Financial Accounting for MBAs 8th Edition Easton Solutions Manua

Financial Accounting for MBAs 8 th Edition BY Easton Solutions Manua Solutions Manual Financial Accounting for MBAs 8th Edition Easton Solutions Manual Solutions Manual Directly From The publisher, 100% Verified Answers. Download Immediately After the Order. Forecasting Accounting Numbers ■■Forecasting Assumptions ■■Forecasting Financial Statements Assessing Profitability and Creditworthiness ■■ROE Disaggregation ■■RNOA Disaggregation Analysis ■■Disaggregation of Margin and Turnover ■■Credit Analysis Reviewing the Financial Statements ■■Income Statement ■■Balance Sheet ■■Off-Balance-Sheet Items ■■Statement of Cash Flows ■■Audit Opinion Valuing Equity Securities ■■Discounted Cash Flow Valuation ■■Residual Operating Income Valuation Comprehensive Case C-1 Comprehensive Case Appendix C Operating Cash Flow Investing Cash Flow Financing Cash Flow Cash Flow by Type $5B $6B $7B $8B $9B $10B $11B $12B $13B $14B $(2.0)B $(1.5)B $(1.0)B $-0.5B $0.0B $0.5B $1.0B $1.5B 2010 2011 2012 2013 2014 2015 2016 2017 2018 Harley-Davidson $0.0B $0.2B $0.4B $0.6B $0.8B $1.0B $1.2B $1.4B 2018 Net Income (Loss) Operating Cash Flow Market Cap Net Income, Operating Cash Flow and Market Cap $5B $7B $9B $11B $13B $15B 2018 Net Income (Loss) Operating Cash Flow Market Cap Net Income, Operating Cash Flow and Market Cap Net income: $752 mil PREVIEW This appendix consists of a comprehensive case that presents a financial accounting analysis and interpretation of Harley-Davidson’s performance and position. We illustrate many of the key financial reporting topics covered in the book. We review the company’s financial statements and notes, forecast key accounts, and conclude with estimates of Harley-Davidson’s equity value. C-2 Road Map LO Learning Objective | Topics Page eLecture C-1 Explain and illustrate a review of financial statements and their components. Income Statement :: Balance Sheet :: Statement of Cash Flows :: Audit Opinion C-3 eC–1 C-2 Assess company profitability and creditworthiness. ROE Disaggregation :: RNOA Disaggregation :: Credit Analysis C-23 eC–2 C-3 Forecast financial statements. Income Statement :: Balance Sheet :: Statement of Cash Flows C-27 eC–3 C-4 Describe and illustrate the valuation of firm equity. Discounted Cash Flow Valuation :: Residual Operating Income Valuation :: Assessment C-30 eC–4 Reviewing Financial Statements This section reviews and analyzes the financial statements of Harley-Davidson. Business Environment for Financial Reporting Harley-Davidson is a Fortune 500 company and has been the historical market share leader in the U.S. 601+cc motorcycle market. The company’s products are sold through a network of independent dealers, of which the majority sell Harley-Davidson motorcycles exclusively. These dealerships stock and sell the company’s motorcycles, parts and accessories, general merchandise and licensed products, and perform service on Harley-Davidson motorcycles. In 2018, Harley reported 1,535 dealerships, 691 (45%) of which are located in the U.S. Harley reports two business segments: the manufacturing company and the financial services subsidiary. Harley-Davidson Financial Services is engaged in the business of financing and servicing wholesale inventory receivables and retail consumer loans, primarily for the purchase of HarleyDavidson motorcycles. Its wholesale activities include financing for its dealers for the purchase of motorcycles for display, and its financing activities provide loan and lease financing to customers. This financial services subsidiary operates like a bank, borrowing money at a given rate to fund the lease receivables and setting a higher rate on its loans and leases. As is common for all lenders, managing the spread between lease income and interest expense and minimizing credit losses are core activities for Harley-Davidson Financial Services. In the MD&A section of its 10-K, Harley-Davidson describes its competitive environment as follows. Competition in the segments of the motorcycle market in which the Company currently competes is based upon a number of factors including product capabilities and features, styling, price, quality, reliability, warranty, availability of financing, and quality of the dealer network that sells the product. The Company believes its motorcycles continue to generally command a premium price at retail relative to competitors’ motorcycles. The Company emphasizes remarkable styling, customization, innovation, sound, quality and reliability in its products and generally offers a two-year warranty for its motorcycles. The Company considers the availability of a line of motorcycle parts & accessories and general merchandise, the availability of financing through HDFS and its global network of independent dealers to be competitive advantages. Although dominant in the U.S. market (accounting for approximately 50% of new motorcycle registrations), Harley-Davidson faces stiff competition outside of the U.S. where it has only a 10% market share. With this as background, we begin the accounting analysis of Harley-Davidson by discussing its financial statements. Income Statement Reporting and Analysis Harley-Davidson’s income statement is reproduced in Exhibit C.1. Net Sales Exhibit C.1 reveals that total revenue (product sales and financial services revenue) increased by 1.2% in 2018 to $5,716.9 million. However, revenues in 2018 are 4.7% lower than in 2016. In its MD&A report, management describes its results as follows. Retail sales of new Harley-Davidson motorcycles in the U.S. were down 10.2% in 2018. Overall, U.S. retail sales of new Harley-Davidson motorcycles were adversely impacted by the continued weak U.S. industry, which was down 8.7% compared to 2017. The Company believes that sales of new motorcycles continued to be adversely impacted by soft used motorcycle prices and a shift in rider preferences toward smaller displacement motorcycles. The Company’s U.S. market share of new 601+cc motorcycles for 2018 was 49.7%, down 1.0 percentage points compared to 2017 (Source: Motorcycle Industry Council). The Company’s U.S. LO1 Explain and illustrate a review of financial statements and their components. MBC eLectures continued C-3 Appendix C Comprehensive Case market share reflects the adverse impact of a highly competitive marketplace and relatively strong growth in segments in which the Company does not currently compete. In the segments in which the Company does compete (Touring and Cruiser), which represent approximately 70% of the 601+cc market, the Company’s market share was up 0.8 percentage points on a full-year basis. International retail sales of new Harley-Davidson motorcycles were up 0.4% in 2018. Retail sales in emerging markets were up 9.8% partially offset by lower retail sales in developed markets, which declined 2.7% during 2018. Exhibit C.1 n Harley-Davidson Income Statement HARLEY-DAVIDSON INC. Consolidated Statements of Income Year Ended December 31 $ thousands Revenue Motorcycles and Related Products . . . . . . . . . . . . . . . . . . $4,968,646 $4,915,027 $5,271,376 Financial Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 748,229 732,197 725,082 Total revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,716,875 5,647,224 5,996,458 Costs and expenses Motorcycles and Related Products cost of goods sold . . . 3,351,796 3,272,330 3,425,997 Financial Services interest expense . . . . . . . . . . . . . . . . . 193,187 180,193 173,756 Financial Services provision for credit losses . . . . . . . . . . 106,870 132,444 136,617 Selling, administrative and engineering expense . . . . . . . 1,258,098 1,180,176 1,213,794 Restructuring expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 93,401 — — Total costs and expenses . . . . . . . . . . . . . . . . . . . . . . . 5,003,352 4,765,143 4,950,164 Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 713,523 882,081 1,046,294 Other income (expense), net . . . . . . . . . . . . . . . . . . . . . . . . 3,039 9,182 2,642 Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 951 3,580 4,645 Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,884 31,004 29,670 Income before provision for income taxes . . . . . . . . . . . . . . 686,629 863,839 1,023,911 Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 155,178 342,080 331,747 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 531,451 $ 521,759 $ 692,164 As required under GAAP, Harley-Davidson recognizes revenue when the ownership of its motorcycles is transferred to its customers. The following footnote provides additional detail on the company’s revenue recognition for motorcycles as well as for its financial services revenue. Motorcycles, Parts & Accessories, and General Merchandise—Sales of motorcycles, parts & accessories, and general merchandise are recorded when control is transferred to wholesale customers (independent dealers). This generally takes place upon shipment of the products . . . The Company offers sales incentive programs to dealers and retail customers designed to promote the sale of motorcycles, parts & accessories, and general merchandise. The Company estimates its variable consideration related to motorcycles and related products sold under its sales incentive programs using the expected value method . . . The Company offers to its dealers the right to return eligible parts & accessories and general merchandise. When the Company offers a right to return, it estimates returns based on an analysis of historical trends and records revenue on the initial sale only in the amount that it expects to be entitled . . . Variable consideration related to sales incentives and rights to return is adjusted at the earliest of when the amount of consideration the Company expects to receive changes or the consideration becomes fixed. Financial Services—Interest income on finance receivables is recorded as earned and is based on the average outstanding daily balance for wholesale and retail receivables. Accrued and uncollected interest is classified with finance receivables. Certain loan origination costs related to finance receivables, including payments made to dealers for certain retail loans, are deferred and recorded within finance receivables and amortized over the estimated life of the contract. continued from previous page Appendix C Comprehensive Case C-4 As is customary, product-related revenues are recognized when Harley has performed its obligations to its customers, that is, when the motorcycles are shipped to its dealers. The amount recognized as revenue is equal to the sales price of the motorcycles less any sales allowances, such as sales discounts and other incentives. For financial services income, interest is accrued when earned over time and is recognized net of any origination costs paid to dealers to generate the finance receivables. Cost of Products Sold and Gross Profit Harley’s 2018 gross profit margin is calculated using only the Motorcycles and Related Products revenue and cost of goods sold. For 2018, gross profit margin is 32.5% ([$4,968,646 − $3,351,796]/$4,968,646), one percentage point lower than the 33.4% gross profit margin reported for 2017. The company describes the factors that affected the change in gross margins as follows. The following factors affected the comparability of net revenue, cost of goods sold and gross profit from 2017 to 2018: • The decrease in volume was due to lower wholesale motorcycle shipments, as well as lower P&A and general merchandise sales. P&A and general merchandise sales were down due in large part to lower motorcycle shipments and lower retail motorcycle sales. • On average, wholesale prices for motorcycles shipped in 2018 were higher than in the prior year resulting in a favorable impact on revenue. The positive impact on revenue was partially offset by increased costs related to the additional content added to motorcycles shipped in 2018 as compared to the prior year. • The favorable revenue impact from foreign currency was partially offset by higher net foreign currency losses due primarily to the remeasurement of foreign-denominated balance sheet accounts, as compared to the prior year. • Shipment mix changes resulted in a positive impact on gross profit resulting from favorable changes in the mix of motorcycle families, as well as the mix of models within motorcycle families. • Raw material prices were higher primarily due to increased steel and aluminum costs which includes the impacts of U.S. tariffs on steel and aluminum imports. • Manufacturing and other costs were negatively impacted by lower fixed cost absorption due to lower production, higher depreciation, the impact of incremental tariffs and temporary inefficiencies associated with the Manufacturing Optimization Plan. In 2018, the impact of incremental tariffs was $23.7 million. The choice of inventory costing method affects cost of goods sold. Harley uses the LIFO method to cost its inventory. In 2018, the company’s LIFO reserve increased slightly by $6.3 million, possibly reflecting the increase in raw materials prices, cited above. The increase in the LIFO reserve meant that cost of goods sold was $6.3 million higher than it would have been under the FIFO inventory costing method; the LIFO method decreased gross profit by the same amount (see inventory discussion later in this appendix). Selling, Administrative, and Engineering Expenses In 2018, Harley-Davidson reports selling, administrative, and engineering expenses of $1,258 million (excluding restructuring expenses of $93.4 million), which is 22% of total revenue, higher than in both 2017 (20.9%) and 2016 (20.2%). Included in that account are research and development expenses of $191.6 million, higher than the $175.2 million in the prior year. SG&A also includes wages for retail and corporate employees, occupancy costs, and other administrative costs not reported separately. Pension Expenses Harley-Davidson’s SG&A expenses include $32.8 million of pension expense (for its regular pension plan as well as for its supplemental employee retirement plan agreements [SERPA]) and $3.7 million of other postretirement benefit expense. This is reported in the following table in the pension footnote. C-5 Appendix C Comprehensive Case $ thousands Pension and SERPA Benefits Postretirement Healthcare Benefits Service cost . . . . . . . . . . . . . . . . . . $ 32,340 $ 31,584 $ 33,437 $ 7,180 $ 7,500 $ 7,478 Interest cost . . . . . . . . . . . . . . . . . . 82,778 85,076 90,827 11,556 13,648 14,814 Expected return on plan assets . . . (147,671) (141,385) (145,781) (14,161) (12,623) (12,069) Amortization of unrecognized: Prior service cost (credit) . . . . . . . . (420) 1,018 1,019 (1,842) (2,171) (2,803) Net loss. . . . . . . . . . . . . . . . . . . . . . 64,773 43,993 46,351 1,817 3,261 3,537 Net curtailment loss (gain) . . . . . . . 1,017 — — (866) — — Settlement loss. . . . . . . . . . . . . . . . — — 1,463 — — — Net periodic benefit cost. . . . . . . . . $ 32,817 $ 20,286 $ 27,316 $ 3,664 $ 9,615 $10,957 For 2018, the expected return on pension investments ($147.7 million) provides an offset to the company’s pension service and interest costs ($32.3 million and $82.8 million, respectively). The pension footnote in Harley-Davidson’s 10-K reveals that pension investments realized an actual return of $185.5 million in 2018. Harley describes how it determines the expected return in its footnotes. It is instructive to review the company’s rationale, which is as follows. Pension Plan Assets—The Company’s investment objective is to ensure assets are sufficient to pay benefits while mitigating the volatility of retirement plan assets or liabilities recorded in the balance sheet. The Company mitigates volatility through asset diversification and partial asset/liability matching. The investment portfolio for the Company’s pension plan assets contains a diversified blend of equity and fixed-income investments. The Company’s current overall targeted asset allocation as a percentage of total market value was approximately 56% equities and 44% fixed-income and cash. Assets are rebalanced regularly to keep the actual allocation in line with targets. Equity holdings primarily include investments in small-, medium- and large-cap companies in the U.S. (including Company stock), investments in developed and emerging foreign markets and other investments such as private equity and real estate. Fixed income holdings consist of U.S. government and agency securities, state and municipal bonds, corporate bonds from diversified industries and foreign obligations. In addition, cash equivalent balances are maintained at levels adequate to meet near-term plan expenses and benefit payments. Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews. The expected return on pension assets offsets service and interest costs, and serves to reduce pension expense. In general, increasing (decreasing) the expected return on pension assets increases (decreases) profit. In 2018, Harley left the expected return on plan assets of 7.25% unchanged from the prior year. The discount rate (used to compute the interest cost component of pension expense) declined by 59 basis points (4.30% to 3.71%). Earnings per Share Harley provides the following footnote relating to its computation of earnings per share. $ thousands, except per share amounts Numerator Income used in computing basic and diluted earnings per share. . . . $531,451 $521,759 $692,164 Denominator Denominator for basic earnings per share-weightedaverage common shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165,672 171,995 179,676 Effect of dilutive securities—employee stock compensation plan . . . Denominator for diluted earnings per share—adjusted weighted-average shares outstanding . . . . . . . . . . . . . . . . . . . . . . 166,504 172,932 180,535 Earnings per common share: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3.21 $3.03 $3.85 Diluted. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3.19 $3.02 $3.83 Appendix C Comprehensive Case C-6 The difference between basic and diluted earnings per share usually arises from the dilutive effects of employee stock options. As Harley discusses in the footnote presented below, however, if stock options are “under water” (stock price is lower than the exercise price of the options), they are considered anti-dilutive, meaning that including them would increase EPS. Accordingly, they are excluded in the diluted EPS computation, but remain potentially dilutive if Harley’s stock price subsequently rises above the exercise price of the options. Harley describes the EPS effects of anti-dilutive stock options in 2018 as follows. Options to purchase 1.1 million, 0.8 million and 1.4 million weighted-average shares of common stock outstanding during 2018, 2017 and 2016, respectively, were not included in the Company’s computation of dilutive securities because the exercise price was greater than the market price and therefore the effect would have been anti-dilutive. Although not present for Harley-Davidson, convertible debt and preferred shares are also potentially dilutive for many companies. Income Taxes Harley-Davidson’s effective tax rate in 2018 is 22.6%, significantly lower than in both prior years, as disclosed in the following footnote. Provision at statutory rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21.0% 35.0% 35.0% State taxes, net of federal benefit. . . . . . . . . . . . . . . . . . . . . . . 2.6 1.9 1.8 Foreign rate differential. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.4 (0.8) (0.6) Domestic manufacturing deduction . . . . . . . . . . . . . . . . . . . . . — (2.2) (2.1) Foreign derived intangible income . . . . . . . . . . . . . . . . . . . . . . (1.2) — — Research and development credit . . . . . . . . . . . . . . . . . . . . . . (1.1) (0.7) (0.4) Unrecognized tax benefits including interest and penalties . . . (0.6) 2.3 (1.3) Valuation allowance adjustments . . . . . . . . . . . . . . . . . . . . . . . 0.1 (0.1) 0.1 Deferred tax balance remeasurement for rate change. . . . . . . (1.2) 5.5 — Territorial tax. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 (0.1) — Global intangible low-taxed income . . . . . . . . . . . . . . . . . . . . . 0.4 — — Adjustments for previously accrued taxes . . . . . . . . . . . . . . . . (1.0) (1.2) 0.2 Rate differential on intercompany transfers . . . . . . . . . . . . . . . 0.9 — — Executive compensation limitation . . . . . . . . . . . . . . . . . . . . . . 0.5 — — Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.4 — (0.3) Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22.6% 39.6% 32.4% While a number of transitory items affected Harley’s effective tax rate, the most significant effect was the reduction of the corporate statutory tax rate from 35% to 21% as a result of the U.S. Tax Cuts and Jobs Act of 2017 (TCJA). Common-Size Income Statement It is useful for analysis purposes to prepare common-size statements. Exhibit C.2 shows HarleyDavidson’s common-size income statement covering the two most recent years. Motorcycles and Related Products cost of goods sold decreased from 66.6% of Motorcycles and Related Products sales in 2017 to 64.5% in 2018, increasing the gross profit margin on product sales by 210 basis points. As the company describes above, the increase in gross margin is due to increases in product prices and a favorable change in the mix of products sold toward higher gross profit items. This was offset, in part, by increases in raw materials prices and unit costs as fixed production costs were spread over a lower unit production base as well as increased tariffs. Harley also increased its selling, administrative, and engineering expense from 20.9% of total revenue in 2017 to 22.0% in 2018. The company attributes this increase to higher recall costs, increased spending on growth initiatives, and restructuring expense. Finally, net income as a percentage of total revenue increased by 0.1 percentage points from 9.2% in 2017 to 9.3% in 2018, primarily from lower income taxes due to the tax legislation passed in late 2017. C-7 Appendix C Comprehensive Case continued Exhibit C.2 n Harley-Davidson Common-Size Income Statement Year Ended December Revenue Motorcycles and Related Products . . . . . . . . . . . . . . . . . . . . . . 86.9% 87.0% Financial Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13.1% 13.0% Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100.0% 100.0% Costs and expenses Motorcycles and Related Products cost of goods sold* . . . . . . 64.5% :: 58.6% 66.6% :: 57.9% Financial Services interest expense . . . . . . . . . . . . . . . . . . . . . 3.4% 3.2% Financial Services provision for credit losses . . . . . . . . . . . . . . 1.9% 2.3% Selling, administrative and engineering expense . . . . . . . . . . . 22.0% 20.9% Restructuring expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.6% 0.0% Total costs and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87.5% 84.4% Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12.5% 15.6% Other income (expense), net . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.1% 0.2% Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.0% 0.1% Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.5% 0.5% Income before provision for income taxes . . . . . . . . . . . . . . . . . . 12.0% 15.3% Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.7% 6.1% Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.3% 9.2% * Two percentage metrics: Motorcycles and Related Products COGS/Motorcycles and Related Products revenue :: Motorcycles and Related Products COGS/Total revenue Management Discussion and Analysis The Management Discussion and Analysis section of a 10-K is informative for interpreting company financial statements and for additional insights into company operations. To illustrate, Harley-Davidson provides the following analysis of its operating results in the MD&A section of its 2018 10-K. The Company’s net income for 2018 was $531.5 million, or $3.19 per diluted share, compared to $521.8 million, or $3.02 per diluted share, in 2017. Operating income from the Motorcycles segment in 2018 was down $184.4 million compared to 2017 due primarily to lower wholesale motorcycle shipments and higher costs related to the impact of incremental tariffs, increased metals costs, voluntary recalls and restructuring activities. During 2018, incremental European Union and China tariffs were imposed on the Company’s products shipped from the U.S., as well as U.S. incremental tariffs on certain items imported from certain international markets. The European Union tariffs on Harley-Davidson motorcycles exported from the U.S. increased from 6% to 31% effective June 22, 2018. By their current terms, these tariffs are scheduled to increase to 56% effective June 1, 2021. The China tariffs on Harley-Davidson products exported from the U.S. increased from 30% to 55%, effective August 23, 2018, and are set to remain in place indefinitely. The Company also experienced increased costs for metals resulting from U.S. steel and aluminum tariffs. Consolidated operating income was down 19.1% in 2018 driven by a decrease in operating income from the Motorcycles segment, which was down $184.4 million compared to 2017. Operating income for the Financial Services segment increased by $15.9 million during 2018 as compared to 2017. Other income in 2018 was adversely impacted by higher amortization of actuarial losses following a 2018 first quarter remeasurement of the assets and obligations of the Company’s qualified pension plan. Investment income was lower due to unfavorable changes in the fair value of marketable securities. The effective income tax rate for 2018 was 22.6% compared to 39.6% for 2017. The lower effective income tax rate was primarily due to the impact of the 2017 Tax Act. The 2017 Tax Act reduced the federal corporate income tax rate beginning in 2018 from 35% to 21%. In addition, because the 2017 Tax Act was enacted in 2017, the Company was required to remeasure its net deferred tax assets in 2017. The impact of remeasuring the deferred tax asset balances combined with other adjustments related to the enactment of the 2017 Tax Act resulted in a non-cash income tax charge of $53.1 million in the fourth quarter of 2017. Diluted earnings per share were $3.19 in 2018, up 5.6% compared to 2017. Diluted earnings per share were positively impacted by the 1.9% increase in net income and also benefited from Appendix C Comprehensive Case C-8 continued from previous page lower diluted weighted average shares outstanding. Diluted weighted average shares outstanding decreased from 172.9 million in 2017 to 166.5 million in 2018 driven by the Company’s repurchases of common stock. Balance Sheet Reporting and Analysis Harley-Davidson’s balance sheet is reproduced in Exhibit C.3 in thousands of dollars and in common size (as a % of total assets). The company reports total assets of $10,666 million in 2018, with noncurrent finance receivables as the largest asset (46.9% of total assets). Total current assets increased from 39.0% of total assets in 2017 to 42.0% in 2018. This decrease was primarily due to an increase in cash. Exhibit C.3 n Harley-Davidson Balance Sheet HARLEY-DAVIDSON INC. Consolidated Balance Sheets December 31, $ thousands, except share amounts As % of Total Assets Assets Current assets Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,203,766 $ 687,521 11.3% 6.9% Marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,007 - 0.1% 0.0% Accounts receivable, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306,474 329,986 2.9% 3.3% Finance receivables, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,214,424 2,105,662 20.8% 21.1% Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 556,128 538,202 5.2% 5.4% Restricted cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,275 47,518 0.5% 0.5% Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144,368 175,853 1.4% 1.8% Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,484,442 3,884,742 42.0% 39.0% Finance receivables, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,007,507 4,859,424 46.9% 48.7% Property, plant and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 904,132 967,781 8.5% 9.7% Prepaid pension costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 19,816 0.0% 0.2% Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55,048 55,947 0.5% 0.6% Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141,464 109,073 1.3% 1.1% Other long-term assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73,071 75,889 0.7% 0.8% $10,665,664 $9,972,672 100.0% 100.0% Liabilities and shareholders’ equity Current liabilities Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 284,861 $ 227,597 2.7% 2.3% Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 601,130 529,822 5.6% 5.3% Short-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,135,810 1,273,482 10.6% 12.8% Current portion of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,575,799 1,127,269 14.8% 11.3% Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,597,600 3,158,170 33.7% 31.7% Long-term debt, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,887,667 4,587,258 45.8% 46.0% Pension liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107,776 54,606 1.0% 0.5% Postretirement healthcare liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94,453 118,753 0.9% 1.2% Other long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204,219 209,608 1.9% 2.1% Commitments and contingencies Shareholders’ equity Preferred stock, none issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 0.0% 0.0% Common stock, (181,931,225 and 181,286,547 shares issued, respectively) . . . 1,819 1,813 0.0% 0.0% Additional paid-in-capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,459,620 1,422,808 13.7% 14.3% Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,007,583 1,607,570 18.8% 16.1% Accumulated other comprehensive loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (629,684) (500,049) (5.9)% (5.0)% Treasury stock (22,273,278 and 13,195,731 shares, respectively), at cost . . . . (1,065,389) (687,865) (10.0)% (6.9)% Total shareholders’ equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,773,949 1,844,277 16.6% 18.5% $10,665,664 $9,972,672 100.0% 100.0% C-9 Appendix C Comprehensive Case On the liability side, current liabilities increased as a percent of total assets from 31.7% in 2017 to 33.7% in 2018. This was largely due to an increase in current maturities of long-term debt and was partially offset by a reduction in short-term debt payable in one year. On balance, Harley is highly levered; only 16.6% of 2018 total assets are financed by owners and 71.2% of 2018 total assets are financed by debt (10.6% + 14.8% + 45.8%). Despite the large proportion of noncurrent assets and high debt levels, the company has strong liquidity measures: current ratio is 1.25 and Cash and marketable securities comprise 11.4% of total assets in 2018 ([$1,206.8 + $10.0] million/$10,665.7 million), up from 6.9% in 2017. The remainder of this section includes a brief review and analysis for each of Harley-Davidson’s balance sheet line items and its related footnote disclosures. Accounts Receivable Harley-Davidson reports $306.5 million in net accounts receivable and $7,221.9 million of short-term and long-term finance receivables at year-end 2018. This represents 70.6% of total assets [($2,214.4 million + $5,007.5 million) / $10,665.7 million]. Harley describes these receivables as follows. Accounts Receivable, Net—The Company’s motorcycles and related products are sold to independent dealers outside the U.S. and Canada generally on open account and the resulting receivables are included in accounts receivable in the Company’s consolidated balance sheets. The allowance for doubtful accounts deducted from total accounts receivable was $4.0 million and $4.1 million as of December 31, 2018 and 2017, respectively. Accounts receivable are written down once management determines that the specific customer does not have the ability to repay the balance in full. The Company’s sales of motorcycles and related products in the U.S. and Canada are financed by the purchasing dealers through HDFS and the related receivables are included in finance receivables in the consolidated balance sheets. Finance Receivables, Net—Finance receivables include both retail and wholesale finance receivables, net, including amounts held by consolidated VIEs. Finance receivables are recorded in the financial statements at amortized cost net of an allowance for credit losses. The provision for credit losses on finance receivables is charged to earnings in amounts sufficient to maintain the allowance for credit losses at a level that is adequate to cover estimated losses of principal inherent in the existing portfolio. Portions of the allowance for credit losses are specified to cover estimated losses on finance receivables specifically identified for impairment. The unspecified portion of the allowance covers estimated losses on finance receivables which are collectively reviewed for impairment. Finance receivables are considered impaired when management determines it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement. Harley’s receivables are a large asset for the company and our analysis of those receivables considers two dimensions. 1. Magnitude Receivables representing sales on open account, the smaller of the two balances for Harley, are generally non-interest-bearing and, therefore, do not earn a return. Further, the company incurs costs to finance them. Accordingly, a company wants to optimize its level of investment in receivables—that is, keep them as low as possible while still meeting industry-specific credit policies to meet customer demands. Finance receivables, such as those arising from lending or leasing activities, include interest. They are financed with borrowed money and the company must earn sufficient interest income to both cover the cost of borrowed funds and to cover the cost of uncollectible amounts. 2. Collectibility Receivables made on open account represent unsecured loans to customers. It is critical therefore, to understand the creditworthiness of these borrowers. Receivables are reported at net realizable value, that is, net of the allowance for doubtful accounts. Finance receivables are generally secured by the motorcycles financed with the loan or lease. This provides additional protection to Harley-Davidson, but the creditworthiness of the borrowers must be monitored nonetheless as repossessed motorcycles may not maintain sufficient resale value to cover the outstanding loan or lease balance. Appendix C Comprehensive Case C-10 Footnotes reveal an allowance for uncollectible accounts of $4.0 million for accounts receivable, about 1.2% of gross accounts receivable. Credit losses on open accounts are not a cause for concern. For its finance receivables, Harley’s allowance for uncollectible accounts is $189.9 million, about 2.6% of gross lease and notes receivable. Due to the greater exposure to credit losses on finance receivables, Harley reports additional data on the allowance for credit losses. For 2018, $ thousands Retail Wholesale Total Balance, beginning of period . . . . . . . . . . . . $186,254 $6,217 $192,471 Provision for credit losses. . . . . . . . . . . . . . . 105,292 1,578 106,870 Charge-offs. . . . . . . . . . . . . . . . . . . . . . . . . . (154,433) (8) (154,441) Recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . 44,985 — 44,985 Balance, end of period . . . . . . . . . . . . . . . . . $182,098 $7,787 $189,885 The company reported a balance in the allowance for credit losses of $192.5 million at the beginning of 2018. During 2018, it increased this allowance account by $106.9 million. This is the amount of bad debt expense reported in the income statement. Write-offs of uncollectible accounts amounted to $154.4 million during the year, and recoveries of amounts written off (usually from the sale of the repossessed motorcycles) amounted to $45.0 million, yielding a $189.9 million balance at year-end. Because the estimated provision of $106.9 is approximately equal to the actual net credit losses for the year ($154.4 million − $45 million = $109.4 million), it appears that the company is adequately reserved for uncollectible accounts. The allowance for credit losses should always reflect the company’s best estimate of the potential loss in its finance receivables. This amount should not be overly conservative (which would understate profit), and it should not be inadequate (which would overstate profit). Harley’s estimate of its potential losses results from its own (unaudited) review of the age of its receivables (older receivables are at greater risk of uncollectibility). And the company provides detail relating to the age of its finance receivables in the footnotes. For 2018, $ thousands Current 31–60 Days Past Due 61–90 Days Past Due Greater than 90 Days Past Due Total Past Due Total Finance Receivables Retail . . . . . . . . . . . . . . . $6,100,186 $136,945 $49,825 $41,245 $228,015 $6,328,201 Wholesale. . . . . . . . . . . . 1,081,729 522 273 1,091 1,886 1,083,615 Total . . . . . . . . . . . . . . $7,181,915 $137,467 $50,098 $42,336 $229,901 $7,411,816 Nearly 97% of its finance receivables are either current or no more than 30 days overdue. Current receivables are less likely to become uncollectible and that is the reason why Harley does not need a significant balance in the allowance for uncollectible accounts. Inventories Harley-Davidson reports $556.1 million in inventories as of 2018. Footnote disclosures reveal the following inventory costing policy. Inventories—Substantially all inventories located in the United States are valued using the last-in, first-out (LIFO) method. Other inventories totaling $247.6 million and $234.9 million at December 31, 2018 and 2017, respectively, are valued at the lower of cost or net realizable value using the first-in, first-out (FIFO) method. The use of multiple inventory costing methods for different pools of inventories is common and acceptable under GAAP. C-11 Appendix C Comprehensive Case Harley-Davidson provides the following footnote disclosure relating to inventories. $ thousands Components at the lower of FIFO cost or market Raw materials and work in process . . . . . . . . . . . . . . . . . $177,110 $161,664 Motorcycle finished goods . . . . . . . . . . . . . . . . . . . . . . . . 301,630 289,530 Parts and accessories and general merchandise. . . . . . . 136,027 139,363 Inventory at lower of FIFO cost or net realizable value. . . 614,767 590,557 Excess of FIFO over LIFO cost. . . . . . . . . . . . . . . . . . . . . (58,639) (52,355) Total inventories, net . . . . . . . . . . . . . . . . . . . . . . . . . . . $556,128 $538,202 Companies aim to optimize their investment in inventories because inventory is a non-incomeproducing asset until sold. Inventories must also be financed, stored, moved, and insured at some cost. Harley-Davidson reports $177.1 million of raw materials and work-in-process inventories, which is 28.8% of the total of $614.8 million FIFO inventories (see table above). Finished goods inventories (motorcycles awaiting sale to dealers) amount to another $301.6 million, and parts and accessories and general merchandise inventories amount to $136.0 million. Harley-Davidson reports its total inventory cost at FIFO at $614.8 million then subtracts $58.6 million from this amount (the LIFO reserve) to yield the inventories balance of $556.1 million at LIFO as reported on the balance sheet. This means that, over time, Harley-Davidson has reduced gross profit and pretax operating profit by a cumulative amount of $58.6 million. This has also reduced pretax income and saved federal income tax and generated cash flow. For example, during 2018, Harley’s LIFO reserve increased by $6,284,000, which reduced pretax income by that amount and saved the company $1,382,480 in taxes, assuming a 22% marginal federal and state tax rate ($6,284,000 × 22%). Property, Plant, and Equipment Harley-Davidson reports Property, Plant, and Equipment (PPE), net, of $904.1 million at year-end 2018. $ thousands Land and related improvements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 73,025 $ 70,256 Buildings and related improvements . . . . . . . . . . . . . . . . . . . . . . . . . . 483,965 464,454 Machinery and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,740,405 1,890,126 Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 733,180 660,090 Construction in progress. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205,786 200,396 3,236,361 3,285,322 Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,332,229) (2,317,541) Total property, plant and equipment, net. . . . . . . . . . . . . . . . . . . . . . $ 904,132 $ 967,781 PPE makes up 8.5% of total assets in 2018. Given the cost of depreciable assets of $2,957.6 million (calculated as $484.0 million in buildings, $1,740.4 million in machinery and equipment, and $733.2 million in capitalized software) and accumulated depreciation of $2,332.2 million, PPE is 78.9% depreciated assuming straight-line depreciation ($2,332.2 million/$2,957.6 million) as of 2018. We conclude that Harley-Davidson’s PPE is older than we would expect assuming a regular replacement policy. Footnotes reveal the following useful lives for depreciable assets. Property, Plant and Equipment—Property, plant and equipment is recorded at cost. Depreciation is determined on the straight-line basis over the estimated useful lives of the assets. The following useful lives are used to depreciate the various classes of property, plant and equipment: buildings—30 years; building, equipment and land improvements—7 years; machinery and equipment −3 to 10 years; furniture and fixtures—5 years; and software—3 to 7 years. Accelerated methods of depreciation are used for income tax purposes. Appendix C Comprehensive Case C-12 Harley-Davidson’s 2018 depreciation expense is $264.5 million (calculated as $264.9 million depreciation and amortization expense reported in the statement of cash flows less $0.4 million amortization expense reported in the footnotes). We calculate an average useful life of 11.3 years for PPE in 2018 as follows: [($2,957.6 million + $3,014.7 million*)/2/$264.5 million]. (2017 depreciable assets = $464.5 million in buildings + $1,890.1 million in machinery and equipment + $660.1 million in capitalized software.) Goodwill and Other Intangible Assets Harley-Davidson reports $55.0 million of goodwill at year-end 2018. This amount represents the excess of the purchase price for acquired companies over the fair market value of the acquired tangible and identifiable intangible assets (net of liabilities assumed). Under GAAP, goodwill is not systematically amortized, but is annually tested for impairment. It describes its accounting for goodwill as follows. Goodwill—Goodwill represents the excess of acquisition cost over the fair value of the net assets purchased. Goodwill is tested for impairment, based on financial data related to the reporting unit to which it has been assigned, at least annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The impairment test involves comparing the estimated fair value of the reporting unit associated with the goodwill to its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, goodwill must be adjusted to its implied fair value. During 2018 and 2017, the Company performed a quantitative test on its goodwill balances for impairment and no adjustments were recorded to goodwill as a result of those reviews. Deferred Tax Assets and Liabilities Harley-Davidson provides the following disclosure relating to deferred tax assets and liabilities. $ thousands Deferred tax assets Accruals not yet tax deductible . . . . . . . . . . . . . . . . . . . . . . $108,284 $ 92,158 Pension and postretirement benefit plan obligations . . . . . 48,347 37,357 Stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,295 12,669 Net operating loss carryforward . . . . . . . . . . . . . . . . . . . . . 34,842 33,171 Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (21,868) (21,561) Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43,870 52,422 226,770 206,216 Deferred tax liabilities Depreciation, tax in excess of book . . . . . . . . . . . . . . . . . . (79,326) (88,989) Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,980) (8,154) (85,306) (97,143) Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $141,464 $109,073 Most of Harley’s deferred tax assets (benefit) results from expenses that are recognized currently in Harley’s income statement that are not deductible until paid. They, therefore, represent future tax deductions and future benefits. Examples include accrued expenses and pension expenses as well as stock compensation expenses. All of these expenses are recognized in Harley’s income statement, but will not be recognized in Harley’s tax returns until a later date when the items are settled in cash. Harley also reports a deferred tax asset of $34.8 million relating to a net operating loss carryforward. The IRS allows companies to carry forward taxable losses to offset future taxable income, thereby reducing future tax expense. This benefit can only be recorded as an asset on the balance sheet if the company expects to generate taxable income before the carryforwards expire. If the company deems it more likely than not that the carryforwards will not be realized, a valuation allowance for the unrealizable portion is required (this is similar to establishing an allowance for C-13 Appendix C Comprehensive Case uncollectible accounts receivable). As of 2018, Harley-Davidson has such a valuation allowance (of $21.9 million). Following is its discussion relating to this allowance. The Company reviews its deferred tax asset valuation allowances on a quarterly basis, or whenever events or changes in circumstances indicate that a review is required. In determining the requirement for a valuation allowance, the historical and projected financial results of the legal entity or consolidated group recording the net deferred tax asset is considered, along with any positive or negative evidence including tax law changes. Since future financial results and tax law may differ from previous estimates, periodic adjustments to the Company’s valuation allowances may be necessary. At December 31, 2018, the Company had approximately $270.4 million of gross state operating loss carryforwards expiring in 2031. At December 31, 2018, the Company also had Wisconsin research and development credit carryforwards of $11.4 million expiring in 2024–2028. The Company had a deferred tax asset of $25.9 million as of December 31, 2018 for the benefit of these losses and credits. A valuation allowance of $2.9 million was established against the deferred tax asset, which is a decrease of $1.6 million from the prior year. The Company had foreign net operating losses (NOL) totaling $8.9 million as of December 31, 2018. It had a valuation allowance of $18.9 million against both the NOLs and other deferred tax assets of $10.0 million. The valuation allowance on foreign net operating losses increased by $1.8 million, reflecting movement related to realizability assessment on additional earnings and loss, as well as movements related to foreign currency rates. Tax loss carryforwards reduce income tax expense in the year they are recognized. However, companies commonly establish both the loss carryforward and the valuation allowance concurrently. The net effect is to leave tax expense (and net income) unchanged. In future years, however, a reduction of the valuation account, in anticipation of utilization of the tax carry forwards (and not as a result of their expiration), reduces tax expense and increases net income. This is a transitory increase in profit and should not be factored into forecasts. Current Liabilities Harley-Davidson reports current liabilities of $3,597.6 million on its year-end balance sheet for 2018, which consists of the following. $ thousands Current liabilities Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . $ 284,861 $ 227,597 Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . 601,130 529,822 Short-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . 1,135,810 1,273,482 Current portion of long-term debt . . . . . . . . . . . . . 1,575,799 1,127,269 Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . $3,597,600 $3,158,170 Of Harley’s current liabilities, $2,711.6 million relates to debt. The remaining items in current liabilities arise from common transactions, such as trade accounts payable and accrued expenses. These transactions are less prone to management reporting bias. We must, however, determine the presence of excessive “leaning on the trade” as a means to boost operating cash flow. Harley’s trade accounts payable have not increased significantly and the increase is not of concern. The possibility of management reporting bias is typically greater for accrued liabilities, which are often estimated (and difficult to audit), involve no external transaction, and can markedly impact reported balance sheet and income statement amounts. All accruals have similar effects on the financial statements: when the accrual is established, the company recognizes both an expense in the income statement and a liability on the balance sheet. The company subsequently reduces the liability as payments are made. Companies can (and do) use accruals to shift income from one period to another, say by over-accruing in one period to intentionally depress current period profits, and later reducing the liability account, rather than recording an expense, to increase future period profits. Accruals are sometimes referred to as “pads.” They represent a cost that has previously been charged to the income statement. They also represent an account that can absorb future costs. We need to monitor accrual accounts carefully for evidence of earnings management. Appendix C Comprehensive Case C-14 Long-Term Debt Harley-Davidson reports $4,887.7 million of long-term debt as of 2018. Footnotes reveal the following. $ thousands Secured debt (Note 12) Asset-backed Canadian commercial paper conduit facility. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 155,951 $ 174,779 Asset-backed U.S. commercial paper conduit facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 582,717 279,457 Asset-backed securitization debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95,216 353,085 Less: unamortized discount and debt issuance costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (49) (461) Total secured debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 833,835 806,860 Unsecured notes (at par value) 6.80% Medium-term notes due in 2018, issued May 2008. . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 877,488 2.25% Medium-term notes due in 2019, issued January 2016. . . . . . . . . . . . . . . . . . . . . . . . . . 600,000 600,000 Floating rate medium-term notes due in 2019, issued March 2017 . . . . . . . . . . . . . . . . . . . . . . 150,000 150,000 2.40% Medium-term notes due in 2019, issued September 2014 . . . . . . . . . . . . . . . . . . . . . . . 600,000 600,000 2.15% Medium-term notes due in 2020, issued February 2015 . . . . . . . . . . . . . . . . . . . . . . . . . 600,000 600,000 Floating rate medium-term notes due in 2020, issued May 2018. . . . . . . . . . . . . . . . . . . . . . . . 450,000 — 2.40% Medium-term notes due in 2020, issued March 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . 350,000 350,000 2.85% Medium-term notes due in 2021, issued January 2016. . . . . . . . . . . . . . . . . . . . . . . . . . 600,000 600,000 Floating rate medium-term notes due in 2021, issued November 2018 . . . . . . . . . . . . . . . . . . . 450,000 — 3.55% Medium-term notes due in 2021, issued May 2018. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350,000 — 2.55% Medium-term notes due in 2022, issued June 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 400,000 3.35% Medium-term notes due in 2023, issued February 2018 . . . . . . . . . . . . . . . . . . . . . . . . . 350,000 — 3.50% Senior unsecured notes due in 2025, issued July 2015 . . . . . . . . . . . . . . . . . . . . . . . . . 450,000 450,000 4.625% Senior unsecured notes due in 2045, issued July 2015 . . . . . . . . . . . . . . . . . . . . . . . . 300,000 300,000 Less: unamortized discount and debt issuance costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (20,369) (19,821) Gross long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,463,466 5,714,527 Less: current portion of long-term debt, net of unamortized discount and debt issuance costs. . . (1,575,799) (1,127,269) Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,887,667 $4,587,258 Most of its long-term financing is in the form of unsecured notes that mature over the next 30 years. GAAP requires disclosure of scheduled maturities for each of the five years subsequent to the balance sheet date. Harley-Davidson’s five-year maturity schedule follows. $ thousands 2023 Thereafter Total Principal payments on debt . . . $2,717,597 $1,562,889 $1,570,815 $578,256 $440,137 $750,000 $7,619,694 We analyze debt maturity to determine whether or not a company is able to repay debt as it comes due. Alternatively, a company can refinance the debt. If a company is unable or unwilling to repay or refinance its debt, it must approach creditors for a modification of debt terms for those issuances coming due. Creditors are often willing to oblige but will likely increase interest rates or impose additional debt covenants and restrictions. However, if creditors are unwilling to modify debt terms, the company might face the prospect of bankruptcy. This highlights the importance of long-term debt maturity disclosures. We have little concern about Harley’s debt maturity schedule as the company has strong cash flows. It is worth noting that Standard & Poor’s debt ratings for Harley is BBB+ with a negative outlook while Moody’s is A3 with a stable outlook. While both ratings are investment grade (described as “lower-medium grade” to “upper-medium grade” debt), S&P is slightly more concerned about the longer-term outlook for Harley given the competitive pressures cited earlier. Noncurrent Employee Benefits and Other Obligations Harley-Davidson reports a (negative) funded status for its pension plan of $(110.1) million at yearend 2018 as well as for its postretirement healthcare benefit plan of $(96.2) million. This means that the company’s pension and postretirement healthcare plans are underfunded by those amounts. This underfunding is computed as the difference between the benefit obligations of $1,984.7 million and $286.6 million, respectively, and the fair value of the plan assets of $1,874.6 million and $190.4 million, respectively. The reconciliation of the benefit obligations and plan assets is provided in the following table in Harley’s footnotes. C-15 Appendix C Comprehensive Case $ thousands Pension and SERPA Benefits Postretirement Healthcare Benefits Change in benefit obligation: Benefit obligation, beginning of period . . . . . . . . . . . . $2,201,021 $1,986,435 $338,488 $ 346,431 Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,340 31,584 7,180 7,500 Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82,778 85,076 11,556 13,648 Actuarial (gains) losses. . . . . . . . . . . . . . . . . . . . . . . . (213,583) 195,444 (42,039) (8,408) Plan participant contributions . . . . . . . . . . . . . . . . . . . — — 2,492 2,525 Plan amendments. . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,926) (13,227) (4,710) — Special early retirement benefits. . . . . . . . . . . . . . . . . (106,280) (84,291) (23,448) (23,208) Benefits paid, net of Medicare Part D subsidy . . . . . . 1,358 — (2,945) — Benefit obligation, end of period . . . . . . . . . . . . . . . . . 1,984,708 2,201,021 286,574 338,488 Change in plan assets: Fair value of plan assets, beginning of period . . . . . . 2,162,885 1,899,889 217,537 170,092 Actual return on plan assets . . . . . . . . . . . . . . . . . . . . (185,468) 320,144 (13,287) 32,445 Company contributions . . . . . . . . . . . . . . . . . . . . . . . . — 25,000 — 15,000 Plan participant contributions . . . . . . . . . . . . . . . . . . . — — 2,492 2,525 Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (102,779) (82,148) (16,385) (2,525) Fair value of plan assets, end of period . . . . . . . . . . . 1,874,618 2,162,885 190,357 217,537 Funded status of the plans, December 31 . . . . . . . . . . . $ (110,090) $ (38,136) $ (96,217) $(120,951) Benefit obligations increase with the passage of time as employees earn additional benefits and as the company accrues interest on the obligations (these obligations are initially discounted to their present values and accrete (grow) over time to the expected pay-off amount at maturity). The obligations also increase or decrease as a result of actuarial gains and losses (changes to the assumptions used to compute the current balance of the obligations). And, when benefits are paid, both the plan assets and the obligations are reduced accordingly. Benefit payments must be funded from a combination of investment income on plan investments and company contributions. Company contributions to other postemployment benefit obligations (future healthcare payments, called OPEB) are generally made as required to fund healthcare payments to retirees. Because federal law does not require minimum funding of these plans, and companies do not receive a tax deduction for such contributions, companies rarely fund OPEB plans in advance. In Harley’s case, the company contribution is small and is not likely to be of concern in the foreseeable future. However, pension and postretirement healthcare funding requirements have been a burden for many companies, most notably General Motors prior to its bankruptcy. The central issue with respect to pensions and other postemployment obligations, which Harley calls postretirement obligations, is the potential demand they present on operating cash flows. Companies can tap cash from two sources to pay pension and other postemployment obligations: from the returns on plan assets (i.e., the cumulative contributions and investment returns that have not yet been paid out to beneficiaries) and/or from operating cash flow. To the extent that plan assets are insufficient to meet retirement obligations, companies must divert operating cash flows from other investment activities, potentially reducing the dollar amount of capital projects that can be funded. We can gain insight into potential cash flow issues by comparing expected future benefit payments to the funds available to make those payments. Companies must provide these disclosures in a schedule to the pension footnotes. Harley provides the following schedule of expected payments in the footnotes to its 10-K. The expected benefit payments for the next five years and thereafter were as follows: $ thousands Pension Benefits SERPA Benefits Postretirement Healthcare Benefits 2019 . . . . . . . . . . . . . $111,980 $ 2,314 $ 25,934 2020 . . . . . . . . . . . . . 93,580 2,862 27,328 2021 . . . . . . . . . . . . . 95,690 3,272 26,660 2022 . . . . . . . . . . . . . 99,118 3,504 25,378 2023 . . . . . . . . . . . . . 102,190 4,467 23,815 2024–2028 . . . . . . . . 568,867 28,663 109,562 Appendix C Comprehensive Case C-16 The schedule shows that Harley expects to pay out $114.3 million ($112.0 million + $2.3 million) in benefits to pension beneficiaries and $25.9 million in healthcare and other postemployment benefits (OPEB) to its former employees in 2019. The schedule also reveals that the company expects these amounts to remain about the same in aggregate over the next five years. Stockholders’ Equity Harley-Davidson reports the following statement of stockholders’ equity for 2018. $ thousands, except share amounts Common Stock Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Balance Total Issued Shares Balance Balance December 31, 2017 . . . . . . . . . . . . . . . . . . . . . 181,286,547 $1,813 $1,422,808 $1,607,570 $(500,049) $ (68