The course builds on my Introduction to Financial Accounting course, which you should complete first. In this course, you will learn how to read, understand, and analyze most of the information provided by companies in their financial statements. These skills will help you make more informed decisions using financial information.
Video 6.6: 3M Company: Long-lived Assets & Marketable Securities
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Financial Accounting, Financial Statement, Accounting, Generally Accepted Accounting Principles, Accounting Terminology
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Jan 30, 2019
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From the lesson
Week 6: Long-lived Assets and Marketable Securities
This week, we will cover assets that represent longer-term investments. We will start with Property, Plant, and Equipment, covering questions like: What gets included in these accounts? How are they depreciated? What happens if their value is impaired? Then, we will cover similar questions for Intangible Assets, including Goodwill. Finally, we will discuss how companies account for investments in debt and equity securities and how the treatment for equity investments in other companies is determined by how much of the other company is owned.
Taught By
Brian J Bushee
The Geoffrey T. Boisi Professor
Hello I'm Professor Brian Bucher, welcome back.
Now it's time for our weekly look at the 3M company financial statement.
We did a lot of material this week, so it's going to be a fairly long video.
We have to look at property plan equipment, goodwill and intangibles, and
markable securities.
So sit back, relax, and enjoy the video.
Okay, we're going to start on the balance sheet on page 48, and
we're basically going to walk through this three times.
Once with PP&E, once with goodwill and intangibles, and
then the last time with markable securities.
So here is the disclosure for PP&E, and we see the typical treatment where they give
the original cost, less the accumulated appreciation, and then the net book value.
One thing that lept out at me was the ratio of accumulated depreciation to
the original cost.
It looks like it's about 64%.
Now, I didn't know that by looking, of course I calculated it in [LAUGH] advance,
[SOUND] but almost two thirds of the original cost is depreciated,
which makes it seem like 3M's equipment is fair, fairly on the old side.
Where there's a lot of it that's been depreciated.
And so one of things we'll want to look for
is are they investing a lot in new CAPEX?
And this is what we can see from the balance sheet.
Now we're going to flip ahead to the Cash Flow statement.
So that's on page 51.
And of course we always find our depreciation and
amortization in the operating section, because we have to add it back.
It's part of net income, it's non-cash so we add it back.
Now this is 1,288, now it's depreciation and amortization, so
we don't have a good feel yet for how much is depreciation versus amortization.
We'll have to dig into the footnotes more to find that.
But one of the things that we, we did was compare the depreciation
to the new capital expenditures which are down here in cash from investing.
So we've got purchase of property, plant and equipment.
And as we can see, the CAPEX, the property, purchase of property, plant and
equipment, are actually larger than depreciation and amortization and
that includes amortization.
So, it's interesting because 3M is actually investing more in
CAPEX than they're depreciating,
which is a sign that they're still building their equipment base.
They're still investing in CAPEX, so that's sort of a puzzle with
the accumulated depreciation that we saw before.
But, but anyway it does seem like they're still trying to grow their capital base.
There's also proceeds from sale of PP&E and other assets, 41.
So it's clear that 3M just does not sell much of its property, plant and equipment.
They must sort of use it up and then either scrap it or I just [LAUGH] or
just keep because it doesn't seem like they're selling much of it.
Their proceeds are very small compared to their CAPEX.
In the next place that we want to look is the Footnote one.
Summary of Significant Accounting Policies to see what they say about their PP&E.
So if we go to page 53.
They have a paragraph on PP&E.
So PP&E includes capitalized interests, so as we saw earlier,
if you incur interest costs by building your own equipment or your own factories,
you get to put that interest cost as part of PP&E as opposed to an expense.
They say depreciation is generally computed using straight line method,
which is common for almost all companies.
Estimated useful lies of buildings ranged from tw, ten to 40 years, majority in,
in the range of 20 to 40 years.
Another example of one of these fairly useless disclosures [LAUGH] that's a big
range to look at, it's hard to see whether there's any meaningful changes that
they've done over time because you can change this a lot and
still be within this range of 20 to 40 years.
Machinery and equipment ten three to 15 years, again, a big range.
So then they say fully depreciated assets are retained in PP&E until disposal.
So, this actually may account for
their fairly high level of accumulated depreciation, even though their investing.
So they're still investing a lot, but what's happening is they seem to
be keeping equipment that's fully depreciated on their books.
So the original cost is there and it's offset by a full amount of deprecation and
they're still using it.
Now to me this seems a little not kosher.
If they got to the point where they thought they were going to continue to
use the equipment, they should have extended the useful lives so
that their still having some depreciation expense.
So one thing to keep [LAUGH] in mind about 3M, is when we look at this depreciation,
it's really understated because they're using equipment for
which they're not recognizing depreciation charges anymore, which is probably why
we're seeing depreciation so much lower than their CAPEX.
And seeing such a high accumulated depreciation as
a percent of their original costs.
Then they talk about the impairment procedure.
And one thing that's nice about this footnote is if you
don't know the accounting for something it also, it often explains it to you.
So it talks about when it's reviewed for impairment and they do
it based on this carrying value exceeds estimated undiscounted future cash flows.
And then if there's a loss then it's based on fair value.
But they really don't talk about having to do any impairments during this period.
Then there's one more place that we're going to look at.
I apologize for the flip through the page.
On page 66 we have Footnote four; Supplemental Balance Sheet Information.
Here's where they give you the full breakdown of PP&E at cost.
So we can see land, buildings, machinery and equipment.
Looks like most of their PP&E is machinery and equipment.
Land, and building an improvement is very small.
Which is sort of a puzzle, like how can you have all this machinery and
equipment, when you don't have much land and building?
[LAUGH] But that's a puzzle that we're going to talk about more next week.
Okay, so I'll tip you off on the puzzle now.
What happens is 3M is going to lease a lot of their buildings and
land through operating leases, which keeps them off their balance sheet.
And we'll talk about that more next week.
But overall, it looks like 3M's a company that does seem to
be actively investing in their CAPEX.
But they have this odd situation where they have a lot of
fully depreciated equipment it seems, plus a lot of things is off,
are off balance sheet in this operating leases.
And so as a result, the full cost of using their property plant equipment to
generate revenue is probably understated in their depreciation,
because the fully depreciated, there's no depreciation and
the off balance sheet stuff, there's no depreciation.
Just something to be aware of if we're comparing 3M to another company, it might
be an adjustment we'd have to make to get an apples to apples comparison.
Okay back to the balance sheet now we'll go through and look at Goodwill and
other intangible assets.
So here they are, goodwill is 7.4 billion, wow.
Their goodwill is almost as big as their property, plant and equipment.
So what that indicates is 3M has been doing a lot of
acquisitions to get Goodwill that high.
Because remember Goodwill only comes in acquisitions and
it's this premium of what you pay over the net fair value of all the assets you
can identify, including any intangible assets that are separable or transferable.
And those are about 2 billion.
So what that indicates is that 3M is doing a lot of acquisitions, and they've been
acquiring a lot of things that they can't separate out as other intangible assets,
things like synergies, and
growth opportunities, and human capital and perhaps even overpayment.
So we're going to want to understand this goodwill a little bit more,
given how big it is.
It's about 20% of their total assets.
So, next place we're going to look is the cash flow statement.
So here in cash from investing activities, we can see acquisitions.
Net of cash acquired.
This is where we're going to get those goodwill and other intangible assets.
And 3M does, did about a billion dollars of acquisitions,
which is pretty comparable to what their CAPEX was.
So it's a company that is doing a lot of internal growth, CAPEX, but
they're also doing a lot of external growth, or
buying a lot of other companies and adding to their growth that way.
And this is not just this year, if you look.
You know, back to 2010, their acquisitions were actually greater than their CAPEX,
so, again, we're seeing evidence of this, a company that does a lot of acquisitions.
So let me go to our summary of significant accounting policies and
look for accounting policies related to these.
So here on page 53 is the paragraph on goodwill.
So again, this is a good place to look if you want to remember the definition of
how these things are accounted for.
They start off by saying it's the excess of the cost of the acquired equity, so
the price you pay over the amounts assigned to assets and
liabilities, that were acquired.
Goodwill is not amortized, which we know.
Tested for impairment annually in the fourth quarter, and
they actually talk about how they do it.
So they do it on a reporting unit level.
So that would be things like the healthcare unit or
the consumer products unit.
And what it says is, an impairment law should be recognized when
the carrying value of the reporting unit's net assets exceeds the fair value.
So we'll see this a little bit in the footnote in a second but
you value all these reporting units as if they were individual businesses using
things like multiples of P ratio or just kind of discount of cash flow analysis
[COUGH] Both of which we're not going to talk about here but if you take our.
Intro to Corporate Finance class, on coarse error,
you'll talk about those kind of techniques in that class.
But we'll', we'll talk more about this goodwill impairment task when we look at
the foot note in a second.
Intangible assets, so
here we can find out what they are acquiring in terms of intangibles.
So they're getting patents, trade names,
other intangibles again they have to be acquired from a third party to show up.
If they have an indefinite not, life, like trade names they're not amortized, but
a definite life they're amortized over periods of one to 20 years.
Again, one of these very vague things on a straight line basis.
Again, there's annual impairment tests that there have, have to be for
all long-lived assets.
And again, they talk about the procedure, which is what we've talked about before.
But then they throw in at the end that costs related to internally developed
intangibles, so, they spend money internally to try to get patents,
that's going to show up as R&D expense.
That's not going to show up as an asset.
So that's our distinction between externally acquired through
an acquisition, and
internally developed through R&D spending through an acquisition.
It shows up as an asset.
Internally it shows up as an expense.
Here our next stop is footnote three, which is on page 63.
This gives us goodwill and intangible assets, tells us how much purchase
goodwill we had from acquisitions in 2012, how much we had in 2011.
So remember the total acquisition for 2012 was about a billion.
And about a third of that was goodwill.
So, paying for things like synergies, growth opportunities, human capital,
potentially overpayment.
That Goodwill then gets allocated to business units, and
that's what they show down here.
So here are their different reporting units, industrial and
transportation, health care, consumer and office et cetera.
What you can see is how much goodwill goes in to each unit, and
then the balance at the end of each year, and in a way they were tasked for
impairment, is you would try to value the healthcare segment, so what do you
think the fair value is using a multiple approach to this kind of cash flow,.
Is it, is the value of health care greater than all of the fair value of assets,
[UNKNOWN} the book value of assets in the segment?
If so, you're fine.
If not, then you may have to write down this goodwill piece
that's assigned to health care.
What 3M says is that they did not have any impairment test in 2012,
or in prior years.
So, makes it a little less likely that it's overpayment,
because we haven't seen them have to write down any of this goodwill.
Then we have acquired intangible assets so
these are the other intangibles that get in acquisitions that they can identify.
So they got about 213 million in their 2012 acquisitions.
So about half of what they acquired, of their 1 billion, is good will and
intangible assets.
So, I guess this makes sense for a company that relies on a lot of technology,
that a lot of what they're acquiring is not inventory, and PP&E, but
it's these intangibles.
And then we can see what they have as of December 31st.
So patents about half a billion, but 2.4,
2.5 billion in other intangibles, so these are trade names, customer in and
te, related intangibles, things like, like trade lists.
They actually use an accumulated amortization account instead of doing it
directly at the account.
We can do this comparison we did in class.
Accumulated amortization on patents versus the original cost.
It looks like about 71% of their patents have been used up.
So the patents that they have acquired,
are getting close to the end of their life.
Whereas if we look at the other intangible assets they have, it's only about 34%.
So a lot more value left in those intangibles which I
guess suggest that they haven't been acquiring much patents recently.
Or they've been acquiring patents that have almost been used up.
But they've been getting other intangibles that have much more life left.
Then non amortized intangible assets.
Primarily tradenames.
So these are not amortized because they're longtime established tradenames.
So basically these are trade names that should last forever.
So this is probably Scotch Tape and Post-it Notes.
It's not a huge portion but they do break out how much of this is not amortized.
Then we can see the amortization expense is 233.
Now remember on the cash flow statement, depreciation and
amortization expense was 1288, which means that it was
about a billion dollars of depreciation, and only 233 of amortization.
So most of what we saw in depreciation and
amortization, we can now see, was depreciation expense.
Amortization expense is pretty small.
It's a very small impact on their income statement.
So I've popped back here to 3M's income statement,
because I want to show you one more line item.
This is their research and
development expenditures, which are about $1.6 billion.
So remember this would be the internal spending on new technology trying to
develop patents which of course can not be created as an asset because it wasn't,
there's no market price, it wasn't externally acquired.
And compare this to their acquisition activity where 3M get about a billion.
You can see that 3M is doing much more internal innovation spending
than they are in doing external spending through acquisitions.
But they still a big amounts in both.
So one thing to keep in mind is if you want to get a sense for
a firm's innovative activity, you have to look in two places.
The research and development spending, which is their internal expenditures, and
then their acquisition activity and the intangible assets they get externally, for
the external measure of their innovative activity.
Both are high for 3M, indicating that 3M is still growing and
trying to expand their technology, build new patents, and grow for the future.
Okay, back to the balance sheet for
one more run through with marketable securities.
And what we see here is 3M is marketable securities current and non current.
So we'll have to look into that why they split it into current and non current.
The cur, current is about 1.6 billion, and the non current is about 1.1 billion.
So that's about 2.8 billion total, which is about 8% of their total assets.
Sorry [LAUGH] for the sloppiness there.
So, so 3M actually puts a lot of their assets into marketable security.
So it's a big deal for them.
Let's go ahead to the cash flow statement and see what the year to year impact is.
So if we go to page 51, cash from investing and
we looked at this before when we did 3M with the cash flow statement.
Purchases of marketable securities and investments, 5.5 billion.
So they're buying 5.5 billion marketable securities in 2012.
They bought 4 billion the prior year, and 3 billion the year before that, so
they buy a lot of marketable securities.
But then if you look, they end up selling a lot too.
So they sell 3 billion, so
that's proceeds from sales and then proceeds from maturities.
So these are debt securities, you buy a bond that pays off,
that's about 2 billion.
The net effect is pretty small, it's about 0.4 billion.
So it looks like what 3M is doing is,
their generating as we saw a whopping amount of cash activities.
So post it notes, scotch tape, their just printing money with that.
They take that cash and just plow it into marketable securities until they need it.
Then when they need it for
something like capital expenditures or acquisitions, then they will sell
those marketable securities to be able to do those acquisitions or make those CAPEX.
So, it's almost like 3M is serving as its own bank.
And instead of putting their excess cash flow in a savings account and
getting half a percent of interest, they take that cash flow,
invest it in marketable securities to get a little bit higher return,
then when they need it for acquisitions or CAPEX they sell them or they,
they use ones that matured and then plow the cash flow back into their investments.
Okay, so I'm going to jump ahead to Footnote 8,
Marketable Securities, which is on page 74.
Now I skipped showing you Footnote 1,
the summary of Significant Accounting Policies.
You should always look at that.
What I did though though was I looked at it myself and I saw what they said about
marketable securities in Footnote 1, they also say in this footnote.
So to avoid repetition I'm just jumping ahead, but you should not do that at home.
I'ma, I'm a trained professional.
I can make those kind of calls.
You know, anyway, in Footnote 8, we get the current and non-current marketable
securities, and we can see some of the things they, they buy, so, government
agency securities, those are like Freddie Mac, Fannie Mae, Sally Mae securities.
Foreign governments, Corporate debt.
That's one of their biggest categories.
So those are bonds issued by other company.
Commercial paper, that's very short-term.
Debt, treasury securities, those are T-Bills T-Bonds.
Asset-backed securities, these are the things created by securitizations.
One of their biggest categories is auto loan related.
So General Motors or Ford sells cars, or I guess more realistically Toyota or
Honda sells cars and they finance the cars and they're basically selling those
receivables off to companies like 3M to provide the financing.
So that gives us our short term.
When we look at the long term,
we see sort of the same mix, but there's not equity securities here at all.
So they're not investing in the stocks for
the companies, just in these debt securities.
So they say the current non-current determination is based on
intended holding period.
The maturity date and liquidity considerations.
And I bet a lot of it is the maturity date, these are probably securities that
mature within the next year, and these are probably beyond the next year.
They say that gross unrealized losses are about 6 million, but
gross unrealized gains are about 3 million.
So, that six and three million compared to 20 point billion total?
So these unrealized gains and losses are almost nothing.
And that makes sense because with debt securities, you just don't have as
much unrealized gain and losses as stock price, stock prices, stock securities.
There's much more volatility in those.
For debt securities, especially short term ones, the only change in
fair value is going to be if there're big changes in interest rates, and
there really haven't been big changes in interest rates recently.
They say gross realized gains and losses are not material,
not material doesn't mean zero, it just means very small.
And that sort to make sense because if there's very little unrealized gains and
losses sitting there, these things really aren't changing value that much, and
so were not getting much realized gains or losses.
Then they talk about impairment charges for marketable securities.
So they note somewhere here that they carry these.
Here it is. So these are all available for sale.
So there's no held maturity.
There's no trading securities.
With available sale we mark them to fair value on the balance sheet.
The unrealized gains and
losses go into ALCI, which is what they say here, Other Comprehensive Income.
The only exception, and I'll talk about this briefly because it's
a little advanced, is if it's other than temporary, now normal human beings would
call other than temporary permanent, but accountants call it other than temporary.
So what this says is if you have an unrealized loss and
you think it's permanent, you think it's never going to come up in value,
then you have to expense that as opposed to put it into ALCI.
And that actually did not happen at all for
3M, is what they say in this what, part of the footnote.
They give you the maturity schedule.
Most of their maturities are less than three years.
So they tend to buy short term securities, and then they give you a breakdown that
they tend to be fairly high-rated securities, as well.
So what we learn from looking at three m's marketable securities is
that they're fairly conservative in their cash management practices.
They're not ultra conservative, they don't put it all in a savings account,
or under a mattress in their headquarters in Saint Paul.
But they're fairly conservative because they put their excess cash flow in to
short, primarily short term or medium term debt instruments that are fairly low risk.
Get sort of a medium return on those and then they liquid,
they sell those debt securities or
have them mature and plow the cash in to things like acquisitions or CAPX.
So they're not gambling on equity securities.
They're not trying to actively make money trading on the market,
which is good that's not why we buy 3M stock.
But sort of prudently and conservatively investing their excess cash flow so
that it's readily available when they have a project that they want to leap on and
invest in right away.
And that wraps up our look at the asset side of the balance sheet.
Next week we will move over to the liabilities side of the balance sheet.
Take a look at time value of money and long-term liabilities.
I'll see you then.
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