CFA Level I · CFA Level I Exam · Financial Reporting Quality
An analyst observes that a company's receivables are growing much faster than its revenue, while its allowance for doubtful accounts as a percentage of receivables has fallen. This pattern most likely indicates:
The pattern most likely indicates possible revenue overstatement or understated bad debt expense. Receivables growing faster than sales can signal aggressive revenue recognition, and a declining allowance ratio means expected credit losses are being under-recorded, both of which inflate reported earnings quality concerns.
- Aa shift to more conservative credit terms with customers
- Bpossible revenue overstatement or understated bad debt expenseCorrect
- Can improvement in operating cash flow relative to net income
Explanation
Receivables outpacing revenue suggests aggressive revenue recognition or loose credit terms. A falling allowance ratio suggests understated bad debt expense. Both raise earnings quality concerns. Conservative terms would slow receivables growth, and cash flow would typically lag net income here.
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