Chapter 1, Introductory Cases Dublin Small Animal Clinic, Inc. 1 page; introductory
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- Employee stock options Income tax reporting for non-qualified employee stock options
- Fair value reporting The fair value option
28 pages; very advancedDefined benefit pension plansRetiree health care plansBankruptcyNegotiationsEthicsCompeting interestsThis case covers GM’s possible bankruptcy and its pension and retiree health care funds. Although the case covers relatively technical pension/retiree health care benefit issues, it is far more interesting than a typical pension case because of the negotiations between the U.S. government, GM, bondholders, and the UAW (Union of Auto Workers). In 2007, GM was in serious financial difficulty but had an overfunded pension plan. The UAW, concerned about losing its health care benefits in the event of a GM bankruptcy, negotiated an arrangement whereby GM transferred its retiree health care fund obligations to the UAW, paid a significant amount into the fund, and promised to later pay more than $20 billion to the newly UAW managed retiree health care fund. GM also agreed to increase retiree benefits from the overfunded pension plan by $66.01 per employee per month beginning January 1, 2010. In 2008, as the stock market collapsed, GM’s pension fund shifted to being underfunded. In late 2008 GM and Chrysler received government loans. In early 2009, the U.S. Government proposed a bankruptcy plan that would preserve the firm’s liability to the UAW pension and retiree health care fund. Bondholders were to receive eight cents in cash for each dollar in bonds, plus sixteen cents in new unsecured debt, and 90% of GM’s equity. The case includes a letter from advisers to the creditors that challenges that offer; it ends before the bankruptcy is resolved. The teaching note includes details on the bankruptcy.
Best uses:Undergraduate intermediate accounting First-year MBA/Executive MBA Financial accounting Financial reporting Financial statement analysis Valuation
Use with:Retiree Benefits in the United States (Chapter 7) 37.Cisco Systems, Inc., Employee Stock Options 20 pages; very advancedEmployee stock optionsIncome tax reporting for non-qualified employee stock optionsFinancial reporting for non-qualified employee stock optionsThis case covers Cisco Systems’ employee stock options disclosures. It includes Cisco’s 2008 income statement, balance sheet, and statement of cash flows, and disclosure notes for Cisco’s employee stock incentive plans and income taxes. The case uses financial statements for 2008 instead of 2009 because Cisco’s employee stock options reporting became more opaque in 2009. The case covers Cisco’s employee stock options plan from two perspectives. First, the case considers how Cisco computes its employee stock option costs and how it reports those costs in its financial statements. Second, the case considers how Cisco reports the tax effects of employee stock options. Cisco issues non-qualified stock options to its employees. When employees exercise non-qualified employee stock options, they must report the difference between the stock’s fair value on the exercise date, and the exercise price paid to Cisco to acquire the stock, as taxable income. Cisco then records that taxable income to its employees as a tax deduction on its own federal income tax return. Cisco computes and records employee stock option costs for accounting purposes using the Black-Scholes or similar option model, and reports a different employee stock option cost for federal income taxes. That is a permanent difference between accounting and tax reporting, but a special rule applies to how the difference is treated on Cisco’s financial statements. Between 2000 and 2008, Cisco’s reporting for employee stock options became increasingly opaque. By 2008, unless a user was very familiar with employee stock option tax laws, accounting reporting rules for employee stock options, and how Cisco reported employee stock options in the past, it was nearly impossible to understand the effect of Cisco’s exercised employee stock options. This case discusses Cisco’s relatively clear disclosures from its 2000 financial statements and its relatively opaque disclosures from its 2008 financial statements. Best uses:Financial reporting Financial statement analysis Valuation
36 pages; very advancedFair value reportingThe fair value optionMerrill’s own long-term debt reported at fair valueSegment disclosuresValuationThis is a complex but interesting case that covers three topics in great detail: fair value; the fair value option, and; segment disclosures. Those disclosures are closely related in the case. Although complex, they do let students understand why Merrill Lynch collapsed and understand how to value Merrill after the collapse. The FASB issued new reporting rules for fair value and the fair value option that were required for 2008, but firms could elect early adoption for 2007. Merrill Lynch and most other large financial institutions elected early adoption, so this case includes highly detailed fair value and fair value option disclosures just as the sub-prime mortgage market collapsed. The case includes Merrill’s financial statements and selected notes from its June 30, 2007, 10-Q and from its December 31, 2008, 10-K. That lets students understand what occurred during the 18-month period when Merrill Lynch went from the world’s largest and most valuable brokerage firm to a bankruptcy that was prevented by an apparently government-forced acquisition by BankAmerica. The case includes three notes for each time period: fair value, fair value options, and segment disclosures. The fair value notes help students understand the value and limitation of fair value disclosures. One problem is that Merrill Lynch suffered about $70-80 billion of losses from its sub-prime mortgage investments, but reported those as Level 2 investments, not Level 3 investments. As a result, investors probably believed that most of Merrill’s reported fair value numbers were relatively objective and were unlikely to decline by much. The fair value notes can show that the detailed loss and gain reporting for Level 3 assets is highly misleading. Level 3 gains or losses are often offsets to hedges that include securities classified as Level 1 or Level 2 securities, so a major Level 3 reported gain or loss is meaningless. A major Level 3 reported gain could have been hedged with a Level 2 investment; the net effect could have been a nearly complete offset of gains and losses, or a net loss. The fair value option notes also show that when Merrill adopted the fair value option rules, it elected the fair value option for some available-for-sale securities with unrecognized losses. That let Merrill transfer the unrecognized losses directly to owners’ equity without first recording the losses on its income statement. The fair value option notes also show that Merrill elected the fair value option for some of its outstanding debt. When Merrill reported major investment losses, and the market value of its debt plummeted, Merrill was required to debit bonds payable so its bonds were reported at fair value. The offsetting credit was to a gain account. Many interested parties criticized the proposed FASB fair value option rule for a firm’s own debt for exactly that reason—it let firms in financial difficulty, with no ability to repurchase outstanding debt, record a gain on that debt as the firm collapsed. Students can also estimate the profitability by business segment for the 18 month period from June 30, 2007, to December 31, 2008. Merrill has four major business segments: retail and institutional brokerage; investment banking; investment management, including mutual funds, and; proprietary trading. During that period the first three business segments remained highly profitable, although they were generally less profitable than prior to the recession. After expenses, Merrill’s proprietary trading group probably lost about $80 billion.
Best uses:Undergraduate intermediate accounting First-year MBA/Executive MBA Financial accounting Financial reporting Financial statement analysis Valuation
Use with:Fair Value Reporting (chapter 7) Directory: resource uploads -> downloads downloads -> Chapter 19 Chapter Outline downloads -> Chapter 1 Practice Quiz Introducing the Economic Way of Thinking downloads -> Bltc-8e Case Problem with Sample Answer Chapter 30: Partnerships 20. 5 Case Problem with Sample Answer downloads -> Cross-7e: Case Problem with Sample Answer downloads -> Atmospheric circulation downloads -> September 3, 2007 downloads -> August 30 2009 Website Update downloads -> Chapter 3 exercises downloads -> Review Sheet: Chapt. 1: The Moral Point of View Moral concerns are unavoidable in life. Ethics downloads -> Chapter 17 Chapter Outline Download 123.35 Kb. Share with your friends:
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