Question 11.

In early 2003 Bristol-Myers Squibb announced that it would have to restate its financial statements as a result of stuffing as much as $3.35 billion worth of products into wholesalers’ warehouses from
1999 through 2001. The company’s sales and cost of sales during this period was as follows:

| 2001 | 2000 | 1999 | Net sales | $18,139 | $17,695 | $16,502 | Cost of products sold | 5,454 | 4,729 | 4,458 |

The company’s marginal tax rate during the three years was 35 percent. What adjustments are required to correct Bristol-Myers Squibb’s balance sheet for December 31, 2001? What assumptions underlie your adjustments? How would you expect the adjustments to affect Bristol-Myers Squibb’s performance in the coming few years.

The problem is that the sales that have been recorded and the associated receivables, tax etc., may be overstated because the company has pushed inventory out to warehouses as if the inventory is sold; however, the revenue may not yet have been earned so there is doubt whether the sales are legitimate.

In the Bristol-Myers Squibb example, the firm's Trade Receivables, Sales, and Net Profit are overstated. To correct for this problem in the 2001 balance sheet, Trade Receivables needs to decline by $3.35 billion, and Inventories need to increase by an amount that reflects the effect of gross profit margins. The Inventories adjustment can be achieved by multiplying the Trade Receivables adjustment by the ratio of Cost of Sales to Sales. The increase in Inventories is approximately $1 billion (3.35 * (5,454/18,139)). The $3.35 billion decline in Trade Receivables is mirrored by a decline in 2001 Sales of the same amount. Similarly, the
$1 billion increase in Inventories reflecting unsold product corresponds to a decline in the Cost of Sales by the same amount. Multiplying the -$2.35 difference between the reduction