Case 1: Occidental Petroleum Corporation

Case 1 Occidental Petroleum Corporation Occidental Petroleum Corporat

Case 1: Occidental Petroleum Corporation reported the following information in a recent annual report. (a) What items other than coin and currency may be included in “cash”? (b) What items may be included in “cash equivalents”? (c) What are compensating balance arrangements, and how should they be reported in financial statements? (d) What are the possible differences between cash equivalents and short-term (temporary) investments? (e) 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? (f) Briefly discuss the impact of the transaction in (e) on Occidental’s liquidity.

Paper For Above instruction

The definition and reporting of cash and cash equivalents are fundamental components of financial statement preparation, influencing a company's liquidity position and cash management strategies. Understanding what constitutes cash, what qualifies as cash equivalents, and how related arrangements and transactions are reported provide critical insights into a company's financial health. This paper explores these concepts within the context of Occidental Petroleum Corporation's recent annual report, addressing specific questions about cash items, types of investments, compensating balances, and the implications of a receivables sale.

Items Included in Cash Beyond Coin and Currency

Cash, beyond tangible coins and currency, encompasses various highly liquid assets that are readily available for use in operations. Banks and cash management systems recognize several items as part of cash, including demand deposits, checking accounts, and petty cash funds. In addition, certain items like undeposited checks received but not yet cleared, and overnight bank balances, qualify as cash because they are immediately accessible for withdrawal or transfer. For multinational corporations like Occidental Petroleum, cash also includes balances in foreign bank accounts that are readily accessible in the company's functional currency, provided they are free from restrictions and readily convertible to domestic currency.

Items Included in Cash Equivalents

Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash with insignificant risk of changes in value. Typical examples include Treasury bills, commercial paper, money market funds, and certain government or corporate short-term debt securities. These instruments usually have original maturities of three months or less from the acquisition date, aligning with the company's cash management policies. For Occidental Petroleum, the inclusion of certain short-term investments as cash equivalents depends on their maturity and liquidity, allowing the company to optimize cash holdings and manage liquidity efficiently.

Compensating Balance Arrangements and Their Reporting

Compensating balance arrangements involve borrower-maintained minimum balances in bank accounts as a condition for obtaining loans or credit lines. These balances serve as compensatory deposits that banks require to secure lending agreements, effectively reducing the available cash for the borrower. In financial reporting, compensating balances should be disclosed as restrictions on cash and cash equivalents. They are typically presented as a deduction from the total cash balance to reflect the net amount available for operational needs. For Occidental Petroleum, appropriate reporting of compensating balances ensures transparent disclosure of restrictions on cash availability, aligning with GAAP standards (FASB ASC 305).

Differences Between Cash Equivalents and Short-term Investments

The primary difference between cash equivalents and short-term (temporary) investments lies in their maturity and marketability. Cash equivalents are instruments with maturities of three months or less from the purchase date, highly liquid, and with minimal risk. Short-term investments, on the other hand, may have maturities extending beyond three months and could include securities with slightly higher risk profiles or lower liquidity. For example, certificates of deposit (CDs) with longer maturities are classified as short-term investments rather than cash equivalents. The distinction impacts liquidity calculations and the presentation of assets on the balance sheet, which critically affects financial analysis of companies like Occidental Petroleum.

Impact of Sale of Receivables on Income

Assuming the sale of receivables by Occidental Petroleum qualifies for sale accounting, the effect on income depends on the sale proceeds, the carrying amount of the receivables sold, and the fair value of the recourse liability. Here, cash proceeds from the sale are $345 million, the receivables' carrying value is $360 million, and the recourse liability's fair value is $15 million. The loss recognized on the sale is the difference between the sale proceeds plus the fair value of the recourse liability and the carrying value of the receivables. Mathematically:

Loss = (Carrying value of receivables) - (Sale proceeds + Fair value of recourse liability) = $360 million - ($345 million + $15 million) = $0. This indicates a break-even transaction with no immediate gain or loss impacting income. However, if calculated differently, slight variances could arise, especially when considering transaction costs or additional disclosures. Ultimately, this transaction would generally not affect income if it perfectly offsets, but any difference signifies a gain or loss affecting earnings.

Effect of the Receivables Sale Transaction on Liquidity

The sale of receivables improves Occidental Petroleum’s liquidity by converting receivables into cash, increasing available working capital. The immediate cash inflow of $345 million enhances the company's ability to meet short-term obligations, invest in operations, or reduce debt. Since receivables often represent a significant portion of current assets, liquidating them through sales allows for a more flexible cash position, especially if the sale is in exchange for cash promptly receivable (Petersen & Rajan, 1994). However, the transaction also entails potential risks related to recourse agreements and future collections. Overall, such receivable sales are strategic tools to manage liquidity efficiently, especially in capital-intensive industries like oil and gas production.

Conclusion

Understanding the nuances of cash, cash equivalents, and related arrangements provides essential insights into a company's liquidity and financial health. For Occidental Petroleum, recognizing the components that comprise cash, the criteria for cash equivalents, and the implications of receivable sales enables better financial statement analysis and strategic decision-making. Proper disclosure of compensating balances and the differentiation between short-term investments further enhances transparency and compliance with accounting standards. Ultimately, effective liquidity management through these instruments and transactions underpins the company's ability to sustain operations and capitalize on growth opportunities amid fluctuating market conditions.

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