Case Sell-it Products Inc.

Transcription

1 Case 08-5 Sell-it Products Inc. Sell-it Products Inc. s (SPI) business is the manufacturing, marketing and distribution of consumer products. SPI sells all its products through grocery stores, drug stores and mass merchandisers in the United States (USA), Canada, Mexico, Asia, and Europe. SPI has a dedicated sales force with individuals assigned by geographic area. Each salesperson is responsible for representing and selling all of SPI s products. SPI is organized into three divisions that include the following products: 1. Beauty Care cosmetics and shampoo. 2. Family Care paper towels and diapers. 3. Drinks and Snacks Blasto Energy Drink, Jazzy Juice and fruit and granola snacks each of these products contain no added sugar or preservatives in order to appeal to the diet/health conscious consumer. The production, distribution and sale of each of SPI s products is subject to the Federal Food, Drug and Cosmetic Act in the USA and other federal, local and state laws in the regions in which SPI conducts business. Although SPI s competition in the cosmetics, shampoo, paper towels, diapers, juice, and snacks markets has remained fairly constant over the past few years and is expected to remain fairly constant in the foreseeable future, SPI expects to face increased competition in the energy drink marketplace due to the introduction of new energy drinks by two of SPI s competitors in Managers responsible for each product line (Product Managers) report to the respective divisional executive vice-presidents (EVPs), who are responsible for the day-to-day operations of the division. The EVPs report to the Chief Executive Officer (CEO). The CEO makes decisions regarding the strategic direction and resource allocations of SPI based on frequent interaction with the EVPs and Product Managers, consultation with the other Corporate Officers and review of the Monthly Operating Package (MOP). The MOP includes financial information for each division (Summary by Division) and product (Summary by Product) on a monthly and year-to-date (YTD) basis. It is the internal financial information used by the CEO to evaluate SPI s performance and to make decisions regarding allocation of resources see Handout 1 for the latest MOP that was provided to the CEO (for simplicity purposes, only the YTD portion of the package has been provided). The MOP is also provided to the Board of Directors and is used by the CEO to facilitate discussion regarding results of operations at the quarterly Board meetings. The CEO is considered SPI s Chief Operating Decision Maker (CODM). Although the CEO consults with other members of the management team, he is the highest level of management that makes decisions about SPI s overall resource allocation to different areas of the business.

2 Case 08-5: Sell-it Products Inc. Page 2 The CEO has publicly stated that he makes strategic decisions primarily based on gross margin. The business section of SPI s Annual Report and SPI s press releases discuss changes in revenue and gross margin for each of SPI s significant products. SPI s MD&A section of the Annual Report discusses fluctuations by division and provides explanations for changes in revenues and gross margins based on the products that produce the changes within the divisions. Your firm has recently been appointed auditors for SPI for As part of your initial auditing procedures, you have obtained the MOP and discussed it with the CEO. The CEO has stated that he focuses on the consolidated results of SPI and the Summary by Division and does not use the Summary by Product information to make resource allocation decisions and/or to assess performance. The CEO also informed you that SPI has just received a comment letter from the SEC regarding SPI s Form 10-K for The letter includes the following comment: Note 15: Business Segments We note that you disclose your businesses into three reportable segments based on your divisions. However, the description of your business and disclosures in your Annual Report appear to indicate that you may have more than three reportable segments as defined in ASC (paragraph 10 of FASB Statement No. 131(Statement 131)). In your Annual Report, you identify seven product lines on page 6. Provide us the following information related to your segments: i. identify your operating segments referring to the guidance in ASC (paragraph 10 of Statement 131); and ii. if you have aggregated operating segments, disclose that fact as required in ASC (paragraph 26 of Statement 131) and provide us with your analysis of the aggregation criteria in ASC (paragraph 17 of Statement 131). The CEO stated that the Controller was in the process of preparing a response to the comment letter. He stated that he and the Controller continue to believe that three reportable segments are appropriate based on the following: As previously stated, the CEO focuses on the consolidated results of SPI and the Summary by Division. SPI s three largest competitors disclose only one segment. SPI is reluctant to provide additional information as it may place the Company at a competitive disadvantage. The CEO has asked whether you agree with SPI s conclusion.

3 Case 08-5: Sell-it Products Inc. Page 3 Required: Answer the following questions, documenting any additional issues you have identified and professional literature to support your recommendations and conclusions for resolving the issues. Issue 1: Identify the Operating Segments for SPI. Issue 2: Determination of Reportable Segments Based on the information provided, identify the facts that are useful and develop initial thoughts as to which of SPI s operating segments can be aggregated. Provide support for your initial thoughts regarding aggregation of operating segments and identify additional information that may be needed in order to reach a conclusion.

4 Case 08-5: Sell-it Products Inc. Page 4 HANDOUT 1 Sell-it Products Inc. s Monthly Operating Package Summary by Division MONTHLY OPERATING PACKAGE - SUMMARY BY DIVISION* 2005 YTD (in millions) Beauty Care Family Care Drinks and Snacks Corporate Eliminations Consolidated TOTAL Revenues (2) 304 Cost of Sales (18) (79) (60) - 2 (155) Margin Margin % 70% 40% 48% 49% Operating Expenses (30) (35) (25) (10) (100) Operating Income (10) Interest Expense (9) (8) (2) (3) (22) Other Non-operating Income, net Income Before Income Taxes (12) - 36 Income Taxes (12) Net Income 23 Total Assets Capital Expenditures * - For simplicity, only year-to-date (YTD) results have been provided.

5 Case 08-5: Sell-it Products Inc. Page 5 Sell-it Products Inc. s Monthly Operating Package Summary by Division (cont d) MONTHLY OPERATING PACKAGE - SUMMARY BY DIVISION* 2004 YTD (in millions) Beauty Care Family Care Drinks and Snacks Corporate Eliminations Consolidated TOTAL Revenues (10) 262 Cost of Sales (15) (70) (50) - 10 (124) Margin Margin % 74% 41% 49% 53% Operating Expenses (31) (29) (19) (9) (88) Operating Income (9) Interest Expense (8) (6) (2) (2) (18) Other Non-operating Income, net Income Before Income Taxes (10) - 38 Income Taxes (13) Net Income 25 Total Assets Capital Expenditures YTD (in millions) Beauty Care Family Care Drinks and Snacks Corporate Eliminations Consolidated TOTAL Revenues (9) 235 Cost of Sales (13) (63) (43) - 9 (109) Margin Margin % 75% 42% 50% 54% Operating Expenses (30) (26) (17) (8) (81) Operating Income (8) Interest Expense (7) (5) (2) (2) (16) Other Non-operating Income, net Income Before Income Taxes (9) - 34 Income Taxes (12) Net Income 22 Total Assets Capital Expenditures * - For simplicity, only year-to-date (YTD) results have been provided.

6 Case 08-5: Sell-it Products Inc. Page 6 Sell-it Products Inc. s Monthly Operating Package Summary by Product MONTHLY OPERATING PACKAGE - SUMMARY BY PRODUCT* Revenues 2004 YTD Actual 2003 YTD Actual COS Margin GM % Revenues COS Margin GM % Beauty Care Products Shampoo 18.2 (6.1) % 16.4 (5.6) % Cosmetics 37.3 (8.5) % 33.9 (7.1) % Total Beauty Care 55.5 (14.6) % 50.3 (12.7) % Family Care Products Diapers 19.1 (6.2) % 17.4 (5.7) % Paper Towels (63.7) % 90.9 (56.9) % Total Family Care (69.9) % (62.6) % Drinks and Snacks Products Jazzy Juice 24.8 (20.3) % 22.5 (18.6) % Blasto Energy Drink 63.6 (21.5) % 57.8 (19.9) % Fruit & Granola Snacks 9.4 (7.9) % 5.2 (4.4) % Total Juice and Snacks 97.8 (49.7) % 85.5 (42.9) % 2005 YTD Actual 2006 Forecast Revenues COS Margin GM % Revenues COS Margin GM % Beauty Care Products Shampoo 20.0 (7.0) % 22.0 (7.7) % Cosmetics 41.0 (11.0) % 45.1 (13.2) % Total Beauty Care 61.0 (18.0) % 67.1 (20.9) % Family Care Products Diapers 21.0 (7.0) % 23.1 (7.7) % Paper Towels (72.0) % (79.2) % Total Family Care (79.0) % (86.9) % Drinks and Snacks Products Jazzy Juice 27.3 (22.7) % 30.0 (24.5) % Blasto Energy Drink 70.0 (23.0) % 77.0 (24.5) % Fruit & Granola Snacks 17.0 (14.0) % 30.6 (24.5) % Total Juice and Snacks (59.7) % (73.5) % * - For simplicity, only year-to-date (YTD) results have been provided.