Question: Case 1: Occidental Petroleum Corporation

Occidental Petroleum Corporation reported the following information in a recent annual report.

Occidental Petroleum Corporation Consolidated Balance Sheets (in millions) Assets at December 31, Current Year Prior year Current assets Cash and cash equivalents \( 683 \) 146 Trade receivables, net of allowances 804 608 Receivables from joint ventures, 330 321 partnerships, and other Inventories 510 491 Prepaid expenses and other 147 307 Total current assets 2,474 1,873 Long-term receivables, net 264 275

Notes to Consolidated Financial Statements Cash and Cash Equivalents. Cash equivalents consist of highly liquid investments. Cash equivalents totaled approximately \(661 million and \)116 million at current and prior year-ends, respectively. Trade Receivables. Occidental has agreement to sell, under a revolving sale program, an undivided percentage ownership interest in a designated pool of non-interest-bearing receivables. Under this program, Occidental serves as the collection agent with respect to the receivables sold. An interest in new receivables is sold as collections are made from customers. The balance sold at current year-end was \(360 million. Instructions What items other than coin and currency may be included in “cash”? What items may be included in “cash equivalents”? What are compensating balance arrangements, and how should they be reported in financial statements? What are the possible differences between cash equivalents and short-term (temporary) investments? Assuming that the sale agreement meets the criteria for sale accounting, cash proceeds were \)345 million, the carrying value of the receivables sold was \(360 million, and the fair value of the recourse liability was \)15 million, what was the effect on income from the sale of receivables? Briefly discuss the impact of the transaction in (e) on Occidental’s liquidity.

Step by step solution

01

Meaning of Trade Receivable

In accounting terms, trade receivables are amounts for which goods and services have been provided but payment has not yet been received. This is the sum total of debt and bills receivable. Trade receivable is reflected in the balance sheet as a current asset.

02

 Step 2: (a) Explaining the items other than coins and currency may be included in “cash”

Among the forms of money that may be considered cash are bank deposits, money orders, certified checks, cashier's checks, personal checks, bank drafts, and money market funds.

03

(b) Explaining the items that may be included in “cash equivalents

Cash equivalents include:

1. Easily convertible into cash, and
2. The risk from interest rate changes is so limited that they are too close to maturity.

Treasury bills, commercial paper, and money market funds are examples of cash equivalents.

04

(c) Explaining the compensating balance arrangements and their reporting in financial statements.

A compensating balance is the percentage of an enterprise's cash deposit that is used to sustain current borrowing agreements with a lending institution.

A compensating amount indicating a legally restricted deposit maintained against short-term borrowing agreements should be reported separately among cash and cash equivalent items. A limited deposit used to offset long-term borrowing should be classed as a noncurrent asset in either the investments or other assets sections.

05

(d) Explaining the possible differences between cash equivalents and short-term (temporary) investments

A short-term investment is held for a short period instead of cash and can be converted to cash when the need for it arises. Short-term investments are stocks, Treasury bills, and other short-term assets.

The main differences between cash equivalents and short-term investments are that.

1. Cash equivalents typically have shorter maturities (less than three months), whereas short-term investments typically have longer maturities (e.g., short-term bonds) or no maturity date (e.g., stock), and

Cash equivalents are readily convertible to known amounts of cash, whereas a company may incur a gain or loss when selling its short-term investments

06

(e) Explaining the effect on income from the sale of receivables

According to the following entry to record the transaction, Occidental would lose $30,000,000:

Date	Particular	Debit ($)	Credit ($)
	Cash	345,000,000
	Loss on Sale of Receivables	30,000,000
	Accounts Receivable		360,000,000
	Recourse Liability		15,000,000

07

(f) Explaining the impact of the transaction in (e) on Occidental’s liquidity.

Occidental's liquidity situation will be harmed by the transaction in (e).

Current assets are decreased $15,000,000, while current liabilities are increased $15,000,000 (for the recourse liability).

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