13 Current Liabilities and Contingencies Financial Reporting Problem 13
Financial Reporting Problem
The Procter & Gamble Company (P&G)
The financial statements of P&G are presented in Appendix B. The company’s complete annual report, including the notes to the financial statements, is available online.
Instructions
Refer to these financial statements and the accompanying notes to answer the following questions.
(a) What was P&G’s 2014 short-term debt and related weighted-average interest rate on this debt?
(b) What was P&G’s 2014 working capital, acid-test ratio, and current ratio? Comment on P&G’s liquidity.
(c) What types of commitments and contingencies has P&G’s reported in its financial statements? What is management’s reaction to these contingencies?
Comparative Analysis Case
The Coca-Cola Company and PepsiCo, Inc.
The financial statements of Coca-Cola and PepsiCo are presented in Appendices C and D, respectively. The companies’ complete annual reports, including the notes to the financial statements, are available online.
Instructions
Use the companies’ financial information to answer the following questions.
(a) How much working capital do each of these companies have at the end of 2014?
(b) Compute each company’s (a) current cash debt coverage, (b) cash debt coverage, (c) current ratio, (d) acid-test ratio,
(e) accounts receivable turnover, and (f) inventory turnover for 2014. Comment on each company’s overall liquidity.
(c) What types of loss or gain contingencies do these two companies have at the end of 2014?
Financial Statement Analysis Cases
CAse 1: Northland Cranberries
Despite being a publicly traded company only since 1987, Northland Cranberries of Wisconsin Rapids, Wisconsin, is one of the world’s largest cranberry growers. During its short life as a publicly traded corporation, it has engaged in an aggressive growth strategy. As a consequence, the company has taken on significant amounts of both short-term and long-term debt. The following information is taken from recent annual reports of the company.
Instructions
(a) Evaluate the company’s liquidity by calculating and analyzing working capital and the current ratio.
(b) The discussion of the company’s liquidity, shown below, was provided by the company in the Management Discussion and Analysis section of the company’s annual report. Comment on whether you agree with management’s statements, and what might be done to remedy the situation.
CAse 2: Mohican Company
Presented below is the current liabilities section and related note of Mohican Company.
…
Instructions
Answer the following questions.
(a) What is the difference between the cash basis and the accrual basis of accounting for warranty costs?
(b) Under what circumstance, if any, would it be appropriate for Mohican Company to recognize deferred revenue on warranty contracts?
(c) If Mohican Company recognized deferred revenue on warranty contracts, how would it recognize this revenue in subsequent periods?
CAse 3: BOP Clothing Co.
As discussed in the chapter, an important consideration in evaluating current liabilities is a company’s operating cycle. The operating cycle is the average time required to go from cash to cash in generating revenue. To determine the length of the operating cycle, analysts use two measures: the average days to sell inventory (inventory days) and the average days to collect receivables (receivable days). The inventory-days computation measures the average number of days it takes to move an item from raw materials or purchase to final sale (from the day it comes in the company’s door to the point it is converted to cash or an account receivable). The receivable-days computation measures the average number of days it takes to collect an account.
Most businesses must then determine how to finance the period of time when the liquid assets are tied up in inventory and accounts receivable. To determine how much to finance, companies first determine accounts payable days—how long it takes to pay creditors. Accounts payable days measures the number of days it takes to pay a supplier invoice. Consider the following operating cycle worksheet for BOP Clothing Co.
These data indicate that BOP has reduced its overall operating cycle (to 261.5 days) as well as the number of days to be financed with sources of funds other than accounts payable (from 78 to 63 days). Most businesses cannot finance the operating cycle with accounts payable financing alone, so working capital financing, usually short-term interest-bearing loans, is needed to cover the shortfall. In this case, BOP would need to borrow less money to finance its operating cycle in 2017 than in 2016.
Instructions
(a) Use the BOP analysis to briefly discuss how the operating cycle data relate to the amount of working capital and the current and acid-test ratios.
(b) Select two other real companies that are in the same industry and complete the operating cycle worksheet, along with the working capital and ratio analysis. Briefly summarize and interpret the results. To simplify the analysis, you may use ending balances to compute turnover ratios. [Adapted from Operating Cycle Worksheet at www.entrepreneur.com]
Accounting, Analysis, and Principles
(Note: For any part of this problem requiring an interest or discount rate, use 10%.)
YellowCard Company manufactures accessories for iPods. It had the following selected transactions during 2017.
1. YellowCard provides a 2-year warranty on its docking stations, which it began selling in 2017. During 2017, YellowCard spent $6,000 servicing warranty claims. At year-end, YellowCard estimates that an additional $45,000 will be spent in the future to service warranties related to 2017 sales.
2. YellowCard has a $200,000 loan outstanding from First Trust Corp. The loan is set to mature on February 28, 2018. For several years, First Trust has agreed to extend the loan, as long as YellowCard makes all its quarterly interest payments (interest is due on the last days of each February, May, August, and November) and maintains an acid-test ratio (also called “quick ratio”) of at least 1.25. First Trust has provided YellowCard a “commitment letter” indicating that First Trust will extend the loan another 12 months, providing YellowCard makes the interest payment due on March 31.
3. During 2016, YellowCard constructed a small manufacturing facility specifically to manufacture one particular accessory. YellowCard paid the construction contractor $5,000,000 cash (which was the total contract price) and placed the facility into service on January 1, 2017. Because of technological change, YellowCard anticipates that the manufacturing facility will be useful for no more than 10 years. The local government where the facility is located required that, at the end of the 10-year period, YellowCard remediate the facility so that it can be used as a community center. YellowCard estimates the cost of remediation to be $500,000.
Accounting
Prepare all 2017 journal entries relating to (a) YellowCard’s warranties, (b) YellowCard’s loan from First Trust Corp., and (c) the new manufacturing facility YellowCard opened on January 1, 2017.
Analysis
Describe how the transactions above affect ratios that might be used to assess YellowCard’s liquidity. How important is the commitment letter that YellowCard has from First Trust Corp. to these ratios?
Principles
YellowCard is contemplating offering an extended warranty. If customers pay an additional $50 at the time of product purchase, YellowCard would extend the warranty an additional two years. Would the extended warranty meet the definition of a liability under current generally accepted accounting principles? Briefly explain.
