Test Bug

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 14-1 Dear Uncle Frank, It was so good to hear from you! I hope you and Aunt Irene are still enjoying your new house. You asked some interesting questions. They relate very well to the material that we are studying now in my accounting class. You said you heard that different users of financial statements are interested in different characteristics of companies. This is true. A short-term creditor, such as a bank, is interested in the company’s liquidity, or ability to pay obligations as they become due. The liquidity of a borrower is extremely important in evaluating the safety of a loan. A long-term creditor, such as a bondholder, would be interested in solvency, the company’s ability to survive over a long period of time. A long-term creditor would also be interested in profitability. They are interested in the likelihood that the company will survive over the life of the debt and be able to meet interest payments. Stockholders are also interested in profitability, and in the solvency of the company. They want to assess the likelihood of dividends and the growth potential of the stock. It is important to compare different financial statement elements to other items. The amount of a financial statement element such as cash does not have much meaning unless it is compared to something else. Comparisons can be done on an intracompany basis. This basis compares an item or financial relationship within a company for the current year to one or more previous years. Intracompany comparisons are useful in detecting changes in financial relationships and significant trends. Comparisons can also be done with industry averages. This basis compares an item or financial relationship with industry averages or norms. Comparisons with industry averages provide information as to a company’s relative performance within the industry. Finally, comparisons can be done on an intercompany basis. This basis compares an item or financial...