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SOLUTIONS TO ANALYZE, THINK, COMMUNICATE – CHAPTER 2
ATC 2-1
(All dollar amounts are in millions.)
1.
Target’s accrual accounts are: Credit card receivables, Accounts
payable, Accrued and other current liabilities, and Income taxes
payable. The Deferred income taxes account shown under
Liabilities is probably best classified as an accrual account, but
students will probably think it is a deferral account.
2.
Target’s deferral accounts are: Inventories, Buildings and
improvements, Fixtures and equipment, Computer hardware and
software, and construction in progress. Students might also list the
Deferred income taxes account shown under Liabilities.
3.
Net income for 2008 was
Cash provided by operating activities for 2008 was
$2,214
$4,430
Thus, cash flow from operating activities exceeded net income by
$2,216.
4.
Net income decreased by $635 from 2007 to 2008 ($2,214 - $2,849).
Cash provided by operating activities increased by $305 from 2007 to
2008 ($4,430 - $4,125). Therefore, the change in net income was the
greatest, but students might be surprised that cash flows increased
even as net income was decreasing. A quick scan shows that this
was mainly because of depreciation and bad debt expense addbacks
which will be covered in later chapters.
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ATC 2-2
a. 1. (in millions)
Revenue
Less: Operating Costs
Net Income
2008
$ 97,354
( 80,470)
$16,884
2007
$ 93,469
( 77,891)
2006
$ 88,182
( 74,809)
$15,578
2.
The balance in Retained earnings is affected as follows:
2008 - retained earnings increased by $16,884 million.
2007 - retained earnings increased by $15,578 million.
2006 - retained earnings increased by $13,373 million.
3.
Growth rates for net earnings are:
2008:
2007:
2006:
($16,884 - $15,578)  $15,578 =
8.4%
($15,578 - $13,373)  $13,373 = 16.5%
($13,373 - $ 7,397)  $ 7,397 = 80.8%
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$13,373
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ATC 2-3
Dollar amounts are in thousands.
a.
2007
$ 2,351,576
(2,189,511)
$
162,065
Revenues
Expenses
Net income
Beg. retained earnings
2008
$ 2,384,521
(2,318,968)
$
65,553
$
302,245
$
449,402
162,065
(
14,908)
$
449,402
65,553
(
16,504)
$
498,451
+ Net income
- Dividends
End. Retained earnings
b.
Revenue increased by 1.4%
($ 2,384,521 - $ 2,351,576)  $ 2,351,576
Net income decreased by 59.6%
($65,553 - $162,065 )  $162,065
= 1.4%
= (59.6%)
c.
2007: $162,065  $ 2,351,576 = 6.9%
2008: $ 65,553  $ 2,384,521 = 2.7%
d.
Although revenues increased in 2008, net income decreased, so
2007 appears to have been a better year for Cracker Barrel than was
2008.
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ATC 2-4
Dollar amounts in thousands.
a. and c.
2007
$329,652
309,998
$ 19,654
Revenues
Expenses
Net income
Cash from operating activities
2008
$422,417
397,982
$ 24,435
$
43,579
$
66,107
(54,687)
(60,134)
873
853
(10,235)
6,826
11,756
$
1,521
1,521
$
8,347
Cash from investing activities
Cash from financing activities
Net change in cash
+ Beg. cash balance
= End. Cash balance
b.
For Buffalo Wild Wings, cash flows from operating activities were
greater than net income for both years.
d.
Negative cash flows from investing activities is most likely an
indication that the company is growing, which is not a negative
situation. But, at a quick glance, American Eagle’s liabilities are
25% of total assets and Aeropostale’s liabilities are 50% of total
assets. So the Net Income to Revenue difference is negligible when
looking at other items. The debt ratio and other areas of analysis
will be covered in later chapters. This is an indication that upon
futher investigation, American Eagle’s strategy may be a more
successful one.
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ATC 2-5
Dollar amounts are in thousands.
a.
American
Eagle
Outfitters
Aeropostale
$
$ 2,988,866
1,885,531
(1,736,109)
(2,809,805)
$
$
179,061
149,422
Revenues
Expenses
Net income
Beg. retained earnings
+ Net income
$
543,911
149,422
$ 1,601,784
179,061
- Dividends
End. Retained earnings
$
0
693,333
(82,394)
$ 1,698,451
b.
Aeropostale:
$149,422  $ 1,885,531 = 7.9%
American Eagle: $ 179,061  $ 2,988,866 = 6.0%
c.
Although American Eagle had higher net income than Aeropostale, it
had lower income as a percentage of revenue. Therefore, based on
this information alone, it might be argued that Aeropostale had the
better performance in 2008.
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ATC 2-6
Dollar amounts in thousands.
a. and c.
Revenues
Expenses
Net income
Cash from operating activities
Cash from investing activities
Cash from financing activities
H&R Block
$4,403,877
(4,712,524)
$ (308,647)
Jackson
Hewitt
$ 278,505
(246,078)
$
32,427
$
$
(1,558,069)
Net change in cash
+ Beg. cash balance
= End. Cash balance
215,787
1,147,289
(
0
2,901
194,993)
921,838
$
726,845
33,949
(31,048)
$
1,693
4,594
b.
Cash flows from operating activities were higher than the net
income for both companies.
d.
Negative cash flows from investing activities is most likely an
indication that the company is growing, which is not a negative
situation.
e.
Negative cash flows from financing activities is not as common as
are negative cash flows from investing activities. However,
negative cash flow from financing activities is usually the result of
the company paying off some of its debt, which is not a negative
situation. It can also relult from the company buying back its own
stock, but students are unlikely to think of this as a cause.
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ATC 2-7
a.
Income Statement
Balance Sheet
Service Revenue $120,000
Assets:
Operating Exp.
Net Income
Liabilities:
(40,000)
$ 80,000
Stockholders’
Equity:
Common Stock
Retained Earnings
Total Liab.
Total Liab. and
Stk. Equity
$167,000
$
5,000
82,000
80,000
162,000
$167,000
Computations for Income Statement Items:
Revenue: $38,000+$82,000 = $120,000
Operating Expense: $70,000  $30,000 = $40,000
Computations for Balance Sheet Items:
Assets: $85,000+$82,000 = $167,000
Liabilities: $35,000  $30,000 = $5,000
Retained Earnings: ($32,000) + $82,000 + $30,000 = $80,000
Comment: Negotiations are not reportable events. The potential
$82,000 should not be reported. The employees did perform
services and the expense needs to be currently recognized.
b.
Willful deception is an act of fraud and punishable under the law.
Good intentions are not sufficient justification for breaking the law.
Students should learn to avoid operating under an ends justifies the
means philosophy. Suppose the unexpected happens in this case.
Glenn fails to obtain the contract and is forced to declare bankruptcy
after having manipulated the statements. He would not only stand
to lose the friend that he deceived, but also may be convicted of a
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felony on charges of fraudulent reporting.
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ACT 2-7 (cont.)
c.
The auditing profession has identified three elements that are
typically present when fraud occurs. They are: (1) the availability of
an opportunity, (2) the existence of some form of pressure leading to
an incentive, and (3) the capacity for rationalization. Glenn had the
opportunity to record the questionable adjustments because he was
the owner and could make whatever adjustments he deemed
appropriate. Glenn’s existence of pressure is the fact that he needs
the financial statements to look good in order to obtain the loan.
Because Glenn was confident that the contracts would be approved,
he was able to rationalize making the adjustments. All three of the
factors of ethical misconduct are present in this case.
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ATC 2-8
This solution is based on Reader’s Digest’s 2008 financial report.
a.
Reader’s Digest’s accrual accounts are:
Accounts receivable, net
Accounts payable
Accrued expenses
Income taxes payable
Other current liabilities (possibly, depending on the nature of the
liability)
Accrued pension (long-term)
b.
Reader’s Digest’s deferral accounts are:
Inventories (Technically a deferral if the inventory was paid for in
cash, but students will probably not think of this as an accrual.)
Prepaid and deferred promotion costs
Prepaid expenses and other current assets
Property, plant and equipment, net
Other intangible assets, net
Prepaid pension assets
Other noncurrent assets (possibly, depending on the nature of the
asset)
Unearned revenues (current)
Unearned revenues (long-term)
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