INSTITUTE OF BUSINESS ADMINISTRATION

FINANCIAL ACCOUNTING & INFORMATION SYSTEM

MBA EXECUTIVE
FINAL EXAMS
ASSIGNMENT NO. 1
20 MARKS

ALBERT ROBINS COMPANY, INC.–TRADE RECEIVABLES

In mid-January 2006, Dave Dixon, director of corporate accounting for Albert Robins Company, Inc.,
was faced with the task of estimating his company’s provision for uncollectible trade receivables for
2005. Dixon was particularly concerned about the mounting trade-receivable balance of one of the
company’s three major product lines, French Fragrances (FF), because he believed that the collectibility
of a large portion of this balance was questionable. Customers (several major U.S. retailers) had grown
accustomed to taking large unauthorized deductions (referred to by Robins as billbacks) on bills from
their suppliers in order to widen their otherwise narrow profit margins. In December, Dixon had given
the FF general manager three weeks to “do something about the receivables problem; to at least get
payment promises from the major retailers or face a large write- off,” but nothing had been done.
Therefore, Dixon was faced not only with analyzing the total outstanding balance in the FF receivables
account, but also with determining the collectibility of the balance of unauthorized customer
deductions. As a consequence of the problem, Dixon was also prepared to reconsider the company’s
policies for setting up trade receivables’ allowances and writing off bad debts.

General Company Background

Albert Robins Company was founded in 1902 as a small apothecary and manufacturing chemist’s
shop. The company grew into a multinational corporation engaged primarily in the manufacture and
marketing of over-the-counter pharmaceutical products, bathroom consumer products, and perfume
products. Although sales in 2005 reached a historic high of $632 million, the company showed a major
loss for the first time. The loss resulted from the write off of nearly $300 million of impaired
goodwill. Also during 2005, the FF trade accounts receivables grew to $1.6 million, an amount equal
to 146 days’ sales, and the outstanding billback balance rose to $411,902. Consistent with the
company’s desire to achieve a proper matching of revenues and expenses, recognize losses as early
as possible, and reflect economic reality, Dixon believed the time had come to review the company’s
accounts-receivable reserves on all trade receivables.

Accounting for Trade Receivables

Dixon realized that the company’s three major product lines were so diverse with respect to
composition and distribution channels that each warranted an individual review of the policy for
providing for uncollectible trade receivables. The pharmaceutical product line consisted of
pharmaceuticals promoted primarily to physicians, hospitals, and pharmacists; pharmaceuticals were
the original products carried by Robins and accounted for 57% of sales and 76% of profits. This
product line was distributed by Robins through large wholesalers in the United States and abroad;
approximately 88% of the sales in this category were to only 410 wholesalers.

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Dixon pointed out that news spread quickly when a particular pharmaceutical wholesaler was in
financial trouble, in which case Robins usually began to quickly monitor the activity in the
customer’s account closely or, if necessary, to terminate Robins’ extension of credit to the
wholesaler. To arrive at a yearly uncollectible receivables provision for the ethical pharmaceutical
line, Dixon set up an allowance based on a review of the individual accounts. Then he prepared an
aging schedule of those accounts that he believed posed collection problems. He typically set up an
allowance for uncollectibles of 10% of the balances that were 1 to 30 days past due; 25% of the
balances 31 to 60 days past due; and 50% of the balances over 60 days past due. In some instances,
when he had particularly insightful financial information on a customer, he made his own subjective
judgment as to the collectibility of the account. Historically, accounts going bad and thus
necessitating a write-off had been less than 0.2% of net sales. The stability of those accounts allowed
Dixon to make his estimates with reasonable confidence.

The distribution system for the consumer products category, which included cough preparations and
pharmaceuticals marketed to the public over the counter, was far more complex than was the system
for the ethical pharmaceuticals category. During 2005, the consumer products line accounted for
39% of sales and 23% of profits. It was sold not only to major wholesalers, but also to thousands of
small pharmacies and brokers. Therefore, the individual uncollectible accounts pertaining to
consumer products customers were generally either very large or very small, depending on whether the
account in trouble was a major wholesaler or one of the numerous “mom and pop” pharmacies. Since
the number of accounts was far too many to review individually, Dixon used an allowance method
based on a percentage of sales. To date, for the fiscal year ended December 31, 2005, $174,490 in
consumer-products accounts receivables had been determined to be completely uncollectible.

The French Fragrance line, with headquarters and production facilities in France, had become a
wholly owned subsidiary of Robins in 1967. The product line was composed of five perfumes, which
were marketed to both the male and female upper-income demographic segments. FF accounted for
less than 2% of Robins’ sales and in 2005 was just breaking even in profitability. It was distributed in
the United States only to major retailers in New York, Atlanta, Miami, Dallas, Chicago, Los
Angeles, and San Francisco; over 80% of U.S. FF sales went to only 35 retail distributors. Dixon
was able to examine the financial standing of each of those customers individually and to establish
an allowance for bad debts using the same method he used for the ethical pharmaceutical line. For
2005, however, he decided to also use the direct write-off method for billbacks that he deemed
uncollectible. Dixon had already determined that $40,000 in accounts receivable for FF (not
including the billbacks) had actually “gone bad,” and were to be written off in 2005 and that the
balance in the allowance account should total $59,383.

History of Collections for Trade Receivables

Prior to 2001, responsibility for the collection and accounting for trade receivables at Robins had been
decentralized on a regional basis with separate credit and collections departments for
pharmaceuticals, consumer products, and FF. During those years, customer accounts were reviewed
individually in order to derive an allowance for bad debts. In 2001, however, with the number of
product lines and accounts growing, the company decided to centralize its receivables function and
to change its policy to combine an individual review of customer accounts with the percentage-of-

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sales method of establishing an allowance for bad debts. The company also developed a
computerized aging schedule to aid in those computations. Dixon pointed out that the receivables
department currently employed nine people, who spent approximately 40% of their time on the FF
accounts.

Since the receivables function had been centralized, Dixon noticed that the days’ sales in trade
receivables had shown a gradual improvement for both ethical pharmaceuticals and the consumer
products. The receivables for ethical pharmaceuticals had been reduced from 65 days’ sales in 2002
to its current balance of 47 days. The consumer-products outstanding trade receivables had improved
from the equivalent of 91 days’ sales in 2003 to 77 days’ sales in 2005.

Although centralization had helped the company control collectibility for these two product lines, the
same was not true for French Fragrances. Here the receivables balance had grown from 73 days’ sales
in 2002 to 146 days in 2005. More important to Dixon, the disputed claims portion of the receivables
(the billbacks) was 25% of the total receivables balance, whereas it ranged between 1% to 5% for the
other two product lines. Financial information pertinent to the three product lines are shown in
Exhibits 1, 2, 3a, 3b, and 4.

The Billback Dilemma

At the end of 2005, the French Fragrance line in the United States had $411,902 in billbacks included
in its $1,599,568 of trade receivables (Exhibit 4). A billback was generated when a retailer made a
payment for less than the invoiced amount. In response, Robins made a new invoice for the unpaid
amount and sent it back to the retailer for payment. For example, a $20,000 invoice might be sent to
Bloomingdale’s, who might remit payment for only $15,000. Robins would record the original
invoice as paid, originate a new invoice (a billback) for the unpaid amount of $5,000, and send it to
Bloomingdale’s for payment. Almost every FF invoice had a subsequent billback, and the historical
collectibility of these billbacks was considered poor. The history of one typical billback is detailed in
Exhibit 5.

A common practice in the United States was for large retailers to take unauthorized deductions on
the bills received from their suppliers and attribute the deduction to a promotion allowance, a
product demonstration salary, or just an unidentified deduction. Of the $411,900 in billbacks on FF,
Dixon decided that $205,000 was attributable to unidentified deductions. The rest Dixon explained
as being more or less the result of a paperwork merry-go-round. Although Robins had agreements
with many of the large retailers to pay for a portion of their promotions or demonstration salaries,
the retailers refused to wait for the paperwork to go through to be reimbursed. Instead, they would
just deduct the amount they believed they were owed from the goods’ invoice amount, which made
bookkeeping an extremely difficult task for Robins. While these practices were rampant in the perfume
industry in the United States, they did not occur with the FF line in France or with Robins’ other
product lines.

Ideally, these large retail customers should have paid their suppliers for the goods received and then
billed the suppliers for any agreed-upon shared expenses. Yet, despite the persistence of Robins’
management, the retailers refused to cooperate. In fact, the situation had grown so serious with one
retailer that Robins had stopped shipments for three weeks. In reality, however, the FF product line
did not carry enough leverage with the major department stores for such threats and actions to
influence their behavior.

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Dixon’s Concern

As Dixon was reviewing the receivables balances for the three product lines for the fiscal year ended
December 31, 2005, he wondered what he should do about the mounting billback problem. He also
needed a realistic estimate for the corporation’s bad debt expense and the receivables allowance
balance for 2005.

Assignment Requirements

1. Recreate the accounting transactions that were made to recognize bad debt expense and
accounts-receivable write-offs during 2004 for each of the three product lines.
2. What is a reasonable estimate of the bad debt expense for 2005 for pharmaceuticals? For
consumer products? For French Fragrances?
3. Make the appropriate year-end accounting transactions for 2005 and set up T-accounts that
show the year-end balance in the allowance accounts.
4. How should Dave Dixon resolve the billback problem with retail customers in the future?
How could the accounting information system assist in successfully implementing your
suggestions?

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 Exhibit 1
ALBERT ROBINS COMPANY, INC.–TRADE RECEIVABLES
Sales and Receivables Data

Sales 2002 2003 2004 2005

Pharmaceuticals $173,712,923 $128,519,975 $160,077,407 $194,951,564

Consumer products 118,653,484 123,229,687 132,557,961 128,532,000
French Fragrances $ 5,132,689 $ 3,860,305 $ 4,899,240 $ 3,993,933

Year-End Trade Receivables

Pharmaceuticals $ 30,691,204 $ 17,206,984 $ 20,364,088 $ 25,014,708

Consumer products 7,641,931 30,763,238 28,959,778 27,257,219
French Fragrances $ 1,014,773 $ 885,190 $ 1,781,617 $ 1,599,568

Billbacks (included in receivables figures above)

Pharmaceuticals $ 552,280 $ 159,908 $ 63,413 $ 218,000

Consumer products 58,932 294,517 1,476,500 1,305,000
French Fragrances $ 24,456 $ 319,000 $ 563,097 $ 411,902

Source: Company records.

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 Exhibit 2
ALBERT ROBINS COMPANY, INC.–TRADE RECEIVABLES
Accounts Receivable Allowance and Write-Off Data

Year-End Balance in Allowance Account 2002 2003 2004

Pharmaceuticals $300,000 $ 203,669 $ 300,000

Consumer products 100,000 241,881 219,000
French Fragrances $ 49,516 $ 28,310 $ 60,900

Accounts Receivable Write-offs 2002 2003 2004

Pharmaceuticals $249,494 $ 278,030 $ 152,283

Consumer products 250,600 474,267 685,671
French Fragrances $ 19,991 $ 21,206 $ 100,038

Source: Company records.

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 Exhibit 3a
ALBERT ROBINS COMPANY, INC.–TRADE RECEIVABLES
Example of Accounts Receivables for Pharmaceutical
Products as of December 31, 2005
(credit terms 2/10, net 30)

Customer Total Balance Current 1–30 Days 31–60 Days Over 60 Days
Name Due Items Past Due Past Due Past Due

1. Amfak Drug Co. $51,193 — — — $51,193

2.* Leigh Laboratories 20,996 $4,338 $16,658 — —
3. Edwards Commissary 109,722 — — $35,802 73,920
4. Central Drug Supply 87,703 — — 4,618 83,085
*
5. Drug Service, Inc. 47,602 — — — 47,602
6. Ames Plaza Drugs 59,606 — — — 59,606
7. Johnson Drug Co. 56,884 — — 56,884 —
*
8. Armco Pharmac. 31,909 — — — 31,909
*
9. Northern Medical Supplies 34,634 4,914 5,910 — 22,814
10. Medco Drugs 48,108 4,100 4,008 40,000 —
11. Reeds Drug Supplies 63,498 — — — 63,498
12. Remco, Inc. 54,022 — — — 54,022
13. Hampton Drug 60,929 — — — 60,929
*
14. South Bay Drug Co. 36,401 36,401 — — —
15. Davis Laboratory Supplies 72,465 — — 26,082 46,383
16. Ridgefield Drugs, Inc. 18,526 — 18,526 — —
17. Geer Drug Corp. 49,101 24,312 24,789 — —
18. Humdico Medical 77,670 18,070 59,600 — —
19. Albertsons Drugs, Inc. 36,317 8,697 9,402 18,218 —
20. Pharmaceutical Supplies 26,965 — — — 26,965
*
21. Virginia Drug, Inc. 28,324 — — — 28,324
22. Total other accounts
(Not considered doubtful) 23,942,138 23,942,138

$25,014,708 $24,042,970 $138,893 $181,604 $650,245

See Exhibit 3b for additional financial information.

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 Exhibit 3b
ALBERT ROBINS COMPANY, INC.–TRADE RECEIVABLES
2005 Information Pertinent to Pharmaceutical Product Line

Drug Service, Inc., reported that it expects to post a fiscal first-quarter loss of more than
$900,000. The company also issued a press release stating that it is in default on a $7 million bank
loan.

The pharmaceutical wholesaler and distributor said it expects revenue for the quarter ended
Sunday of about $3.5 million, down from $11.8 million a year earlier. In the earlier quarter, the
company lost $600,000, and stock prices declined dramatically.

Drug Service, Inc., said it had planned to refinance the loan, which came due Sunday, by
mortgaging some real estate, but that plan fell through.

******

Two former officers of South Bay Drug Co., a small wholesaler for medical supplies and
pharmaceuticals that entered bankruptcy-law proceedings in December 2005, pled guilty to grand
larceny, according to the state attorney general.

Rollin Need, former president of South Bay Drug Co., and Isaac Comerch, former operations
officer, were indicted on charges of conspiracy, fraud, and grand larceny. The conspiracy and fraud
charges were dropped when the two pled guilty to grand larceny, a representative from the attorney
general’s office said. Charges are still pending against another former officer, said Terrence
Whitney, who was chief financial officer and spokesperson for the company.

Need couldn’t be reached for comment on the guilty plea. An attorney for Comerch said he
declined to comment on the case. Whitney couldn’t be reached for comment either.

******

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 Exhibit 3b (continued)

Amfak Drug Co., announced that it had submitted a proposal to its lenders to restructure $1
billion in debt to avert a cash shortage in the first quarter of 2006.

Under the proposal, Amfak Drug Company’s secured lenders would receive interest and
principal payments until about 2008 based on the company’s available cash flow. Principal
payments of about $334 million for Amfak’s secured debt are currently due through 2008. Amfak
said payments under the debt restructuring would be less than the contracted amounts until 2009.
After that, the original payment schedule would resume.

If approved, the debt restructuring will become effective January 1. If lenders don’t agree to the
proposal, a filing under Chapter 11 of the federal bankruptcy code would be likely.

******

Leigh Laboratories, Inc., announced it will dismiss as many as 100 employees in about 30
days. The employees who work at staff positions at the company’s headquarters represent a fraction
of Leigh’s 8,000 workers. However, the layoffs are the first in about 12 years for Leigh. For the third
quarter ended September 31, Leigh’s earnings slumped 66%, the company’s first downturn in
quarterly earnings since 1990. For the quarter, Leigh earned $3.2 million on revenue of $152.7
million.

Leigh didn’t rule out additional layoffs.

******

Armco Pharmaceutical’s most recent financial statements reported a 23% drop in earnings
from operations for its fiscal third quarter ended May 31.

The company blamed its financial condition on the generally weak dollar and on foreign
competition in the pharmaceuticals business. Armco also announced that its plans to expand into
Latin America were now on hold.

******

Northern Medical Supplies recently announced it will close two of its distribution warehouses
in the Atlantic seaboard region due to the need to streamline operations and shed overhead costs.

The company said its warehouse in North Carolina, which employs 180 people, would be
phased out over a period of months. Operations at its South Carolina facility, which has 475
employees, will be reduced in size and eventually closed. According to the company, the closing
date is not yet known.

******
 Exhibit 3b (continued)

Virginia Drug Company, which has filed a request to reorganize under the eyes of the U.S.
Bankruptcy Court in Richmond, is seeking a buyer. James Farin, Virginia Drug Company’s
president, said they hope to be bought by Seifer, Inc., of Alexandria, Virginia. However, no written
agreement has been made.

Virginia Drug Company operated as many as six distribution outlets about two years ago. When
it filed papers in bankruptcy court saying it planned to seek reorganization under Chapter 11, it listed
assets of about $6.2 million and debts of about $9.9 million, including notes totaling about $8.5
million from Union Virginia Bank.
 Exhibit 4
ALBERT ROBINS COMPANY, INC.−TRADE RECEIVABLES
French Fragrances’ Outstanding Billbacks, December 2005

Outstanding
No. of Past Due
Codes Billbacks Current 1–30 Days 31–60 Days 61–90 Days Over 90 Total

51 54 $ (6,571.63) $ (2,154.43) $ (3,838.88) $ (1,650.00) $ (6,268.40) $ (20,483.34)

52* 14 (4,141.33) (2,965.48) .00 (64.89) (880.90) (8,052.60)
53* 60 (2,412.67) (9,991.25) (1,210.71) (795.04) (10,953.36) (25,363.03)
54 488 50,283.27 35,072.97 25,031.08 5,947.62 88,635.20 204,970.14
55* 43 (1,791.29) (3,547.82) (2,358.47) 3,280.52 3,725.40 14,703.50
56 18 54.00 278.66 113.10 217.90 643.84 1,307.50
58 92 5,917.00 333.78 843.41 1,212.36 14,184.41 22,490.90
60 1 .00 .00 .00 .00 252.00 252.00
62 119 8,414.87 274.21 3,368.49 14,785.02 19,303.54 46,146.13
64 7 .00 361.45 .00 154.26 469.44 985.15
66 31 1,749.20 744.14 399.08 233.95 582.38 3,708.75
67 6 48.63 .00 203.12 152.27 50.00 454.02
68 140 4,300.00 1,260.35 1,235.00 8,920.63 111,046.19 126,762.17
69 63 487.30 1,145.69 593.57 4,201.89 14,574.00 21,002.45
70 1 .00 .00 .00 2,025.00 .00 2,025.00
71 1 .00 .00 .00 .00 157.86 157.86
72 1 .00 .00 .00 .00 144.50 144.50
73 45 142.03 (452.98) 510.75 (121.08) 5,386.51 5,465.23
79 26 842.30 80.00 19.20 249.30 14,035.29 15,226.09

Totals 1,210 $60,904.26 $27,534.93 $29,625.68 $38,749.71 $255,087.90 $411,902.48

Source: Company records.


A negative billback was generated when a customer made a payment for more than the invoice amount.
 Exhibit 5
ALBERT ROBINS COMPANY, INC.–TRADE RECEIVABLES
History of a Typical French Fragrance’s Billback

Date Description of Correspondence

2/20/04 Goods shipped to retailer.
3/1/04 Original invoice for $56,702 mailed to retailer, such as Bloomingdale’s.
5/1/04 Past-due notice sent.
7/1/04 Check for $30,000 received by Robins.
7/15/04 Billback invoice for $26,702 mailed to retailer.
9/1/04 FF manager called customer regarding billback. Customer will look into outstanding
balance.
10/1/04 Received letter from customer saying $26,702 discount taken was attributed to a
product promotion booth.
10/15/04 Wrote letter to customer saying only $5,000 was authorized for promotion booth.
11/15/04 FF manager called customer; customer said they’d take care of the discrepancy.
11/28/04 Received check for $6,000.
12/5/04 Billback #2 generated for $15,702.
1/30/05 Call to customer, who said they were trying to clear up outstanding invoices.
2/15/05 Robins’ credit manager informed customer he was planning a visit to their NY office
to clear up all outstanding bills.
3/1/05 Credit manager made NY trip. Customer happened to have billback #2 in their file.
They’ll check into it.
4/1/05 Received check for $7,000.
4/10/05 Call to customer who said the balance not paid was for special product advertising.
5/1/05 Billback #3 generated for $6,702. (Robins allowed $2,000 special-promotions
discount.)
12/31/05 Billback #3 outstanding. No apparent resolution. Write off?