Solutions Manual Financial Accounting for MBAs 8th Edition Easton

Solutions Manual Financial Accounting for MBAs 8th Edition Easton 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 Harley- Davidson 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