Topic:Valuation of Receivables

Background:

SoftServ Corporation was formed on July 1, 2016 by Joe Wozniak (JW), formerly a software engineer at RyteByte Development Corporation, to produce and distribute accounting software.

During the months August through December 2016, JW and his employees devoted all of their efforts to the development of TravelAide (often called "TA"), a specialized accounting program targeted at travel agencies. Because JW had worked on the development of TA prior to forming SoftServ, the company was able to complete a prototype on October 1, 2016.

SoftServ sells TA directly to travel agents at a price of $250 per package. After shipping a few packages during the fourth quarter of 2016, the company's sales picked up during January 2017 when the company began major advertising. JW thinks he will ultimately sell about 2,500 units of TA.

Anxious to encourage potential customers to "'test drive" TravelAide, JW established generous payment and return policies. SoftServ sells all units on credit, telling customers to try the product for 90 days. At the end of 90 days, customers can either keep TravelAide and pay the $250 price or return it and pay nothing. In practice, none of SoftServ's customers pay before the 90-day trial period has elapsed, though some return the product before then.

It is now early in 2018. Joe Wozniak (JW), the founder and president of SoftServ, has been meeting with Sandra Denny, an acquisitions specialist for MacroSoft. JW and Sandra are negotiating a possible purchase price for MacroSoft's acquisition of SoftServ. As part of that negotiation, they were comparing their values for various SoftServ assets, including accounts receivable. JW had previously given MacroSoft the information contained in Appendix A. The receivables are the source of some disagreement.

JW argued, "Almost all of SoftServ's customers will eventually pay their accounts. You should focus on the data for the first quarter 2017 sales, since you can't tell whether payments will be received until a whole year has gone by. After returns, we've so far received payment from 95% of those customers. Although I think that some of the past due accounts will still pay, I'd be willing to conservatively reduce my accounts receivable balances by a 5% allowance for bad debts. Thus the value of my accounts receivable was $108,063 at December 31, 2017."

Sandra countered, "Look, your estimate isn't conservative at all. You haven't even taken into account future returns, which have amounted to 9% so far for first quarter 2017. Furthermore, I think the quality of your sales is declining. You may have received payment from 95% of your first quarter 2017 sales, after returns, but that's not a reasonable estimate for all of your receivables. In fact, payments are already late for nearly 20% of your third quarter 2017 sales. Also, I don't understand why third quarter sales were so low and fourth quarter sales so high. It looks to me like your sales people stretched the limit to pull in all possible sales during the fourth quarter. I don't trust those sales figures at all. You can't expect MacroSoft to pay more than 50% for such risky receivables. I'd do you a favor to value them at $56,875.

NOTE: SEE APPENDIX FOR DETAILED DATA

MACROSOFT INSTRUCTIONS (ICC 16a)

Your Role:

You have recently been hired by MacroSoft to work in the acquisition department. Presently you are assisting Sandra Denny with the SoftServ deal. Negotiations seem to be stuck on the valuation of receivables. Sandra is getting some heat to complete the SoftServ acquisition. She wants to resolve the valuation issue and close the deal ASAP. She asks you to do some analysis and provide her with information that she can use at her next meeting with JW. You want to make a good impression and do a good job on this assignment. You realize that it is important to determine a valuation that is fair for both parties for negotiations to move forward.

Required:

Write an inter-office memo to Sandra. Provide her with information that will be helpful in her negotiations with SoftServ. Your memo must include your recommendation for the valuation for SoftServ's receivables, at December 31. Support your opinion and explain the basis for your estimated future returns and bad debts. Also discuss why it is not possible to determine an "exact" amount for future sales returns and bad debts as of December 31.

Consult May & May for information on memos. You should also follow the suggestions in part one on style, clarity and flow of thought.

SOFTSERV INSTRUCTIONS (ICC 16b)

Your Role:

You are the CFO for SoftServ, and have been assisting JW with the MacroSoft negotiations. It is in your best interest to have the deal get worked out. You will make some money on the buy-out, and be retained by MacroSoft. The new position will be more challenging, pay better, and provide greater career opportunity. Accordingly, you are concerned that the negotiations seem to be bogged down because of the receivables valuation issue. As CFO you feel it is important to attempt to derive a valuation that is fair and acceptable to all parties.

Required:

Write an inter-office memo to JW. Provide him with information that will be helpful in his negotiations with MacroSoft. Your memo must include your recommendation for the valuation for SoftServ's receivables, at December 31. Support your opinion and explain the basis for your estimated future returns and bad debts. Also discuss why it is not possible to determine an "exact" amount for future sales returns and bad debts as of December 31.

Consult May & May for information on memos. You should also follow the suggestions in part one on style, clarity and flow of thought.

Appendix

SoftServ Sales and Accounts Receivable Activity

through December 31, 2017

Units ordered Units shipped toCustomerPayment Acct Rec

duringOrders canceledfill thereturnsreceivedbalance

Quarterthe quarterbefore shipmentquarter's ordersthru 12/31 thru 12/3112-31

2016:4 100101 90

2017:12569 247 2221312

2399 12 387 3733218

3140 413611 10124

4488 18 430 290401

Total1,29343 1,210 100655455

Gross accounts receivable at 12/31/17: 455 units@$250 = $113,750.

To interpret the above table, consider the events that underlie the numbers in the first row. During the first quarter of 2017, SoftServ received orders for 256 units for TA. Nine of these orders were canceled, so the 256 units ordered generated 247 shipments (some of them shipped during the second quarter). Of the 247 units shipped, 22 were returned during the trial period, and 213 units were paid for by December 31, 2017. (Although the table does not reveal the timing of payments, it turns out that payments for 189 units were received on time, payments for 20 units were received between 1 and 90 days late, and payments for 4 units were received between 91 and 180 days late.) As of the end of the year, 12 of the first quarter shipments were still in the hands of customers who had neither paid for the unit nor returned it. SoftServ is trying to collect all overdue accounts. Some of the fourth quarter's orders had not been shipped as of December 31, 2017 and could still be canceled.