Mariela Jasmine Constantino Study the financial statements and notes for Nike and respond to the following questions. Income Statement a. Identify when Nike recognizes revenues. Does this timing of revenue recognition seem appropriate? Explain. Nike recognizes revenue when the customer receives the title, risks, and rewards of ownership of the product based on the terms of sale. This type of recognition seems appropriate as retail stores record revenue at the time of sale and online stores record their revenue when the product has been delivered to the customer. Additionally, Nike records reductions for provisions for post-invoice sales discounts, returns and miscellaneous claims from customers at the time of sale as well. b. Identify the cost-flow assumption(s) that Nike uses to measure cost of goods sold. Does Nike’s choice of cost-flow assumption(s) seem appropriate? Explain. As stated in the notes, Nike identifies their cost-flow assumption as either average or specific identification cost basis. Average cost flow would be appropriate for Nike given their large inventory but may have trouble with specific identification cost basis because of it. But, with the selling of limitededition products, it can prove to be an advantage as there are specific products that are prices differently from the others that are all around the same range when it comes to price. c. Nike reports property, plant, and equipment on its balance sheet and discloses the amount of depreciation for each year in its statement of cash flows. Why doesn’t depreciation expense appear among its expenses on the income statement? Since Nike does not do its own manufacturing, so the depreciation expense in the statement of cash flows refer to the depreciation of the buildings and equipment used in their selling and administrative activities so depreciation for these will be included in selling and administrative expenses. d. What does “demand creation expense” represent? Demand creation expense represents the costs of advertising and promotion. Examples for these are endorsement contracts, television, digital and print advertising, brand events and retail brand presentation. Advertising production costs are expensed the first time an advertisement is run. e. Identify the portion of Nike’s income tax expense of $863 million for 2016 that is currently payable to governmental entities and the portion that is deferred to future years. Why is the amount currently payable to governmental entities in 2016 greater than the income tax expense? As seen in the notes section, ($80) million is being deferred to future years and $943 million is currently payable to the government. As government taxes are dependent a company’s income, they have different accounting rules which is probably why the amount of currently payable to governmental entities is higher. Balance Sheet f. Why do accounts receivable (net) appear net of allowance for doubtful accounts? Identify the events or transactions that cause the allowance account to increase or decrease. Instances of an account receivable not being collected or will not be collected in the future always have the chance to happen. These are put into the bad debt and cash collections account as they are events or transactions that cause the allowance account to increase or decrease. g. What is the largest asset (in dollar amount) on Nike’s balance sheet? How does this asset relate to Nike’s strategy? The largest asset in dollar amount on Nike’s balance sheet is Inventories with $3,947 million. This aligns with their strategy as with their constant expansion of range in sportswear and product lines together with the acquisitions of other apparel companies, it would naturally increase their inventory and become its largest asset as their manufacturing and retail are mostly outsourced anyways. h. Identify the depreciation method(s) that Nike uses for its buildings and equipment. Does Nike’s choice of depreciation method(s) seem appropriate? As seen in the notes, Nike uses the straight-line basis for their depreciation method for buildings and leasehold improvements over 2 to 40 years and for machinery and equipment over 2 to 15 years. This method of depreciation is appropriate as they do not experience much depreciation with wither assets because they mainly outsource. i. Nike includes identifiable intangible assets on its balance sheet. Does this account include the value of Nike’s brand name and Nike’s “swoosh” trademark? Explain. While the value of Nike’s brand name and Nike’s “swoosh” are assets of the company, they do not appear in the balance sheet as these are created by the company. However, if a company made expenditures to purchase trademarks or other intangibles from other companies, these will appear on the balance sheet as assets. Statement of Cash Flows j. Why does the amount of net income differ from the amount of cash flow from operations? Companies usually recognize revenue at the time a sale of a good or service is made, not when they receive the cash from the customers. This is called the accrual basis of accounting. This way, the company has a better understanding of their operating performance because of the matching inputs and outputs as they already matched the expenses with associated revenues k. Why does Nike add depreciation expense back to net income when calculating cash flow from operations? Depreciation expense is added back to net income when calculating cash flow from operations as it is a non cash expense. l. Why does Nike subtract increases in accounts receivable from net income when calculating cash flow from operations for 2016? Increases in accounts receivable is subtracted from net income when calculating cash flow from operations because it is cash you have not received yet. m. Why does Nike adjust net income by subtracting increases in inventory and adding decreases in inventory when calculating cash flow from operations? Net income is subtracted with the increase of inventory as cash was most likely used to make the purchase of the inventory. On the other hand, a decrease in inventory means they have made sales and therefore increases the income. n. When calculating cash flow from operations, why does Nike adjust net income by adding increases and subtracting decreases in accounts payable? If Nike’s accounts payable increases their cash expenses are less than the amount recognized as their expense, leaving them with more income. On the other hand, if the accounts payable decreases, that means that they used cash to pay their accounts, resulting in the decrease of cash and net income. o. Cash flow from operations exceeded net income during fiscal 2015, but not during fiscal 2016. Why? What caused the big drop in cash flows provided by operations from 2015 to 2016? Cash flow from operations exceeded net income during fiscal 2015 because of high amount of accounts payable, accrued liabilities and income tax payable. The decrease in accounts payable, accrued liabilities and income tax payable is what caused the big drop in cash flows as Nike started paying, leaving them with less cash on hand in 2016 than in 2015. p. What were Nike’s primary financing activities during these three years? Nike’s primary financing activities during these three years were repurchases of common stock and dividends – common and preferred. Relations between Financial Statement Items q. Compute the amount of cash collected from customers during 2016. Sales Revenue Change in accounts receivables (decrease) Amount of cash collected r. $32,376 60 $32,436 million Compute the amount of cash payments made to suppliers of merchandise during 2016. Cost of goods sold Change in Inventory Change in Accounts Payable (decrease) Cash paid for purchases of inventory $17,405 590 (60) $17,935 million s. Reconcile the change in retained earnings during 2016. Beginning retained earnings Net income Stock Repurchases $ 4,685 3,760 (3,228) Dividends Ending retained earnings (1,022) $ 4,195 million $ 4,195 million =/= $ 4, 151 million (found on balance sheet) May be because of Nike repurchasing outstanding shares of its common stock each year and retiring them as stated in the notes. Interpreting Financial Statement Relations t. Exhibit 1.28 presents common-size and percentage change income statements for Nike for 2014, 2015, and 2016. What are some reasons for the increases in the net income/sales revenue percentages for Nike between 2014 and 2015, and between 2015 and 2016? The decrease of cost of sales, demand creation expense, and income tax are some reasons for the increases in the net income/sales revenue percentages for Nike between 2014 and 2015, and between 2015 and 2016. u. Exhibit 1.29 presents common-size and percentage change balance sheets for Nike at the end of 2014, 2015, and 2016. What is the likely explanation for the relatively small percentages for property, plant, and equipment? The manufacturing and most of the retailing of products is outsourced by Nike. Because of this, they only have a few PPEs such as buildings and equipment. v. What is the likely explanation for the relatively small percentages for notes payable and longterm debt? Nike generates sufficient cash to not need to take on much debt in order to finance investments. As a result, they do not need any significant notes payable or long-term debt.
