6th edition Module 1 Selected Homework answers

E1-34 Balance sheet : Assets = Liabilities + Equity

a. Advanced Micro Devices

Using the accounting equation applied to end of year data
Assets ($4,556) = Liabilities ($2,956+$334=$3,290) + Equity (?)
Thus: $4,556-$3,290 = $1,266 Equity, end of year

Assets, beginning of year (?) + change in assets ($1,004) = Assets, end of year ($4,556)
Thus: $4,556 - $1,004 = $3,552 Assets, beginning of year

Intel
Using the accounting equation applied to end of year data
Assets ($123,249+4,714=$127,963) = Liabilities ($53,400) + Equity (?)
Thus: $127,963-$53,400 = $74,563 Equity, end of year

Liabilities, beginning of year (?) + change in liabilities (less $860) = Liabilities, end of year
($53,400) Thus: $53,400 + $830 = $54,230 Liabilities, beginning of year

b. Average assets = (assets, beginning of year + Assets, end of year) / 2

Advanced Micro Devices: (3,552 + 4,556) / 2 = 8,108/ 2 = 4,054
Intel: (123,249 + 127,963) / 2 = 251,212 / 2 = 125,606

c. High-tech companies must contend with a substantial amount of risk relating to changing
technology. Future cash flows are, therefore, not as certain and cannot support high levels of
debt. Thus, Intel has a large portion of their assets financed by equity (74,563/127,963) 58% in
the case of Intel.

E1-35 External constituents use accounting information from financial statements to answer
questions such as the following:

1. Shareholders (investors), ask questions such as:

a. Are the company’s resources adequate to carry out strategic plans?
b. Are the company’s debts appropriate in amount given the company’s existing assets
and plans for growth?
c. What is the current level of income (and what are its components)?
d. Is the current stock price indicative of the company’s profitability and level of debt?

2. Creditors, ask questions such as:

a. Does the business have the ability to repay its debts as they come due?
b. Can the business take on additional debt?
c. Are current assets sufficient to cover current liabilities?

3. Employees, ask questions such as:

a. Is the business financially stable?
b. Can the business afford to pay higher salaries?
c. What are growth prospects for the organization?
d. Will the company be able to pay my pension when I retire?
E1-36

a.
Norfolk Southern Inc.

Consolidated Statements of Changes In Retained Income

Beginning Balance at Dec. 31, 2015 $ 10,191

Net income 1,668

Dividends on Common Stock (695)

Share repurchases (731)

Other (8)

Ending Balance at Dec. 31, 2016 10,425

Net income 5,404

Dividends on Common Stock (703) 

Share repurchases (945)

Other (5)

Ending Balance at Dec. 31, 2017 14,176

Net income 2,666

Dividends on Common Stock (844)

Share repurchases (2,639)

Other 81

Ending Balance at Dec. 31, 2018 $ 13,440

b. True. Norfolk Southern did repurchase shares each year. This is shown as a subtraction
because shares repurchased decrease the amount of owners’ investment in the
company.

Retained Earnings is the balance sheet account that provides the link between the balance
sheet and the income statement. Each accounting period, Retained Earnings is updated by
the net income (loss) reported for that period (and is reduced by any dividends that are
declared to shareholders) as well as share repurchases. The balance sheet and the income
statement are, therefore, linked by this balance sheet account.

E1-37
a. Norfolk Southern was profitable during 2018 as evidenced by its positive net profit
margin of 23.3%.
 b. Norfolk Southern was more profitable in 2017 as the profitability ratio is 51.2% which is
higher than their profitability ratio in 2018 of 23.3%.
c. Norfolk Southern’s productivity measure (asset turnover) increased slightly from 0.299 in
2017 to 0.318 in 2018, indicating assets are generating a slightly higher level of sales
than in the prior year. This is a positive development.
d. ROA = Profit margin  asset turnover.
2018 ROA = 23.3%  0.318 = 7.4%.
2017 ROA = 51.2%  0.299 = 15.3%.

e. Number 1 as we see the profitability weakened considerably. The 2018 profit margin is
nearly half of the PM in 2017: 23.3% versus 51.2%

We do not have sufficient information to assess 3 and 4 so they are not true. Productivity
improved in 2018 so 2 is false.

E1-38 NORDSTROM, INC

Return on assets (ROA) = Net Income / Average assets
Average assets = (beginning of year total assets + end of year total assets) / 2
(8,115 + 7,886) / 2 = 16,001 / 2 = 8,000.5

Return on assets = 564 / 8000.5 = 7.05%

P1-41 WALMART INC. (note I updated the amounts based on the net income and equity
numbers per SEC.gov)

a. Return on equity (ROE) = Net Income / Average Equity

Average equity = (end of year equity + beginning of year equity) / 2

2019: (74,669 + 72,496) / 2 = 147,165 / 2 = 73,582.5

2018: (72,496 + 77,869) / 2 = 150,665 / 2 = 75,332.5
2017: (77,869 + 77,798) / 2 = 155,667 / 2 = 77,833.5

2019: ROE = $14,881 / 73,582.5= 20.22%

2018: ROE = $6,670 / 75,332.5 = 8.9%
2017: ROE = $9,862 / 77,833.5 = 12.7%

b. Return on assets (ROA) = Net Income / Average assets

Average assets = (end of year total assets + beginning year total assets) / 2

2019: (236,495 + 219,295) / 2 = 455,790 / 2= 227,895.0

2018: (219,295 + 204,522) / 2 = 423,817 / 2 = 211,908.5
2017: (204,522 + 198,825) / 2 = 403,347 / 2 = 201,673.5

2019: ROA = $14,881 / 227,895 = 6.52%

2018: ROA = $6,670 / 211,908.5 = 3.1%
 2017: ROA = $9,862 / 201,673.5 = 4.9%

Profit Margin = Net Income / Sales

2019: $14,881 / $519,926 = 2.86%

2018: $6,670 / $510,329 = 1.3%
2017: $9,862 / $495,761 = 2.0%

Asset turnover = Sales / Average assets

2019: $519,926 / 227,895.0 = 2.28

2018: $510,329 / 211,908.5 = 2.41
2017: $495,761 / 201,673.5 = 2.46

ROA = Profit margin * Asset turnover

2019: 2.86% * 2.28 = 6.52%

2018: 1.3% * 2.41 = 3.1%
2017: 2.0% * 2.46 = 4.9%

For 2019: per above, the profitability increased considerably as indicated by the profit margin
and the productivity weakened slightly.

Regarding question e in your book, for 2018: the profitability weakened considerably as
indicated by the profit margin and the productivity weakened slightly. The level of revenue and
assets is a factor but not the best explanation, making choices 3 and 4 incorrect.

P1-43 Five Below

Five Below

Income Statement ($ thousands)

For the year ended February 2, 2019

Revenues $1,559,563

Cost of goods sold 994,478

Gross profit 565,085

Expenses 373,278

Income before taxes 191,807

Income tax expense 42,162

 Net income $149,645

Five Below

Balance Sheet ($ thousands)

February 2, 2019

Cash $251,748 Liabilities $337,170

Noncash assets 700,516 Stockholders' equity 615,094

Total assets $952,264 Total liabilities and equity $952,264

Five Below

Statement of Cash Flow ($ thousands)

For the year ended February 2, 2019

Cash from operating activities $184,133

Cash from investing activities (39,472)

Cash from financing activities (5,582)

Net increase (decrease) in cash 139,079

Cash, beginning year 112,669

Cash, ending year $251,748

The company has positive cash from operating activities, its core business.
Negative cash flow from investing activities indicates investments in long-term assets indicating
growth in its infrastructure and is a positive sign.
Negative cash flow from financing activities indicates either repayment of debt or return of cash
to shareholders through dividends and share repurchases.

Average assets (952,264+695,708 / 2 = 823,986

Average equity (458,558+615,094) / 2 = 536,826

Profit margin (PM) * Asset turnover (AT) = Return on assets (ROA)

149,645/1,559,563 1,559,563/823,986 = 149,645/823,986
9.6% * 1.89 = 18.2%

ROE = Net income / Average equity = $149,645 / 536,826= 27.9%

P1-52

a. To answer the questions, hover over the appropriate spot on the graphic on the left and
read the pop-out boxes that appear.
i. Assets in 2017 are $56,669 million, the largest in the 10-year period.
ii. In general, Thermo Fisher’s asset grew steadily over the period. In 2015 assets
dipped and then decreased slightly again in in 2018.
iii. Liabilities track assets very closely. Equity increased smoothly during the period
with no sharp increases or decreases.
iv. Liabilities exceeded equity in four of the ten years: 2014, 2016, 2017 and 2018.

b. To answer the questions, hover over the appropriate spot on the middle graphic and
read the pop-out boxes that appear.
i. Net income more than doubled from 2009 to 2017, increasing from $850 million
to $2,225 million.
ii. Revenue grew each year in the 10-year period.
iii. In 2014, revenue increased $4 billion from about $13 billion to $17 billion. While
revenue increased nearly that much in 2018, it was on a larger base, so
proportionately the 2014 increase was the largest.
iv. In $ millions: 2017 profit margin = $2,225 / $20,918 = 10.6%.
2018 profit margin = $2,838 / $24,358 = 12.1%. Profit margin is larger in 2018.

v. In 2018, the company’s market cap $89,991 million.

c. To answer the questions, hover over the appropriate spot on the graphic on the right and
read the pop-out boxes that appear.
i. Operating cash flow was smallest in 2010, $1,498 million.
ii. The red bar represents financing cash flows, The red bar is left of $0 in five of the
10 years.
iii. In 2014, investing cash flow is very large and negative. In the prior two years
(2012 and 2013) and the next year (2015), investing cash flow fell to nearly $0.

d. The ROA for 2018 = $2,938 million / $56,232 million = 5.2%.

e. All three graphics show that 2014 was an unusual year. The negative investing cash flow
is very large and corresponds to a significant increase in assets (left graphic) and
revenue (middle graphic). One possible explanation is that Thermo Fisher acquired
another company (investing cash flow), which immediately increased both assets and
revenue.

P1-53

a. It is addressed to Twitter’s board of directors and shareholders.

 Auditors work for the benefit of the shareholders and report directly to the board of
directors, the elected representatives of the shareholders whose job it is to protect
shareholder interests. It would not be appropriate for the external auditors to report
directly to management because the auditors are examining management’s activities as
described in the company’s financial statements. Reporting to the board preserves the
auditor’s independence.

b. Statement 1 is true because the nature of the independent auditors’ opinion is that
the financial statements “present fairly, in all material respects, the financial condition
of the company.” Because this is standard audit-report language, any deviations
should raise a flag. “Present fairly” does not mean absolute assurance that the
financials are error-free. It means that a reasonable person would conclude that the
financial statements reasonably describe the financial condition of the company.

Statement 2 is not true because auditors are not responsible for detecting fraud. While
audit procedures might detect fraud, the auditors do not express an opinion about fraud
existence.

Statement 3 would be true if the word “misstatements” had read “material

misstatements”. The misstatements must be material enough to effect a user’s decision.

Statement 4 is true – PwC also rendered an opinion on the company’s system of internal
controls. Internal controls are designed to insure the integrity of the financial reporting
system and the preservation of the company’s assets. A well-functioning internal control
system is a critical component of the company’s overall corporate governance system.

Statement 5 is not true because it would be impossible for PwC to examine MOST of the
transactions. Instead, they audit critical areas and then use statistical techniques to look
at a representational sample of transactions.

c. The opinion is unqualified. This is the type of opinion all companies want.

d. 3 – Again there are two opinions in the audit report. (1) On the 4 Financial
statements as to whether or not the financial statements are fairly presented according
to GAAP and (2) Internal control structure as to whether or not internal control over
financial reporting is effective.