978-1337614689 Chapter 1 Part 2

Overview of Financial Reporting, Financial

Exhibit 1.C—(Problem 1.12)

Nippon

Toyota

Deutsche

Inter-

public

Roche

Marks &

BNP Steel Motor Telekom Accor Group Oracle E.ON Holding Spencer Carrefour Nestlé

1 2 3 4 5 6 7 8 9 10 11 12

BALANCE SHEET

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Statement Analysis, and Valuation

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1.13 Value Chain Analysis and Financial Statement Relations. There are various

approaches to this problem. One approach begins with a particular company,

unique characteristic.

the highest profit margins (that is, net income divided by sales). This would suggest

that Firm (1) is neither Wyeth nor Amgen. Also, Firm (1) has the highest cost of

competition among generic firms should give Mylan a lower profit margin. This

reasoning would suggest that Johnson & Johnson is Firm (7) and Mylan is Firm (1).

Firm (7) also has higher selling and administrative expenses versus Firm (1),

consistent with Johnson & Johnson. The low profit margin of Mylan is the result of

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Statement Analysis, and Valuation

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We are now left with Covance, Cardinal Health, and Walgreens as Firms (2),

(5), and (6). Covance will have very low inventories, whereas Cardinal Health

Covance. This firm will need property, plant, and equipment to conduct the testing

of new drugs. Of the remaining two firms, Cardinal Health and Walgreens,

Walgreens will likely have a higher proportion of assets in property, plant, and

Chapter 1

Overview of Financial Reporting, Financial

Statement Analysis, and Valuation

Exhibit 1.D—(Problem 1.13)

Mylan

Cardinal

Laboratories

Health

Amgen

Wyeth

Covance Walgreens J&J

INCOME STATEMENT

Operating Revenues 100.0% 100.0%

100.0% 100.0%

100.0%

Cost of sales (excluding depreciation) or operating expenses (59.7) (94.4) (15.3) (27.4) (62.5) (72.2)

(29.0)

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Integrative Case 1.1: Walmart

I. Objectives

A. Identify the economics characteristics of the retail industry and Walmart’s

strategy for competing in this industry as background for the integrative case

works well because it is a company that most students understand and find

interesting.

II. Teaching Strategy—We have taught this case with two approaches. If an

opportunity exists to distribute the case prior to the first class, we give students the

solutions to the questions involving the balance sheet, income statement, statement

you can choose to emphasize particular questions based on the amount of time

available and refer students to the solution for the remaining parts.

Note to Instructors:

Walmart is a good company to use for classroom discussion and demonstration of

the techniques throughout this book. Students generally relate easily and readily to

Walmart because they are familiar with Walmart’s retail stores. As a company and

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Industry and Strategy Analysis

a. Porter’s five forces applied to the retail industry:

1. Buyer Power: Buyer power for consumer goods from large retail chains is

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b. Walmart competes on the bases of price, a very large selection of consumer goods,

and convenient store locations. Walmart has a competitive advantage in its brand

name, as a recognized retailer of consumer goods at relatively low prices. Walmart

also has established a competitive advantage through its scale. Given its enormous

size, it has tremendous buying power over suppliers of consumer goods. Walmart

is further leveraging its brand name by selling consumer goods through large

chains of “big box” retail stores, Sam’s Club warehouse stores, and smaller scale

retail stores.

Balance Sheet

c. Cash includes cash on hand and in checking accounts. Cash equivalents include

amounts that a firm can easily convert into cash. Cash equivalents usually have a

maturity date of less than three months at the time of purchase so that changes in

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h. Walmart’s largest liability is long-term debt, which was likely used to finance

Income Statement

apparent on the balance sheet are cash and cash equivalents, which only amount

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Statement of Cash Flows

m. Firms use the accrual basis of accounting in measuring net income. Firms usually

recognize revenue at the time of sale of goods and services, not necessarily when

they receive cash from customers. Firms attempt to match expenses with the time

periods during which they consume economic resources, regardless of when they

expend cash. The accrual basis gives a better indication of a firm’s operating

performance than the cash basis because of the matching of inputs and outputs.

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Relations between Financial Statements

s. Explain the change in retained earnings.

Net income, dividends, and stock repurchases explain almost all of the change in

Interpreting Financial Statement Relations

t. A cautionary note with interpreting percentage changes is that large percentage

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Case 1.2: Nike: Somewhere between a Swoosh and a Slam Dunk

I. Objectives

II. Teaching Strategy—We have taught this case with two approaches. If an

opportunity exists to distribute the case prior to the first class session, we give

Income Statement

a. For wholesale and retail customers, Nike apparently recognizes revenues from the

on either an average or specific-identification cost basis. For inventories in transit

supplies (e.g., thousands of pairs of a particular type of shoe), so using average

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c. Nike outsources its manufacturing. Thus, depreciation expense relates to buildings

current amount of income taxes payable was $943 million, which means that Nike

paid $80 million in tax that increased deferred tax assets or reduced deferred tax

2016 was greater than its income before taxes for financial reporting. Note 9,

revenues and expenses recognized during the year for financial reporting. The

basis for measuring income tax payable is the amount of revenues and expenses

Balance Sheet

f. The allowance for uncollectible accounts arises because, under accrual accounting,

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likely to collect 100% of the amount reported as sales revenue, it must recognize

balance sheet, but this is not the case for Nike because it outsources its

manufacturing of inventory.

h. The notes indicate that Nike uses the straight-line method for buildings and

leasehold improvements, and machinery and equipment. As with the inventory

cost-flow assumption, standard-setting bodies give firms freedom to select any

example, advertising, promotion, and quality control) to develop intangibles (for

Statement of Cash Flows

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of resources generated and consumed in a particular period, apart from the cash

flows of the period. The operating activities section of the statement of cash flows

reports the amount of cash received from customers net of amounts paid to

suppliers of goods and services.

sold included in net income to cash payments to suppliers for inventory items.

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Relations between Financial Statement Items (amounts in millions):

s. Reconcile the change in retained earnings:

difference arise because the amounts of dividends declared in 2016 are greater than

the amounts paid during 2016. This suggests there is some amount of dividends

payable on the balance sheet at the end of fiscal 2016.

Interpreting Financial Statement Relationships

t. The improved net income/sales percentage in 2015 reflects the net result of several

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Statement Analysis, and Valuation

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u. Nike outsources its manufacturing and most of the retailing of its products. Thus,

the property, plant, and equipment needs of Nike for production purposes are

minimal. The principal fixed assets are corporate headquarters, research facilities,

warehouses, and transportation equipment. One might think of Nike as serving

essentially a wholesaling function along with product development and promotion.

v. 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.