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 company’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 financial 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, 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 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 earnings 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.

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EXHIBIT 9.7 H. J. Heinz Company Income Statement (amounts in millions) (Problem 9-9) Year 12 Year 1 Year 10 9,43 8,821 8,939 (6,094) 5,884 (5,789) Gain on sale of weight watchers Cost of goods sold Selling and administrative expenses nterest income Interest expense Other income (expense) Income before Income Taxes and Cumulative 1,746 (1,955) (1,882) (294) (333) (270) (25) Effect of Accounting Changes Income tax expense Income before Cumulative Effect of Accounting Change Cumulative effect of accounting change Net Income $ 1,279 673 $1,463 890 S 834 S478 890 (445) (178) 834 495 (17)