FINANCIAL STATEMENT ANALYSIS 2009 – 10, Term VI CA K.P.Rajendran
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Bausch & Lomb, Inc. (A)
Case Analysis
Bausch & Lomb, Inc. (A) Bausch & Lomb, Inc. (B&L) is a manufacturer of optical and health care products headquartered in New York.
Bausch & Lomb, Inc. (A) The company implemented a change in their distribution and sales strategy near the end of 1993 that pushed a large amount of conventional contact lens inventories onto distributors.
Bausch & Lomb, Inc. (A) B&L recognized the product shipments associated with the new strategy as revenues.
Bausch & Lomb, Inc. (A) What is the impact of the December 1993 shipments of conventional lenses on the Bausch & Lomb 1993 financial statements? Is the impact significant?
Bausch & Lomb, Inc. (A) Increase in net sales as a result of the new sales strategy = $22 million Ratio of cost of goods sold (COGS) to net sales = 45% COGS = 22*45% = $9.9 million
Bausch & Lomb, Inc. (A) Journal entries: Dr. Accounts Receivable Cr. Revenues
$22 million $22 million
Dr COGS $9.9 million Cr Finished Goods Inventory$9.9 million
Bausch & Lomb, Inc. (A) Even though, the ratio of Selling, General and Administrative (SG&A) expenses to net sales is given as 33%, the exact amount of Selling, General and Administrative (SG&A) expenses resulting from the strategy is not given in the case. So it is impossible to determine as it is an indirect and allocated amount.
Bausch & Lomb, Inc. (A) If we take the SG&A expenses as 33% of net sales, it would be: $22million*33% = $7.25 million.
Bausch & Lomb, Inc. (A) Increase in net income (excluding SG&A expenses) would be: $22 million - $9.9 million = $12.1 million
Bausch & Lomb, Inc. (A)
Is this a big deal for B&L?
Bausch & Lomb, Inc. (A) Total sales of B&L for 1993 = $1.8 billion Increase in sales due to new sales strategy= =$22 million
Bausch & Lomb, Inc. (A)
Is the impact material?
Bausch & Lomb, Inc. (A) Net income of B&L for 1993 = $156.6 million Increase in net income resulting from the new sales strategy =$12.1 million
Bausch & Lomb, Inc. (A)
Is the impact material?
Bausch & Lomb, Inc. (A) An information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.
Bausch & Lomb, Inc. (A) While definitions of materiality may vary, it can be concluded that something is material if it would change the opinion of a relatively informed user of the financial statements.
Bausch & Lomb, Inc. (A) Materiality depends on the question being asked, requiring management to attempt to anticipate all of the various ways the information may be used before determining if it is material.
Bausch & Lomb, Inc. (A) Does the new distribution and sales strategy make sense from an operational standpoint? Why or why not?
Bausch & Lomb, Inc. (A) What is the current distribution and sales strategy of B&L?
Bausch & Lomb, Inc. (A) The current distribution and sales strategy of B&L involves selling and delivering directly to large retail customers, while using distributors to service the many smaller retail customers.
Bausch & Lomb, Inc. (A) What is the new distribution and sales strategy of B&L?
Bausch & Lomb, Inc. (A) The new distribution and sales strategy of B&L involves selling and delivering all conventional lens only through distributors to all customers including large retail customers.
Bausch & Lomb, Inc. (A) Whether this change makes sense from a business or operational perspective?
Bausch & Lomb, Inc. (A) Will the new strategy really free up resources to focus on new items?
Bausch & Lomb, Inc. (A) How will the larger retail clients respond to the need to deal with distributors for this one tem? Remember these high volume customers would be continuing to deal with B&L directly for many of their other purchases.
Bausch & Lomb, Inc. (A) Do the distributors have the operational knowledge and financial acumen to manage this large block of inventory?
Bausch & Lomb, Inc. (A) A company’s operational and financial strategy have a direct impact on the accounting decisions.
Bausch & Lomb, Inc. (A) Do you think the product shipments associated with B&L’s new distribution strategy satisfied the FASB criteria for recognizing revenues? Why or Why not? (Exhibit 7 od case study describes the FASB criteria for recognition of revenues and gains).
Bausch & Lomb, Inc. (A) In other words do you consider this transaction should be recorded as revenue?
Bausch & Lomb, Inc. (A) Whether a company can recognize revenues centers upon two basic questions.
Bausch & Lomb, Inc. (A) First, has the company accomplished what it must do in order to enjoy the benefits of the revenue?
Bausch & Lomb, Inc. (A) Second will the revenues ever be realized?
Bausch & Lomb, Inc. (A) The first question does not appear to be critical for B&L. Revenues were recognized at the time of product shipment, which is normal.
Bausch & Lomb, Inc. (A) The second question about realizability: Is the realizability a suspect?
Bausch & Lomb, Inc. (A) Would you think that B&L was not justified in recognizing revenues because of concerns over realizability claim that the year-end timing of the sales strategy is suspect? Remember that according to Exhibit 6
Bausch & Lomb, Inc. (A) Remember that according to Exhibit 6, the percentage of U.S. soft contact lens wearers using conventional lenses during 1992-93 is declining.
Bausch & Lomb, Inc. (A) Exhibits 1 and 2 shows that net sales and earnings are continuously increasing from 1982 to 1993.
Bausch & Lomb, Inc. (A) Considering the continuous growth in revenues and net income for the past years, Would you think that the sales strategy was motivated by pressure to continue showing a positive trend in operating performance, especially under decreasing sales scenario of conventional lenses?
Bausch & Lomb, Inc. (A) Or do you consider that the timing issues alone do not impact the eventual payment of the amounts owed by the distributors?
Bausch & Lomb, Inc. (A) Companies generally recognize revenues at the time of product shipment. B&L has also lacked a formal return policy. The above aspects justify B&L’s accounting choice of recognizing the revenues.
Bausch & Lomb, Inc. (A) The sales strategy did not involve moving different line of business or geographic area where new distributor relationships were being developed.
Bausch & Lomb, Inc. (A) As such, realizability should not have been a concern because the case makes no mention of the company ever having distributor payment problems and the distributors all have long histories with B&L.
Bausch & Lomb, Inc. (A) The company also received a clean audit opinion in 1993 (Refer Exhibit 8) which again justifies B&L’s accounting choice.
Bausch & Lomb, Inc. (A) Remember B&L can also sell accounts receivable attributable to the sales strategy for cash to a factor (otherwise known as factoring).
Bausch & Lomb, Inc. (A) Factoring, allows companies to meet more stringently the realizability criterion for recognizing revenue.
Bausch & Lomb, Inc. (A) Accounting often requires use of judgment and sometimes accounting choices are difficult to make.
