Chapter 12 – financial statement
analysis discussion case
Please complete the financial statement analysis case (Case 1 Merck
and Johnson & Johnson OR Case 2 Analysis of Goodwill). Post your
answer here (by Saturday). Financial Statement Analysis Cases
Case 1: Merck and Johnson & Johnson
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.
(all dollars in millions) Johnson &
Johnson Merc
k Total assets $53,317 $42,5
73 Total revenue ?47,348 ?
9 Net income ??8,509 ??
5,813 Research and development
expense ??5,203 ??
4,010 Intangible assets ?11,842 ??
2,765 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?
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?
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
Case 2: Analysis of Goodwill
As a new intern for the local branch office of a national brokerage firm,
you are excited to get an assignment that allows you to use your
accounting expertise. Your supervisor provides you with the
spreadsheet below, which contains data for the most recent quarter for
three companies that the firm has been recommending to its clients as
“buys.” Each of the companies’ returns on assets has outperformed
their industry cohorts in the past. But, given recent challenges in their
markets, there is concern that the companies may experience
operating challenges and lower earnings. (All numbers in millions,
except return on assets.) Instructions (a)
The fair value for each of these companies is lower than the
corresponding book value. What implications does this have for each
company’s future prospects?
(b) To date, none of these companies has recorded goodwill impairments.
Your supervisor suspects that they will need to record impairments in
the near future, but he is unsure about the goodwill impairment rules.
Is it likely that these companies will recognize impairments? Explain.
Estimate the amount of goodwill impairment for each company and
prepare the journal entry to record the impairment. For each company,
you may assume that the book value less the carrying value of the
goodwill approximates the fair value of the company’s net assets.
Discuss the effects of your entries in part (c) on your evaluation of
these companies based on the return on assets ratio.