In early 2003 Bristol-Myers Squibb announced that it would have to restate its financial statements as a result of stuffing as much as $3.35 billion worth of products into wholesalers’ warehouses from 1999 through 2001. The company’s sales and cost of sales during this period was as follows:
Cost of products sold
The company’s marginal tax rate during the three years was 35 percent. What adjustments are required to correct Bristol-Myers Squibb’s balance sheet for December 31, 2001? What assumptions underlie your adjustments? How would you expect the adjustments to affect Bristol-Myers Squibb’s performance in the coming few years.
The problem is that the sales that have been recorded and the associated receivables, tax etc., may be overstated because the company has pushed inventory out to warehouses as if the inventory is sold; however, the revenue may not yet have been earned so there is doubt whether the sales are legitimate.
In the Bristol-Myers Squibb example, the firm's Trade Receivables, Sales, and Net Profit are overstated. To correct for this problem in the 2001 balance sheet, Trade Receivables needs to decline by $3.35 billion, and Inventories need to increase by an amount that reflects the effect of gross profit margins. The Inventories adjustment can be achieved by multiplying the Trade Receivables adjustment by the ratio of Cost of Sales to Sales. The increase in Inventories is approximately $1 billion (3.35 * (5,454/18,139)). The $3.35 billion decline in Trade Receivables is mirrored by a decline in 2001 Sales of the same amount. Similarly, the $1 billion increase in Inventories reflecting unsold product corresponds to a decline in the Cost of Sales by the same amount. Multiplying the -$2.35 difference between the reduction in Sales and the reduction in Cost of Sales by the firm's 35% marginal tax rate results in a $.82 billion reduction in Tax Expense, with the remaining $1.53 billion ($2.35-.82) difference being charged to Net Profit. The decline in both Tax Expense and in Net Profit are reflected in the Balance Sheet by a decline in Deferred Taxes and in Ordinary Shareholders' Equity, respectively. Adjustments for Dec.31, 2001 ($billions)
Liabilities & Equity
Ordinary Shareholders' Equity
Adjustments for Dec.31, 2001
Cost of Sales
On March 31, 2006, Germany’s largest retailer Metro AG reported in its quarterly financial statements that it held inventories for 54 days sales. The inventories had a book value of €6,345 million. How much excess inventory do you estimate Metro is holding in March 2006 if the firm’s optimal Days’ Inventories is 45 days? Calculate the inventory impairment charge for Metro if 50 percent of this excess inventory is deemed worthless? Record the changes to Metro’s financial statements from adjusting for this impairment.
Metro’s inventories on March 31, 2006 were €6.345 billion, equivalent to 54 days. If the optimal days’ inventories was 45 days, the value of the optimal inventories would be 45/54*€6.345 billion, or $5.288 billion. If 50% of the gap (50%*(6.345-5.288)=$0.529 billion was impaired, the changes to Metro’s financial statements would be as follows:
Deferred Tax Liability
Ordinary Shareholders’ Equity
Cost of Sales
On December 31, 2007 and 2008 Deutsche Telekom AG had net trade receivables in the amount of €7,530 million and €7,224 million, respectively. The following proportion of the receivables was past due on...
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