Answer:
Whole Foods
Balance Sheet
September 28, 2008 |
Cash | $ 30,534 | Current liabilities | $ 666,177 |
Non-cash assets | 3,350,202 | Long-term liabilities | 1,208,535 |
| | Stockholders’ equity | 1,506,024 |
Total assets | $3,380,736 | Total liabilities and equity | $3,380,736 |
Topic: Balance Sheet Components
LO: 2
7. Fill in the blanks to complete the Procter & Gamble Balance Sheet ($ millions).
Procter & Gamble
Balance Sheet
September 28, 2008 |
Cash | 3,313 | Current liabilities | ? |
Non-cash assets | ? | Long-term liabilities | 43,540 |
| | Shareholders’ equity | 69,494 |
Total assets | ? | Total liabilities and equity | 143,992 |
Answer:
Procter & Gamble
Balance Sheet
September 28, 2008 |
Cash | 3,313 | Current liabilities | 30,958 |
Non-cash assets | 140,679 | Long-term liabilities | 43,540 |
| | Shareholders’ equity | 69,494 |
Total assets | 143,992 | Total liabilities and equity | 143,992 |
Topic: Retained Earnings Reconciliation
LO: 2
8. Whole Foods reports the following balances in its stockholders’ equity accounts. Fill in the blanks.
($ millions) | 2008 | 2007 | 2006 |
Retained earnings beginning of year | ? | ? | 486,299 |
Net income | ? | 182,740 | 203,828 |
Dividends | 85,300 | 121,802 | ? |
Retained earnings end of year | 439,422 | 410,198 | ? |
Answer:
($ millions) | 2008 | 2007 | 2006 |
Retained earnings beginning of year | 410,198 | 349,260 | 486,299 |
Net income | 114,524 | 182,740 | 203,828 |
Dividends | 85,300 | 121,802 | 340,867 |
Retained earnings end of year | 439,422 | 410,198 | 349,260 |
Topic: Return on Assets
LO: 3
9. Procter & Gamble reports the following items in their financial statements. Fill in the blanks.
($ millions) | 2008 | 2007 |
Average assets | 141,003 | 136,854 |
Net earnings | 12,075 | ? |
Return on assets | ? | 7.6% |
Answer:
($ millions) | 2008 | 2007 |
Average assets | 141,003 | 136,854 |
Net earnings | 12,075 | 10,340 |
Return on assets | 8.6% | 7.6% |
Topic: Return on Assets
LO: 3
10. Whole Foods reports the following items in their financial statements. Fill in the blanks.
($ thousands) | 2008 |
Average assets | 3,296,959 |
Sales | 7,953,912 |
Net income | 114,524 |
Return on assets | ? |
Profit margin | ? |
Asset turnover | ? |
Answer:
($ thousands) | 2008 |
Average assets | 3,296,959 |
Sales | 7,953,912 |
Net income | 114,524 |
Return on assets | 3.47% |
Profit margin | 1.44% |
Asset turnover | 2.41% |
Problems
Topic: Other Financial Information
LO: 1
1. In addition to the four financial statements, list three sources of financial information available to external stakeholders?
Answer:
Management Discussion and Analysis (MD&A)
Management’s report on internal controls
Annual corporate report
Auditor’s report and opinion
Notes to financial statements
Proxy statements
Various regulatory filings for SEC and IRS, etc.
Topic: Constructing Financial Statements
LO: 2
2. In its September 28, 2008 annual report, Starbucks Corporation reports the following items.
($ millions) | 2008 |
Cash flows from operations | 1,258.7 |
Total revenues | 10,383.0 |
Shareholders’ equity | 2,490.9 |
Cash flows from financing | (183.6) |
Total liabilities | 3,181.7 |
Cash, ending year | 269.8 |
Expenses | 10,067.5 |
Noncash assets | 5,402.8 |
Cash flows from investing | (1,086.6) |
Net earnings | 315.5 |
Cash, beginning year | 281.3 |
a. Prepare the balance sheet for Starbucks for September 28, 2008.
b. Prepare the income statement for Starbucks for the year ended September 28, 2008.
c. Prepare the statement of cash flows for Starbucks for the year ended September 28, 2008.
Answer:
a.
Starbucks Corporation
Balance Sheet
September 28, 2008 |
Cash | $ 269.8 | Total liabilities | $3,181.7 |
Non-cash assets | 5,402.8 | Shareholders’ equity | 2,490.9 |
Total assets | $5,672.6 | Total liabilities and equity | $5,672.6 |
b.
Starbucks Corporation
Income Statement
For Year Ended September 28, 2008 |
Total revenues | $10,383.0 |
Expenses | 10,067.5 |
Net earnings | $ 315.5 |
c.
Starbucks Corporation
Statement of Cash Flows
For Year Ended September 28, 2008 |
Cash flows from operations | $1,258.7 |
Cash flows from investing | (1,086.6) |
Cash flows from financing | (183.6) |
Net change in cash | (11.5) |
Cash, beginning year | 281.3 |
Cash at end of year | $ 269.8 |
Topic: Constructing Financial Statements
LO: 2
3. In its December 31, 2007 annual report, Mattel Inc. reports the following items.
($ thousands) | 2007 |
Net cash flows from operating activities | 560,532 |
Net sales | 5,970,090 |
Stockholders’ equity | 2,306,742 |
Net cash flows from financing activities | (579,646) |
Total assets | 4,805,455 |
Cash, ending year | 901,148 |
Expenses | 5,370,097 |
Noncash assets | 3,904,307 |
Net cash flows from investing activities | (285,290) |
Net income | 599,993 |
Cash, beginning year | 1,205,552 |
a. Prepare the balance sheet for Mattel Inc. for December 31, 2007.
b. Prepare the income statement for Mattel Inc. for the year ended December 31, 2007.
c. Prepare the statement of cash flows for Mattel Inc. for the year ended December 31, 2007.
Answer:
a.
Mattel Inc.
Balance Sheet
December 31, 2007 |
Cash | $ 901,148 | Total liabilities | $2,498,713 |
Non-cash assets | 3,904,307 | Stockholders’ equity | 2,306,742 |
Total assets | $4,805,455 | Total liabilities and equity | $4,805,455 |
b.
Mattel Inc.
Income Statement
For Year Ended December 31, 2007 |
Net sales | $5,970,090 |
Expenses | 5,370,097 |
Net income | $ 599,993 |
c.
Mattel Inc.
Statement of Cash Flows
For Year Ended December 31, 2007 |
Net cash flows from operating activities | $ 560,532 |
Net cash flows from investing activities | (285,290) |
Net cash flows from financing activities | (579,646) |
Net change in cash | (304,404) |
Cash, beginning year | 1,205,552 |
Cash at end of year | $ 901,148 |
Topic: Statement of stockholders’ equity from raw data
LO: 2
4. In its December 31, 2007 annual report, Mattel Inc. reports the following items.
($ thousands) | 2007 |
Retained earnings, December 31, 2006 | 1,652,140 |
Treasury stock, December 31, 2006 | (996,981) |
Treasury stock, December 31, 2007 | (1,571,511) |
Net income for 2007 | 599,993 |
Contributed capital, December 31, 2006 | 2,054,676 |
Dividends during 2007 | 274,677 |
Stock issued during 2007 | 21,931 |
Prepare the Statement of stockholders’ equity for Mattel Inc. for the year ended December 31, 2007.
Answer:
Mattel Inc.
Statement of Stockholders’ Equity
For Year Ended December 31, 2007 |
Contributed capital, beginning of year | $2,054,676 |
Stock issued during 2007 | 21,931 |
Contributed capital, beginning of year | $2,076,607 |
Treasury stock, beginning of year | $(996,981) |
Stock repurchased during 2007 | (574,530) |
Treasury stock, end of year | $(1,571,511) |
Retained earnings, beginning of year | $1,652,140 |
Net income for 2007 | 599,993 |
Dividends during 2007 | (274,677) |
Treasury stock, end of year | $1,977,456 |
Topic: Balance Sheet Relations
LO: 2
5. Nike Inc. has a fiscal year end of May 31. On May 31, 2007, Nike Inc. reported $10,688.3 million in assets and $7,025.4 million in equity. During fiscal 2008, Nike’s assets increased by $1,754.4 million while its equity increased by $799.9 million. What were Nike’s total liabilities at May 31, 2007 and May 31, 2008?
Answer:
Assets = Liabilities + Equity
May 31, 2007: $10,688.3 = Liabilities + $7,025.4, Liabilities = $3,362.9
May 31, 2008: $10,688.3 + $1,754.4 = Liabilities + $7,025.4 + $799.9, Liabilities = $4,617.4
Topic: Calculating ROA
LO: 3
6. Use Southwest Airlines 2008 financial statement information, below to answer the following:
a. Calculate Southwest Airlines’ return on assets (ROA) for the year ending December 31, 2008.
b. Disaggregate Southwest Airlines’ ROA into profit margin (PM) and asset turnover (AT). Explain what each ratio measures.
In millions | |
Total operating revenues | 11,023 |
Net income | 178 |
Total assets, beginning of year | 16,772 |
Total assets, end of year | 14,308 |
Equity | 4,953 |
Answer:
a. Return on Assets = Net income / Average assets
= $178 / [0.5*($16,772 + $14,308)]
= 1.1%
Return on assets measures profitability of a company—specifically, how well a company has employed its average assets in generating net income
b. Profit Margin = Net Income / Sales
= $178/ $11,023
= 1.6%
Profit Margin is an income to sales ratio that reflects the profitability of sales of a company. Southwest Airlines has a profit margin of only 1.6% meaning the company records 1.6 cents of net income (after paying taxes) for every dollar of sales. This is very low – the airline industry is performing poorly in 2008.
Asset Turnover = Sales / Average Assets
= $11,023/ [0.5*($16,772 + $14,308)]
= 0.71
Asset turnover reflects the effectiveness in generating sales from assets. Southwest Airlines’ asset turnover ratio of 0.71, means that the company generates $0.71 in sales for every $1.00 of assets.
Topic: Calculating ROA and ROE
LO: 3
7. Below are several financial statement items for two grocery chains, Whole Foods Market, an upscale organic grocer, and The Kroger Co. a mainstream grocer. ($ millions)
a. Calculate each company’s return on assets (ROA) and return on equity (ROE). Comment on any differences you observe.
b. Disaggregate the ROA for each company into profit margin (PM) and asset turnover (AT). Explain why Kroger has a higher ROA, is it because of PM or AT or both?
| Whole Foods Market | The Kroger Co. |
Net income | 115 | 1,181 |
Sales | 7,954 | 70,235 |
Average assets | 3,297 | 21,757 |
Average stockholders’ equity | 1,482 | 4,919 |
Answer:
a. Return on Assets = Net income / Average assets
Whole Foods = $115 / $3,297 = 3.5%
Kroger = $1,181 / $21,757 = 5.4%
Return on equity = Net income / Average stockholders’ equity
Whole Foods: = 115 / $1,482 = 7.8%
Kroger = $1,181 / $4,919 = 24%
Kroger appears to be more profitable – ROA and ROE are both higher. This is surprising because Whole Foods is a premium grocery store. Perhaps the recent economic downturn in 2007 is causing high-end food buyers to substitute some purchases for more mainstream groceries such as those sold at Kroger.
b. Profit margin = Net income / Sales
Whole Foods = $115 / $7,954 = 1.4%
Kroger = $1,181 / $70,235 = 1.7%
Asset turnover = Sales / Average assets
Whole Foods = $7,954 / $3,297 = 2.4
Kroger = $70,235 / $21,757 = 3.2
Kroger has a higher return on assets because its profit margin is higher and its turnover is higher. Thus Kroger is more profitable and more efficient.
Topic: Competitive Analysis
LO: 4
8. List three of the five competitive forces that confront the company and determine its competitive intensity. Briefly explain each force that you list.
Answer:
These following are the five forces that are key determinants of profitability.
1) Industry competition: Competition and rivalry raise the cost of doing business as companies must hire and train competitive workers, advertise products, research and develop products, and other related activities.
2) Bargaining power of buyers: Buyers with strong bargaining power can extract price concessions and demand a higher level of service and delayed payment terms; this force reduces both profits from sales and the operating cash flows to sellers.
3) Bargaining power of suppliers: Suppliers with strong bargaining power can demand higher prices and earlier payments, yielding adverse effects on profits and cash flows to buyers.
4) Threat of substitution: As the number of product substitutes increases, sellers have less power to raise prices and/or pass on costs to buyers; accordingly, threat of substitution places downward pressure on profits of sellers.
5) Threat of entry: New market entrants increase competition; to mitigate that threat, companies expend monies on activities such as new technologies, promotion, and human development to erect barriers to entry and to create economies of scale.
Topic: The Role of Auditors in Financial Reporting
LO: 5
9. What potential conflicts of interests do auditing firms face in conducting audits of publicly traded companies?
Answer: Auditors often face the issue how to deal with mistakes or deceptive reporting methods of clients, while still trying to please the management of these client firms that ultimately pay their fees. This conflict could lead to auditing firms viewing the CEO, rather than the shareholders or directors, as their client. Warren Buffet has been particularly critical of potential conflicts of interest involving auditors.
Topic: The Effect of the Sarbanes-Oxley Act
LO: 5
10. Accounting debacles, such as in the case of Enron, brought to light the necessity of accuracy in financial reporting and accountability of management. Describe how the introduction of the Sarbanes-Oxley Act has changed the requirements of financial reporting.
Answer: Congress introduced the Sarbanes-Oxley act as a way of restoring confidence in the integrity of financial statement reporting of publicly traded companies. The Act requires the chief executive officer and chief financial officer of the company to personally sign-off on the accuracy and completeness of financial statements and the integrity of the company’s system of internal controls. This requirement is designed to hold management personally accountable for negligence in financial reporting and encourage vigilance in monitoring the company’s financial accounting system.
Essay Questions
Topic: Costs and Benefits of Disclosure
LO: 1
1. Explain the benefits and costs associated with a company's disclosure of information.
Answer:
Supplying information benefits a company by helping it to compete in capital, labor, input, and output markets. A company’s performance hinges on successful business activities and the markets’ awareness of that success. Economic incentives exist for those companies that disclose reliable accounting information, especially when the company discloses good news about products, processes, management, etc. Direct costs associated with the disclosure of information pertain to its preparation and dissemination. More significant are other costs including competitive disadvantage, litigation potential, and political costs. Managers must weigh these costs and benefits to determine how much information to voluntarily disclose.
Topic: Demand for Financial Accounting Information
LO: 1
2. List three users of financial accounting information and explain how each user might use financial information.
Answer:
Managers and employees – Managers and employees demand financial information on the financial condition, profitability and prospects of their companies for their own well-being and future earnings potential. They also demand comparative financial information on competing companies and other business opportunities. This permits them to conduct comparative analyses to benchmark company performance and condition.
Creditors and suppliers – Creditors and other lenders demand financial accounting information to help decide loan terms, dollar amounts, interest rates and collateral. Suppliers similarly demand financial information to establish credit sales terms and to determine their long-term commitment to supply-chain relations. Both creditors and suppliers use financial information to continuously monitor and adjust their contracts and commitments with a debtor company.
Shareholders and directors – Shareholders and directors demand financial accounting information to assess the profitability and risks of companies. Shareholders look for information useful in their investment decisions. Both directors and shareholders use accounting information to evaluate manager performance Managers similarly use such information to request further compensation and managerial power from directors. Outside directors are crucial to determining who runs the company, and these directors use accounting information to evaluate manager performance.
Customers and Sales Staffs – Customers and sales staffs demand accounting information to assess the ability of the company to provide products or services as agreed and to assess the company’s staying power and reliability. Customers and sales staffs also wish to estimate the company’s profitability to assess fairness of returns on mutual transactions.
Regulators and Tax Agencies – Regulators and tax agencies demand accounting information for tax policies, antitrust assessments, public protection, price setting, import-export analyses and various other uses. Timely and reliable information is crucial to effective regulatory policy. Moreover, accounting information is often central to social and economic policy.
Voters and their Representatives – Voters and their representatives to national, state and local governments demand accounting information for policy decisions. The decisions can involve economic, social, taxation and other initiatives. Voters and their representatives also use accounting information to monitor government spending. Contributors to nonprofit organizations also demand accounting information to assess the impact of their donations.
Topic: Owner vs. Nonowner Financing
LO: 2
3. Businesses rely on financing activities to fund their operating and investments. Explain the difference between owner and non-owner financing, and explain the benefits and risks involved in relying more heavily on each type of financing.
Answer:
Owner financing, also called equity, refers to money given to the business in exchange for partial control of the company. Stocks are the most common form of owner financing. Companies are not obligated to guarantee a return on owner investments. However, if returns are unacceptable to owners, they may use their power to take the business in different directions. In sum, owner financing provides cash inflow to the company without any guarantee of repayment. Control over the company is vested in the shareholders.
Non-owner financing refers to money given to the business in exchange for a guaranteed repayment, usually with interest. Loans and bonds are very common examples of non-owner investment. The risk to the company lies in potential default if operations decline. The benefit is that the company does not need to cede operational control to its creditors, unless it defaults on its repayment. In sum, non-owner financing allows the current owners to maintain full control of the company, but requires repayment with interest.
Companies that rely more heavily on owner financing are said to be financed conservatively. Companies that rely more heavily on non-owner financing are said to be financed less conservatively.
Topic: Usefulness of ROA for Managers
LO: 3
4. Investors and lenders place significant importance on management’s effectiveness in generating a high return on assets (ROA). Explain how ROA is also important for managers’ analysis of its own performance, particularly when ROA is disaggregated.
Answer:
Return on assets (ROA) is a helpful measure of a company’s profitability. In its most basic form, ROA is a ratio between net income and average assets, i.e. it indicates the return the company is earning from its assets. While ROA is a valuable indicator for investors, it is just as valuable for company managers. This is because ROA indicates how successful managers are in acquiring and using investments on behalf of shareholders.ROA is particularly useful for managers when it is disaggregated into more focused, meaningful components.
Return on assets can be ‘disaggregated’ into profit margin (PM), which measures profitability and asset turnover (AT), which measures efficiency or productivity.
The ratio of net income to sales is called ‘profit margin’ and the ratio of sales to average assets is called ‘asset turnover.’ The profit component reflects the amount of profit from each dollar of sales, and the productivity component reflects the effectiveness in generating sales from assets.
This disaggregation yields additional insights into the factors that cause overall ROA to change during the year. It could be that the company is more or less profitable or that the company is more or less efficient or both. This disaggregation provides more informative than just knowing that ROA has increased or decreased during the year.
Topic: Corporate Governance
LO: 5
5. Describe three corporate governance mechanisms that are in place to protect users of financial information.
Answer:
Audit Committee - ultimately determined by the company’s Board of Directors. The Board of Directors is elected by the stockholders. They then establish various committees as a form of governance over different areas like strategic plans and financial management. The Audit Committee is responsible for overseeing the audit and meeting with the auditors. The committee must comprise outside directors who focus on internal controls and other policies that ensure reliable accounting.
Sarbanes-Oxley Certification and Statement of Management Responsibility – The Sarbanes-Oxley Act requires the CEO and CFO to certify to the accuracy of financial statements they issue and the efficacy of the company’s internal controls. In addition, the Statement of Management Responsibility asserts that management prepares and assumes responsibility for the financial statements. The financial statements are to be prepared in accordance with the GAAP. Additionally, the system of internal controls should provide assurance that assets are protected. The financial statements are then audited by an outside auditing firm. Finally, the Board of Directors has an Audit Committee to oversee the financial accounting system and internal controls.
Independent audit firm - performs an audit and expresses an opinion whether the financial statements present a company’s financial condition fairly and whether they are prepared in accordance with the GAAP. The financials are management’s responsibility. Auditing involves sampling various transactions and not every transaction during the year. The audit opinion provides assurance that there are no gross material misstatements but is not a guarantee.
SEC - The SEC has the ultimate power in deciding whether to accept or deny the statements depending on the statements’ integrity. If there is a problem, the company may be asked to restate and re-file the statements with the SEC. A restatement is a serious event and could cause the company to lose market value and reputation. Therefore, it is very important that companies submit correct financial statements the first time.
Courts - individuals or other investors that incur financial damages due to errors in a company’s financial statements can seek remedy in the courts. The courts are responsible for settling the dispute and assessing damages to the harmed party.
