1 / 22

Receivables

Receivables. RCJ Chapter 8 (except 405-412). key Issues. How receivables are used to raise cash Recourse vs. non-recourse sales Consequences of different methods on financial statements Role of receivables in earnings management . Allowance Method. Allowance Method (cont’d).

MikeCarlo
Download Presentation

Receivables

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Receivables RCJ Chapter 8 (except 405-412)

  2. key Issues • How receivables are used to raise cash • Recourse vs. non-recourse sales • Consequences of different methods on financial statements • Role of receivables in earnings management Paul Zarowin

  3. Allowance Method Paul Zarowin

  4. Allowance Method (cont’d) ex. C8-1, parts 1, 6, & 7 Paul Zarowin

  5. Using A/R to Raise Cash Sometimes companies have need to accelerate cash collections: • Immediate cash needs • Credit sales: the company is unwilling/unable to bear the cost of processing and collections of credit • Imbalance in the cash cycle: days for payable (to suppliers) is shorter than days for receivables (from customers) • Loan covenants may preclude the company from borrowings In such instances companies can use their A/R to raise cash: • Assignment:Collateralized borrowing (A/R used as collateral) • Factoring:Sale of Receivables Paul Zarowin

  6. Using A/R to Raise Cash: J.E. • Assignment: collateralized borrowing DR Cash DR Finance charge/Interest expense CR Liability • Factoring: sale of receivable DR Cash DR Loss* CR A/R (*) can be gain (CR) if cash > A/R, but unlikely Note: different effects on assets vs. liabilities Paul Zarowin

  7. Recourse vs. Non-Recourse • Is transaction a sale or a borrowing? • Who bears risk of loss? How does this affect price of A/R? The conditions are specified in RCJ, page 400 Paul Zarowin

  8. 3 Possible Cases • Recognize a loss and a contingent liability (disclose in footnote, not on B/S) for the possibility of defaulted receivables. • Recognize interest expense or finance charge and a recognized (on B/S) liability. • Recognize a loss, but no required disclosure (of A/R sale), so can’t distinguish from ordinary collection. • Not allowed. Example: P8-18 Paul Zarowin

  9. Entries for Sale and Borrowing • Why DR AUA for non-recourse sale only? Paul Zarowin

  10. Effect of Cash Receipt on SCF #1 is really collateralized borrowing; cash is recorded as CFO, but should be CFF #2 is actual borrowing, so cash is CFF #3 is acceleration of collection, so cash is CFO (like collection) #1 overstates CFO, understates CFF, understates current liabilities and A/R (no effect on O/E) Paul Zarowin

  11. What is a Holdback? • When the sale or assignment of A/R is with recourse, the factor or borrower usually delays payment of a portion of the amount due – this is called a Holdback. • The factor/borrower uses this held-back amount to cover contingencies, such as sales returns. • The holdback appears as a current asset ‘due from factor’ on the seller’s balance sheet. • If the contingencies do not materialize, the seller gets the money back. Paul Zarowin

  12. Example: Sale (with/without recourse) vs. Borrowing Firm A transfers to a factor $100 of A/R having ADA of $5. The transfer can be treated as sale or a borrowing. • Case 1 -Sale without recourse: the transfer is without recourse, and firm A receives $90. Since there is no recourse, it must be a sale. Note: since sale is without recourse, Firm A DR’s AUA A/R reduces on B/S $90 cash received is CFO Paul Zarowin

  13. Example (cont’d) • Case 2 -Sale with recourse: the transfer is with recourse, and firm A receives $95 (note that the amount received is higher than in case 1, since A still bears the default risk). Assume that the conditions exist for this transfer to be as a sale. Note: since sale is with recourse, Firm A does not DR AUA A/R reduces on B/S contingent liability disclosed for possible default of sold A/R $95 cash received is CFO Paul Zarowin

  14. Example (cont’d) • Case 3 - Assignment with recourse: the transfer is with recourse, and firm A receives $95. Assume that the conditions exist for this transfer to be as a borrowing. Note: total assets and total liabilities higher than in cases 1 or 2 $95 cash received is CFF ex. P8-14 (Atherton Manufacturing) Paul Zarowin

  15. Sale With Recourse: Is It a Sale? Issue: Effects of (non) recognition vs disclosure Is really collateralized borrowing; so assets and liabilities both understated. To correct: If these are equal only effect is on B/S Paul Zarowin

  16. Sale With Recourse: Is It a Sale? (cont’d) of recording a sale instead of a borrowing • What is effect on ratios? • Profitability • ROA (=NI/TA): overstated • ROE (=NI/OE): no effect (why? See slide #9) • Liquidity • Current Ratio (=CA/CL) • If CR>1, it is overstated • If CR<1, it is understated A B Paul Zarowin

  17. Aggressive Revenue Recognition • Aggressive revenue recognition (trade loading, channel stuffing) will increase A/R grows faster than sales. • Below is an illustrative example. Ex. C 3-6, Clear One Communications P. 8-21, Grosse Point Channel Stuffing Paul Zarowin

  18. Case 1: Normal • Sales (all on credit) grow at 10% per year. • Collections equal 50% of current year’s sales (receivables) plus 40% of last year’s sales (receivables). • Any receivables uncollected by the end of the year after sale, must be written off. Thus, 10% of receivables are written off. Paul Zarowin

  19. Case 2: Aggressive(trade loading, channel stuffing) • Sales (all on credit) grow at 20% per year, due to aggressive revenue recognition, but collections are based on “real” sales (see Case 1); i.e., only “real” sales result in collections. • Any receivables uncollected by the end of the year after sale, must be written off. Paul Zarowin

  20. Pfizer’s 2002 Q1 Report • Pfizer’s revenue grew by 11% (from 7,584 to 8,418), while receivables grew by 21% (5,337 to 6,453). • Relevant information: Bristol-Myers, another big pharmaceutical firm, warned earlier this year of a large sales and profit shortfall because it sold too much to wholesalers last year (channel stuffing). • What do you think the increase in Pfizer’s receivables indicates? • Channel stuffing • Legitimate change in the business environment Paul Zarowin

  21. Pfizer’s 2002 Q1 Report (cont’d) • Now consider this additional information: • Two other pharmaceutical companies, Schering-Plough and Eli Lilly, also saw big receivables jumps in the first quarter of 2002. • What do you think about Pfizer’s receivables increase now? • Channel stuffing • Legitimate change in the business environment Paul Zarowin

  22. Factoring to Camouflage Increase in Receivables • Inflate revenues by aggressive revenue recognition. • Growth in A/R ÷ sales is a red flag. • Factorings (sale of the good A/R) hides this signal. • Detection problem: lack of required disclosures for sales without recourse. • See RCJ’s discussion on Bausch and Lomb pg. 348-352, Table 8.1 pg. 349 and Sunbeam pg. 361-362 Key question:is factoring “normal” activity, or to camouflage? ex. C8-3 Paul Zarowin

More Related