The final project for XACC 280 is a 1,750 to 2,050-word (about 3 pages, double spaced) paper in which you provide a comprehensive analysis of the financial health of McDonald’s Corporation and whether or not you would invest in McDonald’s Corporation based on the information provided for 2009 and 2010 in their 2010 Annual Financial Report. The paper, with in-text citations and references, must follow APA formatting guidelines. NOTE: The word count does NOT include the charts and calculations at the end of your paper.
Papers need to include: a cover page, section titles, in-text citations, reference page. Your papers should also be edited to remove spelling errors/word errors (using defiantly instead of definitely for example), paragraph breaks (not one long paragraph), double-spaced, good sentence structure and clearly stated and well supported (with sources) points.
The final project is designed so you can apply the concepts and skills learned in this course to a real-life financial accounting analysis. It incorporates your foundational knowledge—resulting from completion of Discussion questions, Check Points, Exercises, and Assignments—into a paper that describes your financial analyses and conclusion. When navigating each week, keep your final project in mind to help you to prepare and gather needed information.
The paper will include the following (do NOT include calculations within the paper, only the results should be stated and discussed). All calculations should be formatted and included after the concluding paragraph (see below):
Before you begin writing, complete and review all of your calculations first since you will need the results to include in the writing of your paper.
• An introductory paragraph with:
o A statement of the purpose of your paper.
o A synopsis of what readers can expect to find in the paper. It is best to write this after writing the rest of the paper.
• Your explanation of your calculated results in words of at least two Vertical analyses for McDonald’s Corporation.
• Your explanation in words of at least two Horizontal analyses for McDonald’s Corporation.
• Your explanation in words of at least two of each of the Ratio analyses for McDonald’s Corporation, including a test of:
o Explain in words your calculated results of the two ratio tests of Liquidity.
o Explain in words your calculated results of the two ratio tests of Solvency.
o Explain in words your calculated results of the two ratio tests of Profitability.
• NOTE: ONLY USE THE RATIOS PROVIDED IN OUR TEXT (pg 716 – Illustration 15-27), NOT AS A RESULT OF GOOGLE SEARCHES.
• Describe and clearly explain at least two strengths in different areas for McDonald’s Corporation other than using the revenue or net income information.
o Incorporate the data and other information you used to determine each area of strength.
• Describe and clearly explain at least two areas of improvement that McDonald’s Corporation should make to improve its financial health. There can be other nonfinancial areas that fast food stores can improve, but be sure to clearly link these areas to how they would improve McDonald’s financial health.
o Incorporate the data and other information you used to determine each area of improvement.
• If you had money to invest in a company, describe whether or not you would invest in McDonald’s Corporation stock and clearly explain your reasons. State at least two reasons (different from your list of strengths above). Support those reasons with factual information and include the source(s). Your opinion is important, but your opinion should be supported with factual information either from the Annual Report, articles about McDonald’s Corporation or even comparative data from another fast food chain (include the source). (Resist the urge to say you would not invest because you would use the money for something else or that you do not understand investing). All responses must be in the context of McDonald’s financial position in order to earn credit.)
• A concluding paragraph that summarizes your paper. This should be a separate paragraph at the end of your paper.
• After your conclusion in a separate section, include your calculations for all of the analyses and ratios.
o Vertical – You can use your calculations from the Week 7 Check Point, providing you show your work.
o Horizontal – You can use your calculations from the Week 7 Check Point, providing you show your work.
o Liquidity – You can use the Current Ratios you computed in the Week 7 Check Point and select another ratio from that section on pg 716. Show your work.
o Solvency – Use the two ratios on pg 716 in that section and show your work.
o Profitability – Use at least two ratios from that section on pg 716 and show your work.
• After your calculations, then include the list of your references.
696
Chapter 15
Financial Statement
Analysis
Scan Study Objectives ■
Read Feature Story ■
Read Preview ■
Read text and answer Before You Go On
p. 705 ■ p. 716 ■ p. 721 ■
p. 724 ■
Work Demonstration Problems ■
Review Summary of Study Objectives ■
Answer Self-Study Questions ■
Complete Assignments ■
After studying this chapter, you should be
able to:
1 Discuss the need for comparative
analysis.
2 Identify the tools of financial
statement
analysis.
3 Explain and apply horizontal analysis.
4 Describe and apply vertical analysis.
5 Identify and compute ratios used in
analyzing a firm’s liquidity, profitability,
and solvency.
6 Understand the concept of earning
power, and how irregular items are
presented.
7
Understand the concept of
quality of earnings.
The NavigatorS T U D Y O B J E C T I V E S ✓
Feature Story
“FOLLOW THAT STOCK!”
If you thought cab drivers with cell phones were scary, how about a cab
driver with a trading desk in the front seat?
When a stoplight turns red or traffic backs up, New York City cabby Carlos
Rubino morphs into a day trader, scanning real-time quotes of his favorite
stocks as they spew across a PalmPilot mounted next to the steering wheel.
“It’s kind of stressful,” he says, “but I like it.”
Itching to know how a particular stock is doing? Mr. Rubino is happy to look
up quotes for passengers. Yahoo! and Amazon.com are two of the most
requested ones. He even lets customers use his laptop computer to send
The Navigator✓
697
urgent e-mails from the back
seat. Aware of a local law pro-
hibiting cabbies from using cell
phones while they’re driving,
Mr. Rubino extends that rule to
his trading. “I stop the cab at
the side of the road if I have
to make a trade,” he says.
“Safety first.”
Originally from São Paulo,
Brazil, Mr. Rubino has been
driving his cab since 1987, and
started trading stocks a fe
w
years ago. His curiosity grew as he began to educate himself by reading
business publications. The Wall Street brokers he picks up are usually
impressed with his knowledge, he says. But the feeling generally isn’t
mutual. Some of them “don’t know much,” he says. “They buy what people
tell them to buy—they’re like a toll collector.”
Mr. Rubino is an enigma to his fellow cab drivers. A lot of his colleagues say
they want to trade too. “But cab drivers are a little cheap,” he says. “The [real-
time] quotes cost $100 a month. The wireless Internet access is $54 a month.”
Will he give up his brokerage firm on wheels for a stationary job? Not likely.
Though he claims a 70% return on his investments in some months, he says
he makes $1,300 and up a week driving his cab—more than he does trading.
Besides, he adds, “Why go somewhere and have a boss?”
Source: Excerpted from Barbara Boydston, “With This Cab, People Jump in and Shout,
‘Follow that Stock!’,” Wall Street Journal, August 18, 1999, p. C1. Reprinted by permission
of the Wall Street Journal © 1999 Dow Jones & Company, Inc. All Rights Reserved Worldwide.
The Navigator✓
Inside Chapter 15
• How to Manage the Current Ratio (p. 707)
• Keeping Up to Date as an Investor (p. 715)
• What Is Extraordinary? (p. 720)
• All About You: Should I Play the Market Yet? (p.
723
)
BASICS OF FINANCIAL STATEMENT ANALYSIS
Preview of Chapter 15
We can learn an important lesson from the Feature Story: Experience is the best teacher. By now you have
learned a significant amount about financial reporting by U.S. companies. Using some of the basic deci-
sion tools presented in this book, you can perform a rudimentary analysis on any U.S. company and draw
basic conclusions about its financial health. Although it would not be wise for you to bet your life savings
on a company’s stock relying solely on your current level of knowledge, we strongly encourage you to prac-
tice your new skills wherever possible. Only with practice will you improve your ability to interpret financial
numbers.
Before unleashing you on the world of high finance, we will present a few more important concepts and
techniques, as well as provide you with one more comprehensive review of corporate financial statements.
We use all of the decision tools presented in this text to analyze a single company—J.C. Penney Company,
one of the country’s oldest and largest retail store chains.
The content and organization of Chapter 15 are as follows.
Financial Statement Analysis
Basics of Financial
Statement Analysis
• Need for
comparative
analysis
• Tools of analysis
Ratio Analysis
• Liquidity
• Profitability
• Solvency
• Summary
Horizontal and
Vertical Analysis
• Balance sheet
• Income statement
• Retained earnings
statement
Earning Power and
Irregular Items
• Discontinued
operations
•
Extraordinary items
• Changes in
accounting principle
• Comprehensive
income
Quality of Earnings
• Alternative account-
ing methods
• Pro forma income
• Improper
recognition
The Navigator✓
Analyzing financial statements involves evaluating three characteristics: a com-
pany’s liquidity, profitability, and solvency. A short-term creditor, such as a bank, is
primarily interested in liquidity—the ability of the borrower to pay obligations
when they come due. The liquidity of the borrower is extremely important in eval-
uating the safety of a loan. A long-term creditor, such as a bondholder, looks to
profitability and solvency measures that indicate the company’s ability to survive
over a long period of time. Long-term creditors consider such measures as the
amount of debt in the company’s capital structure and its ability to meet interest
payments. Similarly, stockholders look at the profitability and solvency of the com-
pany. They want to assess the likelihood of dividends and the growth potential of
the stock.
Need for Comparative Analysis
Every item reported in a financial statement has significance. When J.C.
Penney Company, Inc. reports cash of $3,016 million on its balance sheet,
we know the company had that amount of cash on the balance sheet date.
But, we do not know whether the amount represents an increase over
Discuss the need for comparative
analysis.
S T U D Y O B J E C T I V E 1
698
prior years, or whether it is adequate in relation to the company’s need for cash. To
obtain such information, we need to compare the amount of cash with other finan-
cial statement data.
Comparisons can be made on a number of different bases. Three are illustrated
in this chapter:
1. Intracompany basis. This basis compares an item or financial relationship
within a company in the current year with the same item or relationship in one
or more prior years. For example, J.C. Penney can compare its cash balance at
the end of the current year with last year’s balance to find the amount of the in-
crease or decrease. Likewise, J.C. Penney can compare the percentage of cash
to current assets at the end of the current year with the percentage in one or
more prior years. Intracompany comparisons are useful in detecting changes in
financial relationships and significant trends.
2. Industry averages. This basis compares an item or financial relationship of a
company with industry averages (or norms) published by financial ratings or-
ganizations such as Dun & Bradstreet, Moody’s, and Standard & Poor’s. For
example, J.C. Penney’s net income can be compared with the average net in-
come of all companies in the retail chain-store industry. Comparisons with in-
dustry averages provide information as to a company’s relative performance
within the industry.
3. Intercompany basis. This basis compares an item or financial relationship of
one company with the same item or relationship in one or more competing
companies. Analysts make these comparisons on the basis of the published fi-
nancial statements of the individual companies. For example, we can compare
J.C. Penney’s total sales for the year with the total sales of a major competitor
such as Kmart. Intercompany comparisons are useful in determining a com-
pany’s competitive position.
Tools of Analysis
We use various tools to evaluate the significance of financial statement
data. Three commonly used tools are these:
• Horizontal analysis evaluates a series of financial statement data over
a period of time.
• Vertical analysis evaluates financial statement data by expressing each item in
a financial statement as a percent of a base amount.
• Ratio analysis expresses the relationship among selected items of financial
statement data.
Horizontal analysis is used primarily in intracompany comparisons. Two fea-
tures in published financial statements facilitate this type of comparison: First, each
of the basic financial statements presents comparative financial data for a mini-
mum of two years. Second, a summary of selected financial data is presented for a
series of five to ten years or more. Vertical analysis is used in both intra- and inter-
company comparisons. Ratio analysis is used in all three types of comparisons. In the
following sections, we explain and illustrate each of the three types of analysis.
Horizontal Analysis 699
XYZ
Co.
2008 ↔ 2009
Intracompany
XYZ
Co.
Industry averages
A
Co.
B
Co.
C
Co.
A + B + C
3
⎫
⎪
⎪
⎪
⎪
⎪
⎪
⎬
⎪
⎪
⎪
⎪
⎪
⎪
⎭
XYZ
Co.
A
Co.
Intercompany
Identify the tools of financial
statement analysis.
S T U D Y O B J E C T I V E 2
HORIZONTAL ANALYSIS
Horizontal analysis, also called trend analysis, is a technique for evaluat-
ing a series of financial statement data over a period of time. Its purpose is
to determine the increase or decrease that has taken place. This change
Explain and apply horizontal
analysis.
S T U D Y O B J E C T I V E 3
may be expressed as either an amount or a percentage. For example, the recent net
sales figures of J.C. Penney Company are as follows.
700 Chapter 15 Financial Statement Analysis
J.C. PENNEY COMPANY
Net Sales (in millions)
2005 2004 2003
$18,781 $18,096 $17,513
If we assume that 2003 is the base year, we can measure all percentage in-
creases or decreases from this base period amount as follows.
Illustration 15-1
J.C. Penney Company’s
net sales
Illustration 15-2
Formula for horizontal
analysis of changes since
base period
Illustration 15-3
Formula for horizontal
analysis of current year in
relation to base year
Illustration 15-4
Horizontal analysis of
J.C. Penney Company’s
net sales in relation to
base period
Change Since
�
Current Year Amount � Base Year Amount
Base Period Base Year Amount
For example, we can determine that net sales for J.C. Penney increased from 2003
to 2004 approximately 3.3% [($18,096 � $17,513) � $17,513]. Similarly, we can de-
termine that net sales increased from 2003 to 2005 approximately 7.2% [($18,781 �
$17,513) � $17,513].
Alternatively, we can express current year sales as a percentage of the base pe-
riod. We do this by dividing the current year amount by the base year amount, as
shown below.
Current Results in
�
Current Year Amount
Relation to Base Period Base Year Amount
Illustration 15-4 presents this analysis for J.C. Penney for a three-year period using
2003 as the base period.
J.C. PENNEY COMPANY
Net Sales (in millions)
in relation to base period 2003
2005 2004 2003
$18,781 $18,096 $17,513
107.2% 103.3% 100.0%
Balance Sheet
To further illustrate horizontal analysis, we will use the financial statements of
Quality Department Store Inc., a fictional retailer. Illustration 15-5 presents a
horizontal analysis of its two-year condensed balance sheets, showing dollar and
percentage changes.
The comparative balance sheets in Illustration 15-5 show that a number of sig-
nificant changes have occurred in Quality Department Store’s financial structure
from 2004 to 2005:
• In the assets section, plant assets (net) increased $167,500, or 26.5%.
• In the liabilities section, current liabilities increased $41,500, or 13.7%.
• In the stockholders’ equity section, retained earnings increased $202,600, or
38.6%.
These changes suggest that the company expanded its asset base during 2005 and
financed this expansion primarily by retaining income rather than assuming addi-
tional long-term debt.
Income Statement
Illustration 15-6 (page 702) presents a horizontal analysis of the two-year con-
densed income statements of Quality Department Store Inc. for the years 2005 and
2004. Horizontal analysis of the income statements shows the following changes:
•
Net sales
increased $260,000, or 14.2% ($260,000 � $1,837,000).
• Cost of goods sold increased $141,000, or 12.4% ($141,000 � $1,140,000).
• Total operating expenses increased $37,000, or 11.6% ($37,000 � $320,000).
Overall, gross profit and net income were up substantially. Gross profit increased
17.1%, and net income, 26.5%. Quality’s profit trend appears favorable.
Horizontal Analysis 701
Illustration 15-5
Horizontal analysis of
balance sheets
QUALITY DEPARTMENT STORE INC.
Condensed Balance Sheets
December 31
Increase or (Decrease)
during 2005
2005 2004 Amount Percent
Assets
Current assets $1,020,000 $ 945,000 $ 75,000 7.9%
Plant assets (net) 800,000 632,500 167,500 26.5%
Intangible assets 15,000 17,500 (2,500) (14.3%)
Total assets
$1,835,000 $1,595,000 $240,000 15.0%
Liabilities
Current liabilities $ 344,500 $ 303,000 $ 41,500 13.7%
Long-term liabilities 487,500 497,000 (9,500) (1.9%)
Total liabilities 832,000 800,000 32,000 4.0%
Stockholders’ Equity
Common stock, $1 par 275,400 270,000 5,400 2.0%
Retained earnings 727,600 525,000 202,600 38.6%
Total stockholders’ equity 1,003,000 795,000 208,000 26.2%
Total liabilities and
stockholders’ equity $1,835,000 $1,595,000 $240,000 15.0%
Retained Earnings Statement
Illustration 15-7 presents a horizontal analysis of Quality Department Store’s com-
parative retained earnings statements. Analyzed horizontally, net income increased
$55,300, or 26.5%, whereas dividends on the common stock increased only $1,200,
or 2%. We saw in the horizontal analysis of the balance sheet that ending retained
earnings increased 38.6%. As indicated earlier, the company retained a significant
portion of net income to finance additional plant facilities.
702 Chapter 15 Financial Statement Analysis
Illustration 15-6
Horizontal analysis of
income statements
QUALITY DEPARTMENT STORE INC.
Condensed Income Statements
For the Years Ended December 31
Increase or (Decrease)
during 2005
2005 2004 Amount Percent
Sales $2,195,000 $1,960,000 $235,000 12.0%
Sales returns and allowances 98,000 123,000 (25,000) (20.3%)
Net sales 2,097,000 1,837,000 260,000 14.2%
Cost of goods sold 1,281,000 1,140,000 141,000 12.4%
Gross profit 816,000 697,000 119,000 17.1%
Selling expenses 253,000 211,500 41,500 19.6%
Administrative expenses 104,000 108,500 (4,500) (4.1%)
Total operating expenses 357,000 320,000 37,000 11.6%
Income from operations 459,000 377,000 82,000 21.8%
Other revenues and gains
Interest and dividends 9,000 11,000 (2,000) (18.2%)
Other expenses and losses
Interest expense 36,000 40,500 (4,500) (11.1%)
Income before income taxes 432,000 347,500 84,500 24.3%
Income tax expense 168,200 139,000 29,200 21.0%
Net income $ 263,800 $ 208,500 $ 55,300 26.5%
Illustration 15-7
Horizontal analysis of
retained earnings statements
QUALITY DEPARTMENT STORE INC.
Retained Earnings Statements
For the Years Ended December 31
Increase or (Decrease)
during 2005
2005 2004 Amount Percent
Retained earnings, Jan. 1 $525,000 $376,500 $148,500 39.4%
Add: Net income 263,800 208,500 55,300 26.5%
788,800 585,000 203,80
0
Deduct: Dividends 61,200 60,000 1,200 2.0%
Retained earnings, Dec. 31 $727,600 $525,000 $202,600 38.6%
H E L P F U L H I N T
Note that though the
amount column is addi-
tive (the total is $55,300),
the percentage column is
not additive (26.5% is
not the total). A separate
percentage has been cal-
culated for each item.
Horizontal analysis of changes from period to period is relatively straightfor-
ward and is quite useful. But complications can occur in making the computations.
If an item has no value in a base year or preceding year but does have a value in the
next year, we cannot compute a percentage change. Similarly, if a negative amount
appears in the base or preceding period and a positive amount exists the following
year (or vice versa), no percentage change can be computed.
Vertical Analysis 703
VERTICAL ANALYSIS
Vertical analysis, also called common-size analysis, is a technique that ex-
presses each financial statement item as a percent of a base amount. On a
balance sheet we might say that current assets are 22% of total assets—
total assets being the base amount. Or on an income statement, we might
say that selling expenses are 16% of net sales—net sales being the base amount.
Balance Sheet
Illustration 15-8 presents the vertical analysis of Quality Department Store Inc.’s
comparative balance sheets. The base for the asset items is total assets. The base for
the liability and stockholders’ equity items is total liabilities and stockholders’ equity.
Describe and apply vertical
analysis.
S T U D Y O B J E C T I V E 4
Illustration 15-8
Vertical analysis of balance
sheets
QUALITY DEPARTMENT STORE INC.
Condensed Balance Sheets
December 31
2005 2004
Amount Percent Amount Percent
Assets
Current assets $1,020,000 55.6% $ 945,000 59.2%
Plant assets (net) 800,000 43.6% 632,500 39.7%
Intangible assets 15,000 0.8% 17,500 1.1%
Total assets $1,835,000 100.0% $1,595,000 100.0%
Liabilities
Current liabilities $ 344,500 18.8% $ 303,000
19.0%
Long-term liabilities 487,500 26.5% 497,000 31.2%
Total liabilities 832,000 45.3% 800,000 50.2%
Stockholders’ Equity
Common stock, $1 par 275,400 15.0% 270,000 16.9%
Retained earnings 727,600 39.7% 525,000 32.9%
Total stockholders’ equity 1,003,000 54.7% 795,000 49.8%
Total liabilities and
stockholders’ equity $1,835,000 100.0% $1,595,000 100.0%
Vertical analysis shows the relative size of each category in the balance sheet.
It also can show the percentage change in the individual asset, liability, and stock-
holders’ equity items. For example, we can see that current assets decreased from
59.2% of total assets in 2004 to 55.6% in 2005 (even though the absolute dollar
amount increased $75,000 in that time). Plant assets (net) have increased from
39.7% to 43.6% of total assets. Retained earnings have increased from 32.9% to
39.7% of total liabilities and stockholders’ equity. These results reinforce the ear-
lier observations that Quality is choosing to finance its growth through retention of
earnings rather than through issuing additional debt.
Income Statement
Illustration 15-9 (page 704) shows vertical analysis of Quality’s income statements.
Cost of goods sold as a percentage of net sales declined 1% (62.1% vs. 61.1%), and
H E L P F U L H I N T
The formula for calculat-
ing these balance sheet
percentages is:
= %
Each item on B/S
��
Total assets
total operating expenses declined 0.4% (17.4% vs. 17.0%). As a result, it is not sur-
prising to see net income as a percent of net sales increase from 11.4% to 12.6%.
Quality appears to be a profitable enterprise that is becoming even more successful.
704 Chapter 15 Financial Statement Analysis
Illustration 15-9
Vertical analysis of income
statements
QUALITY DEPARTMENT STORE INC.
Condensed Income Statements
For the Years Ended December 31
2005 2004
Amount Percent Amount Percent
Sales $2,195,000 104.7% $1,960,000 106.7%
Sales returns and allowances 98,000 4.7% 123,000 6.7%
Net sales 2,097,000 100.0% 1,837,000 100.0%
Cost of goods sold 1,281,000 61.1% 1,140,000 62.1%
Gross profit 816,000 38.9% 697,000 37.9%
Selling expenses 253,000 12.0% 211,500 11.5%
Administrative expenses 104,000 5.0% 108,500 5.9%
Total operating expenses 357,000 17.0% 320,000 17.4%
Income from operations 459,000 21.9% 377,000 20.5%
Other revenues and gains
Interest and dividends 9,000 0.4% 11,000 0.6%
Other expenses and losses
Interest expense 36,000 1.7% 40,500 2.2%
Income before income taxes 432,000 20.6% 347,500 18.9%
Income tax expense 168,200 8.0% 139,000 7.5%
Net income $ 263,800 12.6% $ 208,500 11.4%
An associated benefit of vertical analysis is that it enables you to compare com-
panies of different sizes. For example, Quality’s main competitor is a JC Penney store
in a nearby town. Using vertical analysis, we can compare the condensed income state-
ments of Quality Department Store Inc. (a small retail company) with J.C. Penney
Company, Inc. (a giant international retailer), as shown in Illustration 15-10.
Illustration 15-
10
Intercompany income state-
ment comparison
CONDENSED INCOME STATEMENTS
(in thousands)
Quality Department J. C. Penney
Store Inc. Company1
Dollars Percent Dollars Percent
Net sales $2,097 100.0% $18,781,000 100.0%
Cost of goods sold 1,281 61.1% 11,405,000 60.7%
Gross profit 816 38.9% 7,376,000 39.3%
Selling and administrative expenses 357 17.0% 5,799,000 30.9%
Income from operations 459 21.9% 1,577,000 8.4%
Other expenses and revenues
(including income taxes) 195 9.3% 489,000 2.6%
Net income $ 264 12.6% $ 1,088,000 5.8%
1
2005 Annual Report J.C. Penney Company, Inc. (Dallas, Texas).
H E L P F U L H I N T
The formula for calculat-
ing these income state-
ment percentages is:
� %
Each item on I/S
��
Net sales
J.C. Penney’s net sales are 8,956 times greater than the net sales of relatively
tiny Quality Department Store. But vertical analysis eliminates this difference in
size. The percentages show that Quality’s and J.C. Penney’s gross profit rates were
comparable at 38.9% and 39.3%. However, the percentages related to income from
operations were significantly different at 21.9% and 8.4%. This disparity can be at-
tributed to Quality’s selling and administrative expense percentage (17%) which is
much lower than J.C. Penney’s (30.9%). Although J.C. Penney earned net income
more than 4,121 times larger than Quality’s, J.C. Penney’s net income as a percent
of each sales dollar (5.8%) is only 46% of Quality’s (12.6%).
Ratio Analysis 705
REVIEW IT
1. What are the different tools that might be used to compare financial infor-
mation?
2. What is horizontal analysis?
3. What is vertical analysis?
4. Identify the specific sections in PepsiCo’s 2005 annual report where hori-
zontal and vertical analysis of financial data is presented. The answer to this
question is provided on page 747.
DO IT
Summary financial information for Rosepatch Company is as follows.
December 31, 2008 December 31, 2007
Current assets $234,000 $180,000
Plant assets (net) 756,000 420,000
Total assets $990,000 $600,000
Compute the amount and percentage changes in 2008 using horizontal analysis,
assuming 2007 is the base year.
Action Plan
■ Find the percentage change by dividing the amount of the increase by the
2007 amount (base year).
Solution
Increase in 2008
Amount Percent
Current assets $ 54,000 30% [($234,000 � $180,000) � $180,000]
Plant assets (net) 336,000 80% [($756,000 � $420,000) � $420,000]
Total assets $390,000 65% [($990,000 � $600,000) � $600,000]
Related exercise material: BE15-2, BE15-3, BE15-5, BE15-6, BE15-7, E15-1, E15-3, and E15-4.
Before You Go On…
The Navigator✓
RATIO ANALYSIS
Ratio analysis expresses the relationship among selected items of financial state-
ment data. A ratio expresses the mathematical relationship between one quantity
and another. The relationship is expressed in terms of either a percentage, a rate, or
a simple proportion. To illustrate, in 2005 Nike, Inc., had current assets of $6,351.1
million and current liabilities of $1,999.2 million. We can find the relation-
ship between these two measures by dividing current assets by current li-
abilities. The alternative means of expression are:
Percentage: Current assets are 318% of current liabilities.
Rate: Current assets are 3.18 times current liabilities.
Proportion: The relationship of current assets to liabilities is 3.18:1.
To analyze the primary financial statements, we can use ratios to evaluate liq-
uidity, profitability, and solvency. Illustration 15-11 describes these classifications.
706 Chapter 15 Financial Statement Analysis
Solvency Ratios
Measure the ability of
the company to survive
over a long period of time
Profitability Ratios
Measure the income or
operating success of a company
for a given period of time– =
Net
incomeRevenues Expenses
XYZ Co.
Founded in 1892
Liquidity Ratios
Measure short-term ability
of the company to pay its
maturing obligations and to
meet unexpected needs for cash
Illustration 15-11
Financial ratio classifications
Ratios can provide clues to underlying conditions that may not be apparent
from individual financial statement components. However, a single ratio by itself is
not very meaningful. Thus, in the discussion of ratios we will use the following types
of comparisons.
1. Intracompany comparisons for two years for Quality Department Store.
2. Industry average comparisons based on median ratios for department stores.
3. Intercompany comparisons based on J.C. Penney Company as Quality De-
partment Store’s principal competitor.
Liquidity Ratios
Liquidity ratios measure the short-term ability of the company to pay its matur-
ing obligations and to meet unexpected needs for cash. Short-term creditors
such as bankers and suppliers are particularly interested in assessing liquidity.
The ratios we can use to determine the enterprise’s short-term debt-paying abil-
ity are the current ratio, the acid-test ratio, receivables turnover, and inventory
turnover.
1. CURRENT RATIO
The current ratio is a widely used measure for evaluating a company’s liquidity and
short-term debt-paying ability. The ratio is computed by dividing current assets by
current liabilities. Illustration 15-12 shows the 2005 and 2004 current ratios for
Quality Department Store and comparative data.
Identify and compute ratios used
in analyzing a firm’s liquidity,
profitability, and solvency.
S T U D Y O B J E C T I V E 5
Ratio Analysis 707
Current Assets
Current Ratio �
Current Liabilities
Quality Department Store
2005 2004
$1,020,000
� 2.96�1
$945,000
$344,500 $303,000
� 3.12�1
Industry average J.C. Penney Company
1.28�1 5.72�1
Illustration 15-12
Current ratio
What does the ratio actually mean? The 2005 ratio of 2.96:1 means that for
every dollar of current liabilities, Quality has $2.96 of current assets. Quality’s cur-
rent ratio has decreased in the current year. But, compared to the industry average
of 1.28:1, Quality appears to be reasonably liquid. J.C. Penney has a very high cur-
rent ratio of 5.72 which indicates it has considerable current assets relative to its
current liabilities.
The current ratio is sometimes referred to as the working capital ratio; working
capital is current assets minus current liabilities. The current ratio is a more de-
pendable indicator of liquidity than working capital. Two companies with the same
amount of working capital may have significantly different current ratios.
The current ratio is only one measure of liquidity. It does not take into account
the composition of the current assets. For example, a satisfactory current ratio does
not disclose the fact that a portion of the current assets may be tied up in slow-
moving inventory. A dollar of cash would be more readily available to pay the bills
than a dollar of slow-moving inventory.
H E L P F U L H I N T
Can any company oper-
ate successfully without
working capital? Yes, if it
has very predictable cash
flows and solid earnings.
A number of companies
(e.g., Whirlpool, American
Standard, and Campbell’s
Soup) are pursuing this
goal. The rationale: Less
money tied up in working
capital means more
money to invest in the
business.
ACCOUNTING ACROSS THE ORGANIZATION
How to Manage the Current Ratio
The apparent simplicity of the current ratio can have real-world limitations. An
addition of equal amounts to both the numerator and the denominator causes
the ratio to change.
Assume, for example, that a company has $2,000,000 of current assets and $1,000,000 of
current liabilities. Its current ratio is 2:1. If it purchases $1,000,000 of inventory on account, it will
have $3,000,000 of current assets and $2,000,000 of current liabilities. Its current ratio will
decrease to 1.5:1. If, instead, the company pays off $500,000 of its current liabilities, it will have
$1,500,000 of current assets and $500,000 of current liabilities, and its current ratio will increase
to 3:1. Thus, any trend analysis should be done with care, because the ratio is susceptible to
quick changes and is easily influenced by management.
How might management influence the company’s current ratio?
2. ACID-TEST RATIO
The acid-test (quick) ratio is a measure of a company’s immediate short-term liq-
uidity. We compute this ratio by dividing the sum of cash, short-term investments,
and net receivables by current liabilities. Thus, it is an important complement to the
current ratio. For example, assume that the current assets of Quality Department
Store for 2005 and 2004 consist of the items shown in Illustration 15-13 (page 708).
A L T E R N A T I V E
T E R M I N O L O G Y
The acid-test ratio is also
called the quick ratio.
Cash, short-term investments, and receivables (net) are highly liquid compared
to inventory and prepaid expenses. The inventory may not be readily saleable, and
the prepaid expenses may not be transferable to others. Thus, the acid-test ratio
measures immediate liquidity. The 2005 and 2004 acid-test ratios for Quality
Department Store and comparative data are as follows.
708 Chapter 15 Financial Statement Analysis
Illustration 15-13
Current assets of Quality
Department Store
QUALITY DEPARTMENT STORE INC.
Balance Sheet (partial)
2005 2004
Current assets
Cash $ 100,000 $155,000
Short-term investments 20,000 70,000
Receivables (net*) 230,000 180,000
Inventory 620,000 500,000
Prepaid expenses 50,000 40,000
Total current assets $1,020,000 $945,000
*Allowance for doubtful accounts is $10,000 at the end of each year.
Cash � Short-Term Investments � Receivables (Net)Acid-Test Ratio �
Current Liabilities
Quality Department Store
2005 2004
$100,000 � $20,000 � $230,000
� 1.02�1
$155,000 � $70,000 � $180,000
� 1.34�1
$344,500 $303,000
Industry average J.C. Penney Company
0.33�1 1.19�1
The ratio has declined in 2005. Is an acid-test ratio of 1.02:1 adequate? This de-
pends on the industry and the economy. When compared with the industry average
of 0.33:1 and Penney’s of 1.19:1, Quality’s acid-test ratio seems adequate.
3. RECEIVABLES TURNOVER
We can measure liquidity by how quickly a company can convert certain assets to
cash. How liquid, for example, are the receivables? The ratio used to assess the liq-
uidity of the receivables is receivables turnover. It measures the number of times, on
average, the company collects receivables during the period. We compute receiv-
ables turnover by dividing net credit sales (net sales less cash sales) by the average
net receivables. Unless seasonal factors are significant, average net receivables can
be computed from the beginning and ending balances of the net receivables.2
Assume that all sales are credit sales. The balance of net receivables at the
beginning of 2004 is $200,000. Illustration 15-15 shows the receivables turnover
for Quality Department Store and comparative data. Quality’s receivables
turnover improved in 2005. The turnover of 10.2 times is substantially lower than
J.C. Penney’s 69 times, but is similar to the department store industry’s average of
10.8 times.
Illustration 15-14
Acid-test ratio
2
If seasonal factors are significant, the average receivables balance might be determined by using
monthly amounts.
Average Collection Period. A popular variant of the receivables turnover ratio
is to convert it to an average collection period in terms of days. To do so, we divide
the receivables turnover ratio into 365 days. For example, the receivables turnover
of 10.2 times divided into 365 days gives an average collection period of approxi-
mately 36 days. This means that receivables are collected on average every 36 days,
or about every 5 weeks. Analysts frequently use the average collection period to as-
sess the effectiveness of a company’s credit and collection policies. The general rule
is that the collection period should not greatly exceed the credit term period (the
time allowed for payment).
4. INVENTORY TURNOVER
Inventory turnover measures the number of times, on average, the inventory is sold
during the period. Its purpose is to measure the liquidity of the inventory. We com-
pute the inventory turnover by dividing cost of goods sold by the average inven-
tory. Unless seasonal factors are significant, we can use the beginning and ending
inventory balances to compute average inventory.
Assuming that the inventory balance for Quality Department Store at the
beginning of 2004 was $450,000, its inventory turnover and comparative data are
as shown in Illustration 15-16. Quality’s inventory turnover declined slightly in
2005. The turnover of 2.3 times is relatively low compared with the industry av-
erage of 6.7 and J.C. Penney’s 3.6. Generally, the faster the inventory turnover,
the less cash a company has tied up in inventory and the less the chance of in-
ventory obsolescence.
Ratio Analysis 709
Net Credit Sales
Receivables Turnover �
Average Net Receivables
Quality Department Store
2005 2004
$2,097,000 $1,837,000
$180,000 � $230,000
� 10.2 times
$200,000 � $180,000
� 9.7 times
2 2
Industry average J.C. Penney Company
10.8 times 69 times
[ [ [
[
Illustration 15-15
Receivables turnover
Cost of Goods Sold
Inventory Turnover �
Average Inventory
Quality Department Store
2005 2004
$1,281,000 $1,140,000
$500,000 � $620,000
� 2.3 times
$450,000 � $500,000
� 2.4 times
2 2
Industry average J.C. Penney Company
6.7 times 3.6 times
[ [ [ [
Illustration 15-16
Inventory turnover
Days in Inventory. A variant of inventory turnover is the days in inventory. We
calculate it by dividing the inventory turnover into 365. For example, Quality’s 2005
inventory turnover of 2.3 times divided into 365 is approximately 159 days. An
average selling time of 159 days is also relatively high compared with the industry
average of 54.5 days (365 � 6.7) and J.C. Penney’s 101.4 days (365 � 3.6).
Inventory turnover ratios vary considerably among industries. For example,
grocery store chains have a turnover of 10 times and an average selling period of 37
days. In contrast, jewelry stores have an average turnover of 1.3 times and an aver-
age selling period of 281 days.
Profitability Ratios
Profitability ratios measure the income or operating success of a company for a
given period of time. Income, or the lack of it, affects the company’s ability to
obtain debt and equity financing. It also affects the company’s liquidity position
and the company’s ability to grow. As a consequence, both creditors and
investors are interested in evaluating earning power—profitability. Analysts
frequently use profitability as the ultimate test of management’s operating
effectiveness.
5. PROFIT MARGIN
Profit margin is a measure of the percentage of each dollar of sales that results in
net income. We can compute it by dividing net income by net sales. Illustration 15-17
shows Quality Department Store’s profit margin and comparative data.
710 Chapter 15 Financial Statement Analysis
Net Income
Profit Margin �
Net Sales
Quality Department Store
2005 2004
$263,800 $208,500
$2,097,000
� 12.6%
$1,837,000
� 11.4%
Industry average J.C. Penney Company
3.6% 3.7%
Illustration 15-17
Profit margin
Quality experienced an increase in its profit margin from 2004 to 2005. Its
profit margin is unusually high in comparison with the industry average of 3.6%
and J.C. Penney’s 3.7%.
High-volume (high inventory turnover) enterprises such as grocery stores
(Safeway or Kroger) and discount stores (Kmart or Wal-Mart) generally experi-
ence low profit margins. In contrast, low-volume enterprises such as jewelry
stores (Tiffany & Co.) or airplane manufacturers (Boeing Co.) have high profit
margins.
6. ASSET TURNOVER
Asset turnover measures how efficiently a company uses its assets to generate
sales. It is determined by dividing net sales by average assets. The resulting number
shows the dollars of sales produced by each dollar invested in assets. Unless sea-
sonal factors are significant, we can use the beginning and ending balance of total
assets to determine average total assets. Assuming that total assets at the beginning
of 2004 were $1,446,000, the 2005 and 2004 asset turnover for Quality Department
Store and comparative data are shown in Illustration 15-18.
A L T E R N A T I V E
T E R M I N O L O G Y
Profit margin is also
called the rate of return
on sales.
Asset turnover shows that in 2005 Quality generated sales of $1.22 for each dollar
it had invested in assets. The ratio changed little from 2004 to 2005. Quality’s asset
turnover is below the industry average of 2.37 times and J.C. Penney’s ratio of
1.41 times.
Asset turnover ratios vary considerably among industries. For example, a large
utility company like Consolidated Edison (New York) has a ratio of 0.49 times, and
the large grocery chain Kroger Stores has a ratio of 4.34 times.
7. RETURN ON ASSETS
An overall measure of profitability is return on assets. We compute this ratio by di-
viding net income by average assets. The 2005 and 2004 return on assets for Quality
Department Store and comparative data are shown below.
Ratio Analysis 711
Net Sales
Asset Turnover �
Average Assets
Quality Department Store
2005 2004
$2,097,000 $1,837,000
$1,595,000 � $1,835,000
� 1.22 times
$1,446,000 � $1,595,000
� 1.21 times
2 2
Industry average J.C. Penney Company
2.37 times 1.41 times
[ [ [ [
Illustration 15-18
Asset turnover
Net Income
Return on Assets �
Average Assets
Quality Department Store
2005 2004
$263,800 $208,500
$1,595,000 � $1,835,000
� 15.4%
$1,446,000 � $1,595,000
� 13.7%
2 2
Industry average J.C. Penney Company
8.3% 8.2%
[ [ [ [
Illustration 15-19
Return on assets
Quality’s return on assets improved from 2004 to 2005. Its return of 15.4% is very
high compared with the department store industry average of 8.3% and J.C.
Penney’s 8.2%.
8. RETURN ON COMMON STOCKHOLDERS’ EQUITY
Another widely used profitability ratio is return on common stockholders’ equity.
It measures profitability from the common stockholders’ viewpoint. This ratio
shows how many dollars of net income the company earned for each dollar in-
vested by the owners. We compute it by dividing net income by average common
stockholders’ equity. Assuming that common stockholders’ equity at the beginning
Quality’s rate of return on common stockholders’ equity is high at 29.3%, con-
sidering an industry average of 20.5% and a rate of 24.6% for J.C. Penney.
With Preferred Stock. When a company has preferred stock, we must deduct
preferred dividend requirements from net income to compute income available to
common stockholders. Similarly, we deduct the par value of preferred stock (or call
price, if applicable) from total stockholders’ equity to determine the amount of
common stockholders’ equity used in this ratio. The ratio then appears as follows.
712 Chapter 15 Financial Statement Analysis
Return on Common Net Income
Stockholders’ Equity
�
Average Common Stockholders’ Equity
Quality Department Store
2005 2004
$263,800 $208,500
$795,000 � $1,003,000
� 29.3%
$667,000 � $795,000
� 28.5%
2 2
Industry average J. C. Penney Company
20.5% 24.6%
[ [ [ [
Illustration 15-
20
Return on common
stockholders’ equity
Return on Common
�
Net Income � Preferred Dividends
Stockholders’ Equity Average Common Stockholders’ Equity
Illustration 15-21
Return on common
stockholders’ equity with
preferred stock
Note that Quality’s rate of return on stockholders’ equity (29.3%) is substan-
tially higher than its rate of return on assets (15.4%). The reason is that Quality has
made effective use of leverage. Leveraging or trading on the equity at a gain
means that the company has borrowed money at a lower rate of interest than it is
able to earn by using the borrowed money. Leverage enables Quality Department
Store to use money supplied by nonowners to increase the return to the owners. A
comparison of the rate of return on total assets with the rate of interest paid for
borrowed money indicates the profitability of trading on the equity. Quality
Department Store earns more on its borrowed funds than it has to pay in the form
of interest. Thus the return to stockholders exceeds the return on the assets, due to
benefits from the positive leveraging.
9. EARNINGS PER SHARE (EPS)
Earnings per share (EPS) is a measure of the net income earned on each share
of common stock. It is computed by dividing net income by the number of
weighted average common shares outstanding during the year. A measure of
net income earned on a per share basis provides a useful perspective for deter-
mining profitability. Assuming that there is no change in the number of out-
standing shares during 2004 and that the 2005 increase occurred midyear,
Illustration 15-22 shows the net income per share for Quality Department
Store for 2005 and 2004.
of 2004 was $667,000, Illustration 15-20 shows the 2005 and 2004 ratios for Quality
Department Store and comparative data.
Note that no industry or J.C. Penney data are presented. Such comparisons are
not meaningful because of the wide variations in the number of shares of outstanding
stock among companies. The only meaningful EPS comparison is an intracompany
trend comparison: Quality’s earnings per share increased 20 cents per share in 2005.
This represents a 26% increase over the 2004 earnings per share of 77 cents.
The terms “earnings per share” and “net income per share” refer to the amount
of net income applicable to each share of common stock. Therefore, in computing
EPS, if there are preferred dividends declared for the period, we must deduct them
from net income to determine income available to the common stockholders.
10. PRICE-EARNINGS RATIO
The price-earnings (P-E) ratio is an oft-quoted measure of the ratio of the market
price of each share of common stock to the earnings per share. The price-earnings
(P-E) ratio reflects investors’ assessments of a company’s future earnings. We com-
pute it by dividing the market price per share of the stock by earnings per share.
Assuming that the market price of Quality Department Store Inc. stock is $8 in
2004 and $12 in 2005, the price-earnings ratio computation is as follows.
Ratio Analysis 713
Earnings Net Income
per Share
�
Weighted Average Common Shares Outstanding
Quality Department Store
2005 2004
$263,800 $208,500
� $0.77
270,000 � 275,400
� $0.97
270,000
2[
[
Illustration 15-22
Earnings per share
Market Price per Share of Stock
Price-Earnings Ratio �
Earnings per Share
Quality Department Store
2005 2004
$12.00 $8.00
$0.97
� 12.4 times
$0.77
� 10.4 times
Industry average J.C. Penney Company
26 times 13 times
Illustration 15-23
Price-earnings ratio
In 2005 each share of Quality’s stock sold for 12.4 times the amount that the
company earned on each share. Quality’s price-earnings ratio is lower than the
industry average of 26 times, but almost the same as the ratio of 13 times for
J.C. Penney. The average price-earnings ratio for the stocks that constitute the
Standard and Poor’s 500 Index (500 largest U.S. firms) in early 2006 was a little less
than 20 times.
11. PAYOUT RATIO
The payout ratio measures the percentage of earnings distributed in the form of
cash dividends. We compute it by dividing cash dividends by net income. Companies
that have high growth rates generally have low payout ratios because they reinvest
most of their net income into the business. The 2005 and 2004 payout ratios for
Quality Department Store are computed as shown in Illustration 15-24 (page 714).
Quality’s payout ratio is higher than J.C. Penney’s payout ratio of 12.0%. As in-
dicated earlier (page 703), Quality funded its purchase of plant assets through re-
tention of earnings but still is able to pay dividends.
Solvency Ratios
Solvency ratios measure the ability of a company to survive over a long period of
time. Long-term creditors and stockholders are particularly interested in a com-
pany’s ability to pay interest as it comes due and to repay the face value of debt at
maturity. Debt to total assets and times interest earned are two ratios that provide
information about debt-paying ability.
12. DEBT TO TOTAL ASSETS RATIO
The debt to total assets ratio measures the percentage of the total assets that cred-
itors provide. We compute it by dividing total debt (both current and long-term li-
abilities) by total assets. This ratio indicates the company’s degree of leverage. It
also provides some indication of the company’s ability to withstand losses without
impairing the interests of creditors. The higher the percentage of debt to total
assets, the greater the risk that the company may be unable to meet its maturing
obligations. The 2005 and 2004 ratios for Quality Department Store and compara-
tive data are as follows.
714 Chapter 15 Financial Statement Analysis
Total Debt
Debt to Total Assets Ratio �
Total Assets
Quality Department Store
2005 2004
$832,000 $800,000
$1,835,000
� 45.3%
$1,595,000
� 50.2%
Industry average J.C. Penney Company
40.1% 67.8%
Illustration 15-25
Debt to total assets ratio
A ratio of 45.3% means that creditors have provided 45.3% of Quality
Department Store’s total assets. Quality’s 45.3% is above the industry average of
40.1%. It is considerably below the high 67.8% ratio of J.C. Penney. The lower the
ratio, the more equity “buffer” there is available to the creditors. Thus, from the
creditors’ point of view, a low ratio of debt to total assets is usually desirable.
Cash Dividends
Payout Ratio �
Net Income
Quality Department Store
2005 2004
$61,200 $60,000
$263,800
� 23.2%
$208,500
� 28.8%
Industry average J.C. Penney Company
16.0% 12.0%
Illustration 15-24
Payout ratio
Quality’s interest expense is well covered at 13 times, compared with the in-
dustry average of 12 times and J.C. Penney’s 10.2 times.
Ratio Analysis 715
Times Interest Income before Income Taxes and Interest Expense
Earned
�
Interest Expense
Quality Department Store
2005 2004
$468,000
� 13 times
$388,000
� 9.6 times
$36,000 $40,500
Industry average J.C. Penney Company
12 times 10.2 times
Illustration 15-26
Times interest earned
Keeping Up to Date as an Investor
Today, investors have access to information provided by corporate managers that
used to be available only to professional analysts. Corporate managers have always made
themselves available to security analysts for questions at the end of every quarter. Now, be-
cause of a combination of new corporate disclosure requirements by the Securities and
Exchange Commission and technologies that make communication to large numbers of peo-
ple possible at a very low price, the average investor can listen in on these discussions. For
example, one individual investor, Matthew Johnson, a Nortel Networks local area network
engineer in Belfast, Northern Ireland, “stayed up past midnight to listen to Apple Computer’s
recent Internet conference call. Hearing the company’s news ‘from the dog’s mouth,’ he says
‘gave me better information’ than hunting through chat-rooms.”
Source: Jeff D. Opdyke, “Individuals Pick Up on Conference Calls,” Wall Street Journal, November 20, 2000.
If you want to keep current with the financial and operating developments of a company
in which you own shares, what are some ways you can do so?
I N V E S T O R I N S I G H T
The adequacy of this ratio is often judged in the light of the company’s earn-
ings. Generally, companies with relatively stable earnings (such as public utilities)
have higher debt to total assets ratios than cyclical companies with widely fluctuat-
ing earnings (such as many high-tech companies).
13. TIMES INTEREST EARNED
Times interest earned provides an indication of the company’s ability to meet in-
terest payments as they come due. We compute it by dividing income before inter-
est expense and income taxes by interest expense. Illustration 15-26 shows the 2005
and 2004 ratios for Quality Department Store and comparative data. Note that
times interest earned uses income before income taxes and interest expense. This
represents the amount available to cover interest. For Quality Department Store
the 2005 amount of $468,000 is computed by taking the income before income
taxes of $432,000 and adding back the $36,000 of interest expense.
A L T E R N A T I V E
T E R M I N O L O G Y
Times interest earned is
also called interest
coverage.
716 Chapter 15 Financial Statement Analysis
Ratio Formula Purpose or Use
Liquidity Ratios
1. Current ratio
Current assets
Current liabilities
Measures short-term debt-paying ability.
Cash � Short-term
2. Acid-test (quick) ratio investments � Receivables (net) Measures immediate short-term liquidity.
Current liabilities
3. Receivables turnover
Net credit sales
Average net receivables
Measures liquidity of receivables.
4. Inventory turnover
Cost of goods sold
Average inventory
Measures liquidity of inventory.
Profitability Ratios
5. Profit margin Net income Measures net income generated by each dollar
Net sales of sales.
6. Asset turnover Net sales Measures how efficiently assets are used to
Average assets generate sales.
7. Return on assets
Net income
Average assets
Measures overall profitability of assets.
8. Return on common
Net income
stockholders’ equity
Average common
Measures profitability of owners’ investment.
stockholders’ equity
9. Earnings per share (EPS)
Net income
Weighted average common
Measures net income earned on each share of
shares outstanding
common stock.
10. Price-earnings (P-E) ratio
Market price
per share of stock Measures the ratio of the market price per share to
Earnings per share earnings per share.
11. Payout ratio
Cash dividends
Measures percentage of earnings distributed in the
Net income
form of cash dividends.
Solvency Ratios
12. Debt to total assets ratio Total debt Measures the percentage of total assets provided
Total assets by creditors.
13. Times interest earned
Income before income taxes
and interest expense Measures ability to meet interest payments as they
Interest expense come due.
Illustration 15-27
Summary of liquidity, prof-
itability, and solvency ratios
REVIEW IT
1. What are liquidity ratios? Explain the current ratio, acid-test ratio, receivables
turnover, and inventory turnover.
2. What are profitability ratios? Explain the profit margin, asset turnover ratio,
return on assets, return on common stockholders’ equity, earnings per share,
price-earnings ratio, and payout ratio.
3. What are solvency ratios? Explain the debt to total assets ratio and times
interest earned.
Before You Go On…
Summary of Ratios
Illustration 15-27 summarizes the ratios discussed in this chapter. The summary
includes the formula and purpose or use of each ratio.
EARNING POWER AND IRREGULAR ITEMS
Earning Power and Irregular Items 717
DO IT
Selected financial data for Drummond Company at December 31, 2008, are as
follows: cash $60,000; receivables (net) $80,000; inventory $70,000; current liabilities
$140,000. Compute the current and acid-test ratios.
Action Plan
■ Use the formula for the current ratio: Current assets � Current liabilities.
■ Use the formula for the acid-test ratio: Cash � Short-term investments �
Receivables (net) � Current liabilities.
Solution The current ratio is 1.5:1 ($210,000 � $140,000). The acid-test
ratio is 1:1 ($140,000 � $140,000).
Related exercise material: BE15-9, BE15-10, BE15-11, BE15-12, BE15-13, E15-5, E15-6, E15-7, E15-8,
E15-9, E15-10, and E15-11.
The Navigator✓
Users of financial statements are interested in the concept of earning
power. Earning power means the normal level of income to be obtained in
the future. Earning power differs from actual net income by the amount of
irregular revenues, expenses, gains, and losses. Users are interested in
earning power because it helps them derive an estimate of future earnings
without the “noise” of irregular items.
For users of financial statements to determine earning power or regular income,
the “irregular” items are separately identified on the income statement. Companies
report two types of “irregular” items.
1. Discontinued operations.
2. Extraordinary items.
These “irregular” items are reported net of income taxes.That is, the income statement
first reports income tax on the income before “irregular” items.Then the amount of tax
for each of the listed “irregular” items is computed. The general concept is “let the tax
follow income or loss.”
Discontinued Operations
Discontinued operations refers to the disposal of a significant component of a busi-
ness. Examples involve stopping an entire activity or eliminating a major class of
customers. For example, Kmart reported as discontinued operations its decision to
terminate its interest in four business activities, including PACE Membership
Warehouse and PayLess Drug Stores Northwest.
Following the disposal of a significant component, the company should report
on its income statement both income from continuing operations and income (or
loss) from discontinued operations. The income (loss) from discontinued opera-
tions consists of two parts: the income (loss) from operations and the gain (loss) on
disposal of the segment.
To illustrate, assume that during 2008 Acro Energy Inc. has income before
income taxes of $800,000. During 2008 Acro discontinued and sold its unprofitable
chemical division. The loss in 2008 from chemical operations (net of $60,000 taxes)
was $140,000. The loss on disposal of the chemical division (net of $30,000 taxes)
Understand the concept of
earning power, and how irregular
items are presented.
S T U D Y O B J E C T I V E 6
was $70,000. Assuming a 30% tax rate on income, Illustration 15-28 shows Acro’s
income statement presentation.
718 Chapter 15 Financial Statement Analysis
Illustration 15-28
Statement presentation of
discontinued operations
ACRO ENERGY INC.
Income Statement (partial)
For the Year Ended December 31, 2008
Income before income taxes $800,000
Income tax expense 240,000
Income from continuing operations 560,000
Discontinued operations
Loss from operations of chemical division,
net of $60,000 income tax saving $140,000
Loss from disposal of chemical division,
net of $30,000 income tax saving 70,000 210,000
Net income $350,000
Note that the statement uses the caption “Income from continuing operations,”
and adds a new section “Discontinued operations”. The new section reports both
the operating loss and the loss on disposal net of applicable income taxes. This
presentation clearly indicates the separate effects of continuing operations and
discontinued operations on net income.
Extraordinary Items
Extraordinary items are events and transactions that meet two conditions: They are
(1) unusual in nature, and (2) infrequent in occurrence. To be unusual, the item
should be abnormal and only incidentally related to the company’s customary
activities. To be infrequent, the item should not be reasonably expected to recur in
the foreseeable future.
A company must evaluate both criteria in terms of its operating environment.
Thus, Weyerhaeuser Co. reported the $36 million in damages to its timberland
caused by the volcanic eruption of Mount St. Helens as an extraordinary item. The
eruption was both unusual and infrequent. In contrast, Florida Citrus Company
does not report frost damage to its citrus crop as an extraordinary item, because
frost damage is not infrequent. Illustration 15-29 (next page) shows the classifica-
tion of extraordinary and ordinary items.
Companies report extraordinary items net of taxes in a separate section of the
income statement, immediately below discontinued operations. To illustrate, assume
that in 2008 a foreign government expropriated property held as an investment by
Acro Energy Inc. If the loss is $70,000 before applicable income taxes of $21,000,
the income statement will report a deduction of $49,000, as shown in Illustration
15-30 (next page). When there is an extraordinary item to report, the company adds
the caption “Income before extraordinary item” immediately before the section
for the extraordinary item. This presentation clearly indicates the effect of the
extraordinary item on net income.
What if a transaction or event meets one (but not both) of the criteria for an
extraordinary item? In that case the company reports it under either “Other
revenues and gains” or “Other expenses and losses” at its gross amount (not net of
H E L P F U L H I N T
Observe the dual disclo-
sures: (1) The results of
operations of the discon-
tinued division must be
eliminated from the
results of continuing
operations. (2) The com-
pany must also report the
disposal of the operation.
tax). This is true, for example, of gains (losses) resulting from the sale of property,
plant, and equipment, as explained in Chapter 10. It is quite common for compa-
nies to use the label “Nonrecurring charges” for losses that do not meet the
extraordinary item criteria.
Earning Power and Irregular Items 719
Extraordinary items
1. Effects of major natural
casualties, if rare in
the area.
2. Expropriation (takeover)
of property by a foreign
government.
3. Effects of a newly enacted
law or regulation, such as
a property condemnation
action.
Ordinary items
1. Effects of major natural
casualties, not
uncommon in the area.
2. Write-down of
inventories
or write-off of
receivables.
3. Losses attributable
to labor strikes.
4. Gains or losses from
sales of property,
plant, or equipment.
unco
llecti
ble
XYZ
INVOICE
Illustration 15-29
Examples of extraordinary
and ordinary items
Illustration 15-
30
Statement presentation of
extraordinary items
ACRO ENERGY INC.
Income Statement (partial)
For the Year Ended December 31, 2008
Income before income taxes $800,000
Income tax expense 240,000
Income from continuing operations 560,000
Discontinued operations
Loss from operations of chemical division,
net of $60,000 income tax saving $140,000
Loss from disposal of chemical division,
net of $30,000 income tax saving 70,000 210,000
Income before extraordinary item 350,000
Extraordinary item
Expropriation of investment, net of
$21,000 income tax saving 49,000
Net income $301,000
H E L P F U L H I N T
If there are no discontin-
ued operations, the third
line of the income state-
ment would be labeled
“Income before extraor-
dinary item.”
Changes in Accounting Principle
For ease of comparison, users of financial statements expect companies
to prepare such statements on a basis consistent with the preceding period.
A change in accounting principle occurs when the principle used in the
current year is different from the one used in the preceding year.
Accounting rules permit a change when management can show that the
new principle is preferable to the old principle. An example is a change
in inventory costing methods (such as FIFO to average cost).
Companies report most changes in accounting principle retroactively.
That is, they report both the current period and previous periods using the
new principle. As a result the same principle applies in all periods. This treatment
improves the ability to compare results across years.
Comprehensive Income
The income statement reports most revenues, expenses, gains, and losses recog-
nized during the period. However, over time, specific exceptions to this general
practice have developed. Certain items now bypass income and are reported di-
rectly in stockholders’ equity.
For example, in Chapter 13 you learned that companies do not include in in-
come any unrealized gains and losses on available-for-sale securities. Instead,
they report such gains and losses in the balance sheet as adjustments to stock-
holders’ equity. Why are these gains and losses on available-for-sale securities
excluded from net income? Because disclosing them separately (1) reduces the
volatility of net income due to fluctuations in fair value, yet (2) informs the finan-
cial statement user of the gain or loss that would be incurred if the securities were
sold at fair value.
Many analysts have expressed concern over the significant increase in the
number of items that bypass the income statement. They feel that such reporting
has reduced the usefulness of the income statement. To address this concern, in
addition to reporting net income, a company must also report comprehensive
income. Comprehensive income includes all changes in stockholders’ equity during
a period except those resulting from investments by stockholders and distributions
to stockholders. A number of alternative formats for reporting comprehensive
income are allowed. These formats are discussed in advanced accounting courses.
720 Chapter 15 Financial Statement Analysis
What Is Extraordinary?
Many companies these days are incurring restructuring charges as a result of at-
tempting to reduce costs. Are these costs ordinary or extraordinary? Some companies report
“one-time” restructuring charges over and over. Case in point: Toothpaste and diapers giant
Procter & Gamble Co. reported a restructuring charge in 12 consecutive quarters, and
Motorola had “special” charges 14 quarters in a row. On the other hand, some companies
take a restructuring charge only once in five years. The one-size-fits-all classification therefore
will not work. There appears to be no substitute for a careful analysis of the numbers that
comprise net income.
If a company takes a large restructuring charge, what is the effect on the company’s
current income statement versus future ones?
I N V E S T O R I N S I G H T
E T H I C S N O T E
Changes in accounting
principle should result in
financial statements that are
more informative for statement
users. They should not be used to
artificially improve the reported
performance or financial position
of the corporation.
QUALITY OF EARNINGS
Quality of Earnings 721
REVIEW IT
1. What are the similarities and differences in reporting material items not typ-
ical of regular operations?
2. What is included in comprehensive income?
DO IT
In its proposed 2008 income statement, AIR Corporation reports income before
income taxes $400,000, extraordinary loss $100,000, income taxes (30%)
$120,000, and net income $210,000. Prepare a correct income statement, begin-
ning with income before income taxes.
Action Plan
■ Recall that the loss is extraordinary because it meets the criteria of being both
unusual and infrequent.
■ Disclose the income tax effect of each component of income, beginning with
income before any irregular items.
■ Report irregular items net of any income tax effect.
Solution
AIR CORPORATION
Income Statement (partial)
Income before income taxes $400,000
Income tax expense (30%) 120,000
Income before extraordinary item 280,000
Extraordinary loss net of $30,000 income tax saving 70,000
Net income $210,000
Related exercise material: BE15-14, BE15-15, E15-12, and E15-13.
Before You Go On…
The Navigator✓
In evaluating the financial performance of a company, the quality of a
company’s earnings is of extreme importance to analysts. A company that
has a high quality of earnings provides full and transparent information
that will not confuse or mislead users of the financial statements.
The issue of quality of earnings has taken on increasing importance because
recent accounting scandals suggest that some companies are spending too much
time managing their income and not enough time managing their business. Here
are some of the factors affecting quality of earnings.
Alternative Accounting Methods
Variations among companies in the application of generally accepted accounting
principles may hamper comparability and reduce quality of earnings. For example,
one company may use the FIFO method of inventory costing, while another com-
pany in the same industry may use LIFO. If inventory is a significant asset to both
companies, it is unlikely that their current ratios are comparable. For example, if
General Motors Corporation had used FIFO instead of LIFO for inventory valua-
tion, its inventories in a recent year would have been 26% higher, which signifi-
cantly affects the current ratio (and other ratios as well).
In addition to differences in inventory costing methods, differences also exist in
reporting such items as depreciation, depletion, and amortization. Although these
Understand the concept of
quality of earnings.
S T U D Y O B J E C T I V E 7
differences in accounting methods might be detectable from reading the notes to
the financial statements, adjusting the financial data to compensate for the differ-
ent methods is often difficult, if not impossible.
Pro Forma Income
Companies whose stock is publicly traded are required to present their income state-
ment following generally accepted accounting principles (GAAP). In recent years,
many companies have also reported a second measure of income, called pro forma in-
come. Pro forma income usually excludes items that the company thinks are unusual
or nonrecurring. For example, in a recent year, Cisco Systems (a high-tech company)
reported a quarterly net loss under GAAP of $2.7 billion. Cisco reported pro forma
income for the same quarter as a profit of $230 million. This large difference in profits
between GAAP income numbers and pro forma income is not unusual these days. For
example, during one recent 9-month period the 100 largest firms on the Nasdaq stock
exchange reported a total pro forma income of $19.1 billion, but a total loss as meas-
ured by GAAP of $82.3 billion—a difference of about $100 billion!
To compute pro forma income, companies generally can exclude any items
they deem inappropriate for measuring their performance. Many analysts and in-
vestors are critical of the practice of using pro forma income because these num-
bers often make companies look better than they really are. As the financial press
noted, pro forma numbers might be called EBS, which stands for “earnings before
bad stuff.” Companies, on the other hand, argue that pro forma numbers more
clearly indicate sustainable income because they exclude unusual and nonrecur-
ring expenses. “Cisco’s technique gives readers of financial statements a clear pic-
ture of Cisco’s normal business activities,” the company said in a statement issued
in response to questions about its pro forma income accounting.
Recently, the SEC provided some guidance on how companies should present
pro forma information. Stay tuned: Everyone seems to agree that pro forma numbers
can be useful if they provide insights into determining a company’s sustainable in-
come. However, many companies have abused the flexibility that pro forma numbers
allow and have used the measure as a way to put their companies in a good light.
Improper Recognition
Because some managers have felt pressure from Wall Street to continually increase
earnings, they have manipulated the earnings numbers to meet these expectations.
The most common abuse is the improper recognition of revenue. One practice that
companies are using is channel stuffing: Offering deep discounts on their products
to customers, companies encourage their customers to buy early (stuff the channel)
rather than later. This lets the company report good earnings in the current period,
but it often leads to a disaster in subsequent periods because customers have no
need for additional goods. To illustrate, Bristol-Myers Squibb recently indicated
that it used sales incentives to encourage wholesalers to buy more drugs than
needed to meet patients’ demands. As a result, the company had to issue revised
financial statements showing corrected revenues and income.
Another practice is the improper capitalization of operating expenses. The
classic case is WorldCom. It capitalized over $7 billion dollars of operating ex-
penses so that it would report positive net income. In other situations, companies
fail to report all their liabilities. Enron had promised to make payments on certain
contracts if financial difficulty developed, but these guarantees were not reported
as liabilities. In addition, disclosure was so lacking in transparency that it was im-
possible to understand what was happening at the company.
722 Chapter 15 Financial Statement Analysis
Be sure to read ALL ABOUT YOU: Should I Play the Market Yet? on the
next page for information on how topics in this chapter apply to you.*
Some Facts*
* 83.4 million Americans own stock investments,
either through mutual funds or individual stocks;
89% of stock investors own stock mutual funds.
* 44% of the people who own stock bought their first
stock before 1990.
* The typical equity investor is in his or her late 40s,
is married, is employed, and has a household
income in the low $60,000s.
* 58% of people who own stock said that they rely on
professional financial advisors when making
decisions regarding the purchase and sale of stock.
* 46% of people who own stock used the Internet to
check stock prices, and 38% use it to read online
financial publications.
*all about Y U*
Source: “Equity Ownership in America,” Investment Company Institute and the Securities Industry
Association, 2002, p. 1.
IIn this chapter you learned how to use many toolsfor performing a financial analysis of a company.
Sometimes companies fail even though they have a
good product and good sales growth. All too often
the cause of failure is something that should have
caused only momentary discomfort. But if a company
lacks sufficient liquidity, a momentary hiccup can be
fatal. This is true for individuals as well.
For example, the decision to invest in common
stock can be risky. As a company’s net income changes,
its stock price can be volatile. You must take this into
consideration when deciding whether to buy stock.
You don’t want to be in a situation where you have to
sell a stock whose price has fallen in order to raise
cash to pay your bills.
What Do You Think?*
Rachael West has been working at her new job for six months. She has a good
salary, with lots of opportunities for growth. She has already accumulated
$8,000 in savings, which right now is sitting in a bank savings account earning
very little interest. She has decided to take $7,000 out of this savings account
and buy common stock of her employer, a young company that has been in
business for two years. Rachael’s liquid assets, including her savings account,
total $10,000. Her monthly expenses are approximately $3,000. Should
Rachael make this investment?
YES: She has a good income, and this is a great opportunity for her to get
in on the ground floor of her employer’s fast-growing company.
NO: She shouldn’t invest all of her money in one company, particularly
the company at which she works.
*
The authors’ comments on this situation appear on p. 746.
Source: “Equity Ownership in America,” Investment Company Institute and the Securities Industry
Association, 2002.
0
10
20
30
40
60
50
U.S. Households
(millions) 15.9 30.2 34.6 40.6 49.2 52.7
Equity Ownership in the U.S., 1983–2002, Selected Years
(number and percent of U.S. households)
19.0%
1983 1989 1992 1995 1999 2002
32.5%
36.6%
41.0%
48.2% 49.5%
About the Numbers*
The percentage of Americans who buy stock, either through mutual funds or individ-
ual shares, has increased significantly in recent years. A big part of this increase is
due to the increasing prevalence of employer-sponsored retirement plans, such as
401(k) plans.
Should I Play the Market Yet?
723
724 Chapter 15 Financial Statement Analysis
REVIEW IT
1. What is meant by quality of earnings?
2. Give examples of alternative accounting methods that hamper comparability.
3. What is pro forma income and why are analysts often critical of this number?
Before You Go On…
The Navigator✓
Demonstration Problem 1
The condensed financial statements ot The Estée Lauder Companies, Inc., for the years
ended June 30, 2005 and 2004, are presented below.
THE ESTÉE LAUDER COMPANIES, INC.
Balance Sheets
June 30
(in millions)
Assets 2005 2004
Current assets
Cash and cash equivalents $ 553.3 $ 611.6
Accounts receivable (net) 776.6 664.9
Inventories 768.3 653.5
Prepaid expenses and other current assets 204.4 269.2
Total current assets 2,302.6 2,199.2
Property, plant, and equipment (net) 694.2 647.0
Investments 12.3 12.6
Intangibles and other assets 876.7 849.3
Total assets $3,885.8 $3,708.1
Liabilities and Stockholders’ Equity
Current liabilities $1,497.7 $1,322.0
Long-term liabilities 679.5 637.1
Stockholders’ equity— common 1,708.6 1,749.0
Total liabilities and stockholders’ equity $3,885.8 $3,708.1
THE ESTÉE LAUDER COMPANIES, INC.
Income Statements
For the Year Ended June 30
(in millions)
2005 2004
Revenues $6,336.3 $5,790.4
Costs and expenses
Cost of goods sold 1,617.4 1,476.3
Selling and administrative expenses 4,007.6 3,679.0
Interest expense 13.9 27.1
Total costs and expenses 5,638.9 5,182.4
Income before income taxes 697.4 608.0
Income tax expense 291.3 232.6
Net income $ 406.1 $ 375.4
Demonstration Problem 2 725
Instructions
Compute the following ratios for 2005 and 2004.
(a) Current ratio.
(b) Inventory turnover. (Inventory on 6/30/03 was $599.0.)
(c) Profit margin ratio.
(d) Return on assets. (Assets on 6/30/03 were $3,349.9.)
(e) Return on common stockholders’ equity. (Equity on 6/30/03 was $1,795.9.)
(f) Debt to total assets ratio.
(g) Times interest earned.
action plan
✔ Remember that the
current ratio includes all
current assets. The acid-test
ratio uses only cash, short-
term investments, and net
receivables.
✔ Use average balances for
turnover ratios like inven-
tory, receivables, and assets.
2005 2004
(a) Current ratio:
$2,302.6 � $1,497.7 � 1.5�1
$2,199.2 � $1,322.0 � 1.7�1
(b) Inventory turnover:
$1,617.4 � [($768.3 � $653.5) � 2] � 2.3 times
$1,476.3 � [($653.5 � $599.0) � 2] � 2.4 times
(c) Profit margin:
$406.1 � $6,336.3 6.4%
$375.4 � $5,790.4 6.5%
(d) Return on assets:
$406.1 � [($3,885.8 � $3,708.1) � 2] � 10.7%
$375.4 � [($3,708.1 � $3,349.9) � 2] � 10.6%
(e) Return on common stockholders’ equity:
$406.1 � [($1,708.6 � $1,749.0) � 2] � 23.5%
$375.4 � [($1,749.0 � $1,795.9) � 2] � 21.2%
(f) Debt to total assets ratio:
($1,497.7 � $679.5) � $3,885.8 � 56.0%
($1,322.0 � $637.1) � $3,708.1 � 52.8%
(g) Times interest earned:
($406.1 � $291.3 � $13.9) � $13.9 � 51.2 times
($375.4 � $232.6 � $27.1) � $27.1 � 23.4 times
Solution
The Navigator✓
Demonstration Problem 2
The events and transactions of Dever Corporation for the year ending December 31,
2008, resulted in the following data.
Cost of goods sold $2,600,000
Net sales 4,400,000
Other expenses and losses 9,600
Other revenues and gains 5,600
Selling and administrative expenses 1,100,000
Income from operations of plastics division 70,000
Gain from disposal of plastics division 500,000
Loss from tornado disaster (extraordinary loss) 600,000
Analysis reveals that:
1. All items are before the applicable income tax rate of 30%.
2. The plastics division was sold on July 1.
3. All operating data for the plastics division have been segregated.
Instructions
Prepare an income statement for the year.
726 Chapter 15 Financial Statement Analysis
action plan
✔ Report material items not
typical of operations in sep-
arate sections, net of taxes.
✔ Associate income taxes
with the item that affects
the taxes.
✔ Apply the corporate tax
rate to income before
income taxes to determine
tax expense.
✔ Recall that all data
presented in determining
income before income taxes
are the same as for unincor-
porated companies.
DEVER CORPORATION
Income Statement
For the Year Ended December 31, 2008
Net sales $4,400,000
Cost of goods sold 2,600,000
Gross profit 1,800,000
Selling and administrative expenses 1,100,000
Income from operations 700,000
Other revenues and gains $5,600
Other expenses and losses 9,600 4,000
Income before income taxes 696,000
Income tax expense ($696,000 � 30%) 208,800
Income from continuing operations 487,200
Discontinued operations
Income from operations of plastics division, net of
$21,000 income taxes ($70,000 � 30%) 49,000
Gain from disposal of plastics division, net of $150,000
income taxes ($500,000 � 30%) 350,000 399,000
Income before extraordinary item 886,200
Extraordinary item
Tornado loss, net of $180,000 income tax saving
($600,000 � 30%) 420,000
Net income $ 466,200
Solution
The Navigator✓
SUMMARY OF STUDY OBJECTIVES
1 Discuss the need for comparative analysis. There are
three bases of comparison: (1) Intracompany, which com-
pares an item or financial relationship with other data
within a company. (2) Industry, which compares company
data with industry averages. (3) Intercompany, which com-
pares an item or financial relationship of a company with
data of one or more competing companies.
2 Identify the tools of financial statement analysis.
Financial statements can be analyzed horizontally, verti-
cally, and with ratios.
3 Explain and apply horizontal analysis. Horizontal analysis
is a technique for evaluating a series of data over a period of
time to determine the increase or decrease that has taken
place, expressed as either an amount or a percentage.
4 Describe and apply vertical analysis. Vertical analysis is
a technique that expresses each item within a financial
statement in terms of a percentage of a relevant total or a
base amount.
5 Identify and compute ratios used in analyzing a firm’s
liquidity, profitability, and solvency. The formula and
purpose of each ratio was presented in Illustration 15-27
(page 716).
6 Understand the concept of earning power, and how
irregular items are presented. Earning power refers to a
company’s ability to sustain its profits from operations.
“Irregular items”—discontinued operations and extraordi-
nary items—are presented net of tax below income from
continuing operations to highlight their unusual nature.
7 Understand the concept of quality of earnings. A high
quality of earnings provides full and transparent informa-
tion that will not confuse or mislead users of the financial
statements. Issues related to quality of earnings are (1) al-
ternative accounting methods, (2) pro forma income, and
(3) improper recognition.
The Navigator✓
GLOSSARY
Acid-test (quick) ratio A measure of a company’s immedi-
ate short-term liquidity; computed by dividing the sum of
cash, short-term investments, and net receivables by cur-
rent liabilities. (p. 707).
Asset turnover A measure of how efficiently a company
uses its assets to generate sales; computed by dividing net
sales by average assets. (p. 710).
Change in accounting principle The use of a principle in
the current year that is different from the one used in the
preceding year. (p. 720).
Comprehensive income Includes all changes in stockhold-
ers’ equity during a period except those resulting from in-
vestments by stockholders and distributions to stockhold-
ers. (p. 720).
Current ratio A measure used to evaluate a company’s
liquidity and short-term debt-paying ability; computed by
dividing current assets by current liabilities. (p. 706).
Debt to total assets ratio Measures the percentage of to-
tal assets provided by creditors; computed by dividing total
debt by total assets. (p. 714).
Discontinued operations The disposal of a significant seg-
ment of a business. (p. 717).
Earnings per share (EPS) The net income earned on each
share of common stock; computed by dividing net income
by the number of weighted average common shares out-
standing. (p. 712).
Extraordinary items Events and transactions that are un-
usual in nature and infrequent in occurrence. (p. 718).
Horizontal analysis A technique for evaluating a series of
financial statement data over a period of time, to determine
the increase (decrease) that has taken place, expressed as
either an amount or a percentage. (p. 699).
Inventory turnover A measure of the liquidity of inven-
tory; computed by dividing cost of goods sold by average
inventory. (p. 709).
Leveraging See Trading on the equity.
Liquidity ratios Measures of the short-term ability of the
enterprise to pay its maturing obligations and to meet un-
expected needs for cash. (p. 706).
Payout ratio Measures the percentage of earnings distrib-
uted in the form of cash dividends; computed by dividing
cash dividends by net income. (p. 713).
Price-earnings (P-E) ratio Measures the ratio of the market
price of each share of common stock to the earnings per
share; computed by dividing the market price of the stock
by earnings per share. (p. 713).
Self-Study Questions 727
Profit margin Measures the percentage of each dollar of
sales that results in net income; computed by dividing net
income by net sales. (p. 710).
Profitability ratios Measures of the income or operating
success of an enterprise for a given period of time. (p. 710).
Pro forma income A measure of income that usually ex-
cludes items that a company thinks are unusual or nonre-
curring. (p. 722).
Quality of earnings Indicates the level of full and transpar-
ent information provided to users of the financial state-
ments (p. 721).
Ratio An expression of the mathematical relationship be-
tween one quantity and another. The relationship may be
expressed either as a percentage, a rate, or a simple propor-
tion. (p. 705).
Ratio analysis A technique for evaluating financial state-
ments that expresses the relationship between selected
financial statement data. (p. 705).
Receivables turnover A measure of the liquidity of receiv-
ables; computed by dividing net credit sales by average net
receivables. (p. 708).
Return on assets An overall measure of profitability; com-
puted by dividing net income by average assets. (p. 711).
Return on common stockholders’ equity Measures the
dollars of net income earned for each dollar invested by the
owners; computed by dividing net income by average com-
mon stockholders’ equity. (p. 711).
Solvency ratios Measures of the ability of the enterprise to
survive over a long period of time. (p. 714).
Times interest earned Measures a company’s ability to
meet interest payments as they come due; computed by di-
viding income before interest expense and income taxes by
interest expense. (p. 715).
Trading on the equity Borrowing money at a lower rate of
interest than can be earned by using the borrowed money.
(p. 712).
Vertical analysis A technique for evaluating financial state-
ment data that expresses each item within a financial state-
ment as a percent of a base amount. (p. 703).
SELF-STUDY QUESTIONS
Answers are at the end of the chapter.
1. Comparisons of data within a company are an example of
the following comparative basis:
a. Industry averages.
b. Intracompany.
c. Intercompany.
d. Both (b) and (c).
2. In horizontal analysis, each item is expressed as a percent-
age of the:
a. net income amount.
b. stockholders’ equity amount.
c. total assets amount.
d. base year amount.
3. In vertical analysis, the base amount for depreciation ex-
pense is generally:
a. net sales.
b. depreciation expense in a previous year.
c. gross profit.
d. fixed assets.
4. The following schedule is a display of what type of analysis?
Amount Percent
Current assets $200,000 25%
Property, plant,
and equipment 600,000 75%
Total assets $800,000
(SO 1)
(SO 3)
(SO 4)
(SO 4)
a. Horizontal analysis.
b. Differential analysis.
c. Vertical analysis.
d. Ratio analysis.
5. Sammy Corporation reported net sales of $300,000,
$330,000, and $360,000 in the years, 2006, 2007, and 2008,
respectively. If 2006 is the base year, what is the trend per-
centage for 2008?
a. 77%.
b. 108%.
c. 120%.
d. 130%.
6. Which of the following measures is an evaluation of a
firm’s ability to pay current liabilities?
a. Acid-test ratio.
b. Current ratio.
c. Both (a) and (b).
d. None of the above.
7. A measure useful in evaluating the efficiency in managing
inventories is:
a. inventory turnover.
b. average days to sell inventory.
c. Both (a) and (b).
d. None of the above.
8. In reporting discontinued operations, the income state-
ment should show in a special section:
728 Chapter 15 Financial Statement Analysis
a. gains and losses on the disposal of the discontinued
segment.
b. gains and losses from operations of the discontinued
segment.
c. Both (a) and (b).
d. Neither (a) nor (b).
9. Scout Corporation has income before taxes of $400,000
and an extraordinary loss of $100,000. If the income tax
rate is 25% on all items, the income statement should
show income before extraordinary items and extraordi-
nary items, respectively, of:
a. $325,000 and $100,000.
b. $325,000 and $75,000.
c. $300,000 and $100,000.
d. $300,000 and $75,000.
10. Which situation below might indicate a company has a
low quality of earnings?
a. The same accounting principles are used each year.
b. Revenue is recognized when earned.
c. Maintenance costs are expensed as incurred.
d. The company is continually reporting pro forma in-
come numbers.
Go to the book’s website,
www.wiley.com/college/weygandt,
for Additional Self-Study questions. The Navigator✓
(SO 3)
(SO 5)
(SO 5)
(SO 6)
(SO 6)
(SO 7)
QUESTIONS
1. (a) Juan Marichal believes that the analysis of financial
statements is directed at two characteristics of a com-
pany: liquidity and profitability. Is Juan correct?
Explain.
(b) Are short-term creditors, long-term creditors, and
stockholders interested primarily in the same charac-
teristics of a company? Explain.
2. (a) Distinguish among the following bases of comparison:
(1) intracompany, (2) industry averages, and (3) inter-
company.
(b) Give the principal value of using each of the three
bases of comparison.
3. Two popular methods of financial statement analysis are
horizontal analysis and vertical analysis. Explain the dif-
ference between these two methods.
4. (a) If Leonard Company had net income of $360,000 in
2008 and it experienced a 24.5% increase in net in-
come for 2009, what is its net income for 2009?
(b) If six cents of every dollar of Leonard revenue is net
income in 2008, what is the dollar amount of 2008
revenue?
5. What is a ratio? What are the different ways of expressing
the relationship of two amounts? What information does a
ratio provide?
6. Name the major ratios useful in assessing (a) liquidity and
(b) solvency.
7. Raphael Ochoa is puzzled. His company had a profit mar-
gin of 10% in 2008. He feels that this is an indication that
the company is doing well. Cindy Lore, his accountant,
says that more information is needed to determine the
firm’s financial well-being. Who is correct? Why?
8. What do the following classes of ratios measure? (a)
Liquidity ratios. (b) Profitability ratios. (c) Solvency
ratios.
9. What is the difference between the current ratio and the
acid-test ratio?
10. Donte Company, a retail store, has a receivables turnover
of 4.5 times. The industry average is 12.5 times. Does
Donte have a collection problem with its receivables?
11. Which ratios should be used to help answer the following
questions?
(a) How efficient is a company in using its assets to pro-
duce sales?
(b) How near to sale is the inventory on hand?
(c) How many dollars of net income were earned for each
dollar invested by the owners?
(d) How able is a company to meet interest charges as
they fall due?
12. The price-earnings ratio of General Motors (automobile
builder) was 8, and the price-earnings ratio of Microsoft
(computer software) was 38. Which company did the stock
market favor? Explain.
13. What is the formula for computing the payout ratio?
Would you expect this ratio to be high or low for a growth
company?
14. Holding all other factors constant, indicate whether each of
the following changes generally signals good or bad news
about a company.
(a) Increase in profit margin.
(b) Decrease in inventory turnover.
(c) Increase in the current ratio.
(d) Decrease in earnings per share.
(e) Increase in price-earnings ratio.
(f) Increase in debt to total assets ratio.
(g) Decrease in times interest earned.
15. The return on assets for Tresh Corporation is 7.6%.
During the same year Tresh’s return on common stock-
holders’ equity is 12.8%. What is the explanation for the
difference in the two rates?
16. Which two ratios do you think should be of greatest inter-
est to:
(a) A pension fund considering the purchase of 20-year
bonds?
(b) A bank contemplating a short-term loan?
(c) A common stockholder?
17. Why must preferred stock dividends be subtracted from
net income in computing earnings per share?
18. (a) What is meant by trading on the equity?
(b) How would you determine the profitability of trading
on the equity?
19. Hillman Inc. has net income of $160,000, weighted average
shares of common stock outstanding of 50,000, and pre-
Brief Exercises 729
ferred dividends for the period of $40,000.What is Hillman’s
earnings per share of common stock? Kate Hillman, the
president of Hillman Inc., believes the computed EPS of the
company is high. Comment.
20. Why is it important to report discontinued operations sep-
arately from income from continuing operations?
21. You are considering investing in Shawnee Transportation.
The company reports 2008 earnings per share of $6.50 on
income before extraordinary items and $4.75 on net in-
come. Which EPS figure would you consider more rele-
vant to your investment decision? Why?
22. STL Inc. reported 2007 earnings per share of $3.20 and
had no extraordinary items. In 2008, EPS on income be-
fore extraordinary items was $2.99, and EPS on net in-
come was $3.49. Is this a favorable trend?
23. Indicate which of the following items would be reported
as an extraordinary item in Mordica Corporation’s in-
come statement.
(a) Loss from damages caused by volcano eruption.
(b) Loss from sale of short-term investments.
(c) Loss attributable to a labor strike.
(d) Loss caused when manufacture of a product was pro-
hibited by the Food and Drug Administration.
(e) Loss from flood damage. (The nearby Black River
floods every 2 to 3 years.)
(f) Write-down of obsolete inventory.
(g) Expropriation of a factory by a foreign government.
24. Identify and explain factors that affect quality of earnings.
BRIEF
EXERCISES
Follow the rounding procedures used in the chapter.
BE15-1 You recently received a letter from your Uncle Frank. A portion of the letter is pre-
sented below.
You know that I have a significant amount of money I saved over the years. I am thinking
about starting an investment program. I want to do the investing myself, based on my own re-
search and analysis of financial statements. I know that you are studying accounting, so I have
a couple of questions for you. I have heard that different users of financial statements are in-
terested in different characteristics of companies. Is this true, and, if so, why? Also, some of my
friends, who are already investing, have told me that comparisons involving a company’s fi-
nancial data can be made on a number of different bases. Can you explain these bases to me?
Instructions
Write a letter to your Uncle Frank which answers his questions.
BE15-2 Drew Carey Corporation reported the following amounts in 2007, 2008, and 2009.
2007 2008 2009
Current assets $200,000 $230,000 $240,000
Current liabilities $160,000 $168,000 $184,000
Total assets $500,000 $600,000 $620,000
Instructions
(a) Identify and describe the three tools of financial statement analysis. (b) Perform each of the
three types of analysis on Drew Carey’s current assets.
Identify and use tools of
financial statement analysis.
(SO 2, 3, 4, 5)
Discuss need for comparative
analysis.
(SO 1)
BE15-3 Using the following data from the comparative balance sheet of Rodenbeck
Company, illustrate horizontal analysis.
December 31, 2009 December 31, 2008
Accounts receivable $ 520,000 $ 400,000
Inventory $ 840,000 $ 600,000
Total assets $ 3,000,000 $2,500,000
BE15-4 Using the same data presented above in BE15-3 for Rodenbeck Company, illustrate
vertical analysis.
BE15-5 Net income was $500,000 in 2007, $450,000 in 2008, and $522,000 in 2009. What is the
percentage of change from (a) 2007 to 2008 and (b) 2008 to 2009? Is the change an increase or a
decrease?
BE15-6 If Soule Company had net income of $585,000 in 2009 and it experienced a 30% in-
crease in net income over 2008, what was its 2008 net income?
BE15-7 Horizontal analysis (trend analysis) percentages for Epstein Company’s sales, cost of
goods sold, and expenses are shown below.
Horizontal Analysis 2009
2008 2007
Sales 96.2 106.8 100.0
Cost of goods sold 102.0 97.0 100.0
Expenses 109.6 98.4 100.0
Did Epstein’s net income increase, decrease, or remain unchanged over the 3-year period?
BE15-8 Vertical analysis (common size) percentages for Charles Company’s sales, cost of
goods sold, and expenses are shown below.
Vertical Analysis
2009 2008 2007
Sales 100.0 100.0 100.0
Cost of goods sold 59.2 62.4 64.5
Expenses 25.0 25.6 27.5
Did Charles’s net income as a percent of sales increase, decrease, or remain unchanged over the
3-year period? Provide numerical support for your answer.
BE15-9 Selected condensed data taken from a recent balance sheet of Perkins Inc. are as
follows.
PERKINS INC.
Balance Sheet (partial)
Cash $ 8,041,000
Short-term investments 4,947,000
Accounts receivable 12,545,000
Inventories 14,814,000
Other current assets 5,571,000
Total current assets $45,918,000
Total current liabilities $40,644,000
What are the (a) working capital, (b) current ratio, and (c) acid-test ratio?
BE15-10 McLaren Corporation has net income of $11.44 million and net revenue of $80 mil-
lion in 2008. Its assets are $14 million at the beginning of the year and $18 million at the end of
the year. What are McLaren’s (a) asset turnover and (b) profit margin?
730 Chapter 15 Financial Statement Analysis
Prepare horizontal analysis.
(SO 3)
Prepare vertical analysis.
(SO 4)
Calculate percentage of change.
(SO 3)
Calculate net income.
(SO 3)
Calculate change in net income.
(SO 4)
Calculate liquidity ratios.
(SO 5)
Calculate profitability ratios.
(SO 5)
Calculate change in net income.
(SO 3)
BE15-11 The following data are taken from the financial statements of Morino Company.
2009 2008
Accounts receivable (net), end of year $ 550,000 $ 520,000
Net sales on account 3,960,000 3,100,000
Terms for all sales are 1/10, n/60.
(a) Compute for each year (1) the receivables turnover and (2) the average collection period. At
the end of 2007, accounts receivable (net) was $480,000.
(b) What conclusions about the management of accounts receivable can be drawn from
these data?
BE15-12 The following data are from the income statements of Huntsinger Company.
2009 2008
Sales $6,420,000 $6,240,000
Beginning inventory 980,000 860,000
Purchases 4,340,000 4,661,000
Ending inventory 1,020,000 980,000
(a) Compute for each year (1) the inventory turnover and (2) the average days to sell the inventory.
(b) What conclusions concerning the management of the inventory can be drawn from
these data?
BE15-13 Gladow Company has stockholders’ equity of $400,000 and net income of $66,000. It
has a payout ratio of 20% and a rate of return on assets of 15%. How much did Gladow pay in
cash dividends, and what were its average assets?
BE15-14 An inexperienced accountant for Ming Corporation showed the following in the
income statement: income before income taxes and extraordinary item $400,000, and extraordi-
nary loss from flood (before taxes) $70,000. The extraordinary loss and taxable income are both
subject to a 30% tax rate. Prepare a correct income statement.
BE15-15 On June 30, Reeves Corporation discontinued its operations in Mexico. During the
year, the operating loss was $300,000 before taxes. On September 1, Reeves disposed of the
Mexico facility at a pretax loss of $120,000. The applicable tax rate is 30%. Show the discontin-
ued operations section of the income statement.
Exercises 731
Evaluate collection of accounts
receivable.
(SO 5)
Evaluate management of
inventory.
(SO 5)
Calculate profitability ratios.
(SO 5)
Prepare income statement in-
cluding extraordinary items.
(SO 6)
Prepare discontinued
operations section of income
statement.
(SO 6)
EXERCISES
Follow the rounding procedures used in the chapter.
E15-1 Financial information for Blevins Inc. is presented below.
December 31, 2009 December 31, 2008
Current assets $125,000 $100,000
Plant assets (net) 396,000 330,000
Current liabilities 91,000 70,000
Long-term liabilities 133,000 95,000
Common stock, $1 par 161,000 115,000
Retained earnings 136,000 150,000
Instructions
Prepare a schedule showing a horizontal analysis for 2009 using 2008 as the base year.
E15-2 Operating data for Gallup Corporation are presented below.
2009 2008
Sales $750,000 $600,000
Cost of goods sold 465,000 390,000
Selling expenses 120,000 72,000
Administrative expenses 60,000 54,000
Income tax expense 33,000 24,000
Net income 72,000 60,000
Instructions
Prepare a schedule showing a vertical analysis for 2009 and 2008.
Prepare horizontal analysis.
(SO 3)
Prepare vertical analysis.
(SO 4)
E15-3 The comparative condensed balance sheets of Conard Corporation are presented below.
CONARD CORPORATION
Comparative Condensed Balance Sheets
December 31
2009 2008
Assets
Current assets $ 74,000 $ 80,000
Property, plant, and equipment (net) 99,000 90,000
Intangibles 27,000 40,000
Total assets $200,000 $210,000
Liabilities and stockholders’ equity
Current liabilities $ 42,000 $ 48,000
Long-term liabilities 143,000 150,000
Stockholders’ equity 15,000 12,000
Total liabilities and stockholders’ equity $200,000 $210,000
Instructions
(a) Prepare a horizontal analysis of the balance sheet data for Conard Corporation using 2008 as
a base.
(b) Prepare a vertical analysis of the balance sheet data for Conard Corporation in columnar
form for 2009.
E15-4 The comparative condensed income statements of Hendi Corporation are shown below.
HENDI CORPORATION
Comparative Condensed Income Statements
For the Years Ended December 31
2009 2008
Net sales $600,000 $500,000
Cost of goods sold 483,000 420,000
Gross profit 117,000 80,000
Operating expenses 57,200 44,000
Net income $ 59,800 $ 36,000
Instructions
(a) Prepare a horizontal analysis of the income statement data for Hendi Corporation using 2008
as a base. (Show the amounts of increase or decrease.)
(b) Prepare a vertical analysis of the income statement data for Hendi Corporation in columnar
form for both years.
E15-5 Nordstrom, Inc. operates department stores in numerous states. Selected financial
statement data for the year ending January 29, 2005, are as follows.
732 Chapter 15 Financial Statement Analysis
Prepare horizontal and vertical
analyses.
(SO 3, 4)
Prepare horizontal and vertical
analyses.
(SO 3, 4)
Compute liquidity ratios and
compare results.
(SO 5)
NORDSTROM, INC.
Balance Sheet (partial)
(in millions) End-of-Year Beginning-of-Year
Cash and cash equivalents $ 361 $ 340
Receivables (less allowance of 19 and 20) 646 667
Merchandise inventory 917 902
Prepaid expenses 53 46
Other current assets 595 570
Total current assets $2,572 $2,525
Total current liabilities $1,341 $1,123
For the year, net sales were $7,131, and cost of goods sold was $4,559 (in millions).
Instructions
(a) Compute the four liquidity ratios at the end of the year.
(b) Using the data in the chapter, compare Nordstrom’s liquidity with (1) that of J.C. Penney
Company, and (2) the industry averages for department stores.
E15-6 Leach Incorporated had the following transactions occur involving current assets and
current liabilities during February 2008.
Feb. 3 Accounts receivable of $15,000 are collected.
7 Equipment is purchased for $28,000 cash.
11 Paid $3,000 for a 3-year insurance policy.
14 Accounts payable of $12,000 are paid.
18 Cash dividends of $5,000 are declared.
Additional information:
1. As of February 1, 2008, current assets were $130,000, and current liabilities were $50,000.
2. As of February 1, 2008, current assets included $15,000 of inventory and $2,000 of prepaid
expenses.
Instructions
(a) Compute the current ratio as of the beginning of the month and after each transaction.
(b) Compute the acid-test ratio as of the beginning of the month and after each transaction.
E15-7 Bennis Company has the following comparative balance sheet data.
BENNIS COMPANY
Balance Sheets
December 31
2009 2008
Cash $ 15,000 $ 30,000
Receivables (net) 70,000 60,000
Inventories 60,000 50,000
Plant assets (net) 200,000 180,000
$345,000 $320,000
Accounts payable $50,000 $60,000
Mortgage payable (15%) 100,000 100,000
Common stock, $10 par 140,000 120,000
Retained earnings 55,000 40,000
$345,000 $320,000
Additional information for 2009:
1. Net income was $25,000.
2. Sales on account were $410,000. Sales returns and allowances were $20,000.
3. Cost of goods sold was $198,000.
Instructions
Compute the following ratios at December 31, 2009.
(a) Current.
(b) Acid-test.
(c) Receivables turnover.
(d) Inventory turnover.
E15-8 Selected comparative statement data for Willingham Products Company are presented
on the next page. All balance sheet data are as of December 31.
Exercises 733
Perform current and acid-test
ratio analysis.
(SO 5)
Compute selected ratios.
(SO 5)
Compute selected ratios.
(SO 5)
2009 2008
Net sales $760,000 $720,000
Cost of goods sold 480,000 440,000
Interest expense 7,000 5,000
Net income 50,000 42,000
Accounts receivable 120,000 100,000
Inventory 85,000 75,000
Total assets 580,000 500,000
Total common stockholders’ equity 430,000 325,000
Instructions
Compute the following ratios for 2009.
(a) Profit margin.
(b) Asset turnover.
(c) Return on assets.
(d) Return on common stockholders’ equity.
E15-9 The income statement for Christensen, Inc., appears below.
CHRISTENSEN, INC.
Income Statement
For the Year Ended December 31, 2008
Sales $400,000
Cost of goods sold 230,000
Gross profit 170,000
Expenses (including $16,000 interest and $24,000 income taxes) 105,000
Net income $ 65,000
Additional information:
1. The weighted average common shares outstanding in 2008 were 30,000 shares.
2. The market price of Christensen, Inc. stock was $13 in 2008.
3. Cash dividends of $26,000 were paid, $5,000 of which were to preferred stockholders.
Instructions
Compute the following ratios for 2008.
(a) Earnings per share.
(b) Price-earnings.
(c) Payout.
(d) Times interest earned.
E15-10 Rees Corporation experienced a fire on December 31, 2009, in which its financial
records were partially destroyed. It has been able to salvage some of the records and has ascer-
tained the following balances.
December 31, 2009 December 31, 2008
Cash $ 30,000 $ 10,000
Receivables (net) 72,500 126,000
Inventory 200,000 180,000
Accounts payable 50,000 90,000
Notes payable 30,000 60,000
Common stock, $100 par 400,000 400,000
Retained earnings 113,500 101,000
Additional information:
1. The inventory turnover is 3.5 times.
2. The return on common stockholders’ equity is 24%. The company had no additional paid-in
capital.
3. The receivables turnover is 8.8 times.
4. The return on assets is 20%.
5. Total assets at December 31, 2008, were $605,000.
734 Chapter 15 Financial Statement Analysis
Compute selected ratios.
(SO 5)
Compute amounts from ratios.
(SO 5)
Instructions
Compute the following for Rees Corporation.
(a) Cost of goods sold for 2009.
(b) Net sales (credit) for 2009.
(c) Net income for 2009.
(d) Total assets at December 31, 2009.
E15-11 Scully Corporation’s comparative balance sheets are presented below.
SCULLY CORPORATION
Balance Sheets
December 31
2008 2007
Cash $ 4,300 $ 3,700
Accounts receivable 21,200 23,400
Inventory 10,000 7,000
Land 20,000 26,000
Building 70,000 70,000
Accumulated depreciation (15,000) (10,000)
Total $110,500 $120,100
Accounts payable $ 12,370 $ 31,100
Common stock 75,000 69,000
Retained earnings 23,130 20,000
Total $110,500 $120,100
Scully’s 2008 income statement included net sales of $100,000, cost of goods sold of $60,000, and
net income of $15,000.
Instructions
Compute the following ratios for 2008.
(a) Current ratio.
(b) Acid-test ratio.
(c) Receivables turnover.
(d) Inventory turnover.
(e) Profit margin.
(f) Asset turnover.
(g) Return on assets.
(h) Return on common stockholders’ equity.
(i) Debt to total assets ratio.
E15-12 For its fiscal year ending October 31, 2008, Molini Corporation reports the following
partial data.
Income before income taxes $540,000
Income tax expense (30% � $390,000) 117,000
Income before extraordinary items 423,000
Extraordinary loss from flood 150,000
Net income $273,000
The flood loss is considered an extraordinary item. The income tax rate is 30% on all items.
Instructions
(a) Prepare a correct income statement, beginning with income before income taxes.
(b) Explain in memo form why the income statement data are misleading.
E15-13 Yadier Corporation has income from continuing operations of $290,000 for the year
ended December 31, 2008. It also has the following items (before considering income taxes).
1. An extraordinary loss of $80,000.
2. A gain of $30,000 on the discontinuance of a division.
Exercises 735
Prepare income statement.
(SO 6)
Compute ratios.
(SO 5)
Prepare a correct income
statement.
(SO 6)
3. A correction of an error in last year’s financial statements that resulted in a $20,000 under-
statement of 2007 net income.
Assume all items are subject to income taxes at a 30% tax rate.
Instructions
(a) Prepare an income statement, beginning with income from continuing operations.
(b) Indicate the statement presentation of any item not included in (a) above.
736 Chapter 15 Financial Statement Analysis
(a) Net income (Douglas)
6.6%; (Maulder) 3.0%
Compute ratios from balance
sheet and income statement.
(SO 5)
EXERCISES: SET B
Visit the book’s website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Exercise Set B.
w
w
w
.wiley.co
m
/c
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e
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e/
we
ygandt
PROBLEMS
Follow the rounding procedures used in the chapter.
P15-1 Comparative statement data for Douglas Company and Maulder Company, two com-
petitors, appear below. All balance sheet data are as of December 31, 2009, and December 31,
2008.
Douglas Company Maulder Company
2009 2008 2009 2008
Net sales $1,549,035 $339,038
Cost of goods sold 1,080,490 241,000
Operating expenses 302,275 79,000
Interest expense 8,980 2,252
Income tax expense 54,500 6,650
Current assets 325,975 $312,410 83,336 $ 79,467
Plant assets (net) 521,310 500,000 139,728 125,812
Current liabilities 65,325 75,815 35,348 30,281
Long-term liabilities 108,500 90,000 29,620 25,000
Common stock, $10 par 500,000 500,000 120,000 120,000
Retained earnings 173,460 146,595 38,096 29,998
Instructions
(a) Prepare a vertical analysis of the 2009 income statement data for Douglas Company and
Maulder Company in columnar form.
(b) Comment on the relative profitability of the companies by computing the return
on assets and the return on common stockholders’ equity ratios for both companies.
P15-2 The comparative statements of Villa Tool Company are presented below.
VILLA TOOL COMPANY
Income Statement
For the Year Ended December 31
2009 2008
Net sales $1,818,500 $1,750,500
Cost of goods sold 1,011,500 996,000
Gross profit 807,000 754,500
Selling and administrative expense 516,000 479,000
Income from operations 291,000 275,500
Other expenses and losses
Interest expense 18,000 14,000
Income before income taxes 273,000 261,500
Income tax expense 81,000 77,000
Net income $ 192,000 $ 184,500
Prepare vertical analysis and
comment on profitability.
(SO 4, 5)
Unlike previous chapters,
Chapter 15 has one set of
problems in the book, not two.
A second set appears at the
Student Companion Site.
VILLA TOOL COMPANY
Balance Sheets
December 31
Assets 2009 2008
Current assets
Cash $ 60,100 $ 64,200
Short-term investments 69,000 50,000
Accounts receivable (net) 117,800 102,800
Inventory 123,000 115,500
Total current assets 369,900 332,500
Plant assets (net) 600,300 520,300
Total assets $970,200 $852,800
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable $160,000 $145,400
Income taxes payable 43,500 42,000
Total current liabilities 203,500 187,400
Bonds payable 200,000 200,000
Total liabilities 403,500 387,400
Stockholders’ equity
Common stock ($5 par) 280,000 300,000
Retained earnings 286,700 165,400
Total stockholders’ equity 566,700 465,400
Total liabilities and stockholders’ equity $970,200 $852,800
All sales were on account. The allowance for doubtful accounts was $3,200 on December 31,
2009, and $3,000 on December 31, 2008.
Instructions
Compute the following ratios for 2009. (Weighted-average-common shares in 2009 were 57,000.)
(a) Earnings per share. (f) Receivables turnover.
(b) Return on common stockholders’ equity. (g) Inventory turnover.
(c) Return on assets. (h) Times interest earned.
(d) Current. (i) Asset turnover.
(e) Acid-test. (j) Debt to total assets.
P15-3 Condensed balance sheet and income statement data for Kersenbrock Corporation ap-
pear below.
KERSENBROCK CORPORATION
Balance Sheets
December 31
2009 2008 2007
Cash $ 25,000 $ 20,000 $ 18,000
Receivables (net) 50,000 45,000 48,000
Other current assets 90,000 95,000 64,000
Investments 75,000 70,000 45,000
Plant and equipment (net) 400,000 370,000 358,000
$640,000 $600,000 $533,000
Current liabilities $ 75,000 $ 80,000 $ 70,000
Long-term debt 80,000 85,000 50,000
Common stock, $10 par 340,000 310,000 300,000
Retained earnings 145,000 125,000 113,000
$640,000 $600,000 $533,000
Problems 737
Perform ratio analysis, and
evaluate financial position and
operating results.
(SO 5)
KERSENBROCK CORPORATION
Income Statement
For the Year Ended December 31
2009 2008
Sales $740,000 $700,000
Less: Sales returns and allowances 40,000 50,000
Net sales 700,000 650,000
Cost of goods sold 420,000 400,000
Gross profit 280,000 250,000
Operating expenses (including income taxes) 235,000 220,000
Net income $ 45,000 $ 30,000
Additional information:
1. The market price of Kersenbrock’s common stock was $4.00, $5.00, and $8.00 for 2007, 2008,
and 2009, respectively.
2. All dividends were paid in cash.
Instructions
(a) Compute the following ratios for 2008 and 2009.
(1) Profit margin.
(2) Asset turnover.
(3) Earnings per share. (Weighted-average-common shares in 2009 were 32,000 and in 2008
were 31,000.)
(4) Price-earnings.
(5) Payout.
(6) Debt to total assets.
(b) Based on the ratios calculated, discuss briefly the improvement or lack thereof in
financial position and operating results from 2008 to 2009 of Kersenbrock Corporation.
P15-4 Financial information for Hanshew Company is presented below.
HANSHEW COMPANY
Balance Sheets
December 31
Assets 2009 2008
Cash $ 70,000 $ 65,000
Short-term investments 52,000 40,000
Receivables (net) 98,000 80,000
Inventories 125,000 135,000
Prepaid expenses 29,000 23,000
Land 130,000 130,000
Building and equipment (net) 180,000 175,000
$ 684,000 $648,000
Liabilities and Stockholders’ Equity
Notes payable $100,000 $100,000
Accounts payable 48,000 42,000
Accrued liabilities 50,000 40,000
Bonds payable, due 2012 150,000 150,000
Common stock, $10 par 200,000 200,000
Retained earnings 136,000 116,000
$ 684,000 $648,000
738 Chapter 15 Financial Statement Analysis
Compute ratios, and comment
on overall liquidity and
profitability.
(SO 5)
HANSHEW COMPANY
Income Statement
For the Years Ended December 31
2009 2008
Sales $850,000 $790,000
Cost of goods sold 620,000 575,000
Gross profit 230,000 215,000
Operating expenses 187,000 173,000
Net income $ 43,000 $ 42,000
Additional information:
1. Inventory at the beginning of 2008 was $118,000.
2. Receivables (net) at the beginning of 2008 were $88,000. The allowance for doubtful accounts
was $4,000 at the end of 2009, $3,800 at the end of 2008, and $3,700 at the beginning of 2008.
3. Total assets at the beginning of 2008 were $630,000.
4. No common stock transactions occurred during 2008 or 2009.
5. All sales were on account.
Instructions
(a) Indicate, by using ratios, the change in liquidity and profitability of Hanshew Company from
2008 to 2009. (Note: Not all profitability ratios can be computed.)
(b) Given below are three independent situations and a ratio that may be affected. For each sit-
uation, compute the affected ratio (1) as of December 31, 2009, and (2) as of December 31,
2010, after giving effect to the situation. Net income for 2010 was $50,000. Total assets on
December 31, 2010, were $700,000.
Situation Ratio
(1) 18,000 shares of common stock were sold Return on common stockholders’
at par on July 1, 2010. equity
(2) All of the notes payable were paid in 2010. Debt to total assets
The only change in liabilities was that the
notes payable were paid.
(3) Market price of common stock was $9 Price-earnings ratio
on December 31, 2009, and $12.80 on
December 31, 2010.
P15-5 Selected financial data of Target and Wal-Mart for 2005 are presented here (in millions).
Target Wal-Mart
Corporation Stores, Inc.
Income Statement Data for Year
Net sales $45,682 $285,222
Cost of goods sold 31,445 219,793
Selling and administrative expenses 10,480 51,354
Interest expense 570 986
Other income (expense) 1,157 2,767
Income tax expense 1,146 5,589
Net income $ 3,198 $ 10,267
Balance Sheet Data (End of Year)
Current assets $13,922 $ 38,491
Noncurrent assets 18,371 81,732
Total assets $32,293 $120,223
Current liabilities $ 8,220 $ 42,888
Long-term debt 11,044 27,939
Total stockholders’ equity 13,029 49,396
Total liabilities and stockholders’ equity $32,293 $120,223
Problems 739
Compute selected ratios, and
compare liquidity, profitability,
and solvency for two
companies.
(SO 5)
DILLON COMPANY
Income Statement
For Year Ended December 31
2009 2008
Net sales (all on account) $600,000 $520,000
Expenses
Cost of goods sold 415,000 354,000
Selling and administrative 120,800 114,800
Interest expense 7,800 6,000
Income tax expense 18,000 14,000
Total expenses 561,600 488,800
Net income $ 38,400 $ 31,200
Beginning-of-Year Balances
Total assets $31,416 $105,405
Total stockholders’ equity 11,132 43,623
Current liabilities 8,314 40,364
Total liabilities 20,284 61,782
Other Data
Average net receivables $4,845 $ 1,485
Average inventory 4,958 28,030
Net cash provided by operating activities 3,821 15,044
Instructions
(a) For each company, compute the following ratios.
(1) Current. (7) Asset turnover.
(2) Receivables turnover. (8) Return on assets.
(3) Average collection period. (9) Return on common stockholders’ equity.
(4) Inventory turnover. (10) Debt to total assets.
(5) Days in inventory. (11) Times interest earned.
(6) Profit margin.
(b) Compare the liquidity, solvency, and profitability of the two companies.
P15-6 The comparative statements of Dillon Company are presented below.
740 Chapter 15 Financial Statement Analysis
DILLON COMPANY
Balance Sheets
December 31
Assets 2009 2008
Current assets
Cash $ 21,000 $ 18,000
Short-term investments 18,000 15,000
Accounts receivable (net) 86,000 74,000
Inventory 90,000 70,000
Total current assets 215,000 177,000
Plant assets (net) 423,000 383,000
Total assets $638,000 $560,000
Compute numerous ratios.
(SO 5)
Additional data:
The common stock recently sold at $19.50 per share.
The year-end balance in the allowance for doubtful accounts was $3,000 for 2009 and $2,400 for
2008.
Instructions
Compute the following ratios for 2009.
(a) Current. (h) Return on common stockholders’ equity.
(b) Acid-test. (i) Earnings per share.
(c) Receivables turnover. (j) Price-earnings.
(d) Inventory turnover. (k) Payout.
(e) Profit margin. (l) Debt to total assets.
(f) Asset turnover. (m) Times interest earned.
(g) Return on assets.
P15-7 Presented below is an incomplete income statement and an incomplete comparative
balance sheet of Cotte Corporation.
Problems 741
COTTE CORPORATION
Income Statement
For the Year Ended December 31, 2009
Sales $11,000,000
Cost of goods sold ?
Gross profit ?
Operating expenses 1,665,000
Income from operations ?
Other expenses and losses
Interest expense ?
Income before income taxes ?
Income tax expense 560,000
Net income $ ?
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable $122,000 $110,000
Income taxes payable 23,000 20,000
Total current liabilities 145,000 130,000
Long-term liabilities
Bonds payable 120,000 80,000
Total liabilities 265,000 210,000
Stockholders’ equity
Common stock ($5 par) 150,000 150,000
Retained earnings 223,000 200,000
Total stockholders’ equity 373,000 350,000
Total liabilities and stockholders’ equity $638,000 $560,000
Compute missing information
given a set of ratios.
(SO 5)
Additional information:
1. The receivables turnover for 2009 is 10 times.
2. All sales are on account.
3. The profit margin for 2009 is 14.5%.
4. Return on assets is 22% for 2009.
5. The current ratio on December 31, 2009, is 3.0.
6. The inventory turnover for 2009 is 4.8 times.
Instructions
Compute the missing information given the ratios above. Show computations. (Note: Start with
one ratio and derive as much information as possible from it before trying another ratio. List all
missing amounts under the ratio used to find the information.)
P15-8 Cheaney Corporation owns a number of cruise ships and a chain of hotels. The hotels,
which have not been profitable, were discontinued on September 1, 2008. The 2008 operating
results for the company were as follows.
Operating revenues $12,850,000
Operating expenses 8,700,000
Operating income $ 4,150,000
Analysis discloses that these data include the operating results of the hotel chain, which were:
operating revenues $2,000,000 and operating expenses $2,400,000. The hotels were sold at a gain
of $200,000 before taxes. This gain is not included in the operating results. During the year,
Cheaney suffered an extraordinary loss of $800,000 before taxes, which is not included in the
operating results. In 2008, the company had other revenues and gains of $100,000, which are not
included in the operating results. The corporation is in the 30% income tax bracket.
Instructions
Prepare a condensed income statement.
P15-9 The ledger of LaRussa Corporation at December 31, 2008, contains the following sum-
mary data.
Net sales $1,700,000 Cost of goods sold $1,100,000
Selling expenses 120,000 Administrative expenses 150,000
Other revenues and gains 20,000 Other expenses and losses 28,000
742 Chapter 15 Financial Statement Analysis
COTTE CORPORATION
Balance Sheets
December 31
Assets 2009 2008
Current assets
Cash $ 450,000 $ 375,000
Accounts receivable (net) ? 950,000
Inventory ? 1,720,000
Total current assets ? 3,045,000
Plant assets (net) 4,620,000 3,955,000
Total assets $ ? $7,000,000
Liabilities and Stockholders’ Equity
Current liabilities $ ? $ 825,000
Long-term notes payable ? 2,800,000
Total liabilities ? 3,625,000
Common stock, $1 par 3,000,000 3,000,000
Retained earnings 400,000 375,000
Total stockholders’ equity 3,400,000 3,375,000
Total liabilities and stockholders’ equity $ ? $7,000,000
Prepare income statement with
discontinued operations and
extraordinary loss.
(SO 6)
Net income $2,555,000
Prepare income statement with
nontypical items.
(SO 6)
Your analysis reveals the following additional information that is not included in the data on
page 742.
1. The entire puzzles division was discontinued on August 31. The income from operations for
this division before income taxes was $20,000. The puzzles division was sold at a loss of
$90,000 before income taxes.
2. On May 15, company property was expropriated for an interstate highway. The settlement re-
sulted in an extraordinary gain of $120,000 before income taxes.
3. The income tax rate on all items is 30%.
Instructions
Prepare an income statement for the year ended December 31, 2008. Use the format illustrated
in Demonstration Problem 2 (p. 726).
Broadening Your Perspective 743
PROBLEMS: SET B
Visit the book’s website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Problem Set B.
CONTINUING COOKIE CHRONICLE
(Note: This is a continuation of the Cookie Chronicle from Chapters 1–14.)
CCC15 Natalie and Curtis have comparative balance sheets and income statements for Cookie
& Coffee Creations Inc. They have been told that they can use these financial statements to pre-
pare horizontal and vertical analyses, and to calculate financial ratios, to analyze how their busi-
ness is doing and to make some decisions they have been considering.
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to see the completion of this problem.
Financial Reporting Problem
PepsiCo, Inc.
BYP15-1 Your parents are considering investing in PepsiCo, Inc. common stock. They ask
you, as an accounting expert, to make an analysis of the company for them. Fortunately, ex-
cerpts from a current annual report of PepsiCo are presented in Appendix A of this textbook.
Note that all dollar amounts are in millions.
Instructions
(Follow the approach in the chapter for rounding numbers.)
(a) Make a 5-year trend analysis, using 2001 as the base year, of (1) net sales and (2) net income.
Comment on the significance of the trend results.
(b) Compute for 2005 and 2004 the (1) profit margin, (2) asset turnover, (3) return on assets, and
(4) return on common stockholders’ equity. How would you evaluate PepsiCo’s profitabil-
ity? Total assets at December 27, 2003, were $25,327, and total stockholders’ equity at
December 27, 2003, was $11,896.
(c) Compute for 2005 and 2004 the (1) debt to total assets and (2) times interest earned ratio.
How would you evaluate PepsiCo’s long-term solvency?
(d) What information outside the annual report may also be useful to your parents in making a
decision about PepsiCo, Inc.?
B R O A D E N I N G Y O U R P E R S P E C T I V E
FINANCIAL REPORTING AND ANALYSIS
Net income: $260,400
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Comparative Analysis Problem
PepsiCo, Inc. vs. The Coca-Cola Company
BYP15-2 PepsiCo’s financial statements are presented in Appendix A. The Coca-Cola Comp-
any’s financial statements are presented in Appendix B.
Instructions
(a) Based on the information contained in these financial statements, determine each of the fol-
lowing for each company.
(1) The percentage increase (decrease) in (i) net sales and (ii) net income from 2004 to 2005.
(2) The percentage increase in (i) total assets and (ii) total common stockholders’ (share-
holders’) equity from 2004 to 2005.
(3) The basic earnings per share and price-earnings ratio for 2005. (For Coca-Cola, use the
basic earnings per share.) Coca-Cola’s common stock had a market price of $43.60 at the
end of fiscal-year 2005.
(b) What conclusions concerning the two companies can be drawn from these data?
Exploring the Web
BYP15-3 The Management Discussion and Analysis section of an annual report addresses
corporate performance for the year, and sometimes uses financial ratios to support its claims.
Address: www.ibm.com/investor/tools/index.phtml or go to www.wiley.com/college/weygandt
Steps
1. From IBM’s Investor Tools, choose Investment Guides.
2. Choose Guide to Annual Reports.
3. Choose Anatomy of an Annual Report.
Instructions
Using the information from the above site, answer the following questions.
(a) What are the optional elements that are often included in an annual report?
(b) What are the elements of an annual report that are required by the SEC?
(c) Describe the contents of the Management Discussion.
(d) Describe the contents of the Auditors’ Report.
(e) Describe the contents of the Selected Financial Data.
744 Chapter 15 Financial Statement Analysis
CRITICAL THINKING
Decision Making Across the Organization
BYP15-4 As the CPA for Carismo Manufacturing Inc., you have been asked to develop some
key ratios from the comparative financial statements. This information is to be used to convince
creditors that the company is solvent and will continue as a going concern. The data requested
and the computations developed from the financial statements follow.
2008 2007
Current ratio 3.1 times 2.1 times
Acid-test ratio .8 times 1.4 times
Asset turnover 2.8 times 2.2 times
Net income Up 32% Down 8%
Earnings per share $3.30 $2.50
Book value per share Up 8% Up 11%
Instructions
With the class divided into groups, answer the following.
Carismo Manufacturing Inc. asks you to prepare a list of brief comments stating how each of
these items supports the solvency and going-concern potential of the business. The company
wishes to use these comments to support its presentation of data to its creditors. You are to prepare
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the comments as requested, giving the implications and the limitations of each item separately.
Then prepare a collective inference that may be drawn from the individual items about
Carismo’s solvency and going-concern potential.
BYP15-5 General Dynamics develops, produces, and supports innovative, reliable, and highly
sophisticated military and commercial products. In July of a recent year, the corporation an-
nounced that its Quincy Shipbuilding Division (Quincy) will be closed following the comple-
tion of the Maritime Prepositioning Ship construction program.
Prior to discontinuance, the operating results of Quincy were net sales $246.8 million, income
from operations before income taxes $28.3 million, and income taxes $12.5 million. The corpora-
tion’s loss on disposition of Quincy was $5.0 million, net of $4.3 million income tax benefits.
From its other operating activities, General Dynamics’ financial results were net sales
$8,163.8 million, cost of goods sold $6,958.8 million, and selling and administrative expenses
$537.0 million. In addition, the corporation had interest expense of $17.2 million and interest
revenue of $3.6 million. Income taxes were $282.9 million.
General Dynamics had an average of 42.3 million shares of common stock outstanding dur-
ing the year.
Instructions
With the class divided into groups, answer the following.
(a) Prepare the income statement for the year, assuming that the year ended on December 31,
2008. Show earnings per share data on the income statement. All dollars should be stated in
millions, except for per share amounts. (For example, $8 million would be shown as $8.0)
(b) In the preceding year, Quincy’s earnings were $51.6 million before income taxes of $22.8
million. For comparative purposes, General Dynamics reported earnings per share of $0.61
from discontinued operations for Quincy in the preceding year.
(1) What was the average number of common shares outstanding during the preceding
year?
(2) If earnings per share from continuing operations was $7.47, what was income from con-
tinuing operations during the preceding year? (Round to two decimals.)
Communication Activity
BYP15-6 Beth Harlan is the CEO of Lafferty’s Electronics. Harlan is an expert engineer but
a novice in accounting. She asks you to explain (1) the bases for comparison in analyzing Laf-
ferty’s financial statements, and (2) the factors affecting quality of earnings.
Instructions
Write a letter to Beth Harlan that explains the bases for comparison and factors affecting qual-
ity of earnings.
Ethics Case
BYP15-7 Jack McClintock, president of McClintock Industries, wishes to issue a press release
to bolster his company’s image and maybe even its stock price, which has been gradually falling.
As controller, you have been asked to provide a list of twenty financial ratios along with some
other operating statistics relative to McClintock Industries’ first quarter financials and operations.
Two days after you provide the ratios and data requested, Jeremy Phelps, the public rela-
tions director of McClintock, asks you to prove the accuracy of the financial and operating data
contained in the press release written by the president and edited by Jeremy. In the press re-
lease, the president highlights the sales increase of 25% over last year’s first quarter and the
positive change in the current ratio from 1.5:1 last year to 3:1 this year. He also emphasizes that
production was up 50% over the prior year’s first quarter.
You note that the press release contains only positive or improved ratios and none of the
negative or deteriorated ratios. For instance, no mention is made that the debt to total assets
ratio has increased from 35% to 55%, that inventories are up 89%, and that while the current
ratio improved, the acid-test ratio fell from 1:1 to .5:1. Nor is there any mention that the reported
profit for the quarter would have been a loss had not the estimated lives of McClintock’s plant
and machinery been increased by 30%. Jeremy emphasized, “The prez wants this release by
early this afternoon.”
Broadening Your Perspective 745
Instructions
(a) Who are the stakeholders in this situation?
(b) Is there anything unethical in president McClintock’s actions?
(c) Should you as controller remain silent? Does Jeremy have any responsibility?
“All About You” Activity
BYP15-8 In this chapter you learned how to use many tools for performing a financial analy-
sis of a company. When making personal investments, however, it is most likely that you won’t
be buying stocks and bonds in individual companies. Instead, when most people want to invest
in stock, they buy mutual funds. By investing in a mutual fund, you reduce your risk because
the fund diversifies by buying the stock of a variety of different companies, bonds, and other
investments, depending on the stated goals of the fund.
Before you invest in a fund, you will need to decide what type of fund you want. For ex-
ample, do you want a fund that has the potential of high growth (but also high risk), or are you
looking for lower risk and a steady stream of income? Do you want a fund that invests only in
U.S. companies, or do you want one that invests globally? Many resources are available to help
you with these types of decisions.
Instructions
Go to http://web.archive.org/web/20050210200843/http://www.cnb1.com/invallocmdl.htm and
complete the investment allocation questionnaire. Add up your total points to determine the
type of investment fund that would be appropriate for you.
Answers to Insight and Accounting Across the
Organization Questions
How to Manage the Current Ratio, p. 707
Q: How might management influence the company’s current ratio?
A: Management can affect the current ratio by speeding up or withholding payments on accounts
payable just before the balance sheet date. Management can alter the cash balance by increas-
ing or decreasing long-term assets or long-term debt, or by issuing or purchasing equity shares.
Keeping Up to Date as an Investor, p. 715
Q: If you want to keep current with the financial and operating developments of a company in
which you own shares, what are some ways you can do so?
A: You can obtain current information on your investments through a company’s Web site, fi-
nancial magazines and newspapers, CNBC television programs, investment letters, and a
stockbroker.
What Is Extraordinary?, p. 720
Q: If a company takes a large restructuring charge, what is the effect on the company’s current
income statement versus future ones?
A: The current period’s net income can be greatly diminished by a large restructuring charge,
while the net income in future periods can be enhanced because they are relieved of costs (i.e.,
depreciation and labor expenses) that would have been charged to them.
Authors’ Comments on All About You: Should I Play the
Market Yet?, p. 723
For a number of reasons, it is probably a bad idea for Rachael to buy her employer’s stock. First,
if Rachael is going to invest in the stock market, she should diversify her investments across a
number of different companies. Second, you should never have more than a small portion of your
total investment portfolio invested in your employer. Suppose that your employer starts to do
poorly, the stock price falls, and you get laid off. You lose on two counts: You don’t have income,
and your net worth has been affected adversely by the drop in the stock price. (This exact situa-
tion happened to thousands of Enron employees, who not only lost their jobs, but their retire-
ment savings as well, as Enron’s stock plummeted). Third, after purchasing her employer’s stock,
Rachael’s liquidity would be negatively affected: She would have only $3,000 of remaining liquid
assets.
746 Chapter 15 Financial Statement Analysis
If Rachel invests $7,000, she actually has only enough liquid assets to cover one month’s worth
of expenses. It is true that she could sell her stock, but if it has fallen in value, she will be reluctant
to sell. In short, if she were to buy the stock, her financial flexibility would be very limited.
The bottom line is that we think that Rachael should invest in something that offers a higher
return than her bank savings account, but we question whether she has enough liquidity to invest
in individual stocks. We would recommend that she put some money in a stock mutual fund,
some in a short-term CD, and the rest in a money-market fund.
Answer to PepsiCo Review It Question 4, p. 705
PepsiCo presents horizontal analyses in its “Financial Highlights” section and its Management’s
Discussion and Analysis section. Vertical analysis is used in discussions presented in the
Management’s Discussion and Analysis section.
Answers to Self-Study Questions
1. b 2. d 3. a 4. c 5. c 6. c 7. c 8. c 9. d 10. d
Broadening Your Perspective 747
Remember to go back to the Navigator box on the chapter-opening page and check off your completed work.✓
2010 Annual Report
McDonald’s Corporation
One McDonald’s Plaza
Oak Brook, IL 60523
www.aboutmcdonalds.com
2010 Highlights:
Global
Comparable Sales
Growth
5.0%
Earnings
Per Share
Growth
11%
Average Number of
Customers Served
Every Day
64 Million
Jim Skinner
Vice Chairman and CEO
3-Year Compound Annual Total Return
(2008–2010)
S&P 500
DJIA
12.7%MCD
-1.6%
-2.9%
Operating Income
(In billions)
$6.4
$6.8
$7.5
’08
’09
’10
To Our Valued Shareholders:
It’s been said the real secret to
success is sustaining it … and
that’s what McDonald’s did in 2010.
We began the year determined to build on our momentum
and strengthen our brand around the world. So with the
business environment still challenging — and with many
others forced to hold their ground — we pushed ahead.
We dug for deeper consumer insights, aligned our strate-
gies, and strengthened the pillars of our business, from our
menu and restaurants to our value and convenience.
The result was another banner year for McDonald’s. Global
comparable sales increased 5% in 2010 — our eighth
consecutive year of same store sales growth. Operating
income grew 9% and we continued to gain market share
around the world. In addition, we returned $5.1 billion to
shareholders through share repurchases and dividends
paid, and we provided a 27% return to investors for the
year, ranking us third among the companies comprising the
Dow Jones Industrial Average.
Our success remains global, with all areas of the world
contributing significantly to our results. In the U.S., comparable
sales increased 3.8%, while guest count growth reached
all-time highs. A record number of customers visited our
restaurants and drive-thrus across the U.S., even as overall
dining-out traffic remained flat. Europe grew comparable
sales by 4.4% and also increased guest counts — serving
200 million more customers than the year before. Asia/
Pacific, Middle East and Africa continued to make a strong
impact to our overall results with higher guest counts and
6% comparable sales growth.
We achieved all of this through our Plan to Win, which has
served as our strategic blueprint for the past eight years. The
plan focuses on the core drivers of our business — People,
Products, Place, Price, and Promotion, or the five “P’s.” I often
say the opportunity within each “P” is enormous — and we
intend to go after it. To that end, we continue to focus on the
right priorities to keep our brand relevant and meet the evolv-
ing needs of our customers. This approach has served us
remarkably well and will continue to do so in 2011 and beyond.
McDonald’s Corporation Annual Report 2010 1
Our results could not have been achieved without the
performance of our highly talented management team.
They are focused, aligned, and committed to raising the bar
in everything we do. President and Chief Operating Officer
Don Thompson and our senior leadership operate with
tremendous insight and a keen sense for how to drive
continued growth. In addition, our exceptional Board
of Directors provides strong corporate governance and
knowledgeable perspectives as we continue to deliver
shareholder value.
Meanwhile, the entire McDonald’s System is thriving.
Our world-class franchisees continue to invest in their
restaurants and their people in order to elevate the entire
customer experience, resulting in significant increases
in cash flow. Our suppliers perform what I like to call the
McDonald’s Daily Miracle — providing 32,000 restaurants an
assured supply of safe, high-quality products at competitive
prices, with ever improving efficiency. Lastly, our highly
experienced company employees worked smarter to propel
our business forward.
With the powerful alignment of our System and the Plan to
Win as the foundation, we will continue our winning formula:
building on the basics as we further modernize and differenti-
ate the brand.
As always, running better restaurants is our number one
priority. We will improve operations excellence around the
world through new technology, better training, and service
enhancements that will make it easier for our managers
and crew to quickly and accurately serve the customer.
At the same time, our brand is more contemporary and
convenient and provides great value with menus that feature
all of our iconic favorites — from our Big Mac sandwiches to
French fries — along with local offerings and new products
that today’s consumers want. Whether it’s McWraps in Europe,
Angus Burgers in Australia, or McCafé specialty coffees and
smoothies in the U.S., we are strategically enhancing our menu
to appeal to more customers more often.
92
Consecutive months
of global comparable
sales increases through
December 2010
2 McDonald’s Corporation Annual Report 2010
We are moving ahead with the reimaging of our restaurant
interiors and exteriors to create an even more modern
and inviting dining atmosphere. Around the world, we are
re-invigorating our restaurants with local and relevant new
designs that keep the spirit of our brand alive and delight
our guests with a fresh look and contemporary appeal.
Of course, we must continue to lead in ways that positively
impact the trust in our brand. It starts with delivering
a great restaurant experience every time and extends to
a host of areas to which we are strongly committed —
from charitable giving and supporting the communities
we serve, to environmental stewardship and animal welfare.
In addition, we provide our customers with a variety of menu
options that address balance and choice. We will keep
listening to our customers, engaging our stakeholders,
and embracing the responsibility that comes with being
a socially responsible brand.
As McDonald’s Chief Executive Officer, I am immensely proud
of our performance and confident in our ability to continue
our growth. The secret to our success is staying focused on
the execution in our restaurants on behalf of our customers.
As always, thank you for your investment in McDonald’s.
I appreciate your support and look forward to sharing further
success with you.
Sincerely,
Jim Skinner
Vice Chairman and CEO
McDonald’s Corporation Annual Report 2010 3
Combined Operating Margin
27.4%
30.1%
31.0%
’08
’09
’10
Earnings Per Share
$3.76
$4.11
$4.58
’08
’09
’10
Dividends Paid
(In billions)
$1.8
$2.2
$2.4
’08
’09
’10
Dear Fellow Shareholders:
McDonald’s Corporation
achieved another year of strong
results in 2010, as we continued
to strengthen our connection
with customers around the world.
We maintained our momentum and increased sales amid
a still challenging environment for many. Working within the
framework of our proven Plan to Win strategy, McDonald’s
showed flexibility, decisiveness, and strong business
acumen in meeting the evolving needs of consumers and
staying in step with their lives.
Your Board of Directors believes this is a testament to the
strength of the McDonald’s System, what we refer to as our
“three-legged stool.” Under the leadership of Vice Chairman
and CEO Jim Skinner, all three legs of the stool — franchisees,
suppliers and employees — continue to be firmly aligned behind
the Plan to Win. This stability has been key to sustaining
McDonald’s successful performance and to achieving an
impressive eight years of increasing global comparable sales.
Jim continues to lead our company with tremendous skill
and a deep passion for the brand. His global leadership team,
with its deep insights into the operation of our three-legged
stool, gives us a true competitive advantage in our efforts
to evolve and elevate the McDonald’s customer experience.
The Board of Directors is pleased with McDonald’s
performance and its plans moving forward. We believe
the company has a clear vision — and the right people and
strategies in place —for building our business even further
and delivering profitable growth into the future.
As to our Board responsibilities, we remain committed to
overseeing the company’s direction and promoting strong
corporate governance principles and effective management
oversight. Our team of experienced and diverse directors
is eager to continue doing its part to help strengthen
McDonald’s and deliver shareholder value.
It is our honor and privilege to serve on behalf of you,
our shareholders, and we look forward to the days ahead
for this great brand.
Very truly yours,
Andy McKenna
Chairman
Andy McKenna
Chairman
4 McDonald’s Corporation Annual Report 2010
2010 Financial Report
7 6-year Summary
8 Stock Performance Graph
9 Management’s Discussion and Analysis of Financial
Condition and Results of Operations
26
Consolidated Statement of Income
27
Consolidated Balance Sheet
28
Consolidated Statement of Cash Flows
29
Consolidated Statement of Shareholders’ Equity
30
Notes to Consolidated Financial Statements
42
Quarterly Results (Unaudited)
43 Management’s Assessment of Internal Control over
Financial Reporting
44
Report of Independent Registered Public Accounting Firm
45 Report of Independent Registered Public Accounting Firm
on Internal Control over Financial Reporting
46 Executive Management & Business Unit Officers
47
Board of Directors
48
Investor Information
6 McDonald’s Corporation Annual Report 2010
6-Year Summary
Dollars in millions, except per share data 2010 2009 2008 2007 2006 2005
Company-operated sales $16,233 15,459 16,561 16,611 15,402 14,018
Franchised revenues $ 7,842 7,286 6,961 6,176 5,493 5,099
Total revenues $24,075 22,745 23,522 22,787 20,895 19,117
Operating income $ 7,473(1) 6,841(2) 6,443 3,879(5) 4,433(8) 3,984
Income from continuing operations $ 4,946(1) 4,551(2,3) 4,313(4) 2,335(5,6) 2,866(8) 2,578(10)
Net income $ 4,946(1) 4,551(2,3) 4,313(4) 2,395(5,6,7)3,544(8,9) 2,602(10)
Cash provided by operations $ 6,342 5,751 5,917 4,876 4,341 4,337
Cash used for investing activities $ 2,056 1,655 1,625 1,150 1,274 1,818
Capital expenditures $ 2,136 1,952 2,136 1,947 1,742 1,607
Cash used for (provided by) financing activities $ 3,729 4,421 4,115 3,996 5,460 (442)
Treasury stock repurchased(11) $ 2,648 2,854 3,981 3,949 3,719 1,228
Common stock cash dividends $ 2,408 2,235 1,823 1,766 1,217 842
Financial position at year end:
Total assets $31,975 30,225 28,462 29,392 28,974 29,989
Total debt $11,505 10,578 10,218 9,301 8,408 10,137
Total shareholders’ equity $14,634 14,034 13,383 15,280 15,458 15,146
Shares outstanding in millions 1,054 1,077 1,115 1,165 1,204 1,263
Per common share:
Income from continuing operations–diluted $ 4.58(1) 4.11(2,3) 3.76(4) 1.93(5,6) 2.29(8) 2.02(10)
Net income–diluted $ 4.58(1) 4.11(2,3) 3.76(4) 1.98(5,6,7) 2.83(8,9) 2.04(10)
Dividends declared $ 2.26 2.05 1.63 1.50 1.00 0.67
Market price at year end $ 76.76 62.44 62.19 58.91 44.33 33.72
Company-operated restaurants 6,399 6,262 6,502 6,906 8,166 8,173
Franchised restaurants 26,338 26,216 25,465 24,471 22,880 22,593
Total Systemwide restaurants 32,737 32,478 31,967 31,377 31,046 30,766
Franchised sales(12) $61,147 56,928 54,132 46,943 41,380 38,913
(1) Includes net pretax expense due to Impairment and other charges (credits), net of $29.1 million ($24.6 million after tax or $0.02 per share) primarily related to the Company’s share of
restaurant closing costs in McDonald’s Japan (a 50%-owned affiliate) partially offset by income primarily related to the resolution of certain liabilities retained in connection with the
2007 Latin America developmental license transaction.
(2) Includes net pretax income due to Impairment and other charges (credits), net of $61.1 million ($91.4 million after tax or $0.08 per share) primarily related to the resolution of certain
liabilities retained in connection with the 2007 Latin America developmental license transaction.
(3) Includes income of $58.8 million ($0.05 per share) in Gain on sale of investment related to the sale of the Company’s minority ownership interest in Redbox Automated Retail, LLC.
(4) Includes income of $109.0 million ($0.09 per share) in Gain on sale of investment from the sale of the Company’s minority ownership interest in U.K.-based Pret A Manger.
(5) Includes pretax operating charges of $1.7 billion ($1.32 per share) due to Impairment and other charges (credits), net primarily as a result of the Company’s sale of its businesses in 18
Latin American and Caribbean markets to a developmental licensee.
(6) Includes a tax benefit of $316.4 million ($0.26 per share) resulting from the completion of an Internal Revenue Service (IRS) examination of the Company’s 2003-2004 U.S. federal
tax returns.
(7) Includes income of $60.1 million ($0.05 per share) related to discontinued operations primarily from the sale of the Company’s investment in Boston Market.
(8) Includes pretax operating charges of $134 million ($98 million after tax or $0.08 per share) due to Impairment and other charges (credits), net.
(9) Includes income of $678 million ($0.54 per share) related to discontinued operations primarily resulting from the disposal of the Company’s investment in Chipotle.
(10) Includes a net tax benefit of $73 million ($0.05 per share) comprised of $179 million ($0.14 per share) of income tax benefit resulting from the completion of an IRS examination of the
Company’s 2000-2002 U.S. tax returns, partly offset by $106 million ($0.09 per share) of incremental tax expense resulting from the decision to repatriate certain foreign earnings
under the Homeland Investment Act (HIA).
(11) Represents treasury stock purchases as reflected in Shareholders’ equity.
(12) While franchised sales are not recorded as revenues by the Company, management believes they are important in understanding the Company’s financial performance because these
sales are the basis on which the Company calculates and records franchised revenues and are indicative of the financial health of the franchisee base.
McDonald’s Corporation Annual Report 2010 7
Stock performance graph
At least annually, we consider which companies comprise a read-
ily identifiable investment peer group. McDonald’s is included in
published restaurant indices; however, unlike most other compa-
nies included in these indices, which have no or limited
international operations, McDonald’s does business in more than
100 countries and a substantial portion of our revenues and
income is generated outside the U.S. In addition, because of our
size, McDonald’s inclusion in those indices tends to skew the
results. Therefore, we believe that such a comparison is not
meaningful.
Our market capitalization, trading volume and importance in an
industry that is vital to the U.S. economy have resulted in McDo-
nald’s inclusion in the Dow Jones Industrial Average (DJIA) since
1985. Like McDonald’s, many DJIA companies generate mean-
ingful revenues and income outside the U.S. and some manage
global brands. Thus, we believe that the use of the DJIA compa-
nies as the group for comparison purposes is appropriate.
The following performance graph shows McDonald’s cumulative
total shareholder returns (i.e., price appreciation and reinvestment
of dividends) relative to the Standard & Poor’s 500 Stock Index
(S&P 500 Index) and to the DJIA companies for the five-year
period ended December 31, 2010. The graph assumes that the
value of an investment in McDonald’s common stock, the S&P
500 Index and the DJIA companies (including McDonald’s) was
$100 at December 31, 2005. For the DJIA companies, returns
are weighted for market capitalization as of the beginning of
each period indicated. These returns may vary from those of the
Dow Jones Industrial Average Index, which is not weighted by
market capitalization, and may be composed of different compa-
nies during the period under consideration.
COMPARISON OF CUMULATIVE FIVE YEAR TOTAL RETURN
Dec ’05 ’06 ’07 ’08 ’10’09
McDonald’s Corporation
S&P 500 Index
Dow Jones Industrials
$0
$50
$100
$150
$200
$300
$250
100 135 183 199 207 263
100 116 122 77 97 112
100 119 130 88 108 123
Source: Capital IQ, a Standard & Poor’s business
8 McDonald’s Corporation Annual Report 2010
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Overview
DESCRIPTION OF THE BUSINESS
The Company franchises and operates McDonald’s restaurants.
Of the 32,737 restaurants in 117 countries at year-end 2010,
26,338 were franchised or licensed (including 19,279 franchised
to conventional franchisees, 3,485 licensed to developmental
licensees and 3,574 licensed to foreign affiliates (affiliates)—
primarily Japan) and 6,399 were operated by the Company.
Under our conventional franchise arrangement, franchisees pro-
vide a portion of the capital required by initially investing in the
equipment, signs, seating and décor of their restaurant busi-
nesses, and by reinvesting in the business over time. The
Company owns the land and building or secures long-term leases
for both Company-operated and conventional franchised restau-
rant sites. This maintains long-term occupancy rights, helps
control related costs and assists in alignment with franchisees. In
certain circumstances, the Company participates in reinvestment
for conventional franchised restaurants. Under our developmental
license arrangement, licensees provide capital for the entire
business, including the real estate interest, and the Company has
no capital invested. In addition, the Company has an equity
investment in a limited number of affiliates that invest in real
estate and operate and/or franchise restaurants within a market.
We view ourselves primarily as a franchisor and believe fran-
chising is important to delivering great, locally-relevant customer
experiences and driving profitability. However, directly operating
restaurants is paramount to being a credible franchisor and is
essential to providing Company personnel with restaurant oper-
ations experience. In our Company-operated restaurants, and in
collaboration with franchisees, we further develop and refine
operating standards, marketing concepts and product and pricing
strategies, so that only those that we believe are most beneficial
are introduced in the restaurants. We continually review, and as
appropriate adjust, our mix of Company-operated and franchised
(conventional franchised, developmental licensed and foreign
affiliated) restaurants to help optimize overall performance.
The Company’s revenues consist of sales by Company-
operated restaurants and fees from restaurants operated by
franchisees. Revenues from conventional franchised restaurants
include rent and royalties based on a percent of sales along with
minimum rent payments, and initial fees. Revenues from restau-
rants licensed to affiliates and developmental licensees include a
royalty based on a percent of sales, and generally include initial
fees. Fees vary by type of site, amount of Company investment, if
any, and local business conditions. These fees, along with occu-
pancy and operating rights, are stipulated in franchise/license
agreements that generally have 20-year terms.
The business is managed as distinct geographic segments.
Significant reportable segments include the United States (U.S.),
Europe, and Asia/Pacific, Middle East and Africa (APMEA). In
addition, throughout this report we present “Other Countries &
Corporate” that includes operations in Canada and Latin America,
as well as Corporate activities. The U.S., Europe and APMEA
segments account for 34%, 40% and 21% of total revenues,
respectively. The United Kingdom (U.K.), France and Germany,
collectively, account for over 50% of Europe’s revenues; and
China, Australia and Japan (a 50%-owned affiliate accounted for
under the equity method), collectively, account for over 50% of
APMEA’s revenues. These six markets along with the U.S. and
Canada are referred to as “major markets” throughout this report
and comprise approximately 70% of total revenues.
The Company continues to focus its management and finan-
cial resources on the McDonald’s restaurant business as we
believe significant opportunities remain for long-term growth.
Accordingly, in 2009, the Company sold its minority ownership
interest in Redbox Automated Retail, LLC (Redbox) for total
consideration of $140 million. In 2008, the Company sold its
minority ownership interest in U.K.-based Pret A Manger for cash
proceeds of $229 million. In connection with both sales, the
Company recognized nonoperating gains.
In analyzing business trends, management considers a variety
of performance and financial measures, including comparable
sales and comparable guest count growth, Systemwide sales
growth and returns.
• Constant currency results exclude the effects of foreign cur-
rency translation and are calculated by translating current year
results at prior year average exchange rates. Management
reviews and analyzes business results in constant currencies
and bases certain incentive compensation plans on these
results because we believe this better represents the Compa-
ny’s underlying business trends.
• Comparable sales and comparable guest counts are key per-
formance indicators used within the retail industry and are
indicative of acceptance of the Company’s initiatives as well as
local economic and consumer trends. Increases or decreases
in comparable sales and comparable guest counts represent
the percent change in sales and transactions, respectively,
from the same period in the prior year for all restaurants in
operation at least thirteen months, including those temporarily
closed. Some of the reasons restaurants may be temporarily
closed include reimaging or remodeling, rebuilding, road con-
struction and natural disasters. Comparable sales exclude the
impact of currency translation. McDonald’s reports on a calen-
dar basis and therefore the comparability of the same month,
quarter and year with the corresponding period of the prior
year will be impacted by the mix of days. The number of week-
days and weekend days in a given timeframe can have a
positive or negative impact on comparable sales and guest
counts. The Company refers to these impacts as calendar
shift/trading day adjustments. In addition, the timing of holidays
can impact comparable sales and guest counts. These impacts
vary geographically due to consumer spending patterns and
have the greatest effect on monthly comparable sales and
guest counts while the annual impacts are typically minimal. In
2008, there was an incremental full day of sales and guest
counts due to leap year.
• Systemwide sales include sales at all restaurants, whether
operated by the Company or by franchisees. While franchised
sales are not recorded as revenues by the Company, manage-
ment believes the information is important in understanding the
Company’s financial performance because these sales are the
basis on which the Company calculates and records franchised
revenues and are indicative of the financial health of the fran-
chisee base.
McDonald’s Corporation Annual Report 2010 9
• Return on incremental invested capital (ROIIC) is a measure
reviewed by management over one-year and three-year time
periods to evaluate the overall profitability of the business
units, the effectiveness of capital deployed and the future allo-
cation of capital. The return is calculated by dividing the
change in operating income plus depreciation and amortization
(numerator) by the adjusted cash used for investing activities
(denominator), primarily capital expenditures. The calculation
uses a constant average foreign exchange rate over the peri-
ods included in the calculation.
STRATEGIC DIRECTION AND FINANCIAL PERFORMANCE
The strength of the alignment among the Company, its franchi-
sees and suppliers (collectively referred to as the System) has
been key to McDonald’s success. This business model enables
McDonald’s to deliver consistent, locally-relevant restaurant
experiences to customers and be an integral part of the commun-
ities we serve. In addition, it facilitates our ability to identify,
implement and scale innovative ideas that meet customers’
changing needs and preferences.
McDonald’s customer-focused Plan to Win—which concen-
trates on being better, not just bigger—provides a common
framework for our global business yet allows for local adaptation.
Through the execution of initiatives surrounding the five elements
of our Plan to Win—People, Products, Place, Price and Promo-
tion—we have enhanced the restaurant experience for customers
worldwide and grown comparable sales and customer visits in
each of the last seven years. This Plan, combined with financial
discipline, has delivered strong results for our shareholders.
We have exceeded our long-term, constant currency financial
targets of average annual Systemwide sales growth of 3% to
5%; average annual operating income growth of 6% to 7%; and
annual returns on incremental invested capital in the high teens
every year since the Plan’s implementation in 2003, after adjust-
ing for the loss in 2007 from the Latin America developmental
license transaction. Given the size and scope of our global busi-
ness, we believe these financial targets are realistic and
sustainable over time, keeping us focused on making the best
decisions for the long-term benefit of our System.
In 2010, we continued to enhance the customer experience
by remaining focused on the Company’s key global success fac-
tors of branded affordability, menu variety and beverage choice,
convenience including daypart expansion, ongoing restaurant
reinvestment and operations excellence. Initiatives around these
factors successfully resonated with consumers driving increases
in sales and customer visits despite challenging economies and a
contracting Informal Eating Out (IEO) market in many countries.
As a result, every area of the world contributed to 2010 global
comparable sales and guest counts, which increased 5.0% and
4.9%, respectively.
Growth in comparable sales is driven by the System’s ability
to optimize guest count growth, product mix shifts and menu
price changes. Pricing actions reflect local market conditions,
with a view to preserving and improving margins, while continuing
to drive guest counts and market share gains. In general, the goal
is to achieve a balanced contribution of price and guest counts to
comparable sales growth.
In the U.S., we grew sales, guest counts, market share and
restaurant cash flow, with comparable sales increasing for the
8th consecutive year, rising 3.8% in 2010. These positive results
were achieved despite a declining IEO market. This performance
was attributed to several factors including core menu items like
Chicken McNuggets and burgers, everyday affordability and
value options, such as the Breakfast Dollar Menu, additions to the
McCafé beverage line, new snack offerings and limited time
offerings such as the McRib sandwich. The national launch of
McCafé frappés and real-fruit smoothies provided a meaningful
extension to the McCafé line that was well-received by custom-
ers. Extending the snack wrap line with the Angus Snack Wraps
allowed customers to enjoy popular McDonald’s burgers in a
smaller, more portable fashion. Complementing these menu
offerings were our convenient locations, efficient drive-thru serv-
ice and value-oriented local beverage promotions. We broadened
our accessibility through greater 24 hour operations and offered
customers free Wi-Fi in over 12,000 restaurants. Modernizing the
customer experience remained a focus with the extension of our
interior and exterior reimaging program to enhance the appear-
ance and functionality of our restaurants.
In Europe, comparable sales rose 4.4%, marking the 7th
consecutive year of comparable sales increases. Major contrib-
utors were France, the U.K., Russia and Germany. This
performance reflected Europe’s strategic priorities of upgrading
the customer and employee experience, increasing local rele-
vance, and building brand transparency. Initiatives surrounding
these platforms included leveraging our tiered menu featuring
everyday affordable prices, menu variety including limited-time
offerings, new dessert options, and reimaging almost 1,000 res-
taurants. We expanded our coffee business and have nearly
1,300 McCafé locations, which in Europe generally represent a
separate area inside the restaurant that serves specialty coffees,
indulgent desserts and light snacks. The expansion of self-order
kiosks in France, Germany and Spain and the roll out of the new
drive-thru customer order display system in over 3,000 restau-
rants enhanced service. In addition, we increased our accessibility
and convenience with extended hours. We built upon the
momentum of portable menu offerings with the introduction of
McWraps—larger sized beef and chicken wraps in Germany, and
P’tit Plaisir offerings in France. Finally, we continued building
customer trust in our brand through communications that
emphasized the quality and origin of McDonald’s food and our
sustainable business initiatives.
In APMEA, our momentum continued with nearly every coun-
try delivering positive comparable sales, led by Japan, Australia
and China. Comparable sales rose 6.0% through strategies
emphasizing value, core menu extensions, breakfast and con-
venience. Australia launched Family Dinner Boxes featuring
popular menu items bundled together at a discounted price while
China and Japan concentrated on affordability with Value Lunch
platforms. New menu items such as a third Angus burger option
in Australia and the extension of the Spicy Wings line in China
were popular with consumers. Japan executed a successful
U.S.-themed burger promotion and a Chicken Festival promotion
featuring several products. Our dessert strategy is introducing
consumers to the McDonald’s brand with products such as
McFlurries and dessert kiosks in China, where we have become
one of the largest retailers of ice cream. Our breakfast business
continues to develop and is now offered in approximately 75% of
APMEA restaurants. In Japan, value breakfast items, including
the Sausage McMuffin and McGriddle, were rotated across sev-
eral months, while Australia launched new breakfast menu items.
10 McDonald’s Corporation Annual Report 2010
Nearly two-thirds of APMEA restaurants are now offering some
form of extended hours and over 4,800 restaurants are open 24
hours. Delivery is offered in many APMEA markets and is now in
approximately 1,600 restaurants, including nearly 400 in China.
We continue to offer value to our customers by utilizing a stra-
tegic menu pricing tool that optimizes price, product mix, and
promotions. This approach is complemented by a focus on driving
operating efficiencies and effectively managing restaurant-level
food and paper costs by leveraging our scale, supply chain infra-
structure and risk management practices. Our ability to execute
our strategies successfully in every area of the world, grow
comparable sales, leverage a low commodity cost environment
and control selling, general & administrative expenses resulted in
consolidated combined operating margin (operating income as a
percent of total revenues) of 31.0% in 2010, an improvement of
0.9 percentage points over 2009.
In 2010, strong global sales and margin performance grew
cash from operations, which rose $591 million to $6.3 billion. Our
substantial cash flow, strong credit rating and continued access
to credit provide us significant flexibility to fund capital
expenditures and debt repayments as well as return cash to
shareholders. Capital expenditures of approximately $2.1 billion
were invested in our business primarily to open and reimage
restaurants. Across the System, nearly 1,000 restaurants were
opened and nearly 1,800 existing locations were reimaged. We
returned $5.1 billion to shareholders consisting of $2.4 billion in
dividends and nearly $2.7 billion in share repurchases.
Cash from operations continues to benefit from our heavily
franchised business model as the rent and royalty income
received from owner/operators provides a very stable revenue
stream that has relatively low costs. In addition, the franchise
business model is less capital intensive than the Company-
owned model. We believe locally-owned and operated
restaurants maximize brand performance and are at the core of
our competitive advantage, making McDonald’s not just a global
brand, but also a locally relevant one.
HIGHLIGHTS FROM THE YEAR INCLUDED:
• Comparable sales grew 5.0% and guest counts rose 4.9%,
building on 2009 increases of 3.8% and 1.4%, respectively.
• Revenues increased 6% (5% in constant currencies).
• Company-operated margins improved to 19.6% and franchised
margins improved to 82.4%.
• Operating income increased 9% (9% in constant currencies).
• Earnings per share was $4.58, an increase of 11%.
• Cash provided by operations increased $591 million to $6.3
billion.
• The Company increased the quarterly cash dividend per share
11% to $0.61 for the fourth quarter–bringing our current
annual dividend rate to $2.44 per share.
• One-year ROIIC was 37.3% and three-year ROIIC was 38.3%
for the period ended December 31, 2010 (see reconciliation
on Page 25).
• The Company returned $5.1 billion to shareholders through
share repurchases and dividends paid.
OUTLOOK FOR 2011
We will continue to drive success in 2011 and beyond by enhanc-
ing customer relevance across all elements of our Plan to Win—
People, Products, Place, Price and Promotion. Our global System
continues to be energized by our ongoing momentum and sig-
nificant growth opportunities.
We continue to hold a strong competitive position in the
market place, and we intend to further differentiate our brand by
striving to become our customers’ favorite place and way to eat
and drink. We will continue growing market share by executing
our key strategies in the following areas: optimizing our menu,
modernizing the customer experience and broadening our
accessibility. These efforts will include increasing menu choice,
expanding destination beverages and desserts, enhancing our
food image, accelerating our interior and exterior reimaging
efforts and increasing the level and variety of conveniences pro-
vided to our customers. We will execute these priorities to
increase McDonald’s brand relevance while continuing to prac-
tice operational and financial discipline. Consequently, we are
confident we can again meet or exceed our long-term constant
currency financial targets.
In the U.S., our 2011 focus will include highlighting core
menu classics such as the Big Mac, Quarter Pounder with
Cheese and Chicken McNuggets, emphasizing the convenient
and affordable food offered every day, and encouraging the trial
of new products including Fruit & Maple Oatmeal and additional
McCafé beverage offerings. We will continue offering value
across the menu through the Dollar Menu at breakfast and the
rest of the day. Opportunities around additional staffing at peak
hours and increasing restaurants that operate 24 hours per day
will broaden accessibility to our customers. In addition, our plans
to elevate the brand experience encompass updating our
technology infrastructure with a new point-of-sale (POS) system,
enhancing restaurant manager and crew retention and pro-
ductivity, and contemporizing the interiors and exteriors of
approximately 600 restaurants through reimaging.
Our business in Europe will continue to be guided by three
strategic priorities: increasing local relevance, upgrading the
customer and employee experience, and building brand trans-
parency. We will increase our local relevance by complementing
our tiered menu with a variety of limited-time food events as well
as new snack and dessert options. In 2011, we will reimage
approximately 850 restaurants as we progress towards our goal
of having 90% of our interiors and over 50% of our exteriors
reimaged by the end of 2012. Reimaging reinforces the quality of
our brand while further differentiating us from the competition.
We will leverage service innovations with the deployment of
technologies such as the new POS system, self-order kiosks,
hand-held order devices and drive-thru customer order displays
to enhance the customer experience and help drive increased
transactions and labor efficiency. We believe there is an oppor-
tunity to further build brand transparency by raising customer
awareness about our food quality and product sourcing. In addi-
tion, we will communicate our efforts to preserve the environment
through our sustainable business initiatives. Our European busi-
ness in 2011 faces some headwinds from government-initiated
austerity measures being implemented in many countries. While
we will closely monitor consumer reactions to these measures,
we remain confident that our business model will continue to
drive profitable growth.
In APMEA, we will continue our efforts to become our
customers’ first choice for eating out by focusing on menu varie-
ty, value, restaurant experience and convenience. The markets
will continue to execute against a combination of core menu
McDonald’s Corporation Annual Report 2010 11
items, food events and limited-time offerings to present a bal-
anced mix of products to our customers. Value will continue to be
a key growth driver as we reinforce the affordability of our menu
to consumers and build on our successful Value Lunch platforms.
We will invest in our business primarily by opening over 600 new
restaurants and reimaging over 500 existing restaurants while
elevating our focus on service and operations to drive efficien-
cies. In China, we will continue to build a foundation for long-term
growth by increasing our base of restaurants by approximately
15% in 2011 toward our goal of nearly 2,000 restaurants by the
end of 2013. Convenience initiatives include expanding delivery
service across the region and building on the success of our
extended operating hours.
McDonald’s has an ongoing commitment to optimize our res-
taurant ownership structure. A heavily franchised, less capital-
intensive business model has favorable implications for the
strength and stability of our cash flow, the amount of capital we
invest and long-term returns.
We continue to maintain a strong culture of financial dis-
cipline by effectively managing all spending in order to maximize
business performance. In making capital allocation decisions, our
goal is to elevate the McDonald’s experience by driving sustain-
able growth in sales and market share while earning strong
returns. We remain committed to returning all of our free cash
flow (cash from operations less capital expenditures) to share-
holders over the long term via dividends and share repurchases.
McDonald’s does not provide specific guidance on diluted
earnings per share. The following information is provided to assist
in analyzing the Company’s results:
• Changes in Systemwide sales are driven by comparable sales
and net restaurant unit expansion. The Company expects net
restaurant additions to add approximately 1.5 percentage
points to 2011 Systemwide sales growth (in constant
currencies), most of which will be due to the 541 net traditional
restaurants added in 2010.
• The Company does not generally provide specific guidance on
changes in comparable sales. However, as a perspective,
assuming no change in cost structure, a 1 percentage point
increase in comparable sales for either the U.S. or Europe
would increase annual diluted earnings per share by about
3 cents.
• With about 75% of McDonald’s grocery bill comprised of 10
different commodities, a basket of goods approach is the most
comprehensive way to look at the Company’s commodity costs.
For the full year 2011, the total basket of goods cost is
expected to increase 2-2.5% in the U.S. and to increase
3.5-4.5% in Europe as compared to 2010. Some volatility may
be experienced between quarters in the normal course of
business.
• The Company expects full-year 2011 selling, general & admin-
istrative expenses to decrease 2-3%, in constant currencies,
partly due to higher incentive compensation in 2010 based on
performance. In addition, fluctuations will be experienced
between quarters due to certain items in 2010, such as the
Vancouver Winter Olympics in February and the biennial
Worldwide Owner/Operator Convention in April.
• Based on current interest and foreign currency exchange rates,
the Company expects interest expense for the full year 2011
to increase approximately 7% compared with 2010.
• A significant part of the Company’s operating income is gen-
erated outside the U.S., and about 40% of its total debt is
denominated in foreign currencies. Accordingly, earnings are
affected by changes in foreign currency exchange rates,
particularly the Euro, Australian Dollar, British Pound and
Canadian Dollar. Collectively, these currencies represent
approximately 65% of the Company’s operating income out-
side the U.S. If all four of these currencies moved by 10% in
the same direction, the Company’s annual diluted earnings per
share would change by about 20 cents.
• The Company expects the effective income tax rate for the full
year 2011 to be approximately 30% to 32%. Some volatility
may be experienced between the quarters resulting in a quar-
terly tax rate that is outside the annual range.
• The Company expects capital expenditures for 2011 to be
approximately $2.5 billion. About half of this amount will be
used to open new restaurants. The Company expects to open
about 1,100 restaurants including about 400 restaurants in
affiliated and developmental licensee markets, such as Japan
and Latin America, where the Company does not fund any
capital expenditures. The Company expects net additions of
about 750 traditional restaurants. The remaining capital will be
used for reinvestment in existing restaurants. Over half of this
reinvestment will be used to reimage approximately 2,200
locations worldwide, some of which will require no capital
investment from the Company.
12 McDonald’s Corporation Annual Report 2010
Consolidated Operating Results
Operating results
2010 2009 2008
Dollars in millions, except per share data Amount
Increase/
(decrease) Amount
Increase/
(decrease) Amount
Revenues
Sales by Company-operated restaurants $ 16,233 5% $ 15,459 (7)% $ 16,561
Revenues from franchised restaurants 7,842 8 7,286 5 6,961
Total revenues 24,075 6 22,745 (3) 23,522
Operating costs and expenses
Company-operated restaurant expenses 13,060 3 12,651 (7) 13,653
Franchised restaurants—occupancy expenses 1,378 6 1,302 6 1,230
Selling, general & administrative expenses 2,333 4 2,234 (5) 2,355
Impairment and other charges (credits), net 29 nm (61) nm 6
Other operating (income) expense, net (198) 11 (222) (35) (165)
Total operating costs and expenses 16,602 4 15,904 (7) 17,079
Operating income 7,473 9 6,841 6 6,443
Interest expense 451 (5) 473 (9) 523
Nonoperating (income) expense, net 22 nm (24) 69 (78)
Gain on sale of investment nm (95) 41 (160)
Income before provision for income taxes 7,000 8 6,487 5 6,158
Provision for income taxes 2,054 6 1,936 5 1,845
Net income $ 4,946 9% $ 4,551 6% $ 4,313
Earnings per common share—diluted $ 4.58 11% $ 4.11 9% $ 3.76
Weighted-average common shares outstanding—diluted 1,080.3 1,107.4 1,146.0
nm Not meaningful.
IMPACT OF FOREIGN CURRENCY TRANSLATION ON REPORTED
RESULTS
While changing foreign currencies affect reported results, McDo-
nald’s mitigates exposures, where practical, by financing in local
currencies, hedging certain foreign-denominated cash flows, and
purchasing goods and services in local currencies.
In 2010, foreign currency translation had a positive impact on
consolidated operating results driven by stronger global curren-
cies, primarily the Australian Dollar and Canadian Dollar, partly
offset by the weaker Euro. In 2009, foreign currency translation
had a negative impact on consolidated operating results, primarily
driven by the Euro, British Pound, Russian Ruble, Australian Dol-
lar and Canadian Dollar. In 2008, foreign currency translation had
a positive impact on consolidated operating results, driven by the
stronger Euro and most other currencies, partly offset by the
weaker British Pound.
Impact of foreign currency translation on reported results
Reported amount Currency translation benefit/(cost)
In millions, except per share data 2010 2009 2008 2010 2009 2008
Revenues $24,075 $22,745 $23,522 $ 188 $(1,340) $ 441
Company-operated margins 3,173 2,807 2,908 35 (178) 63
Franchised margins 6,464 5,985 5,731 (14) (176) 120
Selling, general & administrative expenses 2,333 2,234 2,355 (12) 75 (21)
Operating income 7,473 6,841 6,443 13 (273) 163
Net income 4,946 4,551 4,313 13 (164) 103
Earnings per common share—diluted 4.58 4.11 3.76 0.01 (0.15) 0.09
NET INCOME AND DILUTED EARNINGS PER COMMON SHARE
In 2010, net income and diluted earnings per common share
were $4.9 billion and $4.58. Results for the year included after
tax charges due to Impairment and other charges (credits), net of
$25 million or $0.02 per share, primarily related to the Compa-
ny’s share of restaurant closing costs in McDonald’s Japan (a
50%-owned affiliate) in conjunction with the first quarter strate-
gic review of the market’s restaurant portfolio, partly offset by
income related to the resolution of certain liabilities retained in
connection with the 2007 Latin America developmental license
transaction. Foreign currency translation had a positive impact of
$0.01 per share on diluted earnings per share for the year.
In 2009, net income and diluted earnings per common share
were $4.6 billion and $4.11. Results benefited by after tax
income due to Impairment and other charges (credits), net of
$91 million or $0.08 per share, primarily due to the resolution of
McDonald’s Corporation Annual Report 2010 13
certain liabilities retained in connection with the 2007 Latin
America developmental license transaction. Results also bene-
fited by an after tax gain of $59 million or $0.05 per share due to
the sale of the Company’s minority ownership interest in Redbox,
reflected in Gain on sale of investment. Results were negatively
impacted by $0.15 per share due to the effect of foreign cur-
rency translation.
In 2008, net income and diluted earnings per common share
were $4.3 billion and $3.76. Results benefited by a $109 million
or $0.09 per share after tax gain on the sale of the Company’s
minority ownership interest in Pret A Manger, reflected in Gain on
sale of investment.
The Company repurchased 37.8 million shares of its stock for
nearly $2.7 billion in 2010 and 50.3 million shares of its stock for
$2.9 billion in 2009, driving reductions of over 2% and 3% of
total shares outstanding, respectively, net of stock option
exercises.
REVENUES
The Company’s revenues consist of sales by Company-operated
restaurants and fees from restaurants operated by franchisees.
Revenues from conventional franchised restaurants include rent
and royalties based on a percent of sales along with minimum
rent payments, and initial fees. Revenues from franchised restau-
rants that are licensed to affiliates and developmental licensees
include a royalty based on a percent of sales, and generally
include initial fees.
Over the past three years, the Company has continued to
optimize its restaurant ownership mix, cash flow and returns
through its refranchising strategy. The shift to a greater percent-
age of franchised restaurants negatively impacted consolidated
revenues as Company-operated sales shifted to franchised sales,
where the Company receives rent and/or royalties based on a
percent of sales.
In 2010, constant currency revenue growth was driven by
positive comparable sales. The impact of refranchising on con-
solidated revenues lessened because the number of Company-
operated restaurants sold to franchisees has declined compared
with 2009 and 2008, in line with our overall strategy. In 2009,
constant currency revenue growth was driven by positive com-
parable sales and expansion, partly offset by the impact of
refranchising in certain of the Company’s major markets.
Revenues
Amount Increase/(decrease)
Increase/(decrease)
excluding currency
translation
Dollars in millions 2010 2009 2008 2010 2009 2010 2009
Company-operated sales:
U.S. $ 4,229 $ 4,295 $ 4,636 (2)% (7)% (2)% (7)%
Europe 6,932 6,721 7,424 3 (9) 5 3
APMEA 4,297 3,714 3,660 16 1 9 5
Other Countries & Corporate 775 729 841 6 (13) (3) (7)
Total $16,233 $15,459 $16,561 5% (7)% 4% 0%
Franchised revenues:
U.S. $ 3,883 $ 3,649 $ 3,442 6% 6% 6% 6%
Europe 2,637 2,553 2,499 3 2 8 10
APMEA 769 623 571 23 9 11 12
Other Countries & Corporate 553 461 449 20 3 16 9
Total $ 7,842 $ 7,286 $ 6,961 8% 5% 8% 8%
Total revenues:
U.S. $ 8,112 $ 7,944 $ 8,078 2% (2)% 2% (2)%
Europe 9,569 9,274 9,923 3 (7) 6 5
APMEA 5,066 4,337 4,231 17 3 9 6
Other Countries & Corporate 1,328 1,190 1,290 12 (8) 4 (2)
Total $24,075 $22,745 $23,522 6% (3)% 5% 2%
In the U.S., revenues in 2010 and 2009 were positively
impacted by the ongoing appeal of our iconic core products and
the success of new products, as well as continued focus on
everyday value and convenience. New products introduced in
2010 included McCafé frappés and smoothies as well as the
Angus Snack Wraps, while new products introduced in 2009
included McCafé premium coffees and the Angus Third Pounder.
Refranchising activity negatively impacted revenue growth in both
years.
Europe’s constant currency increases in revenues in 2010
and 2009 were primarily driven by comparable sales increases in
the U.K., France and Russia (which is entirely Company-
operated) as well as expansion in Russia. These increases were
partly offset by the impact of refranchising activity, primarily in the
U.K. in 2010 and the U.K. and Germany in 2009.
In APMEA, the constant currency increase in revenues in
2010 was primarily driven by comparable sales increases in
China, Australia and most other markets. The 2009 increase was
primarily driven by comparable sales increases in Australia and
most other Asian markets, partly offset by negative comparable
sales in China. In addition, expansion in China contributed to the
increases in both years.
14 McDonald’s Corporation Annual Report 2010
The following tables present comparable sales and Systemwide sales increases/(decreases):
Comparable sales increases
2010 2009 2008
U.S. 3.8% 2.6% 4.0%
Europe 4.4 5.2 8.5
APMEA 6.0 3.4 9.0
Other Countries & Corporate 11.3 5.5 13.0
Total 5.0% 3.8% 6.9%
On a consolidated basis, comparable guest counts increased
4.9%, 1.4% and 3.1% in 2010, 2009 and 2008, respectively.
Systemwide sales increases/(decreases)
Excluding currency
translation
2010 2009 2010 2009
U.S. 4% 3% 4% 3%
Europe 3 (2) 7 7
APMEA 15 8 7 7
Other Countries &
Corporate 13 13 7
Total 7% 2% 6% 6%
Franchised sales are not recorded as revenues by the Company, but are the basis on which the Company calculates and records
franchised revenues and are indicative of the health of the franchisee base. The following table presents Franchised sales and the
related increases:
Franchised Sales
Amount Increase
Increase excluding
currency translation
Dollars in millions 2010 2009 2008 2010 2009 2010 2009
U.S. $28,166 $26,737 $25,351 5% 5% 5% 5%
Europe 15,049 14,573 14,282 3 2 8 10
APMEA 11,373 9,871 8,895 15 11 7 8
Other Countries & Corporate 6,559 5,747 5,604 14 3 15 9
Total $61,147 $56,928 $54,132 7% 5% 7% 7%
RESTAURANT MARGINS
•
Franchised margins
Franchised margin dollars represent revenues from franchised
restaurants less the Company’s occupancy costs (rent and
depreciation) associated with those sites. Franchised margin
dollars represented about two-thirds of the combined restaurant
margins in 2010, 2009 and 2008. Franchised margin dollars
increased $479 million or 8% (8% in constant currencies) in
2010 and $254 million or 4% (7% in constant currencies) in
2009. Positive comparable sales were the primary driver of the
constant currency growth in franchise margin dollars in both
years. Refranchising activity also contributed to the constant
currency growth in franchise margin dollars in 2009 and to a
lesser extent in 2010.
Franchised margins
In millions 2010 2009 2008
U.S. $3,239 $3,031 $2,867
Europe 2,063 1,998 1,965
APMEA 686 559 511
Other Countries & Corporate 476 397 388
Total $6,464 $5,985 $5,731
Percent of revenues
U.S. 83.4% 83.1% 83.3%
Europe 78.2 78.3 78.6
APMEA 89.3 89.6 89.6
Other Countries & Corporate 86.0 86.1 86.4
Total 82.4% 82.1% 82.3%
In the U.S., the franchised margin percent increase in 2010
was primarily due to positive comparable sales. The 2009
decrease was due to additional depreciation primarily related to
the Company’s investment in the beverage initiative, partly offset
by positive comparable sales.
Europe’s franchised margin percent decreased in 2010 and
2009 as positive comparable sales were more than offset by
higher occupancy expenses, the cost of strategic brand and sales
building initiatives and the refranchising strategy.
In APMEA, the franchised margin percent decrease in 2010
was primarily driven by foreign currency translation, mostly due to
the stronger Australian dollar.
The franchised margin percent in APMEA and Other Coun-
tries & Corporate is higher relative to the U.S. and Europe due to
a larger proportion of developmental licensed and/or affiliated
restaurants where the Company receives royalty income with no
corresponding occupancy costs.
•
Company-operated margins
Company-operated margin dollars represent sales by Company-
operated restaurants less the operating costs of these
restaurants. Company-operated margin dollars increased $366
million or 13% (12% in constant currencies) in 2010 and
decreased $101 million or 3% (increased 3% in constant
currencies) in 2009. Positive comparable sales and lower com-
modity costs were the primary drivers of the constant currency
growth in Company-operated margin dollars and percent in
2010. Positive comparable sales, partly offset by higher commod-
ity costs, drove growth in constant currency Company-operated
margin dollars and percent in 2009. In addition, refranchising
activity negatively impacted Company-operated margin dollars,
but benefited Company-operated margin percent in 2009 and to
a lesser extent in 2010.
McDonald’s Corporation Annual Report 2010 15
Company-operated margins
In millions 2010 2009 2008
U.S. $ 902 $ 832 $ 856
Europe 1,373 1,240 1,340
APMEA 764 624 584
Other Countries & Corporate 134 111 128
Total $3,173 $2,807 $2,908
Percent of sales
U.S. 21.3% 19.4% 18.5%
Europe 19.8 18.4 18.0
APMEA 17.8 16.8 15.9
Other Countries & Corporate 17.2 15.2 15.3
Total 19.6% 18.2% 17.6%
In the U.S., the Company-operated margin percent increased
in 2010 due to lower commodity costs and positive comparable
sales, partly offset by higher labor costs. The margin percent
increased in 2009 due to positive comparable sales, partly offset
by additional depreciation related to the beverage initiative and
higher commodity costs. Refranchising had a positive impact on
both periods.
Europe’s Company-operated margin percent increased in
2010 primarily due to positive comparable sales and lower
commodity costs, partly offset by higher labor costs. The margin
percent increased in 2009 primarily due to positive comparable
sales, partly offset by higher commodity and labor costs. In 2009,
local inflation and the impact of weaker currencies on the cost of
certain imported products drove higher costs, primarily in Russia,
and negatively impacted the Company-operated margin percent.
In APMEA, the Company-operated margin percent increased
in 2010 primarily due to positive comparable sales and lower
commodity costs, partly offset by higher occupancy & other costs
and increased labor costs. The margin percent increased in 2009
due to positive comparable sales, partly offset by higher labor
costs.
• Supplemental information regarding Company-
operated restaurants
We continually review our restaurant ownership mix with a goal of
improving local relevance, profits and returns. In most cases,
franchising is the best way to achieve these goals, but as pre-
viously stated, Company-operated restaurants are also important
to our success.
We report results for Company-operated restaurants based
on their sales, less costs directly incurred by that business includ-
ing occupancy costs. We report the results for franchised
restaurants based on franchised revenues, less associated occu-
pancy costs. For this reason and because we manage our
business based on geographic segments and not on the basis of
our ownership structure, we do not specifically allocate selling,
general & administrative expenses and other operating (income)
expenses to Company-operated or franchised restaurants. Other
operating items that relate to the Company-operated restaurants
generally include gains/losses on sales of restaurant businesses
and write-offs of equipment and leasehold improvements.
We believe the following information about Company-
operated restaurants in our most significant markets provides an
additional perspective on this business. Management responsible
for our Company-operated restaurants in these markets analyzes
the Company-operated business on this basis to assess its per-
formance. Management of the Company also considers this
information when evaluating restaurant ownership mix, subject to
other relevant considerations.
The following table seeks to illustrate the two components of
our Company-operated margins. The first of these relates
exclusively to restaurant operations, which we refer to as “Store
operating margin.” The second relates to the value of our brand
and the real estate interest we retain for which we charge rent
and royalties. We refer to this component as “Brand/real estate
margin.” Both Company-operated and conventional franchised
restaurants are charged rent and royalties, although rent and
royalties for Company-operated restaurants are eliminated in
consolidation. Rent and royalties for both restaurant ownership
types are based on a percentage of sales, and the actual rent
percentage varies depending on the level of McDonald’s invest-
ment in the restaurant. Royalty rates may also vary by market.
As shown in the following table, in disaggregating the compo-
nents of our Company-operated margins, certain costs
with respect to Company-operated restaurants are reflected in
Brand/real estate margin. Those costs consist of rent payable by
McDonald’s to third parties on leased sites and depreciation for
buildings and leasehold improvements and constitute a portion of
occupancy & other operating expenses recorded in the Con-
solidated statement of income. Store operating margins reflect
rent and royalty expenses, and those amounts are accounted for
as income in calculating Brand/real estate margin.
While we believe that the following information provides a
perspective in evaluating our Company-operated business, it is
not intended as a measure of our operating performance or as an
alternative to operating income or restaurant margins as reported
by the Company in accordance with accounting principles gen-
erally accepted in the U.S. In particular, as noted previously, we
do not allocate selling, general & administrative expenses to our
Company-operated business. However, we believe that a range
of $40,000 to $50,000 per restaurant, on average, is a typical
range of costs to support this business in the U.S. The actual
costs in markets outside the U.S. will vary depending on local
circumstances and the organizational structure of the market.
These costs reflect the indirect services we believe are neces-
sary to provide the appropriate support of the restaurant.
16 McDonald’s Corporation Annual Report 2010
U.S. Europe
Dollars in millions 2010 2009 2008 2010 2009 2008
As reported
Number of Company-operated restaurants at year end 1,550 1,578 1,782 2,005 2,001 2,024
Sales by Company-operated restaurants $4,229 $4,295 $4,636 $ 6,932 $ 6,721 $ 7,424
Company-operated margin $ 902 $ 832 $ 856 $ 1,373 $ 1,240 $ 1,340
Store operating margin
Company-operated margin $ 902 $ 832 $ 856 $ 1,373 $ 1,240 $ 1,340
Plus:
Outside rent expense(1) 60 65 74 223 222 254
Depreciation—buildings & leasehold improvements(1) 65 70 70 105 100 110
Less:
Rent & royalties(2) (619) (634) (684) (1,335) (1,306) (1,435)
Store operating margin $ 408 $ 333 $ 316 $ 366 $ 256 $ 269
Brand/real estate margin
Rent & royalties(2) $ 619 $ 634 $ 684 $ 1,335 $ 1,306 $ 1,435
Less:
Outside rent expense(1) (60) (65) (74) (223) (222) (254)
Depreciation—buildings & leasehold improvements(1) (65) (70) (70) (105) (100) (110)
Brand/real estate margin $ 494 $ 499 $ 540 $ 1,007 $ 984 $ 1,071
(1) Represents certain costs recorded as occupancy & other operating expenses in the Consolidated statement of income – rent payable by McDonald’s to third parties on leased sites and
depreciation for buildings and leasehold improvements. This adjustment is made to reflect these occupancy costs in Brand/real estate margin. The relative percentage of sites that are
owned versus leased varies by country.
(2) Reflects average Company–operated rent and royalties (as a percentage of 2010 sales: U.S. – 14.6% and Europe – 19.3%). This adjustment is made to reflect expense in Store
operating margin and income in Brand/real estate margin. Countries within Europe have varying economic profiles and a wide range of rent and royalty rates as a percentage of sales.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Consolidated selling, general & administrative expenses increased 4% (4% in constant currencies) in 2010 and decreased 5% (2% in
constant currencies) in 2009. The Vancouver Winter Olympics in February and the Company’s biennial Worldwide Owner/Operator
Convention in April contributed to the increase in 2010. The 2009 expenses decreased partly due to costs in 2008 related to the Beijing
Summer Olympics and the Company’s biennial Worldwide Owner/Operator Convention.
Selling, general & administrative expenses
Amount Increase/(decrease)
Increase/(decrease)
excluding currency
translation
Dollars in millions 2010 2009 2008 2010 2009 2010 2009
U.S. $ 781 $ 751 $ 745 4% 1% 4% 1%
Europe 653 655 714 (8) 2
APMEA 306 276 300 10 (8) 4 (5)
Other Countries & Corporate(1) 593 552 596 7 (7) 5 (7)
Total $2,333 $2,234 $2,355 4% (5)% 4% (2)%
(1) Included in Other Countries & Corporate are home office support costs in areas such as facilities, finance, human resources, information technology, legal, marketing, restaurant oper-
ations, supply chain and training.
Selling, general & administrative expenses as a percent of revenues were 9.7% in 2010 compared with 9.8% in 2009 and 10.0% in
2008. Selling, general & administrative expenses as a percent of Systemwide sales were 3.0% in 2010 compared with 3.1% in 2009
and 3.3% in 2008. Management believes that analyzing selling, general & administrative expenses as a percent of Systemwide sales, as
well as revenues, is meaningful because these costs are incurred to support Systemwide restaurants.
McDonald’s Corporation Annual Report 2010 17
IMPAIRMENT AND OTHER CHARGES (CREDITS), NET
The Company recorded impairment and other charges (credits),
net of $29 million in 2010, ($61) million in 2009 and $6 million
in 2008. Management does not include these items when review-
ing business performance trends because we do not believe
these items are indicative of expected ongoing results.
Impairment and other charges (credits), net
In millions, except per share data 2010 2009 2008
Europe $ 1 $ 4 $ 6
APMEA 49
Other Countries & Corporate (21) (65)
Total $ 29 $ (61) $ 6
After tax(1) $ 25 $ (91) $ 4
Earnings per common share – diluted $0.02 $(0.08) $0.01
(1) Certain items were not tax effected.
In 2010, the Company recorded expense of $29 million pri-
marily related to its share of restaurant closing costs in
McDonald’s Japan in conjunction with the first quarter strategic
review of the market’s restaurant portfolio, partly offset by income
related to the resolution of certain liabilities retained in con-
nection with the 2007 Latin America developmental license
transaction.
In 2009, the Company recorded income of $61 million
related primarily to the resolution of certain liabilities retained in
connection with the 2007 Latin America developmental license
transaction. The Company also recognized a tax benefit in 2009
in connection with this income, mainly related to the release of a
tax valuation allowance.
OTHER OPERATING (INCOME) EXPENSE, NET
Other operating (income) expense, net
In millions 2010 2009 2008
Gains on sales of restaurant
businesses $ (79) $(113) $(126)
Equity in earnings of
unconsolidated affiliates (164) (168) (111)
Asset dispositions and other
expense 45 59 72
Total $(198) $(222) $(165)
• Gains on sales of restaurant businesses
Gains on sales of restaurant businesses include gains from sales
of Company-operated restaurants as well as gains from
exercises of purchase options by franchisees with business facili-
ties lease arrangements (arrangements where the Company
leases the businesses, including equipment, to franchisees who
generally have options to purchase the businesses). The Compa-
ny’s purchases and sales of businesses with its franchisees are
aimed at achieving an optimal ownership mix in each market.
Resulting gains or losses are recorded in operating income
because the transactions are a recurring part of our business.
The Company realized lower gains on sales of restaurant busi-
nesses in 2010 compared with 2009 and 2008 primarily as a
result of selling less Company-operated restaurants to franchi-
sees.
• Equity in earnings of unconsolidated affiliates
Unconsolidated affiliates and partnerships are businesses in
which the Company actively participates, but does not control.
The Company records equity in earnings from these entities
representing McDonald’s share of results. For foreign affiliated
markets – primarily Japan – results are reported after interest
expense and income taxes. McDonald’s share of results for part-
nerships in certain consolidated markets such as the U.S. is
reported before income taxes. These partnership restaurants are
operated under conventional franchise arrangements and, there-
fore, are classified as conventional franchised restaurants.
Results in 2010 reflected a reduction in the number of uncon-
solidated affiliate restaurants worldwide partly offset by improved
operating performance in Japan. Results in 2009 also reflected
improved operating performance in Japan and benefited from the
stronger Japanese Yen.
• Asset dispositions and other expense
Asset dispositions and other expense consists of gains or losses
on excess property and other asset dispositions, provisions for
restaurant closings and uncollectible receivables, asset write-offs
due to restaurant reinvestment, and other miscellaneous income
and expenses.
18 McDonald’s Corporation Annual Report 2010
OPERATING INCOME
Operating income
Amount Increase/(decrease)
Increase/(decrease)
excluding currency
translation
Dollars in millions 2010 2009 2008 2010 2009 2010 2009
U.S. $3,446 $3,232 $3,060 7% 6% 7% 6%
Europe 2,797 2,588 2,608 8 (1) 12 8
APMEA 1,200 989 819 21 21 11 23
Other Countries & Corporate 30 32 (44) (6) nm (43) nm
Total $7,473 $6,841 $6,443 9% 6% 9% 10%
nm Not meaningful.
In the U.S., 2010 results increased due to higher combined res-
taurant margin dollars. Results for 2009 increased primarily due
to higher franchised margin dollars.
In Europe, results for 2010 and 2009 were driven by stronger
operating performance in France, Russia and the U.K.
In APMEA, 2010 results increased due to stronger results in
Australia and many other markets. The Company’s share of
impairment charges related to restaurant closings in Japan neg-
atively impacted the growth rate by 4 percentage points for the
year. Results for 2009 were driven primarily by strong results in
Australia and expansion in China.
In Other Countries & Corporate, results for 2010 and 2009
included income of $21 million and $65 million, respectively,
primarily related to the resolution of certain liabilities retained in
connection with the 2007 Latin America developmental license
transaction.
• Combined operating margin
Combined operating margin is defined as operating income as a
percent of total revenues. Combined operating margin for 2010,
2009 and 2008 was 31.0%, 30.1% and 27.4%, respectively.
Impairment and other charges (credits), net negatively impacted
the combined operating margin by 0.2 percentage points in
2010, while positively impacting it by 0.3 percentage points in
2009.
INTEREST EXPENSE
Interest expense decreased in 2010 primarily due to lower aver-
age interest rates slightly offset by higher average debt balances.
Interest expense decreased in 2009 primarily due to lower aver-
age interest rates, and to a lesser extent, weaker foreign
currencies, partly offset by higher average debt levels.
NONOPERATING (INCOME) EXPENSE, NET
Nonoperating (income) expense, net
In millions 2010 2009 2008
Interest income $(20) $(19) $(85)
Foreign currency and hedging
activity (2) (32) (5)
Other expense 44 27 12
Total $ 22 $(24) $(78)
Interest income consists primarily of interest earned on short-
term cash investments. Interest income decreased in 2009
primarily due to lower average interest rates. Foreign currency
and hedging activity primarily relates to net gains or losses on
certain hedges that reduce the exposure to variability on certain
intercompany foreign currency cash flow streams. Other expense
primarily consists of amortization of debt issuance costs and
other nonoperating income and expenses.
GAIN ON SALE OF INVESTMENT
In 2009, the Company sold its minority ownership interest in
Redbox to Coinstar, Inc., the majority owner, for total consid-
eration of $140 million. As a result of the transaction, the
Company recognized a nonoperating pretax gain of $95 million
(after tax–$59 million or $0.05 per share).
In 2008, the Company sold its minority ownership interest in
U.K.-based Pret A Manger. In connection with the sale, the
Company received cash proceeds of $229 million and recog-
nized a nonoperating pretax gain of $160 million (after tax–$109
million or $0.09 per share).
PROVISION FOR INCOME TAXES
In 2010, 2009 and 2008, the reported effective income tax rates
were 29.3%, 29.8% and 30.0%, respectively.
In 2010, the effective income tax rate decreased due to
higher tax benefits related to foreign operations.
In 2009, the effective income tax rate benefited by 0.7 per-
centage points primarily due to the resolution of certain liabilities
retained in connection with the 2007 Latin America devel-
opmental license transaction.
Consolidated net deferred tax liabilities included tax assets,
net of valuation allowance, of $1.6 billion and $1.4 billion in 2010
and 2009, respectively. Substantially all of the net tax assets
arose in the U.S. and other profitable markets.
ACCOUNTING CHANGES
• Fair value measurements
In 2006, the Financial Accounting Standards Board (FASB)
issued guidance on fair value measurements, codified primarily in
the Fair Value Measurements and Disclosures Topic of the FASB
Accounting Standards Codification (ASC). This guidance defines
fair value, establishes a framework for measuring fair value in
accordance with generally accepted accounting principles, and
expands disclosures about fair value measurements. This guid-
ance does not require any new fair value measurements; rather, it
applies to other accounting pronouncements that require or
permit fair value measurements. The provisions of the guidance,
as issued, were effective January 1, 2008. However, in February
2008, the FASB deferred the effective date for one year for cer-
tain non-financial assets and non-financial liabilities, except those
that are recognized or disclosed at fair value in the financial
McDonald’s Corporation Annual Report 2010 19
statements on a recurring basis (i.e., at least annually). The
Company adopted the required provisions related to debt and
derivatives as of January 1, 2008 and adopted the remaining
required provisions for non-financial assets and liabilities as of
January 1, 2009. The effect of adoption was not significant in
either period.
• Variable interest entities and consolidation
In June 2009, the FASB issued amendments to the guidance on
variable interest entities and consolidation, codified primarily in
the Consolidation Topic of the FASB ASC. This guidance modi-
fies the method for determining whether an entity is a variable
interest entity as well as the methods permitted for determining
the primary beneficiary of a variable interest entity. In addition,
this guidance requires ongoing reassessments of whether a
company is the primary beneficiary of a variable interest entity
and enhanced disclosures related to a company’s involvement
with a variable interest entity. The Company adopted this guid-
ance as of January 1, 2010.
On an ongoing basis, the Company evaluates its business
relationships such as those with franchisees, joint venture part-
ners, developmental licensees, suppliers, and advertising
cooperatives to identify potential variable interest entities. Gen-
erally, these businesses qualify for a scope exception under the
consolidation guidance. The Company has concluded that con-
solidation of any such entities is not appropriate for the periods
presented. As a result, the adoption did not have any impact on
the Company’s consolidated financial statements.
Cash Flows
The Company generates significant cash from its operations and
has substantial credit availability and capacity to fund operating
and discretionary spending such as capital expenditures, debt
repayments, dividends and share repurchases.
Cash provided by operations totaled $6.3 billion and
exceeded capital expenditures by $4.2 billion in 2010, while cash
provided by operations totaled $5.8 billion and exceeded capital
expenditures by $3.8 billion in 2009. In 2010, cash provided by
operations increased $591 million or 10% compared with 2009
primarily due to increased operating results. In 2009, cash pro-
vided by operations decreased $166 million or 3% compared
with 2008 despite increased operating results, primarily due to
higher income tax payments, higher noncash income items and
the receipt of $143 million in 2008 related to the completion of
an IRS examination.
Cash used for investing activities totaled $2.1 billion in 2010,
an increase of $401 million compared with 2009. This reflects
higher capital expenditures and lower proceeds from sales of
investments and restaurant businesses. Cash used for investing
activities totaled $1.7 billion in 2009, an increase of $31 million
compared with 2008. This reflects lower proceeds from sales of
investments, restaurant businesses and property, offset by lower
capital expenditures, primarily in the U.S.
Cash used for financing activities totaled $3.7 billion in 2010,
a decrease of $692 million compared with 2009, primarily due to
higher net debt issuances, higher proceeds from stock option
exercises and lower treasury stock purchases, partly offset by an
increase in the common stock dividend. Cash used for financing
activities totaled $4.4 billion in 2009, an increase of $307 million
compared with 2008, primarily due to lower net debt issuances,
an increase in the common stock dividend and lower proceeds
from stock option exercises, partly offset by lower treasury stock
purchases.
As a result of the above activity, the Company’s cash and
equivalents balance increased $591 million in 2010 to $2.4 bil-
lion, compared with a decrease of $267 million in 2009. In
addition to cash and equivalents on hand and cash provided by
operations, the Company can meet short-term funding needs
through its continued access to commercial paper borrowings
and line of credit agreements.
RESTAURANT DEVELOPMENT AND CAPITAL EXPENDITURES
In 2010, the Company opened 957 traditional restaurants and
35 satellite restaurants (small, limited-menu restaurants for which
the land and building are generally leased), and closed 406 tradi-
tional restaurants and 327 satellite restaurants. Of these
closures, there were over 400 in McDonald’s Japan due to the
strategic review of the market’s restaurant portfolio. In 2009, the
Company opened 824 traditional restaurants and 44 satellite
restaurants and closed 215 traditional restaurants and 142 satel-
lite restaurants. The majority of restaurant openings and closings
occurred in the major markets in both years. The Company closes
restaurants for a variety of reasons, such as existing sales and
profit performance or loss of real estate tenure.
Systemwide restaurants at year end(1)
2010 2009 2008
U.S. 14,027 13,980 13,918
Europe 6,969 6,785 6,628
APMEA 8,424 8,488 8,255
Other Countries & Corporate 3,317 3,225 3,166
Total 32,737 32,478 31,967
(1) Includes satellite units at December 31, 2010, 2009 and 2008 as follows: U.S. –
1,112, 1,155, 1,169; Europe–239, 241, 226; APMEA (primarily Japan)–1,010,
1,263, 1,379; Other Countries & Corporate–470, 464, 447.
Approximately 65% of Company-operated restaurants and
about 80% of franchised restaurants were located in the major
markets at the end of 2010. About 80% of the restaurants at
year-end 2010 were franchised.
Capital expenditures increased $183 million or 9% in 2010
primarily due to higher investment in new restaurants. Capital
expenditures decreased $184 million or 9% in 2009 primarily
due to fewer restaurant openings, lower reinvestment in existing
restaurants in the U.S. and the impact of foreign currency trans-
lation. In both years, capital expenditures reflected the Company’s
commitment to grow sales at existing restaurants, including
reinvestment initiatives such as reimaging in many markets
around the world.
Capital expenditures invested in major markets, excluding
Japan, represented over 65% of the total in 2010, 2009 and
2008. Japan is accounted for under the equity method, and
accordingly its capital expenditures are not included in con-
solidated amounts.
Capital expenditures
In millions 2010 2009 2008
New restaurants $ 968 $ 809 $ 897
Existing restaurants 1,089 1,070 1,152
Other(1) 78 73 87
Total capital
expenditures $ 2,135 $ 1,952 $ 2,136
Total assets $31,975 $30,225 $28,462
(1) Primarily corporate equipment and other office-related expenditures.
20 McDonald’s Corporation Annual Report 2010
New restaurant investments in all years were concentrated in
markets with acceptable returns or opportunities for long-term
growth. Average development costs vary widely by market
depending on the types of restaurants built and the real estate
and construction costs within each market. These costs, which
include land, buildings and equipment, are managed through the
use of optimally sized restaurants, construction and design effi-
ciencies, and leveraging best practices. Although the Company is
not responsible for all costs for every restaurant opened, total
development costs (consisting of land, buildings and equipment)
for new traditional McDonald’s restaurants in the U.S. averaged
approximately $2.6 million in 2010.
The Company owned approximately 45% of the land and
about 70% of the buildings for restaurants in its consolidated
markets at year-end 2010 and 2009.
SHARE REPURCHASES AND DIVIDENDS
In 2010, the Company returned $5.1 billion to shareholders
through a combination of shares repurchased and dividends paid.
Shares repurchased and dividends
In millions, except per share data 2010 2009 2008
Number of shares repurchased 37.8 50.3 69.7
Shares outstanding at year
end 1,054 1,077 1,115
Dividends declared per share $ 2.26 $ 2.05 $1.625
Dollar amount of shares
repurchased $2,649 $2,854 $3,981
Dividends paid 2,408 2,235 1,823
Total returned to
shareholders $5,057 $5,089 $5,804
In September 2009, the Company’s Board of Directors
approved a $10 billion share repurchase program with no speci-
fied expiration date. In 2009 and 2010 combined, approximately
45 million shares have been repurchased for $3.1 billion under
this program. This program replaced the $10 billion share
repurchase program that the Company’s Board of Directors
approved in September 2007.
The Company has paid dividends on its common stock for 35
consecutive years and has increased the dividend amount every
year. The 2010 full year dividend of $2.26 per share reflects the
quarterly dividend paid for each of the first three quarters of
$0.55 per share, with an increase to $0.61 per share paid in the
fourth quarter. This 11% increase in the quarterly dividend equa-
tes to a $2.44 per share annual dividend rate and reflects the
Company’s confidence in the ongoing strength and reliability of
its cash flow. As in the past, future dividend amounts will be con-
sidered after reviewing profitability expectations and financing
needs, and will be declared at the discretion of the Company’s
Board of Directors.
Financial Position and Capital Resources
TOTAL ASSETS AND RETURNS
Total assets increased $1.8 billion or 6% in 2010. Excluding the
effect of changes in foreign currency exchange rates, total
assets increased $1.7 billion in 2010. Over 70% of total assets
were in major markets at year-end 2010. Net property and
equipment increased $529 million in 2010 and represented
about 70% of total assets at year end. Excluding the effect of
changes in foreign currency exchange rates, net property and
equipment increased $719 million primarily due to capital
expenditures, partly offset by depreciation.
Operating income is used to compute return on average
assets, while net income is used to calculate return on average
common equity. Month-end balances are used to compute both
average assets and average common equity.
Returns on assets and equity
2010 2009 2008
Return on average assets 24.7% 23.4% 21.8%
Return on average common equity 35.3 34.0 30.6
In 2010, 2009 and 2008, return on average assets and
return on average common equity benefited from strong global
operating results. Operating income, as reported, does not
include interest income; however, cash balances are included in
average assets. The inclusion of cash balances in average assets
reduced return on average assets by 1.9 percentage points, 2.0
percentage points and 1.9 percentage points in 2010, 2009 and
2008, respectively.
FINANCING AND MARKET RISK
The Company generally borrows on a long-term basis and is
exposed to the impact of interest rate changes and foreign cur-
rency fluctuations. Debt obligations at
December 31, 2010
totaled $11.5 billion, compared with $10.6 billion at
December 31, 2009. The net increase in 2010 was primarily due
to net issuances of $787 million and changes in exchange rates
on foreign currency denominated debt of $140 million.
Debt highlights(1)
2010 2009 2008
Fixed-rate debt as a percent of total
debt(2,3) 66% 68% 72%
Weighted-average annual interest
rate of total debt(3) 4.3 4.5 5.0
Foreign currency-denominated debt
as a percent of total debt(2) 41 43 45
Total debt as a percent of total
capitalization (total debt and total
shareholders’ equity)(2) 44 43 43
Cash provided by operations as a
percent of total debt(2) 55 55 59
(1) All percentages are as of December 31, except for the weighted-average annual
interest rate, which is for the year.
(2) Based on debt obligations before the effect of fair value hedging adjustments. This
effect is excluded as these adjustments have no impact on the obligation at maturity.
See Debt financing note to the consolidated financial statements.
(3) Includes the effect of interest rate exchange agreements.
Fitch, Standard & Poor’s and Moody’s currently rate, with a
stable outlook, the Company’s commercial paper F1, A-1 and
P-1, respectively; and its long-term debt A, A and A2,
respectively.
Certain of the Company’s debt obligations contain cross-
acceleration provisions and restrictions on Company and
subsidiary mortgages and the long-term debt of certain sub-
sidiaries. There are no provisions in the Company’s debt
obligations that would accelerate repayment of debt as a result of
McDonald’s Corporation Annual Report 2010 21
a change in credit ratings or a material adverse change in the
Company’s business. Under existing authorization from the
Company’s Board of Directors, at December 31, 2010, the
Company has $3 billion of authority remaining to borrow funds,
including through (i) public or private offering of debt securities;
(ii) direct borrowing from banks or other financial institutions; and
(iii) other forms of indebtedness. In addition to registered debt
securities on a U.S. shelf registration statement and a Global
Medium-Term Notes program, the Company has $1.3 billion
available under committed line of credit agreements as well as
authority to issue commercial paper in the U.S. and Global market
(see Debt financing note to the consolidated financial
statements). Debt maturing in 2011 is approximately $601 mil-
lion of long-term corporate debt. In 2011, the Company expects
to issue commercial paper and long-term debt to refinance this
maturing debt. The Company also has $595 million of foreign
currency bank line borrowings outstanding at year-end 2010.
The Company uses major capital markets, bank financings
and derivatives to meet its financing requirements and reduce
interest expense. The Company manages its debt portfolio in
response to changes in interest rates and foreign currency rates
by periodically retiring, redeeming and repurchasing debt, termi-
nating exchange agreements and using derivatives. The
Company does not use derivatives with a level of complexity or
with a risk higher than the exposures to be hedged and does not
hold or issue derivatives for trading purposes. All ex
change
agreements are over-the-counter instruments.
In managing the impact of interest rate changes and foreign
currency fluctuations, the Company uses interest rate exchange
agreements and finances in the currencies in which assets are
denominated. The Company uses foreign currency debt and
derivatives to hedge the foreign currency risk associated with
certain royalties, intercompany financings and long-term invest-
ments in foreign subsidiaries and affiliates. This reduces the
impact of fluctuating foreign currencies on cash flows and
shareholders’ equity. Total foreign currency-denominated debt
was $4.7 billion and $4.5 billion for the years ended
December 31, 2010 and 2009, respectively. In addition, where
practical, the Company’s restaurants purchase goods and serv-
ices in local currencies resulting in natural hedges. See Summary
of significant accounting policies note to the consolidated finan-
cial statements related to financial instruments and hedging
activities for additional information regarding the accounting
impact and use of derivatives.
The Company does not have significant exposure to any
individual counterparty and has master agreements that contain
netting arrangements. Certain of these agreements also require
each party to post collateral if credit ratings fall below, or
aggregate exposures exceed, certain contractual limits. At
December 31, 2010, neither the Company nor its counterparties
were required to post collateral on any derivative position, other
than on hedges of certain of the Company’s supplemental benefit
plan liabilities where our counterparty was required to post
collateral on its liability position.
The Company’s net asset exposure is diversified among a
broad basket of currencies. The Company’s largest net asset
exposures (defined as foreign currency assets less foreign cur-
rency liabilities) at year end were as follows:
Foreign currency net asset exposures
In millions of U.S. Dollars 2010 2009
Euro $5,465 $5,151
Australian Dollars 2,075 1,460
Canadian Dollars 1,123 981
Russian Ruble 589 501
British Pounds Sterling 547 679
The Company prepared sensitivity analyses of its financial
instruments to determine the impact of hypothetical changes in
interest rates and foreign currency exchange rates on the
Company’s results of operations, cash flows and the fair value of
its financial instruments. The interest rate analysis assumed a one
percentage point adverse change in interest rates on all financial
instruments, but did not consider the effects of the reduced level
of economic activity that could exist in such an environment. The
foreign currency rate analysis assumed that each foreign currency
rate would change by 10% in the same direction relative to the
U.S. Dollar on all financial instruments; however, the analysis did
not include the potential impact on revenues, local currency prices
or the effect of fluctuating currencies on the Company’s antici-
pated foreign currency royalties and other payments received in
the U.S. Based on the results of these analyses of the Company’s
financial instruments, neither a one percentage point adverse
change in interest rates from 2010 levels nor a 10% adverse
change in foreign currency rates from 2010 levels would materi-
ally affect the Company’s results of operations, cash flows or the
fair value of its financial instruments.
22 McDonald’s Corporation Annual Report 2010
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company has long-term contractual obligations primarily in
the form of lease obligations (related to both Company-operated
and franchised restaurants) and debt obligations. In addition, the
Company has long-term revenue and cash flow streams that
relate to its franchise arrangements. Cash provided by operations
(including cash provided by these franchise arrangements) along
with the Company’s borrowing capacity and other sources of
cash will be used to satisfy the obligations. The following table
summarizes the Company’s contractual obligations and their
aggregate maturities as well as future minimum rent payments
due to the Company under existing franchise arrangements as of
December 31, 2010. See discussions of cash flows and financial
position and capital resources as well as the Notes to the con-
solidated financial statements for further details.
Contractual cash outflows Contractual cash inflows
In
millions
Operating
leases
Debt
obligations(1)
Minimum rent under
franchise arrangements
2011 $ 1,200 $ 8 $ 2,349
2012 1,116 2,212 2,289
2013 1,034 1,007 2,216
2014 926 708 2,120
2015 827 675 2,001
Thereafter 6,018 6,818 15,379
Total $11,121 $11,428 $26,354
(1) The maturities reflect reclassifications of short-term obligations to long-term obliga-
tions of $1.2 billion, as they are supported by a long-term line of credit agreement
expiring in March 2012. Debt obligations do not include $77 million of noncash fair
value hedging adjustments or $201 million of accrued interest.
The Company maintains certain supplemental benefit plans
that allow participants to (i) make tax-deferred contributions and
(ii) receive Company-provided allocations that cannot be made
under the qualified benefit plans because of IRS limitations. At
December 31, 2010, total liabilities for the supplemental plans
were $439 million. In addition, total liabilities for international
retirement plans were $153 million and the Company recorded
gross unrecognized tax benefits of $573 million.
Other Matters
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management’s discussion and analysis of financial condition and
results of operations is based upon the Company’s consolidated
financial statements, which have been prepared in accordance
with accounting principles generally accepted in the U.S. The
preparation of these financial statements requires the Company
to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses as well as
related disclosures. On an ongoing basis, the Company evaluates
its estimates and judgments based on historical experience and
various other factors that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates
under various assumptions or conditions.
The Company reviews its financial reporting and disclosure
practices and accounting policies quarterly to ensure that they
provide accurate and transparent information relative to the cur-
rent economic and business environment. The Company believes
that of its significant accounting policies, the following involve a
higher degree of judgment and/or complexity:
• Property and equipment
Property and equipment are depreciated or amortized on a
straight-line basis over their useful lives based on management’s
estimates of the period over which the assets will generate rev-
enue (not to exceed lease term plus options for leased property).
The useful lives are estimated based on historical experience
with similar assets, taking into account anticipated technological
or other changes. The Company periodically reviews these lives
relative to physical factors, economic factors and industry trends.
If there are changes in the planned use of property and equip-
ment, or if technological changes occur more rapidly than
anticipated, the useful lives assigned to these assets may need to
be shortened, resulting in the accelerated recognition of
depreciation and amortization expense or write-offs in future
periods.
• Share-based compensation
The Company has a share-based compensation plan which
authorizes the granting of various equity-based incentives includ-
ing stock options and restricted stock units (RSUs) to employees
and nonemployee directors. The expense for these equity-based
incentives is based on their fair value at date of grant and gen-
erally amortized over their vesting period.
The fair value of each stock option granted is estimated on
the date of grant using a closed-form pricing model. The pricing
model requires assumptions, which impact the assumed fair val-
ue, including the expected life of the stock option, the risk-free
interest rate, expected volatility of the Company’s stock over the
expected life and the expected dividend yield. The Company uses
historical data to determine these assumptions and if these
assumptions change significantly for future grants, share-based
compensation expense will fluctuate in future years. The fair
value of each RSU granted is equal to the market price of the
Company’s stock at date of grant less the present value of
expected dividends over the vesting period.
• Long-lived assets impairment review
Long-lived assets (including goodwill) are reviewed for impair-
ment annually in the fourth quarter and whenever events or
changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. In assessing the recoverability of
the Company’s long-lived assets, the Company considers
changes in economic conditions and makes assumptions regard-
ing estimated future cash flows and other factors. Estimates of
future cash flows are highly subjective judgments based on the
Company’s experience and knowledge of its operations. These
estimates can be significantly impacted by many factors including
changes in global and local business and economic conditions,
operating costs, inflation, competition, and consumer and demo-
graphic trends. A key assumption impacting estimated future
cash flows is the estimated change in comparable sales. If the
Company’s estimates or underlying assumptions change in the
future, the Company may be required to record impairment
McDonald’s Corporation Annual Report 2010 23
charges. Based on the annual goodwill impairment test, con-
ducted in the fourth quarter, the Company does not have any
reporting units (defined as each individual country) with goodwill
currently at risk of impairment.
• Litigation accruals
From time to time, the Company is subject to proceedings, law-
suits and other claims related to competitors, customers,
employees, franchisees, government agencies, intellectual prop-
erty, shareholders and suppliers. The Company is required to
assess the likelihood of any adverse judgments or outcomes to
these matters as well as potential ranges of probable losses. A
determination of the amount of accrual required, if any, for these
contingencies is made after careful analysis of each matter. The
required accrual may change in the future due to new develop-
ments in each matter or changes in approach such as a change
in settlement strategy in dealing with these matters. The Com-
pany does not believe that any such matter currently being
reviewed will have a material adverse effect on its financial con-
dition or results of operations.
• Income taxes
The Company records a valuation allowance to reduce its
deferred tax assets if it is more likely than not that some portion
or all of the deferred assets will not be realized. While the Com-
pany has considered future taxable income and ongoing prudent
and feasible tax strategies, including the sale of appreciated
assets, in assessing the need for the valuation allowance, if these
estimates and assumptions change in the future, the Company
may be required to adjust its valuation allowance. This could
result in a charge to, or an increase in, income in the period such
determination is made.
In addition, the Company operates within multiple taxing juris-
dictions and is subject to audit in these jurisdictions. The
Company records accruals for the estimated outcomes of these
audits, and the accruals may change in the future due to new
developments in each matter. In 2010, the Internal Revenue
Service (IRS) concluded its field examination of the Company’s
U.S. federal income tax returns for 2007 and 2008. As part of
this exam, the Company resolved proposed adjustments related
to transfer pricing matters that were previously received from the
IRS. The tax provision impact associated with the completion of
this field examination was not significant. The Company con-
tinues to disagree with the IRS’ proposed adjustments related to
certain foreign tax credits of about $400 million, excluding inter-
est and potential penalties. The Company continues to believe
that these adjustments are not justified, and intends to pursue all
available remedies. The Company cannot predict with certainty
the timing of resolution; however, the Company does not believe
the resolution will have a material impact on its results of oper-
ations or cash flows. During 2008, the IRS examination of the
Company’s 2005 and 2006 U.S. federal income tax returns was
completed. The tax provision impact associated with the com-
pletion of this examination was not significant. The IRS
examination of the Company’s 2009 and 2010 U.S. federal
income tax returns is expected to begin in 2011.
Deferred U.S. income taxes have not been recorded for
temporary differences totaling $11.0 billion related to invest-
ments in certain foreign subsidiaries and corporate affiliates. The
temporary differences consist primarily of undistributed earnings
that are considered permanently invested in operations outside
the U.S. If management’s intentions change in the future,
deferred taxes may need to be provided.
EFFECTS OF CHANGING PRICES—INFLATION
The Company has demonstrated an ability to manage inflationary
cost increases effectively. This ability is because of rapid inventory
turnover, the ability to adjust menu prices, cost controls and sub-
stantial property holdings, many of which are at fixed costs and
partly financed by debt made less expensive by inflation.
RISK FACTORS AND CAUTIONARY STATEMENT ABOUT
FORWARD-LOOKING INFORMATION
This report includes forward-looking statements about our plans
and future performance, including those under Outlook for 2011.
These statements use such words as “may,” “will,” “expect,”
“believe” and “plan.” They reflect our expectations and speak only
as of the date of this report. We do not undertake to update
them. Our expectations (or the underlying assumptions) may
change or not be realized, and you should not rely unduly on
forward-looking statements. We have identified the principal risks
and uncertainties that affect our performance in the Company’s
filings with the Securities and Exchange Commission, and
investors are urged to consider these risks and uncertainties
when evaluating our historical and expected performance.
RECONCILIATION OF RETURNS ON INCREMENTAL INVESTED
CAPITAL
Return on incremental invested capital (ROIIC) is a measure
reviewed by management over one-year and three-year time peri-
ods to evaluate the overall profitability of the business units, the
effectiveness of capital deployed and the future allocation of capi-
tal. This measure is calculated using operating income and constant
foreign exchange rates to exclude the impact of foreign currency
translation. The numerator is the Company’s incremental operating
income plus depreciation and amortization from the base period.
The denominator is the weighted-average adjusted cash used
for investing activities during the applicable one- or three-year
period. Adjusted cash used for investing activities is defined as
cash used for investing activities less cash generated from inves-
ting activities related to the Boston Market, Latin America
developmental license, Pret A Manger and Redbox transactions.
The weighted-average adjusted cash used for investing activities
is based on a weighting applied on a quarterly basis. These
weightings are used to reflect the estimated contribution of each
quarter’s investing activities to incremental operating income. For
example, fourth quarter 2010 investing activities are weighted
less because the assets purchased have only recently been
deployed and would have generated little incremental operating
income (12.5% of fourth quarter 2010 investing activities are
included in the one-year and three-year calculations). In contrast,
fourth quarter 2009 is heavily weighted because the assets
purchased were deployed more than 12 months ago, and there-
fore have a full year impact on 2010 operating income, with little
or no impact to the base period (87.5% and 100.0% of fourth
quarter 2009 investing activities are included in the one-year and
three-year calculations, respectively). Management believes that
weighting cash used for investing activities provides a more
accurate reflection of the relationship between its investments
and returns than a simple average.
24 McDonald’s Corporation Annual Report 2010
The reconciliations to the most comparable measurements, in
accordance with accounting principles generally accepted in the
U.S., for the numerator and denominator of the one-year and
three-year ROIIC are as follows (dollars in millions):
One-year ROIIC Calculation
Years ended December 31, 2010 2009
Incremental
change
NUMERATOR:
Operating income $7,473.1 $6,841.0 $ 632.1
Depreciation and
amortization 1,276.2 1,216.2 60.0
Currency translation(1) (22.2)
Incremental adjusted operating income plus
depreciation and amortization (at constant
foreign exchange rates) $ 669.9
DENOMINATOR:
Weighted–average adjusted cash used for investing
activities(2) $1,821.1
Currency translation(1) (26.5)
Weighted–average adjusted cash used for
investing activities (at constant foreign
exchange rates) $1,794.6
One-year ROIIC(3) 37.3%
(1) Represents the effect of foreign currency translation by translating results at an aver-
age exchange rate for the periods measured.
(2) Represents one-year weighted-average adjusted cash used for investing activities,
determined by applying the weightings below to the adjusted cash used for investing
activities for each quarter in the two-year period ended December 31, 2010.
Years ended December 31,
2009 2010
Cash used for investing activities $1,655.3 $2,056.0
Less: Cash generated from investing
activities related to
Redbox
transaction (144.9)
Adjusted cash used for investing
activities $1,800.2 $2,056.0
AS A PERCENT
Quarters ended:
March 31 12.5% 87.5%
June 30 37.5 62.5
September 30 62.5 37.5
December 31 87.5 12.5
(3) The impact of impairment and other charges (credits), net between 2010 and 2009
negatively impacted the one-year ROIIC by 4.3 percentage points.
Three-year ROIIC Calculation
Years ended December 31, 2010 2007
Incremental
change
NUMERATOR:
Operating income $7,473.1 $3,879.0 $ 3,594.1
Depreciation and
amortization(4) 1,276.2 1,192.8 83.4
Latin America developmental
license transaction(5) 1,665.3 (1,665.3)
Currency translation(6) 137.8
Incremental adjusted operating income plus
depreciation and amortization (at constant
foreign exchange rates) $ 2,150.0
DENOMINATOR:
Weighted–average adjusted cash used for investing
activities(7) $ 5,626.3
Currency translation(6) (17.9)
Weighted–average adjusted cash used for
investing activities (at constant foreign
exchange rates) $ 5,608.4
Three-year ROIIC(8) 38.3%
(4) Represents depreciation and amortization from continuing operations.
(5) Represents impairment charges as a result of the Company’s sale of its businesses in
18 Latin American and Caribbean markets to a developmental licensee.
(6) Represents the effect of foreign currency translation by translating results at an aver-
age exchange rate for the periods measured.
(7) Represents three-year weighted-average adjusted cash used for investing activities,
determined by applying the weightings below to the adjusted cash used for investing
activities for each quarter in the four-year period ended December 31, 2010.
Years ended December 31,
2007 2008 2009 2010
Cash used for
investing
activities $1,150.1 $1,624.7 $1,655.3 $2,056.0
Less: Cash generated from investing activities related to
Boston Market
transaction (184.3)
Latin America
developmental
license
transaction (647.5)
Pret A Manger
transaction (229.4)
Redbox
transaction (144.9)
Adjusted cash
used for
investing
activities $1,981.9 $1,854.1 $1,800.2 $2,056.0
AS A PERCENT
Quarters ended:
March 31 12.5% 100.0% 100.0% 87.5%
June 30 37.5 100.0 100.0 62.5
September 30 62.5 100.0 100.0 37.5
December 31 87.5 100.0 100.0 12.5
(8) The impact of impairment and other charges (credits), net between 2010 and 2007
did not impact the three-year ROIIC.
McDonald’s Corporation Annual Report 2010 25
Consolidated Statement of Income
In millions, except per share data Years ended December 31, 2010 2009 2008
REVENUES
Sales by Company-operated restaurants $16,233.3 $15,458.5 $16,560.9
Revenues from franchised restaurants 7,841.3 7,286.2 6,961.5
Total revenues 24,074.6 22,744.7 23,522.4
OPERATING COSTS AND EXPENSES
Company-operated restaurant expenses
Food & paper 5,300.1 5,178.0 5,586.1
Payroll & employee benefits 4,121.4 3,965.6 4,300.1
Occupancy & other operating expenses 3,638.0 3,507.6 3,766.7
Franchised restaurants–occupancy expenses 1,377.8 1,301.7 1,230.3
Selling, general & administrative expenses 2,333.3 2,234.2 2,355.5
Impairment and other charges (credits), net 29.1 (61.1) 6.0
Other operating (income) expense, net (198.2) (222.3) (165.2)
Total operating costs and expenses 16,601.5 15,903.7 17,079.5
Operating income 7,473.1 6,841.0 6,442.9
Interest expense–net of capitalized interest of $12.0, $11.7 and $12.3 450.9 473.2 522.6
Nonoperating (income) expense, net 21.9 (24.3) (77.6)
Gain on sale of investment (94.9) (160.1)
Income before provision for income taxes 7,000.3 6,487.0 6,158.0
Provision for income taxes 2,054.0 1,936.0 1,844.8
Net income $ 4,946.3 $ 4,551.0 $ 4,313.2
Earnings per common share–basic $ 4.64 $ 4.17 $ 3.83
Earnings per common share–diluted $ 4.58 $ 4.11 $ 3.76
Dividends declared per common share $ 2.26 $ 2.05 $ 1.625
Weighted-average shares outstanding–basic 1,066.0 1,092.2 1,126.6
Weighted-average shares outstanding–diluted 1,080.3 1,107.4 1,146.0
See Notes to consolidated financial statements.
26 McDonald’s Corporation Annual Report 2010
Consolidated Balance Sheet
In millions, except per share data December 31, 2010 2009
ASSETS
Current assets
Cash and equivalents $ 2,387.0 $ 1,796.0
Accounts and notes receivable 1,179.1 1,060.4
Inventories, at cost, not in excess of market 109.9 106.2
Prepaid expenses and other current assets 692.5 453.7
Total current assets 4,368.5 3,416.3
Other assets
Investments in and advances to affiliates 1,335.3 1,212.7
Goodwill 2,586.1 2,425.2
Miscellaneous 1,624.7 1,639.2
Total other assets 5,546.1 5,277.1
Property and equipment
Property and equipment, at cost 34,482.4 33,440.5
Accumulated depreciation and amortization (12,421.8) (11,909.0)
Net property and equipment 22,060.6 21,531.5
Total assets $ 31,975.2 $ 30,224.9
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities
Accounts payable $ 943.9 $ 636.0
Income taxes 111.3 202.4
Other taxes 275.6 277.4
Accrued interest 200.7 195.8
Accrued payroll and other liabilities 1,384.9 1,659.0
Current maturities of long-term debt 8.3 18.1
Total current liabilities 2,924.7 2,988.7
Long-term debt 11,497.0 10,560.3
Other long-term liabilities 1,586.9 1,363.1
Deferred income taxes 1,332.4 1,278.9
Shareholders’ equity
Preferred stock, no par value; authorized – 165.0 million shares; issued – none
Common stock, $.01 par value; authorized – 3.5 billion shares; issued – 1,660.6 million shares 16.6 16.6
Additional paid-in capital 5,196.4 4,853.9
Retained earnings 33,811.7 31,270.8
Accumulated other comprehensive income 752.9 747.4
Common stock in treasury, at cost; 607.0 and 583.9 million shares (25,143.4) (22,854.8)
Total shareholders’ equity 14,634.2 14,033.9
Total liabilities and shareholders’ equity $ 31,975.2 $ 30,224.9
See Notes to consolidated financial statements.
McDonald’s Corporation Annual Report 2010 27
Consolidated Statement of Cash Flows
In millions Years ended December 31, 2010 2009 2008
Operating activities
Net income $ 4,946.3 $ 4,551.0 $ 4,313.2
Adjustments to reconcile to cash provided by operations
Charges and credits:
Depreciation and amortization 1,276.2 1,216.2 1,207.8
Deferred income taxes (75.7) 203.0 101.5
Impairment and other charges (credits), net 29.1 (61.1) 6.0
Gain on sale of investment (94.9) (160.1)
Share-based compensation 83.1 112.9 112.5
Other 211.6 (347.1) 90.5
Changes in working capital items:
Accounts receivable (50.1) (42.0) 16.1
Inventories, prepaid expenses and other current assets (50.8) 1.0 (11.0)
Accounts payable (39.8) (2.2) (40.1)
Income taxes 54.9 212.1 195.7
Other accrued liabilities (43.2) 2.1 85.1
Cash provided by operations 6,341.6 5,751.0 5,917.2
Investing activities
Property and equipment expenditures (2,135.5) (1,952.1) (2,135.7)
Purchases of restaurant businesses (183.4) (145.7) (147.0)
Sales of restaurant businesses and property 377.9 406.0 478.8
Proceeds on sale of investment 144.9 229.4
Other (115.0) (108.4) (50.2)
Cash used for investing activities (2,056.0) (1,655.3) (1,624.7)
Financing activities
Net short-term borrowings 3.1 (285.4) 266.7
Long-term financing issuances 1,931.8 1,169.3 3,477.5
Long-term financing repayments (1,147.5) (664.6) (2,698.5)
Treasury stock purchases (2,698.5) (2,797.4) (3,919.3)
Common stock dividends (2,408.1) (2,235.5) (1,823.4)
Proceeds from stock option exercises 463.1 332.1 548.2
Excess tax benefit on share-based compensation 128.7 73.6 124.1
Other (1.3) (13.1) (89.8)
Cash used for financing activities (3,728.7) (4,421.0) (4,114.5)
Effect of exchange rates on cash and equivalents 34.1 57.9 (95.9)
Cash and equivalents increase (decrease) 591.0 (267.4) 82.1
Cash and equivalents at beginning of year 1,796.0 2,063.4 1,981.3
Cash and equivalents at end of year $ 2,387.0 $ 1,796.0 $ 2,063.4
Supplemental cash flow disclosures
Interest paid $ 457.9 $ 468.7 $ 507.8
Income taxes paid 1,708.5 1,683.5 1,294.7
See Notes to consolidated financial statements.
28 McDonald’s Corporation Annual Report 2010
Consolidated Statement of Shareholders’ Equity
In millions, except per share data
Common stock
issued
Additional
paid-in
capital
Retained
earnings
Accumulated other
comprehensive income (loss)
Common stock
in treasury
Total
shareholders’
equityPensions
Deferred
hedging
adjustment
Foreign
currency
translationShares Amount Shares Amount
Balance at December 31, 2007 1,660.6 $16.6 $4,226.7 $26,461.5 $ (37.7) $ 0.7 $ 1,374.4 (495.3) $(16,762.4) $15,279.8
Net income 4,313.2 4,313.2
Translation adjustments
(including tax benefits of $190.4) (1,223.0) (1,223.0)
Adjustments to cash flow hedges
(including taxes of $29.9) 47.3 47.3
Adjustments related to pensions (including tax
benefits of $29.4) (60.4) (60.4)
Comprehensive income 3,077.1
Common stock cash dividends
($1.625 per share) (1,823.4) (1,823.4)
Treasury stock purchases (69.7) (3,980.9) (3,980.9)
Share-based compensation 109.6 109.6
Stock option exercises and other
(including tax benefits of $169.0) 263.9 2.6 19.7 453.9 720.4
Balance at December 31, 2008 1,660.6 16.6 4,600.2 28,953.9 (98.1) 48.0 151.4 (545.3) (20,289.4) 13,382.6
Net income 4,551.0 4,551.0
Translation adjustments (including taxes of
$47.2) 714.1 714.1
Adjustments to cash flow hedges
(including tax benefits of $18.6) (31.5) (31.5)
Adjustments related to pensions (including tax
benefits of $25.0) (36.5) (36.5)
Comprehensive income 5,197.1
Common stock cash dividends
($2.05 per share) (2,235.5) (2,235.5)
Treasury stock purchases (50.3) (2,854.1) (2,854.1)
Share-based compensation 112.9 112.9
Stock option exercises and other (including tax
benefits of $93.3) 140.8 1.4 11.7 288.7 430.9
Balance at December 31, 2009 1,660.6 16.6 4,853.9 31,270.8 (134.6) 16.5 865.5 (583.9) (22,854.8) 14,033.9
Net income 4,946.3 4,946.3
Translation adjustments (including tax benefits
of $52.2) (3.0) (3.0)
Adjustments to cash flow hedges
(including tax benefits of $1.1) (1.5) (1.5)
Adjustments related to pensions (including
taxes of $3.5) 10.0 10.0
Comprehensive income 4.951.8
Common stock cash dividends
($2.26 per share) (2,408.1) (2,408.1)
Treasury stock purchases (37.8) (2,648.5) (2,648.5)
Share-based compensation 83.1 83.1
Stock option exercises and other (including tax
benefits of $146.1) 259.4 2.7 14.7 359.9 622.0
Balance at December 31, 2010 1,660.6 $16.6 $5,196.4 $33,811.7 $(124.6) $ 15.0 $ 862.5 (607.0) $(25,143.4) $14,634.2
See Notes to consolidated financial statements.
McDonald’s Corporation Annual Report 2010 29
Notes to Consolidated Financial Statements
Summary of Significant Accounting Policies
NATURE OF BUSINESS
The Company franchises and operates McDonald’s restaurants in
the global restaurant industry. All restaurants are operated either
by the Company or by franchisees, including conventional
franchisees under franchise arrangements, and foreign affiliates
and developmental licensees under license agreements.
The following table presents restaurant information by owner-
ship type:
Restaurants at December 31, 2010 2009 2008
Conventional franchised 19,279 19,020 18,402
Developmental licensed 3,485 3,160 2,926
Foreign affiliated 3,574 4,036 4,137
Franchised 26,338 26,216 25,465
Company-operated 6,399 6,262 6,502
Systemwide restaurants 32,737 32,478 31,967
CONSOLIDATION
The consolidated financial statements include the accounts of
the Company and its subsidiaries. Investments in affiliates owned
50% or less (primarily McDonald’s Japan) are accounted for by
the equity method.
In June 2009, the Financial Accounting Standards Board
(FASB) issued amendments to the guidance on variable interest
entities and consolidation, codified primarily in the Consolidation
Topic of the FASB Accounting Standards Codification (ASC).
This guidance modifies the method for determining whether an
entity is a variable interest entity as well as the methods permit-
ted for determining the primary beneficiary of a variable interest
entity. In addition, this guidance requires ongoing reassessments
of whether a company is the primary beneficiary of a variable
interest entity and enhanced disclosures related to a company’s
involvement with a variable interest entity. The Company adopted
this guidance as of January 1, 2010.
On an ongoing basis, the Company evaluates its business
relationships such as those with franchisees, joint venture part-
ners, developmental licensees, suppliers, and advertising
cooperatives to identify potential variable interest entities. Gen-
erally, these businesses qualify for a scope exception under the
consolidation guidance. The Company has concluded that con-
solidation of any such entity is not appropriate for the periods
presented. As a result, the adoption did not have any impact on
the Company’s consolidated financial statements.
ESTIMATES IN FINANCIAL STATEMENTS
The preparation of financial statements in conformity with
accounting principles generally accepted in the U.S. requires
management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company’s revenues consist of sales by Company-operated
restaurants and fees from franchised restaurants operated by
conventional franchisees, developmental licensees and foreign
affiliates.
Sales by Company-operated restaurants are recognized on a
cash basis. The Company presents sales net of sales tax and
other sales-related taxes. Revenues from conventional franchised
restaurants include rent and royalties based on a percent of sales
with minimum rent payments, and initial fees. Revenues from
restaurants licensed to foreign affiliates and developmental
licensees include a royalty based on a percent of sales, and may
include initial fees. Continuing rent and royalties are recognized
in the period earned. Initial fees are recognized upon opening of
a restaurant or granting of a new franchise term, which is when
the Company has performed substantially all initial services
required by the franchise arrangement.
FOREIGN CURRENCY TRANSLATION
Generally, the functional currency of operations outside the U.S.
is the respective local currency.
ADVERTISING COSTS
Advertising costs included in operating expenses of Company-
operated restaurants primarily consist of contributions to
advertising cooperatives and were (in millions): 2010–$687.0;
2009–$650.8; 2008–$703.4. Production costs for radio and
television advertising are expensed when the commercials are
initially aired. These production costs, primarily in the U.S., as well
as other marketing-related expenses included in selling, gen-
eral & administrative expenses were (in millions): 2010–$94.5;
2009–$94.7; 2008–$79.2. In addition, significant advertising
costs are incurred by franchisees through contributions to adver-
tising cooperatives in individual markets.
SHARE-BASED COMPENSATION
Share-based compensation includes the portion vesting of all
share-based payments granted based on the grant date fair
value.
Share-based compensation expense and the effect on diluted
earnings per common share were as follows:
In millions, except per share data 2010 2009 2008
Share-based compensation expense $83.1 $112.9 $112.5
After tax $56.2 $ 76.1 $ 75.1
Earnings per common share-diluted $0.05 $ 0.07 $ 0.07
Compensation expense related to share-based awards is
generally amortized on a straight-line basis over the vesting
period in selling, general & administrative expenses in the Con-
solidated statement of income. As of December 31, 2010, there
was $90.4 million of total unrecognized compensation cost
related to nonvested share-based compensation that is expected
to be recognized over a weighted-average period of 2.0 years.
The fair value of each stock option granted is estimated on
the date of grant using a closed-form pricing model. The follow-
ing table presents the weighted-average assumptions used in the
option pricing model for the 2010, 2009 and 2008 stock option
grants. The expected life of the options represents the period of
time the options are expected to be outstanding and is based on
historical trends. Expected stock price volatility is generally based
on the historical volatility of the Company’s stock for a period
approximating the expected life. The expected dividend yield is
based on the Company’s most recent annual dividend payout.
The risk-free interest rate is based on the U.S. Treasury yield
curve in effect at the time of grant with a term equal to the
expected life.
30 McDonald’s Corporation Annual Report 2010
Weighted-average assumptions
2010 2009 2008
Expected dividend yield 3.5% 3.2% 2.6%
Expected stock price volatility 22.1% 24.4% 24.9%
Risk-free interest rate 2.8% 2.0% 3.0%
Expected life of options In years 6.2 6.2 6.2
Fair value per option granted $9.90 $9.66 $11.85
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; lease-
hold improvements–the lesser of useful lives of assets or lease
terms, which generally include option periods; and equipment–
three to 12 years.
GOODWILL
Goodwill represents the excess of cost over the net tangible
assets and identifiable intangible assets of acquired restaurant
businesses. The Company’s goodwill primarily results from pur-
chases of McDonald’s restaurants from franchisees and
ownership increases in subsidiaries or affiliates, and it is gen-
erally assigned to the reporting unit expected to benefit from the
synergies of the combination. If a Company-operated restaurant
is sold within 24 months of acquisition, the goodwill associated
with the acquisition is written off in its entirety. If a restaurant is
sold beyond 24 months from the acquisition, the amount of
goodwill written off is based on the relative fair value of the busi-
ness sold compared to the reporting unit (defined as each
individual country).
The Company conducts goodwill impairment testing in the
fourth quarter of each year or whenever an indicator of impair-
ment exists. If an indicator of impairment exists (e.g., estimated
earnings multiple value of a reporting unit is less than its carrying
value), the goodwill impairment test compares the fair value of a
reporting unit, generally based on discounted future cash flows,
with its carrying amount including goodwill. If the carrying amount
of a reporting unit exceeds its fair value, an impairment loss is
measured as the difference between the implied fair value of the
reporting unit’s goodwill and the carrying amount of goodwill.
Historically, goodwill impairment has not significantly impacted
the consolidated financial statements.
The following table presents the 2010 activity in goodwill by
segment:
In millions U.S. Europe APMEA(1)
Other Countries
& Corporate(2) Consolidated
Balance at December 31, 2009 $1,151.6 $790.7 $346.4 $136.5 $2,425.2
Net restaurant purchases (sales) 60.4 23.0 2.2 48.5 134.1
Acquisition of subsidiaries/affiliates 9.7 9.7
Currency translation (28.2) 36.4 8.9 17.1
Balance at December 31, 2010 $1,212.0 $785.5 $385.0 $203.6 $2,586.1
(1) APMEA represents Asia/Pacific, Middle East and Africa.
(2) Other Countries & Corporate represents Canada, Latin America and Corporate.
LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment annually in the
fourth quarter and whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be
recoverable. For purposes of annually reviewing McDonald’s res-
taurant assets for potential impairment, assets are initially
grouped together at a television market level in the U.S. and at a
country level for each of the international markets. The Company
manages its restaurants as a group or portfolio with significant
common costs and promotional activities; as such, an individual
restaurant’s cash flows are not generally independent of the cash
flows of others in a market. If an indicator of impairment (e.g.,
negative operating cash flows for the most recent trailing
24-month period) exists for any grouping of assets, an estimate
of undiscounted future cash flows produced by each individual
restaurant within the asset grouping is compared to its carrying
value. If an individual restaurant is determined to be impaired, the
loss is measured by the excess of the carrying amount of the
restaurant over its fair value as determined by an estimate of
discounted future cash flows.
Losses on assets held for disposal are recognized when
management and the Board of Directors, as required, have
approved and committed to a plan to dispose of the assets, the
assets are available for disposal, the disposal is probable of
occurring within 12 months, and the net sales proceeds are
expected to be less than its net book value, among other factors.
Generally, such losses relate to restaurants that have closed and
ceased operations as well as other assets that meet the criteria
to be considered “available for sale”.
FAIR VALUE MEASUREMENTS
The Company measures certain financial assets and liabilities at
fair value on a recurring basis, and certain non-financial assets
and liabilities on a nonrecurring basis. Fair value is defined as the
price that would be received to sell an asset or paid to transfer a
liability in the principal or most advantageous market in an orderly
transaction between market participants on the measurement
date. Fair value disclosures are reflected in a three-level hier-
archy, maximizing the use of observable inputs and minimizing
the use of unobservable inputs.
The valuation hierarchy is based upon the transparency of
inputs to the valuation of an asset or liability on the measurement
date. The three levels are defined as follows:
• Level 1 – inputs to the valuation methodology are quoted
prices (unadjusted) for an identical asset or liability in an active
market.
• Level 2 – inputs to the valuation methodology include quoted
prices for a similar asset or liability in an active market or
model-derived valuations in which all significant inputs are
observable for substantially the full term of the asset or liability.
• Level 3 – inputs to the valuation methodology are
unobservable and significant to the fair value measurement of
the asset or liability.
McDonald’s Corporation Annual Report 2010 31
Certain of the Company’s derivatives are valued using various
pricing models or discounted cash flow analyses that incorporate
observable market parameters, such as interest rate yield curves,
option volatilities and currency rates, classified as Level 2 within
the valuation hierarchy. Derivative valuations incorporate credit
risk adjustments that are necessary to reflect the probability of
default by the counterparty or the Company.
• Certain Financial Assets and Liabilities Measured at
Fair
Value
The following tables present financial assets and liabilities meas-
ured at fair value on a recurring basis by the valuation hierarchy
as defined in the fair value guidance:
December 31, 2010
In millions Level 1 Level 2 Level 3
Carrying
Value
Cash equivalents $722.5 $ 722.5
Investments 131.6* 131.6
Derivative receivables 104.4* $ 88.5 192.9
Total assets at fair
value $958.5 $ 88.5 $1,047.0
Derivative payables $ (8.4) $ (8.4)
Total liabilities at fair
value $ (8.4) $ (8.4)
December 31, 2009
In millions Level 1 Level 2 Level 3
Carrying
Value
Cash equivalents $455.8 $ 455.8
Investments 115.7* 115.7
Derivative receivables 79.6* $ 94.5 174.1
Total assets at fair
value $651.1 $ 94.5 $ 745.6
Derivative payables $ (7.0) $ (7.0)
Total liabilities at fair
value $ (7.0) $ (7.0)
* Includes long-term investments and derivatives that hedge market driven changes in
liabilities associated with the Company’s supplemental benefit plans.
• Non-Financial Assets and Liabilities Measured at Fair
Value on a Nonrecurring Basis
Certain assets and liabilities are measured at fair value on a
nonrecurring basis; that is, the assets and liabilities are not
measured at fair value on an ongoing basis, but are subject to fair
value adjustments in certain circumstances (e.g., when there is
evidence of impairment). At December 31, 2010, no material fair
value adjustments or fair value measurements were required for
non-financial assets or liabilities.
• Certain Financial Assets and Liabilities not Measured
at Fair Value
At December 31, 2010, the fair value of the Company’s debt
obligations was estimated at $12.5 billion, compared to a carry-
ing amount of $11.5 billion. This fair value was estimated using
various pricing models or discounted cash flow analyses that
incorporated quoted market prices and are similar to Level 2
inputs within the valuation hierarchy. The carrying amount for
both cash equivalents and notes receivable approximate fair
value.
FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
The Company is exposed to global market risks, including the
effect of changes in interest rates and foreign currency fluctua-
tions. The Company uses foreign currency denominated debt and
derivative instruments to mitigate the impact of these changes.
The Company does not use derivatives with a level of complexity
or with a risk higher than the exposures to be hedged and does
not hold or issue derivatives for trading purposes.
The Company documents its risk management objective and
strategy for undertaking hedging transactions, as well as all rela-
tionships between hedging instruments and hedged items. The
Company’s derivatives that are designated as hedging instru-
ments consist mainly of interest rate exchange agreements,
forward foreign currency exchange agreements and foreign cur-
rency options. Interest rate exchange agreements are entered
into to manage the interest rate risk associated with the Compa-
ny’s fixed and floating-rate borrowings. Forward foreign currency
exchange agreements and foreign currency options are entered
into to mitigate the risk that forecasted foreign currency cash
flows (such as royalties denominated in foreign currencies) will
be adversely affected by changes in foreign currency exchange
rates. Certain foreign currency denominated debt is used, in part,
to protect the value of the Company’s investments in certain for-
eign subsidiaries and affiliates from changes in foreign currency
exchange rates.
The Company also enters into certain derivatives that are not
designated as hedging instruments. The Company has entered
into equity derivative contracts to hedge market-driven changes
in certain of its supplemental benefit plan liabilities. Changes in
the fair value of these derivatives are recorded in selling, gen-
eral & administrative expenses together with the changes in the
supplemental benefit plan liabilities. In addition, the Company
uses forward foreign currency exchange agreements and foreign
currency exchange agreements to mitigate the change in fair
value of certain foreign currency denominated assets and
liabilities. Since these derivatives are not designated as hedging
instruments, the changes in the fair value of these derivatives are
recognized immediately in nonoperating (income) expense
together with the currency gain or loss from the hedged balance
sheet position. A portion of the Company’s foreign currency
options (more fully described in the Cash Flow Hedging Strategy
section) are undesignated as hedging instruments as the under-
lying foreign currency royalties are earned.
All derivative instruments designated as hedging instruments
are classified as fair value, cash flow or net investment hedges.
All derivatives (including those not designated as hedging
instruments) are recognized on the Consolidated balance sheet
at fair value and classified based on the instruments’ maturity
date. Changes in the fair value measurements of the derivative
instruments are reflected as adjustments to other comprehensive
income (OCI) and/or current earnings.
32 McDonald’s Corporation Annual Report 2010
The following table presents the fair values of derivative instruments included on the Consolidated balance sheet as of December 31,
2010 and 2009:
Asset Derivatives Liability Derivatives
In millions
Balance Sheet
Classification 2010 2009
Balance Sheet
Classification 2010 2009
Derivatives designated as hedging instruments
Foreign currency Prepaid expenses and
other current assets $ 7.5 $ 13.5
Accrued payroll and
other liabilities $(4.6) $(0.1)
Interest rate Prepaid expenses and
other current assets 0.5 1.4
Foreign currency Miscellaneous
other assets 5.4
Interest rate Miscellaneous
other assets 72.1 67.3
Other long-term
liabilities (0.3) (3.4)
Total derivatives designated as hedging instruments $ 80.1 $ 87.6 $(4.9) $(3.5)
Derivatives not designated as hedging instruments
Foreign currency Prepaid expenses and
other current assets $ 6.0 $ 9.3
Accrued payroll and
other liabilities $(3.8) $(5.4)
Equity Prepaid expenses and
other current assets 104.4
Equity Miscellaneous
other assets 79.6
Foreign currency Miscellaneous
other assets 2.7
Other long-term
liabilities (0.5)
Total derivatives not designated as hedging instruments $113.1 $ 88.9 $(3.8) $(5.9)
Total derivatives1 $193.2 $176.5 $(8.7) $(9.4)
1 The fair value of derivatives is presented on a gross basis. Accordingly, the 2010 and 2009 total asset and liability fair values do not agree with the values provided in the Fair Value
Measurements note, because that disclosure reflects netting adjustments of $0.3 million and $2.4 million.
The following table presents the pretax amounts affecting income and OCI for the years ended December 31, 2010 and 2009,
respectively:
In millions
Derivatives in
Fair Value
Hedging
Relationships
(Gain) Loss
Recognized in Income
on Derivative
Hedged Items in
Fair Value
Hedging
Relationships
(Gain) Loss
Recognized in Income on
Related Hedged Items
2010 2009 2010 2009
Interest rate $ (7.0) $ 17.3 Fixed-rate debt $ 7.0 $(17.3)
Derivatives in
Cash Flow
Hedging
Relationships
(Gain) Loss
Recognized in Accumulated
OCI on Derivative
(Effective Portion)
(Gain) Loss
Reclassified from
Accumulated OCI into
Income (Effective Portion)
(Gain) Loss
Recognized in Income on
Derivative (Amount Excluded
from Effectiveness Testing and
Ineffective Portion)
2010 2009 2010 2009 2010 2009
Foreign currency $(11.2) $ 3.4 $(13.4) $(48.3) $ 25.1 $ 27.0
Interest rate(1) (2.1) (0.9) (2.1) (0.3)
Total $(11.2) $ 1.3 $(14.3) $(50.4) $ 24.8 $ 27.0
Net Investment
Hedging Relationships
(Gain) Loss
Recognized in Accumulated
OCI on Derivative
(Effective Portion)
Derivatives Not
Designated as
Hedging
Instruments
(Gain) Loss
Recognized in Income on
Derivative
2010 2009 2010 2009
Foreign currency denominated debt $144.3 $51.3 Foreign currency $(16.4) $(12.2)
Foreign currency derivatives 4.3 Equity(2) (18.8) (2.4)
Total $148.6 $51.3 Total $(35.2) $(14.6)
(Gains) losses recognized in income on derivatives are recorded in nonoperating (income) expense unless otherwise noted.
(1) The amount of (gain) loss reclassified from accumulated OCI into income is recorded in interest expense.
(2) The amount of (gain) loss recognized in income on the derivatives used to hedge the supplemental benefit plan liabilities is recorded in selling, general & administrative expenses.
McDonald’s Corporation Annual Report 2010 33
• Fair Value Hedging Strategy
The Company enters into fair value hedges to reduce the
exposure to changes in the fair values of certain liabilities. The
fair value hedges the Company enters into consist of interest rate
exchange agreements which convert a portion of its fixed-rate
debt into floating-rate debt. All of the Company’s interest rate
exchange agreements meet the shortcut method requirements.
Accordingly, changes in the fair values of the interest rate
exchange agreements are exactly offset by changes in the fair
value of the underlying debt. No ineffectiveness has been
recorded to net income related to interest rate exchange agree-
ments designated as fair value hedges for the year ended
December 31, 2010. A total of $2.3 billion of the Company’s
outstanding fixed-rate debt was effectively converted to floating-
rate debt resulting from the use of interest rate exchange
agreements.
• Cash Flow Hedging Strategy
The Company enters into cash flow hedges to reduce the
exposure to variability in certain expected future cash flows. The
types of cash flow hedges the Company enters into include
interest rate exchange agreements, forward foreign currency
exchange agreements and foreign currency options.
To protect against the reduction in value of forecasted foreign
currency cash flows (such as royalties denominated in foreign
currencies), the Company uses forward foreign currency
exchange agreements and foreign currency options to hedge a
portion of anticipated exposures.
When the U.S. dollar strengthens against foreign currencies,
the decline in present value of future foreign denominated royal-
ties is offset by gains in the fair value of the forward foreign
currency exchange agreements and/or foreign currency options.
Conversely, when the U.S. dollar weakens, the increase in the
present value of future foreign denominated royalties is offset by
losses in the fair value of the forward foreign currency exchange
agreements and/or foreign currency options.
Although the fair value changes in the foreign currency
options may fluctuate over the period of the contract, the
Company’s total loss on a foreign currency option is limited to the
upfront premium paid for the contract. However, the potential
gains on a foreign currency option are unlimited as the settle-
ment value of the contract is based upon the difference between
the exchange rate at inception of the contract and the spot
exchange rate at maturity. In limited situations, the Company uses
foreign currency option collars, which limit the potential gains and
lower the upfront premium paid, to protect against currency
movements.
The hedges typically cover the next 12-15 months for certain
exposures and are denominated in various currencies. As of
December 31, 2010, the Company had derivatives outstanding
with an equivalent notional amount of $434.4 million that were
used to hedge a portion of forecasted foreign currency denomi-
nated royalties.
The Company excludes the time value of foreign currency
options, as well as the discount or premium points on forward
foreign currency exchange agreements, from its effectiveness
assessment on its cash flow hedges. As a result, changes in the
fair value of the derivatives due to these components, as well as
the ineffectiveness of the hedges, are recognized in earnings
currently. The effective portion of the gains or losses on the
derivatives is reported in the deferred hedging adjustment
component of OCI in shareholders’ equity and reclassified into
earnings in the same period or periods in which the hedged
transaction affects earnings.
The Company recorded after tax adjustments related to cash
flow hedges to the deferred hedging adjustment component of
accumulated OCI in shareholders’ equity. The Company recorded
a net decrease of $1.5 million and $31.5 million for the years
ended December 31, 2010 and 2009, respectively. Based on
interest rates and foreign currency exchange rates at
December 31, 2010, no significant amount of the $15.0 million
in cumulative deferred hedging gains, after tax, at December 31,
2010, will be recognized in earnings over the next 12 months as
the underlying hedged transactions are realized.
• Hedge of Net Investment in Foreign Operations
Strategy
The Company primarily uses foreign currency denominated debt
to hedge its investments in certain foreign subsidiaries and affili-
ates. Realized and unrealized translation adjustments from these
hedges are included in shareholders’ equity in the foreign cur-
rency translation component of OCI and offset translation
adjustments on the underlying net assets of foreign subsidiaries
and affiliates, which also are recorded in OCI. As of
December 31, 2010, a total of $3.5 billion of the Company’s
outstanding foreign currency denominated debt was designated
to hedge investments in certain foreign subsidiaries and affiliates.
• Credit Risk
The Company is exposed to credit-related losses in the event of
non-performance by the counterparties to its hedging instru-
ments. The counterparties to these agreements consist of a
diverse group of financial institutions. The Company continually
monitors its positions and the credit ratings of its counterparties
and adjusts positions as appropriate. The Company did not have
significant exposure to any individual counterparty at
December 31, 2010 and has master agreements that contain
netting arrangements. Some of these agreements also require
each party to post collateral if credit ratings fall below, or
aggregate exposures exceed, certain contractual limits. At
December 31, 2010, neither the Company nor its counterparties
were required to post collateral on any derivative position, other
than on hedges of certain of the Company’s supplemental benefit
plan liabilities where its counterparties were required to post col-
lateral on their liability positions.
INCOME TAX UNCERTAINTIES
The Company, like other multi-national companies, is regularly
audited by federal, state and foreign tax authorities, and tax
assessments may arise several years after tax returns have been
filed. Accordingly, tax liabilities are recorded when, in
management’s judgment, a tax position does not meet the more
34 McDonald’s Corporation Annual Report 2010
likely than not threshold for recognition. For tax positions that
meet the more likely than not threshold, a tax liability may be
recorded depending on management’s assessment of how the
tax position will ultimately be settled.
The Company records interest and penalties on unrecognized
tax benefits in the provision for income taxes.
PER COMMON SHARE INFORMATION
Diluted earnings per common share is calculated using net
income divided by diluted weighted-average shares. Diluted
weighted-average shares include weighted-average shares out-
standing plus the dilutive effect of share-based compensation
calculated using the treasury stock method, of (in millions of
shares): 2010–14.3; 2009–15.2; 2008– 19.4. Stock options
that were not included in diluted weighted-average shares
because they would have been antidilutive were (in millions of
shares): 2010–0.0; 2009–0.7; 2008–0.6.
The Company has elected to exclude the pro forma deferred
tax asset associated with share-based compensation in earnings
per share.
STATEMENT OF CASH FLOWS
The Company considers short-term, highly liquid investments with
an original maturity of 90 days or less to be cash equivalents.
SUBSEQUENT EVENTS
The Company evaluated subsequent events through the date the
financial statements were issued and filed with the Securities and
Exchange Commission. There were no subsequent events that
required recognition or disclosure.
Property and Equipment
Net property and equipment consisted of:
In millions December 31, 2010 2009
Land $ 5,200.5 $ 5,048.3
Buildings and improvements
on owned land 12,399.4 12,119.0
Buildings and improvements
on leased land 11,732.0 11,347.9
Equipment, signs and seating 4,608.5 4,422.9
Other 542.0 502.4
34,482.4 33,440.5
Accumulated depreciation and
amortization (12,421.8) (11,909.0)
Net property and equipment $ 22,060.6 $ 21,531.5
Depreciation and amortization expense was (in millions): 2010–
$1,200.4; 2009–$1,160.8; 2008–$1,161.6.
Impairment and Other Charges (Credits), Net
In millions, except per share data 2010 2009 2008
Europe $ 1.6 $ 4.3 $ 6.0
APMEA 48.5 (0.2)
Other Countries & Corporate (21.0) (65.2)
Total $ 29.1 $(61.1) $ 6.0
After tax(1) $ 24.6 $(91.4) $ 3.5
Earnings per common share—diluted $ 0.02 $(0.08) $0.01
(1) Certain items were not tax effected.
In 2010, the Company recorded after tax charges of $39.3
million related to its share of restaurant closing costs in McDo-
nald’s Japan (a 50%-owned affiliate) in conjunction with the first
quarter strategic review of the market’s restaurant portfolio.
These actions were designed to enhance the brand image, over-
all profitability and returns of the market. The Company also
recorded pretax income of $21.0 million related to the resolution
of certain liabilities retained in connection with the 2007 Latin
America developmental license transaction.
In 2009, the Company recorded pretax income of $65.2 mil-
lion related primarily to the resolution of certain liabilities retained
in connection with the 2007 Latin America developmental
license transaction. The Company also recognized a tax benefit in
2009 in connection with this income, mainly related to the
release of a tax valuation allowance.
Other Operating (Income) Expense, Net
In millions 2010 2009 2008
Gains on sales of restaurant
businesses $ (79.4) $(113.3) $(126.5)
Equity in earnings of
unconsolidated affiliates (164.3) (167.8) (110.7)
Asset dispositions and other
expense 45.5 58.8 72.0
Total $(198.2) $(222.3) $(165.2)
• Gains on sales of restaurant businesses
Gains on sales of restaurant businesses include gains from sales
of Company-operated restaurants as well as gains from
exercises of purchase options by franchisees with business facili-
ties lease arrangements (arrangements where the Company
leases the businesses, including equipment, to franchisees who
generally have options to purchase the businesses). The Compa-
ny’s purchases and sales of businesses with its franchisees are
aimed at achieving an optimal ownership mix in each market.
Resulting gains or losses are recorded in operating income
because the transactions are a recurring part of our business.
• Equity in earnings of unconsolidated affiliates
Unconsolidated affiliates and partnerships are businesses in
which the Company actively participates but does not control.
The Company records equity in earnings from these entities
representing McDonald’s share of results. For foreign affiliated
markets – primarily Japan – results are reported after interest
McDonald’s Corporation Annual Report 2010 35
expense and income taxes. McDonald’s share of results for part-
nerships in certain consolidated markets such as the U.S. are
reported before income taxes. These partnership restaurants are
operated under conventional franchise arrangements and, there-
fore, are classified as conventional franchised restaurants.
• Asset dispositions and other expense
Asset dispositions and other expense consists of gains or losses
on excess property and other asset dispositions, provisions for
restaurant closings and uncollectible receivables, asset write-offs
due to restaurant reinvestment, and other miscellaneous income
and expenses.
Gain on Sale of Investment
In 2009, the Company sold its minority ownership interest in
Redbox Automated Retail, LLC to Coinstar, Inc., the majority
owner, for total consideration of $139.8 million. In connection
with the sale, in first quarter 2009, the Company received initial
consideration valued at $51.6 million consisting of 1.5 million
shares of Coinstar common stock at an agreed to value of $41.6
million and $10 million in cash with the balance of the purchase
price deferred. In subsequent quarters of 2009, the Company
sold all of its holdings in the Coinstar common stock for $46.8
million and received $88.2 million in cash from Coinstar as final
consideration. As a result of the transaction, the Company
recognized a nonoperating pretax gain of $94.9 million (after
tax–$58.8 million or $0.05 per share).
In second quarter 2008, the Company sold its minority owner-
ship interest in U.K.-based Pret A Manger. In connection with the
sale, the Company received cash proceeds of $229.4 million and
recognized a nonoperating pretax gain of $160.1 million (after
tax–$109.0 million or $0.09 per share).
Contingencies
From time to time, the Company is subject to proceedings, law-
suits and other claims related to competitors, customers,
employees, franchisees, government agencies, intellectual prop-
erty, shareholders and suppliers. The Company is required to
assess the likelihood of any adverse judgments or outcomes to
these matters as well as potential ranges of probable losses. A
determination of the amount of accrual required, if any, for these
contingencies is made after careful analysis of each matter. The
required accrual may change in the future due to new develop-
ments in each matter or changes in approach such as a change
in settlement strategy in dealing with these matters.
In connection with the sale in 2007 of its businesses in 18
countries in Latin America and the Caribbean to a developmental
licensee organization, the Company agreed to indemnify the
buyers for certain tax and other claims, certain of which are
reflected on McDonald’s Consolidated balance sheet (2010 and
2009: other long-term liabilities–$49.6 million and $71.8 million,
respectively; 2010 and 2009: accrued payroll and other
liabilities–$28.4 million and $25.3 million, respectively). The
change in the total balance was primarily a result of the reso-
lution of certain of these liabilities.
The Company believes any other matters currently being
reviewed will not have a material adverse effect on its financial
condition or results of operation.
Franchise Arrangements
Conventional franchise arrangements generally include a lease
and a license and provide for payment of initial fees, as well as
continuing rent and royalties to the Company based upon a per-
cent of sales with minimum rent payments that parallel the
Company’s underlying leases and escalations (on properties that
are leased). Under this arrangement, franchisees are granted the
right to operate a restaurant using the McDonald’s System and, in
most cases, the use of a restaurant facility, generally for a period
of 20 years. These franchisees pay related occupancy costs
including property taxes, insurance and maintenance. Affiliates
and developmental licensees operating under license agree-
ments pay a royalty to the Company based upon a percent of
sales, and may pay initial fees.
The results of operations of restaurant businesses purchased
and sold in transactions with franchisees were not material either
individually or in the aggregate to the consolidated financial
statements for periods prior to purchase and sale.
Revenues from franchised restaurants consisted of:
In millions 2010 2009 2008
Rents $5,198.4 $4,841.0 $4,612.8
Royalties 2,579.2 2,379.8 2,275.7
Initial fees 63.7 65.4 73.0
Revenues from
franchised restaurants $7,841.3 $7,286.2 $6,961.5
Future minimum rent payments due to the Company under
existing franchise arrangements are:
In millions Owned sites Leased sites Total
2011 $ 1,244.4 $ 1,104.6 $ 2,349.0
2012 1,213.7 1,075.6 2,289.3
2013 1,177.1 1,038.5 2,215.6
2014 1,132.6 986.9 2,119.5
2015 1,075.3 926.1 2,001.4
Thereafter 8,664.2 6,715.1 15,379.3
Total minimum
payments $14,507.3 $11,846.8 $26,354.1
At December 31, 2010, net property and equipment under
franchise arrangements totaled $13.4 billion (including land of
$3.9 billion) after deducting accumulated depreciation and amor-
tization of $6.7 billion.
Leasing Arrangements
At December 31, 2010, the Company was the lessee at 13,957
restaurant locations through ground leases (the Company leases
the land and the Company or franchisee owns the building) and
through improved leases (the Company leases land and
buildings). Lease terms for most restaurants, where market con-
ditions allow, are generally for 20 years and, in many cases,
provide for rent escalations and renewal options, with certain
leases providing purchase options. Escalation terms vary by
geographic segment with examples including fixed-rent escala-
tions, escalations based on an inflation index, and fair-value
market adjustments. The timing of these escalations generally
ranges from annually to every five years. For most locations, the
Company is obligated for the related occupancy costs including
36 McDonald’s Corporation Annual Report 2010
property taxes, insurance and maintenance; however, for fran-
chised sites, the Company requires the franchisees to pay these
costs. In addition, the Company is the lessee under non-
cancelable leases covering certain offices and vehicles.
Future minimum payments required under existing operating
leases with initial terms of one year or more are:
In millions Restaurant Other Total
2011 $ 1,124.1 $ 76.4 $ 1,200.5
2012 1,054.7 60.9 1,115.6
2013 986.7 47.5 1,034.2
2014 885.5 40.4 925.9
2015 797.4 29.6 827.0
Thereafter 5,823.6 194.5 6,018.1
Total minimum payments $10,672.0 $449.3 $11,121.3
The following table provides detail of rent expense:
In millions 2010 2009 2008
Company-operated
restaurants:
U.S. $ 60.4 $ 65.2 $ 73.7
Outside the U.S. 545.0 506.9 532.0
Total 605.4 572.1 605.7
Franchised restaurants:
U.S. 409.7 393.9 374.7
Outside the U.S. 463.5 431.4 409.4
Total 873.2 825.3 784.1
Other 98.1 98.9 101.8
Total rent expense $1,576.7 $1,496.3 $1,491.6
Rent expense included percent rents in excess of minimum
rents (in millions) as follows–Company-operated restaurants:
2010–$142.5; 2009–$129.6; 2008–$130.2. Franchised
restaurants: 2010–$167.3; 2009–$154.7; 2008–$143.5.
Income Taxes
Income before provision for income taxes, classified by source of
income, was as follows:
In millions 2010 2009 2008
U.S. $2,763.0 $2,700.4 $2,769.4
Outside the U.S. 4,237.3 3,786.6 3,388.6
Income before provision for
income taxes $7,000.3 $6,487.0 $6,158.0
The provision for income taxes, classified by the timing and
location of payment, was as follows:
In millions 2010 2009 2008
U.S. federal $1,127.1 $ 792.0 $ 808.4
U.S. state 161.1 152.1 134.7
Outside the U.S. 841.5 788.9 800.2
Current tax provision 2,129.7 1,733.0 1,743.3
U.S. federal (66.8) 186.9 75.6
U.S. state 13.8 8.6 28.7
Outside the U.S. (22.7) 7.5 (2.8)
Deferred tax provision (benefit) (75.7) 203.0 101.5
Provision for income taxes $2,054.0 $1,936.0 $1,844.8
Net deferred tax liabilities consisted of:
In millions December 31, 2010 2009
Property and equipment $ 1,655.2 $ 1,609.4
Other 489.8 419.1
Total deferred tax liabilities 2,145.0 2,028.5
Property and equipment (352.4) (287.7)
Employee benefit plans (356.4) (311.0)
Intangible assets (268.6) (289.3)
Deferred foreign tax credits (310.7) (152.8)
Capital loss carryforwards (37.5) (50.9)
Operating loss carryforwards (56.8) (65.7)
Indemnification liabilities (36.5) (43.5)
Other (284.0) (334.3)
Total deferred tax assets
before valuation
allowance (1,702.9) (1,535.2)
Valuation allowance 104.7 118.1
Net deferred tax liabilities $ 546.8 $ 611.4
Balance sheet presentation:
Deferred income taxes $ 1,332.4 $ 1,278.9
Other assets–miscellaneous (590.4) (541.2)
Current assets–prepaid
expenses and other current
assets (195.2) (126.3)
Net deferred tax liabilities $ 546.8 $ 611.4
The statutory U.S. federal income tax rate reconciles to the
effective income tax rates as follows:
2010 2009 2008
Statutory U.S. federal income tax rate 35.0% 35.0% 35.0%
State income taxes, net of related
federal income tax benefit 1.6 1.6 1.8
Benefits and taxes related to foreign
operations (6.9) (6.3) (6.4)
Other, net (0.4) (0.5) (0.4)
Effective income tax rates 29.3% 29.8% 30.0%
As of December 31, 2010 and 2009, the Company’s gross
unrecognized tax benefits totaled $572.6 million and $492.0 mil-
lion, respectively. After considering the deferred tax accounting
impact, it is expected that about $390 million of the total as of
December 31, 2010 would favorably affect the effective tax rate
if resolved in the Company’s favor.
McDonald’s Corporation Annual Report 2010 37
The following table presents a reconciliation of the beginning
and ending amounts of unrecognized tax benefits:
In millions 2010 2009
Balance at January 1 $492.0 $272.5
Decreases for positions taken in prior years (27.1) (16.4)
Increases for positions taken in prior years 53.3 21.8
Increases for positions related to the current
year
Increases with deferred tax offset 16.3 83.9
Other increases 85.7 178.0
Settlements with taxing authorities (17.4) (20.8)
Lapsing of statutes of limitations (30.2) (27.0)
Balance at December 31(1)(2) $572.6 $492.0
(1) This balance is before consideration of the deferred tax accounting offsets
(2) Of the 2010 balance, $435.9 is included in long-term liabilities, $115.2 is included in
income taxes payable, and $21.5 is included in deferred income taxes on the Con-
solidated balance sheet. Of the 2009 balance, $285.6 is included in long-term
liabilities and $206.4 is included in deferred income taxes on the Consolidated bal-
ance sheet.
In 2010, the Internal Revenue Service (IRS) concluded its
field examination of the Company’s U.S. federal income tax
returns for 2007 and 2008. As part of this exam, the Company
has resolved proposed adjustments related to transfer pricing
matters that were previously received from the IRS. The tax
provision impact associated with the completion of this field
examination was not significant. The Company continues to dis-
agree with the IRS’ proposed adjustments related to certain
foreign tax credits of about $400 million, excluding interest and
potential penalties. The Company continues to believe that these
adjustments are not justified, and intends to pursue all available
remedies. While the Company cannot predict with certainty the
timing of resolution, we do not believe that it is reasonably possi-
ble that these issues will be settled in the next twelve months.
The Company does not believe the resolution will have a material
impact on its results of operations or cash flows. Excluding these
adjustments, it is reasonably possible that the total amount of
unrecognized tax benefits could decrease within the next 12
months by $25 million to $40 million. This decrease would result
from the expiration of the statute of limitations and the com-
pletion of tax audits in multiple tax jurisdictions.
The Company is generally no longer subject to U.S. federal,
state and local, or non-U.S. income tax examinations by tax
authorities for years prior to 2004.
The continuing practice of the Company is to recognize inter-
est and penalties related to income tax matters in the provision
for income taxes. The Company had $44.4 million and $18.7 mil-
lion accrued for interest and penalties at December 31, 2010
and 2009, respectively. The Company recognized interest and
penalties related to tax matters of $29.0 million in 2010,
$1.5 million in 2009, and $13.7 million in 2008.
Deferred U.S. income taxes have not been recorded for
temporary differences related to investments in certain foreign
subsidiaries and corporate joint ventures. These temporary
differences were approximately $11.0 billion at December 31,
2010 and consisted primarily of undistributed earnings consid-
ered permanently invested in operations outside the U.S.
Determination of the deferred income tax liability on these
unremitted earnings is not practicable because such liability, if
any, is dependent on circumstances existing if and when
remittance occurs.
Segment and Geographic Information
The Company operates in the global restaurant industry and
manages its business as distinct geographic segments. All inter-
company revenues and expenses are eliminated in computing
revenues and operating income. Corporate general & admin-
istrative expenses are included in Other Countries & Corporate
and consist of home office support costs in areas such as facili-
ties, finance, human resources, information technology, legal,
marketing, restaurant operations, supply chain and training.
Corporate assets include corporate cash and equivalents, asset
portions of financial instruments and home office facilities.
In millions 2010 2009 2008
U.S. $ 8,111.6 $ 7,943.8 $ 8,078.3
Europe 9,569.2 9,273.8 9,922.9
APMEA 5,065.5 4,337.0 4,230.8
Other Countries &
Corporate 1,328.3 1,190.1 1,290.4
Total revenues $24,074.6 $22,744.7 $23,522.4
U.S. $ 3,446.5 $ 3,231.7 $ 3,059.7
Europe 2,796.8 2,588.1 2,608.0
APMEA 1,199.9(1) 989.5 818.8
Other Countries &
Corporate 29.9(2) 31.7(3) (43.6)
Total operating income $ 7,473.1 $ 6,841.0 $ 6,442.9
U.S. $10,467.7 $10,429.3 $10,356.7
Europe 11,360.7 11,494.4 10,532.7
APMEA 5,374.0 4,409.0 4,074.6
Other Countries &
Corporate 4,772.8 3,892.2 3,497.5
Total assets $31,975.2 $30,224.9 $28,461.5
U.S. $ 530.5 $ 659.4 $ 837.4
Europe 978.5 859.3 864.1
APMEA 493.1 354.6 360.6
Other Countries &
Corporate 133.4 78.8 73.6
Total capital expenditures $ 2,135.5 $ 1,952.1 $ 2,135.7
U.S. $ 433.0 $ 423.8 $ 400.9
Europe 500.5 483.2 506.3
APMEA 232.4 202.9 193.4
Other Countries &
Corporate 110.3 106.3 107.2
Total depreciation and
amortization $ 1,276.2 $ 1,216.2 $ 1,207.8
(1) Includes expense due to Impairment and other charges (credits), net of $39.3 million
related to the Company’s share of restaurant closing costs in McDonald’s Japan (a
50%-owned affiliate).
(2) Includes income due to Impairment and other charges (credits), net of $21.0 million
related to the resolution of certain liabilities retained in connection with the 2007
Latin America developmental license transaction.
(3) Includes income due to Impairment and other charges (credits), net of $65.2 million
primarily related to the resolution of certain liabilities retained in connection with the
2007 Latin America developmental license transaction.
Total long-lived assets, primarily property and equipment,
were (in millions) – Consolidated: 2010–$26,700.9; 2009–
$25,896.1; 2008–$24,385.8;. U.S. based: 2010–$10,430.2;
2009–$10,376.4; 2008–$10,389.7.
38 McDonald’s Corporation Annual Report 2010
Debt Financing
LINE OF CREDIT AGREEMENTS
At December 31, 2010, the Company had a $1.3 billion line of
credit agreement expiring in March 2012 with fees of 0.05% per
annum on the total commitment, which remained unused. Fees
and interest rates on this line are based on the Company’s long-
term credit rating assigned by Moody’s and Standard & Poor’s. In
addition, the Company including certain subsidiaries outside the
U.S. had unused lines of credit totaling $952.0 million at
December 31, 2010; these lines of credit were primarily
uncommitted, short-term and denominated in various currencies
at local market rates of interest.
The weighted-average interest rate of short-term borrowings
was 4.3% at December 31, 2010 (based on $595.0 million of
foreign currency bank line borrowings) and 4.1% at
December 31, 2009 (based on $598.7 million of foreign cur-
rency bank line borrowings).
DEBT OBLIGATIONS
The Company has incurred debt obligations principally through
public and private offerings and bank loans. There are no provi-
sions in the Company’s debt obligations that would accelerate
repayment of debt as a result of a change in credit ratings or a
material adverse change in the Company’s business. Certain of
the Company’s debt obligations contain cross-acceleration provi-
sions, and restrictions on Company and subsidiary mortgages
and the long-term debt of certain subsidiaries. Under certain
agreements, the Company has the option to retire debt prior to
maturity, either at par or at a premium over par. The Company has
no current plans to retire a significant amount of its debt prior to
maturity.
ESOP LOANS
Borrowings related to the leveraged Employee Stock Ownership
Plan (ESOP) at December 31, 2010, which include $47.7 million
of loans from the Company to the ESOP, are reflected as debt
with a corresponding reduction of shareholders’ equity (additional
paid-in capital included a balance of $41.7 million and $48.4 mil-
lion at December 31, 2010 and 2009, respectively). The ESOP is
repaying the loans and interest through 2018 using Company
contributions and dividends from its McDonald’s common stock
holdings. As the principal amount of the borrowings is repaid, the
debt and the unearned ESOP compensation (additional paid-in
capital) are reduced.
The following table summarizes the Company’s debt obligations. (Interest rates and debt amounts reflected in the table include the
effects of interest rate exchange agreements.)
Interest rates(1)
December 31
Amounts outstanding
December 31
In millions of U.S. Dollars
Maturity
dates 2010 2009 2010 2009
Fixed 5.4% 5.6% $ 5,318.0 $ 4,677.6
Floating 3.0 2.9 1,390.0 1,300.0
Total U.S. Dollars 2011-2040 6,708.0 5,977.6
Fixed 4.8 4.8 737.5 932.6
Floating 2.2 1.8 753.4 683.9
Total Euro 2011-2017 1,490.9 1,616.5
Total British Pounds Sterling-Fixed 2020-2032 6.0 6.0 700.7 726.2
Fixed 2.1 2.0 338.7 488.6
Floating 0.5 1.0 985.4 537.0
Total Japanese Yen 2011-2030 1,324.1 1,025.6
Fixed 2.5 2.7 451.6 359.6
Floating 4.1 3.8 752.6 793.3
Total other currencies(2) 2011-2021 1,204.2 1,152.9
Debt obligations before fair value adjustments(3) 11,427.9 10,498.8
Fair value adjustments(4) 77.4 79.6
Total debt obligations(5) $11,505.3 $10,578.4
(1) Weighted-average effective rate, computed on a semi-annual basis.
(2) Primarily consists of Swiss Francs, Chinese Renminbi and Korean Won.
(3) Aggregate maturities for 2010 debt balances, before fair value adjustments, were as follows (in millions): 2011–$8.3; 2012–$2,212.4; 2013–$1,006.4; 2014-$707.9; 2015-
$675.2; Thereafter–$6,817.7. These amounts include a reclassification of short-term obligations totaling $1.2 billion to long-term obligations as they are supported by a long-term line
of credit agreement expiring in March 2012.
(4) The carrying value of underlying items in fair value hedges, in this case debt obligations, are adjusted for fair value changes to the extent they are attributable to the risk designated as
being hedged. The related hedging instrument is also recorded at fair value in prepaid expenses and other current assets, miscellaneous other assets or other long-term liabilities. A por-
tion ($5.1 million) of the adjustments at December 31, 2010 related to interest rate exchange agreements that were terminated in December 2002 and will amortize as a reduction of
interest expense over the remaining life of the debt.
(5) Includes notes payable, current maturities of long-term debt and long-term debt included on the Consolidated balance sheet. The increase in debt obligations from December 31, 2009
to December 31, 2010 was primarily due to (in millions): net issuances ($787.4) and changes in exchange rates on foreign currency denominated debt ($140.1).
McDonald’s Corporation Annual Report 2010 39
Share-based Compensation
The Company maintains a share-based compensation plan which authorizes the granting of various equity-based incentives including
stock options and restricted stock units (RSUs) to employees and nonemployee directors. The number of shares of common stock
reserved for issuance under the plans was 70.9 million at December 31, 2010, including 31.2 million available for future grants.
STOCK OPTIONS
Stock options to purchase common stock are granted with an exercise price equal to the closing market price of the Company’s stock on
the date of grant. Substantially all of the options become exercisable in four equal installments, beginning a year from the date of the
grant, and generally expire 10 years from the grant date. Options granted between May 1, 1999 and December 31, 2000 (approximately
5.8 million options outstanding at December 31, 2010) expire 13 years from the date of grant.
Intrinsic value for stock options is defined as the difference between the current market value of the Company’s stock and the
exercise price. During 2010, 2009 and 2008, the total intrinsic value of stock options exercised was $500.8 million, $302.5 million and
$549.5 million, respectively. Cash received from stock options exercised during 2010 was $463.1 million and the actual tax benefit real-
ized for tax deductions from stock options exercised totaled $139.0 million. The Company uses treasury shares purchased under the
Company’s share repurchase program to satisfy share-based exercises.
A summary of the status of the Company’s stock option grants as of December 31, 2010, 2009 and 2008, and changes during the
years then ended, is presented in the following table:
2010 2009 2008
Options
Shares in
millions
Weighted-
average
exercise
price
Weighted-
average
remaining
contractual
life in years
Aggregate
intrinsic
value in
millions
Shares in
millions
Weighted-
average
exercise
price
Shares in
millions
Weighted-
average
exercise
price
Outstanding at beginning of year 47.8 $38.16 53.4 $34.88 67.5 $31.85
Granted 4.5 63.26 5.6 56.94 5.3 56.55
Exercised (13.6) 33.84 (10.7) 31.17 (18.7) 29.97
Forfeited/expired (1.3) 46.03 (0.5) 47.22 (0.7) 37.53
Outstanding at end of year 37.4 $42.47 5.1 $1,281.8 47.8 $38.16 53.4 $34.88
Exercisable at end of year 26.4 $35.88 3.8 $1,077.3 35.4 40.8
RSUs
RSUs generally vest 100% on the third anniversary of the grant and are payable in either shares of McDonald’s common stock or cash,
at the Company’s discretion. Certain executives have been awarded RSUs that vest based on Company performance. The fair value of
each RSU granted is equal to the market price of the Company’s stock at date of grant less the present value of expected dividends over
the vesting period.
A summary of the Company’s RSU activity during the years ended December 31, 2010, 2009 and 2008 is presented in the following
table:
2010 2009 2008
RSUs
Shares in
millions
Weighted-
average
grant date
fair value
Shares in
millions
Weighted-
average
grant date
fair value
Shares in
millions
Weighted-
average
grant date
fair value
Nonvested at beginning of year 2.8 $46.33 3.0 $40.88 3.4 $35.94
Granted 0.7 56.09 0.9 50.34 0.8 51.10
Vested (1.1) 42.08 (1.0) 34.56 (1.1) 30.38
Forfeited (0.1) 49.61 (0.1) 43.87 (0.1) 40.41
Nonvested at end of year 2.3 $51.17 2.8 $46.33 3.0 $40.88
The Company realized tax deductions of $7.1 million from RSUs vested during 2010. The total fair value of RSUs vested during
2010, 2009 and 2008 was $66.8 million, $59.9 million and $56.4 million, respectively.
40 McDonald’s Corporation Annual Report 2010
Employee Benefit Plans
The Company’s Profit Sharing and Savings Plan for U.S.-based
employees includes a 401(k) feature, an ESOP feature, and a
discretionary employer profit sharing match. The 401(k) feature
allows participants to make pretax contributions that are partly
matched from shares released under the ESOP. The Profit Shar-
ing and Savings Plan also provides for a discretionary employer
profit sharing match after the end of the year for those partic-
ipants eligible to share in the match who have contributed to the
401(k) feature.
All current account balances and future contributions and
related earnings can be invested in several investment alter-
natives as well as McDonald’s common stock in accordance with
each participant’s elections. Participants’ future contributions to
the 401(k) feature and the discretionary employer matching
contribution feature are limited to 20% investment in McDonald’s
common stock. Participants may choose to make separate
investment choices for current account balances and for future
contributions.
The Company also maintains certain supplemental benefit
plans that allow participants to (i) make tax-deferred contributions
and (ii) receive Company-provided allocations that cannot be
made under the Profit Sharing and Savings Plan because of
Internal Revenue Service limitations. The investment alternatives
and returns are based on certain market-rate investment alter-
natives under the Profit Sharing and Savings Plan. Total liabilities
were $439.3 million at December 31, 2010, and $397.3 million at
December 31, 2009, and were primarily included in other long-
term liabilities on the Consolidated balance sheet.
The Company has entered into derivative contracts to hedge
market-driven changes in certain of the liabilities. At
December 31, 2010, derivatives with a fair value of $104.4 mil-
lion indexed to the Company’s stock were included in prepaid
expenses and other current assets and an investment totaling
$92.7 million indexed to certain market indices was included in
miscellaneous other assets on the Consolidated balance sheet.
All changes in liabilities for these nonqualified plans and in the
fair value of the derivatives are recorded in selling, general &
administrative expenses. Changes in fair value of the derivatives
indexed to the Company’s stock are recorded in the income
statement because the contracts provide the counterparty with a
choice to settle in cash or shares.
Total U.S. costs for the Profit Sharing and Savings Plan,
including nonqualified benefits and related hedging activities,
were (in millions): 2010–$51.4; 2009–$51.3; 2008–$61.2.
Certain subsidiaries outside the U.S. also offer profit sharing,
stock purchase or other similar benefit plans. Total plan costs
outside the U.S. were (in millions): 2010–$57.6; 2009–$45.2;
2008–$55.4.
The total combined liabilities for international retirement plans
were $153.2 million and $183.7 million at December 31, 2010
and 2009, respectively, primarily in the U.K. and Canada.
Other postretirement benefits and post-employment benefits
were immaterial.
McDonald’s Corporation Annual Report 2010 41
Quarterly Results (Unaudited)
Quarters ended
December 31
Quarters ended
September 30
Quarters ended
June 30
Quarters ended
March 31
In millions, except per share data 2010 2009 2010 2009 2010 2009 2010 2009
Revenues
Sales by Company-operated
restaurants $4,170.2 $4,030.0 $4,246.6 $4,093.6 $4,013.4 $3,850.2 $3,803.1 $3,484.7
Revenues from franchised
restaurants 2,043.9 1,943.4 2,058.3 1,953.1 1,932.1 1,797.0 1,807.0 1,592.7
Total revenues 6,214.1 5,973.4 6,304.9 6,046.7 5,945.5 5,647.2 5,610.1 5,077.4
Company-operated margin 790.4 758.4 892.6 793.8 798.6 690.9 692.2 564.2
Franchised margin 1,684.1 1,595.0 1,713.9 1,614.5 1,597.8 1,479.0 1,467.7 1,296.0
Operating income 1,857.2(1) 1,826.3(1) 2,096.5 1,932.8 1,845.3 1,681.5 1,674.1(3) 1,400.4
Net income $1,242.3(1) $1,216.8(1) $1,388.4 $1,261.0 $1,225.8 $1,093.7(2) $1,089.8(3) $ 979.5(4)
Earnings per common
share—basic: $ 1.18(1) $ 1.13(1) $ 1.31 $ 1.16 $ 1.14 $ 1.00(2) $ 1.01(3) $ 0.88(4)
Earnings per common
share—diluted: $ 1.16(1) $ 1.11(1) $ 1.29 $ 1.15 $ 1.13 $ 0.98(2) $ 1.00(3) $ 0.87(4)
Dividends declared per
common share $ 1.16(5) $ 1.05(6) $ 0.55 $ 0.50 $ 0.55 $ 0.50
Weighted-average
common shares—basic 1,055.0 1,078.0 1,061.0 1,084.5 1,072.1 1,097.3 1,076.0 1,109.6
Weighted-average
common shares—
diluted 1,068.8 1,093.1 1,074.9 1,098.2 1,085.9 1,111.4 1,090.1 1,124.4
Market price per common
share:
High $ 80.94 $ 64.75 $ 76.26 $ 59.59 $ 71.84 $ 61.01 $ 67.49 $ 64.46
Low 74.40 56.03 65.31 53.88 65.55 51.76 61.06 50.44
Close 76.76 62.44 74.51 57.07 65.87 57.49 66.72 54.57
(1) Includes net pretax income due to Impairment and other charges (credits), net of $12.1 million ($14.4 million after tax or $0.01 per share) in 2010 and $62.0 million ($89.6 million
after tax or $0.08 per share) in 2009 primarily related to the resolution of certain liabilities retained in connection with the 2007 Latin America developmental license transaction.
(2) Includes income of $11.1 million ($0.01 per share) in Gain on sale of investment related to the sale of the Company’s minority ownership interest in Redbox Automated Retail, LLC.
(3) Includes net pretax and after tax expense due to Impairment and other charges (credits), net of $30.0 million ($0.03 per share) related to the Company’s share of restaurant closing
costs in McDonald’s Japan (a 50%-owned affiliate).
(4) Includes income of $47.4 million ($0.04 per share) in Gain on sale of investment due to the sale of the Company’s minority ownership interest in Redbox Automated Retail, LLC.
(5) Includes a $0.55 per share dividend declared and paid in third quarter and a $0.61 per share dividend declared in third quarter and paid in fourth quarter.
(6) Includes a $0.50 per share dividend declared and paid in third quarter and a $0.55 per share dividend declared in third quarter and paid in fourth quarter.
42 McDonald’s Corporation Annual Report 2010
Management’s Assessment of Internal Control Over Financial Reporting
The financial statements were prepared by management, which is responsible for their integrity and objectivity and for establishing and
maintaining adequate internal controls over financial reporting.
The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
The Company’s internal control over financial reporting includes those policies and procedures that:
I. pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of
the assets of the Company;
II. provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made
only in accordance with authorizations of management and directors of the Company; and
III. provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the
Company’s assets that could have a material effect on the financial statements.
There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurances with respect to financial
statement preparation. Further, because of changes in conditions, the effectiveness of internal controls may vary over time.
Management assessed the design and effectiveness of the Company’s internal control over financial reporting as of December 31, 2010.
In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”) in Internal Control – Integrated Framework.
Based on management’s assessment using those criteria, as of December 31, 2010, management believes that the Company’s internal
control over financial reporting is effective.
Ernst & Young, LLP, independent registered public accounting firm, has audited the financial statements of the Company for the fiscal
years ended December 31, 2010, 2009 and 2008 and the Company’s internal control over financial reporting as of December 31, 2010.
Their reports are presented on the following pages. The independent registered public accountants and internal auditors advise
management of the results of their audits, and make recommendations to improve the system of internal controls. Management evaluates
the audit recommendations and takes appropriate action.
McDONALD’S CORPORATION
February 25, 2011
McDonald’s Corporation Annual Report 2010 43
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
McDonald’s Corporation
We have audited the accompanying consolidated balance sheets of McDonald’s Corporation as of December 31, 2010 and 2009, and
the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended
December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of
McDonald’s Corporation at December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of
the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), McDonald’s
Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated
February 25, 2011 expressed an unqualified opinion thereon.
ERNST & YOUNG LLP
Chicago, Illinois
February 25, 2011
44 McDonald’s Corporation Annual Report 2010
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial
Reporting
The Board of Directors and Shareholders of McDonald’s Corporation
We have audited McDonald’s Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria estab-
lished in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). McDonald’s Corporation’s management is responsible for maintaining effective internal control over financial report-
ing, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying report on
Management’s Assessment of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over finan-
cial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the main-
tenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accord-
ance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding pre-
vention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on
the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, McDonald’s Corporation maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2010, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the con-
solidated financial statements of McDonald’s Corporation as of December 31, 2010 and 2009 and for each of the three years in the
period ended December 31, 2010, and our report dated February 25, 2011 expressed an unqualified opinion thereon.
ERNST & YOUNG LLP
Chicago, Illinois
February 25, 2011
McDonald’s Corporation Annual Report 2010 45
Executive Management & Business
Unit Officers
Michael Andres
U.S. Division President (Central)
Jose Armario*
Group President – Canada & Latin America
Peter Bensen*
Corporate EVP and Chief Financial Officer
Stephen Easterbrook*
President – McDonald’s Europe
Timothy Fenton*
President – McDonald’s APMEA
Janice Fields*
President – McDonald’s USA
Richard Floersch*
Corporate EVP and Chief Human Resources Officer
Douglas Goare*
Corporate EVP – Global Supply Chain and Development
James Johannesen
U.S. EVP and Chief Operations Officer
Khamzat Khasbulatov
Europe SVP and Division President Eastern Europe
Karen King
U.S. Division President (East)
Bane Knezevic
Europe SVP and Division President Western Europe
Gillian McDonald
Europe SVP and Division President Northern Europe
David Murphy
APMEA SVP and Division President Pacific/Africa/Singapore/
Malaysia/Korea
Kevin Newell*
Corporate EVP and Chief Brand Officer
Kevin Ozan*
Corporate SVP – Controller
Jean-Pierre Petit
Europe EVP and Division President Southern Europe
Steven Plotkin
U.S. Division President (West)
Peter Rodwell
APMEA SVP and Division President Greater Asia & Middle East
Gloria Santona*
Corporate EVP – General Counsel & Secretary
James Skinner*
Vice Chairman & Chief Executive Officer
Jeffrey Stratton*
Corporate EVP – Chief Restaurant Officer
Donald Thompson*
President and Chief Operating Officer
*Executive Officer
46 McDonald’s Corporation Annual Report 2010
Board of Directors
Susan E. Arnold2, 3
Former President – Global Business Units
The Procter & Gamble Company
Robert A. Eckert2, 4, 6
Chairman and Chief Executive Officer
Mattel, Inc.
Enrique Hernandez, Jr.1, 4, 6
President and Chief Executive Officer
Inter-Con Security Systems, Inc.
Jeanne P. Jackson5, 6
President of Direct to Consumer
NIKE, Inc.
Richard H. Lenny2, 5
Operating Partner
Friedman, Fleischer & Lowe, LLC
Walter E. Massey1, 3
President
School of the Art Institute of Chicago
Andrew J. McKenna4, 6
Chairman of the Board
McDonald’s Corporation
Chairman of the Board
Schwarz Supply Source
Cary D. McMillan1, 5
Chief Executive Officer
True Partners Consulting LLC
Sheila A. Penrose1, 3
Chairman of the Board
Jones Lang LaSalle Incorporated
John W. Rogers, Jr.2, 3, 5
Chairman and Chief Executive Officer
Ariel Investments, LLC
James A. Skinner4
Vice Chairman and Chief Executive Officer
McDonald’s Corporation
Roger W. Stone1, 5, 6
Chairman and Chief Executive Officer
KapStone Paper and Packaging Corporation
Donald Thompson
President and Chief Operating Officer
McDonald’s Corporation
Miles D. White2, 6
Chairman and Chief Executive Officer
Abbott Laboratories
1. Audit Committee
2. Compensation Committee
3. Corporate Responsibility Committee
4. Executive Committee
5. Finance Committee
6. Governance Committee
McDonald’s Corporation Annual Report 2010 47
Investor Information
Common stock
Ticker Symbol: MCD
Stock exchange listing: New York
The number of shareholders of record and beneficial owners of
the Company’s common stock as of January 31, 2011, was
estimated to be 1,348,000.
McDonald’s home office
McDonald’s Corporation
One McDonald’s Plaza
Oak Brook, IL 60523
1.630.623.3000
Annual meeting
May 19, 2011
9:00 a.m. Central Time
McDonald’s Office Campus
Oak Brook, IL 60523
McDonald’s online
Investor information
www.investor.mcdonalds.com
Corporate governance
www.governance.mcdonalds.com
Corporate social responsibility
www.crmcdonalds.com
General information
www.aboutmcdonalds.com
Key phone numbers
Shareholder Services
1.630.623.7428
MCDirect Shares (direct stock purchase plan)
1.800.228.9623
U.S. customer comments/inquiries
1.800.244.6227
Financial media
1.630.623.3678
Franchising
1.630.623.6196
Shareholder account information
Stock transfer agent, registrar and MCDirect Shares
administrator
Computershare
c/o McDonald’s Shareholder Services
P.O. Box 43078
Providence, RI 02940-3078
www.computershare.com/mcdonalds
U.S. and Canada: 1.800.621.7825
International: 1.312.360.5129
TDD (hearing impaired): 1.312.588.4110
Trademarks
All trademarks used herein are the property of their respective
owners and are used with permission.
Available information
Copies of Certifications dated February 25, 2011 of the Compa-
ny’s Chief Executive Officer, James A. Skinner, and Chief
Financial Officer, Peter J. Bensen, pursuant to Rule 13a-14(a) of
the Securities Exchange Act of 1934, are attached as Exhibits
31.1 and 31.2, respectively, to the Company’s Annual Report on
Form 10-K for the fiscal year ended December 31, 2010.
Shareholders may obtain a copy of these certifications and/or a
complete copy of the Company’s Annual Report on Form 10-K
by following the instructions below.
McDonald’s Annual Report on Form 10-K
The financial information included in this report was excerpted
from the Company’s Annual Report on Form 10-K for the period
ended December 31, 2010, filed with the Securities and
Exchange Commission (SEC) on February 25, 2011, and speaks
as of February 25, 2011. Shareholders may access a complete
copy of the 10-K online at www.investor.mcdonalds.com or
www.sec.gov. Shareholders may also request a paper copy at no
charge by calling 1-800-228-9623 or writing to McDonald’s
Corporation, Shareholder Services, Department 720,
One McDonald’s Plaza, Oak Brook, Illinois 60523.
The information in this report is as of March 11, 2011 unless
otherwise indicated.
Reproduction of photography and/or text in whole or in part
without permission is prohibited.
©2011 McDonald’s
Printed in the U.S.A.
MCD11-4644
Design: VSA Partners, Inc., Chicago
Printing: R.R. Donnelley
The Annual Report is printed on paper certified to the standards
of the Forest Stewardship Council™ (FSC®) and includes post-
consumer fiber. The FSC trademark identifies products which
contain fiber from well-managed forests certified in accordance
with FSC standards.
2010 Highlights:
Global
Comparable Sales
Growth
5.0%
Earnings
Per Share
Growth
11%
Average Number of
Customers Served
Every Day
64 Million
2010 Annual Report
McDonald’s Corporation
One McDonald’s Plaza
Oak Brook, IL 60523
www.aboutmcdonalds.com
2010 Financial Report
Table of Contents
6-Year Summary
Stock performance graph
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Consolidated Statement of Income
Consolidated Balance Sheet
Consolidated Statement of Cash Flows
Consolidated Statement of Shareholders’ Equity
Notes to Consolidated Financial Statements
Quarterly Results (Unaudited)
Management’s Assessment of Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
Executive Management & Business Unit Officers
Board Of Directors
Investor Information
Back Cover
Appendix 1
Final Project Overview and Timeline
Final Project Overview
The final project for XACC 280 is a 1,750 to 2,050-word (about 3 pages, double spaced) paper in which you provide a comprehensive analysis of the financial health of McDonald’s Corporation and whether or not you would invest in McDonald’s Corporation based on the information provided for 2009 and 2010 in their 2010 Annual Financial Report. The paper, with in-text citations and references, must follow APA formatting guidelines. NOTE: The word count does NOT include the charts and calculations at the end of your paper.
Papers need to include: a cover page, section titles, in-text citations, reference page. Your papers should also be edited to remove spelling errors/word errors (using defiantly instead of definitely for example), paragraph breaks (not one long paragraph), double-spaced, good sentence structure and clearly stated and well supported (with sources) points.
The final project is designed so you can apply the concepts and skills learned in this course to a real-life financial accounting analysis. It incorporates your foundational knowledge—resulting from completion of Discussion questions, Check Points, Exercises, and Assignments—into a paper that describes your financial analyses and conclusion. When navigating each week, keep your final project in mind to help you to prepare and gather needed information.
The paper will include the following (do NOT include calculations within the paper, only the results should be stated and discussed). All calculations should be formatted and included after the concluding paragraph (see below):
Before you begin writing, complete and review all of your calculations first since you will need the results to include in the writing of your paper.
· An introductory paragraph with:
· A statement of the purpose of your paper.
· A synopsis of what readers can expect to find in the paper. It is best to write this after writing the rest of the paper.
· Your explanation of your calculated results in words of at least
two
Vertical analyses for McDonald’s Corporation.
· Your explanation in words of at least
two
Horizontal analyses for McDonald’s Corporation.
· Your explanation in words of at least two of each of the Ratio analyses for McDonald’s Corporation, including a test of:
· Explain in words your calculated results of the
two
ratio tests of Liquidity.
· Explain in words your calculated results of the
two
ratio tests of Solvency.
· Explain in words your calculated results of the
two
ratio tests of Profitability.
· NOTE: ONLY USE THE RATIOS PROVIDED IN OUR TEXT (pg 716 – Illustration 15-27), NOT AS A RESULT OF GOOGLE SEARCHES.
· Describe and clearly explain at least
two
strengths in different areas for McDonald’s Corporation other than using the revenue or net income information.
· Incorporate the data and other information you used to determine each area of strength.
· Describe and clearly explain at least
two
areas of improvement that McDonald’s Corporation should make to improve its financial health. There can be other nonfinancial areas that fast food stores can improve, but be sure to clearly link these areas to how they would improve McDonald’s financial health.
· Incorporate the data and other information you used to determine each area of improvement.
· If you had money to invest in a company, describe whether or not you would invest in McDonald’s Corporation stock and clearly explain your reasons. State at least
two
reasons (different from your list of strengths above). Support those reasons with factual information and include the source(s). Your opinion is important, but your opinion should be supported with factual information either from the Annual Report, articles about McDonald’s Corporation or even comparative data from another fast food chain (include the source). (Resist the urge to say you would not invest because you would use the money for something else or that you do not understand investing). All responses must be in the context of McDonald’s financial position in order to earn credit.)
· A concluding paragraph that summarizes your paper. This should be a separate paragraph at the end of your paper.
· After your conclusion in a separate section, include your calculations for all of the analyses and ratios.
· Vertical – You can use your calculations from the Week 7 Check Point, providing you show your work.
· Horizontal – You can use your calculations from the Week 7 Check Point, providing you show your work.
· Liquidity – You can use the Current Ratios you computed in the Week 7 Check Point and select another ratio from that section on pg 716. Show your work.
· Solvency – Use the two ratios on pg 716 in that section and show your work.
· Profitability – Use at least two ratios from that section on pg 716 and show your work.
· After your calculations, then include the list of your references.
Final Project Timeline
You should budget your time wisely and work on your project throughout the course. As outlined below, you will receive the information in the course to assist you in creating your final project. If you fulfill the requirements of the course activities (including reading the chapters, asking questions, practicing, participating in discussion and completing the assigned work) and use the feedback provided by the instructor, you will be on the right track to successfully complete your project.
· Suggested in Week One: After you complete the chapter reading for Week 1, you will have some notions about what each of the four financial statements can tell you about a company. Although not part of the assignments for this week, you can look at the McDonald’s Corporation 2010 Annual report (in the link at the bottom of this page) to identify the financial statements. List for yourself the page numbers and information you think might be important to your analysis later on.
· Suggested in Week Six: After you view the two PhxKlips™ Financial Statements and Income Statements for the Exercise, reexamine the 2010 Annual Report for McDonald’s Corporation to locate the financial statements that provide data for your analysis in the final project. Add this to your notes from Week One.
In completing the comprehensive Application in Week Six, you develop financial statements from raw data. Make sure you can trace how data is derived on a financial statement, and its meaning.
· Due in Week Seven: In participating in the discussion and reading the chapters in Week Seven, you select ratios that you think are the most important. You use vertical, horizontal, or ratio analyses to assess the financial health of McDonald’s Corporation. Take notes from the discussions and the chapter reading to prepare you to use the tools of analysis you will employ in the final project. This is a great time to ask questions about the ratios and analysis so that you understand the meaning behind the numbers you calculate because this will be included in your paper.
The Check Point in Week Seven requires that you perform rudimentary vertical, horizontal and one of the ratio analyses on McDonald’s Corporation, the company you will analyze in your final project. You can use the ratios you develop here as the basis for your financial analysis in the project in addition to including the others that are required. You can select additional data you would analyze. It is suggested that you begin the analyses for the final project now.
· Suggested in Week Eight: Continue working through the analyses you started in Week Seven and begin to finalize the rest of the required ratios on solvency and profitability and the second one for liquidity. Make sure you know where to get the numbers for your ratios from the annual report and that you understand what format the answers need to be shown.
· Due in Week Nine: Submit your final project. Submit one Word file with the calculations included, keeping in mind that the word count does NOT include the calculations.
Link to McDonald’s Corporation 2010 Annual Report
http://www.aboutmcdonalds.com/content/dam/AboutMcDonalds/Investors/C-%5Cfakepath%5Cinvestors-2010-annual-report
You can also access by doing the following:
Go to
www.mcdonalds.com
Go to Our Story, then to Corporate Information, then to Investors, then to Annual Reports
Click on the link for the 2010 Annual Report
XACC 280
