Doubts during a Pandemic: Bad Debts on the Rise Fred Phillips, University of Saskatchewan Shana Clor-Proell, Texas Christian University Learning Objectives and Introduction This reading and accompanying questions focus on how the pandemic has affected companies facing doubts about collecting amounts their customers owe them. You will see how prevalent these doubts are across several industries, you will review how these doubts are captured in a companys accounting system, and you will gain practice identifying which companies have doubts about future collections. Doubts pervade the supply chain in the apparel sector The COVID-19 pandemic has impacted entire supply chains, the networks that link manufacturers and wholesalers to retailers. The Wall Street Journal reports that the apparel sector, in particular, has been hit hard by the pandemic.1 With stay-at-home orders and unemployment weighing heavily on the minds of consumers, clothing retailers saw a decline in foot traffic in their stores, resulting in a decrease in sales. That also meant retailers werent generating the cash needed to pay their bills, so they delayed payments to suppliers and cut-back on purchases of additional goods from wholesalers and manufacturers. At the same time, these suppliers were carefully evaluating which retailers they were willing to sell to on credit. Theres no point in selling to a retailer that later defaults on payments. VF Corporation (VFC)maker of Jansport backpacks, The North Face jackets, and Vans shoesprovides a great example of how these challenges impacted its financial results. With about 60% of its products sold to retail stores on credit, VFC reports a significant balance in Accounts Receivable.2 Leading up to the end of December 2019, VFCs sales had been strong. VFC reported more than $1.6 billion in Accounts Receivable, with only a small percentage of those in doubt of collection. However, the pandemic changed everything. In the following quarter, sales of its outdoor and active clothing lines fell 15% and 9%, respectively, as compared to the same period in 2019. These sales declines were accompanied by a 19% drop in Accounts Receivable. At the same time, VFC forecast big problems in collecting from its retail-store customers, leading it to boost its Allowance for Doubtful Accounts by a whopping 75%. Usually, the balances in Accounts Receivable and Allowance for Doubtful Accounts move in the same direction, but not this time. Not in 2020. Doubts pervade other industries Were these collection issues confined to just the apparel sector? Or, might they exist more broadly throughout the manufacturing industry? To determine this, we conducted an analysis that began by downloading data for approximately 670 publicly-traded manufacturing companies in the U.S. All companies had non-zero balances in both Accounts Receivable and Allowance for Doubtful Accounts at December 31, 2019, and March 31, 2020. 1 Broughton, Kristin. Cash crunch at retailers stings suppliers during pandemic, Wall Street Journal, July 15, 2020, downloaded from https://www.wsj.com/articles/cash-crunch-at-retailers-stings-suppliers-during-pandemic-11594818000 on October 6, 2020. 2 All amounts and percentages are based on data reported by VF Corporation in its Form 10-K for the fiscal year ended March 28, 2020, and its Form 10-Q for the quarterly period ended December 28, 2019, downloaded from sec.gov on October 6, 2020. Copyright 2022 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Our sample included a diverse set of manufacturers, including Goodyear (tires), Hasbro (games), International Paper (packaging), Kellogg (cereal), Koss Corporation (headphones), and Sherwin-Williams (paint). Across all manufacturers in our sample, the average Accounts Receivable balance decreased nearly 5%, while at the same time the average Allowance for Doubtful Accounts balance increased 8%. Just as we saw earlier with VFC, these manufacturers had less to collect but yet even more was expected to go bad and never be collected. What about companies in other industries focused on services rather than goods? A recent report by Bloomberg suggests similar concerns arose in the telecom industry just after the pandemic struck.3 Its report describes dramatic increases in the allowance for doubtful accounts at AT&T (+33%), Verizon (+43%), and Comcast (+46%), between the beginning and end of the first quarter of 2020. Having supported the Keep Americans Connected pledge in March 2020, which included delaying cancelation of cell phone service for residential and small business customers unable to pay their monthly charges, these companies were facing a much greater risk of never collecting some Accounts Receivable balances. Concerns about collections existed among tech companies too, including Amazon , Facebook, and Alphabet . Looking solely at Amazon , the graph on the right shows that, during the first quarter of 2020 when the COVID-19 pandemic struck, Amazon reported a 12% drop in its Accounts Receivable yet also reported a 53% increase in its Allowance for Doubtful Accounts. Its struggles were driven mostly by customers of its Amazon Web Services (AWS), which provides cloud computing services to businesses of all sizes in a broad range of industries, suggesting widespread financial difficulties.43 See https://news.bloombergtax.com/financial-accounting/pandemic-accounting-change-trigger-bad-debt-boosts-at-telecoms.4 All amounts and percentages are based on data reported by Amazon in its Form 10-K for the fiscal year ended March 31, 2020, downloaded from sec.gov on October 6, 2020. Discussion Questions Your instructor is likely to ask some or all of the following questions. Prepare for a discussion of these questions by reading the preceding information and making notes relevant to the assigned questions.

1.The reading explains that VFC sells about 60% of its products to retail stores. The remaining 40% is sold direct-to-consumers. Why would VFC have doubts about collecting on sales to retail stores but not sales made direct-to-consumers? (Think about the journal entry recorded for each type of sale.)

2.What is meant by the statement that the balances in Accounts Receivable and Allowance for Doubtful Accounts usually move in the same direction?

3.What is the most likely explanation for the decrease in manufacturers average Accounts Receivable balance between December 31, 2019, and March 31, 2020?