in.wbn.ins.020 Recording inventory write offs using company disclosures and determining their financial-statement effects (RIM)

Transcription

1 Cost of Sales and Inventories» What s Behind the numbers» Ins» Exercises SOLUTIONS in.wbn.ins.020 Recording inventory write offs using company disclosures and determining their financial-statement effects (RIM) Parts I-III of this exercise ask you to record an inventory write-offs entry based on Research in Motion s disclosures and then determine how it affected RIM s financial statements. The entry should be recorded using the accounts on page 4. Pages 5-9 report RIM s financial statements and excerpts from RIM s fiscal F, which is a schedule filed at the SEC by Canadian Companies that issue securities in the US. Part IV aims to help you use ratios effectively. It is based on quarterly information for fiscal years , reported on Page 10. Part I: Record Entry Required (a) Record a journal entry that summarizes the entries RIM recorded in the third and fourth quarters of fiscal 2012 to write off inventories related to PlayBook Tablets and BlackBerry-7 products. Write your entry in the space below using the accounts on page 4. Hint: See the excerpt from the Risk Factors section of the 40F on page 9. RIM's Q3 fiscal 2012 write off of PlayBook Tablets and Q4 fiscal 2012 write off of Blackberry-7 products Debit Credit Cost of goods sold $752 Provision for excess and obsolete inventories $752 Record Keeping This exercise helps you learn how to do record keeping and reporting. Search This exercise helps you learn how to search for information. Usage This exercise helps you learn how to use accounting information. Source: Risk Factors excerpt Part II: Financial-Statement Effects of Entry Required For the entry you recorded in Part I, complete the related table identifying the RIM financial statement line items that would have been directly affected (and the direction of the effects) during the year ended March 3, Guidance: (1) Determine the appropriate line item(s) affected using RIM s financial statements on pages 5-8. For example, write cash and cash equivalents rather than cash because this is on RIM s balance sheet. (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 or four 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 event increased or decreased the line item. Put an X in the appropriate column if the above event 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 increases or decreases that line item. 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. (b) Inventory write-offs of PlayBook Tablets and BlackBerry-7 products in Q3 and Q4 of fiscal 2012 RIM's Q3 fiscal 2012 write off of PlayBook Tablets and Q4 fiscal 2012 write off of Blackberry-7 products CONSOLIDATED BALANCE SHEETS CONSOLIDATED STATEMENTS OF OPERATIONS Line Items Increases Decreases Line Items Increases Decreases Inventories X Cost of sales: Hardware and other X Retained earnings X CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY CONSOLIDATED STATEMENT OF CASH FLOWS Line Items Increases Decreases Line Items Increases Decreases Net income X Net income X Net changes in working capital items (Negatively reported number decreases.) X Part III: Reconciling the entry in Part I with a RIM disclosure Required In Part I, you recorded two prominent inventory write offs during fiscal 2012 that totalled $752 million: $485 million for PlayBook Tablets in Q3 and $267 million for BlackBerry-7 products in Q4. This means the total inventory provision recognized in net income for fiscal 2012 increased cost of sales by at least $752 million. (There could have been other write-offs.) However, the income statement reports Cost of sales: Hardware and other includes a fiscal 2012 inventory provision of $502 million. Why is the $502 million reported on the income statement so much smaller than the total provision recognized and how should you interpret this number? These are the questions we will address here. However, first we will pose a more basic question. The answer to it should help you interpret the $502 million. (c) If Company A writes down a product that it subsequently sells in the same reporting period, the total cost of sales attributable to the product for the period is (choose one): (i) Less than the cost of sales that would have been attributable to the product for the reporting period if the product had not been written down. (ii) The same as the cost of sales that would have been attributable to the product for the reporting period if the product had not been written down. (iii) Greater than the cost of sales that would have been attributable to the product for the reporting period if the product had not been written down. Response: The correct answer is (ii). We will use an example to illustrate that cost of sales would be the same. Suppose the carrying value of a product s inventory is $10 on January 25, the inventory is written down to $7 on January 26 and is sold on January 27. Assuming all three dates are in the same reporting period, cost of sales attributable to the product during the period is $10: $3 related to the write-off and $7 to the sale. However, $10 would also have been recognized as cost of sales if the inventory had not

3 EXERCISE 3 been written down. (d) How should you interpret includes a fiscal 2012 inventory provision of $502 million on RIM s fiscal 2012 income statement? Response: The $502 likely represents write-downs (and thus increases in cost of sales) attributable to products still in inventory at the end of the reporting period, March 3rd, Alternatively, cost of sales was $502 higher than it would have been if there had not been write-offs. Part IV: Using ratios effectively Required (e) Inventory turnover, defined as cost of sales divided by average inventory, is often used to assess how efficiently a company uses its inventory: To the extent a company can increase sales without increasing inventories, it is operating more efficiently - generating more output with the same (or fewer) inputs. Does this mean we can reasonably conclude that RIM used its inventory more efficiently in Q3 and Q4 of fiscal 2012 than in Q2 of fiscal 2012 and Q1 of fiscal 2013? (See the quarterly information). If so, why? If not, why not? Response: There are two implicit assumptions: The turnover ratio measures efficiency to the extent (i) sales (and thus ultimately cash inflows) increase when cost of sales increases or (ii) costs (and thus ultimately cash outflows) decrease when inventories decrease. To the extent these assumptions are violated, inventory turnover fails to measure what it intends to measure - efficiency. Both are violated in Q3 and Q4: write-offs increase cost of sales without increasing sales (and thus cash inflows) and decrease inventories without decreasing costs (and thus cash outflows). (f) Gross margin percentage, defined as (sales - cost of sales)/sales, is often used to assess how well a company maintains prices in its output markets or controls costs in its input markets. Does this mean we can reasonably conclude that RIM either maintained prices better in its product markets or controlled costs better in its input markets in Q4 fiscal 2012 than in Q3 fiscal 2012? Response: No, cost of sales decreases in Q4 because of the Q3 write-offs. Thus, the Q3 write-off increases the Q4 gross margin and decreases the Q3 gross margin, regardless of the extent to which RIM controls costs in its input markets during these quarters. (g) What ratios in Q2 of fiscal 2012 foreshadowed the write-offs in Q3 and Q4 of fiscal 2012? Response: Sharp decreases in RIM s gross margin percentage and inventory turnover in Q2 of fiscal 2012 (relative to prior quarters) foreshadowed the write-offs in Q3 and Q4. This presumes these ratios measure what they are intended to measure (as described above). A healthy skeptic should always check for other explanations.

4 4 NAVIGATING ACCOUNTING CHART OF ACCOUNTS ASSETS Current AR Accounts receivable ARG Accounts receivable, gross Allbd Allowance for bad debts C Cash and cash equivalents Inven Inventories Minv Materials inventories WIP Work in process FGI Finished goods inventories SIdr Segregated inventories: deferred revenue PrvEO Provision for excess and obsolete inventories PrEx Prepaid expenses Non-current PPE Property, plant, and equipment, net PPEhc PP&E (historical cost) AcDep Accumulated depreciation LIABILITIES Current AP Accounts payable AcrL Accrued liabilities DivP Dividend payable Drev Deferred revenue Non-current LTD Long-term debt OWNERS' EQUITY Permanent RE Retained earnings SCap Share capital Net income CGS Cost of goods sold DepEx Depreciation expense G/L Gain/loss PPEGL Gain/Loss on PP&E disposals IncS Income summary Rev Revenues, net SGA Selling, general, and administrative expense

5 EXERCISE 5 Research in Motion Limited Incorporated under the Laws of Ontario (United States dollars, in millions) Consolidated Balance Sheets March 3, 2012 As at February 26, 2011 Assets Current Cash and cash equivalents $1,527 $1,791 Short-term investments Accounts receivable, net 3,062 3,955 Other receivables Inventories 1, Income taxes receivable 135 Other current assets Deferred income tax asset ,056 7,488 Long-term investments Property, plant and equipment, net 2,748 2,504 Goodwill Intangible assets, net 3,286 1,798 13,731 12,875 Liabilities Current Accounts payable Accrued liabilities 2,382 2,511 Income taxes payable 179 Deferred revenue ,389 3,630 Deferred income tax liability Income taxes payable ,631 3,937 Commitments and contingencies Shareholders' Equity Capital stock and additional paid in capital Preferred shares, authorized unlimited number of non-voting, cumulative, redeemable and retractable Common shares, authorized unlimited number of non-voting, redeemable, retractable Class A common shares and unlimited number of voting common shares Issued - 524,159,844 voting common shares (February 26, ,868,644) 2,446 2,359 Treasury stock March 3, ,711,010 (February 26, ,752,890) (299) (160) Retained earnings 7,913 6,749 Accumulated other comprehensive income (loss) 40 (10) 10,100 8,938 13,731 12,875 See notes to consolidated financial statements Research in Motion's fiscal F, sec.gov

6 6 NAVIGATING ACCOUNTING Research in Motion Limited (United States dollars, in millions, except per share data) Consolidated Statements of Operations March 3, 2012 For the fiscal years ended February 26, 2011 February 27, 2010 Revenue Hardware and other $14,031 $16,416 $12,536 Services and software 4,404 3,491 2,417 $18,435 $19,907 $14,953 Costs of sales Hardware and other (includes a fiscal 2012 inventory provision of $502 million) $11,217 $10,516 $7,979 Services and software $11,856 $11,082 $8,369 Gross margin $6,579 $8,825 $6,584 Operating expenses Research and development 1,559 1, Selling, marketing and administration 2,604 2,400 1,907 Amortization Litigation 164 Impairment of goodwill 355 $5,089 $4,189 $3,346 Income from operations 1,490 4,636 3,238 Investment income, net Income before income taxes 1,511 4,644 3,266 Provision for income taxes 347 1, Net income $1,164 $3,411 $2,457 Earnings per share: Basic $2.22 $6.36 $4.35 Diluted $2.22 $6.34 $4.31 See notes to consolidated financial statements Research in Motion's fiscal F, sec.gov

7 EXERCISE 7 Balance as at February 28, 2009 $2,328 $3,546 $1 $5,875 Comprehensive income: Net income 2,457 2,457 Net change in unrealized gains on available-for-sale investments 7 7 Net change in fair value of derivatives designated as cash flow hedges during the year Amounts reclassified to income during the year Shares issued: Exercise of stock options Stock-based compensation Tax benefits related to stock-based compensation 2 2 Purchase of treasury stock (94) (94) Common shares repurchased (46) (729) (775) Balance as at February 27, 2010 $2,372 ($94) $5,274 $51 $7,603 Comprehensive income: Net income 3,411 3,411 Net change in unrealized gains on available-for-sale investments (2) (2) Net change in fair value of derivatives designated as cash flow hedges during the year (20) (20) Amounts reclassified to income during the year (39) (39) Shares issued: Exercise of stock options Stock-based compensation Tax deficiencies related to stock-based compensation (1) (1) Purchase of treasury stock (76) (76) Treasury stock vested (10) 10 Common shares repurchased (141) (1,936) (2,077) Balance as at February 26, 2011 $2,359 ($160) $6,749 ($10) $8,938 Comprehensive income: Net income 1,164 1,164 Net change in unrealized gains on available-for-sale investments (3) (3) Net change in fair value of derivatives designated as cash flow hedges during the year Amounts reclassified to income during the year Shares issued: Exercise of stock options 9 9 Stock-based compensation Tax deficiencies related to stock-based compensation (2) (2) Purchase of treasury stock (156) (156) Treasury stock vested (17) 17 0 Balance as at March 3, 2012 $2,446 ($299) $7,913 $40 $10,100 See notes to consolidated financial statements Research in Motion Limited (United States dollars, in millions) Consolidated Statements of Shareholders' Equity Capital Stock and Additional Paid-in Capital Treasury Stock Retained Earnings Accumulated Other Comprehensive (Loss) Income Total Research in Motion's fiscal F, sec.gov

8 8 NAVIGATING ACCOUNTING March 3, 2012 February 26, 2011 February 27, 2010 Cash flows from operating activities: Net income $ 1,164 $ 3,411 $ 2,457 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 1, Deferred income taxes (5) Income taxes payable (21) 2 5 Stock-based compensation Impairment of goodwill 355 Other Net changes in working capital items (210) (496) (161) Net cash provided by operating activities 2,912 4,009 3,035 Cash flows from investing activities: Acquisition of long-term investments (355) (784) (863) Proceeds on sale or maturity of long-term investments Acquisition of property, plant and equipment (902) (1,039) (1,009) Acquisition of intangible assets (2,217) (557) (421) Business acquisitions, net of cash acquired (226) (494) (143) Acquisition of short-term investments (250) (503) (477) Proceeds on sale or maturity of short-term investments Net cash used in investing activities (3,024) (1,698) (1,470) Cash flows from financing activities Issuance of common stock Tax benefits (deficiencies) related to stock-based compensation (2) (1) 2 Purchase of treasury stock (156) (76) (94) Common shares repurchased (2,077) (775) Repayment of debt (6) Net cash used in financing activities (149) (2,087) (843) Effect of foreign exchange gain (loss) on cash and cash equivalents (3) 16 (6) Net increase (decrease) in cash and cash equivalents for the year (264) Cash and cash equivalents, beginning of year 1,791 1, Cash and cash equivalents, end of year $1,527 $1,791 $1,551 See notes to consolidated financial statements Research in Motion Limited (United States dollars, in millions) Consolidated Statements of Cash Flows For the fiscal years ended Research in Motion's fiscal F, sec.gov

9 EXERCISE 9 Excerpts from RIM s Fiscal F Note 6: Consolidated Balance Sheet Details (excerpt) Inventories Inventories were comprised as follows: (in millions) March 3, 2012 As at February 26, 2011 Raw materials $771 $552 Work in process Finished goods Provision for excess and obsolete inventories (431) (250) $1,027 $618 Excerpt from Note 6 (Consolidated Balance Sheet Details) Research in Motion's fiscal F, sec.gov Risk Factors Section of 40F (excerpt) The Company faces substantial inventory and other asset risk. As the Company develops or announces new products and services, many of its older products and services will reach the end of their life cycle. In addition, the Company may decide or may be required to discontinue sales of certain products or services, or not pursue the development of certain products or services, as a result of such factors as expected demand, lower than expected sales, litigation or government action. As the Company discontinues the manufacturing and sale of these products and services, the Company must manage the liquidation of inventory, supplier commitments and customer expectations. If the Company is unable to manage properly the discontinuation of these products and services, it could have a material adverse effect on the Company s business, results of operations and financial condition. The Company must order components for its products and build inventory in advance of product announcements and shipments. Components are normally acquired through a combination of purchase orders, supplier contracts, open orders and, where appropriate, prepayments, in each case based on projected demand. Because the Company s markets are volatile, competitive and subject to rapid technology and price changes, there is a risk the Company will forecast incorrectly and order or produce excess or insufficient inventories of components or products. The Company records a write-down for product and component inventories that have become obsolete, can no longer be sold or exceed anticipated demand or net realizable value, and accrues necessary cancellation fee reserves for orders of excess products and components. The Company also reviews its long-lived assets for impairment whenever events or changed circumstances indicate the carrying amount of an asset may not be recoverable. If the Company determines that impairment has occurred, it records a write-down equal to the amount by which the carrying value of the assets exceeds its fair market value. For example, the Company recorded a pre-tax provision in the third quarter of fiscal 2012 of approximately $485 million (approximately $356 million after tax) related to its inventory valuation of BlackBerry PlayBook tablets. The charge, which was predominantly noncash, reflected the market environment for the Company s BlackBerry PlayBook tablet at the time and enabled it to expand upon the aggressive level of promotional activity employed by the Company to drive BlackBerry PlayBook tablet adoption. In addition, in the fourth quarter of fiscal 2012, the Company recorded a pre-tax provision of $267 million ($197 million after tax), which was mostly non-cash, primarily related to its inventory valuation of certain BlackBerry 7 products, based on the Company s expectations for sell through, estimated inventory levels in the channel, and excess inventory on hand. The Company s financial condition and results of operations have recently been, and could be in the future, materially and adversely affected by the Company s ability to manage its inventory levels and respond to short-term shifts in customer demand patterns. No assurance can be given that the Company will not incur additional related charges with respect to its existing or future products given the rapid and unpredictable pace of product obsolescence in the industries in which the Company competes. Risk Factors section of RIM s fiscal F, Page 54.

10 10 NAVIGATING ACCOUNTING Quarterly Inventory-related Information Quarterly ending inventories and gross margins Fiscal 2011 Fiscal 2012 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 29-May Aug Nov Feb May Aug Nov-11 3-Mar-12 Raw materials $450 $520 $525 $552 $635 $764 $755 $771 Work in process Finished goods inventory Provision (e.g., allowance) (144) (187) (189) (250) (276) (275) (749) (431) Total, net of allowance $555 $646 $679 $618 $943 $1,372 $868 $1,027 Allowance/ gross inventories 20.60% 22.45% 21.77% 28.80% 22.64% 16.70% 46.32% 29.56% Revenue $4,235 $4,621 $5,495 $5,556 $4,908 $4,168 $5,169 $4,190 Cost of sales $2,312 $2,566 $3,101 $3,103 $2,752 $2,556 $3,759 $2,789 Gross margin percent 45.41% 44.47% 43.57% 44.15% 43.93% 38.68% 27.28% 33.44% Inventory turnover (cgs/average inventory) Fiscal 2013 Fiscal 2014 Q1 Q2 Q3 Q4 Q1 2-Jun-12 1-Sep-12 1-Dec-12 2-Mar-13 1-Jun-13 Raw materials $888 $786 $622 $588 $641 Work in process Finished goods inventory Provision (e.g., allowance) (485) (485) (477) (434) (463) Total, net of allowance $1,018 $785 $457 $603 $887 Allowance/ gross inventories 32.27% 38.19% 51.07% 41.85% 34.30% Revenue $2,814 $2,873 $2,727 $2,678 $3,071 Cost of sales $2,026 $2,126 $1,897 $1,603 $2,029 Gross margin percent 28.00% 26.00% 30.44% 40.14% 33.93% Inventory turnover (cgs/average inventory) Research in Motion Limited website: