FREDERICKS OF HOLLYWOOD PP&E ANALYSIS

Read the case material and answer the following questions:

1. What types of long-term assets does Fredericks of Hollywood own?

2. The 1996 balance sheet shows accumulated depreciation of $19,479,000. How much of this is attributable to the land account? Why?

3. How does Fredericks of Hollywood depreciate property and equipment? Does this policy seem reasonable? What are the tradeoffs management makes in choosing a depreciation policy?

4. Use the balance sheet equation to analyze the transactions in the Property & equipment, at cost and Accumulated depreciation and amortization accounts for the period September 3, 1995 to August 31, 1996. Begin by entering the beginning and ending balances of these accounts. Then determine the increases and decreases in the accounts due to the following events:

i. The purchase of new property and equipment in fiscal 1996.

ii. Depreciation for fiscal 1996.

iii. The sale of property and equipment in fiscal 1996. (According to the statement of cash flows, Fredericks of Hollywood received proceeds on the sale of fixed assets amounting to $7,000 in fiscal 1996 and recorded a loss of $84,000 on this disposal. Using this information to calculate the decrease in Property & equipment, at cost and the increase in Accumulated depreciation and amortization accounts.

5. Assume the fixed assets purchased during fiscal 1996 have an expected useful life of 5 years and a salvage value of $573,000. Prepare a balance sheet equation worksheet to show the (a) cost, (b) accumulated depreciation, (c) book value, and (d) depreciation expense of this equipment for each fiscal year over its expected life, assuming a full-year deprecation is taken in fiscal 1996 and the company uses:

i. Straight-line depreciation.

ii. Double declining balance depreciation.

6. Calculate the fixed asset turnover ratio, which measures the efficiency with which management is using its invested capital, for fiscal 1995 and 1996. The formula is: = /

Frederick's of HollywoodProperty & Equipment Frederick's of Hollywood, Inc. is a specialty retailer, operating a chain of women's intimate apparel stores throughout the United States. The company also has a national mail order apparel business selling lingerie, bras, foundations, dresses, sportswear, leisurewear, swimwear, hosiery, specialty menswear and accessories. Frederick's of Hollywood purchases its merchandise from a variety of manufacturers. . Learning Objectives Synthesize information from various financial statements to analyze fixed asset and depreciation transactions. Prepare journal entries related to fixed asset transactions. Compute depreciation expenses using common accounting methods. Calculate gains and losses on fixed asset disposals. Calculate and interpret the fixed asset turnover ratio. a. Refer to the 1996 financial statements of Frederick's of Hollywood, Inc. Concepts Based on the above description of Frederick's of Hollywood, what sort of property and equipment do you think the company has? b. Does Frederick's of Hollywood own all the property and equipment it reports on the balance sheet? c. The 1996 balance sheet shows accumulated depreciation of $19,479,000. How much of this is attributable to the land account? (Hint: You should be able to answer this without looking at the statements.) d. How does Frederick's of Hollywood depreciate property and equipment? Does this policy seem reasonable? Explain the tradeoffs management makes in choosing a depreciation policy. Process e. Use T-accounts to reconstruct the activity in the Property & equipment, at cost" and "Accumulated depreciation and amortization accounts for the period September 3, 1995 to August 31, 1996. Begin by entering the opening and ending balances in the accounts. Then, determine the appropriate increases and decreases in the account due to the following (Hint: what journal entry did the company record for each event?): i. The purchase of new property and equipment in fiscal 1996. ii. Depreciation for fiscal 1996. iii. The sale of property and equipment in fiscal 1996. f. According to the statement of cash flows, Frederick's of Hollywood received proceeds on the sale of fixed assets amounting to $7,000 in fiscal 1996 and recorded a loss of $84,000 on this disposal. Recalculate the loss and prepare the journal entry to record the transaction. g. Assume that the fixed assets purchased during fiscal 1996 have an expected useful life of five years and a salvage value of $573,000. Prepare a table showing the depreciation expense and net book value of this equipment over its expected life assuming that a full year of depreciation is taken in fiscal 1996 and the company uses: i. Straight-line depreciation. Frederick's of HollywoodProperty & Equipment 1 Copyright 2004 by Prentice Hall, Inc. All rights reserved. No part of this publication may be reproducea in any form for any purpose without the written permission of the publisher. Double declining balance depreciation. h. Assume the equipment purchased in fiscal 1996 was sold September 1, 1996 (i.e., the first day of fiscal 1997) for proceeds of $3,200,000. Prepare the journal entry to record the transaction assuming Frederick's accounting policy states that no depreciation is taken in the year of disposal and that the company uses: i. Straight-line depreciation. ii. Double declining balance depreciation. Analysis A ratio analysts use to gauge the efficiency with which management is using its invested capital is the fixed asset turnover ratio. The ratio is defined as: Sales Fixed Asset Turnover=- Average Fixed Assets Determine Frederick's of Hollywood's fixed asset turnover ratio for fiscal 1995 and 1996. Comment on the year over year change. (The balance of Net Property and Equipment at September 3, 1994 was $19,892,000.) September 3 1995 August 28 1994 $142,931 $132,153 FREDERICK'S OF HOLLYWOOD, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (000's omitted) For the fiscal year ended August 31 1996 Net sales $148,090 Costs and expenses: Cost of goods sold, buying and occupancy costs 88,059 Selling, general and administrative expenses 60,871 Provision for store closing 148.930 Operating profit(loss) (840) Other income (expense): Interest expense (107) Miscellaneous 283 84,203 77, 409 54, 957 (790) 52, 530 3.442 138,370 133.381 4,561 (1,228) (118) (31) (150) (327) 176 (149) (477) (664) (226) 4,412 1,760 (1,705) (682) (438) 2,652 (1,023) 120 Earnings (loss) before income taxes Income taxes (benefit) Earnings (loss) before cumulative effect of a change in accounting principle Cumulative effect of a change in accounting principle Net earnings (loss) Earnings (loss) per share Primary - Classes A & B Fully diluted Classes A & B Weighted average shares outstanding Primary - Classes A & B Fully diluted - Classes A & B $ (438) $ 2.652 $ (903) .05) .05) Vu .31 .30 $ $ .10) .10) 8 745 8,745 8,693 8, 702 8,876 8,875 See accompanying notes to consolidated financial statements September 2 1995 $11, 441 658 213 19,862 765 2.615 35, 554 128 698 13,473 18,878 1.686 34,863 FREDERICK'S OF HOLLYWOOD, INC. CONSOLIDATED BALANCE SHEETS (000's omitted) August 31 1996 Assets Current assets Cash and cash equivalents $ 8,379 Short term investment 480 Accounts receivable 499 Income tax receivable 945 Merchandise inventories 19,553 Deferred income taxes 843 Prepaid expenses 2.215 Total current assets 32,914 Property and equipment, at cost Land 128 Buildings and improvements 881 Fixtures and equipment 14,687 Leasehold improvements 20,130 Property under capital leases 1.686 37,512 Less accumulated depreciation and amortization (19,479) Net property and equipment 18,033 Deferred catalog costs 1,723 Other assets 39 $52.709 Liabilities and Stockholders' Equity Current liabilities Accounts payable $10,298 Dividends payable 221 Current portion of Capital lease obligations 212 ESOP loan guarantee 240 Accrued payroll 430 Accrued insurance 828 Other accrued expenses 238 Total current liabilities 12,467 Capital lease obligations 672 ESOP loan guarantee 240 Deferred rent 811 Deferred income taxes 2,994 Stockholders' equity Capital stock of $i par value Authorized 15,000,000 class A shares, 35,000,000 class B shares; issued 2,955,000 Class A shares, 5,903,000 class B shares in 1996 and 1995 8,858 Additional paid-in capital 732 Reduction for ESOP loan guarantee (456) Treasury stock Retained earnings 26,397 Total stockholders' equity 35,525 $52.709 See accompanying notes to consolidated financial statements. (16,638) 18, 225 2, 107 39 $55.925 $11,617 221 200 240 526 1,018 469 14,291 884 480 669 3,002 (6) 8,858 738 (701) (5) 27,709 36,599 $55.925 on sale 431 283 677 3,011 215 (86) 6.611 2 FREDERICK'S OF HOLLYWOOD, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the fiscal year ended August 31 Sept. 2 (000's omitted) Sept. 3 1996 1995 1994 Cash Flows from Operating Activities: Net income (loss) $ (438) $2,652 $ (903) Adjustments to reconcile net income to net cash provided by en for store closing activities: (1,852) 3,290 4, 174 4,105 4,206 ESOP 257 compensation 224 Loss on of fixed assets 84 358 Changes in assets and liabilities: Accounts receivable 159 (130) (54) Income tax receivable (732) 668 (881) Merchandise inventories 309 (1,948) (753) Prepaid expenses 400 (403) (746) Deferred catalog costs 384 other assets (1) 5 Accounts payable and accrued expenses (1,836) Deferred rent 142 158 Deferred income taxes 779 (1,062) Income taxes payable (258) Net cash provided by operating activities 2,817 4,836 Cash Flows from Investing Activities: Proceeds from sale of fixed assets 7 205 Purchase of short term investments (480) Capital expenditures (4,073) (3.082) (2,348) Net cash used for investing activities (4,546) (2,877) (2,346) Cash Flows from Financing Activities: Payment of capital lease obligations (200) (365) (506) Payment of dividends (869) (431) (443) Payment of dividends on unearned mon ESOP shares (17) wo (11) Purchase of treasury stock (7) (26) Proceeds from exercise of stock options 108 Net increase (decrease) in ESOP loan guarantee (liability) (240) (240) 960 Reduction for ESOP loan guarantee (equity) (960) Stock split (1) (4) Net cash used for financing activities (1,333) (1,074) (845) Net increase (decrease) in cash and cash equivalents (3,062) 885 3,420 Cash and cash equivalents at beginning of year 11,441 10.556 7.136 Cash and cash equivalents at end of year $_8.379_$11.441 $10.556 Supplemental disclosure to consolidated statements of cash flows: Cash flow information: Interest paid $ 111 $ 118 $ 150 Income taxes paid 601 802 1,386 Non-cash investing and financing transactions : Leases capitalized 747 Dividends declared 221 221 Provision for store closing Fixed asset disposal 756 475 Inventory disposal 183 24 FREDERICK'S OF HOLLYWOOD, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (excerpts) One. Summary of Significant Accounting Policies The Company and Basis of Presentation The consolidated financial statements include the accounts of Frederick's of Hollywood, Inc. and its subsidiaries (collectively referred to as the Company). All significant intercompany balances and transactions have been eliminated in consolidation. Depreciation and Amortization Properties and equipment are depreciated on the straight-line method based upon useful lives which range from 10 to 25 years for buildings and improvements and four to ten years for equipment. Leasehold improvements are amortized over the remaining term of the lease or their useful lives, whichever is shorter. Impairment of Long-Lived Assets In the event that facts and circumstances indicate that the cost of long-lived assets or other assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to market value or discounted cash flow value is required. Leases and commitments The Company leases office equipment under capital leases expiring in various years through 2000. Future minimum lease payments under capital leases are as follows (000's omitted): 1997 $ 211 1998 225 1999 238 2000 210 Total minimum lease payments $ 884 Less amount representing interest 102 Present value of minimum lease payments $ 782 are no executory costs of contingent rental provisions in the capital leases $ Frederick's of HollywoodProperty & Equipment Frederick's of Hollywood, Inc. is a specialty retailer, operating a chain of women's intimate apparel stores throughout the United States. The company also has a national mail order apparel business selling lingerie, bras, foundations, dresses, sportswear, leisurewear, swimwear, hosiery, specialty menswear and accessories. Frederick's of Hollywood purchases its merchandise from a variety of manufacturers. . Learning Objectives Synthesize information from various financial statements to analyze fixed asset and depreciation transactions. Prepare journal entries related to fixed asset transactions. Compute depreciation expenses using common accounting methods. Calculate gains and losses on fixed asset disposals. Calculate and interpret the fixed asset turnover ratio. a. Refer to the 1996 financial statements of Frederick's of Hollywood, Inc. Concepts Based on the above description of Frederick's of Hollywood, what sort of property and equipment do you think the company has? b. Does Frederick's of Hollywood own all the property and equipment it reports on the balance sheet? c. The 1996 balance sheet shows accumulated depreciation of $19,479,000. How much of this is attributable to the land account? (Hint: You should be able to answer this without looking at the statements.) d. How does Frederick's of Hollywood depreciate property and equipment? Does this policy seem reasonable? Explain the tradeoffs management makes in choosing a depreciation policy. Process e. Use T-accounts to reconstruct the activity in the Property & equipment, at cost" and "Accumulated depreciation and amortization accounts for the period September 3, 1995 to August 31, 1996. Begin by entering the opening and ending balances in the accounts. Then, determine the appropriate increases and decreases in the account due to the following (Hint: what journal entry did the company record for each event?): i. The purchase of new property and equipment in fiscal 1996. ii. Depreciation for fiscal 1996. iii. The sale of property and equipment in fiscal 1996. f. According to the statement of cash flows, Frederick's of Hollywood received proceeds on the sale of fixed assets amounting to $7,000 in fiscal 1996 and recorded a loss of $84,000 on this disposal. Recalculate the loss and prepare the journal entry to record the transaction. g. Assume that the fixed assets purchased during fiscal 1996 have an expected useful life of five years and a salvage value of $573,000. Prepare a table showing the depreciation expense and net book value of this equipment over its expected life assuming that a full year of depreciation is taken in fiscal 1996 and the company uses: i. Straight-line depreciation. Frederick's of HollywoodProperty & Equipment 1 Copyright 2004 by Prentice Hall, Inc. All rights reserved. No part of this publication may be reproducea in any form for any purpose without the written permission of the publisher. Double declining balance depreciation. h. Assume the equipment purchased in fiscal 1996 was sold September 1, 1996 (i.e., the first day of fiscal 1997) for proceeds of $3,200,000. Prepare the journal entry to record the transaction assuming Frederick's accounting policy states that no depreciation is taken in the year of disposal and that the company uses: i. Straight-line depreciation. ii. Double declining balance depreciation. Analysis A ratio analysts use to gauge the efficiency with which management is using its invested capital is the fixed asset turnover ratio. The ratio is defined as: Sales Fixed Asset Turnover=- Average Fixed Assets Determine Frederick's of Hollywood's fixed asset turnover ratio for fiscal 1995 and 1996. Comment on the year over year change. (The balance of Net Property and Equipment at September 3, 1994 was $19,892,000.) September 3 1995 August 28 1994 $142,931 $132,153 FREDERICK'S OF HOLLYWOOD, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (000's omitted) For the fiscal year ended August 31 1996 Net sales $148,090 Costs and expenses: Cost of goods sold, buying and occupancy costs 88,059 Selling, general and administrative expenses 60,871 Provision for store closing 148.930 Operating profit(loss) (840) Other income (expense): Interest expense (107) Miscellaneous 283 84,203 77, 409 54, 957 (790) 52, 530 3.442 138,370 133.381 4,561 (1,228) (118) (31) (150) (327) 176 (149) (477) (664) (226) 4,412 1,760 (1,705) (682) (438) 2,652 (1,023) 120 Earnings (loss) before income taxes Income taxes (benefit) Earnings (loss) before cumulative effect of a change in accounting principle Cumulative effect of a change in accounting principle Net earnings (loss) Earnings (loss) per share Primary - Classes A & B Fully diluted Classes A & B Weighted average shares outstanding Primary - Classes A & B Fully diluted - Classes A & B $ (438) $ 2.652 $ (903) .05) .05) Vu .31 .30 $ $ .10) .10) 8 745 8,745 8,693 8, 702 8,876 8,875 See accompanying notes to consolidated financial statements September 2 1995 $11, 441 658 213 19,862 765 2.615 35, 554 128 698 13,473 18,878 1.686 34,863 FREDERICK'S OF HOLLYWOOD, INC. CONSOLIDATED BALANCE SHEETS (000's omitted) August 31 1996 Assets Current assets Cash and cash equivalents $ 8,379 Short term investment 480 Accounts receivable 499 Income tax receivable 945 Merchandise inventories 19,553 Deferred income taxes 843 Prepaid expenses 2.215 Total current assets 32,914 Property and equipment, at cost Land 128 Buildings and improvements 881 Fixtures and equipment 14,687 Leasehold improvements 20,130 Property under capital leases 1.686 37,512 Less accumulated depreciation and amortization (19,479) Net property and equipment 18,033 Deferred catalog costs 1,723 Other assets 39 $52.709 Liabilities and Stockholders' Equity Current liabilities Accounts payable $10,298 Dividends payable 221 Current portion of Capital lease obligations 212 ESOP loan guarantee 240 Accrued payroll 430 Accrued insurance 828 Other accrued expenses 238 Total current liabilities 12,467 Capital lease obligations 672 ESOP loan guarantee 240 Deferred rent 811 Deferred income taxes 2,994 Stockholders' equity Capital stock of $i par value Authorized 15,000,000 class A shares, 35,000,000 class B shares; issued 2,955,000 Class A shares, 5,903,000 class B shares in 1996 and 1995 8,858 Additional paid-in capital 732 Reduction for ESOP loan guarantee (456) Treasury stock Retained earnings 26,397 Total stockholders' equity 35,525 $52.709 See accompanying notes to consolidated financial statements. (16,638) 18, 225 2, 107 39 $55.925 $11,617 221 200 240 526 1,018 469 14,291 884 480 669 3,002 (6) 8,858 738 (701) (5) 27,709 36,599 $55.925 on sale 431 283 677 3,011 215 (86) 6.611 2 FREDERICK'S OF HOLLYWOOD, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the fiscal year ended August 31 Sept. 2 (000's omitted) Sept. 3 1996 1995 1994 Cash Flows from Operating Activities: Net income (loss) $ (438) $2,652 $ (903) Adjustments to reconcile net income to net cash provided by en for store closing activities: (1,852) 3,290 4, 174 4,105 4,206 ESOP 257 compensation 224 Loss on of fixed assets 84 358 Changes in assets and liabilities: Accounts receivable 159 (130) (54) Income tax receivable (732) 668 (881) Merchandise inventories 309 (1,948) (753) Prepaid expenses 400 (403) (746) Deferred catalog costs 384 other assets (1) 5 Accounts payable and accrued expenses (1,836) Deferred rent 142 158 Deferred income taxes 779 (1,062) Income taxes payable (258) Net cash provided by operating activities 2,817 4,836 Cash Flows from Investing Activities: Proceeds from sale of fixed assets 7 205 Purchase of short term investments (480) Capital expenditures (4,073) (3.082) (2,348) Net cash used for investing activities (4,546) (2,877) (2,346) Cash Flows from Financing Activities: Payment of capital lease obligations (200) (365) (506) Payment of dividends (869) (431) (443) Payment of dividends on unearned mon ESOP shares (17) wo (11) Purchase of treasury stock (7) (26) Proceeds from exercise of stock options 108 Net increase (decrease) in ESOP loan guarantee (liability) (240) (240) 960 Reduction for ESOP loan guarantee (equity) (960) Stock split (1) (4) Net cash used for financing activities (1,333) (1,074) (845) Net increase (decrease) in cash and cash equivalents (3,062) 885 3,420 Cash and cash equivalents at beginning of year 11,441 10.556 7.136 Cash and cash equivalents at end of year $_8.379_$11.441 $10.556 Supplemental disclosure to consolidated statements of cash flows: Cash flow information: Interest paid $ 111 $ 118 $ 150 Income taxes paid 601 802 1,386 Non-cash investing and financing transactions : Leases capitalized 747 Dividends declared 221 221 Provision for store closing Fixed asset disposal 756 475 Inventory disposal 183 24 FREDERICK'S OF HOLLYWOOD, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (excerpts) One. Summary of Significant Accounting Policies The Company and Basis of Presentation The consolidated financial statements include the accounts of Frederick's of Hollywood, Inc. and its subsidiaries (collectively referred to as the Company). All significant intercompany balances and transactions have been eliminated in consolidation. Depreciation and Amortization Properties and equipment are depreciated on the straight-line method based upon useful lives which range from 10 to 25 years for buildings and improvements and four to ten years for equipment. Leasehold improvements are amortized over the remaining term of the lease or their useful lives, whichever is shorter. Impairment of Long-Lived Assets In the event that facts and circumstances indicate that the cost of long-lived assets or other assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to market value or discounted cash flow value is required. Leases and commitments The Company leases office equipment under capital leases expiring in various years through 2000. Future minimum lease payments under capital leases are as follows (000's omitted): 1997 $ 211 1998 225 1999 238 2000 210 Total minimum lease payments $ 884 Less amount representing interest 102 Present value of minimum lease payments $ 782 are no executory costs of contingent rental provisions in the capital leases $