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Refer to the 2013 financial statements and notes of Callaway Golf Company.

a. Note 11 reveals that the balance sheet inventory amount consists of three types of inventory. What types of costs do you expect to be in the raw materials inventory? In the work-in-process inventory? In the finished goods inventory?

b. Note 2 states that the inventory balance is recorded on a net basis. What are inventories net of?

c. In note 2, Callaway discusses its allowance for obsolete or unmarketable inventory a contra account against the inventory balance. Callaway does not directly disclose the balance or activity in this account in its public reports. For purposes of illustration, assume that Callaway experienced the following information in its allowance for obsolete and unmarketable inventory (in thousands):

Balance, December 31, 2012 $10,800

Provision 13,348

Write-offs, disposals and other (11,628)

Balance, December 31, 2013 $12,520

i. Where does this account appear on Callaways financial statements?

ii. What is the gross amount of inventory at the end of 2013? 2012?

iii. What portion of the reserve for obsolete inventory do you think is attributable to each of the three types of inventory held by Callaway?

d. Recreate the journal entries Callaway prepared to record the activity in the reserve for obsolete inventory account during 2013.

e. Set up five separate T-accounts: one for each of the three inventory accounts, one for Cost of sales and one for Accounts payable. Use the T-accounts to analyze inventory activity during 2013. Make the following simplifying assumptions.

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The only activity in Accounts payable is for raw materials purchases and payments for those purchases. See note 11 for account balances.

During 2013, a total of $126,000 (in thousands) of manufacturing salaries and overhead was debited to Work-in-process. All other activity in the work-in-process account is from raw materials transfers and transfers of completed products to Finished goods.

The reserve for obsolete inventory is included with the finished goods balance presented in note 11.

Complete the five T-accounts to determine the following amounts. Hint: Be sure to consider the journal entries you made in part d, above.

i. The cost of finished goods sold in 2013.

ii. The cost of finished goods transferred from work-in-process in 2013 (i.e., the cost of goods manufactured).

iii. The cost of raw materials transferred to work-in-process in 2013.

iv. The cost of raw materials purchased during 2013.

v. The amount of cash disbursed for raw material purchases during 2013.

f. The inventory turnover ratio measures how efficiently Callaway manages its inventory. The ratio is defined as:

Inventory turnover ratio =

Cost of sales Average inventories, net

Complete the following table to calculate Callaway Golfs inventory turnover ratio for 2013 and 2012. Note: the balance in Inventories, net was $233,070 thousand at December 31, 2011.

2013 2012

Cost of sales

Average inventories, net

Inventory turnover ratio

g. The inventory holding period is another common inventory efficiency ratio. It measures the number of days that it takes to sell inventory, and is defined as:

Inventory holding period =

365

Inventory turnover ratio

On average, how many days did it take for Callaway to manufacture and sell its inventory in 2013 and 2012? That is, what is the inventory holding period for 2013 and 2012? Compare Callaways inventory efficiency for 2013 and 2012. Is the company more or less efficient in its inventory management?

h. Assume that the reserve for obsolete inventory relates entirely to finished goods. Complete the table below to determine the percent of finished goods that Callaway estimated as obsolete in 2013 and 2012. What could explain the change from 2012 to 2013? As an investor or analyst, what additional information would you like from Callaway?

Finished goods inventory, net	2013		2012
+ Reserve for obsolete inventory
Finished goods inventory, gross
Portion obsolete	%		%

CONSOLIDATED BALANCE SHEETS

December 31,

(In thousands, except share and per share data) 2013 2012

Current assets:
Cash and cash equivalents	$ 36,793	$ 52,003
Accounts receivable, net	92,203	91,072
Inventories	263,492	211,734
Deferred taxes, net	6,419	4,170
Income taxes receivable	228	1,810
Other current assets	22,468	23,811
Assets held for sale		2,396
Total current assets	421,603	386,996
Property, plant and equipment, net	71,341	89,093
Intangible assets, net	88,901	89,189
Goodwill	29,212	29,034
Deferred taxes, net	2,299	1,910
Other assets	50,507	41,414
Total assets	$ 663,863	$ 637,636
LIABILITIES AND SHAREHOLDERS EQUITY
Current liabilities:
Accounts payable and accrued expenses	$ 157,120	$ 129,021
Accrued employee compensation and benefits	31,585	20,649
Asset-based credit facility	25,660
Accrued warranty expense	6,406	7,539
Income tax liability	5,425	3,430
Deferred taxes, net		927
Total current liabilities	226,196	161,566
Long-term liabilities:
Income taxes payable	4,387	6,565
Deferred taxes, net	35,271	33,533
Convertible notes, net (Note 4)	107,835	107,133
Long-term incentive compensation and other	5,555	7,131

Commitments and contingencies (Note 13) Shareholders equity:

Common stock, $.01 par value, 240,000,000 shares authorized, 78,314,902 shares and 72,264,020 shares

issued at December 31, 2013 and 2012, respectively	783	723
Additional paid-in capital	205,712	204,510
Retained earnings	77,038	113,831
Accumulated other comprehensive income	12,177	14,770
Less: Common stock held in treasury, at cost, 967,089 shares and 1,267,436 shares at December 31, 2013 and
2012, respectively	(11,091 )		(14,848 )
Total Callaway Golf Company shareholders equity	284,619		318,990
Non-controlling interest in consolidated entity (Note 10)			2,718
Total shareholders equity	284,619		321,708
Total liabilities and shareholders equity	$ 663,863		$ 637,636

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
	Year Ended December 31,
2013	2012	2011
Net sales $ 842,801	$ 834,065	$ 886,528
Cost of sales 528,043	585,897	575,226
Gross profit 314,758	248,168	311,302
Selling expenses 226,496	268,088	265,325
General and administrative expenses 68,087	66,773	92,756
Research and development expenses 30,937	29,542	34,309
Total operating expenses 325,520	364,403	392,390
Loss from operations (10,762 )	(116,235)	(81,088)
Interest income 558	550	546
Interest expense (9,123 )	(5,513 )	(1,618 )
Other income (expense), net 6,005	3,152	(8,101 )
Loss before income taxes (13,322 )	(118,046)	(90,261)
Income tax provision 5,599	4,900	81,559
Net loss (18,921 )	(122,946)	(171,820)
Dividends on convertible preferred stock 3,332	8,447	10,500
Net loss allocable to common shareholders $ (22,253 )	$ (131,393 )	$ (182,320 )
Loss per common share:
Basic $ (0.31 )	$ (1.96 )	$ (2.82 )
Diluted $ (0.31 )	$ (1.96 )	$ (2.82 )
Weighted-average common shares outstanding:
Basic	72,809		67,061		64,601
Diluted	72,809		67,061		64,601

The accompanying notes are an integral part of these consolidated financial statements.

CALLAWAY GOLF COMPANY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

Year Ended December 31,

	2013		2012	2011
Net loss	$ (18,921 )		$ (122,946)	$ (171,820 )
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments	(2,593 )		699	507
Comprehensive loss	$ (21,514 )		$ (122,247)	$ (171,313 )

The accompanying notes are an integral part of these financial statements.

CALLAWAY GOLF COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Year Ended December 31,

2013	2012	2011
Cash flows from operating activities:
Net loss $ (18,921)	$ (122,946)	$ (171,820)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization	25,543	34,411	38,636
Impairment charges		21,933	6,533
Deferred taxes	(2,309)	(1,925)	55,930
Non-cash share-based compensation	3,533	3,142	9,570
Loss/(gain) on disposal of long-lived assets and deferred gain amortization	2,242	(1,261)	(7,491)
Gain on sale of intangible assets		(6,602)
Discount amortization on convertible notes	702	235
Changes in assets and liabilities:
Accounts receivable, net	(6,690)		23,701		28,100
Inventories	(60,966)		20,216		36,460
Other assets	(190)		1,044		20,599
Accounts payable and accrued expenses	34,663		1,042		(12,613)
Accrued employee compensation and benefits	11,523		(4,057)		(4,187)
Income taxes receivable and payable	2,761		2,563		7,653
Accrued warranty expense	(1,133)		(601)		(287)
Other liabilities	293		297		3,015
Net cash (used in) provided by operating activities	(8,949)		(28,808)		10,098
Cash flows from investing activities:
Capital expenditures	(13,038)		(18,403)		(28,931)
Proceeds from sale of intangible assets			26,861
Proceeds from sale of property, plant and equipment	4,148		355		19,371
Investment in golf-related ventures	(13,637)		(3,268)
Net cash (used in) provided by investing activities	(22,527)		5,545		(9,560)
Cash flows from financing activities:
Proceeds from asset-based credit facility	25,660
Proceeds from issuance of convertible notes			46,819
Debt issuance costs			(3,534)		(2,467)
Issuance of common stock					2,195
Exercise of stock options	1,652		19
Equity issuance costs	(341)
Dividends paid, net	(5,599)		(11,019)		(13,093)
Other financing activities	(32)		(159)		80
Net cash provided by (used in) financing activities	21,340		32,126		(13,285)
Effect of exchange rate changes on cash and cash equivalents	(5,074)		117		727
Net (decrease) increase in cash and cash equivalents	(15,210)		8,980		(12,020)
Cash and cash equivalents at beginning of year	52,003		43,023		55,043
Cash and cash equivalents at end of year	$ 36,793		$ 52,003		$ 43,023
Supplemental disclosures:
Cash paid for interest and fees	$ (6,741)		$ (7,544)		$ (3,744)
Cash (paid) received for income taxes, net	$ (4,986)		$ (4,234)		$ 3,473
Noncash investing and financing activities:
Dividends payable	$	$ 131	$ 438
Issuance of common stock in exchange for preferred stock	$ 42,278	$	$
Issuance of convertible notes in exchange for preferred stock	$	$ 60,078	$
Issuance of treasury stock from the settlement of compensatory stock awards	$ 1,649	$ 3,735	$ 5,026
Acquisition of treasury stock for minimum statutory withholding taxes	$ (364)	$ (783)	$ (1,587)
Accrued capital expenditures at period end	$ 1,467	$ 92	$ 1,888

The accompanying notes are an integral part of these consolidated financial statements.

CALLAWAY GOLF COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 2. Significant Accounting Policies (excerpt)

Inventories

Inventories are valued at the lower of cost or fair market value. Cost is determined using the first-in, first-out (FIFO) method. The inventory balance, which includes material, labor and manufacturing overhead costs, is recorded net of an estimated allowance for obsolete or unmarketable inventory. The estimated allowance for obsolete or unmarketable inventory is based upon current inventory levels, sales trends and historical experience as well as managements estimates of market conditions and forecasts of future product demand, all of which are subject to change.

Note 11. Selected Financial Statement Information

	December 31,
(In thousands)	2013 2012
Accounts receivable, net:
Trade accounts receivable	$ 111,192 $ 103,999
Allowance for sales returns	(7,334 ) (6,383 )
Allowance for doubtful accounts	(11,655 ) (6,544 )
	$ 92,203 $ 91,072

Inventories:

Raw materials	$ 56,104		$ 43,469
Work-in-process	328		619
Finished goods	207,060		167,646
	$ 263,492		$ 211,734
Property, plant and equipment, net:
Land	$ 7,452	$ 8,892
Buildings and improvements	64,823	79,707
Machinery and equipment	126,282	153,303
Furniture, computers and equipment	120,943	126,733
Production molds	37,493	37,539
Construction-in-process	1,553	1,155
	358,546	407,329
Accumulated depreciation	(287,205 )	(318,236 )
	$ 71,341	$ 89,093
Accounts payable and accrued expenses:
Accounts payable	$ 59,914	$ 45,376
Accrued expenses	77,492	68,300
Accrued goods in-transit	19,714	15,345
	$ 157,120	$ 129,021
Accrued employee compensation and benefits:
Accrued payroll and taxes	$ 23,748		$ 12,256
Accrued vacation and sick pay	7,225		7,549
Accrued commissions	612		844
	$ 31,585		$ 20,649