Advanced Liquidity Analysis Worksheet Answer Key23

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Advanced Liquidity Analysis Learning Problems Answer Keys Advanced Liquidity Analysis Page 1

Managing Liquidity Ratios No. Transaction Current 1 R atio Quick Ratio 1 Cash Ratio 1 NWC Debt Ratio 1 Borrows $10,000 from the bank on a short-term note ↓ ↓ ↑ - ↑ 2 Writes off a $5,000 customer account ↓ ↓ - ↓ ↑ 3 Issues $25,000 in new common stock for cash ↑ ↑ ↑ ↑ ↓ 4 Purchases $7,000 of new equipment for cash ↓ ↓ ↓ ↓ - 5 $5,000 of inventory is destroyed by fire ↓ - - ↓ ↑ 6 Invests $3,000 in short-term marketable securities - - - - - 7 Issues $10,000 in long-term bonds ↑ ↑ ↑ ↑ ↑ 8 Sells equipment with a book value of $6,000 for $7,000 ↑ ↑ ↑ ↑ ↓ 9 Issues $10,000 of stock in exchange for land - - - - ↓ 10 Purchases $3,000 in inventory for cash - ↓ ↓ - - 11 Purchases $5,000 in inventory on credit ↓ ↓ ↓ - ↑ 12 Pays $2,000 to a supplier on account ↑ ↑ ↓ - ↓ Advanced Liquidity Analysis Page 2

Restructuring Provisions 1. December 31, 2018 Restructuring charges 4,110,000 Restructuring provision 4,110,000 Permissible Costs Severance pay $2,580,000 Retraining and relocation costs 1,530,000 Total $4,110,000 All other costs should not be included in the provision as they do not directly relate to the restructuring. March 1, 2019 Restructuring provision 1,950,000 Cash 1,950,000 April 1, 2019 Restructuring provision 200,000 Cash 200,000 September 1, 2019 Restructuring provision 1,150,000 Cash 1,150,000 November 1, 2019 Restructuring provision 1 810,000 Reversal of restructuring charge 810,000 1 4,110,000 – 1,950,000 – 200,000 – 1,150,000 = 810,000 Because the restructuring provision was for less than a year, the present value of the obligation was not used and no attempt was made to adjust the provision to reflect its proper value in light of new information. 2.  Roanoke attempted to include many costs in the restructuring charge and provision that where not directly related to the restructuring. They relate to the future operation of the business and not the restructuring. The “big bath” would have made 2018’s net income much lower but this would likely have been ignored by analysts given the company’s current financial situation. Costs recognized in future years would have been lower, so net income would have been higher making it appear that the company’s restructuring measures were having a greater positive effect than they really were. The CEO certainly would have taken credit for this improved performance.  Restructuring costs may have been intentionally over estimated so a large restructuring charge reversal could be realized next year. This reversal would help to “smooth” net income if the company was having a difficult year financially. The company may also try to delay recognizing Advanced Liquidity Analysis Page 3

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the reversal of the restructuring change till 2020 or 2021 to give them more flexibility in “smoothing” income.  Restructuring costs may have also been intentionally over estimated so other costs in future years could have been charged against the provision. Roanoke may use this to hide embarrassing cost overages in the future that are difficult to explain or to “pull” operating expenses “below the line” to make ongoing operating income appear larger than it really is. Advanced Liquidity Analysis Page 4

Warranty Provision 1. January 1, 2018 Warranty expense 1 300,000 Warranty provision 300,000 1 15,000,000 x .02 December 31, 2018 Warranty provision 1 220,000 Parts, wages payable etc. 220,000 1 440,000 / 2 December 31, 2019 Warranty provision 220,000 Parts, wages payable etc. 220,000 December 31, 2019 Warranty expense 1 140,000 Warranty provision 140,000 1 300,000 – 220,000 – 220,000 = -140,000 2. Ryan reduced warranty expense in 2018 by lowering the warranty cost estimate from three percent to two percent of sales. Given actual warranty claims, this reduction was not justified. The additional warranty expenses were recognized in 2019 when the obligation expired, but this is likely being used by Ryan to increase 2018 net income to meet its short-term earnings goals. Advanced Liquidity Analysis Page 5

Restoration Cost Provision 1. January 1, 2018 Mine Property 193,611,664 Cash 180,000,000 Restoration cost provision 13,611,664 1 180,000,000 + 20,000,000 / (1 + .08) 5 = 193,611,664 December 31, 2018 Depreciation Expense 1 38,722,333 Mine Property 38,722,333 1 193,611,664 / 5 = 38,722,333 December 31, 2019 Depreciation Expense 38,722,333 Mine Property 38,722,333 Note: Straight-line amortization was used because production at the mine will occur uniformly over the five-year period. If production was not uniform, a units-of-output method should be used. December 31, 2018 Interest expense 1,088,933 Restoration cost provision 1,088,933 December 31, 2019 Interest expense 1,176,048 Restoration cost provision 1,176,048 Period Beginning Balance Interest (.08) Ending Balance 2018 13,611,664 1,088,933 14,700,597 2019 14,700,597 1,176,048 15,876,645 2. Delta may have intentionally underestimated its restoration costs and overestimated its discount rate to reduce depreciation expense and interest expense in the short-term in 2018 and 2019. Advanced Liquidity Analysis Page 6

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Types of Accounting Transactions 1. Error correction that is accounted for retrospectively which means previous financial statements are adjusted to correct the error and make past financial statement more comparable to current statements. 2. Change in accounting estimate that is accounted for prospectively which means it is applied in future periods only. 3. Contingent asset that is noted even though it is probable. It must be virtually certain in order to be recognized based on the conservatism principle. Recognition will most likely occur when the regulatory commission makes its decision. 4. Change in accounting policy that is accounted for retrospectively. Accounting changes should only be made if they improve the quality of the financial information provided to users. A company may switch to FIFO from average cost to manipulate its financial statements by increasing the value of inventory and net income. An auditor may request that the change not be made. 5. Contingent liability that is noted since it is a possible obligation dependent on the outcome of a product liability lawsuit. Also, IFRS gives companies the option to just disclose the contingent liability in general terms with an explanation that saying anything more may prejudice their position in the dispute. 6. Related party transaction that is disclosed. Able and Doris are related because they are parent and subsidiary. The transaction should not be disclosed separately but categorized by the nature of the relationship between the two companies. Doris is Able’s parent, so this transaction should be included in the parent category. Also, IFRS requires that all parent-subsidiary relationships be disclosed even if no transactions between the parties occurred that year. 7. Related party transaction that is disclosed. Jackson and the CEO’s daughter are related as she is a close family member of the CEO who is key management personnel. The transaction should not be disclosed separately but categorized by the nature of the relationship between the two companies. The correct category is other related parties. 8. Even after reporting period that is accrued since the conditions existed at yearend. Even though the company did not learn of the bankruptcy until January 5, it is highly likely that Allison is already experiencing financial distress on December 31. 9. Contingent liability that is noted since it is a possible obligation dependent on the outcome of a product liability suit. Also, IFRS gives companies the option to just disclose the contingent liability in general terms with an explanation that saying anything more may prejudice their position in the dispute. 10. Related party transaction that is disclosed. Charlotte and Sigma are both subsidiaries of Rasputin. The transaction should not be disclosed separately but categorized by the nature of the relationship between the two companies. The correct category is other related parties. Advanced Liquidity Analysis Page 7

11. Source of estimation uncertainty that is disclosed. The estimate of the discount rate and the remaining capacity of the mine could change the value of the mining property by a material amount in the coming year once the study in complete. Estimation uncertainty disclosures should only be provided for items that could be affected in the near term as this is of the most concern to users. 12. Event after reporting that is accrued but only noted since the conditions did not exist at yearend since fires are a random event. 13. Change in accounting estimate that is accounted for prospectively. IFRS specifically states that adopting a different depreciation method is a change in estimate since going from the straight-line to the declining balance method is similar to reducing the depreciation period. 14. Event after reporting that is accrued but only noted since the conditions did not exist at yearend as Zippo was not purchased till March 10, 2018. The two companies were likely discussing the purchase at yearend, but the agreement was not final. 15. Related party transaction that is disclosed. The parent company Ryley and its subsidiary are related. The transaction should not be disclosed separately but categorized by the nature of the relationship between the two companies. Ryley is the parent, so this transaction should be included in the subsidiary category. Also, IFRS requires that all parent-subsidiary relationships be disclosed even if no transactions between the parties occurred that year. This transaction is also a contingent liability that should be noted since it is less than probable and its amount cannot be reasonably determined. It is not remote, so it should be noted. Advanced Liquidity Analysis Page 8