need help on checkpoint accounting

1. CheckPoint: Ratio, Vertical, and Horizontal Analyses The calculations you perform for this CheckPoint form the basis of your analysis of your capstone project. Write in 100 to 200 words an explanation of the three tools of financial statement analysis and the function of each. Examine PepsiCo, Inc.'s Consolidated Balance Sheet on p. A6 in Appendix A of Financial Accounting, especially its Current Assets, Current Liabilities, and Total Assets for years 2005 and 2004. Calculate the following for PepsiCo, Inc. and show your work: o o o The Current Ratio for 2005 The Current Ratio for 2004 Two measures of vertical analysisfor example, compute the current assets divided by total assets for each year, and express your result as a percentage o Two measures of horizontal analysisfor example, compute the total change in assets by percentage, by dividing current assets in 2005 by current assets in 2004. Compute a similar percentage for current liabilities Examine The Coca-Cola Company's Consolidated Balance sheet on p. B2 in Appendix B of Financial Accounting, especially its Current Assets, Current Liabilities, and Total Assets for years 2005 and 2004. Calculate the following for Coca-Cola and show your work: o o o The Current Ratio for 2005 The Current Ratio for 2004 Two measures of vertical analysisfor example, compute the current assets divided by total assets for each year, and express your result as a percentage o Two measures of horizontal analysisfor example, compute the total change in assets by percentage, by dividing current assets in 2005 by current assets in 2004. Compute a similar percentage for current liabilities Post your explanation and calculations. 1. CheckPoint: Ratio, Vertical, and Horizontal Analyses The calculations you perform for this CheckPoint form the basis of your analysis of your capstone project. Write in 100 to 200 words an explanation of the three tools of financial statement analysis and the function of each. Examine PepsiCo, Inc.'s Consolidated Balance Sheet on p. A6 in Appendix A of Financial Accounting, especially its Current Assets, Current Liabilities, and Total Assets for years 2005 and 2004. Calculate the following for PepsiCo, Inc. and show your work: o o o The Current Ratio for 2005 The Current Ratio for 2004 Two measures of vertical analysisfor example, compute the current assets divided by total assets for each year, and express your result as a percentage o Two measures of horizontal analysisfor example, compute the total change in assets by percentage, by dividing current assets in 2005 by current assets in 2004. Compute a similar percentage for current liabilities Examine The Coca-Cola Company's Consolidated Balance sheet on p. B2 in Appendix B of Financial Accounting, especially its Current Assets, Current Liabilities, and Total Assets for years 2005 and 2004. Calculate the following for Coca-Cola and show your work: o o o The Current Ratio for 2005 The Current Ratio for 2004 Two measures of vertical analysisfor example, compute the current assets divided by total assets for each year, and express your result as a percentage o Two measures of horizontal analysisfor example, compute the total change in assets by percentage, by dividing current assets in 2005 by current assets in 2004. Compute a similar percentage for current liabilities Post your explanation and calculations. Appendix A SPECIMEN FINANCIAL STATEMENTS: PepsiCo, Inc. T HE ANNUAL REPORT Once each year a corporation communicates to its stockholders and other interested parties by issuing a complete set of audited financial statements.The annual report, as this communication is called, summarizes the financial results of the company's operations for the year and its plans for the future. Many annual reports are attractive, multicolored, glossy public relations pieces, containing pictures of corporate officers and directors as well as photos and descriptions of new products and new buildings. Yet the basic function of every annual report is to report financial information, almost all of which is a product of the corporation's accounting system. The content and organization of corporate annual reports have become fairly standardized. Excluding the public relations part of the report (pictures, products, etc.), the following are the traditional financial portions of the annual report: Financial Highlights Letter to the Stockholders Management's Discussion and Analysis Financial Statements Notes to the Financial Statements Management's Report on Internal Control Management Certification of Financial Statements Auditor's Report Supplementary Financial Information In this appendix we illustrate current financial reporting with a comprehensive set of corporate financial statements that are prepared in accordance with generally accepted accounting principles and audited by an international independent certified public accounting firm. We are grateful for permission to use the actual financial statements and other accompanying financial information from the annual report of a large, publicly held company, PepsiCo, Inc. FINANCIAL HIGHLIGHTS Companies usually present the financial highlights section inside the front cover of the annual report or on its first two pages. This section generally reports the total or per share amounts for five to ten financial items for the current year and one or more previous years. Financial items from the income statement and the balance sheet that typically are presented are sales, income from continuing operations, net income, net income per share, net cash provided by operating activities, dividends per common share, and the amount of capital expenditures.The financial highlights section from PepsiCo's Annual Report is shown on page A-2. The financial information herein is reprinted with permission from the PepsiCo, Inc. 2005 Annual Report. The complete financial statements are available through a link at the book's companion website. A1 A2 Appendix A Specimen Financial Statements: PepsiCo, Inc. Financial Highlights PepsiCo, Inc. and Subsidiaries ($ in millions except per share amounts; all per share amounts assume dilution) Net Revenue Division Operating Profit Total: $32,562 Total: $6,710 PepsiCo International 35% 5% 28% 32% PepsiCo International 24% Quaker Foods North America 8% Quaker Foods North America 30% Frito-Lay North America 38% PepsiCo Beverages North America Frito-Lay North America PepsiCo Beverages North America % Chg(a) 2005 2004 $32,562 $29,261 11 Division operating profit $6,710 $6,098 10 Total operating profit $5,922 $5,259 13 Net income(b) $4,536 $4,004 13 $2.66 $2.32 15 $4,204 $3,705 13 $5,852 $5,054 16 Capital spending $1,736 $1,387 25 Common share repurchases $3,012 $3,028 (0.5) Dividends paid $1,642 $1,329 24 Long-term debt $2,313 $2,397 (3.5) Summary of Operations Total net revenue Earnings per share(b) Other Data Management operating cash flow(c) Net cash provided by operating activities (a) Percentage changes above and in text are based on unrounded amounts. (b) In 2005, excludes the impact of AJCA tax charge, the 53rd week and restructuring charges. In 2004, excludes certain prior year tax benefits, and restructuring and impairment charges. See page 76 for reconciliation to net income and earnings per share on a GAAP basis. (c) Includes the impact of net capital spending. Also, see \"Our Liquidity, Capital Resources and Financial Position\" in Management's Discussion and Analysis. L ETTER TO THE STOCKHOLDERS Nearly every annual report contains a letter to the stockholders from the chairman of the board or the president, or both. This letter typically discusses the company's accomplishments during the past year and highlights significant events such as mergers and acquisitions, new products, operating achievements, business philosophy, changes in officers or directors, financing commitments, expansion plans, and Financial Statements and Accompanying Notes future prospects. The letter to the stockholders is signed by Steve Reinemund, Chairman of the Board and Chief Executive Officer, of PepsiCo. Only a short summary of the letter is provided below. The full letter can be accessed at the book's companion website at www.wiley.com/college/weygandt. MANAGEMENT'S DISCUSSION AND ANALYSIS The management's discussion and analysis (MD&A) section covers three financial aspects of a company: its results of operations, its ability to pay near-term obligations, and its ability to fund operations and expansion. Management must highlight favorable or unfavorable trends and identity significant events and uncertainties that affect these three factors. This discussion obviously involves a number of subjective estimates and opinions. In its MD&A section, PepsiCo breaks its discussion into three major headings: Our Business, Our Critical Accounting Policies, and Our Financial Results. PepsiCo's MD&A section is 22 pages long. You can access that section at www.wiley.com/college/weygandt. FINANCIAL STATEMENTS AND A CCOMPANYING NOTES The standard set of financial statements consists of: (1) a comparative income statement for 3 years, (2) a comparative statement of cash flows for 3 years, (3) a comparative balance sheet for 2 years, (4) a statement of stockholders' equity for 3 years, and (5) a set of accompanying notes that are considered an integral part of the financial statements. The auditor's report, unless stated otherwise, covers the financial statements and the accompanying notes. PepsiCo's financial statements and accompanying notes plus supplementary data and analyses follow. A3 A4 Appendix A Specimen Financial Statements: PepsiCo, Inc. Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003 (in millions except per share amounts) 2005 2004 2003 Net Revenue........................................................................................................................... $32,562 $29,261 $26,971 Cost of sales........................................................................................................................... Selling, general and administrative expenses ........................................................................ Amortization of intangible assets........................................................................................... Restructuring and impairment charges.................................................................................. Merger-related costs............................................................................................................... 14,176 12,314 150 - - 12,674 11,031 147 150 - 11,691 10,148 145 147 59 Operating Profit ..................................................................................................................... 5,922 5,259 4,781 Bottling equity income............................................................................................................ Interest expense...................................................................................................................... Interest income....................................................................................................................... 557 (256) 159 380 (167) 74 323 (163) 51 Income from Continuing Operations before Income Taxes ................................................. 6,382 5,546 4,992 Provision for Income Taxes................................................................................................... 2,304 1,372 1,424 Income from Continuing Operations ..................................................................................... 4,078 4,174 3,568 Tax Benefit from Discontinued Operations ........................................................................... - 38 - Net Income ............................................................................................................................ $ 4,078 $ 4,212 $ 3,568 Net Income per Common Share Basic Continuing operations ....................................................................................................... Discontinued operations.................................................................................................... $2.43 - $2.45 0.02 $2.07 - Total .................................................................................................................................. $2.43 $2.47 $2.07 Net Income per Common Share Diluted Continuing operations ....................................................................................................... Discontinued operations.................................................................................................... $2.39 - $2.41 0.02 $2.05 - Total .................................................................................................................................. $2.39 $2.44* $2.05 * Based on unrounded amounts. See accompanying notes to consolidated financial statements. Net Revenue Operating Profit $5,922 $32,562 $26,971 2003 $29,261 2004 $5,259 $4,781 2005 2003 2004 2005 Net Income per Common Share Continuing Operations Income from Continuing Operations $2.41 $4,174 $4,078 2004 2005 2003 $2.39 2004 2005 $2.05 $3,568 2003 Financial Statements and Accompanying Notes Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003 (in millions) Operating Activities Net income................................................................................................................................. Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization ............................................................................................. Stock-based compensation expense..................................................................................... Restructuring and impairment charges ............................................................................... Cash payments for merger-related costs and restructuring charges ................................... Tax benefit from discontinued operations............................................................................. Pension and retiree medical plan contributions ................................................................... Pension and retiree medical plan expenses.......................................................................... Bottling equity income, net of dividends .............................................................................. Deferred income taxes and other tax charges and credits ................................................... Merger-related costs............................................................................................................. Other non-cash charges and credits, net ............................................................................. Changes in operating working capital, excluding effects of acquisitions and divestitures Accounts and notes receivable........................................................................................ Inventories ...................................................................................................................... Prepaid expenses and other current assets .................................................................... Accounts payable and other current liabilities................................................................ Income taxes payable...................................................................................................... 2005 2004 2003 $ 4,078 $ 4,212 $ 3,568 1,308 311 - (22) - (877) 464 (411) 440 - 145 1,264 368 150 (92) (38) (534) 395 (297) (203) - 166 1,221 407 147 (109) - (605) 277 (276) (286) 59 101 (272) (132) (56) 188 609 (130) (100) (31) 216 (268) (220) (49) 23 (11) 182 Net change in operating working capital.............................................................................. Other..................................................................................................................................... 337 79 (313) (24) (75) (101) Net Cash Provided by Operating Activities .............................................................................. 5,852 5,054 4,328 (750) (1,736) 88 (345) 214 3 - (1,387) 38 (64) - 52 - (1,345) 49 (71) - 46 (83) 84 (992) (44) 38 (963) (38) 28 (940) (3,517) (2,330) (2,271) Investing Activities Snack Ventures Europe (SVE) minority interest acquisition ....................................................... Capital spending ....................................................................................................................... Sales of property, plant and equipment..................................................................................... Other acquisitions and investments in noncontrolled affiliates ................................................ Cash proceeds from sale of PBG stock ...................................................................................... Divestitures................................................................................................................................ Short-term investments, by original maturity More than three months purchases ................................................................................ More than three months maturities ................................................................................ Three months or less, net ..................................................................................................... Net Cash Used for Investing Activities ..................................................................................... Financing Activities Proceeds from issuances of long-term debt .............................................................................. Payments of long-term debt ...................................................................................................... Short-term borrowings, by original maturity More than three months proceeds................................................................................... More than three months payments ................................................................................. Three months or less, net ..................................................................................................... Cash dividends paid .................................................................................................................. Share repurchases common ................................................................................................. Share repurchases preferred ................................................................................................ Proceeds from exercises of stock options................................................................................... 25 (177) 504 (512) 52 (641) 332 (85) 1,601 (1,642) (3,012) (19) 1,099 153 (160) 1,119 (1,329) (3,028) (27) 965 88 (115) 40 (1,070) (1,929) (16) 689 Net Cash Used for Financing Activities .................................................................................... (1,878) (2,315) (2,902) Effect of exchange rate changes on cash and cash equivalents ............................................... (21) 51 27 Net Increase/(Decrease) in Cash and Cash Equivalents ......................................................... Cash and Cash Equivalents, Beginning of Year ....................................................................... 436 1,280 460 820 (818) 1,638 Cash and Cash Equivalents, End of Year ................................................................................. $ 1,716 $ 1,280 $ 820 See accompanying notes to consolidated financial statements. A5 A6 Appendix A Specimen Financial Statements: PepsiCo, Inc. Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 31, 2005 and December 25, 2004 (in millions except per share amounts) 2005 2004 Cash and cash equivalents................................................................................................................................... $ 1,716 $ 1,280 Short-term investments ........................................................................................................................................ 3,166 2,165 Accounts and notes receivable, net....................................................................................................................... 4,882 3,261 3,445 2,999 Inventories............................................................................................................................................................. 1,693 1,541 Prepaid expenses and other current assets........................................................................................................... 618 654 Total Current Assets ....................................................................................................................................... 10,454 8,639 Property, Plant and Equipment, net .................................................................................................................... 8,681 8,149 Amortizable Intangible Assets, net ...................................................................................................................... 530 598 Goodwill................................................................................................................................................................. 4,088 3,909 Other nonamortizable intangible assets................................................................................................................ 1,086 933 ASSETS Current Assets Nonamortizable Intangible Assets.................................................................................................................. 5,174 4,842 Investments in Noncontrolled Affiliates .............................................................................................................. 3,485 3,284 Other Assets ......................................................................................................................................................... 3,403 2,475 Total Assets................................................................................................................................................ $31,727 $27,987 LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Short-term obligations .......................................................................................................................................... $ 2,889 $ 1,054 Accounts payable and other current liabilities...................................................................................................... 5,971 5,599 Income taxes payable............................................................................................................................................ 546 99 Total Current Liabilities .................................................................................................................................. 9,406 6,752 Long-Term Debt Obligations................................................................................................................................. 2,313 2,397 Other Liabilities .................................................................................................................................................... 4,323 4,099 Deferred Income Taxes ........................................................................................................................................ 1,434 1,216 Total Liabilities ................................................................................................................................................ Commitments and Contingencies 17,476 14,464 Preferred Stock, no par value ............................................................................................................................. 41 41 Repurchased Preferred Stock ............................................................................................................................. (110) (90) Common stock, par value 1 2/3 per share (issued 1,782 shares)....................................................................... 30 30 Capital in excess of par value............................................................................................................................... Retained earnings ................................................................................................................................................. Accumulated other comprehensive loss ................................................................................................................ 614 21,116 (1,053) 618 18,730 (886) 20,707 18,492 Common Shareholders' Equity Less: repurchased common stock, at cost (126 and 103 shares, respectively) ................................................... (6,387) (4,920) Total Common Shareholders' Equity .............................................................................................................. 14,320 13,572 Total Liabilities and Shareholders' Equity ................................................................................................ $31,727 $27,987 See accompanying notes to consolidated financial statements. Financial Statements and Accompanying Notes Consolidated Statement of Common Shareholders' Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003 (in millions) Common Stock 2005 Shares 1,782 2004 Amount $ 30 Shares 1,782 2003 Amount $ 30 Shares 1,782 Amount $ 30 Capital in Excess of Par Value Balance, beginning of year........................................... Stock-based compensation expense............................. Stock option exercises(a) ............................................... 618 311 (315) 548 368 (298) 207 407 (66) Balance, end of year..................................................... 614 618 548 Retained Earnings Balance, beginning of year........................................... Net income ................................................................... Cash dividends declared common .......................... Cash dividends declared preferred ......................... Cash dividends declared RSUs ............................... Other ............................................................................ 18,730 4,078 (1,684) (3) (5) - 15,961 4,212 (1,438) (3) (2) - 13,489 3,568 (1,082) (3) - (11) Balance, end of year..................................................... 21,116 18,730 15,961 (886) (251) (1,267) 401 (1,672) 410 54 (8) (16) 9 (11) (1) 16 24 (2) (19) 6 - 7 1 (1) (1,053) (886) (1,267) Accumulated Other Comprehensive Loss Balance, beginning of year .......................................... Currency translation adjustment.................................. Cash flow hedges, net of tax: Net derivative gains/(losses) .................................. Reclassification of (gains)/losses to net income .... Minimum pension liability adjustment, net of tax ............................................................... Unrealized gain on securities, net of tax ...................... Other ............................................................................ Balance, end of year..................................................... Repurchased Common Stock Balance, beginning of year........................................... Share repurchases........................................................ Stock option exercises .................................................. Other ............................................................................ (103) (54) 31 - (4,920) (2,995) 1,523 5 (77) (58) 32 - (3,376) (2,994) 1,434 16 (60) (43) 26 - (2,524) (1,946) 1,096 (2) Balance, end of year..................................................... (126) (6,387) (103) (4,920) (77) (3,376) Total Common Shareholders' Equity ................................ $14,320 $13,572 $11,896 2005 2004 2003 Comprehensive Income Net income .................................................................. Currency translation adjustment.................................. Cash flow hedges, net of tax........................................ Minimum pension liability adjustment, net of tax ....... Unrealized gain on securities, net of tax ...................... Other ............................................................................ $4,078 (251) 46 16 24 (2) $4,212 401 (7) (19) 6 - $3,568 410 (12) 7 1 (1) Total Comprehensive Income ........................................... $3,911 $4,593 $3,973 (a) Includes total tax benefit of $125 million in 2005, $183 million in 2004 and $340 million in 2003. See accompanying notes to consolidated financial statements. A7 A8 Appendix A Specimen Financial Statements: PepsiCo, Inc. Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation Our financial statements include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates based on our economic ownership interest. We do not control these other affiliates, as our ownership in these other affiliates is generally less than 50%. Our share of the net income of noncontrolled bottling affiliates is reported in our income statement as bottling equity income. Bottling equity income also includes any changes in our ownership interests of these affiliates. In 2005, bottling equity income includes $126 million of pre-tax gains on our sales of PBG stock. See Note 8 for additional information on our noncontrolled bottling affiliates. Our share of other noncontrolled affiliates is included in division operating profit. Intercompany balances and transactions are eliminated. In 2005, we had an additional week of results (53rd week). Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. In connection with our ongoing BPT initiative, we aligned certain accounting policies across our divisions in 2005. We conformed our methodology for calculating our bad debt reserves and modified our policy for recognizing revenue for products shipped to customers by third-party carriers. Additionally, we conformed our method of accounting for certain costs, primarily warehouse and freight. These changes reduced our net revenue by $36 million and our operating profit by $60 million in 2005. We also made certain reclassifications on our Consolidated Statement of Income in the fourth quarter of 2005 from cost of sales to selling, general and administrative expenses in connection with our BPT initiative. These reclassifications resulted in reductions to cost of sales of $556 million through the third quarter of 2005, $732 million in the full year 2004 and $688 million in the full year 2003, with corresponding increases to selling, general and administrative expenses in those periods. These reclassifications had no net impact on operating profit and have been made to all periods presented for comparability. The preparation of our consolidated financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, future cash flows associated with impairment testing for perpetual brands and goodwill, useful lives for intangible assets, tax reserves, stock-based compensation and pension and retiree medical accruals. Actual results could differ from these estimates. See \"Our Divisions\" below and for additional unaudited information on items affecting the comparability of our consolidated results, see \"Items Affecting Comparability\" in Management's Discussion and Analysis. Tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless noted, and are based on unrounded amounts. Certain reclassifications were made to prior years' amounts to conform to the 2005 presentation. ning in the fourth quarter of 2005, we began centrally managing commodity derivatives on behalf of our divisions. Certain of the commodity derivatives, primarily those related to the purchase of energy for use by our divisions, do not qualify for hedge accounting treatment. These derivatives hedge underlying commodity price risk and were not entered into for speculative purposes. Such derivatives are marked to market with the resulting gains and losses recognized as a component of corporate unallocated expense. These gains and losses are reflected in division results when the divisions take delivery of the underlying commodity. Therefore, division results reflect the contract purchase price of the energy or other commodities. Division results are based on how our Chairman and Chief Executive Officer evaluates our divisions. Division results exclude certain Corporate-initiated restructuring and impairment charges, mergerrelated costs and divested businesses. For additional unaudited information on our divisions, see \"Our Operations\" in Management's Discussion and Analysis. Our Divisions We manufacture or use contract manufacturers, market and sell a variety of salty, sweet and grain-based snacks, carbonated and non-carbonated beverages, and foods through our North American and international business divisions. Our North American divisions include the United States and Canada. The accounting policies for the divisions are the same as those described in Note 2, except for certain allocation methodologies for stock-based compensation expense and pension and retiree medical expense, as described in the unaudited information in \"Our Critical Accounting Policies.\" Additionally, begin- Financial Statements and Accompanying Notes PepsiCo Beverages North America (PBNA) Frito-Lay North America (FLNA) 2005 FLNA...................................................................... PBNA..................................................................... PI ......................................................................... QFNA ..................................................................... Total division ........................................................ Divested businesses ............................................. Corporate .............................................................. Restructuring and impairment charges................ Merger-related costs............................................. Total...................................................................... $10,322 9,146 11,376 1,718 32,562 - - 32,562 - - $32,562 PepsiCo International (PI) 2004 Net Revenue $ 9,560 8,313 9,862 1,526 29,261 - - 29,261 - - $29,261 Quaker Foods North America (QFNA) 2003 2005 $ 9,091 7,733 8,678 1,467 26,969 2 - 26,971 - - $26,971 $2,529 2,037 1,607 537 6,710 - (788) 5,922 - - $5,922 2004 Operating Profit $2,389 1,911 1,323 475 6,098 - (689) 5,409 (150) - $5,259 2003 $2,242 1,690 1,061 470 5,463 26 (502) 4,987 (147) (59) $4,781 Division Operating Profit Division Net Revenue QFNA 5% QFNA 8% FLNA 32% PI 35% PBNA 30% PBNA 28% Divested Businesses During 2003, we sold our Quaker Foods North America Mission pasta business. The results of this business are reported as divested businesses. FLNA 38% PI 24% Corporate Corporate includes costs of our corporate headquarters, centrally managed initiatives, such as our BPT initiative, unallocated insurance and benefit programs, foreign exchange transaction gains and losses, and certain commodity derivative gains and losses, as well as profit-in-inventory elimination adjustments for our noncontrolled bottling affiliates and certain other items. Restructuring and Impairment Charges and Merger-Related Costs See Note 3. A9 A10 Appendix A Specimen Financial Statements: PepsiCo, Inc. Other Division Information 2005 FLNA PBNA PI QFNA Total division Corporate(a) Investments in bottling affiliates 2004 Total Assets $ 5,476 6,048 8,921 978 21,423 3,569 2,995 $27,987 $ 5,948 6,316 9,983 989 23,236 5,331 3,160 $31,727 2003 2005 $ 5,332 5,856 8,109 995 20,292 2,384 2,651 $25,327 $ 512 320 667 31 1,530 206 - $1,736 2004 Capital Spending $ 469 265 537 33 1,304 83 - $1,387 (a) Corporate assets consist principally of cash and cash equivalents, short-term investments, and property, plant and equipment. Total Assets Capital Spending Net Revenue QFNA 2% Other 27% Other 12% FLNA 19% FLNA 30% PBNA 20% QFNA 3% 2005 2004 2003 Amortization of Intangible Assets $3 $3 $3 76 75 75 71 68 66 - 1 1 150 147 145 - - - $150 $147 $145 2005 U.S. Mexico United Kingdom Canada All other countries Other 19% Mexico 10% PI 38% United States 61% PBNA 18% PI 31% FLNA PBNA PI QFNA Total division Corporate Canada 4% United Kingdom 6% 2004 2003 Net Revenue(a) $19,937 $18,329 $17,377 3,095 2,724 2,642 1,821 1,692 1,510 1,509 1,309 1,147 6,200 5,207 4,295 $32,562 $29,261 $26,971 2005 2004 2003 Depreciation and Other Amortization $ 419 $ 420 $ 416 264 258 245 420 382 350 34 36 36 1,137 1,096 1,047 21 21 29 $1,158 $1,117 $1,076 2005 2004 2003 Long-Lived Assets(b) $10,723 $10,212 $ 9,907 902 878 869 1,715 1,896 1,724 582 548 508 3,948 3,339 3,123 $17,870 $16,873 $16,131 (a) Represents net revenue from businesses operating in these countries. (b) Long-lived assets represent net property, plant and equipment, nonamortizable and net amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. Long-Lived Assets Other 22% Canada 3% United Kingdom 10% Mexico 5% United States 60% 2003 $ 426 332 521 32 1,311 34 - $1,345 Financial Statements and Accompanying Notes Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue upon shipment or delivery to our customers based on written sales terms that do not allow for a right of return. However, our policy for direct-storedelivery (DSD) and chilled products is to remove and replace damaged and out-ofdate products from store shelves to ensure that our consumers receive the product quality and freshness that they expect. Similarly, our policy for warehouse distributed products is to replace damaged and out-of-date products. Based on our historical experience with this practice, we have reserved for anticipated damaged and outof-date products. For additional unaudited information on our revenue recognition and related policies, including our policy on bad debts, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. We are exposed to concentration of credit risk by our customers, Wal-Mart and PBG. Wal-Mart represents approximately 9% of our net revenue, including concentrate sales to our bottlers which are used in finished goods sold by them to Wal-Mart; and PBG represents approximately 10%. We have not experienced credit issues with these customers. sales incentives, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. Other marketplace spending includes the costs of advertising and other marketing activities and is reported as selling, general and administrative expenses. Advertising expenses were $1.8 billion in 2005, $1.7 billion in 2004 and $1.6 billion in 2003. Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments, promotional materials in inventory, and production costs of future media advertising. Deferred advertising costs of $202 million and $137 million at year-end 2005 and 2004, respectively, are classified as prepaid expenses in our Consolidated Balance Sheet. Sales Incentives and Other Marketplace Spending We offer sales incentives and discounts through various programs to our customers and consumers. Sales incentives and discounts are accounted for as a reduction of revenue and totaled $8.9 billion in 2005, $7.8 billion in 2004 and $7.1 billion in 2003. While most of these incentive arrangements have terms of no more than one year, certain arrangements extend beyond one year. For example, fountain pouring rights may extend up to 15 years. Costs incurred to obtain these arrangements are recognized over the contract period and the remaining balances of $321 million at December 31, 2005 and $337 million at December 25, 2004 are included in current assets and other assets in our Consolidated Balance Sheet. For additional unaudited information on our Cash Equivalents Cash equivalents are investments with original maturities of three months or less which we do not intend to rollover beyond three months. Distribution Costs Distribution costs, including the costs of shipping and handling activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $4.1 billion in 2005, $3.9 billion in 2004 and $3.6 billion in 2003. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use. Capitalized software costs are included in property, plant and equipment on our Consolidated Balance Sheet and amortized on a straight-line basis over the estimated useful lives of the software, which generally do not exceed 5 years. Net capitalized software and development costs were $327 million at December 31, 2005 and $181 million at December 25, 2004. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional information on our commitments, see Note 9. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Property, Plant and Equipment and Intangible Assets Note 4 and, for additional unaudited information on brands and goodwill, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. Income Taxes Note 5 and, for additional unaudited information, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. Stock-Based Compensation Expense Note 6 and, for additional unaudited information, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. Pension, Retiree Medical and Savings Plans Note 7 and, for additional unaudited information, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. Risk Management Note 10 and, for additional unaudited information, see \"Our Business Risks\" in Management's Discussion and Analysis. There have been no new accounting pronouncements issued or effective during 2005 that have had, or are expected to have, a material impact on our consolidated financial statements. A11 A12 Appendix A Specimen Financial Statements: PepsiCo, Inc. Note 3 Restructuring and Impairment Charges and Merger-Related Costs 2005 Restructuring Charges In the fourth quarter of 2005, we incurred a charge of $83 million ($55 million aftertax or $0.03 per share) in conjunction with actions taken to reduce costs in our operations, principally through headcount reductions. Of this charge, $34 million related to FLNA, $21 million to PBNA, $16 million to PI and $12 million to Corporate (recorded in corporate unallocated expenses). Most of this charge related to the termination of approximately 700 employees. We expect the substantial portion of the cash payments related to this charge to be paid in 2006. 2004 and 2003 Restructuring and Impairment Charges In the fourth quarter of 2004, we incurred a charge of $150 million ($96 million after-tax or $0.06 per share) in conjunction with the consolidation of FLNA's manufacturing network as part of its ongoing productivity program. Of this charge, $93 million related to asset impairment, primarily reflecting the closure of four U.S. plants. Production from these plants was redeployed to other FLNA facilities in the U.S. The remaining $57 million included employee-related costs of $29 million, contract termination costs of $8 million and other exit costs of $20 million. Employee-related costs primarily reflect the termination costs for approximately 700 employees. Through December 31, 2005, we have paid $47 million and incurred non-cash charges of $10 million, leaving substantially no accrual. In the fourth quarter of 2003, we incurred a charge of $147 million ($100 million after-tax or $0.06 per share) in conjunction with actions taken to streamline our North American divisions and PepsiCo International. These actions were taken to increase focus and eliminate redundancies at PBNA and PI and to improve the efficiency of the supply chain at FLNA. Of this charge, $81 million related to asset impairment, reflecting $57 million for the closure of a snack plant in Kentucky, the retirement of snack manufacturing lines in Maryland and Arkansas and $24 million for the closure of a PBNA office building in Florida. The remaining $66 million included employeerelated costs of $54 million and facility and other exit costs of $12 million. Employee-related costs primarily reflect the termination costs for approximately 850 sales, distribution, manufacturing, research and marketing employees. As of December 31, 2005, all terminations had occurred and substantially no accrual remains. Merger-Related Costs In connection with the Quaker merger in 2001, we recognized merger-related costs of $59 million ($42 million after-tax or $0.02 per share) in 2003. Note 4 Property, Plant and Equipment and Intangible Assets Average Useful Life Property, plant and equipment, net Land and improvements 10 - 30 yrs. Buildings and improvements 20 - 44 Machinery and equipment, including fleet and software 5 - 15 Construction in progress Depreciation expense Amortizable intangible assets, net Brands Other identifiable intangibles Accumulated amortization Amortization expense 5 - 40 3 - 15 2004 $ 685 3,736 $ 646 3,605 11,658 1,066 17,145 (8,464) $ 8,681 10,950 729 15,930 (7,781) $ 8,149 $1,103 Accumulated depreciation 2005 $1,062 $1,054 257 1,311 (781) $ 530 $1,008 225 1,233 (635) $ 598 $150 $147 2003 $1,020 $145 Depreciation and amortization are recognized on a straight-line basis over an asset's estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. Amortization of intangible assets for each of the next five years, based on average 2005 foreign exchange rates, is expected to be $152 million in 2006, $35 million in 2007, $35 million in 2008, $34 million in 2009 and $33 million in 2010. Depreciable and amortizable assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. For additional unaudited information on our amortizable brand policies, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. Financial Statements and Accompanying Notes Nonamortizable Intangible Assets Perpetual brands and goodwill are assessed for impairment at least annually to ensure that discounted future cash flows continue to exceed the related book value. A perpetual brand is impaired if its book value exceeds its fair value. Goodwill is evaluated for impairment if the book value of its reporting unit exceeds its fair value. A reporting unit can be a division or business within a division. If the fair value of an evaluated asset is less than its book value, the asset is written down based on its discounted future cash flows to fair value. No impairment charges resulted from the required impairment evaluations. The change in the book value of nonamortizable intangible assets is as follows: Balance, Beginning 2004 Frito-Lay North America Goodwill PepsiCo Beverages North America Goodwill Brands PepsiCo International Goodwill Brands Quaker Foods North America Goodwill Corporate Pension intangible Total goodwill Total brands Total pension intangible Acquisition Translation and Other Balance, End of 2004 Acquisition $ 130 $- $8 $ 138 $- 2,157 59 2,216 - - - 4 - 4 2,161 59 2,220 1,334 808 2,142 29 - 29 72 61 133 175 - 2 3,796 867 2 $4,665 - 29 - - $29 Translation and Other $ Balance, End of 2005 7 $ 145 - - - 3 - 3 2,164 59 2,223 1,435 869 2,304 278 263 541 (109) (106) (215) 1,604 1,026 2,630 - 175 - - 175 3 84 61 3 $148 5 3,909 928 5 $ 4,842 - 278 263 - $541 (4) (99) (106) (4) $(209) 1 4,088 1,085 1 $5,174 A13 A14 Appendix A Specimen Financial Statements: PepsiCo, Inc. Note 5 Income Taxes 2005 Income before income taxes continuing operations U.S.................................................................................................................................................... Foreign.............................................................................................................................................. Provision for income taxes continuing operations Current: U.S. Federal....................................................................................................................... Foreign .............................................................................................................................. State ................................................................................................................................. Deferred: U.S. Federal ....................................................................................................................... Foreign .............................................................................................................................. State ................................................................................................................................. Tax rate reconciliation continuing operations U.S. Federal statutory tax rate .......................................................................................................... State income tax, net of U.S. Federal tax benefit.............................................................................. Taxes on AJCA repatriation................................................................................................................ Lower taxes on foreign results .......................................................................................................... Settlement of prior years' audit ........................................................................................................ Other, net.......................................................................................................................................... Annual tax rate ................................................................................................................................. 2004 2003 $3,175 3,207 $6,382 $2,946 2,600 $5,546 $3,267 1,725 $4,992 $1,638 426 118 2,182 137 (26) 11 122 $2,304 $1,030 256 69 1,355 11 5 1 17 $1,372 $1,326 341 80 1,747 (274) (47) (2) (323) $1,424 35.0% 1.4 7.0 (6.5) - (0.8) 36.1% 35.0% 0.8 - (5.4) (4.8) (0.9) 24.7% Deferred tax liabilities Investments in noncontrolled affiliates ............................................................................................ Property, plant and equipment ......................................................................................................... Pension benefits ............................................................................................................................... Intangible assets other than nondeductible goodwill....................................................................... Zero coupon notes ............................................................................................................................ Other................................................................................................................................................. Gross deferred tax liabilities............................................................................................................. Deferred tax assets Net carryforwards ............................................................................................................................. Stock-based compensation............................................................................................................... Retiree medical benefits................................................................................................................... Other employee-related benefits....................................................................................................... Other................................................................................................................................................. Gross deferred tax assets ................................................................................................................. Valuation allowances........................................................................................................................ Deferred tax assets, net.................................................................................................................... Net deferred tax liabilities ................................................................................................................ $ 993 772 863 135 35 169 2,967 $ 850 857 669 153 46 157 2,732 608 426 400 342 520 2,296 (532) 1,764 $1,203 666 402 402 379 460 2,309 (564) 1,745 $ 987 Deferred taxes included within: Prepaid expenses and other current assets.................................................................................. Deferred income taxes .................................................................................................................. $231 $1,434 $229 $1,216 Analysis of valuation allowances Balance, beginning of year............................................................................................................... (Benefit)/provision........................................................................................................................ Other (deductions)/additions........................................................................................................ Balance, end of year......................................................................................................................... $564 (28) (4) $532 $438 118 8 $564 35.0% 1.0 - (5.5) (2.2) 0.2 28.5% $487 (52) 3 $438 Financial Statements and Accompanying Notes For additional unaudited information on our income tax policies, including our reserves for income taxes, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. Carryforwards, Credits and Allowances Operating loss carryforwards totaling $5.1 billion at year-end 2005 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.1 billion in 2006, $4.1 billion between 2007 and 2025 and $0.9 billion may be carried forward indefinitely. In addition, certain tax credits generated in prior periods of approximately $39.4 million are available to reduce certain foreign tax liabilities through 2011. We establish valuation allowances for our deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Undistributed International Earnings The AJCA created a one-time incentive for U.S. corporations to repatriate undistributed international earnings by providing an 85% dividends received deduction. As approved by our Board of Directors in July 2005, we repatriated approximately $7.5 billion in earnings previously considered indefinitely reinvested outside the U.S. in the fourth quarter of 2005. In 2005, we recorded income tax expense of $460 million associated with this repatriation. Other than the earnings repatriated, we intend to continue to reinvest earnings outside the U.S. for the foreseeable future and, therefore, have not recognized any U.S. tax expense on these earnings. At December 31, 2005, we had approximately $7.5 billion of undistributed international earnings. Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. During 2004, we recognized $266 million of tax benefits related to the favorable resolution of certain open tax issues. In addition, in 2004, we recognized a tax benefit of $38 million upon agreement with the IRS on an open issue related to our discontinued restaurant operations. At the end of 2003, we entered into agreements with the IRS for open years through 1997. These agreements resulted in a tax benefit of $109 million in the fourth quarter of 2003. As part of these agreements, we also resolved the treatment of certain other issues related to future tax years. The IRS has initiated their audits of our tax returns for the years 1998 through 2002. Our tax returns subsequent to 2002 have not yet been examined. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. Our tax reserves, covering all federal, state and foreign jurisdictions, are presented in the balance sheet within other liabilities (see Note 14), except for any amounts relating to items we expect to pay in the coming year which are included in current income taxes payable. For further unaudited information on the impact of the resolution of open tax issues, see \"Other Consolidated Results.\" Note 6 Stock-Based Compensation Our stock-based compensation program is a broad-based program designed to attract and retain employees while also aligning employees' interests with the interests of our shareholders. Employees at all levels participate in our stock-based compensation program. In addition, members of our Board of Directors participate in our stockbased compensation program in connection with their service on our Board. Stock options and RSUs are granted to employees under the shareholder-approved 2003 Long-Term Incentive Plan (LTIP), our only active stock-based plan. Stock-based compensation expense was $311 million in 2005, $368 million in 2004 and $407 million in 2003. Related income tax benefits recognized in earnings were $87 million in 2005, $103 million in 2004 and $114 million in 2003. At yearend 2005, 51 million shares were available for future executive and SharePower grants. For additional unaudited informa- tion on our stock-based compensation program, see \"Our Critical Accounting Policies\" in Management's Discussion and Analysis. SharePower Grants SharePower options are awarded under our LTIP to all eligible employees, based on job level or classification, and in the case of international employees, tenure as well. All stock option grants have an exercise price equal to the fair market value of our common stock on the day of grant and generally have a 10-year term with vesting after three years. Executive Grants All senior management and certain middle management are eligible for executive grants under our LTIP. All stock option grants have an exercise price equal to the fair market value of our common stock on the day of grant and generally have a 10-year term with vesting after three years. There have been no reductions to the exer- cise price of previously issued awards, and any repricing of awards would require approval of our shareholders. Beginning in 2004, executives who are awarded long-term incentives based on their performance are offered the choice of stock options or RSUs. RSU expense is based on the fair value of PepsiCo stock on the date of grant and is amortized over the vesting period, generally three years. Each restricted stock unit can be settled in a share of our stock after the vesting period. Executives who elect RSUs receive one RSU for every four stock options that would have otherwise been granted. Senior officers do not have a choice and are granted 50% stock options and 50% RSUs. Vesting of RSU awards for senior officers is contingent upon the achievement of pre-established performance targets. We granted 3 million RSUs in both 2005 and 2004 with weighted-average intrinsic values of $53.83 and $47.28, respectively. A15 A16 Appendix A Specimen Financial Statements: PepsiCo, Inc. Our weighted-average Black-Scholes fair value assumptions include: Method of Accounting and Our Assumptions We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock-based compensation expense at the date of grant. We adopted SFAS 123R, Share-Based Payment, under the modified prospective method in the first quarter of 2006. We do not expect our adoption of SFAS 123R to materially impact our financial statements. 2005 6 yrs. 3.8% 23% 1.8% Expected life Risk free interest rate Expected volatility Expected dividend yield 2004 6 yrs. 3.3% 26% 1.8% 2003 6 yrs. 3.1% 27% 1.15% Our Stock Option Activity(a) Outstanding at beginning of year Granted Exercised Forfeited/expired Outstanding at end of year Exercisable at end of year 2005 Options Average Price(b) 174,261 $40.05 12,328 53.82 (30,945) 35.40 (5,495) 43.31 150,149 42.03 89,652 40.52 Options 198,173 14,137 (31,614) (6,435) 174,261 2004 Average Price(b) $38.12 47.47 30.57 43.82 40.05 94,643 36.41 2003 Options Average Price(b) 190,432 $36.45 41,630 39.89 (25,833) 26.74 (8,056) 43.56 198,173 38.12 97,663 32.56 Stock options outstanding and exercisable at December 31, 2005(a) Range of Exercise Price $14.40 to $21.54 $23.00 to $33.75 $34.00 to $43.50 $43.75 to $56.75 Options Outstanding Options Average Price(b) Average Life(c) 905 $ 20.01 3.56 yrs. 14,559 30.46 3.07 82,410 39.44 5.34 52,275 49.77 7.17 150,149 42.03 5.67 Options Exercisable Options Average Price(b) Average Life(c) 905 $20.01 3.56 yrs. 14,398 30.50 3.05 48,921 39.19 4.10 25,428 49.48 6.09 89,652 40.52 4.45 (a) Options are in thousands and include options previously granted under Quaker plans. No additional options or shares may be granted under the Quaker plans. (b) Weighted-average exercise price. (c) Weighted-average contractual life remaining. Our RSU Activity(a) Outstanding at beginning of year Granted Converted Forfeited/expired Outstanding at end of year RSUs 2,922 3,097 (91) (259) 5,669 2005 Average Intrinsic Value(b) $47.30 53.83 48.73 50.51 50.70 Average Life(c) 1.8 yrs. RSUs - 3,077 (18) (137) 2,922 Stock Options 2004 $12.04 $667,001 $2,062,153 $1,464,926 2003 $11.21 $466,719 $1,641,505 $1,348,658 2004 Average Intrinsic Value(b) $ - 47.28 47.25 47.25 47.30 Average Life(c) 2.2 yrs. (a) RSUs are in thousands. (b) Weighted-average intrinsic value. (c) Weighted-average contractual life remaining. Other stock-based compensation data Weighted-average fair value of options granted Total intrinsic value of options/RSUs exercised/converted(a) Total intrinsic value of options/RSUs outstanding(a) Total intrinsic value of options exercisable(a) 2005 $13.45 $632,603 $2,553,594 $1,662,198 RSUs 2005 2004 $4,974 $334,931 $914 $151,760 (a) In thousands. At December 31, 2005, there was $315 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation is expected to be recognized over a weighted-average period of 1.6 years. Financial Statements and Accompanying Notes Note 7 Pension, Retiree Medical and Savings Plans Our pension plans cover full-time employees in the U.S. and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. U.S. retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the costs. We use a September 30 measurement date and all plan assets and liabilities are