Merck & Co., Inc. and Johnson & Johnson are two leading producers of healthcare products. Each has considerable assets, and each expends considerable funds each year toward the development of new products. The development of a new healthcare product is often very expensive, and risky. New products frequently must undergo considerable testing before approval for distribution to the public. For example, it took Johnson & Johnson 4 years and $200 million to develop its 1-DAY ACUVUE contact lenses. Below are some basic data compiled from the financial statements of these two companies.

$$\begin{array}{lccc} {\text{(all dollars in millions)}}&\underline{\hspace{2pt}\text{Johnson \& Johnson}\hspace{2pt}}&\underline{\hspace{15pt}\text{Merck}\hspace{15pt}}\\ \text{Total assets}&\$53,317&\$42,573\\ \text{Total revenue}&47,348&22,939\\ \text{Net income}&8,509&5,813\\ \text{Research and development expense}&5,203&4,010\\ \text{Intangible assets}&11,842&2,765\\ \end{array}$$

Instructions

a. What kinds of intangible assets might a healthcare products company have? Does the composition of these intangibles matter to investors-that is, would it be perceived differently if all of Merck's intangibles were goodwill than if all of its intangibles were patents?

b. Suppose the president of Merck has come to you for advice. He has noted that by eliminating research and development expenditures the company could have reported $4 billion more in net income. He is frustrated because much of the research never results in a product, or the products take years to develop. He says shareholders are eager for higher returns, so he is considering eliminating research and development expenditures for at least a couple of years. What would you advise?

c. The notes to Merck's financial statements note that Merck has goodwill of$1.1 billion. Where does recorded goodwill come from? Is it necessarily a good thing to have a lot of goodwill on a company's books?

Merck & Co., Inc. is one of the largest pharmaceutical companies in the world. Merck was restructured into five divisions after it completed the buyout of rival Schering Plough in 2009 for $41.1 billion. The five divisions are Global Human Health, Animal Health, Consumer Health Care, Merck Research Laboratories, and Merck Manufacturing. “The Organizational structure for the new Merck was designed to capture the opportunities in the broader and deeper in-line pharmaceutical franchises that would be created through the integration of Merck and Schering-Plough products,” Merck said in a statement. Draw the organizational structure of the new Merck. What type of organizational structure is it?

Suppose the following information was taken from the 2014 financial statements of pharmaceutical giant Merck and Co. (All dollar amounts are in millions.)

Retained earnings, January 1, 2014    $43,698.8
Cost of goods sold                      9,018.9
Selling and administrative expenses     8,543.2
Dividends                               3,597.7
Sales revenue                          38,576.0
Research and development expense        5,845.0
Income tax expense                      2,267.6

Instructions

(b) Suppose that Merck decided to reduce its research and development expense by 50%. What would be the short-term implications? What would be the long-term implications? How do you think the stock market would react?

Merck & Co., Inc. and Johnson & Johnson are two leading producers of healthcare products. Each has considerable assets, and each expends considerable funds each year toward the development of new products. The development of a new healthcare product is often very expensive, and risky. New products frequently must undergo considerable testing before approval for distribution to the public. For example, it took Johnson & Johnson 4 years and $200 million to develop its 1-DAY ACUVUE contact lenses. Below are some basic data compiled from the financial statements of these two companies.

$$\begin{array}{lcc} \text{{(all dollars in millions)}}&\text{\underline{Johnson \& Johnson}}&\text{\underline{Merck}}\\ \text{Total assets}&\text{\$\hspace{5pt}53,317}&\text{\$\hspace{5pt}42,573}\\ \text{Total revenue}&\text{\hspace{10pt}47,348}&\text{\hspace{10pt}22,939}\\ \text{Net income}&\text{\hspace{14pt}8,509}&\text{\hspace{14pt}5,813}\\ \text{Research and development expense}&\text{\hspace{14pt}5,203}&\text{\hspace{14pt}4,010}\\ \text{Intangible assets}&\text{\hspace{9pt}11,842}&\text{\hspace{14pt}2,765}\\ \end{array}$$

Instructions

• a. What kinds of intangible assets might a healthcare products company have? Does the composition of these intangibles matter to investors—that is, would it be perceived differently if all of Merck’s intangibles were goodwill than if all of its intangibles were patents?
• b. Suppose the president of Merck has come to you for advice. He has noted that by eliminating research and development expenditures the company could have reported $4 billion more in net income. He is frustrated because much of the research never results in a product, or the products take years to develop. He says shareholders are eager for higher returns, so he is considering eliminating research and development expenditures for at least a couple of years. What would you advise?
• c. The notes to Merck’s financial statements note that Merck has goodwill of$1.1 billion. Where does recorded goodwill come from? Is it necessarily a good thing to have a lot of goodwill on a company’s books?

A statement that guides the ethical behavior of a company and its employees is called a code of conduct. Merck & Co., Inc., a leading pharmaceutical company, makes its code of conduct available to its employees, consultants, and the public. The document, titled "Our Values and Standards, Edition 111," begins by stating:

Our values and standards have always formed the basis of our success. They inspire trust and confidence on the part of the medical community, government officials, regulatory agencies, financial markets, our customers and patients, all whom are essential to our success.

The code of conduct contains sections that focus on Merck's relationship with customers, employees, shareholders, suppliers, and communities/society. Each section contains specific guidance on Merck policies. Common questions and answers are provided to expand on these policies. Throughout the document, individuals are encouraged to seek the guidance of their supervisor, the Legal Department, and the Office of Ethics if they are unsure whether their actions comply with the code of conduct.

INSTRUCTIONS

Obtain access to Merck's code of conduct. Can Merck employees do the following:

1. Give a physician a gift consisting of a medical textbook?

A statement that guides the ethical behavior of a company and its employees is called a code of conduct. Merck & Co., Inc., a leading pharmaceutical company, makes its code of conduct available to its employees, consultants, and the public. The document, titled "Our Values and Standards, Edition 111," begins by stating:

Our values and standards have always formed the basis of our success. They inspire trust and confidence on the part of the medical community, government officials, regulatory agencies, financial markets, our customers and patients, all whom are essential to our success.

The code of conduct contains sections that focus on Merck's relationship with customers, employees, shareholders, suppliers, and communities/society. Each section contains specific guidance on Merck policies. Common questions and answers are provided to expand on these policies. Throughout the document, individuals are encouraged to seek the guidance of their supervisor, the Legal Department, and the Office of Ethics if they are unsure whether their actions comply with the code of conduct.

INSTRUCTIONS

Obtain access to Merck's code of conduct. Can Merck employees do the following:

3. Accept a gift of two Super Bowl tickets from a customer?

MGM Resorts International owns and operates hotels and casinos including the MGM Grand and the Bellagio in Las Vegas, Nevada. As of a recent year, MGM reported accounts receivable of $415,654,000 and allowance for doubtful accounts of$93,760,000. Johnson & Johnson manufactures and sells a wide range of healthcare products including Band-Aids and Tylenol. As of a recent year, Johnson & Johnson reported accounts receivable of $10,114,000,000 and allowance for doubtful accounts of$340,000,000. a. Compute the percentage of the allowance for doubtful accounts to the accounts receivable for MGM Resorts International. Round to one decimal place.

Hospital length of stay. Health insurers and the federal government are both putting pressure on hospitals to shorten the average length of stay (LOS) of their patients. The average LOS in the United States is $4.5$ days (Healthcare Cost and Utilization Project Statistical Brief, October 2014). A random sample of 20 hospitals in one state had a mean LOS of $3.8$ days and a standard deviation of $1.2$ days. Use a $90 \%$ confidence interval to estimate the population mean LOS for the state's hospitals.

Alladin Company purchased Machine #201 on May 1, 2017. The following information relating to Machine #201 was gathered at the end of May.

$$\begin{array}{lrr} \text{Price}&\text{\$\hspace{5pt}85,000}\\ \text{Freight-in}&\text{800}\\ \text{Preparation and installation costs}&\text{3,800}\\ \text{Labor costs during regular production operations}&\text{10,500}\\ \text{Credit terms}&\text{2/10, n/30}\\ \end{array}$$

It is expected that the machine could be used for 10 years, after which the salvage value would be zero. Alladin intends to use the machine for only 8 years, however, after which it expects to be able to sell it for $1,500. The invoice for Machine #201 was paid May 5, 2017. Alladin uses the calendar year as the basis for the preparation of financial statements.

• a. Compute the depreciation expense for the years indicated using the following methods. (Round to the nearest dollar.) (1) Straight-line method for 2017. (2) Sum-of-the-years’-digits method for 2018. (3) Double-declining-balance method for 2017.
• b. Suppose Kate Crow, the president of Alladin, tells you that because the company is a new organization, she expects it will be several years before production and sales reach optimum levels. She asks you to recommend a depreciation method that will allocate less of the company’s depreciation expense to the early years and more to later years of the assets’ lives. What method would you recommend?

McDonald’s is the largest and best-known global food-service retailer, with more than 32,000 restaurants in 118 countries. On any day, McDonald’s serves approximately 1 percent of the world’s population. The following is information related to McDonald’s property and equipment.

McDonald’s Corporation Summary of Significant Accounting Policies Section

Property and Equipment. Property and equipment are stated at cost, with depreciation and amortization provided using the straight-line method over the following estimated useful lives: buildings—up to 40 years; leasehold improvements—the lesser of useful lives of assets or lease terms, which generally include option periods; and equipment—three to 12 years.

[In the notes to the financial statements:]

Property and Equipment Net property and equipment consisted of:

$$\begin{array}{lrr} \text{December 31} \end{array}$$

$$\begin{array}{lrr} \text{\underline{(In millions)}}&\text{\underline{\hspace{13pt}2014\hspace{13pt}}}&\text{\underline{\hspace{13pt}2013\hspace{13pt}}}\\ \text{Land}&\text{\$\hspace{10pt}5,788.4}&\text{\$\hspace{10pt}5,849.3}\\ \text{Buildings and improvements on owned land}&\text{14,322.4}&\text{14,715.6}\\ \text{Buildings and improvements on leased land}&\text{13,284.0}&\text{13,825.2}\\ \text{Equipment, signs and seating}&\text{5,113.8}&\text{5,376.8}\\ \text{Other}&\underline{\text{\hspace{25pt}617.5}}&\underline{\text{\hspace{25pt}588.7}}\\ \text{}&\text{39,126.1}&\text{40,355.6}\\ \text{Accumulated depreciation and amortization}&\underline{\text{\hspace{5pt}(14,568.6)}}&\underline{\text{\hspace{5pt}(14,608.3)}}\\ \text{Net property and equipment}&\text{\underline{\underline{\$\hspace{8pt}24,557.5}}}&\text{\underline{\underline{\$\hspace{8pt}25,747.3}}}\\ \end{array}$$

$$\begin{array}{lrr} \text{Depreciation and amortization expense for property and equipment was}\\ \text{(in millions): 2014—\$1,539.3; 2013—\$1,498.8; 2012—\$1,402.2.}\\ \end{array}$$

[In its 6-year summary, McDonald’s provides the following information.]

$$\begin{array}{lrrr} \text{\underline{(In millions)}}&\text{\underline{\hspace{5pt}2014\hspace{5pt}}}&\text{\underline{\hspace{5pt}2013\hspace{5pt}}}&\text{\underline{\hspace{5pt}2012\hspace{5pt}}}\\ \text{Cash provided by operations}&\text{\$\hspace{5pt}6,370}&\text{\$\hspace{5pt}7,121}&\text{\$\hspace{5pt}6,966}\\ \text{Capital expenditures}&\text{2,583}&\text{2,825}&\text{3,049}\\ \end{array}$$

Instructions

• a. What method of depreciation does McDonald’s use?
• b. Does depreciation and amortization expense cause cash flow from operations to increase? Explain.
• c. What does the schedule of cash flow measures indicate?

Alladin Company purchased Machine #201 on May 1, 2020. The following information relating to Machine #201 was gathered at the end of May.

$$\begin{array} {lrrrrr} \text{Price}& \hspace{10pt}\text{\$85,000}&\\ \text{Credit terms}& \hspace{10pt}\text{2/10, n/30}&\\ \text{Freight-in}& \text{\$800}&\\ \text{Preparation and installation costs}& \hspace{10pt}\text{\$3,800}&\\ \text{Labor costs during regular production operations}& \hspace{10pt}\text{\$10,500}&\\ \end{array}$$

It is expected that the machine could be used for 10 years, after which the salvage value would be zero. Alladin intends to use the machine for only 8 years, however, after which it expects to be able to sell it for $1,500. The invoice for Machine #201 was paid May 5, 2020. Alladin uses the calendar year as the basis for the preparation of financial statements.

Instructions

a. Compute the depreciation expense for the years indicated using the following methods. (Round to the nearest dollar.)

1. Straight-line method for 2020.

2. Sum-of-the-years-digits method for 2021.

3. Double-declining-balance method for 2020.

b. Suppose Kate Crow, the president of Alladin, tells you that because the company is a new organization, she expects it will be several years before production and sales reach optimum levels. She asks you to recommend a depreciation method that will allocate less of the company's depreciation expense to the early years and more to later years of the assets' lives. What method would you recommend?

The financial statements of Coca-Cola and PepsiCo are presented in Appendices C and D, respectively. The companies complete annual reports, including the notes to the financial statements, are available online.

Instructions

Use the companies' financial information to answer the following questions.

a. 1. What amounts for intangible assets were reported in their respective balance sheets by Coca-Cola and PepsiCo at year-end 2017?

2. What percentage of total assets is each of these reported amounts at year-end 2017?

3. What was the change in the amount of intangibles from 2016 to 2017 for Coca-Cola and PepsiCo?

b. 1. On what basis and over what periods of time did Coca-Cola and PepsiCo amortize their intangi ble assets?

2. What were the amounts of accumulated amortization reported by Coca-Cola and PepsiCo at the end of 2016 and 2017?

3. What was the composition of the identifiable and unidentifiable intangible assets reported by Coca-Cola and PepsiCo at the end of 2017?

The financial statements of P&G are presented in Appendix B. The company's complete annual report. including the notes to the financial statements, is available online.

Instructions

Refer to P&G's financial statements and the accompanying notes to answer the following questions.

a. Does P&G report any intangible assets, especially goodwill, in its 2017 financial statements and accompanying notes?

b. How much research and development (R&D) cost was expensed by P&G in 2016 and 2017? What percentage of sales revenue and net income did P&G spend on R&D in 2016 and 2017?

All of the following are key similarities between GAAP and IFRS with respect to accounting for intangible assets except:

a. for accounting purposes, costs associated with research and development activities are segregated into the two components.

b. the accounting for intangibles acquired in a business combination.

c. recovery of impairments on intangibles other than goodwill.

d. the accounting for impairments of assets held for disposal.