Financial Reporting Problem
The Procter & Gamble Company (P&G)
The financial statements of P&G are presented in Appendix B. The company’s complete annual report, including the notes to the financial statements, is available online.
Instructions
Refer to P&G’s financial statements and the accompanying notes to answer the following questions.
(a) What type of income statement format does P&G use? Indicate why this format might be used to present income statement information.
(b) What are P&G’s primary revenue sources?
(c) Compute P&G’s gross profit for each of the years 2012–2014. Explain why gross profit decreased in 2014.
(d) Why does P&G make a distinction between operating and nonoperating revenue?
(e) What financial ratios did P&G choose to report in its “Financial Summary” section covering the years 2009–2014?
Comparative Analysis Case
The Coca-Cola Company and PepsiCo, Inc.
The financial statements of Coca-Cola and PepsiCo are presented in Appendices C and D, respectively. The companies’ complete annual reports, including the notes to the financial statements, are available online.
Instructions
Use the companies’ financial information to answer the following questions.
(a) What type of income format(s) is used by these two companies? Identify any differences in income statement format between these two companies.
(b) What are the gross profits, operating profits, net incomes, and net incomes attributable to noncontrolling interests for these two companies over the 3-year period 2012–2014? Which company has had better financial results over this period of time?
(c) What income statement format do these two companies use to report comprehensive income?
Financial Statement Analysis Cases
Case 1: Bankruptcy Prediction
The Z-score bankruptcy prediction model uses balance sheet and income information to arrive at a Z-Score, which can be used to predict financial distress:
Z = × 1.2 + × 1.4 + × 3.3 + × 0.99 + × 0.6
EBIT is earnings before interest and taxes. MV equity is the market value of common equity, which can be determined by multiplying stock price by shares outstanding.
Following extensive testing, it has been shown that companies with Z-scores above 3.0 are unlikely to fail; those with Z-scores below 1.81 are very likely to fail. While the original model was developed for publicly held manufacturing companies, the model has been modified to apply to companies in various industries, emerging companies, and companies not traded in public markets.
Instructions
(a) Use information in the financial statements of Walgreens or Deere & Co. to compute the Z-score for the past 2 years (2014 and 2013).
(b) Interpret your result. Where does the company fall in the financial distress range?
(c) The Z-score uses EBIT as one of its elements. Why do you think this income measure is used?
Case 2: P/E Ratios
One of the more closely watched ratios by investors is the price/earnings (P/E) ratio. By dividing price per share by earnings per share, analysts get insight into the value the market attaches to a company’s earnings. More specifically, a high P/E ratio (in comparison to companies in the same industry) may suggest the stock is overpriced. Also, there is some evidence that companies with low P/E ratios are underpriced and tend to outperform the market. However, the ratio can be misleading.
P/E ratios are sometimes misleading because the E (earnings) is subject to a number of assumptions and estimates that could result in overstated earnings and a lower P/E. Some analysts conduct “revenue analysis” to evaluate the quality of an earnings number. Revenues are less subject to management estimates and all earnings must begin with revenues. These analysts also compute the price-to-sales ratio (PSR = price per share ÷ sales per share) to assess whether a company is performing well compared to similar companies. If a company has a price-to-sales ratio significantly higher than its competitors, investors may be betting on a stock that has yet to prove itself.
Instructions
(a) Identify some of the estimates or assumptions that could result in overstated earnings.
(b) Compute the P/E ratio and the PSR for Tootsie Roll and Hershey for 2014.
(c) Use these data to compare the quality of each company’s earnings.
Accounting, Analysis, and Principles
Counting Crows Inc. provided the following information for the year 2017.
Retained earnings, January 1, 2017 $ 600,000
Administrative expenses 240,000
Selling expenses 300,000
Sales revenue 1,900,000
Cash dividends declared 80,000
Cost of goods sold 850,000
Loss on discontinued operations 110,000
Rent revenue 102,700
Unrealized holding gain on available-for-sale securities 17,000
Income tax applicable to continuing operations 187,000
Income tax benefit applicable to loss on discontinued operations 60,500
Income tax applicable to unrealized holding gain on available-for-sale securities 2,000
Accounting
Prepare (a) a single-step income statement for 2017, (b) a retained earnings statement for 2017, and (c) a statement of comprehensive income using the two statement format. Shares outstanding during 2017 were 100,000.
Analysis
Explain how a multiple-step income statement format can provide useful information to a financial statement user.
Principles
In a recent meeting with its auditor, Counting Crows’ management argued that the company should be able to prepare a pro forma income statement with some one-time administrative expenses reported similar to discontinued operations. Is such reporting consistent with the qualitative characteristics of accounting information as discussed in the conceptual framework? Explain.
