Reference no: EM133095283

BUAD 5107 Accounting - College of William & Mary

Part 1.
When standards are used, a common agency problem is the challenge of monitoring behavior to address the consequences associated with not meeting the standard. Assume a new staff member in a professional services firm is given a job to complete; and the new staff member is told that the standard time expected for the work based on previous years' experience is 15 hours. In this example, let's say the new staff member spends a total of 21 hours to complete the work. Knowing the standard time is 15 hours, this staff member might decide to remain after hours in the workplace to work hours that the staff member does not intend to record when accounting for the time worked. In this example, assume the new staff member decided to work 6 six hours "off the clock" (i.e., six hours is the amount of personal "after-hours time" the employee spent doing the work, and the staff member recorded only 15 hours of work as part of their official time log).

What are the likely motivations for the new staff member to work 6 hours off-the-clock and not account for this time?

While in this case the standard has been attained, what are the important reasons why the firm should be concerned about tolerating this practice?

Part 2.
The emergence of global capital markets has created the demand for harmonization of financial reporting standards.

Explain the difference between "adoption" and "convergence."

Explain why it is highly unlikely from a political perspective that the United States will "adopt" International Financial Reporting Standards.

Part 3.
Whether we are preparing a personal retirement plan or leading an organization, ratios are useful when making decisions involving financial resources and strategies because they highlight relationships. This problem is designed to illustrate the power of financial ratios and the relationship between "numbers and strategy" using Netflix as a case study.

In the introductory paragraphs of their SEC Form 10-K, prepared for the 2020 fiscal year, Netflix describes their company as "... one of the world's leading entertainment services with approximately 204 million paid memberships in over 190 countries enjoying TV series, documentaries and feature films across a wide variety of genres and languages." (Netflix Inc., 2020, p. 1) Numbers are an essential part of the Netflix story.

Netflix was founded in 1997 on a business model that employed the then "new idea" of placing videos in mailers and mailing them to subscribers in return for small rents. Subscribers would take the videos out of the mailers, watch them on their players at home, and send them back to Netflix. The company has come a long way since 1997. Netflix is an outstanding example of a company that has continuously "reinvented itself" in response to challenges emanating from a rapidly changing environment. Still, their future success is in no way guaranteed. The following excerpt is from the 2020 10-K report Netflix filed with the SEC.

We are a pioneer in the internet delivery of TV shows and movies, launching our streaming service in 2007. Since this launch, we have developed an ecosystem for internet-connected screens and have added increasing amounts of content that enable consumers to enjoy TV shows and movies directly on their internet-connected screens. As a result of these efforts, we have experienced growing consumer acceptance of, and interest in, the delivery of TV shows and movies directly over the internet.

Our core strategy is to grow our streaming membership business globally within the parameters of our profit margin targets. We are continuously improving our members' experience by expanding our streaming content with a focus on a programming mix of content that delights our members. In addition, we are continuously enhancing our user interface and extending our streaming service to more internet-connected screens. Our members can download a selection of titles for offline viewing. (Netflix Inc., 2020, p. 1)

Netflix has embraced the concept of providing original programming. Their programs and documentaries have been honored with Emmy, Golden Globe, and Academy Oscar awards.

Required
An Excel spreadsheet file containing six worksheets accompanies this problem and will be referenced in the remainder of this Module Submission. The Excel file contains financial data relevant to the questions that follow. The purpose of providing the Excel file is to eliminate the added time it would take for you to compile financial data from the SEC filings and enter numbers into a calculating program. This Excel file greatly simplifies the process and focuses your limited time to the best advantage. You can use the Excel spreadsheet to make calculations - the spreadsheets are for your use and should not be submitted. You must use the data provided in the Excel File to respond to the questions which follow. You should record your response to each question in this document in the space provided following each question -- DO NOT submit a spreadsheet file or any other additional files. Submit ONLY ONE document.

Liquidity Metrics

Managing liquidity is a challenge faced by individuals and organizations alike. In the case of a shutdown by the Federal government, most federal employees who do not receive their regular paychecks would become acutely aware of the potential for a liquidity crisis in their households. The business strategy embraced by Netflix is a high-risk strategy that also underscores the importance of managing liquidity. You can think of the current ratio as a "financial vital sign" corresponding to pulse or blood pressure in the domain of "medical vital signs."

Compute the current ratio for Netflix as of December 31, 2020, December 31, 2019, December 31, 2018. Do NOT include "Deferred revenue" in the computation of this ratio. Round to 2 decimal places.

During the three years covering fiscal years 2018, 2019, and 2020, Netflix's current ratio dipped to a level that signaled an impending liquidity crisis. If Netflix had not responded to the impending crisis and had maintained the same cash balance on December 31, 2020, that they reported on December 31, 2019, what would have been the value of its current ratio on December 31, 2020? Do NOT include "Deferred revenue" in the computation of this ratio. Round to 2 decimal places.

Operating/Profitability Metrics

3.2.A. During the three years covering fiscal years 2018, 2019, and 2020, the amounts Netflix reported as "revenue" increased substantially. Netflix depends heavily on marketing to drive demand. Compute the percentage of sales revenue spent on marketing expenses for the fiscal years ended December 31, 2018, and December 31, 2020. What is the change in the percentage of sales revenue spent on marketing expense from the year ended December 31, 2018, to the year ended December 31, 2020, and has the percentage increased or (decreased)? Round percentages to 1 decimal places (e.g., xx.x%)

Marketing appears to be a crucial part of Netflix's operating strategy and cost structure. Compute the percentage of "Operating expenses" dedicated to marketing for the fiscal years ending December 31, 2020, 2019, and 2018. The term "Operating expenses" includes all expenses considered in the calculation of "Operating income" except "Cost of revenues." Round percentages to 1 decimal place (e.g., xx.x%).

If Netflix did not consider marketing essential, we can assume they would cut back on marketing and devote those funds to other purposes. Without a major commitment to marketing, it appears that Netflix cannot achieve its goal of protecting and increasing market share. Explain how the relationship between marketing expense and total operating expenses creates a cost structure that results in a barrier to entry that discourages or prevents existing and potential competitors from attempting to compete with Netflix for market share.

The "inventory" that Netflix streams includes previously canceled series from other networks, licensed and co-produced content, and Netflix original content. Netflix uses the term "content," which roughly corresponds to "inventory," and the term "cost of revenue," which roughly corresponds to "cost of goods sold." Content assets are intangible property rights. Our course has considered the importance of managing costs and cost accounting. These topics are of crucial significance to Netflix now that they have decided to produce their own original content.

The ratio of cost-of-revenue/revenue provides a metric to assess how well Netflix has managed its gross profit percentage. An increase in rates charged to customers and/or a decrease in the cost of revenue will result in an increase in the gross profit ratio. Relatively small changes in these ratios can have a substantial impact on financial performance. The change in the ratio of cost-of- revenue/revenue over the three-year period is indicative of proactive measures undertaken by Netflix. If the ratio of cost-of-revenue/revenue reported for the year ended December 31, 2018, had remained constant over the three-year period, how much in thousands of dollars would operating income for the year ended December 31, 2020 have decreased? Note: To avoid rounding errors, use a spreadsheet for all calculations.

With reference to the preceding calculation (part 3.2.D), is the dollar amount of the improvement in net income that is attributable to an improvement in the ratio of cost-of- revenue/revenue material? In other words, is the amount of the impact of the improvement significant in comparison to the net income reported for the year ended December 31, 2020? Explain.

Netflix makes content for streaming rather than making a tangible product, such as furniture or widgets. When accounting for the cost of original content, Netflix will account for the direct materials, direct labor, and overhead expended to create the content. Producing content requires production assets, licenses, and an investment in technology. Explain how accounting choices regarding methods of depreciation and amortizations can influence the determination of the amounts reported as "cost-of-revenue."

Capitalization Metrics

Many individuals have chosen to purchase their homes rather than rent, and many of these owners depend upon mortgages as a source of long-term financing. During the housing crisis beginning in 2008, homeowners who bought with minimal down payments and homeowners who borrowed extensively against their home's appreciation found themselves in a highly leveraged position when the housing crisis struck. These decisions made by homeowners' parallel decisions made by Netflix executives. As reported on December 31, 2020, December 31, 2019, and December 31, 2018, what percentage of total assets is financed by long-term debt? Round percentages to 1 decimal place.

As reported on December 31, 2020, December 31, 2019, and December 31, 2018 what percentage of total assets is financed by contributed capital paid-in by stockholders? Round percentages to 1 decimal place.

As reported on December 31, 2020, what percentage of total assets is financed by past profits that were reinvested in the company? Note: Ignore the amount reported as "Accumulated other comprehensive loss;" it is relatively small and immaterial. Round percentage to 1 decimal place.

During the three-year period ended December 31, 2020, has Netflix depended upon leveraging debt as an essential part of its growth strategy? Explain.

In October of 2018, Netflix announced its intent to sell $2 billion in bonds to institutional buyers through an offering of U.S. dollar and Euro-denominated bonds. The bonds are not secured by fixed assets or any other collateral, and the proceeds will be used for operating purposes. At issuance, Moody's assigned Netflix a long-term credit rating of Ba3, which is considered speculative, or 'junk.' Investors purchasing these bonds will receive relatively higher interest payments to compensate them for the underlying risk. Netflix will incur higher debt carrying expenses because of the relatively high rate it must pay. On the other hand, Netflix stockholders have not received any dividends during the three years ended December 31, 2020. How do you explain the stockholders' willingness to accept the Board of Directors' decision to withhold dividend payments to stockholders?

Part 4.
Presented below are SWOT analyses for Netflix and JetBlue prepared as of December 7, 2021, and sourced from D&B Hoovers. SWOT is a familiar acronym that stands for Strengths, Weaknesses, Opportunities, and Threats. Strengths and Weaknesses describe conditions internal to the organization. Opportunities and Threats are terms used to describe the external environment within which the organizations operate. Not surprisingly, COVID-19 is identified as a threat for JetBlue but not for Netflix.

Required:
Financial data for JetBlue are provided in the accompanying Excel Spreadsheet prepared for this Module Submission. Over the three years included in the Excel Spreadsheet, sales and gross margin for JetBlue have changed dramatically due to travel bans and other secondary effects of the COVID- 19 pandemic.

To approximate the drop in revenue from December 31, 2019, to December 31, 2020, that is associated with the impact of COVID-19, express the change in revenue from fiscal year 2019 to fiscal year 2020 as a percentage of the revenue reported for the year ended December 31, 2019. Include "Other revenue" in the calculation. Round percentage to 1 decimal place.

Faced with a dramatic drop in revenue in fiscal year 2020, JetBlue would be expected to focus on cost containment. Costs that cannot be reduced by more than 20% during a period when there is a much greater decline in revenue are considered to be costs that are classified as "semi- fixed costs in the short run." Using this classification, which of the "costs and expenses" reported by JetBlue in fiscal-year 2020 would be classified as "semi-fixed in the short run"?

"Aircraft fuel and related taxes" is an expense that is likely to be a variable cost and vary directly as a function of revenue. Was the management of JetBlue successful in employing the practice of flexible budgeting to reduce the expense for "aircraft fuel and related taxes" in fiscal-year 2020 to a level that should be expected for a cost that is a variable cost? Include the necessary numerical calculations needed to support your response.

When faced with a devasting financial crisis, "running out of cash" is a short route to bankruptcy and financial failure. A company that has no cash cannot pay operating costs and meet financial obligations. For JetBlue, the balances in cash and current investments in marketable securities reported as of December 31, 2020, are significantly greater than in previous years. On first consideration, this increase appears to be contraindicated; a company experiencing a devasting financial crisis shouldn't be expected to report a significant increase in cash. The success of the leadership of JetBlue in being resourceful and responding to a looming cash crisis by shoring up their cash position is reflected in the Dunn and Bradstreet SWOT analysis, which lists "Cash Position" as one of JetBlue's strengths.
How much of the increase in cash during fiscal-year 2020 is the result of financing activities?

How much of the increase in cash during fiscal-year 2020 is the result of operating activities? Explain.

Attachment:- Accounting.rar