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- This topic has 1 reply, 2 voices, and was last updated 6 years ago by MikeLittle.
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- April 25, 2018 at 1:22 am #448728
Hello Mike,
I cannot understand the examiner’s comments as follow:
“The area of trade receivables tested candidate’s ability to apply the skills used in an analytical review and identify that the increase in provision was inconsistent with the fall in collection days and as such candidates often missed the risk in the question of overprovision and spent time discussing the provision being understated.”
My question is “why increase in provision was inconsistent with the fall in collection days”?
From the case, we can learn the below info:
-net trade receivables increase from $390m to $450m, if collection period being calculated using the figures, the collection period will increase.
-collection period for residential customers increase from 58 days to 65 days
-while collection period for business customers decrease from 55 days to 50 days
-Allowances for credit losses increase by 45.45% over the year.My understanding is that if allowance for credit loss increase over the years, then logically the total net trade receivable would decrease assuming that the total trade receivable are at similar level for both years.
In this regard, the collection period calculated based on the above total net trade receivable would decrease over the year accordingly. That’s why I feel the increase in provision is consistent with the fall in collection days.
Thank you.
Regards,
MarthewApril 25, 2018 at 8:21 am #448752“My question is “why increase in provision was inconsistent with the fall in collection days”?”
A number of points spring out at me in this question:
Business customers’ receivables has increased by 23% and the days’ collection period has fallen by 9.1%
On balance, we have to conclude that the quality of the business customers’ receivables is relatively strong and would suggest a minimal need for any allowance for credit losses
In that case, substantially the whole of the 64 allowance most probably relates to residential customers
That figure of 64 represents an increase of 45.45% compared with last year whereas the level of the residential customers’ receivables has risen by only 9%
The days’ collection period for residential customers has also risen, this time by 12.1%
If I apply these two increases (days’ collection and level of debt) to the allowance figure brought forward, we arrive at 44 * 1.121 * 1.09 = 54
So with no account being taken of any anticipated improvements as a result of the introduction of the new billing system, the worst position that we could reasonably expect would be an allowance of 54
And yet the client has proposed 64
Their figure shows an increase of double what we might reasonably expect on a bad day (we could expect an increase of 10 whereas the client has proposed an increase of 20)
To quote a bit of Shakespeare, there’s something rotten in the state of Denmark
I can fully accept the examiner’s comment “that the increase in provision was inconsistent with the fall in collection days”
As an interesting exercise, I have gone further with this question
It is possible to calculate the revenue from credit sales for both the residential customers and the business customers
For the residential customers we have this:
receivables * 365 / revenue = days
so receivables * 365 / days = revenue
Therefore revenue is 887.2
Applying the same logic to business customers, we have revenue of 2,598.8
Now we arrive at total revenue of 3,486 of which 75% relates to business customers
Aggregate days’ collection period is 514 * 365 / 3,486 = 53.8 days
This is along way below the 65 days for residential customers
For comparison, the equivalent figures for last year were:
Revenue for residential customers 912.5
Revenue for business customers 1,917.9
Aggregate revenue 2,830.4 of which 68% relates to business customers
Aggregate days’ collection period is 434 * 365 / 2,830.4 = 56 daysThe proportion of aggregate revenue related to business customers has increased from 68% to 75% – that’s an increase of greater than 10% – and I’ve already suggested that the business customers appear to be the quality debt
There is therefore even less justification for a 45% increase in the allowance for credit losses
Does all that make sense?
OK?
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