rv.wbn.rec.020 Recording entries using company disclosures, determining their financial-statement effects and analyzing related risks (HP)

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1 Revenue and Related Balance Sheet Concepts» What s Behind the numbers» Receivables» Exercises EXERCISES rv.wbn.rec.020 Recording entries using company disclosures, determining their financial-statement effects and analyzing related risks (HP) This exercise asks you to record entries based on HP s disclosures and then determine how these entries affected HP s financial statements. The entries should be recorded using the accounts on page 5. HP s financial statements and Valuation and Qualifying Accounts (Schedule II of 10K) are on pages Part I: Record Entries Record Keeping This exercise helps you learn how to do record keeping and reporting. Simplifying Assumptions Assume for the purpose of this question that HP s allowance for doubtful accounts is only affected by bad debts and, in particular, that the effects of product returns, sales rebates and other programs offered to customers are immaterial or non-existent. This is likely a reasonable assumption: HP only mentions customer returns once in its K (page 84) and Schedule II reports Addition of bad debt provision, suggesting most, if not all, of the provision is attributable to bad debts. Assume for the purpose of this question that HP writes off the gross margin associated with receivables secured by collateral before recording the recovery of the returned property. For example, if a customer originally purchased a product for $100 on account with $70 cost of sales and HP writes off the account, it records two entries: (i) writes off the $30 portion of the $100 receivable associated with the margin when it decides the account is not collectible and (ii) writes off the remaining $70 receivable when the collateral is recovered. The first entry is the only one that affects the allowance and the only one you are to record here. In terms of wording in HP s Schedule II, the $30 recorded in entry (i) writes off the $100 receivable, net of the $70 recovery: the allowance would report a $30 Deduction, net of recoveries. Search This exercise helps you learn how to search for information. Usage This exercise helps you learn how to use accounting information. Guidance The chart of accounts includes one bad debt expense account. Record the combined expense for accounts receivable and financing receivables into this account. HP s balance sheet reports financing receivables as current and non-current assets. This means HP maintains separate current and non-current accounts for gross financing receivables and for the allowance for bad debts. However, HP s Valuation and Qualifying Accounts (Schedule II) doesn t report separate current and non-current allowances. This means you can t perfectly replicate HP s related entries (into current and non-current accounts). Instead, as indicated in the chart of accounts, you are to record entries into fictitious accounts that combine the current and non-current effects. For example, you will record the bad debt expense associated with current and non-current financing receivables into a single allowance for financing receivables. You may customize this work, as long as you credit G. Peter & Carolyn R. Wilson and respect the Creative Commons Attribution-Noncommercial-Share Alike United States license NavAcc LLC.

2 2 NAVIGATING ACCOUNTING Required (a) Record a journal entry that recognizes HP s bad debts expense for the year ended October 31, Write your entry in the space below using the accounts on page 5. Replenish bad debt allowance Debit Credit (b) Record a journal entry that recognizes HP s write-offs (net of recoveries) of receivables (accounts and financing) for the year ended October 31, Follow the guidance for part (a). Write off bad debts (net of recoveries) Debit Credit Part II: Financial-Statement Effects of Entries Required For the entries you recorded in Part I, complete the related table identifying the HP financial statement line items that would have been directly affected (and the direction of the effects) during the year ended October 31, Choose the most appropriate line items on HP s financial statements. As indicated in the guidance for Part I (a), HP doesn t disclose enough information to record separate amounts for the current and non-current accounts related to financing receivables. However, even though we combined the current and non-current accounts in Part I, here we want you to assume you recorded them separately. That is, you are to identify the line items that were affected when HP wrote off receivables using current and non-current accounts for financing receivables. Guidance: (1) Determine the appropriate line item(s) affected using HP s financial statements on pages 6-9 For example, write cash and cash equivalents rather than cash because this is on HP s balance sheet. (2) Include line item(s) directly affected, including the effect(s) of closing entries for events affecting income. Ignore taxes. (3) Don t include totals or sub-totals indirectly affected by the entry. For example, don t report net income on the income statement. However, net income is NOT a total on the statement of shareholders equity. (4) Three or four lines were included below for each statement, but you may need none or more than one line. Write NONE if no line item is effected on the statement.

3 EXERCISE 3 (5) Indicate if the effect(s) of the entries associated with the event increased or decreased the line item. Put an X in the appropriate column if the above event increases or decreases that line item. Be sure to mark only one box in each statement s row. NOTE: If a reported negative number changes from -2 to -3, it decreases; if it changes from - 2 to - 1, it increases. (c) Replenishing the allowances: Replenish bad debt allowance CONSOLIDATED BALANCE SHEETS CONSOLIDATED STATEMENTS OF INCOME Line Items Increases Decreases Line Items Increases Decreases CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY STATEMENT OF CASH FLOWS Line Items Increases Decreases Line Items Increases Decreases (d) Writing off receivables: Write off bad debts (net of recoveries) CONSOLIDATED BALANCE SHEETS CONSOLIDATED STATEMENTS OF INCOME Line Items Increases Decreases Line Items Increases Decreases CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY STATEMENT OF CASH FLOWS Line Items Increases Decreases Line Items Increases Decreases

4 4 NAVIGATING ACCOUNTING Part III: Risk comparisons Required (e) Note 11 of HP s K reports $7,693 of gross financing receivables (current and non-current) at the end of fiscal 2012 with an allowance for doubtful accounts of $149 (page 122). Thus, the allowance is 1.94% of gross financing receivables. HP s balance sheet reports $16,407 of accounts receivable at the end of fiscal 2012 and the Valuation and Qualifying Allowances table (Schedule II) reports $464 of related allowance for doubtful accounts. Thus, gross accounts receivable were $16,871 and the allowance was 2.75% of gross accounts receivable. This suggests the credit risk associated with accounts receivable was slightly greater than the risk associated with the financing receivables. Based solely on the following background information and concepts covered thus far, hypothesize two reasons accounts receivable may have been riskier than financing receivables. Background information The following quotes are from HP s K (trade receivables are the same as accounts receivable): Moreover, some of our wholesale and retail distributors may have insufficient financial resources and may not be able to withstand changes in business conditions, including economic weakness and industry consolidation. Many of our significant distributors operate on narrow product margins and have been negatively affected by business pressures. Considerable trade receivables that are not covered by collateral or credit insurance are outstanding with our distribution and retail channel partners. (Page 26) HP sells a significant portion of its products through third-party distributors and resellers and, as a result, maintains individually significant receivable balances with these parties. If the financial condition or operations of all of these distributors and resellers aggregated accounts deteriorate substantially, HP s operating results could be adversely affected. The ten largest distributor and reseller receivable balances, which were concentrated primarily in North America and Europe, collectively represented approximately 14% of gross accounts receivable at both October 31, 2012 and October 31, No single customer accounts for more than 10% of accounts receivable. Credit risk with respect to other accounts receivable and financing receivables is generally diversified due to the large number of entities comprising HP s customer base and their dispersion across many different industries and geographical regions. HP performs ongoing credit evaluations of the financial condition of its third-party distributors, resellers and other customers and requires collateral, such as letters of credit and bank guarantees, in certain circumstances. The past due or delinquency status of a receivable is based on the contractual payment terms of the receivable. (Page 88) Financing receivables represent sales-type and direct-financing leases resulting from the placement of HP and third-party products. These receivables typically have terms from two to five years and are usually collateralized by a security interest in the underlying assets. Financing receivables also include billed receivables from operating leases. (Page 122)

5 EXERCISE 5 ASSETS Current AR C Inven PrEx CHART OF ACCOUNTS Accounts receivable ARG Accounts receivable, gross ARall Allowance for bad debts: accounts receivable Cash and cash equivalents Inventories FGI Finished goods inventories SIdr Segregated inventories: deferred revenue Prepaid expenses Current and non-current combined (Fictitious accouts that allow outsiders to record related entries using footnote information.) FR Financing receivables (current and non current combined) FRG Financing receivables, gross FRall Allowance for bad debts: financing receivables Non-current PPE Property, plant, and equipment, net PPEhc PP&E (historical cost) AcDep Accumulated depreciation LIABILITIES Current AP Accounts payable AcrL Accrued liabilities DivP Dividend payable Drev Deferred revenue Non-current LTD Long-term debt OWNERS' EQUITY Permanent RE SCap Net income BadEx CGS DepEx G/L IncS MSGA Rev Retained earnings Share capital Bad debt expense: accounts receivable & financing receivables Cost of goods sold Depreciation expense Gain/loss PPEGL Gain/Loss on PP&E disposals ONOGL Other non-operating gains/losses Income summary Miscellaneous SG&A expense Revenues, net

6 6 NAVIGATING ACCOUNTING HEWLETT PACKARD COMPANY AND SUBSIDIARIES Consolidated Balance Sheets October In millions, except par value ASSETS Current assets: Cash and cash equivalents $11,301 $8,043 Accounts receivable 16,407 18,224 Financing receivables 3,252 3,162 Inventory 6,317 7,490 Other current assets 13,360 14,102 Total current assets 50,637 51,021 Property, plant and equipment 11,954 12,292 Long-term financing receivables and other assets 10,593 10,755 Goodwill 31,069 44,551 Purchased intangible assets 4,515 10,898 Total assets $108,768 $129,517 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable and short-term borrowings $6,647 $8,083 Accounts payable 13,350 14,750 Employee compensation and benefits 4,058 3,999 Taxes on earnings 846 1,048 Deferred revenue 7,494 7,449 Accrued restructuring Other accrued liabilities 13,500 14,459 Total current liabilities 46,666 50,442 Long-term debt 21,789 22,551 Other liabilities 17,480 17,520 Commitments and contingencies Stockholders' equity: HP stockholders' equity Preferred stock, $0.01 par value (300 shares authorized; none issued) Common stock, $0.01 par value (9,600 shares authorized; 1,963 and ,991 shares issued and outstanding, respectively) Additional paid-in capital 6,454 6,837 Retained earnings 21,521 35,266 Accumulated other comprehensive loss (5,559) (3,498) Total HP stockholders' equity 22,436 38,625 Non-controlling interests Total stockholders' equity 22,833 39,004 Total liabilities and stockholders' equity $108,768 $129,517 Hewlett Packard K, sec.gov

7 EXERCISE 7 HEWLETT PACKARD COMPANY AND SUBSIDIARIES Consolidated Statements of Earnings For the fiscal years ended October In millions, except per share amounts Net revenue: Products $77,887 $84,757 $84,799 Services 42,008 42,039 40,816 Financing income Total net revenue 120, , ,033 Costs and expenses: Cost of products 59,468 65,167 65,064 Cost of services 32,600 31,945 30,486 Financing interest Research and development 3,399 3,254 2,959 Selling, general and administrative 13,500 13,577 12,822 Amortization of purchased intangible assets 1,784 1,607 1,484 Impairment of goodwill and purchased intangible assets 18, Restructuring charges 2, ,144 Acquisition-related charges Total operating expenses 131, , ,554 (Loss) earnings from operations (11,057) 9,677 11,479 Interest and other, net (876) (695) (505) (Loss) earnings before taxes (11,933) 8,982 10,974 Provision for taxes (717) (1,908) (2,213) Net (loss) earnings ($12,650) $7,074 $8,761 Net (loss) earnings per share: Basic ($6.41) $3.38 $3.78 Diluted ($6.41) $3.32 $3.69 Weighted-average shares used to compute net (loss) earnings per share: Basic 1,974 2,094 2,319 Diluted 1,974 2,128 2,372 Hewlett Packard K, sec.gov

8 8 NAVIGATING ACCOUNTING HEWLETT PACKARD COMPANY AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Common Stock Number of Shares Par Value Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive (Loss) Income Total HP Stockholders' Equity Noncontrolling Interests Total In millions, except number of shares in thousands Balance October 31, ,364,809 $24 $13,804 $29,936 ($3,247) $40,517 $247 $40,764 Net earnings 8,761 8,761 8,761 Other comprehensive loss (590) (590) (590) Comprehensive income 8,171 8,171 Issuance of common stock in connection 80, ,606 2,607 2,607 with employee stock plans and other Repurchases of common stock (241,246) (3) (5,809) (5,259) (11,071) (11,071) Net excess tax benefits from employee stock plans Cash dividends declared (743) (743) (743) Stock-based compensation expense Changes in non-controlling interest Balance October 31, ,203,898 $22 $11,569 $32,695 ($3,837) $40,449 $332 $40,781 Net earnings 7,074 7,074 7,074 Other comprehensive income Comprehensive income 7,413 7,413 Issuance of common stock in connection 45, with employee stock plans and other Repurchases of common stock (258,853) (3) (6,296) (3,669) (9,968) (9,968) Net excess tax benefits from employee stock plans Cash dividends declared (834) (834) (834) Stock-based compensation expense Changes in non-controlling interest Balance October 31, ,990,506 $20 $6,837 $35,266 ($3,498) $38,625 $379 $39,004 Net loss (12,650) (12,650) (12,650) Other comprehensive loss (2,061) (2,061) (2,061) Comprehensive loss (14,711) (14,711) Issuance of common stock in connection 39, with employee stock plans and other Repurchases of common stock (66,736) (1,525) (101) (1,626) (1,626) Net excess tax benefits from employee stock plans (175) (175) (175) Cash dividends declared (995) (995) (995) Stock-based compensation expense Changes in non-controlling interest Balance October 31, ,962,838 $20 $6,454 $21,521 ($5,559) $22,436 $397 $22,833 Hewlett Packard K, sec.gov

9 EXERCISE 9 Cash flows from operating activities: HEWLETT PACKARD COMPANY AND SUBSIDIARIES Consolidated Statements of Cash Flows For the fiscal years ended October In millions Net (loss) earnings $ (12,650) $ 7,074 $ 8,761 Adjustments to reconcile net (loss) earnings to net cash provided by operating activities: Depreciation and amortization 5,095 4,984 4,820 Impairment of goodwill and purchased intangible assets 18, Stock-based compensation expense Provision for doubtful accounts accounts and financing receivables Provision for inventory Restructuring charges 2, ,144 Deferred taxes on earnings (711) Excess tax benefit from stock-based compensation (12) (163) (294) Other, net 265 (46) 169 Changes in operating assets and liabilities: Accounts and financing receivables 1,269 (227) (2,398) Inventory 890 (1,252) (270) Accounts payable (1,414) 275 (698) Taxes on earnings (320) Restructuring (840) (1,002) (1,334) Other assets and liabilities (2,356) (293) 89 Net cash provided by operating activities 10,571 12,639 11,922 Cash flows from investing activities: Investment in property, plant and equipment (3,706) (4,539) (4,133) Proceeds from sale of property, plant and equipment Purchases of available-for-sale securities and other investments (972) (96) (51) Maturities and sales of available-for-sale securities and other investments Payments in connection with business acquisitions, net of cash acquired (141) (10,480) (8,102) Proceeds from business divestiture, net Net cash used in investing activities (3,453) (13,959) (11,359) Cash flows from financing activities: (Payments) issuance of commercial paper and notes payable, net (2,775) (1,270) 4,156 Issuance of debt 5,154 11,942 3,156 Payment of debt (4,333) (2,336) (1,323) Issuance of common stock under employee stock plans ,617 Repurchase of common stock (1,619) (10,117) (11,042) Excess tax benefit from stock-based compensation Cash dividends paid (1,015) (844) (771) Net cash used in financing activities (3,860) (1,566) (2,913) Increase (decrease) in cash and cash equivalents 3,258 (2,886) (2,350) Cash and cash equivalents at beginning of period 8,043 10,929 13,279 Cash and cash equivalents at end of period $ 11,301 $ 8,043 $ 10,929 Hewlett Packard K, sec.gov

10 10 NAVIGATING ACCOUNTING HEWLETT PACKARD COMPANY AND SUBSIDIARIES Valuation and Qualifying Accounts For the fiscal years ended October In millions Allowance for doubtful accounts accounts receivable: Balance, beginning of period $470 $525 $629 Increase in allowance from acquisitions 27 7 Addition of bad debt provision Deductions, net of recoveries (106) (105) (191) Balance, end of period $464 $470 $525 Allowance for doubtful accounts financing receivables: Balance, beginning of period Additions to allowance Deductions, net of recoveries (23) (68) (44) Balance, end of period $149 $130 $140 Hewlett Packard K, sec.gov