Chapter 5.

Operating Cycle, Revenue Recognition and Receivable

Valuation

Suggested Solutions to Questions, Exercises, Problems, and Corporate Analyses

Difficulty Rating for Exercises and Problems:

Easy: E5.12; E5.13; E5.14; E5.15; E5.16

Medium: E5.17; E5.18; E5.19
P5.21; P5.22; P5.23; P5.26; P5.27; P5.30; P5.31
Difficult: E5.20
P5.24; P5.25; P5.28; P5.29

QUESTIONS

Q5.1 Revenue Recognition Criteria. In general, the revenue recognition principle

suggests that four criteria should be satisfied before revenue can be
recognized. These criteria include:

1. The firm has completed a significant portion of any required work.

2. The amount of revenue to be recognized is known or can be estimated with
reasonable certainty.
3. The amount of costs associated with the revenue is known or can be
estimated with reasonable certainty.
4. Collection of any uncollected cash is reasonably assured.

MicroStrategy should not recognize any revenue at contract signing as that

would violate the first criterion. Revenue recognition when the monthly billings
are sent is appropriate so long as cash collection is reasonably assured.
Revenue recognition at the end of the contract is probably unnecessarily
conservative.

Q5.2 The Materiality Concept. An often-mentioned standard of materiality is:

Income statement: Five percent of net income or three percent of net sales
Balance sheet: Three percent of total assets

There is no right or wrong answer here, but we often find it instructive to get a
sampling of answers from students on the board to see the variability in views
of what is (or is not) material. The takeaway point is that the variance that they
see on the board is probably also taking place among the firms they want to
invest in, work for, or read about.

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Q5.3 Accrual Accounting, Accounts Receivable, and Cash Flow. Mr. Baileys
message is very simple: A business cannot exist without cash flow; but, since
the accrual-based income statement doesnt report cash earnings (and may
give a manager a false sense of security when net income is positive), do not
forget to track the cash flow from operations (i.e., cash earnings) on the
statement of cash flow.

Q5.4 Revenue Recognition, the Matching Principle, and the Bad Debt Expense.
Given Urcarcos target market (i.e., customers with bad or no credit rating), the
company should use the installment basis to recognize revenue. The
installment method is appropriate in this case because cash collection is
uncertain and the probability of default (and repossession) is high. If Urcarco
adopts the installment method as its basis of revenue recognition, there is no
need to estimate the bad debts expense since no uncollected revenue is
recognized.

Q5.5 Revenue Recognition in the Air Transportation Industry. U.S. Airways could
recognize revenue at the point of ticket sale (i.e., when cash is collected and is
nonrefundable), at the point when a flight is actually taken, or at the end of one
year when the ticket expires. Revenue recognition at the point of sale would not
be GAAP, however, as no service has yet been provided. Thus, for purposes of
the GAAP financial statements, U.S. Airways policy choice is limited to either
when a flight is actually taken or at the end of the one-year expiration period.

Q5.6 Managing Earnings and the Bad Debt Expense. This discussion question is
based on the Nortel Networks Corporation illustration in Chapter 5:
2008 2009
Allowance for doubtful accounts gross
accounts receivable 25% 13.6%
Total Networks allowance for doubtful accounts as a percentage of gross
accounts receivable declined by nearly 50 percent. This would imply that there
had been a 100 percent improvement in the accounts receivable payment
behavior of Totals customers, which of course is unlikely to happen in such a
short period of time. An alternative explanation is that Total lowered its
probabilities of non-collection when estimating its bad debt expense for 2009.
Reducing the bad debt estimate for 2009 allows Total to report a higher pretax
net income. Assuming that the companys customers did not change their
payment behavior, the bad debt expense for 2009 would be underestimated by
$125 million and pretax net income over-estimated by the same amount.

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5-2 Financial Accounting for Executives & MBAs, 3 rd Edition
Q5.7 Sales Channel Stuffing. On the surface, it appears that RIM is engaging in
channel stuffing wherein inventory is shipped to retailers and is booked as
revenue at the time of shipment, with the possibility that any unsold product can
be returned at a later date with no cost to the buyer. However, according to the
Wall Street Journal article:

RIM chairman Jim Balsillie dismisses the idea that the

Blackberry shipments versus subscriber sign-ups difference
indicates that unsold Blackberries are piling up on store
shelves. He says many subscribers are chucking older
Blackberries in favor of the latest models that offer faster Web
surfing . . .

Theres definitely a healthy upgrade cycle.

Thus, the question is whether the upgrade cycle will be sufficient to absorb
the excess of the shipment to subscriber sign-up difference.

Analysts worry about channel stuffing because of the risk of subsequent

revenue restatements that can adversely affect firm share price.

Q5.8 Sales Forecasts and Share Prices. It is generally agreed that revenues are
the key driver of share price. Thus, it is not surprising to see a firms share price
take a substantial hit when revenues are forecasted to decline. At issue here,
however, is whether the decline in sales forecast for 2006 for Bausch & Lomb
will persist after 2006. If the company is able to recover the temporarily lost
market share in 2007 and, thereafter, then perhaps the 15 percent share price
drop was excessive. At the time, according to Yahoo Finance, Bausch & Lomb
traded at a price-to-sales multiple of 1.12 times; thus, a drop in sales of 4.6
percent could translate into a share price reduction of 5.15 percent. In short, the
price drop of 15 percent seems excessive in this instance.

Q5.9 Revenue Recognition by Software Companies. Although Microsofts policy

decision is defensible, it is nonetheless widely criticized by analysts who
observe that Microsoft immediately receives all of the cash for its products. The
problem is, as Microsoft points out, some of the cash outflows associated with
its software product (i.e., for upgrades and technical support) occur
subsequently; and thus, to achieve the most effective matching of revenue and
expenses, the company is correct to defer a portion of its revenue associated
with those subsequent cash outflows. Analysts point out, however, that the
practice creates an earnings reserve on Microsofts balance sheet, and since
Microsoft has met or exceeded Wall Streets earnings forecasts for the past 19
years, the policy choice seems to suggest that Microsoft might (or at least,
could) use the earnings reserve to manage its earnings.

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Q5.10 Revenue Recognition by Aircraft Manufacturers. Airbus and Boeing could
recognize revenue at the following points in time:
As production milestones are met (i.e., a percentage-of-completion
basis).
At completion of production (i.e., completed contract basis).
When flight testing is complete and title is transferred.

Given the length of the production cycle for these firms (i.e., nine months or
more), most analysts expect to see these companies use the percentage-of-
completion basis, especially since cash collection is unlikely to be an issue for
the companies (i.e., because of the down payment of $100 million).

Q5.11 (Ethics Perspective) Ethics and the Tone at the Top. The role of the leader
is to provide guidance and rules for their employees, in addition to providing a
direction in which the organization wishes to move. If ethical behavior is part of
that vision, and he or she emphasizes this, then we will expect to see a more
ethical culture.

But what if the leader does not walk the way they talk? There are two theories
that explain behavior in organizations: espoused theory and theory-in-use. The
espoused theory is what people claim to do. For example, when leadership
publicly states that a company values ethical behavior, this is espoused theory.
Theory-in-use, on the other hand, is what actually occurs, and it may or may
not be in line with espoused theory. Leadership may claim to value ethical
behavior, but in reality it is unethical behavior that is rewarded. In such cases,
where there is a discrepancy between espoused theory and theory-in-use, the
saying actions speak louder than words applies. Employees may nod their
heads and smile when they hear espoused theory, but if the mechanisms in the
organization dont support ethical behavior, it is unlikely that ethical behavior
will be practiced. The point is that it is not enough to simply claim to act
ethically. Action at the top needs to match the tone at the top.

It is ethical to be a whistle-blower, but standing up against injustices and deceit

does not come without a price. It could cost the person their reputation, along
with a financial cost. Even so, a person with the courage to stand up against
unethical behavior is rewarded with the sense that they have done the right
thing. In order to encourage whistle-blowing, the Sarbanes-Oxley Act put in
place safeguards to protect whistle-blowers.

(Note: This answer was based on the writings of Jasper Matt Jarman and
Liliane Contreraz.)

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5-4 Financial Accounting for Executives & MBAs, 3 rd Edition
 EXERCISES

E5.12 Revenue Recognition Policy Decisions.

1. SAB 101 (see Appendix A at the end of the chapter) now requires a
prorata recognition of such fees over the life of the contract. Where receipt
of full payment is in doubt, an installment basis approach would be
preferable.

2. Given that the $1,500 is paid in full at the time of purchase of the
warranty contract, revenue recognition should occur at that time. However, a
related issue is matching: Global Motors must estimate its future costs to
service the warranty agreements. If it is unable to do so, then a partial
recognition approach would be needed, wherein the $1,500 would be pro-
rated over the warranty period.

3. Arcadia Promotions should recognize revenue from the sale of the

coupon books at the point of sale since the company retains no further
liability to either the merchants or the coupon-book buyer.

4. Assuming that cash collection is reasonably assured, Luxury Furniture

could recognize revenue from the sale of its furniture at the point of sale.
When the purchase contracts are subsequently resold, the related
receivables would be written off. Service fee income would be recognized
upon receipt or when earned.

5. Community News, Inc. should recognize the number of newspaper sold

each week, adjusted (up or down) depending upon the level of returned,
unsold papers.

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E5.13 Revenue Recognition. Davis has four choices as to when to recognize the
$100,000 in revenue from the Longo contract:
December 2009 when the order is placed
January 2010 as work on the order proceeds
February 2010 when work on the order is completed and the order is
shipped to Longo
March 2010 when Davis is paid by Longo

In general, recognizing revenue in December before any work commenced on

the project would not be acceptable under U.S. GAAP. January is possible if
Davis uses a percentage-of-completion approach to revenue recognition.
February is the preferred point of revenue recognition under SAB 101 (i.e., the
work is complete and shipped), so long as cash collection from Longo is
reasonably assured (which is presumably the case or else Davis would not
have extended the trade credit in the first place). March is the preferred point of
revenue recognition when cash collection from Longo is not reasonably
assured.

E5.14 Analyzing Accounts Receivable.

Year 1 Year 2
Allowance for uncollectible accounts
gross accounts receivable 3.0% 3.5%

An increase in this ratio indicates that Lincolns customers are taking a longer
time to pay their bills, increasing the riskiness of the companys accounts
receivable and reducing the likelihood of collecting the full value of the
outstanding accounts receivable.

If the bad debt expense for Year 2 did not equal $2,700, it was because there
was an existing balance in the allowance for uncollectible accounts after
considering the write-off of known uncollectible accounts. The existing balance
in the allowance account would cause the bad debt expense to be higher or
lower than $2,700.

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E5.15 Analyzing Accounts Receivable.

Year 1 Year 2
Allowance for uncollectible accounts
gross accounts receivable 3.5% 3.0%

A decrease in this ratio indicates that the payment behavior of the Couche
Corporation customers is improving (i.e., they are paying more quickly),
reducing the riskiness of the cash flows associated with the companys
receivables and increasing the likelihood of collecting the full value of any
outstanding receivables.

Since the Year 2 bad debt expense for The Couche Corporation did not equal
$4,100, there must have been an existing balance in the allowance for
uncollectible accounts caused by greater (or lesser) actual account receivable
write-offs in the prior period.

E5.16 Accounting for Quick-Pay Incentives.

July 1 July 10
Order Order Total

Revenues $120,000 $80,000 $200,000

Less: Sales discount (2,400) (0) (2,400)
Net sales $117,600 + $80,000 = $197,600

Charles Smith Inc. is willing to offer a price discount to its credit customers as a
financial incentive to pay for any purchased equipment within ten days of the
original sale transaction. Customers who fail to pay quickly implicitly transfer
the cost of financing their credit purchases to Charles Smith, Inc. This hidden
cost lowers the profitability of Charles Smith by raising the companys cost of
financing. Sales discounts are valuable to the customers of Charles Smith
because it enables them to lower their cost of goods purchased.

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E5.17 Preparing an Aging Schedule.

Non-Collection Bad Debt

Account Age Balance Probability Estimate

0-30 days $725,000 0.5% $3,625

31-60 days 275,000 1.5% 4,125
61-90 days 170,000 2.5% 4,250
91-120 days 100,000 4.0% 4,000
Over 120 days 40,000 20.0% 8,000
$1,310,00
0 $24,000

Realizable value = $1,310,000 - $24,000 = $1,286,000. If Beall Inc. implements

a policy of writing off all accounts receivable older than 120 days, the actual
write-off will reduce both the gross accounts receivable balance and the
balance in the allowance for uncollectible accounts by the same amount (ie.
$40,000), and the allowance account will end up with a $16,000 debit balance.
Based on the remaining receivables, the allowance should have a credit
balance of $16,000, necessitating an adjustment to increase the bad debt
expense by $32,000 and the allowance account by the same amount.

E5.18 Analyzing Accounts Receivable.

Year 1 Year 2
Receivable turnover ratio 9.64x 10.38x
Receivable collection period 37.9 days 35.2 days

Additional cash flow in Year 2 if Coca-Cola Enterprises is able to reduce its

receivable collection period to 30 days (i.e., a turnover ratio of 12.17 times):

Revised receivable balance (Year 2) = $18,706 12.17 = $1,537 million

Additional cash flow = $1,802 - $1,537 = $265 million.

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5-8 Financial Accounting for Executives & MBAs, 3 rd Edition
E5.19 Analyzing Accounts Receivable.

Year 1 Year 2

Receivable turnover ratio 5.61x 5.25x

Receivable collection period 65.1 days 69.5 days

Additional cash flow in Year 2 if The Mann Corporation is able to reduce its
receivable collection period to 60 days (i.e., a turnover ratio of 6.08 times):

Revised receivable balance (Year 2) = $25,649 6.08 = $4,219 million.

Additional cash flow = $4,883 - $4,219 = $664 million.

E5.20 Revenue Policy Change: Software Service Contracts.

1. Item Effect
a. Revenue Decrease
b. Total assets No effect
c. Cash flow from operations No effect
d. Total liabilities Increase

2. The policy change is desirable because revenue should not be recognized

until earned, and recognition at contract signing preceded the realization
process.

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 PROBLEMS

P5.21 Installment Basis versus Point-of-Sale Revenue Recognition.

1. Point-of-sale method.

Year 1 Year 2
Revenues $400,000 $600,000
Less: Cost of goods sold
Beg. Inventory $0 $120,000
Add: Purchases 360,000 480,000
Less: End. Inventory (120,000) (228,000)
(240,000) (372,000)
Gross margin 160,000 228,000
Less: Operating expenses (64,000) (88,000)
Net income $96,000 $140,000

2. Installment Method.

Year 1 Year 2
Revenues $180,000 $460,000
Less: Cost of goods sold
180/400 (240,000) (108,000)
460/600 (372,000) (285,200)
Gross margin 72,000 174,800
Less: Operating expenses (64,000) (88,000)
Net income $8,000 $86,800

P5.22 Revenue Recognition.

Luxury Homes, Inc.
Balance Sheet
(1) (2) (3) (4)
Assets:
Cash $ 21,000 $ 21,000 $ 21,000 $ 21,000
Receivables:
Renovation 150,000 150,000 150,000 150,000
New construction1 280,000 -0- 280,000 -0-
Interest 3,000 3,000 3,000 3,000
Inventory 2,600 2,600 2,600 2,600
Construction in progress -0- 161,540 108,857 2 270,397 3
Total $456,600 $338,140 $565,457 $446,997
Equities:
Payables $44,600 $44,600 $44,600 $44,600
Unearned revenue -0- -0- 150,000 150,000
Owners investment 242,540 242,540 242,540 242,540
Retained earnings 169,460 51,000 128,317 9,857
Total $456,600 $338,140 $565,457 $446,997

1
The new construction receivable is an unbilled receivable.
2
$127,000 - $18,143 = $108,857.
3
$108,857 + $161,540 = $270,397.

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5-10 Financial Accounting for Executives & MBAs, 3 rd Edition
 Luxury Homes, Inc.
Income Statement
Alternative Approaches
(1) (2) (3) (4)
Revenue recognition approach:
Renovation of home Sale Sale Cash receipt Cash receipt
New construction Construction Completion Construction Completion
Revenue:
Renovation of home $175,000 $175,000 $25,000 $25,000
New home construction 280,000 1 -0- 280,000 -0-
Interest 3,000 2 3,000 3,000 3,000
Total 458,000 178,000 308,000 28,000
Expenses:
Renovation of home 127,000 127,000 18,143 18,143 3
New home construction 161,540 -0- 161,540 -0-
Total 288,540 127,000 179,683 18,143
Net income $169,460 $51,000 $128,317 $9,857

1
$400,000 x .70 =$ 280,000.
2
$150,000 x .12 x 2/12 =$ 3,000.
3
$127,000 x (25,000/175,000) = $18,143.

P5.23 Completed Contract Method versus Percentage-of-Completion Method

1. Completed contract method ($ thousands)

Yr 1 Yr 2 Yr 3 Yr 4 Total
Revenues -$0- -$0- -$0- $240,000 $240,000
Less: Expenses -0- -0- -0- (200,000) (200,000)
Net income -$0- -$0- -$0- $40,000 $40,000

2. Percentage-of-completion method ($ thousands)

Yr 1 Yr 2 Yr 3 Yr 4 Total
Percentage complete 20% 30% 35% 15% 100%
Revenues
20% ($240,000) $48,000
30% ($240,000) $72,000
35% ($240,000) $84,000
15% ($240,000) $36,000
$240,000
Less: Expenses (40,000) (60,000) (70,000) (30,000) (200,000)
Net income $8,000 $12,000 $14,000 $6,000 $40,000

3. The percentage-of-completion method is generally regarded as the most

realistic way to portray a companys operating performance when faced with
a multiyear contract.

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P5.24 Revenue Recognition under Long-Term Construction Contracts
1. a. Percentage of completion.

2011 2012 2013 Total

Estimated revenues $3,000,000 $3,000,000 $4,000,000 $10,000,000
Actual expenses (2,490,000) (3,100,000) (3,110,000) (8,700,000)
Net income $510,000 $(100,000) $890,000 $1,300,000

The estimated revenue figures reflect completion percentages of 30, 30,

and 40 percent, respectively. These percentages correspond to those
certified by the independent engineers. According to U.S. GAAP, the
percentage of completion should be assessed on the basis of physical
estimates, costs incurred, assessment of work performed, or billings
made. Because of the possibility of misrepresenting revenue, and hence
net income, the need for independent verification of completion
estimates cannot be over emphasized. The problem provides a good
illustration of how the use of cost estimates to determine the percentage
of work completed, and hence revenue to be recognized, can be
inappropriate in that the use of cost estimates will cause a postponement
in the recognition of the cost overrun until 2013. On the basis of cost
estimates, the following completion percentages are obtained:

2011: $2.49 / $8.30 = 30.0%

2012: $3.10 / $8.30 = 37.3%

2013 $3.11 / $8.30 = 37.5%

Using the cost estimate approach, excess revenue would be recognized

(37.3 percent) in 2012 as compared to actual work completed (30
percent), and the bad news of the cost overrun would be postponed
until 2013.

In 2011, while $3.0 million in revenue is recognized, only $2.5 million in

cash progress payments are received by the Biltmore Construction
Company (BCC). The instructor may wish to point out that the difference
of $500,000 represents hold-out or retainage to ensure that BCC fully
completes the contract. Also, from an accounting perspective, the
$500,000 is carried on BCCs financial statements as an unbilled
account receivable.

Continued next page

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5-12 Financial Accounting for Executives & MBAs, 3 rd Edition
 1. Continued
b. Completed Contract

2011 2012 2013 Totals

Estimated revenues $0 $0 $10,000,000 $10,000,000
Actual expenses (0) (0) (8,700,000) (8,700,000)
Net income $0 $0 $1,300,000 $1,300,000

It is instructive to point out that even though no revenue is being

recognized, the cash progress payments will be received and accounted
for as deferred revenue in 2011 and 2012. For example, in 2011, the
cash received would be recorded as an increase in cash of $2.5 million
and an increase in deferred revenue, a liability, for $2.5 million.

Similarly, even though the expenditures that are being made are not
being recognized currently on the income statement as an expense, they
are being reported on the balance sheet as an asset. For example, in
2011, the expenditure would be recognized by a decrease in cash for
$2.49 million and an increase in construction-in-progress, an asset, for
$2.49 million.

In 2013, when the contract is completed, both the deferred revenue and
the construction-in-progress accounts are transferred to the income
statement.

c. Cash basis.

2011 2012 2013 Totals

Cash inflows $2,500,000 $2,500,000 $5,000,000 $10,000,000
Cash outflows (2,490,000) (3,100,000) (3,110,000) (8,700,000)
Net cash flow $10,000 $(600,000) $1,890,000 $1,300,000

2. For financial reporting purposes, the percentage-of-completion method best

represents the actual operating activity of BCC. It is important to explain to
students, however, that a company like BCC will probably utilize both
methods simultaneously, with the completed contract method used for
relatively short-term contracts and the percentage-of-completion method
used for longer-term contracts.

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P5.25 Revenue Recognition: R & D Company. Wind Technology Inc. has three
sources of revenue: (1) the seed grant of $50,000 in 2011; (2) the contract
revenue of $2.4 million; and (3) the interest income implicit in the deferred
annuity of $300,000 per year for seven years (i.e., 2013-2019). Since the
$50,000 grant is nonrefundable, it may be recognized in full in 2011 when
received, in 2012 when the DOE option contract expires, or in both 2011 and
2012 on some prorata basis. With respect to the sale of R&D results, the critical
event appears to be the exercise of the DOE purchase option; thus, despite the
fact that delivery is delayed until March 1, 2013, it would be reasonable to
recognize the entire proceeds in 2012. Once the option to buy is exercised,
Wind Technology is assured that the transaction will be completed and is also
certain as to the revenue and costs to be recognized. Thus, for income
statement purposes, the 2012 financial statements would include the initial
$300,000 payment plus the discounted value of the seven annuity payments of
$300,000 each.

With respect to the developmental costs, because of the uncertainty of finding a

definitive purchaser for the R&D work, and thus, the relative uncertainty
associated with the ultimate recoverability of those costs, it seems appropriate
to invoke GAAP guidance that the research and development costs be
expensed in the period incurred (R&D is discussed in further detail in Chapter
7). Thus, the earnings statement for Wind Technology for the years 2010
through 2013 might appear as follows:

2010 2011 2012 2013

Revenue:
Contract proceeds -- -- $1,760,400 1 --
Seed grant -- $50,000 -- --
Interest income -- -- -- $146,040
Total revenue $0 50,000 1,760,400 146,040

Less: Expenses
Research & development (363,000) (529,000) (210,000) --
Net earnings (loss) $(363,000) $(479,000) $1,550,400 $146,040
1
$300,000 + present value of an annuity of $300,000 per period for seven periods at 10 percent.

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P5.26 Aging of Accounts Receivable.
1. Aging Schedule

Probability of Expected
Age Balance Noncollectio Loss
n

0-30 days $800,000 0.5% $ 4,000

31-60 days 180,000 1.0% 1,800
61-90 days 80,000 10.0% 8,000
91-120 days 40,000 70.0% 28,000
$41,800

With an existing credit balance of $34,200 in the allowance for uncollectible

accounts, the bad debt expense would be only $7,600, the same as the
increase in the allowance for uncollectible accounts.

2. The existence of a positive (credit) balance in the allowance for uncollectible

accounts might suggest that the expected credit losses in prior periods were
overstated. If the prior balance had been a negative (debit) balance instead,
it could suggest that prior estimates of expected uncollectible losses had
been underestimated.

P5.27 Accounts Receivable Analysis.

1. Write-off of worthless receivables: decrease accounts receivable and
decrease the allowance for uncollectible accounts by $5,000.

2. Aging of accounts receivable

$44,000 x 0.04 = $ 1,760

31,000 x 0.08 = 2,480
22,000 x 0.12 = 2,640
13,000 x 0.14 = 1,820
9,000 x 0.20 = 1,800
$10,500

Allowance for Uncollectible Accounts

2,700 Beginning balance
Write-off 5,000
12,800 New estimate of bad
debt expense

10,500 Desired balance

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 3. Option B ($4,000) is cheaper than Option A ($4,400):

Cost of Option A: $40,000 x 11% = $4,400

Cost of Option B: $40,000 x 6% = $2,400

Expected loss on uncollectible accounts = 1,600 ($40,000 x 4%)

$4,000

Therefore, Kate should choose Option B.

P5.28 Factoring versus Pledging of Accounts Receivable. Under the terms of the
factoring agreement, the sale of $2 million in accounts receivable on a non-
recourse basis would be accounted for by an increase in cash of $1.69 million,
an increase in financing expense of $310,000 (i.e., $2 million x 15.5%), and a
reduction in accounts receivable of $2 million.

Assuming that the company elects to borrow $1,690,000 instead, $2,061,800 in

receivables would have to be pledged or assigned to the bank (i.e., based on
an 82 percent loan-to-value ratio), and the borrowing would be accounted for as
an increase in cash of $1.69 million and an increase in the bank loan payable
account for $1.69 million

Assuming that the bank loan was outstanding for 60 days, Global Markets
would incur interest costs of $36,617 ($1,690,000 x 13% x 2/12). Thus, the
financing costs under the borrowing option are $36,617 plus any fees the bank
might charge (assumed to be zero here) considerably less than the factoring
expense of $310,000. However, whether the borrowing option is superior or not
depends on the expected bad debt losses on the $2,000,000 in receivables. If
the expected bad debt expense exceeds $273,383 ($310,000 - $36,617), then
the sale of the receivables may be a preferable alternative because the risk of
non-collection is passed on to the factor.

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P5.29 Improving Cash Flow through Receivable Management.
1.
2003 2004
Receivable turnover 4.81x 3.16x
Receivable collection period 75.9 days 115.5 days

Receivable management is declining as evidenced by the dramatic increase

in the receivable collection period from 75.9 days in 2003 to 115.5 days in
2004.

2.
2003 2004
Revised receivable balance:
(60 x $2.56 billion)/365 $0.421 billion
(60 x $1.78 billion)/365 $0.293 billion

2003 2004

Increase in cash flow from receivables:

($0.81 - $0.421) $0.389 billion
($0.37 - $0.293) $0.077 billion

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 5 5-17
 CORPORATE ANALYSIS

CA5.30 The Procter & Gamble Company.

a. According to Note 1, Summary of Significant Accounting Policies, P & B
recognizes revenue;
When revenue is realized or realizable and has been
earned
When title to the product, ownership and risk of loss
transfers to the customer, which can be on the date of shipment or the
date of receipt by the customer.

b. The companys long-term financial targets are:

Grow organic sales 1% to 2% faster than the market
grows in the categories and geographies in which they compete.
Deliver core EPS growth of high single digits to low
double digits, and
Generate free cash flow productivity of 90% or greater.

Based on 2012 net sales of $83,680, forecasted 2013 net sales would be
projected to be at $85,688. P&Gs actual sales growth was 4.6% in 2011
and 3.2% in 2012. The projected sales growth for 2013 is substantially
below that achieved in either 2011 or 2012.

c. P&G recognizes sales discounts and sales returns as a reduction in sales in

the same period that the revenue is recognized.

d. Receivable Turnover Ratio and Receivable Collection Period:

2012 2011
Receivable turnover ratio 13.8 12.9

Receivable collection period 26.5 days 28.2 days

P & Gs receivable turnover ratio increased from 2011 to 2012 and is

reflected in a declining collection period that fell from 28.2 days to 26.5
days, a decrease of 1.7 days.

Cambridge Business Publishers, 2014

5-18 Financial Accounting for Executives & MBAs, 3 rd Edition
 e. Ratio of Allowance for Uncollectible Accounts:

2012 2011

Allowance for uncollectible accounts = $180 $205

Gross Accounts Receivable ($180 + $6,068) ($205 + $6,275)

= 2.9% 3.2%

This ratio decreased from 2011 to 2012 and would indicate that the
proportion of uncollectible accounts encountered by P&G decreased slightly
from 2011 to 2012, reflecting the slight improvement in economic conditions
that characterized the time period.

f. Forecasted Balance of 2013 Accounts Receivable:

Forecasted 2013 sales: $85,688

2012 A/R Turnover 13.79
Forecasted 2013 accounts receivable: $ 6,214

CA5.31.Internet-based Analysis. No solution is provided as any solution would be

unique to the company selected.

CA5.32 IFRS Financial Statements. LVMH Moet Hennessey-Louis Vuitton S.A.

a. LVMH recognizes revenue
at the point of sale when customers buy in a store
at the point of shipment when sales are to distributors

Revenue recognition at the point of shipment is possible because

distributors apparently assume the risks and rewards of ownership when
product leaves the LVMH warehouse.

b. LVMHs revenue recognition policy is very similar to what might be used by

a high-end retailer in the U.S. with the exception that it is rare that a firm
will assume ownership at the point of shipment. In the U.S., ownership
more commonly is passed when goods arrive at the purchasers
warehouse or distribution center.

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 5 5-19