The document discusses ABF's credit risk profile based on its retail and food manufacturing operations. It finds that: 1) ABF's retail operations do not involve credit risk as customers pay cash. 2) Its food manufacturing customers, mainly food retailers, are unlikely to have liquidity issues settling payments. 3) ABF appears to closely manage credit risk and has significant experience with its low-risk customers. The document then questions whether ABF needs its allowance for doubtful accounts balance of £24m given it wrote off only £3m in the prior year and has a conservative customer base. It suggests ABF may be over-reserving to create a "cookie jar" buffer for future

1. Is the company likely to run a high credit risk?
• Recall from seminar 2 that ABF has significant retail operations. Credit risk?
• ABF has significant food manufacturing operations. Who are the most likely
customers? Credit risk?
• How does the company manage its credit risk?

2. Is the company likely to run a high credit risk?
• Recall from seminar 2 that ABF has significant retail operations. These are not
likely to involve credit risk.
• ABF has significant food manufacturing operations. Who are the most likely
customers? Food retailers: are they likely to have liquidity issues (not being able
to settle current liabilities to suppliers?). Not likely.
• The company appears to manage credit risk quite closely and have significant
experience with its customers.

3. Building the Allowances for doubtful accounts
 Bad debt expense: “ Increase charged to the income statement”
 Reversal of allowance, decreasing the allowance and generating an income item on the
income statement (typically aggregated with the expense above): “Amounts released”
 Receivables that will never be received, therefore written off against the allowance:
“Amounts written off”

4. Building the Allowances for doubtful accounts
 In 2019, the company had an opening balance of £23m, which has been used to write
off £3m. At the same the company decided to release another £3m in the income
statement as an income (23-3-3=17).
 To build a closing balance of £24m, the company had to incur an expense of £7m
(17+7=24).

5. Building the Allowances for doubtful accounts
 Does the company need an allowance of £24m?

6. Building the Allowances for doubtful accounts
 The question that arises is whether the company needs an allowance of £24m. It can be
seen that the opening balance of allowances £23m could cover easily the write off of
£3m. In addition, given the narrative in the note, the customer base of the company has
a low credit risk: tights checks are conducted and the company has a long history with
its customers (note: retail customers do not bring about credit risk as they pay cash).
 Very conservative allowances (23/3>1). Does the company build a “cookie jar” for
years when any of its lines of activities may underperform?