Assignment 3 (Session 2 – Winter)
This assignment requires you to apply the knowledge you have gained in FA3 through to the end of Module 9 and in your previous Financial Accounting courses. It is estimated that this assignment should take approximately 8 hours to complete. It is graded out of 50 marks, and is worth 5% of your final grade.
Answer all questions in sentence and paragraph form using the template provided. Point form is NOT acceptable.
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QOE assignment (50 marks)
Quality-of-earnings (QOE) analysis attempts to evaluate whether the reported earnings of a company reflect its true, economic earnings, and also evaluates the ability of reported earnings to predict future earnings. This problem asks you to evaluate factors related to QOE for a given company in relation to a comparator company. You must select and justify your choice of comparator company. You have been provided with Word templates to organize your response (Exhibits 1-3). You can add lines as needed.
Procedure:
1.Access the December 31, 2009, annual financial statements of High River Gold Mines Ltd. from.cga-education.org/2011-12/redir.asp?course=fa3&page=sedar”>www.sedar.com (posted April 19, 2010). Also access the MD&A that covers these financial statements (April 19, 2010).?
2.Use your judgment to identify a comparator company for High River Gold Mines Ltd. Choose a public company, listed on the TSX, that files public information on sedar.com, and access its 2009 annual financial statements.??Note: Comparator companies might be identified in the financial press. Another possible source is through the sedar.com search database tab. Use the industry groups section. Carefully choose the industry grouping that is appropriate, and request financial statements only for the appropriate time frame in order to reduce the number of files that are selected. Companies that act as good comparators will share the following characteristics: ?
? They will be in the same general business.
? They will not be conglomerates or involved in many disparate business lines.
? They will not be in the development stage.
? They will be approximately the same size.
3.?Length and complexity of the financial statements is another factor; some financial statements are very long and should be avoided. It will be a challenge to satisfy all these conditions; however, the first three are the most critical factors to consider.
Required:
1.(45 marks: 2 marks for part a, 32 marks for part b, 5 marks for part 3, and 6 marks for part d)?
a. Calculate the difference between cash flow from operations and net income for each company for 2009 and 2008. For example, if the net income (loss) was ($3) and cash flow from operations was $12, the difference would be $15. (2 marks)?
b. Identify five different adjustments on the statement of cash flow (SCF) of High River Gold Mines Ltd. that have QOE implications, and explain their significance. You will have to refer to the financial statement notes, especially the accounting policy information, to assess the nature of these items, and/or the MD&A. Items chosen can be transactions or events (for example, the presence of business acquisitions) or accounting policies (for example, revenue recognition issues) but may not be ratios.Quality answers will be detailed and specific. (32 marks)??Note: No marks will be awarded for using the example provided.?
c. Analyze your comparator company and explain and evaluate similar adjustments, if any exist. Complete the grid in Exhibit 2 of the solution template for each item. (5 marks)?
d. Conclude with your assessment of the relative quality of earnings for High River Gold Mines Ltd. and its comparator company, based on your (limited) examination. (6 marks)
2.?Refer to Exhibits 1 and 2 of Earnings Quality: Its Time to Measure and Report (Topic 1.8) and the discussion in the module notes for examples of sensitive areas. ??Note: Topical coverage may span all topics in FA2 and FA3. An example item is provided for you on the first section of the grid in Exhibit 2. ?
3.Supply the statement of cash flow (SCF) of your comparator company in Exhibit 3 of the solution. (You will lose marks if this is not provided.)
Procedure:
a. Open the financial statements of your comparator company, and go to the SCF. ?
b. Right click and hold the button down; move the mouse to highlight the entire SCF content. Hold down the CRTL key and then hit the C key. ?
c. Return to your solution Word document and press CRTL and the V key. This will copy the material with no spacing, which is acceptable for this submission.??(Alternatively, you may use the snapshot tool in Adobe.)?
4.(5 marks)??Comment on your choice of comparator company. First, evaluate and contrast the two companies. What justification do you have for the choice you made? Then, comment on the difficulties you experienced in identifying a comparator company. Provide a paragraph or two explaining these points in Exhibit 1 of the solution template.
Exhibit 1: Solution template QOE analysis
QOE analysis company
High River Gold Mines Ltd., December 31, 2009
Comparator company
Part 5: Comparator company choice commentary
(5 marks)
(add lines and complete paragraphs here)
Exhibit 2: Solution template QOE adjustments analysis
($ in millions)
Example:
QOE adjustment:
High River Gold Mines
The overall adjustment in operating activities for changes in non-cash working capital is $3.5 in 2009, while it was $33.7 in 2008. This is very inconsistent. Note 23 shows that accounts receivable increased by $3.6, after a smaller increase of $0.6 in 2008; receivables continue to increase. Sales have more than doubled, so this is not consistent with sales. There had been a large increase of $16.1 for inventory in 2008, but only $1.7 in 2009. This is a further growth in inventory, but the trend has slowed despite more activity. Other assets show an increase of $0.98. In 2008, other assets had significantly declined, resulting in a material add-back of $38.8. Again, this is not a pattern consistent with activity. Accounts payable increased by $9.9, the second year of material increase (2008 increase of $12.2), reflecting consistent increase in current liabilities. This may be linked to the higher activity in the year. The MD&A comments that cash flow from operating activities is improved because of positive cash flow from mines but does not address specific components.
Significance of adjustment
QOE is preserved if there is a consistent relationship between income and cash flow from operating activities. When changes in working capital items are not predictable based on income from year-to-year, QOE suffers. High River shows lower QOE because the amounts and their direction are not consistent over the two years shown.
Analysis of comparator company
ABC Co (a fictitious company) has large adjustments for working capital in the operating activities section of its SCF. The company adds back $40 and $21, respectively, for AR and inventory in 2009. The comparative add-backs in 2008 are $30 and $23. For this company, though, these adjustments are consistent in size from year-to-year and are a (roughly) constant percentage of sales. ABC shows higher QOE in this regard.
Part 3A
Excess of cash flow from operations over net income for 2009 and 2008
High River Gold Mines
2009: 2008:
Comparator company
2009: 2008:
Parts 3B and 3C
Item 1
QOE adjustment:
High River Gold Mines
Significance of adjustment
Analysis of comparator company
Item 2
QOE adjustment:
High River Gold Mines