Question & Answer

Why will additional advertising lead to smaller and smaller increases in sales?

Fontenot Corporation sold some machinery to its majority owner Gray (an individual who owns 60 percent of Fontenot). Fontenot purchased the machinery for $100,000 and has claimed a total of $40,000 of depreciation expense deductions against the property. Gray will provide Fontenot with $10,000 of cash today and a $100,000 note that will pay Fontenot $50,000 one year from now and $50,000 two years from now.  a. What gain or loss does Fontenot realize on the sale? b. What are the amount and character of the gain or loss that Fontenot must recognize in the year of sale (if any) and each of the two subsequent years? (Hint: Use the Internal Revenue Code and start with §453; please give appropriate citations.)

1. Explain the shape of the LRMC curve in diagram (d) in Figure 6.12. 2. What would the LRMC curve look like if the LRAC curve were ‘flat bottomed’ as in Figure 6.11?

What are the arguments for and against relying entirely on discretionary regional and urban policy?

Which circumstances might cause a stimulative monetary policy to be ineffective? (LO2)

Using the facts in the previous problem, what are some ways that Bendetta could shift some of the rental income to Jenine? What are the disadvantages associated with these income-shifting strategies?

Johnson & Johnson, the world’s leading and most diversified health-care corporation, serves its customers through specialized worldwide franchises. Each of its franchises consists of a number of companies throughout the world that focus on a particular health-care market, such as surgical sutures, consumer pharmaceuticals, or contact lenses. Information related to its property, plant, and equipment in its 2011 annual report is shown in the notes to the financial statements below.     Instructions (a) What was the cost of buildings and building equipment at the end of 2011? (b) Does Johnson & Johnson use a conservative or liberal method to depreciate its property, plant, and equipment? (c) What was the actual interest expense paid by the company in 2011? (d) What is Johnson & Johnson’s free cash flow? From the information provided, comment on Johnson & Johnson’s financial flexibility.

Illustrate on a diagram similar to Figure 7.4 what would happen in the long run if price were initially below PL.

Incentives and risk management Part B Once the Western Australian operation has settled and sales are going well, Bernard considers further expansion opportunities. Given the mature life cycle status of the brewery industry, declining consumption, strong competition from leading producers and competition from substitute products, Bernard wants to expand his business in other value-adding ways. He calls on his management team for ideas. One potential idea worth pursuing comes from Damien Poulsen, a long-term employee.   Damien Poulsen has been Bernard’s one and only production manager in charge of Mountain Mist’s spring water. Bernard has great respect for Damien’s work ethic and long-standing commitment to Mountain Mist. Damien is also a qualified microbiologist and employs a team of experts to extract and process the Mountain Mist spring water for the brewing department. A large portion of the Spring Water department’s (SWD) activities relates to the quality control (QC) function for Mountain Mist Brewery. Their main requirement is to ensure the spring water continually meets Mountain Mist’s strict specifications. The mix of sulphates, calcium, phosphorous and magnesium must be correct as excessive amounts of any ingredient can result in poor tasting ales. It can also lead to residue forming on the ale containers.   As the spring water from Mountain Mist’s Macedon Ranges spring provides beautifully tasting spring water (free of excessive mineral content) and more than enough spring water for the beer manufacture, Damien Poulsen suggested to Bernard that they expand production into bottled water sales. He points out that spring water is the fastest growing beverage type in Australia and Mountain Mist would be foolish not to take advantage of the opportunity to participate in this market. Australians spent more than $500 million on bottled water last year, a 1.6 per cent increase on the previous year. The current key competitors in the bottled water market include Coca-Cola Amatil Limited (42.0 per cent), P&N Beverages Australia Pty Ltd (22.0 per cent) and others (36.0 per cent). These key competitors own prominent brands including Mount Franklin, Peats Ridge and Cool Ridge. Damien suggest to Bernard that a niche marketing opportunity exists and that they should compete with the higher-priced sparkling and still water brands, which include European imports such as San Pellegrino and Perrier.   Damien is also aware of exploiting the growing market sensitivities towards increased water consumption. For instance, climate change has increased demand for bottled water (because of the extended hot summers). However, the demand remains high throughout the cooler seasons of the year for other sports and health-related reasons. The factors that significantly contribute to increasing demand for bottled water include general health awareness and greater knowledge of the benefits of adequate water consumption, concerns about the microbiological condition and taste of tap water in some regions, and that fact that many consumers are beginning to acknowledge bottled water as a healthy alternative to high-sugar soft drinks.   In Damien’s proposal, he outlines the cost structure required for the bottled spring water proposal. He builds his figures from the 2009 industry data. He bases his figures on the average retail price for 1-litre of bottled water ($2.53). Damien outlines the purchases that are most significant to this industry. They include containers, labels and other packaging materials. He explains how the costs for water extraction, such as pumping equipment, have been included in the depreciation cost (but mentions that these costs are currently paid for in full by the brewery). Water costs are relatively minor. That is, they pay the Macedon Ranges Shire Council fees for ground water extraction; however, the fees are insignificant.   In the proposal, Damien also mentions that he could draw on existing labour for the production processes, but will need a small number of additional staff to handle the clerical, sales and marketing functions. The total labour costs are equivalent to 14.7 per cent of revenue. In this machine-intensive industry, approximately 53 per cent of total labour is required for managerial, clerical, sales, marketing and other functions. The remaining 47 per cent of total labour is involved in the bottled water production. Damien includes asset acquisitions and associated depreciation costs in his proposal. To begin, he includes full depreciation costs on existing equipment required for the filtration, UV sterilisation and zonation processes that remove undesirable compounds and organic elements from the spring water. Damien also includes the purchase of new assets such as computers and automated bottle production lines in his depreciation costs. In addition, he includes the purchase and depreciation on two trucks required to transport the bottled water to distributors from the Mountain Mist source. In Damien’s list of acquisitions required, he makes mention of new legislative requirements associated with environmental emissions. With this impending legislation, Damien allocates funds to the newly implemented carbon pollution reduction scheme (CPRS) that will measure, monitor and report on the Mountain Mist carbon emissions. To meet the legislative requirements, Damien needs to allocate a percentage of staff resources (15 per cent of one full-time employee’s wages) and equipment to correctly measure their carbon emissions. He notes that this additional cost will be incurred regardless of the decision to invest in the bottled spring water project.   Damien also includes accounting, auditing, repair, maintenance, market research and advertising as components of ‘other’ costs. Marketing is a significant cost to the bottled water industry given the need to differentiate a largely homogeneous product. He explains that, in Europe, for water to be designated ‘natural’ it must be bottled at the spring. This could be an important marketing feature for Mountain Mist bottled spring water, even though Australia does not have such a labelling requirement. He mentions how competitor water that has been transported in holding tanks to bottlers can risk contamination. As such, water that is not bottled on site may require chlorination which in turn affects the taste. Mountain Mist water, as it is bottled onsite, can truly offer the ‘natural’ European equivalent marketing feature. Damien explains how they would pitch this style of marketing in the up-market hospitality channel representing pubs, restaurants, cafes, cinemas and arenas. They will also focus on marketing to supermarkets and convenience stores as sales through these major outlets comprise 67 per cent of total bottled water sales, but, in this setting, they will not compete on price. He points out that while price is important (that is, they will compete with house brands and generics), the image, particularly from the large brands, remains the most important factor in establishing market share. The niche market could bear additional costs for perceived additional quality and image created by the brewery arm.   The main thrust of Damien’s argument is for Mountain Mist to exploit its economies of scope by expanding its beverage offerings. He explains that while materials and packaging are the main cost pressures, he hopes to achieve up to 60 per cent gross profit margin on the Mountain Mist private-label bottle water sales. He argues that he can reduce many of the costs. For example, input costs will be reduced as Mountain Mist has the spring water onsite. Rent is not applicable as Mountain Mist owns the Macedon Ranges facilities. In addition, wages, much of the depreciation and other costs can be allocated to the brewing division as it is currently paying for them anyway.   As Bernard evaluates Damien’s $30 million bottled water proposal, he also considers the key success factors in the bottled water manufacturing industry. ·           Control of distribution arrangements — arrangement of distribution ensures timely delivery, low costs and maximised product reach. ·           Economies of scope — economies of scope refers to the efficiencies in distribution, marketing and administration when a firm produces a wide range of beverage brands. ·           Having a good reputation — first movers have an advantage in this industry in that they can establish strong reputations, which new competitors need to spend heavily on marketing to match. ·           Market research and understanding — market research into consumer profiles, attitudes and preferences are important for informing both brand promotion and bottle and label design. ·           Marketing of differentiated products — product innovation and differentiation (including packaging) contributes significantly to selling the industry’s products. ·           Economies of scale — scale economies are very important to a low value product since high volumes must be produced and sold to achieve reasonable profits. ·           Establishment of brand names — strong brand names contribute to the appeal of bottled water as an accessory, as well as building a product’s reputation of quality. This allows bottlers to both win market share within particular consumer segments, and to charge premium prices. ·           Attractive product presentation — the design of the bottle is of importance in winning market share and justifying higher pricing in this competitive industry. ·           Effective product promotion — use of in-store merchandising can have a strong influence on consumer choice.   This all sounds quite interesting to Bernard, but he does wonder at the affect of the carbon pollution reduction scheme and the more recent negative publicity bottled water is receiving. This negative publicity surrounds the view that bottled water is not environmentally friendly as it produces significant greenhouse gas emissions and plastic bottles commonly end up in landfill.   Bernard wonders at the viability of Damien’s $30 million proposal.   Required (a)          Advise Bernard on the types of strategic risks you might associate with Mountain Mist. In your discussion, include the risks associated with the expansion of Mountain Mist’s brewing to Western Australia and into the spring water market. You may also wish to discuss the beverage industry in general. (b)          What do you consider the level of risk exposure for Mountain Mist? Justify using the risk profile discussion in this chapter. (c)           What suggestions do you have for Bernard to overcome these risks? (LO2, 3, 4 and 6)

Employees are paid every Saturday for the preceding work week. If a balance sheet is prepared on Wednesday, December 31, what does the amount of wages earned during the first three days of the week (12/29, 12/30, 12/31) represent? Explain.

What are the potential costs and benefits of mergers to (i) shareholders; (ii) managers; (iii) customers?

Assume Rafael can earn an 8 percent after-tax rate of return. Would he prefer $1,000 today or $1,500 in five years?

What is the purpose of a fair value hedge?

Ethical decision-making timely reporting of sustainability budget problems A dilemma that individuals face is whether to be truthful when it appears that a project is over budget. Being over budget typically means that actual costs exceed budgeted costs or that a planned timeline will not be met. People often delay reporting an over-budget condition either because they believe they can catch up later or because they wish to delay negative repercussions. Unfortunately, information delays prevent managers from responding rapidly and decisively to delays in project timing and cost overruns, leading to additional dissatisfaction and inefficiencies.   Suppose an energy company establishes a budget of professional hours for a particular sustainability audit job. The hours are broken down by audit area with one area being the valuation of ‘clean energy’ inventory and cost of goods sold. During the last year, the audit client adopted new procedures for assigning product costs to individual units. The audit budget includes extra hours for the estimated time needed to document and assess the reasonableness of the new method.   Many factors could cause this part of the audit to be over budget. Consider the following two scenarios: 1.       The client failed to establish appropriate records needed to easily audit the new method, and this part of the audit will require more than the budgeted time to complete. 2.       The auditor assigned to this part of the audit is inexperienced and is unable to complete the work in the budgeted time.   Regardless of the reason for the overage, managers in charge of the audit need to be notified as soon as possible so that they can consider possible ways to realign staff and complete the total job on time. In addition, in the first scenario the audit entity might be able to bill the client for the extra work involved if the audit contract includes a provision for such price adjustments. However, this scenario would most likely require the client to be notified promptly, while the work is still being performed. In the second scenario, the overage may result in a poor performance evaluation, especially if the auditor has similar problems in other audit areas. Yet the overage may be considered reasonable in light of the auditor’s inexperience. Even so, the auditor should be able to accomplish the following: ·           develop alternative estimates of time and resource requirements for a project ·           effectively facilitate and control the project process and take corrective action as needed Therefore, the auditor must quickly recognise an impending overage and formulate appropriate strategies for completing the task as efficiently as possible. The auditor also needs to keep her supervisor apprised of the situation and seek help, when needed.       Required (a)     Have you ever failed to meet a deadline on a group project? If so, what were the reasons for the delay? When and how did you report the delay to your team members? Has someone else ever failed to meet a deadline? Does a failure to meet an agreed-upon deadline create an ethical problem? Why? (b)     Explore the responsibilities, expectations, assumptions, incentives, and consequences for this problem from different perspectives, including: §  the team member who is late §  other team members §  the team’s client. (c)     Draft a policy statement that you could adopt with future team members to handle project delays. How might this policy lead to improved team performance? (d)     Think about your future career. How can you work toward developing your professional responsibility as a member of a work team? (LO 2 and 5)

] Lindley has become very frustrated in researching a tax issue using keyword searches.  What suggestions can you give her?

What would have happened if countries in deficit had not responded to an outflow of gold by reducing total expenditure?

18    Direct and indirect costs Frida’s Tax Practice has two departments, tax and audit. The tax department has two product lines, business returns and individual returns. A list of costs and three cost objects from Frida’s Tax Practice follow.   Required For each cost, identify whether it is direct or indirect for each cost object.

How would you attempt to assess whether the technology used by an industry in a developing country was ‘inappropriate’?

For what reasons do countries experience very different long-run rates of economic growth from each other?

Why does the exchange-rate transmission mechanism strengthen the interest-rate transmission mechanism?

Describe the Fed’s monetary policy response to the credit crisis that began in 2008. (LO2)

Under what conditions must an employer accrue a liability for the cost of compensated absences?

1. Why does the LRMC curve cross the MRL curve directly below the tangency point of the LRAC and ARL curves?   2. Assuming that supernormal profits can be made in the short run, will there be any difference in the long-run and short-run elasticity of demand? Explain.

1. How will the length of the short run for the airline depend on the state of the aircraft industry? 2. Up to roughly how long is the short run in the following cases? (a) A firm supplying DJs for clubs and parties. (b) Nuclear power generation. (c) A street food wagon. (d) Superstore Hypermarkets Ltd. In each case specify your assumptions.

Joblonsky Inc. has recently hired a new independent auditor, Karen Ogleby, who says she wants “to get everything straightened out.” Consequently, she has proposed the following accounting changes in connection with Joblonsky Inc.’s 2014 financial statements. 1. At December 31, 2013, the client had a receivable of $820,000 from Hendricks Inc. on its statement of financial position. Hendricks Inc. has gone bankrupt, and no recovery is expected. The client proposes to write off the receivable as a prior period item. 2. The client proposes the following changes in depreciation policies. (a) For office furniture and fixtures, it proposes to change from a 10-year useful life to an 8-year life. If this change had been made in prior years, retained earnings at December 31, 2013, would have been $250,000 less. The effect of the change on 2014 income alone is a reduction of $60,000. (b) For its new equipment in the leasing division, the client proposes to adopt the sum-of-the-years’- digits depreciation method. The client had never used SYD before. The first year the client operated a leasing division was 2014. If straight-line depreciation were used, 2014 income would be $110,000 greater. 3. In preparing its 2013 statements, one of the client’s bookkeepers overstated ending inventory by $235,000 because of a mathematical error. The client proposes to treat this item as a prior period adjustment. 4. In the past, the client has spread preproduction costs in its furniture division over 5 years. Because its latest furniture is of the “fad” type, it appears that the largest volume of sales will occur during the first 2 years after introduction. Consequently, the client proposes to amortize preproduction costs on a per-unit basis, which will result in expensing most of such costs during the first 2 years after the furniture’s introduction. If the new accounting method had been used prior to 2014, retained earnings at December 31, 2013, would have been $375,000 less. 5. For the nursery division, the client proposes to switch from FIFO to average-cost inventories because it believes that average-cost will provide a better income measure. The effect of making this change on 2014 earnings will be an increase of $320,000. The client says that the effect of the change on December 31, 2013, retained earnings cannot be determined. 6. To achieve an appropriate recognition of revenues and expenses in its building construction division, the client proposes to switch from the cost-recovery method of accounting to the percentageof- completion method. Had the percentage-of-completion method been employed in all prior years, retained earnings at December 31, 2013, would have been $1,075,000 greater. Instructions (a) For each of the changes described above, decide whether: (1) The change involves an accounting policy, accounting estimate, or correction of an error. (2) Restatement of opening retained earnings is required. (b) What would be the proper adjustment to the December 31, 2013, retained earnings?