1. Common-Size Income Statements and Horizontal Analysis
2. Income statements for Mariners Corp. for the past two years are as follows:
   

3. 	(amounts in thousands of dollars)
   	2017	2016
   Sales revenue	$60,000	$50,000
   Cost of goods sold	42,000	30,000
   Gross profit	$18,000	$20,000
   Selling and administrative expense	9,000	5,000
   Operating income	$9,000	$15,000
   Interest expense	2,000	2,000
   Income before tax	$7,000	$13,000
   Income tax expense	2,000	4,000
   Net income	$5,000	$9,000

4. Required:

1. 1. Using the format in Example 13-5, prepare common-size comparative income statements for the two years for Mariners Corp. Round percentages to one decimal point.

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1. 2. Based on Mariner's common size statements in 2017 compared to 2016, it can be concluded that

1. all of these are true.
2. gross profit as a percentage of sales declined due to higher cost of goods sold.
3. net income decreased both in dollars and as a percentage of sales.
4. selling and administrative expenses increased both in dollars as well as percentage of sales.

1. a

• b
• c
• d

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1. 3. Using the format in Example 13-2, prepare comparative income statements for Mariners Corp., including columns for the dollars and for the percentage increase or decrease in each item on the statement. Round all percentages to the nearest whole percent. If an answer is zero, enter "0".

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1. 4. Identify the two items on the income statement that experienced the largest change from one year to the next. For each of these items, where you would look to find additional information about the change.

1. selling and administration expense, and for information refer to individual expense records.
2. Income tax expense, and for information refer to income tax return and supporting records.
3. cost of goods sold, and for information refer to refer to individual expense records.
4. sales revenue, and for information refer to sales ledgers and supporting records.

1. a and b

• b and c
• c and d
• d and a

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CASE 3: Charitable Contributions and Debt: A Comparison of St. Jude Children’s Research Hospital/ALSAC and Universal Health Services

CASE TOPICS OUTLINE

1. St. Jude Children’s Research Hospital/ALSAC

A. Primary Objective

B. Sources of Capital

C. Reporting Practices

2. Universal Health Services

A. Investor-Owned Hospital

B. Debt Including Leases

3. Comparison

Hospitals are an industry in which both not-for-profits and investor-owned facilities operate. The sources of capital available to the not-for-profits include charitable contributions and debt offerings—unless they are governmental, in which case, higher taxes are also an alternative. Debt availability is always, in part, a function of performance, and just as failures have arisen in both sectors, about one-third of the investor-owned hospitals have been described as losing money. Of interest is how can one effectively evaluate such an industry, with this type of diversity in organizational forms and capital availability? A necessary prerequisite to such an evaluation is to have a firm understanding of how charitable contributions are presented.

St. Jude Children’s Research Hospital/ALSAC has the mission of finding cures for children with catastrophic diseases through research and treatment. For the fiscal year 1999, this entity reported total assets of $221,664,232 and income of $177,071,890. A Web site at http://www.stjude.org, as well as Guidestar’s listing, references a Form 990 (Return of Organization Exempt from Income Tax) filing, availability of audited financial statements upon request, and information that the hospital has 2,100 employees and 350 volunteers. Founded in 1962, the organization seeks funds from contributions and grants for unrestricted operating expenses, specific projects, buildings, and endowments. More than 4,000 patients are seen annually, with a hospital maintaining 56 beds. The Form 990, Part III states that the hospital provided 15,231 inpatient days of care during the fiscal year and patients made 40,982 clinic visits. ALSAC is the American Lebanese Syrian Associated Charities, Inc., the fund-raising arm of St. Jude Children’s Research Hospital. It reported 1999 total assets of $1,007,699,320 and income of $274,123,399. This organization reports the number of employees as 565 and the number of volunteers as 800,000. With its sole focus on the hospital, ALSAC’s self-description explains that no child has ever been turned away due to an inability to pay for treatment and explains key accomplishments in the research area achieved by St. Jude’s research and treatment of children with catastrophic diseases. What is borne out by the example of St. Jude is the fact that a review of the Form 990 filed for the fiscal year ending 6/30/99 indicates in Part VI the names of related organizations: ALSAC and St. Jude Hospital Foundation, both of which are tax exempt. To gain a sense of capital availability to a not-for-profit entity, affiliated entities must be considered. In addition, the role of volunteers is a source of human capital not effectively captured within the framework of financial statements for not-for-profits, as reflected in the Form 990 for the fiscal year ending 6/30/99 for ALSAC, which states in Part VI:

Unpaid volunteers have made significant contributions of their time, principally in fund-raising activities. The value of these services is not recognized in the financial statements since it is not susceptible to an objective measurement or valuation and because the activities of these volunteers are not subject to the operating supervision and control present in an employer/employee relationship.

Hence, as one evaluates capital sources and uses by not-for-profits, care is needed to consider affiliated organizations’ role, total contributions, and the effect of volunteerism on the comparability between not-for-profit and investor-owned operations.

Universal Health Services, Inc. filed its 10-K on March 28, 2001, for the calendar year 2000, which includes comparative information for 1999. Analysts have described the company as the most aggressive company in the industry over the 1999–2001 time frame in making acquisitions, particularly of not-for-profit operations and investor-owned operations experiencing losses. The company is praised for it high operating leverage, the relatively small number of shareholders relative to the magnitude of total revenue, and stock price as a multiple of earnings. The company operates 59 hospitals and, as of 1999, had an average number of licensed beds of 4,806 at acute care hospitals and 1,976 at behavioral health centers, with patient days of 963,842 and 444,632, respectively. Of interest is a commentary on the competition found in the company’s filing:

Competition

In all geographical areas in which the Company operates, there are other hospitals which provide services comparable to those offered by the Company’s hospitals, some of which are owned by governmental agencies and supported by tax revenues, and others of which are owned by nonprofit corporations and may be supported to a large extent by endowments and charitable contributions. Such support is not available to the Company’s hospitals. Certain of the Company’s competitors have greater financial resources, are better equipped and offer a broader range of services than the Company. Outpatient treatment and diagnostic facilities, outpatient surgical centers and freestanding ambulatory surgical centers also impact the healthcare marketplace. In recent years, competition among healthcare providers for patients has intensified as hospital occupancy rates in the United States have declined due to, among other things, regulatory and technological changes, increasing use of managed care payment systems, cost containment pressures, a shift toward outpatient treatment and an increasing supply of physicians. The Company’s strategies are designed, and management believes that its facilities are positioned, to be competitive under these changing circumstances. (Source: 10-K filed 3/28/2001)

Financial information is provided in Tables 5.3-1 and 5.3-2 for both the not-for-profit and the investor-owned hospitals.

Table 5.3-1: Financial Comparisons of the Not-for-Profit Entities

* The GuideStar.org Web site (http://www.guidestar.org) provides access to Forms 990 in .PDF format.

Table 5.3-2: Universal Health Services, Inc.’s Financial Excerpts*

* The 10-K filing as of 3/28/2001 at EDGAR (http://www.sec.gov/edgar.shtml) provides financial statement information for 2000 and 1999.

Requirement A: Recording Revenue

1. What is meant by the reference in Table 5.3-1 to an FAS 116 adjustment?

2. How are contributions recorded? Is there a distinction between pledges receivable and accounts receivable?

3. Are there circumstances when financial statements can quantify volunteers’ services?

4. Can financial statement users of not-for-profit hospitals’ financial statements expect to be fully informed regarding affiliated parties, such as the linkages between St. Jude Children’s Research Hospital, ALSAC, and the foundation cited? Explain.

Requirement B: Revenue Mix (Strategy-Related Considerations)

The 10-K filing of Universal Health Services, Inc. describes the mix of revenue sources, as depicted in Table 5.3-3.

Table 5.3-3: Patient Revenue Mix

1. How does this revenue mix compare with the revenue blend of the not-for-profit entity, St. Jude Children’s Research Hospital (ALSAC)? Access the latest SEC filing and compare the reported revenue mix; has it changed?

2. What does that imply as to the strategies of investor-owned hospitals in managing risk and ensuring adequate capital relative to not-for-profit entities? An opportunity exists to explore the greater social and political questions that are frequently debated about the compatibility of profit-oriented entities and quality of health care, relative to not-for-profit entities. As background, identify what the latest SEC filings report concerning charity care.

How would your answers to Requirements A and B differ if the government owned and operated the hospital?

Part II: Revenue recognition Coffee House Part I should be completed before beginning Part II. Background: Day two: the same student goes into the Coffee House and orders a large coffee in a campus-branded, thermal coffee mug as part of a “welcome back to school” daily special. As the student is focused on sustainability, the student plans to use this mug daily for refills rather than using paper cups. The barista pours the coffee into the mug and delivers it to the student. The cashier then collects $7 from the student. Standalone selling prices are $5 for the coffee and $3 for the mug, so the student got a bargain on the combined purchase. The student takes the coffee in the new mug and enjoys it while reading The Wall Street Journal. Requirements: ► Review ASC 606-10-25-19 through 22 and ASC 606-10-32-31 through 32. ► For each of the five steps: – Describe how the revenue model applies to this transaction. For any step that is not applicable, simply indicate it is not applicable. – Draw a conclusion as to whether the requirements for that step were complied with. ► As a final conclusion, determine the amount of revenue that should be recognized with detailed calculations and provide the journal entry to record the transaction. Revenue recognition – case studies 2 © 2017 Ernst & Young Foundation (US). All Rights Reserved. SCORE No. 01182-161US Part III: Revenue recognition Coffee House Part II should be completed before beginning Part III. Background: Day three: the same student goes into the Coffee House bringing in his coffee mug and orders a large coffee and a croissant. Standalone selling prices are $5 for the coffee and $2 for the croissant. The cashier tells the student they are out of croissants. The cashier then offers the student the large coffee and a coupon for two croissants (its typical business practice) for $7. The student pays the $7 to the cashier. The cashier gives the student a coupon for two croissants. The barista pours the coffee into the coffee mug and hands it to the student. The student then takes the coffee and the coupon and heads to the dorm to study for the upcoming accounting exam. The Coffee House sells a coupon for two croissants for $3.50. To increase visits, these coupons can be redeemed any date after the date of purchase. The Coffee House has limited experience with these coupons but, so far, these coupons have always been redeemed. Requirements: ► Review ASC 606-10-25-2 through 6. ► For each of the five steps: – Describe how the revenue model applies to this transaction. For any step that is not applicable, simply indicate it is not applicable. – Draw a conclusion as to whether the requirements for that step were complied with. ► As a final conclusion, determine the amount of revenue that should be recognized with detailed calculations and provide the journal entry to record the transaction. Revenue recognition – case studies 3 © 2017 Ernst & Young Foundation (US). All Rights Reserved. SCORE No. 01182-161US Part IV: Revenue recognition Coffee House Part III should be completed before beginning Part IV. Background: Day four: the same student goes into the Coffee House and orders two croissants. The cashier takes the order and asks for a $4 payment. The student hands the cashier the coupon. The cashier reviews the coupon and determines it is valid and accepts it as payment. The cashier gives the student the two croissants. The student then heads off to share the croissants with a friend from the Accounting Club. Requirements: ► Complete the revenue recognition for the contract established in Part III by addressing only step five for the redemption of the coupon: – Describe how the revenue model applies to this transaction. – Draw a conclusion as to whether the requirements for this step were complied with. ► As a final conclusion, determine the amount of revenue that should be recognized with detailed calculations and provide the journal entry to record the transaction.

Capital Budgeting Risk Analysis Project Instruction Create the pro forma income statement and estimate the cash flows for the following project. Decide whether to accept this project based on analysis of the NPV, Profitability Index, and IRR. Project Assumptions (Base Case) Equipment Life 6 Years Initial Equipment Cost $2,500,000 in year 0 Depreciation Straight Line Method Initial Revenue $1,000,000 in year 1 Revenue growth rate year 2 10% Revenue growth rate year 3 15% Revenue growth rate year 4 10% Revenue growth rate year 5 5% Variable Costs 60% of this year's revenue Fixed Costs $75,000 in year 1 Fixed Costs Inflation Rate 3% per year Long-term growth rate 2% per year Net Working Capital 4% of next year's revenue Tax Rate 35% Discount Rate 18% Model Structure Since this project does not have an end date we need to decide how many years of detailed analysis we will conduct. For this assignment, we will estimate detailed cash flows for 5 years and estimate the terminal value at the end of year 5. The Income Statement is the building block for cash flow estimation. Your income statement should contain the following items. You may include additional items if you find them useful in your model. Revenue Variable Cost Gross Profit Cash Fixed Cost Depreciation EBIT (Earnings Before Interest and Tax) Tax Net Income Cash Flows: • Operating Cash Flow = EBIT + Depreciation – Taxes • Other cash flow items o initial investment o change in Net Working Capital o Terminal value   Analyses 1. Scenario Analysis: prepare a scenario summary report. Use the values in the original assumption as the base case and add the following two cases. Case 1 (worst case) Variable Costs 65% of this year's revenue Fixed Costs $80,000 in year 1 Fixed Costs Inflation Rate 5% per year Long-term growth rate 1% per year Case 2 (best case) Variable Costs 55% of this year's revenue Fixed Costs $70,000 in year 1 Fixed Costs Inflation Rate 3% per year Long-term growth rate 3% per year 2. Sensitivity Analysis: prepare a one-way data table. Make sure to use the base case values. Allow the long-term growth rate to vary from -3.0% to +3.0% in increments of 0.5%. Show the impact on NPV and IRR. 3. Breakeven Analysis: identify the initial revenue level that will result in $0 NPV. Things to turn in: 1. A one-page memo explaining the results of your analysis and your recommendation. The memo should include important results of your analysis such as a summary table or graph. The memo is limited to one page so be very selective on what information to include. 2. An Excel spreadsheet showing the following: • Entire model for the base case • Scenario Analysis (Scenario Summary Report) • Sensitivity Analysis (Data Table) • Breakeven Analysis (Goal Seek result) Check Figures (Base case): Model Year 0 1 5 6 Pro Forma Incremental Income Statement Revenue 1,000,000 1,461,075 1,490,297 Net Income (59,583) 54,178 Pro Forma Incremental Balance Sheet Net Working Capital 40,000 44,000 59,612 Pro Forma Incremental Cash Flows Total Net AT CF (2,540,000) 353,083 3,463,856

Demand: Qd=90-4P, where Qd is quantity demanded and P is price

Supply: Qs=-100+15P, where Qs is quantity supplied and P is price

Recall that equilibrium price was 19, while quantity was 50. At that price, the price elasticity of demand was -0.80.

1. Now I want you to rearrange each equation, putting P on the left-hand side, and solve again for equilibrium P and Q (you ought to get the same answer).
   1. Now we want to figure the monopoly price. Take the supply equation that you just developed (with P on the left-hand side), and make it your marginal cost equation. That is, just replace P with MC.

2. Total revenue is (P*Qd) and marginal revenue is the first derivative of total revenue with respect to Qd. Calculate total revenue and marginal revenue equations, derived from the demand equation developed above.

3. Now calculate price and quantity at the monopoly equilibrium (set MR=MC, solve for Q, the solve for P from the demand equation). How does monopoly P and Q compare to that calculated under competition?

4. What’s the price elasticity of demand at the monopoly price and quantity? Is it more or less elastic than the price elasticity at the competitive equilibrium?

1. A price elasticity of demand, estimated at the profit-maximizing monopoly price, will always be in the elastic range (that is, less than -1.0). Can you explain why?

yates Corporation enters into an agreement with Browning Rentals Co. on January 1, 2020 for the purpose of leasing a machine to be used in its manufacturing operations. The following data pertain to the agreement:

(a) The term of the noncancelable lease is 3 years with no renewal option. Payments of $574,864 are due on January 1 of each year.

(b) The fair value of the machine on January 1, 2020, is $1,660,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon the termination of the lease.

(c) Yates depreciates all machinery it owns on a straight-line basis.

(d) yates’s incremental borrowing rate is 10% per year. yates does not have knowledge of the 8% implicit rate used by Browning.

A) If Browning records this lease as a financing lease, what amount would be recorded as Lease Receivable at the inception of the lease? Show all of your work. a. $574,864 b. $1,572,563 c. $1,600,000 d. $1,724,592

B) How much depreciation expense would Browning, the lessor, show in Year 1 for this asset?

C) How much Interest Revenue would Browning show in Year 1 on this transaction?

D) Which of the following lease-related revenue and expense items would be recorded by Browning if the lease is accounted for as an operating lease? a. Lease Revenue only b. Interest Revenue only c. Depreciation Expense only d. Lease Revenue and Depreciation Expense

Each part should be no more than 1 page in length.

Part I

The rules of accounting provide management with “some” latitude in determining when revenue is earned. Assume that a company normally required acceptance by its customers prior to recording revenue as earned, delivers a product to a customer near the end of the quarter. The company believes that customer acceptance is assured, but cannot obtain it prior to the quarter-end. Recording the revenue would assure “making its numbers” for the quarter. Although formal acceptance is not obtained, the salesperson records the sale, fully intending to obtain written acceptance as soon as possible.

1. What are the revenue recognition requirements in this case?

2. What are the ethical issues relating to this sale?

3. Assume you are on the board of directors of this company. What safeguards can you put in place to provide assurance that the company’s revenue recognition policy is followed?

Part II

Research and review what a financial statement derivative is. Identify an example and how company’s use to leverage the business activities.

Part III

A company’s return on net operating assets (RNOA = NOPAT/Average NOA) is commonly used to evaluate financial performance. If managers cannot increase NOPAT, they can still increase this return by reducing the amount of net operating assets (NOA). In bullet form, list specific ways that managers could reduce the following assets:

1. Receivables

2. Inventories

3. Plant, property equipment

Percentage-of-Completion and Completed Contract Methods

Philbrick Company signed a three-year contract to provide sales training to the employees of Elliot Company. The contract price is $1,200 per employee and the estimated number of employees to be trained is 400. The expected number to be trained in each year and the expected training costs follow.

Required

For each year, compute the revenue, expense, and gross profit reported assuming revenue is recognized using the following method.
(Do not round until your final answers. Round your answers to two decimal places.)

1. Percentage-of-completion method, where percentage-of-completion is determined by the number of employees trained.

2. Percentage-of-completion method, where percentage-of-completion is determined by the costs incurred.

3. Completed contract method.