is.wbn.is.je.060 Recording entries and determining financial-statement effects (Google)

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1 Income Statements» What s Behind Income Statements» Exercises SOLUTIONS is.wbn.is.je.060 Recording entries and determining financial-statement effects (Google) Base your responses to parts (a)-(c) on the accounts on page 6; Google s financial statements on pages 7-9; and the following excerpt from the Management Discussion and Analysis of Financial Condition and Results of Operations section of Google s K (Page 35). Charge Related to the Resolution of Department of Justice Investigation In connection with a resolution of an investigation by the United States Department of Justice into the use of Google advertising by certain advertisers, we accrued $500 million during the three months ended March 31, 2011, which was paid in August 2011 upon final resolution of that matter. Record Keeping This exercise helps you learn how to do record keeping and reporting. Required (a) Using the accounts on page 6, record Google s March 31, 2011 journal entry to accrue the $500 million resolution of the investigation by the United States Department of Justice. Note: Four rows have been provided, but you may not need them all. Debit Credit Resolution of Department of Justice investigation expense $500 Other accrued liabilities $500 (b) Using the accounts on page 6, record Google s August 2011 journal entry to pay the $500 million resolution of the investigation by the United States Department of Justice. Note: Four rows have been provided, but you may not need them all. Debit Credit Other accrued liabilities $500 Cash $500 (c) In this question, you are to consider the NET effect of the entries you recorded in parts (a) and (b) on Google s financial statements for the year ended December 31, Identify the line items that were directly affected (and the direction of the effects). If the effect of one entry on a financial statement line item was offset by the effect of the other entry, there is no net effect on the line item. Guidance: (1) Determine the appropriate line item(s) affected using Google s statements. For example, write cash and cash equivalents rather than cash because this is on Google s balance sheet. You may customize this work, as long as you credit G. Peter & Carolyn R. Wilson and respect the Creative Commons Attribution-Noncommercial-Share Alike United States license NavAcc LLC.

2 2 NAVIGATING ACCOUNTING (2) Include line item(s) directly affected, including the effect(s) of closing entries for events affecting income. Ignore taxes. (3) Don t include totals or sub-totals indirectly affected by the entry. For example, don t report net income on the income statement. However, net income is NOT a total on the statement of shareholders equity. (4) Three lines were included below for each statement, but you may need none or more than one line. Write NONE if no line item is effected on the statement. (5) Indicate if the effect(s) of the entries associated with the above event increased or decreased the line item. Put an in the appropriate column if the above event increases or decreases that line item. For full credit, be sure to mark only one box in each statement s row. NOTE: If a reported negative number changes from -2 to -3, it decreases; if it changes from - 2 to - 1, it increases. WARNING: Google reports the most recent year in the far right column. Balance Sheets Statement of Shareholders' Equity Line Items Increases Decreases Line Items Increases Decreases Cash and cash equivalents Net income Retained earnings x Statement of Income Line Items Increases Decreases Charge related to the resolution of Department of Justice investigation Relevant information for parts (d) and (e) Base your responses to parts (d) and (e) on Google s financial statements in the supplement; the following excerpt from Google s Summary of Significant Accounting Policies footnote (Google s K, Page 57); definitions on the next page; and the specific event description and assumptions described on the next page. Summary of Significant Accounting Policies footnote excerpt Cost of Revenues Cost of revenues consists primarily of traffic acquisition costs. Traffic acquisition costs consist of amounts ultimately paid to our Google Network members under AdSense arrangements and to certain other partners (our distribution partners) who distribute our toolbar and other products (collectively referred to as access points) or otherwise direct search queries to our website (collectively referred to as distribution arrangements). These amounts are primarily based on the revenue share and fixed fee arrangements with our Google Network Members and distribution partners. Certain distribution arrangements require us to pay our partners based on a fee per access point delivered and not exclusively or at all based on revenue share. These fees are non-refundable. Further, these arrangements are terminable at will, although under the terms of certain contracts we or our distribution partners may be subject to penalties in the event of early termination. We recognize fees under these arrangements over the estimated useful lives of the access points (approximately two years) to the extent we can reasonably estimate those lives and they are longer than one year, or based on any contractual revenue share, if greater. Otherwise, the fees are charged to expense as incurred. The estimated useful life of the access points is based on the historical average period of time they generate traffic and revenues. Further, we review the access points for impairment by distribution partner, type, and geography, and we have not made any impairment to date.

3 EERCISE 3 Prepaid revenue share and distribution fees are included in prepaid revenue share, expenses, and other assets on the accompanying Consolidated Balance Sheets. Definitions Adsense Google AdSense refers to the online programs through which we distribute our advertisers AdWords ads for display on our Google Network Members websites, as well as programs to deliver ads on television broadcasts. (page 56, Google s K) AdWords Google AdWords is our auction-based advertising program that enables advertisers to place text-based and display ads on our websites and our Google Network Members websites. (page 56, Google s K) Event Description and Assumptions for parts (d) and(e) For the purpose of this question, assume Google continued a distribution arrangement with Apple during the year ended December 31, 2011 by paying Apple $1,000 million cash to have Google be the default search engine in Apple s Safari browser for the next two years (commencing on the payment date). Assume for the purpose of this question that Google expects to recognize the $1,000 fee under this arrangement evenly over the two year contractual period. Assume for the purpose of this question, when Google enters a multi-year contract, it records the benefits expected to be received within one year in a different account than those expected to be received thereafter. (d) Using the accounts on page 6, record Google s journal entry for the $1,000 of cash paid to Apple to have Google be the default search engine in Apple s Safari browser for the next two years, as described above. Note: Four rows have been provided, but you may not need them all. Debit Prepaid traffic acquisition costs: current $500 Prepaid traffic acquisition costs: non-current $500 Credit Cash $1,000 (e) Identify the Google financial statement line items that would have been directly affected (and the direction of the effects) if Google had recorded the journal entry in Part 4(a) for a $1,000 payment to Apple. Follow the guidance given in part (c). Balance Sheets Statement of Shareholders' Equity Line Items Increases Decreases Line Items Increases Decreases Cash and cash equivalents None Prepaid revenue share, expenses and other assets Prepaid revenue share, expenses and other assets, non-current Statement of Income Line Items Increases Decreases NONE

4 4 NAVIGATING ACCOUNTING Relevant information for parts (f) and (g) Parts (d) and (e) center on a fictitious entry: while Google pays Apple to have Google be the default search engine in Apple s Safari browser, we fabricated the contractual terms for the purpose of this exam. In particular, we fabricated the numbers you recorded. By contrast, parts (f) and (g) center on one or more numbers actually reported in Google s K. Here are specific facts and simplifying assumptions: Excerpts from Google s K Cost of revenues (Same as presented earlier, repeated here for your convenience): Certain distribution arrangements require us to pay our partners based on a fee per access point delivered and not exclusively or at all based on revenue share. These fees are non-refundable. Further, these arrangements are terminable at will, although under the terms of certain contracts we or our distribution partners may be subject to penalties in the event of early termination. We recognize fees under these arrangements over the estimated useful lives of the access points (approximately two years) to the extent we can reasonably estimate those lives and they are longer than one year, or based on any contractual revenue share, if greater. Otherwise, the fees are charged to expense as incurred. The estimated useful life of the access points is based on the historical average period of time they generate traffic and revenues. Further, we review the access points for impairment by distribution partner, type, and geography, and we have not made any impairment to date. (Summary of Significant Accounting Policies footnote, page 57) Traffic acquisition costs related to distribution arrangements included in Cost of revenues For the year ended December 31, 2011, Google reports $1,517 million of Traffic acquisition costs related to distribution arrangements are included in Cost of revenues. (Management Discussion and Analysis of Financial Condition and Results of Operations section, page 33) Simplifying assumptions For all fees paid under distribution arrangements during the year ended December 31, 2011, Google concluded it could reliably recognize these fees over periods lasting more than one year. Google recorded a single entry during the year ended December 31, 2011 to recognize traffic acquisition costs related to distribution arrangements in Cost of revenues. Google transfers non-current prepaid expenses to current prepaid expenses when the benefits are expected to be realized within one year and thus before these costs are expensed (f) Using the accounts on page 6, record a journal entry that recognizes the $1,517 million of Traffic acquisition costs related to distribution arrangements that Google included in Cost of revenues during the year ended December 31, 2011, given the simplifying assumptions above. Note: Four rows have been provided, but you may not need them all Debit Credit Traffic acquisition expense $1,517 Prepaid traffic acquisition: current $1,517

5 EERCISE 5 (g) Determine the direct effect(s) on the following Google metrics, everything else equal (ignore taxes) from the entry you recorded in part(f). Guidance Include the direct affects, including the effect(s) of closing entries for events affecting income. Put an in the appropriate box. Increases Decreases No Effect Working capital (current assets - current liabilities) Financial leverage (liabilities / assets)

6 6 NAVIGATING ACCOUNTING ASSETS Current AR C Einvc Inv OprEx Ptacc Chart of Accounts Accounts receivable Cash Equity and other investments: current Inventories Other prepaid expenses Prepaid traffic acquisition: current Noncurrent Property, plant, and equipment HcPPE PP&E historical cost AcDep PP&E accumulated depreciation Einvn Equity and other investments: non-current Gdw Goodwill Ptacn Prepaid traffic acquisition: non-current Tmks Trademarks, net LIABILITIES Current Accm Accrued compensation and related expenses AP Accounts payable Drevc Deferred revenue: current DP Dividends payable Oacl Other accrued liabilities STD Short-term debt Noncurrent Drevc Deferred revenue: non-current LTD Long-term debt OLTL Other long-term liabilities OWNERS' EQUITY Permanent AOCI Accumulated other comprehensive income APIC Additional paid-in capital CS Common stock NCI Noncontrolling interest RE Retained earnings Net income Cost of revenues TacEx Traffic acquisition expense Ocrev Other cost of revenues DepEx Depreciation expense Gppe Gain on sale of PP&E Ginvs Gain on sale of investments Gimp Goodwill impairment IncS Income summary Intinc Interest income ResEx Resolution of Department of Justice investigation expense Rev Revenues, net SG&A Selling, general, and administrative expense

7 EERCISE 7 Google Inc. Consolidated Balance Sheets $ in millions, except share and par value amounts, which are reflected in thousands, and par value per share amounts As of December 31, 2010 As of December 31, 2011 Assets Current assets: Cash and cash equivalents $13,630 $9,983 Marketable securities 21,345 34,643 Total cash, cash equivalents, and marketable securities (including securities loaned of $4,031 and $2,778) 34,975 44,626 Accounts receivable, net of allowance of $101 and $133 4,252 5,427 Receivables under reverse repurchase agreements Deferred income taxes, net Prepaid revenue share, expenses and other assets 1,326 1,745 Total current assets 41,562 52,758 Prepaid revenue share, expenses and other assets, non-current Deferred income taxes, net, non-current Non-marketable equity securities Property and equipment, net 7,759 9,603 Intangible assets, net 1,044 1,578 Goodwill 6,256 7,346 Total Assets $57,851 $72,574 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $483 $588 Short-term debt 3,465 1,218 Accrued compensation and benefits 1,410 1,818 Accrued expenses and other current liabilities 961 1,370 Accrued revenue share 885 1,168 Securities lending payable 2,361 2,007 Deferred revenue Income taxes payable, net Total current liabilities 9,996 8,913 Long-Term Debt 0 2,986 Deferred revenue, non-current Income taxes payable, non-current 1,200 1,693 Deferred income taxes, net, non-current Other long-term liabilities Commitments and contingencies Stockholders' equity Convertible preferred stock, $0.001 par value per share: 100,000 shares authorized; no shares issued and outstanding 0 0 Class A and Class B common stock and additional paid-in capital, $0.00 par value per share; 9,000,000 shares authorized; 321,301 (Class A 250,413, Class B 70,888) and par value $321 (Class A $250, Class B $71) and 324,895 (Class A 257,553, Class B 67,342) and par value $325 (Class A $258, Class B$67) shares issued and outstanding 18,235 20,264 Accumulated other comprehensive income Retained earnings 27,868 37,605 Total stockholders' equity 46,241 58,145 Total liabilities and stockholders' equity $57,851 $72,574 See accompanying notes Google's K, Page 51

8 8 NAVIGATING ACCOUNTING Google Inc. Consolidated Statement of Income $ in millions, except per share amounts Year ended December Revenues $23,651 $29,321 $37,905 Costs and expenses: Cost of revenues (including stock based compensation expense of $47, $67, $249) 8,844 10,417 13,188 Research and development(including stock based compensation expense of $725, $861, $1,061) 2,843 3,762 5,162 Sales and marketing(including stock based compensation expense of $231, $261, $361) 1,984 2,799 4,589 General and administrative(including stock based compensation expense of $161, $187, $303) 1,668 1,962 2,724 Charge related to the resolution of Department of Justice investigation Total costs and expenses 15,339 18,940 26,163 Income from operations 8,312 10,381 11,742 Interest and other income, net Income before income taxes 8,381 10,796 12,326 Provision for income taxes 1,861 2,291 2,589 Net income $6,520 $8,505 $9,737 Net income per share of Class A and Class B common stock: Basic $20.62 $26.69 $30.17 Diluted $ $ $ See accompanying notes Google's K, Page 52

9 EERCISE 9 Google Inc. Consolidated Statement of Shareholders' Equity (In millions, except for share amounts which are reflected in thousands) Class A and Class B Common Stock and Additional Paid-in Capital Accumulated Other Comprehensive Retained Total Stockholders' Shares Amount Income Earnings Equity Balances at January 1, ,114 $14,450 $227 $13,562 $28,239 Common stock issued 2, Stock-based compensation expense 1, ,164 Stock-based compensation tax benefits Tax withholding related to vesting of restricted stock units (207) 0 0 (207) Net income 0 0 6,520 6,520 Other comprehensive loss 0 (122) 0 (122) Balance December 31, ,772 15, ,082 36,004 Common stock issued 5,126 1, ,412 Common stock repurchased (1,597) (82) 0 (719) (801) Stock-based compensation expense 1, ,376 Stock-based compensation tax benefits Tax withholding related to vesting of restricted stock units (360) 0 0 (360) Net income 0 0 8,505 8,505 Other comprehensive income Balance December 31, ,301 18, ,868 46,241 Common stock issued 3, Stock-based compensation expense 1, ,974 Stock-based compensation tax benefits Tax withholding related to vesting of restricted stock units (626) 0 0 (626) Net income 0 0 9,737 9,737 Other comprehensive income Balance December 31, ,895 $20,264 $276 $37,605 $58,145 See Notes to Consolidated Financial Statements Best Buy's K, Page 54