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Module 1 Financial Accounting for MBAs QUESTIONS Q1-1.

Organizations undertake four major activities: planning, financing, investing, and operating. Financing is the means a company uses to pay for resources. Investing refers to the buying and selling of resources necessary to carry out the organization’s plans. Operating activities are the actual carrying out of these plans. Planning is the glue that connects these activities, including the organization’s ideas, goals and strategies. Financial accounting information provides valuable input into the planning process, and, subsequently, reports on the results of plans so that corrective action can be taken, if necessary.

Q1-2.

An organization’s financing activities (liabilities and equity = sources of funds) pay for investing activities (assets = uses of funds). An organization’s assets cannot be more or less than its liabilities and equity combined. This means: assets = liabilities + equity. This relation is called the accounting equation (sometimes called the balance sheet equation), and it applies to all organizations at all times.

Q1-3.

The four main financial statements are: income statement, balance sheet, statement of stockholders’ equity, and statement of cash flows. The income statement provides information about the company’s revenues, expenses and profitability over a period of time. The balance sheet lists the company’s assets (what it owns), liabilities (what it owes), and stockholders’ equity (the residual claims of its owners) as of a point in time. The statement of stockholders’ equity reports on the changes to each stockholders’ equity account during the period. The statement of cash flows identifies the sources (inflows) and uses (outflows) of cash, that is, where the company got its cash from and what it did with it. Together, the four statements provide a complete picture of the financial condition of the company.

Q1-4.

The balance sheet provides information that helps users understand a company’s resources (assets) and claims to those resources (liabilities and stockholders’ equity) as of a given point in time.

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Q1-5.

The income statement covers a period of time. An income statement reports whether the business has earned a net income (also called profit or earnings) or incurred a net loss. Importantly, the income statement lists the types and amounts of revenues and expenses making up net income or net loss.

Q1-6.

The statement of cash flows reports on the cash inflows and outflows relating to a company’s operating, investing, and financing activities over a period of time. The sum of these three activities yields the net change in cash for the period. This statement is a useful complement to the income statement, which reports on revenues and expenses, but which conveys relatively little information about cash flows.

Q1-7.

Retained earnings (reported on the balance sheet) is increased each period by any net income earned during the period (as reported in the income statement) and decreased each period by the payment of dividends (as reported in the statement of cash flows and the statement of stockholders’ equity). Transactions reflected on the statement of cash flows link the previous period’s balance sheet to the current period’s balance sheet. The ending cash balance appears on both the balance sheet and the statement of cash flows.

Q1-8.

External users and their uses of accounting information include: (a) lenders for measuring the risk and return of loans; (b) shareholders for assessing the return and risk in acquiring shares; and (c) analysts for assessing investment potential. Other users are auditors, consultants, officers, directors for overseeing management, employees for judging employment opportunities, regulators, unions, suppliers, and appraisers.

Q1-9.

Managers deal with a variety of information about their employers and customers that is not generally available to the public. Ethical issues arise concerning the possibility that managers might personally benefit by using confidential information. There is also the possibility that their employers and/or customers might be harmed if certain information is not kept confidential.

Q1-10.

The five forces (according to Professor Michael Porter) are (A) industry competition, (B) buyer power, (C) supplier power, (D) product substitutes, and (E) threat of entry.

Q1-11.

W SWOT stands for Strengths and Weaknesses (both are internal factors) Opportunities and Threats (both external factors).

Q1-12.

Seagate’s independent auditor is EY LLP. The auditor expressly states that “our responsibility is to express an opinion on these financial statements based on our audits.” The auditor also states that “these financial statements are the responsibility of the company’s management.” Thus, the auditor does not assume responsibility for the financial statements.

Financial & Managerial Accounting for MBAs, 6th Edition

Q1-13.

While firms acknowledge the increasing need for more complete disclosure of financial and nonfinancial information, they have resisted these demands to protect their competitive position. Corporate executives must weigh the benefits they receive from the financial markets as a result of more transparent and revealing financial reporting against the costs of divulging proprietary information to competitors and others.

Q1-14.

Generally Accepted Accounting Principles (GAAP) are the various methods, rules, practices, and other procedures that have evolved over time in response to the need to regulate the preparation of financial statements. They are primarily set by the Financial Accounting Standards Board (FASB), a private sector entity with representatives from companies that issue financial statements, accounting firms that audit those statements, and users of financial information. Other bodies that contribute to GAAP are the AICPA, the EITF, and the SEC.

Q1-15.

Corporate governance is the system of policies, procedures and mechanisms that protect the interests of stakeholders in the business. These stakeholders include investors, creditors, regulatory bodies, and employees, to name a few. Sound corporate governance involves the maintenance of an effective internal auditing function, an independent and effective external auditing function, an informed and impartial board of directors, governmental oversight (such as from the SEC), and the oversight of the courts.

Q1-16.

The auditor’s primary function is to express an opinion as to whether the financial statements fairly present the financial condition of the company and are free from material misstatements. Auditors do not prepare the financial statements; they only audit them and issue their opinion on them. The auditors provide no guarantees about the financial statements or about the company’s continued performance.

Q1-17.

Financial accounting information is frequently used in order to evaluate management performance. The return on equity (ROE) and return on assets (ROA) provide useful measures of financial performance as they combine elements from both the income statement and the balance sheet. Financial accounting information is also frequently used to monitor compliance with external contract terms. Banks often set limits on such items as the amount of total liabilities in relation to stockholders’ equity or the amount of dividends that a company may pay. Audited financial statements provide information that can be used to monitor compliance with these limits (often called covenants). Regulators and taxing authorities also utilize financial information to monitor items of interest.

Q1-18.

Managers are vitally concerned about disclosing proprietary information that might benefit the company’s competitors. Of most concern, is the “cost” of losing some competitive advantage. There traditionally has been tension between companies and the financial professionals (especially investment analysts) who press firms for more and more financial and nonfinancial information.

Solutions Manual, Module 1

Q1-19.

Net income is an important measure of financial performance. It indicates that the market values the company’s products or services, that is, it is willing to pay a price for the products or services enough to cover the costs to bring them to market and to provide the company’s investors with a profit. Net income does not tell the whole story, however. A company can always increase its net income with additional investment in something as simple as a bank savings account. A more meaningful measure of financial performance comes from measuring the level of net income relative to the investment made. One investment measure is the balance of stockholders’ equity, and the comparison of net income to average stockholders’ equity (ROE) is a fundamental measure of financial performance.

Q1-20.

Borrowed money must be repaid, both the principal amount borrowed, as well as interest on the borrowed funds. These payments have contractual due dates. If payments are not prompt, creditors have powerful legal remedies, including forcing the company into bankruptcy. Consequently, when comparing two companies with the same return on equity, the one using less debt would generally be viewed as a safer (less risky) investment.

Financial & Managerial Accounting for MBAs, 6th Edition

MINI EXERCISES M1-21. (10 minutes) All three types of business activities will be affected.  Additional CAPEX of $23 billion will increase investing activities. The company will acquire additional property and equipment.  Operating activities will likely increase because the additional equipment is to either expand or improve on the company’s footprint. All things equal, this will increase the number of customers or perhaps increase revenue per customer.  Financing activities will likely increase. The additional CAPEX will need to be financed either by owners or nonowners.

M1-22. (10 minutes) Financial-statement users Questions A. Current shareholders

2. Will the company have enough cash to pay dividends?

B. Company CEO

4. Will there be sufficient profits and cash flow to pay bonuses?

C. Banker

5. Will the company have enough cash to repay its loans?

D. Equity analyst

1. What is expected net income for next quarter?

E. Supplier

3. Has the company paid for inventory purchases promptly in the past?

M1-23. (10 minutes) a. Answer: $176,130 million Explanation:$ millions Assets $258,848

Liabilities $176,130

Equity $82,718

b. Answer: NONOWNERS Explanation: Microsoft receives more of its financing from nonowners ($176,130 million) than from owners ($82,718 million). c. Answer: 32% Explanation: Owner financing is 32% of its total financing ($82,718 million / $258,848 million). Nonowners finance 68% of Microsoft’s total assets.

Solutions Manual, Module 1

M1-24. (10 minutes) a. Answer: 1, 3, and 4. b. Answer: $3,306 million Explanation: $ millions Assets

Liabilities

$12,901

Equity

$9,595

$3,306

c. Answer: Nonowners. Explanation: Best Buy received $9,595 million from nonowners which is larger than the $3,306 million from owners. d. 74.4% Explanation: $9,595 million / $12,901 million = 74.4%

M1-25. (15 minutes) ($ millions) Assets Hewlett-Packard General Mills Target

$106,882 $21,712 (c) $40,262

Levels of Owner vs. Nonowner Financing. company follows: Hewlett-Packard.................... General Mills......................... Target....................................

26.3% 24.4% 32.2%

Liabilities $78,731 (b) $16,405 $27,305

Equity (a) $28,151 $5,307 $12,957

The percent of owner financing for each

($28,151 million / $106,882 million) ($5,307 million / $ 21,712 million) ($12,957 million / $ 40,262 million)

Target has the highest percentage of owner financing. General Mills and HP are financed with roughly the same proportions of nonowner financing, with General Mills having slightly more.

Financial & Managerial Accounting for MBAs, 6th Edition

M1-26. (15 minutes) a. Answer: Assets $24,156.4

Liabilities $22,980.6

Equity $1,175.8

b. Answer: $24,156.4=$22,980.6+$1,175.8 c. Answer: 4.9% Explanation: $1,175.8 / $24,156.4 = 4.9%

M1-27. (20 minutes) Answer: Symantec Corp. Statement of Retained Earnings For Year Ended March 30, 2018 $ millions Balance, start of year $ (761) Net income (loss) 1,138 Cash dividends (49) Balance, end of year $ 328

M1-28. (20 minutes) a. BS and SCF

BS and SE

b. IS

g. SCF and SE

c. BS

h. SCF and SE

d. BS and SE

e. SCF

Solutions Manual, Module 1

M1-29. (10 minutes) There are many stakeholders impacted by this business decision, including the following (along with a description of how):  You as a Manager—your reputation, self-esteem, and potentially your livelihood could be negatively impacted. 

Creditors and Bondholders—credit decisions based on inaccurate information could occur.



Shareholders—buying or selling shares based on inaccurate information could occur.



Management and other Employees of your company—repercussions of your decision extend to all other employees. Also, a decision to record these revenues suggests an environment condoning dishonesty.

Indeed, your decisions can affect many more parties than you might initially realize. The short-term benefit of meeting Wall Street’s expectations could have serious long-term ramifications.

M1-30. (15 minutes) Apple—product differentiation and barriers to entry due to technological advantages and legal Walmart—buyer power due to size and cost leader Pfizer—product differentiation arising from specific compounds and barriers to entry due to technological advantages and legal Uber—none, low barriers to entry and product is essentially undifferentiated American Airlines—some competitive advantage due to barriers to entry arising from significant capital expenditures and government regulation UPS—none, product is essentially undifferentiated McDonald’s—buyer power due to size and cost leader

Financial & Managerial Accounting for MBAs, 6th Edition

M1-31. (25 minutes) a. (in millions) Total assets, start of fiscal year Total assets, end of fiscal year Average total assets Net income (consolidated) Revenue

Boston Medtronic Scientific $99,857 $19,042 91,393 20,999 95,625 20,021 3,095 1,671 29,953 9,823

Return on assets (ROA) Profit margin (PM) Asset turnover (AT)

Boston Medtronic Scientific 3.2% 8.3% 10.3% 17.0% 0.31 0.49

c. Answer: Boston Scientific Explanation: Boston Scientific’s ROA is 8.3% which is more than twice that of Medtronic. d. Answer: As compared to Boston Scientific, Medtronic has a weaker profit margin and a weaker asset turnover.

M1-32. (10 minutes) Internal controls are designed for the following purposes:  Monitoring an organization’s activities to promote efficiency and to prevent wrongful use of its resources 

Ensuring the validity and credibility of external accounting reports



Promoting effective operations



Ensuring reliable internal reporting

Congress has a special interest in internal controls and reports about them. Specifically, the absence or failure of internal controls can adversely affect the effectiveness of domestic and global financial markets. Enron provided Congress with a case in point.

Solutions Manual, Module 1

EXERCISES E1-33. (15 minutes) a. Target’s inventories consist of the product lines it carries: clothing, electronics, home furnishings, food products, and so forth. b. Target’s Property and Equipment assets consist of land, buildings, store improvements such as lighting, flooring, HVAC, store shelving, shopping carts, and cash registers. c. Although Target sells some of its merchandise via its Website, the majority of its sales activity is conducted in its retail locations. These stores represent a substantial and necessary capital investment for its business model.

E1-34. (20 minutes) a. ($ millions) Advanced Micro Devices

Assets, start of year $3,552

Assets, end of year $4,556

Liabilities, start of year $2,956

Liabilities, end of year $3,290

Stockholders' Equity, end of year $1,266

$123,249

$127,963

$54,230

$53,400

$74,563

Intel Corp

Explanation: AMD assets: $4,556 - $1,004 = $3,552. AMD liabilities: $2,956 + $334 = $3,290. AMD equity: $4,556 - $3,290 = $1,266 Intel assets: $123,249 + $4,714 = $127,963. Intel liabilities: $53,400 + $830 = $54,230 Intel equity: $127,963 - $53,400 = $74,563 b. AMD: ($3,552 + $4,556) / 2 = $4,054 Intel: ($123,249 + $127,963) / 2 = $125,606 c. Intel Explanation: Assets, end of year Advanced Micro Devices Intel

Stockholders' Equity, end of year

Stockholders' Equity / Assets

$4,556

$1,266

28%

$127,963

$74,563

58%

Financial & Managerial Accounting for MBAs, 6th Edition

E1-35. (15 minutes) External constituents use accounting information from financial statements to answer questions such as the following: 1. Shareholders (investors), ask questions such as: a. Are the company’s resources adequate to carry out strategic plans? b. Are the company’s debts appropriate in amount given the company’s existing assets and plans for growth? c. What is the current level of income (and what are its components)? d. Is the current stock price indicative of the company’s profitability and level of debt? 2. Creditors, ask questions such as: a. Does the business have the ability to repay its debts as they come due? b. Can the business take on additional debt? c. Are current assets sufficient to cover current liabilities? 3. Employees, ask questions such as: a. Is the business financially stable? b. Can the business afford to pay higher salaries? c. What are growth prospects for the organization? d. Will the company be able to pay my pension when I retire?

E1-36. (10 minutes) a. Norfolk Southern Inc. Consolidated Statements of Changes In Retained Income Beginning Balance at Dec. 31, 2015 $ 10,191 Net income 1,668 Dividends on Common Stock (695) Share repurchases (731) Other (8) Ending Balance at Dec. 31, 2016 10,425 Net income 5,404 Dividends on Common Stock (703) Share repurchases (945) Other (5) Ending Balance at Dec. 31, 2017 14,176 Net income 2,666 Dividends on Common Stock (844) Share repurchases (2,639) Other 81 Ending Balance at Dec. 31, 2018 $ 13,440

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b. True. Norfolk Southern did repurchase shares each year. This is shown as a subtraction because shares repurchased decrease the amount of owners’ investment in the company.

E1-37. (20 minutes) a. Yes. Norfolk Southern was profitable during 2018 as evidenced by its positive net profit margin of 23.3%. b. 2017 The 2018 profit margin is nearly half of the PM in 2017: 23.3% versus 51.2%. c. Positive. Norfolk Southern’s productivity measure (asset turnover) increased slightly from 0.299 in 2017 to 0.318 in 2018. This indicates that assets are generating a slightly higher level of sales than in the prior year. This is a positive development. d. ROA = Profit margin  asset turnover. 2018 ROA = 23.3%  0.318 = 7.4%. 2017 ROA = 51.2%  0.299 = 15.3%. e. Answer: 1 We do not have sufficient information to assess 3 and 4 so they are not true. Productivity improved in 2018 so 2 is false. 1 is correct because 2017’s PM is double 2018’s PM, causing 2018’s ROA to be half that of 2017.

E1-38. (15 minutes) Return on assets (ROA)

= = =

Net income / Average assets $564 / [($8,115 + $7,886) / 2] 7.05%

Financial & Managerial Accounting for MBAs, 6th Edition

E1-39. (20 minutes) a. Creditors are an important group of external stakeholders. They are primarily interested in the ability of the company to generate sufficient cash flow in order to repay the amounts owed. Stockholders are another significant stakeholder in the company. They are primarily interested in the company’s ability to effectively raise capital and to invest that capital in projects with a rate of return in excess of the cost of the capital raised, that is, to increase the value of the firm. Regulators such as the SEC and the tax authorities, including the IRS and state and local tax officials, are important constituents that are interested in knowing whether the company is complying with all applicable laws and regulations. b. Generally Accepted Accounting Principles (GAAP) are the various methods, rules, practices, and other procedures that have evolved over time in response to the need to regulate the preparation of financial statements. They are primarily set by the Financial Accounting Standards Board (FASB), a private sector entity with representatives from companies that issue financial statements, accounting firms that audit those statements, and users of financial information. Other bodies that contribute to GAAP are the AICPA, the EITF, and the SEC. c. Financial information provides users with information that is useful in assessing the financial performance of companies and, therefore, in setting stock and bond prices. To the extent that these prices are accurate, the costs of the funds that companies raise will accurately reflect their relative efficiency and risk of operations. Companies that can utilize capital more effectively will be able to obtain that capital at a reasonable cost and society’s financial resources will be effectively allocated. d. First, the preparation of financial statements involves an understanding of complex accounting rules and significant assumptions and considerable estimation. Second, GAAP allows for differing accounting treatments for the same transaction. And third, auditors are at a relative information disadvantage vis-à-vis company accountants. As the capital markets place increasing pressures on companies to perform, accountants are often placed in a difficult ethical position to use the flexibility given to them under GAAP in order to bias the financial results or to use their inside information to their advantage.

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E1-40. (20 minutes) a. ROE = Net income / Average stockholders’ equity = $4,518.3 million / [($5,450.1 million + $1,169.5 million) / 2] = 136.5% b. Increase. The repurchase of common stock reduces the denominator (average stockholders’ equity). The outflow of cash for the repurchase, however, reduces net income by the return on the cash that is forgone. Generally, the reduction in the denominator is greater than that for the numerator, and consequently ROE increases. That is one of the reasons cited for share repurchases. c. Equity would have been $1,169.5 million + $7,208.7 million = $8,378.2 million ROE = $4,518.3 million / [($5,450.1 million + $8,378.2 million) / 2] = 65.3%

Financial & Managerial Accounting for MBAs, 6th Edition

PROBLEMS P1-41. (40 minutes) a. 2018 ROE = $6,670 / [($72,496 + $77,869) / 2] = 8.9% 2017 ROE = $9,862 / [($77,869 + $77,798) / 2] = 12.7% b. 2018 ROA = $6,670 / [($219,295 + $204,522) / 2] = 3.1% 2017 ROA = $9,862 / [($204,522 + $198,825) / 2] = 4.9% c. 2018 PM = $6,670 / $510,329 = 1.3% 2017 PM = $9,862 / $495,761 = 2.0% d. 2018 AT = $510,329 / / [($219,295 + $204,522) / 2] = 2.41 2017 AT = $495,761 / [($204,522 + $198,825) / 2] = 2.46 e. Answer: 1 Profit in dollar terms fell and PM decreased from 2% to 1.3%, while small in absolute terms, this is a considerable decrease proportionately. Asset productivity (AT) weakened but not considerably, making choice 2 incorrect. The level of revenue and assets is a factor but not the best explanation, making choices 3 and 4 incorrect.

P1-42. (30 minutes) a. General Mills Income Statement ($ millions) For the year ended May 27, 2018 Revenues Cost of goods sold Gross profit Expenses Income before taxes Income tax expense Net income

15,740.4 10,312.9 5,427.5 3,207.2 2,220.3 57.3 2,163.0

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Cash Noncash assets Total assets

General Mills Balance Sheet ($ millions) May 27, 2018 $399.0 Liabilities 30,225.0 Stockholders' equity $30,624. 0 Total liabilities and equity

$24,131.6 6,492.4 $30,624.0

d. General Mills Statement of Cash Flow ($ millions) For the year ended May 27, 2018 Cash from operating activities Cash from investing activities Cash from financing activities ($5,445.5 + $31.8) Net increase (decrease) in cash Cash, beginning year (= $367.1 + $399.0) Cash, ending year

$2,841.0 (8,685.4) 5,477.3 (367.1) 766.1 $399.0

e. ROA = Net income / Average assets = $2,163 / [($30,624.0 + $21,812.6) / 2] = 8.2% f.

PM = Net income / Revenue = $2,163 / $15,740.4 = 13.7%

g. AT = Revenue / Average assets = $15,740.4 / [($30,624.0 + $21,812.6) / 2] = 0.60 P1-43. (30 minutes) a. Five Below Income Statement ($ thousands) For the year ended February 2, 2019 Revenues Cost of goods sold Gross profit Expenses Income before taxes Income tax expense Net income

$1,559,563 994,478 565,085 373,278 191,807 42,162 $149,645

Financial & Managerial Accounting for MBAs, 6th Edition

Cash Noncash assets Total assets

Five Below Balance Sheet ($ thousands) February 2, 2019 $251,748 Liabilities 700,516 Stockholders' equity $952,264 Total liabilities and equity

$337,170 615,094 $952,264

c. Five Below Statement of Cash Flow ($ thousands) For the year ended February 2, 2019 Cash from operating activities Cash from investing activities Cash from financing activities Net increase (decrease) in cash Cash, beginning year Cash, ending year

$184,133 (39,472) (5,582) 139,079 112,669 $251,748

d. ROA = Net income / Average assets = $149,645 / [($952,264 + $695,708) / 2] = 18.2% e. PM = Net income / Revenue = $149,645 / $1,559,563 = 9.6% f.

AT = Revenue / Average assets = $1,559,563 / [($952,264 + $695,708) / 2] = 1.89

g. ROE = Net income / Average equity = $149,645 / [($615,094 + $458,558) / 2] = 27.9%

Solutions Manual, Module 1

P1-44. (30 minutes) a. J M Smucker Co Income Statement ($ millions) For the year ended April 30, 2018 Revenues Cost of product sold Gross profit Expenses Net income

$7,357.1 4,521.0 2,836.1 1,497.5 $1,338.6

b. To solve this we can start with the balance sheet numbers we know for 2018 and solve for the missing number. 2018 Total assets Total liabilities Total equity

?? $7,410.1 $7,891.1

2018 Total assets = $7,891.1 + $7,410.1 = $15,301.2. Then, we can determine current versus long-term as follows: Long-term assets = $15,301.2 - $1,555.0 = $13,746.2. Current liabilities = $7,410.1 - $6,376.3 = $1,033.8.

Current assets Long-term assets

Total assets

J M Smucker Co Balance Sheet ($ millions) April 30, 2018 $1,555.0 Current liabilities 13,746.2 Long-term liabilities Total liabilities Stockholders' equity $15,301.2 Total liabilities and equity

$1,033.8 6,376.3 7,410.1 7,891.1 $15,301.2

Financial & Managerial Accounting for MBAs, 6th Edition

c. J M Smucker Co Statement of Cash Flow ($ millions) For the year ended April 30, 2018 Cash from operating activities Cash from investing activities Cash from financing activities Net increase (decrease) in cash Cash, beginning of year Cash, end of year

$1,218.0 (277.6) (914.6) 25.8 166.8 $ 192.6

d. ROA = Net income / Average assets = $1,338.6 / [($15,301.2 + $15,639.7) / 2] = 8.7% e. PM = Net income / Revenue = $1,338.6 / $7,357.1 = 18.19% = 18.2% rounded f.

AT = Revenue / Average assets = $7,357.1 / [($15,301.2 + $15,639.7) / 2] = 0.48

g. ROE = Net income / Average equity = $1,338.6 / [($7,891.1 + $6,850.2) / 2] = 18.16% = 18.2% rounded

P1-45. (15 minutes) CROCKER CORPORATION Statement of Stockholders’ Equity For Year Ended December 31, 2019

December 31, 2018 Issuance of common stock Net income Cash dividends December 31, 2019

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Contributed Capital $120,000 30,000 _______ $150,000

Retained Stockholders’ Earnings Equity $ 30,000 $150,000 30,000 50,000 50,000 (25,000) (25,000 $ 55,000 $205,000

P1-46. (20 minutes) WINNEBAGO INDUSTRIES Statement of Stockholders’ Equity For Year Ended August 25, 2018

$ thousands

Contributed Capital

Treasury Stock

August 26 , 2017

$106,289

Issuance of stock

5,822

Accum. Other Comp. Income

Retained Earnings

$(342,730)

$679,138

$(1,023)

(4,644)

Net income

102,416

Other comp. income (loss)

1,915

Dividends

(12,738) $112,111

$441,674 5,822

Repurchase of stock

August 25, 2018

Total Stockholders’ Equity

$(347,374)

$768,816

1,915 (12,738)

892

$534,445

2017 $ 205,876 1,498,677 1,411,412 14.6%

2016

P1-47. (30 minutes) ($ thousands) a. 2018 $ 208,542 1,743,157 1,620,917 12.9%

Net income Total assets Average Total assets ROA = Net income / Average Total assets

$1,324,147

b. Net income Sales Profit margin = Net income / Sales

2018 $ 208,542 2,566,863 8.1%

2017 $ 205,876 2,221,427 9.3%

c. Sales Total assets Average Total assets Asset turnover = Sales / Average Total assets

2018 $ 2,566,863 1,743,157 1,620,917 1.58

2017 2016 $ 2,221,427 1,498,677 $ 1,324,147 1,411,412 1.57

d. Profit margin. Logitech’s profit margin decreased by 120 basis points in 2018 from 9.3% to 8.1% while asset turnover was essentially flat from 2017 to 2018.

Financial & Managerial Accounting for MBAs, 6th Edition

e. Net income Equity Average Equity ROE = Net income / Average Equity f.

2018 $ 208,542 1,050,557 953,334 21.9%

2017 $ 205,876 856,111 808,030 25.5%

2016 $ 759,948

Increase The repurchase of common stock reduces both the numerator (net income) and denominator (stockholders’ equity) of the return on equity calculation. Repurchases reduce net income by the forgone profit on the cash that is used to buy the stock on the open market. This is likely very small in the current economic environment. Generally, the denominator effect dominates: its reduction is greater than the reduction of the numerator. Therefore, it is reasonable to predict that Logitech’s repurchase would increase ROE.

P1-48. (30 minutes) ($ millions) a. Feb. 02, 2019 $ 564 7,886 8,001 7.0%

Net income Total assets Average Total assets ROA = Net income / Average Total assets

Feb. 03, 2018 $ 437 8,115 7,987 5.5%

Jan. 28, 2017 $ 7,858

b. Answer Feb 2019: 3.6% Feb 2018: 2.8% Explanation Net income Sales Profit margin = Net income / Sales

Feb. 02, 2019 $ 564 15,860 3.6%

Feb. 03, 2018 $ 437 15,478 2.8%

Sales Total assets Average Total assets Asset turnover = Sales / Average Total assets

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Feb. 02, 2019 $15,860 7,886 8,001 1.98

Feb. 03, 2018 $ 15,478 8,115 7,987 1.94

Jan. 28, 2017 $ 7,858

d. Both. Nordstrom’s profit margin increased by 80 basis points in fiscal year ended February 2019 from 2.8% to 3.6% and asset turnover increased marginally from 1.94 to 1.98. e.

Net income Equity Average Equity ROE = Net income / Average Equity f.

Feb. 02, 2019 $ 564 873 925 61.0%

Feb. 03, 2018 $ 437 977 924 47.3%

Jan. 28, 2017 $ 870

Increase. The large negative balance decreases Equity, the denominator in the ROE ratio and so the ROE is higher as a result.

P1-49. (20 minutes) a.

Sales Cost of sales Gross profit

Capri Holdings ($ millions) 2018 2017 $ 4,718.6 $ 4,493.7 1,859.3 1,832.3 2,859.3 2,661.4

Five Below ($ thousands) 2018 2017 $ 1,559,563 $ 1,278,208 994,478 814,795 565,085 463,413

Sales Gross profit (from part a) Gross profit margin %

Capri Holdings ($ millions) 2018 2017 $ 4,718.6 $ 4,493.7 2,859.3 2,661.4 60.6% 59.2%

Five Below ($ thousands) 2018 2017 $ 1,559,563 $ 1,278,208 565,085 463,413 36.2% 36.3%

Net income Average equity ROE

Capri Holdings ($ millions) 2018 2017 $ 592.1 $ 551.5 1,805 1,794 32.8% 30.7%

Five Below ($ thousands) 2018 2017 $ 149,645 $ 102,451 536,826 394,982 27.9% 25.9%

d. 3; Kors / Jimmy Choo / Versace brand loyalty and the nature of luxury goods, in general, create the opportunity for Capri to premium price its clothes and accessories. While costs of these goods is not low, the mark up can be significant because the consumer is willing to pay for the brand name and the perceived status that comes from wearing the labels.

Financial & Managerial Accounting for MBAs, 6th Edition

P1-50. (30 minutes) a. $ millions Net income Assets, start of year Assets, end of year Average assets ROA = Net income / Average assets

2018 $ 5,924.3 33,803.7 32,811.2 33,307.5 17.8%

2017 $ 5,192.3 31,023.9 33,803.7 32,413.8 16.0%

b. $ millions Net income Sales Profit margin (PM) = Net income / Sales

2018 $ 5,924.3 21,025.2 28.2%

2017 $ 5,192.3 22,820.4 22.8%

c. $ millions Sales Assets, start of year Assets, end of year Average assets Asset turnover (AT) = Sales / Average assets

2018 $21,025.2 33,803.7 32,811.2 33,307.5 0.63

2017 $22,820.4 31,023.9 33,803.7 32,413.8 0.70

d. Profit margin. McDonald’s ROA increased from 2017 to 2018 because profitability increased during the year (from 22.8% to 28.2%) and the increase in profitability was sufficient to outweigh the decrease in productivity (from 0.70 to 0.63).

P1-51. (30 minutes) a. $ millions Net income Assets, start of year Assets, end of year Average assets ROA = Net income / Average assets

2016 $ 5,058.0 32,883.0 32,906.0 32,894.5 15.4%

2017 $ 4,869.0 32,906.0 37,987.0 35,446.5 13.7%

2018 $ 5,363.0 37,987.0 36,500.0 37,243.5 14.4%

b. $ millions Net income Sales Profit margin (PM) = Net income / Sales

Solutions Manual, Module 1

2016 $ 5,058.0 30,109.0 16.8%

2017 $ 4,869.0 31,657.0 15.4%

2018 $ 5,363.0 32,765.0 16.4%

c. $ millions Sales Assets, start of year Assets, end of year Average assets Asset turnover (AT) = Sales / Average assets

2016 $30,109.0 32,883.0 32,906.0 32,894.5 0.92

2017 $31,657.0 32,906.0 37,987.0 35,446.5 0.89

2018 $32,765.0 37,987.0 36,500.0 37,243.5 0.88

d. Both. 3M’s ROA decreased from 15.4% in 2016 to 13.7% in 2017 because profitability margin decreased during the year (from 16.8% to 15.4%). Compounding this was the decrease in asset productivity (AT) (from 0.92 to 0.89). Thus, both factors decreased the ROA. e. Profit margin. 3M’s ROA increased from 13.7% 2017 to 14.4% in 2018 because profitability increased during the year (from 15.4% to 16.4%) and the increase in profitability was sufficient to outweigh the very slight decrease in productivity (from 0.89 to 0.88). P1-52 (35 minutes) a. To answer the questions, hover over the appropriate spot on the graphic on the left and read the pop-out boxes that appear. i. Assets in 2017 are $56,669 million, the largest in the 10-year period. ii. In general, Thermo Fisher’s asset grew steadily over the period. In 2015 assets dipped and then decreased slightly again in in 2018. iii. Liabilities track assets very closely. Equity increased smoothly during the period with no sharp increases or decreases. iv. Liabilities exceeded equity in four of the ten years: 2014, 2016, 2017 and 2018. b. To answer the questions, hover over the appropriate spot on the middle graphic and read the pop-out boxes that appear. i. Net income more than doubled from 2009 to 2017, increasing from $850 million to $2,225 million. ii. Revenue grew each year in the 10-year period. iii. In 2014, revenue increased $4 billion from about $13 billion to $17 billion. While revenue increased nearly that much in 2018, it was on a larger base, so proportionately the 2014 increase was the largest. iv. In $ millions: 2017 profit margin = $2,225 / $20,918 = 10.6%. 2018 profit margin = $2,838 / $24,358 = 12.1%. Profit margin is larger in 2018. v. In 2018, the company’s market cap $89,991 million.

Financial & Managerial Accounting for MBAs, 6th Edition

c. To answer the questions, hover over the appropriate spot on the graphic on the right and read the pop-out boxes that appear. i. Operating cash flow was smallest in 2010, $1,498 million. ii. The red bar represents financing cash flows, The red bar is left of $0 in five of the 10 years. iii. In 2014, investing cash flow is very large and negative. In the prior two years (2012 and 2013) and the next year (2015), investing cash flow fell to nearly $0. d. The ROA for 2018 = $2,938 million / $56,232 million = 5.2%. e. All three graphics show that 2014 was an unusual year. The negative investing cash flow is very large and corresponds to a significant increase in assets (left graphic) and revenue (middle graphic). One possible explanation is that Thermo Fisher acquired another company (investing cash flow), which immediately increased both assets and revenue. P1-53 (25 minutes) a. Twitter’s board of directors and shareholders. Auditors work for the benefit of the shareholders and report directly to the board of directors, the elected representatives of the shareholders whose job it is to protect shareholder interests. It would not be appropriate for the external auditors to report directly to management because the auditors are examining management’s activities as described in the company’s financial statements. Reporting to the board preserves the auditor’s independence. b. 1 and 4. Statement 1 is true because the nature of the independent auditors’ opinion is that the financial statements “present fairly, in all material respects, the financial condition of the company.” Because this is standard audit-report language, any deviations should raise a flag. “Present fairly” does not mean absolute assurance that the financials are error-free. It means that a reasonable person would conclude that the financial statements reasonably describe the financial condition of the company. Statement 2 is not true because auditors are not responsible for detecting fraud. While audit procedures might detect fraud, the auditors do not express an opinion about fraud existence. Statement 3 would be true if the word “misstatements” had read “material misstatements” Continued

Solutions Manual, Module 1

b. continued Statement 4 is true – PwC also rendered an opinion on the company’s system of internal controls. Internal controls are designed to insure the integrity of the financial reporting system and the preservation of the company’s assets. A well-functioning internal control system is a critical component of the company’s overall corporate governance system. Statement 5 is not true because it would be impossible for PwC to examine MOST of the transactions. Instead, they audit critical areas and then use statistical techniques to look at a representational sample of transactions. c. The opinion is unqualified. d. 3

P1-54. (20 minutes) a. Jack Dorsey made assertions that the Sarbanes-Oxley Act requires all CEOs and CFOs to make. In particular, Dorsey certified that: 

He has read the financial reports.



The financial reports do not contain any significant (material) misstatement or omit to state a significant fact that should have been included. The financial reports are, therefore, complete.

 

The financial reports fairly present the financial condition of the company. The company maintains a system of internal controls and those controls are functioning correctly.

b. Congress passed the Sarbanes-Oxley Act following a spate of corporate accounting scandals in the early 2000s. The impetus for the legislation was the belief that some CEOs and CFOs no longer assumed responsibility for the financial reporting of their companies. By requiring these high-ranking executives to personally certify to the items referenced in part a above, Congress wanted to encourage closer scrutiny of the financial reporting process at the highest levels of the company. c. The Sarbanes-Oxley Act prescribes significant penalties for falsely certifying to the completeness and correctness of the financial reports. CEOs and CFOs face fines of up to $5 million and prison terms of up to 20 years. Additionally, should the company later restate its financial statements as a result of wrongful false reporting, the CEOs and CFOs may be required to forfeit any profits earned as a result of that reporting. This forfeiture has been labeled “disgorgement” in the financial press.

Financial & Managerial Accounting for MBAs, 6th Edition

P1-55. (30 minutes) Following is part of the statement of corporate governance from GE’s site. Source: https://www.ge.com/investor-relations/sites/default/files/governance_principles.pdf

continued

Solutions Manual, Module 1

continued

Financial & Managerial Accounting for MBAs, 6th Edition

a. The cornerstone of GE’s governance structure is its reliance on an independent and qualified Board of Directors. Independence means that insiders are not involved in oversight of the company’s managers. This helps avoid potential conflicts of interest. “Highly qualified” directors ensure that those responsible for oversight have the knowledge to perform their duties and the conviction to ask probing questions. b. Governance structures serve shareholders (and indirectly, public interest). The shareholders of GE hope to ensure that the company’s policies are adhered to and that the interests of shareholders are given paramount consideration in the management of the business.

Solutions Manual, Module 1

IFRS APPLICATIONS I1-56. (20 minutes) a. (currency in millions)

OMV Group Ericsson BAE Systems

Assets € 36,961 SEK 268,761 (c) £30,364

Liabilities € 21,619 (b) SEK 180,991 £24,746

Equity (a) €15,342 SEK 87,770 £5,618

b. OMV Group Explanation: Owner Financing = Equity / Assets OMV Group (Austria) Euros millions Ericsson (Sweden) SEK millions BAE Systems (UK) pounds millions

41.5% 32.7% 18.5%

c. BAE Systems Explanation: Nonowner Financing = Liabilities / Assets OMV Group (Austria) Euros millions Ericsson (Sweden) SEK millions BAE Systems (UK) pounds millions

58.5% 67.3% 77.3%

I1-57. (25 minutes) a. € millions Net profit (Loss) Assets, start of year Assets, end of year Average assets ROA = Net income / Average assets

2018 3,298.0 31,576.0 36,961.0 34,268.5 9.6%

2017 1,486.0 32,112.0 31,576.0 31,844.0 4.7%

2016 (230.0) 32,664.0 32,112.0 32,388.0 -0.7%

b. € millions Net profit (Loss) Sales Profit margin (PM) = Net income / Sales

2018 3,298.0 22,930.0 14.4%

2017 1,486.0 20,222.0 7.3%

2016 (230.0) 19,260.0 -1.2%

Financial & Managerial Accounting for MBAs, 6th Edition

c. € millions Sales Assets, start of year Assets, end of year Average assets Asset turnover (AT) = Sales / Average assets

2018 22,930.0 31,576.0 36,961.0 34,268.5 0.67

2017 20,222.0 32,112.0 31,576.0 31,844.0 0.64

2016 19,260.0 32,664.0 32,112.0 32,388.0 0.59

d. Both. OMV’s ROA increased from -0.7% in 2016 to 4.7% in 2017 because profitability margin improved during the year (from -1.2% to 7.3%). Compounding this was the increase in asset productivity (AT) (from 0.59 to 0.64). Thus, both factors increased the ROA. e. Both. OMV’s ROA increased from 7.3% in 2017 to 14.4% in 2018 because profitability increased during the year (from 7.3% to 14.4%) and the increase in profitability was augmented by the increase in productivity (from 0.64 to 0.67). f. € millions Net profit (Loss) Equity, start of year Equity, end of year Average equity ROE = Net income / Average equity

Solutions Manual, Module 1

2018 3,298.0 14,334.0 15,342.0 14,838.0 22.2%

2017 1,486.0 13,925.0 14,334.0 14,129.5 10.5%

2016 (230.0) 14,298 13,925 14,111.5 -1.6%

MANAGEMENT APPLICATIONS MA1-58. (30 minutes) Financing can come from a number of sources, including operating creditors, borrowed funds, and the sale of stock. Each has its strengths and weaknesses. 1. Operating creditors – operating creditors are merchandise and service suppliers, including employees. Generally, these liabilities are non-interest bearing. As a result, companies typically use this source of credit to the fullest extent possible, often stretching payment times. However, abuse of operating creditors has a significant downside. The company may be unable to supply its operating needs and the damage to employee morale might have significant repercussions. Operating credit must, therefore, be used with care. 2. Borrowed funds – borrowed money typically carries an interest rate. Because interest expense is deductible for tax purposes, borrowed funds reduce income tax expense. The taxes saved are called the “tax shield.” The deductibility of interest reduces the effective cost of borrowing. The downside of debt is that the company must make principal and interest payments as scheduled. Failure to make payments on time can result in severe consequences – creditors have significant legal remedies, including forcing the company into bankruptcy and requiring its liquidation. The lower cost of debt must be balanced against the fixed payment obligations. 3. Sale of stock – companies can sell various classes of stock to investors. Some classes of stock have mandatory dividend payments. On other classes of stock, dividends are not a legal requirement until declared by the board of directors. Consequently, unlike debt payments, some dividends can be curtailed in business downturns. The downside of stock issuance is its cost. Because equity is the most expensive source of capital, companies use it sparingly.

Financial & Managerial Accounting for MBAs, 6th Edition

MA1-59. (30 minutes) Each of the three primary financial statements provides a different perspective on the company’s financial performance and condition. 1. Income statement. The income statement provides information on the company’s sales, expenses, and net income or loss. Profitability indicates that the company’s goods or services are valued by the market, that is, customers are willing to pay a price that is sufficient to cover the costs of providing those goods and/or services together with an adequate return on invested capital. Further, the income statement is prepared on an accrual basis, where revenues are recognized when “earned” and expenses when “incurred.” Accountants do not wait for cash to be received or paid to record revenues and expenses. Consequently, management is able to communicate some of its private information about expected cash inflows or outflows through its recording of revenues and expenses. Presumably this information is valuable to financial statement readers because the income statement provides information about the economic profit of the company. 2. Balance sheet. The balance sheet reports the resources available to the company and how the company obtained those resources (the sources). The balance sheet also reveals asset categories (providing insight into management’s investment philosophy) and the manner in which management has financed its operations (the relative use of debt versus equity). Efficient management of the balance sheet is critical to financial performance and careful analysis of the balance sheet can provide clues into the effectiveness of the company’s management team and the viability of the company within the context of its industry. 3. Statement of cash flows. Cash is important to a company’s continued operations. Debts must be paid in cash and employees typically only accept cash in payment of their services. Companies must generate positive cash flow over the long run in order to survive. The income statement, prepared on an accrual basis, does not directly provide information about cash flows. But the statement of cash flows does, and, for that reason, it is a critical financial statement. The statement of cash flows tells us the sources of cash and how cash has been used. In particular, the statement reports operating, investing and financing cash flows. From the statement we can infer whether the company’s sources of cash are long-term or transitory. This is important to forecasting future cash flows. In addition, the uses of cash provide insight into management’s investment philosophy, which can be a valuable input into our evaluation of management and valuation of the company.

Solutions Manual, Module 1

MA1-60. (30 minutes) Transparency is the degree to which the financial statements accurately and completely portray the financial condition of the company and the results of its operating activities. Transparent financial statements are timely and provide all the information required to effectively evaluate the financial performance of the company. Accuracy, timeliness, and completeness are important to financial statement readers who seek financial information that is relevant and reliable. Transparency became a central issue in financial reporting following the accounting scandals of the early 2000s, when analysts believed too many financial statements lacked transparency. Balancing companies’ desire to issue transparent financial statements is their need to protect proprietary information. Markets are very competitive, and the information disclosed to investors and creditors is also disclosed to the company’s competitors. Most critical is information relating to the company’s strategic direction. Even historical information, however, provides insight into the relative profitability of the company’s operating units that can be effectively utilized by future competitors. There has traditionally been tension between companies and the financial professionals (especially investment analysts) who press firms for more and more financial and nonfinancial information.

MA1-61. (30 minutes) Accounting measures other than net income have become commonplace in corporate press releases. By their use, companies seek to redefine the benchmark the market uses to evaluate the companies’ performance. These non-GAAP income metrics often create a lower bar that companies can more easily reach. By touting non-GAAP performance measures, companies hope to improve the market’s assessment of performance. The SEC will not accept non-GAAP financial statements for quarterly and annual financial reporting. In fact, auditors must cite GAAP exceptions in their audit opinion, which creates a significant red flag. Companies are allowed to use non-GAAP measures in press releases, provided that they also reconcile the non-GAAP numbers to GAAP numbers in the same press release. It is a criminal offense to issue false or misleading financial statements for the purpose of influencing security prices. Also, most companies have developed and published to employees, codes of conduct that prohibit the falsification of financial reporting for the purpose of job retention, promotion, or compensation. Officially, senior management believes that false financial reports pose significant ethical issues that must be clearly communicated to all employees. Nonetheless, we continue to witness corporate executives doing a “perp walk” on national TV as they are escorted to jail by federal authorities. Continued © Cambridge Business Publishers, 2021 1-34

Financial & Managerial Accounting for MBAs, 6th Edition

Condoning exceptions to financial reporting implicitly condones theft in all of its forms, and the corporate culture quickly deteriorates. Proper corporate governance requires the communication of clear guidelines about what information may be communicated in press releases and how internal performance measures are to be constructed. These must be enforced to the letter. MA1-62.B (30 minutes) The SEC has voiced its concern over the perceived lack of independence of auditors, and Congress has passed legislation to define the activities that auditors may and may not perform for their clients. The issue of independence first arose when auditors faced no controls. In response to declining audit fees, public accounting firms sought to bolster their income with management consulting engagements, such as software development, M&A assistance, internal audit outsourcing, supply chain management, and a host of other services. As management consulting revenues and profits grew disproportionately compared to traditional audit revenues and profit, the SEC became concerned that auditors might be unduly influenced to issue biased audit reports rather than risk losing lucrative management consulting fees from the same client. In response, the SEC compelled public accounting firms to divest their management consulting subsidiaries. Further, firms were limited as the types of non-audit engagements they could perform for clients. Auditors are an important component of the corporate governance system, and their effectiveness is lessened if their independence is compromised. The board of directors (specifically, the audit committee) must continually evaluate the independence of the company’s auditors.

Solutions Manual, Module 1

Module 2 Introducing Financial Statements QUESTIONS Q2-1.

Q2-2.

An asset represents resources a company owns or controls. Assets should provide future economic benefits. Assets arise from past events or transactions. A liability is an obligation that will require a future economic sacrifice. Equity is the difference between assets and liabilities. It represents the claims of the company’s owners to its income and assets. The following are some examples of each: Assets

   

Cash Receivables Inventories Plant, property and equipment (PPE)

Liabilities

    

Accounts payable Accrued liabilities Deferred revenue Notes payable Long-term debt

Equity

    

Contributed capital (common and preferred stock) Additional paid-in capital Retained earnings Accumulated other comprehensive income Treasury stock

A cost that creates an immediate benefit is reported on the income statement as an expense. A cost that creates a future benefit is added to the balance sheet as an asset (capitalized) and will be transferred to the income statement as the benefit is realized. For example, PPE creates a future benefit and the cost of the PPE is transferred to the income statement (as depreciation expense) over the life of the PPE.

Solutions Manual, Module 2

Q2-3.

Accrual accounting means that we record revenues when earned (when the performance obligation is satisfied) and record expenses when they are incurred. Accrual accounting does not rely on cash flows in determining when items are revenues or expenses. This is why net income (a GAAP measure) differs from cash from operations.

Q2-4.

Transitory items are revenues and expenses that are not expected to recur. One objective of financial analysis is to predict future performance. Given that perspective, transitory (nonrecurring) items are not relevant except to the extent that they convey information about future financial performance.

Q2-5.

The statement of stockholders’ equity provides information about the events that impact stockholders’ equity during the period. It contains information relating to net income, stock sales and repurchases, option exercises, dividends and other accumulated comprehensive income.

Q2-6.

The statement of cash flows reports the company’s cash inflows and outflows during the period, and categorizes them according to operating, investing and financing activities. The income statement reports profit earned under accrual accounting, but does not provide sufficient information concerning cash flows. The statement of cash flows fills that void.

Q2-7.

Articulation refers to the fact that the four financial statements are linked to each other and that changes in one statement affect the other three. For example, net income reported on the income statement is linked to the statement of retained earnings, which in turn is linked to the balance sheet. Understanding how the financial statements articulate helps us to analyze transactions and events and to understand how events affect each financial statement separately and all four together.

Q2-8.

When a company purchases a machine it records the cost as an asset because it will provide future benefits. As the machine is used up, a portion of this cost is transferred from the balance sheet to the income statement as depreciation expense. The machine asset is, thus, reduced by the depreciation, and equity is reduced as the expense reduces net income and retained earnings. If the entire cost of the machine was immediately expensed, profit would be reduced considerably in the year the machine was purchased. Then, in subsequent years, net income would be far too high as none of the machine’s cost would be reported in those years even though the machine produced revenues during that period.

Financial & Managerial Accounting for MBAs, 6th Edition

Q2-9.

An asset must be “owned” or “controlled,” it must provide “future economic benefits,” and it must arise from a past transaction or event. Owning means having title to the asset (some leased assets are also recorded on the balance sheet because they are controlled, as we will discuss in our Module 10 entitled, “Reporting and Analyzing Off-Balance-Sheet Financing”). Future benefits may mean the future inflows of cash, or an increase in another asset, or reduction of a liability. Past event means the company has purchased the asset or acquired it in some other cash or noncash transaction or event.

Q2-10.

Liquidity refers to the ready availability of cash. That is, how much cash the company has on hand, how much cash is being generated, and how much cash can be raised quickly. Liquidity is essential to the survival of the business. After all, firms must pay loans and employee wages with cash.

Q2-11.

Current means that the asset will be liquidated (converted to cash) or used in operations within the next year (or the operating cycle if longer than one year).

Q2-12.

GAAP uses historical costs because they are less subjective than market values. Market values can be biased for two reasons: first, we may not be able to measure them accurately (consider our inability to accurately measure the market value of a manufacturing facility, for example), and second, managers may intervene in the reporting process to intentionally bias the results to achieve a particular objective (like enhancing the stock price).

Q2-13.

Generally, excluded intangible (unrecorded) assets are those that contribute to a company’s sustainable competitive advantage, but that cannot be measured accurately. Some examples include the value of a brand, the management of a company, employee morale, a strong supply chain, superior store locations, credibility with the financial markets, reputation, and so forth.

Q2-14.

An intangible asset is an asset that is not physical in nature. To be included on the balance sheet, it has to meet two tests: the company must own or control the asset, it must provide future economic benefits, and the asset must arise from a past event or transaction. Some examples are goodwill, patents and trademarks, contractual agreements like royalties, leases, and franchise agreements. An intangible asset is only recorded on the balance sheet when it is purchased from an outside party. For example, goodwill arises when the company acquires (either with cash or stock) another company’s brand name or any of the other intangibles listed above.

Q2-15.

An accrued liability is an obligation for expenses that have been incurred but not yet paid for with cash. Examples include wages that have been earned by employees and not yet paid, interest owing on a bank loan, and potential future warranty claims for products sold to customers. When the liability is recognized on the balance sheet, a corresponding expense is recognized in the income statement.

Solutions Manual, Module 2

Q2-16.

Net working capital = Current assets – Current liabilities. Increasing the amount of trade credit (e.g., accounts payable to suppliers) increases current liabilities and reduces net working capital. Trade credit is like borrowing from a supplier to make purchases. As trade credit increases, the supplier is lending more money than before. This frees up cash, which the company can use for other purposes such as paying down interest-bearing debt or purchasing additional productive assets. Thus, net working capital decreases. This can be a good thing. As a business grows, its net working capital grows because inventories and receivables generally grow faster than accounts payable and accrued liabilities do. Net working capital must be financed just like long-term assets.

Q2-17.

Book value is the amount at which an asset (or liability) is carried on the balance sheet. The book value of the company is the book value of all the assets less the book value of all the liabilities, that is, the book value of stockholders’ equity. Book values are determined in accordance with GAAP. Market value is the sale price of an asset or liability. Markets are not constrained by GAAP standards and, therefore, can consider a number of factors that accountants cannot. Market values, therefore, generally differ significantly from book values.

Q2-18

The income statement and the equity section on the balance sheet are linked via retained earnings. When a company reports net income, the amount increases retained earnings. Similarly, losses on the income statement decrease retained earnings on the balance sheet. When a company pays a dividend, retained earnings decrease. The amount of the dividend paid is reported on the statement of cash flows as a use of funds (outflow) in the financing section.

Financial & Managerial Accounting for MBAs, 6th Edition

MINI EXERCISES M2-19. (15 minutes) a. Income statement

Balance sheet

b. Balance sheet

g. Income statement

c. Income statement

h. Balance sheet

d. Balance sheet

Income statement

e. Income statement

M2-20. (15 minutes) a. Balance sheet

g. Balance sheet

b. Income statement

h. Balance sheet

c. Balance sheet

Income statement

d. Income statement

Income statement

e. Balance sheet

k. Balance sheet

Balance sheet

M2-21. (15 minutes) On February 28, 2019 Kraft Heinz announced that they would record a goodwill impairment of $7.1 billion in the next quarterly earnings report. The company’s stock price had recently fallen and had not rebounded. Goodwill impairment tests revealed that current fair value was less than the carrying value of seven of the company’s 20 reporting units (similar to subsidiaries) and six of its major brands.

M2-22. (15 minutes) a. A e. b. L f. c. E g. d. A h.

Solutions Manual, Module 2

L E E L

M2-23. (10 minutes)

Beginning retained earnings Add: Net income (loss) Less: Dividends Ending retained earnings

2020 $189,089 (19,455) 0 $169,634

2019 $ 155,957 48,192 (15,060 $189,089

M2-24. (10 minutes) ($ millions) Retained earnings, December 31, 2017 Add: Net earnings Less: Other retained earnings changes Less: Dividends Retained earnings, December 30, 2018

$101,793 15,297 (1,380) (9,494) $106,216

Financial & Managerial Accounting for MBAs, 6th Edition

EXERCISES E2-25. (15 minutes) a. One plausible reason that Credit Suisse prepared its financial statements in accordance with US GAAP, is to make it easier for financial statement users including securities analysts, investors, and regulators to compare to Credit Suisse’s close competitors, many of which are U.S. companies. b. Credit Suisse wants its investors, customer, regulators and other stakeholders to know that it is a good corporate citizen. A proactive statement claiming to take seriously the international anti-terrorist laws and to have implemented strong policies and procedures to combat crime, seeks to decrease the perceived riskiness of the company’s operations, and thereby decrease the company’s equity cost of capital.

E2-26. (15 minutes) Analysts would want to know about other income statement and balance sheet accounts that relate to the allowance. For example to assess the variability of the allowance account, the balance could be common-sized to total assets or as a percentage of total accounts receivable. The changes in the allowance account, when expressed in percentage terms, might be immaterial (a positive signal) or might vary even more drastically (a negative signal). Analysts would also want to use industry-wide information – what have H&R Block’s competitors experienced with bad debt and doubtful accounts? Answering that question will help determine if additional research and analysis are required.

E2-27. (20 minutes) BARTH COMPANY Income Statement For Year Ended December 31, 2019 Sales revenue Expenses Cost of goods sold Wages expense Supplies expense Total expenses Net income

$500,000 $180,000 40,000 6,000 226,000 $274,000 continued

Solutions Manual, Module 2

BARTH COMPANY Balance Sheet December 31, 2019 Assets Cash Accounts receivable Supplies inventory Inventory Total current assets Land Equipment Buildings Goodwill Total assets

Liabilities and equity $148,000 Accounts payable 30,000 Bonds payable 3,000 Total liabilities 36,000 217,000 80,000 Common stock 70,000 Retained earnings 151,000 Total equity 8,000 $526,000 Total liabilities and equity

$ 16,000 200,000 216,000

150,000 160,000 310,000 $526,000

E2-28. (15 minutes) BAIMAN CORPORATION Income Statement For Month Ended January 31 Sales Wage expense Net income (loss)

BAIMAN CORPORATION Balance Sheet January 31 $40,000Cash 12,000Accounts receivable $28,000Total assets Wages payable Retained earnings Total liabilities and equity

0 40,000 $40,000 $12,000 28,000 $40,000

Financial & Managerial Accounting for MBAs, 6th Edition

E2-29. (30 minutes)

Balance sheet Cash Noncash assets Total liabilities Contributed capital Retained earnings Other equity Statement of cash flows Operating cash flow Investing cash flow Financing cash flow

+ +

–

+ –

–

+ –

–

+ –

Income statement Revenues Expenses Net income

+ –

Statement of stockholders’ equity Contributed capital + Retained earnings

–

Solutions Manual, Module 2

–

E2-30. (30 minutes)

Balance sheet Cash Noncash assets Total liabilities Contributed capital Retained earnings Other equity Statement of cash flows Operating cash flow Investing cash flow Financing cash flow

– +

–

+ –

–

+ +

– +

–

Income statement Revenues Expenses Net income

+ + +

+ –

Statement of stockholders’ equity Contributed capital + Retained earnings

–

Financial & Managerial Accounting for MBAs, 6th Edition

E2-31. (15 minutes) a. Best Buy Inc. ($ millions)

Amount

Sales Accumulated depreciation Depreciation expense Retained earnings Net income Property, plant and equipment, net Selling, general and admin expense Accounts receivable Total liabilities Total stockholders' equity

$42,879 6,690 770 2,985 1,464 2,510 8,015 1,015 9,595 3,306

Classification I B I B I B I B B B

b. Total assets = Total liabilities + Total stockholders’ equity Total assets = $9,595 million + $3,306 million = $12,901 million Sales – Total expenses = Net income $42,879 million – Total expenses = $1,464 million Thus, Total expenses = $41,415 million

E2-32. (15 minutes) a. Terex Corp ($ millions) Total revenues Accrued compensation and benefits Depreciation and amortization expense Retained earnings Net income Property, plant & equipment Selling, general & admin expense Inventory Total liabilities Total stockholders' equity

Amount Classification $5,125.0 I 152.2 B 59.7 I 749.0 B 113.7 I 345.6 B 673.5 I 1,212.0 B 2,624.9 B 861.0 B

b. Total assets = Total liabilities + Total stockholders’ equity Total Assets = $2,624.9 million+ $861.0 million = $3,485.9 million Total revenue – Total expenses = Net income $5,125.0 million – Total expenses = $113.7 million Thus, Total expenses = $5,011.3 million Solutions Manual, Module 2

E2-33. (15 minutes) a. ($ thousands) Sales Cost of goods sold Gross profit Total expenses Net income

ANF $3,590,109 100.0% 1,430,193 39.8% 2,159,916 60.2% 2,081,108 58.0% 78,8082.2%

TJX $38,972,934 100.0% 27,831,177 71.4% 11,141,757 28.6% 8,081,959 20.7% $ 3,059,798 7.9%

ANF is a high-end retailer and TJX operates in the value-priced segment of the market. Clearly, their respective business models are evident in the gross profit margin. ANF’s gross profit margin is more than twice that of TJX (60.2% compared to 28.6%). This implies that ANF adds a healthy markup to determine their merchandise sales price. The high-end segment also requires additional personnel, advertising, and other operating costs. ANF’s expense margin is nearly three times higher (58% compared to 20.7%). On balance, TJX is more profitable than ANF with each sales dollar (7.9% vs. 2.2%). b. ($ thousands) Current assets Long-term assets Total assets Current liabilities Long-term liabilities Total liabilities Stockholders' equity Total liab. and equity

ANF $1,335,950 56.0% 1,049,643 44.0% $2,385,593 100.0%

TJX $ 8,469,222 59.1% 5,856,807 40.9% $14,326,029 100.0%

$ 558,91723.4% 608,05525.5% 1,166,972 48.9% 1,218,621 51.1% $2,385,593 100.0%

$ 5,531,374 38.6% 3,746,049 26.1% 9,277,423 64.8% 5,048,606 35.2% $14,326,029 100.0%

ANF has slightly lower levels of current assets relative to total assets than does TJX. For clothing retailers, current assets are primarily cash and inventories. If the two companies have about the same levels of cash, we would conclude that ANF holds less inventory. This makes sense given that TJX has discount-type stores chock-full of merchandise. c. ANF has a much smaller proportion of total liabilities in its capital structure (48.9% compared to 64.8% at TJX) which might seem to imply that TJX relies more on debt to fund its assets and is therefore riskier. However, TJX has significantly more current liabilities that are low risk because they are typically non-interest bearing and are paid off with sales of inventory and available cash (current assets are greater than current liabilities for both companies). The proportion of long-term liabilities is about the same across the two companies. Because long-term debt bears interest and requires periodic payments of interest and principal, it is riskier than current liabilities. On par, TJX is a slightly riskier company. © Cambridge Business Publishers, 2021 2-12

Financial & Managerial Accounting for MBAs, 6th Edition

E2-34. (15 minutes) a. ($ millions)

Pfizer

Dr. Reddy’s

Sales COGS

$53,647100.0% 11,24821.0%

$2,181 100.0% 1,009 46.3%

Gross profit Total expenses

42,39979.0% 31,21158.2%

1,172 53.7% 1,021 46.8%

Net income

$11,18820.9%

$ 151

6.9%

Dr. Reddy’s COGS is more than twice that of Pfizer (46.3% compared to 21.0%). This is likely due to two factors: first, Pfizer manufactures and sells branded, patented drugs and therapeutics whereas Dr. Reddy’s is a generics and compounding firm. Dr. Reddy’s competition is more intense and Pfizer can premium price its products. Second, Dr. Reddy’s has a larger global footprint, selling in markets where price competition is fierce. b. ($ millions)

Pfizer

Dr. Reddy’s

Current assets Long-term assets

49,92631.3% 109,49668.7%

1,684 48.6% 1,781 51.4%

Total assets

159,422100.0%

3,465 100.0%

Current liabilities Long-term liabilities

31,85820.0% 63,80640.0%

1,070 30.9% 453 13.1%

Total liabilities Stockholders' equity

95,66460.0% 63,75840.0%

1,523 44.0% 1,942 56.0%

Total liabilities and equity

159,422100.0%

3,465 100.0%

Pfizer holds fewer current assets and liabilities than Dr. Reddy’s and has more liabilities (60% for Pfizer and only 44% for Dr. Reddy’s.) Pfizer has a smaller proportion of stockholders’ equity in its capital structure. A greater proportion of equity is generally viewed as a less risky capital structure. However, Pfizer’s relatively low level of equity arises from the fact that the company has repurchased its stock and retired shares. This decreases retained earnings, a component of equity.

Solutions Manual, Module 2

E2-35. (15 minutes) a. ($ millions)

CMCSA

Sales Operating costs

$94,507100.0% 75,49879.9%

$130,863 100.0% 108,585 83.0%

Operating profit Nonoperating expenses

19,00920.1% 7,147 7.6%

22,278 17.0% 6,2394.8%

Net income

$11,86212.6%

$ 16,039 12.3%

Verizon’s product lines yield slightly lower operating profit margin than do Comcast’s. Its nonoperating expense, however, is lower than Comcast’s. The operating and nonoperating relative effects offset leaving the two companies with profit margins that are roughly equal. b. ($ millions)

CMCSA

Current assets Long-term assets

$ 21,848 8.7% 229,83691.3%

$ 34,636 13.1% 230,193 86.9%

Total assets

$251,684100.0%

$264,829 100.0%

Current liabilities Long-term liabilities

$ 27,60311.0% 151,57960.2%

$ 37,930 14.3% 172,189 65.0%

Total liabilities Stockholders' equity Total liabilities and equity

179,18271.2% 72,50228.8% $251,684100.0%

210,119 79.3% 54,710 20.7% $264,829 100.0%

Verizon is larger in both sales and total assets. Both companies are highly capital intensive, with long-term assets accounting for about 90% of total assets. Both companies’ business models necessitate continued investment in long-term assets as they seek to continue to develop their telecom infrastructure. c. The two companies have relatively high debt loads. This is typical for capital-intensive industries like telecom. Given the large level of capital expenditures (CAPEX) that the companies will make over the next decade, and the amount of additional debt that they will have to incur to fund CAPEX, the debt levels will be a continuing financial issue for both companies.

Financial & Managerial Accounting for MBAs, 6th Edition

E2-36. (30 minutes) a. TJX ($ thousands) $38,972,934 100.0% 27,831,177 71.4% 11,141,757 28.6% 8,081,959 20.7% $ 3,059,798 7.9%

Sales COGS Gross profit Total expenses Net income

Pfizer ($ millions) $53,647 100.0% 11,24821.0% 42,39979.0% 31,21158.2% $11,18820.9%

TJX is a value-priced clothing retailer whose main expense is cost of sales. Pfizer brandname products are well differentiated and patent-protected. The difference in their respective business models is clearly evident in the level of gross profit. Pfizer’s gross profit margin percentage is more than 2.5 times greater than TJX’s. This does not imply that Pfizer is a better-managed company. Much of the difference in operating percentages between companies in different industries is related to differences in their respective business models. Pfizer incurs significant expenses for R&D, selling, marketing, and advertising, which contribute to the 58.2% expense margin compared to 20.7% at TJX. b. Sales Total assets Sales / Total assets

TJX ($ thousands) $38,972,934 14,326,029 2.72

Pfizer ($ millions) $53,647 159,422 0.34

TJX’s sales are almost three times its total assets. Pfizer’s sales are only one third its total assets. It might be tempting, therefore, to conclude that Pfizer is more capital intensive than TJX. However, significant levels of total assets consist of cash and marketable securities as well as intangible assets acquired when Pfizer bought other pharmaceutical companies. This points to the need to study the financial statements and footnotes more thoroughly before coming to broad conclusions. c. ($ millions) Total liabilities Stockholders' equity Total liabilities / Stockholders' equity

TJX ($ thousands) $9,277,423 5,048,606 1.84

Pfizer ($ millions) $95,664 63,758 1.50

TJX operates with slightly more debt relative to equity than does Pfizer. Companies with higher proportions of debt are generally viewed as riskier because failure to make required debt payments can have significant negative consequences. Pfizer has high equity because of retained earnings – many years of large profits – but in recent years has repurchased large amounts of its own stock, which depresses equity and inflates the ratios above.

Solutions Manual, Module 2

E2-37. (35 minutes) a. Balance sheet Cash Noncash assets Total liabilities Contributed capital Retained earnings Other equity

+ +

–

– +

–

+ –

–

Statement of cash flows Operating cash flow Investing cash flow Financing cash flow Income statement Revenues Expenses Net income

–

– –

+ –

Statement of stockholders’ equity Contributed capital Retained earnings –

+ + +

+ –

–

Financial & Managerial Accounting for MBAs, 6th Edition

PROBLEMS P2-38. (30 minutes) a. ($ millions) Current Long-term Total Assets Assets Assets

2018 2017 2016

13,709 14,277 11,726

22,791 23,710 21,180

36,500 37,987 32,906

Current Liabilitie s

Long-term Total Stockholders' Liabilities Liabilities Equity

7,244 7,687 6,219

19,408 18,678 16,344

26,652 26,365 22,563

9,848 11,622 10,343

b. The following would not be included among 3M’s current assets: 2. Property plant & equipment 4. Accounts payable 6. Goodwill 7. Accrued expenses c. The following would be included among 3M’s long-term assets: 2. Property, plant & equipment 3. Intangible assets 5. Goodwill

P2-39. (30 minutes) a. Common-sized balance sheet items, such as the allowance for doubtful accounts, express the item as a percentage of total assets. For Community Health Systems this is as follows: Allowance Total assets Common size allowance

2017 $ 3,870 17,450 22.2%

2016 $ 3,773 21,994 17.2%

2015 $ 4,110 26,861 15.3%

The allowance is higher percentage terms in 2017 as compared to both 2016 and 2015. This could indicate that the company is having more difficulty collecting money from its patients. b. Community Health Systems operates hospitals, which typically provide services for indigent and uninsured patients as well as for patients who can pay personally or who have insurance coverage. This means that many services are “charged” to patients but the company has no reasonable expectation of collecting the amount or the entire amount. To verify this idea, analysts would gather information from other hospitals and compute similar ratios and use those as a benchmark to assess Community Health Systems. Solutions Manual, Module 2

c. Common-sized income statement items, such as the bad debt expense, express the item as a percentage of Revenue. For Community Health Systems this is as follows:

Bad debt expense Revenue Common size expense

2017 3,054 18,398 16.6%

2016 2,849 21,275 13.4%

2015 3,168 22,564 14.0%

In 2015, the common-size bad debt expense was 16.6%, which means that for every dollar of revenue, the company recorded nearly 17 cents of bad debt expense. This seems high and the ratio is higher than the prior two years. d. Answer: 3 If Community Health Systems had recorded $500 less of bad debt expense, total expenses would have been lower and thus, the operating loss before tax would have been $500 smaller, or $1,378 loss instead of $1,878 loss. This would have had no effect on cash from operations because bad debt expense is a non-cash item.

P2-40. (50 minutes) a. Facebook’s form 10-K was filed on January 31, 2019 and the company’s fiscal year end was December 31, 2018. The SEC filing is a month after year end because the auditors took a month to complete the audit. b. The company’s mission is “to give people the power to share and make the world more open and connected.” c. The company claims to compete with the following:  Companies that offer products that replicate the full range of capabilities that Facebook provides. For example, Google has integrated social functionality into a number of its products, including search and Android, as well as other, largely regional, social networks that have strong positions in particular countries. 

Companies that develop applications, particularly mobile applications, that provide social or other communications functionality, such as messaging, photo- and video-sharing, and micro-blogging.



Companies that provide web- and mobile-based information and entertainment products and services that are designed to engage people and capture time spent on mobile devices and online.



Traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns.

Financial & Managerial Accounting for MBAs, 6th Edition

d. As of December 31, 2018, Facebook employed approximately 33,587 people. e. Facebook had 1.52 billion daily active users (DAUs) on average in December 2018, an increase of 9% compared to December 2017. f.

Facebook does not include Schedule II. The Form 10-K says, “All schedules have been omitted because they are not required, not applicable, not present in amounts sufficient to require submission of the schedule, or the required information is otherwise included.” This implies that the uncollectible accounts receivable are relatively immaterial, or insubstantial. The balance sheet reports allowance of $229 million, which is immaterial compared to accounts receivable of $7,587 million and total assets of $97,334 million.

g. The company is audited by Ernst & Young out of the San Francisco office.

P2-41. (30 minutes) a.

Company Target Nike Harley-Davidson Pfizer

Gross Profit / Sales

Net Income/ Sales

29% 44% 41% 79%

4% 5% 9% 21%

Net Income/ Equity

Liabilities/ Equity

26% 20% 30% 18%

2.65 1.30 5.01 1.50

b. Companies generally realize higher gross profit margins if there is some limit on competition, such as a barrier to entry. This barrier to entry can be legal in nature such as that afforded by a patent; or operational, such as that created by strong brand identity. Pfizer, Nike and Harley all enjoy above-average gross profit margins. Pfizer is a pharmaceutical company that benefits from patents on desirable drugs and therapeutics. Nike and Harley have strong and valuable brands. Nike relies on its advertising campaigns while Harley enjoys its cult following. Target, while a strong brand, sells goods that are difficult to differentiate and the company cannot command the pricing power that the other three companies enjoy. Profit margin (Net income / Sales) is a function of both gross profit margin and expense control. Pfizer’s ratios is the highest of the companies in this sample, resulting from its high gross profit margin and excellent expense control. The other three companies have mid-range profit margin with Target’s being the lowest. Again, Target lacks the ability to differentiate itself and has significant advertising expense.

Solutions Manual, Module 2

c. Harley enjoys the highest return on equity (measured as net income to equity), followed by Target whose equity is relatively low due to recent stock buybacks (which decreases equity). Harley and Nike are premium brands that have effectively differentiated their products and can, therefore, enjoy above-average returns on stockholder investment. d. Harley has the highest proportion of debt in its capital structure because of the HarleyDavidson Financial Services (its loan and lease financing subsidiary). The balance sheets and income statements of Harley’s financial operations are similar to that of a bank – high debt levels and relatively low margins. Harley must consolidate its financial operations with its operating company. This inflates its consolidated debt level above what we typically observe for pure-play manufacturing operations. Finally, Nike and Pfizer have lower levels of fixed assets, which typically require debt financing. Thus their liabilities / equity ratios are relatively low.

P2-42. (30 minutes) a. Company Macy’s Home Depot Best Buy Target Walmart

Net Income / Sales 4.3% 10.3% 3.4% 3.9% 1.3%

Rank 2 1 4 3 5

Home Depot, Macy’s and Target report the highest profit margins. These companies have succeeded at effectively differentiating their brands and/or controlling their costs. Walmart operates in highly competitive markets with undifferentiated product lines and Best Buy products are easily purchased online because product characteristics are known and competition is fierce. b. Company Macy’s Home Depot Inc. Best Buy Target Corp. Walmart Stores

Operating Cash Flow / Sales 6.7% 12.0% 5.6% 7.9% 5.4%

Rank 3 1 4 2 5

Home Depot, Target, and Macy’s report the highest level of operating cash flow as a percentage of sales. These are very efficient operations. Walmart and Best Buy are not as effective on this dimension. The rankings for this ratio are nearly exactly the same as for the net profit margins.

Financial & Managerial Accounting for MBAs, 6th Edition

c. Company Macy’s Home Depot Inc. Best Buy Target Corp. Walmart Stores

Investing Cash Flow / Sales -1.8% -2.2% 1.2% -4.5% -4.7%

Rank 4 3 5 2 1

Investing cash flows are typically negative (cash outflow), representing the purchase of PPE and other long-lived assets including intangible assets and goodwill purchased in a merger or acquisition. The companies’ rankings here, do not correspond with their rankings in parts a and b. Best Buy is not expanding, its cash flow is positive. Walmart and Target are expanding most among the five companies.

P2-43. (45 minutes) a. The largest asset is marketable securities $275.3 billion or 66% of total assets. The smallest asset is inventory, only $4.9 billion or 1.29% of total assets. b. We can see that the company is slightly smaller in 2018 compared to 2017 (total assets of $275.3 billion compared to $265.7 billion). However, the composition of the balance sheet has changed noticeably. The most significant change on the asset side is the decrease in marketable securities both in dollar terms (from $249 billion to $211 billion) and in proportionate terms (from 66% of total assets down to 58%). c. On the liabilities and equity side, changes from 2017 to 2018 were less dramatic. Accounts payable and other liabilities grew proportionately. Earned capital decreased significantly, from 26% to 18% of total assets. The company was profitable but paid out dividends and bought back stock in excess of net income. d. Apple started paying dividends in 2012. Dividends have increased steadily over time but not by the same rate as net income. e. Apple has bought back significant amounts of stock beginning in 2013. In both 2014 and 2018, Apple bought back more stock than it earned in net income. We see that the red part is higher up on the graphic than the black part, in those year. In other years, the proportions were roughly the same. f.

In 2018, retained earnings decreased. The sum of dividends (green) and stock buybacks (red) is greater than net income (black).

Solutions Manual, Module 2

IFRS ASSIGNMENTS I2-44. (15 minutes) a. Income Statement

Sales Cost of goods sold Gross profit Total expenses Net income

Tesco February 24, 2019 £millions % £ 63,911100.0% 59,767 93.5% 4,144 6.5% 2,824 4.4% £ 1,320 2.1%

Carrefour December 31, 2019 €millions % € 77,917 100.0% 60,850 78.1% 17,067 21.9% 17,411 22.3% € (344) -0.4%

Carrefour’s gross profit margin (21.9%) is about three times that of Tesco (6.5%) due to their relatively low cost of goods sold. The difference might be in the type of product each company sells or the product mix. For example Carrefour might sell more specialty, high-end groceries or wines that command a higher margin. But the opposite pattern holds for the total expenses. This could indicate that the companies classify certain expenses differently—Tesco classifies more expenses as COGS. b. Balance Sheet

Current assets Long-term assets Total assets Current liabilities Long-term liabilities Total liabilities Equity Total liabilities and equity

Tesco February 24, 2019 (£ millions) % £12,668 25.8% 36,379 74.2% 49,047 100.0% 20,680 42.2% 13,533 27.6% 34,213 69.8% 14,834 30.2% £49,047 100.0%

Carrefour December 31, 2018 (€millions) % €18,670 39.4% 28,708 60.6% 47,378 100.0% 23,162 48.9% 12,930 27.3% 36,092 76.2% 11,286 23.8% €47,378 100.0%

Tesco holds far less current assets than Carrefour, 25.8% compared to 39.4%. We observe a similar difference for current liabilities, with 42.2% for Tesco and 48.9% for Carrefour. The two companies have about the same level of long-term liabilities. c. Tesco has a greater proportion of stockholders’ equity in its capital structure: 30.2% compared to Carrefour’s 23.8%. A greater proportion of debt is generally viewed as a riskier capital structure. So, on that basis, we would conclude that Carrefour is the riskier company. That said, neither of these companies carries a large percentage of long-term debt. We would conclude that they are both very solvent.

Financial & Managerial Accounting for MBAs, 6th Edition

MANAGEMENT APPLICATIONS MA2-45. (25 minutes) a. The cash conversion cycle is the number of days that pass from the time the company pays cash to purchase or manufacture inventory, sells the inventory and ultimately collects the accounts receivable. This period of time is reduced to the extent that suppliers finance a portion of the inventory purchase. Receivables and inventories are costly to maintain. They must be financed (either with borrowed funds or by forgoing investment in other earning assets), collected (with some prospect of loss), stored, insured, and moved. By reducing the amount of investment in these assets, companies can reduce their expenses and their need for external capital. b. A company might reduce its cash conversion cycle by reducing receivables and inventories and by increasing accounts payable. 1. Receivables—managers can reduce receivables by invoking more stringent creditgranting policies. Companies need appropriate policies to decide to whom to extend credit and in what dollar amount. As credit policies become more restrictive, the dollar amount of receivables declines. Managers can also implement more aggressive and or efficient collection practices 2. Inventories—for retailers, inventories are the cost of the goods purchased for resale. For manufacturers, inventory costs include raw materials, and additional labor and overhead costs to convert the goods into salable form. Reducing inventory levels will reduce the cash conversion cycle time. This can happen with more efficient buying (purchasing for actual orders rather than for estimated demand) and with leaner manufacturing processes. 3. Payables—lengthening the time to pay accounts payable (“leaning on the trade”) reduces the cash conversion cycle time because less of the company’s own capital is invested in receivables and inventories. c. Each action described above has implications for the company’s relations with customers and suppliers. 1. Receivables—receivables are a marketing tool, like advertising, product promotions and selling expenses. Tightening a company’s credit policies can adversely affect sales. On the other hand, more restrictive credit policies can reduce collection costs, bad debt expense, and financing costs. Establishing a credit policy and collection procedures involves balancing the competing effects of lost sales with cost savings. continued

Solutions Manual, Module 2