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impact on financial statements. What criteria should an analyst employ to assess whether to
include or eliminate items from the financial statements related to these eight topics?

9.5 EFFECT OF ALTERNATIVE GAAP ON FINANCIAL STATEMENT

ANALYSIS. Nestlé Group, a multinational food products firm based in Switzerland,
recently issued its financial statements. The auditor’s opinion attached to the financial
statements stated the following: “In our opinion, the Consolidated Accounts give a true and
fair view of the financial position, the net profit and cash flows in accordance with
International Financial Reporting Standards (IFRS) and comply with Swiss law.” Note that
Nestlé’s financial reports are prepared using IFRS standards. One of Nestlé’s competitors is
PepsiCo, which prepares financial reports following U.S. GAAP. Describe the necessary
steps an analyst should consider to develop comparable accounting data when conducting
a profitability and risk analysis of these two firms.

9.6 REPORTING IMPAIRMENT AND RESTRUCTURING CHARGES.

Checkpoint Systems is a global leader in shrink management, merchandising visibility, and
apparel labeling solutions. The firm is a leading provider of source tagging, handheld label-
ing systems, retail merchandising systems, and bar-code labeling systems. In a press release,
Checkpoint stated the following:
GAAP reported net loss for the fourth quarter of 2004 was $29.3 million, or $0.78 per
diluted share, compared to net earnings of $4.5 million, or $0.13 per diluted share,
for the fourth quarter 2003. Excluding impairment and restructuring charges, net of
tax, the Company’s net income for the fourth quarter 2004 was $0.30 per diluted
share, compared to $0.27 per diluted share in the fourth quarter 2003.
Calculate the amount of the impairment and restructuring charges reported by Checkpoint
in 2004 and 2003. Discuss why the firm reported earnings both including and excluding
impairment and restructuring charges.

9.7 CONCEPT OF A PERIPHERAL ACTIVITY. Firms often enter into transac-

tions that are peripheral to their core operations but generate gains and losses that must be
reported on the income statement. A gain labeled “peripheral” by one firm may not be
labeled as such for another firm. Provide an example in which a gain generated from the
sale of an equity security may be labeled a peripheral activity by one firm but is considered
a core activity by another firm.

9.8 REPORTING IMPAIRMENT CHARGES. Statement No. 144 requires firms

to assess whether they will recover carrying amounts of long-lived assets and, if not, to
write down the assets to their fair value and recognize an impairment loss in income from
continuing operations. Impairment charges often appear as a separate line item on the
income statement of companies that experience reductions in the future benefits originally
anticipated from the long-lived assets. Conduct a search to identify a firm (other than the
examples given in this chapter) that has recently reported an impairment charge. Discuss
how the firm (a) reported the charge on the income statement, (b) determined the amount
of the charge, and (c) used cash related to the charge.

Problems and Cases

9.9 ADJUSTING FOR UNUSUAL INCOME STATEMENT AND CLASSI-
FICATION ITEMS. H. J. Heinz is one of the world’s leading marketers of branded
foods to retail and foodservice channels. According to the firm, Heinz holds the number
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one or two branded products in more than 50 world product markets. Among the com-
pany’s well-known brands are Heinz®, StarKist®, Kibbles ’n Bits®, and 9Lives®. Exhibit 9.7
presents an income statement for Heinz for Year 10, Year 11, and Year 12. Notes to the finan-
cial statements reveal the following information:
1. Gain on sale of Weight Watchers. In Year 10, Heinz completed the sale of the Weight
Watchers classroom business for $735 million. The transaction resulted in a pretax
gain of $464.5 million. The sale did not include Weight Watchers® frozen meals,
desserts, and breakfast items. Heinz did not disclose the tax effect of the gain
reported in Exhibit 9.7.
2. Accounting change for revenue recognition. In Year 11, Heinz changed its method
of accounting for revenue recognition to recognizing revenue upon the passage of
title, ownership, and risk of loss to the customer. The change was driven by a new
SEC ruling on revenue recognition. The cumulative effect of the change on prior
years resulted in a charge to income of $17 million, net of income taxes of $10 million.
Heinz indicated that the effect on Year 11 and prior years was not material.
3. Sale and promotion costs. In Year 11, Heinz changed the classification of certain
sale and promotion incentives provided to customers and consumers. In the past,
Heinz classified these incentives as selling and administrative expenses (see Exhibit 9.7),
with the gross amount of the revenue associated with the incentives reported in
sales. Beginning in Year 11, Heinz changed to reporting the incentives as a reduction
of revenues. As a result of this change, the firm reduced reported revenues by $693
million in Year 12, $610 million in Year 11, and $469 million in Year 10. The firm
stated that selling and administrative expenses were “correspondingly reduced such

EXHIBIT 9.7
H. J. Heinz Company
Income Statement
(amounts in millions)
(Problem 9-9)

Year 12 Year 11 Year 10

Sales $ 9,431 $ 8,821 $ 8,939
Gain on sale of weight watchers — — 465
Cost of goods sold (6,094) (5,884) (5,789)
Selling and administrative expenses (1,746) (1,955) (1,882)
Interest income 27 23 25
Interest expense (294) (333) (270)
Other income (expense) (45) 1 (25)
Income before Income Taxes and Cumulative
Effect of Accounting Changes $ 1,279 $ 673 $ 1,463
Income tax expense (445) (178) (573)
Income before Cumulative Effect of Accounting Change $ 834 $ 495 $ 890
Cumulative effect of accounting change — (17) —
Net Income $ 834 $ 478 $ 890
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762 Chapter 9 Accounting Quality

that net earnings were not affected.” Exhibit 9.7 already reflects the adjustments to
sales revenues and selling and administrative expenses for Years 10 through 12.
4. Tax rate. The U.S. federal statutory income tax rate was 35 percent for each of the
years presented in Exhibit 9.7.

Required
a. Discuss whether you would adjust for each of the following items when using earn-
ings to forecast the future profitability of Heinz:
(1) Gain on sale of Weight Watchers classroom business
(2) Accounting change for revenue recognition
b. Indicate the adjustment you would make to Heinz’s net income for each item in Part a.
c. Discuss whether you believe the reclassification adjustments made by Heinz for the
sale and promotion incentive costs (Item 3) are appropriate.
d. Prepare a common-size income statement for Year 10, Year 11, and Year 12 using the
amounts in Exhibit 9.7. Set sales equal to 100 percent.
e. Repeat Part d after making the income statement adjustments in Part b.
f. Assess the changes in the profitability of Heinz during the three-year period.

9.10 UNUSUAL INCOME STATEMENT ITEMS. Vulcan Materials Company, a

member of the S&P 500 Index, is the nation’s largest producer of construction aggregates,
a major producer of asphalt mix and concrete, and a leading producer of cement in Florida.
Following is a summarized income statement prepared from Vulcan’s Consolidated
Statement of Earnings for the years ended December 31, 2008, 2007, and 2006.

In thousands 2008 2007 2006

Total revenues $3,651,438 $3,327,787 $3,342,475
Cost of revenues 2,901,726 2,376,884 2,410,571
SG&A 342,584 289,604 264,276
Goodwill impairment 252,664 — —
Loss (gain) on sale of property, plant &
equipment and businesses, net (94,227) (58,659) (5,557)
Other operating (income) expense, net (411) 5,541 (21,904)
Total operating expenses, net 3,402,336 2,613,370 2,647,386
Operating earnings 249,102 714,417 695,089
Other income (expense), net (4,357) (5,322) 28,541
Interest income 3,126 6,625 6,171
Interest expense (172,813) (48,218) (26,310)
Earnings from continuing operations
before income taxes 75,058 667,502 703,491
Provision for income taxes (76,724) (204,416) (223,313)
Earnings from continuing operations (1,666) 463,086 480,178
Discontinued operations (Note 2)
Loss from results of discontinued operations (4,059) (19,327) (16,624)
Income tax benefit 1,610 7,151 6,660
Loss on discontinued operations,
net of income taxes (2,449) (12,176) (9,964)
Net earnings (loss) $ (4,115) $ 450,910 $ 470,214
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In Note 2 to the Consolidated Financial Statements, “Discontinued Operations,” Vulcan

describes a June 2005 sale of substantially all assets of its Chemicals business, known as
Vulcan Chemicals, to Basic Chemicals, a subsidiary of Occidental Chemical Corporation.
Basic Chemicals assumed certain liabilities relating to the chemicals business, including the
obligation to monitor and remediate all releases of hazardous materials at or from the
Wichita, Geismar, and Port Edwards plant facilities. The decision to sell the chemicals
business was based on Vulcan’s desire to focus its resources on the construction materials
business. The amounts reported as discontinued operations are not revenues and expenses
from Vulcan operating the discontinued segment. Instead, the amounts represent a contin-
ual updating of the amount payable by the segment buyer. The receivable held by Vulcan
from the sale is dependent on the levels of gas and chemical prices through the end of 2012.
Vulcan classifies this financial instrument as a derivative contract that must be marked to
market. The derivative does not hedge an existing transaction; therefore, its value changes
are reflected in income as part of discontinued operations. As of 2008, Vulcan reported that
final gains on disposal (if any) would occur after December 31, 2008.
Goodwill impairment relates to Vulcan’s cement segment. Vulcan explains the need for
the impairment as arising from the need to increase discount rates due to disruptions in
credit markets as well as weak levels of construction activity.

Required
a. Discuss the appropriate treatment of the following when forecasting future earnings
of Vulcan Materials: (1) goodwill impairment; (2) discontinued operations; and
(3) loss (gain) on sale of property, plant, and equipment and businesses (net).
b. Prepare common-size income statements for Vulcan Materials. Interpret changes in
profit margin over the three-year period in light of the special items.

9.11 IMPLICATIONS OF A GOODWILL IMPAIRMENT CHARGE

FOR FUTURE CASH FLOW AND PROFITABILITY. Northrop Grumman
Corporation is a leading global security company that provides innovative systems prod-
ucts and solutions in aerospace, electronics, information systems, shipbuilding, and techni-
cal services to government and commercial customers worldwide. In an early 2009 press
release, Northrop reported that it would record a non-cash, after-tax charge of between
$3.0 billion and $3.4 billion for impairment of goodwill in its 2008 fourth-quarter income
statement. As a result of the charge, Northrop reported net losses for the fourth quarter and
all of 2008.
Northrop explained how it determined the impairment as follows: “The company per-
formed its required annual testing of goodwill as of Nov. 30, 2008 using a discounted cash
flow analysis supported by comparative market multiples to determine the fair value of its
businesses versus their book values. Testing as of Nov. 30, 2008 indicated that book values
for Shipbuilding and Space Technology exceeded the fair values of these businesses. . . . This
non-cash charge does not impact the company’s normal business operations.”

Required
a. Explain how a company computes a goodwill impairment. Describe the usefulness
of discounted cash flow and comparative market multiples in the computation of an
impairment.
b. Explain the consequences of a goodwill impairment for the assessment of (1) cur-
rent period profitability as measured by ROA, (2) future earnings projections, and
(3) future period profitability as measured by ROA.