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A problem from the Book: Financial Reporting, Financial Statement Analysis and Valuation

The financial statements of Starbucks Corporation are presented in Exhibits 1.261.28. The income tax note to those financial statements reveals the information regarding income taxes shown in Exhibit 2.18.

REQUIRED

a. Assuming that Starbucks had no significant permanent differences between book income and taxable income, did income before taxes for financial reporting exceed or fall short of taxable income for 2012? Explain.

b. Will the adjustment to net income for deferred taxes to compute cash flow from operations in the statement of cash flows result in an addition or subtraction for 2012?

c. Starbucks rents retail space for its coffee shops. It must recognize rent expense as it uses rental facilities but cannot claim an income tax deduction until it pays cash to the landlord. Suggest the scenario that would give rise to a deferred tax asset instead of a deferred tax liability related to occupancy cost (Accrued occupancy costs).

d. Starbucks recognizes an expense related to retirement benefits as employees rendered services but cannot claim an income tax deduction until it pays cash to a retirement fund. Why do the deferred taxes for deferred compensation appear as a deferred tax asset (Accrued compensation and related costs)? Suggest possible reasons why the deferred tax asset decreased slightly between the end of 2011 and the end of 2012

e. Starbucks reports deferred revenue for sales of store value cards, such as the Starbucks Card and gift certificates. These amounts are taxed when collected, but not recognized in financial reporting income until tendered at a store. Why does the tax effect of deferred revenue appear as a deferred tax asset?

f. Starbucks recognizes a valuation allowance on its deferred tax assets to reflect net operating losses of consolidated foreign subsidiaries. Why might the valuation allowance have increased between 2011 and 2012?

g. Starbucks uses the straight-line depreciation method for financial reporting and accelerated depreciation for income tax reporting. Like most firms, the largest deferred tax liability is for property, plant, and equipment (depreciation). Explain how depreciation leads to a deferred tax liability. Suggest possible reasons why the amount of the deferred tax liability related to depreciation increased between 2011 and 2012.

Reference: Exhibits 1.261.28

Exhibit 2.18 Starbucks Income Tax Disclosures (amounts in millions) (Integrative Case 2.1) For the Year Ended September 30 and October 2, respectively: 2012 2011 Income Tax Expense Current: Federal State Foreign Deferred Total $466.0 79.9 76.8 $674.451.7 $344.7 61.2 37.3 $563.1119.9 As of the Year Ended September 30 and October 2, respectively: 2012 2011 Components of Deferred Tax Assets and Liabilities Deferred tax assets: Property, plant, and equipment Accrued occupancy costs Accrued compensation and related costs Other accrued liabilities Asset retirement obligation asset Deferred revenue Asset impairments Tax credits Stock based compensation Net operating losses Other Total Deferred Tax Assets Valuation allowance Net Deferred Tax Assets Deferred tax liabilities: Property, plant, and equipment Intangible assets and goodwill Other Total Deferred Tax Liabilities Net Deferred Tax Asset $62.7 72.0 66.9 15.7 20.1 43.7 38.5 14.6 131.8 99.2 $646.180.9 $491.9(154.2) $(89.0) (34.0) $324.1$(167.8)(44.8) $46.4 55.9 69.6 27.8 19.0 47.8 60.0 23.0 128.8 85.5 58.6622.4 $485.0(137.4) $(66.4) (25.2) Source: Starbucks Corporation, Form 10-K, for the fiscal year ended September 30, 2012. Exhibit 1.28 Starbucks Corporation Comparative Statements of Cash Flows (amounts in millions) (Integrative Case 1.1) Fiscal Year Ended 30-Sep20122-Oct20113Oct201027Sep2009 OPERATING ACTIVITIES: Net earnings Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization Gain on sale of properties Provision for impairments and asset disposals Deferred income taxes, net Equity in income of investees $1,385$1,248$948$ 392 Distributions of income from equity investees Stock-based compensation Tax benefit from exercise of stock options Excess tax benefit from exercise of stock options Other Cash provided/(used) by changes in operating assets and liabilities: Accounts receivable Inventories Accounts payable Accrued liabilities and insurance services Accrued taxes Deferred revenue Other operating assets Other operating liabilities Prepaid expenses, other current assets and other assets Net cash provided by operating activities INVESTING ACTIVITIES: Purchase of investments \begin{tabular}{rrrr} 581 & 550 & 541 & 563 \\ - & (30) & - & - \\ - & - & - & 224 \\ 61 & 106 & (42) & (70) \\ (61) & (66) & (61) & (78) \\ - & - & - & 53 \\ 154 & 145 & 114 & 2 \\ - & - & - & 2 \\ - & - & - & (16) \\ 24 & 33 & 76 & 5 \\ (90) & (89) & (33) & - \\ (273) & (422) & 123 & 29 \\ 105 & 228 & (4) & (53) \\ 24 & (82) & (19) & - \\ - & - & - & 57 \\ 61 & 36 & 24 & 16 \\ - & - & - & 121 \\ - & - & - & 61 \\ (20) & (23) & 17 & - \\ \cline { 2 - 4 } & $1,612 & $1,705 & $1,389 \end{tabular} Purchase of available-for-sale securities Maturities and calls of investments Maturity of available-for-sale securities Sale of available-for-sale securities Acquisitions, net of cash acquired (1,749) (966) (549) Net purchases of equity, other investments and other assets Additions to property, plant and equipment Cash proceeds from sale of property, plant and equipment Proceeds from sale of property, plant and equipment 1,796 - (129) (56) 210 (129) 2 (16) 5 - 29 (53) 57 16 61

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