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(BQ) Part 2 book “Financial accounting” has contents: Reporting and interpreting cost of goods sold and inventory, reporting and interpreting liabilities, reporting and interpreting bond securities, analyzing financial statements,… and other contents.
www.downloadslide.com Reporting and Interpreting Cost of Goods Sold and Inventory T he Harley-Davidson eagle trademark was once known best as a popular request in tattoo parlors Now, Harley-Davidson dominates the heavyweight motorcycle market in North America with a 53.3 percent market share Harley is also a market leader in Canada, Japan, and Australia and is a growing presence in Europe But the heavyweight king took a major hit from the worldwide economic downturn that started in 2008 Harley responded with an aggressive plan to enhance profitability through continuous improvement in manufacturing, product development, and business operations These plans are aimed at shortening product development lead times and implementing flexible manufacturing at its Wisconsin, Missouri, and Pennsylvania facilities, which reduce costs and allow the company to better respond to the needs of the dealer network Controlling inventory quality, quantities, and cost are key to maintaining gross profit margin Introducing new products to stay ahead of major competitors Honda and BMW and providing a premium dealer experience to all of Harley’s customers will also increase gross margin Finally, selecting appropriate accounting methods for inventory can have a dramatic effect on the amount Harley-Davidson pays in income taxes Harley produced strong financial Lea r ni ng Obj ec ti ves After studying this chapter, you should be able to: 7-1 Apply the cost principle to identify the amounts that should be included in inventory and the expense matching principle to determine cost of goods sold for typical retailers, wholesalers, and manufacturers 7-2 Report inventory and cost of goods sold using the four inventory costing methods 7-3 Decide when the use of different inventory costing methods is beneficial to a company 7-4 Report inventory at the lower of cost or market (LCM) 7-5 Evaluate inventory management using the inventory turnover ratio 7-6 Compare companies that use different inventory costing methods 7-7 Understand methods for controlling inventory, analyze the effects of inventory errors on financial statements, and analyze the effects of inventory on cash flows www.downloadslide.com chapter Gary Gardiner/Bloomberg via Getty Images results in 2014, but continuous improvement in all of these areas will be necessary for the Harley-Davidson eagle to continue its rise U N D E RSTA N D I N G T H E B U S I N E S S The cost and quality of inventory are concerns faced by all modern manufacturers and merchandisers and so we turn our attention to cost of goods sold (cost of sales, cost of products sold) on the income statement and inventory on the balance sheet Exhibit 7.1 presents the relevant excerpts from Harley-Davidson’s financial statements that include these accounts Note that Cost of Goods Sold is subtracted from Net Sales to produce Gross Profit on its income statement On the balance sheet, Inventory is a current asset; it is reported below Cash, Marketable Securities, and Accounts and Finance Receivables because it is less liquid than those assets The primary goals of inventory management are to have sufficient quantities of high-quality inventory available to serve customers’ needs while minimizing the costs of carrying inventory (production, storage, obsolescence, and financing) Low quality leads to customer dissatisfaction, returns, and a decline in future sales Also, purchasing or producing too few units of a hot-selling item causes stock-outs, which mean lost sales revenue and decreases in customer satisfaction Conversely, purchasing too many units of a slow-selling item increases storage costs as well as interest costs on short-term borrowings used to finance the purchases It may even lead to losses if the merchandise cannot be sold at normal prices The accounting system plays three roles in the inventory management process First, the system must provide accurate information for preparation of periodic financial statements and tax returns Second, it must provide up-to-date information on inventory quantities and costs to facilitate ordering and manufacturing FOCUS COMPANY: Harley-Davidson, Inc BUILDING A LEGEND INTO A WORLD-CLASS MANUFACTURER www.harley-davidson.com www.downloadslide.com 334 CHAPTER Reporting and Interpreting Cost of Goods Sold and Inventory HARLEY-DAVIDSON, INC EXHIBIT 7.1 Income Statement and Balance Sheet Excerpts Consolidated Statements of Income (In thousands)* Years Ended December 31, Net Sales Cost of Goods Sold Gross Profit 2014 2013 2012 $5,567,681 $5,258,290 $4,942,582 3,542,601 3,395,918 3,222,394 $2,025,080 $1,862,372 $1,720,188 HARLEY-DAVIDSON, INC REAL WORLD EXCERPT: Annual Report HARLEY-DAVIDSON, INC Consolidated Balance Sheets (In thousands)* 2014 2013 $ 906,680 57,325 247,621 1,916,635 $1,066,612 99,009 261,065 1,773,686 Inventories 448,871 424,507 Deferred income taxes Other current assets 89,916 281,047 103,625 260,299 $3,948,095 $3,988,803 Assets Current Assets Cash and cash equivalents Marketable securities Accounts receivable, net Finance receivables, net Total current assets *Harley-Davidson’s statements have been simplified for purposes of our discussion decisions Third, because inventories are subject to theft and other forms of misuse, the system must also provide the information needed to help protect these important assets Harley’s mix of product lines makes it a particularly good example for this chapter Although best known as a manufacturer of motorcycles, Harley also purchases and resells completed products such as its popular line of Motorclothes apparel In the second case, it acts as a wholesaler Both the motorcycle and Motorclothes product lines are sold to the company’s network of independent dealers From an accounting standpoint, these independent dealers are Harley-Davidson’s customers The independent dealers are the retailers who sell the products to the public We begin this chapter with a discussion of the makeup of inventory, the important choices management must make in the financial and tax reporting process, and how these choices affect the financial statements and taxes paid Then we discuss how managers and analysts evaluate the efficiency of inventory management Finally, we briefly discuss how accounting systems are organized to keep track of inventory quantities and costs for decision making and control This topic will be the principal subject matter of your managerial accounting course www.downloadslide.com CHAPTER Reporting and Interpreting Cost of Goods Sold and Inventory 335 OR G AN I Z ATI ON of the Chapter Nature of Inventory and Cost of Goods Sold Ů Items Included in Inventory Ů Costs Included in Inventory Purchases Ů Flow of Inventory Costs Ů Cost of Goods Sold Equation Ů Perpetual and Periodic Inventory Systems Inventory Costing Methods Valuation at Lower of Cost or Market Ů Specific Identification Method Ů Cost Flow Assumptions (FIFO, LIFO, Average Cost) Ů Financial Statement Effects of Inventory Methods Ů Managers’ Choice of Inventory Methods Evaluating Inventory Management Control of Inventory Ů Measuring Efficiency in Inventory Management Ů Inventory Turnover Ratio Ů Inventory Methods and Financial Statement Analysis N AT U R E O F I N V E N TO RY A N D C O ST OF GOODS SOLD Items Included in Inventory Inventory is tangible property that is (1) held for sale in the normal course of business or (2) used to produce goods or services for sale Inventory is reported on the balance sheet as a current asset because it normally is used or converted into cash within one year or the next operating cycle The types of inventory normally held depend on the characteristics of the business Merchandisers (wholesale or retail businesses) hold the following: Merchandise inventory Goods (or merchandise) held for resale in the normal course of business The goods usually are acquired in a finished condition and are ready for sale without further processing For Harley-Davidson, merchandise inventory includes the Motorclothes line and the parts and accessories it purchases for sale to its independent dealers Manufacturing businesses hold three types of inventory: Raw materials inventory Items acquired for processing into finished goods These items are included in raw materials inventory until they are used, at which point they become part of work in process inventory Work in process inventory Goods in the process of being manufactured but not yet complete When completed, work in process inventory becomes finished goods inventory Finished goods inventory Manufactured goods that are complete and ready for sale Inventories related to Harley-Davidson’s motorcycle manufacturing operations are recorded in these accounts Ů Internal Control of Inventory Ů Errors in Measuring Ending Inventory Ů Inventory and Cash Flows LEARN I N G O BJ E CTI VE 7-1 Apply the cost principle to identify the amounts that should be included in inventory and the expense matching principle to determine cost of goods sold for typical retailers, wholesalers, and manufacturers INVENTORY Tangible property held for sale in the normal course of business or used in producing goods or services for sale MERCHANDISE INVENTORY Goods held for resale in the ordinary course of business RAW MATERIALS INVENTORY Items acquired for the purpose of processing into finished goods www.downloadslide.com 336 CHAPTER Reporting and Interpreting Cost of Goods Sold and Inventory Harley-Davidson’s recent inventory note reports the following: WORK IN PROCESS INVENTORY Goods in the process of being manufactured HARLEY-DAVIDSON, INC Notes to Consolidated Financial Statements FINISHED GOODS INVENTORY ADDITIONAL BALANCE SHEET AND CASH FLOWS INFORMATION (dollars in thousands) Manufactured goods that are complete and ready for sale December 31, 2014 2013 $151,254 230,309 117,210 $140,302 205,416 127,515 HARLEY-DAVIDSON, INC Inventories: Components at the lower of FIFO cost or market: Raw materials and work in process Motorcycle finished goods Parts and accessories and general merchandise REAL WORLD EXCERPT: Annual Report Note that Harley-Davidson combines the raw materials and work in process into one number Other companies separate the two components The parts and accessories and general merchandise category includes purchased parts and Motorclothes and other accessories that make up merchandise inventory.1 Costs Included in Inventory Purchases Goods in inventory are initially recorded at cost Inventory cost includes the sum of the costs incurred in bringing an article to usable or salable condition and location When HarleyDavidson purchases raw materials and merchandise inventory, the amount recorded should include the invoice price to be paid plus other expenditures related to the purchase, such as freight charges to deliver the items to its warehouses (freight-in) and inspection and preparation costs Any purchase returns and allowances or purchase discounts taken are subtracted In general, the company should cease accumulating purchase costs when the raw materials are ready for use or when the merchandise inventory is ready for shipment Any additional costs related to selling the inventory to the dealers, such as marketing department salaries and dealer training sessions, are incurred after the inventory is ready for use So they should be included in selling, general, and administrative expenses in the period in which they are incurred FINANCIAL A N A LY S I S Applying the Materiality Constraint in Practice Incidental costs such as inspection and preparation costs often are not material in amount (see the discussion of materiality in Chapter 5) and not have to be assigned to the inventory cost Thus, for practical reasons, many companies use the invoice price, less returns and discounts, to assign a unit cost to raw materials or merchandise and record other indirect expenditures as a separate cost that is reported as an expense Flow of Inventory Costs The flow of inventory costs for merchandisers (wholesalers and retailers) is relatively simple, as Exhibit 7.2A shows When merchandise is purchased, the merchandise inventory account is increased When the goods are sold, cost of goods sold is increased and merchandise inventory is decreased These not add up to the balance reported in Exhibit 7.1 because they not include the LIFO adjustment discussed later www.downloadslide.com CHAPTER STAGE 1: PURCHASING/ PRODUCTION ACTIVITIES Reporting and Interpreting Cost of Goods Sold and Inventory STAGE 2: ADDITIONS TO INVENTORY ON THE BALANCE SHEET STAGE 3: SALE– COST OF GOODS SOLD ON INCOME STATEMENT Merchandise inventory Cost of goods sold A MERCHANDISER Merchandise purchased 337 EXHIBIT 7.2 Flow of Inventory Costs B MANUFACTURER Raw materials purchased Raw materials inventory Work in process inventory Finished goods inventory Cost of goods sold Direct labor incurred Factory overhead incurred The flow of inventory costs in a manufacturing environment is more complex, as diagrammed in Exhibit 7.2B First, raw materials (also called direct materials) must be purchased For Harley-Davidson, these raw materials include steel and aluminum castings, forgings, sheet, and bars, as well as certain motorcycle component parts produced by its small network of suppliers, including carburetors, batteries, and tires When they are used, the cost of these materials is removed from the raw materials inventory and added to the work in process inventory Two other components of manufacturing cost, direct labor and factory overhead, are also added to the work in process inventory when they are used Direct labor cost represents the earnings of employees who work directly on the products being manufactured Factory overhead costs include all other manufacturing costs For example, the factory supervisor’s salary and the cost of heat, light, and power to operate the factory are included in factory overhead When the motorcycles are completed and ready for sale, the related amounts in work in process inventory are transferred to finished goods inventory When the finished H Mark Weidman Photography/Alamy goods are sold, cost of goods sold increases, and finished goods inventory decreases As Exhibit 7.2 indicates, there are three stages to inventory cost flows for both merDIRECT LABOR chandisers and manufacturers The first involves purchasing and/or production activities In The earnings of employees who the second stage, these activities result in additions to inventory accounts on the balance sheet work directly on the products In the third stage, the inventory items are sold and the amounts become cost of goods sold being manufactured expense on the income statement Since the flow of inventory costs from merchandise inventory and finished goods to cost of goods sold are very similar, we will focus the rest of our FACTORY OVERHEAD discussion on merchandise inventory Manufacturing costs that are not Cost of Goods Sold Equation Cost of goods sold (CGS) expense is directly related to sales revenue Sales revenue during an accounting period is the number of units sold multiplied by the sales price Cost of goods sold is the same number of units multiplied by their unit costs raw material or direct labor costs www.downloadslide.com 338 CHAPTER Reporting and Interpreting Cost of Goods Sold and Inventory EXHIBIT 7.3 Beginning inventory $40,000 Cost of Goods Sold for Merchandise Inventory + = Beginning inventory + Purchases of merchandise during the year Goods available for sale - Ending inventory The sum of beginning inventory and purchases (or transfers to finished goods) for the period COST OF GOODS SOLD EQUATION BI + P − EI = CGS Goods available for sale $95,000 (Inventory remaining) Cost of goods sold GOODS AVAILABLE FOR SALE Purchases $55,000 (Inventory sold) Ending inventory $35,000 Cost of goods sold $60,000 (Balance Sheet) (Income Statement) Let’s examine the relationship between cost of goods sold on the income statement and inventory on the balance sheet Harley-Davidson starts each accounting period with a stock of inventory called beginning inventory (BI) During the accounting period, new purchases (P) are added to inventory The sum of the two amounts is the goods available for sale during that period What remains unsold at the end of the period becomes ending inventory (EI) on the balance sheet The portion of goods available for sale that is sold becomes cost of goods sold on the income statement The ending inventory for one accounting period then becomes the beginning inventory for the next period The relationships between these various inventory amounts are brought together in the cost of goods sold equation: BI + P − EI = CGS To illustrate, assume that Harley-Davidson began the period with $40,000 worth of Motorclothes in beginning inventory, purchased additional merchandise during the period for $55,000, and had $35,000 left in inventory at the end of the period These amounts are combined as follows to compute cost of goods sold of $60,000: Beginning inventory + Purchases of merchandise during the year Goods available for sale - Ending inventory $40,000 55,000 95,000 35,000 Cost of goods sold $60,000 These same relationships are illustrated in Exhibit 7.3 and can be represented in the merchandise inventory T-account as follows: Merchandise Inventory (A) Beginning inventory Add: Purchases of inventory 40,000 55,000 Ending inventory 35,000 Deduct: Cost of goods sold 60,000 If three of these four values are known, either the cost of goods sold equation or the inventory T-account can be used to solve for the fourth value www.downloadslide.com CHAPTER Reporting and Interpreting Cost of Goods Sold and Inventory PAU S E F O R F E E D B AC K Inventory should include all items owned that are held for resale Costs flow into inventory when goods are purchased or manufactured They flow out (as an expense) when they are sold or disposed of The cost of goods sold equation describes these flows SELF-STUDY QUIZ Assume the following facts for Harley-Davidson’s Motorclothes leather baseball jacket product line for the year 2016 Beginning inventory: 400 units at unit cost of $75 Purchases: 600 units at unit cost of $75 Sales: 700 units at a sales price of $100 (cost per unit $75) Using the cost of goods sold equation, compute the dollar amount of goods available for sale, ending inventory, and cost of goods sold of leather baseball jackets for the period Beginning inventory + Purchases of merchandise during the year Goods available for sale - Ending inventory Cost of goods sold Assume the following facts for Harley-Davidson’s Motorclothes leather baseball jacket product line for the year 2017 Beginning inventory: 300 units at unit cost of $75 Ending inventory: 600 units at unit cost of $75 Sales: 1,100 units at a sales price of $100 (cost per unit $75) Using the cost of goods sold equation, compute the dollar amount of purchases of leather baseball jackets for the period Remember that if three of these four values are known, the cost of goods sold equation can be used to solve for the fourth value Beginning inventory + Purchases of merchandise during the year - Ending inventory Cost of goods sold After you have completed your answers, check them below GUIDED HELP 7-1 For additional step-by-step video instruction on using the cost of goods sold equation to compute relevant income statement amounts, go to http://www.mhhe.com/libby9e_7a Beginning inventory (400 × $75) + Purchases of merchandise during the year (600 × $75) Goods available for sale (1,000 × $75) - Ending inventory (300 × $75) Cost of goods sold (700 × $75) BI = 300 × $75 = $22,500 EI = 600 × $75 = $45,000 CGS = 1,100 × $75 = $82,500 $30,000 45,000 75,000 22,500 $52,500 BI + P - EI = CGS 22,500 + P - 45,000 = 82,500 P = 105,000 Solutions to SELF-STUDY QUIZ 339 www.downloadslide.com 340 CHAPTER Reporting and Interpreting Cost of Goods Sold and Inventory Perpetual and Periodic Inventory Systems The amount of purchases for the period is always accumulated in the accounting system The amount of cost of goods sold and ending inventory can be determined by using one of two different inventory systems: perpetual or periodic PERPETUAL INVENTORY SYSTEM An inventory system in which a detailed inventory record is maintained, recording each purchase and sale during the accounting period PERIODIC INVENTORY SYSTEM An inventory system in which ending inventory and cost of goods sold are determined at the end of the accounting period based on a physical inventory count Perpetual Inventory System To this point in the text, all journal entries for purchase and sale transactions have been recorded using a perpetual inventory system In a perpetual inventory system, purchase transactions are recorded directly in an inventory account When each sale is recorded, a companion cost of goods sold entry is made, decreasing inventory and recording cost of goods sold You have already experienced the starting point for that process when your purchases are scanned at the checkout counter at Walmart or Target Not only does that process determine how much you must pay the cashier, it also removes the sold items from the store inventory records As a result, information on cost of goods sold and ending inventory is available on a continuous (perpetual) basis In a perpetual inventory system, a detailed record is maintained for each type of merchandise stocked, showing (1) units and cost of the beginning inventory, (2) units and cost of each purchase, (3) units and cost of the goods for each sale, and (4) units and cost of the goods on hand at any point in time This up-to-date record is maintained on a transaction-by-transaction basis Most modern companies could not survive without this information As noted at the beginning of the chapter, cost and quality pressures brought on by increasing competition, combined with dramatic declines in the cost of computers, have made sophisticated perpetual inventory systems a requirement at all but the smallest companies As a consequence, we will continue to focus on perpetual inventory systems throughout the book Periodic Inventory System Under the periodic inventory system, no up-to-date record of inventory is maintained during the year An actual physical count of the goods remaining on hand is required at the end of each period The number of units of each type of merchandise on hand is multiplied by unit cost to compute the dollar amount of the ending inventory Cost of goods sold is calculated using the cost of goods sold equation Because the amount of inventory is not known until the end of the period when the inventory count is taken, the amount of cost of goods sold cannot be reliably determined until the inventory count is complete The primary disadvantage of a periodic inventory system is the lack of inventory information Managers are not informed about low or excess stock situations I N V E N TO RY C O ST I N G M E T H O D S L EAR NING O B JEC T IVE 7-2 Report inventory and cost of goods sold using the four inventory costing methods In the Motorclothes example presented in the Self-Study Quiz, the cost of all units of the leather baseball jackets was the same—$75 If inventory costs normally did not change, this would be the end of our discussion As we are all aware, however, the prices of most goods change In recent years, the costs of many manufactured items such as automobiles and motorcycles have risen gradually In some industries such as computers, costs of production have dropped dramatically along with retail prices When inventory costs have changed, which inventory items are treated as sold or remaining in inventory can turn profits into losses and cause companies to pay or save millions in taxes A simple example will illustrate these dramatic effects Do not let the simplicity of our example mislead you It applies broadly to actual company practices Assume that a Harley-Davidson dealer made the following purchases: Jan Jan 12 Jan 14 Jan 15 Had beginning inventory of two units of a Model A leather jacket at $70 each Purchased four units of the Model A leather jacket at $80 each Purchased one unit of the Model A leather jacket at $100 Sold four units of the Model A leather jacket for $120 each www.downloadslide.com CHAPTER Reporting and Interpreting Cost of Goods Sold and Inventory 341 Note that the cost of the leather jacket rose rapidly during January On January 15, four units are sold for $120 each and revenues of $480 are recorded What amount is recorded as cost of goods sold? The answer depends on which specific goods we assume are sold Four generally accepted inventory costing methods are available for determining cost of goods sold: Specific identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Average cost The four inventory costing methods are alternative ways to assign the total dollar amount of goods available for sale between (1) ending inventory and (2) cost of goods sold The first method identifies individual items that remain in inventory or are sold The remaining three methods assume that the inventory costs follow a certain flow Specific Identification Method When the specific identification method is used, the cost of each item sold is individually identified and recorded as cost of goods sold This method requires keeping track of the purchase cost of each item In the leather jacket example, any four of the items could have been sold If we assume that one of the $70 items, two of the $80 items, and the one $100 item have been sold, the cost of those items ($70 + $80 + $80 + $100) would become cost of goods sold ($330) The cost of the remaining items would be ending inventory The specific identification method is impractical when large quantities of similar items are stocked On the other hand, when dealing with expensive unique items such as houses or fine jewelry, this method is appropriate As a consequence, most inventory items are accounted for using one of three cost flow assumptions SPECIFIC IDENTIFICATION METHOD An inventory costing method that identifies the cost of the specific item that was sold Cost Flow Assumptions The choice of an inventory costing method is NOT based on the physical flow of goods on and off the shelves That is why they are called cost flow assumptions A useful tool for representing inventory cost flow assumptions is a bin, or container Try visualizing these inventory costing methods as flows of inventory in and out of the bin First-In, First-Out Method The first-in, first-out method, frequently called FIFO, assumes that the earliest goods purchased (the first ones in) are the first goods sold, and the last goods purchased are left in ending inventory Under FIFO, cost of goods sold and ending inventory are computed as if the flows in and out of the FIFO inventory bin in Exhibit 7.4A had taken place First, each purchase is treated as if it were deposited in the bin from the top in sequence (two units of beginning inventory at $70 followed by purchases of four units at $80 and one unit at $100), producing goods available for sale of $560 Each good sold is then removed from the bottom in sequence (two units at $70 and two at $80); first in is first out These goods totaling $300 become cost of goods sold (CGS) The remaining units (two units at $80 and one unit at $100 = $260) become ending inventory FIFO allocates the oldest unit costs to cost of goods sold and the newest unit costs to ending inventory Cost of Goods Sold Calculation (FIFO) Beginning inventory + Purchases Goods available for sale - Ending inventory Cost of goods sold (2 units at $70 each) (4 units at $80 each) (1 unit at $100) (2 units at $80 each and unit at $100) (2 units at $70 each and units at $80 each) $140 320 100 560 260 $300 FIRST-IN, FIRST-OUT (FIFO) METHOD An inventory costing method that assumes that the first goods purchased (the first in) are the first goods sold www.downloadslide.com 20 MBA COMPANION L EAR NING O B JEC T IVE S -7 Define other postretirement obligations Leases, Income Taxes, and Retirement Obligations Other Postretirement Obligations In addition to pension benefits, many companies also cover at least a portion of retired employees’ health care and insurance costs Estimating the liability associated with these benefits, along with the asset needed to satisfy the liability, is similar to estimating a company’s pension plan obligation and pension plan assets under a defined benefit pension plan Since the appropriate accounting methods are also essentially the same, we will not cover them in detail Just be aware that some companies provide a breakdown in their footnotes of their other postretirement obligations along with their pension obligations Eli Lilly is one such company Exhibit S.13 shows the calculation of the company’s retiree health benefit expense This information is provided in the same footnote in which Eli Lilly discusses its pension plan obligations.5 The Importance of Understanding Pension and Other Postretirement Obligation Disclosures Like taxes, companies typically satisfy pension and other postretirement obligations with cash For some companies, these commitments are substantial For example, in its 2012 annual report, General Motors reported pension and other postretirement liabilities of $35 billion This liability exceeded $54 billion prior to General Motors’s reorganization in 2009 Understanding General Motors’s employee retirement obligation is critical to understanding the health (or lack thereof) of the company and its future cash commitments It is also important for you to keep in mind the subjectivity inherent in many of the estimates required to calculate retirement-related expenses, liabilities, and assets For example, calculating pension expense in a given period requires an estimate of the expected return on plan assets The expected return acts to reduce pension expense If a company’s expected return is overly optimistic, its pension expense will be understated Having an understanding of how companies calculate pension and other postretirement expenses allows you to make more informed decisions about a company’s current and future financial health EXHIBIT S.1 Retiree Health Benefit Plans 2012 2011 2010 Components of net periodic benefit cost Service cost Interest cost Expected return on plan assets Amortization of prior service cost (benefit) Recognized actuarial loss $ 63.3 114.9 (127.2) (39.8) 98.4 $ 72.4 118.0 (129.4) (42.9) 88.7 $ 56.5 121.4 (122.6) (37.2) 85.0 Net period benefit cost $109.6 $106.8 $103.1 (in millions) Eli Lilly’s Other Retiree Health Benefits ELI LILLY REAL WORLD EXCERPT: Annual Report Unlike pensions, companies are not legally required to set aside assets to fund their other postretirement obligations Eli Lilly does, but you may encounter other companies that provide information about their postretirement expenses without showing any “plan assets” to satisfy their other postretirement obligations These firms fund their programs on a “pay-as-you-go” basis www.downloadslide.com MBA COMPANION Leases, Income Taxes, and Retirement Obligations C H A P T E R TA K E -AWAYS After studying this supplement you should be able to: S-1 Distinguish between operating and capital leases p For accounting purposes a company can lease an asset by signing either an operating lease or a capital lease Signing a capital lease requires the company to recognize a lease asset and a lease liability on its balance sheet The lease asset and lease liability are depreciated (some use the term “amortized”) over the life of the lease Signing an operating lease does not require the company to recognize an asset or liability, but rather to simply recognize rent expense at the end of each period S-2 Define a leasehold improvement p Leasehold improvements are modifications that a lessee makes to a leased property Companies depreciate leasehold improvements over the life of a lease, or over the life of the improvement if it is shorter than the life of the lease S-3 Analyze the impact of accounting for leases on a company’s financial statements p In their footnotes, companies disclose much of the information analysts need to convert a company’s operating leases (which not impact liabilities on the balance sheet) to capital leases (which impact liabilities on the balance sheet) Analysts carry out this conversion in order to better assess a company’s total set of future financial obligations S-4 Explain why income tax expense reported on the income statement does not typically equal taxes paid to the Internal Revenue Service p 11 For financial reporting purposes, companies follow generally accepted accounting principles (GAAP) when preparing financial statements for submission to the Securities and Exchange Commission For tax reporting purposes, companies follow the Internal Revenue Code (IRC) when preparing tax returns for submission to the Internal Revenue Service Differences in GAAP and the IRC create differences in the tax expense reported on a company’s income statement and the tax obligation reported on the company’s tax return S-5 Define deferred tax assets and deferred tax liabilities p 12 A deferred tax asset is an asset created by deferring a tax benefit to a future period A deferred tax liability is a liability created by deferring a tax obligation to a future period Both deferred tax assets and deferred tax liabilities are created by companies reporting revenues and expenses in different periods for financial reporting purposes rather than for tax purposes S-6 Distinguish between a defined benefit and a defined contribution pension plan p 17 A defined contribution pension plan requires a company to contribute a defined amount to a retirement fund; it does not make any promises about what will be available from the fund when an employee retires A defined benefit pension plan requires a company to contribute an estimated amount to a retirement fund in order to provide a defined set of benefits in the future Under a defined benefit plan, the risk associated with making sure those benefits are available when employees retire resides with the company, not the employee S-7 Define other postretirement obligations p 20 Many companies cover at least a portion of retired employees’ health care and insurance costs Benefits other than pension benefits are typically referred to as “other postretirement obligations.” Estimating the liability associated with these benefits, and the assets needed to satisfy the liability, is very similar to estimating a company’s pension plan obligation and pension plan assets under a defined benefit pension plan M U LT I P L E - C H O I C E Q U E S T I O N S Defining a Lessor Which of the following best describes a lessor? a The party that pays rent expense under an operating lease b The party that owns a leased asset c The party that services a leased asset under an operating lease d The party that pays for the right to use a leased asset S MC-1 LOS-1 21 www.downloadslide.com 22 MBA COMPANION S MC-2 LOS-1 Leases, Income Taxes, and Retirement Obligations Defining a Capital Lease Which of the following best describes a capital lease? a A lease that requires the lessor to recognize a lease asset and a lease liability on its balance sheet b A lease that does not require the lessee to recognize a lease asset or a lease liability on its balance sheet c A lease that is for a period longer than three years d A lease that requires the lessee to recognize a lease asset and a lease liability on its balance sheet S MC-3 LOS-4 Defining a Company’s Statutory Tax Rate S MC-4 LOS-5 Defining Deferred Tax Assets S MC-5 LOS-6 Defining a Defined Benefit Pension Plan S MC-6 LOS-6 Defining an Underfunded Pension Plan Which of the following best describes a company’s statutory tax rate? a The rate tax law says a company should pay given its level of income b The tax rate reflected on a company’s income statement c The tax rate a company actually pays to the IRS d The tax rate a company pays in the state in which it is incorporated Which of the following best describes a deferred tax asset? a An asset created when a company purchases tax-free bonds b An asset created by deferring a tax benefit to a future period c An asset created when a company prepays its income taxes to the IRS d An asset created by deferring a tax obligation to a future period Which of the following best describes a defined benefit pension plan? a A plan that provides medical benefits to retired employees b A plan that requires a company to contribute a defined amount to a retirement fund c A plan that defines the benefits available to employees upon retirement d The type of plan being offered to employees by most new companies Which of the following best describes an underfunded pension plan? a A pension plan with plan liabilities greater than plan assets b A pension plan that is in technical default c A pension plan that does not meet legal pension requirements d A pension plan with plan assets greater than plan liabilities MINI-EXERCISES S M-1 LOS-1, S-3 Computing the Present Value of a Lease S M-2 LOS-1, S-3 Computing the Present Value of a Lease S M-3 LOS-1, S-3 Comparing Lease Terms Intel Corporation is leasing an office building for three years Terms of the lease require Intel to make a $5,000 rental payment at the end of each month over the life of the lease Assuming an annual discount rate of 10 percent, what is the present value of this lease? Microsoft Corporation is leasing an office building for four years Terms of the lease require Microsoft to make a $20,000 rental payment at the end of each year over the life of the lease, as well as a lump-sum payment at the end of the lease of $10,000 Assuming an annual discount rate of percent, what is the present value of this lease? Apple Corporation is deciding between two leases The first lease is a five-year lease and requires Apple to make a $2,000 rental payment at the end of each month over the life of the lease The second www.downloadslide.com MBA COMPANION Leases, Income Taxes, and Retirement Obligations lease is also a five-year lease It requires Apple to make a lump-sum payment of $120,000 at the end of the lease Assume that for both leases interest accrues monthly and the appropriate annual discount rate is percent Which lease is a better deal in present value terms? S M-4 Computing the Present Value of a Future Retirement Obligation Costco Corporation has agreed to pay employees who have worked for the company more than 10 years a retirement bonus of $20,000 upon retirement Rick Jamison has worked for Costco for 15 years Costco estimates that Rick will retire in seven years If interest accrues quarterly and Costco can earn an annual return on deposits of percent, how much would Costco have to deposit today in order to have exactly $20,000 to pay Rick at the end of seven years? LOS-6 EXERCISES S E-1 Recording Rent Expense Amazon Corporation signed a five-year operating lease on January to rent a distribution center Rent payments of $10,000 are due at the end of each month Prepare the journal entry to record the payment of cash for rent on January 31 LOS-1 Depreciating Leasehold Improvements S E-2 At the beginning of its first fiscal quarter, Caribou Coffee signed a five-year lease for retail space in the Ithaca Mall Before opening the space, Caribou made various leasehold improvements, one of which was to build a new coffee counter where customers can watch baristas make their espresso drinks The cost to build the coffee counter was $12,500, which Caribou paid for with cash The counter is expected to provide benefits for the duration of the lease Caribou depreciates equipment on a quarterly basis using the straight-line method of depreciation Prepare the journal entry to record the depreciation of the coffee counter at the end of the first quarter Assume that Caribou takes a full quarter of depreciation during the first quarter LOS-2 Depreciating and Amortizing Lease Assets and Liabilities S E-3 On January 1, 2013, Google Corporation leased a package of high-speed servers by signing a five-year capital lease Lease payments of $300,000 are due at the end of each year Google uses the straight-line method to depreciate leased assets and the effective interest rate method to amortize lease liabilities Assume that the appropriate annual discount rate is percent Fill in the depreciation and amortization table below LOS-1, S-3 DEPRECIATION AND AMORTIZATION SCHEDULE FOR LEASED SERVERS Depreciation Book value Interest Book value expense of lease expense of servers on recorded on payable on recorded on Year January December 31 January December 31 Amortization Cash paid of lease payable to lessor on recorded on December 31 December 31 2013 2014 2015 2016 2017 Depreciating and Amortizing Lease Assets and Liabilities Refer to your answer for S E-3 Provide the journal entries to record the depreciation of the lease asset and the amortization of the lease liability on December 31, 2014 S E-4 LOS-1, S-3 23 www.downloadslide.com 24 MBA COMPANION S E-5 LOS-5 Leases, Income Taxes, and Retirement Obligations Calculating a Deferred Tax Liability On January 1, 2013, Berkshire Hathaway purchased a piece of equipment for $90,000 The following table reflects how Berkshire is depreciating the equipment for financial reporting purposes and for tax purposes: TAX Fiscal Year Ending Depreciation Expense Accumulated Depreciation Book Value 2013 2014 2015 30,000 40,005 19,995 30,000 70,005 90,000 90,000 60,000 19,995 FINANCIAL REPORTING Fiscal Year Ending Depreciation Expense Accumulated Depreciation Book Value 2013 2014 2015 30,000 30,000 30,000 30,000 60,000 90,000 90,000 60,000 30,000 Use the information above to fill in the deferred tax liability column below: FINANCIAL REPORTING S E-6 Fiscal Year Ending Revenue Taxable Income Tax Expense 2013 200,000 170,000 59,500 2014 200,000 170,000 59,500 2015 200,000 170,000 59,500 Deferred Tax Liability Accounting for a Deferred Tax Liability LOS-5 Refer to your answer for S E-5 Provide the journal entries to record income tax expense for financial reporting purposes at the end of each fiscal year (2013–2015) S E-7 Using a Company’s Effective Tax Rate LOS-4 Below is information from Amazon’s 2012 income tax footnote: RECONCILIATION OF AMAZON’S STATUTORY AND EFFECTIVE TAX RATES YEAR ENDED DECEMBER 31 Federal statutory tax rate State taxes, net of federal impact Impact of foreign tax differential Tax credits Nondeductible stock-based compensation Other Effective income tax rate 2012 2011 2010 35.0% 0.2 31.5 (4.4) 11.1 5.2 21.8% 35.0% 1.5 (8.4) (3.2) 4.1 2.2 27.4% 35.0% 1.5 (12.7) (1.1) 1.6 (0.8) 27.9% www.downloadslide.com MBA COMPANION Leases, Income Taxes, and Retirement Obligations Amazon reported tax expense on its 2012 income statement of $428 million What did Amazon report as income before income taxes on its 2012 income statement? S E-8 Reporting Deferred Tax Assets and Deferred Liabilities In 2012, Trek Bicycle Company reported the following information related to its deferred tax assets and deferred tax liabilities: Long-term deferred tax assets Long-term deferred tax liabilities Valuation allowance LOS-5 $17 million $16 million $ million Will Trek report a long-term net deferred tax asset or a long-term net deferred tax liability on its 2012 balance sheet? S E-9 Recording a Company’s Defined Contribution Pension Expense Caribou Coffee Company offers employees a defined contribution pension plan At the end of fiscal 2012, the company contributed $100,000 to the plan Prepare the journal entry to record Caribou’s contribution to the pension plan LOS-6 Recording a Company’s Other Postretirement Obligations Expense S E-10 The Walt Disney Company offers employees postretirement medical benefits The table below summarizes Disney’s expense associated with this benefit in 2012 Assume Disney paid for this benefit with cash Prepare the journal entry to record Disney’s “other postretirement benefit expense” for 2012 LOS-7 DISNEY’S POSTRETIREMENT MEDICAL PLANS (IN MILLIONS) YEAR ENDED DECEMBER 31 2012 2011 2010 Service cost Interest cost Expected return on plan assets Amortization of prior year service costs Recognized net actuarial (gain)/loss $ 21 74 (23) (2) 31 $ 18 66 (24) (1) $ 21 70 (26) (2) Total other postretirement expense $101 $ 68 $ 70 PROBLEMS Converting Operating Leases to Capital Leases S P-1 Apple Corporation discloses the following information about its noncancelable operating leases in its 2012 annual report (in millions) 2013 2014 2015 2016 2017 Thereafter $ 516 556 542 513 486 1,801 Total minimum lease payments $4,414 LOS-1, S-3 25 www.downloadslide.com 26 MBA COMPANION Leases, Income Taxes, and Retirement Obligations Assume that the payment amount in the “thereafter” row is all due at the end of 2018 and that the appropriate discount rate is percent What is the present value of Apple’s “total minimum lease payments” at the end of fiscal 2012? S P-2 LOS-1, S-3 S P-3 LOS-4 Converting Operating Leases to Capital Leases Refer to Apple’s operating lease disclosure provided in S P-1 Assume that the payment amount in the “thereafter” row is equally spread out over the years 2018–2022 and that the appropriate discount rate is still percent What is the present value of Apple’s “total minimum lease payments” at the end of fiscal 2012? Computing Effective Tax Rates Below is Columbia Sportwear’s 2012 income statement What is Columbia’s effective tax rate? COLUMBIA SPORTSWEAR COMPANY Consolidated Statements of Operations (in thousands, except per share amounts) Year Ended December 31 2012 2011 2010 $1,669,563 953,169 $1,693,985 958,677 $1,483,524 854,120 Gross profit Selling, general, and administrative expenses Net licensing income 716,394 596,635 13,769 735,308 614,658 15,756 629,404 534,068 7,991 Income from operations Interest income, net 133,528 379 136,406 1,274 103,327 1,564 Income before income tax Income tax expense (Note 10) 133,907 (34,048) 137,680 (34,201) 104,891 (27,854) Net sales Cost of sales Net income S P-4 LOS-5 $ 99,859 $ 103,479 $ 77,037 Classifying and Reporting Deferred Taxes Below is deferred tax information for 2012 for Whole Foods Market How will Whole Foods report deferred taxes on its 2012 balance sheet? (in thousands) Current deferred tax assets Noncurrent deferred tax assets Current deferred tax liabilities Noncurrent deferred tax liabilities S P-5 LOS-6 $150,000 135,116 17,754 92,282 Classifying and Reporting Defined Benefit Pension Obligations Below is The Walt Disney Company’s defined benefit pension disclosure for fiscal 2012 What amount will Disney report on its 2012 balance sheet, and will that amount be reported as a net pension plan asset or liability? www.downloadslide.com MBA COMPANION Leases, Income Taxes, and Retirement Obligations Pension Plans (in millions) September 29, 2012 Projected benefit obligations Beginning obligations Service cost Interest cost Actuarial (loss)/gain Plan amendments and other Benefits paid Ending obligations Fair value of plan’s assets Beginning fair value Actual return on plan assets Contributions Benefits paid Expenses and other Ending fair value October 1, 2011 $ (9,481) (278) (440) (1,635) 51 253 $(8,084) (293) (411) (919) 218 $(11,530) $(9,481) $ 6,551 972 833 (253) (54) $ 5,684 188 926 (218) (29) $ 8,049 $ 6,551 Calculating Defined Contribution Pension Expense S P-6 Trader Joe’s offers its employees a defined contribution pension plan For every dollar that an employee contributes to the plan, Trader Joe’s contributes $0.50 Assume that during fiscal 2013, Trader Joe’s had 2,000 employees and each employee on average contributed $1,200 to the pension fund What will Trader Joe’s recognize as pension expense in fiscal 2013? LOS-6 CASES Analyzing Starbucks’s Lease Disclosures The following questions pertain to Starbucks’s 2012 balance sheet and lease footnote shown below Does Starbucks sign mainly operating or capital leases? Where does Starbucks disclose its operating leases on its balance sheet? Assume a discount rate of percent and that the amount in the “thereafter” row in Starbucks’s footnote disclosure is equally spread over the years 2018–2022 What is the present value of Starbucks’s operating leases at the end of fiscal 2012? What is the impact on Starbucks’s 2012 debt-to-equity ratio of adding the present value of its operating leases to the liability section of its 2012 balance sheet? Would making the adjustment in requirement (4) change your opinion about Starbucks’s creditworthiness? S C-1 LOS-1, S-3 27 www.downloadslide.com 28 MBA COMPANION Leases, Income Taxes, and Retirement Obligations STARBUCKS’S 2012 BALANCE SHEET STARBUCKS CORPORATION Consolidated Balance Sheets (in millions, except per share data) September 30, 2012 October 2, 2011 $1,188.6 848.4 485.9 1,241.5 196.5 238.7 $1,148.1 902.6 386.5 965.8 161.5 230.4 4,199.6 116.0 459.9 2,658.9 385.7 399.1 3,794.9 107.0 372.3 2,355.0 409.6 321.6 Total assets $8,219.2 $7,360.4 LIABILITIES AND EQUITY Current liabilities: Accounts payable Accrued liabilities Insurance reserves Deferred revenue $ 398.1 1,133.8 67.7 510.2 $ 540.0 940.9 145.6 449.3 Total current liabilities Long-term debt Other long-term liabilities 2,209.8 549.6 345.3 2,075.8 549.5 347.8 Total liabilities Shareholders’ equity: Common stock ($0.001 par value)—authorized, 1,200.0 shares; issued and outstanding, 749.3 and 744.8 shares, respectively (includes 3.4 common stock units in both periods) Additional paid-in capital Retained earnings Accumulated other comprehensive income 3,104.7 2,973.1 0.7 39.4 5,046.2 22.7 0.7 40.5 4,297.4 46.3 5,109.0 5.5 4,384.9 2.4 5,114.5 4,387.3 $8,219.2 $7,360.4 ASSETS Current assets: Cash and cash equivalents Short-term investments Accounts receivable, net Inventories Prepaid expenses and other current assets Deferred income taxes, net Total current assets Long-term investments—available-for-sale securities Equity and cost investments Property, plant and equipment, net Other assets Goodwill Total shareholders’ equity Noncontrolling interests Total equity Total liabilities and equity See Notes to Consolidated Financial Statements www.downloadslide.com MBA COMPANION Leases, Income Taxes, and Retirement Obligations STARBUCKS’S 2012 LEASE FOOTNOTE EXCERPTS The company mainly uses operating leases Rental expense under operating lease agreements (in millions): Fiscal Year Ended September 30, 2012 October 2, 2011 October 3, 2010 Minimum rentals Contingent rentals $759.0 44.7 $715.6 34.3 $688.5 26.1 Total $803.7 $749.9 $714.6 Minimum future rental payments under noncancelable operating leases as of September 30, 2012 (in millions): Fiscal Year Ending 2013 2014 2015 2016 2017 Thereafter $ 787.9 728.5 640.4 531.5 403.4 968.5 Total minimum lease payments $4,060.2 The company has subleases related to certain of its operating leases During fiscal 2012, 2011, and 2010, we recognized sublease income of $10.0 million, $13.7 million, and $10.9 million, respectively S C-2 Analyzing Disney’s Income Tax Disclosures The following questions pertain to Disney’s 2012 financial statements and income taxes footnote shown below How much did Disney report as income tax expense in fiscal 2012? How much cash did Disney pay during the year for income taxes? In general, why these numbers differ? What is Disney’s 2012 statutory tax rate? What is its 2012 effective tax rate? In general, why these rates differ? Why does Disney deduct a “valuation allowance” from its net deferred tax liability in its income tax footnote? Disney reports a net deferred tax liability of $1,486 million in fiscal 2012 How is this amount reflected on Disney’s balance sheet? In its income taxes footnote, speculate as to why Disney reports “depreciable, amortizable and other property” as a deferred tax liability rather than a deferred tax asset DISNEY’S 2012 FINANCIAL STATEMENTS Consolidated Statements of Income (in millions, except per share data) Revenues Costs and expenses Restructuring and impairment charges Other income/(expense), net Net interest expense Equity in the income of investees Income before income taxes Income taxes 2012 2011 2010 $ 42,278 (33,415) (100) 239 (369) 627 $ 40,893 (33,112) (55) 75 (343) 585 $38,063 (31,337) (270) 140 (409) 440 9,260 (3,087) 8,043 (2,785) 6,627 (2,314) (continued) LOS-4, S-5 29 www.downloadslide.com 30 MBA COMPANION Leases, Income Taxes, and Retirement Obligations Consolidated Statements of Income (in millions, except per share data) 2012 Net income Less: Net income attributable to noncontrolling interests 2011 2010 5,258 (451) 6,173 (491) 4,313 (350) Net income attributable to Disney $ 5,682 $ 4,807 $ 3,963 Earnings per share attributable to Disney: Diluted $ 3.13 $ 2.52 $ 2.03 $ 3.17 $ 2.56 $ 2.07 Basic Weighted average number of common and common equivalent shares outstanding: Diluted Basic 1,818 1,909 1,948 1,794 1,878 1,915 See Notes to Consolidated Financial Statements Consolidated Balance Sheets (in millions, except per share data) September 29, 2012 ASSETS Current assets Cash and cash equivalents Receivables Inventories Television costs Deferred income taxes Other current assets October 1, 2011 3,387 6,540 1,537 676 765 804 $ 3,185 6,182 1,595 674 1,487 634 13,709 4,541 2,723 13,757 4,357 2,435 38,582 (20,687) 35,515 (19,572) Projects in progress Land 17,895 2,453 1,164 15,943 2,625 1,127 Intangible assets, net Goodwill Other assets 21,512 5,015 25,110 2,288 19,695 5,121 24,145 2,614 $ 74,898 $ 72,124 $ $ 6,362 3,055 $ Total current assets Film and television costs Investments Parks, resorts and other property, at cost attractions, buildings and equipment Accumulated depreciation Total assets LIABILITIES AND EQUITY Current liabilities Accounts payable and other accrued liabilities Current portion of borrowings 6,393 3,614 www.downloadslide.com MBA COMPANION September 29, 2012 Leases, Income Taxes, and Retirement Obligations October 1, 2011 Unearned royalties and other advances 2,806 2,671 Total current liabilities Borrowings Deferred income taxes Other long-term liabilities Commitments and contingencies (Note 14) Equity Preferred stock, $0.01 par value Authorized—100 million shares, Issued—none Common stock, $0.01 par value Authorized—4.6 billion shares, Issued—2.8 billion shares at September 29, 2012, and 2.7 billion shares at October 1, 2011 Retained earnings Accumulated other comprehensive loss 12,813 10,697 2,251 7,179 12,088 10,922 2,866 6,795 — — Treasury stock, at cost, 1.0 billion shares at September 29, 2012, and 0.9 billion shares at October 1, 2011 Total Disney shareholders’ equity Noncontrolling interests Total equity Total liabilities and equity 31,731 42,965 (3,266) 30,296 38,375 (2,630) 71,430 66,041 (31,671) (28,656) 39,759 2,199 37,385 2,068 41,958 39,453 $ 74,898 $ 72,124 See Notes to Consolidated Financial Statements Consolidated Statements of Cash Flows (in millions) OPERATING ACTIVITIES Net income Depreciation and amortization Gains on acquisitions and dispositions Deferred income taxes Equity in the income of investees Cash distributions received from equity investees Net change in film and television costs Equity-based compensation Impairment charges Other 2012 2011 2010 $ 6,173 1,987 (184) 472 (627) 663 (52) 408 22 195 $ 5,258 1,841 (75) 127 (585) 608 332 423 16 188 $ 4,313 1,713 (118) 133 (440) 473 238 391 132 (continued) 31 www.downloadslide.com 32 MBA COMPANION Leases, Income Taxes, and Retirement Obligations 2012 Changes in operating assets and liabilities Receivables Inventories Other assets Accounts payable and other accrued liabilities Income taxes 2011 (518) (199) (189) (367) 134 (108) 18 (151) (608) (242) Cash provided by operations 2010 (686) (127) 42 649 (144) 7,966 6,994 6,578 INVESTING ACTIVITIES Investments in parks, resorts, and other property Proceeds from dispositions Acquisitions Other (3,784) 15 (1,088) 98 (3,559) 564 (184) (107) (2,110) 170 (2,493) (90) Cash used in investing activities (4,759) (3,286) (4,523) FINANCING ACTIVITIES Commercial paper borrowings, net Borrowings Reduction of borrowings Dividends Repurchases of common stock Proceeds from exercise of stock options Other 467 3,779 (3,822) (1,076) (3,015) 1,008 (326) 393 2,350 (1,096) (756) (4,993) 1,128 (259) 1,190 — (1,371) (653) (2,669) 1,133 (293) Cash used in financing activities (2,985) (3,233) (2,663) (20) (12) (87) Impact of exchange rates on cash and cash equivalents Increase/(decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year 202 3,185 463 2,722 Cash and cash equivalents, end of year $ 3,387 $ 3,185 Supplemental disclosure of cash flow information: Interest paid $ $ Income taxes paid $ 2,630 See Notes to Consolidated Financial Statements 718 (695) 3,417 $ 2,722 377 $393 $ 2,341 $ 2,170 www.downloadslide.com MBA COMPANION Leases, Income Taxes, and Retirement Obligations DISNEY’S 2012 INCOME TAXES FOOTNOTE EXCERPTS Income Taxes Income Before Income Taxes Domestic (including U.S exports) Foreign subsidiaries Income Tax Expense/(Benefit) Current Federal State Foreign 2012 2011 2010 $8,105 1,155 $7,330 713 $6,074 553 $9,260 $8,043 $6,627 $1,975 227 422 $1,851 272 521 $1,530 236 432 2,624 2,644 2,198 Deferred Federal State 465 (2) 147 (6) 307 (191) 463 141 116 $3,087 $2,785 $2,314 September 29, 2012 Components of Deferred Tax Assets and Liabilities Deferred tax assets Accrued liabilities Foreign subsidiaries Equity-based compensation Noncontrolling interest net operating losses Other Total deferred tax assets Deferred tax liabilities Depreciable, amortizable, and other property Licensing revenues Leveraged leases Other Total deferred tax liabilities Net deferred tax liability before valuation allowance Valuation allowance Net deferred tax liability October 1, 2011 $(3,034) (579) (160) (584) (361) $(2,806) (566) (323) (554) (386) (4,718) (4,635) 4,924 336 33 100 4,959 301 38 136 5,393 5,434 675 811 799 580 $ 1,486 $ 1,379 The valuation allowance principally relates to tax attributes of $193 million acquired with UTV and a $584 million deferred tax asset for the noncontrolling interest share of net operating losses at the International Theme Parks The ultimate recognition of the noncontrolling interest share of the net operating losses, which have an indefinite carryforward period, would not have an impact on net income attributable to Disney as any income tax benefit would be offset by a charge to noncontrolling interests in the income statement 33 www.downloadslide.com 34 MBA COMPANION Leases, Income Taxes, and Retirement Obligations A reconciliation of the effective income tax rate to the federal rate is as follows: Federal income tax rate State taxes, net of federal benefit Domestic production activity deduction Other, including tax reserves and related interest 2012 2011 2010 35.0% 2.0 (2.5) (1.2) 35.0% 2.1 (2.3) (0.2) 35.0% 2.6 (1.7) (1.0) 33.3% 34.6% 34.9% Images used throughout: Pause for Feedback: Comstock Images/Alamy; Financial Analysis: Jason Reed/ Getty Images; International Perspective: PhotoDisc/Getty Images; Focus on Cash Flows: Royalty-Free/ Corbis; Written Communication: Duncan Smith/Photodisc/Getty Images; Questions of Ethics: PhotoDisc/ Getty Images; Internet icon: Tom Grill/Photographer’s Choice RF/Getty Images; Team icon: Ryan McVay/ Getty Image ... 31, Net Sales Cost of Goods Sold Gross Profit 20 14 20 13 20 12 $5,567,681 $5 ,25 8 ,29 0 $4,9 42, 5 82 3,5 42, 601 3,395,918 3 ,22 2,394 $2, 025 ,080 $1,8 62, 3 72 $1, 720 ,188 HARLEY-DAVIDSON, INC REAL WORLD EXCERPT:... thousands)* 20 14 20 13 $ 906,680 57, 325 24 7, 621 1,916,635 $1,066,6 12 99,009 26 1,065 1,773,686 Inventories 448,871 424 ,507 Deferred income taxes Other current assets 89,916 28 1,047 103, 625 26 0 ,29 9 $3,948,095... Units Unit Cost Total Cost Jan Jan 17 1,000 1,000 2, 000 4,000 1,000 $20 .60 20 .60 22 .00 22 .00 25 .10 $ 20 ,600 20 ,600 44,000 88,000 25 ,100 Jan 27 Total $198,300 359 www.downloadslide.com 360 CHAPTER