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3-14 Intermediate Accounting, 8/e
FINANCIAL DISCLOSURES (continued)
Management responsibilities
➢ Annual reports include a management's responsibility
section that:
Asserts the responsibility of management for the information
contained in the annual report as well as an assessment of the
company's internal control systems.
States the responsibility of the auditors to attest to
management’s assessment of the effectiveness of internal
control over financial reporting.
Auditors’ report
➢ The auditors' report provides the analyst with an
independent and professional opinion about the fairness of
the representations in the financial statements and the
effectiveness of the company’s internal control over
financial reporting.
Compensation of Directors and Top Executives
➢ The proxy statement reported each year to shareholders
include information on the compensation (including stock
options) to directors and executives.
LIQUIDITY RATIOS
➢ Liquidity ratios provide measures of a company's ability to
satisfy its short-term obligations.
Current ratio = Current assets
Current liabilities
Acid-test ratio = Quick assets
(or quick ratio) Current liabilities
T3-9
3-16 Intermediate Accounting, 8/e
FINANCING RATIOS
➢ Financing ratios provide some indication of the riskiness of a
company with regard to its ability to pay its long-term debts.
Debt to equity ratio = Total liabilities
Shareholders' equity
Times interest earned ratio = Net income + interest expense + taxes
Interest expense
T3-10
REPORTING SEGMENT INFORMATION
Information is reportable for identifiable operating segments.
An operating segment is a component of an enterprise
➢ That engages in business activities from which it may recognize revenues
and incur expenses (including revenues and expenses relating to
transactions with other components of the same enterprise).
Only segments of a certain size (10% or more of total
company revenues, assets, or net income) must be disclosed.
However, a company must account for at least 75% of
consolidated revenue through segment disclosures.
For areas determined to be operating segments, the following
disclosures are required:
➢ General information about the operating segments.
➢ Information about reported segment profit or loss, including certain
T3-11
3-18 Intermediate Accounting, 8/e
Suggestions for Class Activities
1. Research Activity
The balance sheet does not portray the market value of the entity. A company’s book value
(shareholders’ equity) will likely be less than its market value as measured by the market value of its
shares outstanding (number of common stock shares outstanding multiplied by price per share).
Market value often is referred to as the company’s “market capitalization.”
Suggestions:
Have the class obtain and compare the book value and market value for a number of large
companies. Ask them to think of reasons why the ratios of market to book differ across their sample
2. Research Activity
The ratio of market-to-book for most oil and gas companies is significantly greater than 1.0.
Suggestions:
Have the class consider why an oil and gas company would have a ratio greater than 1.0. One
reason is that these companies have proven oil and gas reserves listed in their balance sheets that are
3. PetSmart Analysis
1. Compare the balance sheet with that presented in the 2014 report in Appendix B of the text.
Are there any differences in the classifications used or the elements contained in those
classifications?
2. Compare the Summary of Significant Accounting Policies disclosure note with that presented
in the 2014 report. Have there been any discernible changes in accounting policies employed
by the company?
3. Compute the financing ratios discussed in the chapter for the most recent annual report year
and for the 2014 year and compare their results. Are there any discernible trends? How might
they be interpreted?
5. Use EDGAR to locate the most recent annual report information for PetMed Express, a pet
pharmacy company. Using the most recent annual report information for both companies,
compare financing ratios discussed in the chapter. Also, are there any accounting policy
differences that could have an impact on the comparison of the two companies?
4. Professional Skills Development Activities
The following are suggested assignments from the end-of-chapter material that will help your
students develop their communication, research, analysis and judgment skills.
Communication Skills. In addition to Communication Case 3-1, Judgment Case 3-11 can be
adapted to ask students to write a letter to a client explaining the effects of the two financing
Research Skills. In their careers, our graduates will be required to locate and extract relevant
information from available resource material to determine the correct accounting practice,
Analysis Skills. The “Broaden Your Perspective” section includes Analysis Cases that direct
students to gather, assemble, organize, process, or interpret data to provide options for making
Judgment Skills. The “Broaden Your Perspective” section includes Judgment Cases that require
students to critically analyze issues to apply concepts learned to business situations in order to
5. Ethical Dilemma
The chapter contains the following ethical dilemma:
ETHICAL DILEMMA
The Raintree Cosmetic Company has several loans outstanding with a local bank. The debt
agreements all contain a covenant stipulating that Raintree must maintain a current ratio of at least
0.9. Jackson Phillips, company controller, estimates that the 2016 year-end current assets and
current liabilities will be $2,100,000 and $2,400,000, respectively. These estimates provide a
current ratio of only 0.875. Violation of the debt agreement will increase Raintree's borrowing
costs as the loans are renegotiated at higher rates.
Jackson proposes to the company president that Raintree purchase inventory of $600,000 on
credit before year-end. This will cause both current assets and current liabilities to increase by the
same amount, but the current ratio will increase to 0.9. The extra $600,000 in inventory will be
used over the later part of 2017. However, the purchase will cause warehousing costs and
financing costs to increase.
Jackson is concerned about the ethics of his proposal. What do you think?
You may wish to discuss this in class. If so, discussion should include these elements.
Step 1—The Facts:
The debt agreements for loans of Raintree Cosmetic Company require the firm to maintain a
current ratio of 0.9. If the company does not maintain the required ratio, borrowing costs on the
Step 2—The Ethical Issue and the Stakeholders:
The ethical issue or dilemma is whether the controller's obligation to reduce the company's
borrowing costs is greater than his obligation to provide information that is not misleading to users
of the financial statements. Users include the bank making the loans.
Step 3—Values:
Values include honesty, integrity, objectivity, loyalty to the company, and responsibility to users
of financial statements.
Step 4—Alternatives:
1. Purchase the additional $600,000 of inventory in order to maintain the current ratio at 0.9.
to the required 0.9.
Step 5—Evaluation of Alternatives in Terms of Values:
1. Alternative 1 illustrates loyalty to the company's effort to maintain the debt covenant and
reduce borrowing costs.
2. Alternative 2 exhibits the values of competence, honesty, integrity, objectivity, and
Step 6—Consequences:
Alternative 1
Positive consequences: Jackson may please the president and other top managers by enabling the
company to meet the current ratio agreement. Borrowing costs would remain the same.
Negative consequences: Users of the financial statements, including the bank, may believe that
Alternative 2
Positive consequences: Users of financial statements would receive more relevant and reliable
information regarding the company's current ratio and financial position. Jackson would maintain
Alternative 3
Positive consequences: The bank may agree to the lower current ratio and not renegotiate
borrowing costs. Jackson would receive the respect of the president and other managers.
Step 7—Decision:
Student(s) must decide their course of action.
3-22 Intermediate Accounting, 8/e
Assignment Chart
Learning Est. time
Questions Objective(s) Topic (min.)
3-1
1
Purpose of the balance sheet
5
3-2
1
Usefulness of the balance sheet
5
3-3
2
Current assets
5
3-4
3
Current liabilities
5
3-5
2,3
Operating cycle
5
3-7
2
Property, plant, and equipment
5
3-8
2
Property, plant, and equipment versus intangibles
5
3-9
3
Liability classification
5
3-11
4
Disclosure notes
5
3-12
4
Significant accounting policies
5
3-13
4
Subsequent events
5
3-14
5
Management discussion and analysis
5
3-15
6
Audit report
5
3-16
4
Proxy statement
5
3-17
8
Liquidity ratios
5
3-19
9
IFRS; balance sheet presentation
5
3-20
9
IFRS; balance sheet presentation
5
3-21
A
Segment reporting [Based on Appendix]
5
3-23
9,A
IFRS; segment reporting; [Based on Appendix]
5
Brief Learning Est. time
Exercises Objective(s) Topic (min.)
3-1
2,3
Current versus noncurrent classification
5
3-3
2,3
Balance sheet classification
5
3-4
2,3
Balance sheet preparation
15
3-5
2,3
Balance sheet preparation
15
3-7
2,3
Balance sheet preparation; missing elements
10
3-8
4
Financial disclosures
5
3-9
8
Calculating ratios
10
3-11
8
Calculating ratios; solving for unknowns
10
Learning Est. time
Exercises Objective(s) Topic (min.)
3-1
2,3,8
Balance sheet; missing elements
10
3-2
2,3
Balance sheet classification
10
3-3
2,3
Balance sheet classification
10
3-4
2,3
Balance sheet preparation
15
3-6
2,3
Current versus noncurrent classification
15
3-7
2,3
Balance sheet preparation; errors
20
3-8
2,3
Balance sheet; current versus noncurrent
classification
10
3-9
2,3
Balance sheet preparation; cash versus accrual;
Chapters 2&3
30
3-10
4
Financial disclosures
10
3-11
4
Disclosures notes
15
3-12
4
Financial disclosures
10
3-14
2,4
FASB codification research
20
3-15
2,3,4,6
Concepts; terminology
15
3-16
8
Calculating ratios
10
3-17
8
Calculating ratios; Best Buy
15
3-18
8
Calculating ratios; solve for unknowns
25
3-19
8
Calculating ratios; solve for unknowns
20
3-20
8
Effect of management decisions on ratios
20
3-22
9,A
IFRS; segment reporting [Based on Appendix]
10
3-24 Intermediate Accounting, 8/e
CPA/CMA Learning Est. time
Exam Questions Objective(s) Topic (min.)
CPA-1
2
Current versus noncurrent classification
3
CPA-2
3
Current versus noncurrent classification
3
CPA-3
4
Disclosure notes
3
CPA-4
6
Auditors’ report
3
CPA-5
8
Ratios
3
CPA-7
9
IFRS
3
CPA-8
9,A
IFRS [Based on Appendix]
3
CMA-1
4
Related party transactions disclosure
3
CMA-3
8
Ratios
3
Learning Est. time
Problems Objective(s) Topic (min.)
3-1
2,3
Balance sheet preparation
15
3-3
2,3
Balance sheet preparation
30
3-4
2,3
Balance sheet preparation
30
3-5
2,3
Balance sheet preparation
40
3-6
2,3,4
Balance sheet preparation, disclosures
45
3-7
2,3
Balance sheet preparation; errors
35
3-8
2,3
Balance sheet; errors; missing amounts
40
3-9
2,3
Balance sheet preparation
30
Learning Est. time
Cases Objective(s) Topic (min.)
Communication Case 3-1
2
Current versus noncurrent classification
10
Analysis Case 3-2
2,3
Current versus noncurrent classification
15
Communication Case 3-3
2
Inventory or property, plant, and equipment
20
IFRS Case 3-4
2,3,9
IFRS; balance sheet presentation; Vodafone
20
Judgment Case 3-5
2,3,4
Balance sheet; errors
30
Judgment Case 3-6
4
Financial disclosures
15
Real World Case 3-7
2,3,4,8
Balance sheet and significant accounting policies
disclosure; Walmart
20
Judgment Case 3-8
4
Post fiscal year-end events
15
Research Case 3-9
4
FASB codification; disclosure of related party
transactions; Enron
35
Real World Case 3-10
4,6
Disclosures; proxy statement; Coca-Cola Co.
45
Judgment Case 3-11
7
Debt versus equity
25
Analysis Case 3-12
4,6,7,8
Obtain and critically evaluate an actual annual
report
50
Analysis Case 3-13
4,7,8
Obtain and compare annual reports from
companies in the same industry
95
Analysis Case 3-14
2,3,4
Balance sheet information; Petsmart
15
Analysis Case 3-15
9,A
IFRS; segment reporting concepts [Based on
Appendix]
15
Ethics Case 3-16
A
Segment reporting [Based on Appendix]
20
Air France-KLM Case
9
IFRS; balance sheet presentation; Air France-
KLM
15
