Assignment:
General Information:
The Sherwin-Williams Company (Sherwin-Williams; ticker symbol SHW) was founded in 1866. The company develops, manufactures, distributes and sells paints, coatings, and related products to professional, industrial, commercial and retail customers. The Company is organized into three segments – Paint Stores Group, Consumer Group and Global Finishes Group.
All of the questions on the exam relate to the 2008 financial statements for Sherwin-Williams. I have posted excerpts from Sherwin-Williams’ Annual Report in a separate file on WebCT. The materials posted are sufficient to answer the questions.
Please address the questions in the space provided. Bullet point answers are acceptable (and preferred). Your grade is a function of the content of your response, not the length. Be sure to show details of your computations to be eligible for partial credit. In answering the questions, focus on 2008 only, unless specifically asked to do otherwise.
Additional information:
• Assume a tax rate of 35% if necessary.
Part 1: Essentials of FSA
Required: Please address the questions in the space provided. Be sure to show details of your computations to be eligible for partial credit. In answering the questions, focus on 2008 only, unless specifically asked to do otherwise.
Q1. FSA consists of three key steps. What are they?
Q2. Read Sherwin-Williams’ “Summary” section in its “Management Discussion and Analysis”. What does the company’s management say about how Sherwin-Williams has been affected by the economic downturn? Make note of at least three distinct items.
Q3. Before looking at Sherwin-Williams’ financial statements explain how you might expect the items you identified above to impact the company’s balance sheet and/or income statement.
Q4. Now look at Sherwin-Williams financial statements, do you observe what you expected to observe?
Q5. What is “measurement error” as we defined it in class? What are the three sources of measurement error in financial statements? Of these which one(s) is the focus of accounting analysis?
Q6. List three factors that might motivate a manager to engage in managerial manipulation?
Q7. What is it about accrual accounting that provides managers with the opportunity to engage in managerial manipulation?
Part 2: Financial Statement Overview
Required: Please address the questions in the space provided. Be sure to show details of your computations to be eligible for partial credit. In answering the questions, focus on 2008 only, unless specifically asked to do otherwise.
Q1. What is the extra paragraph that appears in Sherwin-Williams’ audit report? Specifically, what did the company do to warrant this addition? What is the date of the audit report? What is the significance of this date?
Q2. Why is Sherwin-Williams’s diluted EPS always less than its basic EPS? (1 point)
Q3. Sherwin-Williams indicates that its income statement is a “Consolidated” statement. What does that mean? The lack of a minority interest account implies what?
Q4. What is obviously unusual about Sherwin-Williams balance sheet presentation?
Q5. Where does Sherwin-Williams provide its Statement of Comprehensive Income? What is Sherwin-Williams net income for the year? What is Sherwin-Williams comprehensive income? What item(s) explain the difference between these measures of income?
Q6. Using the rough computation we discussed in class (CFO – CFI) how much free cash flow did Sherwin-Williams’ generate in each of the last three years? How much cash did they return/pay to shareholders?
Part 3: Revenue Recognition
Required: Please address the questions in the space provided. Be sure to show details of your computations to be eligible for partial credit. In answering the questions, focus on 2008 only, unless specifically asked to do otherwise.
Q1. Based on your reading of Sherwin-Williams revenue recognition policy and understanding of their business, identify any opportunities for managerial manipulation of reported revenues.
Q2. Using the Compustat North America database available on-line at https://wrds.wharton.upenn.edu/ collect accounts receivable and sales data for Sherwin-Williams (ticker symbol SHW) for 1980 through the most recent year of data available. Use these data to assess whether Sherwin-Williams appears to engage in channel stuffing on occasion. Include your data, a graph, and be sure to state what years you believe they might have engaged in channel stuffing (if any).
Q3. How might you detect when a firm is prematurely recording revenues, particularly if they are failing to appropriately apply the matching principle?
Part 4: Inventory Analysis
Required: Please address the questions in the space provided. Be sure to show details of your computations to be eligible for partial credit. In answering the questions, focus on 2008 only, unless specifically asked to do otherwise.
Q1. What method or methods does Sherwin-Williams use to account for its inventories? Explain why firms often state that FIFO inventory values approximate “replacement cost.”
Q2. As of the end of 2008, what is the cumulative amount of the holding gain Sherwin-Williams has experienced on its LIFO inventories? What is the cumulative amount at the end of 2007? Did they generate a holding gain or a holding loss during 2008? How much was the holding gain (loss) they generated during 2008?
Q3. How much tax have they saved to date from using LIFO? How much tax did they save this year?
Q4. Sherwin-Williams discloses an amount of $49,184 which it labels “Decrease in net income due to LIFO.” Assume a tax rate of 38.3% and demonstrate the link between the figure that Sherwin-Williams disclosed, and the 2008 holding gain (or loss) that you computed in question 2. Your answer won’t be exact, but should be close.
Q5. Estimate the rate of inflation (or deflation) in Sherwin-Williams’ product markets.
Q6. Estimate the replacement cost of Sherwin-Williams’ total inventories as at the end of 2008 and 2007. What is their average inventory balance using the reported amounts? What is their average inventory balance using the replacement cost amounts?
Q7. Complete the following table to show how Sherwin-Williams’s 2008 balance sheet would change if it accounted for its LIFO inventories using FIFO instead of LIFO. Ignore income tax effects.
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Assets
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Liabilities
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Owners' Equity
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As reported:
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Inventory Adjustment:
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Adjusted figures:
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Q8. Compute Sherwin-Williams total debt to equity ratio, before and after adjustment for the measurement error in reported inventory. Interpret the results. Which is a better reflection of Sherwin-Williams economic solvency?
Q9. Compute Sherwin-Williams current assets to current liabilities ratio, before and after adjustment for the measurement error in reported inventory. Interpret the results. Which is a better reflection of Sherwin-Williams economic solvency?
Q10. ompute Sherwin-Williams inventory turnover ratio using reported cost of goods sold and total inventories. Repeat the computation with replacement costs in the numerator and denominator. (Ignore the impact of the reserve for obsolescence in doing this analysis.) Interpret the results. Which is a better reflection of Sherwin-Williams economic solvency?
Part 5: Goodwill
Required: Please address the questions in the space provided. Be sure to show details of your computations to be eligible for partial credit. In answering the questions, focus on 2008 only, unless specifically asked to do otherwise.
Q1. Goodwill comprises what percentage of Sherwin-Williams’ assets? How does this compare to the mean/median figures for 2008 we discussed in class?
Q2. What must have happened for Sherwin-Williams to report goodwill on their balance sheet?
Q3. Economically what does goodwill represent?
Q4. For each year, 2006 through 2008, compute a rough estimate of Sherwin-Williams’ ROE by dividing its net income by total stockholders’ equity. Assume that Sherwin-Williams cost of equity capital is approximately 10%. Does Sherwin-Williams’ goodwill appear to be economically sound? Why or why not?
Q5. During 2008, Sherwin-Williams took an impairment charge against its goodwill and indefinite-lived intangibles. How much was the impairment charge? What event(s) does management say precipitated the impairment charge (see discussion in Footnote 3). Why might a manager be motivated to overstate the amount of the impairment charge taken? Why might now be a good a time to do so?