A750 Mid-Term Exam Solution

7/29/2019 A750 Mid-Term Exam Solution

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Points w ill be awarded as fo ll ows: Attainable ActualP art I: Inventory 18Par t I I: Income Taxes 17Part i ll : Analys is and Earnings 24 IPart IV Cashflow Statement ilil'1 #P art V : Ratios 15P art V I: O th er a re as 8TOTAL:

NAME:STUDENT NUMBER:

FIN ANCIA L STA TEMENT ANALYSISA750Duration: 180 m inutes Instructor: E. Bentzen-Bi.lkvistMcMas ter Univers ityMid-Tenn Examina tion November 2005

INSTRUCTIONS1. This exam ination is com prised of 17 pages. There are 6 parts, w hich are to be answ ered inth e sp ac e p rovid ed fo r a to ta l o f 1 00 poin ts. B e b rief in yo ur a nsw ers.2 . Y ou are resp on sib le fo r e nsu rin g th at y ou r c op y o f t he q ue stio n p ap er is comp lete . B rin g a nydiscrepancy to the a tt en tion of the inv ig il ator .3. O n this page, fill in your nam e and student num ber. T he entire test paper m ust be returned tohave any c redit.4. The use of a calculator is pennitted. YOU MUST SHOW ALL COMPUT AnONS TOHAVE ANY CREDIT .5. Answ er the q uestions to the best of your ability. No questions w ill be entertained by theinvigilators during the exam ination period. T his policy w as put in place to assure equal

t rea tment of a ll s tudents .6. Reasonable annotated 8 ~ x 11 sheet of paper is allowed in the exam .7.


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(We stwood E le ctric al S upply ; e ffe cts o f c ost-flow a ssumptio n on re poned g ro ss ma rg in .)a. Year 5 IJEQ Diffi EIEQrenceBeginn ing Inventory. .. .. .. $ 1.258 + $338 $ 1.596Purchases .. .. .. . . .. .. .. .. .. . 11.295 11.295Avail ab le f or Sal es ... ...... $ 12.553 $12.891L ess E nd in g In ve nto ry . . . . 0.473) + 497 (1.970)Cost of Goods Sold .... ... $ 11.080 $10.921 '*Sales....................... .. $ 14.296 $14,296Cost o f Goods Sold ....... (11.080) 00.921 )Gross Marg in .... .......... . $ 3.216 j.3.375 it

Y ear 6Beginn ing Inventory. .. .. .. $ 1.473 + $497 $ 1.970Purchases. . . . . . . . .. . .. . . . . . . 12.847 12.847Avai lable for Sale. .. .. .. .. . $ 14.320 $14.817L ess E nd in g In ve nto ry . . . . (1.186) + 376 (1.562)Cost of Goods Sold ....... $ 13,134 $13.255 A -S ales. . . . .... . . . ..... ....... ~ . $ 17.287 $17,287 C ontinued... ..Cost of Goods Sold ....... ~(I~.2SS)~OrolSa r C i n . . . . ........... UQU

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PART I INVENTORY (18 marks )Selected in fonnati on r egar ding the i nven to rie s and cos t o f goods sold o f Westwood E lectr ic alS up p ly fo r Y ea r 5 a nd Y ea r 6 a pp ea rs b elow:I ncome S ta temen t Year 6 Year 5

Sales $17,287Cost of Goods Sold 13.134Gross Margin $ 4.153$14,29611.080$ 3 .2 16

December 31Balance Sheet Year 6 Year 5Inventories $1,186 $1,473 Year 4$1,258

Notes to the F in an cial S tatem en tsWestwood Elec tr ica l Supply uses a las t- in , f ir st -ou t (LIFO)cost -f low assumpt ion for inventor iesand cos t o f goods sold . I nven to rie s on a f ir st- in , f ir st- ou t (FIFO) cos t- fl ow assump ti on wouldhav e ex ceeded the am ounts rep orted on a L IFO b asis by $376 at the end of Y ear 6 , $497 at theend of Y ear 5, and $338 at the end of Y ear 4.a) C ompu te the am ount of cost o f goods sold and gross m argin on a FIFO basis for Y ear 5 andYear 6. (6 marks)


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b. Gross M argin Percentage Ym .E-1FOYear 5 : $ 3,2 16 + $14,296 ..... 22.5% 2 \.


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--.. -...- ~....."&&."'j-'d.J.I1JIC;JIU - 1.~come (3.6) (5.Sn en cy ta ns Ia tio n 'n .~:ederalbX benef it s) _u(1.1) O.S..... _ A~ - - -

-

The fo llowing is th e In come T ax d isc lo su re note fo r G illette C ompa ny 's 2 002 F in an cia l S ta temp .n 1.4"""""0'" 0. &''_It ~__ ___ ~ . ..

&&6..,uu .-.= }llUIJIUUOn $ 35 $ - $ 37 $~ % - ~lUed opera tions 2 - 41, 85 - 12 7I ring and a ss et impairments 15 Meous r es er ve s a nd a cc ruals f f ' )

.. $380 $481t

$ 77 $ - $136 $;la tion e ff ec t o f pas s- th rough entitie s - 101 _- 128 - 15and c redit c ar ry forwa rds 15 - 19 .and equ ipmen t - 5 2 2 _ 3 9 ~- 2 7 - 5 1n t _ _


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QUESTIONS:I. W as taxable income greater or less than book income before taxes for 2002? (3 marks)

f"c:t,


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Page 63 . Assume that dep recia tion expense s for f inancia l r epor tingwas $500,000 ,000 for2002. Compu tethe am ount of depreciation expenses for tax reporting for 2002. (4 m arks)

" SOD DIN eN "J I) S + 00" 0,-,) )

4. W hat w ere the deferred tax liabilities? . ! 2 ! s out ~item aD d explain w hat it m eans. (3 m arks)

Curre nc y tr.m sla tio n e ffe ct o f p ass-th ro ug h e ntitie sIntangibles

- .P rope rt y, p lant and equ ipmen tOther

5. Give o~ple ofa pennanent difference between Financial Reporting and Tax Reportingfor G illette. (3 marks)

Goo dw ill amo rtiz atio n a nd a sse t im pa irm en tsTaxes on foreign incom eE ffe ct o f fo re ig n c urre nc y tra nsla tio nS tate tax es (ne t o f F ed eral tax b en efits)O th er d if fe re nc es

Cont inued . .. ..


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PART III ANALYSIS OF EARNINGS

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(2 4 mar ks)I nte rnati onal Paper Comp i s the la rges t fo re st p roducts company in t he worl d. The exh ib it belowp re se nts. In te rn atio na l P ap er's in come sta temen t fo r Y ea r 4 , Y ea r 5 , Y ea r 6 and Yea r 7 .

In te rnati onal PaperIncome Statements(amounts in mi ll ions)

Y ear Ended D ecem ber 31Year 4

Sales $12,960Cost of Goods Sold. . . . . . . . (9,930)Se ll ing and Adminis tr at ive Expenses. (1,595)Restructuring charges (212)Interest Expense (277)Income Taxes (377)Income from Continuing $ 569Extraord inary Loss on Debt. .. .. .Changes in Accounting Pr inciples .. .. .. .. ..Net Income $262

YearS$ 1 2,7 03(10,041)(1,649)(60)(315)(239)$ 399(215)

(377)

Year 6$ 1 3,5 98(10,987)(1,760)

(398)(247)JA}$ 142(6 )(50)$ 86

Year 7$ 1 3,6 85(11,089)(1,786)(310)illJ}$ 289

The n ote s to th e fin an cia l a sse ssm ents re vea l th e fo llo wing inform atio n.RESTRUCTURING CHARGES . In D ec ember Y ea r 4 , th eC omp an y comp le te d a re view o fope ra tion s in the con tact o f i ts ongoing p rogr ams to emphas ize value- added p roducts in g row ingma rk ets a nd imp rove th e e ffic ie ncy o f its fa cilitie s. A s a re su lt, th e Company re co rd ed a p re ta xcha rge o f$212 mi lli on ($137 mi ll ion a fte r taxe s); p rincipally r ela ted to the p lanned s ale o rc lo su re o f cer ta in wood p roducts and conver ting facili tie s, t he e st ima ted cos t o f remed ia ti on , andseverance and other personnel expenses assoc ia ted wi th the improvement program.In D ecem ber Y ear 5, the C om pany recorded a $60 m illion ($37 m illion after taxes) reduction inw ork charge to cover severance costs associated w ith the elim ination of m ore than 1,000positions from its w orldw ide w ork force.In November Y ea r 6 , th e Company re co rd ed a p re ta x cha rg eo f $398 m illio n ($263 m illio n a fte rtaxe s) to e stablis h a p roducti vity improvement re se rve. Over 80 per cent o f th is cha rge repr es en tsasset s wr it e-downs for fac il ity c losings or rea lignments and related severance and reloca tioncos ts . The bal ance cover s one -time cos ts o f env ir onmen ta l c l ean- up , remed ia ti on , and lega lcosts.EXTRAORDINARY ITEM . T he C ompan y re co rd ed a lo ss o f $ 6 m illio n o n th e e arlyexti nguis hmen t o f h igh- in te re st ra te deb t du ri ng Year 6 .

Conti nued .. . ..


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Page 8ACCOUNTING CHANGES. The Company a dopted th e p ro vis io n o fFASB S ta tement No . 106 ,"Emp loye r's Accoun ting fo r Pos tr etiremen t Bene fits Other Than Pen sions ", on J anua ry I , Year 5 .T he Company re co gn iz ed a p re ta x c ha rg e o f$ 350 millio n ($ 215 millio n afte r ta xes ). T hecompany adopt ed th e p rovis ions o f FASB S ta temen t No . 109 , "Accounting for In come Taxes ", onJ an ua ry I , Yea r 6 , re su ltin g in a c ha rg e o f $ 50 millio n.a ) Discuss the appropriate t reatmen to f : I ) Rest ructur ingCharges (2 ) Ex trao rd inary Item (3)

Accoun ting Chan~e s. in an a ss es smento f th e p ro fita bilityo f In te rn at iona lPaper. ( 12 ma rk s)T fe atmen t o f In come ItemsA. Restructuring Charges -- In ternational P aper (IP ) recognized restructuring, charges in Y ear 4, Y ear 5, and Y ear 6, but did not recognize any such chargesin Y ear 7. The charges relate to plant closings, em ployee severances, andenvironm ental cleanup. The charges affect all product segm ents of IP , w iththe d istribu tion and forest prod ucts segments h it a b it more h eav ily in Year 4a nd th e p rin tin g p ap ers, sp ec ia lty p ro du cts , an d fo re st p ro du cts se gments h it abit m ore heavily in Y ear 6. The argum ents for including and excluding theseitems from net in come when a sse ssin g IP 's p ro fita bility ap pe ar b elow.

1 . A rguments for In clu din g Restructurin g Charg es in Net In comea. Charges are recurring.b. Charges relate to industry consolidation and environmentalregu lation s that are an integ ral part o f o perating a fo rest p ro du ctscompany.

2. A rgum ents for E xcluding R estructuring C harges from Net Incom ea. C harges are m aterial and distort net incom e amounts.b. C harges occur in years of otherwise poor earnings perform anceand across all segm ents, suggesting that m anagem ent is taking ab ath . Management is ta kin g write offs p rima rily to sh ow imp ro ve d

p ro fita bility in th e fu tu re . F or e xamp le, th e d istrib utio n a nd fo res tpro du cts segmen ts b oth showed improv ed p ro fitab ility in Year 5an d Yea r 6 a fte r re co gn iz in g re stru ctu rin g ch arg es in Yea r 4 .,j. Extraordinary Loss on Extinguishm ent


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Page 9b) A ssum e now that you have decided to elim inate each of the item s in part a). Indicate the

a dju stm en ts to th e in come sta tement o f In te rn atio na l P ap er to e lim in ate e ac h o f th e items in p arta). The income tax rate was 35 percent in Year 4, Year 5, Year 6 and Year 7. (12 marks)

Adjustment for Nonrecur ring I tems --The adju stmen ts made if e ach item d isc uss edis e lim in ate d fr om net in come appea r b elow (amoun ts in m illio ns ):A . Year 4 Restructurin~ Charge

Restructuring Charges .................Income Tax Expense .... . .. .. . .. .. . .. .. . .. . .. . .. . .. . .. .. . .. .. . .. .. . ..Income from Continuing Operation . .. .. .. .. .. .. .. .. .. .. .. .. .B . Year 5 Restructurin~ Char~e

Res tructuring Charges...............................................Income Tax Expenses .... . .. . .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .Income from Continuing Operations . .. .. .. .. .. .. .. .. .. .. .. .

$ -212$ +75$+137

$ -60$ +23$ +37c. Year 6 Restructurin~ Char~e

Restructuring Charges .............Income Tax Expenses .... . .. . .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .Income from Continuing Operations . .. .. .. .. .. .. .. .. .. .. .. .D . Year 6 Extraordinary Loss

Extraordinary Loss $ +6

x .~ ~ 5 Inc om e S tatem en tChange in AccountingPrinciple $+215

Yea r 6 Accountin g Change \D ~.Deferred Tax Liab il ity ..J:...:~.....................Retained Earnings .................................

E. e t~I(' ~c,

Defe rr ed Tax Assets ..~ .............R etained E arnings ...................................Noncu rre nt L ia bilitie s .................................

F.

Y ea r 6 In come S ta tement

$ -398$+135$+263

$+ 1 35$ -215$+350

$ +50$ -50

Change in Accounting Principle $ +50N ote that none of these adjustm ents has cash flow effects. IP adds back there str uc tu rin g cha rg es a nd adju stmen ts fo r c hang es in a ccountin g p rin cip le s tonet income. so they do not affect cash flow from operations. IP added thee x t r a o r d i n a r y loss on the early debt retirement and included it in other8ddbacks during Year 6. N 0 ~ Cp


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. L~ / l" - \: .,J

. 'Yo' ,\v \,

l~OQ 2",0) \ 1,'0'" ,... IG LA~\:. \A.W.. of

cJC r~~\~y-I':.

( 5 ma rk s)2.UI>"z~u \

~. ,I:-,, 'luq'L,. l.()

..... N1. U..J"'-..'2 o~1.. - '''I,')'. w l>f l.. .: t. .\ ,. Jl ~P \~A '- f i\. v- - o l' "\t../)"- h-..J\"\b G..~I.'q 0" ff:)~,_l'"

Ohl

~ ''''' 1.> -~ (~I~'2 ,.1 >"\1 1.1 .' ...~ vfoIle ; In .. Jl ,k,.Jl). Sl~" ~.; ~~

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2. W hat were the ftee cash flows for 2000,2001 and 2002 for Gi llet te Company?(3marks)

Continued. . . . .


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, 2o~~( 40 ) )( Lj21 )l(,,15]

S(.o

~20\) 0

-

r 1 ,"0,,$ +13)(14'-$(bf\)

( ~0 ~)

4 . In 2 00 2, $ 52 9 "fu nd in g o f C ompa ny p en sio n p la n" ap pea rs as a n eg ativ e item in th eoperating section of the cash flow statement. Why? (3 marks)

~tc.,>"'-'>C:t>

51 'IN A "Ntc.n\,Jt~

at.1- '

~\W-ntN l. c. I \ n 1I'l. 0,.)

Continued . .. ..


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Page 12PART V RATIOS (15 marks)In the G ille tte Compan y fina nc ial sta tem en ts (se e p age s 1 5-17 ), comp ute th e followin g ratio s for th eyear ended D ecem ber 31, 2002.l. R etu rn on A ss ets. r fY\;

r-JI -t (I -la" to , 0 (r~t u .0 \1,\ ~* (Ie .~'\)


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PART VI OTHER AREAS (8 mark s)A nsw er th e fo llow in g q ue stio ns in the sp ace pro vid ed (e ach m ultiple q uestion = 2 mark s)I. W hy m ight the use of accelerated depreciation rather than straight-line depreciation produce

e arn in gs o f h ig he r q ua lity ?a) A cc elerate d d ep reciatio n m ore a ccu rately refle cts fin an cial reality be cau se h ig herdepreciation expense w ould be taken in the early years of its productive period.b) D uring infla tio na ry pe riod s, risin g price s in cre ase rep la cem en t c osts of m ost asse ts,resulting in a n u ndersta tem ent o f dep rec ia tio n b ase d o n histo ric al c ost.c) Both (a) and (b).

d) None of the above.

2. W hich of the follow ing are m ethods by w hich m anagem ent can m anipulate earnings andp ossib ly lowe r th e q ua lity o f re po rte d e arn in gs?a) C hanging an accounting policy to increase earnings.b) R efusing to take a loss on inventory in an accounting period w hen the inventory is know nto b e obs ole te .c ) D ecre asin g d iscre tio na ry ex pen ses.d) A ll of the above.

c.3 . Wh ic h o f h e fo llowin g statem en ts is false?a) A negative ~ash flow can occur in a year in which net incom e is positive.b ) An increa se in accounts r eceivab le r ep re sents accounts not yet colle cted cash.c ) An in cre ase in a ccounts p ay ab le re pre se nts a ccounts not y et c olle cte d in c as h.d ) To obta in c as h flow fTomope ra tio ns , th e r eporte d n et in come must b e adju ste d.

s.

4 . G ains an d lo sses o n sale s o f p ro perty , p lan t an d e qu ipmen t for c asha ) a re a pp ro xim ate ly eq ual to th e c ash re ceiv ed in th e saleb ) ap pear in th e in vestin g sectio n o f th e S tatem en t o f C ash F lows, w ith th e lab el gain or lossc ) s hould b e in clu ded in th e s ale s, g en era l a nd adm in is tr ativ e cos ts (SG&A) componen t o fIncomed) all of a, b, ce) none ora, b, c

Continued. . . .

A750 Mid-Term Exam Solution

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