Assume you are an analyst for Big Bank and you are putting together financial information on two clothing manufacturers, Lava Fashions Inc. and Flow Designs Inc., for your boss, to help her monitor Big Bank’s loans with those two companies. Lava Fashions is a public company that follows IFRS and Flow Designs is a private company that follows ASPE.
One of the most significant assets for both companies is the accounts receivable from retailer customers. You know that your boss will be interested in knowing both the receivables’ net realizable value and the receivables’ exposure to credit risk (the risk that some of the customers won’t ultimately pay for the goods they purchased).
You look at the notes to the financial statements and find that the information provided is considerably different.
The aging of gross trade receivables at each reporting date was as follow
Lava is exposed to normal credit risk with respect to its accounts receivable. It has provisions for potential credit losses. It reduces the potential for such losses because it has no significant exposure to any single customer and because it evaluates a potential customer’s creditworthiness before extending credit.
Flow provides credit to its customers in the normal course of its operations. It continually conducts credit checks on its customers and has provisions for contingent credit losses. Three major customers represent 30% of the company’s ac- counts receivable as at December 31, 2011.
Instructions
(a) Which company’s financial statement note provides more useful information on the carrying value and credit risk for accounts receivable? Why?
(b) Why do you think Lava Fashions provides more information on its accounts receivable than Flow Designs?
(c) What additional information do you think Big Bank would want in order to assess the credit risk in trade receivables for Lava Fashions and Flow Designs?
(d) Where else do you think Big Bank could get information on the credit risk in trade receivables for Lava Fashions and Flow Designs?
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