I

ACCOUNTINGSTANDARDSANDTOPICSIMPLEMENTEDANDANALYZED

byMakenzieCourtlandMcNeill

AthesissubmittedtothefacultyofTheUniversityofMississippiinpartialfulfillmentoftherequirementsoftheSallyMcDonnellBarksdaleHonorsCollege.

OxfordMay2019

Approvedby

Advisor:Dr.VictoriaDickinson

Reader:DeanMarkWilder

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ABSTRACTMAKENZIECOURTLANDMCNEILL:AccountingStandardsandTopicsImplementedand

Analyzed(UnderthedirectionofDr.VictoriaDickinson)

Theobjectiveofthisthesisistoreportonmultipleaccountingstandardsandtopics

throughtheuseoftwelvedifferentcases.Thecasesthatwereresearchedincludedthe

topicsofevaluationoffinancialstatements,profitabilityandearnings,accounts

receivable,andworkingthroughatimevalueofmoneyproblem.Additionally,subjects

suchasresearchanddevelopmentcosts,thedataanalyticstoolIBMWatson,long-term

debt,stockholders’equity,marketablesecurities,deferredincometaxes,andrevenue

recognitionwerealsoanalyzedthroughoutthispaper.Thesecaseswerewrittentohelp

thereader,andothers,learnfromtheirquestions.Thequestionsinthecases,asshown

inthispaper,aremeanttoactasaguidanceandlearningtoolthoughthevarious

accountingstandardslistedabove.

III

TABLEOFCONTENTS

CaseStudyOne–HomeHeaters:FinancialStatementsAnalyses………………………………….1

CaseStudyTwo–MolsonCoors:ProfitabilityandEarningsPersistence………………………18

CaseStudyThree–Pearsonplc–AccountsReceivable………………….….………………..………24

CaseStudyFour–TimeValueofMoneyAccountingProblem..………………………………..…32

CaseStudyFive–PalfingerAG–Property,Plant,andEquipment………..………………..……36

CaseStudySix–VolvoGroup–Research&DevelopmentCosts………….…………….….……44

CaseStudySeven–DataAnalyticsCase-IBMWatson…………………….…………………...……51

CaseStudyEight–RiteAidCorporation–Long-TermDebt…………………….…………....……57

CaseStudyNine–Merck&Co.,Inc.andGlaxoSmithKlineplc–Shareholders’Equity…65

CaseStudyTen–StateStreetCorporation–MarketableSecurities…….………………..……72

CaseStudyElevenZAGGInc.–DeferredIncomeTaxes……………………………..….……...……79

CaseStudyTwelve–AppleInc.–RevenueRecognition……………..………………………...……86

LISTOFREFRENCES……………………………………………………………………………………………….…….91

1

CASEONEHomeHeaters,Inc.:FinancialStatementsAnalyses

2

Thiscasesurroundedtwocompanies,GlenwoodHeating,Inc.andEadsHeaters,

Inc.,whichbothsellhomeheatingunits.Throughouttheyear,bothbusinesseshad

identicaloperationsandtransactions,includingtheissuanceofstock,purchasesof

equipment,andpaymentsofdividends.Thesetransactionsaredescribedandlisted

throughoutPartAofthiscase.Atyearend,themanagersofeachcompanywerefaced

withaccountingdecisionsthatwouldaffecthowtheiraccountingstatementswouldbe

prepared.Thus,PartBofthiscasedescribedhowGlenwoodHeating,Inc.andEads

Heaters,Inc.differentiatedinrecordingfivetransactions.Becausebothcompanies

begantheyearidentically,thiscasehelpsusunderstandtheeffectsthatvarious

manager’saccountingdecisionscanhaveonacompany’sfinancialstatementsatthe

endoftheyear.

Asawhole,thiscasewasverybeneficialasalearningtoolformanyreasons.

First,IfeelthatIlearnedasignificantamountabouthowtoreadanddrawdatafrom

sizabletextintoaspreadsheet,suchasExcel.Ihaven’thadmuchexperiencewiththis

before,sospendingagreatdealoftimeonthiscasefamiliarizedmyselfwiththe

process.Thiscasealsohelpedmewithmyorganizational,timemanagement,andgroup

skills,whichIneededinordertofinishsuchaproject.Inaddition,thecase

encompassedseveralaccountingskillsthatIhadnotusedinawhile.Itpushedmeto

reviewafewideas,aswellasfollowthroughthecompleteprocessfromjournaling

transactionstofinancialstatements,likeIwouldintherealworld.Icanseemy

experiencefromthiscasebenefitingmeinthefuture,specificallyinmyotherclasses.

3

PartA

4

HomeHeaters

TrialBalance-PartA

Debit CreditCash $47,340

AccountsReceivable 99,400

Inventory 239,800Land 70,000Building 350,000Equipment 80,000

AccountsPayable

26,440NotePayable 380,000

InterestPayable

6,650

CommonStock

160,000Dividend 23,200

Sales

398,500

OtherOperatingExpenses 34,200

InterestExpense 27,650

Total $971,590 $971,590

5

PartB

GlenwoodHeating,Inc.:

1. BadDebtExpense 994

AllowanceforDoubtfulAccounts 994

(99,400*.01)

2. CostofGoodsSold 177,000

Inventory 177,000

3. DepreciationExpense–Equipment 9,000

AccumulatedDepreciation–Equipment 9,000

((80,000-8000)/8)

DepreciationExpense–Building 10,000

AccumulatedDepreciation–Building 10,000

((350,000-50,000)/30)

4. RentExpense 16,000

Cash 16,000

5. IncomeTaxExpense 30,914

Cash 30,914

((398500-177000-16000-10000-9000-34200-27650-944)*.25)

6

EadsHeaters,Inc.:

1. BadDebtExpense 4,907

AllowanceforDoubtfulAccounts 4,907

(99,400*.05)

2. CostofGoodsSold 188,800

Inventory 188,800

3. DepreciationExpense–Equipment 20,000

AccumulatedDepreciation–Equipment 20,000

(1/8*2*80,000)

DepreciationExpense–Building 10,000

AccumulatedDepreciation–Building 10,000

4. LeaseEquipment 92,000

LeasePayable 92,000

LeasePayable 8,640

InterestExpense 7,360

Cash 16,000

DepreciationExpense 11,500

AccumulatedDepreciation 11,500

(92,000/8)

5. IncomeTaxExpense 23,505

Cash 23,505

((398500-188800-10000-20000-34200-7360-27650-4970-11500)*.25)

7

PartB

8

9

GlenwoodHeating,Inc.

PartB–RecordingofAdditionalInformation(continued)

Table1(continued)

Liabilities

Stockholder'sEquity

10

AccountsPayable

InterestPayable

NotePayable

CommonStock

RetainedEarnings

Balances:PartA $26,440 $6,650 $380,000

$160,000 $313,450PartB(1)BadDebts

(994)

PartB(2)COGS

(177,000)PartB(3)Depreciation

Building

(10,000)Equipment

(9,000)

PartB(4)EquipmentRentalPayment

(16,000)

PartB(5)Incometax

(30,914)Balances $26,440 $6,650 $380,000

$160,000 $69,542

11

GlenwoodHeating,Inc.

PartB:TrialBalanceDecember31,20X1

Debits CreditsCash $426

AccountsReceivable 99,400AllowanceforBadDebts

994

Inventory 62,800Land 70,000Building 350,000Accumulated

Depreciation-building

10,000Equipment 80,000

AccumulatedDepreciation-equipment

9,000

AccountsPayable

26,440InterestPayable

6,650

NotePayable

380,000CommonStock

160,000

Dividend 23,200Sales

398,500

CostofGoodsSold 177,000OtherOperatingExpenses 34,200BadDebtExpense 4,970DepreciationExpense-

Building 10,000DepreciationExpense-

Equipment 9,000RentExpense 12,024InterestExpense 27,650ProvisionforIncomeTax 30,914Total $991,584 $991,584

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GlenwoodHeating,Inc. IncomeStatement ForYearEndedDecember31,20X1 Sales $398,500CostofGoodsSold (177,000)GrossProfit 221,500OperatingExpenses DepreciationExpense-Building (10,000)DepreciationExpense-Equipment (9,000)RentExpense (16,000)BadDebtExpense (994)OtherOperatingExpenses (34,200)IncomefromOperations 151,306OtherExpenses InterestExpense (27,650)IncomeBeforeIncomeTax 123,656IncomeTax (30,914)NetIncomefortheYear $92,742

GlenwoodHeating,Inc. StatementofRetainedEarnings ForYearEndedDecember31,20X1 Retainedearnings,January1 - Add:NetIncome 92,742

92,742Less:Dividends (23,200)

Retainedearnings,December31 $69,542

13

GlenwoodHeating,Inc.

BalanceSheet

December31,20X1

ASSETS CurrentAssets

Cash

$426AccountsReceivable

99,400

Less:AllowanceforDoubtfulAccounts

(994) 98,406Inventories

62,800

TotalCurrentAssets

161,632

Property,Plant,andEquipment Land-atcost

70,000

Buildings-atcost

350,000Less:AccumulatedDepreciation

(10,000) 340,000

Equipment-atcost

80,000Less:AccumulatedDepreciation

(9,000) 71,000

TotalProperty,Plant,andEquipment

481,000

TotalAssets

$642,632

LIABILITIESANDEQUITY CurrentLiabilities

AccountsPayable

$26,440InterestPayable

6,650

TotalCurrentLiabilities

33,090Long-TermLiabilities NotesPayable 380,000TotalLiabilities 413,090

Stockholder'sEquity CommonStock

160,000RetainedEarnings

69,542

TotalStockholder'sEquity

229,542

TotalLiabilitiesandStockholder'sEquity

$642,632

14

15

EadsHeaters,Inc.

PartB–RecordingofAdditionalInformation(continued)

Liabilities

Stockholders'Equity

AccountsPayable

Interestpayable

NotesPayable

LeasePayable

CommonStock

RetainedEarnings

Balances:PartA $26,440 $6,650 $380,000

$160,000 $313,450

PartB(1)BadDebts

(4,970)

PartB(2)COGS

(188,800)

PartB(3)Depreciation

Building

(10,000)

Equipment

(20,000)

PartB(4)Equipment

Lease

92,000

LeasePayment

(8,640)

(7,360)

Depreciation

(11,500)

PartB(5)Incometax

(23,505)

Balances $26,440 $6,650 $380,000 $83,360

$160,000 $47,315

Table2(continued)

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17

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Thefinancialinformationprovidedbythetwocompaniesisvaluabletopresent

andpossibleequitylendersandcreditorsinmakingdecisionsaboutprovidingresources

orinvestmentstocompanies.Accordingtotheinformationfromthiscase,Iwould

ratherinvestorlendmoneytoGlenwoodHeating,Inc.forseveralreasons.First,from

theirincomestatement,itisseenthattheyhaveanetincomeof$92,742,andagross

profitof$221,500.BothoftheseoutweighEadsHeaters,Inc.’snetincomeandgross

profitsof$70,515and$209,700,respectively,leadingmetobelievethattheyaremore

profitable.Fromthestatementofretainedearnings,itcanbeseenthatGlenwood

Heating,Inc.hasayear-endretainedearningsbalanceof$139,084,whichis$37,094

morethatcanbereinvestedinitsbusinessthanitscompetitor,thathadayear-end

retainedearningsbalanceof$101,990.Inaddition,itcanbeconcludedfromthe

balancesheetthatGlenwoodhasalargeramountofcurrentassetsonhand,at

$161,632,ratherthan$145,430forEads.Also,theproportionofcurrentassetsto

currentliabilitiesismoreconcerninginEadscasethaninGlenwood,becauseofthe

higheramountofcurrentliabilitiesthatEadshascollected.Forthesereasons,Iwould

choosetoinvestorlendmoneytoGlenwoodHeating,Inc.

20

CASETWOMolsonCoors:ProfitabilityandEarningsPersistence

21

ThiscasewasfocusedonMolsonCoorsBrewingCompany,whichformedwhen

AdolphCoorsCompanyjoinedwithMolsonInc.in2005.Thecaseincludedthe

company’sfinancialstatements,followedbynotes.Thefinancialstatementsthatwere

includedweretheconsolidatedstatementsofoperations,theconsolidatedstatements

ofcomprehensiveincome,andtheconsolidatedbalancesheets.Thenotestothe

consolidatedfinancialstatementswentintogreaterdetailaboutseveralitemsonthe

financialstatementstohelptheuserbetterunderstandthenumbersandtotalsonthe

statements.Someoftheitemsdiscussedinthenotessectionincludeexcisetaxes,cost

ofgoodssold,specialitems,otherincomeandexpense,incometax,andrevenue

recognition.

Afterhavingtoreviewtheincomestatement,itsmajorparts,anditsimportance

intheaccountingcycle,IfeelthatIhaveagreaterunderstandingofthepurposeof

financialstatements.Itisimportanttoknowhowtopredictforthefutureusingthe

itemsgiventoyouinthefinancialstatements.Youhopethatthenumbersarepreciseso

thatyoucanmakethemostaccuratepredictionpossibleregardingyourbusinessor

investments.Inaddition,Ihaveabetterknowledgeofwhatcomprehensiveincomeis,

andhowitdiffersfromnetincomeafteransweringthequestionsinthiscase.Also,I

learnedaboutsomeclassificationitemsthatIwasnotfamiliarwithpriortothiscase,

suchas“Specialitems”.Thecategorizationofitemsonthefinancialstatementsis

important,becausethemisplacementofonethingcouldthrowofftheendingbalance

completely.

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MolsonCoorsBrewingCompany–ProfitabilityandEarningsPersistence

Concepts

a. Whatarethemajorclassificationsonanincomestatement?

Themajorclassificationsthatanincomestatementcontainsaretheoperatingsection,nonoperatingsection,incometax,discontinuedoperations,noncontrollinginterest,andearningspershare.Theoperatingsectionwouldincludesales,costofgoodssold,sellingexpenses,andadministrativeorgeneralexpenses.Nonoperatingsectionadditionallycomprisesofotherrevenuesandgainsandotherexpensesandlosses.Also,discontinuedoperationsismaterialgainsorlossesresultedfromthedispositionofacomponentofthebusiness.Finally,noncontrollinginterestcanbedescribedastheallocationofincometononcontrollingshareholders.

b. Explainwhy,underU.S.GAAP,companiesarerequiredtoprovide“classified”incomestatements.

Companiesarerequiredtoprovideclassifiedincomestatementsbecauseitleaveslessroomfordishonestly,inadditiontomakingthemeasierfortheusertoread.AccordingtotheFullDisclosurePrinciple,companiesmustincludealldetailssufficientenoughtomakeadifferencetousersintheirfinancialstatements.Thus,mostincomestatementswillhavetobedetailed,andclassifiedincomestatementshelpkeeptheincreasedinformationorganized.Thishelpsthereaderanalyzetheinformationefficiently. Thetypesofinformationthataclassifiedincomestatementprovidesincludessubtotalsforthreespecificsections.Thesesectionsincludethegrossmargin,operatingexpenses,andnon-operatingexpensessectionsofanincomestatement.Whentherearemanylineitems,bybeingabletoeasilyspotsubtotalsforthesesectionsallowstheusertogatherinformation.Fromaclassifiedincomestatement,ausercouldmakeconclusionsastowhetherthecompanyhadanetprofitorlossfortheperiodorwasabletoproduceaprofit.Thiscouldleadausertowanttoinvestinacompany,orviceversa.

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c. Ingeneral,whymightfinancialstatementusersbeinterestedinameasureofpersistentincome?

Financialstatementuserswanttohavealeveloftrustwhenreadingtheirfinancialstatements,andareexpectingthattheinformationgivenisfreefromerror.Theyarehopefulthattheycanmakeaccuratepredictionsaboutthefuturebasedoffoftheincomefromthefinancialstatements. Anexampleofusersthatmightbenefitfromthisinformationincludeinvestorsandcreditors,investmentanalysts,andcompetitors.Competitorsmightusefinancialstatementsofarivalcompanytogagehowwelltheymightdointhefuture.

d. Definecomprehensiveincomeanddiscusshowitdiffersfromnetincome.

Comprehensiveincomeisthechangeinequityofanentityduringaperiodfromtransactionsandothereventsandcircumstancesfromnonownersources.Itincludesallchangesinequityduringaperiodexceptthoseresultingfrominvestmentsbyownersanddistributionstoowners.NetIncomecanbedefinedastheresidualamountofearningsafterallexpenseshavebeendeductedfromsales.Wherecomprehensiveincomeisusedtomeasurethechangeinanowner’sinterestinabusiness,netincomeisreallyjustthemeasureofearningsforaperiod.

Processe. Theincomestatementreports“Sales”and“Netsales.”Whatisthedifference?

WhydoesMolsonCoorsreportthesetwoitemsseparately?

Salesarethetotalrevenuesforthecompanyfortheperiod.Netsalesaresalesafterreturns,discounts,andanyexcisetaxesarededucted.MolsonCoorsBrewingCompanyreportsthesetwoitemsseparatelysothatitcanshowtheeffectofanexcisetaxonbeer.

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f. Considertheincomestatementitem“Specialitems,net”andinformationinNotes1and8.

i. Ingeneral,whattypesofitemsdoesMolsonCoorsincludeinthislineitem?

MolsonCoorsincludesinfrequentorunusualitems,impairmentorassetabandonment-relatedlosses,restructuringchargesandotheratypicalemployeerelatedcosts,andfeesonterminationofsignificantoperatingagreementsandgains(losses)ondisposalofinvestmentsinthe“Specialitems”lineitem.ii.Explainwhythecompanyreportstheseonaseparatelineitemratherthanincludingthemwithanotherexpenseitem.MolsonCoorsclassifiesthesespecialitemsasoperatingexpenses.Doyouconcurwiththisclassification?Explain.

Specialitemsarereportedonaseparatelineitemratherthanincludingthemwithanotherexpenseitembecausetheyarenotindicativeofcoreoperations.Yet,theyareincludedsoinvestorscanmoreaccuratelycomparethecompany’snumbersacrossaccountingperiods.Iagreethatitisimportanttoseparatetheseitems,buttheyshouldbeincludedsothatinvestorscanbemadeawareofthem.

g. Considertheincomestatementitem“Otherincome(expense),net”andtheinformationinNote6.Whatisthedistinctionbetween“Otherincome(expense),netwhichisclassifiedanonoperatingexpense,and“Specialitems,net”whichMolsonCoorsclassifiesasoperatingexpenses?

Otherincomeexpensesdonotdirectlyaffecttheincomeportionoftheincomestatement;thustheyareclassifiedasanonoperatingexpense.However,MolsonCoorsisdirectlyimpactedbytheSpecialitems,whichiswhytheyareclassifiedasoperatingexpenses.

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h. Refertothestatementofcomprehensiveincome.i.Whatistheamountofcomprehensiveincomein2013?Howdoesthisamountcomparetonetincomein2013?

Theamountofcomprehensiveincomein2013is$760.20(million).Theamountofnetincomein2013is$567.30(million).Thecomprehensiveincomeis$192.90(million)greaterthanthenetincome.ii.Whataccountsforthedifferencebetweennetincomeandcomprehensiveincomein2013?Inyourownwords,howaretheitemsincludedinMolsonCoors’comprehensiveincomerelated?Thedifferencebetweenthenetincomeandcomprehensiveincomein2013includeforeigncurrencytranslationadjustments,unrealizedgain(loss)onderivativeinstruments,reclassificationofderivative(gain)losstoincome,tensionandotherpostretirementbenefitadjustments,amortizationofnetpriorservice(benefit)costandnet.Theseitemsarerelatedbecausetheitemshavenotbeenrealizedyet,andthereforewouldbechallengingtorecordthem.

Analysisj. Considertheinformationonincometaxes,inNote7. WhatisMolsonCoors’effectivetaxratein2013?

EffectiveTaxRate= "#$%&'(")*+",+-($.("/0(12*+"3$%&'( !!

!!!!!!= #,%&&&,&&'(%,(&& !!

=12.8%

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CASETHREE

Pearsonplc–AccountsReceivable

27

PearsonInc.isacasethatconcentratesonthetopicofaccountsreceivable,and

thevariouscomponentsthatcangointothissubject.Itisimportanttonotethat

PearsonisaneducationandbusinessinformationcompanylocatedinLondon,England,

thereforetheirfinancialstatementsarerecordedinmillionsofpounds,notU.S.dollars.

Includedinthiscasearethefocusesofaccountsreceivables,notesreceivables,contra

accounts(suchassalesreturnsandallowances,allowanceforsalesreturnsand

allowances,andallowancefordoubtfulaccounts),andbaddebtsexpense.Inaddition,

thiscaseasksseveraltimesfort-accountsandjournalentries,whichIfeelissignificant

todotounderstandthefundamentalbasisofwhatIamdoinginaproblem.

First,afterreviewingthemajorelementsofreceivables,Ifeelmore

understandingoftheimportanceofaccountsreceivable,andhowtheyareusedin

majorbusinessoperationssuchasthisone.Additionally,thiscasetaughtmeseveral

thingsaboutthecriticalthinkingneededtoconsiderwhenfinancialstatementsare

doneinonecountryandareneededtobeconvertedandanalyzedbyanothercountry.

Thesearethingsthathappenintherealworldeveryday,anditiscrucialthatIbeginto

implementmyaccountingknowledgetoeverydaysituations.Ialsolearnedaboutthe

term“provision”andthattheyuseittomean“allowance”intheUK.

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Pearsonplc–AccountsReceivable

Conceptsa.Whatisanaccountreceivable?Whatothernamesdoesthisassetgoby?

Accountsreceivableismoneyowedtoacompanybyitsdebtors.Othernamesthisassetgoesbymayincludetradereceivablesandreceivables.

b.Howdoaccountsreceivabledifferfromnotesreceivable?

Anotesreceivableisanassetofacompanythatholdsawrittenpromissorynotefromanotherparty(resultingfromsales,financing,orothertransactions),whereasanaccountsreceivabledoesnotrequireawrittenpromissorynoteforthereceivable.Anaccountsreceivableissimplyanonanoralpromisetopay.Accountsreceivableareusuallyshort-term,collectedwithin30to60days,butnotesreceivablecaneitherbeshort-termorlong-term.Additionally,notesreceivableareofteninterest-bearing,whileaccountsreceivablearenot.

c.Whatisacontraaccount?WhattwocontraaccountsareassociatedwithPearson’stradereceivables(seeNote22)?Whattypesofactivitiesarecapturedineachofthesecontraaccounts?Describefactorsthatmanagersmightconsiderwhendecidinghowtoestimatethebalanceineachofthesecontraaccounts.

Acontraaccountisageneralledgeraccountwhichisintendedtohaveitsbalancereducethenormalbalanceforitscorrespondingaccount.Contraaccountsallowsomeflexibilityinthepresentationoffinancialinformation.ThetwocontraaccountsassociatedwithPearson’stradereceivablesareallowanceforbaddebts(calledprovisionforbadanddoubtfuldebtsintheUK)andallowanceforsalesreturns(calledprovisionforsalesreturnsintheUK).Managersmightconsidercustomers’credithistoriesorcreditscoreswhenestimatingallowanceforbaddebtsandallowanceforsalesreturns.Companiesmustalsotakeintoconsiderationeconomicconditions.

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d.Twocommonlyusedapproachesforestimatinguncollectibleaccountsreceivablearethepercentage-of-salesprocedureandtheaging-of-accountsprocedure.Brieflydescribethesetwoapproaches.Whatinformationdomanagersneedtodeterminetheactivityandfinalaccountbalanceundereachapproach?Whichofthetwoapproachesdoyouthinkresultsinamoreaccurateestimateofnetaccountsreceivable?

Thepercentage-of-salesprocedureisusingcreditsalesfromtheperiodtoestimatetheuncollectibleaccountsreceivableasapercentage.Theformulaforthisis:

BadDebtsExpense=Estimated%xCreditSales.Fromthis,historicaldataandothervariousfactorsareusedtodeterminewhichaccountsshouldbeuncollectible.Theaging-of-accountprocedureorganizesacompany’saccountsreceivableaccordingtothelengthoftimeaninvoicehasbeenoutstanding.Thosethathavebeenunpaidforalongerperiodoftimearedeemedtohaveahigherlikelihoodofdefault,andaremorelikelytobeconsidereduncollectible.Ifeelthattheaging-of-accountsprocedureresultsinamoreaccurateestimateofnetaccountsreceivablebecauseitconsidersthefactorsaffectingeachindividualcustomer.

e.IfPearsonanticipatesthatsomeaccountswillbeuncollectible,whydidthecompanyextendcredittothosecustomersinthefirstplace?Discusstherisksthatmanagersmustconsiderwithrespecttoaccountsreceivable.

Onereasoncompanieswillextendcredittocustomersinthefirstplaceisbecauseitcouldencouragesalesbecauseoftheeaseofpaymentupfront.Also,itisverydifficultforacompanytoknowaperson’sinabilitytopaypriortoasale.Thereisalwaysriskthatthedebtorwillfaultinpaymentwithanytypeofcredit,butasacompanyitmaybelessofariskthannotofferingtheuseofcredittocustomersatall.

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Processf.Note22reportsthebalanceinPearson’sprovisionforbadanddoubtfuldebts(fortradereceivables)andreportstheaccountactivity(“movements”)duringtheyearendedDecember31,2009.NotethatPearsonreferstothetradereceivablescontraaccountasa“provision.”UnderU.S.GAAP,thereceivablescontraaccountistypicallyreferredtoasan“allowance”whilethetermprovisionisusedtodescribethecurrent-periodincomestatementchargeforuncollectibleaccounts(alsoknownasbaddebtexpense).

i.UsetheinformationinNote22tocompleteaT-accountthatshowstheactivityintheprovisionforbadanddoubtfuldebtsaccountduringtheyear.Explain,inyourownwords,thelineitemsthatreconcilethechangeinaccountduring2009.

5,000,000

20,000,000

Atthebeginningoftheperiod,£72,000,000isthebalanceintheprovisionforbadanddoubtfuldebtsaccount.Theexchangedifferenceslineitemaccountsfortheexchangeratethatdifferedfromcountrytocountry,andthusresultedinadebitof£5,000,000.The£26,000,000creditistheestimateofbaddebtsexpensefor2009,andthenthe£20,000,000debitistheactualbaddebtbeingwrittenoffin2009,alsocalledhousekeeping.Anadditionalcreditbalanceof£3,000,000ismadefromacquiringanotherbusiness.Attheendof2009,PearsonInc.isleftwithacreditbalanceof£76,000,000inthisaccount.

£72,000,00026,000,0003,000,000£76,000,000

ProvisionforBadandDoubtfulDebts

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ii.PreparethejournalentriesthatPearsonrecordedduring2009tocapture1)badanddoubtfuldebtsexpensefor2009(thatis,the“incomestatementmovements”)and2)thewrite-offofaccountsreceivable(thatis,theamount“utilized”)during2009.Foreachaccountinyourjournalentries,notewhethertheaccountisabalancesheetorincomestatementaccount. 1)1/1/09 BadDebtExpense 26,000,000

ProvisionforBadandDoubtfulDebts26,000,000

2)12/31/09 ProvisionforBadandDoubtfulDebts20,000,000

AccountsReceivable 20,000,000

Baddebtsexpenseisanincomestatementaccount,andprovisionforbadanddoubtfuldebtsandaccountsreceivablearebothbalancesheetaccounts.

iii.Whereintheincomestatementistheprovisionforbadanddoubtfuldebtsexpenseincluded?

Thisaccountwouldbeincludedinthecurrentexpenseportionoftheincomestatement.Itisincludedinoperatingexpenses,whichisseparatedfromtheotherexpensessectionoftheincomestatement.Estimatedsalesreturnsaredeductedfromgrosssales,andthusthisreachesthetotalofnetsales.

g.Note22reportsthatthebalanceinPearson’sprovisionforsalesreturnswas£372atDecember31,2008and£354atDecember31,2009.UnderU.S.GAAP,thiscontraaccountistypicallyreferredtoasan“allowance”andreflectsthecompany’santicipatedsalesreturns.

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i.CompleteaT-accountthatshowstheactivityintheprovisionforsalesreturnsaccountduringtheyear.AssumethatPearsonestimatedthatreturnsrelatingto2009Salestobe£425million.Inreconcilingthechangeintheaccount,twotypesofjournalentriesarerequired,onetorecordtheestimatedsalesreturnsfortheperiodandonetorecordtheamountofactualbookreturns.

443,000,000

ii.PreparethejournalentriesthatPearsonrecordedduring2009tocapture,1)the2009estimatedsalesreturnsand2)theamountofactualbookreturnsduring2009.Inyouranswer,notewhethereachaccountinthejournalentriesisabalancesheetorincomestatementaccount. 1)1/1/09 SalesReturnsandAllowances 425,000,000

ProvisionforSalesReturns 425,000,000

2)12/31/09ProvisionforSalesReturns 443,000,000

AccountsReceivable 443,000,000

Thesalesreturnsandallowancesandprovisionsforsalesreturnsaccountsareincomestatementaccounts,andaccountsreceivableisabalancesheetaccount.

iii.Inwhichincomestatementlineitemdoestheamountof2009estimatedsalesreturnsappear?

Theestimatedsalesreturnswouldappearinthesaleslineitemofanincomestatementasacontra-revenueaccount,becausethisaccounthastheoppositeeffectonnetincomefromsales.

ProvisionforSalesReturns

£372,000,000425,000,000£354,000,000

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h.CreateaT-accountfortotalorgrosstradereceivables(thatis,tradereceivablesbeforedeductingtheprovisionforbadanddoubtfuldebtsandtheprovisionforsalesreturns).AnalyzethechangeinthisT-accountbetweenDecember31,2008and2009.(Hint:yoursolutiontopartsfandgwillbeusefulhere).Assumethatallsalesin2009wereonaccount.Thatis,theyareall“creditsales.”Youmayalsoassumethattherewerenochangestotheaccountduetobusinesscombinationsorforeignexchangeratechanges.Preparethejournalentriestorecordthesalesonaccountandaccountsreceivablecollectionactivityinthisaccountduringtheyear.

12/31/2009 TradeReceivables 5,624,000

Sales 5,624,000

12/31/2009 Cash 5,679,000

TradeReceivables 5,679,000

Thetradereceivablesaccountbeginswitha£1,474,000debitbalancefrom2008.Ithasbeentoldtousthatallthesalesin2009werecreditsales,thusthatnumberis£5,624,000.Sothecreditbalanceforthetradereceivablesaccountis£5,679,000.

TradeReceivables£1,474,0005,624,000£1,419,000

5,679,000

34

CASEFOURTimeValueofMoneyAccountingProblem

35

ThisisadifficultproblemfromChapter6(AccountingandtheTimeValueof

Money)fromintermediateaccounting.IamworkingoutthisproblemasifIwas

teachingapoorlyskilledintermediatestudent.

Problem6-4:

JuliaBakerdied,leavingherhusbandBrentaninsurancepolicycontract

thatprovidesthatthebeneficiary(Brent)canchooseanyoneofthefollowingfour

options.

(a) $55,000immediatecash.

(b) $4,000every3monthspayableattheendofeachquarterfor5years.

(c) $18,000immediatecashand$1,800every3monthsfor10years,payableat

thebeginningofeach3-monthperiod.

(d) $4,000every3monthsfor3yearsand$1,500eachquarterforthefollowing

25quarters,allpaymentspayableattheendofeachquarter.

Ifthemoneyisworth2½%perquarter,compoundedquarterly,whichoption

wouldyourecommendthatBrentexercise?

First,todothisproblem,youwouldneedtounderstandthedifferencebetween

presentvaluesandfuturevalues,andordinaryannuityandannuitydues.Presentvalues

arethevaluenowofafuturesumorsumsdiscountedassumingcompoundinterest.

Futurevalueisthevalueatafuturedateofagivensumorsumsinvestedassuming

compoundinterest.Ordinaryannuitiesareannuitieswheretherentsoccurattheendof

36

eachperiod,andannuityduesarewheretherentsoccuratthebeginningofeach

period.

Forthisproblem,Iwillcalculateeachparts(b)-(d)inpresentvalueinorderto

compareitto(a)$55,000thatBrentcouldreceiveimmediately.

Forpart(b)Iwouldusetheformula:

PV=Rent(PVFn=15,i=2½)

Igot15periodsfrommultiplying5x12,andthendividingby4(sinceit

compoundedquarterly).ThenIwouldplugintherentandnumberfoundfromTable6-4

PresentValueofanOrdinaryAnnuity.

PV=4,000(12.38138)

=$49,525.52

Forpart(c)Iwouldcalculateforanannuitydue,sinceitispayableatthe

beginningofeachofthe3periods.Itwouldgoasfollows:

PV=Rent(PVFn=30,i=2½)

=1,800(21.45355)

=$38,616.39+(theimmediatecash)$18,000

=$56,616.39

Igottheperiodamountof30mymultiplying10x12andthendividingby4.

Forpart(d),Iwouldcalculatebyusingthepresentvalueforordinaryannuities

formulaandtable.Iwouldcalculatetheamountsforthispartasfollows:

PV=Rent(PVFn=9,i=2½)

=4,000(7.97087)

37

=$31,883.48

Icalculatedtheperiodamountof9bymultiplying3x12andthendividingby4.

PV=Rent(PVFn=25,i=2½)

=1,500(18.42438)

=$27,636.57

Whenyouaddthesetwoamountstogetheryougetatotalof$59,520.05.

Thus,Iwouldrecommendoption(d)toBrent,asitresultsinthegreatest

amountofmoneyforhim.Hemightnotgetitallimmediately,butitallowshimthe

greatestreturnfromhiswife’sinsurancepolicy.

38

CASEFIVE

PalfingerAG–Property,Plant,andEquipment

39

PalfingerAGisacompanythatmanufactureslargemachinessuchascranes,

forklifts,andtailgatesforvariousindustries.Theseindustriesincludeconstruction,

agricultureandforestry,andtransport.Inordertoconstructtheseheftymachinesand

solutions,Palfingerrequiresagreatdealofproperty,plant,andequipment.Thiscase

followsthiscompanyinthe2007fiscalyear,andliststheirconsolidatedbalancesheet

andincomestatement,aswellasthecorrespondingnotesrelatedtothesefinancial

statements.Thesenotesgivethereaderabetterunderstandingoftheproperty,plant,

andequipmentacquiredbyPalfinger.ThiscompanyislocatedinAustriaandreports

theirfinancialstatementsinEuros.

Thiscasewashelpfulingettingabetterunderstandingofproperty,plant,and

equipmentforalargecompanysuchasPalfinger.Igrewinmyknowledgeofhowto

analyzedepreciation,usingandcomparingboththestraight-lineanddouble-declining

balancedepreciationmethodsforthesametimeperiod.Ialsolearnedwhat

“prepaymentsandassetsunderconstruction”meant,whichIdidnotknowpriortothis

case.Itwasbeneficialformetohavetocalculategainsorlossesfortheperiodunder

thetwodepreciationpolicies,andcomparethemagainsteachother.Thisgavemea

greaterunderstandingofwhatcertaincalculationsmean.

40

PalfingerAG–Property,Plant,andEquipment

Conceptsa. BasedonthedescriptionofPalfingerabove,whatsortofpropertyandequipment

doyouthinkthecompanyhas?FromthedescriptionofPalfingergiven,Ibelievethecompanyhaspropertyandequipmentcontaininglargewarehousesandworkshopstomaketheircranes,platforms,andforklifts;heavymachinerythatisusedtomeltandmoldmetal;andmachineryusedtotransportandputtogetherforkliftsandcranes.Inaddition,anyassemblylinesandthelandthatthewarehousesarecontainedonwouldalsobeincludedinthepropertyandequipmentthatthiscompanyowns.

b. The2007balancesheetshowsproperty,plant,andequipmentof€149,990.What

doesthisnumberrepresent?Thisnumberrepresentstheacquisitioncostofproperty,plant,andequipmentlesstheaccumulateddepreciationandimpairmentcosts.Inthenotestotheconsolidatedfinancialstatementsin2007,thecarryingamountsatDecember31,2007adduptothisamountof€149,990.

c. WhattypesofequipmentdoesPalfingerreportinnotestothefinancial

statements?Inthenotestothefinancialstatements,Palfingerreportsmachinery,andotherplant,fixtures,fittings,andequipment(whichmayincludeothersmaller,movablepiecesofequipment)astypesofequipment.

d. Inthenotes,Palfingerreports“Prepaymentsandassetsunderconstruction.”What

doesthissubaccountrepresent?Whydoesthisaccounthavenoaccumulateddepreciation?Explainthereclassificationof€14,958inthisaccountduring2007.

Thissubaccountrepresentsaself-constructedasset,whereyouwoulddebit“constructioninprogress”asthebuildingisbeingbuilt.Thisaccounthasnoaccumulateddepreciationbecausethebuildingisnotyetavailableforuse.Oncethebuildingisdonebeingconstructed,itcanbeginbeingdepreciated.The

41

reclassificationof€14,958wouldaccountforPalfingerfinishingabuilding,andtakingitoutoftheprepaymentsandassetsunderconstructionaccount.

e. HowdoesPalfingerdepreciateitspropertyandequipment?Doesthispolicyseemreasonable?Explainthetrade-offsmanagementmakesinchoosingadepreciationpolicy.

Palfingerdepreciatesitspropertyandequipmentonastraight-linebasis,basedontheusefullife.Onastraight-linebasis,theyusethesamerateeachyear.Forbuildingsandinvestmentsinthird-partybuildings,Palfingerusesausefullifeof8-50years,forplantandmachinerytheyuseausefullifeof3-15years,andforfixtures,fittings,andequipmenttheyuseausefullifeof3-10years.Thispolicyseemsreasonable,exceptforthefactthattheusefullifeofbuildingsandinvestmentshaveausefullifeof8to50years.Ifeelthatwiththeuseofanothermethodoramorerealisticusefullifeofbuildings,theycouldhaveamorenotableoutcome.

f. Palfingerroutinelyoptstoperformmajorrenovationsandvalue-enhancing

modificationstoequipmentandbuildingsratherthanbuynewassets.HowdoesPalfingertreattheseexpenditures?Whatisthealternativeaccountingtreatment?

Palfingercapitalizestheseinvestmentsanddepreciatesthemovereitherthenewortheoriginalusefullife.Inaddition,maintenanceandrepairworkarebookedascurrentexpensesintheyearinwhichtheyoccur.Thealternativeaccountingtreatmentistowriteitoffasanexpense.

Processg. Usetheinformationinthefinancialstatementnotestoanalyzetheactivityinthe

“Property,plantandequipment”and“Accumulateddepreciationandimpairment”accountsfor2007.Determinethefollowingamounts:

i.Thepurchaseofnewproperty,plantandequipmentinfiscal2007.

Thecostofnewproperty,plant,andequipmentinfiscal2007was€61,444.

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ii.Governmentgrantsforpurchasesofnewproperty,plantandequipmentin2007.Explainwhatthesegrantsareandwhytheyaredeductedfromtheproperty,plant,andequipmentaccount.

Therearegovernmentgrantsof€733forpurchasesofnewproperty,plant,andequipmentinthe2007year.Thesegrantsarepresentedasreductionsofthemanufacturingoracquisition,andthusreduceshowmuchisdepreciatedfromassetsduringtheirlife.

iii.Depreciationexpenseforfiscal2007. Depreciationexpenseforfiscal2007was€12,557.iv.Thenetbookvalueofproperty,plant,andequipmentthatPalfingerdisposedofinfiscal2007.

Thenetbookvalueofproperty,plant,andequipmentdisposedofinfiscal2007was€1,501,whichwascalculatedbytaking€13,799andsubtracting€12,298.

h.Thestatementofcashflows(notpresented)reportsthatPalfingerreceivedproceedsonthesaleofproperty,plant,andequipmentamountingto€1,655infiscal2007.CalculatethegainorlossthatPalfingerincurredonthistransaction.Hint:usethenetbookvalueyoucalculatedinpartgiv,above.Explainwhatthisgainorlossrepresentsineconomicterms.

Palfingerincurredagainof€154onthistransaction,whichwascalculatedbytakingtheproceedsonthesaleofproperty,plant,andequipment(€1,655)andsubtractingthenetbookvalue(€1,501).

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i.Considerthe€10,673addedto“Otherplant,fixtures,fittings,andequipment”duringfiscal2007.Assumethatthesenetassetshaveanexpectedusefullifeoffiveyearsandasalvagevalueof€1,273.PrepareatableshowingthedepreciationexpenseandnetbookvalueofthisequipmentoveritsexpectedlifeassumingthatPalfingerrecordedafullyearofdepreciationin2007andthecompanyuses:

i.Straight-linedepreciation.€10,673-€1,273/5=€1,880peryearYear Depreciation

Expense

AccumulatedDepreciation

BookValue

0 €10,673

1 €1,880 €1,880 8,793

2 1,880 3,760 6,913

3 1,880 5,640 5,033

4 1,880 7,520 3,153

5 1,880 9,400 €1,273

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ii.Double-declining-balancedepreciation.

Year BookValue(Beginningof

Year)

DepreciationExpense

BalanceAccumulatedDepreciation

BookValue(EndofYear)

0 €10,673

1 €10,673 €4,269 €4,269 6,404

2 6,404 2,562 6,831 3,842

3 3,842 1,537 8,368 2,305

4 2,305 922 9,290 1,383

5 1,383 110 9,400 €1,273

j.Assumethattheequipmentfromparti.wassoldonthefirstdayoffiscal2008forproceedsof€7,500.AssumethatPalfinger’saccountingpolicyistotakenodepreciationintheyearofsale.

i.Calculateanygainorlossonthistransactionassumingthatthecompanyusedstraight-linedepreciation.WhatisthetotalincomestatementimpactoftheequipmentforthetwoyearsthatPalfingerownedit?Considerthegainorlossondisposalaswellasthetotaldepreciationrecordedontheequipment(i.e.theamountfromparti.i.).

Tofindthis,take€8,793(bookvalueafteryear1whenthecompanyusedstraight-linedepreciation)less€7,500(proceeds),whichequalsalossof€1,293ondisposal.Fromthisinformation,itisfoundthatthereisatotalincomestatementimpactof€3,173(€1,880+€1,293)ontheequipmentforthetwoyearsthatthecompanyownedit.

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ii.Calculateanygainorlossonthistransactionassumingthecompanyuseddouble-decliningbalancedepreciation.WhatisthetotalincomestatementimpactofthisequipmentforthetwoyearsthatPalfingerownedthem?Considerthegainorlossondisposalaswellasthetotaldepreciationrecordedontheequipment(i.e.theamountfromparti.ii.).

Tofindthis,take€6,404(bookvalueafteryear1whenthecompanyuseddouble-decliningdepreciation)less€7,500(proceeds),whichequalsagainof€1,096ondisposal.Fromthisinformation,itisfoundthatthereisatotalincomestatementimpactof€3,173(€4,269-€1,096)ontheequipmentforthetwoyearsthatthecompanyownedit.

iii.Comparethetotaltwo-yearincomestatementimpactoftheequipmentunderthetwodepreciationpolicies.Commentonthedifference.

Forboththestraight-lineandthedouble-decliningbalancedepreciationpolicies,theimpactontheincomestatementoftheequipmentwastheexactsameat€3,173.Whilethestraight-linedepreciationhasalossondisposal,thedouble-decliningbalancedepreciationhasagainondisposal.Bothendupgivingyouthesameamount,workeddifferentways,becausethecostofequipmentwas€10,673lesstheproceedsof€7,500equalsthesametotalof€3,173.

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CASESIX

VolvoGroup–Research&DevelopmentCosts

47

VolvoGroupisacompanythatisheadquarteredinSwedenthatsupplies

commercialvehiclessuchastrucks,engines,buses,andaircraftenginecomponentsout

tocustomers,inadditiontofinancialsolutions.ThiscaseisfocusedonVolvoGroup’s

researchanddevelopment(innovativeactivitiesundertakenbycorporationsor

governmentsindevelopingnewservicesorproducts,orimprovingexistingservicesor

products),whichcostthemaround13billionSEKayear.TheGroupfocustheirR&Don

restrainingtheireffectontheenvironmentallovertheglobe.Volvoalsohasproduction

facilitiesaroundtheworldin19differentcountries,inadditiontogeneratingsalesin

180countries.

Itakeawayfromthiscaseanintensifiedknowledgeofresearchand

developmentcosts.WhereaspriortothiscaseIunderstoodthebasicsofR&D,thiscase

helpedmeunderstandexactlywhatkindsofexpenditurescanbeclassifiedasresearch

anddevelopmentcostsandhowtospecificallycapitalizeandexpensethesecosts.Also,

IwasintroducedtoIAS38,whichthiscompanyfollowsfortheirresearchand

developmentexpendituresastheiraccountingrequirementsforintangibleassets.

BecomingfamiliarwiththeexcerptofIAS38thatwaspresentinthiscaseIfeelwas

beneficialtomeasIcontinuetoworkwithintangibleassetsinmyfuturecourses.

Finally,becomingacquaintedwiththedifferencesbetweentheU.S.andinternational

researchanddevelopmentclassifications(where95%nevermatchtorevenueinthe

U.S.,andyoujustcapitalizethedevelopmentaspectoftheexpendituresinternationally)

isalwaysimportantformetolearnfromthesecases.

48

VolvoGroup–Research&DevelopmentCostsConceptsa. The2009incomestatementshowsresearchanddevelopmentexpensesofSEK

13,193(millionsofSwedishKrona).Whattypesofcostsarelikelyincludedintheseamounts?

Researchanddevelopmentexpensescanincludedevelopmentofnewproducts,productionsystems,andsoftware.Inaddition,improvisationofexistingproductsandservicescanalsobeincludedintheseamounts.Inthe“researchanddevelopmentexpenses”sectionofthenotestoconsolidatedfinancialstatements,Volvoreportsnewproducts,productionsystems,andsoftwareasintangibleassets.Thesewillbeamortizedovertheirestimatedusefullife.

b. VolvoGroupfollowsIAS38—IntangibleAssets,toaccountforitsresearchand

developmentexpenditures(seeIAS38excerptsattheendofthiscase).Assuch,thecompanycapitalizescertainR&Dcostsandexpensesothers.WhatfactorsdoesVolvoGroupconsiderasitdecideswhichR&Dcoststocapitalizeandwhichtoexpense?

AccordingtoIAS38,VolvoGroupwouldhavetoconsiderfactorssuchaswhetheranexpenditureonresearchshouldberecognizedasanexpenseorcapitalized,suchas:- Ifabusinesscannotdifferentiatebetweentheresearchphasefromthe

developmentphaseofaninternalproject,itistreatedasanexpense.- Expenditureonresearchisexpensedwhenincurred.(Nointangibleasset

fromresearchisrecognized.)- Ifnofutureeconomicbenefitcanbeshownfromanintangibleasset,then

theexpenditureisrecognizedasanexpense.

49

c. TheR&DcoststhatVolvoGroupcapitalizeseachperiod(labeledProductand

softwaredevelopmentcosts)areamortizedinsubsequentperiods,similartoothercapitalassetssuchaspropertyandequipment.NotestoVolvo’sfinancialstatementsdisclosethatcapitalizedproductandsoftwaredevelopmentcostsareamortizedoverthreetoeightyears.Whatfactorswouldthecompanyconsiderindeterminingtheamortizationperiodforparticularcosts?

Factorsthatthecompanywouldconsiderindeterminingtheamortizationperiodforparticularcostswouldincludetheusefullifeoftheasset,aswellasanylegal,regulatory,orcontractualprovisionsthatmaylimittheusefullife.

d. UnderU.S.GAAP,companiesmustexpenseallR&Dcosts.Inyouropinion,which

accountingprinciple(IFRSorU.S.GAAP)providesfinancialstatementsthatbetterreflectcostsandbenefitsofperiodicR&Dspending?

SinceR&Dspendingdoesnotcometofruition95%ofthetime,andthusyoucannotmatchrevenuestoexpensesundertheseconditions,IfeelthattheIFRSisabetterreflectionofcostsandbenefitsofperiodicR&Dspending.ThisallowscompaniestojustcapitalizetheDevelopmentaspectofR&D.

Processe. Refertofootnote14whereVolvoreportsanintangibleassetfor“Productand

softwaredevelopment.”Assumethattheproductandsoftwaredevelopmentcostsreportedinfootnote14aretheonlyR&DcoststhatVolvocapitalizes.

i.Whatistheamountofthecapitalizedproductandsoftwaredevelopmentcosts,netofaccumulatedamortizationattheendoffiscal2009?WhichlineitemonVolvoGroup’sbalancesheetreportsthisintangibleasset?

Thecapitalizedproductandsoftwaredevelopmentcostsattheendof2009equals11,409SEK(25,148–13,739).Thelineitemof“Intangibleassets”reportsthisintangibleassetonthebalancesheet.

50

ii.CreateaT-accountfortheintangibleasset“Productandsoftwaredevelopment,”netofaccumulatedamortization.Entertheopeningandendingbalancesforfiscal2009.ShowentriesintheT-accountthatrecordthe2009capitalization(capitalexpenditures)andamortization.Tosimplifytheanalysis,groupallotheraccountactivityduringtheyearandreportthenetimpactasoneentryintheT-account.

f. RefertoVolvo’sbalancesheet,footnotes,andtheeleven-yearsummary.Assumethattheproductandsoftwaredevelopmentcostsreportedinfootnote14aretheonlyR&DcoststhatVolvocapitalizes.

i.CompletethetablebelowforVolvo’sProductandsoftwaredevelopmentintangibleasset.

(inSEKmillions)2007 2008 2009

1)Productandsoftwaredevelopmentcostscapitalizedduringtheyear

2,057 2,150 1,858

2)TotalR&Dexpenseontheincomestatement 11,059 14,348 13,193

3)Amortizationofpreviouslycapitalizedcosts(includedinR&Dexpense)

2,357 2,864 3,126

4)TotalR&Dcostsincurredduringtheyear=1+2-3 10,759 13,634 11,925

CapitalizedProductandSoftware,net23,290

11,409

25,148

13,739

472

51

iii.WhatproportionofTotalR&DcostsincurreddidVolvoGroupcapitalize(asproductandsoftwaredevelopmentintangibleasset)ineachofthethreeyears?

TheproportionofTotalR&DcostsincurredbyVolvoGroupthatwerecapitalizedin2007were19.1%(2,057/10,759x100).In2008,thisproportionwas15.8%(2,150/13,634x100)andin2009thisproportionwas15.6%(1,858/11,925x100).

g. AssumethatyouworkasafinancialanalystforVolvoGroupandwouldliketo

compareVolvo’sresearchanddevelopmentexpenditurestoaU.S.competitor,NavistarInternationalCorporation.NavistarfollowsU.S.GAAPthatrequiresthatallresearchanddevelopmentcostsbeexpensedintheyeartheyareincurred.YougatherthefollowinginformationforNavistarforfiscalyearendOctober31,2007through2009.

(inUS$millions)

2007 2008 2009

TotalR&Dcostsincurredduringtheyear,expensedontheincomestatement

375 384 433

Netsales,manufacturedproducts11,910 14,399 11,300

Totalassets11,448 10,390 10,028

Operatingincomebeforetax(73) 191 359

52

i.UsetheinformationfromVolvo’seleven-yearsummarytocompletethefollowingtable:

ii.Calculatetheproportionoftotalresearchanddevelopmentcostsincurredtonetsalesfromoperations(called,netsalesfrommanufacturedproducts,forNavistar)forbothfirms.Howdoestheproportioncomparebetweenthetwocompanies?

Navistar 2007 2008 2009

Netsalesfrommanufacturedproducts,forNavistar

3.15%(375/11,910)

2.67%(384/14,399)

3.83%(433/11,300)

Volvo 2007 2008 2009

Netsalesfrommanufacturedproducts,forVolvo

3.9%(10,759/276,795)

4.6%(13,634/294,932)

5.7%(11,925/208,487)

TheproportionofVolvoissteadilyincreasingoverthepastthreeyears.ThisshowshowthecompanyisincreasingitsR&Dcoststoitsnetsaleseachyear.Yet,in2009eventhoughitwasaproportionalincrease,Volvodiddecreaseinbothitscostsandsales.Navistar’spercentagesseeadropin2008fromalargeincreaseinnetsales,whichgoesbackdownin2009.ThiscompanyalsohasasteadyincreaseinR&Dcostsfrom2007to2009from$375to$433.

(inSEKmillions)2007 2008 2009

Netsales,industrialoperations276,795 294,932 208,487

Totalassets,frombalancesheet321,647 372,419 332,265

53

CASESEVEN

DataAnalyticsCase–IBMWatson

54

Thiscasefocusesonthetopicsof11variousdataanalyticstools.Inparticular,

ourgroupwasassignedthetoolIBMWatsontoexploreinmoredetail.Thecasefirst

detailsthehistoryandbackgroundofthetool,aswellasthefunctionsofthedevicein

thebusinessrealm.Thisincludeshowitisusedtomakebusinessdecisionsandbenefit

businessesintheiroperations.Next,thiscaselooksattheskillsthatareneededto

properlyuseanddrawbusinessconclusionsfromWatson.Specifically,theskillsand

abilitiesthatstudentsmyagewouldrequirewhenworkingwithatoolsuchasWatson.

Then,welookathowIBMWatsoncouldbeusedincertainbusinesssettings,

particularlyinAuditing,TaxPlanning,andAdvisorysituations.Andfinally,thiscaseasks

ustoplaceourselvesinaPartnerposition,andrequestfortheinvestmentofthistool

forthefirm.Thismakesusthinkoutsideofthebox,andplacesusinabusinessmindset.

AlloftheseactivitieshelpedmeunderstandthetoolIBMWatsonanditspurpose.

Afteranalyzingthisdevice,itisamazingtomehowfartechnologyhasgrown.

Thistoolspecificallyshowshowscarytheworldoftechnologycanbecome.Itis

magnificentandadvantageousbecauseitcanteachusandhelpuslearnnewthingsin

businessandscience.Yet,itisalsofrighteningbecauseitalmostseemstobemore

powerfulthanhumans(suchaswhenWatsonovercametheJeopardy!champions).It

seemsthathumansaremakinggreatstridesintheprogressoftechnology,butweneed

tobecautiousinwhatmotiveswehaveforthesedevices.Inaddition,Ialsolearneda

greatdealabouttheIBMWatsonitselfthatIdidnotknowpriortothiscase.Havinga

betterunderstandingofdevisessuchasthisonecanhelpmeinthefuture,suchasin

mycareer.

55

DataAnalyticsCase-IBMWatson

1) Identifythehistoryandpurposeofthistoolanddescribe,ingeneral,howitisusedtomakebusinessdecisions.Bespecificaboutwhatkindoftechnologyplatformituses,etc.andotherrecoursesthatneedtobeinplacetofullyutilizethefunctionalityofthetool.

In2011,IBMWatsonfamouslywentupagainstthequizshowJeopardy!’stoptwowinners,andbeatthemboth.Watsonwasdevelopedasadatatechnologyquestionansweringdevice,createdbyIBMResearch.Ithasatotalof2,880processorcoresand90servers,andoveryears’timehasbeenequippedwithmillionsofpagesofinformation.Afterbeingfedaquestion,ithasover100algorithmsanalyzethequestion,andcanspitoutananswerinunderthreeseconds.

BusinessescanuseWatsoninvariousways.Withthisdevice,researchcanprimarilybeconductedfaster.Watsoncancombthroughimmensesourcesofdatatoobtainthemostsignificantdetails.Also,thistechnologycananticipateissuesbeforetheyarise,becauseWatsonmonitorstheconditionofthebusiness’systemsconstantly.Thisisextremelybeneficialbecauseitcouldsavethebusinessfromheftycosts.Furthermore,Watsonhelpscreateasenseofcertaintywhenunderstandinganddrawingconclusionsfromalargesetofdata.Becauseofthetool’sgreatintelligenceandlogic,itcanaidmanagersinmakingdecisionswhenlookingatawidevarietyofinformation.

Watsonhasdistinctiveskillstobenefitbusinessesaswell.Thisdevicecanunderstandtextmining,whichisdataenclosedinnaturallanguagetext.Thiscanbebeneficialtoabusinessorganizationinreadingcontentthatistext-basedindocumentsandonsocialmedia,givingtheminsightintoinformationtheycouldhavemissedwithoutthetechnologyofWatson.Also,Watsoncanlookatpreviousbuyingandsellingpatterns,andcomputeleadsbasedonthegiveninformation,givingthemanotherwaytogaininsightonthebusiness.

Watsongeneratesbetterevidencebaseddecisionsfromcomplexvolumesofdata,revolutionizingthewaybusinesspeoplebecomeexperts.Thecapabilitiesofthisdevicealloworganizationstostretchtheircapacityfurtherthanpreviouslypossible,whilesavingvaluabletimeandmoney.

56

2) Whatspecialskillsareneededtousethistooltoaidinbusinessdecisionmaking.Howmightastudentlikeyourselfgainthoseskills?

IBMWatsonissuchadevelopedtechnologythatitdoesmostoftheworkforyou.Inorderforastudentlikemyselftogrowspecialskillsthatwouldbeneededtousethistooltoaidinbusinessdecisionmaking,theywouldneedtoengageintutorialsandtrainingthatwouldheightentheirdataanalyticsanddevelopmentskills.

IBMhasa“LearningLab”thatgivestutorialsinmanythingsfromdataanalyticstocloudcomputing,InternetofThings,blockchain,andevenJava.Eachofthesecoursesrangeintimetocomplete,usuallyafewhours,andconsistofvideos,tutorials,andonlinelabs.Havingagreaterunderstandingofeachofthesetopicswouldbetterenhancethedecision-makingprocessforauserofIBMWatson.Thiswouldbebecauseifapersoncomprehendedwhatdataanalytics,forexample,waspriortousingthedevice,itwouldhelpthemtodecipherwithbetterdiscernmentwhatWatsonwassayingorsuggestingforabusiness.

3) How,specifically,wouldusethetoolinthefollowingbusinesssettings?Create

atleastthreespecificscenariosforeachcategoryinwhichthetoolwouldleadtomoreefficiencyand/orbettereffectiveness.Besuretodescribewhatkindsofdatayourtoolwoulduseforeachscenario.

a. Auditingi. ThedeviceofIBMWatsoncanassistauditorsincheckingfor

completenessofitemssuchasfinancialstatements.Wherehumanscanmakeerrors,andmaymissfactorsduringanactualaudit,atoolsuchasWatsoncouldbeafaultcorrector.Watsoncouldbegincheckingforaccuracyandcompletenessbeforetheauditoreventouchestheclient’spaperwork.Thiscouldbeanextremelybeneficialfactorforabusinessbecauseitwouldsavethemtime,andinturn,savethemmoney.

ii. Valuation–Watsoncanalsobeagreatjudgementofvaluationinfinancialstatementsandothervariousdatathatacompanygives.Thedevicecanmakesurethateverythingismeasuredcorrectly,thatallnumbersaddup,andthatalldatamatchestoeachotherandtootheroutsidesources–ifnecessary.Watsoncanactasanextramindtotheauditteam.

57

iii. Thisdevicecanhelpgaininsightfromthedatapresentedfromclients,andallowauditorstoquicklyassesslargeamountsofdatasothattheycanspendmoretimeonitemslikeriskassessment.KPMGisjustonefirmthatisputtingthistechnologytousetoday.TheyareusingWatsontoenhancetheircustomerrelationsandincreasetheusetechnologyintheirworkplace.

b. TaxPlanningi. AcompanywouldbeabletouseIBMWatsontounderstand

globaltaxratesforvariouscountries,andwhendoingbusinesswiththem,wouldallowthemtoeasilyorganizebusinesstransactions.Becausedifferenttaxrateseffectthebottomline,beingabletokeepthemsystematizedinatoolsuchasWatsonforlargecompaniescouldbeverybeneficial.

ii. Thistoolcouldbeusedtopushafirmforwardandhelpfosterbreakthroughideastopushthroughchallenges.TaxInternsandAssociatesatKPMGIgnitioninDenver,calledtheInnovationLab,usetechnologiessuchasIBMWatsontodevelopandmaintaintaxsoftwaretoperformatthebestcapablefunction.Watsoncaninspireandhelptheseprofessionalscreatetoolstouseintaxpracticetoadvancebusinessinbeneficialways.

iii. IBMWatsoncanbegivendataandhelpacompanyworkoutfinancialssothattheycanbeabletolimittheiroveralllegalworldwidepayment.Inordertodothis,acompanycoulddecreaseexpensesandcutcostsasmuchaspossible,aswellasdecreasetaxeswherepossible.Watsoncananalyzedataandseewherethisispossible,andassistacompanyplanforcuttingexpenditures.

c. FinancialStatementAnalysis/Valuation/Advisoryi. IBMWatsonwouldbespecificallyhelpfulinthejobofforensic

accounting,wheretheyconcentrateinanalysisofelectronicdatatobackuptheclaimoffinancialfraud.Watsonwouldcollect,prepare,analyze,andreportondata,whichwouldhelpanaccountantreviewanddrawconclusionstomaketheircaseagainstfraud.

ii. Beingabletovalueacompany’sassetsorliabilitiesforfinancialreportingpurposesisimportantinanyaccountingsystem.Understandingthecorrectvaluationtoplaceonsaidassetsorliabilitiesiscrucialtoreportingacompanycorrectly.IBMWatson

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couldaidinassetvaluationbyassessingbookvaluesvsmarketvalues,evaluatingcashflowpotential,andaccumulateddepreciation.

iii. Equityresearch–IBMWatsoncanhelpafirmsearchthoughfinancialsandcarryoutratioanalysiswithgreateaseandaccuracy.Onceitcompletesthesesteps,thistoolcanmakepredictionsforthefuturefromthesecalculationsofdata.Thiscanhelpacompanyexploreitsoptionsofbuyingandsellingstockinvestment,thusWatsoncanmakeproposalsforwhatitthinkswouldbethebestdecisionsforthem.

4) Writeafewparagraphstoyourfuturepublicaccountingpartnerexplainingwhyyourteamshouldinvestintheacquisitionofandtraininginthistool.Explainhowthetoolwillimpactthestaffingandscopeofyourfutureengagements.

IBMWatsonisdatatechnologyweneedinouraccountingfirm.Itwillchangethewaywedobusiness.

Thetrainingthatwouldbenecessaryforthistoolwillonlybebeneficialforouremployeesandassociates,wheretheskillstheyobtainfromtrainingwillhelpthemnotonlywiththeuseanddecisionmakingofthisdevice,butinotherpartsofbusiness.Itwillbewellworththetimeandmoney,andwewillgetareturnonourinvestmentfromourstaff.

IBMWatsonwillgiveusanadvantageoverthecompetition.Thisdevicecangenerateleadsfromsubstantialamountsofpreviousdata,andcanhelpusasabusinesspredictforthefuture.Inaddition,itisatoolthatcanreadtextmining,andcananalyzetheotherfirm’ssocialmediaanddocumentsthatweashumansmightnotbeabletoread.Also,itisamachinethatneverstops.Itisconstantlyatwork,whichcansaveusasafirmvaluabletimeandkeepusaheadofthegame.

Thistechnologywillhelpustomakebetterevidencebaseddecisionsandallowusasafirmtogrowwithourclientsandstaff.IbelieveitisinourbestinteresttoinvestintheacquirementandthetrainingoftheIBMWatsonandIhopeyouwillagree.

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CASEEIGHT

RiteAidCorporation–Long-TermDebt

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ThiscasewascenteredaroundRiteAid,aretailpharmacythatisintheUnited

States.Itisconsideredthethirdlargestinitsmarket,andin2009,thecompanyfilled

over300millionprescriptions.While68%ofitssalesareattributedtoits

pharmaceuticals,thechainalsosellsmerchandisesuchasfood,photoprocessing,

beautysupplies,andseasonalitems.Foracompanyaslargeasthisone,itisboundto

havelong-termdebtandotherdebtrelatedrequirements.Includedinthiscasearethe

distinctionsbetweensecuredandunsecureddebt,aswellasdifferentloanterms.The

casethengoesintothespecificsofRiteAid’sbalancesheetandnote11,whichfocuses

onindebtednessandcreditagreements.Thecasethenconsidersthreedifferentnotes

atvaryingfacevaluesandanalyzesthem.Anamortizationscheduleisalsocreatedafter

theconsiderationofthethirdnote.

Allinall,thetopicoflong-termdebtissomethingthatIhavedippedmytoes

into,buthavenotstudiedingreatdepth.Thiscasewidenedbyunderstandingofhowa

companyshowstheseitemsonfinancialstatements,howIneedtoreadandanalyze

themfromstatementsandnotes,andhowtoanalyzesuchitemscorrectly.Iwasalso

refreshedonhowtojournalizebasicaccountingentries,aswellashowtocreatean

amortizationschedule,bothofwhichIhavedonemanytimes.Yet,Ilearnednewskills

aswell,suchasnewcalculationsthatIdidnotknowpriortothiscasethatIwilltake

withmegoingforwardinthefuture.

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RiteAidCorporation–Long-TermDebtConcepts

a. Considerthevarioustypesofdebtdescribedinnote11,IndebtednessandCreditAgreement.i. ExplainthedifferencebetweenRiteAid’ssecuredandunsecureddebt.

WhydoesRiteAiddistinguishbetweenthesetwotypesofdebt?

Secureddebtisbackedbyanasset(suchasahomeorcar),knownascollateral.Thelenderofaloanisallowedtocapturethecollateralinthecasethattheborrowerdefaultsontheloan.Anunsecuredloanisnotbackedbysuchcollateral.ItisimportantforacompanysuchasRiteAidtodistinguishbetweenthesetwotypesofdebtssothatthecompanycandifferentiatebetweeninterestratesandborrowinglimits,andsothatcreditorscanunderstandwhichloansaresecuredandwhicharenot.

ii. Whatdoesitmeanfordebttobe“guaranteed”?Accordingtonote11,whohasprovidedtheguaranteeforsomeofRiteAid’sunsecureddebt?

Iftheborrowerofaloandefaultstopay,aguaranteedloanisapromisebyanotherparty(knownastheguarantor)topayadebtresponsibility.Theguaranteedloancanbelimitedorunlimited,whichwouldmakethepartyresponsibleforeitherjustapartofthedebtthattheborrowerdidnotpay,ortheentirebalance.Innote11,itstatesthatRiteAid’s“wholly-ownedsubsidiaries”guaranteethecompany’sunsecureddebt.

iii. Whatismeantbytheterms“senior,”“fixed-rate,”and“convertible”?Theterm“senior”isusedtodescribeanoteorbondthathaspriorityforrepaymentbytheborrower.A“fixed-rate”meansthattheinterestrateremainsconstantforthelifeoftheloan.Andfinally,theterm“convertible”aredebtsecuritythattheholdercanconverttoacertainquantityofsharesofcommonstockatspecifictimesofthebond’slife.

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iv. SpeculateastowhyRiteAidhasmanydifferenttypesofdebtwitha

rangeofinterestrates.RiteAidhasvaryingtypesofdebt(suchasseniorsecured,guaranteedunsecured,andunsecuredunguaranteeddebts)inordertodealwithcertainbusinessandcreditactivitiesinthebestwaypossible.Therangeofinterestratescanbestbedescribedbecausedifferentbondsareissuedatdifferenttimesoftheyear.

Processb. Considernote11,IndebtednessandCreditAgreement.Howmuchtotaldebt

doesRiteAidhaveatFebruary27,2010?Howmuchofthisisduewithinthecomingfiscalyear?Reconcilethetotaldebtreportedinnote11withwhatRiteAidreportsonitsbalancesheet.

(Allnumbersinthousands)Totalamountofdebtfor2010=$6,370,899CurrentMaturitiesofLong-TermDebt $51,502Long-TermDebt 6,185,633CapitalLeaseObligations 133,764TotalDebt $6,370,899

Thecurrentmaturitiesoflong-termdebtarewhatisduewithinthecomingfiscalyear,whichis$51,502.Thistotaldebtislessthanthetotalamountofassetsfor2010,givingthecompanyadebttoassetratioof0.79,whichtellsusthetotalamountofassetsthatwerefinancedbyliabilities.Thecurrentmaturitiesoflong-termdebtaretheliabilitiesthatareduewithinthecurrentfiscalyearandlong-termdebtareapartoflong-termliabilities.Aseachoftheseincrease,thecorrespondingliabilitiescategoriesincrease.Finally,netincomeisimpactedbydebtbywhennewdebtistakenon,netincomeindecreased.Whatistheeffectonassets,liabilities,andnetincome,anddiscussoneachpart.

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c. Considerthe7.5%seniorsecurednotesdueMarch2017.

i. Whatisthefacevalue(i.e.theprincipal)ofthesenotes?Howdoyouknow?

Thefacevalueofthesenotes(i.e.theprincipal)is$500,000.Thisisknownbecausetherearenounamortizeddiscounts.

ii. PreparethejournalentrythatRiteAidmusthavemadewhenthesenoteswereissued.

NoteatIssuance: Cash 500,000 NotesPayable 500,000

iii. Preparetheannualinterestexpensejournalentry.Notethattheinterestpaidonanoteduringtheyearequalsthefacevalueofthenotetimesthestatedrate(i.e.,couponrate)ofthenote.

InterestExpense(500,000x.075)37,500 Cash 37,500

iv. PreparethejournalentrythatRiteAidwillmakewhenthesenotes

maturein2017.NotesPayable 500,000 Cash 500,000

InterestExpensewentupinpartc,thusthenetincomeofRiteAidwoulddecreaseasitbecomesgreater.NotesPayableareitemsthataffecttheliabilitiesportionofabalancesheet,andcashareassetsofRiteAid.Asseenhere,thebondswillfullymaturein2017,andwillbewrittenoffthoseaccounts.

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d. Considerthe9.375%seniornotesdueDecember2015.Assumethatinterestispaidannually.

i.Whatisthefacevalue(orprincipal)ofthesenotes?Whatisthecarryingvalue(netbookvalue)ofthesenotesatFebruary27,2010?Whydothetwovaluesdiffer?

AtFebruary27,2010,thefacevalue(orprincipal)amountofthesenotesis$410,000,whilethecarryingvalue(ornetbookvalue)is$405,951.Theseamountsdifferbecausethereisanunamortizeddiscount.

ii.HowmuchinterestdidRiteAidpayonthesenotesduringthefiscal

2009? Thecashinterestpaymentofthisnotein2009forRiteAidwas

$38,438.(410,000x.09375x12/12)

iii.DeterminethetotalamountofinterestexpenserecordedbyRiteAidonthesenotesfortheyearendedFebruary27,2010.Notethatthereisacashandanoncashportiontointerestexpenseonthesenotesbecausetheywereissuedatadiscount.Thenoncashportionofinterestexpenseistheamortizationofthediscountduringtheyear(thatis,theamountbywhichthediscountdecreasedduringtheyear).

ThetotalamountofinterestexpenserecordedbyRiteAidonthesenotesfortheyearendedFebruary27,2010is$39,143.(Thisiscalculatedbytaking$38,438andaddingthediscountonnotespayableof$705).

v. Preparethejournalentrytorecordinterestexpenseonthesenotesfor

fiscal2009.Considerboththecashanddiscount(noncash)portionsoftheinterestexpensefrompartiiiabove. InterestExpense 39,143 Disc.onNotesPayable 705 Cash 38,438

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v.Computethetotalrateofinterestrecordedforfiscal2009onthese

notes.

Thetotalrateofinterestrecordedforfiscal2009onthesenotesis9.64%.

(!"#$%$&#'()*$"&$+, '!!= !",$%!%&',"'$= ) .0964!!)

Theinterestexpenseof$39,143forRiteAidwillaffectnetincome,andwillmakeitlessthanthelastinterestpaymentof$37,500wouldhavebecauseitisalargeramount.Asbefore,thenotewillbewhateffectstheassetsandliabilities.Becauseofthediscount,thereisextrainterestthatmustbepaidoverthelifeofthenotewhichwemustaccountfor.

e. Considerthe9.75%notesdueJune2016.AssumethatRiteAidissuedthese

notesonJune30,2009andthatthecompanypaysinterestonJune30thofeachyear.

i.Accordingtonote11,theproceedsofthenotesatthetimeofissue

were98.2%ofthefacevalueofthenotes.PreparethejournalentrythatRiteAidmusthavemadewhenthesenoteswereissued.

6/2009 Cash 402,620

Disc.onNotesPayable 7,380 NotesPayable 410,000

ii.Atwhateffectiveannualrateofinterestwerethesenotesissued?

Theeffectiveannualrateofinterestthatthenoteswereissuedatwas10.1212%.

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iii.AssumethatRiteAidusestheeffectiveinterestratemethodtoaccountforthisdebt.Usethetablethatfollowstoprepareanamortizationscheduleforthesenotes.Usethelastcolumntoverifythateachyear’sinterestexpensereflectsthesameinterestrateeventhoughtheexpensechanges.Note:Guidancefollowsthetable.

Date CashInterestPayment

InterestExpense

DiscountAmortization

CarryingValue

6/30/09 --- --- --- $402,6206/30/10 $39,975 40,750 775 403,3956/30/11 39,975 40,828 853 404,2486/30/12 39,975 40,915 940 405,1886/30/13 39,975 41,010 1,035 406,2336/30/13 39,975 41,115 1,140 407,3636/30/14 39,975 41,230 1,255 408,6186/30/15 39,975 41,357 1,382 $410,000

iv.Basedontheaboveinformation,preparethejournalentrythatRite

AidwouldhaverecordedFebruary27,2010,toaccrueinterestexpenseonthesenotes.

InterestExpense 27,167 Disc.onNotesPayable 517 InterestPayable 26,650 v.Basedonyouranswertopartiv.,whatwouldbethenetbookvalue

ofthenotesatFebruary27,2010? ThenetbookvalueofthenotesatFebruary27,2010wouldbe

$403,137.($403,395+517)

Here,wehaveasmallerinterestexpenseof$27,167whichwouldhavelessofanimpactonournetincome,leavingitlarger.Ourdiscountonnotespayableislesscomparedtopartd,at$517comparedto$705.

67

CASENINEMerck&Co.,Inc.andGlaxoSmithKlineplc–Shareholders’Equity

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ThepartofthecasethatwewerecenteredonwasthecompanyofMerck&Co.,

Inc.,whichisapharmaceuticalcompanythatfocusesonimprovinghumanandanimal

healthworldwide.Theydoagreatdealofresearchintheirdailybusinessoperations,

andareheadquarteredinNewJersey.Theydohavepubliclytradedstockthatarelisted

onboththeNewYorkandPhiladelphiaStockExchanges.Thiscasefirstanalyzesthe

company’scommonshares.Itthendiscussestopicssuchasdividendsandstock

repurchases.Adividendactivityjournalentryisaskedtobemade,andthetopicof

treasurystockisalsoexplored.Variousratiosarecalculatedforboth2006and2007for

thecompanyandthendividendratiosarecalculatedforMerckCo.,Inc.attheendof

thecase.

DividendsareatopicIenjoystudyingandunderstandalittlebitmoreeachtime

wetouchonthetopicinmydifferentclasses.Treasurystock,buybacks,andshare

repurchasesaresomethingIgraspedatasurfacelevel,butafterdoingmyownresearch

Inowunderstandthegreaterreasonsbehindwhyacompanywouldwanttorepurchase

theirownshares.Justhavingtoreviewfinancialstatementsandanswerquestionsto

understandwhatnumbersarecomingfromwhere,reallyshowtheimportanceofwhy

wedothesescasestudies.Inthefirstpartofthiscase,weareaskedtoidentifyitems

suchascommonsharedauthorizedandissued,heldintreasury,andoutstanding.This

wasagreatexercisetobeabletodistinguishthesenumbersfromthesameinformation.

Thiscasealsofocusedonajournalentryforcommondividendactivityanddividend

relatedratios.

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Merck&Co.,Inc.andGlaxoSmithKlineplc–Shareholders’EquityConcepts

a. ConsiderMerck’scommonshares.

i. HowmanycommonsharesisMerckauthorizedtoissue?

Merckhas5,400,000,000commonsharestoissue. ii. HowmanycommonshareshasMerckactuallyissuedatDecember31,

2007? 2,983,508,675shareshaveactuallybeenissuedatDecember31,2007.

iii. ReconcilethenumberofsharesissuedatDecember31,2007,tothedollarvalueofcommonstockreportedonthebalancesheet. The$29.8million-dollarvalueofcommonstockreportedonthebalancesheetcanbefoundbymultiplyingthe2,983,508,675sharesofcommonstockbytheparvalueofonecent.

iv. HowmanycommonsharesareheldintreasuryatDecember31,2007? ThenumberofsharesheldintreasuryatDecember31,2007isequalto811,005,791shares.

v. HowmanycommonsharesareoutstandingatDecember31,2007?ThenumberofcommonsharesoutstandingatDecember31,2007isequalto2,172,502,884shares.

vi. AtDecember31,2007,Merck’sstockpriceclosedat$57.61pershare.CalculatethetotalmarketcapitalizationofMerckonthatday. ThetotalmarketcapitalizationofMerckonthatdayis$125,157,891,147.24.

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c. Whydocompaniespaydividendsontheircommonorordinaryshares?Whatnormallyhappenstoacompany’ssharepricewhendividendsarepaid?

Dividendsareawaytoregularlypayshareholdersofacompanyoutofitsretainedearnings.Investorsenjoythesteadyincomethatcomeswithdividends,sotheyaremorelikelytobuycompany’sstock.Investorsputinmoneyinacompanywithhighhopesfortheirfutureincome.Yet,whenacompanypaysdividends,theirsharepriceusuallyfallsbytheamountofthepayout.

d. Ingeneral,whydocompaniesrepurchasetheirownshares?

Thiscanbeknownasasharerepurchase,orbuyback.Thiscanhappeninoneoftwoways–tenderoffersorontheopenmarket.Thereareseveralreasonsbehindwhyacompanymightwanttorepurchasetheirownshares.First,itcouldbetoimprovetheirfinancialratios.Buybacksreducesthenumberofsharesoutstanding,reducestheassetsonthebalancesheet,andhaslessequityoutstanding.Thus,ROAandROEbothincrease.Inaddition,whenstockisundervalued,companiesaremorepronetorepurchasetheirstock.Whenthestockpricegoesbackup,theywillthenre-issuethemonthemarketwithouthavingtoissueanyadditionalshares.

Process

e. ConsiderMerck’sstatementofcashflowandstatementofretainedearnings.PrepareasinglejournalentrythatsummarizesMerck’scommondividendactivityfor2007.

RetainedEarnings 3,310,700,000

Cash 3,307,300,000

DividendsPayable 3,400,000

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g. During2007,Merckrepurchasedanumberofitsowncommonsharesontheopenmarket.

i.DescribethemethodMerckusestoaccountforitstreasurystocktransactions.

ThemethodthatMerckusestoaccountforitstreasurystocktransactionsisthecostmethod.Thismethodoverlookstheparvalueofthesharesandthetotalreceivedfrominvestorswhentheshareswereinitiallyissued.

ii.Refertonote11toMerck’sfinancialstatements.HowmanysharesdidMerckrepurchaseontheopenmarketduring2007?

Merckrepurchased26.5millionsharesontheopenmarketduring2007.

iii.HowmuchdidMerckpay,intotalandpershare,onaverage,tobuybackitsstockduring2007?Whattypeofcashflowdoesthisrepresent?

Merckpaidintotal$1,429,700,000and$53.95persharetobuybackitsstockduring2007.Thisrepresentsafinancingcashflow.

iv.Whydoesn’tMerckdiscloseitstreasurystockasanasset?

Treasurystockbydefinitionisconsideredacontra-equityaccount,thusshouldnotbedisclosedasanasset.

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Analysis

i.Determinethemissingamountsandcalculatetheratiosinthetablesbelow.Forcomparability,usedividendspaidforbothcompaniesratherthandividendsdeclared.Usethenumberofsharesoutstandingatyearendforper-sharecalculations.WhatdifferencesdoyouobserveinMerck’sdividend-relatedratiosacrossthetwoyears?Whatdifferencesdoyouobserveinthetwocompanies’dividend-relatedratios?

Merck

(inmillions)2007 2006

Dividendspaid $3,307.30 3,322.60

Sharesoutstanding 2,172,502,884 2,167,785,445

Netincome 3,275.40 4,433.80

Totalassets 48,350.70 44,569.80

Operatingcashflows 6,999.20 6,765.20

Year-endstockprice

$57.61 $41.94

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Somedividendrelatedratiostoconsidercouldincludethedividendpayoutratio,dividendstototalassetsratio,anddividendyieldforMerck.First,thedifferenceindividendpayoutacrossthetwoyearswas74.94%in2006to100.97%in2007.Thiswasthebiggestjumpindividendratiosbecauseofthecompany’sratioofdividendstonetincome,asnetincomedecreasedmorethanitsdividendspaiddecreased.Next,thedividendstototalassetsratioin2006was7.44%,whileitwas6.84%in2007.Thisremainedfairlyconstant.Finally,thedividendyieldwas3.65%in2006,anddroppedslightlyto2.64%in2007.

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CASETEN

StateStreetCorporation–MarketableSecurities

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StateStreetCorporationisafinancialholdingcompanythatlaunchedin1792.

BeginningwiththefoundingoftheUnionBank,thecorporationisnowdedicatedon

assistinginstitutionalinvestors.StateStreetmanagestwolinesofbusiness,Investment

ManagementandInvestmentServicing.Withintheselinesareavarietyofproducts

whichincluderiskandinvestmentresearch,tradingservices,performance,securities

finance,andbrokerage,tonameafew.TheyareheadquarteredoutofBoston.Thiscase

followsthecompanythroughthe2010through2012fiscalyears,asseenthroughtheir

financialstatements.

Thiscasewasfocusedonthetopicofmarketablesecurities.Igrewinmy

knowledgeofhowtodistinguishtrading,available-for-sale,andheld-to-maturity

securitiesfromeachother(eachwillbedefinedlateroninthiscase).Understandingthe

differencesbetweendebtandequitysecurities,andhowtomakemoneyfromeachare

importanttopicstocomprehend.Thebeginningsectionsofthiscaseallowedmeto

practicemyskillsinajournalentrytoincreasethemarketvalueofatrading,available-

for-sale,orheld-to-maturitysecuritiesaccount.Additionally,thiscasealsoremindedme

howtorecorddividendsreceivedforbothtradingandavailable-for-salesecurities.This

casealsoallowedmetopracticethejournalentriesforsecuritiespurchases,sales,and

year-endadjustments.Allinall,afterStateStreetCorporation’scase,Ifeelmore

confidentaboutthetopicofmarketablesecurities.

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StateStreetCorporation–MarketableSecurities

Concepts

a. Considertradingsecurities.NotethatfinancialinstitutionssuchasStateStreettypicallycallthesesecurities“Tradingaccountassets.”

i. Ingeneral,whataretradingsecurities? Tradingsecuritiesareshort-term(usuallywithin3months)securitiesboughtandheldprimarilyforsaletogenerateincome.Theseincludebothdebtandequitysecuritiesandarereportedatfairvalue.

ii.Howwouldacompanyrecord$1ofdividendsorinterestreceivedfromtradingsecurities?

Cash 1 DividendRevenue 1 Cash 1 InterestRevenue 1 iii.Ifthemarketvalueoftradingsecuritiesincreasedby$1duringthe

reportingperiod,whatjournalentrywouldthecompanyrecord? TradingSecurities 1 UnrealizedHoldingGain(orLoss) 1

b. Considersecuritiesavailable-for-sale.NotethatStateStreetcallsthese,“Investmentsecuritiesavailableforsale.”

i. Ingeneral,whataresecuritiesavailable-for-sale? Securitiesnotclassifiedasheld-to-maturityortradingsecurities,whichareboughtwiththepurposeofsellingbeforematurity.Theseincludebothdebtandequitysecuritiesandarereportedatfairvalue.

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ii. Howwouldacompanyrecord$1ofdividendsorinterestreceivedfromsecuritiesavailable-for-sale? Cash 1 DividendRevenue 1Cash 1 InterestRevenue 1

iii. Ifthemarketvalueofsecuritiesavailable-for-saleincreasedby$1duringthereportingperiod,whatjournalentrywouldthecompanyrecord? AvailableforSaleSecurities 1 UnrealizedHoldingGain(EquityorOCI) 1

c. Considersecuritiesheld-to-maturity.NotethatStateStreetcallsthese,“Investmentsecuritiesheldtomaturity.”

i. Ingeneral,whatarethesesecurities?Whyareequitysecuritiesneverclassifiedasheld-to-maturity? Securitiesthatthecompanyhasthepositiveintentandabilitytoholdtomaturity.Theseonlyincludedebtsecuritiesandarereportedatamortizedcost.

ii. Ifthemarketvalueofsecuritiesheld-to-maturityincreasedby$1duringthereportingperiod,whatjournalentrywouldthecompanyrecord?Inthiscase,therewouldbenoentry.

Process

d. Considerthe“Tradingaccountassets”onStateStreet’sbalancesheet.

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i. WhatisthebalanceinthisaccountonDecember31,2012?Whatisthemarketvalueofthesesecuritiesonthatdate?

Thebalanceonthe“Tradingaccountassets”onDecember31,2012is$637,000,000.Themarketvalueofthesecuritiesonthisdateisalso$637,000,000becausetheywererecordedatfairvalue.

ii. Assumethatthe2012unadjustedtrialbalancefortradingaccountassetswas$552million.WhatadjustingjournalentrywouldStateStreetmaketoadjustthisaccounttomarketvalue?Ignoreanyincometaxeffectsforthispart.

TradingAccountAssets 85,000,000 UnrealizedHoldingGain 85,000,000

e. Considerthebalancesheetaccount“Investmentsecuritiesheldtomaturity”andtherelateddisclosuresinNote4.

i. Whatisthe2012year-endbalanceinthisaccount?

The2012year-endbalanceinthe“Investmentsecuritiesheldtomaturity”accountis$11,379,000,000.

ii. WhatisthemarketvalueofStateStreet’sinvestmentsecuritiesheldtomaturity?

ThemarketvalueofStateStreet’sinvestmentsecuritiesheldtomaturityis$11,661,000,000.

iii. Whatistheamortizedcostofthesesecurities?Whatdoes“amortizedcost”represent?Howdoesamortizedcostcomparetotheoriginalcostofthesecurities?

Theamortizedcostofthesesecuritiesis$11,379,000,000.Theamortizedcost($11,379,000,000)islowerthantheoriginalcost($11,661,000,000)becausethecarryingvalueofthebondsisrepresentedbytheamortizedcost.

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iv. Whatdoesthedifferencebetweenthemarketvalueandtheamortizedcostrepresent?Whatdoesthedifferencesuggestabouthowtheaveragemarketrateofinterestonheld-to-maturitysecuritieshaschangedsincethepurchaseofthesecuritiesheldbyStateStreet? Thedifferencebetweenthemarketvalueandtheamortizedcostrepresentsthattheinvestmentsareworthmorethanwhattheyarelistedfor,becausetheamortizedcostislowerthanthemarketvalue.Thismeansthattherateofinterestonheld-to-maturitysecuritieshasdroppedsincethepurchaseofthesecuritiesheldbyStateStreet.

f. Considerthebalancesheetaccount“Investmentsecuritiesavailableforsale”andtherelateddisclosuresinNote4.

i. Whatisthe2012year-endbalanceinthisaccount?Whatdoesthisbalancerepresent?

The2012year-endbalanceinthe“Investmentsecuritiesavailableforsale”accountis$109,162,000,000.Thisbalancerepresentsafairvalue.

ii. Whatistheamountofnetunrealizedgainsorlossesontheavailable-for-salesecuritiesheldbyStateStreetatDecember31,2012?Besuretonotewhethertheamountisanetgainorloss.

Theamountofnetunrealizedgainsontheavailable-for-salesecuritiesheldbyStateStreetatDecember31,2012is$1,119,000,000.

iii. Whatwastheamountofnetrealizedgains(losses)fromsalesofavailable-for-salesecuritiesfor2012?HowwouldthisamountimpactStateStreet’sstatementsofincomeandcashflowsfor2012?

Theamountofnetrealizedgainsfromsalesofavailable-for-salesecuritiesfor2012is$55,000,000.ThisamountwouldincreaseStateStreet’sincomestatementandcashflowsfor2012.

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g. StateStreet’sstatementofcashflowfor2012(notincluded)showsthefollowinglineitemsinthe“InvestingActivities”sectionrelatingtoavailable-for-salesecurities(inmillions): Proceedsfromsalesofavailable-for-salesecurities$5,399 Purchasesofavailable-for-salesecurities$60,812

i. ShowthejournalentryStateStreetmadetorecordthepurchaseofavailable-for-salesecuritiesfor2012. InvestmentinAFS 60,812 Cash 60,812

ii. ShowthejournalentryStateStreetmadetorecordthesaleofavailable-for-salesecuritiesfor2012.Note13(notincluded)reportsthattheavailable-for-salesecuritiessoldduring2012had“unrealizedpre-taxgainsof$67millionasofDecember31,2011.”Hint:besuretoremovethecurrentbook-valueofthesesecuritiesinyourentry. Cash 5,399UnrealizedHoldingGain 67 InvestmentinAFS 5,411 RealizedGainonAFS 55

iii. Usetheinformationinpartg.iitodeterminetheoriginalcostoftheavailable-for-salesecuritiessoldduring2012.

Theoriginalcostoftheavailable-for-salesecuritiessoldduring2012was$5,344,000,000.

(Gain=Proceeds–BV) (55=5,399–BV) (BV=5,344)

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CASEELEVENZAGGInc.–DeferredIncomeTaxes

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ZAGGInc.isacompanythatspecializesinmobiledeviceaccessories.ZAGG,

whichstandsfor“ZealousAboutGreatGadgets”startedin2005justcreatingplastic

protectionsforwristwatches.Today,theirwiderangeofaccessoriesincludecases,

headphones,mobilekeyboards,portablepower,andapatentedinvisibleSHIELDthat

canbeplacedonsmartphoneandtabletscreens.iFrogz,amanufacturerofdigitalaudio

accessories,wasacquiredbyZAGGin2011topromoteexpansion.Thecompanyisnota

marketleader,andispubliclytradedontheNASDAQ.

ThiscaseonZAGGInc.gavegreatinsightintodeferredincometaxes.Deferred

incometaxescanbeoutlinedasanobligationtopaytaxesonacompany’sbalance

sheetthatareattributabletotaxabletemporarydifferences.Inthiscase,Idefinedthe

differencebetweenbookandtaxableincome,andevaluatedthisdifferenceonZAGG’s

financials.Inaddition,Inowbetterunderstandthedifferencesbetweenpermanentand

temporarytaxdifferences,aswellaseffectiveandstatutorytaxratesfollowingthis

case.AfteranalyzingtheCodification740,Ihaveagreaterunderstandingofwhya

companyreportsdeferredincometaxesaspartoftheirtotalincometaxexpense,as

wellasthedifferencebetweenadeferredincometaxassetfromadeferredincometax

liability.Additionally,Ibecamefamiliarwithwhatadeferredincometaxvaluation

allowanceis,andwhenitshouldbeusedinaccounting.Thiscasealsohelpedme

understandthejournalentriesthatgoalongwithdeferredincometax.

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ZAGGInc.–DeferredIncomeTaxes

Concepts

a. Describewhatismeantbythetermbookincome?WhichnumberinZAGG’sstatementofoperationcapturesthisnotionforfiscal2012?Describehowacompany’sbookincomediffersfromitstaxableincome.

Thefirm’sbookincomeispre-taxfinancialincomethatisreportedintheIncomeStatement.ThisistheamountthatisrequiredtobecomputedbyU.S.GAAPtobeusedbyinvestorsandcreditorsattheendofthefiscalyear.ThenumberinZAGG’sstatementofoperationthatcapturesthisnotionforfiscal2012is$23,898(inthousands).Acompany’sbookincomeandtaxableincomehavedifferentobjectives.Taxableincomeiscomputedforacompany’staxreturnthatissubmittedtotheIRS.

b. Inyourownwords,definethefollowingterms:

i. Permanenttaxdifferences(alsoprovideanexample)Permanenttaxdifferencesaredefinedasatransactionthatisstateddifferentlyatbookincomeandtaxableincome.Thisdifferencecanneverbeeradicated.Someexamplesofpermanenttaxdifferencesincludepenaltiesandfines,lifeinsuranceproceeds,andinterestonmunicipalbonds.

ii. Temporarytaxdifference(alsoprovideanexample)

Whenrevenuesorexpensesarerecognizedfordifferentperiodsforthebookandtaxvalues,itproducestemporarytaxdifferences.Thisresultsinatransactionthatreportsdifferentlyatbookincomeandtaxableincome,butthateventuallyeradicatesitselfovertimebecauseitistemporary.Examplesoftemporarytaxdifferencesincludedepreciationandaccruedliabilities.

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iii. Statutorytaxrate

Thestatutorytaxrateistherateoftaxthatismandatedbylaw,thatisstatedasapercentage.

iv. Effectivetaxrate

Theeffectivetaxrateistheratethatanindividualorcorporationistaxedonincome.Itiscalculatedbytakingtaxexpenseanddividingitbypretaxincome.

c. Explainingeneraltermswhyacompanyreportsdeferredincometaxesaspart

oftheirtotalincometaxexpense.Whydon’tcompaniessimplyreporttheircurrenttaxbillastheirincometaxexpense?

Deferredincometaxesareliabilitiesonacompany’sbalancesheetthatareattributabletotaxabletemporarydifferences.Theyrepresenttheincreaseintaxespayableinfutureyearsasresultoftaxabletemporarydifferencesexistingattheendofthecurrentyear.Theamountisusuallyduetothewayacompanycalculatesitsincomeforfinancialpurposesandtaxpurposes.Thecomputationforincometaxexpensehastwocomponents–currenttaxexpenseanddeferredtaxexpense.Whenyouincreasedeferredtaxliabilitiesfromthebeginningoftheperiodtotheendoftheperiod,itresultsinadeferredtaxexpense. Acompanyreportsdeferredincometaxesaspartoftheirtotalincometaxexpenseforseveralreasons.First,GAAPrequiresthatmatchingprinciplebefollowedbycompanies.Underthematchingprinciple,expensesmustbematchedwith,andthusexpensed,inthesameperiodtherevenuewasearnedthatcausedtheexpensestobeincurred.Often,duetotaxrules,incometaxesaren’tpaidinthesameperiodinwhichtheincomewasearnedthatgeneratedthetax.Investorspayattentiontodeferredincometaxtobetterascertainacompany’sshort-termliabilitiesandobligationsthatwillrequiretheuseofcashinthenearfuture. WhenlookingattheCodificationASC740,thetwoobjectivesofaccountingforincometaxesarelistedas“recognizetheamountoftaxespayableorrefundableforthecurrentyear”and“recognizedeferredtaxliabilitiesandassetsforthefuturetaxconsequencesofeventsthathavebeenrecognizedinan

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entity’sfinancialstatementsortaxreturns.”Insection740-10-10-3,itstatesthattheobjectiveisthemeasurethedeferredtaxassetorliabilityusingthetaxratesandapplythattotaxableincomeintheperiodsinwhichtheassetorliabilityisexpectedtobesettledorrealized.Thisisallaboutmatchingtheitemstothecorrectperiodssothatrevenuescanmatchexpenses.

Inpartbof740-10-25-2itstatesthat“adeferredtaxliabilityorassetshallberecognizedfortheestimatedfuturetaxeffectsattributabletotemporarydifferencesandcarryforwards.”Thisismeaningthatdeferredtaxesshouldberecognizedfortheestimationsbasedontimingdifferencesordeductionsthatcannotbeutilizedonthetaxreturn.

Companiesarerequiredtoshowthecomponentsofincometaxexpenseeitherintheincomestatementorinthefinancialstatementnotes.Someexpertsdismissdeferredincometaxeswhenevaluatingthestrengthofacompany,buttheFASBindicatesthattheyareliabilitiesbecausetheyresultfromapasttransaction,areapresentobligation,andrepresentafuturesacrifice.Deferredtaxesdoprovideincrementalinformationaboutfuturetaxpayments.

d. Explainwhatdeferredincometaxassetsanddeferredincometaxliabilitiesrepresent.Giveanexampleofasituationthatwouldgiverisetoeachoftheseitemsonthebalancesheet.

Deferredincometaxassetsaredeferredtaxconsequencesthatareattributabletodeductibletemporarydifferencesandcarryforwards.Theyaremeasuredusingtheapplicableenactedtaxrateandprovisionsoftheenactedtaxlaw.Theyarereducedbyavaluationallowanceifitismorelikelythannotthatsomeportionorallofadeferredtaxassetwillnotberealized.Somereasonswhydeferredtaxassetsarenecessaryincludethatrevenuesarerecognizedinoneperiodfortaxpurposesandinadifferentperiodforaccountingpurposes,thecompanypaidtoomuchtaxanddeservessomemoneyreturned,orsomeassetshaveadifferenttaxbaseforgovernmentalagenciescomparedtoaccountingpractices.Anexampleofasituationthatwouldgiverisetoadeferredtaxassetwouldbethecarry-overoflosses.Ontheotherhand,deferredincometaxliabilitiesaredeferredtaxconsequencesattributabletotaxabletemporarydifferences.Theyaremeasuredusingtheapplicableenactedtaxrateandprovisionsoftheenactedtaxlawaswell.Itisthedifferencesinthewaynetincomeiscalculatedforfinancialpurposesandthe

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wayitiscalculatedforincometaxpurposes.Themostcommonbookincomeandtaxincomedifferenceforthisissueisdepreciation,wheretaxrulesmayallowforaccelerateddepreciationmethodsthatarenotallowedforfinancialreporting.Anotherexampleofdeferredtaxliabilityisaninstallmentsale,wherecreditispaidoffinequalamountsovertime.

e. Explainwhatadeferredincometaxvaluationallowanceisandwhenitshould

berecorded. Acompanyshouldreduceadeferredtaxassetbyavaluationallowanceifitismorethan50%likelythatitwillnotrealizesomeportionorallofthedeferredtaxasset.Companiesrecognizeadeferredtaxassetforalldeductibletemporarydifferences.

Process

f. ConsidertheinformationdisclosedinNote8–IncomeTaxestoanswerthefollowingquestions:

i. UsinginformationinthefirsttableinNote8,showthejournalentrythatZAGGrecordedfortheincometaxprovisioninfiscal2012? (entriesinthousands)IncomeTaxExpense 9,393DTA,net 8,293 IncomeTaxPayable 17,686

ii. UsingtheinformationinthethirdtableinNote8,decomposethe

amountof“netdeferredincometaxes”recordedinincometaxjournalentryinpartf.i.intoitsdeferredincometaxassetanddeferredincometaxliabilitycomponents. (entriesinthousands)

IncomeTaxExpense 9,393DTA,netofVA(14302–6300) 8,002DTL 291 IncomeTaxPayable 17,686

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iii. ThesecondtableinNote8providesareconciliationofincometaxescomputedusingthefederalstatutoryrate(35%)toincometaxescomputedusingZAGG’seffectivetaxrate.CalculateZAGG’s2012effectivetaxrateusingtheinformationprovidedintheirincomestatement.WhataccountsforthedifferencebetweenthestatutoryrateandZAGG’seffectivetaxrate? ZAGG’seffectivetaxratein2012is39.3%,whichwascalculatedbydividingthecompany’staxexpenseof$9,393byitstaxableincomeof$23,898.ThedifferencebetweenthestatutoryrateandZAGG’seffectivetaxratecanbeaccountedbythedifferenceinitsbookandtaxableincome.

iv. AccordingtothethirdtableinNote8–IncomeTaxes,ZAGGhadanet

deferredincometaxassetbalanceof$13,508,000atDecember31,2012.ExplainwherethisamountappearsonZAGG’sbalancesheet.

NetDTA 14,302NetDTL (794)TotalNetDTABalance,netofVA,netofDTL $13,508ThisbalanceappearsonZAGG’sbalancesheetasCurrentDeferredIncomeTaxof$6,912and$6,596,whichwhenaddedtogetherequal$13,508.

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CASETWELVEAppleInc.–RevenueRecognition

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AppleInc.isamajorcompanyintoday’smarket.Thecorporationisresponsible

foravarietyofelectronicsonthemarket,includingpersonalcomputers,portablemusic

andvideoplayers,andphones.Theyalsosellrelatedsoftware,services,andnetworking

solutionsthatcoordinatewiththeirproducts.AppleInc.specializesinmarketingand

designingproductsthatmakethemstandoutfromtheircompetitors.Thecompanyis

abletoselltheirmerchandiseworldwidethroughanarrayofoutletsincludingretail

stores,directsalesforce,resellers,onlinestores,andthird-partywholesalers.

Thiscasefocusedonthetopicofrevenuerecognition.First,Itookalookbackon

thedifferencesbetweengainsandrevenues.Thisdistinctionwasimportantformeto

rememberbeforedivingintotherestofthecase.IalsoanalyzedApple’srevenue

recognitionpolicies,whilelookingalongsidetheFASB’sStatementofConceptsNo.5

andtheASC606.IfeelthatitisimportantformetobelookingattheRevenue

RecognitionStandard,theCodification,andtheStatementofConceptssothatIam

familiarwiththembeforegradschoolorevengoingintowork.Inaddition,Idefined

multiple-elementcontractsandhowtheyinterferedwithrevenuerecognition.Thisis

somethingthatIhadneverheardofbefore.Finally,IwentthroughApple’sfootnotes

andevaluatedhowtheyrecognizedrevenuesforfourdifferentsituations:iTunessongs

soldonline,Mac-brandedaccessories,iPodssoldtothirdpartyresellerinanother

country,andsalesfromgiftcards.ThiswasaninterestingcaseformebecauseAppleis

suchaprevalentcompanyinmyeverydayactivities,soitwasintriguingtobeabletoget

toanalyzetheirfinancialsandlearnalittlemoreabouthowtheyrecognizetheir

revenues.

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AppleInc.–RevenueRecognition

Concepts

a. Inyourownwords,define“revenues.”Explainhowrevenuesaredifferentfrom“gains.”

Revenuescanbedefinedasacompany’sincomethatitgathersfromconductingbusiness,suchassellinggoodsorservices,afterdiscountsandsubtractionshavebeenmade.Theycanalsobereferredtoassales.Gains,ontheotherhand,areadditionsinnetassetsfromperipheraloperationsofabusiness.

b. Describewhatitmeansforabusinessto“recognize”revenues.Whatspecific

accountsandfinancialstatementsareaffectedbytheprocessofrevenuerecognition?DescribetherevenuerecognitioncriteriaoutlineintheFASB’sStatementofConceptsNo.5. ThecoreprincipleofthenewstandardofASC606statesthatcompaniesrecognizerevenueinordertodepictthetransferofpromisedgoodsorservicestocustomersinanamountthatreflectstheconsiderationofwhichthebusinessexpectstobeentitledinexchangeforthosegoodsorservices.ThespecificaccountsandfinancialstatementsthatareaffectedbytheprocessofrevenuerecognitionincludeAccountsReceivableontheBalanceSheetandRevenuesorSalesontheIncomeStatement.TherevenuerecognitioncriteriaoutlinedintheFASB’sStatementofConceptsNo.5setsforthrecognitioncriteriaonwhatinformationshouldbeincorporatedintothefinancialstatementsandwhenitshouldbedone.Itstatesthatrecognitionistheprocessofproperlyrecordinganiteminthefinancialstatements,anddisclosurebyothermeansisnotconsideredrecognition.

c. RefertotheRevenueRecognitiondiscussioninNote1.Ingeneral,whendoes

Applerecognizerevenue?ExplainApple’sfourrevenuerecognitioncriteria.Dotheyappeartobealignedwiththerevenuerecognitioncriteriayoudescribedinpartb,above? Ingeneral,Note1statesthatApplerecognizesrevenuewhenpersuasiveevidenceofanarrangementexists,deliveryhasoccurred,thesalespriceisfixedordeterminable,andcollectionisprobable.First,byhavingpersuasiveevidenceofanarrangementexists,thismeansthatabusinessmusthaveacontractoran

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agreementwithitscustomertoestablishclearandpersuasiveevidencethatthecustomerintendsandagreestobuyfromthebusiness.Next,onceaproducthasbeenshippedandtitleandriskoflosshavebeentransferred,thecompanydeemstheproductdelivered.MostofApple’ssalesareconsidereddeliveredatthetimeofshipment.Yet,foronlinesalesthecompanydefersrevenueuntilthecustomerobtainstheproductbecauseofriskoflossduringtransit.Thirdly,Appledecidessellingpricescontractually,dependingonwhatagreementitisspecifically.Thecompanyusesahierarchytodeterminethepricetouseforallocatingrevenue–startingwithvendor-specificobjectiveevidenceoffairvalue,followedbythird-partyevidenceofsellingprice,andendingwithbestestimateofthesellingprice.Finally,thecollectionthatitisabletomakewillnotincludeaccountspayabledeemeduncollectableatyear’sendfromcustomers.Apple’srevenuerecognitionconditionsarealignedwiththecriteriathatIdescribedinpartbabove.

d. Whataremultiple-elementcontractsandwhydotheyposerevenue

recognitionproblemsforcompanies? Multiple-elementcontractsarewhenvendorsprovidemultipleproductsorservicestotheircustomersaspartofasinglearrangementoraseriesorrelatedarrangements.Thesedeliverablesmaybeprovidedatdifferentpointsovertime.Thiscancauseissuesbecauseitisdifficultforthevendortoseparatethesemultipledeliverablesandhowtoallocatetheoverallarrangementconsideration.

e. Ingeneral,whatincentivesdomanagershavetomakeself-servingrevenue

recognitionchoices? Thinkingingeneralterms,Applesellsmostofitsproductsinaretailstoresetting.Thesemanagersmaketheirrevenuebysellingtheirproducts.Incentivesthatwouldbebeneficialtothestore,andthatwouldpotentiallymakestoreprofitabilityincreasewouldbecoupons,bundlingproducts,prizes,sales,etc.Thus,thiswouldmakethestoremanagerlookgoodfromacorporationstandpoint.

Process

f. RefertoApple’srevenuerecognitionfootnote.Inparticular,whendoesthecompanyrecognizerevenueforthefollowingtypesofsales?i. iTunessongssoldonline.

ForcertainsalesmadethroughiTunes,Appleisnottheownerofthesoftware.Thus,third-partycreatorsestablishthesellingpriceofthesoftware.Appleaccountsforthesalesoftheseproductsonanetbasis

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recognizingonlythecommissionitretainsfromeachsaleandincludingthatcommissioninnetsales.

ii. Mac-brandedaccessoriessuchasheadphones,poweradaptors,and

backpackssoldintheApplestores.Whatiftheaccessoriesaresoldonline?

Wheninstore,revenuesarerecognizedwhentheseaccessoriesaresold,atthepointofsale.Ifitisanonlinesaletoanindividual,Appledefersrevenueuntilthecustomerreceivestheproductbecauseoftheriskoflossduringtransit.Oncetheyacquiretheproduct,thenthecompanyrecognizesrevenues.Codification605-45-45-12statesthat“physicallossinventoryriskexistsiftitletotheproductsistransferredtoanentityatshippingpoint…Physicallossinventoryriskalsoexistsifanentitytakestitletotheproductafteracustomerorderhasbeenreceivedbutbeforetheproducthasbeentransferredtoacarrierforshipment.”

iii. iPodssoldtoathird-partyresellerinIndia.

Applecanrecognizethegrossamountbilledfromthethird-partyoncetheothercompanymakesasale.TheCodification605-45-55-12statesthat“revenuesfromsalesofproductsfromtheoverseassourceshouldbereportedbasedonthegrossamountchargedtocustomers.”

iv. Revenuefromgiftcards.

Thecompanyrecordsdeferredrevenueuponthesaleofthecard,whichisrelieveduponredemptionofthecardbythecustomer.

“Onmyhonor,IpledgethatIhaveneithergiven,received,norwitnessedanyunauthorizedhelponthiscase.”Signed______________________________

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