ACCOUNTING-This problem set focuses on revenue recognition, accounts receivable and inventory.
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Group Number: Student Names: |
Dr. Maria Correia
MBA 2017
Problem Set No. 2
This problem set focuses on revenue recognition, accounts receivable and inventory. Please submit your work in a clear and organized manner.
Part I. Revenue Recognition – Bally Total Fitness Holdings
Bally Total Fitness is one of the leading
owners and operators of health clubs in the world. When a customer signs up for a health club
membership, she/he agrees to an up front initiation fee (to start the membership), as well as additional monthly
payments for the right to use the health club.
Using their balance sheet (and an extract from one of their footnotes)
on the following two pages, please answer these questions.
1. As of the end of Year 2, what is the total value of club memberships that Bally’s customers had paid but that Bally has not yet recognized as revenue?
2. (a) What is the ratio of current assets divided by current liabilities (known as the current ratio) for Bally as of December 31st of Year 2?
(b) What would the (current) ratio be if Bally recognized all of this revenue immediately instead of deferring it?
3. BONUS QUESTION – ANSWER NOT REQUIRED – WILL BE DISCUSSED IN THE TUTORIAL. Banks usually look for a current ratio greater than 1.5 when assessing liquidity. Using your answers to question 2 (above), should Bally’s lenders be concerned about its liquidity (why or why not)?
Bally Total Fitness
CONSOLIDATED
BALANCE SHEETS (All dollar amounts in thousands)
DECEMBER 31,
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YEAR 2 YEAR 1
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ASSETS
Current assets:
Cash and equivalents $ 64,382 $ 61,679
Short-term investments 199,979 168,011
Other current assets 34,212 31,743
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Total current assets 298,573 261,433
Long-term Assets:
Property and equipment, net of accum. depr. 361,300 311,197
Intangible assets 101,815 101,220
Deferred membership origination costs 97,901 86,737
Other assets 269,256 206,979
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Total long-term assets 830,272 706,133
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$1,128,845 $ 967,566
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 40,957 $ 36,908
Income taxes payable 2,608 2,342
Accrued liabilities 67,515 56,124
Current maturities of long-term debt 5,799 27,145
Deferred revenues 282,806 270,853
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Total current liabilities 399,685 393,372
Long-term Liabilities
Long-term debt, less current maturities 482,199 405,425
Other liabilities 6,226 7,459
Deferred revenues 78,952 90,989
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Total Long-term Liabilities 567,377 503,873
Stockholder's Equity 161,783 70,321
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$1,128,845 $ 967,566
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Excerpt fromNOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MEMBERSHIP REVENUE RECOGNITION
The Company's fitness centers primarily offer a dues membership, which permits members, upon paying an initial membership fee, to maintain their membership on a month-to-month basis as long as monthly dues payments are made. Revenues from initial membership fees are deferred and recognized ratably over the weighted average expected life of the memberships. Costs directly related to the origination of memberships are also deferred and are amortized using the same methodology as for initial membership fees described above.
Part II –Revenue Recognition: Google
This exercise builds on our class discussion of Google and Yahoo. As you probably know, Google provides targeted advertising as well as intranet solutions via a search appliance. In the following pages, you can find the income statement of Google for 2005, the year after its IPO. Using these statements and the supplementary notes, please answer the following questions:
1. What was Google’sgross profit margin for 2005?
Gross profit margin = (revenues-cost of revenues)/revenues
2. Google provides two types of advertising services: Google AdWords and Google AdSense. Through Google AdWords, the company offers the advertisers the ability to place ads on its own websites targeted to users’ search queries. Through Google AdSense, the company distributes its advertisers’ ads for display on web sites of its Google Network members (other companies). Based on the information provided on revenue recognition (pages 11-12 of this exercise), answer the three following questions:
a. What is Google’s revenue recognition policy for the business it gets from Google AdWords?
b. What is Google’s revenue recognition policy for the business it gets from Google AdSense?
c. Is Google using the same revenue recognition policy as the one it used before its IPO (as discussed in class – presentation slides and article can be obtained from portal)?
3. Approximately, what amount would Google have recognized as revenue if it had recognised all advertising revenue on a net basis? Hint: check the supplementary note that explains Google’s cost of revenue (p. 7 of this exercise). Traffic acquisition costs (in millions) are the costs attributable to Google’s advertising business.
4. Calculate the gross profit margin again using your answer from question 3
5. Open-ended question (no single solution): What is your take-away from this exercise and the Google vs. Yahoo class discussion?
Supplemetary notes
1. Revenues breakdown
2. Cost of revenues
Cost of revenues consists of traffic acquisition costs, which are attributable to Google’s advertising business, and other costs such as depreciation, labor, energy etc. The following table shows the traffic acquisition costs:
3. Revenue recognition
Recognition of revenue from Google AdWords program
Recognition of revenue from Google AdSense program
Part III: Accounts Receivables and Uncollectible Amounts
Using the balance sheet of Google provided in the next page, answer the following questions:
1. As of December 31st, 2005, how much does Google expect to collect from its customers in the future because of sales that were made prior to January 1st, 2006?
2. Assume that Google had written off $2,500 (thousand) of its accounts receivable as permanently uncollectible during the year ended December 31st, 2005. How much bad debt expense did Google record during 2005?
Part IV: Inventory
Please consider the Income Statement and Note 17 (Supplemental information) for General Mills below and answer the following questions. For the purpose of this problem, assume that inventory values determined using the average cost method are equivalent to FIFO values. Also assume that revenue is presented net of bad debt expense.
1. Assume that the Company charged $7 million as bad debt expense. Compute the amount of bad debts written off in 2010.
2. Compute the amount of cash collected from customers during the year ended May 30th, 2010.
3. Compute the cost of sales for the year ended May 30th, 2010, assuming all inventory is valued under FIFO.
4. Did General Mills pay more or less taxes during the year ended May 30th, 2010, by using LIFO instead of FIFO? (Assume the tax rate is 35%)
5. Estimate the tax savings from using LIFO since the company’s adoption of LIFO. (Assume the tax rate is 35%)
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Rating:
/5
Solution: ACCOUNTING-answering qn 3 and 4