Please answer Case 19-62. Deciphering Financial Statements (Derivatives:IBM)

19 - 58 Part 4 Other Dimensions of Financial Reporting EOC the summary information that goes into the quarterly report. The last straw for Grant was when he learned that the quarterly report is not audited. Grant has absolutely refused to accept this slipshod method of quarterly reporting and has vowed that he will bottle up board action on all other decisions until the board agrees to the preparation of a quarterly report that contains the same detail, the same accounting practices, and the same type of audit opinion as the annual report. You have been appointed by the board to reason with Grant. What will you tell him? Case 19-60 Deciphering Financial Statements (The Walt Disney Company) Locate the 2009 financial statements for The Walt Disney Company on the Internet. Once you have located those financial statements, consider the following questions. 1. In Note 17 on derivative instruments, Disney explains how the company manages interest rate risk and foreign exchange risk. What types of instruments does Disney use to manage foreign exchange risk? What specific currency risk is Disney trying to hedge against? Does Disney speculate with its foreign currency transactions? 2. What types of instruments does Disney use to manage interest rate risk? 3. What interesting details about pending lawsuits does Disney include in the notes to the financial statements? 4. Disney has five primary business segments: Media Networks, Parks and Resorts, Studio Entertainment, Consumer Products, and Interactive Media. Which of these five yields the highest return on assets (Operating income/Identifiable assets)? (Note: Use information from the financial statement notes.) 5. Find Disney's Quarterly Financial Summary. Do you detect any seasonal pattern in Disney's revenues? Explain. Case 19-61 Deciphering Financial Statements (Interim Reporting: Toys \"R\" Us) Toys \"R\" Us is the biggest toy store chain in the United States, with significant operations outside the United States as well. The following quarterly financial data were taken from the 2009 annual report of Toys \"R\" Us. First Quarter Second Quarter Third Quarter Fourth Quarter 2009 Net Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,477 $2,567 $2,667 $5,857 2009 Gross Margin . . . . . . . . . . . . . . . . . . . . . . . . . 890 951 950 1,987 2009 Net Earnings/(Loss) . . . . . . . . . . . . . . . . . . . . (35) 27 (67) 387 2008 Net Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,719 2,771 2,773 5,461 2008 Gross Margin . . . . . . . . . . . . . . . . . . . . . . . . . 977 1,014 960 1,797 2008 Net Earnings/(Loss) . . . . . . . . . . . . . . . . . . . . (36) 13 (104) 345 1. Does Toys \"R\" Us have any seasonal pattern in its sales? 2. Compute gross profit (or margin) percentage (Gross margin/Sales) for each quarter for fiscal years 2008 and 2009. Is the gross profit percentage in the fourth quarter substantially different from other quarters? 3. Assume that first-quarter sales for fiscal 2010 are $2,700 million. What is your prediction of fourth-quarter sales? Case 19-62 Deciphering Financial Statements (Derivatives: IBM) In Note L to its 2009 financial statements, IBM includes disclosure about its derivatives as follows: EOC Derivatives, Contingencies, Business Segments, and Interim Reports 19 - 59 Fair Values of Derivative Instruments on the Consolidated Statement of Financial Position ($ in millions) Fair Value of Derivative Assets Designated as Hedging Instruments At December 31, 2009: Not Designated as Hedging Instruments Fair Value of Derivative Liabilities Total Designated as Hedging Instruments Not Designated as Hedging Instruments Total Interest rate contracts: Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . $ 43 $ $ 43 $ Investments and sundry assets . . . . . . . . . . . . 383 383 Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . 2 2 Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . 74 151 225 Investments and sundry assets . . . . . . . . . . . . 156 26 182 Other accrued expenses and liabilities . . . . . . . 602 304 906 Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . 423 224 647 Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . 5 5 Other accrued expenses and liabilities . . . . . . . 0 0 Fair value of derivative assets and liabilities. . . . . . . . . . . . . . . . . . . . . . . . $656 $182 $838 $1,027 $528 $1,555 $ $ Foreign exchange contracts: Equity contracts: Total debt designated as hedging instruments: Short-term debt. . . . . . . . . . . . . . . . . . . . . . . . NA NA NA $1,440 $1,440 Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . NA NA NA 2,618 2,618 $838 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,613 The Effect of Derivative Instruments on the Consolidated Statement of Earnings ($ in millions) For the year ended December 31, 2009: Gain (Loss) Recognized in Earnings Derivative Instruments in Fair Value Hedges Consolidated Statement of Earnings Line Item Attributable to Risk Being Hedged(3) Cost of financing $ (172) $344 Interest expense Interest rate contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recognized on Derivatives(2) (97) 193 $(269) $537 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gain (Loss) Recognized in Earnings and Other Comprehensive Income Derivative Instruments in Cash Flow Hedges Interest rate contracts Foreign exchange contracts Effective Portion Recognized in AOCI $ (0) (718) Consolidated Statement Of Earnings Line Item Interest income Effective Portion Reclassified from AOCI to Earnings Ineffectiveness and Amounts Excluded from Effectiveness Testing(4) $ (13) $ Other (income) and expense 143 (3) Cost of sales (49) SG&A expense Total $(718) 14 $ 94 $ (3) 19 - 60 Part 4 Other Dimensions of Financial Reporting EOC Gain (Loss) Recognized in Earnings and Other Comprehensive Income Effective Portion Recognized in AOCI Foreign exchange contracts $234 Effective Portion Reclassified from AOCI to Earnings Ineffectiveness and Amounts Excluded from Effectiveness Testing(5) Interest income $ $1 Other (income) and expense Derivative Instruments in Net Investment Hedges $ $ Consolidated Statement of Earnings Line Item Derivative Instruments Not Designated as Hedging Instruments(1) Consolidated Statement of Earnings Line Item Gain (Loss) Recognized in Earnings Foreign exchange contracts Other (income) and expense $(128) Equity contracts SG&A expense 177 $ 50 Total Note: AOCI represents Accumulated other comprehensive income/(loss) in Consolidated Statement of Changes in Equity. (1) (2) (3) (4) (5) See pages 76 and 77 for additional information on the purpose for entering into derivatives not designated as hedging instruments. Includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required under these derivative contracts. Includes basis adjustments to the carrying value of the hedged item recorded during the period and amortization of basis adjustments recorded on de-designated hedging relationships during the period. Amount of gain (loss) recognized in income represents ineffectiveness on hedge relationships. Amount of gain (loss) recognized in income represents amounts excluded from effectiveness assessment. At December 31, 2009, in connection with cash flow hedges of anticipated royalties and cost transactions, the company recorded net losses of $718 million (before taxes) in accumulated other comprehensive income/(loss); $427 million of losses are expected to be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying anticipated transactions. At December 31, 2009, net losses of approximately $18 million (before taxes) were recorded in accumulated other comprehensive income/(loss) in connection with cash flow hedges of the company's borrowings; $10 million of losses are expected to be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying transactions. For the 12 months ending December 31, 2009, there were no significant gains or losses recognized in earnings representing hedge ineffectiveness or excluded from the assessment of hedge effectiveness (for fair value hedges), or associated with an underlying exposure that did not or was not expected to occur (for cash flow hedges); nor are there any anticipated in the normal course of business. 1. IBM reports that it uses both fair value and cash flow hedges in its debt risk management program. Most of these hedges are accomplished through interest rate swaps. Some of the interest rate swaps are pay-fixed, receive-variable swaps, and some are pay-variable, receive-fixed swaps. Which of these two types of swaps are fair value hedges, and which are cash flow hedges? Explain. 2. IBM lists $2,618 million in long-term debt as a hedge. What does this debt hedge, and how does the debt serve as an effective hedge? 3. As of December 31, 2009, IBM has recognized $736 million in net unrealized losses associated with cash flow hedges. Of these net losses, how much is related to cash flow transactions expected to occur within one year? 4. What type of disclosure would give the best indication of IBM's exposure to foreign exchange and interest rate risk? Case 19-63 Deciphering Financial Statements (Segment Reporting: PepsiCo) Refer to the 2009 segment information for PepsiCo given in Exhibit 19-4. 1. Compute operating profit margin (Operating profit/Net revenue) for 2009 for each of the following: (a) Frito-Lay North America, (b) Quaker Foods North America, (c) Latin America Foods, (d) PepsiCo Americas Beverages, (e) Europe, and (f) Asia, Middle East & Africa 2. For each of the segments listed in (1), compute asset turnover (Net revenue/ Total assets)