b. Income, assets, and equity would decrease in the period of the
change. Liabilities would increase.
E5-1 If purchased goodwill is not amortized, amortization expense will be less,
net income will be greater, assets and equity will be greater than if the change
had not been implemented. c. The deferral would require TJX to reduce sales in the period of the
change was made. On the income statement, sales and cost of goods sold
would decrease. On the balance sheet, accounts receivable would decrease and
inventories would increase. Any deposits received on the layaway merchandise
result in an increase in unearned revenue. The SEC suggests the caption
“deposits
received from customers for layaway sales.” Retained earnings would decrease
as a result of the accounting change.
E5-2 a. The increase in inventories means that Cisco was producing or
purchasing more inventories than it could sell, if the inventory increase could
not be justified by the increased sales. The fact that receivables grew faster
than sales can be attributed to significant sales right at the end of the fiscal
period, a change in the type of customers to less credit worthy customers or a
slow down in payments from customers for other reasons such as dissatisfaction
with the product.
b. Financial analysts were concerned for a number of reasons: E5-4Income can decline because the company can be recognizing significant
expenses that do not affect cash in the period the expenses were recognized or
that are noncash expenses that will never affect cash. In Viacom’s case, the
company recognized a drop in the value of its Internet investments. This
recognition required the company to take a charge to earnings while reducing
the value of the Internet investments on its balance sheet. This is a “noncash”
adjustment that does not affect cash flow. In addition, the company’s results
reflected higher amortization of goodwill, resulting from Viacom’s merger with
CBS. Amortization of goodwill is a noncash expense. The company’s cash flow
(earnings before interest, taxes, depreciation and amortization), increased from
$595 million the year earlier to $1.36 billion.
1. Growing inventories relative to sales will mean that Cisco may have to
reduce selling prices, cutting into profit margins.
2. Large customers are ordering fewer goods, hurting future revenues.
For example, sales to auto makers were projected to be $100 million less than
what the company had predicted only a few months previously.
3. Many smaller customers that have provided a base for future growth
have gone out of business or downsized significantly. In fact sales to dot-coms
fell to half of the previous year’s levels.
4. The change in accounts receivable relative to sales suggested that the
sales force struggled to record sales in the closing days of the quarter. This
would suggest even slower revenue growth in future quarters.
E5-3 a. According to the Financial Accounting Standards Board’s Statement
of Financial Accounting Concepts Number 5, revenue should not be
recognized until it is realized or realizable and earned. In Staff Accounting
Bulletin 101, the SEC reiterates FASB’s criteria, stating that revenue is
generally realized or realizable and earned when: 1) persuasive evidence of
an arrangement exists, delivery has occurred or services have been rendered,
the seller’s price to the buyer is fixed or determinable and collectibility is
reasonably assured. The SEC’s interpretive response regarding layaway sales
states that, provided that the other criteria are met, revenue from sales made
under a layaway program should be recognized upon the delivery of the
merchandise to the customer. The justification is that, generally, the selling
company retains the rights of ownership of the merchandise, receives only a
deposit from customers, and does not have an enforceable right to the
remainder of any purchase price. (SEC Staff Accounting Bulletin 101)
1 Solution-05-Exercises
