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Research Queries Non-Trade Items on Balance Sheet

Tammy Whitehouse | February 8, 2013

A brokerage firm is taking note of non-trade items growing on corporate balance sheets and wondering if companies are managing them in a way that makes some of their key performance metrics look a little healthier.

Wunderlich Securities says in a recent research report it believes non-trade items are sometimes leading indicators of hidden future margin or earnings exposures. “We believe understanding the accounting in this area can make investors more aware of how companies can manage amounts to make certain metrics like inventory days and receivable days look more favorable,” the firms says.

Non-trade items are typically receivables of some kind, says the report. They are usually a hybrid asset, so they don't meet a clear definition of whether they constitute a receivable or inventory. They might arise, for example, when a manufacturer supplies component to a supplier, who uses them to build components of a product or perform some sub-assembly, which is later sold back to the manufacturer. Such transfers blur the application of accepted definitions of “sale,” “inventory,” or “accounts receivable,” giving rise to their categorization as non-trade receivables, which have no effect on the income statement.

The report explains that classifying such amounts outside of accounts receivable or inventory has the effect of making working capital metrics like inventory days and receivable days look more favorable. The report also notes: “the income statement gross margin impact, which is usually a cost of sales item, can be affected depending upon how and when the cost/profit associated with these transactions gets recorded.”

The reports also notes some issues investors should keep in mind as they consider the effect of non-trade receivables on a company's financial statements. Such receivables are expected to be recovered in future periods by receiving future inventory, cash, or offsets against liabilities, such as payables. If those amounts are not recovered, companies should write them down. Most companies studied by the brokerage firm treat such items as non-recurring or one-time events, but there's a reasonable question about whether such transactions should be treated as normal provisions against recurring earnings, the firms says.

There's also a reasonable question, says the report, in whether support provided between companies engaged in such transactions could be deemed under accounting rules to constitute one company becoming a variable interest entity to the other, meaning it should be consolidated to financial statements.

The Wunderlich report notes that tech companies Apple and Seagate Technologies provide disclosures on their accounting methods, presumably because the amounts are material. “We believe many others (especially in the technology sector) have similar arrangements with their suppliers,” the report says. “However, transactions are undisclosed under the premise that amounts are relatively immaterial.”