bausch & lomb_case analysis
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Bausch and LombTRANSCRIPT
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Bausch & Lomb, Inc. (A)
Case Analysis
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Bausch & Lomb, Inc. (A)
Bausch & Lomb, Inc. (B&L) is a manufacturer of optical and health care products headquartered in New York.
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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.
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Bausch & Lomb, Inc. (A)
B&L recognized the product shipments associated with the new strategy as revenues.
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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?
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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
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Bausch & Lomb, Inc. (A) Journal entries:
Dr. Accounts Receivable $22 millionCr. Revenues $22 million
Dr COGS $9.9 millionCr Finished Goods Inventory$9.9 million
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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.
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Bausch & Lomb, Inc. (A)
If we take the SG&A expenses as 33% of net sales, it would be:
$22million*33% = $7.25 million.
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Bausch & Lomb, Inc. (A)
Increase in net income (excluding SG&A expenses) would be:
$22 million - $9.9 million = $12.1 million
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Bausch & Lomb, Inc. (A)
Is this a big deal for B&L?
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Bausch & Lomb, Inc. (A)
Total sales of B&L for 1993= $1.8 billion
Increase in sales due to new sales strategy=
=$22 million
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Bausch & Lomb, Inc. (A)
Is the impact material?
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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
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Bausch & Lomb, Inc. (A)
Is the impact material?
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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.
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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.
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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.
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Bausch & Lomb, Inc. (A)
Does the new distribution and sales strategy make sense from an operational standpoint?
Why or why not?
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Bausch & Lomb, Inc. (A)
What is the current distribution and sales strategy of B&L?
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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.
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Bausch & Lomb, Inc. (A)
What is the new distribution and sales strategy of B&L?
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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.
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Bausch & Lomb, Inc. (A)
Whether this change makes sense from a business or operational perspective?
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Bausch & Lomb, Inc. (A)
Will the new strategy really free up resources to focus on new items?
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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.
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Bausch & Lomb, Inc. (A)
Do the distributors have the operational knowledge and financial acumen to manage this large block of inventory?
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Bausch & Lomb, Inc. (A)
A company’s operational and financial strategy have a direct impact on the accounting decisions.
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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).
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Bausch & Lomb, Inc. (A)
In other words do you consider this transaction should be recorded as revenue?
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Bausch & Lomb, Inc. (A)
Whether a company can recognize revenues centers upon two basic questions.
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Bausch & Lomb, Inc. (A)
First, has the company accomplished what it must do in order to enjoy the benefits of the revenue?
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Bausch & Lomb, Inc. (A)
Second will the revenues ever be realized?
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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.
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Bausch & Lomb, Inc. (A)
The second question about realizability: Is the realizability a suspect?
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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
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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.
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Bausch & Lomb, Inc. (A)
Exhibits 1 and 2 shows that net sales and earnings are continuously increasing from 1982 to 1993.
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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?
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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?
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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.
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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.
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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.
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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.
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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).
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Bausch & Lomb, Inc. (A)
Factoring, allows companies to meet more stringently the realizability criterion for recognizing revenue.
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Bausch & Lomb, Inc. (A)
Accounting often requires use of judgment and sometimes accounting choices are difficult to make.