Assignment - Financial Management & Reporting

FOOTNOTES, CLIPPINGS, AND OTHER INFORMATION

1. Trading Securities. Trading securities (TS) on the balance sheet are marked-to-market, i.e., reported at fair market value. Of the total dividend revenue, $30,000 was for TS in 2015; $25,000 in 2014; and $21,000 in 2013. For simplicity, assume that most purchases and sales of TS occur at in the middle of the year.

During 2013, the firm sold trading securities at year-end 2013; this sale constituted the vast majority of the $163,000 "gain from sale of TS" amount reported on the 2013 income statement.

2. Accounts Receivable. Accounts receivable are shown net of the allowance for doubtful accounts. An internal memo showed that beginning in 2014, the credit manager predicted that the firm was going to experience a higher than normal default rate and this prediction was an important factor in the 2014 bad debt estimate. The credit manager has a reputation for consistency delivering what is needed on behalf of top management.

3. Inventory. In 2014, the firm began to report its inventory using the last-in, first-out (LIFO) cost flow assumption. If the firm had used the first-in, first-out (FIFO) cost flow assumption, then its inventory amount would have been $742,000 at year-end 2015 and $610,000 at year-end 2014.

During late-2010, the firm began to develop a new product with the expectation of bringing it to market in 2012. Initial reports showed a high likelihood that this product was to be well-received. Unfortunately, the product's sales fell well short of expectations in 2012 and continuing in 2013. By 2013, the consumer interest for this product reached a point of no return; that is, it just wasn't well accepted and its reputation was such that it was highly unlikely that this product would ever meet expectations. As a result, in late-2013, the firm wrote-off $200,000 of this inventory. The book value of this inventory after the write-off was $52,000. On the write-off announcement date, the firm's stock price decreased by 11 percent.

4. Available for Sale Securities. Available for Sale securities (AFS) on the balance sheet are marked to market. For simplicity, assume that most purchases and sales of AS occur in the middle of the year.

5. Equity Method Securities, Investment in Cunningham. On 1/2/13, the firm purchased 50 percent of the common stock of Cunningham Corporation for $250,000 cash. At the time of purchase, the book value of Cunningham equaled its market value. In addition, at the time of purchase, Cunningham had $1,400,000 of liabilities. On 12/31/13, 12/31/14, and 12/31/15, Cunningham reported $2,500,000, $4,110,000, and $7,330,000 of total assets.

Even though the firm only owns 50 percent of the stock of Cunningham, it has effectively controlled its operational and financial decisions since its initial purchase. On 12/31/15, an investment firm estimated that the market value of Cunningham to be $3,500,000.

6. Goodwill: During 2010, the firm purchased 100% of the common stock of Jones Corporation for cash. 40 percent of the purchase price premium was allocated to goodwill. At each year-end, if the estimated value of indefinite life goodwill is below its market value, the firm recognizes an impairment loss for the difference. At year-end 2010 through year-end 2014, the firm's analyses showed that the market value of goodwill was greater than its book value.

During 2013 and 2014, many analysts reported that EAP was not getting the benefits from this acquisition based on what they intended at the date of purchase. Their estimate is that EAP realized the following returns from its investment: 7 percent in 2011; 7.3 percent in 2012; 7.9 percent in 2013; and 8.1 percent in 2014. On the acquisition date, EAP expected a 17 percent return on its investment beginning in 2013.  On the write-off announcement date, the firm's stock price decreased by .001 percent.

7. Land: Land is purchased with the intent of opening new retail, sales, or administrative sites. The market value of land was $2,600,000 at year-end 2013; $2,900,000; at year-end 2014 and $3,100,000 at year-end 2015.

8. Buildings: All buildings (plant) are depreciated on a straight-line basis using a 20-year life with no salvage value.

At year-end 2013, 2014, and 2015, EAP estimated that the market value of the buildings was $7,100,000 at year-end 2013; $7,200,000 at year-end 2014; and $7,800,000 at year-end 2015. 2015.

9. Equipment: Equipment is depreciated on a straight-line basis using a ten-year life with no salvage value. The market value of equipment was approximately $1,100,000 at year-end 2013; $1,200,000 at year-end 2014; and $1,000,000 at year-end 2015.

10. Notes Payable: Notes Payable represents amounts borrowed from National Bank at a 2% interest rate. The market value of the notes payable is $7,700,000 at year-end 2013; $7,500,000 at year-end 2014; and $6,300,000 at year-end 2015.

11. Common Stock: The firm had 200,000 shares of stock that were classified as "issued" during 2013, 2014, and 2015.

Market Price of Common Stock: The market price of stock was $17 at 12/31/13, $22 at 12/31/14, and $38 at 12/31/15.

Treasury Stock: The firm purchased 10,000 treasury shares at year-end 2013; 5,000 at year-end 2014; and 25,000 at year-end 2015.

12. Analysts Earnings Forecast: During 2015, the firm's CEO was very bullish about its prospects and it led to a consensus earnings forecast of $15.20 per share and continued growth in its other metrics such as ROE, ROA, etc.

13. Research and Development Costs: All research and development costs are expensed as incurred. The firm has enjoyed a higher success rate with its R&D relative to its industry peers. There are two types of R&D and each type equals about 50 percent of total R&D costs: software development and patent development. For both types, the turnaround time between initial research and the beginning of benefits from a particular project averages 18 months. For software projects, once benefits begin, the firm estimates that it lasts four years until new technology has superseded it. See footnote 14 for patent research and development costs. For sake of simplicity, assume that all R&D costs occur at the beginning of each calendar year.

14. Pending Litigation: During 2014, Wood Inc. (i.e., a competitor of EAP) filed a lawsuit against EAP for patent infringement. The lawsuit claims $1,500,000 of damages. EAP has denied any wrongdoing. The court proceedings began in 2015 and will continue into 2016. The plaintiff argues that beginning in 2013, EAP used Wood's patents to develop its products and such generated revenue and income, which - they argue - is a direct result of Wood's technology. EAP's lawyers have argued that because there is still more litigation, they are unable to make predictions about the likelihood of a verdict and the amount. Legal experts that have followed this case argue that the Wood has provided compelling evidence that Wood used its technology and that Wood is likely to lose and the damages will be anywhere from $1,000,000 to $1,500,000. The technology for these patents expires in 2016.

15. Patents Purchased Externally: On December 31, 2012, EAP purchased a patent from Rotech for $500,000. Even though the patent had 14-years remaining on its legal life, EAP estimated that the useful life would be closer to ten years on the date of purchase. An analyst recently noted that EAP has been able to leverage this patent with its existing product line to facilitate top line revenue growth. As a result, this analyst believes that the true value of this patent at year-end 2015 is approximately $1,000,000.

Patents Generated Internally: The research and development cost for patents has generated several technologies that are currently benefitting the firm. The original costs of these patents was $4,000,000 and so far have generated benefits well in excess of this amount. The R&D for these patents was completed in early-2012 and immediately began generating revenues; these revenues are expected to benefit the firm through year-end 2019 although the expected benefits over the next four years are not as great as the first four years. As of year-end 2015, the value of these patents is estimated at $2,800,000.

Questions-

Accounts Receivable

1. Calculate the dollar amount of write-offs during 2015.

2. This question is a general question. Describe the difference between a write-off and bad debt expense.

3. Is there any evidence to show that the credit manager either over, under, or correctly estimated the 2014 accounts receivable default rate? Identify two pieces of evidence that supports your conclusion.

Inventory

LIFO/FIFO

4. Calculate the balance in the LIFO Reserve at year-end 2014 and 2015.

5. Calculate 2014 net income after tax under FIFO.

6. Calculate 2015 cash under FIFO.

Write-off

7. Explain how the 2013 write-off impacted the income statement, balance sheet, and statement of cash flows. Assume no taxes.

8. Explain the intuition behind how, on the write-off announcement date, the stock price declined by 11 percent.          

Trading Securities

9. Prepare the 2015 t-account for trading securities.

10. Calculate the dollar return that the firm earned on its trading securities during 2015. Assume no taxes.

11. Calculate the percent return that the firm earned on its trading securities during 2015. Assume no taxes.

12. Did the firm earn a strong percent on its return? Comment.

Available for Sale Securities

13. Prepare the 2015 t-account for available for sale securities.

14. Calculate the original cost of available for sale securities held at year-end 2015.

Investment in Cunningham

15. Calculate the "cash received from dividends" for Cunningham only (not for TS or AS) that would be reported on the 2015 direct method cash flow statement.

16. Calculate the total assets, total liabilities, and total stockholders' equity of Cunningham at 12/31/15. Assume no taxes.

Research & Development and Patents

17. Recalculate the 2015 return on assets assuming that the firm capitalized the amount that it invested in its internally generated patents. Assume no taxes.

Treasury Stock

18. Prepare the journal entry to record the 2013 purchase of treasury stock.

Goodwill

19. Calculate the original purchase price that EAP paid for Jones Corporation during 2010.

20. Prepare the journal entry to record the goodwill write-off.

21. Upon the announcement of the goodwill write-off, the stock price decreased by .001 percent. Provide an explanation as to why this change is so small.

Pending Litigation

22. Assume that in 2016, the firm loses the lawsuit and pays out $1,200,000 of damages. Prepare the journal entry for this loss. Also show how this journal entry impacts the balance sheet, income statement, statement of cash flows, and statement of stockholders' equity.

Other Questions

23. How much of the 2015 ROE is derived from the operational strategy of the firm and how much from its financial strategy.

24. Prepare the 2015 operating activities section of the direct method statement of cash flows.