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Callaway Golf CompanyManufacturing Inventory Callaway Golf Company is a California corporation formed in 1982. The Company designs, develops, manufactures and markets high-quality, innovative golf clubs and golf balls, and also sells golf footwear and accessories. Callaway operates two distinct product-based segments: Golf Clubs and Golf Balls. The golf club segment consists primarily of woods, hybrids, irons, wedges and Odyssey putters and golf accessories under the Callaway Golf, Odyssey and Strata brand names. The Company also licenses its trademarks and service marks in exchange for a royalty fee to third parties for use on golf related accessories, including golf apparel and footwear, prescription eyewear, golf gloves, umbrellas, and practice aids. The Company's products are sold in the United States and in over 100 countries around the world. (Source: Company Form 10-K) Learning Objectives Disaggregate manufacturing inventory and understand its underlying components. Interpret the allowance for obsolete inventory. Trace product cost flows from raw materials through to finished goods inventory. Infer raw material purchases and calculate cash disbursements related to inventory. Calculate and analyze financial statement ratios related to inventory. Refer to the 2013 financial statements and notes of Callaway Golf Company. Concepts

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? Process

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 Provision Write-offs, disposals and other $10,800 13,348 (11,628) Balance, December 31, 2013 $12,520

i. Where does this account appear on Callaway's 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.

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. Analysis

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 Golf's 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 Callaway's 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? 2013 2012 Finished goods inventory, net + Reserve for obsolete inventory Finished goods inventory, gross Portion obsolete % Callaway Golf CompanyManufacturing Inventory 3 % CALLAWAY GOLF COMPANY CONSOLIDATED BALANCE SHEETS December 31, (In thousands, except share and per share data) 2013 2012 $ 36,793 $ 52,003 92,203 91,072 263,492 211,734 6,419 4,170 ASSETS Current assets: Cash and cash equivalents Accounts receivable, net Inventories Deferred taxes, net Income taxes receivable 228 1,810 Other current assets 22,468 23,811 Assets held for sale 2,396 421,603 71,341 386,996 Intangible assets, net 88,901 89,189 Goodwill 29,212 29,034 Total current assets Property, plant and equipment, net Deferred taxes, net 89,093 2,299 1,910 50,507 41,414 $ 663,863 $ 637,636 $ 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 927 226,196 161,566 Other assets Total assets LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses Total current liabilities Long-term liabilities: Income taxes payable 4,387 Convertible notes, net (Note 4) 6,565 35,271 Deferred taxes, net 33,533 107,835 107,133 5,555 7,131 Long-term incentive compensation and other Commitments and contingencies (Note 13) Shareholders' equity: Preferred stock, $.01 par value, 3,000,000 shares authorized, 0 and 417,639 shares issued and outstanding at December 31, 2013 and 2012, respectively 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 4 783 723 205,712 204,510 Retained earnings 77,038 113,831 Accumulated other comprehensive income 12,177 14,770 (11,091 ) 284,619 (14,848 ) Additional paid-in capital Less: Common stock held in treasury, at cost, 967,089 shares and 1,267,436 shares at December 31, 2013 and 2012, respectively Total Callaway Golf Company shareholders' equity 318,990 2,718 284,619 321,708 $ 663,863 $ 637,636 Non-controlling interest in consolidated entity (Note 10) Total shareholders' equity Total liabilities and shareholders' equity 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, 2012 2013 2011 $ 842,801 528,043 $ 834,065 585,897 $ 886,528 575,226 Gross profit Selling expenses General and administrative expenses Research and development expenses 314,758 226,496 68,087 30,937 248,168 268,088 66,773 29,542 311,302 265,325 92,756 34,309 Total operating expenses Loss from operations Interest income Interest expense 325,520 (10,762 ) 558 (9,123 ) 364,403 (116,235) 550 (5,513 ) 392,390 (81,088) 546 (1,618 ) Other income (expense), net Loss before income taxes Income tax provision 6,005 (13,322 ) 5,599 3,152 (118,046) 4,900 (8,101 ) (90,261) 81,559 Net loss Dividends on convertible preferred stock (18,921 ) 3,332 (122,946) 8,447 (171,820) 10,500 $ (131,393 ) $ (182,320 ) $ $ $ $ Net sales Cost of sales Net loss allocable to common shareholders $ (22,253 ) Loss per common share: Basic Diluted Weighted-average common shares outstanding: $ $ (0.31 ) (0.31 ) (1.96 ) (1.96 ) (2.82 ) (2.82 ) 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 Net loss Other comprehensive income (loss), net of tax: $ Foreign currency translation adjustments Comprehensive loss (18,921 ) 2012 $ (2,593 ) $ (21,514 ) (122,946) 2011 $ 699 $ The accompanying notes are an integral part of these financial statements. (122,247) (171,820 ) 507 $ (171,313 ) 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: 25,543 34,411 Depreciation and amortization 21,933 6,533 (1,925) 55,930 Impairment charges (2,309) Deferred taxes 38,636 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) (6,602) 702 235 Gain on sale of intangible assets Discount amortization on convertible notes Changes in assets and liabilities: (6,690) 28,100 20,216 36,460 (190) Inventories 23,701 (60,966) Accounts receivable, net Accounts payable and accrued expenses 1,044 20,599 34,663 Other assets 1,042 (12,613) 11,523 (4,057) (4,187) Income taxes receivable and payable 2,761 2,563 7,653 Accrued warranty expense (1,133) Accrued employee compensation and benefits (601) (287) 297 293 Other liabilities 3,015 (8,949) (28,808 ) 10,098 (13,038) Net cash (used in) provided by operating activities (18,403) (28,931) Cash flows from investing activities: Capital expenditures 26,861 4,148 355 19,371 Proceeds from sale of intangible assets Proceeds from sale of property, plant and equipment 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: 25,660 Proceeds from issuance of convertible notes 46,819 Debt issuance costs (3,534) Proceeds from asset-based credit facility (2,467) 2,195 1,652 19 Issuance of common stock Exercise of stock options Equity issuance costs (341) Dividends paid, net (5,599) Other financing activities (32) (5,074) Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year (13,285) 117 8,980 727 (12,020) 43,023 52,003 $ 80 (159) (15,210) Effect of exchange rate changes on cash and cash equivalents (13,093) 32,126 21,340 Net cash provided by (used in) financing activities (11,019) 55,043 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 $ Accrued capital expenditures at period end $ (364) 1,467 The accompanying notes are an integral part of these consolidated financial statements. $ (783) $ (1,587) $ 92 $ 1,888 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 management's 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) Accounts receivable, net: Trade accounts receivable Allowance for sales returns Allowance for doubtful accounts 2013 $ $ Inventories: Raw materials Work-in-process Finished goods $ 2012 111,192 (7,334 ) (11,655 ) 92,203 $ 103,999 (6,383 ) (6,544 ) $ 91,072 56,104 328 207,060 $ 43,469 619 167,646 $ 263,492 $ 211,734 $ $ Property, plant and equipment, net: Land Buildings and improvements Machinery and equipment Furniture, computers and equipment Production molds Construction-in-process 7,452 64,823 126,282 120,943 37,493 1,553 407,329 (318,236 ) 358,546 (287,205 ) Accumulated depreciation 8,892 79,707 153,303 126,733 37,539 1,155 $ 71,341 $ 89,093 $ 59,914 77,492 19,714 $ 45,376 68,300 15,345 Accounts payable and accrued expenses: Accounts payable Accrued expenses Accrued goods in-transit $ 157,120 Accrued employee compensation and benefits: Accrued payroll and taxes Accrued vacation and sick pay Accrued commissions $ 129,021 $ 23,748 7,225 612 $ 12,256 7,549 844 $ 31,585 $ 20,649