BA 270 - Mid Term Exam
Fall, 2003
TENTATIVE SOLUTION
Name: __________________________________________________
(Please Print)
PID: ___________________________________
Scheduled Class Time:
Question
I.
8:00
9:30
(Circle One)
11:00
Suggested Time
Points
1 ¾ hours
60
II.
1 ¼ hour
Because of Isabel and Saturday exams
Total
3 hours
2:00
37
+3
100
Show your work for partial credit—close counts in horseshoes, hand grenades and
BA270, but only if you show your work. If you feel that you need to make an
assumption on a problem, please state it. If you are really confused by a question, I will
be in the hall to answer questions.
Attached are the UK GAAP financial statements for Manchester United. Assume that,
although the format of their financial statements differs from US GAAP, the basic
accounting principles are consistent with those we’ve discussed in class. All amounts
are in thousand of pounds (£’000) unless noted otherwise—please round to £’000s.
(In some cases columns will not add up exactly because of rounding—don’t worry about
it). Note that Manchester United’s year ends on July 31, so 2003 refers to the year
ending July 31, 2003. Assume that the 2003 soccer season also runs from August 1,
2002 to July 31, 2003. Assume a 25% tax rate throughout.
Part I:
Your goal is to forecast an income statement, statement of cash flows and balance sheet
for Manchester United for 2003. For the purposes of this part, refer only to the attached
summary financial statements and the following assumptions. If at all possible, please
provide journal entries in the space provided below. If you really hate journal entries,
indicate which accounts go up or down in the space below the description of the
transaction, but don’t leave that space blank if you want partial credit. Do not worry
if your accounts temporarily have negative balances (the transactions below are not
sequential; they are aggregations over the period).
Manchester United has three primary lines of revenue—ticket sales, media sales (e.g., the
television rights to the games) and merchandise sales.
1.
You forecast that Manchester United will earn £56,321 from tickets to games
during the 2003 season. Assume that Manchester United sells some of the 2003
seats through game-day sales (£10,844) and that the remainder (£45,477) will be
for season tickets sold in 2002 covering the 2003 season (“unearned revenue” on
the balance sheet). Assume further that Manchester United sells (for cash)
£48,976 of tickets during 2003 for the 2004 season. (6 points)
Deferred Income
Ticket Turnover
45,477
Cash
10,844
Ticket Turnover
45,477
10,844
Cash
48,976
Deferred Income
2.
48,976
Manchester United also derives revenue from media sales (broadcasters paying
for the rights to televise games). Assume that contracts for media coverage are
signed prior to the start of the season (e.g., contracts covering the 2003 season
were signed in 2002), but the cash is received both during and after the end of the
season (e.g., cash for the 2003 season media rights is received in 2003 and 2004).
You forecast that Manchester United will earn £80,544 from media sales for the
2003 season, of which £49,863 will be paid in cash during 2003 and £30,681 will
remain uncollected (“debtors” on the balance sheet) at year end 2003. In addition,
Manchester United will collect any amounts due it as of the beginning of 2003
during 2003. Finally, during 2003, Manchester United will sign a contract for
£82,332 for rights to the 2004 season, payment to be received in 2004 and 2005.
(8 points)
Cash
49,863
Media Turnover
49,863
Debtors
Media Turnover
30,681
Cash
32,279
30,681
Debtors
3.
32,279
Finally, Manchester United derives revenue from merchandise sales (hats, t-shirts
and the like). In general, they charge royalties on the merchandise rather than
taking delivery themselves. Assume that Manchester United will receive £12,136
in cash during 2003 for merchandise sold in 2003. (2 points)
Cash
12,136
Merchandise Turnover
12,136
4.
5.
6.
7.
An unusual aspect of Manchester United’s business is that they buy and sell
player registrations (contracts) for cash. Basically, the idea is analogous to
property, plant and equipment—when they buy a player registration, they
depreciate it straightline over its life and record a sale if the player’s contract is
ultimately sold. Assume that in 2003 they buy additional player registrations of
£40,150 and record amortization totaling £22,700 on all player registrations.
Assume further, that player registrations have a life of 5 years and that during
2003 they sell player registrations with a historical cost of £20,500 which are
three years through their life at the time of sale and receive £20,800 of cash on the
sale. (10 points)
Cost of Player Registration
Cash
40,150
Amortization of Player Registrations
Accumulated Amortization
22,700
Cash
Accumulated Amortization
Cost of Player Registrations
Profit on Disposal of Players
20,800
12,300
40,150
22,700
20,500
12,600
In addition, they buy tangible fixed assets (property, plant and equipment) for
cash of £18,023 and record depreciation of £10,234. No tangible fixed assets will
be sold during 2003. (5 points)
Cost of Tangible Assets
Cash
18,023
Depreciation of Tangible Fixed Assets
Accum. Depr. on Tangible Assets
10,234
18,023
10,234
Employees (including players) will earn £73,442 for services rendered in 2003.
The ending balance in the accrued salaries account will be £12,377 (5 points)
Compensation Expense
Accrued Salaries
73,442
Accrued Salaries
Cash
75,626
73,442
75,626
Administrative expenses will be £21,289, all paid during 2003. (2 points)
Administrative Expense
Cash
21,289
21,289
8.
9.
Taxes are paid in the first quarter of the year on the previous year’s profits. New
taxes payable are recorded at year-end at 25% of pre-tax income. (6 points)
Corporation Tax
Cash
7,308
Taxation
Corporation Tax
8484
7,308
8484
The ending cash balance will be £1,010. Any excess cash is paid out as a
dividend and any shortfall is made up by issuing stock. (3 points)
Profit and Loss Account
Cash
12,425
Ticket Turnover
Media Turnover
Merchandise Turnover
Profit on Disposal of Players
Administrative Expense
Compensation Expense
Amortization of Player Reg.
Depreciation of Tang. Assets
Taxation
Profit and Loss Account
56,321
80,544
12,136
12,600
12,425
21,289
73,442
22,700
10,234
8,484
25,452
Prepare Manchester United’s forecasted 2003 balance sheet (4 points), income statement
(3 points) and cash flow statement (5 points).
Cost of Player
Registrations
108,427
(4) 40,150 (4) 20,500
Accumulated Amort.
of Player Registrations
26,218
(4) 12,300 (4) 22,700
128,077
36,618
Accumulated Deprec.
of Tangible Assets
31,792
(5) 10,234
Debtors
32,279
(2) 30,681
42,026
30,681
Cost of Tangible Assets
160,121
(5) 18,023
178144
Cash
(2) 32,279
933
(1) 10,844
(1) 48,976
(2) 49,863
(2) 32,279
(3) 12,136
(4) 20,800
1,010
(4) 40,150
(5) 18,023
(6) 75,626
(7) 21,289
(8) 7,308
(9) 12,425
Accrued Salaries
14,561
75,626 (6) (6) 73,442
Corporation Tax
7308
(8) 7308
(8) 8484
Deferred Income
45,477
(1) 45,477 (1) 48,976
12,377
8484
48,976
Profit and Loss Account
110,966
12,425
25,452
123,993
Merchandising Turnover
12,136 (3)
(9) 12,136
12,136
Amortization of Player
Registrations
(4) 22,700
22,700
22,700 (9)
Taxation
(8) 8,484
8,484
8,484 (9)
Ticket Turnover
45,477 (1)
10,844 (1)
(9) 56,321
56,321
Administration Expense
(7) 21,289
21,289
21,289 (9)
Depreciation of Tangible
Fixed Assets
(5) 10,234
10,234
10,234 (9)
Media Turnover
49,863 (2)
30,681 (2)
(9) 80,544
80,544
Compensation Expense
(6) 73,442
73,442
73,442 (9)
Profit on Disposal of
Players
(4) 12,600
(9) 12,600
12,600
CONSOLIDATED PROFIT AND LOSS ACCOUNT
Turnover
Tickets
Media and Commercials
Merchandising
Total Turnover
Administration Expenses
Compensation Expense
Amortization of Player Registrations
Depreciation of Tangible Assets
Operating Profit
Profit on Disposal of Players
Profit on Disposal of Tangible Fixed Assets
Profit Before Taxation
Taxation
Profit for the Year
Dividends
Retained Profit for the Year
56253
78441
11368
146062
56321
80544
12136
149001
35940
69999
17647
7685
14791
17406
150
32347
7308
25039
8053
16986
21289
73442
22700
10234
21336
12600
0
33936
8484
25452
12426
13026
108427
26218
82209
128077
36618
91459
160121
31792
128329
1789
212327
178144
42026
136118
1789
229366
32279
933
196
33408
30681
1,010
196
31887
14561
7308
31590
53459
-20051
12377
8484
31590
52451
-20564
9356
9356
CONSOLIDATED BALANCE SHEET
Fixed Assets
Intangible Assets
Cost of Player Registrations
Accumulated Amortisation of Player Registrations
Net Book Value of Player Registrations
Tangible Assets
Cost of Tangible Assets
Accumulated Depreciation of Tangible Assets
Net Book Value of Tangible Assets
Investments in Associates
Total Fixed Assets
Current Assets
Debtors
Cash
Other
Total Current Assets
Creditors--amounts falling due within one year
Accrued Salaries
Corporation Tax
Other
Total Current Liabilities
Net Current Liabilities
Creditors--amounts falling due after one year
Deferred Taxation
Deferred Income
Total Noncurrent Liabilities
Net Assets
45477
54833
137443
48976
58332
150470
Share Capital
Profit and Loss Account
Shareholders' Funds
26477
110966
137443
26477
123993
150470
Profit for the Year
Depreciation Charges
Amortization of Player Registrations
Profit on Disposal of Tangible Fixed Assets
Profit on Disposal of Players
Decrease/(increase) in stocks
Decrease/(increase) in debtors
(Decrease)/increase in accrued salaries
(Decrease)/increase in corporation tax
(Decrease)/increase in deferred income
Other
Net Cash Inflow from Operaitons
25039
7685
17647
-150
-17406
2013
1470
-1060
-91
2789
-4486
33450
25452
10234
22700
0
-12600
0
1598
-2184
1176
3499
0
49875
33450
Cash from Investing
Proceeds from Sale of Player Registrations
Purchase of Player Registrations
Proceeds from Sale of Tangible Fixed Assets
Purchase of Tangible Fixed Assets
Net Cash from Investing
13,006
-25089
1165
-15088
-26,006
20800
-40150
0
-18023
-37,373
-8053
2779
-5274
-12425
0
-12425
2170
77
CONSOLIDATED CASH FLOW STATEMENT
Cash from Financing
Equity Dividends Paid
Other
Net Cash from Financing
Change in Cash
Part II
This section uses the information provided here as well as the some of the information
in financial statements for 2002, but don’t use your forecasted numbers for 2003.
1. In June 2003, Manchester United sold Beckham’s registration to Real Madrid. The
selling price of 27.5 million Euro had two main components (based on the Manchester
United Press Release). Manchester United had the choice between an unconditional 17.5
million Euro divided equally over the next four years or 16.3 million Euro in September
2003, the difference reflecting the time value of money. In addition, Manchester United
is to receive 10 million Euro conditional on Real Madrid's performances in the UEFA
Champions League, 1.25 million Euro of it payable in each of the next four seasons if
Real Madrid qualifies for the Champions League, and a further 1.25 million Euro each
season if Real Madrid reaches the quarter-finals.
a. Should Real Madrid record any liability to Manchester United in June
2003 related to the purchase of Beckham? Explain (briefly) your
reasoning. (2 points)
Yes. All conditions are met. In particular, unavoidable obligation, past
transaction or event, reasonably estimable. It is not an executory contract
because Manchester United has satisfied all of its obligations—it is like selling
PP&E. If Beckham were to break a leg, Real Madrid would still be out the
money.
b. Assuming a liability is recorded for some portion of the 27.5 million Euro
total potential payment, what amount (if any) should Real Madrid record
for the unconditional portion of the payment? Explain your reasoning. (2
points)
16.3 million—present value of the future cash flows. The unconditional nature of
the obligation makes it a liability.
c. Assuming a liability is recorded for some portion of the 27.5 million Euro
total potential payment, what amount (if any) do you think Real Madrid
should record for the conditional portion? Why? (I’m not sure there is a
clear right answer here, but I am looking for your reasoning. (2 points)
The obligation is contingent, but the nature of the contingency is unusual because
it is not contingent on anything that Manchester United has control over. The
answer really comes down to whether it is deemed reasonably estimable, which it
may or may not be.
2.
What journal entries did Manchester United record in 2002 on the player
contracts (your answer should explain the change in the cost of player
registration and accumulated amortization of player registration accounts—the
Beckham transaction is not included since that occurred in 2003). The
beginning of 2002 balances were £104,075 for cost of player registrations and
£23,708 for accumulated amortization of player registrations. Hint: this
problem has multiple parts—break it down into its parts and solve each part
separately. (14 points).
Cost of player registrations (SCF)
Cash
25,089
Amortization Expense (SCF)
Accumulated Amortization
17,647
Cash (SCF)
Accumulated Amortization (plug t-account)
Cost of player registration (plug t-acct.)
Profit on Disposal (SCF)
23,006
15,137
25,089
17,647
20,737
17,406
3.
One of the areas for which Manchester United is best known is developing
young talent and selling the player registrations. Beckham, for example,
signed up with a Manchester United club team as a teenager and was
developed internally. In exchange for training, a player like Beckham
commits to a long term contract with no upfront payment. Suppose that
Manchester United spent £500 developing Beckham to the point where he was
ready to play for a professional club. Would they recognize an asset for the
£500? Explain briefly. (2 points)
No. That is just training costs (Beckham is an internally developed intangible).
Real Madrid would book him as an asset at purchase price because they
purchased his contract.
4.
What was Manchester United’s return on equity in 2002? Assume a
beginning balance in shareholders’ equity of £85,840 and in total assets of
£218,409. (4 points)
Average shareholders’ equity 85,840+137,443/2 = 111,642
Net Income 25039
ROE = 25,039/111,642 = 0.224
Decompose their return on equity into three pieces as we did in class. (4
points)
Average total assets (218,409+245,735)/2 = 232,072
Sales 146,062
Net Income/Sales x Sales/Average Total Assets x ATA/Average SH Equity
25,039/146,062 x 146,062/232,072 x 232,072/111,642
.171 x .629 x 2.08 = .224
5.
Suppose that Manchester United’s CEO is evaluated based on return on
equity.
a. Suggest a way that he could increase the third term in the decomposition
(leverage). Which of the other three terms is most likely to be reduced
and why? (2 points)
Take on more debt. Reduce net income/sales because of interest..
b. Suppose he decided to increase advertising and suppose that changed two
of the three terms. Which two terms would be most likely to change, in
what direction and why? (2 points)
Profit margin would drop because of advertising expense and total asset
turnover would increase because of increased sales..
c. Suppose the CEO decided to issue long term debt and use the proceeds to
pay a dividend. Would that change return on assets? If so, would it go up
or down? Explain (you don’t need to compute it). (2 points).
There would be no effect on ROA—it is before financing. Income is before
interest and assets are before financing.
6. Note that Manchester United’s owners’ equity consists of “Share Capital”
(contributed capital) and “Profit and Loss Account” (retained earnings). What
does that tell you about their international subsidiaries? (1 point)
Manchester United has no foreign currency translation adjustment, implying
no international subsidiaries keeping their books in foreign currencies.
Manchester United has foreign sales, but they are probably through the U.K.
parent.