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financial statement analysis

The Analysis And Use Of Financial Statements 3rd Edition Gerald I. White, Ashwinpaul C. Sondhi, Haim D. Fried - Solutions

g. Discuss Westvaco's possible motivation for changing the ex- pected return on plan assets in light of the actual returns for these years.
h. Forecast the amortization of the transition asset for the three years ending 2002 i. Forecast fiscal 2000 pension cost, stating any assumptions. J. Calculate each of the following for 1998 and 1999 (i) Recurring pension cost (ii) (iross pension cost (iii) Nonsmoothed pension cost k. Compare the
1. Calculate and justify the adjustments you would make to Westvaco's balance sheet at October 31, 1999 10 reflect the economic position of its pension plan m. State the principal reason for the difference between the adjust- ment in part t and the adjustment required at October 31, 1998
3. [Analysis of pension plan disclosures; Pfizer] Use Note of Pfizer's 1999 financial statements to answer the following questions:a. State the most likely reason for the 1998 actuarial loss.
b. Pfizer had an actuarial loss in 1999 State two reasons why a loss would be expected and one reason to expect a gain
c. Explain why the reconciliation of both the projected benefit obligation and plan assets have foreign exchange impacts and state the information conveyed by the direction of those changes
d. State why Pfizer's balance sheet contains an accrued benefit lability despite the excess of plan assets over the benefit obligatione. Explain what is represented by the amount ($317 million for 1999) shown in accumulated other comprehensive income.f. Compute the actual rate of return on assets
4. [Effect of actuarial assumptions]a. For 2000, Ford decreased (from 7 75% to 7.50%) the dis- count rate used to calculate its pension obligation, but in- creased (from 6.25% to 7.75%) the discount rate used to calculate pension expense. Explain how this is possible.
b. Describe the effect of the 2000 discount rate changes on 2000 and 2001. (i) Service cost (ii) Interest cost (iii) Net pension cost (iv) PBOc. Estimate how Ford arrived at its reported interest cost for 1999 and 2000 using the reported PBOd. Calculate the actual rate of return on Ford's U.S. plan
5. [Analysis of Ford's U.S. pension plan disclosures] Use the data from Exhibit 12P-1 to answer the following questionsa. Calculate each of the following for 1999 and 2000 (i) Recurring pension cost (ii) Gross pension cost (iii) Nonsmoothed pension costb. Forecast Ford's 2001 pension cost (U.S.
6. [Significance of plan amendments] The plan amendment in 1999 reflects increased benefits under Ford's union contracts cov- cring U.S. employees whose benefits are flat (not pay-related).a. Describe the effect of the amendment on (i) The funded status of the U.S. plans at December 31. 1999 (ii)
7. [Analysis of pension plan disclosures] Exhibit 12P-2 pro- vides information taken from Electronic Data Systems [EDS] pension plan footnotes.a. The reconciliation of the PBO shows an actuarial loss in 2000 and an actuarial gain in 2001 Discuss the likely reasons for these changes.
b. Explain why the reconciliations of both the projected benefit obligation and plan assets have foreign exchange impacts and state the information conveyed by the direction of those changes.
c. Calculate each of the following for 1999 2001 (i) Recurring pension cost (ii) Gross pension cost (iii) Nonsmoothed pension costd. Compare the measures of pension cost calculated in part e with (i) Pension cost reported by EDS (ii) The pension plan cash flowse. In 1999, FDS reported a change for
8. [Analysis of pension plan disclosures] Exhibit 12P-3 con- tairs pension plan data from the financial statement footnotes of AMR Corporation [AMR].a. The PBO reconciliation shows a large actuarial gain (loss) in 1999 (2000) Explain why.b. Calculate the following measures of pension cost for
9. [Effect of investment performance on pension cost] Exhibit 12P-4 contains pension plan data from the 2001 financial state- ment footnotes of General Electric [GC]. GF reported that the expected return on assets assumption for 2002 would be 8.5%. compared with 9.5% for 2001.a. Estimate the
b. Compute the effect on the expected return on assets compo- nent of GE's 2002 pension cost of each of the following. (I) Change in ROA assumption (ii) Negative return on assets in 2001 (assume that GE had camed its expected ROA in that year)
10. [Effect of transition asset on pension cost! Exhibit 12P-4 contains pension plan data from the 2001 financial statement footnotes of General Electric [GE].a. Describe the origin of the "amortization of transition asset" component of 2000 pension cost.b. Explain why that component does not
11. [Taxable pension plans] Principal Financial [PFG] reported in its 2000 annual report that the expected return on plan assets was 5% for taxable plans and 8.1% for nontaxable plans.a. Explain why a different return on assets assumption is re- quired for taxable plans.b. Compute the implied
12. [Analysis of pension plan disclosures] Fxhibit 12P-5 con- tairs pension plan data for Lucent [LU] for the five years ended September 30, 2001a. Compute the four-year totals for the following: (i) Recurring cost (ii) Gross pension cost (iii) Nonsmoothed pension cost (iv) Benefits paid (v)
13. [Effect of change in accounting method] Effective the year ending October 1, 1999, Lucent [LL] changed its method of calculating the expected return on assets component of pension cost from the market-related method (valuation changes recog- nized over a five-year period) to use of the full
14. [Analysis of disclosures under IAS standards] Exhibit 12P-6 contains benefit plan data from the 2000 and 2001 financial statement footnotes of Roche.a. Compute the actual rate of retum on plan assets for 2000 and 2001 and compare those rates to the expected rates.b. Discuss the most likely
15. [Effect of postretirement plan assumptions; CFAC adapted] A security analyst concludes that a company has increased re- ported earnings by changing assumptions for its postretirementhealth care plans. Explain the change in each of the following assumptions that would mercase reperted earnings.
16. [Analysis of postretirement benefit plans: Westvaco] Jse Note M of Westvaco's 1999 financial statements to answer the following questions:a. The number of Westvaco employces fell from 1997 to 1999. Explain why this reduction would have decreased service cost and resulted in actuarial gains for
17. [Analysis of OPEB disclosures] Exhibit 12P-7 contains health care and life insurance benefit plan data from the 1999 and 2000 financial statement footnotes of AMRa. Effective December 31. 2000 AMR increased its assumed health care cost trend to 7% (declining to 4% by 2004) from 5% (declining to
18. [Sensitivity to changes in the assumed health care cost rate] AMR reported that a 1% change in the assumed health care cost rate would have the following effects (in Smillions). December 31, 1999 December 31, 2000 1% 1% 1% 1% Increase Decrease Increase Decrease Service and interest cost Benefit
19. [Analysis of postretirement benefit plan disclo- sures] Note 5 of Sears's 1999 annual report con- tains disclosures regarding postretirement benefitsa. Explain the origin and likely future trend of the unrecognized prior service benefit.
b. Explain the origin of the actuarial gain in 1999.c. Forecast 2000 postretirement benefit cost. stating any as- sumptions.d. Calculate and justify the adjustments you would make to Sears's balance sheet at December 31, 1999 to reflect the economic position of its postretirement benefit plans.e.
20. [Analysis of postretirement benefit plan disclosures) Exhibit 12P-8 contains health care and life insurance benefit plan data from the 2000 and 2001 financial statement footnotes of General Electric [GE].a. Describe the impact of the 2000 plan amendments on: (i) 2000 plan status (ii) The trend
b. Discuss the size and direction of actuarial gains and losses in reference to the assumed discount rate. State the information conveyed by the gains and losses not explained by discount rate changes.
c. Compare the level and trend of postretirement benefit cost (on an economic basis and as reported), GE contributions. and benefits paid, and discuss any differences.d. Explain why the expected return component of benefit cost Increased in 1999-2001 despite a steady decline in plan assetse.
21. Stock options plans] Note 16 of Pfizer's 1999 annual report contains data on its stock option plansa. State and justify whether valuation of Pfizer shares should be based on as reported or pro forma diluted earnings per share.
b. Explain the principal factor accounting for the increase in the fair value of options issued in 1999 compared with options is- sued in 1997 and 1998.c. State and justify the effect of an increase in each of the fol- lowing on the fair value of options' (i) Expected dividend yield (ii) Risk-free
Explain the usefulness of this calculation.e. Pfizer reports substantial tax benefits related to stock option transactions. State and justify whether these benefits should be considered part of cash from operations.f. State and justify whether these benefits should be considered part of cash from
22. [Stock option repricing program] At a special meeting on January 25, 2002, the stockholders of Eastman Kodak [EK] ap- proved a stock option exchange program, under which employ- ces were permitted to exchange existing options for fewer options at a new (lower) exercise price New options would
1. Define the characteristics of different deprecialion methods.
2. Explain the role of depreciable ltvcs and s~!vage values in the computation of depreciation expense.
3. Show the effects uf different depreciation methods on the financial stutemenK
4. Discuss how inflation impact:. the measurement of cconomtc dcpreci~tion.
5. Illustrate the tmpact of changes from one deprectation method to another.ANAlYSIS OF FIXED ASSET DISCLOSURES
E-;timating Relative Age and Useful Lives htimating the Age of Assets IMPAIRMENT OF lONG-LIVED ASSETS Financial Reporting of hnpaired Assets Impairment of Assets Held for Sale Impairment of Asset:; Remaining in Uoe Financial Statement Impact of Impairments Effec: of SF AS 121 on Analysts of
6. Define the measurement of relative age, useful life.and average age of fixed assets, and the use of these measures.
1. Illustrate the finaocial reponing of asset impairment aJJd its financial statement effects.
8. D•scuss the financial statement effects of recognizing obhgauons associated wtth disposal activities.
9. Discuss the liability for closure, removal, and environmental effects of long-lived operating assets and the financial :.tatcment impacts of recognizing that l iahility.
7. Effects of accelerated depreciation] Exhibit 8P- contains data from the 1999 annual report of Boeing [BA], a leading man- ufacturer of aviation equipment.a. Despite more than $5 billion of capital expenditures over the four years 1996 1999, Boeing's net plant and equipment rose by barely 4% One
8. [Change in depreciation method, effect and motivation] Pope and Talbot [POP] changed the method of depreciation for its US. pulp production assets from straight-line to units-of-pro- duction in 1998 in order to bring the accounting methods of the Company's pulp mills into conformity with its
9. [Comparison of firms with different depreciable lives] Delta Airlines [DALI, a competitor of AMR, reported the following information regarding its depreciation of flight equipment Property and Equipment-- Property and equipment is recorded at cost and depreciated on a straight-line basis to
b. Discuss any effect of the AMR change in 1999 on your an- swer to part
10. [Change in depreciable lives] Teekay Shipping [TK], a major owner of oil tankers, merged with Bona Shipholding in June 1999. Effective April 1, 1999 Teckay: revised the estimated useful life of its vessels from 201 years to 25 years. This change in accounting estimate resulted in a reduction of
b. Compare the percentage change in income from vessel opera- tions assuming no accounting change with the percentage change reported.
c. Describe the effect of the accounting change on Teckay's: (i) Shareholders' equity at December 31, 1999 (ii) Cash from operations for the period ended Decem- ber 31, 1999 (iii) Asset turnover for the period ended December 31, 1999 (is) Quality of carnings
d. Describe the effect of the accounting change on Teekay's in- come from vessel operations for the year ended December 31, 2000
11. [Change in depreciation for regulated company] Laclede Group [LC] is a distributor of natural gas in St. Louis and nearby areas of Missouri. Its rates and accounting methods are regulated by the Missouri Public Service Commission (MoPSC). Laclede's 1999 annual report includes the follow- ing
12. [Change in depreciation lives] On March 6, 2000. Pepsi Bottling Group [PBG] issued a press release containing the following In recognition of its long-standing success in preventive maintenance programs. The Pepsi Bottling Group, Inc. (NYSE PBG) today announced a change in the deprecia- non
13. [Change in depreciation lives and residual values; follow-up to Problem 8-12] In 2000, Coca-Cola Enterprises [CCE] changed the estimated useful lives and residual values of certain fixed assets. Exhibit 8P-3 contains extracts from the CCE's 10-K report for 2000a. Compute the gross margin and
b. Compute how much of the improvement in the operating margin was due to the depreciation change.c. Based on the disclosures in Exhibits 8P-2 and 8P-3. discuss: (i) Which company's disclosures regarding its depreciation lives is more useful for financial analysis (il) Which company has the better
14. [Analysis of fixed assets] Roche's summary of significant accounting policies states Property, plant and equipment are initially recorded at cost of purchase or construction and are depreciated on a straight-line basis, except for land, which is not depreciated Estimated useful lives of major
15. [Impairment] Roche, in its report for the half-year ended June 30, 2000, adopted IAS 36 (Impairment), with the following disclosure "Impairment of assets. When the recoverable amount of an asset, being the higher of its net selling price and its value in use, is less than its carrying amount,
A reduction in deferred tax liabilities of 348 million Swiss francs was also recorded, giving a net charge of 813 million Swiss francs in the consolidated re- sults. Also included within this is a minor amount relating to impairment on a small number of products acquired in an earlier acquisition
b. Discuss the effects of the 1998 and 1999 impairment charges on IEC's 1999: (i) Cash from operations (ii) Fixed-asset turnover (iii) Debt-to-equity ratioc. Discuss the effects of the accounting change on [EC's 2000. (i) Net income (ii) Cash from operations (iii) Fixed-asset turnover (lv)
I. l.xammc the liabllity method used to a~count for in.:ome tax under U.S. and lAS GAA?.
2. l.xplam how the tax effects of operatmg lnsses are Jccountcd for under the liability method.
3. Discuss how the vaiUltion allowance affects the income smtement and balance sheet.
4. Discu:.s the factors govcmmg the level and trend of tldcrred tax assets and !•abilities.
S. Evaluate the rclevanc< of deferred tax asset> and liahllnics to firm valuation
6. De~cribe the three ditfercnt measures of the effective tax rdtC.
7. D1ffcrentiate between temp\lf3ry and permanent differences betwe~n taxable mcomc and pretax income.
11. Show ho"' financial statement disclosures can be used to analyze and forct:ast tile firm's cflectJve tax rate.
9. Examine the relationship between deferred taxes and cash outflows for tax payments.
10. 01>CUSS international dilferencc~ m the accounting for income taxes.
1. [Deferred tax classification. (FAC adapted] Explain in which of the following categories deferred taxes can be found. Provide an example for each category in your answer (i) Current liabilities (ii) Long-term liabilities (iii) Stockholders' equity (iv) Current assets (v) Long-term assets
2. [Deferred taxes: CFA adapted] State which of the follow- ang statements are correct under SFAS 109 Explain why. (i) The deferred tax liability account must be adjusted for the effect of enacted changes in tax laws or rates in the period of enactment (ii) The deferred tax asset account must be
3. [Permanent versus temporary differences, CFA adapted[a. Define permanent differences and describe two events or transactions that generate such differences.b. Describe the impact of permanent differences on a firm's ef- fective tax rate.
4. [Treatment of deferred tax liability, (FAO adapted]a. When computing a firm's debt-to-equity ratio, describe the conditions for treating the deferred tax liability: (i) As equity (ii) As debtb. Provide arguments for excluding deferred tax liabilities from both the numerator and the denominator
S. [Depreciation methods and deferred taxes] The Incurious George Company acquires assets K. L. and M at the beginning of year 1. Each asset has the same cost, a five-year life. and an expected salvage value of $3,000 For financial reporting, the firm uses the straight-line, sum-of-the-years'
a. Calculate the tax return depreciation expense for each asset in year 2b. Calculate the financial statement depreciation expense for as sets K and M in year 2c. Calculate the deferred tax credit (liability) or debit (asset) for each asset at the end of (i) Year 2 (ii) Year 5
6. [Analysis of deferred tax, CFA adapted] On December 29. 2000, Mother Prewitt's Handmade Cookies Corp acquires a nu- merically controlled chocolate chip-milling machine. Due to dif- ferences in tax and financial accounting, depreciation for tax purposes is $150,000 more than depreciation in the
b. Explain your treatment of deferred taxes when calculating Mother Prewitt's solvency and leverage ratios
c. In 2001, Mother Prewitt's tax rate will be 40%. Discuss the adjustments to each of the two deferred tax items in 2001 because of the change in the tax rate, assuming the use of SFAS 109.d. Discuss the conditions under which Mother Prewitt would need to recognize a valuation allowance for any
7. [Tax effect of restructuring] In 1998, Silicon Graphics [SG!] made the following announcements: 1998; restructuring charges of $144 million, including a 547 million write-down of operating assets. 1999: $4.2 million of operating asset write-downs and a $16 milhon write-down of capitalized
8. [Tax effect of permanently reinvested earnings] Silicon Graphics reports, in the tax footnote to its fiscal 1999 Annual Re- port, that We have not provided US federal taxes on approximately $242 million of accumulated undistributed carmings of cer- tain of our foreign subsidiaries, since it is
9. [Basis for and change in valuation allowance] Silicon Graphics reported the following components of (loss) income before income taxes Years ended June 30 $ in thousands 1998 1999 2000 United States $(601.962) $ 10,699 $(367,033) Foreign 5,043 115.022 (14,851) Total pretax inconic $(596,919)
10. Effect of foreign operations on income tax rate and future effective tax rates] PepsiCo [PEP] reported the following tax rate reconciliation in its 2000 Annual Report: 1998 1999 2000 Statutory rate 35 0% 35.0% 35.0% Effect of lower foreign tax rate (3.0) (2.7) (3.0) Settlement prior years (5.7)
11. [Tax effect of zero coupon debt] PepsiCo [PEP] reported a deferred tax asset of $73 million at December 31. 2000 ($76 and $79 million at December 31, 1999 and 1998, respectively) re- sulting from outstanding zero coupon debt.a. Explain why zero coupon debt might generate deferred tax assets.b.
12. [Analysis of income tax footnote data] Exhibit 9P-1 con- lains the income tax footnote from the 2001 Annual Report of Honda [7267], a multinational automobile manufacturer based in Japan. Note that these data are prepared under U.S GAAP.a. Calculate the differences (in yen) between Honda's
13. [Deferred taxes and interm reports] State Auto Financial [STFC] reported the following operating results for the first three quarters of 1991 and 1992 (S in thousands): 1991 QI Q2 Q3 Pretax income $4.797 $2,600 $3,244 Income tax expense (1.224) (624) (848) Net income $3.573 $1,976 $2,396 1992
b. Using the data given, show how the change in the estimated tax rate increased third-quarter 1992 income by approxi- mately $600,000
c. Describe how the changed tax rate assumption distorted the comparison of third-quarter net income for 1991 and 1992.d. Suggest two ways by which analysis can offset the distortion discussed in partc. e. Assume that State Auto had estimated a tax rate of 17% for the first two quarters of 1992.
1. D•~cuss the difli:rcncc between operating and financing liabiht1es.
2. Ikscribe the effect on reported financial >latements, in.-luding the carrytng amount. the pattern of expense r~tognition. and reported cash flo"''· of:• Debt issued ut a premium or dis~ount• Zero-coupon debt• l'ixed- nnd vnrinblc-rate debt• Debt denommatcd in fore1gn currencies• Debt
3. Cumparc the effects o( changes 1n interest r~tes on both the mterest payments and market val1.1e of fixedand variable-rate debt.Effects of Changes in Interest Rate~Debt: Markel Ol' Bo{)J. Value.'Debt of Finns m Distress Ac('mmling for Re.H/'ucrured and {mp.urcd Dehl Retirement of Debt Prior to
4. Estimate the market value of debt and discuss its uoefulness.
5. hplain how interest rate swaps change the finn's risk exposure to changing interest rates
6. Ikscribc the circumstances under which preferred stock should be treated as debt, or debt as equity for financial analysis.
7. Differentiate between the economic and accounting effects (often different) of debt retirement or refinancing.S. Explain the role of debt covenants in protecting creditors by limiting the firm's freedom to invest, pay d1vidcnds, or make other opei-ating and strategic decisions.
Question no 2 13. [Capitalization of startup costs] Repsol [REP], a multina- tional oil and gas company headquartered in Spain, prepares its financial statements using Spanish GAAP. Under Spanish GAAP, Repsol is permitted to capitalize startup expenses, which must be expensed as incurred under U.S.
10. [Capitalization of research and development] SmithKline Beecham [SB], a multinational drug company, announced on August 31, 2000 that it had signed agreements to divest itself of drugs to other pharmaceutical firms for a total of 1,529 million. The sale resulted in a pretax gain of 1.416
9. [Capitalization of research and development] Pfizer's 1999 annual report contains a financial summary (p 62) with 11 years of data including research and development expense.a. Compute R&D expense as a % of sales for the five years end- ing in 1999, Discuss what this trend tells you about the
8. [Capitalization of development costs] Ericsson [ERICA] is a major producer of wireless telephone equipment, and reports ac- cording to Swedish GAAP. Its financial statements report that: "Research and development costs are expensed as incurred."a. Discuss the effect of the differences between

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