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CH 7: Cash and Receivables
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Suggestions for Class Activities
1.
Real World Scenario
A January 29, 1999 Wall Street Journal article described changes made by Sears, Roebuck &
Co. in the way it accounts for bad debts on its credit card receivables. The following are
excerpts from that article:
Sears, Roebuck & Co. is moving toward more conservative accounting
methods used by competing credit-card issuers which will boost its
loan losses by about $200 million during the next five quarters and
result in a higher percentage of accounts classified as delinquent.
Sears said it has already set aside funds to cover the expected increase
in loan losses, so 1999 profits won’t be hurt. But the move shows that
problems in the company’s $28.4 billion credit-card loan portfolio have
been worse than previously thought.
Under the new accounting method, Sears will classify accounts
delinquent sooner and take loan losses earlier. Under its old system,
many accounts went past the credit-card industry standard of 90 days
before Sears classified them as delinquent. What’s more, accounts
weren’t charged off until the overdue balance reached eight times the
minimum payment, which usually didn’t happen until about 270 days
after the first payment was missed.
Sears will adopt the industry standard 90-day delinquency cutoff. On
charging loans off, Sears will meet the industry halfway: Bank card
issuers typically charge off loans after 210 days; Sears is moving to 240
days.
Suggestions:
There are a number of issues that could be discussed with the class. For example, the
company “said it has already set aside funds to cover the expected increase in loan losses,
…” What is wrong with the terminology used in that sentence? The third paragraph of
excerpts indicates that “Sears will classify accounts delinquent sooner and take loan losses
earlier.” What does this mean? You could also have the class access the most recent
financial statements of Sears using the Edgarscan database and have them investigate the
relationship between receivables and the allowance and then compare the relationship with
a competitor such as J.C. Penney.
Points to note:
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Intermediate Accounting, 2/e
Of course, no “funds” were set aside to cover the expected increase in loan losses. The
correct terminology is that the company had already provided a sufficient allowance for
uncollectible accounts to cover the increase in bad debts.
The new accounting method indicates that Sear’s uses an aging approach to estimate
uncollectible amounts. They will now move accounts into the delinquent category sooner.
The delinquent category applies a higher percentage to receivable amounts as uncollectible
than the prior age category.
2.
FedEx/UPS Analysis
Have students, individually or in groups, go to the most recent Federal Express annual
report using Edgarscan at: http://edgarscan.tc.pw.com. Ask them to:
1. Compare the allowance for doubtful accounts with the amount reported in 2003 in the
2002. Has there been any change in the relationship between the allowance and gross
receivables? If so, how might this be interpreted?
2. Compute the current year's average collection period and compare it to 2002.
Interpret your results in light of your findings in requirement 1 above.
3. Use Edgarscan to locate the most recent annual report information for United Parcel
Service of America, FedEx’s competitor. Using the most recent annual report
information for both companies, compare the relationship between gross receivables
the allowance for uncollectibles, the receivables turnover ratio, and the average
collection period.
3.
Group Activities
1. Ethics Case 7-6 and Research Case 7-13 do well as group assignments.
2. Both of the above cases also create good class discussions.
4.
Communication Activities
1. Real World Case 7-10 and Communication Case 7-3 are suitable for student
presentation(s).
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5.
Ethical Dilemma
The chapter contains the following ethical dilemma:
ETHICAL DILEMMA
The management of the Auto Parts Division of the Santana Corporation receives a
bonus if the division's income achieves a specific target. For 2000 the target will be
achieved by a wide margin. Mary Beth Williams, the controller of the division, has been
asked by Philip Stanton, the head of the division's management team, to try to reduce this
year's income and "bank" some of the profits for future years. Mary Beth suggests that
the division's bad debt expense as a percentage of net credit sales for 2000 be increased
from 3% to 5%. She believes that 3% is the more accurate estimate but knows that both
the corporation's internal auditors as well as the external auditors allow some flexibility
when estimates are involved. Does Mary Beth's proposal present an ethical dilemma?
You may wish to discuss this in class. If so, discussion should include these elements.
Step 1—The Facts:
Managers of the Auto Parts Division receive bonuses for attaining division target net
income. The 2000 target net income has been achieved. The head of the management team
asks Mary Beth Williams, division controller, to defer some of this year's income to future
years in order to provide bonuses in later reporting periods. The controller, although
believing the 3% is a reasonable estimate, suggests increasing the bad debt percentage of
net credit sales to 5% as a way to defer the income to future periods. By changing the bad
debt percentage, the controller makes both net receivables and net income less reliable and
possibly misleading to users of the financial statements.
Step 2—The Ethical Issue and the Stakeholders:
The ethical issue or dilemma is whether the controller's obligation to the management
team to provide for future profit and the ensuing bonuses is greater than her obligation to
provide information that is not misleading to users of the financial statements.
Stakeholders include Mary Beth Williams, controller, Philip Stanton, head of the
management team, other division managers, the top management of Santana Corporation,
internal and external auditors, current and future creditors, and current and future
investors.
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Step 3—Values:
Values include competence, honesty, integrity, objectivity, loyalty to the company,
loyalty to the management team, and responsibility to users of financial statements.
Step 4—Alternatives:
1. Follow the suggestion of Philip Stanton to defer some 2000 income to future years.
2. Refuse to defer profit to the future and record the 2000 bad debt expense at the best
estimate of 3% of net credit sales.
3. Report Stanton's request to a higher level of management, the audit committee, or the
auditors.
4. Resign from the company and seek employment elsewhere.
Step 5—Evaluation of Alternatives in Terms of Values:
1.
Alternative 1 illustrates loyalty to the management team.
2,3. Alternatives 2 and 3 illustrate loyalty to the company as a whole and also
incorporate the values of competence, honesty, integrity, objectivity, and
responsibility to users of the financial statements.
4.
Alternative 4 supports the values of honesty and integrity, but does not reflect
competence, objectivity, or responsibility to financial statement users and the
company as a whole.
Step 6—Consequences:
Alternative 1
Positive consequences: The controller would please the management team who would
probably receive bonuses in future years.
Negative consequences: Users of the financial statements, including corporate top
management, would be misinformed. The increased bad debt expense would reduce
operating income and place the division in a less favorable financial position for 2000. Net
accounts receivable would be lower. The controller may lose her self-respect, the respect of
co-workers, and possibly her job if the manipulation of 2000 income is detected by
corporate top management.
Alternative 2
Positive consequences: Users of financial statements would receive a more relevant and
reliable estimate of net income for 2000 and future years. Net income and bonuses in
future years would be fairly stated. The controller would maintain her integrity, may
receive praise for being honest, and may keep her job.
Negative consequences: The controller may incur the disfavor of division management
and may lose the trust of other managers. Bonuses in future years may be lower or
nonexistent.
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Alternative 3
Positive consequences: The controller maintains her integrity. Users may receive a more
relevant and reliable estimate of reported income if upper management levels or the audit
committee compel fair presentation of the bad debt expense in the financial statements.
Negative consequences: The controller may incur the disfavor of division management
and the trust of other employees, resulting in a loss of future promotions or her job.
Whistle blowers often are not rewarded.
Alternative 4
Positive consequences: The controller maintains her integrity and avoids conflict with
division management.
Negative consequences: The controller has no job and may have difficulty getting
references for a new job. Users of financial statements, including corporate management,
still do not receive relevant and reliable information regarding bad debt expense and
bonuses. Bonuses in future years may not be correctly calculated.
Step 7—Decision:
Student(s) must decide their course of action.
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Intermediate Accounting, 2/e