Hello, i am professor Brian Bushee. Welcome back. In this video, we are going to take a look at the accounts receivable and inventory disclosures for the 3M Company. But then, since those disclosures are not going to be that exciting, we're also going to bring in a couple guest star companies. We're going to bring in Best Buy, another Minnesota company, to take a look at their disclosure for their allowance for bad debts. And Honeywell, which used to be a Minnesota company, now it's based in New Jersey. We'll bring in their financial statements to take a look at their inventory disclosure. Let's get started. Let's start with the balance sheet which is on page 48 of the 3M report. Here they report their accounts receivable, 4061 and 3867. Those are net of allowances and they give you the allowances right here. 105 and 108. So one of the things that we calculated in the videos was what percent of the gross accounts receivable does the company not expect to collect. So what's the percentage estimated on collectables, and has that gone up or down over time? So, we can do that for 3M. In 2012 we would take 105 divided by not 4,061 but 4,061 plus 105, which is 4,166, we want 4,166, because that's the gross accounts receivable. So 105 divided 4166 we could probably all do in out head, that's 2.5%. We can do the same thing for 2011. We would take 108 as the allowance divided by 108 plus 3867, which is 3975. So 108 divided by 3975 is 2.7%. So 3M's percent of expected uncollectibles has gone down slightly, from 2.7% to 2.5 %, which is not surprising, because just by looking at the numbers here, we can see 108 was a bigger allowance, but it was on a smaller net balance. So the allowance has gone down at the same time that receivables have gone up. Now, we're going to look for more accounts receivable information in a second, but since we're here, why don't we go ahead and take a look at inventories. So on 3M's balance sheet, they give you the breakdown into finished goods, work in process, raw materials and supplies. And what we see is each category is growing, consistent with a growing company. So they're bringing in more raw materials towards the end of the year than they have the beginning of the year. They're building up their work in process over the year. And they're building up their finished goods inventory, presumably in anticipation of future demand, but we can actually see whether that's the case. So that's what we can see about accounts receivable and inventory on the balance sheet. Okay, we'll make a quick stop on the cash flow statement. So here we have the change in accounts receivable, so accounts receivable have gone up, so that's a negative number on the cash flow statement. But if you remember, when we looked through the cash flow statement, we didn't see any provision for doubtful accounts or bad debt expense. So 3M is using the alternative where this accounts receivable is the change in the net number. So instead of breaking up bad debt separately and then showing the change in the gross, they just show the change in the net. And as we've talked about before, this change of 133 is not going to match the change we saw on the balance sheet because some of this accounts receivable could have come in an acquisition, or there could be foreign currency involved. The next part of the financial statements you always want to check out is note one Significant Accounting Policies to see how they do the accounting for the accounts receivable in inventory. If we go to page 53, you'll see a note for inventories, and 3M says inventories are stated at lower of cost or market, which is not a surprise because that's the rule. You always have to carry the lower cost or market, and they say cost determined on a first in first out basis. So 3M uses FIFO for all of their inventories. So we're not going to get any of those interesting LIFO disclosures in 3M. And it also for this reason, 3M doesn't have a separate inventory footnote because they've shown you the breakdown of raw material, work in process, finished goods on the balance sheet. They're using FIFO, so there's no kind of LIFO related disclosures. So they actually don't have a special footnote for inventory. Then if we jump ahead to page 55 there's a section for accounts receivable and allowances. So, trade accounts receivable are recorded at invoiced amount, but do not bear interest. That's common. May maintain allowance for bad debts, cash discounts, product returns and other items. So, we talked about the bad debts. We didn't talk about product returns. If you allow customers to return some of their goods for a full refund, you have to make an allowance for that at the time of sale. The accounting works exactly the same as the allowance for bad debts, where you would basically create the contra asset account to keep track of expected product returns. And then when the returns come in, you would get rid of the accounts receivable and get rid of that allowance. So, there's really nothing new to look at there, it's just changing bad debts to product returns in the prior stuff that we've done. So for allowance for doubtful accounts, they say it's based on their best estimate of probable credit losses. They do it based on historical write off experience, by industry and regional economic data, and they use historical sales returns for the product returns. Nothing that new or interesting here. Last place that 3M talks about accounts receivable and inventory is on page 35, which is part of the MDNA There's a little bit of a mention of working capital and inventory as they talk, sorry, accounts payable and inventory as they talk about their working capital. They say receivables increased 5% compared to the prior year, driven by an increase in fourth quarter sales. So it's growth. They also had some acquisitions that brought in accounts receivable, and some foreign currency adjustments. Inventory increased by 12% with increases partially contributal to an increase in demand in the fourth quarter of 2012. I guess they must be building more inventory in response to the demand. There were also some acquisitions that added to the inventory and currency translation effects. So the currency translation effects and the acquisitions are why we don't see the balance sheet change match the change on the cash flow statement. And that's all I can find about bad debt and inventory in the 3M report, which means there was something very interesting that they left out. Do you know what it is? What's missing is that 3M never discloses in their report what their bad debt expense is. How can they get away with that? Well there's something called the materiality principle, which says that if an item is so small that its disclosure would not change how investors view the company, then you don't need to disclose it separately. For instance, you never see paper clip expense on income statement. Paper clip expense is just lumped in with SGNA expense. So you can assume in a case like 3M, if they're not disclosing bad debt expense, it's very small and you can treat it as effectively zero if you're doing some of the calculations that we've done during this week. Now, let's take a look at our special guest company, Best Buy, for how they treat their accounts receivable and bad debts. So, on their balance sheet, they have a receivables number, and notice it doesn't say anything about allowances here. Now when we look at these balances which are 2,704 at the end of the year, 2,288 at the beginning of the year, those are still net balances. We just don't know what they're net of because there's no disclosure of the allowance here. If we go to Best Buy's cash flow statement. Up here in the things that we add back, we might see provision for doubtful accounts or bad debt expense added back. We don't see it, so they're using the technique where they just take their change in net receivables. And they don't break out bad debt separately, but then what Best Buy provided was something called Schedule II. Now this used to be required for all companies, but now the SEC says you don't have to do this anymore. But Best Buy still does it. And this is where they put all of their information in their allowances. So notice they have here allowance for doubtful accounts. They have a beginning balance and an ending balance. So this is the spot where they're showing you the allowances that that balance sheet number is net of. So remember the balance sheet number at the beginning of the period was 2288, which means that the balance and gross at the beginning of the period was 2288 plus 72 equals 2360. And at the end of the period the net number on the balance sheet was 2704. If we add 92 we would get 2796 for the gross amount. One of the things we can now do though is we have is we can figure out cash collection from customers because we have bad debt expense, and more importantly the write offs and recoveries, which is the number that we need to plug into that accounts receivable account to try to get at cash collections. So if we set up a T account, what we're going to to do is have a beginning balance of 2360. This is an accounts receivable, and by the way if there's anybody taking this class that works for Adobe, and you can figure out a way in the next update to avoid it catching this thing all the time, so I have to hit escape, please feel free to add that update. That would be awesome. Anyway, so in our accounts receivable we have 2360 beginning balance. 2796 as our ending balance. Write offs and recoveries were 14. You put those on the credit side. Now this is write offs and recoveries, so it's net of that. So we don't have to worry about finding separate recoveries. This is just the net number. And so, what we can do then is plug in sales on the debit side of the T account. So hang on, I'm going to flip back to the income statement for a second. Here's revenue 45,085. So we can put 45,085 here on the debit side. And then the only thing that we're missing is cash collection from customers. So we can plug that answer as 44635. Now if we hadn't been able to find these write offs and recoveries, we would've been pretty close. We would only have been off by 14. So you can always, even if you can't find that, you can do it as an approximation. But this gives you a little bit more of an exact number on the cash collection from customers by Best Buy. So if you don't see allowances on the balance sheet, one thing to look for in the report is there may be a separate schedule, which gives you all the details on both the balance and the allowance, and the bad debt expense, which you can then use to do your calculations. One thing I find interesting comparing Best Buy to what we saw with 3M is that if you calculate the percent of Best Buy's allowance as a percent of gross accounts receivable, it's about 3.1% in 2011 and 3.4% in 2012, which is not that much bigger than 3M's 2.7%. But yet 3M is saying it's immaterial and not disclosing it, whereas Best Buy we are getting a disclosure. And I think what's going on here is Best Buy is in the retail segment, and I think there's probably more demand from investors and analysts to keep up on bad debt expense in the retail segment than there is in the manufacturing segment where 3M operates. So I think there's an example where investors must not care that much about 3M's bad debt expense, whereas Best Buy it is something they want to see even if it's small so they can track trends over time or compare to other retailers. Now let's take quick look at our other special guest company, Honeywell. So on their balance sheet they disclose inventories. 4,235 at the end of the year. 4,264 at the beginning of the year. They don't provide the breakout of raw materials, work in process, or finished goods. And if you ever see a manufacturing company that doesn't provide that breakout, they probably have a separate footnote where they give that breakout later, which is what we will see with Honeywell. Their summary of significant accounting policies, if we go down to inventories, we can see inventories are valued at the lower of cost or market. No duh, they're always valued at the lower of cost or market, using the first in, first out or average cost method, so FIFO or weighted average. And the LIFO method for certain qualifying domestic inventories. So, why does Honeywell use different methods? Because they're a multinational company, and inside the U.S., they could use LIFO or these other methods. Outside the U.S., they don't have much of a choice, because they can't do LIFO. It's either FIFO or average cost. And so, what Honeywell must realize is that they can get some tax savings in the U.S. by using LIFO. So, they use it here for certain inventories. But then outside the U.S., they have to use either FIFO or average costs. So if we go to the next page of the excerpts, there is a footnote for inventories and here it is, the breakdown of raw materials, work in process, and finished goods. Then we have a subtotal, reduction to cost basis. This is the LIFO reserve. Then we have below that the total inventory. This is what shows up on the balance sheet. This is the balance sheet that includes LIFO. Now, notice it's not all LIFO, but it includes the LIFO evaluation of the inventories that are on LIFO, which means that this number above the reserve is what it would be under FIFO or weighted average, which is what they all say it is. And down below they say inventories valued at LIFO amounted to 325 and 302. This 325 is how much of that inventory is carried at LIFO. So as you can see, the vast majority of their inventory is not carried at LIFO. It's FIFO or weighted average. But this LIFO reserve of 197, or you can get the number here. It applies to that 325 of inventory. So you can actually see there's been some pretty big price movements because the LIFO reserve is a big chunk, almost two thirds of the value of this and in about LIFO inventory, which means that they've historically got a lot of tax saving in the U.S. by using the LIFO inventory. One last thing is if they had a LIFO liquidation, so they sold more LIFO inventory than they produced, and it helped their cost of goods sold, that would be disclosed here. But if you don't see any mention of a LIFO liquidation, it means that they didn't have one. And so there was no benefit to their cost to console their earnings due to a LIFO liquidation during the period. I guess I should apologize to the state of New Jersey. I was watching back the intro. I noticed that I sneered a little bit when I said New Jersey. I actually love New Jersey, go there every weekend in the summer to enjoy it's beautiful shore. So I sincerely apologize to the state of New Jersey. Probably a good time to wrap up this week, so that's the end of our week on accounts receivable and inventory. Next week we're going to do some videos on ratio analysis. And you'll get a chance to do the mid course exam. I'll see you next week.