In July 2006, Par Pharmaceuticals announced that it would restate financial results for fiscal years 2004 and 2005 and for the first quarter of fiscal 2006 due to an understatement of the allowance for uncollectibles for accounts receivable. The understatement resulted from delays in recognizing customer credits and uncollectible customer accounts. The company expects the restatement would total a deduction of $55 million of revenues for the time period.
The investing Web site seekingalpha.com (posted July 7, 2006) responded to Par's announcement with some calculations regarding receivables. Seekingalpha.com figured that receivables dropped 3.7 percent from 2004 to 2005 but that revenue dropped an even greater 37.2 percent over the same period. The relative growth in receivables (as compared to sales size) implies a slowing of the collection period. The Web site calculated that accounts receivables days grew from 79 days to 121 days; the site further states, "From this we see that on top of the decline in sales for 2005, the quality of the sales also declined-the company made sales on credit that it ultimately was unable to collect."
REQUIRED:
Discuss the implications of selling on credit to customers who ultimately do not pay. How is the basic accounting equation affected at the time of the sale and at the time of the realization that too many of the receivables will not be collected? What does it mean when receivables "days" increases? How can a reader of financial statements predict future restatements of revenue?