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ACCOUNTINGSTANDARDSANDTOPICSIMPLEMENTEDANDANALYZED
byMakenzieCourtlandMcNeill
AthesissubmittedtothefacultyofTheUniversityofMississippiinpartialfulfillmentoftherequirementsoftheSallyMcDonnellBarksdaleHonorsCollege.
OxfordMay2019
Approvedby
Advisor:Dr.VictoriaDickinson
Reader:DeanMarkWilder
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ABSTRACTMAKENZIECOURTLANDMCNEILL:AccountingStandardsandTopicsImplementedand
Analyzed(UnderthedirectionofDr.VictoriaDickinson)
Theobjectiveofthisthesisistoreportonmultipleaccountingstandardsandtopics
throughtheuseoftwelvedifferentcases.Thecasesthatwereresearchedincludedthe
topicsofevaluationoffinancialstatements,profitabilityandearnings,accounts
receivable,andworkingthroughatimevalueofmoneyproblem.Additionally,subjects
suchasresearchanddevelopmentcosts,thedataanalyticstoolIBMWatson,long-term
debt,stockholders’equity,marketablesecurities,deferredincometaxes,andrevenue
recognitionwerealsoanalyzedthroughoutthispaper.Thesecaseswerewrittentohelp
thereader,andothers,learnfromtheirquestions.Thequestionsinthecases,asshown
inthispaper,aremeanttoactasaguidanceandlearningtoolthoughthevarious
accountingstandardslistedabove.
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TABLEOFCONTENTS
CaseStudyOne–HomeHeaters:FinancialStatementsAnalyses………………………………….1
CaseStudyTwo–MolsonCoors:ProfitabilityandEarningsPersistence………………………18
CaseStudyThree–Pearsonplc–AccountsReceivable………………….….………………..………24
CaseStudyFour–TimeValueofMoneyAccountingProblem..………………………………..…32
CaseStudyFive–PalfingerAG–Property,Plant,andEquipment………..………………..……36
CaseStudySix–VolvoGroup–Research&DevelopmentCosts………….…………….….……44
CaseStudySeven–DataAnalyticsCase-IBMWatson…………………….…………………...……51
CaseStudyEight–RiteAidCorporation–Long-TermDebt…………………….…………....……57
CaseStudyNine–Merck&Co.,Inc.andGlaxoSmithKlineplc–Shareholders’Equity…65
CaseStudyTen–StateStreetCorporation–MarketableSecurities…….………………..……72
CaseStudyElevenZAGGInc.–DeferredIncomeTaxes……………………………..….……...……79
CaseStudyTwelve–AppleInc.–RevenueRecognition……………..………………………...……86
LISTOFREFRENCES……………………………………………………………………………………………….…….91
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CASEONEHomeHeaters,Inc.:FinancialStatementsAnalyses
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Thiscasesurroundedtwocompanies,GlenwoodHeating,Inc.andEadsHeaters,
Inc.,whichbothsellhomeheatingunits.Throughouttheyear,bothbusinesseshad
identicaloperationsandtransactions,includingtheissuanceofstock,purchasesof
equipment,andpaymentsofdividends.Thesetransactionsaredescribedandlisted
throughoutPartAofthiscase.Atyearend,themanagersofeachcompanywerefaced
withaccountingdecisionsthatwouldaffecthowtheiraccountingstatementswouldbe
prepared.Thus,PartBofthiscasedescribedhowGlenwoodHeating,Inc.andEads
Heaters,Inc.differentiatedinrecordingfivetransactions.Becausebothcompanies
begantheyearidentically,thiscasehelpsusunderstandtheeffectsthatvarious
manager’saccountingdecisionscanhaveonacompany’sfinancialstatementsatthe
endoftheyear.
Asawhole,thiscasewasverybeneficialasalearningtoolformanyreasons.
First,IfeelthatIlearnedasignificantamountabouthowtoreadanddrawdatafrom
sizabletextintoaspreadsheet,suchasExcel.Ihaven’thadmuchexperiencewiththis
before,sospendingagreatdealoftimeonthiscasefamiliarizedmyselfwiththe
process.Thiscasealsohelpedmewithmyorganizational,timemanagement,andgroup
skills,whichIneededinordertofinishsuchaproject.Inaddition,thecase
encompassedseveralaccountingskillsthatIhadnotusedinawhile.Itpushedmeto
reviewafewideas,aswellasfollowthroughthecompleteprocessfromjournaling
transactionstofinancialstatements,likeIwouldintherealworld.Icanseemy
experiencefromthiscasebenefitingmeinthefuture,specificallyinmyotherclasses.
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PartA
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HomeHeaters
TrialBalance-PartA
Debit CreditCash $47,340
AccountsReceivable 99,400
Inventory 239,800Land 70,000Building 350,000Equipment 80,000
AccountsPayable
26,440NotePayable 380,000
InterestPayable
6,650
CommonStock
160,000Dividend 23,200
Sales
398,500
OtherOperatingExpenses 34,200
InterestExpense 27,650
Total $971,590 $971,590
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PartB
GlenwoodHeating,Inc.:
1. BadDebtExpense 994
AllowanceforDoubtfulAccounts 994
(99,400*.01)
2. CostofGoodsSold 177,000
Inventory 177,000
3. DepreciationExpense–Equipment 9,000
AccumulatedDepreciation–Equipment 9,000
((80,000-8000)/8)
DepreciationExpense–Building 10,000
AccumulatedDepreciation–Building 10,000
((350,000-50,000)/30)
4. RentExpense 16,000
Cash 16,000
5. IncomeTaxExpense 30,914
Cash 30,914
((398500-177000-16000-10000-9000-34200-27650-944)*.25)
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EadsHeaters,Inc.:
1. BadDebtExpense 4,907
AllowanceforDoubtfulAccounts 4,907
(99,400*.05)
2. CostofGoodsSold 188,800
Inventory 188,800
3. DepreciationExpense–Equipment 20,000
AccumulatedDepreciation–Equipment 20,000
(1/8*2*80,000)
DepreciationExpense–Building 10,000
AccumulatedDepreciation–Building 10,000
4. LeaseEquipment 92,000
LeasePayable 92,000
LeasePayable 8,640
InterestExpense 7,360
Cash 16,000
DepreciationExpense 11,500
AccumulatedDepreciation 11,500
(92,000/8)
5. IncomeTaxExpense 23,505
Cash 23,505
((398500-188800-10000-20000-34200-7360-27650-4970-11500)*.25)
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PartB
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GlenwoodHeating,Inc.
PartB–RecordingofAdditionalInformation(continued)
Table1(continued)
Liabilities
Stockholder'sEquity
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AccountsPayable
InterestPayable
NotePayable
CommonStock
RetainedEarnings
Balances:PartA $26,440 $6,650 $380,000
$160,000 $313,450PartB(1)BadDebts
(994)
PartB(2)COGS
(177,000)PartB(3)Depreciation
Building
(10,000)Equipment
(9,000)
PartB(4)EquipmentRentalPayment
(16,000)
PartB(5)Incometax
(30,914)Balances $26,440 $6,650 $380,000
$160,000 $69,542
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GlenwoodHeating,Inc.
PartB:TrialBalanceDecember31,20X1
Debits CreditsCash $426
AccountsReceivable 99,400AllowanceforBadDebts
994
Inventory 62,800Land 70,000Building 350,000Accumulated
Depreciation-building
10,000Equipment 80,000
AccumulatedDepreciation-equipment
9,000
AccountsPayable
26,440InterestPayable
6,650
NotePayable
380,000CommonStock
160,000
Dividend 23,200Sales
398,500
CostofGoodsSold 177,000OtherOperatingExpenses 34,200BadDebtExpense 4,970DepreciationExpense-
Building 10,000DepreciationExpense-
Equipment 9,000RentExpense 12,024InterestExpense 27,650ProvisionforIncomeTax 30,914Total $991,584 $991,584
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GlenwoodHeating,Inc. IncomeStatement ForYearEndedDecember31,20X1 Sales $398,500CostofGoodsSold (177,000)GrossProfit 221,500OperatingExpenses DepreciationExpense-Building (10,000)DepreciationExpense-Equipment (9,000)RentExpense (16,000)BadDebtExpense (994)OtherOperatingExpenses (34,200)IncomefromOperations 151,306OtherExpenses InterestExpense (27,650)IncomeBeforeIncomeTax 123,656IncomeTax (30,914)NetIncomefortheYear $92,742
GlenwoodHeating,Inc. StatementofRetainedEarnings ForYearEndedDecember31,20X1 Retainedearnings,January1 - Add:NetIncome 92,742
92,742Less:Dividends (23,200)
Retainedearnings,December31 $69,542
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GlenwoodHeating,Inc.
BalanceSheet
December31,20X1
ASSETS CurrentAssets
Cash
$426AccountsReceivable
99,400
Less:AllowanceforDoubtfulAccounts
(994) 98,406Inventories
62,800
TotalCurrentAssets
161,632
Property,Plant,andEquipment Land-atcost
70,000
Buildings-atcost
350,000Less:AccumulatedDepreciation
(10,000) 340,000
Equipment-atcost
80,000Less:AccumulatedDepreciation
(9,000) 71,000
TotalProperty,Plant,andEquipment
481,000
TotalAssets
$642,632
LIABILITIESANDEQUITY CurrentLiabilities
AccountsPayable
$26,440InterestPayable
6,650
TotalCurrentLiabilities
33,090Long-TermLiabilities NotesPayable 380,000TotalLiabilities 413,090
Stockholder'sEquity CommonStock
160,000RetainedEarnings
69,542
TotalStockholder'sEquity
229,542
TotalLiabilitiesandStockholder'sEquity
$642,632
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EadsHeaters,Inc.
PartB–RecordingofAdditionalInformation(continued)
Liabilities
Stockholders'Equity
AccountsPayable
Interestpayable
NotesPayable
LeasePayable
CommonStock
RetainedEarnings
Balances:PartA $26,440 $6,650 $380,000
$160,000 $313,450
PartB(1)BadDebts
(4,970)
PartB(2)COGS
(188,800)
PartB(3)Depreciation
Building
(10,000)
Equipment
(20,000)
PartB(4)Equipment
Lease
92,000
LeasePayment
(8,640)
(7,360)
Depreciation
(11,500)
PartB(5)Incometax
(23,505)
Balances $26,440 $6,650 $380,000 $83,360
$160,000 $47,315
Table2(continued)
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Thefinancialinformationprovidedbythetwocompaniesisvaluabletopresent
andpossibleequitylendersandcreditorsinmakingdecisionsaboutprovidingresources
orinvestmentstocompanies.Accordingtotheinformationfromthiscase,Iwould
ratherinvestorlendmoneytoGlenwoodHeating,Inc.forseveralreasons.First,from
theirincomestatement,itisseenthattheyhaveanetincomeof$92,742,andagross
profitof$221,500.BothoftheseoutweighEadsHeaters,Inc.’snetincomeandgross
profitsof$70,515and$209,700,respectively,leadingmetobelievethattheyaremore
profitable.Fromthestatementofretainedearnings,itcanbeseenthatGlenwood
Heating,Inc.hasayear-endretainedearningsbalanceof$139,084,whichis$37,094
morethatcanbereinvestedinitsbusinessthanitscompetitor,thathadayear-end
retainedearningsbalanceof$101,990.Inaddition,itcanbeconcludedfromthe
balancesheetthatGlenwoodhasalargeramountofcurrentassetsonhand,at
$161,632,ratherthan$145,430forEads.Also,theproportionofcurrentassetsto
currentliabilitiesismoreconcerninginEadscasethaninGlenwood,becauseofthe
higheramountofcurrentliabilitiesthatEadshascollected.Forthesereasons,Iwould
choosetoinvestorlendmoneytoGlenwoodHeating,Inc.
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CASETWOMolsonCoors:ProfitabilityandEarningsPersistence
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ThiscasewasfocusedonMolsonCoorsBrewingCompany,whichformedwhen
AdolphCoorsCompanyjoinedwithMolsonInc.in2005.Thecaseincludedthe
company’sfinancialstatements,followedbynotes.Thefinancialstatementsthatwere
includedweretheconsolidatedstatementsofoperations,theconsolidatedstatements
ofcomprehensiveincome,andtheconsolidatedbalancesheets.Thenotestothe
consolidatedfinancialstatementswentintogreaterdetailaboutseveralitemsonthe
financialstatementstohelptheuserbetterunderstandthenumbersandtotalsonthe
statements.Someoftheitemsdiscussedinthenotessectionincludeexcisetaxes,cost
ofgoodssold,specialitems,otherincomeandexpense,incometax,andrevenue
recognition.
Afterhavingtoreviewtheincomestatement,itsmajorparts,anditsimportance
intheaccountingcycle,IfeelthatIhaveagreaterunderstandingofthepurposeof
financialstatements.Itisimportanttoknowhowtopredictforthefutureusingthe
itemsgiventoyouinthefinancialstatements.Youhopethatthenumbersarepreciseso
thatyoucanmakethemostaccuratepredictionpossibleregardingyourbusinessor
investments.Inaddition,Ihaveabetterknowledgeofwhatcomprehensiveincomeis,
andhowitdiffersfromnetincomeafteransweringthequestionsinthiscase.Also,I
learnedaboutsomeclassificationitemsthatIwasnotfamiliarwithpriortothiscase,
suchas“Specialitems”.Thecategorizationofitemsonthefinancialstatementsis
important,becausethemisplacementofonethingcouldthrowofftheendingbalance
completely.
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MolsonCoorsBrewingCompany–ProfitabilityandEarningsPersistence
Concepts
a. Whatarethemajorclassificationsonanincomestatement?
Themajorclassificationsthatanincomestatementcontainsaretheoperatingsection,nonoperatingsection,incometax,discontinuedoperations,noncontrollinginterest,andearningspershare.Theoperatingsectionwouldincludesales,costofgoodssold,sellingexpenses,andadministrativeorgeneralexpenses.Nonoperatingsectionadditionallycomprisesofotherrevenuesandgainsandotherexpensesandlosses.Also,discontinuedoperationsismaterialgainsorlossesresultedfromthedispositionofacomponentofthebusiness.Finally,noncontrollinginterestcanbedescribedastheallocationofincometononcontrollingshareholders.
b. Explainwhy,underU.S.GAAP,companiesarerequiredtoprovide“classified”incomestatements.
Companiesarerequiredtoprovideclassifiedincomestatementsbecauseitleaveslessroomfordishonestly,inadditiontomakingthemeasierfortheusertoread.AccordingtotheFullDisclosurePrinciple,companiesmustincludealldetailssufficientenoughtomakeadifferencetousersintheirfinancialstatements.Thus,mostincomestatementswillhavetobedetailed,andclassifiedincomestatementshelpkeeptheincreasedinformationorganized.Thishelpsthereaderanalyzetheinformationefficiently. Thetypesofinformationthataclassifiedincomestatementprovidesincludessubtotalsforthreespecificsections.Thesesectionsincludethegrossmargin,operatingexpenses,andnon-operatingexpensessectionsofanincomestatement.Whentherearemanylineitems,bybeingabletoeasilyspotsubtotalsforthesesectionsallowstheusertogatherinformation.Fromaclassifiedincomestatement,ausercouldmakeconclusionsastowhetherthecompanyhadanetprofitorlossfortheperiodorwasabletoproduceaprofit.Thiscouldleadausertowanttoinvestinacompany,orviceversa.
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c. Ingeneral,whymightfinancialstatementusersbeinterestedinameasureofpersistentincome?
Financialstatementuserswanttohavealeveloftrustwhenreadingtheirfinancialstatements,andareexpectingthattheinformationgivenisfreefromerror.Theyarehopefulthattheycanmakeaccuratepredictionsaboutthefuturebasedoffoftheincomefromthefinancialstatements. Anexampleofusersthatmightbenefitfromthisinformationincludeinvestorsandcreditors,investmentanalysts,andcompetitors.Competitorsmightusefinancialstatementsofarivalcompanytogagehowwelltheymightdointhefuture.
d. Definecomprehensiveincomeanddiscusshowitdiffersfromnetincome.
Comprehensiveincomeisthechangeinequityofanentityduringaperiodfromtransactionsandothereventsandcircumstancesfromnonownersources.Itincludesallchangesinequityduringaperiodexceptthoseresultingfrominvestmentsbyownersanddistributionstoowners.NetIncomecanbedefinedastheresidualamountofearningsafterallexpenseshavebeendeductedfromsales.Wherecomprehensiveincomeisusedtomeasurethechangeinanowner’sinterestinabusiness,netincomeisreallyjustthemeasureofearningsforaperiod.
Processe. Theincomestatementreports“Sales”and“Netsales.”Whatisthedifference?
WhydoesMolsonCoorsreportthesetwoitemsseparately?
Salesarethetotalrevenuesforthecompanyfortheperiod.Netsalesaresalesafterreturns,discounts,andanyexcisetaxesarededucted.MolsonCoorsBrewingCompanyreportsthesetwoitemsseparatelysothatitcanshowtheeffectofanexcisetaxonbeer.
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f. Considertheincomestatementitem“Specialitems,net”andinformationinNotes1and8.
i. Ingeneral,whattypesofitemsdoesMolsonCoorsincludeinthislineitem?
MolsonCoorsincludesinfrequentorunusualitems,impairmentorassetabandonment-relatedlosses,restructuringchargesandotheratypicalemployeerelatedcosts,andfeesonterminationofsignificantoperatingagreementsandgains(losses)ondisposalofinvestmentsinthe“Specialitems”lineitem.ii.Explainwhythecompanyreportstheseonaseparatelineitemratherthanincludingthemwithanotherexpenseitem.MolsonCoorsclassifiesthesespecialitemsasoperatingexpenses.Doyouconcurwiththisclassification?Explain.
Specialitemsarereportedonaseparatelineitemratherthanincludingthemwithanotherexpenseitembecausetheyarenotindicativeofcoreoperations.Yet,theyareincludedsoinvestorscanmoreaccuratelycomparethecompany’snumbersacrossaccountingperiods.Iagreethatitisimportanttoseparatetheseitems,buttheyshouldbeincludedsothatinvestorscanbemadeawareofthem.
g. Considertheincomestatementitem“Otherincome(expense),net”andtheinformationinNote6.Whatisthedistinctionbetween“Otherincome(expense),netwhichisclassifiedanonoperatingexpense,and“Specialitems,net”whichMolsonCoorsclassifiesasoperatingexpenses?
Otherincomeexpensesdonotdirectlyaffecttheincomeportionoftheincomestatement;thustheyareclassifiedasanonoperatingexpense.However,MolsonCoorsisdirectlyimpactedbytheSpecialitems,whichiswhytheyareclassifiedasoperatingexpenses.
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h. Refertothestatementofcomprehensiveincome.i.Whatistheamountofcomprehensiveincomein2013?Howdoesthisamountcomparetonetincomein2013?
Theamountofcomprehensiveincomein2013is$760.20(million).Theamountofnetincomein2013is$567.30(million).Thecomprehensiveincomeis$192.90(million)greaterthanthenetincome.ii.Whataccountsforthedifferencebetweennetincomeandcomprehensiveincomein2013?Inyourownwords,howaretheitemsincludedinMolsonCoors’comprehensiveincomerelated?Thedifferencebetweenthenetincomeandcomprehensiveincomein2013includeforeigncurrencytranslationadjustments,unrealizedgain(loss)onderivativeinstruments,reclassificationofderivative(gain)losstoincome,tensionandotherpostretirementbenefitadjustments,amortizationofnetpriorservice(benefit)costandnet.Theseitemsarerelatedbecausetheitemshavenotbeenrealizedyet,andthereforewouldbechallengingtorecordthem.
Analysisj. Considertheinformationonincometaxes,inNote7. WhatisMolsonCoors’effectivetaxratein2013?
EffectiveTaxRate= "#$%&'(")*+",+-($.("/0(12*+"3$%&'( !!
!!!!!!= #,%&&&,&&'(%,(&& !!
=12.8%
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CASETHREE
Pearsonplc–AccountsReceivable
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PearsonInc.isacasethatconcentratesonthetopicofaccountsreceivable,and
thevariouscomponentsthatcangointothissubject.Itisimportanttonotethat
PearsonisaneducationandbusinessinformationcompanylocatedinLondon,England,
thereforetheirfinancialstatementsarerecordedinmillionsofpounds,notU.S.dollars.
Includedinthiscasearethefocusesofaccountsreceivables,notesreceivables,contra
accounts(suchassalesreturnsandallowances,allowanceforsalesreturnsand
allowances,andallowancefordoubtfulaccounts),andbaddebtsexpense.Inaddition,
thiscaseasksseveraltimesfort-accountsandjournalentries,whichIfeelissignificant
todotounderstandthefundamentalbasisofwhatIamdoinginaproblem.
First,afterreviewingthemajorelementsofreceivables,Ifeelmore
understandingoftheimportanceofaccountsreceivable,andhowtheyareusedin
majorbusinessoperationssuchasthisone.Additionally,thiscasetaughtmeseveral
thingsaboutthecriticalthinkingneededtoconsiderwhenfinancialstatementsare
doneinonecountryandareneededtobeconvertedandanalyzedbyanothercountry.
Thesearethingsthathappenintherealworldeveryday,anditiscrucialthatIbeginto
implementmyaccountingknowledgetoeverydaysituations.Ialsolearnedaboutthe
term“provision”andthattheyuseittomean“allowance”intheUK.
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Pearsonplc–AccountsReceivable
Conceptsa.Whatisanaccountreceivable?Whatothernamesdoesthisassetgoby?
Accountsreceivableismoneyowedtoacompanybyitsdebtors.Othernamesthisassetgoesbymayincludetradereceivablesandreceivables.
b.Howdoaccountsreceivabledifferfromnotesreceivable?
Anotesreceivableisanassetofacompanythatholdsawrittenpromissorynotefromanotherparty(resultingfromsales,financing,orothertransactions),whereasanaccountsreceivabledoesnotrequireawrittenpromissorynoteforthereceivable.Anaccountsreceivableissimplyanonanoralpromisetopay.Accountsreceivableareusuallyshort-term,collectedwithin30to60days,butnotesreceivablecaneitherbeshort-termorlong-term.Additionally,notesreceivableareofteninterest-bearing,whileaccountsreceivablearenot.
c.Whatisacontraaccount?WhattwocontraaccountsareassociatedwithPearson’stradereceivables(seeNote22)?Whattypesofactivitiesarecapturedineachofthesecontraaccounts?Describefactorsthatmanagersmightconsiderwhendecidinghowtoestimatethebalanceineachofthesecontraaccounts.
Acontraaccountisageneralledgeraccountwhichisintendedtohaveitsbalancereducethenormalbalanceforitscorrespondingaccount.Contraaccountsallowsomeflexibilityinthepresentationoffinancialinformation.ThetwocontraaccountsassociatedwithPearson’stradereceivablesareallowanceforbaddebts(calledprovisionforbadanddoubtfuldebtsintheUK)andallowanceforsalesreturns(calledprovisionforsalesreturnsintheUK).Managersmightconsidercustomers’credithistoriesorcreditscoreswhenestimatingallowanceforbaddebtsandallowanceforsalesreturns.Companiesmustalsotakeintoconsiderationeconomicconditions.
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d.Twocommonlyusedapproachesforestimatinguncollectibleaccountsreceivablearethepercentage-of-salesprocedureandtheaging-of-accountsprocedure.Brieflydescribethesetwoapproaches.Whatinformationdomanagersneedtodeterminetheactivityandfinalaccountbalanceundereachapproach?Whichofthetwoapproachesdoyouthinkresultsinamoreaccurateestimateofnetaccountsreceivable?
Thepercentage-of-salesprocedureisusingcreditsalesfromtheperiodtoestimatetheuncollectibleaccountsreceivableasapercentage.Theformulaforthisis:
BadDebtsExpense=Estimated%xCreditSales.Fromthis,historicaldataandothervariousfactorsareusedtodeterminewhichaccountsshouldbeuncollectible.Theaging-of-accountprocedureorganizesacompany’saccountsreceivableaccordingtothelengthoftimeaninvoicehasbeenoutstanding.Thosethathavebeenunpaidforalongerperiodoftimearedeemedtohaveahigherlikelihoodofdefault,andaremorelikelytobeconsidereduncollectible.Ifeelthattheaging-of-accountsprocedureresultsinamoreaccurateestimateofnetaccountsreceivablebecauseitconsidersthefactorsaffectingeachindividualcustomer.
e.IfPearsonanticipatesthatsomeaccountswillbeuncollectible,whydidthecompanyextendcredittothosecustomersinthefirstplace?Discusstherisksthatmanagersmustconsiderwithrespecttoaccountsreceivable.
Onereasoncompanieswillextendcredittocustomersinthefirstplaceisbecauseitcouldencouragesalesbecauseoftheeaseofpaymentupfront.Also,itisverydifficultforacompanytoknowaperson’sinabilitytopaypriortoasale.Thereisalwaysriskthatthedebtorwillfaultinpaymentwithanytypeofcredit,butasacompanyitmaybelessofariskthannotofferingtheuseofcredittocustomersatall.
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Processf.Note22reportsthebalanceinPearson’sprovisionforbadanddoubtfuldebts(fortradereceivables)andreportstheaccountactivity(“movements”)duringtheyearendedDecember31,2009.NotethatPearsonreferstothetradereceivablescontraaccountasa“provision.”UnderU.S.GAAP,thereceivablescontraaccountistypicallyreferredtoasan“allowance”whilethetermprovisionisusedtodescribethecurrent-periodincomestatementchargeforuncollectibleaccounts(alsoknownasbaddebtexpense).
i.UsetheinformationinNote22tocompleteaT-accountthatshowstheactivityintheprovisionforbadanddoubtfuldebtsaccountduringtheyear.Explain,inyourownwords,thelineitemsthatreconcilethechangeinaccountduring2009.
5,000,000
20,000,000
Atthebeginningoftheperiod,£72,000,000isthebalanceintheprovisionforbadanddoubtfuldebtsaccount.Theexchangedifferenceslineitemaccountsfortheexchangeratethatdifferedfromcountrytocountry,andthusresultedinadebitof£5,000,000.The£26,000,000creditistheestimateofbaddebtsexpensefor2009,andthenthe£20,000,000debitistheactualbaddebtbeingwrittenoffin2009,alsocalledhousekeeping.Anadditionalcreditbalanceof£3,000,000ismadefromacquiringanotherbusiness.Attheendof2009,PearsonInc.isleftwithacreditbalanceof£76,000,000inthisaccount.
£72,000,00026,000,0003,000,000£76,000,000
ProvisionforBadandDoubtfulDebts
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ii.PreparethejournalentriesthatPearsonrecordedduring2009tocapture1)badanddoubtfuldebtsexpensefor2009(thatis,the“incomestatementmovements”)and2)thewrite-offofaccountsreceivable(thatis,theamount“utilized”)during2009.Foreachaccountinyourjournalentries,notewhethertheaccountisabalancesheetorincomestatementaccount. 1)1/1/09 BadDebtExpense 26,000,000
ProvisionforBadandDoubtfulDebts26,000,000
2)12/31/09 ProvisionforBadandDoubtfulDebts20,000,000
AccountsReceivable 20,000,000
Baddebtsexpenseisanincomestatementaccount,andprovisionforbadanddoubtfuldebtsandaccountsreceivablearebothbalancesheetaccounts.
iii.Whereintheincomestatementistheprovisionforbadanddoubtfuldebtsexpenseincluded?
Thisaccountwouldbeincludedinthecurrentexpenseportionoftheincomestatement.Itisincludedinoperatingexpenses,whichisseparatedfromtheotherexpensessectionoftheincomestatement.Estimatedsalesreturnsaredeductedfromgrosssales,andthusthisreachesthetotalofnetsales.
g.Note22reportsthatthebalanceinPearson’sprovisionforsalesreturnswas£372atDecember31,2008and£354atDecember31,2009.UnderU.S.GAAP,thiscontraaccountistypicallyreferredtoasan“allowance”andreflectsthecompany’santicipatedsalesreturns.
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i.CompleteaT-accountthatshowstheactivityintheprovisionforsalesreturnsaccountduringtheyear.AssumethatPearsonestimatedthatreturnsrelatingto2009Salestobe£425million.Inreconcilingthechangeintheaccount,twotypesofjournalentriesarerequired,onetorecordtheestimatedsalesreturnsfortheperiodandonetorecordtheamountofactualbookreturns.
443,000,000
ii.PreparethejournalentriesthatPearsonrecordedduring2009tocapture,1)the2009estimatedsalesreturnsand2)theamountofactualbookreturnsduring2009.Inyouranswer,notewhethereachaccountinthejournalentriesisabalancesheetorincomestatementaccount. 1)1/1/09 SalesReturnsandAllowances 425,000,000
ProvisionforSalesReturns 425,000,000
2)12/31/09ProvisionforSalesReturns 443,000,000
AccountsReceivable 443,000,000
Thesalesreturnsandallowancesandprovisionsforsalesreturnsaccountsareincomestatementaccounts,andaccountsreceivableisabalancesheetaccount.
iii.Inwhichincomestatementlineitemdoestheamountof2009estimatedsalesreturnsappear?
Theestimatedsalesreturnswouldappearinthesaleslineitemofanincomestatementasacontra-revenueaccount,becausethisaccounthastheoppositeeffectonnetincomefromsales.
ProvisionforSalesReturns
£372,000,000425,000,000£354,000,000
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h.CreateaT-accountfortotalorgrosstradereceivables(thatis,tradereceivablesbeforedeductingtheprovisionforbadanddoubtfuldebtsandtheprovisionforsalesreturns).AnalyzethechangeinthisT-accountbetweenDecember31,2008and2009.(Hint:yoursolutiontopartsfandgwillbeusefulhere).Assumethatallsalesin2009wereonaccount.Thatis,theyareall“creditsales.”Youmayalsoassumethattherewerenochangestotheaccountduetobusinesscombinationsorforeignexchangeratechanges.Preparethejournalentriestorecordthesalesonaccountandaccountsreceivablecollectionactivityinthisaccountduringtheyear.
12/31/2009 TradeReceivables 5,624,000
Sales 5,624,000
12/31/2009 Cash 5,679,000
TradeReceivables 5,679,000
Thetradereceivablesaccountbeginswitha£1,474,000debitbalancefrom2008.Ithasbeentoldtousthatallthesalesin2009werecreditsales,thusthatnumberis£5,624,000.Sothecreditbalanceforthetradereceivablesaccountis£5,679,000.
TradeReceivables£1,474,0005,624,000£1,419,000
5,679,000
34
CASEFOURTimeValueofMoneyAccountingProblem
35
ThisisadifficultproblemfromChapter6(AccountingandtheTimeValueof
Money)fromintermediateaccounting.IamworkingoutthisproblemasifIwas
teachingapoorlyskilledintermediatestudent.
Problem6-4:
JuliaBakerdied,leavingherhusbandBrentaninsurancepolicycontract
thatprovidesthatthebeneficiary(Brent)canchooseanyoneofthefollowingfour
options.
(a) $55,000immediatecash.
(b) $4,000every3monthspayableattheendofeachquarterfor5years.
(c) $18,000immediatecashand$1,800every3monthsfor10years,payableat
thebeginningofeach3-monthperiod.
(d) $4,000every3monthsfor3yearsand$1,500eachquarterforthefollowing
25quarters,allpaymentspayableattheendofeachquarter.
Ifthemoneyisworth2½%perquarter,compoundedquarterly,whichoption
wouldyourecommendthatBrentexercise?
First,todothisproblem,youwouldneedtounderstandthedifferencebetween
presentvaluesandfuturevalues,andordinaryannuityandannuitydues.Presentvalues
arethevaluenowofafuturesumorsumsdiscountedassumingcompoundinterest.
Futurevalueisthevalueatafuturedateofagivensumorsumsinvestedassuming
compoundinterest.Ordinaryannuitiesareannuitieswheretherentsoccurattheendof
36
eachperiod,andannuityduesarewheretherentsoccuratthebeginningofeach
period.
Forthisproblem,Iwillcalculateeachparts(b)-(d)inpresentvalueinorderto
compareitto(a)$55,000thatBrentcouldreceiveimmediately.
Forpart(b)Iwouldusetheformula:
PV=Rent(PVFn=15,i=2½)
Igot15periodsfrommultiplying5x12,andthendividingby4(sinceit
compoundedquarterly).ThenIwouldplugintherentandnumberfoundfromTable6-4
PresentValueofanOrdinaryAnnuity.
PV=4,000(12.38138)
=$49,525.52
Forpart(c)Iwouldcalculateforanannuitydue,sinceitispayableatthe
beginningofeachofthe3periods.Itwouldgoasfollows:
PV=Rent(PVFn=30,i=2½)
=1,800(21.45355)
=$38,616.39+(theimmediatecash)$18,000
=$56,616.39
Igottheperiodamountof30mymultiplying10x12andthendividingby4.
Forpart(d),Iwouldcalculatebyusingthepresentvalueforordinaryannuities
formulaandtable.Iwouldcalculatetheamountsforthispartasfollows:
PV=Rent(PVFn=9,i=2½)
=4,000(7.97087)
37
=$31,883.48
Icalculatedtheperiodamountof9bymultiplying3x12andthendividingby4.
PV=Rent(PVFn=25,i=2½)
=1,500(18.42438)
=$27,636.57
Whenyouaddthesetwoamountstogetheryougetatotalof$59,520.05.
Thus,Iwouldrecommendoption(d)toBrent,asitresultsinthegreatest
amountofmoneyforhim.Hemightnotgetitallimmediately,butitallowshimthe
greatestreturnfromhiswife’sinsurancepolicy.
38
CASEFIVE
PalfingerAG–Property,Plant,andEquipment
39
PalfingerAGisacompanythatmanufactureslargemachinessuchascranes,
forklifts,andtailgatesforvariousindustries.Theseindustriesincludeconstruction,
agricultureandforestry,andtransport.Inordertoconstructtheseheftymachinesand
solutions,Palfingerrequiresagreatdealofproperty,plant,andequipment.Thiscase
followsthiscompanyinthe2007fiscalyear,andliststheirconsolidatedbalancesheet
andincomestatement,aswellasthecorrespondingnotesrelatedtothesefinancial
statements.Thesenotesgivethereaderabetterunderstandingoftheproperty,plant,
andequipmentacquiredbyPalfinger.ThiscompanyislocatedinAustriaandreports
theirfinancialstatementsinEuros.
Thiscasewashelpfulingettingabetterunderstandingofproperty,plant,and
equipmentforalargecompanysuchasPalfinger.Igrewinmyknowledgeofhowto
analyzedepreciation,usingandcomparingboththestraight-lineanddouble-declining
balancedepreciationmethodsforthesametimeperiod.Ialsolearnedwhat
“prepaymentsandassetsunderconstruction”meant,whichIdidnotknowpriortothis
case.Itwasbeneficialformetohavetocalculategainsorlossesfortheperiodunder
thetwodepreciationpolicies,andcomparethemagainsteachother.Thisgavemea
greaterunderstandingofwhatcertaincalculationsmean.
40
PalfingerAG–Property,Plant,andEquipment
Conceptsa. BasedonthedescriptionofPalfingerabove,whatsortofpropertyandequipment
doyouthinkthecompanyhas?FromthedescriptionofPalfingergiven,Ibelievethecompanyhaspropertyandequipmentcontaininglargewarehousesandworkshopstomaketheircranes,platforms,andforklifts;heavymachinerythatisusedtomeltandmoldmetal;andmachineryusedtotransportandputtogetherforkliftsandcranes.Inaddition,anyassemblylinesandthelandthatthewarehousesarecontainedonwouldalsobeincludedinthepropertyandequipmentthatthiscompanyowns.
b. The2007balancesheetshowsproperty,plant,andequipmentof€149,990.What
doesthisnumberrepresent?Thisnumberrepresentstheacquisitioncostofproperty,plant,andequipmentlesstheaccumulateddepreciationandimpairmentcosts.Inthenotestotheconsolidatedfinancialstatementsin2007,thecarryingamountsatDecember31,2007adduptothisamountof€149,990.
c. WhattypesofequipmentdoesPalfingerreportinnotestothefinancial
statements?Inthenotestothefinancialstatements,Palfingerreportsmachinery,andotherplant,fixtures,fittings,andequipment(whichmayincludeothersmaller,movablepiecesofequipment)astypesofequipment.
d. Inthenotes,Palfingerreports“Prepaymentsandassetsunderconstruction.”What
doesthissubaccountrepresent?Whydoesthisaccounthavenoaccumulateddepreciation?Explainthereclassificationof€14,958inthisaccountduring2007.
Thissubaccountrepresentsaself-constructedasset,whereyouwoulddebit“constructioninprogress”asthebuildingisbeingbuilt.Thisaccounthasnoaccumulateddepreciationbecausethebuildingisnotyetavailableforuse.Oncethebuildingisdonebeingconstructed,itcanbeginbeingdepreciated.The
41
reclassificationof€14,958wouldaccountforPalfingerfinishingabuilding,andtakingitoutoftheprepaymentsandassetsunderconstructionaccount.
e. HowdoesPalfingerdepreciateitspropertyandequipment?Doesthispolicyseemreasonable?Explainthetrade-offsmanagementmakesinchoosingadepreciationpolicy.
Palfingerdepreciatesitspropertyandequipmentonastraight-linebasis,basedontheusefullife.Onastraight-linebasis,theyusethesamerateeachyear.Forbuildingsandinvestmentsinthird-partybuildings,Palfingerusesausefullifeof8-50years,forplantandmachinerytheyuseausefullifeof3-15years,andforfixtures,fittings,andequipmenttheyuseausefullifeof3-10years.Thispolicyseemsreasonable,exceptforthefactthattheusefullifeofbuildingsandinvestmentshaveausefullifeof8to50years.Ifeelthatwiththeuseofanothermethodoramorerealisticusefullifeofbuildings,theycouldhaveamorenotableoutcome.
f. Palfingerroutinelyoptstoperformmajorrenovationsandvalue-enhancing
modificationstoequipmentandbuildingsratherthanbuynewassets.HowdoesPalfingertreattheseexpenditures?Whatisthealternativeaccountingtreatment?
Palfingercapitalizestheseinvestmentsanddepreciatesthemovereitherthenewortheoriginalusefullife.Inaddition,maintenanceandrepairworkarebookedascurrentexpensesintheyearinwhichtheyoccur.Thealternativeaccountingtreatmentistowriteitoffasanexpense.
Processg. Usetheinformationinthefinancialstatementnotestoanalyzetheactivityinthe
“Property,plantandequipment”and“Accumulateddepreciationandimpairment”accountsfor2007.Determinethefollowingamounts:
i.Thepurchaseofnewproperty,plantandequipmentinfiscal2007.
Thecostofnewproperty,plant,andequipmentinfiscal2007was€61,444.
42
ii.Governmentgrantsforpurchasesofnewproperty,plantandequipmentin2007.Explainwhatthesegrantsareandwhytheyaredeductedfromtheproperty,plant,andequipmentaccount.
Therearegovernmentgrantsof€733forpurchasesofnewproperty,plant,andequipmentinthe2007year.Thesegrantsarepresentedasreductionsofthemanufacturingoracquisition,andthusreduceshowmuchisdepreciatedfromassetsduringtheirlife.
iii.Depreciationexpenseforfiscal2007. Depreciationexpenseforfiscal2007was€12,557.iv.Thenetbookvalueofproperty,plant,andequipmentthatPalfingerdisposedofinfiscal2007.
Thenetbookvalueofproperty,plant,andequipmentdisposedofinfiscal2007was€1,501,whichwascalculatedbytaking€13,799andsubtracting€12,298.
h.Thestatementofcashflows(notpresented)reportsthatPalfingerreceivedproceedsonthesaleofproperty,plant,andequipmentamountingto€1,655infiscal2007.CalculatethegainorlossthatPalfingerincurredonthistransaction.Hint:usethenetbookvalueyoucalculatedinpartgiv,above.Explainwhatthisgainorlossrepresentsineconomicterms.
Palfingerincurredagainof€154onthistransaction,whichwascalculatedbytakingtheproceedsonthesaleofproperty,plant,andequipment(€1,655)andsubtractingthenetbookvalue(€1,501).
43
i.Considerthe€10,673addedto“Otherplant,fixtures,fittings,andequipment”duringfiscal2007.Assumethatthesenetassetshaveanexpectedusefullifeoffiveyearsandasalvagevalueof€1,273.PrepareatableshowingthedepreciationexpenseandnetbookvalueofthisequipmentoveritsexpectedlifeassumingthatPalfingerrecordedafullyearofdepreciationin2007andthecompanyuses:
i.Straight-linedepreciation.€10,673-€1,273/5=€1,880peryearYear Depreciation
Expense
AccumulatedDepreciation
BookValue
0 €10,673
1 €1,880 €1,880 8,793
2 1,880 3,760 6,913
3 1,880 5,640 5,033
4 1,880 7,520 3,153
5 1,880 9,400 €1,273
44
ii.Double-declining-balancedepreciation.
Year BookValue(Beginningof
Year)
DepreciationExpense
BalanceAccumulatedDepreciation
BookValue(EndofYear)
0 €10,673
1 €10,673 €4,269 €4,269 6,404
2 6,404 2,562 6,831 3,842
3 3,842 1,537 8,368 2,305
4 2,305 922 9,290 1,383
5 1,383 110 9,400 €1,273
j.Assumethattheequipmentfromparti.wassoldonthefirstdayoffiscal2008forproceedsof€7,500.AssumethatPalfinger’saccountingpolicyistotakenodepreciationintheyearofsale.
i.Calculateanygainorlossonthistransactionassumingthatthecompanyusedstraight-linedepreciation.WhatisthetotalincomestatementimpactoftheequipmentforthetwoyearsthatPalfingerownedit?Considerthegainorlossondisposalaswellasthetotaldepreciationrecordedontheequipment(i.e.theamountfromparti.i.).
Tofindthis,take€8,793(bookvalueafteryear1whenthecompanyusedstraight-linedepreciation)less€7,500(proceeds),whichequalsalossof€1,293ondisposal.Fromthisinformation,itisfoundthatthereisatotalincomestatementimpactof€3,173(€1,880+€1,293)ontheequipmentforthetwoyearsthatthecompanyownedit.
45
ii.Calculateanygainorlossonthistransactionassumingthecompanyuseddouble-decliningbalancedepreciation.WhatisthetotalincomestatementimpactofthisequipmentforthetwoyearsthatPalfingerownedthem?Considerthegainorlossondisposalaswellasthetotaldepreciationrecordedontheequipment(i.e.theamountfromparti.ii.).
Tofindthis,take€6,404(bookvalueafteryear1whenthecompanyuseddouble-decliningdepreciation)less€7,500(proceeds),whichequalsagainof€1,096ondisposal.Fromthisinformation,itisfoundthatthereisatotalincomestatementimpactof€3,173(€4,269-€1,096)ontheequipmentforthetwoyearsthatthecompanyownedit.
iii.Comparethetotaltwo-yearincomestatementimpactoftheequipmentunderthetwodepreciationpolicies.Commentonthedifference.
Forboththestraight-lineandthedouble-decliningbalancedepreciationpolicies,theimpactontheincomestatementoftheequipmentwastheexactsameat€3,173.Whilethestraight-linedepreciationhasalossondisposal,thedouble-decliningbalancedepreciationhasagainondisposal.Bothendupgivingyouthesameamount,workeddifferentways,becausethecostofequipmentwas€10,673lesstheproceedsof€7,500equalsthesametotalof€3,173.
46
CASESIX
VolvoGroup–Research&DevelopmentCosts
47
VolvoGroupisacompanythatisheadquarteredinSwedenthatsupplies
commercialvehiclessuchastrucks,engines,buses,andaircraftenginecomponentsout
tocustomers,inadditiontofinancialsolutions.ThiscaseisfocusedonVolvoGroup’s
researchanddevelopment(innovativeactivitiesundertakenbycorporationsor
governmentsindevelopingnewservicesorproducts,orimprovingexistingservicesor
products),whichcostthemaround13billionSEKayear.TheGroupfocustheirR&Don
restrainingtheireffectontheenvironmentallovertheglobe.Volvoalsohasproduction
facilitiesaroundtheworldin19differentcountries,inadditiontogeneratingsalesin
180countries.
Itakeawayfromthiscaseanintensifiedknowledgeofresearchand
developmentcosts.WhereaspriortothiscaseIunderstoodthebasicsofR&D,thiscase
helpedmeunderstandexactlywhatkindsofexpenditurescanbeclassifiedasresearch
anddevelopmentcostsandhowtospecificallycapitalizeandexpensethesecosts.Also,
IwasintroducedtoIAS38,whichthiscompanyfollowsfortheirresearchand
developmentexpendituresastheiraccountingrequirementsforintangibleassets.
BecomingfamiliarwiththeexcerptofIAS38thatwaspresentinthiscaseIfeelwas
beneficialtomeasIcontinuetoworkwithintangibleassetsinmyfuturecourses.
Finally,becomingacquaintedwiththedifferencesbetweentheU.S.andinternational
researchanddevelopmentclassifications(where95%nevermatchtorevenueinthe
U.S.,andyoujustcapitalizethedevelopmentaspectoftheexpendituresinternationally)
isalwaysimportantformetolearnfromthesecases.
48
VolvoGroup–Research&DevelopmentCostsConceptsa. The2009incomestatementshowsresearchanddevelopmentexpensesofSEK
13,193(millionsofSwedishKrona).Whattypesofcostsarelikelyincludedintheseamounts?
Researchanddevelopmentexpensescanincludedevelopmentofnewproducts,productionsystems,andsoftware.Inaddition,improvisationofexistingproductsandservicescanalsobeincludedintheseamounts.Inthe“researchanddevelopmentexpenses”sectionofthenotestoconsolidatedfinancialstatements,Volvoreportsnewproducts,productionsystems,andsoftwareasintangibleassets.Thesewillbeamortizedovertheirestimatedusefullife.
b. VolvoGroupfollowsIAS38—IntangibleAssets,toaccountforitsresearchand
developmentexpenditures(seeIAS38excerptsattheendofthiscase).Assuch,thecompanycapitalizescertainR&Dcostsandexpensesothers.WhatfactorsdoesVolvoGroupconsiderasitdecideswhichR&Dcoststocapitalizeandwhichtoexpense?
AccordingtoIAS38,VolvoGroupwouldhavetoconsiderfactorssuchaswhetheranexpenditureonresearchshouldberecognizedasanexpenseorcapitalized,suchas:- Ifabusinesscannotdifferentiatebetweentheresearchphasefromthe
developmentphaseofaninternalproject,itistreatedasanexpense.- Expenditureonresearchisexpensedwhenincurred.(Nointangibleasset
fromresearchisrecognized.)- Ifnofutureeconomicbenefitcanbeshownfromanintangibleasset,then
theexpenditureisrecognizedasanexpense.
49
c. TheR&DcoststhatVolvoGroupcapitalizeseachperiod(labeledProductand
softwaredevelopmentcosts)areamortizedinsubsequentperiods,similartoothercapitalassetssuchaspropertyandequipment.NotestoVolvo’sfinancialstatementsdisclosethatcapitalizedproductandsoftwaredevelopmentcostsareamortizedoverthreetoeightyears.Whatfactorswouldthecompanyconsiderindeterminingtheamortizationperiodforparticularcosts?
Factorsthatthecompanywouldconsiderindeterminingtheamortizationperiodforparticularcostswouldincludetheusefullifeoftheasset,aswellasanylegal,regulatory,orcontractualprovisionsthatmaylimittheusefullife.
d. UnderU.S.GAAP,companiesmustexpenseallR&Dcosts.Inyouropinion,which
accountingprinciple(IFRSorU.S.GAAP)providesfinancialstatementsthatbetterreflectcostsandbenefitsofperiodicR&Dspending?
SinceR&Dspendingdoesnotcometofruition95%ofthetime,andthusyoucannotmatchrevenuestoexpensesundertheseconditions,IfeelthattheIFRSisabetterreflectionofcostsandbenefitsofperiodicR&Dspending.ThisallowscompaniestojustcapitalizetheDevelopmentaspectofR&D.
Processe. Refertofootnote14whereVolvoreportsanintangibleassetfor“Productand
softwaredevelopment.”Assumethattheproductandsoftwaredevelopmentcostsreportedinfootnote14aretheonlyR&DcoststhatVolvocapitalizes.
i.Whatistheamountofthecapitalizedproductandsoftwaredevelopmentcosts,netofaccumulatedamortizationattheendoffiscal2009?WhichlineitemonVolvoGroup’sbalancesheetreportsthisintangibleasset?
Thecapitalizedproductandsoftwaredevelopmentcostsattheendof2009equals11,409SEK(25,148–13,739).Thelineitemof“Intangibleassets”reportsthisintangibleassetonthebalancesheet.
50
ii.CreateaT-accountfortheintangibleasset“Productandsoftwaredevelopment,”netofaccumulatedamortization.Entertheopeningandendingbalancesforfiscal2009.ShowentriesintheT-accountthatrecordthe2009capitalization(capitalexpenditures)andamortization.Tosimplifytheanalysis,groupallotheraccountactivityduringtheyearandreportthenetimpactasoneentryintheT-account.
f. RefertoVolvo’sbalancesheet,footnotes,andtheeleven-yearsummary.Assumethattheproductandsoftwaredevelopmentcostsreportedinfootnote14aretheonlyR&DcoststhatVolvocapitalizes.
i.CompletethetablebelowforVolvo’sProductandsoftwaredevelopmentintangibleasset.
(inSEKmillions)2007 2008 2009
1)Productandsoftwaredevelopmentcostscapitalizedduringtheyear
2,057 2,150 1,858
2)TotalR&Dexpenseontheincomestatement 11,059 14,348 13,193
3)Amortizationofpreviouslycapitalizedcosts(includedinR&Dexpense)
2,357 2,864 3,126
4)TotalR&Dcostsincurredduringtheyear=1+2-3 10,759 13,634 11,925
CapitalizedProductandSoftware,net23,290
11,409
25,148
13,739
472
51
iii.WhatproportionofTotalR&DcostsincurreddidVolvoGroupcapitalize(asproductandsoftwaredevelopmentintangibleasset)ineachofthethreeyears?
TheproportionofTotalR&DcostsincurredbyVolvoGroupthatwerecapitalizedin2007were19.1%(2,057/10,759x100).In2008,thisproportionwas15.8%(2,150/13,634x100)andin2009thisproportionwas15.6%(1,858/11,925x100).
g. AssumethatyouworkasafinancialanalystforVolvoGroupandwouldliketo
compareVolvo’sresearchanddevelopmentexpenditurestoaU.S.competitor,NavistarInternationalCorporation.NavistarfollowsU.S.GAAPthatrequiresthatallresearchanddevelopmentcostsbeexpensedintheyeartheyareincurred.YougatherthefollowinginformationforNavistarforfiscalyearendOctober31,2007through2009.
(inUS$millions)
2007 2008 2009
TotalR&Dcostsincurredduringtheyear,expensedontheincomestatement
375 384 433
Netsales,manufacturedproducts11,910 14,399 11,300
Totalassets11,448 10,390 10,028
Operatingincomebeforetax(73) 191 359
52
i.UsetheinformationfromVolvo’seleven-yearsummarytocompletethefollowingtable:
ii.Calculatetheproportionoftotalresearchanddevelopmentcostsincurredtonetsalesfromoperations(called,netsalesfrommanufacturedproducts,forNavistar)forbothfirms.Howdoestheproportioncomparebetweenthetwocompanies?
Navistar 2007 2008 2009
Netsalesfrommanufacturedproducts,forNavistar
3.15%(375/11,910)
2.67%(384/14,399)
3.83%(433/11,300)
Volvo 2007 2008 2009
Netsalesfrommanufacturedproducts,forVolvo
3.9%(10,759/276,795)
4.6%(13,634/294,932)
5.7%(11,925/208,487)
TheproportionofVolvoissteadilyincreasingoverthepastthreeyears.ThisshowshowthecompanyisincreasingitsR&Dcoststoitsnetsaleseachyear.Yet,in2009eventhoughitwasaproportionalincrease,Volvodiddecreaseinbothitscostsandsales.Navistar’spercentagesseeadropin2008fromalargeincreaseinnetsales,whichgoesbackdownin2009.ThiscompanyalsohasasteadyincreaseinR&Dcostsfrom2007to2009from$375to$433.
(inSEKmillions)2007 2008 2009
Netsales,industrialoperations276,795 294,932 208,487
Totalassets,frombalancesheet321,647 372,419 332,265
53
CASESEVEN
DataAnalyticsCase–IBMWatson
54
Thiscasefocusesonthetopicsof11variousdataanalyticstools.Inparticular,
ourgroupwasassignedthetoolIBMWatsontoexploreinmoredetail.Thecasefirst
detailsthehistoryandbackgroundofthetool,aswellasthefunctionsofthedevicein
thebusinessrealm.Thisincludeshowitisusedtomakebusinessdecisionsandbenefit
businessesintheiroperations.Next,thiscaselooksattheskillsthatareneededto
properlyuseanddrawbusinessconclusionsfromWatson.Specifically,theskillsand
abilitiesthatstudentsmyagewouldrequirewhenworkingwithatoolsuchasWatson.
Then,welookathowIBMWatsoncouldbeusedincertainbusinesssettings,
particularlyinAuditing,TaxPlanning,andAdvisorysituations.Andfinally,thiscaseasks
ustoplaceourselvesinaPartnerposition,andrequestfortheinvestmentofthistool
forthefirm.Thismakesusthinkoutsideofthebox,andplacesusinabusinessmindset.
AlloftheseactivitieshelpedmeunderstandthetoolIBMWatsonanditspurpose.
Afteranalyzingthisdevice,itisamazingtomehowfartechnologyhasgrown.
Thistoolspecificallyshowshowscarytheworldoftechnologycanbecome.Itis
magnificentandadvantageousbecauseitcanteachusandhelpuslearnnewthingsin
businessandscience.Yet,itisalsofrighteningbecauseitalmostseemstobemore
powerfulthanhumans(suchaswhenWatsonovercametheJeopardy!champions).It
seemsthathumansaremakinggreatstridesintheprogressoftechnology,butweneed
tobecautiousinwhatmotiveswehaveforthesedevices.Inaddition,Ialsolearneda
greatdealabouttheIBMWatsonitselfthatIdidnotknowpriortothiscase.Havinga
betterunderstandingofdevisessuchasthisonecanhelpmeinthefuture,suchasin
mycareer.
55
DataAnalyticsCase-IBMWatson
1) Identifythehistoryandpurposeofthistoolanddescribe,ingeneral,howitisusedtomakebusinessdecisions.Bespecificaboutwhatkindoftechnologyplatformituses,etc.andotherrecoursesthatneedtobeinplacetofullyutilizethefunctionalityofthetool.
In2011,IBMWatsonfamouslywentupagainstthequizshowJeopardy!’stoptwowinners,andbeatthemboth.Watsonwasdevelopedasadatatechnologyquestionansweringdevice,createdbyIBMResearch.Ithasatotalof2,880processorcoresand90servers,andoveryears’timehasbeenequippedwithmillionsofpagesofinformation.Afterbeingfedaquestion,ithasover100algorithmsanalyzethequestion,andcanspitoutananswerinunderthreeseconds.
BusinessescanuseWatsoninvariousways.Withthisdevice,researchcanprimarilybeconductedfaster.Watsoncancombthroughimmensesourcesofdatatoobtainthemostsignificantdetails.Also,thistechnologycananticipateissuesbeforetheyarise,becauseWatsonmonitorstheconditionofthebusiness’systemsconstantly.Thisisextremelybeneficialbecauseitcouldsavethebusinessfromheftycosts.Furthermore,Watsonhelpscreateasenseofcertaintywhenunderstandinganddrawingconclusionsfromalargesetofdata.Becauseofthetool’sgreatintelligenceandlogic,itcanaidmanagersinmakingdecisionswhenlookingatawidevarietyofinformation.
Watsonhasdistinctiveskillstobenefitbusinessesaswell.Thisdevicecanunderstandtextmining,whichisdataenclosedinnaturallanguagetext.Thiscanbebeneficialtoabusinessorganizationinreadingcontentthatistext-basedindocumentsandonsocialmedia,givingtheminsightintoinformationtheycouldhavemissedwithoutthetechnologyofWatson.Also,Watsoncanlookatpreviousbuyingandsellingpatterns,andcomputeleadsbasedonthegiveninformation,givingthemanotherwaytogaininsightonthebusiness.
Watsongeneratesbetterevidencebaseddecisionsfromcomplexvolumesofdata,revolutionizingthewaybusinesspeoplebecomeexperts.Thecapabilitiesofthisdevicealloworganizationstostretchtheircapacityfurtherthanpreviouslypossible,whilesavingvaluabletimeandmoney.
56
2) Whatspecialskillsareneededtousethistooltoaidinbusinessdecisionmaking.Howmightastudentlikeyourselfgainthoseskills?
IBMWatsonissuchadevelopedtechnologythatitdoesmostoftheworkforyou.Inorderforastudentlikemyselftogrowspecialskillsthatwouldbeneededtousethistooltoaidinbusinessdecisionmaking,theywouldneedtoengageintutorialsandtrainingthatwouldheightentheirdataanalyticsanddevelopmentskills.
IBMhasa“LearningLab”thatgivestutorialsinmanythingsfromdataanalyticstocloudcomputing,InternetofThings,blockchain,andevenJava.Eachofthesecoursesrangeintimetocomplete,usuallyafewhours,andconsistofvideos,tutorials,andonlinelabs.Havingagreaterunderstandingofeachofthesetopicswouldbetterenhancethedecision-makingprocessforauserofIBMWatson.Thiswouldbebecauseifapersoncomprehendedwhatdataanalytics,forexample,waspriortousingthedevice,itwouldhelpthemtodecipherwithbetterdiscernmentwhatWatsonwassayingorsuggestingforabusiness.
3) How,specifically,wouldusethetoolinthefollowingbusinesssettings?Create
atleastthreespecificscenariosforeachcategoryinwhichthetoolwouldleadtomoreefficiencyand/orbettereffectiveness.Besuretodescribewhatkindsofdatayourtoolwoulduseforeachscenario.
a. Auditingi. ThedeviceofIBMWatsoncanassistauditorsincheckingfor
completenessofitemssuchasfinancialstatements.Wherehumanscanmakeerrors,andmaymissfactorsduringanactualaudit,atoolsuchasWatsoncouldbeafaultcorrector.Watsoncouldbegincheckingforaccuracyandcompletenessbeforetheauditoreventouchestheclient’spaperwork.Thiscouldbeanextremelybeneficialfactorforabusinessbecauseitwouldsavethemtime,andinturn,savethemmoney.
ii. Valuation–Watsoncanalsobeagreatjudgementofvaluationinfinancialstatementsandothervariousdatathatacompanygives.Thedevicecanmakesurethateverythingismeasuredcorrectly,thatallnumbersaddup,andthatalldatamatchestoeachotherandtootheroutsidesources–ifnecessary.Watsoncanactasanextramindtotheauditteam.
57
iii. Thisdevicecanhelpgaininsightfromthedatapresentedfromclients,andallowauditorstoquicklyassesslargeamountsofdatasothattheycanspendmoretimeonitemslikeriskassessment.KPMGisjustonefirmthatisputtingthistechnologytousetoday.TheyareusingWatsontoenhancetheircustomerrelationsandincreasetheusetechnologyintheirworkplace.
b. TaxPlanningi. AcompanywouldbeabletouseIBMWatsontounderstand
globaltaxratesforvariouscountries,andwhendoingbusinesswiththem,wouldallowthemtoeasilyorganizebusinesstransactions.Becausedifferenttaxrateseffectthebottomline,beingabletokeepthemsystematizedinatoolsuchasWatsonforlargecompaniescouldbeverybeneficial.
ii. Thistoolcouldbeusedtopushafirmforwardandhelpfosterbreakthroughideastopushthroughchallenges.TaxInternsandAssociatesatKPMGIgnitioninDenver,calledtheInnovationLab,usetechnologiessuchasIBMWatsontodevelopandmaintaintaxsoftwaretoperformatthebestcapablefunction.Watsoncaninspireandhelptheseprofessionalscreatetoolstouseintaxpracticetoadvancebusinessinbeneficialways.
iii. IBMWatsoncanbegivendataandhelpacompanyworkoutfinancialssothattheycanbeabletolimittheiroveralllegalworldwidepayment.Inordertodothis,acompanycoulddecreaseexpensesandcutcostsasmuchaspossible,aswellasdecreasetaxeswherepossible.Watsoncananalyzedataandseewherethisispossible,andassistacompanyplanforcuttingexpenditures.
c. FinancialStatementAnalysis/Valuation/Advisoryi. IBMWatsonwouldbespecificallyhelpfulinthejobofforensic
accounting,wheretheyconcentrateinanalysisofelectronicdatatobackuptheclaimoffinancialfraud.Watsonwouldcollect,prepare,analyze,andreportondata,whichwouldhelpanaccountantreviewanddrawconclusionstomaketheircaseagainstfraud.
ii. Beingabletovalueacompany’sassetsorliabilitiesforfinancialreportingpurposesisimportantinanyaccountingsystem.Understandingthecorrectvaluationtoplaceonsaidassetsorliabilitiesiscrucialtoreportingacompanycorrectly.IBMWatson
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couldaidinassetvaluationbyassessingbookvaluesvsmarketvalues,evaluatingcashflowpotential,andaccumulateddepreciation.
iii. Equityresearch–IBMWatsoncanhelpafirmsearchthoughfinancialsandcarryoutratioanalysiswithgreateaseandaccuracy.Onceitcompletesthesesteps,thistoolcanmakepredictionsforthefuturefromthesecalculationsofdata.Thiscanhelpacompanyexploreitsoptionsofbuyingandsellingstockinvestment,thusWatsoncanmakeproposalsforwhatitthinkswouldbethebestdecisionsforthem.
4) Writeafewparagraphstoyourfuturepublicaccountingpartnerexplainingwhyyourteamshouldinvestintheacquisitionofandtraininginthistool.Explainhowthetoolwillimpactthestaffingandscopeofyourfutureengagements.
IBMWatsonisdatatechnologyweneedinouraccountingfirm.Itwillchangethewaywedobusiness.
Thetrainingthatwouldbenecessaryforthistoolwillonlybebeneficialforouremployeesandassociates,wheretheskillstheyobtainfromtrainingwillhelpthemnotonlywiththeuseanddecisionmakingofthisdevice,butinotherpartsofbusiness.Itwillbewellworththetimeandmoney,andwewillgetareturnonourinvestmentfromourstaff.
IBMWatsonwillgiveusanadvantageoverthecompetition.Thisdevicecangenerateleadsfromsubstantialamountsofpreviousdata,andcanhelpusasabusinesspredictforthefuture.Inaddition,itisatoolthatcanreadtextmining,andcananalyzetheotherfirm’ssocialmediaanddocumentsthatweashumansmightnotbeabletoread.Also,itisamachinethatneverstops.Itisconstantlyatwork,whichcansaveusasafirmvaluabletimeandkeepusaheadofthegame.
Thistechnologywillhelpustomakebetterevidencebaseddecisionsandallowusasafirmtogrowwithourclientsandstaff.IbelieveitisinourbestinteresttoinvestintheacquirementandthetrainingoftheIBMWatsonandIhopeyouwillagree.
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CASEEIGHT
RiteAidCorporation–Long-TermDebt
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ThiscasewascenteredaroundRiteAid,aretailpharmacythatisintheUnited
States.Itisconsideredthethirdlargestinitsmarket,andin2009,thecompanyfilled
over300millionprescriptions.While68%ofitssalesareattributedtoits
pharmaceuticals,thechainalsosellsmerchandisesuchasfood,photoprocessing,
beautysupplies,andseasonalitems.Foracompanyaslargeasthisone,itisboundto
havelong-termdebtandotherdebtrelatedrequirements.Includedinthiscasearethe
distinctionsbetweensecuredandunsecureddebt,aswellasdifferentloanterms.The
casethengoesintothespecificsofRiteAid’sbalancesheetandnote11,whichfocuses
onindebtednessandcreditagreements.Thecasethenconsidersthreedifferentnotes
atvaryingfacevaluesandanalyzesthem.Anamortizationscheduleisalsocreatedafter
theconsiderationofthethirdnote.
Allinall,thetopicoflong-termdebtissomethingthatIhavedippedmytoes
into,buthavenotstudiedingreatdepth.Thiscasewidenedbyunderstandingofhowa
companyshowstheseitemsonfinancialstatements,howIneedtoreadandanalyze
themfromstatementsandnotes,andhowtoanalyzesuchitemscorrectly.Iwasalso
refreshedonhowtojournalizebasicaccountingentries,aswellashowtocreatean
amortizationschedule,bothofwhichIhavedonemanytimes.Yet,Ilearnednewskills
aswell,suchasnewcalculationsthatIdidnotknowpriortothiscasethatIwilltake
withmegoingforwardinthefuture.
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RiteAidCorporation–Long-TermDebtConcepts
a. Considerthevarioustypesofdebtdescribedinnote11,IndebtednessandCreditAgreement.i. ExplainthedifferencebetweenRiteAid’ssecuredandunsecureddebt.
WhydoesRiteAiddistinguishbetweenthesetwotypesofdebt?
Secureddebtisbackedbyanasset(suchasahomeorcar),knownascollateral.Thelenderofaloanisallowedtocapturethecollateralinthecasethattheborrowerdefaultsontheloan.Anunsecuredloanisnotbackedbysuchcollateral.ItisimportantforacompanysuchasRiteAidtodistinguishbetweenthesetwotypesofdebtssothatthecompanycandifferentiatebetweeninterestratesandborrowinglimits,andsothatcreditorscanunderstandwhichloansaresecuredandwhicharenot.
ii. Whatdoesitmeanfordebttobe“guaranteed”?Accordingtonote11,whohasprovidedtheguaranteeforsomeofRiteAid’sunsecureddebt?
Iftheborrowerofaloandefaultstopay,aguaranteedloanisapromisebyanotherparty(knownastheguarantor)topayadebtresponsibility.Theguaranteedloancanbelimitedorunlimited,whichwouldmakethepartyresponsibleforeitherjustapartofthedebtthattheborrowerdidnotpay,ortheentirebalance.Innote11,itstatesthatRiteAid’s“wholly-ownedsubsidiaries”guaranteethecompany’sunsecureddebt.
iii. Whatismeantbytheterms“senior,”“fixed-rate,”and“convertible”?Theterm“senior”isusedtodescribeanoteorbondthathaspriorityforrepaymentbytheborrower.A“fixed-rate”meansthattheinterestrateremainsconstantforthelifeoftheloan.Andfinally,theterm“convertible”aredebtsecuritythattheholdercanconverttoacertainquantityofsharesofcommonstockatspecifictimesofthebond’slife.
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iv. SpeculateastowhyRiteAidhasmanydifferenttypesofdebtwitha
rangeofinterestrates.RiteAidhasvaryingtypesofdebt(suchasseniorsecured,guaranteedunsecured,andunsecuredunguaranteeddebts)inordertodealwithcertainbusinessandcreditactivitiesinthebestwaypossible.Therangeofinterestratescanbestbedescribedbecausedifferentbondsareissuedatdifferenttimesoftheyear.
Processb. Considernote11,IndebtednessandCreditAgreement.Howmuchtotaldebt
doesRiteAidhaveatFebruary27,2010?Howmuchofthisisduewithinthecomingfiscalyear?Reconcilethetotaldebtreportedinnote11withwhatRiteAidreportsonitsbalancesheet.
(Allnumbersinthousands)Totalamountofdebtfor2010=$6,370,899CurrentMaturitiesofLong-TermDebt $51,502Long-TermDebt 6,185,633CapitalLeaseObligations 133,764TotalDebt $6,370,899
Thecurrentmaturitiesoflong-termdebtarewhatisduewithinthecomingfiscalyear,whichis$51,502.Thistotaldebtislessthanthetotalamountofassetsfor2010,givingthecompanyadebttoassetratioof0.79,whichtellsusthetotalamountofassetsthatwerefinancedbyliabilities.Thecurrentmaturitiesoflong-termdebtaretheliabilitiesthatareduewithinthecurrentfiscalyearandlong-termdebtareapartoflong-termliabilities.Aseachoftheseincrease,thecorrespondingliabilitiescategoriesincrease.Finally,netincomeisimpactedbydebtbywhennewdebtistakenon,netincomeindecreased.Whatistheeffectonassets,liabilities,andnetincome,anddiscussoneachpart.
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c. Considerthe7.5%seniorsecurednotesdueMarch2017.
i. Whatisthefacevalue(i.e.theprincipal)ofthesenotes?Howdoyouknow?
Thefacevalueofthesenotes(i.e.theprincipal)is$500,000.Thisisknownbecausetherearenounamortizeddiscounts.
ii. PreparethejournalentrythatRiteAidmusthavemadewhenthesenoteswereissued.
NoteatIssuance: Cash 500,000 NotesPayable 500,000
iii. Preparetheannualinterestexpensejournalentry.Notethattheinterestpaidonanoteduringtheyearequalsthefacevalueofthenotetimesthestatedrate(i.e.,couponrate)ofthenote.
InterestExpense(500,000x.075)37,500 Cash 37,500
iv. PreparethejournalentrythatRiteAidwillmakewhenthesenotes
maturein2017.NotesPayable 500,000 Cash 500,000
InterestExpensewentupinpartc,thusthenetincomeofRiteAidwoulddecreaseasitbecomesgreater.NotesPayableareitemsthataffecttheliabilitiesportionofabalancesheet,andcashareassetsofRiteAid.Asseenhere,thebondswillfullymaturein2017,andwillbewrittenoffthoseaccounts.
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d. Considerthe9.375%seniornotesdueDecember2015.Assumethatinterestispaidannually.
i.Whatisthefacevalue(orprincipal)ofthesenotes?Whatisthecarryingvalue(netbookvalue)ofthesenotesatFebruary27,2010?Whydothetwovaluesdiffer?
AtFebruary27,2010,thefacevalue(orprincipal)amountofthesenotesis$410,000,whilethecarryingvalue(ornetbookvalue)is$405,951.Theseamountsdifferbecausethereisanunamortizeddiscount.
ii.HowmuchinterestdidRiteAidpayonthesenotesduringthefiscal
2009? Thecashinterestpaymentofthisnotein2009forRiteAidwas
$38,438.(410,000x.09375x12/12)
iii.DeterminethetotalamountofinterestexpenserecordedbyRiteAidonthesenotesfortheyearendedFebruary27,2010.Notethatthereisacashandanoncashportiontointerestexpenseonthesenotesbecausetheywereissuedatadiscount.Thenoncashportionofinterestexpenseistheamortizationofthediscountduringtheyear(thatis,theamountbywhichthediscountdecreasedduringtheyear).
ThetotalamountofinterestexpenserecordedbyRiteAidonthesenotesfortheyearendedFebruary27,2010is$39,143.(Thisiscalculatedbytaking$38,438andaddingthediscountonnotespayableof$705).
v. Preparethejournalentrytorecordinterestexpenseonthesenotesfor
fiscal2009.Considerboththecashanddiscount(noncash)portionsoftheinterestexpensefrompartiiiabove. InterestExpense 39,143 Disc.onNotesPayable 705 Cash 38,438
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v.Computethetotalrateofinterestrecordedforfiscal2009onthese
notes.
Thetotalrateofinterestrecordedforfiscal2009onthesenotesis9.64%.
(!"#$%$&#'()*$"&$+, '!!= !",$%!%&',"'$= ) .0964!!)
Theinterestexpenseof$39,143forRiteAidwillaffectnetincome,andwillmakeitlessthanthelastinterestpaymentof$37,500wouldhavebecauseitisalargeramount.Asbefore,thenotewillbewhateffectstheassetsandliabilities.Becauseofthediscount,thereisextrainterestthatmustbepaidoverthelifeofthenotewhichwemustaccountfor.
e. Considerthe9.75%notesdueJune2016.AssumethatRiteAidissuedthese
notesonJune30,2009andthatthecompanypaysinterestonJune30thofeachyear.
i.Accordingtonote11,theproceedsofthenotesatthetimeofissue
were98.2%ofthefacevalueofthenotes.PreparethejournalentrythatRiteAidmusthavemadewhenthesenoteswereissued.
6/2009 Cash 402,620
Disc.onNotesPayable 7,380 NotesPayable 410,000
ii.Atwhateffectiveannualrateofinterestwerethesenotesissued?
Theeffectiveannualrateofinterestthatthenoteswereissuedatwas10.1212%.
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iii.AssumethatRiteAidusestheeffectiveinterestratemethodtoaccountforthisdebt.Usethetablethatfollowstoprepareanamortizationscheduleforthesenotes.Usethelastcolumntoverifythateachyear’sinterestexpensereflectsthesameinterestrateeventhoughtheexpensechanges.Note:Guidancefollowsthetable.
Date CashInterestPayment
InterestExpense
DiscountAmortization
CarryingValue
6/30/09 --- --- --- $402,6206/30/10 $39,975 40,750 775 403,3956/30/11 39,975 40,828 853 404,2486/30/12 39,975 40,915 940 405,1886/30/13 39,975 41,010 1,035 406,2336/30/13 39,975 41,115 1,140 407,3636/30/14 39,975 41,230 1,255 408,6186/30/15 39,975 41,357 1,382 $410,000
iv.Basedontheaboveinformation,preparethejournalentrythatRite
AidwouldhaverecordedFebruary27,2010,toaccrueinterestexpenseonthesenotes.
InterestExpense 27,167 Disc.onNotesPayable 517 InterestPayable 26,650 v.Basedonyouranswertopartiv.,whatwouldbethenetbookvalue
ofthenotesatFebruary27,2010? ThenetbookvalueofthenotesatFebruary27,2010wouldbe
$403,137.($403,395+517)
Here,wehaveasmallerinterestexpenseof$27,167whichwouldhavelessofanimpactonournetincome,leavingitlarger.Ourdiscountonnotespayableislesscomparedtopartd,at$517comparedto$705.
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CASENINEMerck&Co.,Inc.andGlaxoSmithKlineplc–Shareholders’Equity
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ThepartofthecasethatwewerecenteredonwasthecompanyofMerck&Co.,
Inc.,whichisapharmaceuticalcompanythatfocusesonimprovinghumanandanimal
healthworldwide.Theydoagreatdealofresearchintheirdailybusinessoperations,
andareheadquarteredinNewJersey.Theydohavepubliclytradedstockthatarelisted
onboththeNewYorkandPhiladelphiaStockExchanges.Thiscasefirstanalyzesthe
company’scommonshares.Itthendiscussestopicssuchasdividendsandstock
repurchases.Adividendactivityjournalentryisaskedtobemade,andthetopicof
treasurystockisalsoexplored.Variousratiosarecalculatedforboth2006and2007for
thecompanyandthendividendratiosarecalculatedforMerckCo.,Inc.attheendof
thecase.
DividendsareatopicIenjoystudyingandunderstandalittlebitmoreeachtime
wetouchonthetopicinmydifferentclasses.Treasurystock,buybacks,andshare
repurchasesaresomethingIgraspedatasurfacelevel,butafterdoingmyownresearch
Inowunderstandthegreaterreasonsbehindwhyacompanywouldwanttorepurchase
theirownshares.Justhavingtoreviewfinancialstatementsandanswerquestionsto
understandwhatnumbersarecomingfromwhere,reallyshowtheimportanceofwhy
wedothesescasestudies.Inthefirstpartofthiscase,weareaskedtoidentifyitems
suchascommonsharedauthorizedandissued,heldintreasury,andoutstanding.This
wasagreatexercisetobeabletodistinguishthesenumbersfromthesameinformation.
Thiscasealsofocusedonajournalentryforcommondividendactivityanddividend
relatedratios.
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Merck&Co.,Inc.andGlaxoSmithKlineplc–Shareholders’EquityConcepts
a. ConsiderMerck’scommonshares.
i. HowmanycommonsharesisMerckauthorizedtoissue?
Merckhas5,400,000,000commonsharestoissue. ii. HowmanycommonshareshasMerckactuallyissuedatDecember31,
2007? 2,983,508,675shareshaveactuallybeenissuedatDecember31,2007.
iii. ReconcilethenumberofsharesissuedatDecember31,2007,tothedollarvalueofcommonstockreportedonthebalancesheet. The$29.8million-dollarvalueofcommonstockreportedonthebalancesheetcanbefoundbymultiplyingthe2,983,508,675sharesofcommonstockbytheparvalueofonecent.
iv. HowmanycommonsharesareheldintreasuryatDecember31,2007? ThenumberofsharesheldintreasuryatDecember31,2007isequalto811,005,791shares.
v. HowmanycommonsharesareoutstandingatDecember31,2007?ThenumberofcommonsharesoutstandingatDecember31,2007isequalto2,172,502,884shares.
vi. AtDecember31,2007,Merck’sstockpriceclosedat$57.61pershare.CalculatethetotalmarketcapitalizationofMerckonthatday. ThetotalmarketcapitalizationofMerckonthatdayis$125,157,891,147.24.
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c. Whydocompaniespaydividendsontheircommonorordinaryshares?Whatnormallyhappenstoacompany’ssharepricewhendividendsarepaid?
Dividendsareawaytoregularlypayshareholdersofacompanyoutofitsretainedearnings.Investorsenjoythesteadyincomethatcomeswithdividends,sotheyaremorelikelytobuycompany’sstock.Investorsputinmoneyinacompanywithhighhopesfortheirfutureincome.Yet,whenacompanypaysdividends,theirsharepriceusuallyfallsbytheamountofthepayout.
d. Ingeneral,whydocompaniesrepurchasetheirownshares?
Thiscanbeknownasasharerepurchase,orbuyback.Thiscanhappeninoneoftwoways–tenderoffersorontheopenmarket.Thereareseveralreasonsbehindwhyacompanymightwanttorepurchasetheirownshares.First,itcouldbetoimprovetheirfinancialratios.Buybacksreducesthenumberofsharesoutstanding,reducestheassetsonthebalancesheet,andhaslessequityoutstanding.Thus,ROAandROEbothincrease.Inaddition,whenstockisundervalued,companiesaremorepronetorepurchasetheirstock.Whenthestockpricegoesbackup,theywillthenre-issuethemonthemarketwithouthavingtoissueanyadditionalshares.
Process
e. ConsiderMerck’sstatementofcashflowandstatementofretainedearnings.PrepareasinglejournalentrythatsummarizesMerck’scommondividendactivityfor2007.
RetainedEarnings 3,310,700,000
Cash 3,307,300,000
DividendsPayable 3,400,000
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g. During2007,Merckrepurchasedanumberofitsowncommonsharesontheopenmarket.
i.DescribethemethodMerckusestoaccountforitstreasurystocktransactions.
ThemethodthatMerckusestoaccountforitstreasurystocktransactionsisthecostmethod.Thismethodoverlookstheparvalueofthesharesandthetotalreceivedfrominvestorswhentheshareswereinitiallyissued.
ii.Refertonote11toMerck’sfinancialstatements.HowmanysharesdidMerckrepurchaseontheopenmarketduring2007?
Merckrepurchased26.5millionsharesontheopenmarketduring2007.
iii.HowmuchdidMerckpay,intotalandpershare,onaverage,tobuybackitsstockduring2007?Whattypeofcashflowdoesthisrepresent?
Merckpaidintotal$1,429,700,000and$53.95persharetobuybackitsstockduring2007.Thisrepresentsafinancingcashflow.
iv.Whydoesn’tMerckdiscloseitstreasurystockasanasset?
Treasurystockbydefinitionisconsideredacontra-equityaccount,thusshouldnotbedisclosedasanasset.
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Analysis
i.Determinethemissingamountsandcalculatetheratiosinthetablesbelow.Forcomparability,usedividendspaidforbothcompaniesratherthandividendsdeclared.Usethenumberofsharesoutstandingatyearendforper-sharecalculations.WhatdifferencesdoyouobserveinMerck’sdividend-relatedratiosacrossthetwoyears?Whatdifferencesdoyouobserveinthetwocompanies’dividend-relatedratios?
Merck
(inmillions)2007 2006
Dividendspaid $3,307.30 3,322.60
Sharesoutstanding 2,172,502,884 2,167,785,445
Netincome 3,275.40 4,433.80
Totalassets 48,350.70 44,569.80
Operatingcashflows 6,999.20 6,765.20
Year-endstockprice
$57.61 $41.94
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Somedividendrelatedratiostoconsidercouldincludethedividendpayoutratio,dividendstototalassetsratio,anddividendyieldforMerck.First,thedifferenceindividendpayoutacrossthetwoyearswas74.94%in2006to100.97%in2007.Thiswasthebiggestjumpindividendratiosbecauseofthecompany’sratioofdividendstonetincome,asnetincomedecreasedmorethanitsdividendspaiddecreased.Next,thedividendstototalassetsratioin2006was7.44%,whileitwas6.84%in2007.Thisremainedfairlyconstant.Finally,thedividendyieldwas3.65%in2006,anddroppedslightlyto2.64%in2007.
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CASETEN
StateStreetCorporation–MarketableSecurities
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StateStreetCorporationisafinancialholdingcompanythatlaunchedin1792.
BeginningwiththefoundingoftheUnionBank,thecorporationisnowdedicatedon
assistinginstitutionalinvestors.StateStreetmanagestwolinesofbusiness,Investment
ManagementandInvestmentServicing.Withintheselinesareavarietyofproducts
whichincluderiskandinvestmentresearch,tradingservices,performance,securities
finance,andbrokerage,tonameafew.TheyareheadquarteredoutofBoston.Thiscase
followsthecompanythroughthe2010through2012fiscalyears,asseenthroughtheir
financialstatements.
Thiscasewasfocusedonthetopicofmarketablesecurities.Igrewinmy
knowledgeofhowtodistinguishtrading,available-for-sale,andheld-to-maturity
securitiesfromeachother(eachwillbedefinedlateroninthiscase).Understandingthe
differencesbetweendebtandequitysecurities,andhowtomakemoneyfromeachare
importanttopicstocomprehend.Thebeginningsectionsofthiscaseallowedmeto
practicemyskillsinajournalentrytoincreasethemarketvalueofatrading,available-
for-sale,orheld-to-maturitysecuritiesaccount.Additionally,thiscasealsoremindedme
howtorecorddividendsreceivedforbothtradingandavailable-for-salesecurities.This
casealsoallowedmetopracticethejournalentriesforsecuritiespurchases,sales,and
year-endadjustments.Allinall,afterStateStreetCorporation’scase,Ifeelmore
confidentaboutthetopicofmarketablesecurities.
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StateStreetCorporation–MarketableSecurities
Concepts
a. Considertradingsecurities.NotethatfinancialinstitutionssuchasStateStreettypicallycallthesesecurities“Tradingaccountassets.”
i. Ingeneral,whataretradingsecurities? Tradingsecuritiesareshort-term(usuallywithin3months)securitiesboughtandheldprimarilyforsaletogenerateincome.Theseincludebothdebtandequitysecuritiesandarereportedatfairvalue.
ii.Howwouldacompanyrecord$1ofdividendsorinterestreceivedfromtradingsecurities?
Cash 1 DividendRevenue 1 Cash 1 InterestRevenue 1 iii.Ifthemarketvalueoftradingsecuritiesincreasedby$1duringthe
reportingperiod,whatjournalentrywouldthecompanyrecord? TradingSecurities 1 UnrealizedHoldingGain(orLoss) 1
b. Considersecuritiesavailable-for-sale.NotethatStateStreetcallsthese,“Investmentsecuritiesavailableforsale.”
i. Ingeneral,whataresecuritiesavailable-for-sale? Securitiesnotclassifiedasheld-to-maturityortradingsecurities,whichareboughtwiththepurposeofsellingbeforematurity.Theseincludebothdebtandequitysecuritiesandarereportedatfairvalue.
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ii. Howwouldacompanyrecord$1ofdividendsorinterestreceivedfromsecuritiesavailable-for-sale? Cash 1 DividendRevenue 1Cash 1 InterestRevenue 1
iii. Ifthemarketvalueofsecuritiesavailable-for-saleincreasedby$1duringthereportingperiod,whatjournalentrywouldthecompanyrecord? AvailableforSaleSecurities 1 UnrealizedHoldingGain(EquityorOCI) 1
c. Considersecuritiesheld-to-maturity.NotethatStateStreetcallsthese,“Investmentsecuritiesheldtomaturity.”
i. Ingeneral,whatarethesesecurities?Whyareequitysecuritiesneverclassifiedasheld-to-maturity? Securitiesthatthecompanyhasthepositiveintentandabilitytoholdtomaturity.Theseonlyincludedebtsecuritiesandarereportedatamortizedcost.
ii. Ifthemarketvalueofsecuritiesheld-to-maturityincreasedby$1duringthereportingperiod,whatjournalentrywouldthecompanyrecord?Inthiscase,therewouldbenoentry.
Process
d. Considerthe“Tradingaccountassets”onStateStreet’sbalancesheet.
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i. WhatisthebalanceinthisaccountonDecember31,2012?Whatisthemarketvalueofthesesecuritiesonthatdate?
Thebalanceonthe“Tradingaccountassets”onDecember31,2012is$637,000,000.Themarketvalueofthesecuritiesonthisdateisalso$637,000,000becausetheywererecordedatfairvalue.
ii. Assumethatthe2012unadjustedtrialbalancefortradingaccountassetswas$552million.WhatadjustingjournalentrywouldStateStreetmaketoadjustthisaccounttomarketvalue?Ignoreanyincometaxeffectsforthispart.
TradingAccountAssets 85,000,000 UnrealizedHoldingGain 85,000,000
e. Considerthebalancesheetaccount“Investmentsecuritiesheldtomaturity”andtherelateddisclosuresinNote4.
i. Whatisthe2012year-endbalanceinthisaccount?
The2012year-endbalanceinthe“Investmentsecuritiesheldtomaturity”accountis$11,379,000,000.
ii. WhatisthemarketvalueofStateStreet’sinvestmentsecuritiesheldtomaturity?
ThemarketvalueofStateStreet’sinvestmentsecuritiesheldtomaturityis$11,661,000,000.
iii. Whatistheamortizedcostofthesesecurities?Whatdoes“amortizedcost”represent?Howdoesamortizedcostcomparetotheoriginalcostofthesecurities?
Theamortizedcostofthesesecuritiesis$11,379,000,000.Theamortizedcost($11,379,000,000)islowerthantheoriginalcost($11,661,000,000)becausethecarryingvalueofthebondsisrepresentedbytheamortizedcost.
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iv. Whatdoesthedifferencebetweenthemarketvalueandtheamortizedcostrepresent?Whatdoesthedifferencesuggestabouthowtheaveragemarketrateofinterestonheld-to-maturitysecuritieshaschangedsincethepurchaseofthesecuritiesheldbyStateStreet? Thedifferencebetweenthemarketvalueandtheamortizedcostrepresentsthattheinvestmentsareworthmorethanwhattheyarelistedfor,becausetheamortizedcostislowerthanthemarketvalue.Thismeansthattherateofinterestonheld-to-maturitysecuritieshasdroppedsincethepurchaseofthesecuritiesheldbyStateStreet.
f. Considerthebalancesheetaccount“Investmentsecuritiesavailableforsale”andtherelateddisclosuresinNote4.
i. Whatisthe2012year-endbalanceinthisaccount?Whatdoesthisbalancerepresent?
The2012year-endbalanceinthe“Investmentsecuritiesavailableforsale”accountis$109,162,000,000.Thisbalancerepresentsafairvalue.
ii. Whatistheamountofnetunrealizedgainsorlossesontheavailable-for-salesecuritiesheldbyStateStreetatDecember31,2012?Besuretonotewhethertheamountisanetgainorloss.
Theamountofnetunrealizedgainsontheavailable-for-salesecuritiesheldbyStateStreetatDecember31,2012is$1,119,000,000.
iii. Whatwastheamountofnetrealizedgains(losses)fromsalesofavailable-for-salesecuritiesfor2012?HowwouldthisamountimpactStateStreet’sstatementsofincomeandcashflowsfor2012?
Theamountofnetrealizedgainsfromsalesofavailable-for-salesecuritiesfor2012is$55,000,000.ThisamountwouldincreaseStateStreet’sincomestatementandcashflowsfor2012.
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g. StateStreet’sstatementofcashflowfor2012(notincluded)showsthefollowinglineitemsinthe“InvestingActivities”sectionrelatingtoavailable-for-salesecurities(inmillions): Proceedsfromsalesofavailable-for-salesecurities$5,399 Purchasesofavailable-for-salesecurities$60,812
i. ShowthejournalentryStateStreetmadetorecordthepurchaseofavailable-for-salesecuritiesfor2012. InvestmentinAFS 60,812 Cash 60,812
ii. ShowthejournalentryStateStreetmadetorecordthesaleofavailable-for-salesecuritiesfor2012.Note13(notincluded)reportsthattheavailable-for-salesecuritiessoldduring2012had“unrealizedpre-taxgainsof$67millionasofDecember31,2011.”Hint:besuretoremovethecurrentbook-valueofthesesecuritiesinyourentry. Cash 5,399UnrealizedHoldingGain 67 InvestmentinAFS 5,411 RealizedGainonAFS 55
iii. Usetheinformationinpartg.iitodeterminetheoriginalcostoftheavailable-for-salesecuritiessoldduring2012.
Theoriginalcostoftheavailable-for-salesecuritiessoldduring2012was$5,344,000,000.
(Gain=Proceeds–BV) (55=5,399–BV) (BV=5,344)
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CASEELEVENZAGGInc.–DeferredIncomeTaxes
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ZAGGInc.isacompanythatspecializesinmobiledeviceaccessories.ZAGG,
whichstandsfor“ZealousAboutGreatGadgets”startedin2005justcreatingplastic
protectionsforwristwatches.Today,theirwiderangeofaccessoriesincludecases,
headphones,mobilekeyboards,portablepower,andapatentedinvisibleSHIELDthat
canbeplacedonsmartphoneandtabletscreens.iFrogz,amanufacturerofdigitalaudio
accessories,wasacquiredbyZAGGin2011topromoteexpansion.Thecompanyisnota
marketleader,andispubliclytradedontheNASDAQ.
ThiscaseonZAGGInc.gavegreatinsightintodeferredincometaxes.Deferred
incometaxescanbeoutlinedasanobligationtopaytaxesonacompany’sbalance
sheetthatareattributabletotaxabletemporarydifferences.Inthiscase,Idefinedthe
differencebetweenbookandtaxableincome,andevaluatedthisdifferenceonZAGG’s
financials.Inaddition,Inowbetterunderstandthedifferencesbetweenpermanentand
temporarytaxdifferences,aswellaseffectiveandstatutorytaxratesfollowingthis
case.AfteranalyzingtheCodification740,Ihaveagreaterunderstandingofwhya
companyreportsdeferredincometaxesaspartoftheirtotalincometaxexpense,as
wellasthedifferencebetweenadeferredincometaxassetfromadeferredincometax
liability.Additionally,Ibecamefamiliarwithwhatadeferredincometaxvaluation
allowanceis,andwhenitshouldbeusedinaccounting.Thiscasealsohelpedme
understandthejournalentriesthatgoalongwithdeferredincometax.
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ZAGGInc.–DeferredIncomeTaxes
Concepts
a. Describewhatismeantbythetermbookincome?WhichnumberinZAGG’sstatementofoperationcapturesthisnotionforfiscal2012?Describehowacompany’sbookincomediffersfromitstaxableincome.
Thefirm’sbookincomeispre-taxfinancialincomethatisreportedintheIncomeStatement.ThisistheamountthatisrequiredtobecomputedbyU.S.GAAPtobeusedbyinvestorsandcreditorsattheendofthefiscalyear.ThenumberinZAGG’sstatementofoperationthatcapturesthisnotionforfiscal2012is$23,898(inthousands).Acompany’sbookincomeandtaxableincomehavedifferentobjectives.Taxableincomeiscomputedforacompany’staxreturnthatissubmittedtotheIRS.
b. Inyourownwords,definethefollowingterms:
i. Permanenttaxdifferences(alsoprovideanexample)Permanenttaxdifferencesaredefinedasatransactionthatisstateddifferentlyatbookincomeandtaxableincome.Thisdifferencecanneverbeeradicated.Someexamplesofpermanenttaxdifferencesincludepenaltiesandfines,lifeinsuranceproceeds,andinterestonmunicipalbonds.
ii. Temporarytaxdifference(alsoprovideanexample)
Whenrevenuesorexpensesarerecognizedfordifferentperiodsforthebookandtaxvalues,itproducestemporarytaxdifferences.Thisresultsinatransactionthatreportsdifferentlyatbookincomeandtaxableincome,butthateventuallyeradicatesitselfovertimebecauseitistemporary.Examplesoftemporarytaxdifferencesincludedepreciationandaccruedliabilities.
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iii. Statutorytaxrate
Thestatutorytaxrateistherateoftaxthatismandatedbylaw,thatisstatedasapercentage.
iv. Effectivetaxrate
Theeffectivetaxrateistheratethatanindividualorcorporationistaxedonincome.Itiscalculatedbytakingtaxexpenseanddividingitbypretaxincome.
c. Explainingeneraltermswhyacompanyreportsdeferredincometaxesaspart
oftheirtotalincometaxexpense.Whydon’tcompaniessimplyreporttheircurrenttaxbillastheirincometaxexpense?
Deferredincometaxesareliabilitiesonacompany’sbalancesheetthatareattributabletotaxabletemporarydifferences.Theyrepresenttheincreaseintaxespayableinfutureyearsasresultoftaxabletemporarydifferencesexistingattheendofthecurrentyear.Theamountisusuallyduetothewayacompanycalculatesitsincomeforfinancialpurposesandtaxpurposes.Thecomputationforincometaxexpensehastwocomponents–currenttaxexpenseanddeferredtaxexpense.Whenyouincreasedeferredtaxliabilitiesfromthebeginningoftheperiodtotheendoftheperiod,itresultsinadeferredtaxexpense. Acompanyreportsdeferredincometaxesaspartoftheirtotalincometaxexpenseforseveralreasons.First,GAAPrequiresthatmatchingprinciplebefollowedbycompanies.Underthematchingprinciple,expensesmustbematchedwith,andthusexpensed,inthesameperiodtherevenuewasearnedthatcausedtheexpensestobeincurred.Often,duetotaxrules,incometaxesaren’tpaidinthesameperiodinwhichtheincomewasearnedthatgeneratedthetax.Investorspayattentiontodeferredincometaxtobetterascertainacompany’sshort-termliabilitiesandobligationsthatwillrequiretheuseofcashinthenearfuture. WhenlookingattheCodificationASC740,thetwoobjectivesofaccountingforincometaxesarelistedas“recognizetheamountoftaxespayableorrefundableforthecurrentyear”and“recognizedeferredtaxliabilitiesandassetsforthefuturetaxconsequencesofeventsthathavebeenrecognizedinan
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entity’sfinancialstatementsortaxreturns.”Insection740-10-10-3,itstatesthattheobjectiveisthemeasurethedeferredtaxassetorliabilityusingthetaxratesandapplythattotaxableincomeintheperiodsinwhichtheassetorliabilityisexpectedtobesettledorrealized.Thisisallaboutmatchingtheitemstothecorrectperiodssothatrevenuescanmatchexpenses.
Inpartbof740-10-25-2itstatesthat“adeferredtaxliabilityorassetshallberecognizedfortheestimatedfuturetaxeffectsattributabletotemporarydifferencesandcarryforwards.”Thisismeaningthatdeferredtaxesshouldberecognizedfortheestimationsbasedontimingdifferencesordeductionsthatcannotbeutilizedonthetaxreturn.
Companiesarerequiredtoshowthecomponentsofincometaxexpenseeitherintheincomestatementorinthefinancialstatementnotes.Someexpertsdismissdeferredincometaxeswhenevaluatingthestrengthofacompany,buttheFASBindicatesthattheyareliabilitiesbecausetheyresultfromapasttransaction,areapresentobligation,andrepresentafuturesacrifice.Deferredtaxesdoprovideincrementalinformationaboutfuturetaxpayments.
d. Explainwhatdeferredincometaxassetsanddeferredincometaxliabilitiesrepresent.Giveanexampleofasituationthatwouldgiverisetoeachoftheseitemsonthebalancesheet.
Deferredincometaxassetsaredeferredtaxconsequencesthatareattributabletodeductibletemporarydifferencesandcarryforwards.Theyaremeasuredusingtheapplicableenactedtaxrateandprovisionsoftheenactedtaxlaw.Theyarereducedbyavaluationallowanceifitismorelikelythannotthatsomeportionorallofadeferredtaxassetwillnotberealized.Somereasonswhydeferredtaxassetsarenecessaryincludethatrevenuesarerecognizedinoneperiodfortaxpurposesandinadifferentperiodforaccountingpurposes,thecompanypaidtoomuchtaxanddeservessomemoneyreturned,orsomeassetshaveadifferenttaxbaseforgovernmentalagenciescomparedtoaccountingpractices.Anexampleofasituationthatwouldgiverisetoadeferredtaxassetwouldbethecarry-overoflosses.Ontheotherhand,deferredincometaxliabilitiesaredeferredtaxconsequencesattributabletotaxabletemporarydifferences.Theyaremeasuredusingtheapplicableenactedtaxrateandprovisionsoftheenactedtaxlawaswell.Itisthedifferencesinthewaynetincomeiscalculatedforfinancialpurposesandthe
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wayitiscalculatedforincometaxpurposes.Themostcommonbookincomeandtaxincomedifferenceforthisissueisdepreciation,wheretaxrulesmayallowforaccelerateddepreciationmethodsthatarenotallowedforfinancialreporting.Anotherexampleofdeferredtaxliabilityisaninstallmentsale,wherecreditispaidoffinequalamountsovertime.
e. Explainwhatadeferredincometaxvaluationallowanceisandwhenitshould
berecorded. Acompanyshouldreduceadeferredtaxassetbyavaluationallowanceifitismorethan50%likelythatitwillnotrealizesomeportionorallofthedeferredtaxasset.Companiesrecognizeadeferredtaxassetforalldeductibletemporarydifferences.
Process
f. ConsidertheinformationdisclosedinNote8–IncomeTaxestoanswerthefollowingquestions:
i. UsinginformationinthefirsttableinNote8,showthejournalentrythatZAGGrecordedfortheincometaxprovisioninfiscal2012? (entriesinthousands)IncomeTaxExpense 9,393DTA,net 8,293 IncomeTaxPayable 17,686
ii. UsingtheinformationinthethirdtableinNote8,decomposethe
amountof“netdeferredincometaxes”recordedinincometaxjournalentryinpartf.i.intoitsdeferredincometaxassetanddeferredincometaxliabilitycomponents. (entriesinthousands)
IncomeTaxExpense 9,393DTA,netofVA(14302–6300) 8,002DTL 291 IncomeTaxPayable 17,686
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iii. ThesecondtableinNote8providesareconciliationofincometaxescomputedusingthefederalstatutoryrate(35%)toincometaxescomputedusingZAGG’seffectivetaxrate.CalculateZAGG’s2012effectivetaxrateusingtheinformationprovidedintheirincomestatement.WhataccountsforthedifferencebetweenthestatutoryrateandZAGG’seffectivetaxrate? ZAGG’seffectivetaxratein2012is39.3%,whichwascalculatedbydividingthecompany’staxexpenseof$9,393byitstaxableincomeof$23,898.ThedifferencebetweenthestatutoryrateandZAGG’seffectivetaxratecanbeaccountedbythedifferenceinitsbookandtaxableincome.
iv. AccordingtothethirdtableinNote8–IncomeTaxes,ZAGGhadanet
deferredincometaxassetbalanceof$13,508,000atDecember31,2012.ExplainwherethisamountappearsonZAGG’sbalancesheet.
NetDTA 14,302NetDTL (794)TotalNetDTABalance,netofVA,netofDTL $13,508ThisbalanceappearsonZAGG’sbalancesheetasCurrentDeferredIncomeTaxof$6,912and$6,596,whichwhenaddedtogetherequal$13,508.
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CASETWELVEAppleInc.–RevenueRecognition
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AppleInc.isamajorcompanyintoday’smarket.Thecorporationisresponsible
foravarietyofelectronicsonthemarket,includingpersonalcomputers,portablemusic
andvideoplayers,andphones.Theyalsosellrelatedsoftware,services,andnetworking
solutionsthatcoordinatewiththeirproducts.AppleInc.specializesinmarketingand
designingproductsthatmakethemstandoutfromtheircompetitors.Thecompanyis
abletoselltheirmerchandiseworldwidethroughanarrayofoutletsincludingretail
stores,directsalesforce,resellers,onlinestores,andthird-partywholesalers.
Thiscasefocusedonthetopicofrevenuerecognition.First,Itookalookbackon
thedifferencesbetweengainsandrevenues.Thisdistinctionwasimportantformeto
rememberbeforedivingintotherestofthecase.IalsoanalyzedApple’srevenue
recognitionpolicies,whilelookingalongsidetheFASB’sStatementofConceptsNo.5
andtheASC606.IfeelthatitisimportantformetobelookingattheRevenue
RecognitionStandard,theCodification,andtheStatementofConceptssothatIam
familiarwiththembeforegradschoolorevengoingintowork.Inaddition,Idefined
multiple-elementcontractsandhowtheyinterferedwithrevenuerecognition.Thisis
somethingthatIhadneverheardofbefore.Finally,IwentthroughApple’sfootnotes
andevaluatedhowtheyrecognizedrevenuesforfourdifferentsituations:iTunessongs
soldonline,Mac-brandedaccessories,iPodssoldtothirdpartyresellerinanother
country,andsalesfromgiftcards.ThiswasaninterestingcaseformebecauseAppleis
suchaprevalentcompanyinmyeverydayactivities,soitwasintriguingtobeabletoget
toanalyzetheirfinancialsandlearnalittlemoreabouthowtheyrecognizetheir
revenues.
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AppleInc.–RevenueRecognition
Concepts
a. Inyourownwords,define“revenues.”Explainhowrevenuesaredifferentfrom“gains.”
Revenuescanbedefinedasacompany’sincomethatitgathersfromconductingbusiness,suchassellinggoodsorservices,afterdiscountsandsubtractionshavebeenmade.Theycanalsobereferredtoassales.Gains,ontheotherhand,areadditionsinnetassetsfromperipheraloperationsofabusiness.
b. Describewhatitmeansforabusinessto“recognize”revenues.Whatspecific
accountsandfinancialstatementsareaffectedbytheprocessofrevenuerecognition?DescribetherevenuerecognitioncriteriaoutlineintheFASB’sStatementofConceptsNo.5. ThecoreprincipleofthenewstandardofASC606statesthatcompaniesrecognizerevenueinordertodepictthetransferofpromisedgoodsorservicestocustomersinanamountthatreflectstheconsiderationofwhichthebusinessexpectstobeentitledinexchangeforthosegoodsorservices.ThespecificaccountsandfinancialstatementsthatareaffectedbytheprocessofrevenuerecognitionincludeAccountsReceivableontheBalanceSheetandRevenuesorSalesontheIncomeStatement.TherevenuerecognitioncriteriaoutlinedintheFASB’sStatementofConceptsNo.5setsforthrecognitioncriteriaonwhatinformationshouldbeincorporatedintothefinancialstatementsandwhenitshouldbedone.Itstatesthatrecognitionistheprocessofproperlyrecordinganiteminthefinancialstatements,anddisclosurebyothermeansisnotconsideredrecognition.
c. RefertotheRevenueRecognitiondiscussioninNote1.Ingeneral,whendoes
Applerecognizerevenue?ExplainApple’sfourrevenuerecognitioncriteria.Dotheyappeartobealignedwiththerevenuerecognitioncriteriayoudescribedinpartb,above? Ingeneral,Note1statesthatApplerecognizesrevenuewhenpersuasiveevidenceofanarrangementexists,deliveryhasoccurred,thesalespriceisfixedordeterminable,andcollectionisprobable.First,byhavingpersuasiveevidenceofanarrangementexists,thismeansthatabusinessmusthaveacontractoran
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agreementwithitscustomertoestablishclearandpersuasiveevidencethatthecustomerintendsandagreestobuyfromthebusiness.Next,onceaproducthasbeenshippedandtitleandriskoflosshavebeentransferred,thecompanydeemstheproductdelivered.MostofApple’ssalesareconsidereddeliveredatthetimeofshipment.Yet,foronlinesalesthecompanydefersrevenueuntilthecustomerobtainstheproductbecauseofriskoflossduringtransit.Thirdly,Appledecidessellingpricescontractually,dependingonwhatagreementitisspecifically.Thecompanyusesahierarchytodeterminethepricetouseforallocatingrevenue–startingwithvendor-specificobjectiveevidenceoffairvalue,followedbythird-partyevidenceofsellingprice,andendingwithbestestimateofthesellingprice.Finally,thecollectionthatitisabletomakewillnotincludeaccountspayabledeemeduncollectableatyear’sendfromcustomers.Apple’srevenuerecognitionconditionsarealignedwiththecriteriathatIdescribedinpartbabove.
d. Whataremultiple-elementcontractsandwhydotheyposerevenue
recognitionproblemsforcompanies? Multiple-elementcontractsarewhenvendorsprovidemultipleproductsorservicestotheircustomersaspartofasinglearrangementoraseriesorrelatedarrangements.Thesedeliverablesmaybeprovidedatdifferentpointsovertime.Thiscancauseissuesbecauseitisdifficultforthevendortoseparatethesemultipledeliverablesandhowtoallocatetheoverallarrangementconsideration.
e. Ingeneral,whatincentivesdomanagershavetomakeself-servingrevenue
recognitionchoices? Thinkingingeneralterms,Applesellsmostofitsproductsinaretailstoresetting.Thesemanagersmaketheirrevenuebysellingtheirproducts.Incentivesthatwouldbebeneficialtothestore,andthatwouldpotentiallymakestoreprofitabilityincreasewouldbecoupons,bundlingproducts,prizes,sales,etc.Thus,thiswouldmakethestoremanagerlookgoodfromacorporationstandpoint.
Process
f. RefertoApple’srevenuerecognitionfootnote.Inparticular,whendoesthecompanyrecognizerevenueforthefollowingtypesofsales?i. iTunessongssoldonline.
ForcertainsalesmadethroughiTunes,Appleisnottheownerofthesoftware.Thus,third-partycreatorsestablishthesellingpriceofthesoftware.Appleaccountsforthesalesoftheseproductsonanetbasis
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recognizingonlythecommissionitretainsfromeachsaleandincludingthatcommissioninnetsales.
ii. Mac-brandedaccessoriessuchasheadphones,poweradaptors,and
backpackssoldintheApplestores.Whatiftheaccessoriesaresoldonline?
Wheninstore,revenuesarerecognizedwhentheseaccessoriesaresold,atthepointofsale.Ifitisanonlinesaletoanindividual,Appledefersrevenueuntilthecustomerreceivestheproductbecauseoftheriskoflossduringtransit.Oncetheyacquiretheproduct,thenthecompanyrecognizesrevenues.Codification605-45-45-12statesthat“physicallossinventoryriskexistsiftitletotheproductsistransferredtoanentityatshippingpoint…Physicallossinventoryriskalsoexistsifanentitytakestitletotheproductafteracustomerorderhasbeenreceivedbutbeforetheproducthasbeentransferredtoacarrierforshipment.”
iii. iPodssoldtoathird-partyresellerinIndia.
Applecanrecognizethegrossamountbilledfromthethird-partyoncetheothercompanymakesasale.TheCodification605-45-55-12statesthat“revenuesfromsalesofproductsfromtheoverseassourceshouldbereportedbasedonthegrossamountchargedtocustomers.”
iv. Revenuefromgiftcards.
Thecompanyrecordsdeferredrevenueuponthesaleofthecard,whichisrelieveduponredemptionofthecardbythecustomer.
“Onmyhonor,IpledgethatIhaveneithergiven,received,norwitnessedanyunauthorizedhelponthiscase.”Signed______________________________
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