Analyzing Financial Statements

PROCTOR & GAMBLE

Boermeester, Sabrina B
Intermediate Accounting I
Introduction

Each year, Proctor & Gamble Company communicates to their stockholders their

performance during the year through their annual Form 10-K. Stockholders and other interested

parties analyze the financial statements and other relevant information in the Form 10-K such as

notes to the financial statements to determine their position in regards to the company. As

presented in Wiley’s Intermediate Accounting textbook, Proctor & Gamble’s 2012-2014

financial statements are shown in Appendix B. These financial statements include P&G’s

consolidated statements of retained earnings, statements of comprehensive income, balance

sheets, statements of stockholders’ equity, and statements of cash flows.

When looking at the financial statements in a brief, overview perspective, an interested

party right off the bat can notice any significant changes in broad areas of interest from year to

year such as changes in net income, net earnings, asset/liability differences, cash flows, and

stockholders’ equity. For example, a reader may notice that in 2012, P&G had a relatively low

total comprehensive income as seen on the consolidated statement of comprehensive income of

$3,501,000,000 compared to the following years of $13,142,000,000 (2013) and

$11,475,000,000 (2014). Assets have also increased by $5,003,000,000 from 2013 to 2014 and

total liabilities have increased by $3,736,000,000 respectively as seen on the consolidated

balance sheets of those years. The most significant asset increases from each year include an

increase in property, plant, and equipment of $638,000,000, $2,128,000,000 of available for sale

securities, and $2,849,000,000 of assets held for sale. As a result, liabilities held for sale

increased by $660,000,000 from 2013 to 2014 and long-term debt also increased by

$800,000,000. Cash has also been steadily increasing between 2012 and 2014.
 As a whole from an overview perspective, an interested party/potential investor is able to

recognize right away that Proctor & Gamble Company is able to expand their business by

increasing assets and sales while being able to pay off debts in an effective, well-balanced way.

Stockholders’ Equity is also steadily increasing, starting from $64,035,000,000 in 2012 to

$69,976,000,000 in 2014. This indicates to a potential investor that the company is expanding

and more apt to pay out dividends to their shareholders which is exactly what a shareholder is

interested in when investing in a company.

Chapter 2

(A) Proctor & Gamble recognize sales when revenue is earned and realized. Similarly,

revenue is recognized when ownership/title of the inventory is transferred over to the customer.

This ownership includes risk of loss and can be determined “transferred” by the shipment date or

receipt date by the customer. Revenue is recorded with sales net of taxes and other related costs

associated with the inventory being sold. Sales discounts and allowances are also recorded within

the same period that revenue is recognized.

In regards to trade promotions, sales are recorded net of incurred costs associated with

the applicable trade promotion and is recorded around the same time that the sale takes place.

This may include allowances and coupons for merchandise. These costs related to trade

promotions are generally listed under other accrued liabilities on the company’s balance sheet

and have terms of about one year.

(B) Fair value is generally used to approximate cash equivalents and short-term debt

financial instruments. According to page 40 of P&G’s Form 10-K, fair value is also used to

estimate goodwill and other intangible assets. Proctor & Gamble uses a third party source to help

with the valuation of these assets that are based on historical information and future expectations.
In addition, they use an income method to value these assets which is future-based, using

forecasts of expected future cash flows that correspond with particular assets. Other assets such

as investment securities as well as foreign currency instruments and net investment hedges

recorded under the liabilities section of the balance sheet are recorded at fair value for financial

reporting purposes. These items and their totals can be found on page 60 of Proctor & Gamble’s

Form 10-K.

When reporting items at fair value, Proctor & Gamble would like to keep their hierarchy

based on Level 1 which includes observable inputs opposed to Level 3 which includes

unobservable inputs. This way, items are more accurately and reasonably valued compared to

prices of those in similar active markets.

As for historical cost measures, assets such as property, plant, and equipment are

recorded at cost while incorporating depreciation as the asset increases in age. Historical cost

information is needed for depreciable assets in order to determine the amount depreciation to

charge against the asset and record on the income statement as an expense. It is also used to

determine an asset’s useful life. A second example of historical cost information used in P&G’s

financial statements include investments that are not controlled by the company with significant

influence. In these cases, the (historical) cost method is used and listed under other noncurrent

assets in P&G’s balance sheet.

(C) An interested party can determine that the accounting principles used by P&G are

consistent with those of previous years by looking at the notes to their financial statements in

their Form 10-K. Proctor & Gamble Company prepare their financial statements in accordance

with U.S. GAAP, automatically indicating that they keep their policies fairly consistent, as that is

a requirement of Generally Accepted Accounting Principles. By knowing this, a reader would be

able to recognize if any changes were made in principles as it would be disclosed in the notes to

the financial statements in accordance with GAAP.

(D) Advertising costs for Proctor & Gamble are charged as expenses when costs are

actually incurred. Being a high-product based business, marketing plays a huge role in the

success of the business as it is necessary to target the right markets and utilize advertising and

research costs as effectively as possible. It is also essential in order to keep up with a rapidly

changing environment and maintain innovation. Advertising expenses include TV, print, radio,

internet, and in-store advertising expenses as well as costs associated with consumer promotions,

product sampling, and sales aids. Advertising costs fall under the Selling, general, and

administrative (SG&A) expense section. P&G’s advertising accounting policy does not fall in

accordance with the expense recognition principle where costs follow revenues. Instead,

advertising costs are expensed as incurred to accurately account for variation of advertising

needs.

Chapter 3

(A) According to the Consolidated Balance Sheet of Proctor & Gamble, total assets as of

June 30, 2013 and 2014 were $ 139,263,000,000 and $144,266,000,000 respectively, resulting in

a $5,003,000,000 increase from 2013 to 2014. (B) Cash and cash equivalents located in the

current assets section of the consolidated balance sheets of 2013 and 2014 have a balance of

$5,947,000,000 in 2013 and a $8,558,000,000 balance in 2014, indicating a $2,611,000,000

increase in cash and cash equivalents in the year.

(C) According to page 12 of the Proctor & Gamble Company’s Form 10-K under the

“Research and Development Expenditures” section, P&G’s research and development costs for

both 2013 and 2014 were about $2,000,000,000. When looking at the unaudited financial
summary on page 21 of P&G’s Form 10-K, 2013’s research and development expenses totaled

$1,980,000,000 and $2,023,000,000 in 2014.

(D) At Proctor & Gamble, revenue consists of net inventory sales. As seen on the

Consolidated Statements of Earnings in the financial statements, P&G recorded net sales of

$82,581,000,000 in 2013 and $83,062,000,000 of net sales in 2014. This increase of net sales

over the year totals $481,000,000.

(E) When looking at P&G’s financial statements and related notes, some items that may

result in adjusting entries for deferrals and accruals include accrued liabilities in the current

liabilities section of the balance sheet which include accrued accounts payable, interest,

marketing and promotion, compensation expenses, restructuring expenses, taxes payable, etc.

(shown on page 56 of the Form 10-K). These accrued adjustments would affect both the liability

account and associating expense account for each.

If P&G does not make an adjustment for deferrals, the asset and liability accounts are

overstating, resulting in an understatement of related expenses and revenues. Such deferrals, in

this case for year 2014, that need to be adjusted may include prepaid expenses ($3,845,000,000),

income taxes ($1,092,000,000), and depreciation. Adjusting entries for these types of deferrals

would affect the asset account and related expense account.

(F) Proctor & Gamble’s depreciation and amortization expenses totaled $3,204,000,000

in 2012, $2,982,000,000 in 2013, and $3,141,000,000 in 2014 as seen on the consolidated

statement of cash flows for P&G Company. On page 79 of P&G’s Form 10-K, depreciation and

amortization is broken down into its amounts for each of their major departments: beauty,

grooming, health care, fabric care and home care, baby, feminine, and family care, and

corporate.
Chapter 4

(A) Proctor & Gamble Company uses a transaction approach format for their income

statements that focus on income-related activities that occurred during the period (year). The

statements show operating income as well as non-operating income, net income from continuing

and discontinued operations, and non-controlling interests. Having both an operating and non-

operating section with discontinued operations and non-controlling interests makes P&G’s

income statements multi-step. This is often times preferable for big companies like P&G as it

separates operating transactions from non-operating transactions and matches costs and expenses

with related revenues. Furthermore, it distinguishes between regular and non-regular activities of

the business that allow investors to take note of that and realize that non-recurring activities that

may be unfavorable are unlikely to recur. Lastly, this type of income statement can allow

investors to compare operating incomes of different/similar companies in order to determine

which company has the better operating efficiency.

(B) On page 42 of P&G’s Form10-K, it is noted that in 2014, baby, feminine and family

care carried the highest net sales growth of 2% and health care contributed 6% in 2013. As seen

on page 74 of P&G’s Form 10-K under Note 12, segments of P&G company are broken down

into each segment’s contribution to U.S. sales. U.S. sales totaled $29,400,000,000,

$29,200,000,000, and $28,400,000,000 for the years 2012, 2013, and 2014. As of 2014, the

largest business unit contributors to net sales (revenues) for P&G Company were fabric care at

20% of sales, baby care at 13%, and hair care and color at 11%. The rest which include shave,

beauty, home, family, oral, feminine, and other care are fairly distributed between 7-9% for

mostly all units. P&G also notes in this sections that Wal-Mart Stores, Inc. and its affiliates

contribute 14% of consolidated net sales consistently through the years 2012-2014 and continue
to be their largest customer. Page 75 includes the breakdown of each department and their net

sales from 2012-2014. As of 2014, beauty contributed $19,507,000,000, grooming contributed

$8,009,000,000, and health care contributed $7,798,000,000 to net sales.

(C) P&G’s gross profit can be calculated by subtracting cost of products sold from net

sales for each year. This information is found on P&G’s consolidated statement of earnings and

can also be found on page 21 of their Form 10-K in its unaudited financial summary. P&G’s

gross profit is $40,595,000,000 for 2012, $41,190,000,000 for 2013, and $40,602,000,000 in

2014. Gross profit for P&G decreased in 2014 because even though net sales increased by

$481,000,000 from 2013 to 2014, cost of goods sold spiked $1,069,000,000 respectively.

(D) Proctor & Gamble Company makes a distinction between operating and non-

operating revenues to indicate their operating efficiency of a business. As mentioned on page 35

of their Form 10-K, P&G uses operating cash flow as the main source of funding for operating

needs and capital expenditures and uses the excess cash in order to pay out dividends. This is

important to shareholders because they want to make sure that they will be getting paid if they

choose to invest in the company. Using this operating income to pay off operating expenses is a

key indicator, too, of if P&G is able to cover current liabilities. P&G wants to be able to show to

potential investors that they are a stable, reliable company and this allows them to easily

communicate that information. It is also important for companies like P&G to report non-

operating activity gains or losses separately from operating activities to indicate that they are

unusual or infrequent. This is helpful because if there is a non-operating loss that significantly

impacts net income of the company, P&G wants it to be clear to potential investors that this is an

unusual and infrequent occurrence that is not anticipated to occur again in the future.
 (E) Some financial ratios that Proctor & Gamble Company cover from 2009-2014 in the

Financial Summary section on page 21 of their Form 10-K include basic net earnings per

common share and diluted net earning per common share for both continuing and discontinued

operations both of which are calculated based on net earnings attributable to the company for

each year. In addition, the financial summary of P&G includes ratios of dividends per common

share for the company from 2009-2014. All of these ratios go to show the company’s

performance quality for the year in regards to earnings and dividends per common share.

Chapter 5

(A) Proctor & Gamble Company adopted the report form of a balance sheet to report

their consolidated balance sheets which lists sections one on top of another on a single page. This

avoids the disadvantage of the account form, an alternate balance sheet format that P&G could

have used, that lists assets on the left side by sections and liabilities and stockholders’ equity on

the right side by sections. This is a disadvantage to companies that use this form because it is

oftentimes hard to present the wide-spread information on one page. P&G also could have used a

more uncommon format by showing current liabilities deducted from current assets to show net

working capital or they could deduct all liabilities from all assets. By choosing the report form,

all accounts are neatly organized and presented in detail in one page which is easier for interested

parties to read and understand.

(B) In order to disclose additional pertinent financial information in its financials such as

contingencies, accounting policies, contractual situations, and fair value measures, P&G used

parenthetical explanation techniques and notes to the financial statements for their choice of

disclosure techniques. They have used limited parenthetical explanations in the stockholders’

equity section of the consolidated balance sheets to plainly and simply point out information
regarding to shares for easy, quick disclosure. P&G has also used supporting schedules that can

be found in their Form 10-K that goes into more detail of the numbers represented on the

financial statements. As for all other information, P&G chose to use notes to the financial

statements as a disclosure technique in order to elaborate on all essential facts as completely as

possible and to also include any terminology clarifications of what is presented on the financial

statements.

Other disclosure techniques that P&G could have used in order to communicate

important information in the financial statements is cross-reference and contra-items that show a

direct relationship between assets and liabilities on the balance sheet in the body of the financial

statement. Contra assets and liabilities are also used sometimes on the face of the financial

statement; however, P&G chose to disclose those accounts in the notes to the financial

statements for simplicity reasons.

(C) Proctor & Gamble Company have investment securities that are readily marketable

securities that are classified as trading debt securities and available-for-sale securities. These

investments are reported at fair value and unrealized gains or losses from trading investments are

charged against earnings. Investments are recorded in the current and noncurrent assets of P&G’s

consolidated balance sheets. Some of these investments recorded at fair value listed on page 60

of P&G’s Form 10-K include U.S. government securities, corporate bond securities, and other

investments.

Additionally, according to P&G’s Form 10-K on page 53, investments use the equity

method for those that take significant influence from the company but don’t have control over

financial and operating decisions of, and investments that are not controlled by P&G and don’t

have significant influence in are accounted for using the cost method.
 Working capital for P&G on June 30, 2014 was $(2,109,000,000) and $(6,047,000,000)

on June 30, 2013.

(D) As seen on the consolidated statement of cash flows for P&G in 2014, cash flow

from operating activities were $13,958,000,000, cash flow from investing activities were

$(4,107,000,000), and cash flow from financing activities were $(7,279,000,000). Over a span of

three years from 2012-2014, cash flow from operating activities remained positive and is steadily

increasing. There was a small drop in 2014 from 2013, however cash flows from operating

activities in 2014 remained higher than it was in 2012 which is good.

Change in accounts payable and in accrued and other liabilities is added to net income to

arrive at net cash provided by operating activities because if accounts payable is going up, that

means that the company is “borrowing” more money, therefore it would be added to net income

to show the net cash provided by operating activities. If accounts payable is going down, that

means the company is paying off its liabilities with cash and therefore it would be taken out of

net income when calculating cash flow from operating activities.

(E) P&G’s current cash debt coverage is calculated by taking net cash provided by

operating activities and dividing it by the average current liabilities for the year using P&G’s

consolidated statement of cash flows and their consolidated balance sheets. This ultimately

measures P&G’s ability to pay off current liabilities from cash generated by operating activities.

P&G’s cash debt coverage for 2014 is 0.41 ($13,958 million/$33,726 million).

P&G’s cash-debt coverage is calculated by dividing net cash provided by operating

activities found on P&G’s consolidated balance sheet for 2014 by average total liabilities found

on P&G’s consolidated statement of cash flows for 2014. This ratio measures P&G’s ability to
pay off total liabilities using cash from operating activities in a year. This ratio is for P&G is 0.19

($13,958 million/$74,290 million).

P&G’s free cash flow for 2014 is calculated by subtracting capital expenditures and cash

dividends from net cash provided by operating activities. All three of these values can be found

in P&G’s consolidated statement of cash flows for 2014 and this ratio measures the amount of

“discretionary” cash flow that P&G has for the year. The free cash flow for P&G in 2014 is

$3,199,000,000 ($13,958 million - $3,848 million - $6,911 million).

Based on these ratios, a reader could conclude that P&G is only able to cover 41% of

current liabilities and 19% of total liabilities with just operating cash flow for the year. Typically,

companies would like this number to be over 1 (100%) so that they are able to cover more of

their liabilities in the year while still having some spare money left over in case of an emergency

or occurrence of unexpected events that cause liabilities to increase significantly. These ratios

indicate that P&G company just has to find other sources of financing in order to cover their

liabilities for the year which isn’t always bad but it is definitely more desirable to have a higher

ratio for companies. Finally, a positive discretionary spending number indicates that P&G is in a

decent financial position where it is still generating positive cash flows.

Chapter 7

(A) Cash and cash equivalents are reported on Proctor & Gamble’s consolidated balance

sheets as current assets. Cash and cash equivalents are highly liquid investments with maturities

usually three months or less. Cash and cash equivalents may include treasury bills, commercial

paper, and money market funds.

(B) As seen on P&G’s consolidated balance sheet, the cash and cash equivalents balance

for 2014 was $8,558,000,000. The major uses of cash as presented in the consolidated statement
of cash flows for 2014 include spending on capital expenditures ($3,848,000,000), purchases of

available-for-sale investment securities ($568,000,000), distributing dividends to shareholders

($6,911,000,000), paying off long-term debt ($4,095,000,000), and investments in treasury stock

($6,005,000,000). These are good uses of cash for P&G because they are investing more into the

company through capital expenditures, distributed even more dividends to their shareholders

than previous years, and invested in treasury stock for financing.

(C) Since Proctor & Gamble does not report allowance for doubtful accounts, they likely

use the direct write-off method because bad debt expense is not material, thus making the direct

write-off method acceptable. Since Proctor & Gamble Company is so widely known by the

population and such a huge corporation, they likely have no problem making money, even when

debt is not collectible, thus making it reasonable for them to not have an allowance for doubtful

accounts contra-asset account to accounts receivable.

Summary

After analyzing the financial statements of Proctor & Gamble Company as of 2014, I

found a lot that was interesting to me. To mention a few, I thought it was interesting that there

was a pretty significant amount of discontinued operations in 2012 compared to future years and

even more in 2009 and 2010 that are noted in the financial summary of the company’s Form 10-

K. I never stop to think that big companies like P&G would be discontinuing operations as much

as they may do because individuals don’t tend to notice those types of actions when the company

is so big.

Additionally, right off the bat noticed that there was no allowance for doubtful accounts

noted in either the body of the financial statements or the notes to the financial statements. I

always figured that big companies like that that are selling billions of dollars worth of inventory
in a year would have a significant amount of uncollectible amounts sitting in their accounts,

however after research and analyzing the statements thoroughly, it made sense to me that

uncollectible amounts would be immaterial to them.

Finally, I found it interesting that they are able to maintain positive cash flows, steadily

increase shareholders’ equity year to year, and still gradually increase their dividend payments to

their shareholders’ year to year. The Proctor & Gamble Company continues to expand each year

and I find it so fascinating that a company that large can maintain growth and success.