1.) Restate Nuware’s 2013 earnings as if the company had used the same accounting methods and assumptions as R.P. Stuart. Your answer should focus on, but not necessarily be limited to, Nuware’s accounting for investments, receivables, inventory, and PP&E.
From the discussions in Nuware’s notes and the comparison with RP.Stuart’s financial statement, we noticed that there are several different accounting policies being adopted, including receivables, inventory, advertisement cost and PP&E. Moreover, it seems that Nuware is using gains on investment to manipulate total income. Therefore, we made some adjustment to make the comparison between Nuware and R.P Stuart more reliable. For instance, we assumed the same reserve/receivable ratios of these two companies to avoid potential aggressive revenue recognition by Nuware’s management (see Appendix). However, there is not enough information to make adjustment on PP&E depreciations.
Then we can compare the performance of these two companies in 2013 (as shown below). However, we cannot get find enough information to make a comprehensive adjustment on 2012 data (in particular, we don’t have the estimation on 2011 inventory using FIFO method). As a result, we cannot calculate the growth rate of EPS precisely here.
2.) Assess the financial performance of Nuware versus R.P. Stuart. Nuware and R.P. Stuart are in the same industry and share virtually identical business model, which make them comparable. Before adjustment, Nuware showed a much better financial performance than that of R.P Stuart regards to net income, gross profit margin, return on asset & equity, and EPS growth etc. After making necessary adjustment, we found that Nuware still outperforms R.P.Stuart, but with a smaller margin. The real net income is only 71% of the original figure, which subsequently lowered the return on assets and equity. But due to the higher leverage ratio, Nuware’s return on equity is still 2x that of R.P.Stuart (originally 3x). However, what worries us most is the combination of a negative earnings growth and slower sales growth. Using these criteria, Nuware is not beating the industry (actually performed worse than R.P Stuart in terms of sales growth in 20131).
3.) Would you characterize the accounting discretion applied by Nuware’s management as aggressive? Why or why not?
Nuware’s Management accounting discretion can be seen as aggressive for several reasons: 1. They artificially lower the allowance of account receivable to boost income and gross margin. Moreover, when estimating reserves, percentage of sales method is less accurate than the detailed monthly review method adopted by R.P Stuart’s. 2. Compared to R.P. Stuart, LIFO reduced the tax and LIFO liquidation in year 2013 resulting in artificially high net income as well. 3. The recognition of unrealized gains for available for sale investment assets also contributed to the higher net income, which should be considered separately from income from its core business. 4. There might be some aggressive assumptions when depreciating PP&E, which deserves more detailed analysis.