Question 3FSAC - Intermediate Accounting (Kieso)

Question

Case 3: Deere & Company Presented below is the SEC-mandated disclosure of contractual obligations provided by Deere & Company in a recent annual report. Deere & Company reported current assets of \(50,060 and total current liabilities of \)21,394 at year-end. (All dollars are in millions.)

Aggregate Contractual Obligations 

The payment schedule for the company’s contractual obligations at year-end in millions of dollars is as follows:

	Total	Less than 1 year	1-3 Years	4 and 5 Years	More than 5 Years
Debt
Equipment Operations	\( 5,091	\) 434	\( 270	\)775	\( 3,612
Financial services	31,692	9,962	11,477	6,578	3,675
Total	36,783	10,396	11,747	7,353	7,287
Interest on debt	4,777	609	1,069	745	2,354
Account payable	2,743	2,611	90	39	3
Capital lease	87	39	42	4	2
Purchase obligations	3,007	2,970	37	0	0
Operating leases	371	121	134	70	46
Total	\) 47,768	\( 16,746	\)13,119	8,211	9,692

 

Instructions 

(a) Compute Deere & Company’s working capital and current ratio (current assets ÷ current liabilities) with and without the off-balance-sheet contractual obligations reported in the schedule. 

(b) Briefly discuss how the information provided in the contractual obligation disclosure would be useful in evaluating Deere & Company for loans (1) due in one year and (2) due in five years.

Step-by-Step Solution

Answer

The business entity is performing well in terms of liquidity. 

Definition of Off-Balance Sheet Items

The business entity does not record some of its assets and liability on the balance sheet because the business does not directly own them; these assets and liabilities are known as off-balance sheet items.

Current ratio and working capital without contractual obligation

Particular	Amount $
Current assets	$50,060
Less: Current liabilities	(21,394)
Working capital	$28,666

 

Current ratio:

$\begin{array}{rcl}& & \begin{array}{c}\mathbf{\text{Current ratio}}\mathbf{=}\frac{\mathbf{\text{Current assets}}}{\mathbf{\text{Current liabilities}}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{50}\mathbf{,}\mathbf{060}}{\mathbf{\$}\mathbf{21}\mathbf{,}\mathbf{394}}\\ \mathbf{=}\mathbf{2}\mathbf{.33}\mathbf{\text{\hspace{0.17em}times}}\end{array}\end{array}$

Current ratio and working capital with contractual obligation

Particular	Amount $
Current assets	$50,060
Less: Contractual obligations($2,970+121$)	(3,091)
Less: Current liabilities	(21,394)
Working capital	$25,575

 

 $\begin{array}{rcl}\mathrm{Current} \mathrm{Ratio}& =& \frac{\mathrm{Current} \mathrm{Assets}}{\mathrm{Current} \mathrm{Liabilities}}\\ & =& \frac{\$50,060}{\$24,485}\\ & =& 2.04 \mathrm{Times}\end{array}$

Usefulness of information

1. Liquidity condition of the business entity is good and the business entity is able to pay a loan up to $25,575.
2. The business entity has the additional contractual obligation of $13,119 in years 2 and 3 and $8,211 in years 4 and 5. For evaluating the capacity to pay these loans, an analyst has to develop predictions of cash flow up to 5 years.