Financial Accounting in an Economic Context, 9th Edition

APPENDIX B

Quality of Earnings Cases: A Comprehensive Review

Case 1: Liberty Manufacturing

You have recently been hired by Capital City Bank as a credit analyst. One of the tasks of your new position is to review the financial statements submitted by loan applicants. You have been instructed to assess the solvency and earning power of the applicants as well as the quality and persistence of the reported earnings number. After completing your analysis, you should report your conclusions to your supervisor, recommending whether the applicant should be further considered for the loan and why.

Company Description

You are now asked to review the file of a loan applicant, Liberty Manufacturing, which has applied for a long-term $500,000 loan. This company is a medium-sized, family-run operation that manufactures a component used in a wide variety of engines. Liberty has been in existence for approximately twenty years and has grown consistently during that time, reporting profits in each of the last ten years. The company has recently begun to move into foreign markets and is seeking the loan to finance investments in property, plant, and equipment and to complete the acquisition of a small foreign supplier, Packer Technical.

The demand for Liberty's product seems stable, and the company has made recent technical advancements in product design that may lead to increased sales in the future. At present, the company appears to hold a solid position in its industry. Prices in the industry, ...