Chapter 4, Problem 4.3CP

Comparing Companies within an Industry and Over Time

Refer to the financial statements of American Eagle Outfitters in Appendix B, Urban Outfitters in Appendix C, and the Industry Ratio Report in Appendix D at the end of this book.

Required:

1. 1. What was Advertising Expense for each company for the most recent year? Where did you find this information?
2. 2. Compute the percentage of Advertising Expense to Net Sales ratio (rounded to two decimal places) for most recent year for both companies. Which company incurred the higher percentage? Show computations. Are you able to perform the same comparison for the previous two years? If so, show the computations. If not. explain why not.
3. 3. Compare the Advertising Expense to Net Sales ratio for the most recent year computed in requirement (2) to the industry average found in the Industry Ratio Report (Appendix D). Were these two companies spending more or less than their average competitor on advertising (on a relative basis)? What does this ratio tell you about the general effectiveness of each company’s advertising strategy?
4. 4. Both companies include a note to the financial statements explaining the accounting policy for advertising. How do the policies differ, if at all?
5. 5. Compute each company’s total asset turnover ratio (rounded to three decimal places) for the three years reported. What do your results suggest to you about each company over time and in comparison to each other?
6. 6. Compare each company's total asset turnover ratio for the most recent year to the industry average total asset turnover ratio in the Industry Ratio Report (Appendix D). Were these two companies performing better or worse than the average company in the industry?

To determine

Identify the amount of advertising expense for each company for the most recent year and to identify the source of this information.

Explanation of Solution

The amount of advertising expense for each Company A for the most recent year is $73.1million.

The amount of advertising expense for each Company U for the most recent year is $103.9million.

This information is found from the “Advertising cost” in Appendix B.

This information is found from the “Advertising cost” in Appendix C.

To determine

Compute the percentage of advertising expense to net sales ratio for most recent year for both companies and to show the higher percentage of the Company.

Explanation of Solution

Compute the percentage of advertising expense to net sales ratio for most recent year:

Company A

For the year 2015:

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$94,200}{\$3,282,867}\times 100\\ =2.9\%\end{array}$

For the year 2014:

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$87,000}{\$3,305,802}\times 100\\ =2.6\%\end{array}$

For the year 2013:

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$90,000}{\$3,475,802}\times 100\\ =2.6\%\end{array}$

Company U

For the year 2015:

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$103,882}{\$3,323,077}\times 100\\ =3.1\%\end{array}$

For the year 2014:

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$91,615}{\$3,086,608}\times 100\\ =3.0\%\end{array}$

For the year 2013:

$\begin{array}{c}\text{Percentage of advertising expenses = }\frac{\text{Advertising expense}}{\text{Net sales}}\times 100\\ =\frac{\$81,944}{\$2,794,925}\times 100\\ =2.9\%\end{array}$

Company U has incurred the higher percentage in all three years. Both the company has increased their advertising expense over the three-year period and also increased the advertising expense as a percentage of sales each year.

To determine

Compare the percentage of advertising expense to net sales ratio for most recent year computed in requirement 2 to the industry average found in the Industry ratio report and to see whether these two companies spending more or less than their average competitor on advertising and to say the advertising strategy each company used.

Explanation of Solution

Compare the percentage of advertising expense to net sales ratio for most recent year computed in requirement 2 to the industry average found in the Industry ratio report:

	Industry average	Company A	Company U
Advertising/Sales	4.0%	2.9%	3.1%

Table (1)

The Company A and Company U is spending less on advertising as a percentage of sales than the average company in the industry.  This might indicate that they are more effective at generating lesser sales per dollar which has been spent on advertising.  Another interpretation is that they are weak in supporting their brand, and sales will eventually decrease as their brand loses its value.

To determine

Explain the accounting policy for advertising for both the companies which includes note to the financial statements.

Explanation of Solution

Explain the accounting policy for advertising for both the companies which includes note to the financial statements:

When the marketing campaigns become publicly available both accounting policies are similar by indicating that advertising costs are expensed. Company U capitalizes expenses associated with direct-to-consumer advertising and amortizes these expenses over the expected period of future benefits.

To determine

Compute each company’s total asset turnover ratio for the three years reported and suggest about each company over time and in comparison to each other.

Explanation of Solution

For Company A:

Calculation of total asset turnover for 2015:

$\begin{array}{c}\text{Total asset turnover ratio }=\frac{\text{Sales}\text{revenues}}{\text{Average total assets}}\\ =\frac{\$3,282,867}{\left(\frac{\$1,696,908+\$1,694,164}{2}\right)}\\ =\frac{\$3,282,867}{\$1,695,536}\\ =1.936\end{array}$

Calculation of total asset turnover for 2014:

$\begin{array}{c}\text{Total asset turnover ratio }=\frac{\text{Sales}\text{revenues}}{\text{Average total assets}}\\ =\frac{\$3,305,802}{\left(\frac{\$1,694,164+\$1,756,053}{2}\right)}\\ =\frac{\$3,305,802}{\$1,725,109}\\ =1.916\end{array}$

Calculation of total asset turnover for 2013:\

$\begin{array}{c}\text{Total asset turnover ratio }=\frac{\text{Sales}\text{revenues}}{\text{Average total assets}}\\ =\frac{\$3,475,802}{\left(\frac{\$1,756,053+\$1,950,802}{2}\right)}\\ =\frac{\$3,475,802}{\$1,853,428}\\ =1.875\end{array}$

For Company U:

Calculation of total asset turnover for 2015:

$\begin{array}{c}\text{Total asset turnover ratio }=\frac{\text{Sales}\text{revenues}}{\text{Average total assets}}\\ =\frac{\$3,475,802}{\$2,054,978}\\ =1.617\end{array}$

Calculation of total asset turnover for 2014:

$\begin{array}{c}\text{Total asset turnover ratio }=\frac{\text{Sales}\text{revenues}}{\text{Average total assets}}\\ =\frac{\$3,086,608}{\$2,009,213}\\ =1.536\end{array}$

Calculation of total asset turnover for 2013:

$\begin{array}{c}\text{Total asset turnover ratio }=\frac{\text{Sales}\text{revenues}}{\text{Average total assets}}\\ =\frac{\$2,794,925}{\$1,640,460}\\ =1.704\end{array}$

Company A and Company U has increased their total asset turnover ratios over time and by suggesting more efficient management of assets to generate revenues. In each year, Company A has a higher turnover ratio than Company U, by suggesting more efficiency in asset utilization.

To determine

Compare each company’s total asset turnover ratio for the most recent year to the industry average found in the Industry ratio report and to see whether these two companies spending better or worse than their average company in the industry.

Explanation of Solution

Compare the percentage of total asset turnover ratio for most recent year to the industry average found in the Industry ratio report:

	Industry average	Company A	Company U
Total asset turnover ratio (for fiscal year ended 2015)	2.017	1.936	1.617

Table (2)

The Company A and Company U has lower total asset turnover ratios than the average company in their industry.  This suggests both companies are less effective at utilizing total assets to generate sales.  This ratio is affected by growth strategies in which companies invest in additional property and equipment or other assets, but the new assets are not yet generating sales levels of established stores.

When comparing the total asset turnover ratio of Company A (1.936 times) and Company U (1.617) with the average companies (2.017) in the industry, it is evident that both the Companies A and U are less efficient in utilizing the total assets in order to generate sales.  The growth strategies in which companies have invested in the plant, property and equipment or other assets affects the total asset turnover ratio. However, the new assets are still not generating the sales levels of the established stores.