978-1259722653 Chapter 1 Solution Manual Part 3

P1-14. Debt Covenants and Aggressive Accounting Practices (LO 1-4)

Requirement 1:

When a company violates its debt covenants, lenders can respond in

any of several ways. They can simply waive the violation which is

akin to a “slap on the wrist”. Or, they can amend the loan agreement

Requirement 2:

Although the details of the company’s EBITDA covenant are not

spelled out in the company’s press release, Friedman’s is required to

maintain a minimum level of profitability (measured using EBITDA)

over several periods. Aggressive accounting practices—premature

Requirement 3:

Friedman’s is required to maintain a minimum ratio of accounts

P1-15. Toshiba Corporation (LO 1-6)

Requirement 1:

The company’s 2015 annual report opens with a Management

Discussion and Analysis typical of U.S. companies. This MD&A

contains a five-year summary of selected income statement and

balance sheet accounts, a review of operations and key performance

Requirement 2:

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.

The following financial statements are included in the 2015 annual

report: Consolidate Balance Sheets, Statements of Income,

Requirement 3:

According to Note 2 Summary of Significant Accounting Policies, the

company’s financial statements are prepared in accordance with

Japanese GAAP. However, “certain adjustments and reclassifications

have been incorporated in the accompanying consolidated financial

Requirement 4:

In this case, the answer lies in the response to Requirement 3: No

P1-16. Carrefour Group (LO 1-5)

Requirement 1:

The company’s 2015 “annual report” contains summary consolidated

financial statements of income, financial position, and cash flow. No

Requirement 2:

Most of the annual report is devoted to describing the company, its

strategic goals and core values including the customer value

proposition: brand strategy, store configuration and development

goals, convenience and pricing. A section of the annual report

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.

Requirement 3:

The company’s 2015 “financial report” contains detailed consolidate

financial statements (financial position, income, shareholders’ equity,

Requirement 4:

Carrefour’s consolidated financial statements are prepared in

Requirement 5:

The order in which individual accounts are listed by Carrefour Group

on the asset side and liabilities/equity side of the statement of financial

position is the reverse of what is common among U.S. companies.

For example, the first asset listed is Goodwill, followed by other

Financial Reporting and Analysis (7th Ed.)

Chapter 1 Solutions

The Economic and Institutional Setting for Financial Reporting

Cases

C1-1. Novartis AG: Form 20-F Reconciliation (LO 1-6)

Requirement 1:

For 2006, the difference between IFRS net income from continuing

Requirement 2:

Most people would argue that Novartis management would prefer to

report the high dollar amount (IFRS net income) rather than the lower

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.

Requirement 3:

Which is warmer, a room with a temperature of 22.2 Celsius or one

where the temperature is 72 Fahrenheit? Even though “72” is bigger

Sophisticated investors understand that a similar concept applies to

income measured using two different accounting scales: US GAAP

Requirement 4:

Investors who contemplate buying (selling) a foreign company’s stock

traded on a U.S. stock exchange may evaluate its relative profit

Requirement 5:

Form 20-F reconciliations of IFRS earnings to U.S. GAAP earnings

are less important to investors in this setting. There may be rare

cases where investors who contemplate buying (selling) a foreign

company’s stock traded on a foreign stock exchange want to evaluate

C1-2. Henley Manufacturing Inc.: Announcing sales and earnings

goals (LO 1-3)

Requirement A:

1) Potential costs of announcing earnings and sales goals include:

(a) possible shareholder lawsuits if goals are not met; (b) loss of

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.

Potential benefits include: (a) investors can better understand the

risks and rewards of stock ownership because they know more about

the management’s plans; (b) disclosure may improve relationships

2) Should management disclose its earnings and sales goals? It

Easily achievable goals are likely to be disclosed without much

reservation. Difficult goals are less likely to be disclosed because

management may not want to risk disappointing investors if results fall

3) In all likelihood, the recommendation would change. Consideration

would now be given to the fact that, as the planning horizon increases,

Requirement B:

In this case, the nature of the goals is quite varied. In all likelihood,

investors and financial analysts are going to be more interested in

C1-3. Fortress International: Disclosing major customers (LO 1-2)

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.

1) The SEC requires firms to alert financial statement readers about

major customers that contribute 10% or more to annual sales. Such

information helps investors and analysts assess sales volatility and

2) Financial analysts might use these disclosures in the following

ways:

 To assess customer risk. The more revenue a company derives

from a single customer or small group of customers, the greater the

 By studying a firm’s major customers (i.e., the products they sell,

expected future demand for such products, untapped markets in

other countries or geographical areas), an analyst can determine

3) Fortress International (now TSS Inc.) offers planning, design,

engineering, construction management, commissioning and

maintenance services for specialized facilities such as data centers,

The primary reason major customers might monitor the financial

health of Fortress International is to ensure that Fortress can be relied

upon as a supplier of facilities services for new or existing locations.

Customers are likely to be interested in monitoring Fortress’s overall

4) Fortress monitors the financial health of key customers to ensure

that they will be a continuing source of demand for its services in the

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.

C1-4. The gap in GAAP (LO 1-4)

1) Advantages of allowing managers some flexibility in the choice of

financial reporting methods include:

 Accounting must serve as a slave to many masters. Stated

differently, financial accounting information is used for many

purposes including valuation, credit analysis, and contracting, and

 If managers have some latitude in their choice of financial

reporting methods, they can adapt the firm’s financial reporting

practices to changes in the firm’s economic characteristics and/or

environment over time. For example, a change in the rate of

2) The current financial reporting system in the United States is really a

combination of the two approaches.

On the one hand, firms have latitude in the selection of accounting

methods to summarize various transactions and events. Examples

include inventory valuation where firms may select from LIFO, FIFO,

On the other hand, there are numerous cases where the FASB (or

SEC) has mandated a single accounting method or treatment for

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.

3) The advantages of a single set of accounting methods include:

 Facilitates comparability of financial information across firms at a

 Ease of verification by the auditing profession. This may lead to

fewer shareholder lawsuits against the company or its auditors for

The disadvantages of a single set of accounting methods include:

 Assumes that the financial performance and condition of all firms

can adequately be captured by a single set of accounting methods.

 Assumes that a single set of accounting methods serves all the

 Firms can tailor their choice of financial reporting methods to the

specifics of their economic environment and circumstances. For

example, depending on whether the prices of its input products are

increasing or decreasing, FIFO may be a more realistic choice of

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.

The disadvantages of allowing some flexibility in the choice of

financial reporting methods include:

 Managers may use their discretion over reporting methods to

distort the firm’s performance. They might adopt financial reporting

practices that create the appearance of profitability in an attempt to

C1-5. Landfil’s accounting change (LO 4)

Here are the major positions outlined at the meeting:

“It’s consistent with GAAP and fully disclosed.” While true, this approach may

not be comforting to analysts and investors concerned about whether

capitalization makes the company look more profitable than it really is. Given

“We capitalize, and we’re proud of it!” The heart of this strategy is the notion

that the company has already made the “correct” accounting decision—one

“We can afford to change.” Even if capitalization is the “best” (most

appropriate) accounting method for Landfil, it still might be advantageous to

change. First, a change to immediate expensing will dispel any remaining

skepticism on the part of investors and analysts. Second, it demonstrates

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sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or

posted on a website, in whole or part.