Chapter three



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Chapter three




Income Statement Concepts: Income, Revenues, and Expenses

Questions
1. Define income and describe its three important characteristics.

2. What are net assets?

3. Define revenues and give three examples of revenues.

4. Define expenses and give four examples of expenses.

5. Are the expenses in a period the cash outflows in that period? Explain.

6. Are expenses always outflows of cash? Explain.

7. Are the revenues in a period the cash inflows in that period? Explain.

8. Are revenues always inflows of cash? Explain.

9. Are dividends to shareholders an expense? Explain.

10. Is interest on outstanding debt an expense for the debtor? Explain.

11. Give three criteria that must be met for revenue to be recognized.

12. Give three examples of revenue recognition points.

13. What is accrual accounting?

14. What is matching?

15. Are increases in expenses debits or are they credits? Explain.

16. Are increases in revenues debits or are they credits? Explain.

17. What is a temporary account and what purpose do temporary accounts serve?

18. What are adjustments?

19. How does the process of adjusting the accounts relate to the accrual basis of accounting?

20. What is closing?



  1. Do accounts that are not closed appear on the balance sheet? Are their final

totals reflected somewhere on the balance sheet? Explain.

22. Do accounts that are closed appear on the balance sheet? Are their pre-closing totals reflected somewhere on the balance sheet? Explain.

23. Cash-basis accounting keeps account only of cash flows. Cash is the only asset that is recognized, and there is no adjustment process. When would cash-basis accounting recognize revenues? When would it recognize expenses?

24. Briefly assess the strengths and weaknesses of cash-basis accounting relative to accrual accounting.

25. “An advantage of cash-basis accounting is that it is totally objective.” Comment.

26. “An advantage of cash-basis accounting is that management cannot manipulate cash income.” Comment.



Exercises

E3-1 SLH, Inc. is a retailer, buying goods at one price and selling them at a higher price.

a. Why would SLH be able to sell goods at a higher price than it pays for them?

b. Assume that SLH had 100 inventory items on hand at December 31, 2001. Also, assume that the balance in SLH’s inventory account was $100,000. Assume, on January 1, 2002, that SLH buys 500 inventory items that cost $500,000, paying cash. Indicate the impact of this transaction on the accounting equation. Indicate the specific accounts that would be impacted, the direction of the impact, and the amount.

c. Prepare a journal entry to record the transaction in (a).

d. What would the balance in SLH’s inventory account be at the end of the day on January 1, 2002?

e. Assume that SLH sells 400 inventory items at various times from January 2, 2002, through January 31, 2002, for $1,500 cash each. What is the balance in SLH’s inventory account at the end of the day, January 31, 2002?

f. How much did the inventory items that SLH sold during January 2002 cost? How much did the inventory items that SLH bought during January 2002 cost? Which one of these two should appear on SLH’s January 2002 income statement as an expense?

E3-2 RetailBiz, Inc., is incorporated on December 1, 2000. During December, RetailBiz:

a. Issues common stock to various investors, raising $60,000 cash.



  1. Buys a parcel of land, paying $5,000 cash.



Here is RetailBiz, Inc.’s balance sheet as of December 31, 2000.

RetailBiz, Inc.

Statement of Financial Position as of December 31, 2000

Assets Liabilities

Cash $55,000 Total liabilities 0

Total current assets $55,000 Stockholders’ equity:

   Common Stock 60,000

Land 5,000 Total liabilities & stockholders’

Total assets $60,000    equity $60,000


During 2001:

c. RetailBiz receives delivery of 490,000 cans of product, paying $49,000 cash.

d. RetailBiz sells all 490,000 cans during 2001. The selling price is 15 cents per can, generating $73,500 (490,000 x $0.15) cash.

Required

Construct a December 31, 2001 balance sheet and an income statement for the year ended December 31, 2001, for RetailBiz, Inc.


E3-3 Information regarding LDH, Inc. is as follows:

LDH, Inc.

Statement of Financial Position as of December 31, 2000

Assets Liabilities

Cash $52,000 Total current liabilities None

Prepaid rent $ 3,000 Note payable 40,000

Total current assets $55,000 Equity:

Land 5,000 Common stock 20,000

Total assets $60,000 Total liabilities & equity $60,000


a. During 2001, LDH purchases with cash, for 10 cents per can, and sells, for 15 cents per can, 490,000 cans of Drinkit, receiving cash for all sales.

b. The prepaid rent on December 31, 2000, gives LDH the contractual right to use a building for the first six months of 2001. On July 1, 2001, LDH prepays an additional eight months rent at $500 per month.

c. The loan is due on December 31, 2003, and interest of 10 percent annually on the balance is due on January 1 of each year, excluding January 1, 2001.

d. LDH’s manager’s salary is $1,000 per month, payable on the first of each month. Since the manager’s first day was January 1, 2001, the manager’s first paycheck is written on February 1, 2001, the second on March 1, the third on April 1, etc.

Construct a December 31, 2001 balance sheet and an income statement for the year e nded December 31, 2001, for LDH, Inc.
E3-4 Refer to the information regarding LDH, Inc. in E3-3. How would LDH’s 2001 income statement and December 31, 2001 balance sheet change if LDH declared and paid a $2,000 cash dividend on December 31, 2001?

E3-5 In 2001, Aamodt Construction Company began work on a construction project. Aamodt will be paid $2,200,000 when construction is completed. Sometimes Aamodt’s customers are unable to pay the full contracted price. However, the vast majority of customers do pay, and the amount that Aamodt is unable to collect is very stable over time. On average, Aamodt is able to collect 95% of its contract amounts. Aamodt’s progress on the project is as follows:

2001 2002 2003

Percent completed as of December 31 10 40 90


What amounts of revenue should Aamodt recognize in 2001 and 2002?
E3-6 During 2003, Lizant Corp. paid an advertising agency $1,500,000 cash for various costs (television and radio air time, print ads, billboard space, ad and script writers, artwork, etc.) related to an advertising campaign during 2003. The purpose of the campaign was to raise consumer awareness of the Lizant brand name. The ads ran during 2003, and the campaign ended at the end of 2003.

a. Why do firms spend money on advertising?

b. Assume that we can be certain that Lizant’s advertising campaign will generate additional sales for 2003 and 2004 in approximately equal amounts each year. Conceptually, should Lizant show anything on its 2003 year-end balance sheet? If so, how much? Assume that the $1,500,000 cash expenditure occurred at the beginning of 2003.

c. Assume that we can be certain that Lizant’s advertising campaign will generate additional sales for 2003 only. Conceptually, should Lizant show anything on its 2003 year-end balance sheet? If so, how much? Assume that the $1,500,000 cash expenditure occurred at the beginning of 2003.

Refer to the Coldwater Creek, Inc. financial statements provided for C3-3 on pages 37–39.

a. What was the balance in Coldwater’s inventory account at the start of business on March 2, 1997?

b. What was the balance in Coldwater’s inventory account at the close of business on February 28, 1998?

c. What kind of transaction makes Coldwater’s inventory account balance increase? What kind of transaction makes Coldwater’s inventory account balance decrease?

d. Coldwater sold many inventory items (i.e., goods) during the year ended February 28, 1998. How much (total) did all the inventory items Coldwater sold cost? Why does this number appear on Coldwater’s income statement?

e. Given how much inventory Coldwater began the year with (part a) and how much they sold during the year (part d), why isn’t the balance at the end of the year (February 28, 1998) negative? How much is the dollar amount of Coldwater’s purchases of inventory during the year ended February 28, 1998?


Problems

P3-1 Newman Properties, Inc., is a real estate management company. Newman signed management contracts on January 1, 2001, to manage three large shopping malls. A number of costs for document preparation, travel, and other activities associated with securing tenants for the centers must be incurred before the malls are opened for business. These up-front costs for the three projects are as follows:

Project 1 Project 2 Project 3

Up-front costs $450,000 $600,000 $500,000


a. Tenants for Project 1 have not yet been secured. However, Newman expects to be able to rent all stores for 2001, 2002, 2003, and 2004 and estimates rental revenue will be $840,000 per year. Newman’s management contract for Project 1 ends at the end of 2004. What amount should be shown on Newman’s December 31, 2001 balance sheet for “Up-front costs: Project 1”?

b. Tenants for Project 2 have been secured and all stores have been rented for 2001, 2002, 2003, and 2004. The rental revenue for each year for Project 2 is as follows:



2001 2002 2003 2004

Rental revenue $200,000 $400,000 $400,000 $500,000

Newman’s management contract on Project 2 ends at the end of 2004. What amount should be shown on Newman’s December 31, 2001 balance sheet for “Up-front costs: Project 2”?

c. Newman was unable to secure tenants for Project 3 and, during 2001, decided to abandon the project. What amount should be shown on Newman’s December 31, 2001 balance sheet for “Up-front costs: Project 3”?


P3-2 Miloslav began a magazine delivery service, which he named Miloslav’s Magazines, on January 1, 2001. The following transactions occurred during 2001:

a. Sold stock for $3,000 cash on January 1.

b. Borrowed $20,000 cash on April 1. The interest rate on the loan is 12% annually, and the interest is due each December 31, until the note is repaid.

c. Bought a bicycle for $1,000 cash on January 1. The bicycle has an estimated life of five years, and no salvage value.

d. Bought 10,000 magazines for $2.00 cash each on April 5.

e. Sold magazines at various times for a total of $22,500. All sales were on account.

f. Collected $20,500 from customers.

g. Paid himself a salary of $3,000 cash.

h. Paid the stockholders a dividend of $50 on the $3,000 in stock.

i. Paid the interest on the loan in b.

j. On December 31, Miloslav determined by a physical count that there were 1,000 magazines left in the storage bin at the warehouse.

Required

Prepare journal entries for the above transactions. Post the journal entries to appropriate T-accounts. Prepare any necessary adjusting and closing entries needed at December 31, 2001. Prepare a December 31, 2001 balance sheet and an income statement for the year ended December 31, 2001.


P3-3 Ofer’s Office Designs began operations on January 1, 2001. Listed below is a summary of events experienced by Ofer’s Office Designs during 2001.

a. The company issued 2,000 shares of common stock for cash at their par value of $50 per share.

b. On April 1, 2001, the company purchased eight sets of office furniture that it will sell to customers. Each set cost $20,000. Ofer’s paid $10,000 in cash and signed a two-year note with an 8% interest rate for the remainder of the purchase price. Interest on the note is due on January 1 of each year the note remains unpaid.

c. The company performed consulting services for a total fee of $200,000, receiving $50,000 in cash up front.

d. A potential customer communicated its intent to have Ofer’s perform $80,000 of consulting services.

e. The company paid $100,000 cash for wages.

f. The company paid $20,000 cash for rent on July 1, 2001. The company is charged rent at the rate of $1,083.33 dollars per month. Prior to July 1, 2001, rent for January through June had not been paid. The remainder of the $20,000 payment was applied to future months’ rent as it became due.

g. On December 31, 2001, the company paid the holder of the note $15,000.

h. The company declared and paid cash dividends of $19,000.

i. The company received $30,000 in cash as payments for outstanding receivables.

j. The company sold three sets of office furniture for $28,000 cash each.

Required

Prepare the journal entry(ies), if necessary, for each event. Also, prepare any closing entries as needed and prepare a December 31, 2001 balance sheet and an income statement for 2001. Ignore taxes.


P3-4 Ralphy started a business on April 1, 2001, and had the following transactions on April 1:

a. Issued 20,000 shares of $5 par value common stock for $100,000 cash.

b. Bought equipment to be used for making products, for $60,000. The equipment has a six-year life and is to be depreciated on a straight-line basis, with no salvage value.

c. Paid $4,000 for one year’s rent on a building.

d. Bought $30,000 of inventory on credit.

e. Bought $25,000 of Yahoo common stock as a short-term investment.

f. Issued a bond with a face value of $20,000 and an interest rate of 10%. Interest is to be paid annually.

Between April 1 and December 31, the following transactions occurred:

g. Sold inventory that cost $25,000 for $40,000. All sales were on credit.

h. Paid $15,000 to suppliers of inventory for the credit purchase in (d) above.

i. Collected $30,000 from customers on their accounts.

j. A customer owing $200 declared bankruptcy, and notice was received that the customer would pay only $50 of this debt. The $50 payment was enclosed.

k. Salaries and wages of $6,000 were paid.

On December 31:

l. Salaries and wages of $1,000 had been earned but not paid.

m. The market value of Ralphy’s inventory was $12,500.



Required

1. Enter the above transactions in T-accounts. Use appropriate account titles.

2. Enter all adjusting and closing entries required at December 31.

3. Prepare a balance sheet for December 31.

4. Prepare an income statement for the period April 1 to December 31.
P3-5 Rick and Stan started a business on October 1, 2002, and had the following transactions on October 1:

a. Issued 10,000 shares of $5 par value common stock for $110,000 cash.

b. Bought equipment to be used for making products for $60,000 cash. The equipment has a five-year life and is to be depreciated on a straight-line basis, with no salvage value.

c. Paid $3,000 for one year’s rent on a building.

d. Bought $35,000 of inventory on credit.

e. Took out a $20,000 bank loan at an interest rate of 12%. Interest is to be paid annually.

Between October 1 and December 31, 2002, the following transactions occurred:

f. Sold inventory costing $25,000 for $45,000. All sales were on credit.

g. Paid $31,000 to suppliers of inventory for the credit purchase in (d).

h. Collected $36,000 from customers.

i. Salaries and wages of $16,000 were paid.

On December 31:

j. Salaries and wages of $2,000 had been earned but not paid.

k. The market value of Rick and Stan’s inventory was $27,500.



Required

1. Enter the above transactions in T-accounts. Use appropriate account titles.

2. Enter all adjusting and closing entries required at December 31.

3. Prepare a balance sheet for December 31, 2002.

4. Prepare an income statement for the period October 1 to December 31, 2002.

Cases and Projects

C3-1 The 1995 Rubbermaid financial statements follow. Dollar amounts are in millions.

Rubbermaid

Consolidated Statement of Earnings (dollars in millions)

Year ended December 31 1995 1994

Net sales $2,344 $2,169

Cost of sales 1,673 1,466

Selling, general, and administrative expense 403 348

Restructuring costs 158 0

Other charges (credits), net:

  Interest expense 14 7

   Interest income (3) (5)

   Miscellaneous, net 4 (13)

Earnings before income taxes 95 366

Income taxes 35 139

Net earnings $ 60 $ 227


Rubbermaid

Consolidated Balance Sheet (dollars in millions)

At December 31 1995 1994

Current assets

   Cash $ 51 $ 92

   Marketable securities 0 59

   Receivables 499 471

   Inventories 252 295

   Other current assets 49 9

    Total current assets $ 851 $ 926

   Property, plant, and equipment 1,262 1,163

    Accumulated depreciation (636) (556)

  Intangible assets, net 214 175

Total assets $1,691 $1,708

Current liabilities

   Notes payable $ 123 $ 22

   Accounts payable 102 103

   Accrued liabilities 190 171

   Total current liabilities $ 415 $ 296

   Long-term debt 6 12

   Other long-term liabilities 135 116

Shareholders’ equity

   Common stock 234 233

   Retained earnings 1,099 1,120

   Foreign currency translation adj. (20) (18)

  Treasury shares (at cost) (178) (51)

Total shareholders’ equity $1,135 $1,284
The following hypothetical transactions and events occurred during 1996. (These selected transactions are all the items that are relevant to answering the required questions.)

a. Purchased $1,800 of inventory on account.

b. Payments to suppliers of inventory totaled $1,850.

c. Inventory items costing $1,500 were sold in 1996 for $2,500. All sales were credit sales.

d. On December 31, 1996, Rubbermaid purchased property, plant, and equipment by paying $40 cash. No property, plant, and equipment was sold or discarded during the year.

e. 10 million shares of common stock were issued for $60 per share.

f. Accrued liabilities consist solely of salaries payable. $400 of salaries were paid with cash.

g. Employees earned $300 in salaries.

h. Property, plant, and equipment has a useful life of 10 years, with no salvage value. Rubbermaid uses straight-line depreciation for all depreciable assets.

i. Intangible assets (except for the prepaid insurance in j.) have a useful life of 15 years and no salvage value and originally cost $600. Assume straight-line amortization. No intangible assets were sold or acquired in 1996.

j. On September 30, 1996, Rubbermaid purchased a two-year insurance policy by paying $16 cash. Rubbermaid recorded the current portion of prepaid insurance in “Other current assets” and the long-term portion in “Intangible assets.”

Required

Determine the amount that would be reported in the December 31, 1996 balance sheet or the 1996 income statement for the following items. If an item would not appear on either the income statement or the balance sheet, write ‘0’ next to the item.

1. Accounts payable

2. Inventory

3. Property, plant, and equipment

4. Accumulated depreciation

5. Intangible assets, net

6. Other current assets

7. Insurance expense

8. Common stock


C3-2 Use the following hypothetical information and the Apple Computer, Inc., financial statements that follow to prepare a pro forma September 24, 1994 balance sheet and a pro forma fiscal 1994 income statement. (A pro forma statement is a statement compiled to show the effects of assumptions. Note that Apple’s fiscal 1994 begins on September 25, 1993, and ends on September 24, 1994.) All dollar amounts given below, except per-share amounts, are in thousands.
Apple Computer Inc.

Consolidated Balance Sheet

as of September 24, 1993

(Dollars in thousands)

ASSETS

   Current assets:

     Cash and cash equivalents $676,413

     Short-term investments 215,890

     Accounts receivable, net of allowance

        for doubtful accounts of $83,776 1,381,946

     Inventories 1,506,638

     Deferred tax assets 268,085

     Other current assets 289,383

       Total current assets $4,338,355

   Property, plant, and equipment:

     Land and buildings 404,688

     Machinery and equipment 578,272

     Office furniture and equipment 167,905

   Leasehold improvements 261,792

$1,412,657

     Accumulated depreciation and amortization (753,111)

       Net property, plant, and equipment $659,546

     Other assets 173,511

       Total assets $5,171,412



Liabilities and shareholders’ equity:

   Current liabilities:

     Short-term borrowings $823,182

     Accounts payable 742,622

     Accrued compensation and employee benefits 144,779

     Accrued marketing and distribution 174,547

     Accrued restructuring costs 307,932

     Other current liabilities 315,023

       Total current liabilities $2,508,085

  Long-term debt 7,117

   Deferred tax liabilities 629,832

       Total liabilities $3,145,036

   Shareholders’ equity:

     Common stock, no par value;

       320,000,000 shares authorized;

       116,147,035 shares issued and

       outstanding 203,613

    Retained earnings 1,842,600

     Accumulated translation adjustment (19,835)

       Total shareholders’ equity $2,026,378

   Total liabilities and shareholders’ equity $5,171,412
a. Net sales increased from 1993 to 1994 by the same percentage that net sales increased from 1992 to 1993. All sales are credit sales.

b. Collections on sales totaled $6,500,000 during 1994.

c. Purchases of inventory during fiscal 1994 totaled $5,800,000, all on account.

d. A count of inventories on September 24, 1994, revealed inventory costing $1,520,000 is in various warehouses.

e. Payments to suppliers of inventory totaled $4,800,000.

f. Salaries earned by sales staff and corporate officers totaled $1,500,000.

g. Payments for salaries for sales staff and corporate officers totaled $1,400,000.

h. Research and development costs totaled $600,000, all paid in cash.

i. On March 25, 1994, Apple borrowed $500,000 from a bank. The loan is due March 24, 2000.

j. On September 24, 1994, Apple purchased machinery and equipment by paying $400,000 cash.

k. Depreciation expense totaled $170,000 for fiscal 1994.

l. Restructuring costs were $0 in 1994.

m. Interest and other income in 1994 was $75,000, all received in cash.

n. Deferred income taxes are the same at September 24, 1994, as at September 24, 1993.

o. Ignore the allowance for doubtful accounts; i.e., assume that the balance in accounts receivable at September 24, 1993, is $1,381,946.

p. All accrued restructuring costs at September 24, 1993, were paid during fiscal 1994.

q. Marketing and distribution expenses totaled $150,000 during 1994. $140,000 of marketing and distribution costs were paid in cash in 1994.

r. Assume no change in the accumulated translation adjustment during fiscal 1994.

s. Ten million shares of common stock were issued for $60 cash per share during 1994. (Remember, dollar amounts in the financial statements are in thousands. Numbers of shares and per share amounts are not in thousands.)

t. Apple incurred $49,800 in interest expense in fiscal 1994. Interest payments in fiscal 1994 totaled $49,000. Interest payable is included in “Other current liabilities.”

u. The provision for income taxes in 1994 was $300,000, none of which was paid in cash. All of the deferred tax assets were used, and the remainder increased deferred tax liabilities.

v. Other current assets at September 24, 1993, consisted of office supplies and small, short-lived repair tools. $100,000 of these items were purchased in 1994 with cash. The balance in other current assets at September 24, 1994, was $250,000.

w. The other current liabilities at September 24, 1993, were paid during fiscal 1994.

x. On September 15, 1994, Apple declared cash dividends of $50,000. The dividends were paid on September 22, 1994.

y. During fiscal 1994, creditors agreed to extend the maturity date of Apple’s short-term borrowings to October 10, 1994.
Apple Computer Inc.

Consolidated Statements of Income

(In thousands, except per-share amounts)

Fiscal years ended September 24

1993 1992

Net sales $7,976,954 $7,086,542

Costs and expenses:

   Cost of sales 5,248,834 3,991,337

   Research and development 664,564 602,135

   Selling, general and administrative 1,632,362 1,687,262

   Restructuring costs 320,856 0

7,866,616 6,280,734

Net operating income 110,338 805,808

Interest and other income (expense), net 29,321 49,634

Income before income taxes 139,659 855,442

Provision for income taxes 53,070 325,069

Net income $ 86,589 $ 530,373


C3-3 Coldwater Creek1

Coldwater Creek operates a direct mail catalog business, primarily in the U.S. The company distributes four distinct catalogs entitled “Northcountry,” “Spirit of the West,” “Milepost,” and “Bed and Bath.” Items marketed through these catalogs include women’s and men’s apparel, jewelry, and household items. The company’s executive offices are located in Sandpoint, Idaho, and its web site is at www.coldwatercreek.com.

The major objective of this project is to gain insight into the major entries that resulted in Coldwater Creek’s 1997 income statement and February 28, 1998 balance sheet. The entries will then tell us about major transactions and events that affected Coldwater Creek in fiscal 1997.

Required

Use the beginning and ending 1998 balance sheets, the 1998 income statement, and selected information from the footnotes to the financial statements to complete the attached set of T-accounts. Working through the T-accounts should do two things for you:

1. Help you make sure your view of the entries and events is not self-contradictory.

2. Enable you to get far more information out of the financial statements than you could by simply inspecting them.



Hints and Useful Assumptions

As we will see throughout this book, there is often more than one way to record a set of events and transactions. When trying to analyze financial statements, this means that a given set of financial statements can be consistent with different possible sets of entries. There is not one absolutely correct answer to this problem.

1. Accounts Payable relate only to purchases of Inventories.

2. Prepaid Expenses are related to Selling, General, and Administrative Expenses.

3. All depreciation is reflected in Selling, General, and Administrative Expenses.

4. We combine Prepaid Catalog Costs and Deferred Catalog Costs into one account, which we call Catalog Costs. Amortization of catalog costs is reflected in Selling, General, and Administrative Expenses and is credited to Catalog Costs.

5. Income Taxes Payable and Deferred Income Taxes accounts both represent income taxes that have not yet been paid, but will be paid in a future period. For our purposes, these accounts can be treated like the liability associated with the Provision for Income Taxes. (Provision for Income Taxes is Coldwater Creek’s name for the expense account related to income taxes.) Also, it is sufficient for our purposes to combine both Deferred Income Taxes accounts with Income Taxes Payable so that we analyze only the total of these three accounts and not the breakdown among them.

6. Accrued liabilities are associated with Selling, General, and Administrative Expenses. Catalog costs are first incurred as Accrued Liabilities, analogous to the way purchases of merchandise are first incurred as Accounts Payable.

7. There were no sales of property, plant, and equipment during the year ended February 28, 1998.

Coldwater Creek Inc. and Subsidiary—Consolidated Balance Sheets

(in thousands, except share data)

Assets Feb. 28, 1998 Mar. 1, 1997

Current assets:

   Cash and cash equivalents $ 331 $ 9,095

   Receivables 4,019 2,342

   Inventories 53,051 25,279

   Prepaid expenses 2,729 456

   Prepaid catalog costs 2,794 1,375

     Total current assets $62,924 $38,547

Deferred catalog costs 7,020 3,347

Property and equipment, net 26,661 20,080

Executive loans 1,620

     Total assets $98,225 $61,974

Liabilities and stockholders’ equity

Current liabilities:

   Revolving line of credit $10,264 $ —

   Accounts payable 27,275 18,061

   Accrued liabilities 10,517 5,969

   Income taxes payable — 451

   Deferred income taxes 919 76

     Total current liabilities: $48,975 $24,557

Deferred income taxes 375 230

     Total Liabilities: $49,350 $24,787

Stockholders’ equity:

   Common stock, $.01 par value, 15,000,000

shares authorized, 10,120,118

issued and outstanding $ 101 $ 101

   Additional paid-in capital 38,748 38,748

   Retained earnings (accumulated deficit) 10,026 (1,662)

     Total stockholders’ equity 48,875 37,187

     Total liabilities and stockholders’ equity $98,225 $61,974

The accompanying notes are an integral part of these financial statements.

Coldwater Creek Inc. and Subsidiary—Consolidated Statements of Operations
(in thousands, except per share data)


Fiscal Year Ended
Feburary 28, March 1, March 2,
1998 1997 1996

Net sales $246,697 $143,059 $75,905

Cost of sales 120,126 66,430 32,786

Gross profit $126,571 $ 76,629 $43,119

Selling, general, and administrative

expenses 107,083 64,463 37,356

Income from operations $ 19,488 $ 12,166 $ 5,763

Interest, net, and other 57 (153) (149)

Income before provision for income taxes $ 19,545 $ 12,013 $ 5,614

Provision for income taxes 7,857 1,197 —

Net income $ 11,688 $ 10,816 $ 5,614

Net income per share—basic $1.15 $1.46 $0.77

Net income per share—diluted $1.10 $1.41 $0.77
The accompanying notes are an integral part of these financial statements.
Coldwater Creek Inc. and Subsidiary

Notes to the Consolidated Financial Statements

1. SIGNIFICANT ACCOUNTING POLICIES

Organizational Structure and Nature of Operations

Coldwater Creek Inc. (the “Company”), a Delaware corporation headquartered in Sandpoint, Idaho, is a specialty direct-mail retailer of apparel, gifts, jewelry, and home furnishings, marketing its merchandise through regular catalog mailings. The principal markets for the Company’s merchandise are individuals within the United States. Net sales realized from other geographic markets, principally Canada and Japan, have been less than five percent of net sales in each reported period.

The Company also operates retail stores in Sandpoint, Idaho, and Jackson Hole, Wyoming, where it sells catalog items and unique store merchandise. Additionally, the Company operates four outlet stores through its wholly-owned subsidiary, Coldwater Creek Outlet Stores, Inc., which is consolidated in these financial statements. All material intercompany balances and transactions have been eliminated.
Revenue Recognition

The Company recognizes sales and the related cost of sales at the time merchandise is shipped to customers. . . .


Catalog Costs

Catalog costs include all direct costs associated with the production and mailing of the Company’s direct-mail catalogs and are classified as prepaid catalog costs until they are mailed.

When the Company’s catalogs are mailed, these costs are reclassified as deferred catalog costs and amortized over the periods in which the related revenues are expected to be realized. Substantially all revenues are generated within the first three months after a catalog is mailed. Amortization of deferred catalog costs was $66.6 million in fiscal 1997, $38.7 million in fiscal 1996, and $24.8 million in fiscal 1995.

3. PROPERTY AND EQUIPMENT

Property and equipment, net, consists of:

February 28, March 1,
1998 1997
(in thousands)

Land $ 1,899 $ 150

Building and land improvements 14,383 12,028

Furniture and fixtures 2,434 1,751

Machinery and equipment 16,018 10,486

34,734 24,415

Less accumulated depreciation 8,073 4,335

$26,661 $20,080

5. EXECUTIVE LOAN PROGRAM

Effective June 30, 1997, the Company established an Executive Loan Program under which the Company may make, at its sole discretion and with prior approvals from the Chief Executive Officer and the Board of Directors’ Compensation Committee, secured long-term loans to key executives. Each loan is secured by the executive’s personal net assets, inclusive of all vested stock options in the Company, bears interest at three percent per annum, and becomes due and payable on the earlier of (i) the date 10 days before the date on which the vested stock options serving as partial security expire, or (ii) 90 days from the date on which the executive’s employment with the Company terminates for any reason. If material, compensation expense is recognized by the Company for the difference between the stated interest rate and the prevailing prime rate.

Cash

Dr. Cr.

BB 9.1

EB 0.3

Executive Loans

Dr. Cr.

BB 0.0

EB 1.6
Accounts Receivable

Dr. Cr.

BB 2.3
EB 4.0



Inventory

Dr. Cr.

BB 25.3
EB 53.1



PP&E

Dr. Cr.

BB 24.4


EB 34.7
Prepaid Expenses

Dr. Cr.

BB 0.5


EB 2.7
Catalog Costs

Dr. Cr.

BB 4.7


EB 9.8
Acc. Depreciation

Dr. Cr.

4.3 BB


8.1 EB
Accrued Liabilities

Dr. Cr.

6.0


10.5
Retained Earnings

Dr. Cr.

BB 1.7


10.0 EB
Cost of Goods Sold

Dr. Cr.

0.0
SG&A



Dr. Cr.

0.0
Revolving



Line of Credit

Dr. Cr.

0.0 BB


10.3 EB

Deferred & Payable Taxes

Dr. Cr.

0.8 BB


1.3 EB
Sales

Dr. Cr.

0.0
Prov. For Inc. Tax



Dr. Cr.

0.0
Accounts Payable



Dr. Cr.

18.1 BB


27.3 EB

Common Stock &

APIC

Dr. Cr.

38.8 BB


38.8 EB

Interest Revenue

Dr. Cr.


0.0
Income Summary

Dr. Cr.

0.0



1 This case was developed for educational purposes only. Assumptions are adopted to simplify the required analysis and are not necessarily realistic or representative of the company’s actual actions, nor are they to be construed as conveying any information or opinion. The company’s full set of financial statements is available at www.sec.gov.


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