Financial Statement Analysis Cases
Case 1: Merck and Johnson & Johnson
Merck & Co., Inc. and Johnson & Johnson are two leading producers of health care products. Each has considerable assets, and each expends considerable funds each year toward the development of new products. The development of new health care products is often very expensive, and risky. New products frequently must undergo considerable testing before approval for distribution to the public. For example, it took Johnson & Johnson 4 years and $200 million to develop its 1-DAY ACUVUE contacts lenses. Below are some basic data compiled from the financial statement of these two companies?
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(All dollars in millions)
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Johnson & Johnson
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Merck
|
|
Total assets
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$53,317
|
$42,573
|
|
Total revenue
|
47,348
|
22,939
|
|
Net income
|
8,509
|
5,813
|
|
Research and development expense
|
5,203
|
4,010
|
|
Intangible assets
|
11,842
|
2,765
|
Instructions:
1. What kinds of intangible assets might a health care products company have? Does the composition of this intangible matter to investors that is, would it be perceived differently if all of Merck's intangibles were goodwill than if all of its intangible was patents?
2. Suppose the president of Merck has come to you for advice. He has noted that by eliminating research and development expenditure the company could have reported $4 billion more in net income. He is frustrated because much of the research never results in a product, or the products take years to develop. He says shareholders are eager for higher returns, so he is considering eliminating research and development expenditure for at least a couple of years. What would you advise?
3. The notes to Merck's financial statement note that Merck has goodwill of $1.1 billion. Where does recorded goodwill come from? Is it necessarily a good thing to have a lot of goodwill on a company's books?
Case 2: Analysis of Goodwill
As a new intern for the local branch office of a national brokerage firm, you are excited to get an assignment that allows you to use your accounting expertise. Your supervisor provides you the spreadsheet below, which contains data for the most recent quarter for three companies that the firm has been recommending to its clients as "buys". Each of the companies' returns on assets has outperformed their industry cohorts in the past. But, given recent challenges and lower earnings. (All number in millions, except return on assets.)
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Company
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Fair value of company
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Book Value
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Carrying value of goodwill
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Return on assets
|
|
Sprint Nextel
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$36,361
|
$51,271
|
$30,718
|
3.5%
|
|
Washington Mutual
|
11,742
|
23,941
|
9,062
|
2.4%
|
|
E* Trade Financial
|
1,639
|
4,104
|
2,035
|
5.6%
|
Instruction:
1. The fair value of each of these companies is lower than the corresponding book value. What implication does this have for each company's future prospects?
2. To date, none of these companies has recorded goodwill impairments. Your supervisor suspects that they need to record impairments in the near future, but he is unsure about the goodwill impairment rules. Is it likely that these companies will recognize impairments? Explain.
3. Estimate the amount of goodwill impairment for each company and prepare the journal entry to record the impairment. For each company, you may assume that the book value less than the carrying value of the goodwill approximate the fair value of the companies' net assets.
4. Discuss the effects of your entries in part (3) on your evaluation of these companies based on the return on asset ratio?