FAST

Resource2.pdf

Home >Business & Finance homework help >Accounting homework help >FAST

Chapter

3 Balance Sheet

The principal financial statements are the balance sheet, income statement, and state-ment of cash flows. This chapter will review the balance sheet in detail. Other titlesused for the balance sheet are statement of financial position and statement of finan- cial condition. The title balance sheet is the predominant title used.1

Another statement, called the statement of stockholders’ equity, reconciles the changes in stockholders’ equity, a section of the balance sheet. This statement will also be reviewed in this chapter. Many alternative titles are used for the statement of stockholders’ equity. The title most frequently used is the statement of stockholders’ equity. Another frequently used title is the statement of shareholders’ equity.2

Basic Elements of the Balance Sheet A balance sheet shows the financial condition of an accounting entity as of a particular date. The balance sheet consists of assets, the resources of the firm; liabilities, the debts of the firm; and stockholders’ equity, the owners’ interest in the firm.

The assets are derived from two sources, creditors and owners. At any point in time, the assets must equal the contribution of the creditors and owners. The accounting equation expresses this relationship:

Assets = Liabilities + Stockholders’ Equity

On the balance sheet, the assets equal the liabilities plus the stockholders’ equity. This may be presented side by side (account form) or with the assets at the top and the liabilities and stockholders’ equity at the bottom (report form). Exhibit 3-1 presents a typical report form format, and Exhibit 3-2 presents a typical account form format. The report form is dominant in the United States.3

Balance sheet formats differ across nations. For example, nations influenced by British financial reporting report the least liquid assets first and cash last. Nations influenced by the United States report a balance sheet emphasizing liquidity, as illustrated in this chapter.RS

he rw oo

d Ve ith

/i St oc kp

ho to .c om

Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

EXHIBIT 3-1 Quaker Chemical Corporation*

QUAKER CHEMICAL CORPORATION CONSOLIDATED BALANCE SHEET

Report Form

December 31,

2010 2009

(In thousands, except par value and share amounts)

ASSETS Current Assets Cash and cash equivalents $ 25,766 $ 25,051 Construction fund (restricted cash) — 2,358 Accounts receivable, net 116,266 108,793 Inventories 60,841 50,040 Current deferred tax assets 4,624 5,523 Prepaid expenses and other current assets 7,985 7,409

Total current assets 215,482 199,174 Property, plant and equipment, net 76,535 67,426 Goodwill 52,758 46,515 Other intangible assets, net 24,030 5,579 Investments in associated companies 9,218 8,824 Non-current deferred tax assets 28,846 28,237 Other assets 42,561 39,537

Total assets $449,430 $395,292

LIABILITIES AND EQUITY Current liabilities Short-term borrowings and current portion of long-term debt $ 890 $ 2,431 Accounts payable 61,192 58,389 Dividends payable 2,701 2,550 Accrued compensation 17,140 16,656 Accrued pension and postretirement benefits 1,672 4,717 Current deferred tax liabilities 181 213 Other current liabilities 17,415 15,224

Total current liabilities 101,191 100,180 Long-term debt 73,855 63,685 Non-current deferred tax liabilities 6,108 5,213 Accrued pension and postretirement benefits 30,016 27,602 Other non-current liabilities 51,161 42,317

Total liabilities 262,331 238,997 Commitments and contingencies — —

Equity Common stock, $1 par value; authorized 30,000,000 shares; Issued:

2010-11,492,142 shares, 2009-11,085,549 shares 11,492 11,086 Capital in excess of par value 38,275 27,527 Retained earnings 144,347 123,140 Accumulated other comprehensive loss (13,736) (10,439)

Total Quaker shareholders’ equity 180,378 151,314 Noncontrolling interest 6,721 4,981 Total equity 187,099 156,295

Total liabilities and shareholders’ equity $449,430 $395,292

*“Quaker develops, produces, and markets a broad range of formulated chemical specialty products for various heavy industrial and manufacturing applications and, in addition, offers and markets chemical management services (“CMS”).” 10-K Source: Quaker Chemical Corporation 2010 10-K

96 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

EX H IB IT 3- 2

Z eb ra

T ec hn

ol og ie s C or po

ra tio

A cc ou

nt Fo

Z eb ra

T ec hn

ol og

ie s C or po

ra ti on

C on

so lid

at ed

B al an

ce Sh

ee ts

(A m ou

nt s in

th ou

sa nd

D ec em

be r 31

, D ec em

be r 31

20 10

20 09

20 10

20 09

A SS E T S

L IA

B IL IT

IE S A N D

ST O C K H O L D E R S’

E Q U IT

Y C ur re nt

A ss et s:

C ur re nt

lia bi lit ie s:

C as h an

d eq ui va le nt s

$ 47

,4 76

$ 38

,9 43

A cc ou

nt s pa

ya bl e

$ 35

,3 04

$ 28

,1 37

R es tr ic te d ca sh

1, 37

8 1, 72

5 A cc ru ed

lia bi lit ie s

68 ,0 90

52 ,5 91

In ve st m en ts an

d m ar ke ta bl e se cu ri ti es

12 5, 56

7 11

4, 06

4 D ef er re d re ve nu

e 26

,7 57

24 ,0 82

A cc ou

nt s re ce iv ab

le ,n

et of

al lo w an

ce of

$2 ,1 61

in 20

10 an

d $2

,1 86

in 20

09 15

4, 14

6 15

0, 99

2 In co m e ta xe s pa

ya bl e

5, 90

0 —

T ot al

cu rr en t lia

bi lit ie s

13 6, 05

1 10

4, 81

0 In ve nt or ie s, ne t

11 3, 74

2 79

,9 26

D ef er re d re nt

2, 40

6 4, 10

8 D ef er re d in co m e ta xe s

19 ,1 62

10 ,7 92

O th er

lo ng

-t er m

lia bi lit ie s

10 ,3 75

9, 43

2 In co m e ta xe s pa

ya bl e

— 4, 72

4 T ot al

lia bi lit ie s

14 8, 83

2 11

8, 35

0 Pr ep ai d ex pe ns es

an d ot he r cu rr en t as se ts

14 ,8 33

9, 77

1 C om

m it m en ts an

d co nt in ge nc ie s (N

ot e 11

) T ot al

C ur re nt

A ss et s

47 6, 30

4 41

0, 93

7 St oc kh

ol de rs ’ eq ui ty :

Pr op

er ty

an d eq ui pm

en t at

co st ,n

et of

ac cu m ul at ed

de pr ec ia ti on

an d am

or ti za ti on

: 88

,9 83

77 ,5 89

Pr ef er re d st oc k

— —

C la ss

A C om

m on

St oc k

72 2

L on

g te rm

de fe rr ed

in co m e ta xe s

21 ,2 54

35 ,8 42

A dd

it io na

lp ai d ca pi ta l

12 9, 71

5 13

6, 10

4 G oo

dw ill

15 1, 93

3 15

3, 22

5 T re as ur y st oc k

(4 62

,0 29

) (3 85

,8 31

) O th er

in ta ng

ib le s, ne t

49 ,7 06

55 ,9 82

R et ai ne d ea rn in gs

1, 07

0, 97

3 96

9, 19

5 L on

g te rm

in ve st m en ts an

d m ar ke ta bl e se cu ri ti es

85 ,4 78

91 ,9 89

A cc um

ul at ed

ot he r co m pr eh en si ve

in co m e (l os s)

(9 ,3 49

) (8 ,0 61

) O th er

as se ts

5, 20

6 4, 91

5 T ot al

st oc kh

ol de rs ’ eq ui ty

73 0, 03

2 71

2, 12

9 T ot al

as se ts

$8 78

,8 64

$8 30

,4 79

T ot al

lia bi lit ie s an

d st oc kh

ol de rs ’ eq ui ty

$ 87

8, 86

4 $ 83

0, 47

*“ Z eb ra

de liv

er s pr od

uc ts an

d so lu ti on

s th at

im pr ov

e ou

r cu st om

er s’ ab

ili ty

to pu

t th ei r cr it ic al

as se ts to

w or k sm

ar te r by

id en ti fy in g,

tr ac ki ng

an d m an

ag in g as se ts ,t ra ns ac ti on

s an

d pe op

le .”

10 -K

So ur ce :Z

eb ra

T ec hn

ol og

ie s C or po

ra ti on

20 10

10 -K

CHAPTER 3 • Balance Sheet 97

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Assets Assets are probable future economic benefits obtained or controlled by an entity as a result of past transactions or events.4 Assets may be physical, such as land, buildings, inventory of supplies, material, or finished products. Assets may also be intangible, such as patents and trademarks.

Assets are normally divided into two major categories: current and noncurrent (long- term). Current assets are assets (1) in the form of cash (2) that will normally be realized in cash or (3) that conserve the use of cash during the operating cycle of a firm or for one year, whichever is longer. The operating cycle covers the time between the acquisition of inventory and the realization of cash from selling the inventory. Noncurrent or long-term assets take longer than a year or an operating cycle to be converted to cash or to conserve cash. Some industries, such as banking (financial institutions), insurance, and real estate, do not divide assets (or liabilities) into current and noncurrent. Chapter 12 reviews specialized industries.

When a significant subsidiary is consolidated from an industry that does not use the con- cept of current and noncurrent, then the consolidated statements will not use the concept of current and noncurrent. These companies often present supplementary statements, handling the subsidiary as an investment (nonconsolidated).

For example, General Electric does not use the concept of current and noncurrent. Gen- eral Electric Company’s consolidated financial statements represent the combination of man- ufacturing and nonfinancial services businesses of General Electric Company (GE) and the accounts of General Electric Capital Services, Inc. (GECS).

Current Assets Current assets are listed on the balance sheet in order of liquidity (the ability to be converted to cash). Current assets typically include cash, marketable securities, short-term receivables, inventories, and prepaids. In some cases, assets other than these may be classified as current. If so, management is indicating that it expects the asset to be converted into cash during the operating cycle or within a year, whichever is longer. An example is land held for immediate disposal. Exhibit 3-3 includes the items that the 2006 edition of Accounting Trends & Tech- niques reported as being disclosed as other current assets. The definition of current assets excludes restricted cash, investments for purposes of control, long-term receivables, the cash surrender value of life insurance, land and other natural resources, depreciable assets, and long-term prepayments.

Cash

Cash, the most liquid asset, includes negotiable checks and unrestricted balances in checking accounts, as well as cash on hand. Savings accounts are classified as cash even though the bank may not release the money for a specific period of time. Exhibit 3-4 illustrates the pre- sentation of cash.

EXHIBIT 3-3 Other Current Asset Captions*

Number of Entities

Nature of Asset 2009 2008 2007 2006

Deferred and prepaid income taxes 381 371 450 434 Derivatives 232 55 50 56 Property held for sale 79 80 120 120 Unbilled costs 15 13 24 21 Advances or deposits 8 22 23 18 Other – identified 33 48 41 37

*Appearing in either the balance sheet or the notes to financial statements 2008 – 2009 based on 500 entities surveyed; 2006 – 2007 based on 600 entities surveyed. Source: Accounting Trends & Techniques, copyright © 2010 by American Institute of Certified Public Accountants, Inc., p. 175. Reprinted with permission.

98 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Marketable Securities

Marketable securities (also labeled short-term investments) are characterized by their mar- ketability at a readily determinable market price. A firm holds marketable securities to earn a return on near-cash resources. Management must intend to convert these assets to cash during the current period for them to be classified as marketable securities.

The carrying basis of debt and equity marketable securities is fair value. Refer to Exhibit 3-4 for a presentation of marketable securities.

Accounts Receivable

Accounts receivable are monies due on accounts that arise from sales or services rendered to customers. Accounts receivable are shown net of allowances to reflect their realizable value. This amount is expected to be collected. The most typical allowances are for bad debts (uncollectible accounts). Other allowances may account for expected sales discounts, which are given for prompt payment or for sales returns. These types of allowances recognize expenses in the period of sale, at which time the allowance is established. In future periods, when the losses occur, they are charged to the allowance. All of the allowances are presented in one allowance account. Exhibit 3-4 presents the accounts receivable of SeaChange Inter- national, Inc. (less allowances). At January 31, 2011, the firm expects to realize $48,843,000. The gross receivables can be reconciled as follows:

Receivables, net $48,843,000 Plus: Allowances 995,000 Receivables, gross $49,838,000

Other receivables may also be included in current assets. These receivables may result from tax refund claims, investees/affiliates, contracts, finance, retained interest in sold receiv- ables, insurance claims, vendors/suppliers, asset disposals, and employees.

Receivables other than trade receivables include tax refund claims, affiliates, contracts, finance, and insurance claims.5

Inventories

Inventories are the balance of goods on hand. In a manufacturing firm, they include raw materials, work in process, and finished goods. In a retail firm the inventory is merchandise inventory. Inventories will be carried at cost, expressed in terms of lower-of-cost-or-market.

EXHIBIT 3-4 SeaChange International, Inc.*

SEACHANGE INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEET (In Part)

(In thousands, except share data)

January 31, 2011

January 31, 2010

ASSETS Current Assets: Cash and cash equivalents $ 73,145 $ 37,647 Restricted cash 1,332 73 Marketable securities 7,340 2,114 Accounts receivable, net of allowance for doubtful accounts of

$995 in 2011 and $852 in 2010, respectively 48,843 50,337 Unbilled receivables 5,644 3,941 Inventories, net 14,393 17,830 Prepaid expenses and other current assets 7,148 7,253 Deferred tax assets 3,775 2,474

Total current assets 161,620 121,669

*“SeaChange International, Inc. (“SeaChange”, “we” or “us”), a Delaware corporation founded on July 9, 1993, is a global leader in the delivery of multi-screen video.” 10-K Source: Seachange International, Inc. 2010 10-K

CHAPTER 3 • Balance Sheet 99

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

(Cost methods and lower-of-cost-or-market are covered in Chapter 7.) Refer to Exhibit 3-5 for a presentation of inventory.

Raw Materials These are goods purchased for direct use in manufacturing a product, and they become part of the product. For example, in the manufacture of shirts, the fabric and buttons would be raw materials.

EXHIBIT 3-5 Simpson Manufacturing Co., Inc.*

Illustration of Inventory

Simpson Manufacturing Co., Inc. and Subsidiaries Consolidated Balance Sheets (In Part) (In thousands, except per share data)

December 31,

2010 2009

ASSETS Current assets Cash and equivalents $335,049 $250,381 Trade accounts receivable, net 68,256 77,317 Inventories 152,297 163,754 Deferred income taxes 10,189 13,970 Assets held for sale 10,787 7,887 Other current assets 14,678 16,766

Total current assets 591,256 530,075

Notes to Consolidated Financial Statements (In Part)

1. Operations and Summary of Significant Accounting Policies (In Part)

Inventory Valuation Inventories are stated at lower of cost or net realizable value (market). Cost includes all costs incurred in bringing each product to its present location and condition, as follows:

• Raw materials and purchased finished goods for resale – principally valued at cost determined on a weighted average basis.

• In-process products and finished goods – cost of direct materials and labor plus attributable overhead based on a normal level of activity.

The Company applies net realizable value and obsolescence to the gross value of the inventory. The Company estimates net realizable value based on estimated selling price less further costs to comple- tion and disposal. The Company provides for slow-moving products by comparing inventories on hand to future projected demand. Obsolete inventory is on-hand supply of a product in excess of two years’ sales of that product or a supply of that product that the Company believes is no longer marketable. The Company revalues obsolete inventory as having no net realizable value and writes off its full carrying value. The Company has consistently applied this methodology. The Company believes that this approach is prudent and makes suitable provisions for slow-moving and obsolete inventory. When provisions are established, a new cost basis of the inventory is created.

4. Inventories

The components of inventories consisted of the following:

December 31,

(In thousands) 2010 2009

Raw materials $ 61,996 $ 61,408 In-process products 18,364 21,113 Finished products 71,937 81,233

$152,297 $163,754

*“Simpson Manufacturing Co., Inc., a Delaware Corporation, (the “Company”), through its subsidiary, Simpson Strong-Tie Company Inc. (“Simpson Strong-Tie” or “SST”), designs, engineers and is a leading manufacturer of wood-to-wood, wood-to-concrete and wood-to-masonry connectors, fasteners and fastening systems, and pre-fabricated shearwalls.” 10-K Source: Simpson Manufacturing Co., Inc, 10-K

100 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Work in Process Work in process represents goods started but not ready for sale. Work in process includes the cost of materials, labor costs for workers directly involved in the manu- facture, and factory overhead. Factory overhead includes such cost items as rent, indirect wages, and maintenance.

Finished Goods Finished goods are inventory ready for sale. These inventory costs also include the cost of materials, labor costs for workers directly involved in the manufacture, and a portion of factory overhead.

Since retailing and wholesaling firms do not engage in the manufacture of a product but only in the sale, their only inventory item is merchandise. These firms do not have raw mate- rials, work in process, inventory, or finished goods.

Supplies In addition to goods on hand, the firm may have supplies. Supplies could include register tapes, pencils, or sewing machine needles for the shirt factory. Details relating to in- ventory are usually disclosed in a note.

Prepaids

A prepaid is an expenditure made in advance of the use of the service or goods. It represents future benefits that have resulted from past transactions. For example, if insurance is paid in advance for three years, at the end of the first year, two years’ worth of the outlay will be prepaid. The entity retains the right to be covered by insurance for two more years.

Typical prepaids include advertising, taxes, insurance, promotion costs, and early payments on long-term contracts. Prepaids are often not disclosed separately. In both Exhibit 3-1 and Exhibit 3-2, the prepaid account is not disclosed separately.

Long-Term Assets Long-term assets are usually divided into four categories: tangible assets, investments, intan- gible assets, and other.

Tangible Assets

These are the physical facilities used in the operations of the business. The tangible assets of land, buildings, machinery, and construction in progress will now be reviewed. Accumulated depreciation related to buildings and machinery will also be reviewed.

Land Land is shown at acquisition cost and is not depreciated because land does not get used up. Land containing resources that will be used up, however, such as mineral deposits and timberlands, is subject to depletion. Depletion expense attempts to measure the wearing away of these resources. It is similar to depreciation except that depreciation deals with a tangible fixed asset and depletion deals with a natural resource.

Buildings Structures are presented at cost plus the cost of permanent improvements. Build- ings are depreciated (expensed) over their estimated useful life.

Machinery Machinery is listed at historical cost, including delivery and installation, plus any material improvements that extend its life or increase the quantity or quality of service. Machinery is depreciated over its estimated useful life.

Construction in Progress Construction in progress represents cost incurred for projects under construction. These costs will be transferred to the proper tangible asset account upon completion of construction. The firm cannot use these assets while they are under construc- tion. Some analysis is directed at how efficiently the company is using operating assets. This analysis can be distorted by construction in progress, since construction in progress is classi- fied as part of tangible assets. To avoid this distortion, construction in progress should be classified under long-term assets, other.

Accumulated Depreciation Depreciation is the process of allocating the cost of buildings and machinery over the periods benefited. The depreciation expense taken each period is accumulated in a separate account (Accumulated Depreciation). Accumulated depreciation is

CHAPTER 3 • Balance Sheet 101

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

subtracted from the cost of plant and equipment. The net amount is the book value of the asset. It does not represent the current market value of the asset.

There are a number of depreciation methods that a firm can use. Often, a firm depreci- ates an asset under one method for financial statements and another for income tax returns. A firm often wants to depreciate slowly for the financial statements because this results in the highest immediate income and highest asset balance. The same firm would want to de- preciate faster for income tax returns because this results in the lowest immediate income and thus lower income taxes. Over the life of an asset, the total depreciation will be the same regardless of the depreciation method selected.

Three factors are usually considered when computing depreciation: (1) the asset cost, (2) length of the life of the asset, and (3) its salvage value when retired from service. The length of the asset’s life and the salvage value must be estimated at the time that the asset is placed in service. These estimates may be later changed if warranted.

Exhibit 3-6 indicates the depreciation methods used for financial reporting purposes by the firms surveyed for the 2010 edition of Accounting Trends & Techniques. The most pop- ular method was straight-line. Many firms use more than one depreciation method.

The following assumptions will be made to illustrate some depreciation methods:

1. Cost of asset—$10,000 2. Estimated life of asset—5 years 3. Estimated salvage (or residual) value—$2,000 4. Estimated total hours of use—16,000

Straight-Line Method The straight-line method recognizes depreciation in equal amounts over the estimated life of the asset. Compute depreciation using the straight-line method as follows:

Cost� Salvage Value Estimated Life

¼ Annual Depreciation

For the asset used for illustration, the annual depreciation would be computed as follows:

$10,000� $2,000 5 years

¼ $1,600

The $1,600 depreciation amount would be recognized each year of the five-year life of the asset. Do not depreciate the salvage value.

EXHIBIT 3-6 Depreciation Methods

Number of Companies

2009 2008 2007 2006

Straight-line 488 494 594 592 Declining-balance 10 10 13 16 Sum-of-the-years’ digits 3 3 4 5 Accelerated method—not specified 17 21 24 27 Units-of-production 16 14 20 23 Group/Composite 10 7 11 9

2008 – 2009 based on 500 entities surveyed; 2006 – 2007 based on 600 entities surveyed

102 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Declining-Balance Method The declining-balance method, an accelerated method, applies a multiple times the straight-line rate to the declining book value (cost minus accumulated depreciation) to achieve a declining depreciation charge over the estimated life of the asset. This book will use double the straight-line rate, which is the maximum rate that can be used. Compute depreciation using the declining-balance method as follows:

1 Estimated Life of Asset

× 2× Book Amount at Beginning of the Year¼Annual Depreciation

For the asset used for illustration, the first year’s depreciation would be computed as follows:

1 5

× 2 × ð$10,000� 0Þ ¼ $4,000

The declining-balance method results in the following depreciation amounts for each of the five years of the asset’s life:

Year Cost

Accumulated Depreciation at

Beginning of Year

Book Amount at Beginning of

Year Depreciation for Year

Book Amount at End of Year

1 $10,000 — $10,000 $4,000 $6,000 2 10,000 $4,000 6,000 2,400 3,600 3 10,000 6,400 3,600 1,440 2,160 4 10,000 7,840 2,160 160 2,000 5 10,000 8,000 2,000 — 2,000

Estimated salvage value is not considered in the formula, but the asset should not be depreciated below the estimated salvage value. For the sample asset, the formula produced a depreciation amount of $864 in the fourth year. Only $160 depreciation can be used in the fourth year because the $160 amount brings the book amount of the asset down to the sal- vage value. Once the book amount is equal to the salvage value, no additional depreciation may be taken.

Sum-of-the-Years’-Digits Method The sum-of-the-years’-digits method is an accelerated depreciation method. Thus, the depreciation expense declines steadily over the estimated life of the asset. This method takes a fraction each year times the cost less salvage value. The nu- merator of the fraction changes each year. It is the remaining number of years of the asset’s life. The denominator of the fraction remains constant; it is the sum of the digits representing the years of the asset’s life. Compute depreciation using the sum-of-the-years’-digits method as follows:

Remaining Number of Years of Life Sum of the Digits Representing the Years of Life

× ðCost�SalvageÞ ¼Annual Depreciation

For the asset used for illustration, the first year’s depreciation would be computed as follows:

5 ð5þ 4þ 3þ 2þ 1Þ or 15 × ð$10,000� $2,000Þ ¼ $2,666:67

The sum-of-the-years’-digits method results in the following depreciation amounts for each year of the five years of the asset’s life:

Year Cost Less

Salvage Value Fraction Depreciation for Year

Accumulated Depreciation at End of Year

Book Amount at End of Year

1 $8,000 5/15 $2,666.67 $2,666.67 $7,333.33 2 8,000 4/15 2,133.33 4,800.00 5,200.00 3 8,000 3/15 1,600.00 6,400.00 3,600.00 4 8,000 2/15 1,066.67 7,466.67 2,533.33 5 8,000 1/15 533.33 8,000.00 2,000.00

CHAPTER 3 • Balance Sheet 103

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Unit-of-Production Method The unit-of-production method relates depreciation to the out- put capacity of the asset, estimated for the life of the asset. The capacity is stated in terms most appropriate for the asset, such as units of production, hours of use, or miles. Hours of use will be used for the asset in our example. For the life of the asset, it is estimated that there will be 16,000 hours of use. The estimated output capacity is divided into the cost of the asset less the salvage value to determine the depreciation per unit of output. For the example asset, the depreciation per hour of use would be $0.50 [(cost of asset, $10,000 − salvage, $2,000) divided by 16,000 hours].

The depreciation for each year is then determined by multiplying the depreciation per unit of output by the output for that year. Assuming that the output was 2,000 hours during the first year, the depreciation for that year would be $1,000 ($0.50 × 2,000). Further depreciation cannot be taken when the accumulated depreciation equals the cost of the asset less the salvage value. For the example asset, this will be when accumulated depreciation equals $8,000.

In Exhibit 3-7, Kelly Services, Inc., presents these assets as property, plant, and equip- ment at cost. Added detailed information is disclosed in the notes.

Leases

Leases are classified as operating leases or capital leases. If the lease is in substance an own- ership arrangement, it is a capital lease; otherwise, the lease is an operating lease. Assets leased under a capital lease are classified as long-term assets. They are shown net of amorti- zation (depreciation) and listed with plant, property, and equipment. (The discounted value of the obligation, a liability, will be part current and part long term.) Chapter 7 covers the topic of leases in more length.

Investments

Long-term investments, usually stocks and bonds of other companies, are often held to maintain a business relationship or to exercise control. Long-term investments are different from marketable securities, where the intent is to hold for short-term profits and to achieve liquidity. (Financial reports often refer to marketable securities as investments.)

Debt securities under investments are to be classified as held-to-maturity securities or available-for-sale securities. Held-to-maturity securities are securities that the firm has the intent and ability to hold to maturity. Debt securities classified as held-to-maturity securities are carried at amortized cost. Debt securities classified as available-for-sale securities are car- ried at fair value.

Equity securities under investments are to be carried at fair value. An exception for fair value is used for common stock where there is significant influence. For these common stock investments, the investment is carried under the equity method. Under the equity method, the cost is adjusted for the proportionate share of the rise (fall) in retained profits of the sub- sidiary (investee). For example, a parent company owns 40% of a subsidiary company, pur- chased at a cost of $400,000. When the subsidiary company earns $100,000, the parent company increases the investment account by 40% of $100,000, or $40,000. When the sub- sidiary company declares dividends of $20,000, the parent company decreases the invest- ment account by 40% of $20,000, or $8,000. This decrease occurs because the investment account changes in direct proportion to the retained earnings of the subsidiary.

The FASB has given guidance on the use of fair value. Fair value is the price that a com- pany would receive to sell an asset (or transfer a liability) in an orderly transaction between market participants on the date of measurement. With fair value, the firm selects the highest appropriate level for valuation. The levels of input for valuation are as follows:

1. Level 1: Quoted price for identical asset (or liability) in active market. 2. Level 2: Adjusted quoted price for similar asset (or liability). Level 2 inputs are to be

used when level 1 inputs are not readily available. 3. Level 3: Unobservable inputs (e.g., present value of expected cash flows). The present

value of an asset is the net amount of discounted future cash inflows less the discounted future cash outflows relating to the asset.

104 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

EXHIBIT 3-7 Kelly Services, Inc.*

Properties and Depreciation

CONSOLIDATED BALANCE SHEETS (In Part) Kelly Services, Inc. and Subsidiaries

2010 2009

(In millions of dollars) ASSETS Current Assets Cash and equivalents $ 80.5 $ 88.9 Trade accounts receivable, less allowances of

$12.3 million and 15.0 million, respectively 810.9 717.9 Prepaid expenses and other current assets 44.8 70.6 Deferred taxes 22.4 21.0

Total current assets 958.6 898.4 Property and Equipment Land and buildings 59.0 58.8 Computer hardware, software and other 260.3 264.0 Accumulated depreciation (215.3) (195.7)

Net property and equipment 104.0 127.1 Noncurrent Deferred Taxes 84.0 77.5 Goodwill, net 67.3 67.3 Other Assets 154.5 142.2 Total Assets $1,368.4 $1,312.5

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Part) Kelly Services, Inc. and Subsidiaries

1. Summary of Significant Accounting Policies (In Part)

Property and Equipment Property and equipment are stated at cost and are depreciated over their estimated useful lives, principally by the straight-line method. Cost and estimated useful lives of property and equipment by function are as follows:

Category 2010 2009 Life

(In millions of dollars)

Land $ 3.8 $ 3.8 — Work in progress 7.0 8.2 — Buildings and improvements 55.2 55.0 15 to 45 years Computer hardware and software 183.4 181.0 3 to 12 years Equipment, furniture and fixtures 33.9 36.9 5 years Leasehold improvements 36.0 37.9 The lesser of the life of

the lease or 5 years. Total property and equipment $319.3 $322.8

The Company capitalizes external costs and internal payroll costs incurred in the development of software for internal use as required by the Internal-Use Software Subtopic of the Financial Accounting and Standards Board (“FASB”) Accounting Standards Codification (“ASC”). Work in process represents capitalized costs for internal use software not yet in service and is included with computer hardware, software and other on the consolidated balance sheet. Depreciation expense from continuing operations was $31.3 million for 2010, $36.0 million for 2009 and $41.4 million for 2008.

*“We have evolved from a United States-based company concentrating primarily on traditional office staffing into a global workforce solutions leader with a breath of specialty businesses.” 10-K Source: Kelly Services, Inc. 2010 10-K

CHAPTER 3 • Balance Sheet 105

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

A company must segregate its fair value measurements into those based on level 1, 2, and 3 inputs. For level 3, the company must include the valuation technique used to measure the fair value, a reconciliation of the changes in fair value during the period, and a related discussion. The investments of Gentex Corporation are illustrated in Exhibit 3-8.

Intangibles

Intangibles are nonphysical assets, such as patents and copyrights. Intangibles are recorded at historical cost. An intangible asset that has a finite life is amortized over its useful life. An intangible asset with an indefinite life are reviewed for impairment. Research and

EXHIBIT 3-8 Gentex Corporation*

Investments

GENTEX CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Part)

AS OF DECEMBER 31, 2010 AND 2009

2010 2009

ASSETS CURRENT ASSETS: Cash and cash equivalents $ 348,349,773 $ 336,108,446 Short-term investments 86,447,596 17,123,647 Accounts receivable 95,647,612 71,159,512 Inventories 100,728,730 53,608,996 Prepaid expenses and other 24,095,563 27,412,894

Total current assets 655,269,274 505,413,495 PLANT AND EQUIPMENT: Land, buildings and improvements 120,578,714 112,276,501 Machinery and equipment 352,618,391 327,554,073 Construction-in-process 13,351,954 6,973,175

486,549,059 446,803,749 Less-Accumulated depreciation and amortization (281,441,303) (249,273,500)

205,107,756 197,530,249 OTHER ASSETS: Long-term investments 129,091,167 109,155,248 Patents and other assets, net 13,222,442 10,504,497

142,313,609 119,659,745 $1,002,690,639 $ 822,603,489

Gentex Corporation and Subsidiaries Notes to Consolidated Financial Statements (In Part)

(1) Summary of Significant Accounting and Reporting Policies (In Part)

Investments The Financial Accounting Standards Board (FASB) has issued authoritative guidance at ASC 820 “Fair Value Measurements.” This statement establishes a framework for measuring the fair value of assets and liabilities. This framework is intended to pro- vide increased consistency in how fair value determinations are made under various existing accounting standards that permit, or in come cases, require estimates of fair-market value. This standard also expands financial statement disclosure require- ments about a company’s use of fair value measurements, including the effect of such measure on earnings.

The Company adopted the provisions of ASC 820 related to its financial assets and liabilities in 2008, and to its non- financial assets and liabilities in 2009, neither of which had a material impact on the Company’s consolidated financial position, results of operations or cash flows. The Company’s investment securities are classified as available for sale and are stated at fair value based on quoted market prices. Adjustments to the fair value of investments are recorded as increases or decreases, net of income taxes, within accumulated other comprehensive income (loss) in shareholders’ investment (excluding other-than-tempo- rary impairments). Assets or liabilities that have recurring measurements are shown below as of December 31, 2010.

*“Gentex Corporation (the Company) designs, develops, manufactures and markets proprietary products employing electro-optic technology: automatic-dimming rearview automotive mirrors with electronic features and fire protection products. The Company also developed and manufactures variable dimmable windows for the aircraft industry and non-automatic-dimming rearview automotive mirrors with electronic features.” 10-K Source: Gentex Corporation: Investments 2010 10-K

106 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Fair Value Measurements at Reporting Date Using

Description Total as of

December 31, 2010

Quoted Prices in Active Markets for Identical

Assets (Level 1)

Significant Other Observable Inputs

(Level 2)

Significant Unobservable Inputs (Level 3)

Cash & Cash Equivalents $348,349,773 $348,349,773 $ — $ — Short-Term Investments: Government Securities 36,136,760 36,136,760 — — U.S. Treasury Notes 50,156,250 — 50,156,250 — Other 154,586 154,586 — —

Long-Term Investments: Common stocks 63,637,711 63,637,711 — — Mutual Funds – Equity 55,234,901 55,234,901 — — Limited Partnership – Equity 9,363,555 — 9,363,555 — Certificate of Deposit 500,000 — 500,000 — Other – Equity 355,000 355,000 — —

Total $563,888,536 $503,868,731 $ 60,019,805 $ —

The Company determines the fair value of its U.S. Treasury Notes by utilizing monthly valuation statements that are provided by its broker. The broker bases the investment valuation by using the bid price in the market. The Company also refers to third party sources to validate valuations. In addition, the Company determines the fair value of its limited partnership equity invest- ments by utilizing monthly valuation statements that are provided by the limited partnership. The limited partnership bases its eq- uity investment valuations on unadjusted quoted prices in active markets. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these securities does not entail a significant degree of judgment.

The amortized cost, unrealized gains and losses, and market value of investment securities are shown as of December 31, 2010 and 2009:

Unrealized

2010 Cost Gains Losses Market Value

Short-Term Investments: Government Securities $ 36,137,467 $ 9,254 $ (9,961) $ 36,136,760 U.S. Treasury Notes 50,095,921 60,329 — 50,156,250 Other 154,586 — — 154,586

Long-Term Investments: Common Stocks 44,899,944 18,819,518 (81,751) 63,637,711 Mutual Funds-Equity 42,106,776 13,128,125 — 55,234,901 Limited Partnership-Equity 7,844,022 1,519,533 — 9,363,555 Certificate of Deposit 500,000 — — 500,000 Other-Equity 338,506 16,494 — 355,000

Total $182,077,222 $33,553,253 $(91,712) $215,538,763

Unrealized

2009 Cost Gains Losses Market Value

Short-Term Investments: Government Securities $ 17,058,641 $ 4,924 $ (16,045) $ 17,047,520 U.S. Treasury Notes — — — — Other 76,127 — — 76,127

Long-Term Investments: Common Stocks 42,674,630 15,834,086 (157,625) 58,351,091 Mutual Funds-Equity 34,174,483 7,410,833 (23,738) 41,561,578 Limited Partnership-Equity 7,963,296 937,483 — 8,900,779 Certificate of Deposit — — — — Other-Equity 338,506 3,294 — 341,800

Total $102,285,683 $24,190,620 $(197,408) $126,278,895

EXHIBIT 3-8 Gentex Corporation (continued)

(continued)

CHAPTER 3 • Balance Sheet 107

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

development costs must be expensed as incurred. Thus, research and development costs in the United States represent an immediate expense, not an intangible. This requirement is not common in many other countries. The following are examples of intangibles that are recorded in the United States.

Goodwill Goodwill arises from the acquisition of a business for a sum greater than the phys- ical asset value, usually because the business has unusual earning power. It may result from good customer relations, a well-respected owner, and so on. Purchased goodwill is not amor- tized but is subject to annual impairment reviews.6

The global treatment of goodwill varies significantly. In some countries, goodwill is not recorded because it is charged to shareholders’ equity. In this case, there is no influence to reported income. In other countries, goodwill is expensed in the year acquired. In many countries, goodwill is recorded and amortized.

Patents Patents, exclusive legal rights granted to an inventor for a period of 20 years, are valued at their acquisition cost. The cost of a patent should be amortized over its legal life or its useful life, whichever is shorter.

Trademarks Trademarks are distinctive names or symbols. Rights are granted indefinitely as long as the owner uses it in connection with the product or service and files the paper- work. Since a trademark has an indefinite life, it should not be amortized. Trademarks should be tested for impairment at least annually.

Unrealized losses on investments as of December 31, 2010 (excluding other-than-temporary impairments), are as follows:

Aggregate Unrealized Losses Aggregate Fair Value

Less than one year $91,712 $17,007,886 Greater than one year — —

ASC 320, “Accounting for Certain Investments in Debt and Equity Securities,” as amended and interpreted, provides guidance on determining when an investment is other-than-temporarily impaired. The Company reviews its fixed income and equity investment portfolio for any unrealized losses that would be deemed other-than-temporary and require the recognition of an impairment loss in income. If the cost of an investment exceeds its fair value, the Company evaluates, among other factors, general market conditions, the duration and extent to which the fair value less than cost, and our intent and ability to hold the investments. Management also considers the type of security, related-industry and sector performance, as well as published investments ratings and analyst reports, to evaluate its portfolio. Once a decline in fair value is determined to be other-than- temporary, an impairment charge is recorded and new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, the Company may incur future impairments. Management considered equity investment losses of $17,909,901 to be other-than-temporary at December 31, 2008. The Company considered additional equity investment losses of $1,290,590 to be other-than-temporary at March 31, 2009. Accordingly, the losses were recognized in the consoli- dated statement of income in their respective reporting periods. No investments were considered to be other-than-temporary impaired in 2010.

Fixed income securities as of December 31, 2010, have contractual maturities as follows:

Due within one year $86,447,596 Due between one and five years 500,000 Due over five years —

$86,947,596

Fair Value of Financial Instruments

The Company’s financial instruments consist of cash and cash equivalents, investments, accounts receivable and accounts pay- able. The Company’s estimate of the fair values of these financial instruments approximates their carrying amounts at Decem- ber 31, 2010 and 2009.

EXHIBIT 3-8 Gentex Corporation (continued)

108 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Franchises Franchises are the legal right to operate under a particular corporate name, pro- viding trade-name products or services. The cost of a franchise with a limited life should be amortized over the life of the franchise.

Copyrights Copyrights are rights that authors, painters, musicians, sculptors, and other artists have in their creations and expressions. A copyright is granted for the life of the creator, plus 70 years. The costs of the copyright should be amortized over the period of expected benefit.

Exhibit 3-9 displays the Briggs & Stratton Corporation presentation of intangibles. It consists of goodwill and other intangibles.

EXHIBIT 3-9 Briggs & Stratton Corporation*

Intangibles

Consolidated Balance Sheet (In Part) As of June 27, 2010 and June 28, 2009

(in thousands)

ASSETS 2010 2009

CURRENT ASSETS: Cash and Cash Equivalents $ 116,554 $ 15,992 Receivables, Less Reserves of $11,317 and $7,360, Respectively 286,426 262,934 Inventories:

Finished Products and Parts 278,922 359,429 Work in Process 114,483 109,774 Raw Materials 6,941 8,136 Total Inventories 400,346 477,339

Deferred Income Tax Asset 41,138 51,658 Assets Held for Sale 4,000 4,000 Prepaid Expenses and Other Current Assets 57,179 48,597 Total Current Assets 905,643 860,520

GOODWILL 252,975 253,854 INVESTMENTS 19,706 18,667 DEFERRED LOAN COSTS, Net 525 1,776 OTHER INTANGIBLE ASSETS, Net 90,345 92,190 LONG-TERM DEFERRED INCOME TAX ASSET 72,492 23,165 OTHER LONG-TERM ASSETS, Net 10,608 8,676 PLANT AND EQUIPMENT:

Land and Land Improvements 17,303 17,559 Buildings 136,725 133,749 Machinery and Equipment 804,362 827,259 Construction in Progress 21,508 13,115

979,898 991,682 Less – Accumulated Depreciation 642,135 631,507

Total Plant and Equipment, Net 337,763 360,175 $1,690,057 $1,619,023

Notes to Consolidated Financial Statements (In Part)

For the Fiscal Years Ended June 27, 2010, June 28, 2009 and June 29, 2008

(2) Summary of Significant Accounting Policies (In Part)

GoodwilI and Other Intangible Assets: Goodwill reflects the cost of acquisitions in excess of the fair values assigned to identifi- able net assets acquired. Goodwill is assigned to reporting units based upon the expected benefit of the synergies of the acquisi- tion. The reporting units are Engine, Home Power Products and Yard Power Products and have goodwill at June 27, 2010 of $136.9 million, $83.3 million, and $32.8 million, respectively. Other Intangible Assets reflect identifiable intangible assets that arose from purchase acquisitions. Other Intangible Assets are comprised of trademarks, patents and customer relationships.

*“Briggs & Stratton (the “Company”) is the world’s largest producer of air cooled gasoline engines for outdoor power equipment. Briggs & Stratton designs, manufactures, markets and services these products for original equipment manufacturers (OEMs) worldwide.” 10-K Source: Briggs & Stratton Corporation 2010 10-K (continued)

CHAPTER 3 • Balance Sheet 109

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Other Noncurrent Assets

Firms will occasionally have assets that do not fit into one of the previously discussed classi- fications. These assets, termed “other,” might include noncurrent receivables and noncurrent prepaids. Exhibit 3-10 summarizes types of other assets from a financial statement compila- tion in Accounting Trends & Techniques.

Goodwill and trademarks, which are considered to have indefinite lives are not amortized; however, both must be tested for impairment annually. Amortization is recorded on a straight-line basis for other intangible assets with finite lives. Patents have been assigned an estimated weighted average useful life of thirteen years. The customer relationships have been assigned an estimated useful life of twenty-five years. The Company is subject to financial statement risk in the event that goodwill and in- tangible assets become impaired. The Company performed the required impairment tests in fiscal 2010, 2009 and 2008, and found no impairment of the assets.

(5) Goodwill and Other Intangible Assets:

Goodwill reflects the cost of acquisitions in excess of the fair values assigned to identifiable net assets acquired. Goodwill is assigned to reporting units based upon the expected benefit of the synergies of the acquisition. The reporting units are Engine, Home Power Products and Yard Power Products and have goodwill at June 27, 2010 of $136.9 million, $83.3 million, and $32.8 million, respectively.

The changes in the carrying amount of goodwill for the fiscal years ended June 27, 2010 and June 28, 2009 are as follows (in thousands):

2010 2009

Beginning Goodwill Balance $253,854 $248,328 Victa Acquisition — 8,063 Tax Benefit on Amortization (1,779) (1,779) Reclassification 263 — Effect of Translation 637 (758) Ending Goodwill Balance $252,975 $253,854

The Company’s other intangible assets for the years ended June 27, 2010 and June 28, 2009 are as follows (in thousands):

2010 2009

Gross Carrying Amount

Accumulated Amortization Net

Gross Carrying Amount

Accumulated Amortization Net

Amortized Intangible Assets: Patents $ 13,601 $ (7,049) $ 6,552 $ 13,601 $(5,843) $ 7,758 Customer Relationships 17,910 (4,298) 13,612 17,910 (3,582) 14,328 Miscellaneous 279 (279) — 279 (277) — Effect of Translation 22 — 22 — — — Total Amortized Intangible Assets 31,812 (11,626) 20,186 31,790 (9,704) 22,086

Unamortized Intangible Assets: Trademarks/Brand Names 69,841 — 69,841 70,104 — 70,104 Total Unamortized Intangible Assets 69,841 — 69,841 70,104 — 70,104 Effect of Translation 318 — 318 — — — Total Intangible Assets $101,971 $(11,626) $90,345 $101,894 $(9,704) $92,190

Amortization expense of other intangible assets amounts to approximately $1.9 million in each of 2010, 2009, and 2008. The estimated amortization expense of other intangible assets for the next five years is (in thousands):

2011 $1,911 2012 1,911 2013 1,911 2014 1,911 2015 1,860

$9,504

EXHIBIT 3-9 Briggs & Stratton Corporation (continued)

110 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Liabilities Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.7 Liabilities are usually classified as either current or long-term liabilities.

Current Liabilities Current liabilities are obligations whose liquidation is reasonably expected to require the use of existing current assets or the creation of other current liabilities within a year or an oper- ating cycle, whichever is longer. They include the following items.

Payables

These include short-term obligations created by the acquisition of goods and services, such as accounts payable (for materials or goods bought for use or resale), wages payable, and taxes payable. Payables may also be in the form of a written promissory note, notes payable.

Unearned Income

Payments collected in advance of the performance of service are termed unearned. They include rent income and subscription income. Rather than cash, a future service or good is due the customer.

Other Current Liabilities

Many other current obligations require payment during the year. Exhibit 3-11 displays other current liabilities reported by Accounting Trends & Techniques in 2010. Exhibit 3-12 shows the current liabilities of Google, Inc.

Long-Term Liabilities Long-term liabilities are those due in a period exceeding one year or one operating cycle, whichever is longer. Long-term liabilities are generally of two types: financing arrangements of assets and operational obligations.

EXHIBIT 3-10 Other Noncurrent Assets*

Number of Entities

2009 2008 2007 2006

Deferred income taxes 277 261 287 261 Pension asset 160 169 235 200 Derivatives 150 47 50 46 Segregated cash or securities 103 100 105 82 Software 87 98 116 117 Debt issue costs 68 79 110 104 Property held for sale 43 45 57 68 Cash surrender value of life insurance 42 32 39 43 Assets of nonhomogeneous operations 9 10 10 8 Contracts 8 10 21 16 Estimated insurance recoveries 5 6 9 12 Assets leased to others 5 4 11 13 Other identified noncurrent assets 58 62 68 60

*Appearing either in the balance sheet and/or the notes to financial statements

2008 – 2009 based on 500 entities surveyed; 2006 – 2007 based on 600 entities surveyed

CHAPTER 3 • Balance Sheet 111

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Liabilities Relating to Financing Agreements

The long-term liabilities that are financing arrangements of assets usually require systematic pay- ment of principal and interest. They include notes payable, bonds payable, and credit agreements.

EXHIBIT 3-11 Other Current Liabilities*

Number of Entities

2009 2008 2007 2006

Derivatives 253 88 76 70 Costs related to discontinued operations/restructuring 158 148 172 162 Deferred revenue 140 150 175 161 Interest 123 128 146 143 Deferred taxes 118 122 104 97 Taxes other than federal income taxes 116 122 135 139 Warranties 99 101 126 120 Insurance 86 83 97 101 Advertising 64 63 70 73 Dividends 59 62 75 68 Environmental costs 59 58 68 67 Rebates 55 54 54 59 Customer advances, deposits 54 57 65 68 Litigation 43 39 56 50 Tax uncertainties 33 29 N/C** N/C** Billings on uncompleted contracts 26 26 38 29 Due to afflicted companies 23 25 22 22 Royalties 19 20 23 21 Asset retirement obligations 15 18 24 20 Other – described 135 127 146 156

*Appearing in either the balance sheet and/or the notes to financial statements. **N/C = Not Compiled. Line item was not included in the table for the year shown.

2008 – 2009 based on 500 entities surveyed; 2006 – 2007 based on 600 entities surveyed

EXHIBIT 3-12 Google, Inc.*

Current Liabilities – Google, Inc.

Google, Inc. Consolidated Balance Sheets (In Part)

(In millions)

As of December 31,

2009 2010

Current liabilities: Accounts payable $ 216 $ 483 Short-term debt 0 3,465 Accrued compensation and benefits 982 1,410 Accrued expenses and other current liabilities 570 961 Accrued revenue share 694 885 Securities lending payable 0 2,361 Deferred revenue 285 394 Income taxes payable, net 0 37 Total current liabilities $2,747 $9,996

*“Google is a global technology leader focused on improving the ways people connect with information.” 10-K Source: Google, Inc., 2010 10-K

112 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Notes Payable Promissory notes due in periods greater than one year or one operating cycle, whichever is longer, are classified as long term. If secured by a claim against real property, they are called mortgage notes.

Bonds Payable A bond is a debt security normally issued with $1,000 par per bond and nor- mally requiring semiannual interest payments based on the coupon rate. Bonds payable is simi- lar to notes payable. Bonds payable are usually for a longer duration than notes payable.

Bonds are not necessarily sold at par. They are sold at a premium if the stated rate of interest exceeds the market rate, and they are sold at a discount if the stated rate of interest is less than the market rate. If sold for more than par, a premium on bonds payable arises and increases bonds payable to obtain the current carrying value. Similarly, if sold at less than par, a discount on bonds payable arises and decreases bonds payable on the balance sheet. Each of these accounts, discount or premium, will be gradually written off (amortized) to interest expense over the life of the bond. At the maturity date, the carrying value of bonds payable will be equal to the par value. Amortization of bond discount increases interest expense; amortization of bond premium reduces it. Exhibit 3-13 illustrates bonds sold at par, premium, or discount.

Bonds that are convertible into common stock at the option of the bondholder (creditor) are exchanged for a specified number of common shares, and the bondholder becomes a common stockholder. Often, convertible bonds are issued when the common stock price is low, in management’s opinion, and the firm eventually wants to increase its common equity. By issuing a convertible bond, the firm may get more for the specified number of common shares than could be obtained by issuing the common shares. The conversion feature allows the firm to issue the bond at a more favorable interest rate than would be the case with a bond lacking the conversion feature. Also, the tax deductible interest paid on the convertible bond reduces the firm’s cost for these funds. If common stock had been issued, the dividend on the common stock would not be tax deductible. Thus, a firm may find that issuing a con- vertible bond can be an attractive means of raising common equity funds in the long run. However, if the firm’s stock price stays depressed after issuing a convertible bond, then the firm will have the convertible bond liability until the bond comes due. Convertible bonds of VeriSign, Inc., and subsidiaries are displayed in Exhibit 3-14.

EXHIBIT 3-13 Bonds at Par, Premium, or Discount

The market interest rate becomes the effective rate of interest.

Premium

Par

(Face Value)

Discount

10%

Bond

Contractual

Interest Rate

Issued When

Market

Interest

Rate

Bonds

Sold at

CHAPTER 3 • Balance Sheet 113

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Credit Agreements Many firms arrange loan commitments from banks or insurance compa- nies for future loans. Often, the firm does not intend to obtain these loans but has arranged the credit agreement just in case a need exists for additional funds. Such credit agreements do not represent a liability unless the firm actually requests the funds. From the point of view of analysis, the existence of a substantial credit agreement is a positive condition in that it could relieve pressure on the firm if there is a problem in meeting existing liabilities.

In return for giving a credit agreement, the bank or insurance company obtains a fee. This commitment fee is usually a percentage of the unused portion of the commitment. Also, banks often require the firm to keep a specified sum in its bank account, referred to as a compensat- ing balance. Exhibit 3-15 shows credit agreements for Carlisle Companies Incorporated.

Liabilities Relating to Operational Obligations

Long-term liabilities relating to operational obligations include obligations arising from the operation of a business, mostly of a service nature, such as pension obligations, postretirement benefit obligations other than pension plans, deferred taxes, and service warranties. Chapter 7 covers at length pensions and postretirement benefit obligations other than pension plans.

Deferred Taxes Deferred taxes are caused by using different accounting methods for tax and reporting purposes. For example, a firm may use accelerated depreciation for tax purposes and straight-line depreciation for reporting purposes. This causes tax expense for reporting purposes to be higher than taxes payable according to the tax return. The difference is deferred tax. Any situation where revenue or expense is recognized in the financial statements in a different time pe- riod than for the tax return will create a deferred tax situation (asset or liability). For example, in the later years of the life of a fixed asset, straight-line depreciation will give higher depreciation and, therefore, lower net income than an accelerated method. Then tax expense for reporting purposes will be lower than taxes payable, and the deferred taxwill be reduced (paid). Since firms often buy more and higher-priced assets, however, the increase in deferred taxes may exceed the decrease. In this case, a partial or a total reversal will not occur. The taxes may be deferred for a very long time, perhaps permanently. Chapter 7 covers deferred taxes in more detail.

Warranty Obligations Warranty obligations are estimated obligations arising out of prod- uct warranties. Product warranties require the seller to correct any deficiencies in quantity,

EXHIBIT 3-14 VeriSign, Inc. and Subsidiaries*

Liabilities (Convertible Bonds)

VeriSign, Inc. Consolidated Balance Sheets (In Part)

In thousands

December 31,

2010 2009

Liabilities Current liabilities: Accounts payable and accrued liabilities $ 195,235 $ 243,967 Deferred revenues 457, 478 642,507

Total current liabilities 652,713 886,474 Long-term deferred revenues 205,560 245,734 Convertible debentures, including contingent interest derivative 581,626 574,378 Long-term deferred tax liabilities 309,696 144,777 Other long-term liabilities 17,981 20,117

Total long-term liabilities 1,114,863 985,006 Total liabilities $1,767,576 $1,871,480

Notes to Consolidated Financial Statements (In part)

Note 7: Debt and Interest Expense (In part)

*“We are a provider of Internet infrastructure services.” 10-K Note: There was an extensive description of the terms of the Junior Subordinated Convertible Debentures. Note: There was an extensive description of the terms of the Junior Subordinated Convertible Debentures. *“We are a provider of Internet infrastructure services.” 10-K Source: Verisign, Inc. and Subsidiaries

114 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

EXHIBIT 3-15 Carlisle Companies Incorporated*

Credit Agreements

Carlisle Companies Incorporated Consolidated Balance Sheets (In Part)

Dollars in Millions

Liabilities At December 31,

Current liabilities: 2010 2009

Short-term debt, including current maturities $ 69.0 $ — Accounts payable 195.4 132.7 Accrued expenses 174.9 143.5 Deferred revenue 17.1 17.3 Current liabilities associated with assets held for sale — 7.6

Total current liabilities 456.4 301.1 Long-term liabilities: Long-term debt 405.1 156.1 Deferred revenue 122.6 113.2 Other long-term liabilities 204.7 125.1

Total long-term liabilities 732.4 394.4

Notes to Consolidated Financial Statements (In Part)

Note 7 Borrowings (In Part)

As of December 31, 2010 and 2009, the Company’s borrowings are as follows:

In millions 2010 2009

5.125% notes due 2020, net of unamortized discount of ($1.1) $248.9 $ — 6.125% notes due 2016, net of unamortized discount of ($0.6) and ($0.7)

respectively 149.4 149.3 8.75% Hawk senior notes due 2014 59.0 Revolving credit facility 10.0 — Industrial development and revenue bonds through 2018 6.7 6.7 Other, including capital lease obligations 0.1 0.1

474.1 156.1 Less revolving credit facility and the Hawk senior notes classified as current (69.0) — Long-term debt $405.1 $156.1

Revolving Credit Facilities

At December 31, 2010 the Company had $458.5 million available under its $500.0 million revolving credit facility (the “Facil- ity”). Of the amount unavailable for borrowings at December 31, 2010, $10.0 million was borrowed and outstanding in con- nection with the financing of the Hawk acquisition. Under the terms of the Facility, and at the Company’s election, the $10.0 million is payable on January 31, 2011 (30 days from the date of funding) and accordingly has been presented in Short-term debt, including current maturities in the consolidated balance sheet. The Company has the option to roll over amounts pay- able, at differing tenors and interest rates, until the facility expires in July of 2012. The remainder of the amount unavailable for borrowings relates to issued letters of credit amounting to $31.5 million. At December 31, 2009, the Company had $466.0 million available under the Facility, with the reduction in availability attributable to letters of credit of $34.0 million. Letters of credit are issued primarily to provide security under insurance arrangements and certain borrowings. The revolving credit facility provides for grid-based interest pricing based on the credit rating of the Company’s senior unsecured bank debt or other unsecured senior debt and the Company’s utilization of the facility. The average interest rate of the revolving credit facil- ity for 2010 and 2009 was 0.65% and 0.85%, respectively.

The Company also maintains a $55.0 million uncommitted line of credit all of which was available for borrowing as of De- cember 31, 2010 and 2009. The average interest rate on the uncommitted line was 1.87% for 2010 and 2.88% for 2009.

*“Carlisle is a diversified manufacturing company consisting of five segments which manufacture and distribute a broad range of products.” 10-K Source: Carlisle Companies Incorporated 2010 10-K

CHAPTER 3 • Balance Sheet 115

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

quality, or performance of the product or service for a specific period of time after the sale. Warranty obligations are estimated in order to recognize the obligation at the balance sheet date and to charge the expense to the period of the sale.

Exhibit 3-16 shows the warranty obligations of Ford Motor Company.

Noncontrolling Interest (previously called “Minority Interest”)

Noncontrolling interest reflects the ownership of noncontrolling shareholders in the equity of consolidated subsidiaries less than wholly owned. Consider the following simple example. Parent P owns 90% of the common stock of Subsidiary S.

Parent P Balance Sheet December 31, 2010

Subsidiary S Balance Sheet December 31, 2010

Current assets $100 $10 Investment in Subsidiary S 18 — Other long-term assets 382 40

$500 $50 Current liabilities 100 10 Long-term liabilities 200 20

Total liabilities $300 $30 Stockholders’ equity Common stock 50 5 Additional paid in capital 40 5 Retained earnings 110 10

Total stockholders’ equity 200 20 Total liabilities and stockholders’ equity $500 $50

EXHIBIT 3-16 Ford Motor Company and Subsidiaries*

Warranty Obligations

For the Fiscal Year Ended December 31, 2010

NOTE 31. COMMITMENTS AND CONTINGENCIES (In Part)

Guarantees are recorded at fair value at the inception of the guarantee. Litigation and claims are accrued when losses are deemed probable and reasonably estimable.

Estimated warranty costs and additional service actions are accrued for at the time the vehicle is sold to a dealer, including costs for basic warranty coverage on vehicles sold, product recalls, and other customer service actions. Fees or premiums for the issuance of extended service plans are recognized in income over the contract period in proportion to the costs expected to be incurred in performing services under the contract.

Warranty Included in warranty cost accruals are the costs for basic warranty coverages on products sold. These costs are estimates based primarily on historical warranty claim experience. Warranty accruals accounted for in Accrued liabilities and deferred revenue at December 31 were as follows (in millions):

2010 2009

Beginning balance $ 3,147 $ 3,239 Payments made during the period (2,176) (2,484) Changes in accrual related to warranties issued during the period 1,522 1,652 Changes in accrual related to pre-existing warranties 203 584 Foreign currency translation and other (50) 156

Ending Balance $ 2,646 $ 3,147

Excluded from the table above are costs accrued for product recalls and customer satisfaction actions.

*“We are one of the world’s largest producers of cars and trucks.” 10-K Source: Ford Motor Company and Subsidiaries 2010 10-K

116 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

This will be shown on the consolidated balance sheet as follows:

Parent P and Subsidiary S Consolidated Balance Sheet

December 31, 2010

(In millions) Current assets $110 Long-term assets 422

$532 Current liabilities $110 Long-term liabilities 220

Total liabilities 330 Stockholders equity

Common stock 50 Additional paid in capital 40 Retained earnings 110 Noncontrolling interest 2 Total stockholders’ equity 202

Total liabilities and stockholders’ equity $532

Prior to the new standard that took effect for fiscal years beginning after December 15, 2008, noncontrolling interest was called minority interest and was usually presented after liabilities and before shareholders’ equity. With the new standard, noncontrolling interest is presented with shareholders’ equity.

Noncontrolling interest is seldom material. In a firm where noncontrolling interest is material, the analysis can be performed twice, one with noncontrolling interest as a liability to be conservative, and then as a shareholders’ equity item. The analysis in this book will leave the noncontrolling interest as a shareholders’ equity item. Refer to Exhibit 3-17 for an illustration of noncontrolling interest (minority interest).

Under the new standard, a reconciliation of the beginning and ending balances of both the parent and the noncontrolling interest equity amounts must be presented. This includes net income and owner contributions attributable to each of them. This presentation can be in a note or in a statement of stockholders’ equity. The statement of stockholders’ equity is illustrated in Chapter 4.

Other Noncurrent Liabilities

Many other noncurrent liabilities may be disclosed. It would not be practical to discuss all of the possibilities. An example would be deferred profit on sales.

Redeemable Preferred Stock

Redeemable preferred stock is subject to mandatory redemption requirements or has a redemption feature outside the control of the issuer. If this feature is coupled with such char- acteristics as no vote or fixed return, often preferred stock and bond characteristics, then this type of preferred stock is more like debt than equity. For this reason, the SEC directs that the three categories of stock—redeemable preferred stock, nonredeemable preferred stock, and common stock—not be totaled in the balance sheet. Further, the stockholders’ equity section should not include redeemable preferred stock. Redeemable preferred stock is illustrated in Exhibit 3-18. Because redeemable preferred stock is more like debt than equity, consider it as part of total liabilities for purposes of financial statement analysis.

Shareholders’ or Stockholder’s Equity Shareholders’ (Stockholder’s) equity is the residual ownership interest in the assets of an en- tity that remains after deducting its liabilities.8 Usually divided into two basic categories, paid-in capital and retained earnings, other accounts may appear in shareholders’ equity that are usually presented separately from paid-in capital and retained earnings. Other accounts include accumulated other comprehensive income, equity-oriented deferred compensation, and employee stock ownership plans (ESOPs).

CHAPTER 3 • Balance Sheet 117

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

EXHIBIT 3-17 Cummins, Inc. and Subsidiaries*

Noncontrolling Interest

Cummins Inc. and Subsidiaries Consolidated Balance Sheets (In part)

In millions, except par value

December 31,

2010 2009

LIABILITIES Current liabilities Loans payable (Note 9) $ 82 $ 37 Accounts payable (principally trade) 1,362 957 Current portion of accrued product warranty (Note 10) 421 426 Accrued compensation, benefits and retirement costs 468 366 Deferred revenue 182 128 Taxes payable (including taxes on income) 202 94 Other accrued expenses 543 424

Total current liabilities 3,260 2,432 Long-term liabilities Long-term debt (Note 9) 709 637 Pensions (Note 11) 195 514 Postretirement benefits other than pensions (Note 11) 439 453 Other liabilities and deferred revenue (Note 12) 803 760

Total liabilities 5,406 4,796 Commitments and contingencies (Note 13) — —

EQUITY Cummins Inc. shareholders’ equity (Note 14) Common stock, $2.50 par value, 500 shares authorized, 221.8 and 222.0 shares issued 1,934 1,860 Retained earnings 4,445 3,575 Treasury stock, at cost, 24.0 and 20.7 shares (964) (731) Common stock held by employee benefits trust, at cost, 2.1 and 3.0 shares (25) (36) Accumulated other comprehensive loss

Defined benefit postretirement plans (646) (788) Other (74) (107)

Total accumulated other comprehensive loss (720) (895) Total Cummins Inc. shareholders’ equity 4,670 3,773

Noncontrolling interests (Note 17) 326 247 Total equity 4,996 4,020

Total liabilities and equity $10,402 $8,816

Notes to Consolidated Financial Statements (In Part)

Note 17. NONCONTROLLING INTEREST Noncontrolling interests in the equity of consolidated subsidiaries are as follows:

December 31,

In millions 2010 2009

Cummins India Ltd. $247 $185 Wuxi Cummins Turbo Technologies Co. Ltd. 60 36 Other 19 26 Total $326 $247

*“Cummins Inc. was founded in 1919 as a corporation in Columbus, Indiana, as one of the first diesel engine manufacturers. We are a global power leader that designs, manufacturers, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration, exhaust aftertreatment, fuel systems, controls and air handling systems.” 10-K Source: Cummins, Inc. and Subsidiaries 2010 10-K

118 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Paid-In Capital The first type of paid-in capital account is capital stock. Two basic types of capital stock are preferred and common.

Both preferred stock and common stock may be issued as par-value stock. (Some states call this stated value stock.) The articles of incorporation establish the par value, a desig- nated dollar amount per share. Many states stipulate that the par value of issued stock times the number of shares outstanding constitutes the legal capital. Many states also designate that, if original-issue stock is sold below par value, the buyer is contingently liable for the difference between the par value and the lower amount paid. This does not usually pose a problem because the par value has no direct relationship to market value, the selling price of the stock. To avoid selling a stock below par, the par value is usually set very low in relation to the intended selling price. For example, the intended selling price may be $25.00, and the par value may be $1.00.

EXHIBIT 3-18 Nike, Inc.*

Redeemable Preferred Stock

NIKE, INC. Consolidated Balance Sheet (In Part)

May 31,

2010 2009

(In millions)

Total current liabilities 3,364.2 3,277.0 Long-term debt (Note 8) 445.8 437.2 Deferred income taxes and other liabilities (Notes 9 and 18) 855.3 842.0 Commitments and contingencies (Note 15) — — Redeemable Preferred Stock (Note 10) 0.3 0.3 Shareholders’ equity: Common stock at stated value (Note 11):

Class A convertible – 90.0 and 95.3 shares outstanding 0.1 0.1 Class B – 394.0 and 390.2 shares outstanding 2.7 2.7

Capital in excess of stated value 3,440.6 2,871.4 Accumulated other comprehensive income (Note 14) 214.8 367.5 Retained earnings 6,095.5 5,451.4

Total shareholders’ equity 9,753.7 8,693.1 Total liabilities and shareholders’ equity $14,419.3 $13,249.6

Notes to Consolidated Financial Statements (In Part)

Note 10 – Redeemable Preferred Stock

Sojitz America is the sole owner of the Company’s authorized Redeemable Preferred Stock, $1 par value, which is redeemable at the option of Sojitz America or the Company at par value aggregating $0.3 million. A cumulative dividend of $0.10 per share is payable annually on May 31 and no divi- dends may be declared or paid on the common stock of the Company unless dividends on the Redeemable Preferred Stock have been declared and paid in full. There have been no changes in the Redeemable Preferred Stock in the three years ended May 31, 2010, 2009, and 2008. As the holder of the Redeemable Preferred Stock, Sojitz America does not have general voting rights but does have the right to vote as a separate class on the sale of all or substantially all of the assets of the Company and its subsidiaries, on merger, consolidation, liquidation or dissolution of the Company or on the sale or assignment of the NIKE trademark for athletic footwear sold in the United States.

*“Our principal business activity is the design, development and worldwide marketing of high quality footwear apparel, equipment, and accessory products.” 10-K Source: Nike, Inc. 2010 10-K

CHAPTER 3 • Balance Sheet 119

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Some states allow the issuance of no-par stock (either common or preferred). Some of these states require that the entire proceeds received from the sale of the no-par stock be des- ignated as legal capital.

Additional paid-in capital arises from the excess of amounts paid for stock over the par or stated value of the common and preferred stock. Also included here are amounts over cost from the sale of treasury stock (discussed later in this chapter), capital arising from the dona- tion of assets to the firm, and transfer from retained earnings through stock dividends when the market price of the stock exceeds par.

Common Stock Common stock shares in all the stockholders’ rights and represents ownership that has vot- ing and liquidation rights. Common stockholders elect the board of directors and vote on major corporate decisions. In the event of liquidation, the liquidation rights of common stockholders give them claims to company assets after all creditors’ and preferred stockhold- ers’ rights have been fulfilled.

Preferred Stock Preferred stock seldom has voting rights. When preferred stock does have voting rights, it is usually because of missed dividends. For example, the preferred stockholders may possibly receive voting rights if their dividends have been missed two consecutive times. Some other preferred stock characteristics include the following:

• Preference as to dividends • Accumulation of dividends • Participation in excess of stated dividend rate • Convertibility into common stock • Callability by the corporation • Redemption at future maturity date (see the previous discussion of redeemable preferred

stock) • Preference in liquidation

Preference as to Dividends

When preferred stock has a preference as to dividends, the current year’s preferred dividend must be paid before a dividend can be paid to common stockholders. For par-value (or stated value) stock, the dividend rate is usually stated as a percentage of par. For example, if the dividend rate were 6% and the par were $100 per share, then the dividend per share would be $6. For no-par stock, if the dividend rate is stated as $5, then each share should receive $5 if a dividend is paid. A preference as to dividends does not guarantee that a pre- ferred dividend will be paid in a given year. The board of directors must declare a dividend before a dividend is paid. The lack of a fixed commitment to pay dividends and the lack of a due date on the principal are the primary reasons that many firms elect to issue preferred stock instead of bonds. Preferred stock usually represents an expensive source of funds, com- pared to bonds. The preferred stock dividends are not tax deductible, whereas interest on bonds is deductible.

Accumulation of Dividends

If the board of directors does not declare dividends in a particular year, a holder of noncumu- lative preferred stock will never be paid that dividend. To make the preferred stock more attractive to investors, a corporation typically issues cumulative preferred stock. If a corpora- tion fails to declare the usual dividend on the cumulative preferred stock, the amount of passed dividends becomes dividends in arrears. Common stockholders cannot be paid any dividends until the preferred dividends in arrears and the current preferred dividends are paid.

To illustrate dividends in arrears, assume a corporation has outstanding 10,000 shares of 8%, $100 par cumulative preferred stock. If dividends are not declared in 2010 and 2011, but are declared in 2012, the preferred stockholders would be entitled to dividends in arrears of $160,000 and current dividends in 2012 of $80,000 before any dividends could be paid to common stockholders.

120 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Participation in Excess of Stated Dividend Rate

When preferred stock is participating, preferred stockholders may receive an extra dividend beyond the stated dividend rate. The terms of the participation depend on the terms included with the stock certificate. For example, the terms may state that any dividend to common stockholders over $10 per share will also be given to preferred stockholders.

To illustrate participating preferred stock, assume that a corporation has 8%, $100 par preferred stock. The terms of the participation are that any dividend paid on common shares over $10 per share will also be paid to preferred stockholders. For the current year, a divi- dend of $12 per share is declared on the common stock. Therefore, a dividend of $10 must be paid per share of preferred stock for the current year: (8% × $100) + $2.00 = $10.00.

Convertibility into Common Stock

Convertible preferred stock contains a provision that allows the preferred stockholders, at their option, to convert the share of preferred stock at a specific exchange ratio into another security of the corporation. The other security is almost always common stock. The conver- sion feature is very attractive to investors. For example, the terms may be that each share of preferred stock can be converted to four shares of common stock.

Convertible preferred stock is similar to a convertible bond, except that there are no fixed payout commitments with the convertible preferred stock. The preferred dividend need not be declared, and the preferred stock does not have a due date. The major reason for issu- ing convertible preferred stock is similar to that for issuing convertible bonds: If the current common stock price is low, in the opinion of management, and the firm eventually wants to increase its common equity, then the firm can raise more money for a given number of com- mon shares by first issuing convertible preferred stock.

A firm usually prefers to issue convertible bonds rather than convertible preferred stock if its capital structure can carry more debt without taking on too much risk. The interest on the convertible bond is tax deductible, while the dividend on the preferred stock is not.

Callability by the Corporation

Callable preferred stock may be retired (recalled) by the corporation at its option. The call price is part of the original stock contract. When the preferred stock is also cumulative, the call terms normally require payment of dividends in arrears before the call is executed.

The call provision favors the company because the company decides when to call. Investors do not like call provisions. Therefore, to make a security that has a call provision marketable, the call provision can normally not be exercised for a given number of years. For example, callable preferred stock issued in 2011 may have a provision that the call option cannot be exercised prior to 2021.

Preference in Liquidation

Should the corporation liquidate, the preferred stockholders normally have priority over common stockholders for settlement of claims. However, the claims of preferred stockhold- ers are secondary to the claims of creditors, including bondholders.

Preference in liquidation for preferred stock over common stock is not usually consid- ered to be an important provision. This is because often, in liquidation, funds are not suffi- cient to pay claims of preferred stock. Even creditors may receive only a few cents on the dollar in satisfaction of their claims.

Disclosures

Preferred stock may carry various combinations of provisions. The provisions of each pre- ferred stock issue should be disclosed either parenthetically in the stockholders’ equity sec- tion of the balance sheet or in a note. A company may have various preferred stock issues, each with different provisions. Preferred stock is illustrated in Exhibit 3-19.

Donated Capital Donated capital may be included in the paid-in capital. Capital is donated to the company by stockholders, creditors, or other parties (such as a city). For example, a city may offer

CHAPTER 3 • Balance Sheet 121

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

land to a company as an inducement to locate a factory there to increase the level of employ- ment. The firm records the donated land at the appraised amount and records an equal amount as donated capital in stockholders’ equity.

Another example would be a company that needs to increase its available cash. A plan is devised, calling for existing common stockholders to donate a percentage of their stock to the company. When the stock is sold, the proceeds are added to the cash account, and the donated capital in stockholders’ equity is increased.

Retained Earnings Retained earnings are the undistributed earnings of the corporation—that is, the net income for all past periods minus the dividends (both cash and stock) that have been declared. Retained earnings, cash dividends, and stock dividends are reviewed in more detail in Chapter 4. Exhibit 3-19 illustrates the presentation of retained earnings.

Quasi-Reorganization A quasi-reorganization is an accounting procedure equivalent to an accounting fresh start. A company with a deficit balance in retained earnings “starts over” with a zero balance rather than a deficit. A quasi-reorganization involves the reclassification of a deficit in retained earnings. It removes the deficit and an equal amount from paid-in capital. A quasi-reorganization may also include a restatement of the carrying values of assets and liabilities to reflect current values.

When a quasi-reorganization is performed, the retained earnings should be dated as of the readjustment date and disclosed in the financial statements for a period of five to ten years. Exhibit 3-20 illustrates a quasi-reorganization of Owens Corning.

Accumulated Other Comprehensive Income Conceptually, accumulated other comprehensive income represents retained earnings from other comprehensive income. In addition to the aggregate amount, companies are required to disclose the separate categories that make up accumulated other comprehensive income.

EXHIBIT 3-19 The Procter & Gamble Company*

Preferred Stock

The Procter & Gamble Company Consolidated Balance Sheet (In Part)

Amounts in millions

June 30,

2010 2009

SHAREHOLDERS’ EQUITY Convertible Class A preferred stock, stated value $1 per share (600

shares authorized) 1,277 1,324 Non-voting Class B preferred stock, stated value $1 per share (200

shares authorized) — — Common stock, stated value $1 per share (10,000 shares authorized;

shares issued: 2010 – 4,007.6, 2009 – 4,007.3) 4,008 4,007 Additional paid-in capital 61,697 61,118 Reserve for ESOP debt retirement (1,350) (1,340) Accumulated other comprehensive income (loss) (7,822) (3,358) Treasury stock, at cost (shares held: 2010 – 1,164, 2009 – 1,090.3) (61,309) (55,961) Retained earnings 64,614 57,309 Noncontrolling interest 324 283 TOTAL SHAREHOLDERS’ EQUITY $ 61,439 $ 63,382

*“The Procter & Gamble Company is focused on providing branded consumer packaged goods of superior quality and value to improve the lives of the world’s consumers.” 10-K Source: The Procter & Gamble Company 2010 10-K

122 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

The disclosure of the separate components can be made on the face of the balance sheet, in the statement of stockholders’ equity, or in the notes. Chapter 4 covers comprehensive income. Exhibit 3-19 illustrates the presentation of accumulated other comprehensive income (loss).

Employee Stock Ownership Plans (ESOPs) An employee stock ownership plan (ESOP) is a qualified stock-bonus, or combination stock- bonus and money-purchase pension plan, designed to invest primarily in the employer’s securities. A qualified plan must satisfy certain requirements of the Internal Revenue Code. An ESOP must be a permanent trusteed plan for the exclusive benefit of the employees.

The trust that is part of the plan is exempt from tax on its income, and the employer/ sponsor gets a current deduction for contributions to the plan. The plan participants become eligible for favorable taxation of distributions from the plan.

An ESOP may borrow the funds necessary to purchase the employer stock. These funds may be borrowed from the company, its stockholders, or a third party such as a bank. The

EXHIBIT 3-20 Owens Corning*

Quasi-Reorganization For the Fiscal Year Ended December 31, 2006

Owens Corning and Subsidiaries Notes to Consolidated Financial Statements (in Part)

3. Fresh-Start Accounting** (in Part) On the Effective Date, the Company adopted fresh-start accounting in accordance with SoP 90-7. This resulted in a new reporting entity on November 1, 2006, which has a new basis of account- ing, a new capital structure and no retained earnings or accumulated losses. The Company was required to implement fresh-start accounting as the holders of existing voting shares immediately before confirmation received less than 50% of the voting shares of the Successor Company. The fresh-start accounting principles pursuant to SoP 90-7 provide, among other things, for the Com- pany to determine the value to be assigned to the equity of the reorganized Company as of a date selected for financial reporting purposes.

The reorganization value represents the amount of resources available for the satisfaction of post-petition liabilities and allowed claims, as negotiated between the Company and its creditors. The Company’s total enterprise value at the time of emergence was $5.8 billion, with a total value for common equity of $3.7 billion, including the estimated fair value of the Series A Warrants and Service B Warrants issued on the Effective Date.

In accordance with fresh-start accounting, the reorganization value of the Company was allo- cated based on the fair market values of the assets and liabilities in accordance with SFAS 141. The fair values represented the Company’s best estimates at the Effective Date based on internal and external appraisals and valuations. Liabilities existing at the Effective Date, other than deferred taxes, were stated at present values of amounts to be paid determined at appropriate cur- rent interest rates. Any portion not attributed to specific tangible or identified intangible assets was recorded as goodwill. While the Company believes that the enterprise value approximates fair value, differences between the methodology used in testing for goodwill impairment, as discussed in Note 10, and the negotiated value could adversely impact the Company’s results of operations.

Pursuant to SoP 90-7, the results of operations of the ten months ended October 31, 2006 include a pre-emergence gain on the cancellation of debt of $5.9 billion resulting from the discharge of liabilities subject to compromise and other liabilities under the Plan; and a pre- emergence gain of $2.2 billion, net of tax, resulting from the aggregate remaining changes to the net carrying value of the Company’s pre-emergence assets and liabilities to reflect the fair values under fresh-start accounting.

*“Owens Corning, a global company incorporated in Delaware, is headquartered in Toledo, Ohio, and is a leading producer of residential and commercial building materials and glass fiber reinforcements and other similar materials for composite systems.” 10-K **Application of fresh-start accounting at October 31, 2006. Source: Owens Corning 2010 10-K

CHAPTER 3 • Balance Sheet 123

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

company can guarantee the loan to the ESOP. Financial leverage—the ability of the ESOP to borrow in order to buy employer securities—is an important aspect.

The Internal Revenue Code favors borrowing for an ESOP. Commercial lending institu- tions, insurance companies, and mutual funds are permitted an exclusion from income for 50% of the interest received on loans used to finance an ESOP’s acquisition of company stock. Thus, these institutions are willing to charge a reduced rate of interest for the loan.

From a company’s perspective, an ESOP has both advantages and disadvantages. One advantage is that an ESOP serves as a source of funds for expansion at a reasonable rate. Other possible advantages are as follows:

1. A means to buy the stock from a major shareholder or possibly an unwanted shareholder.

2. Help in financing a leveraged buyout. 3. Reduction of potential of an unfriendly takeover. 4. Help in creating a market for the company’s stock.

Some firms do not find an ESOP attractive because it can result in a significant amount of voting stock in the hands of their employees. Existing stockholders may not find an ESOP desirable because it will probably dilute their proportional ownership.

The employer contribution to an ESOP reduces cash, and an unearned compensation item decreases stockholders’ equity. The unearned compensation is amortized on the income statement in subsequent periods. When an ESOP borrows funds and the firm (in either an informal or a formal guarantee) commits to future contributions to the ESOP to meet the debt-service requirements, then the firm records this commitment as a liability and as a deferred compensation deduction within stockholders’ equity. As the debt is liquidated, the liability and deferred compensation are reduced.

Exhibit 3-21 shows Sara Lee Corporation reporting of the ESOP.

Treasury Stock A firm creates treasury stock when it repurchases its own stock and does not retire it. Since treasury stock lowers the stock outstanding, it is subtracted from stockholders’ equity. Treasury stock is, in essence, a reduction in paid-in capital.

A firm may record treasury stock in two ways. One method records the treasury stock at par or stated value, referred to as the par-value method of recording treasury stock. This method removes the paid-in capital in excess of par (or stated value) from the original issue. The treasury stock appears as a reduction of paid-in capital.

The other method, referred to as the cost method, records treasury stock at the cost of the stock (presented as a reduction of stockholders’ equity).Most firms record treasury stock at cost.

Exhibit 3-22 illustrates the presentation of treasury stock for Johnson & Johnson and Subsidiaries. Note that a firm cannot record gains or losses from dealing in its own stock. Any apparent gains or losses related to treasury stock must impact stockholders’ equity, such as a reduction in retained earnings.

Stockholders’ Equity in Unincorporated Firms These firms do not have stockholders. Stockholders’ equity in an unincorporated firm is termed capital. The amount invested by the owner plus the retained earnings may be shown as one sum. A sole proprietorship form of business has only one owner (one capital account). A partnership form of business has more than one owner (capital account for each owner). Chapter 2 reviewed these forms of business.

Statement of Stockholders’ Equity Firms are required to present reconciliations of the beginning and ending balances of their stockholder accounts. This is accomplished by presenting a “statement of stockholders’ equity.”

This statement will include all of the stockholders’ equity accounts. It is important when performing analysis to be aware of changes in these accounts. For example, common stock will indicate changes in common stock, retained earnings will indicate changes in retained

124 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

earnings, and treasury stock will indicate changes in treasury stock. This statement is illus- trated in Chapter 4.

For many firms, it is important to observe changes to the account Accumulated Other Comprehensive Income (loss). This account is related to comprehensive income, which is covered in Chapter 4.

Problems in Balance Sheet Presentation Numerous problems inherent in balance sheet presentation may cause difficulty in analysis. First, many assets are valued at cost, so one cannot determine the market value or replace- ment cost of many assets and should not assume that their balance sheet amount approxi- mates current valuation.

Second, varying methods are used for asset valuation. For example, inventories may be valued differently from firm to firm and, within a firm, from product to product. Similar problems exist with long-term asset valuation and the related depreciation alternatives.

A different type of problem exists in that not all items of value to the firm are included as assets. For example, such characteristics as good employees, outstanding management, and a well-chosen location do not appear on the balance sheet. In the same vein, liabilities

EXHIBIT 3-21 The Sara Lee Corporation*

Employee Stock Ownership Program (ESOP)

July 3, 2010 June 27, 2009

Dollars in Millions Equity Sara Lee common stockholders’ equity: Common stock: (authorized 1,200,000,000 shares; $0.01 par

value) Issued and outstanding – 662,118,377 shares in 2010 and 695,658,110 shares in 2009 7 7

Capital surplus 17 17 Retained earnings 2,472 2,721 Unearned stock of ESOP (97) (104) Accumulated other comprehensive income (loss) (912) (605) Total Sara Lee common stockholders’ equity 1,487 2,036 Noncontrolling interest 28 34 Total equity 1,515 2,070

Notes to Consolidated Financial Statements (In Part)

Note 10 – Employee Stock Ownership Trust

The corporation maintains an ESOP that holds common stock of the corporation that is used to fund a portion of the corporation’s matching program for its 401(k) savings plan for domestic non-union employees. The purchase of the original stock by the Sara Lee ESOP was funded both with debt guaranteed by the corporation and loans from the corporation. The debt guaranteed by the corporation was fully paid in 2004, and only loans from the corporation to the ESOP remain. Each year, the corporation makes contributions that, with the dividends on the common stock held by the Sara Lee ESOP, are used to pay loan interest and principal. Shares are allocated to par- ticipants based upon the ratio of the current year’s debt service to the sum of the total principal and interest payments over the remaining life of the loan. The number of unallocated shares in the ESOP was 7 million at July 3, 2010 and 8 million at June 27, 2009. Expense recognition for the ESOP is accounted for under the grandfathered provisions contained within US GAAP.

The expense for the 401(k) recognized by the ESOP amounted to $7 million in 2010, $5 million in 2009 and $7 million in 2008. Payments to the Sara Lee ESOP were $11 million in 2010 and 2009, and $16 million in 2008.

*“Sara Lee Corporation… is a global manufacturer and marketer of high-quality, brand-name products for consumers throughout the world focused primarily on meats, bakery and beverage categories.” 10-K Source: The Sara Lee Corporation, 2010 10-K

CHAPTER 3 • Balance Sheet 125

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

related to contingencies also may not appear on the balance sheet. Chapters 6 and 7 present many of the problems of the balance sheet.

These problems do not make statement analysis impossible. They merely require that qualitative judgment be applied to quantitative data in order to assess the impact of these problem areas.

International Consolidated Balance Sheet (IFRS) IFRS do not require a standard format for the balance sheet. Usually noncurrent assets are presented first, followed by current assets. For liabilities and owners’ equity, “capital and reserves” are usually listed first, then noncurrent liabilities, and last, current liabilities.

The reserves sections of “capital and reserves” would not be part of U.S. GAAP. Reserves may result from upward revaluations of properties and investments. Reserves may also result from currency translation differences, similar to the U.S. GAAP classification of other comprehensive income.

Deloitte Touche Tohmatsu Limited, one of the big four public accounting firms, presents model financial statements under IFRS available on www.deloitte.com. These model finan- cial statements will be used to illustrate statements under IFRS:

International GAAP Holdings Limited Financial statements for the year ended 31 December 2011 The model financial statements of International GAAP Holdings Limited for the year ended 31 December 2011 are intended to illustrate the presentation and disclosure requirements of International Financial Reporting Standards (IFRSs). They also contain additional disclosures that are considered to be best practice, particularly where such dis- closures are included in illustrative examples provided with a specific Standard.

International GAAP Holdings Limited is assumed to have presented financial state- ments in accordance with IFRSs for a number of years. Therefore, it is not a first-time adopter of IFRSs. Readers should refer to IFRS 1 First-time Adoption of International Fi- nancial Reporting Standards for specific requirements regarding an entity’s first IFRS fi- nancial statements, and to the IFRS 1 section of Deloitte’s Compliance, Presentation and Disclosure Checklist for details of the particular disclosure requirements applicable for

EXHIBIT 3-22 Johnson & Johnson and Subsidiaries*

Treasury Stock

Johnson & Johnson and Subsidiaries Consolidated Balance Sheets (In Part)

At January 3, 2011 and January 3, 2010 Dollars in Millions Except Share and Per Share Data

Shareholders’ equity Preferred stock – without par value (authorized and unissued 2,000,000 shares) — — Common stock – par value $1.00 per share (Note 12) (authorized

4,320,000,000 shares; issued 3,119,843,000 shares) 3,120 3,120 Accumulated other comprehensive income (Note 13) (3,531) (3,058) Retained earnings 77,773 70,306

77,362 70,368 Less: common stock held in treasury, at cost (Note 12) (381,746,000 shares

and 365,522,000 shares) 20,783 19,780 Total shareholders’ equity 56,579 50,588

*“Johnson & Johnson and its subsidiaries (the “Company”) have approximately 114,000 employees worldwide engaged in the research and development, manufacture and sale of a broad range of products in the health care field.” 10-K Source: Johnson & Johnson and Subsidiaries, 2010 10-K

© 2011 Deloitte Touch Tohmatsu. Deloitte, Deloitte & Touch, Deloitte Touche Tohmatsu, the Deloitte logo, the Deloitte Touch Tohmatsu logo, and certain product names mentioned in this material are trademarks or registered trademarks of Deloitte Touche Tohmatsu, which has no connection to the author or publisher of this book and has no responsibility for its contents.

126 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

first-time adopters. Deloitte’s Compliance, Presentation and Disclosure Checklist can be downloaded from Deloitte’s web site www.iasplus.com.

The model financial statements have illustrated the impact of a number of new and revised Standards and Interpretations that are mandatorily effective on 1 January 2011 (see note 2 to the model financial statements for details). The model financial statements have not illustrated the impact of new and revised Standards and Interpretations that are not yet mandatorily effective on 1 January 2011 (e.g. IFRS 9 Financial Instruments).

In addition, the model financial statements have been presented without regard to local laws or regulations. Preparers of financial statements will need to ensure that the options selected under IFRSs do not conflict with such sources of regulation (e.g. the reval- uation of assets is not permitted in certain regimes – but these financial statements illus- trate the presentation and disclosures required when an entity adopts the revaluation model under IAS 16 Property, Plant and Equipment). In addition, local laws or securities regulations may specify disclosures in addition to those required by IFRSs (e.g. in relation to directors’ remuneration). Preparers of financial statements will consequently need to adapt the model financial statements to comply with such additional local requirements.

The model financial statements do not include separate financial statements for the parent, which may be required by local laws or regulations, or may be prepared volun- tarily. Where an entity presents separate financial statements that comply with IFRSs, the requirements of IAS 27 Consolidated and Separate Financial Statements will apply. Separate statements of comprehensive income, financial position, changes in equity and cash flows for the parent will generally be required, together with supporting notes.

Suggested disclosures are cross-referenced to the underlying requirements in the texts of the relevant Standards and Interpretations.

For the purposes of presenting the statements of comprehensive income and cash flows, the alternatives allowed under IFRSs for those statements have been illustrated. Preparers should select the alternatives most appropriate to their circumstances and apply the chosen presentation method consistently.

Note that in these model financial statements, we have frequently included line items for which a nil amount is shown, so as to illustrate items that, although not applicable to International GAAP Holdings Limited, are commonly encountered in practice. This does not mean that we have illustrated all possible disclosures. Nor should it be taken to mean that, in practice, entities are required to display line items for such ‘nil’ amounts.”

Disclaimer Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private com- pany limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. “Deloitte” is the band [brand] under which tens of thousands of dedicated profes- sionals in independent firms throughout the world collaborate to provide audit, consult- ing, financial advisory, risk management, and tax services to selected clients. These firms are member[s] of Deloitte Touche Tohmatsu Limited (DTTL), a UK private company limited by guarantee. Each member firm provides services in a particular geographic area and is subject to the laws and professional regulations of the particular country or coun- tries in which it operates. DTTL does not itself provide services to clients. DTTL and each DTTL member firm are separate and distinct legal entities, which cannot obligate each other. DTTL and each DTTL member firm are liable for only their own acts or omissions and not those of each other. Each DTTL member firm is structured differently in accordance with national laws, regulations, customary practice, and other factors, and may secure the provision of professional services in its territory through subsidiaries, affiliates and/or other entities. This publication contains general information only, and none of Deloitte Touche Tohmatsu Limited, its member firms, or its and their affiliates are, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your finances or your business. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional advisor. None of Deloitte Touche Tohmatsu Limited, its member

CHAPTER 3 • Balance Sheet 127

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

firms, or its and their respective affiliates shall be responsible for any loss whatsoever sustained by any person who relies on this publication.

The model consolidated balance sheet (consolidated statement of financial position) is presented in Exhibit 3-23.

EXHIBIT 3-23 IFRS Model Consolidated Balance Sheet

Source International GAAP Holdings Limited

IAS 1.10(a),(f),51(b),(c) Consolidated statement of financial position at 31 December 2011

IAS 1.113 Notes 31/12/11 31/12/10 01/01/10

IAS 1.51(d), (e) CU’000 CU’000 CU’000 Assets

IAS 1.60 Non-current assets IAS 1.54(a) Property, plant and equipment 15 109,783 135,721 161,058 IAS 1.54(b) Investment property 16 1,968 1,941 170 IAS 1.55 Goodwill 17 20,285 24,060 23,920 IAS 1.54(c) Other intangible assets 18 9,739 11,325 12,523 IAS 1.54(e) Investments in associates 20 7,402 7,270 5,706 IAS 1.54(o) Deferred tax assets 10 2,083 1,964 1,843 IAS 1.55 Finance lease receivables 26 830 717 739 IAS 1.54(d) Other financial assets 22 10,771 9,655 7,850 IAS 1.55 Other assets 23 — — —

Total non-current assets 162,861 192,653 213,809

IAS 1.60 Current assets IAS 1.54(g) Inventories 24 31,213 28,982 29,688 IAS 1.54(h) Trade and other receivables 25 19,249 14,658 13,550 IAS 1.55 Finance lease receivables 26 198 188 182 IAS 1.55 Amounts due from customers under

construction contracts 27 240 230 697 IAS 1.54(d) Other financial assets 22 8,757 6,949 5,528 IAS 1.54(n) Current tax assets 10 125 60 81 IAS 1.55 Other assets 23 — — — IAS 1.54(i) Cash and bank balances 46 23,446 19,778 9,082

83,228 70,845 58,808 IAS 1.54(j) Assets classified as held for sale 12 22,336 — —

Total current assets 105,564 70,845 58,808 Total assets 268,425 263,498 272,617

Note: IAS 1.10(f) requires that an entity should present a statement of financial position as at the beginning of the earliest comparative period when it applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements. However, IAS 1 does not provide further clarification as to when an entity is required to present an additional statement of financial position.

IAS 1.31 states that an entity need not provide a specific disclosure required by an IFRS if the information is not material. In determining whether it is necessary to present an additional statement of financial position, entities should consider the materiality of the information that would be contained in the additional statement of financial position and whether this would affect economic decisions made by a user of the financial statements. Specifically, it would be useful to consider factors such as the nature of the change, the alternative disclosures provided and whether the change in accounting policy actually affected the financial position at the beginning of the comparative period. Specific views from regulators should be considered in the assessment.

In this model, the application of new and revised standards does not result in any retrospective restatement of items in the financial statements (see note 2). However, this model does include the additional statement of financial position and the related notes for illustrative purposes only in order to show the level of detail to be disclosed when entities, after considering the specific facts and circumstances and exercising judgement, conclude that the additional statement of financial position and the related notes should be presented.

Source: © 2011 Deloitte Touch Tohmatsu. Deloitte, Deloitte & Touch, Deloitte Touche Tohmatsu, the Deloitte logo, the Deloitte Touch Tohmatsu logo, and certain product names mentioned in this material are trademarks or registered trademarks of Deloitte Touche Tohmatsu, which has no connection to the author or publisher of this book and has no responsibility for its contents.

128 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Subsequent Events Subsequent events occur during the time period between the balance sheet data and the date statements are issued. There are two types of subsequent events under GAAP; those that require retroactive recognition (these require balance sheet and income statement recogni- tion), and those that do not require retroactive recognition but require disclosure in the notes to the financial statements. Both types of subsequent events should be material.

Source International GAAP Holdings Limited

IAS 1.10(a),(f),51(b),(c) Consolidated statement of financial position at 31 December 2011

IAS 1.113 Notes 31/12/11 31/12/10 01/01/10

IAS 1.51(d), (e) CU’000 CU’000 CU’000 Equity and liabilities Capital and reserves

IAS 1.55 Issued capital 28 32,439 48,672 48,672 IAS 1.55 Reserves 29 4,237 3,376 1,726 IAS 1.55 Retained earnings 30 110,805 94,909 73,824

147,481 146,957 124,222 IAS 1.55 Amounts recognised directly in

equity relating to assets classified as held for sale 12 — — —

IAS 1.54(r) Equity attributable to owners of the Company 147,481 146,957 124,222

IAS 1.54(q) Non-controlling interests 31 24,316 20,005 17,242 Total equity 171,797 166,962 141,464

IAS 1.60 Non-current liabilities IAS 1.55 Borrowings 32 17,868 29,807 25,785 IAS 1.54(m) Other financial liabilities 34 15,001 — — IAS 1.55 Retirement benefit obligation 39 2,861 2,023 2,968 IAS 1.54(o) Deferred tax liabilities 10 6,729 5,657 4,436 IAS 1.54(l) Provisions 35 2,294 2,231 4,102 IAS 1.55 Deferred revenue 41 59 165 41 IAS 1.55 Other liabilities 36 180 270 —

Total non-current liabilities 44,992 40,153 37,332

IAS 1.60 Current liabilities IAS 1.54(k) Trade and other payables 37 16,373 21,220 52,750 IAS 1.55 Amounts due to customers under

construction contracts 27 36 15 245 IAS 1.55 Borrowings 32 22,446 25,600 33,618 IAS 1.54(m) Other financial liabilities 34 116 18 — IAS 1.54(n) Current tax liabilities 10 5,270 5,868 4,910 IAS 1.54(l) Provisions 35 3,356 3,195 2,235 IAS 1.55 Deferred revenue 41 265 372 63 IAS 1.55 Other liabilities 36 90 95 —

47,952 56,383 93,821 IAS 1.54(p) Liabilities directly associated with

assets classified as held for sale 12 3,684 — — Total current liabilities 51,636 56,383 93,821 Total liabilities 96,628 96,536 131,153 Total equity and liabilities 268,425 263,498 272,617

EXHIBIT 3-23 IFRS Model Consolidated Balance Sheet (continued)

(Continued)

CHAPTER 3 • Balance Sheet 129

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Subsequent events that require retroactive recognition usually relate to estimates that were made and the subsequent event indicates that the estimates were substantially incorrect. Possibly a major customer has gone bankrupt and a reasonable amount was not provided for in allowance for doubtful accounts.

The second type of subsequent event does not affect the balance sheet date but does appear to be significant to the users of the financial statements. Possibly the CEO has died and the company is searching for a new CEO. Another example would be the issuance of a signifi- cant amount of common stock. This type of subsequent event is illustrated in Exhibit 3-24.

Summary The balance sheet shows the financial condition of an accounting entity as of a particular date. It is the most basic financial statement, and it is read by various users as part of

their decision-making process. This chapter also covered the international consolidating balance sheet (IFRS).

Questions Q 3-1 Name and describe the three major categories of balance sheet accounts.

Q 3-2 Are the following balance sheet items (A) assets, (L) liabilities, or (E) stockholders’ equity?

a. Cash dividends payable b. Mortgage notes payable c. Investments in stock d. Cash e. Land

f. Inventory g. Unearned rent h. Marketable securities i. Patents j. Capital stock k. Retained earnings l. Accounts receivable

m. Taxes payable n. Accounts payable

EXHIBIT 3-24 Best Buy Co., Inc.

Subsequent Event

16. Subsequent Event (Dollars in millions) In March 2011, we sold $350 principal amount of notes due March 15, 2016 (the “2016 Notes”) and $650 principal amount of notes due March 15, 2021 (the “2021 Notes”, and together with the 2016 Notes, the “Notes”). The 2016 Notes bear interest at a fixed rate of 3.75% per year, while the 2021 Notes bear interest at a fixed rate of 5.50% per year. Interest on the Notes is pay- able semi-annually on March 15 and September 15 of each year, beginning September 15, 2011. The Notes were issued at a slight discount to par, which when coupled with underwriting dis- counts of $6, resulted in net proceeds from the sale of the Notes of $990.

We may redeem some or all of the Notes at any time at a redemption price equal to the greater of (i) 100% of the principal amount of the Notes redeemed and (ii) the sum of the present values of each remaining scheduled payment of principal and interest on the Notes redeemed discounted to the redemption date on a semiannual basis, plus accrued and unpaid interest on the principal amount of the Notes to the redemption date as described in the indenture (including the supple- mental indenture) relating to the Notes. Furthermore, if a change of control triggering event occurs, unless we have previously exercised our option to redeem the Notes, we will be required to offer to purchase the Notes at a price equal to 101% of the principal amount of the Notes, plus accrued and unpaid interest to the purchase date.

The Notes are unsecured and unsubordinated obligations and rank equally with all of our other unsecured and unsubordinated debt. The Notes contain covenants that, among other things, limit our ability and the ability of our North American subsidiaries to incur debt secured by liens or to enter into sale and lease-back transactions.

Source: Best Buy, Inc. 2010 10-K

130 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

o. Organizational costs p. Prepaid expenses q. Goodwill r. Tools s. Buildings

Q 3-3 Classify the following as (CA) current asset, (IV) investments, (IA) intangible asset, or (TA) tangible asset:

a. Land b. Cash c. Copyrights d. Marketable securities e. Goodwill f. Inventories g. Tools h. Prepaids i. Buildings j. Accounts receivable k. Long-term investment in stock l. Machinery

Q 3-4 Usually, current assets are listed in a specific order, starting with cash. What is the objective of this order of listing?

Q 3-5 Differentiate between marketable securities and long-term investments. What is the purpose of owning each?

Q 3-6 Differentiate between accounts receivable and accounts payable.

Q 3-7 What types of inventory will a retailing firm have? A manufacturing firm?

Q 3-8 What is depreciation? Which tangible assets are depreciated, and which are not? Why?

Q 3-9 For reporting purposes, management prefers higher profits; for tax purposes, lower taxable income is desired. To meet these goals, firms often use different methods of depreciation for tax and reporting purposes. Which depreciation method is best for reporting and which for tax purposes in the short run? Why?

Q 3-10 A rental agency collects rent in advance. Why is the rent collected treated as a liability?

Q 3-11 A bond carries a stated rate of interest of 6% and par of $1,000. It matures in 20 years. It is sold at 83 (83% of $1,000, or $830).

a. Under normal conditions, why would the bond sell at less than par?

b. How would the discount be disclosed on the statements?

Q 3-12 To be conservative, how should noncontrolling in- terest on the balance sheet be handled for primary analysis?

Q 3-13 Many assets are presented at historical cost. Why does this accounting principle cause difficulties in financial statement analysis?

Q 3-14 Explain how the issuance of a convertible bond can be a very attractive means of raising common equity funds.

Q 3-15 Classify each of the following as a (CA) current asset, (NA) noncurrent asset, (CL) current liability, (NL) noncurrent liability, or (E) equity account. Choose the best or most frequently used classification.

a. Supplies b. Notes receivable c. Unearned subscription revenue d. Accounts payable e. Retained earnings f. Accounts receivable g. Preferred stock h. Plant i. Prepaid rent j. Capital k. Wages payable l. Mortgage bonds payable

m. Unearned interest n. Marketable securities o. Paid-in capital from sale of treasury stock p. Land q. Inventories r. Taxes accrued s. Cash

Q 3-16 Explain these preferred stock characteristics:

a. Accumulation of dividends b. Participation in excess of stated dividend rate c. Convertibility into common stock d. Callability by the corporation e. Preference in liquidation

Q 3-17 Describe the account Unrealized Exchange Gains or Losses.

Q 3-18 What is treasury stock? Why is it deducted from stockholders’ equity?

Q 3-19 A firm, with no opening inventory, buys 10 units at $6 each during the period. In which accounts might the $60 appear on the financial statements?

Q 3-20 How is an unconsolidated subsidiary presented on a balance sheet?

Q 3-21 When would noncontrolling interest be pre- sented on a balance sheet?

Q 3-22 DeLand Company owns 100% of Little Florida, Inc. Will DeLand Company show a noncontrolling interest on its balance sheet? Would the answer change if it owned only 60%? Will there ever be a case in which the subsidiary, Little Florida, is not consolidated?

CHAPTER 3 • Balance Sheet 131

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Q 3-23 Describe the item Unrealized Decline in Market Value of Noncurrent Equity Investments.

Q 3-24 What is redeemable preferred stock? Why should it be included with debt for purposes of financial statement analysis?

Q 3-25 Describe fair value as it relates to assets and liabilities.

Q 3-26 With fair value the firm selects the highest appro- priate level for valuation. Why the direction to select the highest appropriate level of valuation?

Q 3-27 For level 3 valuation (fair value), the company must include the valuation technique used to measure fair value, a reconciliation of the changes in fair value during the period, and a related discussion. Why the related discussion?

Q 3-28 Describe quasi-reorganization.

Q 3-29 Describe employee stock ownership plans (ESOPs).

Q 3-30 Why are commercial lending institutions, insur- ance companies, and mutual funds willing to grant loans to an employee stock ownership plan at favorable rates?

Q 3-31 What are some possible disadvantages of an em- ployee stock ownership plan?

Q 3-32 How does a company recognize, in an informal or a formal way, that it has guaranteed commitments to future contributions to an ESOP tomeet debt-service requirements?

Q 3-33 Describe depreciation, amortization, and deple- tion. How do they differ?

Q 3-34 What are the three factors usually considered when computing depreciation?

Q 3-35 An accelerated system of depreciation is often used for income tax purposes but not for financial reporting.Why?

Q 3-36 Which depreciation method will result in the most depreciation over the life of an asset?

Q 3-37 Should depreciation be recognized on a building in a year in which the cost of replacing the building rises? Explain.

Q 3-38 Describe the account Accumulated Other Com- prehensive Income.

Q 3-39 Describe donated capital.

Q 3-40 Assume that a city donated land to a company. What accounts would be affected by this donation, and what would be the value?

Q 3-41 Describe the two types of subsequent events under GAAP.

Problems P 3-1 The following information was obtained from the accounts of Airlines International dated December 31, 2012. It is presented in alphabetical order.

Accounts payable $ 77,916 Accounts receivable 67,551 Accrued expenses 23,952 Accumulated depreciation 220,541 Allowance for doubtful accounts 248 Capital in excess of par 72,913 Cash 28,837 Common stock (par $0.50, authorized 20,000 shares, issued 14,304 shares) 7,152

Current installments of long-term debt 36,875 Deferred income tax liability (long term) 42,070 Inventory 16,643 Investments and special funds 11,901 Long-term debt, less current portion 393,808 Marketable securities 10,042 Other assets 727 Prepaid expenses 3,963 Property, plant, and equipment at cost 809,980 Retained earnings 67,361 Unearned transportation revenue (airline tickets expiring within one year) 6,808

Required Prepare a classified balance sheet in report form.

P 3-2 The following information was obtained from the accounts of Lukes, Inc., as of December 31, 2012. It is presented in scrambled order.

132 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Common stock, no par value, 10,000 shares authorized, 5,724 shares issued $ 3,180

Retained earnings 129,950 Deferred income tax liability (long term) 24,000 Long-term debt 99,870 Accounts payable 35,000 Buildings 75,000 Machinery and equipment 300,000 Land 11,000 Accumulated depreciation 200,000 Cash 3,000 Receivables, less allowance of $3,000 58,000 Accrued income taxes 3,000 Inventory 54,000 Other accrued expenses 8,000 Current portion of long-term debt 7,000 Prepaid expenses 2,000 Other assets (long term) 7,000

Required Prepare a classified balance sheet in report form. For assets, use the classifications of current assets, plant and equipment, and other assets. For liabilities, use the classifications of current liabilities and long-term liabilities.

P 3-3 The following information was obtained from the accounts of Alleg, Inc., as of De- cember 31, 2012. It is presented in scrambled order.

Common stock, authorized 21,000 shares at $1 par value, issued 10,000 shares $ 10,000

Additional paid-in capital 38,000 Cash 13,000 Marketable securities 17,000 Accounts receivable 26,000 Accounts payable 15,000 Current maturities of long-term debt 11,000 Mortgages payable 80,000 Bonds payable 70,000 Inventory 30,000 Land and buildings 57,000 Machinery and equipment 125,000 Goodwill 8,000 Patents 10,000 Other assets 50,000 Deferred income taxes (long-term liability) 18,000 Retained earnings 33,000 Accumulated depreciation 61,000

Required Prepare a classified balance sheet in report form. For assets, use the classifications of current assets, plant and equipment, intangibles, and other assets. For liabilities, use the classifications of current liabilities and long-term liabilities.

P 3-4 The following is the balance sheet of Ingram Industries:

INGRAM INDUSTRIES Balance Sheet June 30, 2012

Assets Current assets:

Cash (including $13,000 in sinking fund for bonds payable) $ 70,000

Marketable securities 23,400 Investment in subsidiary company 23,000 Accounts receivable 21,000 Inventories (lower-of-cost-or-market) 117,000 $254,400

(continued)

CHAPTER 3 • Balance Sheet 133

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Assets Plant assets:

Land and buildings $160,000 Less: Accumulated depreciation 100,000 $ 60,000

Investments: Treasury stock 4,000

Deferred charges: Discount on bonds payable $ 6,000 Prepaid expenses 2,000 8,000

$326,400 Liabilities and Stockholders’ Equity

Liabilities: Notes payable to bank $ 60,000 Accounts payable 18,000 Bonds payable 61,000

Total liabilities $139,000 Stockholders’ equity:

Preferred and common (each $10 par, 5,000 shares preferred and 6,000 shares common) $110,000

Capital in excess of par 61,000 Retained earnings 16,400

187,400 Total liabilities and stockholders’ equity $326,400

Required Indicate your criticisms of the balance sheet and briefly explain the proper treat- ment of any item criticized.

P 3-5 The following is the balance sheet of Rubber Industries:

RUBBER INDUSTRIES Balance Sheet

For the Year Ended December 31, 2012

Assets Current assets:

Cash $ 50,000 Marketable equity securities 19,000 Accounts receivable, net 60,000 Inventory 30,000 Treasury stock 20,000 Total current assets $179,000

Plant assets: Land and buildings, net 160,000

Investments: Short-term U.S. notes 20,000

Other assets: Supplies 4,000 Total assets $363,000

Liabilities and Stockholders’ Equity Liabilities:

Bonds payable $123,000 Accounts payable 40,000 Wages payable 10,000 Total liabilities $173,000

Stockholders’ equity: Common stock ($20 par, 20,000 shares authorized, 6,000 shares outstanding) 120,000

Retained earnings 50,000 Redeemable preferred stock 20,000 Total liabilities and stockholders’ equity $363,000

Required Indicate your criticisms of the balance sheet and briefly explain the proper treat- ment of any item criticized.

(P 3-4 CONTINUED)

134 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

P 3-6 The following is the balance sheet of McDonald Company:

McDONALD COMPANY December 31, 2012

Assets Current assets: Cash (including $10,000 restricted for payment of note) $ 40,000 Marketable equity securities 20,000 Accounts receivable, less allowance for doubtful

accounts of $12,000 70,000 Inventory 60,000

Total current assets $190,000 Plant assets: Land $ 40,000 Buildings, net 100,000 Equipment $80,000 Less: Accumulated depreciation 20,000 60,000 Patent 20,000 Organizational costs 15,000

235,000 Other assets: Prepaid insurance 5,000

Total assets $430,000 Liabilities and Stockholders’ Equity

Current liabilities: Accounts payable $ 60,000 Wages payable 10,000 Notes payable, due July 1, 2014 20,000 Bonds payable, due December 2018 100,000

Total current liabilities $190,000 Dividends payable 4,000 Deferred tax liability, long term 30,000 Stockholders’ equity: Common stock ($10 par, 10,000 shares authorized,

5,000 shares outstanding) $ 50,000 Retained earnings 156,000

Total stockholders’ equity 206,000 Total liabilities and stockholders’ equity $430,000

Required Indicate your criticisms of the balance sheet and briefly explain the proper treat- ment of any item criticized.

P 3-7 You have just started as a staff auditor for a small CPA firm. During the course of the audit, you discover the following items related to a single client firm:

a. During the year, the firm declared and paid $10,000 in dividends. b. Your client has been named defendant in a legal suit involving a material amount. You

have received from the client’s counsel a statement indicating little likelihood of loss. c. Because of cost control actions and general employee dissatisfaction, it is likely that the

client will suffer a costly strike in the near future. d. Twenty days after closing, the client suffered a major fire in one of its plants. e. The cash account includes a substantial amount set aside for payment of pension

obligations. f. Marketable securities include a large quantity of shares of stock purchased for control

purposes. g. Land is listed on the balance sheet at its market value of $1,000,000. It cost $670,000

to purchase 12 years ago. h. During the year, the government of Uganda expropriated a plant located in that

country. There was substantial loss.

Required How would each of these items be reflected in the year-end balance sheet, includ- ing notes?

CHAPTER 3 • Balance Sheet 135

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

P 3-8 Corvallis Corporation owns 80% of the stock of Little Harrisburg, Inc. At December 31, 2012, Little Harrisburg had the following summarized balance sheet:

LITTLE HARRISBURG, INC. Balance Sheet

December 31, 2012

Current assets $100,000 Current liabilities $ 50,000 Long-term debt 150,000

Property, plant, and equipment (net) 400,000 Capital stock 50,000 $500,000 Retained earnings 250,000

$500,000

The earnings of Little Harrisburg, Inc., for 2012 were $50,000 after tax. Required a. What would be the amount of noncontrolling interest on the balance sheet of Corvallis

Corporation? b. What would be the noncontrolling interest in share of earnings on the income

statement of Corvallis Corporation?

P 3-9 Aggarwal Company has had 10,000 shares of 10%, $100 par-value preferred stock and 80,000 shares of $5 stated-value common stock outstanding for the last three years. During that period, dividends paid totaled $0, $200,000, and $220,000 for each year, respectively. Required Compute the amount of dividends that must have been paid to preferred stock- holders and common stockholders in each of the three years, given the following four inde- pendent assumptions:

a. Preferred stock is nonparticipating and cumulative. b. Preferred stock participates up to 12% of its par value and is cumulative. c. Preferred stock is fully participating and cumulative. d. Preferred stock is nonparticipating and noncumulative.

P 3-10 Rosewell Company has had 5,000 shares of 9%, $100 par-value preferred stock and 10,000 shares of $10 par-value common stock outstanding for the last two years. Dur- ing the most recent year, dividends paid totaled $65,000; in the prior year, dividends paid totaled $40,000. Required Compute the amount of dividends that must have been paid to preferred stockhold- ers and common stockholders in each year, given the following independent assumptions:

a. Preferred stock is fully participating and cumulative. b. Preferred stock is nonparticipating and noncumulative. c. Preferred stock participates up to 10% of its par value and is cumulative. d. Preferred stock is nonparticipating and cumulative.

P 3-11 An item of equipment acquired on January 1 at a cost of $100,000 has an estimated life of 10 years. Required Assuming that the equipment will have a salvage value of $10,000, determine the depreciation for each of the first three years by the:

a. Straight-line method b. Declining-balance method c. Sum-of-the-years’-digits method

P 3-12 An item of equipment acquired on January 1 at a cost of $60,000 has an estimated use of 25,000 hours. During the first three years, the equipment was used 5,000 hours, 6,000 hours, and 4,000 hours, respectively. The estimated salvage value of the equipment is $10,000. Required Determine the depreciation for each of the three years, using the unit-of-production method.

136 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

P 3-13 An item of equipment acquired on January 1 at a cost of $50,000 has an estimated life of five years and an estimated salvage of $10,000.

Required a. From a management perspective, from among the straight-line method, declining-

balance method, and sum-of-the-years’-digits method of depreciation, which method should be chosen for the financial statements if income is to be at a maximum the first year? Which method should be chosen for the income tax returns, assuming that the tax rate stays the same each year? Explain and show computations.

b. Is it permissible to use different depreciation methods in financial statements than those used in tax returns?

P 3-14 Required Answer the following multiple-choice questions:

a. Which of the following accounts would not appear on a conventional balance sheet?

1. Accounts receivable 2. Accounts payable 3. Patents 4. Gain from sale of land 5. Common stock

b. Current assets typically include all but which of the following assets?

1. Cash restricted for the retirement of bonds 2. Unrestricted cash 3. Marketable securities 4. Receivables 5. Inventories

c. The Current Liabilities section of the balance sheet should include

1. Land. 2. Cash surrender value of life insurance. 3. Accounts payable. 4. Bonds payable. 5. Preferred stock.

d. Inventories are the balance of goods on hand. In a manufacturing firm, they include all but which of the following?

1. Raw materials 2. Work in process 3. Finished goods 4. Supplies 5. Construction in process

e. Which of the following accounts would not usually be classified as a current liability?

1. Accounts payable 2. Wages payable 3. Unearned rent income 4. Bonds payable 5. Taxes payable

f. For the issuing firm, redeemable preferred stock should be classified where for analysis purposes?

1. Marketable security 2. Long-term investment 3. Intangible 4. Liabilities 5. Shareholders’ equity

(continued)

CHAPTER 3 • Balance Sheet 137

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

g. Which of the following accounts would not be classified as an intangible?

1. Goodwill 2. Patent 3. Accounts receivable 4. Trademarks 5. Franchises

h. Which of the following is not true relating to intangibles?

1. Research and development usually represents a significant intangible on the financial statements.

2. Goodwill arises from the acquisition of a business for a sum greater than the physical asset value.

3. Purchased goodwill is not amortized but is subject to annual impairment reviews. 4. The global treatment of goodwill varies significantly. 5. Intangibles are usually amortized over their useful lives or legal lives, whichever is shorter.

i. Growth Company had total assets of $100,000 and total liabilities of $60,000. What is the balance of the stockholders’ equity?

1. $0 2. $40,000 3. $60,000 4. $100,000 5. None of the above.

j. The Current Assets section of the balance sheet should include

1. Inventory. 2. Taxes payable. 3. Land. 4. Patents. 5. Bonds payable.

k. Which of the following is not a typical current liability?

1. Accounts payable 2. Wages payable 3. Interest payable 4. Pension liabilities 5. Taxes payable

l. Which of the following is a current liability?

1. Unearned rent income 2. Prepaid interest 3. Land 4. Common stock 5. None of the above.

m. Treasury stock is best classified as a

1. Current liability. 2. Current asset. 3. Reduction of stockholders’ equity. 4. Contra asset. 5. Contra liability.

n. Considering IFRSs, which of the following statements would be considered false?

1. IFRSs do not require a standard format for the balance sheet. 2. With IFRSs, usually nonconcurrent assets are presented first, followed by current assets. 3. Under IFRS for liabilities and owners’ equity, capital and listed reserves are usually

listed first, then noncurrent liabilities, and then current liabilities last.

(P 3-14 CONTINUED)

138 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

4. The reserves section of capital and reserves would not be part of U.S. GAAP. 5. All of these items would be considered to be true.

o. Considering IFRSs, which of the following statements would be considered false?

1. When using IFRSs, local laws or securities regulations may specify disclosures in addition to those required by IFRSs.

2. IAS introduced a number of terminology changes. The new titles for the financial statements are not mandatory.

3. The IFRS model consolidated balance sheet, as presented by Deloitte Touche, puts an emphasis on liquidity.

4. Under IFRS, noncontrolling interests are usually presented as the last item in total equity. 5. None of these statements would be considered false.

Cases CASE 3-1 CONVENIENCE FOODS

Kellogg Company and Subsidiaries* Consolidated Balance Sheet

(millions, except share data) 2010 2009

Current assets Cash and cash equivalents $ 444 $ 334 Accounts receivable, net 1,190 1,093 Inventories 1,056 910 Other current assets 225 221

Total current assets $ 2,915 $ 2,558 Property, net 3,128 3,010 Goodwill 3,628 3,643 Other intangibles, net 1,456 1,458 Other assets 720 531

Total assets $11,847 $11,200 Current liabilities Current maturities of long-term debt $ 952 $ 1 Notes payable 44 44 Accounts payable 1,149 1,077 Other current liabilities 1,039 1,166

Total current liabilities $ 3,184 $ 2,288 Long-term debt 4,908 4,835 Deferred income taxes 697 425 Pension liability 265 430 Other liabilities 639 947 Commitments and contingencies Equity Common stock, $.25 par value, 1,000,000,000

shares authorized. Issued: 419,272,027 shares in 2010 and 419,058,168 shares in 2009 105 105

Capital in excess of par value 495 472 Retained earnings 6,122 5,481 Treasury stock at cost: 53,667,635 shares in

2010 and 37,678,215 shares in 2009 (2,650) (1,820) Accumulated other comprehensive income (loss) (1,914) (1,966)

Total Kellogg Company equity $ 2,158 $ 2,272 Noncontrolling interests (4) 3

Total equity 2,154 2,275 Total liabilities and equity $11,847 $11,200

*“Kellogg Company, founded in 1906 and incorporated in Delaware in 1922, and its subsidiaries are engaged in the manufacture and marketing of ready-to-eat cereal and convenience foods.” 10-K Source: Kellogg Company and Subsidiaries 2010 10-K (continued)

CHAPTER 3 • Balance Sheet 139

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Kellogg Company and Subsidiaries

Notes to Consolidated Financial Statements (In Part)

NOTE 1 ACCOUNTING POLICIES (In Part)

Basis of presentation The consolidated financial statements include the accounts of Kellogg Company and its majority-owned subsidiaries (Kellogg or the Company). Intercompany balances and transac- tions are eliminated.

The Company’s fiscal year normally ends on the Saturday closest to December 31 and as a result, a 53rd week is added approximately every sixth year. The Company’s 2010 and 2009 fiscal years each contained 52 weeks and ended on January 1, 2011 and January 2, 2010, respectively. The Company’s 2008 fiscal year ended on January 3, 2009, and included a 53rd week. While quarters normally consist of 13-week periods, the fourth quarter of fis- cal 2008 included a 14th week.

Use of estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of con- tingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from those estimates.

Cash and cash equivalents Highly liquid investments with remaining stated maturities of three months or less when pur- chased are considered cash equivalents and recorded at cost.

Accounts receivable Accounts receivable consists principally of trade receivables, which are recorded at the invoiced amount, net of allowances for doubtful accounts and prompt payment discounts. Trade receiv- ables do not bear interest. The allowance for doubtful accounts represents management’s esti- mate of the amount of probable credit losses in existing accounts receivable, as determined from a review of past due balances and other specific account data. Account balances are writ- ten off against the allowance when management determines the receivable is uncollectible. The Company does not have off-balance sheet credit exposure related to its customers.

Inventories Inventories are valued at the lower of cost ormarket. Cost is determined on an average cost basis.

Property The Company’s property consists mainly of plants and equipment used for manufacturing activities. These assets are recorded at cost and depreciated over estimated useful lives using straight-line methods for financial reporting and accelerated methods, where permitted, for tax reporting. Major property categories are depreciated over various periods as follows (in years): manufacturing machinery and equipment 5–20; office equipment 4–5; computer equipment and capitalized software 3–5; building components 15–30; building structures 50. Cost includes interest associated with significant capital projects.

Plant and equipment are reviewed for impairment when conditions indicate that the carry- ing value may not be recoverable. Such conditions include an extended period of idleness or a plan of disposal. Assets to be disposed of at a future date are depreciated over the remaining period of use. Assets to be sold are written down to realizable value at the time the assets are being actively marketed for sale and a sale is expected to occur within one year. As of year- end 2010 and 2009, the carrying value of assets held for sale was insignificant.

Goodwill and other intangible assets Goodwill and indefinite-lived intangibles are not amortized, but are tested at least annually for impairment. An intangible asset with a finite life is amortized on a straight-line basis over the estimated useful life.

(CASE 3-1 CONTINUED)

140 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

For the goodwill impairment test, the fair value of the reporting units are estimated based on market multiples. This approach employs market multiples based on earnings before interest, taxes, depreciation and amortization, earnings for companies that are com- parable to the Company’s reporting units and discounted cash flow. The assumptions used for the impairment test are consistent with those utilized by a market participant performing similar valuations for the Company’s reporting units.

Similarly, impairment testing of other intangible assets requires a comparison of carrying value to fair value of that particular asset. Fair values of non-goodwill intangible assets are based primarily on projections of future cash flows to be generated from that asset. For instance, cash flows related to a particular trademark would be based on a projected royalty stream attributable to branded product sales, discounted at rates consistent with rates used by market participants.

These estimates are made using various inputs including historical data, current and anticipated market conditions, management plans, and market comparables.

. . . . .

Research and development The costs of research and development (R&D) are expensed as incurred and are classified in SGA expense. R&D includes expenditures for new product and process innovation, as well as significant technological improvements to existing products and processes. The Com- pany’s R&D expenditures primarily consist of internal salaries, wages, consulting, and sup- plies attributable to time spent on R&D activities. Other costs include depreciation and maintenance of research facilities and equipment, including assets at manufacturing locations that are temporarily engaged in pilot plant activities.

Income taxes The Company recognizes uncertain tax positions based on a benefit recognition model. Pro- vided that the tax position is deemed more likely than not of being sustained, the Company recognizes the largest amount of tax benefit that is greater than 50 percent likely of being ulti- mately realized upon settlement. The tax position is derecognized when it is no longer more likely than not of being sustained. The Company classifies income tax–related interest and penalties as interest expense and SGA expense, respectively, on the Consolidated Statement of Income. The current portion of the Company’s unrecognized tax benefits is presented in the Consolidated Balance Sheet in other current assets and other current liabilities, and the amounts expected to be settled after one year are recorded in other assets and other liabilities.

Required a. 1. The statement is entitled “Consolidated Balance Sheets.” What does it mean to have

a consolidated balance sheet? 2. For subsidiaries where control is present, does Kellogg have 100% ownership?

Explain. b. 1. With this information, can the gross receivables be determined? Explain.

2. What is the estimated amount that will be collected on receivables outstanding at the end of 2010?

c. 1. What is the total amount of inventory at the end of 2010? 2. What indicates that the inventory is stated on a conservative basis? 3. What is the trend in inventory balance? Comment.

d. 1. What is the net property and equipment at the end of 2010? 2. What depreciation method is used for financial reporting purposes? Where permitted,

what depreciation methods are used for tax reporting? Comment on why the difference in depreciation methods for financial reporting versus tax reporting.

3. What is the accumulated depreciation on land at the end of 2010? e. 1. Describe the treasury stock account.

2. What method is used to record treasury stock? 3. Why is treasury stock presented as a reduction in stockholders’ equity?

(continued)

CHAPTER 3 • Balance Sheet 141

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

f. 1. What is the fiscal year? 2. Comment on the difference in length of fiscal year.

g. Comment on the use of estimates. h. Does it appear that cash and cash equivalents are presented conservatively? i. 1. Comment on the source of goodwill.

2. How are goodwill and indefinite-lived intangibles handled for write-offs? j. When is research and development expensed? k. Why is a benefit recognition model used for computing income taxes?

CASE 3-2 WORLD WIDE ENTERTAINMENT

The Walt Disney Company – 2010 Annual Report*

CONSOLIDATED BALANCE SHEETS (In millions, except per share data)

October 2, 2010 October 3, 2009

ASSETS Current assets Cash and cash equivalents $ 2,722 $ 3,417 Receivables 5,784 4,854 Inventories 1,442 1,271 Television costs 678 631 Deferred income taxes 1,018 1,140 Other current assets 581 576

Total Current Assets 12,225 11,889 Film and television costs 4,773 5,125 Investments 2,513 2,554 Parks, resorts and other property, at cost Attractions,

buildings and equipment 32,875 32,475 Accumulated depreciation (18,373) (17,395)

14,502 15,080 Projects in progress 2,180 1,350 Land 1,124 1,167

17,806 17,597 Intangible assets, net 5,081 2,247 Goodwill 24,100 21,683 Other assets 2,708 2,022

$ 69,206 $ 63,117

LIABILITIES AND EQUITY Current Liabilities Accounts payable and other accrued liabilities $ 6,109 $ 5,616 Current portion of borrowings 2,350 1,206 Unearned royalties and other advances 2,541 2,112

Total current liabilities 11,000 8,934 Borrowings 10,130 11,495 Deferred income taxes 2,630 1,819 Other long-term liabilities 6,104 5,444 Commitments and contingencies (note 15) Equity Preferred stock, $.01 par value

Authorized – 100 million shares, Issued – none —– —–

(CASE 3-1 CONTINUED)

*“The Walt Disney Company, together with its subsidiaries, is a diversified worldwide entertaining company with operations in five business segments: Media Networks, Parks and Resorts, Studio Entertainment, and Consumer Products and Interactive Media.” 10-K Source: The Walt Disney Company 2010 10-K

142 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

October 2, 2010 October 3, 2009

Common stock, $.01 par value Authorized – 4.6 billion shares at October 2,

2010 and 3.6 billion shares at October 3, 2009 Issued – 2.7 billion shares at October 2, 2010

and 2.6 billion shares at October 3, 2009 28,736 27,038 Retained earnings 34,327 31,033 Accumulated other comprehensive loss (1,881) (1,644)

61,182 56,427 Treasury stock, at cost, 803.1 million shares at

October 2, 2010 and 781.7 million shares at October 3, 2009 (23,663) (22,693)

Total Disney Shareholder’s equity 37,519 33,734 Noncontrolling interests 1,823 1,691

Total Equity 39,342 35,425 Total liabilities and equity $ 69,206 $ 63,117

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Part) (Tabular dollars in millions, except per share amounts)

1. Description of the Business and Segment Information (In Part) The Walt Disney Company, together with the subsidiaries through which businesses are con- ducted (the Company), is a diversified worldwide entertainment company with operations in the following business segments: Media Networks, Parks and Resorts, Studio Entertainment, Consumer Products and Interactive Media.

2. Summary of Significant Accounting Policies (In Part)

Principles of Consolidation The consolidated financial statements of the Company include the accounts of The Walt Disney Company and its majority-owned and controlled subsidiaries. Intercompany accounts and trans- actions have been eliminated in consolidation. In December 1999, DVD Financing, Inc. (DFI), a subsidiary of Disney Vacation Development, Inc. and an indirect subsidiary of the Company, completed a receivable sale transaction that established a facility that permitted DFI to sell receiv- ables arising from the sale of vacation club memberships on a periodic basis. In connection with this facility, DFI prepares separate financial statements, although its separate assets and liabilities are also consolidated in these financial statements. DFI’s ability to sell new receivables under this facility ended onDecember 4, 2008. (SeeNote 16 for further discussion of this facility)

Reporting Period The Company’s fiscal year ends on the Saturday closest to September 30 and consists of fifty-two weeks with the exception that approximately every six years, we have a fifty-three week year. When a fifty-three week year occurs, the Company reports the additional week in the fourth quarter. Fiscal 2009 was a fifty-three week year beginning on September 28, 2008 and ending on October 3, 2009.

Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and footnotes thereto. Actual results may differ from those estimates.

Revenue Recognition Broadcast advertising revenues are recognized when commercials are aired. Revenues from television subscription services related to the Company’s primary cable programming serv- ices are recognized as services are provided. Certain of the Company’s contracts with cable and

(continued)

CHAPTER 3 • Balance Sheet 143

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

satellite operators include annual live programming commitments. In these cases, recognition of revenues subject to the commitments is deferred until the annual commitments are satisfied, which generally results in higher revenue recognition in the second half of the year.

Revenues from advance theme park ticket sales are recognized when the tickets are used. For non-expiring, multi-day tickets, revenues are recognized over a three-year time period based on estimated usage, which is derived from historical usage patterns.

Revenues from the theatrical distribution of motion pictures are recognized when motion pictures are exhibited. Revenues from DVD and video game sales, net of anticipated returns and customer incentives, are recognized on the date that video units are made avail- able for sale by retailers. Revenues from the licensing of feature films and television pro- gramming are recorded when the content is available for telecast by the licensee and when certain other conditions are met.

Merchandise licensing advances and guarantee royalty payments are recognized based on the contractual royalty rate when the licensed product is sold by the licensee. Non- refundable advances and minimum guarantee royalty payments in excess of royalties earned are generally recognized as revenue at the end of the contract term.

Revenues from our internet and mobile operations are recognized as services are ren- dered. Advertising revenues at our internet operations are recognized when advertisements are viewed online.

Taxes collected from customers and remitted to governmental authorities are presented in the Consolidated Statements of Income on a net basis.

Allowance for doubtful accounts The Company maintains an allowance for doubtful accounts to reserve for potentially uncol- lectible receivables. The allowance for doubtful accounts is estimated based on our analysis of trends in overall receivables aging, specific identification of certain receivables that are at risk of not being paid, past collection experience and current economic trends. In times of domestic or global economic turmoil, the Company’s estimates and judgments with respect to the col- lectability of its receivables are subject to greater uncertainty than in more stable periods.

Advertising Expense Advertising costs are expensed as incurred. Advertising expense for fiscal 2010, 2009 and 2008 was $2.6 billion, $2.7 billion and $2.9 billion, respectively.

Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand and marketable securities with original maturities of three months or less.

Inventories Inventory primarily includes vacation timeshare units, merchandise, materials, and supplies. Carrying amounts of vacation ownership units are recorded at the lower of cost or net realiz- able value. Carrying amounts of merchandise, materials, and supplies inventories are generally determined on a moving average cost basis and are recorded at the lower of cost or market.

14. Detail of Certain Balance Sheet Accounts (In Part)

October 2, 2010 October 3, 2009

Current receivables Accounts receivable $5,454 $4,794 Other 656 396 Allowance for doubtful accounts (326) (336)

$5,784 $4,854

Required a. The statement is entitled “Consolidated Balance Sheets.” What does it mean to have a

consolidated balance sheet? b. 1. What is the gross amount of current receivables at October 2, 2010?

2. What is the trend in receivables?

(CASE 3-2 CONTINUED)

144 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

c. 1. Does there appear to be a significant increase in projects in progress? 2. Are projects in progress and land depreciated?

d. 1. What is the amount of total assets at October 2, 2010? 2. What is the total current assets at October 2, 2010? 3. What is the total inventory at October 2, 2010? Does the inventory method appear to

be conservative? Comment. e. Comment on the use of estimates. f. Why are advertising expenses expensed as incurred? g. Are cash and cash equivalents presented conservatively? Comment. h. Revenue recognition; comment on the following:

1. Broadcast advertising revenues 2. Revenues from advance theme park ticket sales 3. Revenues from the theatrical distribution of motion pictures 4. Merchandise licensing advances and guarantee royalty payments 5. Revenues from internet and mobile operations 6. Why the use of several revenue recognition methods? 7. Are the revenue recognition methods industry-specific?

i. Describe treasury stock and how it is reported. j. Describe noncontrolling interests. k. 1. Describe the reporting period.

2. Does the reporting period create an inconsistency?

CASE 3-3 HEALTH CARE PRODUCTS

Abbott Laboratories and Subsidiaries*

Consolidated Balance Sheet (dollars in thousands)

December 31

2010 2009 2008

Liabilities and Shareholders’ Investment Current Liabilities: Short-term borrowings $ 4,349,796 $ 4,978,438 $ 1,691,069 Trade accounts payable 1,535,759 1,280,542 1,351,436 Salaries, wages and commissions 1,328,665 1,117,410 1,011,312 Other accrued liabilities 6,014,772 4,363,032 4,216,742 Dividends payable 680,749 620,640 559,064 Income taxes payable 1,307,723 442,140 805,397 Obligation in connection with conclusion of

the TAP Pharmaceutical Products Inc. joint venture — 36,105 915,982

Current portion of long-term debt 2,044,970 211,182 1,040,906 Total Current Liabilities 17,262,434 13,049,489 11,591,908 Long-term Debt 12,523,517 11,266,294 8,713,327 Post-employment Obligations and Other

Long-term Liabilities 7,199,851 5,202,111 4,595,278 Commitments and Contingencies Shareholders’ Investment: Preferred shares, one dollar par value

Authorized – 1,000,000 shares, none issued — — —

*“Abbott Laboratories is an Illinois corporation, incorporated in 1900. Abbott’s principal business is the discovery, development, manufacture, and sale of a broad and diversified line of health care products.” 10-K Source: Abbott Laboratories and Subsidiaries 2010 10-K

(continued)

CHAPTER 3 • Balance Sheet 145

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

December 31

2010 2009 2008

Common shares, without par value Authorized – 2,400,000,000 shares Issued at stated capital amount – Shares: 2010: 1,619,689,876; 2009:

1,612,683,987; 2008: 1,601,580,899 8,744,703 8,257,873 7,444,411 Common shares held in treasury, at cost –

Shares: 2010: 72,705,928; 2009: 61,516,398; 2008: 49,147,968 (3,916,823) (3,310,347) (2,626,404)

Earnings employed in the business 18,927,101 17,054,027 13,825,383 Accumulated other comprehensive income

(loss) (1,366,846) 854,074 (1,163,839) Total Abbott Shareholders’ Investment 22,388,135 22,855,627 17,479,551 Noncontrolling Interests in Subsidiaries 88,329 43,102 39,140 Total Shareholders’ Investment 22,476,464 22,898,729 17,518,691

$59,462,266 $52,416,623 $42,419,204

Required a. The statement is entitled “Consolidated Balance Sheet.” What does it mean to have a

consolidated balance sheet? b. 1. What current liability decreased the most?

2. What current liability increased the most? c. 1. How many common shares had been issued as of December 31, 2010?

2. How many shares were held in the treasury at December 31, 2010? 3. How many shares were outstanding at December 31, 2010? 4. What is the treasury stock method?

d. Abbott Laboratories discloses the account “Earnings employed in the business.” What is this account usually called?

CASE 3-4 BEST

Best Buy Co., Inc.* Consolidated Balance Sheets (In Part)

$ in millions, except per share and share amounts

February 26, 2011

February 27, 2010

Assets Current Assets Cash and cash equivalents $ 1,103 $ 1,826 Short-term investments 22 90 Receivables 2,348 2,020 Merchandise inventories 5,897 5,486 Other current assets 1,103 1,144

Total current assets 10,473 10,566 Property and Equipment Land and buildings 766 757 Leasehold improvements 2,318 2,154 Fixtures and equipment 4,701 4,447 Property under capital lease 120 95

7,905 7,453 Less accumulated depreciation 4,082 3,383

Net property and equipment 3,823 4,070

(CASE 3-3 CONTINUED)

*“We are a multinational retailer of consumer electronics, home-office products, entertainment products, appliance and related services.” 10-K Source: Best Buy Co., Inc. 2010 10-K

146 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

February 26, 2011

February 27, 2010

Goodwill 2,454 2,452 Tradenames, Net 133 159 Customer Relationships, Net 203 279 Equity and Other Investments 328 324 Other Assets 435 452 Total Assets $17,849 $18,302

Notes to Consolidated Financial Statements (In Part) $ in millions except per share amounts or as otherwise noted

1. Summary of Significant Accounting Policies (In Part)

Basis of Presentation The consolidated financial statements include the accounts of Best Buy Co., Inc. and its con- solidated subsidiaries. Investments in unconsolidated entities over which we exercise signifi- cant influence but do not have control are accounted for using the equity method. We have eliminated all intercompany accounts and transactions.

In order to align our fiscal reporting periods and comply with statutory filing require- ments in certain foreign jurisdictions, we consolidate the financial results of our Europe, China, Mexico and Turkey operations on a two-month lag. Our policy is to accelerate re- cording the effect of events occurring in the lag period that significantly affect our consoli- dated financial statements. Except for our fiscal 2011 restructuring, for which we recorded the effects of certain restructuring charges, no significant intervening event occurred in these operations that would have materially affected our financial condition, results of operations, liquidity or other factors had it been recorded during fiscal 2011. Accordingly, the $171 of restructuring charges related to our International segment were included in our fiscal 2011 results. For further information about our fiscal 2011 restructuring and the nature of the charges we recorded, refer to Note 5, Restructuring Charges.

Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (’’GAAP’’) requires us to make estimates and assumptions. These esti- mates and assumptions affect the reported amounts in the consolidated balance sheets and statements of earnings, as well as the disclosure of contingent liabilities. Future results could be materially affected if actual results were to differ from these estimates and assumptions.

Fiscal Year Our fiscal year ends on the Saturday nearest the end of February. Fiscal 2011, 2010 and 2009 each included 52 weeks.

Cash and Cash Equivalents Cash primarily consists of cash on hand and bank deposits. Cash equivalents consist of money market funds, U.S. Treasury bills, commercial paper and time deposits such as certificates of deposit with an original maturity of three months or less when purchased. The amounts of cash equivalents at February 26, 2011, and February 27, 2010, were $120 and $1,108, respec- tively, and the weighted-average interest rates were 0.3% and 0.1%, respectively.

Outstanding checks in excess of funds on deposit (book overdrafts) totaled $57 and $108 at February 26, 2011, and February 27, 2010, respectively, and are reflected as accounts payable in our consolidated balance sheets.

Receivables Receivables consist principally of amounts due from mobile phone network operators for commissions earned; banks for customer credit card, certain debit card and electronic bene- fits transfer (EBT) transactions; and vendors for various vendor funding programs.

(continued)

CHAPTER 3 • Balance Sheet 147

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

We establish allowances for uncollectible receivables based on historical collection trends and write-off history. Our allowances for uncollectible receivables were $107 and $101 at February 26, 2011, and February 27, 2010, respectively.

Merchandise Inventories Merchandise inventories are recorded at the lower of cost using either the average cost or first-in first-out method, or market. In-bound freight-related costs from our vendors are included as part of the net cost of merchandise inventories. Also included in the cost of in- ventory are certain vendor allowances that are not a reimbursement of specific, incremental and identifiable costs to promote a vendor’s products. Other costs associated with acquiring, storing and transporting merchandise inventories to our retail stores are expensed as incurred and included in cost of goods sold.

Our inventory valuation reflects adjustments for anticipated physical inventory losses (e.g., theft) that have occurred since the last physical inventory. Physical inventory counts are taken on a regular basis to ensure that the inventory reported in our consolidated finan- cial statements is properly stated.

Our inventory valuation also reflects markdowns for the excess of the cost over the amount we expect to realize from the ultimate sale or other disposal of the inventory. Mark- downs establish a new cost basis for our inventory. Subsequent changes in facts or circum- stances do not result in the reversal of previously recorded markdowns or an increase in that newly established cost basis.

Restricted Assets Restricted cash and investments in debt securities totaled $490 and $496, at February 26, 2011, and February 27, 2010, respectively, and are included in other current assets or equity and other investments in our consolidated balance sheets. Such balances are pledged as col- lateral or restricted to use for vendor payables, general liability insurance, workers’ compen- sation insurance and warranty programs.

Property and Equipment Property and equipment are recorded at cost. We compute depreciation using the straight- line method over the estimated useful lives of the assets. Leasehold improvements are depre- ciated over the shorter of their estimated useful lives or the period from the date the assets are placed in service to the end of the initial lease term. Leasehold improvements made sig- nificantly after the initial lease term are depreciated over the shorter of their estimated useful lives or the remaining lease term, including renewal periods, if reasonably assured. Acceler- ated depreciation methods are generally used for income tax purposes.

When property is retired or otherwise disposed of, the cost and accumulated deprecia- tion are removed from our consolidated balance sheets and any resulting gain or loss is reflected in our consolidated statements of earnings.

Repairs and maintenance costs are charged directly to expense as incurred. Major renewals or replacements that substantially extend the useful life of an asset are capitalized and depreciated.

Costs associated with the acquisition or development of software for internal use are capitalized and amortized over the expected useful life of the software, from three to seven years. A subsequent addition, modification or upgrade to internal-use software is capitalized to the extent that it enhances the software’s functionality or extends its useful life. Capital- ized software is included in fixtures and equipment. Software maintenance and training costs are expensed in the period incurred.

Property under capital lease is comprised of buildings and equipment used in our retail operations and corporate support functions. The related depreciation for capital lease assets is included in depreciation expense. The carrying value of property under capital lease was $74 and $54 at February 26, 2011, and February 27, 2010, respectively, net of accumulated depreciation of $45 and $41, respectively.

(CASE 3-4 CONTINUED)

148 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Estimated useful lives by major asset category are as follows:

Asset Life

(in years)

Buildings 25–50 Leasehold improvements 3–25 Fixtures and equipment 3–20 Property under capital lease 2–20

Required a. 1. What is the balance in receivables at February 26, 2011 and February 27, 2010?

2. What is the gross receivables at February 26, 2011 and February 27, 2010? b. Merchandise Inventories

“Our inventory valuation reflects adjustments for anticipated physical inventory losses (e.g., theft) that have occurred since the last physical inventory.” Why make this adjustment?

c. 1. What does it mean to have a consolidated balance sheet? 2. Comment on the consolidation policy with regard to Europe, China, Mexico and Turkey.

d. Comment on the use of estimates. e. Comment on the fiscal year. f. Cash and cash equivalents – are they presented conservatively? g. 1. What depreciation methods are generally used for income tax purposes?

2. What depreciation method is used for financial reporting? 3. Why the difference in depreciation between financial reporting and tax purposes?

CASE 3-5 OUR PRINCIPAL ASSET IS OUR PEOPLE

Dana Corporation included the following in its 2001 financial report:

Foundation Business: Focused Excellence Dana’s foundation businesses are: axles, drive shafts, structures, brake and chassis products, fluid systems, filtration products, and bearing and sealing products.

These products hold strong market positions—number one or two in the markets they serve. They provide value-added manufacturing, are technically advanced, and each has fea- tures that are unique and patented.

Management Statement (in Part) We believe people are Dana’s most important asset. The proper selection, training, and de- velopment of our people as a means of ensuring that effective internal controls are fair, uni- form reporting are maintained as standard practice throughout the Company.

Required a. Dana states that “We believe people are Dana’s most important asset.” Currently,

generally accepted accounting principles do not recognize people as an asset. Speculate on why people are not considered to be an asset.

b. Speculate on what concept of an asset Dana is considering when it states “We believe people are Dana’s most important asset.”

CASE 3-6 BRAND VALUE*

Brand values are expressed in terms of words such as “quality” and “integrity.” The Mar- keting Society rated the brand value of McDonald’s in 2008 at $10,417,000,000.*

Required a. Define an asset. b. In your opinion, do brands represent a valuable asset? Comment. c. Under generally accepted accounting principles, should an internally generated brand

value be recognized as an asset? Comment. d. If the brand was purchased, should it be recognized as an asset? Comment.

*Adopted from www.brandfinance.com/docs/50_golden_brands.asp

CHAPTER 3 • Balance Sheet 149

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

CASE 3-7 ADVERTISING—ASSET?

Big Car Company did substantial advertising in late December. The company’s year-end date was December 31. The president of the firm was concerned that this advertising cam- paign would reduce profits.

Required a. Define an asset. b. Would the advertising represent an asset? Comment.

CASE 3-8 TELECOMMUNICATIONS – PART 1

China Unicom (Hong Kong) Limited provides a full range of telecommunications services, including mobile and fixed online services, in China.

They are listed on the New York Stock Exchange and filed a Form 20-F with the SEC for the period ended December 31, 2010.

The following are presented from the Form 20-F filing:

1. Special Note on Our Financial Information and Certain Statistical Information Presented in This Annual Report

2. Audit Report 3. Consolidated Balance Sheets

Special Note on Our Financial Information and Certain Statistical Information Presented in This Annual Report

Our consolidated financial statements as of and for the years ended December 31, 2007, 2008, 2009 and 2010 included in this annual report on Form 20-F have been prepared in ac- cordance with International Financial Reporting Standards, or IFRS, as issued by the Interna- tional Accounting Standards Board, or the IASB. These financial statements also comply with Hong Kong Financial Reporting Standards, or HKFRS, which collective term includes all ap- plicable individual Hong Kong Financial Reporting Standards, Hong Kong Accounting Stand- ards and Interpretations issued by the Hong Kong Institute of Certified Public Accountants, or HKICPA. As applied to our company, HKFRS is consistent with IFRS in all material respects.

The statistical information set forth in this annual report on Form 20-F relating to the PRC is taken or derived from various publicly available government publications that have not been prepared or independently verified by us. This statistical information may not be consistent with other statistical information from other sources within or outside the PRC.

Report of Independent Registered Public Accounting Firm

TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF CHINA UNICOM (HONG KONG) LIMITED In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, changes in equity and cash flows present fairly, in all material respects, the financial position of China Unicom (Hong Kong) Limited and its subsidiaries (together, the “Group”) at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with International Financial Reporting Standards as issued by the Interna- tional Accounting Standards Board and in conformity with Hong Kong Financial Reporting Standards issued by the Hong Kong Institute of Certified Public Accountants. Also in our opin- ion, the Group maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Inte- grated Framework issued by the Committee of Sponsoring Organizations of the Treadway

Source: China Unicom 2010 10-K

150 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Commission (“COSO”). The Group’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the Management’s Annual Report on Internal Control Over Financial Reporting included in Item 15 of this Annual Report on Form 20-F. Our responsibility is to express opinions on these financial statements and on the Group’s internal control over financial reporting based on our integrated audits. We con- ducted our audits in accordance with the standards of the Public Company Accounting Over- sight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material mis- statement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evi- dence supporting the amounts and disclosures in the financial statements, assessing the account- ing principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of in- ternal control based on the assessed risk. Our audits also included performing such other proce- dures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As discussed in Note 2.25 (a) to the consolidated financial statements, the Group adopted the accounting policy of relative fair value method when accounting for its preferen- tial promotional service packages retrospectively on January 1, 2010.

A company’s internal control over financial reporting is a process designed to provide rea- sonable assurance regarding the reliability of financial reporting and the preparation of finan- cial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of fi- nancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authoriza- tions of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers Hong Kong May 24, 2011

CHINA UNICOM (HONG KONG) LIMITED CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2009 AND 2010

(All amounts in Renminbi (“RMB” millions))

As of December 31

Note 2009 2010 2010

RMB RMB US$ ASSETS Non-current assets

Property, plant and equipment 6 351,157 366,060 55,464 Lease prepayments 7 7,729 7,607 1,153 Goodwill 8 2,771 2,771 420

(continued)

CHAPTER 3 • Balance Sheet 151

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

As of December 31

Note 2009 2010 2010

RMB RMB US$ ASSETS

Deferred income tax assets 9 5,202 4,840 733 Available-for-sale financial assets 10 7,977 6,214 942 Other assets 12 11,596 11,753 1,780

386,432 399,245 60,492 Current assets

Inventories and consumables 13 2,412 3,728 565 Accounts receivable, net 14 8,825 9,286 1,407 Prepayments and other current assets 15 4,252 5,115 775 Amounts due from related parties 40.1 53 50 8 Amounts due from domestic carriers 40.2 1,134 1,261 191 Proceeds receivable for the disposal of the

CDMA Business 36, 40.2 5,121 — — Short-term bank deposits 16 996 273 41 Cash and cash equivalents 17 7,820 22,495 3,408

30,613 42,208 6,395 Total assets 417,045 441,453 66,887

EQUITY Equity attributable to owners of the parent

Share capital 18 2,310 2,310 350 Share premium 18 173,435 173,436 26,278 Reserves 19 (18,088) (18,273) (2,769) Retained profits - Proposed final dividend 37 3,770 1,885 286 - Others 45,038 46,483 7,043

206,465 205,841 31,188 Non-controlling interests 2 — — Total equity 206,467 205,841 31,188

LIABILITIES Non-current liabilities Long-term bank loans 20 759 1,462 222 Promissory notes 21 — 15,000 2,273 Convertible bonds 22 — 11,558 1,751 Corporate bonds 23 7,000 7,000 1,061 Deferred income tax liabilities 9 245 22 3 Deferred revenue 2,562 2,171 328 Other obligations 24 187 162 25

10,753 37,375 5,663 Current liabilities Accounts payable and accrued

liabilities 25 104,072 97,659 14,795 Taxes payable 912 1,484 225 Amounts due to ultimate holding

company 40.1 308 229 35 Amounts due to related parties 40.1 5,438 5,191 787 Amounts due to domestic carriers 40.2 1,136 873 132 Payables in relation to disposal of the

CDMA business 40.2 7 — — Commercial papers 26 — 23,000 3,485 Short-term bank loans 27 63,909 36,727 5,565 Current portion of long-term bank

loans 20 62 58 9 Dividends payable 37 331 431 65 Current portion of deferred revenue 1,397 1,042 158 Current portion of other obligations 24 2,534 2,637 400

(CASE 3-8 CONTINUED)

152 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Advances from customers 19,719 28,906 4,380 199,825 198,237 30,036

Total liabilities 210,578 235,612 35,699 Total equity and liabilities 417,045 441,453 66,887 Net current liabilities (169,212) (156,029) (23,641)

Total assets less current liabilities 217,220 243,216 36,851

Required a. Special Note, etc.

1. Financial statements were prepared under what reporting standards? 2. Did they reconcile to GAAP? 3. The financial statements also comply with Hong Kong Financial Reporting Standards

or HKFRS. Does this mean that the standards are identical. b. Audit Report

1. How many years are included? 2. What financial reporting standards were used? 3. Internal control was guided by what? 4. Comment on management’s responsibility for the statements. 5. Comment on the auditing standards used. 6. Proper internal controls will prevent or detect misstatements. Comment.

c. Consolidated Balance Sheet 1. Why presented in RMB and U.S. $? 2. Comment on the assets presentation. 3. Comment on the equity presentation. 4. Comment on the liabilities presentation.

CASE 3-9 GLOBAL HEALTH CARE

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Part) Merck & Co., Inc. and Subsidiaries* ($ in millions except per share amounts)

Years Ended December 31 2010 Annual Report

Fair Value Measurements (In Part) Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:

(continued)

As of December 31

Note 2009 2010 2010

RMB RMB US$

*“The Company is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies, animal health, and consumer care products, which it markets directly and through its joint ventures.” 10-K Source: Merck & Co., Inc. and Subsidiaries 2010 10-K

CHAPTER 3 • Balance Sheet 153

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Level 1 — Quoted prices in active markets for identical assets or liabilities. The Company’s Level 1 assets include equity securities that are traded in an active exchange market.

Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company’s Level 2 assets and liabilities primarily include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, corporate notes and bonds, U.S. and foreign government and agency securities, certain mortgage-backed and asset-backed securities, mu- nicipal securities, commercial paper and derivative contracts whose values are determined using pricing models with inputs that are observable in the market or can be derived princi- pally from or corroborated by observable market data.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are fi- nancial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation. The Company’s Level 3 assets include certain mortgage-backed securities with limited market activity. At December 31, 2010, $13 million, or approximately 0.4%, of the Company’s investment securities were categorized as Level 3 assets.

If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis** Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below:

Fair Value Measurements Using Fair Value Measurements Using

Quoted Prices In Active Markets

for Identical Assets

(Level 1)

Significant Other

Observable Inputs

(Level 2)

Significant Unobservable

Inputs (Level 3) Total

Quoted Prices In Active Markets

for Identical Assets

(Level 1)

Significant Other

Observable Inputs

(Level 2)

Significant Unobservable

Inputs (Level 3) Total

2010 2009

Assets Investments Corporate notes and bonds $ — $1,133 $— $1,133 $— $ 205 $— $ 205 Commercial paper — 1,046 — 1,046 — — — — U.S. government and agency

securities — 500 — 500 — 216 — 216 Municipal securities — 361 — 361 — 187 — 187 Asset-backed securities(1) — 171 — 171 — 36 — 36 Mortgage-backed

securities(1) — 99 13 112 — — — — Foreign government bonds — 10 — 10 — — — — Equity securities 117 23 — 140 39 39 — 78 Other debt securities — 3 — 3 — 3 — 3

117 3,346 13 3,476 39 686 — 725 Other assets Securities held for employee

compensation 181 — — 181 108 14 — 122 Other assets — — — — — 55 72 127

181 — — 181 108 69 72 249 Derivative assets(2)

Purchased currency options — 477 — 477 — 292 — 292

**In millions

(CASE 3-9 CONTINUED)

154 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Fair Value Measurements Using Fair Value Measurements Using

Quoted Prices In Active Markets

for Identical Assets

(Level 1)

Significant Other

Observable Inputs

(Level 2)

Significant Unobservable

Inputs (Level 3) Total

Quoted Prices In Active Markets

for Identical Assets

(Level 1)

Significant Other

Observable Inputs

(Level 2)

Significant Unobservable

Inputs (Level 3) Total

2010 2009

Forward exchange contracts — 95 — 95 — 60 — 60 Interest rate swaps — 56 — 56 — 27 — 27

— 628 — 628 — 379 — 379 Total assets $298 $3,974 $13 $4,285 $147 $1,134 $72 $1,353 Liabilities Derivative liabilities(2)

Forward exchange contracts $ — $ 54 $— $ 54 $ — $ 73 $— $ 73 Interest rate swaps — 7 — 7 — — — — Total liabilities $ — $ 61 $— $ 61 $ — $ 73 $— $ 73

(1)Substantially all of the asset-backed securities are highly-rated (Standard & Poor’s rating of AAA and Moody’s Investors Service rating of Aaa), secured primarily by credit card, auto loan, and home equity receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies.

(2)The fair value determination of derivatives includes an assessment of the credit risk of counterparties to the derivatives and the Company’s own credit risk, the effects of which were not significant.

Required a. Entities are required to use a fair value hierarchy. Why? b. There are three levels of inputs that may be used to measure fair value. What are the

three levels and describe each. c. For Merck & Co., Inc. describe the assets and liabilities for each level of inputs.

WEB CASE THOMSON ONE Business School Edition

Please complete the Web case that covers material discussed in this chapter at www.cengagebrain.com. You’ll be using Thomson ONE Business School Edition, a powerful tool that combines a full range of fundamental financial information, earnings estimates, market data, and source documents for 500 publicly traded companies.

TO THE NET CASE

1. Go to the SEC Web site (www.sec.gov). Under “Filings & Forms (EDGAR),” click on “Search for Company Filings.” Click on “Company or Fund, etc.” Under Company Name, enter “Cooper Tire” (or under Ticker Symbol, enter “CTB”). Select the 10-K filed February 25, 2011. a. What is the total stockholders’ equity at December 31, 2010? b. What is the cost of treasury shares at December 31, 2010? c. Why is treasury stock subtracted from stockholders’ equity?

2. Go to the SEC Web site (www.sec.gov). Under “Filings & Forms (EDGAR),” click on “Search for Company Filings.” Click on “Company or Fund, etc.” Under Company Name, enter “Yahoo” (or under Ticker Symbol, enter “YHOO”). Select the 10-K filed February 28, 2011. a. What is the total current assets at December 31, 2010? b. What is the net intangibles at December 31, 2010? c. Why are intangibles amortized?

3. Go to the SEC Web site (www.sec.gov). Under “Filings & Forms (EDGAR),” click on “Search for Company Filings.” Click on “Company or Fund, etc.” Under Company Name, enter “Boeing Co” (or under Ticker Symbol, enter “BA”). Select the 10-K filed February 9, 2011.

(continued)

CHAPTER 3 • Balance Sheet 155

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

a. What is the total for inventories at December 31, 2010? b. Go to Note 1, Summary of Significant Accounting Policies. Go to Inventories. Describe the

inventory policy, consistent with industry practice, that is unique for this industry. How does this practice impact liquidity appearance?

4. Go to the SEC Web site (www.sec.gov). Under “Filings & Forms (EDGAR),” click on “Search for Company Filings.” Click on “Company or Fund, etc.” Under Company Name, enter “Dell Inc.” (or under ticker symbol, enter “Dell”). Select the 10-K filed March 15, 2011. a. What is the balance in accrued warranty at January 28, 2011? b. Comment on the subjectivity in determining this balance.

5. Go to the SEC Web site (www.sec.gov). Under “Filings & Forms (EDGAR),” click on “Search for Company Filings.” Click on “Company or Fund, etc.” Under Company Name, enter “McDonalds” (or under Ticker Symbol, enter “MCD”). Select the 10-K filed February 25, 2011. a. What is the total assets at December 31, 2010? b. What is the total for investments in and advances to affiliates at December 31, 2010? c. In your opinion, are the companies receiving the “investments in and advances to affiliates”

consolidated with McDonald’s Corporation? Comment. d. Considering the balance in “investments in and advances to affiliates” in relation to “total

assets,” does this relationship of dollars likely represent the importance of affiliates to McDonald’s Corporation? Comment.

6. Go to the SEC site (www.sec.gov). Under “Filings & Forms” click on “Search for Company Filings.” Click on “Company or fund, etc.” Under Company Name, enter “Hershey Food” (or under Ticker Symbol, enter “HSY”). Select the 10-K filed February, 2011. a. Note 16 – Capital Stock and Net Income Per Share

1. Comment on the voting control of Milton Hershey School Trust. b. Note 1 – Summary of Significant Accounting Policies

1. Describe their accounting for investments under the equity method. 2. Why do they review equity investments for impairment?

7. Go to the SEC site (www.sec.gov). Under “Filings & Forms,” click on “Search for Company Filings.” Click on “Company or fund, etc.” Under Company Name, enter “Terra Industries Inc.” (or under Ticker Symbol, enter “TRA”). Select the 10-K filed February 25, 2010. a. Go to Note 27 – Subsequent Events

1. Describe the type of subsequent event and the disclosure requirement. 2. Describe the particular subsequent event.

Endnotes 1. Accounting Trends & Techniques (American Institute of Certified Public Accountants, New York:

2010), p. 147.

2. Ibid., p. 300.

3. Ibid., p. 147.

4. Statement of Financial Accounting Concepts No. 6, “Elements of Financial Statements” (Financial Accounting Standards Board, Stamford, CT: 1985), par. 25.

5. Accounting Trends & Techniques (American Institute of Certified Public Accountants, New York: 2010), p. 138.

6. SFAS No. 141 (R), “Business Combinations,” issued in December 2007, represents the current standard for computing goodwill. SFAS No. 142, “Goodwill and Other Intangible Assets,” issued in June 2001, represents the standard relating to when to write down or off goodwill. Prior to SFAS No. 142, goodwill was amortized over a period of 40 years or less.

7. Statement of Financial Accounting Concepts No. 6, par. 35.

8. Statement of Financial Accounting Concepts No. 6, par. 212.

(TO THE NET CONTINUED)

156 CHAPTER 3 • Balance Sheet

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Chapter

4 Income Statement

The income statement is often considered to be the most important financial statement.Frequently used titles for this statement include statement of operations, statement ofincome, and statement of earnings. Both the statement of operations and statement of income are very popular titles.1

Basic Elements of the Income Statement An income statement summarizes revenues and expenses and gains and losses, and ends with the net income for a specific period. A multiple-step income statement usually presents sepa- rately the gross profit, operating income, income before income taxes, and net income.

A simplified multiple-step income statement might look as follows:

Net Sales (Revenues) $XXX − Cost of Goods Sold (cost of sales) XXX

Gross Profit XXX − Operating Expenses (selling and

administrative) XXX Operating Income XXX

+(−) Other Income or Expense XXX Income before Income Taxes XXX

− Income Taxes XXX Net Income $XXX Earnings per Share $XXX

Some firms use a single-step income statement, which totals revenues and gains (sales, other income, etc.) and then deducts total expenses and losses (cost of goods sold, operating expenses, other expenses, etc.). A simplified single-step income statement might look as follows:

R Sh

er w oo

d Ve ith

/i St oc kp

ho to .c om

157

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Revenue: Net Sales $XXX Other Income XXX

Total Revenue XXX Expenses: Cost of Goods Sold (cost of sales) XXX Operating Expenses (selling and administrative) XXX Other Expense XXX Income Tax Expense XXX

Total Expenses XXX Net Income $XXX Earnings per Share $XXX

A single-step income statement lists all revenues and gains (usually in order of amount) and then lists all expenses and losses (usually in order of amount). Total expense and loss items deducted from total revenue and gain items determine the net income. Most firms that present a single-step income statement modify it in some way, such as presenting federal income tax expense as a separate item.

Exhibits 4-1 and 4-2 illustrate the different types of income statements. In Exhibit 4-1, Ryder System, Inc., uses a single-step income statement, while in Exhibit 4-2, Intel Corpora- tion uses a multiple-step format.

EXHIBIT 4-1 Ryder System, Inc.*

Single-Step Income Statement

RYDER SYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS

Years ended December 31

2010 2009 2008

(In thousands, except per share amounts)

Revenue $5,136,435 4,887,254 5,999,041 Operating expense (exclusive of items shown separately) 2,441,924 2,229,539 2,959,518 Salaries and employee-related costs 1,255,659 1,233,243 1,345,216 Subcontracted transportation 261,325 198,860 233,106 Depreciation expense 833,841 881,216 836,149 Gains on vehicle sales, net (28,727) (12,292) (39,020) Equipment rental 63,228 65,828 78,292 Interest expense 129,994 144,342 152,448 Miscellaneous (income) expense, net (7,114) (3,657) 2,564 Restructuring and other charges, net — 6,406 21,480

4,950,130 4,743,485 5,589,753 Earnings from continuing operations before income taxes 186,305 143,769 409,288 Provision for income taxes 61,697 53,652 151,709 Earnings from continuing operations $ 124,608 90,117 257,579

Loss from discontinued operations, net of tax (6,438) (28,172) (57,698) Net earnings $ 118,170 61,945 199,881

Earnings (loss) per common share – Basic Continuing operations $ 2.38 1.62 4.54 Discontinued operations (0.13) (0.51) (1.02) Net earnings $ 2.25 1.11 3.52

Earnings (loss) per common share – Diluted Continuing operations $ 2.37 1.62 4.51 Discontinued operations (0.12) (0.51) (1.01) Net earnings $ 2.25 1.11 3.50

*“Ryder System, Inc. (Ryder), a Florida corporation founded in 1993, is a global leader in transportation and supply chain management solutions.” 10-K Source: Ryder System, Inc. 2010 10-K

158 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

For firms that have cost of goods sold, cost of goods manufactured, or cost of services, a multiple-step income statement should be used for analysis. The multiple-step format provides intermediate profit figures useful in analysis. You may need to construct the multiple-step format from the single-step. Exhibit 4-3 contains a comprehensive multiple-step income state- ment illustration. This illustration resembles the vast majority of income statements as pre- sented in the United States. Be familiar with this illustration. It serves as a guide to much of our analysis.

Net Sales (Revenues) Sales (revenues) represent revenue from goods or services sold to customers. The firm earns revenue from the sale of its principal products. Sales are usually shown net of any discounts, returns, and allowances.

Cost of Goods Sold (Cost of Sales) This category shows the cost of goods sold to produce revenue. For a retailing firm, the cost of goods sold equals beginning inventory plus purchases minus ending inventory. In a manu- facturing firm, the cost of goods manufactured replaces purchases since the goods are pro- duced rather than purchased. A service firm will not have cost of goods sold or cost of sales, but it will often have cost of services.

Other Operating Revenue Depending on the operations of the business, there may be other operating revenue, such as lease revenue and royalties.

EXHIBIT 4-2 Intel Corporation

Multiple-Step Income Statement

INTEL CORPORATION* CONSOLIDATED STATEMENTS OF INCOME

Three Years Ended December 25, 2010 (In Millions, Except Per Share Amounts) 2010 2009 2008

Net revenue $43,623 $35,127 $37,586 Cost of sales 15,132 15,566 16,742 Gross margin 28,491 19,561 20,844 Research and development 6,576 5,653 5,722 Marketing, general and administrative 6,309 7,931 5,452 Restructuring and asset impairment charges — 231 710 Amortization of acquisition-related intangibles 18 35 6 Operating expenses 12,903 13,850 11,890 Operating income 15,588 5,711 8,954 Gains (losses) on equity method investments, net 117 (147) (1,380) Gains (losses) on other equity investments, net 231 (23) (376) Interest and other, net 109 163 488 Income before taxes 16,045 5,704 7,686 Provision for taxes 4,581 1,335 2,394 Net income $11,464 $ 4,369 $ 5,292

Basic earnings per common share $ 2.06 $ 0.79 $ 0.93 Diluted earnings per common share $ 2.01 $ 0.77 $ 0.92 Weighted average shares outstanding: Basic 5,555 5,557 5,663

Diluted 5,696 5,645 5,748

*“We are the world’s largest semiconductor chip maker, based on revenue.” 10-K Source: Intel Corporation, 2010 10-K

CHAPTER 4 • Income Statement 159

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Operating Expenses Operating expenses consist of two types: selling and administrative. Selling expenses, result- ing from the company’s effort to create sales, include advertising, sales commissions, sales supplies used, and so on. Administrative expenses relate to the general administration of the company’s operation. They include office salaries, insurance, telephone, bad debt expense, and other costs difficult to allocate.

Other Income or Expense In this category are secondary activities of the firm that are not directly related to the opera- tions. For example, if a manufacturing firm has a warehouse rented, this lease income would be other income. Dividend and interest income and gains and losses from the sale of assets are also included here. Interest expense is categorized as other expense.

Special Income Statement Items To comprehend and analyze profits, you need to understand income statement items that require special disclosure. Exhibit 4-3 contains items that require special disclosure. These items are lettered to identify them for discussion. Note that some of these items are presented before tax and some are presented net of tax.

(A) Unusual or Infrequent Item Disclosed Separately Certain income statement items are either unusual or occur infrequently. They might include such items as a gain on sale of securities, write-downs of receivables, or write-downs of

EXHIBIT 4-3 Illustration of Special Items

G AND F COMPANY Income Statement (Multiple-Step Format) For the Year Ended December 31, 2007

Net sales $ XXX Cost of products sold (cost of sales) (XXX) Gross profit XXX Other operating revenue XXX Operating expenses:

Selling expenses $ XXX General expenses XXX (XXX)

Operating income XXX Other income (includes interest income) XXX Other expenses (includes interest expense) (XXX)

[A] Unusual or infrequent item disclosed separately [loss] (XXX) [B] Equity in earnings of nonconsolidated subsidiaries [loss] XXX

Income before taxes XXX Income taxes related to operations (XXX) Net income from operations XXX

[C] Discontinued operations: Income [loss] from operations of discontinued segment (less applicable

income taxes of $XXX) $(XXX) Income [loss] on disposal of division X (less applicable income taxes of $XXX) (XXX) (XXX)

[D] Extraordinary gain [loss] (less applicable income taxes of $XXX) (XXX) [E] Cumulative effect of change in accounting principle [loss]

(less applicable income taxes of $XXX) XXX

Net income before noncontrolling interest $ XXX [F] Net income—noncontrolling interest (XXX)

Net income $ XXX Earnings per share $ XXX

Source: U.S. Securities and Exchange

160 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

inventory. These items are shown with normal, recurring revenues and expenses, and gains and losses. If material, they will be disclosed separately, before tax. Unusual or infrequent items are typically left in primary analysis because they relate to operations.

In supplementary analysis, unusual or infrequent items should be removed net after tax. Usually, an estimate of the tax effect will be necessary. A reasonable estimate of the tax effect can be made by using the effective income tax rate, usually disclosed in a note, or by dividing income taxes by income before taxes.

Refer to Exhibit 4-4, which illustrates an unusual or infrequent item disclosed separately for Advanced Micro Devices, Inc. The unusual or infrequent item is gain in legal settlement in 2010 and 2009.

EXHIBIT 4-4 Advanced Micro Devices, Inc.*

Unusual or Infrequent Item

ADVANCED MICRO DEVICES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS

Year Ended

December 25, 2010

December 26, 2009

December 27, 2008

(In millions, except per share amounts) Net revenue $6,494 $ 5,403 $ 5,808 Cost of sales 3,533 3,131 3,488 Gross margin 2,961 2,272 2,320

Research and development 1,405 1,721 1,848 Marketing, general and administrative 934 994 1,304 Legal settlement (283) (1,242) — Amortization of acquired intangible assets 61 70 137 Impairment of goodwill and acquired intangible assets — — 1,089 Restructuring charges (reversals) (4) 65 90 Gain on sale of 200 millimeter equipment — — (193) Operating income (loss) 848 664 (1,955)

Interest income 11 16 39 Interest expense (199) (438) (391) Other income (expense), net 311 166 (37) Income (loss) before equity in net loss of investees and

income taxes 971 408 (2,344) Provision for income taxes 38 112 68 Equity in net loss of investee (462) — — Income (loss) from continuing operations 471 296 (2,412)

Loss from discontinued operations, net of tax — (3) (684) Net income (loss) 471 293 (3,096)

Net income (loss) attributable to noncontrolling interest — 83 (33) Class B preferred accretion — (72) — Net income (loss) attributable to AMD common

stockholders $ 471 $ 304 $(3,129) Net income (loss) attributable to AMD common stockholders

per common share Basic

Continuing operations $ 0.66 $ 0.46 $ (4.03) Discontinued operations — — (1.12)

Basic net income (loss) attributable to AMD common stockholders per common share $ 0.66 $ 0.46 $ (5.15)

Diluted Continuing operations $ 0.64 $ 0.45 $ (4.03)

*“We are a global semiconductor company with facilities around the world.” 10-K Source: Advanced Micro Devices, Inc. 2010 10-K (continued)

CHAPTER 4 • Income Statement 161

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

(B) Equity in Earnings of Nonconsolidated Subsidiaries When a firm accounts for its investments in stocks using the equity method (the investment is not consolidated), the investor reports equity earnings (losses). Equity earnings (losses) are the investor’s proportionate share of the investee’s earnings (losses). If the investor owns 20% of the stock of the investee, for example, and the investee reports income of $100,000, then the investor reports $20,000 on its income statement. In this book, the term equity earnings will be used unless equity losses are specifically intended.

To the extent that equity earnings are not accompanied by cash dividends, the investor reports earnings greater than the cash flow from the investment. If an investor company reports material equity earnings, its net income could be much greater than its ability to pay dividends or cover maturing liabilities.

For purposes of analysis, the equity in the net income of nonconsolidated subsidiaries raises practical problems. For example, the equity earnings represent earnings of other com- panies, not earnings from the operations of the business. Thus, equity earnings can distort the reported results of a business’s operations. For each ratio influenced by equity earnings, this book suggests a recommended approach described when the ratio is introduced.

Refer to Exhibit 4-5, which illustrates equity in earnings of nonconsolidated subsidiaries for KB Home. Leaving these accounts in the statements presents a problem for profitability analysis because most of the profitability measures relate income figures to other figures

EXHIBIT 4-5 KB Home*

Equity Income

KB HOME CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Amounts)

Year Ended November 30,

2010 2009 2008

Total revenues $ 1,589,996 $ 1,824,850 $ 3,033,936 Homebuilding:

Revenues $ 1,581,763 $ 1,816,415 $ 3,023,169 Construction and land costs (1,308,288) (1,749,911) (3,314,815) Selling, general and administrative expenses (289,520) (303,024) (501,027) Goodwill impairment — — (67,970)

Operating loss (16,045) (236,520) (860,643)

Year Ended

December 25, 2010

December 26, 2009

December 27, 2008

(In millions, except per share amounts) Discontinued operations — — (1.12)

Diluted net income (loss) attributable to AMD common stockholders per common share $ 0.64 $ 0.45 $ (5.15)

Shares used in per share calculation Basic 711 673 607 Diluted 733 678 607

*“KB Home is one of the nation’s largest homebuilders and has been building homes for more than 50 years.” 10-K Source: KB Home Equity Income 2010 10-K

EXHIBIT 4-4 Advanced Micro Devices, Inc. (continued)

162 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

(usually balance sheet figures). Because these earnings are from nonconsolidated subsidiaries, an inconsistency can result between the numerator and the denominator when computing a ratio. (Chapter 5 presents a detailed discussion of ratios.)

Some ratios are distorted more than others by equity earnings. For example, the ratio that relates income to sales can be distorted because of equity earnings. The numerator of the ratio includes the earnings of the operating company and the equity earnings of noncon- solidated subsidiaries. The denominator (sales) includes only the sales of the operating com- pany. The sales of the unconsolidated subsidiaries will not appear on the investor’s income statement because the subsidiary was not consolidated. This causes the ratio to be distorted.

Equity in earnings of nonconsolidated subsidiaries (equity earnings) will be presented before tax. Any tax will be related to the dividend received, and it will typically be immate- rial. When removing equity earnings for analysis, do not attempt a tax computation.

Income Taxes Related to Operations Federal, state, and local income taxes, based on reported accounting profit, are shown here. Income tax expense includes taxes paid and taxes deferred. Income taxes reported here will not include taxes on items presented net of tax.

(C) Discontinued Operations A common type of unusual item is the disposal of a business or product line. If the disposal meets the criteria of a discontinued operation, then a separate income statement category for the gain or loss from disposal of a segment of the business must be provided. In addition, the results of operations of the segment that has been or will be disposed of are reported in con- junction with the gain or loss on disposal. These effects appear as a separate category after continuing operations.

Discontinued operations pose a problem for profitability analysis. Ideally, income from continuing operations would be the better figure to use to project future income. Several practical problems associated with the removal of a gain or a loss from the discontinued operations occur in the primary profitability analysis. These problems revolve around two points: (1) an inadequate disclosure of data related to the discontinued operations, in order to remove the balance sheet amounts associated with the discontinued operations; and (2) the lack of past profit and loss data associated with the discontinued operations.

Year Ended November 30,

2010 2009 2008

Interest income 2,098 7,515 34,610 Interest expense, net of amounts

capitalized/loss on early redemption of debt (68,307) (51,763) (12,966) Equity in loss of unconsolidated joint ventures (6,257) (49,615) (152,750)

Homebuilding pretax loss (88,511) (330,383) (991,749) Financial services:

Revenues 8,233 8,435 10,767 Expenses (3,119) (3,251) (4,489) Equity in income of unconsolidated joint venture 7,029 14,015 17,540

Financial services pretax income 12,143 19,199 23,818 Total pretax loss (76,368) (311,184) (967,931) Income tax benefit (expense) 7,000 209,400 (8,200) Net loss $ (69,368) $ (101,784) $ (976,131)

Basic and diluted loss per share $ (.90) $ (1.33) $ (12.59) Basic and diluted average shares outstanding 76,889 76,660 77,509

EXHIBIT 4-5 KB Home (continued)

CHAPTER 4 • Income Statement 163

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Exhibit 4-6 illustrates the presentation of discontinued operations in net income. The best analysis would remove the income statement items that relate to the discontinued operations.

The income statement items that relate to a discontinued operation are always presented net of applicable income taxes. Therefore, the items as presented on the income statement can be removed for primary analysis without further adjustment for income taxes. Supplementary analysis considers discontinued operations in order to avoid disregarding these items.

EXHIBIT 4-6 Bristol-Myers Squibb Company

Discontinued Operations

BRISTOL-MYERS SQUIBB COMPANY* CONSOLIDATED STATEMENTS OF EARNINGS Dollars and Shares in Millions, Except Per Share Data

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Years Ended December 31,

2010 2009 2008

EARNINGS Net Sales $19,484 $18,808 $17,715 Cost of products sold 5,277 5,140 5,316 Marketing, selling and administrative 3,686 3,946 4,140 Advertising and product promotion 977 1,136 1,181 Research and development 3,566 3,647 3,512 Acquired in-process research and development — — 32 Provision for restructuring 113 136 215 Litigation expense, net (19) 132 33 Equity in net income of affiliates (313) (550) (617) Gain on sale of ImClone shares — — (895) Other (income)/expense 126 (381) 22 Total Expenses 13,413 13,206 12,939

Earnings from Continuing Operations Before Income Taxes 6,071 5,602 4,776 Provision for income taxes 1,558 1,182 1,090 Net earnings from Continuing Operations 4,513 4,420 3,686

Discontinued Operations: Earnings, net of taxes — 285 578 Gain on disposal, net of taxes — 7,157 1,979

Net Earnings from Discontinued Operations — 7,442 2,557 Net Earnings 4,513 11,862 6,243 Net Earnings Attributable to Noncontrolling Interest 1,411 1,250 996

Net Earnings Attributable to Bristol-Myers Squibb Company $ 3,102 $10,612 $ 5,247

Amounts Attributable to Bristol-Myers Squibb Company: Net Earnings from Continuing Operations $ 3,102 $ 3,239 $ 2,697 Net Earnings from Discontinued Operations — 7,373 2,550 Net Earnings Attributable to Bristol-Myers Squibb Company $ 3,102 $10,612 $ 5,247

Earnings per Common Share from Continuing Operations Attributable to Bristol-Myers Squibb Company:

Basic $ 1.80 $ 1.63 $ 1.36 Diluted $ 1.79 $ 1.63 $ 1.35

Earnings per Common Share Attributable to Bristol-Myers Squibb Company:

Basic $ 1.80 $ 5.35 $ 2.64 Diluted $ 1.79 $ 5.34 $ 2.62

Dividends declared per common share $ 1.29 $ 1.25 $ 1.24

*“We are engaged in the discovery, development, licensing, manufacturing, marketing, distribution and sale of biopharmaceutical products on a global basis.” 10-K Source: Bristol-Myers Squibb Company 2010 10-K

164 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Ideally, the balance sheet accounts that relate to the discontinued operations should be removed for primary analysis. Consider these items on a supplemental basis because they will not contribute to future operating revenue. However, inadequate disclosure often makes it impossible to remove these items from your analysis.

The balance sheet items related to discontinued operations are frequently disposed of when the business or product line has been disposed of prior to the year-end balance sheet date. In this case, the balance sheet accounts related to discontinued operations do not pres- ent a problem for the current year.

(D) Extraordinary Items Extraordinary items are material events and transactions distinguished by their unusual na- ture and by the infrequency of their occurrence. Examples include a major casualty (such as a fire), prohibition under a newly enacted law, or an expropriation. These items, net of their tax effects, must be shown separately. Some pronouncements have specified items that must be considered extraordinary; an example is a material tax loss carryover. The effect of an extraordinary item on earnings per share must also be shown separately. Exhibit 4-7 presents an extraordinary gain.

In analysis of income for purposes of determining a trend, extraordinary items should be eliminated since the extraordinary item is not expected to recur. In supplementary analysis, these extraordinary items should be considered, as this approach avoids disregarding these items.

Extraordinary items are always presented net of applicable income taxes. Therefore, the items as presented on the income statement are removed without further adjustment for income taxes.

EXHIBIT 4-7 CenturyLink, Inc.*

Extraordinary Item

CenturyLink, Inc. Consolidated Statements of Income (In Part)

Year Ended December 31,

2010 2009 2008

INCOME BEFORE INCOME TAX EXPENSE $1,532,085 814,512 561,387 Income tax expense 582,951 301,881 194,357

INCOME BEFORE NONCONTROLLING INTERESTS AND EXTRAORDINARY ITEM 949,134 512,631 367,030

Noncontrolling interests (1,429) (1,377) (1,298) NET INCOME BEFORE EXTRAORDINARY ITEM 947,705 511,254 365,732 Extraordinary item, net of income tax expense and

noncontrolling interests (see Note 16) — 135,957 — NET INCOME ATTRIBUTABLE TO CENTURYLINK, INC. $ 947,705 647,211 365,732

BASIC EARNINGS PER SHARE Before extraordinary item $ 3.13 2.55 3.53 Extraordinary item $ — .68 — Basic earnings per share $ 3.13 3.23 3.53

DILUTED EARNINGS PER SHARE Before extraordinary item $ 3.13 2.55 3.52 Extraordinary item $ — .68 — Diluted earnings per share $ 3.13 3.23 3.52

DIVIDENDS PER COMMON SHARE $ 2.90 2.80 2.1675 AVERAGE BASIC SHARES OUTSTANDING 300,619 198,813 102,268

AVERAGE DILUTED SHARES OUTSTANDING 301,297 199,057 102,560

*“CenturyLink, together with its subsidiaries, is an integrated communications company engaged primarily in providing a broad array of communications services, including voice, Internet, data and video services.” 10-K Source: Centurylink 2010 10-K

CHAPTER 4 • Income Statement 165

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

(E) Change in Accounting Principle At times the company will change from one generally accepted accounting principle to another generally accepted accounting principle or an account principle is made obsolete by a new standard from the FASB.

Current GAAP requires a retrospective approach to changes in accounting principles unless it is impracticable to do so. This means that prior years’ financial statements that are presented are revised in the year of change. (The balance sheet is presented for two years, income statement for three years, and statement of cash flows for three years).

The cumulative effect on prior years reported (prior to the change year) is reflected in the company’s beginning retained earnings in the change year.

With this standard there is comparability of accounting principles for the statements pre- sented. When using prior annual reports, there will not be comparability. This does present a challenge when doing analysis. It will not be possible to do a consistent analysis if more than one annual report is used.

When it is impracticable to determine the retrospective approach on prior years, then it may be possible to determine the difference to the opening balances in the accounts. Then the opening retained earnings in the year of change will reflect the cumulative effect on prior years.

In this case, prior years’ financial statements that are presented are not revised in the year of change.

Prior to the current GAAP, voluntary changes in accounting principle were presented using the prospective method in the United States. With the prospective method, the accounts of each year prior period are not adjusted to reflect the effects of applying the new principle. The new accounting principle is used in the current financial statements, and the effect of using the new principle in prior financial statements is disclosed on the current income statement as a cumulative effect of change in accounting principle, net of tax.

The United States reporting prior to the new standard was inconsistent with the report- ing under the International Financial Reporting Standards (IFRS).

The current standard does not rule out the possibility that a new standard could include spe- cific directions on how to report a change in principle. Thus it is possible that the cumulative effect could be directed to be reported in the income statement in the year of change. A standard making the LIFO inventory method obsolete could possibly be handled that way. If such a stand- ard is issued then remove the cumulative effect of accounting change in the primary analysis.

See Exhibit 4-8 for the cumulative effect of accounting change on the income statement.

EXHIBIT 4-8 Zebra Technologies Corporation*

Cumulative Effect of Change in Accounting Principle

Zebra Technologies Corporation Consolidated Statements of Earnings (Loss) (In Part)

Amounts in thousands, except per share data

Year Ended December 31,

2008 2007 2006

Operating income (loss) (15,346) $143,185 $ 80,429 Other income (expense): Investment income 1,281 23,966 23,182 Foreign exchange gain (loss) 3,518 523 (635) Other, net (1,366) (299) (1,334)

Total other income 3,433 24,190 21,213 Income (loss) before income taxes and cumulative effect of

accounting change (11,913) 167,375 101,642 Income taxes 26,508 57,262 32,015 Income (loss) before cumulative effect of accounting change (38,421) 110,113 69,627

*“Zebra delivers products and solutions that improve our customers’ ability to help our customers put their critical assets to work smarter by identifying, tracking and managing assets, transactions and people.” 10-K Source: Zebra Technologies Corporations 2010 10-K

166 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

(F) Net Income—Noncontrolling Interest (previously minority share of earnings) If a firm consolidates subsidiaries not wholly owned, the total revenues and expenses of the subsidiaries are included with those of the parent. However, to determine the income that would accrue to the parent, it is necessary to deduct the portion of income that would belong to the net income—noncontrolling interest. Prior to December 31, 2009, this was called “mi- nority share of earnings.” This item should be presented net of tax.

Noncontrolling interest reflects income from ownership of noncontrolling shareholders in the equity of consolidated subsidiaries less than wholly owned. Exhibit 4-9 illustrates net income attributable to the noncontrolling interest.

Some ratios can be materially distorted because of a net income—noncontrolling inter- est. For each ratio influenced by a net income—noncontrolling interest, this book suggests a recommended approach.

EXHIBIT 4-9 Honeywell International, Inc.*

Net Income – Noncontrolling Interest (Minority Interest)

Honeywell International Inc. Consolidated Statement of Operations

Year Ended December 31,

2010 2009 2008

(Dollars in millions, except per share amounts) Product sales $26,262 $23,914 $29,212 Service sales 7,108 6,994 7,344 Net sales 33,370 30,908 36,556 Costs, expenses and other Cost of products sold 20,701 19,317 25,610 Cost of services sold 4,818 4,695 5,508

25,519 24,012 31,118 Selling, general and administrative expenses 4,717 4,443 5,130 Other (income) expense (95) (55) (748) Interest and other financial charges 386 459 456

30,527 28,859 35,956

Year Ended December 31,

2008 2007 2006

Cumulative effect of accounting change, net of income taxes of $694 (see Note 2) — — 1,319

Net income (loss) $(38,421) $110,113 $ 70,946 Basic earnings (loss) per share before cumulative effect of

accounting change $ (0.60) $ 1.61 $ 0.99 Diluted earnings (loss) per share before cumulative effect of

accounting change $ (0.60) $ 1.60 $ 0.98 Basic earnings (loss) per share $ (0.60) $ 1.61 $ 1.01 Diluted earnings (loss) per share $ (0.60) $ 1.60 $ 1.00 Basic weighted average shares outstanding 64,524 68,463 70,516 Diluted weighted average and equivalent shares outstanding 64,524 68,908 70,956

*“Honeywell International, Inc. (Honeywell) is a diversified technology and manufacturing company, serving customers worldwide with aerospace products and services, control, sensing and security technologies for buildings, homes and industry, turbochargers, automotive products, specialty chemicals, electronic and advanced materials, process technology for refining and petrochemicals, and energy efficient products and solutions for homes, business and transportation.” 10-K Source: Honeywell International Inc. 2010 10-K

EXHIBIT 4-8 Zebra Technologies Corporation (continued)

(continued)

CHAPTER 4 • Income Statement 167

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Earnings per Share In general, earnings per share is earnings divided by the number of shares of outstanding common stock. Chapter 9 presents earnings per share in detail and explains its computation. Meanwhile, use the formula of net income divided by outstanding shares of common stock.

Retained Earnings Retained earnings, an account on the balance sheet, represents the undistributed earnings of the corporation. A reconciliation of retained earnings summarizes the changes in retained earnings. It shows the retained earnings at the beginning of the year, the net income for the year as an addi- tion, the dividends as a subtraction, and concludes with end-of-year retained earnings. It also includes, if appropriate, prior period adjustments (net of tax) and some adjustments for changes in accounting principles (net of tax). These restate beginning retained earnings. Other possible changes to retained earnings are beyond the scope of this book.

Sometimes a portion of retained earnings may be unavailable for dividends because it has been appropriated (restricted). Appropriated retained earnings remain part of retained earnings. The appropriation of retained earnings may or may not have significance.

Appropriations that result from legal requirements (usually state law) and appropria- tions that result from contractual agreements are potentially significant. The appropriations may leave unappropriated retained earnings inadequate to pay dividends. (Note: A corpora- tion will not be able to pay a cash dividend even with an adequate unrestricted balance in retained earnings unless it has adequate cash or ability to raise cash and has complied with the state law where it is incorporated.)

Most appropriations result from management decisions. These are usually not signifi- cant because management can choose to remove the appropriation.

Caution should be exercised not to confuse retained earnings or appropriated retained earn- ings with cash or any other asset. There is no cash or any other asset in retained earnings. The reason for an appropriation will be disclosed either in the reconciliation of retained earnings or in a note. From this disclosure, try to arrive at an opinion as to the significance, if any.

The reconciliation of retained earnings usually appears as part of a statement of stockholders’ equity. Sometimes it is combined with the income statement. Exhibit 4-10 gives an example of a reconciliation of retained earnings being presented with a stockholders’ equity statement.

Dividends and Stock Splits Dividends return profits to the owners of a corporation. A cash dividend declared by the board of directors reduces retained earnings by the amount of the dividends declared and creates the current liability, dividends payable. The date of payment occurs after the date of declaration. The dividend payment eliminates the liability, dividends payable, and reduces cash. Note that the date of the declaration of dividends, not the date of the dividend pay- ment, affects retained earnings and creates the liability.

Year Ended December 31,

2010 2009 2008

(Dollars in millions, except per share amounts) Income before taxes 2,843 2,049 600 Tax expense (benefit) 808 465 (226) Net income 2,035 1,584 826 Less: Net income attributable to the noncontrolling interest 13 36 20 Net income attributable to Honeywell $ 2,022 $ 1,548 $ 806 Earnings per share of common stock – basic $ 2.61 $ 2.06 $ 1.09 Earnings per share of common stock – assuming dilution $ 2.59 $ 2.05 $ 1.08 Cash dividends per share of common stock $ 1.21 $ 1.21 $ 1.10

EXHIBIT 4-9 Honeywell International, Inc. (continued)

168 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

EXHIBIT 4-10 Reliance Steel & Aluminum Co.*

Consolidated Statements of Equity

RELIANCE STEEL & ALUMINUM CO. CONSOLIDATED STATEMENTS OF EQUITY (In thousands, except share and per share amounts)

Reliance Shareholders

Common Stock Retained Earnings

Accumulated Other

Comprehensive Income (loss)

Non- Controlling Interests TotalShares Amount

Balance at January 1, 2008 74,906,824 $ 646,406 $1,439,598 $ 20,245 $ 1,699 $2,107,948 Net income — — 482,777 — 858 483,635 Other comprehensive loss: Foreign currency translation loss — — — (42,624) — (42,624) Unrealized loss on investments, net of tax — — — (1,163) — (1,163) Minimum pension liability, net of tax — — — (8,474) — (8,474)

Comprehensive income 431,374 Noncontrolling interests acquired — — — — 2,300 2,300 Payment to noncontrolling interest holder — — — — (1,225) (1,225) Share based compensation — 13,189 — — — 13,189 Stock options exercised 844,338 17,987 — — — 17,987 Share based compensation tax benefits — — 9,693 — — 9,693 Stock repurchased (2,443,500) (114,774) — — — (114,774) Adjustment to initially apply EITF 06-10 — — (2,479) — — (2,479) Stock issued under incentive bonus plan 5,052 284 — — — 284 Cash dividends – $0.40 per share — — (29,229) — — (29,229)

Balance at December 31, 2008 73,312,714 563,092 1,900,360 (32,016) 3,632 2,435,068 Net income — — 148,158 — 1,018 149,176 Other comprehensive income: Foreign currency translation gain — — — 25,870 — 25,870 Unrealized gain on investments, net of tax — — — 524 — 524 Minimum pension liability, net of tax — — — 4,099 — 4,099

Comprehensive income 179,669 Noncontrolling interests purchased — (1,758) — — (903) (2,661) Payments to noncontrolling interest holder — — — — (2,057) (2,057) Share based compensation — 15,530 — — — 15,530 Stock options exercised 427,697 10,490 — — — 10,490 Share based compensation tax benefits — — 1,208 — — 1,208 Stock issued under incentive bonus plan 10,360 258 — — — 258 Cash dividends – $0.40 per share — — (29,383) — — (29,383)

Balance at December 31, 2009 73,750,771 587,612 2,020,343 (1,523) 1,690 2,608,122 Net income — — 194,353 — 3,496 197,849 Other comprehensive income: Foreign currency translation gain — — — 9,657 — 9,657 Unrealized gain on investments, net of tax — — — 220 — 220 Minimum pension liability, net of tax — — — 1,921 — 1,921

Comprehensive income 209,647 Issuance of equity interest in subsidiary to

noncontrolling interest — (1,462) — — 1,604 142 Consolidation of a joint venture entity — — — — 1,370 1,370 Payments to noncontrolling interest holders — — — — (1,778) (1,778) Share based compensation 61,000 17,334 — — — 17,334 Stock options exercised 827,452 21,248 — — — 21,248 Share based compensation tax benefits — — 3,721 — — 3,721 Cash dividends – $0.40 per share — — (29,692) — — (29,692)

Balance at December 31, 2010 74,639,223 $ 624,732 $2,188,725 $ 10,275 $ 6,382 $2,830,114

*“We are the largest metals service center company in North America (U.S. and Canada).” 10-K Source: Reliance Steel & Aluminum Co. 2010 10-K

CHAPTER 4 • Income Statement 169

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

The board of directors may elect to declare and issue another type of dividend, termed a stock dividend. The firm issues a percentage of outstanding stock as new shares to existing shareholders. If the board declares a 10% stock dividend, for example, an owner holding 1,000 shares would receive an additional 100 shares of new stock. The accounting for a stock dividend, assuming a relatively small distribution (less than 25% of the existing stock), requires removing the fair market value of the stock at the date of declaration from retained earnings and transferring it to paid-in capital. With a material stock dividend, the amount removed from retained earnings and transferred to paid-in capital is determined by multiply- ing the par value of the stock by the number of additional shares. Note that the overall effect of a stock dividend leaves total stockholders’ equity and each owner’s share of stockholders’ equity unchanged. However, the total number of outstanding shares increases.

A stock dividend should reduce the market value of individual shares by the percentage of the stock dividend. Total market value considering all outstanding shares should not change in theory. In practice, themarket value changemay not be the same percentage as the stock dividend.

A more drastic device to change the market value of individual shares is by declaring a stock split. A 2-for-1 split should reduce the market value per share to one-half the amount prior to the split. The market value per share in practice may not change exactly in propor- tion to the split. The market value will result from the supply and demand for the stock.

Lowering the market value is sometimes desirable for stocks selling at high prices (as perceived by management). Stocks with high prices are less readily traded. A stock dividend or stock split can influence the demand for the stock.

A stock split merely increases the number of shares of stock. It does not usually change retained earnings or paid-in capital. For example, if a firm had 1,000 shares of common stock, a 2-for-1 stock split would result in 2,000 shares.

For a stock split, the par or stated value of the stock is changed in proportion to the stock split, and no change is made to retained earnings, additional paid-in capital, or capital stock. For example, a firm with $10 par common stock that declares a 2-for-1 stock split would reduce the par value to $5.

Sometimes the company wants to increase the market value of individual shares by declaring a reverse stock split. In this case, the company recalls its present stock and issues a lesser number of shares. This could be one-for-two, one-for-three, one-for-four, one-for-five, one-for-six, etc.

The Sanmina-Sci Corporation did a reverse stock split. They included the following in their 2009 annual report:

“Reverse Stock Split. On July 20, 2009, the Board of Directors of the Company author- ized a reverse stock split of its common stock at a ratio of one-for-six, effective August 14, 2009. The Company’s stockholders previously approved the reverse split in September 2008. As a result of the reverse split, every six shares of common stock outstanding were combined into one share of common stock. The reverse split did not affect the amount of eq- uity the Company has nor did it affect the Company’s market capitalization.”

Since the number of shares changes under both a stock dividend and stock split, any ra- tio based on the number of shares must be restated for a meaningful comparison. For exam- ple, if a firm had earnings per share of $4 in 2010, a 2-for-1 stock split in 2011 would require restatement of the earnings per share to $2 in 2010 because of the increase in the shares. Restatement will be made for all prior financial statements presented with the current financial statements, including a 5- or 10-year summary.

Source: Sanmina-Sci Corporation 2010 10-K

Legality of Distributions to Stockholders The legality of distributions to stockholders is governed by applicable state law. Currently, the 50 states may be classified into one of three groups for purposes of distributions to stock- holders. These groups are the following:2

1. Distributions to stockholders are acceptable as long as the firm has the ability to pay debts as they come due in the normal course of business.

2. Distributions to stockholders are acceptable as long as the firm is solvent and the distributions do not exceed the fair value of net assets.

3. Distributions consist of solvency and balance sheet tests of liquidity and risk.

170 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Thus, the appropriateness of a distribution to stockholders is a legal interpretation. Accountants have not accepted the role of disclosing the firm’s capacity to make distribu- tions to stockholders. Accountants have accepted the role of disclosing appropriations (restrictions) of retained earnings. Appropriations can temporarily limit the firm’s ability to make distributions. These appropriations are typically directed toward limiting or prohibit- ing the payment of cash dividends.

During the 1980s and 1990s, many distributions to stockholders exceeded the net book value of the firm’s assets. These were often accompanied by debt-financed restructurings. Of- ten, the result was a deficit balance in retained earnings and sometimes a deficit balance in total stockholders’ equity.

During 1988, Holiday Corporation (owner of Holiday Inns of America) distributed a $65 per share dividend to prevent a hostile takeover. The result was a substantial deficit to retained earnings and approximately a $770 million deficit to total stockholders’ equity.3

A similar situation took place at Owens Corning during the 1980s as it made a substan- tial distribution to stockholders by way of a debt-financed restructuring. Owens Corning also had substantial expenses related to asbestos-related illnesses. At the end of 1995, Owens Corning had a deficit in retained earnings of $781 million and a deficit in total stockholders’ equity of $212 million.

An Owens Corning news release of June 20, 1996, stated (in part):

The Board of Directors has approved an annual dividend policy of 25 cents per share and declared a quarterly dividend of 6-1/4 cents per share payable on October 15, 1996 to shareholders of record as of September 30, 1996.

In reference to the dividend, we were able to initiate this action because debt has been reduced to target levels and cash flow from operations will be in excess of internal funding requirements.

We are delighted to be able to reward our shareholders with a dividend. Reinstating the dividend has been a priority of mine since joining the company and I am pleased that we now are in a position to set the date.

Comprehensive Income Chapter 1 described the Concept Statements that serve as the basis for evaluating existing standards of financial accounting and reports. Concept Statement Nos. 5 and 6 included the concept of comprehensive income. Comprehensive income was described in SFAC No. 6 as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources.

Subsequently, SFAS No. 130 was issued, requiring the reporting of comprehensive income, but using a narrower definition than in SFAC No. 6. Under SFAS No. 130, compre- hensive income is net income plus the period’s change in accumulated other comprehensive income. Accumulated other comprehensive income is a category within stockholders’ equity, described in Chapter 3.

Categories within accumulated other comprehensive income are:

1. Foreign currency translation adjustments. The expansion of international business and extensive currency realignment have created special accounting problems. The biggest difficulty has been related to translating foreign financial statements into the financial statements of a U.S. enterprise.

U.S. financial reporting calls for postponing the recognition of unrealized exchange gains and losses until the foreign operation is substantially liquidated. This postponement is accomplished by creating a separate category within stockholders’ equity to carry unrealized exchange gains and losses. This method eliminates the wide fluctuations in earnings from translation adjustments for most firms. For subsidiaries operating in highly inflationary economies, translation adjustments are charged to net earnings. Also, actual foreign currency exchange gains (losses) are included in net earnings.

2. Unrealized holding gains and losses on available-for-sale marketable securities. Debt and equity securities classified as available-for-sale securities are carried at fair value.

CHAPTER 4 • Income Statement 171

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Unrealized holding gains and losses are included in a separate category within stockholders’ equity until realized. Thus, the unrealized holding gains and losses are not included in net earnings. Note that this accounting only applies to securities available for sale. Trading securities are reported at their fair values on the balance sheet date, and unrealized holding gains and losses are included in income of the current period. Debt securities held to maturity are reported at their amortized cost on the balance sheet date.

3. Changes to stockholders’ equity resulting from additional minimum pension liability adjustments. Accounting standards require a reduction in stockholders’ equity for a minimum pension liability under a defined benefit plan. Accounting for a defined benefit plan is reviewed in Chapter 7.

4. Unrealized gains and losses from derivative instruments. Derivative instruments are financial instruments or other contracts where rights or obligations meet the definitions of assets or liabilities. The gain or loss for some derivative instruments is reported in current earnings. For other derivative instruments, the gain or loss is reported as a component of other comprehensive income. The gain or loss for these instruments is recognized in subsequent periods in income as the hedged forecasted transactions affect earnings.

Required disclosures are the following:

• Comprehensive income • Each category of other comprehensive income • Reclassification adjustments for categories of other comprehensive income • Tax effects for each category of other comprehensive income • Balances for each category of accumulated other comprehensive income

The accounting standard provided considerable flexibility in reporting comprehensive income. One format uses a single income statement to report net income and comprehensive income. The second format reports comprehensive income in a separate statement of finan- cial activity. The third format reports comprehensive income within the statement of changes in stockholders’ equity. Exhibit 4-10 presents the accumulated other comprehensive income (loss) of Reliance Steel & Aluminum Co. Reliance presents this within its consolidated state- ments of shareholders’ equity.

The first two options were not popular because they require that comprehensive income be closely tied to the income statement. Comprehensive income will typically be more vola- tile than net income. This is because the items within accumulated other comprehensive income have the potential to be volatile. A good case could be made that comprehensive income is a better indication of long-run profitability than is net income. Some firms elected to disclose comprehensive income as a note to the financial statements.

The FASB and IASB entered into a joint project to improve the presentation of compre- hensive income in a manner that is as convergent as possible. At that time the IFRS only pro- vided for comprehensive income to be presented either in a single statement or in two consecutive statements.

The result of this joint project was that the FASB in 2011 issued an amendment of the FASB Accounting Standards Codification which ruled out the option of reporting compre- hensive income within the statement of changes in shareholders’ equity.

Thus with the effective fiscal year after December 15, 2011, only the following options are available:

1. A single income statement reporting net income and comprehensive income, or 2. Report comprehensive income in a separate statement immediately following the

statement of income.

Exhibit 4-11 has illustrations—reporting comprehensive income. Illustration (A)—single income statement to report net income and comprehensive income and illustration (B)— comprehensive income in a separate statement.

This new standard is effective for interim periods. The coverage of comprehensive income in analysis is in Chapter 12.

172 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

International Consolidated Income Statement (IFRS) IFRS and U.S. GAAP for the income statement are similar, with some presentation differen- ces. U.S. GAAP requires either a single-step or multiple-step format. There is no required for- mat under IFRS. Under IFRS, expenses are classified by their nature or function.

Under IFRS, equipment may be revalued. This would result in the adjustment of depreci- ation expenses. IFRS allows for alternative performance measures to be presented in the income statement that are not allowed by U.S. GAAP.

EXHIBIT 4-11 Illustrations – Reporting Comprehensive Income

Illustration (A) – Single income statement to report net income and comprehensive income

Convergys Corporation* Consolidated Statements of Operations and Comprehensive Income (Loss)

Year Ended December 31,

(Amounts in millions, except per share amounts) 2010 2009 2008

Revenues $2,203.4 $2,421.0 $2,526.3 Operating Costs and Expenses: Cost of providing services and products sold(1) 1,340.9 1,461.6 1,623.8 Selling, general and administrative expenses 575.7 616.4 561.7 Research and development costs 56.2 74.2 54.9 Depreciation 97.3 110.3 109.7 Amortization 10.1 10.9 11.3 Restructuring charges 38.7 43.3 23.9 Asset impairment 181.1 3.1 —

Total costs and expenses 2,298.0 2,319.8 2,385.3 Operating (Loss) Income (94.6) 101.2 141.0 Equity in earnings of Cellular Partnerships 47.2 41.0 35.7 Other income (expense), net 8.9 (17.2) 16.2 Interest expense (19.5) (28.9) (22.5) (Loss) income before income taxes (58.0) 96.1 170.4 Income tax expense 16.7 11.6 23.9 (Loss) income from continuing operations (74.7) 84.5 146.5 Income (loss) from discontinued operations, net of tax 21.5 (161.8) (239.4) Net (Loss) Income $ (53.2) $ (77.3) $ (92.9) Other Comprehensive Income (Loss), net of tax: Foreign currency translation adjustments $ 11.7 $ 25.4 $ (59.4) Change related to pension liability (net of tax benefit

(expense) of $2.9, ($2.4), and $12.2) (3.5) 2.2 (20.3) Unrealized gain (loss) on hedging activities (net of tax

benefit (expense) of $20.0, ($27.9), and $57.5) 33.5 51.8 (107.0) Total Comprehensive (Loss) Income $ (11.5) $ 2.1 $ (279.6)

Basic Earnings (Loss) per share: Continuing Operations $ (0.61) $ 0.69 $ 1.19 Discontinued operations 0.18 (1.32) (1.94) Net basic (loss) earnings per share $ (0.43) $ (0.63) $ (0.75)

Diluted Earnings (Loss) per share: Continuing Operations $ (0.61) $ 0.68 $ 1.16 Discontinued Operations 0.18 (1.30) (1.90) Net diluted (loss) earnings per share $ (0.43) $ (0.62) $ (0.74)

Weighted average common shares outstanding: Basic 123.1 122.8 123.5 Diluted 123.1 124.9 125.8

*“Convergys Corporation (the Company or Convergys) is a global leader in relationship management.” 10-K (1)Exclusive of depreciation and amortization, with the exception of amortization of deferred charges. Source: Convergys Corporation 2010 10-K

(continued)

CHAPTER 4 • Income Statement 173

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Deloitte Touche Tohmatsu Limited, one of the big four public accounting firms, presents model financial statements under IFRS available on www.deloitte.com. These following model financial statements will be used to illustrate statements under IFRS:

International GAAP Holdings Limited Financial statements for the year ended 31 December 2011

The model financial statements of International GAAP Holdings Limited for the year ended 31 December 2011 are intended to illustrate the presentation and disclosure requirements of International Financial Reporting Standards (IFRSs). They also contain additional disclosures that are considered to be best practice, particularly where such disclosures are included in illustrative examples provided with a specific Standard. International GAAP Holdings Limited is assumed to have presented financial statements in accordance with IFRSs for a number of years. Therefore, it is not a first- time adopter of IFRSs. Readers should refer to IFRS 1 First-time Adoption of International Financial Reporting Standards for specific requirements regarding an entity’s first IFRS financial statements, and to the IFRS 1 section of Deloitte’s Compliance, Presentation and Disclosure Checklist for details of the particular disclosure requirements applicable for first-time adopters. Deloitte’s Compliance, Presentation and Disclosure Checklist can be downloaded from Deloitte’s web site www.iasplus.com. The model financial statements have illustrated the impact of a number of new and revised Standards and Interpretations that are mandatorily effective on 1 January 2011 (see note 2 to the model financial statements for details). The model financial statements have not illustrated the impact of new and revised Standards and Interpretations that are not yet mandatorily effective on 1 January 2011 (e.g. IFRS 9 Financial Instruments). In addition, the model financial statements have been presented without regard to local laws or regulations. Preparers of financial statements will need to ensure that the options selected under IFRSs do not conflict with such sources of regulation (e.g. the revaluation of assets is not permitted in certain regimes – but these financial statements illustrate the presentation and disclosures required when an entity adopts the revaluation model under IAS 16 Property, Plant and Equipment). In addition, local laws or securities regulations may specify disclosures in addition to those required by IFRSs (e.g. in relation to directors’ remuneration). Preparers of financial statements will

Illustration (B) – Comprehensive income in a separate statement

Zebra Technologies Corporation* Consolidated Statements of Comprehensive Income (Loss)

(Amounts in thousands)

Year Ended December 31,

2010 2009 2008

Net income (loss) $101,778 $47,104 $(38,421) Other comprehensive income (loss): Unrealized gain/(loss) on hedging transactions,

net of income taxes (949) 19 5,750 Unrealized holding gains/(losses) on investments,

net of income taxes (406) 737 (543) Foreign currency translation adjustment 67 3,972 (22,991)

Comprehensive income (loss) $100,490 $51,832 $(56,205)

*“Zebra delivers products and solutions that improve our customers’ ability to put their critical assets to work smarter by identifying, tracking and managing assets, transactions and people.” 10-K

EXHIBIT 4-11 Illustrations – Reporting Comprehensive Income (continued)

174 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

consequently need to adapt the model financial statements to comply with such additional local requirements.

The model financial statements do not include separate financial statements for the parent, which may be required by local laws or regulations, or may be prepared voluntarily. Where an entity presents separate financial statements that comply with IFRSs, the requirements of IAS 27 Consolidated and Separate Financial Statements will apply. Separate statements of comprehensive income, financial position, changes in equity and cash flows for the parent will generally be required, together with supporting notes.

Suggested disclosures are cross-referenced to the underlying requirements in the texts of the relevant Standards and Interpretations.

Disclaimer

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. “Deloitte” is the band under which tens of thousands of dedicated professionals in independent firms throughout the world collaborate to provide audit, consulting, financial advisory, risk management, and tax services to selected clients. These firms are member of Deloitte Touche Tohmatsu Limited (DTTL), a UK private company limited by guarantee. Each member firm provides services in a particular geographic area and is subject to the laws and professional regulations of the particular country or countries in which it operates. DTTL does not itself provide services to clients. DTTL and each DTTL member firm are separate and distinct legal entities, which cannot obligate each other. DTTL and each DTTL member firm are liable for only their own acts or omissions and not those of each other. Each DTTL member firm is structured differently in accordance with national laws, regulations, customary practice, and other factors, and may secure the provision of professional services in its territory through subsidiaries, affiliates and/or other entities. This publication contains general information only, and none of Deloitte Touche Tohmatsu Limited, its member firms, or its and their affiliates are, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your finances or your business. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional advisor. None of Deloitte Touche Tohmatsu Limited, its member firms, or its and their respective affiliates shall be responsible for any loss whatsoever sustained by any person who relies on this publication.

The model income statement in Exhibit 4-12 aggregates expense to their function. The model income statement in Exhibit 4-13 aggregates expenses according to their nature.

Exhibit 4-12 combines the income statement and comprehensive income. This results in an exhibit title of IFRS Model Consolidated Statement of Comprehensive Income.

Exhibit 4-13 presents the Consolidated Income Statement separate from the Consolidated Statement of Comprehensive Income. This results in an exhibit title of IFRS Model Consoli- dated Income Statement – followed by – Consolidated Statement of Comprehensive Income.

CHAPTER 4 • Income Statement 175

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

EXHIBIT 4-12 IFRS Model Consolidated Statement of Comprehensive Income

Source International GAAP Holdings Limited

IAS 1.10(b), 51(b),(c)

Consolidated statement of comprehensive income for the year ended 31 December 2011 [Alt 1]

IAS 1.113 Notes

Year ended 31/12/11

Year ended 31/12/10

IAS 1.51(d),(e) CU’000 CU’000 Continuing operations

IAS 1.82(a) Revenue 5 140,918 151,840 IAS 1.99 Cost of sales (87,897) (91,840)

IAS 1.85 Gross profit 53,021 60,000

IAS 1.85 Investment income 7 3,608 2,351 IAS 1.85 Other gains and losses 8 647 1,005 IAS 1.99 Distribution expenses (5,087) (4,600) IAS 1.99 Marketing expenses (3,305) (2,254) IAS 1.99 Administration expenses (13,129) (17,325)

Other expenses (2,801) (2,612) IAS 1.82(b) Finance costs 9 (4,418) (6,023) IAS 1.82(c) Share of profits of associates 20 1,186 1,589 IAS 1.85 Gain recognised on disposal of interest in former associate 20 581 — IAS 1.85 Other [describe] — —

IAS 1.85 Profit before tax 30,303 32,131 IAS 1.82(d) Income tax expense 10 (11,564) (11,799)

IAS 1.85 Profit for the year from continuing operations 13 18,739 20,332

Discontinued operations IAS 1.82(e) Profit for the year from discontinued operations 11 8,310 9,995 IAS 1.82(f) Profit for the year 27,049 30,327

Other comprehensive income, net of income tax IAS 1.82(g) Exchange differences on translating foreign operations (39) 85 IAS 1.82(g) Net gain on available-for-sale financial assets 66 57 IAS 1.82(g) Net gain on hedging instruments entered into for cash flow hedges 39 20 IAS 1.82(g) Gain on revaluation of properties — 1,150 IAS 1.82(h) Share of other comprehensive income of associates — —

IAS 1.85 Other comprehensive income for the year, net of tax 66 1,312

IAS 1.82(i) Total comprehensive income for the year 27,115 31,639

Profit attributable to: IAS 1.83(a) Owners of the Company 23,049 27,564 IAS 1.83(a) Non-controlling interests 4,000 2,763

27,049 30,327 Total comprehensive income attributable to:

IAS 1.83(b) Owners of the Company 23,115 28,876 IAS 1.83(b) Non-controlling interests 4,000 2,763

27,115 31,639 Earnings per share 14 From continuing and discontinued operations

IAS 33.66 Basic (cents per share) 132.2 137.0

IAS 33.66 Diluted (cents per share) 115.5 130.5 From continuing operations

IAS 33.66 Basic (cents per share) 84.5 87.3 IAS 33.66 Diluted (cents per share) 74.0 83.2

176 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

EXHIBIT 4-13 IFRS Model Consolidated Income Statement – followed by – Consolidated Statement of Comprehensive Income

Source International GAAP Holdings Limited

IAS 1.10(b) 81(b),51(b),(c)

Consolidated income statement for the year ended 31 December 2011 [Alt 2]

IAS 1.113 Notes

Year ended 31/12/11

Year ended 31/12/10

IAS 1.51(d),(e) CU’000 CU’000

Continuing operations IAS 1.82(a) Revenue 5 140,918 151,840 IAS 1.85 Investment income 7 3,608 2,351 IAS 1.85 Other gains and losses 8 647 1,005 IAS 1.99 Changes in inventories of finished goods and work in progress 7,134 2,118 IAS 1.99 Raw materials and consumables used (84,659) (85,413) IAS 1.99 Depreciation and amortisation expenses 13 (11,193) (13,878) IAS 1.99 Employee benefits expense 13 (10,113) (11,527) IAS 1.82(b) Finance costs 9 (4,418) (6,023) IAS 1.99 Consulting expense (3,120) (1,926)

Other expenses (10,268) (8,005) IAS 1.82(c) Share of profits of associates 20 1,186 1,589 IAS 1.85 Gain recognised on disposal of interest in former associate 20 581 — IAS 1.85 Other [describe] — —

IAS 1.85 Profit before tax 30,303 32,131

IAS 1.82(d) Income tax expense 10 (11,564) (11,799) IAS 1.85 Profit for the year from continuing operations 13 18,739 20,332

Source International GAAP Holdings Limited

Note: Alt 1 above illustrates the presentation of comprehensive income in one statement. Alt 2 (see next pages) illustrates the presentation of comprehensive income in two statements. Whichever presentation is selected, the distinction is retained between items recognised in profit or loss and items recognised in other comprehensive income. The only difference between the one-statement and the two-statement approaches is that, for the latter, a total is struck in the separate income statement at ‘profit for the year’ (this is the same amount as is presented as a sub-total under the one-statement approach). This ‘profit for the year’ is then the starting point for the statement of comprehensive income, which is required to be presented immediately following the income statement. Under the two-statement approach, the analysis of ‘profit for the year’ between the amount attributable to the owners of the parent and the amount attributable to non-controlling interests is presented at the end of the separate income statement.

Irrespective of whether the one-statement or the two-statement approach is followed, for the components of other comprehensive income, additional presentation options are available, as follows.

IAS 1.90 : The individual components may be presented net of tax in the statement of comprehensive income (as illustrated on the previous page), or they may be presented gross with a single line deduction for tax (see Alt 2). Whichever option is selected, the income tax relating to each component of comprehensive income must be disclosed, either in the statement of comprehensive income or in the notes (see note 29).

IAS 1.93 : For reclassification adjustments, an aggregated presentation may be adopted, with separate disclosure of the current year gain or loss and reclassification adjustments in the notes (see previous page and note 29). Alternatively, using a disaggregated presentation, the current year gain or loss and reclassification adjustments are shown separately in the statement of comprehensive income (see Alt 2).

Alt 1 aggregates expenses according to their function.

(continued)

EXHIBIT 4-12 IFRS Model Consolidated Statement of Comprehensive Income (continued)

CHAPTER 4 • Income Statement 177

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Discontinued operations IAS 1.82(e) Profit for the year from discontinued operations 11 8,310 9,995 IAS 1.82(f) Profit for the year 27,049 30,327

Attributable to: IAS 1.83(a) Owners of the Company 23,049 27,564 IAS 1.83(a) Non-controlling interests 4,000 2,763

27,049 30,327

Earnings per share 14 From continuing and discontinued operations

IAS 33.66, 67A Basic (cents per share) 132.2 137.0 IAS 33.66, 67A Diluted (cents per share) 115.5 130.5

From continuing operations: IAS 33.66, 67A Basic (cents per share) 84.5 87.3

IAS 33.66, 67A Diluted (cents per share) 74.0 83.2

Note: The format outlined above aggregates expenses according to their nature. See the previous page for a discussion of the format of the statement of comprehensive income. Note that where the two-statement approach is adopted (above and on the next page), as required by IAS 1.12, the income statement must be displayed immediately before the statement of comprehensive income.

IAS 1.10(b) 81(b), 51(b),(c)

Consolidated statement of comprehensive income for the year ended 31 December 2011 [Alt 2]

IAS 1.113

Year ended 31/12/11

Year ended 31/12/10

IAS 1.51(d),(e) CU’000 CU’000

IAS 182(f) Profit for the year 27,049 30,327 Other comprehensive income

IAS 1.82(g) Exchange differences on translating foreign operations Exchange differences arising during the year 75 121 Loss on hedging instruments designated in hedges of the

net assets of foreign operations (12) — Reclassification adjustments relating to foreign operations

disposed of in the year (166) — Reclassification adjustments relating to hedges of the net

assets of foreign operations disposed of in the year 46 — (57) 121

IAS 1.82(g) Available-for-sale financial assets Net gain on available-for-sale financial assets during the year 94 81 Reclassification adjustments relating to available-for-sale financial

assets disposed of in the year — — 94 81

IAS 1.82(g) Cash flow hedges Gains arising during the year 436 316 Reclassification adjustments for amounts recognised in profit or loss (123) (86) Adjustments for amounts transferred to the initial carrying

amounts of hedged items (257) (201) 56 29

IAS 1.82(g) Gain on revaluation of properties — 1,643 IAS 1.82(h) Share of other comprehensive income of associates — —

Income tax relating to components of other comprehensive income (27) (562) IAS 1.82(i) Total comprehensive income for the year 27,115 31,639

Total comprehensive income attributable to: IAS 1.83(b) Owners of the Company 23,115 28,876 IAS 1.83(b) Non-controlling interests 4,000 2,763

27,115 31,639

EXHIBIT 4-13 IFRS Model Consolidated Income Statement – followed by – Consolidated Statement of Comprehensive Income (continued)

[Alt 2]

Notes Year ended Year ended 31/12/11 31/12/10

178 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Summary The income statement summarizes the profit for a specific period of time. To understand and analyze profitability, the reader must be familiar with the components of income, as well as income statement items that require special disclosure. This chapter presented special income statement items, such as unusual or infrequent items disclosed separately, equity in

earnings of nonconsolidated subsidiaries, discontinued opera- tions, extraordinary items, and net income—noncontrolling in- terest. This chapter also covered the reconciliation of retained earnings, dividends and stock splits, and comprehensive income, and international consolidated income statements (IFRS).

Questions Q 4-1 What are extraordinary items? How are they shown on the income statement?Why are they shown in that manner?

Q 4-2 Which of the following would be classified as extraordinary?

a. Selling expense b. Interest expense c. Gain on the sale of marketable securities d. Loss from flood e. Income tax expense f. Loss from prohibition of red dye g. Loss from the write-down of inventory

Q 4-3 Give three examples of unusual or infrequent items that are disclosed separately. Why are they shown separately? Are they presented before or after tax? Why or why not?

Q 4-4 Why is the equity in earnings of nonconsolidated subsidiaries sometimes a problem in profitability analysis? Discuss with respect to income versus cash flow.

Q 4-5 A health food distributor selling wholesale dairy products and vitamins decides to discontinue the division that sells vitamins. How should this discontinuance be clas- sified on the income statement?

Q 4-6 Why are unusual or infrequent items disclosed before tax?

Q 4-7 In the future, we should expect few presentations of a “cumulative effect of change in accounting principle.”Comment.

Q 4-8 How does the declaration of a cash dividend affect the financial statements? How does the payment of a cash dividend affect the financial statements?

Q 4-9 What is the difference in the impact on financial statements of a stock dividend versus a stock split?

Q 4-10 Why is net income–noncontrolling interest deducted before arriving at net income?

Q 4-11 Explain the relationship between the income statement and the reconciliation of retained earnings.

Q 4-12 List the three types of appropriated retained earn- ings accounts. Which of these types is most likely not a det- riment to the payment of a dividend? Explain.

Q 4-13 A balance sheet represents a specific date, such as “December 31,” while an income statement covers a pe- riod of time, such as “For the Year Ended December 31, 2011.” Why does this difference exist?

Q 4-14 Describe the following items:

a. Net income–noncontrolling interest b. Equity in earnings of nonconsolidated subsidiaries

Q 4-15 An income statement is a summary of revenues and expenses and gains and losses, ending with net income for a specific period of time. Indicate the two traditional formats for presenting the income statement. Which of these formats is preferable for analysis? Why?

Q 4-16 Melcher Company reported earnings per share in 2011 and 2010 of $2.00 and $1.60, respectively. In 2012, there was a 2-for-1 stock split, and the earnings per share for 2012 were reported to be $1.40. Give a three-year pre- sentation of earnings per share (2010–2012).

Q 4-17 Comment on your ability to determine a firm’s capacity to make distributions to stockholders, using pub- lished financial statements.

Q 4-18 Management does not usually like to tie comprehen- sive income closely with the income statement. Comment.

Q 4-19 Review the consolidated income statement, expenses analyzed by function (Exhibit 4-12). Comment on similarities and differences to the U.S. GAAP income statement.

Q 4-20 Review the consolidated income statement, expenses analyzed by nature (Exhibit 4-13). Comment on sim- ilarities and differences to the U.S. GAAP income statement.

Problems P 4-1 The following information for Decher Automotives covers the year ended 2012:

Administrative expense $ 62,000 Dividend income 10,000 (continued)

CHAPTER 4 • Income Statement 179

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Income taxes $ 100,000 Interest expense 20,000 Merchandise inventory, 1/1 650,000 Merchandise inventory, 12/31 440,000 Flood loss (net of tax) 30,000 Purchases 460,000 Sales 1,000,000 Selling expenses 43,000

Required a. Prepare a multiple-step income statement. b. Assuming that 100,000 shares of common stock are outstanding, calculate the earnings

per share before extraordinary items and the net earnings per share. c. Prepare a single-step income statement.

P 4-2 The following information for Lesky Corporation covers the year ended December 31, 2012:

LESKY CORPORATION Income Statement

For the Year Ended December 31, 2012

Revenue: Revenues from sales $362,000 Rental income 1,000 Interest 2,400

Total revenue 365,400 Expenses: Cost of products sold $242,000 Selling expenses 47,000 Administrative and general expenses 11,400 Interest expense 2,200 Federal and state income taxes 20,300

Total expenses 322,900 Net income $ 42,500

Required Change this statement to a multiple-step format, as illustrated in this chapter.

P 4-3 The accounts of Consolidated Can contain the following amounts at December 31, 2012:

Cost of products sold $410,000 Dividends 3,000 Extraordinary gain (net of tax) 1,000 Income taxes 9,300 Interest expense 8,700 Other income 1,600 Retained earnings, 1/1 270,000 Sales 480,000 Selling and administrative expense 42,000

Required Prepare a multiple-step income statement combined with a reconciliation of retained earnings for the year ended December 31, 2012.

P 4-4 The following items are from Taperline Corporation on December 31, 2012. Assume a flat 40% corporate tax rate on all items, including the casualty loss.

Sales $670,000 Rental income 3,600

(P 4-1 CONTINUED)

180 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Gain on the sale of fixed assets $ 3,000 General and administrative expenses 110,000 Selling expenses 97,000 Interest expense 1,900 Depreciation for the period 10,000 Extraordinary item (casualty loss—pretax) 30,000 Cost of sales 300,000 Common stock (30,000 shares outstanding) 150,000

Required a. Prepare a single-step income statement for the year ended December 31, 2012. Include

earnings per share for earnings before extraordinary items and net income. b. Prepare a multiple-step income statement. Include earnings per share for earnings

before extraordinary items and net income.

P 4-5 The income statement of Rawl Company for the year ended December 31, 2012, shows the following:

Net sales $360,000 Cost of sales 190,000 Gross profit 170,000 Selling, general, and administrative expense 80,000 Income before unusual write-offs 90,000 Provision for unusual write-offs 50,000 Earnings from operations before income taxes 40,000 Income taxes 20,000 Net earnings from operations before extraordinary

charge 20,000 Extraordinary charge, net of tax of $10,000 (50,000) Net earnings (loss) $ (30,000)

Required Compute the net earnings remaining after removing unusual write-offs and the extraordinary charge. Remove these items net of tax. Estimate the tax rate for unusual write-offs based on the taxes on operating income.

P 4-6 At the end of 2012, vandals destroyed your financial records. Fortunately, the con- troller had kept certain statistical data related to the income statement, as follows:

a. Cost of goods sold was $2 million. b. Administrative expenses were 20% of the cost of sales but only 10% of sales. c. Selling expenses were 150% of administrative expenses. d. Bonds payable were $1 million, with an average interest rate of 11%. e. The tax rate was 48%. f. 50,000 shares of common stock were outstanding for the entire year.

Required From the information given, reconstruct a multiple-step income statement for the year. Include earnings per share.

P 4-7 The following information applies to Bowling Green Metals Corporation for the year ended December 31, 2012:

Total revenues from regular operations $832,000 Total expenses from regular operations 776,000 Extraordinary gain, net of applicable income taxes 30,000 Dividends paid 20,000 Number of shares of common stock outstanding during the year 10,000

Required Compute earnings per share before extraordinary items and net earnings. Show how this might be presented in the financial statements.

CHAPTER 4 • Income Statement 181

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

P 4-8 You were recently hired as the assistant treasurer for Victor, Inc. Yesterday, the treasurer was injured in a bicycle accident and is now hospitalized, unconscious. Your boss, Mr. Fernandes, just informed you that the financial statements are due today. Searching through the treasurer’s desk, you find the following notes:

a. Income from continuing operations, based on computations done so far, is $400,000. No taxes are accounted for yet. The tax rate is 30%.

b. Dividends declared and paid were $20,000. During the year, 100,000 shares of stock were outstanding.

c. The corporation experienced an uninsured $20,000 pretax loss from a freak hailstorm. Such a storm is considered to be unusual and infrequent.

d. The company decided to change its inventory pricing method from average cost to the FIFO method. The effect of this change is to increase prior years’ income by $30,000 pretax. The FIFO method has been used for 2012. (Hint: This adjustment should be placed just prior to net income.)

e. In 2012, the company settled a lawsuit against it for $10,000 pretax. The settlement was not previously accrued and is due for payment in February 2013.

f. In 2012, the firm sold a portion of its long-term securities at a gain of $30,000 pretax. g. The corporation disposed of its consumer products division in August 2012, at a loss

of $90,000 pretax. The loss from operations through August was $60,000 pretax.

Required Prepare an income statement for 2012, in good form, starting with income from continuing operations. Compute earnings per share for income from continuing operations, discontinued operations, extraordinary loss, cumulative effect of a change in accounting principle, and net income.

P 4-9 List the statement on which each of the following items may appear. Choose from (A) income statement, (B) balance sheet, or (C) neither.

a. Net income b. Cost of goods sold c. Gross profit d. Retained earnings e. Paid-in capital in excess of par f. Sales g. Supplies expense h. Investment in G. Company i. Dividends j. Inventory k. Common stock

l. Interest payable m. Loss from flood n. Land o. Taxes payable p. Interest income q. Gain on sale of property r. Dividend income s. Depreciation expense t. Accounts receivable u. Accumulated depreciation v. Sales commissions

P 4-10 List where each of the following items may appear. Choose from (A) income state- ment, (B) balance sheet, or (C) reconciliation of retained earnings.

a. Dividends paid b. Notes payable c. Income from noncontrolling interest d. Accrued payrolls e. Loss on disposal of equipment f. Land g. Adjustments of prior periods h. Redeemable preferred stock i. Treasury stock j. Extraordinary loss

k. Unrealized exchange gains and losses l. Equity in net income of affiliates

m. Goodwill n. Unrealized decline in market value of

equity investment o. Cumulative effect of change in

accounting principle p. Common stock q. Cost of goods sold r. Supplies

182 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

P 4-11 The income statement of Tawls Company for the year ended December 31, 2012, shows the following:

Revenue from sales $ 980,000 Cost of products sold 510,000 Gross profit 470,000 Operating expenses: Selling expenses $110,000 General expenses 140,000 250,000

Operating income 220,000 Equity on earnings of nonconsolidated

subsidiary 60,000 Operating income before income taxes 280,000 Taxes related to operations 100,000 Net income from operations 180,000 Extraordinary loss from flood (less

applicable taxes of $50,000) (120,000) Net income—noncontrolling interest (40,000) Net income $ 20,000

Required a. Compute the net earnings remaining after removing nonrecurring items. b. Determine the earnings from the nonconsolidated subsidiary. c. For the subsidiary that was not consolidated, what amount of income would have been

included if this subsidiary had been consolidated? d. What earnings relate to minority shareholders of a subsidiary that was consolidated? e. Determine the total tax amount.

P 4-12 The income statement of Jones Company for the year ended December 31, 2012, follows.

Revenue from sales $ 790,000 Cost of products sold 410,000 Gross profit 380,000 Operating expenses: Selling expenses $ 40,000 General expenses 80,000 120,000

Operating income 260,000 Equity in earnings of nonconsolidated subsidiaries (loss) (20,000) Operating income before income taxes 240,000 Taxes related to operations (94,000) Net income from operations 146,000 Discontinued operations: Loss from operations of discontinued segment (less applicable

income tax credit of $30,000) $(70,000) Loss on disposal of segment (less applicable income tax credit

of $50,000) (100,000) (170,000) Income before cumulative effect of change in accounting

principle (24,000) Cumulative effect of change in accounting principle

(less applicable income taxes of $25,000) 50,000 Net income $ 26,000

Required a. Compute the net earnings remaining after removing nonrecurring items. b. Determine the earnings (loss) from the nonconsolidated subsidiary. c. Determine the total tax amount.

CHAPTER 4 • Income Statement 183

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

P 4-13 Uranium Mining Company, founded in 1982 to mine and market uranium, purchased a mine in 1983 for $900 million. It estimated that the uranium had a market value of $150 per ounce. By 2012, the market value had increased to $300 per ounce. Records for 2012 indicate the following:

Production 200,000 ounces Sales 230,000 ounces Deliveries 190,000 ounces Cash collection 210,000 ounces Costs of production including depletion* $50,000,000 Selling expense $ 2,000,000 Administrative expenses $ 1,250,000 Tax rate 50%

*Production cost per ounce has remained constant over the last few years, and the company has maintained the same production level.

Required a. Compute the income for 2012, using each of the following bases:

1. Receipt of cash 2. Point of sale 3. End of production 4. Based on delivery

b. Comment on when each of the methods should be used. Which method should Uranium Mining Company use?

P 4-14 Each of the following statements represents a decision made by the accountant of Growth Industries:

a. A tornado destroyed $200,000 in uninsured inventory. This loss is included in the cost of goods sold.

b. Land was purchased 10 years ago for $50,000. The accountant adjusts the land account to $100,000, which is the estimated current value.

c. The cost of machinery and equipment is charged to a fixed asset account. The machinery and equipment will be expensed over the period of use.

d. The value of equipment increased this year, so no depreciation of equipment was recorded this year.

e. During the year, inventory that cost $5,000 was stolen by employees. This loss has been included in the cost of goods sold for the financial statements. The total amount of the cost of goods sold was $1 million.

f. The president of the company, who owns the business, used company funds to buy a car for personal use. The car was recorded on the company’s books.

Required State whether you agree or disagree with each decision.

P 4-15 The following information for Gaffney Corporation covers the year ended Decem- ber 31, 2012:

GAFFNEY CORPORATION Income Statement

For the Year Ended December 31, 2012

Revenue: Revenues from sales $450,000 Other 5,000

Total revenue 455,000 Expenses: Cost of products sold $280,000 Selling expenses 50,000 Administrative and general expenses 20,000 Federal and state income taxes 30,000

Total expenses 380,000 Net income 75,000

184 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Other comprehensive income Available-for-sale securities adjustment, net of $5,000 income tax $ 7,000 Foreign currency translation adjustment, net of $3,000 income tax 8,000

Other comprehensive income 15,000 Comprehensive income $ 90,000

Required a. Will net income or comprehensive income tend to be more volatile? Comment. b. Which income figure will be used to compute earnings per share? c. What is the total tax expense reported? d. Will the items within other comprehensive income always net out as an addition to net

income? Comment.

P 4-16 Required Answer the following multiple-choice questions:

a. Which of the following items would be classified as operating revenue or expense on an income statement of a manufacturing firm?

1. Interest expense 2. Advertising expense 3. Equity income 4. Dividend income 5. Cumulative effect of change in accounting principle

b. Which of the following is a recurring item?

1. Error of a prior period 2. Equity in earnings of nonconsolidated subsidiaries 3. Extraordinary loss 4. Cumulative effect of change in accounting principle 5. Discontinued operations

c. The following relate to the income statement of Growth Company for the year ended 2012. What is the beginning inventory?

Purchases $180,000 Purchase returns 5,000 Sales 240,000 Cost of goods sold 210,000 Ending inventory 30,000

1. $6,000 2. $65,000 3. $50,000 4. $55,000 5. $70,000

d. Which of the following items are considered to be nonrecurring items?

1. Equity earnings 2. Unusual or infrequent item disclosed separately 3. Discontinued operations 4. Extraordinary item 5. Cumulative effect of change in accounting principle

e. If the investor company owns 30% of the stock of the investee company and the investee company reports profits of $150,000, then the investor company reports equity income of

1. $25,000. 2. $35,000. 3. $45,000. 4. $50,000. 5. $55,000.

(continued)

CHAPTER 4 • Income Statement 185

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

f. Which of the following would be classified as an extraordinary item on the income statement?

1. Loss from tornado 2. Loss on disposal of a segment of business 3. Write-down of inventory 4. Correction of an error of the current period 5. Loss from strike

g. Which of the following is true when a cash dividend is declared and paid?

1. The firm is left with a liability to pay the dividend. 2. Retained earnings is reduced by the amount of the dividend. 3. Retained earnings is increased by the amount of the dividend. 4. Retained earnings is not influenced by the dividend. 5. Stockholders’ equity is increased.

h. Which of the following is true when a 10% stock dividend is declared and distributed?

1. Retained earnings is increased. 2. Stockholders’ equity is increased. 3. Stockholders’ equity is decreased. 4. Authorized shares are increased. 5. The overall effect is to leave stockholders’ equity in total and each owner’s share

of stockholders’ equity unchanged; however, the total number of shares increases.

P 4-17 Required Answer the following multiple-choice questions:

a. The following relate to Owens data in 2012. What is the ending inventory?

Purchases $580,000 Beginning inventory 80,000 Purchase returns 8,000 Sales 900,000 Cost of goods sold 520,000

1. $150,000 2. $132,000 3. $152,000 4. $170,000 5. $142,000

b. Changes in account balances of Gross Flowers during 2012 were as follows:

Increase

Assets $400,000 Liabilities 150,000 Capital stock 120,000 Additional paid-in capital 110,000

b. Assuming there were no charges to retained earnings other than dividends of $20,000, the net income (loss) for 2012 was

1. $(20,000). 2. $(40,000). 3. $20,000. 4. $40,000. 5. $60,000.

(P 4-16 CONTINUED)

186 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

c. Which of the following would be classified as an extraordinary item on the income statement?

1. Loss on disposal of a segment of business. 2. Cumulative effect of a change in accounting principle. 3. A sale of fixed assets. 4. An error correction that relates to a prior year. 5. A loss from a flood in a location that would not be expected to flood.

d. Net income–noncontrolling interest comes from which of the following situations?

1. A company has been consolidated with our income statement, and our company owns less than 100% of the other company.

2. A company has been consolidated with our income statement, and our company owns 100% of the other company.

3. Our company owns less than 100% of another company, and the statements are not consolidated.

4. Our company owns 100% of another company, and the statements are not consolidated.

5. None of the above.

e. Which of the following will not be disclosed in retained earnings?

1. Declaration of a stock dividend 2. Adjustment for an error of the current period 3. Adjustment for an error of a prior period 4. Net income 5. Net loss

f. Bell Company has 2 million shares of common stock with par of $10. Additional paid- in capital totals $15 million, and retained earnings is $15 million. The directors declare a 5% stock dividend when the market value is $10. The reduction of retained earnings as a result of the declaration will be

1. $0. 2. $1 million. 3. $800,000. 4. $600,000. 5. None of the above.

g. The stockholders’ equity of Gaffney Company at November 30, 2012, is presented below.

Common stock, par value $5, authorized 200,000 shares, 100,000 shares issued and outstanding $500,000

Paid-in capital in excess of par 100,000 Retained earnings 300,000

$900,000

g. On December 1, 2012, the board of directors of Gaffney Company declared a 5% stock dividend, to be distributed on December 20. The market price of the common stock was $10 on December 1 and $12 on December 20. What is the amount of the change to retained earnings as a result of the declaration and distribution of this stock dividend?

1. $0 2. $40,000 3. $50,000 4. $60,000 5. None of the above.

(continued)

CHAPTER 4 • Income Statement 187

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

h. Schroeder Company had 200,000 shares of common stock outstanding with a $2 par value and retained earnings of $90,000. In 2010, earnings per share were $0.50. In 2011, the company split the stock 2 for 1. Which of the following would result from the stock split?

1. Retained earnings will decrease as a result of the stock split. 2. A total of 400,000 shares of common stock will be outstanding. 3. The par value would become $4 par. 4. Retained earnings will increase as a result of the stock split. 5. None of the above.

i. Which of the following is not a category within accumulated other comprehensive income?

1. Foreign currency translation adjustments. 2. Unrealized holding gains and losses on available-for-sale marketable securities. 3. Changes to stockholders’ equity resulting from additional minimum pension

liability. 4. Unrealized gains and losses from derivative instruments. 5. Extraordinary item.

Cases CASE 4-1 HOMEBUILDERS

LENNAR CORPORATION AND SUBSIDIARIES* CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended November 30, 2010, 2009 and 2008

2010 2009 2008

(Dollars in thousands, except per share amounts)

Revenues: Lennar Homebuilding $2,705,639 2,834,285 4,263,038 Lennar Financial services 275,786 285,102 312,379 Rialto Investments 92,597 — —

Total revenues 3,074,022 3,119,387 4,575,417 Costs and expenses: Lennar Homebuilding (1) 2,543,323 3,210,386 4,541,881 Lennar Financial services (2) 244,502 249,120 343,369 Rialto Investments 67,904 2,528 — Corporate general and administrative 93,926 117,565 129,752

Total costs and expenses 2,949,655 3,579,599 5,015,002 Lennar Homebuilding equity in loss from

unconsolidated entities (3) (10,966) (130,917) (59,156) Lennar Homebuilding other income (expense), net (4) 19,135 (98,425) (172,387) Other interest expense (70,245) (70,850) (27,594) Gain on recapitalization of Lennar Homebuilding

unconsolidated entity — — 133,097 Rialto Investments equity in earnings from

unconsolidated entities 15,363 — — Rialto Investments other income, net 17,251 — — Earnings (loss) before income taxes 94,725 (760,404) (565,625) Benefit (provision) for income taxes (5) 25,734 314,345 (547,557) Net earnings (loss) (including net earnings (loss)

attributable to noncontrolling interests) 120,459 (446,059) (1,113,182)

(P 4-17 CONTINUED)

*“We are one of the nation’s largest homebuilders, a provider of financial services and through our Rialto Investments (“Rialto”) segment, an investor in distressed real estate assets.” 10-K Source: Lennar Corporation and Subsidiaries Consolidated 2010 10-K

188 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

2010 2009 2008

(Dollars in thousands, except per share amounts)

Less: Net earnings (loss) attributable to noncontrolling interests (6) 25,198 (28,912) (4,097)

Net earnings (loss) attributable to Lennar $ 95,261 (417,147) (1,109,085) Basic earnings (loss) per share $ 0.51 (2.45) (7.01) Diluted earnings (loss) per share $ 0.51 (2.45) (7.01)

(1) Lennar Homebuilding costs and expenses include $51.3 million, $373.5 million and $340.5 million, respectively, of valuation adjustments and write-offs of option deposits and pre-acquisition costs for the years ended November 30, 2010, 2009 and 2008.

(2) Lennar Financial Services costs and expenses for the year ended November 30, 2008 include a $27.2 million impairment of goodwill.

(3) Lennar Homebuilding equity in loss from unconsolidated entities includes the Company’s share of valuation adjustments related to assets of unconsolidated entities in which the Company has investments of $10.5 million, $101.9 million and $32.2 million, respectively, for the years ended November 30, 2010, 2009 and 2008.

(4) Lennar Homebuilding other income (expense), net includes valuation adjustments to investments in Lennar Homebuilding unconsolidated entities of $1.7 million, $89.0 million and $172.8 million, respectively, for the years ended November 30, 2010, 2009 and 2008.

(5) Benefit (provision) for income taxes for the year ended November 30, 2010 primarily related to settlements with various taxing authorities. For the year ended November 30, 2009, benefit (provision) for income taxes includes a reversal of the Company’s deferred tax asset valuation allowance of $351.8 million. For the year ended November 30, 2008, benefit (provision) for income taxes includes a $730.8 million valuation allowance recorded against the Company’s deferred tax assets.

(6) Net earnings (loss) attributable to noncontrolling interests for the year ended November 30, 2010 includes $33.2 million related to the FDIC’s interest in the portfolio of real estate loans that the Company acquired in partnership with the FDIC. Net earnings (loss) attributable to noncontrolling interests for the year ended November 30, 2009 includes ($13.6) million recorded as a result of $27.2 million of valuation adjustments to inventories of 50%-owned consolidated joint ventures.

Required a. Would you consider the presentation to be a multiple-step income statement or a single-

step income statement? Comment. b. Does it appear that there is a 100% ownership in all consolidated subsidiaries? c. If a subsidiary were not consolidated but rather accounted for using the equity method,

would this change net earnings (loss)? Explain. d. Describe equity in loss from unconsolidated entities. e. Comment on Note 1. Does this note project favorably on the future of Lennar

Corporation? Explain. f. Comment on Note 2. Why take an impairment for goodwill under financial services?

CHAPTER 4 • Income Statement 189

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

CASE 4-2 COMMUNICATION PRODUCTS

Motorola Solutions, Inc. and Subsidiaries* Consolidated Statements of Operations

Years Ended December 31

(In millions, except per share amounts) 2010 2009 2008

Net sales $19,282 $18,147 $25,109 Cost of sales 12,384 12,406 18,171 Gross margin 6,898 5,741 6,938 Selling, general and administrative expenses 3,367 3,058 3,912 Research and development expenditures 2,530 2,598 3,399 Other charges 212 577 2,169 Operating earnings (loss) 789 (492) (2,542) Other income (expense):

Interest income (expense), net (131) (132) 38 Gains on sales of investments and businesses, net 48 74 76 Other (29) 47 (425)

Total other income (expense) (112) (11) (311) Earnings (loss) from continuing operations before

income taxes 677 (503) (2,853) Income tax expense (benefit) 406 (159) 1,584 Earnings (loss) from continuing operations 271 (344) (4,437) Earnings from discontinued operations, net of tax 379 316 197 Net earnings (loss) 650 (28) (4,240) Less: Earnings attributable to noncontrolling

interests 17 23 4 Net earnings (loss) attributable to Motorola

Solutions, Inc. $ 633 $ (51) $ (4,244) Amounts attributable to Motorola Solutions, Inc.

common shareholders: Earnings (loss) from continuing operations, net of

tax $ 254 $ (367) $ (4,441) Earnings from discontinued operations, net of tax 379 316 197 Net earnings (loss) $ 633 $ (51) $ (4,244) Earnings (loss) per common share:

Basic: Continuing operations $ 0.76 $ (1.12) $ (13.72) Discontinued operations 1.14 0.96 0.61

$ 1.90 $ (0.16) $ (13.11) Diluted: Continuing operations $ 0.75 $ (1.12) $ (13.72) Discontinued operations 1.12 0.96 0.61

$ 1.87 $ (0.16) $ (13.11) Weighted average common shares outstanding:

Basic 333.3 327.9 323.6 Diluted 338.1 327.9 323.6

Dividends paid per share $ — $ 0.35 $ 1.40

Presentation gives effect to the Reverse Stock Split, which occurred on January 4, 2011.

*“We provide technologies, products, systems and services that make a broad range of mobile experiences possible.” 10-K

1. Summary of Significant Accounting Policies (In Part)

Motorola Mobility Separation

On July 1, 2010, an initial registration statement on Form 10 was filed with the U.S. Secur- ities and Exchange Commission (“SEC”) in connection with the Company’s separation into two independent, publicly traded companies. Amendments to the initial registration

Source: Motorola Solution, Inc. and Subsidiaries Consolidated 2010 10-K

190 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

statement were filed on August 31, 2010, October 8, 2010, November 12, 2010 and November 30, 2010. On December 1, 2010, the SEC granted effectiveness to the Form 10.

On January 4, 2011 (the “Distribution Date”), the separation of Motorola Mobility Holdings, Inc. (“Motorola Mobility”) from Motorola Solutions (the “Separation”) was completed. Motorola Mobility is now an independent public company trading under the symbol “MMI” on the New York Stock Exchange. On January 4, 2011, the stockholders of record as of the close of business on December 21, 2010 (the “Record Date”) received one (1) share of Motorola Mobility common stock for each eight (8) shares of Motorola, Inc. common stock held as of the Record Date (the “Distribution”). The Separation was com- pleted pursuant to an Amended and Restated Master Separation and Distribution Agree- ment, effective as of July 31, 2010, among Motorola, Inc., Motorola Mobility and Motorola Mobility, Inc. All consolidated per share information presented does not give effect to the Distribution.

After the Distribution Date, the Company does not beneficially own any shares of Motorola Mobility common stock and will not consolidate Motorola Mobility financial results for the purpose of its own financial reporting. The financial information presented in this Form 10-K contains the consolidated position of the Company as of December 31, 2010, which includes the results of Motorola Mobility. Beginning in the first quarter of 2011, the historical financial results of Motorola Mobility will be reflected in the Company’s consolidated financial statements as discontinued operations.

Changes in Presentation

Reverse Stock Split and Name Change

On November 30, 2010, Motorola Solutions announced the timing and details regarding the Separation and the approval of a reverse stock split at a ratio of 1-for-7. Immediately following the Distribution of Motorola Mobility common stock, the Company completed a 1-for-7 reverse stock split (“the Reverse Stock Split”) and changed its name to Motorola Solutions, Inc. All consolidated per share information presented gives effect to the Reverse Stock Split.

Required a. On January 4, 2011, the stockholders of record as of the close of business on December

21, 2010 (the “Record Date”) received one (1) share of Motorola Mobility common stock for each eight (8) shares of Motorola Inc. Describe this distribution.

b. Does the name change? c. Describe the reverse stock split. d. Why would they do a reverse split?

CASE 4-3 APPAREL COMPANIES

PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES* CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED (amounts in thousands, except per share data)

January 29, 2011

January 30, 2010

January 31, 2009

Revenues: Net sales $763,884 $729,217 $825,868 Royalty income 26,404 24,985 25,429

Total revenues 790,288 754,202 851,297 Cost of sales 507,829 505,104 573,046 Gross profit 282,459 249,008 278,251

*“We are one of the leading apparel companies in the United States.” 10-K Source: Perry Ellis International, Inc. and Subsidiaries Consolidated 2010 10-K

(continued)

CHAPTER 4 • Income Statement 191

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

January 29, 2011

January 30, 2010

January 31, 2009

Operating expenses Selling, general and administrative expenses 220,018 200,356 236,840 Depreciation and amortization 12,211 13,625 14,784 Impairment on long-lived assets 392 254 22,299

Total operating expenses 232,621 214,235 273,923 Operating income 49,838 34,863 4,328 Costs on early extinguishment of debt 730 357 — Impairment on marketable securities — — 2,797 Interest expense 13,203 17,371 17,491 Net income (loss) before income taxes 35,905 17,135 (15,960) Income tax provision (benefit) 11,393 3,615 (3,682) Net income (loss) $ 24,512 $ 13,520 $ (12,278)

Less: Net income attributed to noncontrolling interest 400 353 612

Net income (loss) attributed to Perry Ellis International, Inc. $ 24,112 $ 13,167 $ (12,890)

Net income (loss) attributed to Perry Ellis International, Inc. per share: Basic $ 1.84 $ 1.04 $ (0.89) Diluted $ 1.70 $ 1.01 $ (0.89)

Weighted average number of shares outstanding Basic 13,110 12,699 14,416 Diluted 14,149 13,005 14.416

PERRY ELLIS INTERNATIONAL, INC. AND SUBSIDIARIES FOOTNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Part) FOR THE YEARS ENDED JANUARY 29, 2011, JANUARY 30, 2010 AND

JANUARY 31, 2009

2. Summary of Significant Accounting Policies (In Part)

The following is a summary of the Company’s significant accounting policies: PRINCIPLES OF CONSOLIDATION – The consolidated financial statements include

the accounts of Perry Ellis International, Inc. and its wholly-owned and controlled subsidia- ries. All intercompany transactions and balances have been eliminated in consolidation. The ownership interest in consolidated subsidiaries of non-controlling shareholders is reflected as noncontrolling interest. The Company’s consolidation principles would also consolidate any entity in which the Company would be deemed a primary beneficiary.

USE OF ESTIMATES — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires manage- ment to make estimates and assumptions that affect the amounts in the consolidated finan- cial statements and the accompanying footnotes. Actual results could differ from those estimates.

Required a. 1. Comment on the principles of consolidation.

2. Does it appear that there is a 100% ownership in all consolidated subsidiaries? b. Comment on the use of estimates. c. Would you expect an impairment in marketable securities? d. What type of “special item” would be “costs on early extinguishment debt”?

(CASE 4-3 CONTINUED)

192 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

CASE 4-4 THE BIG ORDER

On October 15, 1990, United Airlines (UAL Corporation) placed the largest wide-body air- craft order in commercial aviation history—60 Boeing 747-400s and 68 Boeing 777s—with an estimated value of $22 billion. With this order, United became the launch customer for the B777. This order was equally split between firm orders and options.

Required a. Comment on when United Airlines should record the purchase of these planes. b. Comment on when Boeing should record the revenue from selling these planes. c. Speculate on how firm the commitment was on the part of United Airlines to accept

delivery of these planes. d. 1. Speculate on the disclosure for this order in the 1990 financial statements and notes

of United Airlines. 2. Speculate on the disclosure for this order in the 1990 annual report of United

Airlines. (Exclude the financial statements and notes.) e. 1. Speculate on the disclosure for this order in the 1990 financial statements and notes

of Boeing. 2. Speculate on the disclosure for this order in the 1990 annual report of Boeing.

(Exclude the financial statements and notes.)

CASE 4-5 CELTICS

Boston Celtics Limited Partnership II and Subsidiaries presented the following consolidated statements of income for 1998, 1997, and 1996.

BOSTON CELTICS LIMITED PARTNERSHIP II AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME

For the Year Ended

June 30, 1998

June 30, 1997

June 30, 1996

Revenues: Basketball regular season $39,107,960 $31,813,019 $35,249,625

Ticket sales 28,002,469 23,269,159 22,071,992 Television and radio broadcast rights fees 8,569,485 7,915,626 7,458,651

Other, principally promotional advertising 75,679,914 62,997,804 64,780,268 Costs and expenses: Basketball regular season

Team 40,401,643 40,941,156 27,891,264 Game 2,820,107 2,386,042 2,606,218

General and administrative 13,464,566 13,913,893 15,053,333 Selling and promotional 4,819,478 4,680,168 2,973,488 Depreciation 208,162 189,324 140,894 Amortization of NBA franchise and other

intangible assets 165,035 164,702 164,703 61,878,991 62,275,285 48,829,900 13,800,923 722,519 15,950,368

Interest expense (6,017,737) (5,872,805) (6,387,598) Interest income 6,402,366 6,609,541 8,175,184 Net realized gains (losses) on disposition of

marketable securities and other short-term investments (18,235) 361,051 (101,138)

Income from continuing operations before income taxes 14,167,317 1,820,306 17,636,816

Provision for income taxes 1,900,000 1,400,000 1,850,000 Income from continuing operations 12,267,317 420,306 15,786,816

(continued)

Source: Boston Celtics Limited Partnership II and Subsidiaries 2010 10-K

CHAPTER 4 • Income Statement 193

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

For the Year Ended

June 30, 1998

June 30, 1997

June 30, 1996

Discontinued operations: Income from discontinued operations

(less applicable income taxes of $30,000) 82,806 Gain from disposal of discontinued operations

(less applicable income taxes of $17,770,000) 38,330,907 NET INCOME 12,267,317 420,306 54,200,529 Net income applicable to interests of General

Partners 306,216 62,246 1,291,014 Net income applicable to interests of Limited

Partners $11,961,101 $ 358,060 $52,909,515 Per unit: Income from continuing operations—basic $ 2.45 $ 0.07 $ 2.68 Income from continuing operations—diluted $ 2.17 $ 0.06 $ 2.59 Net income—basic $ 2.45 $ 0.07 $ 9.18 Net income—diluted $ 2.17 $ 0.06 $ 8.89

Distributions declared $ 2.00 $ 1.00 $ 1.50

Required a. Comment on Amortization of NBA Franchise and Other Intangible Assets. b. Would the discontinued operations be included in projecting the future? Comment. c. The costs and expenses include team costs and expenses. Speculate on the major reason

for the increase in this expense between 1996 and 1997. d. What were the major reasons for the increase in income from continuing operations

between 1997 and 1998? e. Speculate on why distributions declared were higher in 1998 than 1996. (Notice that net

income was substantially higher in 1996.)

CASE 4-6 HOMEBUILDING

D.R. HORTON, INC. AND SUBSIDIARIES* CONSOLIDATED STATEMENTS OF OPERATIONS

Year Ended September 30,

2010 2009 2008

(In millions, except per share data)

Homebuilding: Revenues: Home sales $4,302.3 $3,563.6 $ 6,164.3 Land/lot sales 7.4 40.3 354.3

4,309.7 3,603.9 6,518.6 Cost of sales: Home sales 3,558.3 3,096.1 5,473.1 Land/lot sales 4.6 34.9 324.2 Inventory impairments and land option cost write-offs 64.7 407.7 2,484.5

3,627.6 3,538.7 8,281.8 Gross profit (loss): Home sales 744.0 467.5 691.2 Land/lot sales 2.8 5.4 30.1 Inventory impairments and land option cost write-offs (64.7) (407.7) (2,484.5)

682.1 65.2 (1,763.2) Selling, general and administrative expense 522.0 523.0 791.8 Goodwill impairment — — 79.4

(CASE 4-5 CONTINUED)

*“D.R. Horton, Inc. is one of the largest homebuilding companies in the United States.” 10-K Note: Net cash provided by operating activities, 2010 $709,400,000; 2009 $1,141,200,000; 2008 $1,876,500,000

194 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Year Ended September 30,

2010 2009 2008

(In millions, except per share data)

Interest expense 86.3 100.2 39.0 Loss (gain) on early retirement of debt, net 4.9 (3.9) 2.6 Other (income) (9.2) (12.8) (9.1)

78.1 (541.3) (2,666.9) Financial Services: Revenues, net of recourse and reinsurance expense 90.5 53.7 127.5 General and administrative expense 77.2 78.1 100.1 Interest expense 1.9 1.5 3.7 Interest and other (income) (10.0) (10.4) (11.4)

21.4 (15.5) 35.1 Income (loss) before income taxes 99.5 (556.8) (2,631.8)

(Benefit from) provision for income taxes (145.6) (7.0) 1.8 Net income (loss) $ 245.1 $ (549.8) $(2,633.6)

Basic net income (loss) per common share $ 0.77 $ (1.73) $ (8.34)

Net income (loss) per common share assuming dilution $ 0.77 $ (1.73) $ (8.34) Cash dividends declared per common share $ 0.15 $ 0.15 $ 0.45

D.R. HORTON, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (In Part)

Note A – Summary of Significant Accounting Policies (In Part)

Inventories and Cost of Sales (In part)

For those assets deemed to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. The Company’s determination of fair value is primarily based on discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flow streams. When an impairment charge for a community is determined, the charge is then allocated to each lot in the community in the same manner land and devel- opment costs are allocated to each lot. The inventory within each community is categorized as construction in progress and finished homes, residential land and lots developed and under development, and land held for development, based on the stage of production or plans for future development.

The Company typically does not purchase land for resale. However, when the Company owns land or communities under development that no longer fit into its development and construction plans and it is determined that the best use of the asset is the sale of the asset, the project is accounted for as land held for sale, assuming the land held for sale criteria are met. The Company records land held for sale at the lesser of its carrying value or fair value less estimated costs to sell. In performing impairment evaluation for land held for sale, sev- eral factors are considered including, but not limited to, prices for land in recent comparable sales transactions, market analysis studies, which include the estimated price a willing buyer would pay for the land and recent legitimate offers received. If the estimated fair value less costs to sell an asset is less than the current carrying value, the asset is written down to its estimated fair value less costs to sell.

Impairment charges are also recorded on finished homes in substantially completed com- munities when events or circumstances indicate that the carrying values are greater than the fair values less estimated costs to sell these homes. The key assumptions relating to the valua- tions are impacted by local market economic conditions and the actions of competitors, and are inherently uncertain. Due to uncertainties in the estimation process, actual results could differ from such estimates. The Company’s quarterly assessments reflect management’s

(continued)

CHAPTER 4 • Income Statement 195

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

estimates and it continues to monitor the fair value of held-for-sale assets through the dispo- sition date. See Note D.

Goodwill

Goodwill represents the excess of purchase price over net assets acquired. The Company tests goodwill for potential impairment annually as of September 30, or more frequently if an event occurs or circumstances change that indicate the remaining balance of goodwill may not be recoverable. In analyzing the potential impairment of goodwill, a two-step proc- ess is utilized that begins with the estimation of the fair value of the operating segments. If the results of the first step indicate that impairment potentially exists, the second step is per- formed to measure the amount of the impairment, if any. Impairment is determined to exist when the estimated fair value of goodwill is less than its carrying value.

In performing its goodwill impairment analysis, the Company estimates the fair value of its operating segments utilizing the present values of expected future cash flows. As a result of the analyses performed as of September 30, 2010 and 2009, it was determined that the fair value of the operating segments was greater than their carrying value and therefore, no impair- ment of goodwill existed. As a result of the analysis performed as of September 30, 2008, the Company recorded a goodwill impairment charge of $79.4 million, all of which related to its Southwest reporting segment. Combined with previous impairments, accumulated goodwill impairment losses at September 30, 2010 and 2009 totaled $553.5 million. As of September 30, 2010 and 2009, the Company’s remaining goodwill balance was $15.9 million, all of which related to its South Central reporting segment. The goodwill assessment procedures require management to make comprehensive estimates of future revenues and costs.

Required a. Does it appear that inventories are a highly liquid asset? b. Goodwill impairment – what does this imply? c. Why have early retirement of debt?

CASE 4-7 TELECOMMUNICATIONS – PART 2

China Unicom (Hong Kong) Limited provides a full range of telecommunications services, including mobile and fixed line service, in China.

They are listed on the New York Stock Exchange and filed a Form 20-F with the SEC for the period ended December 31, 2010. The consolidated income statement is presented with this case.

CHINA UNICOM (HONG KONG) LIMITED CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2008, 2009 AND 2010 (All amounts in RMB millions, except per share data)

Year ended December 31

Note 2008 2009 2010 2010

RMB RMB RMB US$ Continuing operations Revenue 5, 28, 40 159,792 153,945 171,298 25,954 Interconnection charges (13,038) (12,955) (13,727) (2,082) Depreciation and amortization (51,847) (47,587) (54,433) (8,247) Networks, operations and

support expenses 29, 43 (18,736) (23,728) (26,383) (3,997) Employee benefit expenses 30 (20,758) (21,931) (23,327) (3,534) Other operating expenses 31 (37,997) (36,723) (48,269) (7,313) Finance costs 32 (3,269) (1,036) (1,749) (265) Interest income 265 91 142 22 Impairment loss on property,

plant and equipment 6 (12,494) — — —

(CASE 4-6 CONTINUED)

Source: China Unicom Limited 2010 10-K

196 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

Year ended December 31

Note 2008 2009 2010 2010

RMB RMB RMB US$ Realized loss on changes in fair

value of derivative component of the convertible bonds 33 — 1,239 — —

Other income – net 34 2,141 962 1,221 185 Income from continuing

operations before income tax 4,059 12,277 4,773 723 Income tax expenses 9 (1,828) (2,721) (922) (140) Income from continuing

operations 2,231 9,556 3,851 583 Discontinued operations Income from discontinued

operations 36 1,438 — — — Gain on the disposal of

discontinued operations 36 26,135 — — — Net income 29,804 9,556 3,851 583 Attributable to: Owners of the parent 29,804 9,556 3,851 583 Non-controlling interests — — — —

29,804 9,556 3,851 583

Required a. Consolidated income statement

1. Why presented in RMB and U.S. $? 2. Contrast note reference with U.S. GAAP. 3. Comment on the presentation relating net income to “attributable to.”

WEB CASE THOMSON ONE Business School Edition

Please complete theWeb case that covers material discussed in this chapter at www.cengagebrain.com. You’ll be using Thomson ONE Business School Edition, a powerful tool that combines a full range of fundamental financial information, earnings estimates, market data, and source documents for 500 publicly traded companies.

TO THE NET CASE

1. Go to the SEC site (www.sec.gov). Under “Filings & Forms” click on “Search for Company Filings.” Click on “Company or fund, etc.” Under Company Name, enter “Freeport-McMoran Copper & Gold Inc.” (or under Ticker Symbol, enter “FCX”). Select the 10-K filed February 25, 2011. a. What is the amount of net income attributable to noncontrolling interests for 2010? b. What is the equity in affiliated companies net earnings for 2010? c. Describe equity earnings.

2. Go to the SEC site (www.sec.gov). Under “Filings & Forms,” click on “Search for Company Filings.” Click on “Company or fund, etc.” Under Company Name, enter “Amazon.com Inc.” (or under Ticker Symbol, enter “AMZN”). Select the 10-K filed January 28, 2011. a. What were the net sales for 2010, 2009 and 2008? b. What were the income from operations for 2010, 2009 and 2008? c. What were the interest expenses for 2010, 2009 and 2008? d. What were the diluted earnings per share for 2010, 2009 and 2008? e. Comment considering the data in (a), (b), (c) and (d).

(continued)

CHAPTER 4 • Income Statement 197

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis

3. Go to the SEC site (www.sec.gov). Under “Filings & Forms,” click on “Search for Company Filings.” Click on “Company or fund, etc.” Under Company Name, enter “Alexander & Baldwin, Inc.” (or under Ticker Symbol, enter “ALEX”). Select the 10-K filed February 25, 2011. a. Determine the business industries of Alexander Baldwin. b. Determine the total operating revenue for 2010, 2009 and 2008. c. Determine the operating income for 2010, 2009 and 2008. d. Comment on the trends in (b) and (c) considering the description of the company in (a). e. Determine income from discontinued operations, net of income taxes for 2010, 2009 and

2008. f. Comment on how material is income from discontinued operations in relation to net

income. 4. Go to the SEC site (www.sec.gov). Under “Filings & Forms,” click on “Search for Company

Filings.” Click of “Company or fund, etc.” Under Company Name, enter “Kroger Co.” (or under Ticker Symbol, enter “KR”). Select the 10-K filed March 29, 2011. a. What is the goodwill account on the balance sheet? b. What is the balance on goodwill at January 29, 2011 and January 30, 2010? c. Determine the goodwill impairment charge for 2010, 2009 and 2008? d. Determine the details for the impairment charge in 2009. Why the change? e. Why is the goodwill impairment charge an adjustment to reconcile net earnings to net cash

provided by operating activities? 5. Go to the SEC site (www.sec.gov). Under “Filings & Forms,” click on “Search for Company

Filings.” Click on “Company or fund, etc.” This exercise will review the presentation format for two companies and how they present

comprehensive income. Firm #1 “Occidental Petroleum Corporation” (or under Ticker Symbol, enter “OXY”).

Select the 10-K filed February 24, 2011 a. Indicate the format presentation selected by Occidental Petroleum Corporation.

Firm #2 “Arden Group, Inc.” (or under Ticker Symbol, enter “ARDNA”). Select the 10-K filed March 10, 2011

b. Indicate the format presentation selected by Arden Group, Inc. c. Which of these two formats presentations is the best for the user of the statement?

Endnotes 1. Accounting Trends & Techniques (New York: American Institute of Certified Public Accountants,

2008), p. 311.

2. Michael L. Roberts, William D. Samson, and Michael T. Dugan, “The Stockholders’ Equity Section: Form without Substance,” Accounting Horizon (December 1990), pp. 35–46.

3. Ibid., p. 36.

(TO THE NET CONTINUED)

198 CHAPTER 4 • Income Statement

08/14/2019 - RS0000000000000000000001583532 - Financial Reporting and Analysis