FINANCIAL ACCOUNTING (Williams et al.

)
Suggested Answers for Your Turn cases
Chapter 1
You as a Creditor
As a creditor, you are interested in the borrowers ability to repay the $10,000 that she
borrows, plus an additional amount for the use of your banks money for the time the loan
is outstanding. Information that would assist you in making a decision regarding the
creditworthiness of the potential borrower would include employment and income
information, other expenses that she must pay (for example, rent or house payment), and
her history of borrowing and repaying loans. In other words, you are interested in the
borrowers cash flow prospects, or her ability to repay the amount of the loan, plus a
fee for the use of the banks money (called interest) in accordance with the agreement
reached at the time the loan is made.
You as a Professional Accountant
This situation puts you in a very difficult position. On the one hand, you want to do the
right thing and, in your opinion, that involves an in-depth study of the problem you have
found. On the other hand, you are pulled in the direction of doing what your superior says
to do because you must respect her position as your superior. You may want to discuss
with your superior the potential implications of the irregularities that you have found and
try to convince her that some additional effort to better understand what is going on may
be very important. You may want to discuss this with a peer or another person not directly
involved in your engagement but whose opinion you value. You may want to talk with a
person higher up in the organization than your superior, although you should be careful to
avoid creating a conflict with your superior. You probably should keep a record of the
steps you have taken to resolve the situation and certainly keep your eyes open for a
pattern of similar behavior that may be a signal to you that you need to consider a job
elsewhere. Also, if you are responsible for auditing this area and you believe that the
audit procedures employed to date are insufficient, following your superiors instructions
will generally not be an adequate defense if regulators or private litigants name you in a
lawsuit. Simply following orders was not an adequate defense at the Nuremberg Trials
(Nazi war crimes trials), it was not an adequate defense for Lieutenant Calley in Vietnam,
and it is not an adequate defense in business.
Chapter 2
You as a Home Owner
In both situations, sales of comparable homes in the same location provide information
about the value of your home. However, as your home has not been recently sold, the
specific home value (asset value) is unknown. The ethical dilemma arises in precisely
what objective information to report. For example, if 10 homes in the immediate area
have sold within the last three months, which of those sales would you report? If the real
estate assessors office asked for three comparable sales, what information might be

provided? The assessors office will be concerned about the objectivity of the reporting
choices made by the home owner.
Because home owners wish to minimize their tax burden, many municipalities employ a
city property appraiser to verify the value of real estate. This appraiser assesses whether
the current assessment amount is a fair representation of a houses current market value.
Alternatively, because home owners wish to maximize the sales price of their homes,
they might choose different comparable home sales prices to report to a buyer than those
chosen for the real estate assessor. Thus, although buyers may request comparable home
sales information from the seller, they will usually undertake their own investigation (i.e.
hire their own appraiser) to verify the value of the home.
The ethical issues are related to objective (not selective) reporting. Having independent
parties make an independent assessment of the market price of your home mitigates some
of the ethical issues related to objective reporting.
You as a Creditor
The primary factor you would want to consider is when the notes payable listed on
Overnights balance sheet must be paid. If the notes payable must be paid within the next
year, Overnight has more than twice as much in current liabilities than it has in current
assets. A current ratio of .48:1 indicates that Overnight may have difficulty paying its
bills as they become due. And, given Overnights modest profit of $800, it probably will
not be able to generate sufficient cash flow to pay $37,000 of liabilities within the next
year. One alternative would be to lend to Overnight, subject to receiving a personal
guarantee of the debt from Overnights owners. In essence, the personal assets of
Overnights owners would serve as additional collateral for the credit that your company
is providing Overnight.
Chapter 3
You as Overnight Auto Services Accountant
You should tell Fred Jonas that the information he requests is confidential and you cannot
disclose it to him. Many professional entities, including International Federation of
Accountants (IFAC), have established a code of ethics that includes a requirement of
confidentiality. Confidentiality means that accounting personnel should refrain from
disclosing confidential information. The request from Fred Jonas would require you to
violate the confidentiality requirement. For more information on the IFACs code of
ethics, visit its Web site at: www.ifac.org/ethics
Chapter 4
You as a Car Owner
Yes, in most cases you will receive a full refund equal to the unexpired portion of your
policy. You are entitled to a refund because you will not consume four full months
coverage that remain on your policy at the time of cancellation. Thus you should receive
a check for $400 (or $100 per month for April, May, June, and July).

You as Overnight Autos Service Department Manager

It is true that Overnight Auto might consider the items Betty took home as immaterial to
the preparation of its financial records. Thus, Overnight Auto might choose to account for
screwdrivers and cans of oil in the easiest and most convenient manner, that is, by
expensing the costs as they are incurred.
However, the materiality issue is unrelated to the ethical issue of stealing from the
company. Betty should either be fired or asked to return and/or replace the missing items.
Another option would be to put Betty on probation and monitor supplies for missing
items. As the manager of the department, you might wish to implement sign-out
procedures for supplies that would allow you to monitor the use and location of
equipment used in servicing vehicles.
Chapter 5
You as Overnight Autos Independent Auditor
Pending lawsuits are usually disclosed in the notes to the financial statements only if
there is reasonable certainty that the defendant will incur a significant loss. Thus,
Overnight need not disclose its pending lawsuit if the risk of it sustaining a material loss
is remote. This is certainly an issue requiring the professional judgments of the
companys management, accountants, legal counsel, and auditors.
You as a Financial Analyst Evaluating Overnight Auto Service
You should tell the owner that financial ratios are most useful for evaluating a companys
performance when a basis for comparison exists. Often the basis for comparison is the
performance of other companies in the same industry. You might ask the owner for
financial statements of competing companies so that you can compare Overnights
performance against its peer group. In other cases, the companys past performance
serves as the basis for comparison. Overnight has been in business for only one year, but
in the future, its performance can be assessed by evaluating how well it has performed
from one year to the next.
It is not possible to compare Overnights relative performance against its peers from the
information provided; however, the absolute level of Overnights performance is very
good. A profit percentage over 10 percent is impressive, and a return on equity of 43
percent is quite high (shareholders often expect returns in the range of 10 percent to 15
percent). Finally, a current ratio above 1:1 generally suggests the potential for a company
to meet its cash obligations as they come due. Overnights current ratio is approximately
50 percent higher than this rough benchmark.
Chapter 6
You as the Inventory Manager for Computer City
An issue of key importance in auditing inventory is that the auditor be present when the
physical inventory count is made. A major fraud discovered at the McKesson & Robbins
company in 1938 motivated the accounting profession to change audit procedures to

include the physical observation of inventory. Prior to that time, auditors avoided
responsibility for determining either the physical existence or the accuracy of the count of
inventory. In 1937 McKesson & Robbins reported assets of US$87 million of which
approximately US$10 million of inventory was subsequently determined to be
nonexistent. Although the auditor often coordinates the inventory counts with
management, the auditor may want to take an inventory count on a surprise basis.
Auditing standards on fraud require the auditor to incorporate an element of
unpredictability into the auditing procedures. You should support the auditors access to
the physical inventory. It is Computer Citys responsibility to allow access to the physical
inventory or the auditor may not issue an unqualified audit opinion.
You as a Buyer for a Retail Business
If Japan Home maintains perpetual inventory records, these records would provide a
host of information that would be useful to your purchasing decision. From the perpetual
inventory records, you can determine the number, brand, and type of grills currently on
hand and the number of each sold in prior summer seasons. This information will be very
useful in estimating the goods needs for the current season. If Japan Home does not have
perpetual inventory records, you would be forced to make your decision without this
information about inventory on hand and prior sales, or to spend a significant amount of
time developing the information.
Chapter 7
You as a Used Car Purchaser
Whether you read the relevant contract or consult a lawyer, you will find that factoring
accounts receivable is neither illegal nor unethical. You contract to make the monthly
payments most likely includes a clause to pay whoever owns the receivable. The legal
requirements for the sale of accounts receivable to a third party may not be violated. The
ethics of the situation may depend on what customers were promised when they made
purchases on account. At a minimum, a letter should be sent to all customers explaining
that the receivables have been sold and will now be collected by a collection agency.
Many customers do not like their accounts receivable to be sold to a third party. Thus,
using factoring as a short-term solution to a cash flow problem may cause long-term
problems with lost customers and ultimately lost revenues.
You as a Credit Manager
Shown below are accounts receivable turnover rates and average-days-outstanding
figures for the past four years. Days outstanding were computed by dividing 365 days by
the turnover rate.
2009 2008 2007 2006
Sales $17,000 $14,580 $9,600 $9,000
Divided by:
Average accounts receivable 1,700 1,620 1,600 1,800
Turnover rate 10 times 9 times 6 times 5 times

Days outstanding 37 days 41 days 61 days 73 days

Based on these data, it appears that the new credit policy was successful in two ways.
First, over the four-year period, it resulted in the doubling of the companys accounts
receivable turnover rate (and thereby reduced its average collection period from 73 days
to 37 days). Furthermore, the new policy successfully improved the quality of accounts
receivable without adversely affecting sales growth.
Chapter 9
You as the New Facility Manager for Exercise-for-Health
Your ability to earn profits 10 percent over the budgeted amount will be impacted by the
amount of the depreciation charge on the building. The amount of depreciation each year
will depend on the dollar amount recorded for the building asset. Thus, if you ask the
bookkeeper to correct the building account, it may make it more difficult to achieve your
bonus. However, it is your ethical responsibility to inform Exercise-for-Healths
management about the error in the appraisal. Management will respect your integrity.
Your reputation for honesty and ethical behavior will be enhanced.
You as a Financial Analyst
Companies differ in their R&D expense-to-sales ratios primarily because the importance
of R&D expenditures in contributing to business success differs across industries. For
example, success in the R&D function is essential to success in the life sciences industry
group and among high technology companies. Conversely, given the mature nature of the
industry and the commodity nature of its products, R&D success may be of lesser
importance in the chemical industry (as reflected by the low R&D expense-to-sales ratios
for PetroChina and Sinopec in Exhibit 99). The R&D expense-to-sales ratio also may be
affected by how many years a company has been in business and by the companys
success (profitability).
Chapter 10
You as a Financial Advisor
The interest payments generated by a bond remain constant, regardless of fluctuations in
market interest rates that occur over the bonds life. Thus, if bond issuers consistently
fulfill their responsibility to make timely interest payments, the couples annual cash flow
from their investment will remain relatively stable throughout their retirement.
Fluctuations in market interest rates could adversely affect the couple should they decide
to sell any of their bonds before the bonds mature. If interest rates are relatively high at
the time the bonds are sold, their selling price may be substantially less than their
redemption value at maturity.
You as a Credit Analyst
The interns recommendation is too simplistic and is therefore flawed. Dell is an excellent
short term credit risk. While Dells working capital and current ratio may be low using
certain benchmarks, its quick ratio, a more stringent measure of liquidity, is strong. Dell

has US$0.85 of quick assets (cash, short-term investments, and receivables) for every
US$1 of current liabilities. Dells cash flow from operations is strong for the two years
presented, US$3,949 million and US$3,969 million. Finally, Dell is extremely profitable
and is becoming more profitable over timein the two-year period reported, the
companys profit has grown from US$2.503 billion to US$2.947 billion. Dells high level
of liquid current assets, its strong operating cash flows, and its profit performance suggest
that it is an excellent short-term credit risk.
Chapter 11
You as a Loan Officer
GOTCHA! does not appear to be a good credit risk for a $200,000 loan. The company
has few liquid assets that can be used to repay a loan. Also, the proposed loan is very
large in relation to the small corporations assets and owners equity. Because GOTCHA!
is organized as a corporation, Woods is not personally responsible for the companys
debtsunless she agrees to be.
Many loan officers would want to find a way to make this loan. They certainly would not
want to refuse a 20-year customer of the bank a loan that amounts to less than half of the
normal balance she maintains in her checking, savings, and money market accounts. But
they would ask that Woods personally guarantee the loan, rather than depend solely on
GOTCHA! for repayment. Woods should not be offended by this requirement; in
situations such as this, it is standard business practice.
You as a Financial Analyst
You would probably compare BP plcs return on shareholders equity with that of other
companies, particularly companies in the same industry (for example, Royal Dutch
Shell). You also would likely compare BP plcs return on shareholders equity over time.
However, a 23.2 percent return is quite high regardless of what other analyses might
reveal. A 23.2 percent return on equity is likely substantially in excess of the return on
capital expected by shareholders. For example, if BP plcs share price rises in tandem
with its return on equity, BP plcs share price will double in a little over three years. (We
can use a rough rule of thumb for computing how long it takes for an amount of money to
double by dividing 72 by the expected return. In the case of BP plc, its share price will
double in slightly more than three years [72 23.2 percent] if BP plcs share price rises
in tandem with its return on equity and if BP plc can maintain a 23.2 percent return on
equity over this period.)
Chapter 12
You as an Investor
A good starting point for estimating the future profit of Worsham Corporation is income
from continuing operations. Working backward from profit, it is calculated as $4,450,000
($4,000,000 + $750,000 $300,000). Discontinued operations and extraordinary items

generally would not be expected to be repeated in future years and, therefore, should be
eliminated in predicting future amounts.
You as a Financial Analyst
Dont be misled by the negative trend in earnings per share (EPS) on profit: $1.60 to
$1.51 to $1.12. While you should not completely ignore this trend, the more relevant
trend for purposes of assessing future profitability is the trend in EPS on income from
continuing operations: $1.75 to $2.56 to $3.02. The discontinued operation figures, which
are between income from continuing operations and profit, relate to a part of the business
which is no longer part of the company. By far the best predictor of future earnings is
income from continuing operations which should be the primary factor in your
evaluation.
Chapter 13
You as a Sales Manager
It is ethical for companies to make loans to their customers so that their customers can
place orders for their products. This is called vendor financing, and it is a useful selling
technique in moderation.
However, Sunny Foods Ltd. must be careful so that it doesnt end up buying its own
product. The problem is, the sale may not be real revenue; it might be a bad note
receivable. For this reason, many companies have policies against vendor financing. As a
sales manager, your responsibility is to check the corporate policy about vendor financing
before you respond to Bagginss request. Company policies of this nature are determined
by top headquarters management such as the president, vice president of marketing,
and/or the CEO.
You as a Financial Analyst
Based on the analysis below (AQ: Insert here: Hong Kong dollar amounts are in
millions?), only COSCO meets your bosss investment screens of free cash flow to cash
flow from operations of 50 percent or more and dividends to cash flow from operations
of 25 percent or more. Hysan is also close to meeting these two criteria. Hysans free
cash flow is 45.2 percent of its cash flow from operations and dividends of 54.4 percent
of cash flow from operations are paid.

You tell the prospective client that the relative level of free cash flow (free cash flow to
cash flow from operations) is an important metric because it provides a measure of a
companys financial flexibility. A company with financial flexibility has the ability to
quickly take advantage of business opportunities without having to tap outside financing
(i.e., issuing new debt or equity).
Unexpected opportunities include the opportunity to buy other companies, to expand into
new markets, to introduce new products, and so on. A company with a high level of free
cash flow to cash flow from operations also is better positioned to withstand an economic
downturn. The relative level of dividends is an important metric for two reasons. First, by
paying a current period dividend, investors receive an immediate and tangible return on
their investment in the companys shares. Over long periods of time, dividend payouts
have been an important source of market return on the investment in shares. Companies
that generate substantial cash flows from operations but that dont pay dividends may put
these excess cash flows to unproductive uses, particularly if the company operates in a
slow-growth industry. Paying dividends imposes a discipline on management, reducing
the risk that cash flow will be spent unwisely. Finally, you tell the prospective client that
young, rapidly growing companies typically do not pay dividends. These firms believe
that cash flows from operations are best reinvested in the business to help fund future
growth initiatives. The funding of future growth initiatives might involve building
additional productive capacity, investing in research and development activities, investing
in marketing campaigns to build market share, investing in the companys infrastructure
(for example, computer systems, distribution systems), and building a cash cushion to
help the company weather any economic downturns. In essence, companies that reinvest
earnings believe that they can earn a higher return on the reinvested funds than
shareholders could earn on the cash that they would have to reinvest if the companys
earnings were returned to them in the form of dividends.
Chapter 14
You as a Member of the House of Representatives

There is no correct answer to whether the compliance burden imposed by the SarbanesOxley Act is excessive. There are three essential issues in this debate. The first is whether
the additional requirements imposed by the Sarbanes-Oxley Act (SOX) will lead to
improved financial reporting. Since SOX was only passed in 2002, Congress needs time
to see if there is a decline in financial reporting fraud, earnings restatements, and
inappropriate earnings management. Second, Congress needs to see whether public
companies are going private and whether the number of companies going public declines
after SOX. Third, even if SOX improves financial reporting quality, Congress needs to
assess whether the benefits of improved financial information to investors and other
financial statement users outweigh the compliance costs imposed on companies. These
compliance costs include not only whether public companies go private and whether
private companies choose not to go public, but also the actual costs incurred by those
companies that choose to remain public. These costs (as are all costs) will either be
passed on to: (1) consumers in the form of higher prices, (2) employees in the form of
lower wages and fringe benefits, and/or (3) investors in the form of lower profits.
Investors might be willing to accept lower profits because of the compliance burden, if
their risk goes down as a result of an increase in the quality of the information they now
have for decision making.
Although it is too early to definitely answer the above questions, anecdotal evidence
suggests that the compliance burden of SOX will be significant; that some public
companies will go private; and that auditors, boards of directors, and management teams
are now more serious about financial reporting quality. The compliance burden created by
SOX includes a significant increase in audit costs, higher costs to attract and retain board
members, and costs (including opportunity costs) incurred by management in
documenting compliance with SOXs provisions. There have been a number of public
companies that have gone private since SOX was passed, and some of these companies
specifically refer to SOX and the increased compliance burden as their reason for going
private. Finally, there also is evidence that auditors, boards of directors, and management
teams are investing more resources to ensure high-quality financial reporting. Auditors
have significantly expanded the amount of their audit testing, leading to the increase in
audit fees that companies are experiencing. Boards of directors, and particularly the audit
committee of the board, are meeting more often, for longer periods of time, and with a
greater commitment to fulfilling their responsibility for overseeing the companys
financial reporting process. Management teams are spending more time documenting,
redesigning, and testing internal control systems; reviewing the companys financial
reports; and, in a number of companies, creating or expanding the internal audit function.
You as a Financial Analyst
For your client who is primarily interested in the dividends that will be received, you
might advise him to evaluate investment possibilities much as a short-term creditor
would. This would focus attention on liquiditythe current and quick ratios and the
extent to which operating activities are generating positive cash flows. Also, you should
suggest that he look at the companys dividend policy and the consistency with which
dividends have been paid in the past. For the investor that is more interested in the market
value of the share, you should suggest that he look at information that focuses on the

long-term potential for the successful operation of the companies being considered
profit, growth over time in sales, and return on assets and shareholders equity. You
should also suggest that he look at the pattern of changes in the value of the shares of the
companies. For both investors, information in managements discussion and analysis may
be helpful in identifying companies that are consistent with the specific investment
objectives of each client.
Chapter 15
You as a Consumer
If the Singapore dollar strengthens against the euro over the coming month, then goods
imported from Italy should cost customers in Singapore less. Goods imported from the
United Kingdom should cost more as the Singapore dollar weakens against the pound. As
the Singapore dollar strengthens, you can purchase more euros with each dollar;
therefore, you should investigate the prices of racing bicycles imported from Italy. If you
believe the Singapore dollar will continue to strengthen over the coming month, you
should delay your shopping to get the greatest benefit from the exchange rate fluctuations
toward the end of the month.