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Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-30
in whole or in part.
Case 1.2: Nike: Somewhere between a Swoosh and a Slam Dunk
I. Objectives
flows.
B. Introduce common-size and percentage-change income statements and
balance sheets and the insights that such statements provide.
first class session to discussing this last section of the case. If we cannot distribute
the case ahead of time, we devote approximately three hours of class time to
discussing the case. Alternatively, you can choose to emphasize particular
questions based on the amount of time available and refer students to the solution
for the remaining parts.
Income Statement
no indication that returns are substantial; furthermore, Nike recognizes a reduction
for return sales at the time of sales. The “Futures” ordering program likely matches
products to specific customer needs. Nike carries substantial accounts receivable
from its customers. The allowance for uncollectible accounts had a balance equal
revenue recognition appears appropriate.
b. The notes indicate that Nike uses FIFO for domestic and international inventories.
Firms are free to select their inventory cost-flow assumption from the set deemed
acceptable by standard-setting bodies. These bodies do not provide a set of criteria
Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-31
in whole or in part.
by using FIFO for reporting to foreign governments and to its shareholders in the
United States.
d. The notes indicate that in 2009, income tax expense was $469.8 million, whereas
the current amount of income taxes payable was $763.9 million, which means that
Nike paid $294.1 million in tax that increased deferred tax assets or reduced
deferred tax liabilities. Firms recognize deferred taxes for temporary differences
measuring the amount of income tax expense is the amount of revenues and
expenses recognized during the year for financial reporting. The basis for
measuring income tax payable is the amount of revenues and expenses recognized
during the year for tax reporting. Because these amounts are usually different,
bodies have permitted firms to delay paying taxes. Rather, it indicates the desire of
standard-setters to match income tax expense with income before taxes for
financial reporting.
Balance Sheet
balance in the allowance account for actual customers’ accounts deemed
uncollectible. Nike reports the balance in the allowance account as a subtraction
from gross accounts receivable.
Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-32
in whole or in part.
depreciation methods for income tax reporting even though it uses straight-line
methods for financial reporting. The accelerated methods that Nike uses for tax
reporting are determined by the government’s tax accounting rules, which permit
accelerated deductions for depreciation to encourage capital investments. Thus,
g. U.S. GAAP require firms to expense in the year incurred any expenditures (for
example, advertising, promotion, and quality control) to develop intangibles (for
example, patents, trademarks, and goodwill). Thus, expenditures made to develop
the Nike name or its trademarks will not appear on the balance sheet as assets.
h. Deferred tax assets arise when a temporary difference provides a future tax benefit
for a firm. This occurs (1) when a firm recognizes revenue earlier for tax reporting
than for financial reporting (subsequent recognition of the revenue for financial
reporting will not give rise to a tax payment) or (2) when a firm recognizes
recognizes an expense earlier for tax reporting than for financial reporting
(subsequent recognition of the expense for financial reporting does not give rise to
a tax deduction, thereby increasing taxable income and taxes payable). Note that
the classification of deferred taxes on the balance sheet depends on (1) the
Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-33
in whole or in part.
i. The FASB concluded that firms should report changes in assets and liabilities that
million).
Statement of Cash Flows
j. Under U.S. GAAP and IFRS, firms must use the accrual basis of accounting when
measuring net income. Firms usually recognize revenue at the time of sale of
k. Depreciation expense reduces net income but does not require a cash expenditure
in the year of the expense recognition. The cash effect occurred in the year a firm
acquired the property, plant, and equipment; the firm classified the cash outflow as
l. Requirement d in the text says that Nike paid more income taxes during 2009 than
it recognized as income tax expense. Net income on the first line of the statement
m. Net income on the first line of the statement of cash flows includes revenues
recognized each year. Nike does not necessarily collect cash each year in an
n. Net income on the first line of the statement of cash flows includes a subtraction
purchased more than it sold. Thus, the cash outflow for purchases potentially
Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-34
in whole or in part.
o. Accounts payable reflects amounts owed to suppliers for inventory items
included in net income to cash payments to suppliers for inventory items. The
accrued liabilities accounts reflect amounts owed to suppliers of various services.
Purchases of these services increase these liabilities, and cash payments reduce
them. Net income on the first line of the statement of cash flows includes an
p. The FASB requires firms to report the proceeds from selling property, plant, and
equipment or divesting a subsidiary as an investing activity. Their rationale for this
classification is twofold: (1) Selling such noncurrent assets is not the primary
operating activity of most companies and (2) cash expenditures to purchase these
2008 from operating activities and added proceeds of $246.0 million as an
investing activity.
q. The FASB requires firms to report changes in short-term bank borrowing as a
statement of cash flows.
Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-35
in whole or in part.
Relations between Financial Statement Items (amounts in millions):
r. Sales Revenue ................................................................................ $ 19,176.1
*Amount taken from the Consolidated Statement of Cash Flows.
s. Cost of Goods Sold ........................................................................ $ 10,571.7
Decrease in Inventories* ............................................................... (32.2)
Accounts Payable during the year.
t. Property, Plant and Equipment (at Cost):
Balance, May 31, 2008 .................................................................. $ 4 ,103.0
Purchases of Property, Plant and Equipment ................................ 423.7
Accumulated Depreciation:
Balance, May 31, 2008 .................................................................. $ 2 ,211.9
u. Retained Earnings:
Balance, May 31, 2008 .................................................................. $ 5 ,073.3
Net Income in fiscal 2009 ............................................................. 1,486.7
Retained earnings increased during 2009 by $378.1 million ($5,451.4 – $5,073.3).
Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-36
in whole or in part.
separate line in the shareholders’ equity section of the balance sheet. Nike chooses
resulting from the retention of earnings.
Interpreting Financial Statement Relationships
v. The improved net income/sales percentage in 2008 reflects the net result of a
decrease in the cost of sales percentage, an increase in the selling and
restructuring charges and impairment charges in 2009.
w. The move to apparel changes the product mix and may result in sales of more
higher-margin products. The move to Europe and other countries also may result
in higher-margin sales. The introduction of more upscale shoes also is likely to
x. The increase in selling and administrative expense to sales percentages between
2007 and 2009 likely results from the need to increase marketing efforts
(advertising and celebrity endorsements) in a period of slower growth in sales.
z. Nike has few fixed assets to serve as collateral for borrowing. Also, Nike generates
more than sufficient cash flow from operations to finance the small amount of
investments in fixed assets. Thus, Nike does not need significant notes payable or
long-term debt financing.
Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-37
in whole or in part.
operations.
cc. Cash flow from operations exceeded expenditures on property, plant, and
equipment each year, so Nike did not need to rely on external financing for its
capital expenditures. Indeed, Nike uses excess cash flows each year to pay
dividends and repurchases common shares.
of the stock.
ee. In fact, Nike increased its dividend payout rate (dividends as a percentage of net
income) during this three-year period. The total amount of dividends paid out each
year increased relative to net income. Nike may be using dividend payout together
Chapter 1
Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
1-38
in whole or in part.
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