2301, University Hall, Open Book and Notes

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1 Accounting 516 Mid-term Summer 2014 Ram T. S. Ramakrishnan , University Hall, Open Book and Notes Tuesday, July 15, 2014 Show all your work in the answer sheets. You will not get credit for a right answer unless you show all the steps in these sheets. As a courtesy to fellow test takers, please turnoff all phones and tablets. Question Points Cash Flow Statements 1 30 Basic Ratios 2 10 Profitability Analysis 3 or 4 25 Off-Balance-Sheet Leases 5 20 Tax positions 6 15 Total 100 UIN This course and its associated coursework are being administered under the policies of the University of Illinois at Chicago (UIC) College of Business Administration Honor Code. I respect and uphold this code. I have used my laptop only for accessing the course materials. I did not contact any on else during the test and did not access the Internet Signature First name Last name

2 FedEx-13 Case 1 1 Description of Business We provide a broad portfolio of transportation, e-commerce and business services through companies competing collectively, operating independently and managed collaboratively, under the respected FedEx brand. Our primary operating companies are Federal Express Corporation ( FedEx Express ), the world s largest express transportation company; FedEx Ground Package System, Inc. ( FedEx Ground ), a leading North American provider of small-package ground delivery services; and FedEx Freight, Inc. ( FedEx Freight ), a leading North American provider of less-than-truckload ( LTL ) freight services. These companies represent our major service lines and, along withfedex Corporate Services, Inc. ( FedEx Services ), form the core of our reportable segments. Our FedEx Services segment provides sales, marketing, information technology, communications and back-office support to our transportation segments. in addition, the FedEx Services segment provides customers withretail access to FedEx Express and FedEx Ground shipping services through FedEx Office and Print Services, Inc. ( FedEx Office ) and provides customer service, technical support and billing and collection services through FedEx TechConnect, Inc. ( FedEx TechConnect ). See Reportable Segments for further discussion Attached are sections of the consolidated balance sheets of FedEx Corporation as of May 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders investment of FedEx Corporation

3 FEDEX CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years ended May 31, (in millions, except per share amounts) Revenues $ 44,287 $ 42,680 $ 39,304 Operating Expenses: Salaries and employee benefits 16,570 16,099 15,276 Purchased transportation 7,272 6,335 5,674 Rentals and landing fees 2,521 2,487 2,462 Depreciation and amortization 2,386 2,113 1,973 Fuel 4,746 4,956 4,151 Maintenance and repairs 1,909 1,980 1,979 Business realignment, impairment and other charges Other 5,672 5,390 5,322 41,736 39,494 36,926 Operating Income 2,551 3,186 2,378 Other Income (Expense): Interest expense (82) (52) (86) Interest income Other, net (35) (6) (36) (96) (45) (113) Income Before Income Taxes 2,455 3,141 2,265 Provision For Income Taxes 894 1, Net Income $ 1,561 $ 2,032 $ 1,452 Basic Earnings Per Common Share $ 4.95 $ 6.44 $ 4.61 Diluted Earnings Per Common Share $ 4.91 $ 6.41 $ 4.57 The accompanying notes are an integral part of these consolidated financial statements. 39

4 FedEx-13 Case 3 3 Fedex Corporation in Millions, Except Per Share Data Consolidated Balance Sheets 05/31/ /31/2012 Increase Assets Cash and cash equivalents 4,917 2, Receivables, less allowances of $176 and $178 5,044 4, Spare parts, supplies and fuel, less allowances Deferred income taxes Prepaid expenses and other Total current assets 11,274 9,056 Property and Equipment, at Cost Aircraft and related equipment 14,716 14,360 Package handling and ground support equipment 6,452 5,912 Computer and electronic equipment 4,958 4,646 Vehicles 4,080 3,654 Facilities and other 7,903 7,592 38,109 36,164 1,945 Less accumulated depreciation and amortization (19,625) (18,916) (709) Net property and equipment 18,484 17,248 Goodwill 2,755 2, Other assets 1,054 1,212 (158) 33,567 29,903 3,664 Liabilities and Stockholders' Investment Current Liabilities Current portion of long-term debt (166) Accrued salaries and employee benefits 1,688 1, Accounts payable 1,879 1, Accrued expenses 1,932 1, Total current liabilities 5,750 5,374 Long-Term Debt, Less Current Portion 2,739 1,250 1,489 Other Long-Term Liabilities Deferred income taxes 1, Pension, postretirement healthcare and other benefit obligations 3,916 5,582 (1,666) Self-insurance accruals Deferred lease obligations (6) Deferred gains, principally related to aircraft transactions (24) Other liabilities (16) Total other long-term liabilities 7,680 8,552 Common Stockholders' Equity Common stock, $0.10 par value; 800 million shares authorized; 318 million shares issued as of May 31, 2013 and 317 million shares issued as of May 31, Additional paid-in capital 2,668 2, Retained earnings 18,519 17,134 1,385 Accumulated other comprehensive loss -3,820-4,953 1,133 Treasury stock, at cost Total common stockholders' investment 17,398 14,727 33,567 29,903 3,664

5 FedEx-13 Case 4 4 Fedex Corporation Consolidated Statements of Changes in Stockholders' Investment (in millions, except per share amounts) Additional Common Paid-in Retained Stock Capital Earnings Balance at May 31, ,595 17,134 Net income 1,561 Other comprehensive gain, net of tax of $665 Purchase of treasury stock Cash dividends declared ($0.56 per share) (176) Employee incentive plans and other (4,172,976 shares issued) 73 Balance at May 31, ,668 18,519 C o n t i n u e d C o n t i n u e d Accumulated Other Comprehensive Treasury Income Stock Total Balance at May 31, , ,727 Net income 1,561 Other comprehensive gain, net of tax of $665 1,133 1,133 Purchase of treasury stock Cash dividends declared ($0.56 per share) -176 Employee incentive plans and other (4,172,976 shares issued) Balance at May 31, 2013 (3,820) (1) 17,398 Consolidated Statements of Compre Hensive Income (Loss ) (in millions) Years ended May 31, Net Income 1,561 2,032 1,452 Other Comprehensive Income (Loss): Foreign currency translation adjustments, net of tax benefit of $12 and $26 in 2013 and 2012 and tax expense of $27 in (95) 125 Amortization of unrealized pension actuarial gains/losses and other, net of tax expense of $677 in 2013 and tax benefit of $1,369 and $141 in 2012 and ,092 (2,308) (235) 1,133 (2,403) (110) Comprehensive Income (Loss) 2,694 (371) 1,342

6 FedEx-13 Case 5 5 Fedex Corporation Notes to Consolidated Financial Statements Note 1 FISCAL YEARS. Except as otherwise specified, references to years indicate our fiscal year ended May 31, 2013 or ended May 31 of the year referenced CAPITALIZED INTEREST. Interest on funds used to finance the acquisition and modification of aircraft, including purchase deposits, construction of certain facilities, and development of certain software up to the date the asset is ready for its intended use is capitalized and included in the cost of the asset if the asset is actively under construction. Capitalized interest was $45 million in 2013, $85 million in 2012 and $71 million in SELF-INSURANCE ACCRUALS. We are primarily self-insured for workers' compensation claims, vehicle accidents and general liabilities, benefits paid under employee healthcare programs and long-term disability benefits. Accruals are primarily based on the actuarially estimated, undiscounted cost of claims, which includes incurred-but-not-reported claims. Current workers' compensation claims, vehicle and general liability, employee healthcare claims and long-term disability are included in accrued expenses. We self-insure up to certain limits that vary by operating company and type of risk. Periodically, we evaluate the level of insurance coverage and adjust insurance levels based on risk tolerance and premium expense. DEFERRED GAINS. Gains on the sale and leaseback of aircraft and other property and equipment are deferred and amortized ratably over the life of the lease as a reduction of rent expense. Substantially all of these deferred gains are related to aircraft transactions. LEASES. We lease certain aircraft, facilities, equipment and vehicles under capital and operating leases. the commencement date of all leases is the earlier of the date we become legally obligated to make rent payments or the date we may exercise control over the use of the property. In addition to minimum rental payments, certain leases provide for contingent rentals based on equipment usage principally related to aircraft leases at FedEx Express and copier usage at FedEx Office. Rent expense associated withcontingent rentals is recorded as incurred. Certain of our leases contain fluctuating or escalating payments and rent holiday periods. the related rent expense is recorded on a straight-line basis over the lease term. the cumulative excess of rent payments over rent expense is accounted for as a deferred lease asset and recorded in Other assets in the accompanying consolidated balance sheets. the cumulative excess of rent expense over rent payments is accounted for as a deferred lease obligation. Leasehold improvements associated withassets utilized under capital or operating leases are amortized over the shorter of the asset s useful life or the lease term. GOODWILL. Goodwill is recognized for the excess of the purchase price over the fair value of tangible and identifiable intangible net assets of businesses acquired. Several factors give rise to goodwill in our acquisitions, such as the expected benefit from synergies of the combination and the existing workforce of the acquired entity. Goodwill is reviewed at least annually for impairment by comparing the fair value of each reporting unit withits carrying value (including attributable goodwill). Fair value for our reporting units is determined using an income or market approach incorporating market participant considerations and management's assumptions on revenue growth rates, operating margins, discount rates and

7 FedEx-13 Case 6 6 expected capital expenditures. Fair value determinations may include both internal and thirdparty valuations. Unless circumstances otherwise dictate, we perform our annual impairment testing in the fourth quarter.total goodwill amortized in 2013 was $120 million. INTANGIBLE ASSETS. Intangible assets include customer relationships, trade names, technology assets and contract-based intangibles acquired in business combinations. Intangible assets are amortized over periods ranging from 2 to 15 years, either on a straightline basis or an accelerated basis depending upon the pattern in which the economic benefits Total Intangible assets amortized in 2013 was $98 million. Note 6: Selected Current Liabilities The components of selected current liability captions were as follows (in millions): 2,013 2,012 Accrued Salaries and Employee Benefits Salaries Employee benefits, including variable compensation Compensated absences ,688 1,635 Accrued Expenses Self-insurance accruals Taxes other than income taxes Other ,932 1,709

8 FedEx-13 Case 7 7 Note 8: Leases We utilize certain aircraft, land, facilities, retail locations and equipment under capital and operating leases that expire at various dates through We leased 10% of our total aircraft fleet under operating leases as of May 31, 2013 and 10% of our total aircraft fleet under supplemental aircraft are leased by us under agreements that provide for cancellation upon 30 days notice. Our leased facilities include national, regional and metropolitan sorting facilities, retail facilities and administrative buildings. Rent expense under operating leases for the years ended May 31 was as follows (in millions) for years ended May 31, Minimum rentals 2,061 2,018 2,025 Contingent rentals ,253 2,228 2,218 A summary of future minimum lease payments under noncancelable operating leases withan initial or remaining term in excess of one year at May 31, 2013 is as follows (in millions Operating Leases Aircraft and Related Facilities Total Operating Equipment and Other Lease ,474 1, ,386 1, ,183 1, ,298 1, ,230 Thereafter 824 5,826 6,650 2,904 12,071 14,975 Property and equipment recorded under capital leases and future minimum lease payments under capital leases were immaterial at May 31, The weighted-average remaining lease term of all operating leases outstanding at May 31, 2013 was approximately six years. While certain of our lease agreements contain covenants governing the use of the leased assets or require us to maintain certain levels of insurance, none of our lease agreements include material financial covenants or limitations. FedEx Express makes payments under certain leveraged operating leases that are sufficient to pay principal and interest on certain pass-through certificates. the pass-through certificates are not direct obligations of, or guaranteed by, FedEx or FedEx Express.

9 FedEx-13 Case 8 8 Note 12: Income Taxes The components of the provision for income taxes for the years ended May 31 were as follows (in millions): Current provision (benefit Domestic: Federal 512 (120) 79 State and local Foreign Deferred provision (benefit) Domestic: Federal State and local (7) Foreign (42) (9) , A reconciliation of the statutory federal income tax rate to the effective income tax rate for the years ended May 31 was as follows: Statutory U.S. income tax rate State and local income taxes, net of federal benefit Other, net (0.70) (1.80) (0.80) Effective tax rate Our 2012 rate was favorably impacted by the conclusion of the IRS audit of our consolidated income tax returns. The significant components of deferred tax assets and liabilities as of May 31 were as follows (in millions): Deferred Deferred Deferred Tax Deferred Tax Tax Assets Liabilities Tax Assets Liabilities Property, equipment, 157 3, ,436 leases and intangibles Employee benefits 1, , Self-insurance accruals Other Net operating loss/credit carryforwards Valuation allowance (204) (145) 2,806 3,925 3,415 3,718

10 FedEx-13 Case The net deferred tax liabilities as of May31 have been classified in the balance sheets as follows (in millions): Current deferred tax asset Noncurrent deferred tax liability (1,652) (836) (1,119) (303) The valuation allowance primarily represents amounts reserved for operating loss and tax credit carryforwards, which expire over varying periods starting in as a result of this and other factors, we believe that a substantial portion of the se deferred tax assets may not be realized. Permanently reinvested earnings of our foreign subsidiaries amounted to $1.3 billion at the end of 2013 and $1 billion at the end of We have not recognized deferred taxes for U.S. federal income tax purposes on those earnings. in 2013, our permanent reinvestment strategy with respect to unremitted earnings of our foreign subsidiaries provided a 1.2% benefit to our effective tax rate. Were the earnings to be distributed, in the form of dividends or otherwise, these earnings could be subject to U.S. federal income tax and non-u.s. withholding taxes. Unrecognized foreign tax credits potentially could be available to reduce a portion of any U.S. tax liability. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable due to uncertainties related to the timing and source of any potential distribution of such funds, along withother important factors such as the amount of associated foreign tax credits. Cash in offshore jurisdictions associated withour permanent reinvestment strategy totaled $420 million at the end of 2013 and $410 million at the end of In 2013, more than 85% of our total enterprise-wide income was earned in U.S. companies of FedEx that are taxable in the United States. as a U.S. airline, our FedEx Express unit is required by Federal Aviation Administration and other rules to conduct its air operations, domestic and international, through a U.S. company. However, we serve more than 220 countries and territories around the world, and are required to establish legal entities in many of them

11 FedEx-13 Case Schedule II Fedex Corporation Valuation and Qualifying Accounts (In Millions) For the Years Ended May 31, 2013, 2012, and 2011 Description Balance Charged Deductions BALANCE At To AT Beginning Other END OF Of Year Accounts YEAR Accounts Receivable Reserves: Allowance for Doubtful Accounts a a a 97 Allowance for Revenue Adjustments c c c 85 Inventory Valuation Allowance: (a) Uncollectible accounts written off, net of recoveries. (b) Principally charged against revenue. (c) Service failures, rebills and other.

12 FedEx-13 Case Question 1 Consolidated Statements of Cash Flows Construct the Consolidated Statements of Cash Flows for FedEx for the year ending 05/31/2013 using the indirect method. for your convenience, the increases in all balance sheet accounts are also given.

13 FedEx-13 Case Question a Average Debt for year ending 05/31/13. b Average operating assets for year ending 05/31/13. c Average operating liabilities for year ending 05/31/13. d Times Interest Earned for year ending 05/31/13.

14 FedEx-13 Case Question e Margin before Interest & Taxes for year ending 05/31/13. f Asset Turnover for year ending 05/31/13. g Return on Assets (ROA) for year ending 05/31/13. h Return on Total capital (ROTC) for year ending 05/31/13. i Return on Equity (ROE) for year ending 05/31/13. j Derive ROA from Margin-Before-Interest-and-taxes and Asset Turnover for year ending 05/31/13. k Derive ROE from ROTC and interest rate for year ending 05/31/13.

15 FedEx-13 Case Question l NOPAT for year ending 05/31/13. m Net Operating Profit Margin for year ending 05/31/13. n Net Operating Assets Turnover for year ending 05/31/13. o Return on Net Operating Assets (RNOA) for year ending 05/31/13. p Return on Equity (ROE) for year ending 05/31/13. q Derive RNOA from Net Operating Profit Margin and Net Operating Assets Turnover for year ending 05/31/13. r Derive ROE from RNOA and Net Nonoperating Expense percent for year ending 05/31/13.

16 FedEx-13 Case Question Assume that the discount rate for all leases is 3%. Assume that the useful life for reporting purposes for assets under leases is 12 years a Suppose you want to consider the operating leases of FedEx as capital leases from 05/31/12. Convert the operating leases as of 05/31/12 into capital leases. Assume that the amounts listed for years after five years 2011 are to be paid uniformly over 6 years. What changes need to be made in the balance sheets of 05/31/12 and 05/31/13. What changes need to be made in the income statement for the year ending 05/31/13?

17 FedEx-13 Case Using data from adjustments that you computed earlier, compute the following ratios on 05/31/13qqDo they show a better picture of FedEx? Comment on the differences. b Debt - to - equity ratio average for the year. c Times Interest Earned (for year ending 05/31/13).

18 FedEx-13 Case Question a How much depreciation expense on property did FedEx count for tax purposes for the fiscal year ending 05/31/13? Use information in the footnote for deferred taxes. b What was the average foreign statutory tax rate faced by FedEx in the year ending 5/31/2013? c What was the average state tax rate faced by FedEx in the year ending 5/31/2013? You can assume that all state taxes are paid in the US. d How much did FedEx expense more than the cash spent for the self-insurance workers compensation claims etc.? Note 1 describes FedEx accounting policy towards self-insurance. Derive the amount in two different ways. Use figures from the balance sheet and Note 6 for one way and Note 12 for the other way.