
For the Year Ended December 31, Current Year

Total sales revenue (given) $140,000

Total expenses, excluding income taxes (given) 89,100
Earnings before income taxes 50,900
Income tax expense ($50,900 x 30%) 15,270
Net earnings $ 35,630

Req. 2
NUCLEAR COMPANY
Statement of Shareholders’ Equity
For the Year Ended December 31, Current Year

Contributed Capital Retained Earnings

Balance, January 1, current year $ – $ –*
Issuance of shares (given) 87,000 –
+Net earnings (from req. 1) _ – 35,630
Balance, December 31, current year $87,000 $35,630

* Because this is the first year of operations, these beginning balances are zero.

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-5
P1–1 (continued)

Req. 3

NUCLEAR COMPANY
Statement of Financial Position
As at December 31, Current Year
Assets
Cash (given) $ 25,000
Accounts receivable (given) 12,000
Merchandise inventory (given) 90,000
Equipment, net (given) 45,000
Total assets $172,000

Liabilities and Shareholders’ Equity

Liabilities
Accounts payable (given) $47,370
Salary payable (given) 2,000
Total liabilities $ 49,370
Shareholders' equity
Contributed capital (given) 87,000
Retained earnings 35,630
Total shareholders' equity 122,630
Total liabilities and shareholders' equity $172,000

Req. 4

A creditor will know that $12,000 will be received by this company within a short period but
that it must also pay suppliers $47,370, also within a short period. When making a lending
decision, a creditor would use this information to determine the likelihood that the company
could repay a loan.

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-6
E12–13

Req. 1
Transaction Impact on Current Ratio (1.8)
(1) Increase, current liabilities will decrease proportionally more than current
assets.
(2) Decrease, current assets will decrease with no effect on current liabilities.
(3) No effect. The decrease in accounts receivable is offset by the decrease in the
allowance for doubtful accounts, assuming that the allowance method is used
as required by IFRS.
(4) Increase, current liabilities will decrease proportionally more than current
assets.

Req. 2

Current
Current Assets Current Liabilities Ratio
(1) (2) (1) ÷ (2)
Start $100,000 ($100,000 ÷ 1.5) $66,667 1.50
Transaction (1) Cash –6,000 Accounts payable –6,000
Subtotal 94,000 60,667 1.55

Transaction (2) Cash –20,000

Subtotal 74,000 60,667 1.22
Transaction (3) No effect
Transaction (4) Cash –20,000 Dividends payable –20,000
$ 54,000 $40,667 1.33

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-7
E12–14

Net sales = 2.01 x $2,148 million = $4,317.48 million

Less: cost of sales = 3.98 x $611 million = 2,431.78 million
Gross profit $1,885.70 million

E12–15

Current
Current Assets Current Liabilities Ratio
(1) (2) (1) ÷ (2)
Start $1,000,000 ($1,000,000 ÷ 2.0) $500,000 2.00
Transaction (1) Cash +26,000 Accounts payable +26,000
Subtotal 1,026,000 526,000 1.95

Transaction (2) 0 Dividends payable +40,000

Subtotal 1,026,000 566,000 1.81

Transaction (3) Prepaid expenses +24,000

Cash –24,000

Transaction (4) Cash –40,000 Dividends payable –40,000

Subtotal 986,000 526,000 1.87

Transaction (5) Cash +20,000

Accounts receivable –20,000

Transaction (6) 0 Current portion of +90,000

long-term debt
$986,000 $616,000 1.60

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-8
PROBLEMS
P12–1
Req. 1
Increase (Decrease)
Year 2 over Year 1
Amount Percentage
Statement of earnings
Sales revenue............................................................................... $30,000 18.18
Cost of sales................................................................................. 20,000 20.00
Gross profit.................................................................................. 10,000 15.38
Operating expenses and interest expense.................................. 7,000 13.21
Earnings before income taxes...................................................... 3,000 25.00
Income tax expense..................................................................... 1,000 33.33
Net earnings................................................................................. $ 2,000 22.22
Statement of financial position
Cash.............................................................................................. $ (4,000) (50.00)
Accounts receivable (net)............................................................ (3,000) (16.67)
Inventory...................................................................................... 5,000 14.29
Property, plant, and equipment (net)......................................... 7,000 18.42
$ 5,000 5.05
Current liabilities.......................................................................... $ (3,000) (15.79)
Long-term debt............................................................................ 6,000 15.38
Common shares........................................................................... – –
Retained earnings........................................................................ 2,000 18.18
$ 5,000 5.05
Req. 2
a. Working capital
Year 2 Year 1
Current assets
Cash ………………………………………………………………………………. $ 4,000 $ 8,000
Accounts receivables (net) …………………………………………….. 15,000 18,000
Inventory ……………………………………………………………………….. 40,000 35,000
Total current assets ………………………………………………………….. 59,000 61,000
Current liabilities ………………………………………………………………. 16,000 19,000
Working capital ……………………………………………………………… $43,000 $42,000

Change: $43,000 – $42,000 = $1,000 increase

b. Average income tax rates:

Year 1: $3,000 ÷ $12,000 = 25% Year 2: $4,000 ÷ $15,000 = 26.7%
Change in average tax rate = (26.7 – 25.0) ÷ 25 = 6.8% increase

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-9
P12–1 (continued)

c. Cash inflow from revenues

Total revenue ……………………………………………………………………………………….. $195,000
Decrease in accounts receivable ($18,000 – $15,000) …………………………… 3,000
Total ………………………………………………………………………………………………. $198,000

d. Year 1: $65,000 ÷ $165,000 = 39.4%

Year 2: $75,000 ÷ $195,000 = 38.5%
0.9% Decrease in gross profit margin ratio

Percentage change in this ratio = 0.9% ÷ 39.4% = 2.3%

P12–5

Req. 1
Ratio Armstrong Company Blair Company
Profitability ratios
1. Return on equity $22,500 ÷ $120,000 = 18.75% $45,000 ÷ $340,000 = 13.24%
2. Return on assets $22,500 ÷ $200,000 = 11.25% $45,000 ÷ $400,000 = 11.25%
3. Gross profit margin $102,500 ÷ $225,000 = 45.56% $202,500 ÷ $405,000 = 50%
4. Net profit margin $22,500 ÷ $225,000 = 10% $45,000 ÷ $405,000 = 11.11%
5. Earnings per share $22,500 ÷ 7,500 shares = $3.00 $45,000 ÷ 25,000 shares = $1.80
Asset turnover ratios
6. Fixed asset turnover $225,000 ÷ $70,000 = 3.21 $405,000 ÷ $200,000 = 2.03
7. Receivables turnover $75,000 ÷ $135,000 ÷
[($10,000 + $20,000) ÷ 2] = 5.00 [($20,000 + $15,000) ÷ 2] = 7.71
8. Inventory turnover $ 122,500 ÷ $202,500 ÷
[($46,000 + $50,000) ÷2] = 2.55 [($24,000 + $20,000) ÷ 2] = 9.20
Liquidity ratios
9. Current ratio $87,500 ÷ $50,000 = 1.75 $46,000 ÷ $25,000 = 1.84
10. Quick ratio $37,500 ÷ $50,000 = 0.75 $26,000 ÷ $25,000 = 1.04
11. Cash ratio $17,500 ÷ $50,000 = 0.35 $11,000 ÷ $25,000 = 0.44
Solvency ratios
12. Times interest earned ratio ($22,500 + $3,000 + $9,643*) ÷ ($45,000 + $3,500 + $19,286*) ÷
$3,000 = 11.71 $3,500 = 19.37
*[$22,500 (NE) ÷ (1–0.30)] x 0.3 * [$45,000 (NE) ÷ (1 – 0.30)] x 0.3
13. Debt-to-equity ratio $80,000 ÷ $120,000 = 0.67 $60,000 ÷ $340,000 = 0.18
Market ratios
14. Price/earnings ratio $18 ÷ $3 = 6.0 $15 ÷ $1.80 = 8.33
15. Dividend yield ratio ($18,000 ÷ 7,500 shares) ÷ $18 = ($75,000 ÷ 25,000 shares) ÷ $15
13.33% = 20%

Req. 2
Recommended choice: Armstrong Company

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-10
Basis for recommendation:
1. The reported information for Armstrong Company is audited; therefore, it has more
credibility.
2. Armstrong Company is more likely to be profitable in the future than Blair Company
because its return on equity is 19% (compared with 13% for Blair Company). Armstrong
Company obtains 40% ($80,000/$200,000) of its total resources by borrowing compared
with 15% ($60,000/$400,000) by Blair Company. Both companies can borrow at 7% net of
tax while earning equal rates of return on assets.

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-11
P12–5 (continued)

Req. 2 (continued)

Armstrong Company is taking better advantage of this leverage. Armstrong Company has a
net profit margin of 10% (compared with a slightly higher net profit margin (11%) for Blair
Company). Armstrong Company reported net earnings of $22,500 while using total
investment of only $200,000. Blair Company reported net earnings of $45,000 while using
total investment of $400,000, but Armstrong Company has a much higher return on its total
investment because of its use of debt that pays an after-tax interest rate of 7% (thus,
achieving a much higher return on shareholders’ equity: 19% compared with 13%).
3. Armstrong Company is more effective than Blair Company in managing its fixed assets, but
could improve on its management of both accounts receivable and inventory.
4. Blair Company has a better liquidity position if measured in terms of the current ratio (1.84
compared with 1.75) and its quick ratio is better (1.04 compared with 0.75).
5. Blair Company is in a better position in respect to credit and collections (receivables
turnover of 7.71 compared with 5.0) as well as inventory turnover (9.20 compared with
2.55).
6. The market ratios are in favour of Blair Company. However, Blair Company declared and
paid a dividend in excess of the current year’s net earnings. This pattern may not continue
as Blair Company is lower on cash ($11,000). Also, the high amount of “other” assets
($154,000, or 39%) raises the question of their contribution to earnings.

Constraint — The above analysis is based on only one year, which poses a problem of
evaluation. Selected detailed data for the prior year should be analyzed in a similar manner. A
five- to ten-year summary of selected values also would be quite useful. Other particularly
important information should be evaluated, such as the characteristics of the company, the
industry, economic conditions, and the quality of the company’s management.

Note to Instructor – a recommendation of either company is acceptable as long as it is

consistent with the analysis.

Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-12
Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved.
1-13