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FINANCIAL STATEMENT ANALYSIS 2009 – 10, Term VI CA K.P.Rajendran [email protected]

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.