Chapter 3.

Measuring Performance: Cash Flow and Net Income

Suggested Solutions to Questions, Exercises, Problems, and Corporate Analyses

Difficulty Rating for Exercises and Problems:

Easy: E3.13; E3.14

Medium: E3.15; E3.16; E3.17
P3.22; P3.23; P3.24
Difficult: E3.18; E3.19; E3.20; E3.21
P3.25; P3.26; P3.27; P3.28

QUESTIONS

Q3.1 Building Shareholder Value.

The most commonly agreed upon managerial actions to build shareholder
value are the following, which are rank-ordered by their expected effectiveness:

1. Invest in positive net-present-value projects (e.g., a new plant, an

acquisition).
2. Repurchase stock.
3. Retire debt early.
4. Increase the dividend paid per share.

Since businesses generally have superior investment-opportunity sets, with

higher expected internal rates of return, than do individual investors,
investments in positive net-present-value projects are believed to be the most
effective way to build shareholder value, with share repurchase a close second,
ceterus paribus. It is generally believed that early debt retirement and
increasing the dividend paid per share are the least effective approaches to
building shareholder value.

Q3.2 Litigation, Reported Income, and Share Prices.

Since a jury ruled against the company and established a damage award of
$4.5 million, the company should report the award as a special loss in its
income statement and accrue a liability for future payment on its balance sheet.
During 2005, since no adverse court decision had yet been reached, Merck
would merely have disclosed the existence of the pending lawsuits in its
footnotes (i.e., in the Commitments and Contingent Liabilities footnote). For its
2006 financial statements, similar disclosure would be expected for the
remaining undecided lawsuits (i.e., in the footnotes only).

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-1
Q3.3 Basic Versus Diluted Earnings per Share.
Merck’s annual report discloses that the increase in shares used in the
calculation of basic versus diluted EPS was due entirely to shares issuable
primarily under share-based compensation plans. Although research suggests
that diluted EPS is more closely associated with share price, P/E multiples most
commonly rely on basic EPS unless there is a high expectation of a debt or
preferred stock conversion.

Q3.4 Assessing the Quality of Reported Earnings Using Cash Flow Data.
At the first level, it is possible to confirm the quality of a firm’s reported earnings
using cash flow data by calculating the operating funds ratio. For Blockbuster,
the result for 1987 and 1988 is:

1988 1987
CFFO ÷ net income 3.12 2.52

This ratio indicates the amount of operating cash flow generated relative to
reported net income. Thus, in 1988, for every dollar of earnings, Blockbuster
generated over $3 in operating cash flow.

At issue here, according to Mr. Seidler, is whether the cash outlay for
videocassette rental inventory is properly reported as an investing activity on
the statement of cash flow. He believes that it is incorrectly classified, and
instead, should be reflected as a cash outflow under the company’s operating
activities. Following Mr. Seidler’s line of argument, we can restate Blockbuster’s
cash flow from operations as follows:

1988 1987

CFFO (as reported) $48.3 $10.3

Less: Videocassette purchases (51.3) (14.3)
CFFO (restated) $(3.0) $(4.0)

And, the restated cash-flow-to-net-income ratio would be:

1988 1987
CFFO ÷ net income -0.19 -0.98

The restated ratio suggests that Blockbuster lost $0.19 in operating cash flow in
1988 for every dollar of reported net earnings, a very different result from the
original calculation. This restated ratio calls into question the quality of
Blockbuster’s reported net income.

©Cambridge Business Publishers, 2017

3-2 Financial Accounting for Executives & MBAs, 4th Edition
Q3.5 Earnings Announcements and Share Prices.
There are two potential factors to explain the market’s negative reaction to the
record earnings announcement of Apple:

1. Prior expectations (i.e., an earning’s surprise)

2. Future expectations (i.e., earnings’ guidance)

First, if the market was negatively surprised by Apple’s report, this could readily
explain the negative market response. Second, if as part of the announcement,
Apple indicated that the “future looked grim,” or perhaps not as rosy as the past
has been, this could also explain the downward price movement.

Q3.6 Managing Earnings.

It is frequently alleged that the Enron, WorldCom, and Global Crossing failures
were all examples of cases in which executives managed the company’s
reported accounting data. The most commonly cited motivations for earnings
management include:

 To make executive stock options more valuable.

 To avoid violating a debt covenant.
 To achieve executive bonuses linked either to earnings or share price.

Two cases where downward earnings management has been alleged include:

 Microsoft. Microsoft defers a portion of its software revenue and

expenses its software development costs (even though some could be
capitalized) to manage its earnings downward. According to some
investment professionals, the purpose of this accounting treatment is to
avoid having the company appear “monopolistic.” Allegedly, this is part
of the company’s defense against EU charges of anti-competitiveness in
the EU marketplace.

 Heinz & Co. In a lawsuit in the 1970s, shareholders sued Heinz for
inappropriately deducting prepaid advertising expenses, and hence,
depriving shareholders of potential share price appreciation by managing
earnings downward. Heinz took the excess deductions in an effort to
smooth its earnings growth at approximately 15 percent, a growth
percentage that the company’s executives believed was what the capital
markets desired to see (i.e., consistent positive earnings growth implies
lower firm risk).

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-3
Q3.7 Goodwill Impairment and Sustainable Earnings.
Bank of America’s and AT&T’s huge write-downs of its acquisition goodwill will
lower their 2011 net income, and hence, retained earnings, as well as their
goodwill asset account. Assuming the goodwill is not tax-deductible (i.e.
acquisition goodwill is often not tax deductible), the write-down will lower total
assets and shareholders’ equity (and hence, firm book value) by the full amount
of the write-down. The announcement will also negatively affect market
capitalization as analysts lower their future estimate of the earnings-generating
capacity of these acquisitions. The calculation of current year sustainable
earnings is unaffected by the noncash write-down of goodwill; however, future
estimates of sustainable earnings will be reduced for the lower revenue
estimates associated with the acquisition’s assets.

Q3.8 Special Charges.

AMR’s special charge of $718 million in 2001 and $1,466 million in 2002 are
described as “nonoperational” in the company’s footnotes (see footnote 3 in
AMR’s 2002 annual report). Since the charges are not infrequent (i.e., aircraft
hijackings have occurred on many prior occasions), the FASB determined that
all write-downs associated with the terrorist attacks of September 11, 2001,
should be treated as “unusual or special items.” AMR will disclose the write-
down as a “special charge,” deducted in arriving at operating income, with a
parallel write-down of its assets on the balance sheet. The special charges will
not be included in AMR’s sustainable earnings for either 2001 or 2002.

Q3.9 New Accounting Standard.

An alternative treatment for AMR’s impairment charge is to treat the $1.4 billion
write-off as a “special item” or “special charge,” to be included in operating
income. AMR’s treatment of the write-off removes the special charge from
operating income and gives it special attention at the bottom of AMR’s income
statement. Thus, treatment as the “cumulative effect of accounting method
change” avoids having any financial statement user mistakenly include the
write-off as part of the firm’s recurring or sustainable earnings. Regardless of
the approach used to disclose these events, the write-down should not affect
AMR’s 2002 sustainable earnings. However, the signal of the write-down is
unambiguous – analysts need to lower their future revenue (and hence, future
sustainable earnings) forecasts for this company.

©Cambridge Business Publishers, 2017

3-4 Financial Accounting for Executives & MBAs, 4th Edition
Q3.10 Market Capitalization, Book Value, and Intrinsic Value.

 Market capitalization: the market price per share times the number of
outstanding shares.
 Book value: total assets less total liabilities (i.e., the value of shareholders’
equity).
 Intrinsic value: the fair market value of a business, which in an efficient
market would equal market capitalization.
 Procter & Gamble – this data was obtained from Yahoo Finance in Spring
2013:

Book value $23.99 per share

Market capitalization $79.26 per share
Intrinsic value (i.e., analysts’ consensus price): $88.48 per share

Q3.11 Accounting Statement Restatements.

One possible explanation for the increase in financial statement restatements is
that the full effect of the internal control standards imposed by the Sarbanes-
Oxley Act was finally felt by companies. The financial penalties (i.e., up to $5
million in fines) and incarceration (i.e., up to 20 years) that can be imposed on
CEOs and CFOs under the Act was no doubt driving many executives to “get it
right.” The surprising element to these findings, however, is that there were so
many companies applying GAAP incorrectly, and that these incorrect
applications of GAAP were not being identified by their independent auditors.

As to the market’s reaction to financial statement restatement, the response is

usually negative or none at all, depending upon the nature of the restatement.
For example, in 2005, AIG announced the first of three accounting
restatements, and within three months, saw a market capitalization decline of
$55 billion.

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-5
Q3.12 (Ethics Perspective) Earnings Management to Prevent Technical Defaults.
This question can be approached from several directions. One might argue
that the only responsibility of management is to serve the shareholders. Under
this premise, one can argue that lenders are responsible for their own welfare,
and if they fail to adequately protect themselves through covenants then it is
acceptable for managers to exploit these lenders. This argument implicitly
implies that managers have a responsibility to only one stakeholder, the
shareholders. The fact that a different stakeholder may be harmed is not of
concern under this argument.

The question raises the moral dilemma of whether the ends justify the means.
Ultimately, whether earnings management to avoid a loan covenant is an
ethical breach depends on where one philosophically locates oneself to the
question of, do the ends justify the means? A utilitarian view would argue that
earnings management to avoid technical default is not an ethical breach.
Rather, this view argues that the goodness of not exposing shareholders to the
loss they would experience far outweighs any associated badness associated
with earnings management. In fact, it could be argued that under this approach
it is actually the responsibility of management to do everything legal to prevent
a technical default, and as a consequence, earnings management would be the
correct thing for managers to do.

A counterargument is that the ends should never justify the means. A wrong or
immoral act can never be justified by an ultimate good ending. If one believes
that earnings management is wrong, then it remains wrong even if employing it
achieves a desirable outcome. Someone who follows this thinking would likely
feel that any positive effects to the business associated with avoiding technical
default are irrelevant in comparison to the negative consequences of an
unethical act.

(Note: This answer was based on the writing of Leah Emkin.)

©Cambridge Business Publishers, 2017

3-6 Financial Accounting for Executives & MBAs, 4th Edition
 EXERCISES

E3.13 Classifying Accounting Events.

See QuestromTools Site.

E3.14 Classifying Accounting Transactions.

1. Investing
2. Financing
3. Operating
4. None-of-the-above (i.e., noncash event)
5. Financing
6. Operating
7. Operating
8. Investing
9. None-of-the-above (i.e., noncash event)
10. Financing

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-7
E3.15 Analyzing Cash Flow Data.
The Longo Company’s primary source of cash is its financing activities; that is,
Longo is selling stock or borrowing to support its operating and investing
activities. The Davis Company is generating cash both from the sale of assets
(investing) and the sale of stock or borrowing (financing); these funds are being
used to cover its operating cash deficit.

The change in the cash balance for The Davis Company is an increase in cash
of $51, while for the Longo Corporation the change in its cash balance is a
decrease of $1,598.

The Longo Corporation cash flow from operations of $(1,320) is substantially

less than its operating loss of $(6,050), probably due to the add-back of such
noncash expenses as depreciation and amortization.

E3.16 Analyzing Cash Flow Data.

Pfizer’s primary source of cash is operations, and it uses this cash flow to
support its investing program, to reduce its various sources of financing, and to
pay dividends. Despite paying almost $3 billion for its investing activities and
over $11 billion to reduce its outside financing, Pfizer still managed to increase
its cash balance by $299 million.

Like Pfizer, Johnson & Johnson’s primary source of cash is operations, which it
uses to pay for its investing activities, to reduce its financing, and to pay
dividends. However, Johnson & Johnson cash balance decreased by $791
million.

Both firms’ cash flow from operations are greater than its net income largely
due to the add-back of such noncash charges as depreciation and amortization,
asset write-offs and impairments, and a foreign currency exchange losses.
Other sources of cash include increases in its accounts payables and other
liabilities and decreases in other assets (i.e., working capital accounts).

©Cambridge Business Publishers, 2017

3-8 Financial Accounting for Executives & MBAs, 4th Edition
E3.17 Calculating Earnings per Share.

a) Basic EPS.

$3.2 million - $28,500 *

EPS = = $12 .69
250,000 shares

*(Preferred stock dividend = $28,500 = ($100 x 9.5%) x 3,000 shares)

b) Diluted EPS.

$3.2 million
EPS = = $12.36
250,000 + 9,000

E3.18 Calculating Earnings per Share.

a) Basic EPS

$159,000
EPS = = $2.65
60,000

b) Diluted EPS

$159,000
EPS = = $2.34 (See note below.)
(60,000 + 8,000)

The above calculation of diluted EPS does not consider the effect of the
treasury stock buyback as this technical issue is not covered in the chapter.
For instructors desiring to illustrate this point, the treasury stock buyback would
amount to 7,040 shares (8,000 shares x $22.00 = $176,000; $176,000 / $25.00
= 7,040 shares). And, diluted EPS would amount to $2.61 ($159,000 / (60,000
+ 8,000 - 7,040).

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-9
E3.19 Permanent versus Transitory Earnings.

Year 3 Year 2 Year 1

Net income (as reported) $1,078 $(35,866) $(17,919)
Adjustments:
Impairment of purchased product rights -- +1,134 --
Restructuring charges -- +13,623 -1,079
Loss from equity investments +1,111 +603 +602
Realized loss on investments -- -- +220
Write-down of long-term strategic
investments -- +2,780 +1,238
Permanent earnings $2,189 $(17,726) $(16,938)

Given that Entrust’s share price is only $3.80 at year-end Year 3, it doesn’t
appear that the market believes that the company’s improving earnings and
cash flow from operations are going to be sustained.

E3.20 Converting Indirect Method Cash Flows to Direct Method Cash Flows.

2016
Operating Activities
Cash from sales ($2,430 – $150) $2,280
Cash for cost-of-goods sold(-$1200-15+50) (1,165)
Cash for selling, general and administrative revenues (240)
Cash flow from operations $875

E3.21 Measuring Sustainable Earnings.

 Sustainable earnings for Harnischfeger:

Income before income taxes (as reported) $5,738
Less: Pretax increase in net income due to estimated
useful life change (3,200)
Restated pretax net income 2,538
Effective tax rate ($2,425 ÷ $ 5,738) = 0.42
Provision for income taxes (1,066)
Sustainable earnings $1,472

 The capital market is likely to consider these two voluntary accounting policy
changes adversely, resulting in a share price decline. Existing empirical
research suggests that these types of accounting policy changes (i.e. that
lead to an increase in reported net income) tend to be associated with share
price declines as the market apparently worries that the policy change is an
attempt to cover up poor future operating results – which was exactly the
case for Harnischfeger.
©Cambridge Business Publishers, 2017
3-10 Financial Accounting for Executives & MBAs, 4th Edition
 PROBLEMS
P3.22 Statement of Cash Flow.

See QuestromTools Site.

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-11
P3.23 Statement of Cash Flow.

The Mann Corporation

Statement of Cash Flow
For Year Ended 2016
Cash flow from operations
Net income $600,000
Add: Depreciation expense 30,000
Accounts receivable (230,000)
Inventory (310,000)
Prepaid expenses 0
Accounts payable 70,000
Accrued expenses payable (20,000)
CFFO 140,000
Cash flow for investing
Investments in affiliate companies (100,000)
Property & equipment (510,000)
CFFI (610,000)
Cash flow from financing
Notes payable 500,000
Common stock + APIC 140,000
Dividends paid (20,000) ($90,000* – $70,000)
CFFF 620,000
Increase in cash 150,000
Cash, beginning 250,000
Cash, end $400,000

*Retained earnings (end) – Retained earnings (beg) = (660,000 – 150,000) = 510,000.

Net income – Change in retained earnings = (600,000 – 510,000) = 90,000.

Mann Corporation’s statement of cash flow reveals the following:

1. The company is generating both positive net income and operating cash
flow (i.e. CFFO is $140,000).
2. The company’s dividend is covered both by its net income and its operating
cash flow.
3. The company is investing in future revenue-producing assets like PP&E,
and is financing these capital investments using internally generated cash
flow as well as debt and equity financing (i.e. its free cash flow is negative
$470,000; note this calculation is based on operating cash flow less
investments in property plant and investments in affiliated companies that,
by assumption, are related to operations).

©Cambridge Business Publishers, 2017

3-12 Financial Accounting for Executives & MBAs, 4th Edition
P3.24 Statement of Cash Flow.

Casual Clothing, Inc.

Statement of Cash Flow
FYE 12/31/17
Cash flow from operations
Net income $877,497
Add: Amortization expense 2,700
Depreciation expense 123,000
Merchandise inventory (52,108)
Accounts receivable (7,900)
Other current assets (9,710)
Accounts payable (18,738)
Accrued expenses & other liabilities 32,499
Income taxes payable (8,439)
CFFO 938,801

Cash flow for investing

Buildings, furniture & equipment (290,873)
Land (821,114)
Construction-in-process (200,997)
Intangibles (5,780)
CFFI (1,318,764)

Cash flow from financing

Notes payable 603,020
Current maturities of long-term debt (100,000)
Long-term debt 99,291
Dividends paid (220,906)
CFFF 381,405

Increase in cash 1,442

Cash, beginning 7,352
Cash, end $8,794

Casual Clothing Inc.’s statement of cash flow reveals that:

1. The company is generating both positive net income and operating cash
flow.
2. The company’s cash dividend is well covered by both its net income and its
operating cash flow.
3. The company is making substantial capital investments in new revenue
producing assets like buildings and equipment, among others. Financing for
these investments is coming from operating cash flow and new debt (i.e.
notes payable and long-term debt). Casual’s free cash flow is negative
$379,963, hence the need for external financing.

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-13
P3.25 Statement of Cash Flow.

Catalina Divers Supply Company

Statement of Cash Flow
FYE 12/31/17
Cash flow from operations
Net income $22,400
Add: Depreciation expense 12,400
Loss on sale of equipment 8,400
Accounts receivable (net) (4,400)
Inventory 1,200
Prepaid rent 1,200
Accounts payable (6,800)
Wages payable 4,400
Interest payable (1,400)
Deferred revenue 3,600
CFFO 41,000

Cash flow for investing

Equipment ($12,000 + $12,400 + $8,400) (32,800)
CFFI (32,800)

Cash flow from financing

Bank loan (800)
Dividends paid (6,200)
CFFF (7,000)

Increase in cash 1,200

Cash, beginning 10,800
Cash, end $12,000

The statement of cash flow for Catalina Divers reveals the following:

1. The company’s performance, whether measured in terms of net income or

in terms of operating cash flows, appears solid.
2. The company’s cash dividend of $6,200 is easily covered by either net
income or its operating cash flow.
3. The company is investing in future revenue-producing equipment and is
financing these investments principally with operating cash flow (i.e. its free
cash flow is $8,200, or $41,000 - $32,800).

©Cambridge Business Publishers, 2017

3-14 Financial Accounting for Executives & MBAs, 4th Edition
P3.26 Analyzing and Interpreting Cash Flow Data: A Growing Enterprise.

1. Despite the positive and growing net income, L.A. Gear generated negative
cash flow from operations (CFFO). The negative CFFO appears to be a
direct consequence of the firm’s rapid growth, as evidenced by the large
and growing investments in accounts receivable and inventories.

2. In Year 1, L.A. Gear financed its operations by selling marketable securities

($5,661) and by increasing its short-term borrowings ($4,566). In Year 2,
financing came again from an increase in short-term borrowing ($50,104). In
Year 3, financing was provided by a sale of stock ($69,925).

In essence, L.A. Gear executed a strategy of financing based on cost and

availability. In Year 1, the company used self-financing by selling
marketable securities and supplemented this with low-cost, short-term debt.
In Year 2, the company used further low-cost, short-term debt since it had
exhausted its internal sources of self-financing. Finally, in Year 3, the firm
accessed the high-cost equity market, no doubt at a point when its share
price was at, or near, its all-time high. An alternative to equity financing in
Year 3 was the sale of convertible debentures.

3. L.A. Gear’s depreciation expense is very low during this period because the
company probably (a) outsourced most of its manufacturing and (b) leased
(using operating leases) most of its company-owned stores.

P3.27 Analyzing and Interpreting Cash Flow Data: A Failing Enterprise.

In 1995, L.A. Gear lost $51.4 million; in 1996, when the company filed for
bankruptcy, it lost $61.7 million. Due to the continuing operating losses,
external financing opportunities were essentially nonexistent. The only external
cash financing in 1995 or 1996 came from a small international line of credit
($622,000 in 1995). Thus, the company was forced to generate its own
financing and it did so from its working capital accounts, as follows.

(in millions)
1996 1995
Financing Sources
Collections on accounts receivables $20.6 $30.6
Reductions in inventories 18.1 6.1
Reductions in prepaids 1.5 3.3
Increase in accounts payable 16.2 0
Total $56.4 $40.0

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-15
P3.28 Statement of Cash Flow: International.

The Hoechst Group

Statement of Cash Flow
FYE 12/31/Year 2
(in millions, Deutsche Marks)

Cash flow from operations

Net income €1,895
Add: Depreciation expense 2,190
Amortization expense 1,000
Less: Gain on sale of investments (300)
Inventories 1,232
Receivables & prepaid items 278
Provisions for pension (27)
Other provisions (725)
Liabilities & deferred income (218)
CFFO 5,325

Cash flow from investing

Intangible assets (123-1,000) (877)
Property & equipment (2,903-2,190) 713
Investments (226+300) 526
CFFI 362

Cash flow from financing

Corporate debt (4,106)
Dividends paid (1,895-587) (1,308)
CFFF (5,414)

Minority interests (517)

Decrease in liquid assets (244)
Beg. liquid assets 635
End. liquid assets € 391

The company’s statement of cash flows reveals that Hoechst is generating both
positive earnings and cash flow. Further, both earnings and cash flow are large
enough to fully cover the company’s cash dividend. Of concern is the cash flow
from investing, which suggests that the company may be downsizing.

©Cambridge Business Publishers, 2017

3-16 Financial Accounting for Executives & MBAs, 4th Edition
P3.29 Creating a Statement of Cash Flow from existing Balance Sheets and
Income Statements.

Statement of cash flow for 2014 2015

Cash flow from operating activities
Net income $100 $130
Plus depreciation 50 60
Increase in A/R (135) (95)
Increase in inventory (125) (175)
Increase in other current assets (40) --
Increase in accounts payable 80 10
Cash used in operations (70) (70)

Cash flow from investing activities

Purchase of equipment (650) (85)
Cash flow used from investing activities (650) (85)

Cash flow from financing activities

Issuance of common stock 300 --
Proceeds from loans 540 220
Payments of dividends (20) (25)
Cash flow from financing activities 820 195

Change in cash 100 40

Beginning cash 0 100
Ending cash $100 $140

ROA (levered) = Net income / Total assets: 9.52% 9.00%

Based on the company’s ROA they appear to be doing fine considering these
are the first two years of operations. However, while Arrow appears profitable
based on positive net income and ROA for each year, the company has a
serious cash flow problem. Cash from operations is negative both years and
the company is dependent on external funding to stay in business.

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-17
 CORPORATE ANALYSIS

CA3.30 The Procter and Gamble Company.

 Cash conversion ratio = cash sales ÷ accrual sales.

To compute cash sales, estimate as: Totals sales less the increase in
accounts receivable plus the increase in unearned revenue. Unearned
revenue is not reported for Procter and Gamble, and thus in this case is
assumed to be zero.

Cash sales = $76,279 – (4,861 – 6,386) = $77,804

Cash conversion ratio = 77,804 / 76,279 = 102%

 The cash conversion ratio tells financial statement users how much of
each dollar of sales reported on the income statement was actually
collected. For P & G, the collection rate is over 100 percent. This is good
news and it speaks favorably about the company’s credit granting and
credit collection policies.

a. EBITDA, Free Cash Flow, and Discretionary Cash Flow.

2015 2014 2013

EBITDA
EBT $11,846 $14,337 $14,179
+ Interest 626 710 667
Amortization
+ Depreciation1) 3,134 3,141 2,982
$15,606 $18,188 $17,828
1) See statement of cash flow

2015 2014 2013

Free cash flow
CFFO $14,608 $13,958 $14,873
- Capital expenditures2) 761 (3,278) (3,424)
$15,369 $10,680 $11,449
2)Capital expenditures were calculated on a net basis; that is, the “proceeds from
asset sales” is subtracted against the outflow for capital expenditures.

Continued next page

©Cambridge Business Publishers, 2017

3-18 Financial Accounting for Executives & MBAs, 4th Edition
 2015 2014 2013
Discretionary cash flow
CFFO $14,608 $13,958 $14,873
- Dividends (7,287) (6,911) (6,519)
- Debt3) ( 12,021) (15,606) N/A
$(4,700) $(8,559) NA
3) Current maturities of debt (i.e., “debt due within one year).

Conclusion: Although P & G’s EBITDA and free cash flow are positive
each year, there are no discretionary cash flows available in either 2015 or
2014. This may be a cause for concern considering the discretionary cash
flows are quite large.

b. Sustainable Earnings before taxes.

2015 2014 2013

Sustainable earnings
Net income before tax $11,846 $14,337 $14,179
Goodwill & indefinite lived asset
impairment charges ― ― 308
Venezualan econsolidation charge 2,028 ―
Nonoperating income (net) (531) (206)
) (941)
$13,343 $14,131 $13,546

Conclusion: Overall, P & G’s earnings appear healthy and fairly persistent
in 2013 through 2015. In 2015, there was a large drop in bottom line
earnings as P&G had a significant decrease in net income due to the large
net loss from discontinued operations as well as a deconsolidation charge
of $2,028. Overall, the bottom line 2015 earnings were more sustainable
than they otherwise appeared.

CA3.31 Internet-based Analysis.

No solution is provided as any solution would be unique to the company

selected.

©Cambridge Business Publishers, 2017

Solutions Manual, Chapter 3 3-19
CA3.32 IFRS Financial Statements - LVMH Moet Hennessey-Louis Vuitton S.A.

a. The income statement format under IFRS very closely resembles that
under U.S. GAAP. A few noteworthy differences include:

 Under IFRS, the bottom-line is called “net profit” as contrasted with

“net earnings” or “net income” under U.S. GAAP.
 This point is not obvious on the LVMH statement, but IFRS does not
disclose extraordinary gains/losses as a separate income statement
category; these items get lumped into “Other income and expenses.”
 Under IFRS, we adjust for income attributable to “minority interests”,
while under U.S. GAAP it is usually referred to as income attributable
to “noncontrolling interest.”

b. With respect to the statement of cash flows, Texas Instruments segments

its total cash flow into three categories—operating, investing, and
financing LVMH, on the other hand, segments its total cash flow into five
categories operating activities and operating investments, financial
investments, transactions relating to equity, financing activities, and effect
of exchange rate changes. LVMH essentially segments its “financing
activities” into two types: equity financing, and debt financing. With respect
to the effect of exchange rate changes, this information is usually reported
within the operating and investing sections of the statement under U.S.
GAAP.

Despite these classification differences, both statements reconcile to the

change in the cash account on the balance sheet, and thus, contain the
exact same information.

©Cambridge Business Publishers, 2017

3-20 Financial Accounting for Executives & MBAs, 4th Edition