Hidden Liabilities

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Liabilities are debts owed to another person or entity, obligations incurred for which payment or assignment of limited resources is due.

Liabilities are generally easy to identify. When purchasing goods or services, the transactions are clear. Something has been received and a liability has been incurred. That liability is called a payable. These liabilities are rarely overlooked because of the regular collection procedures normally enforced by suppliers.

Liabilities can also arise from more subtle developments that transpire with the passage of time or with changes in conditions that affect our business. The very nature of our business—publishing—also gives rise to certain other liabilities. These liabilities could be hidden in a variety of ways. They usually arise from a failure to identify or recognize change, or from over-optimism in projecting revenues.

As financial managers it is important to be able to detect changes as they happen and to address how these changes affect our business and how they should be reflected when preparing financial statements.

For the purposes of this paper, we will use the framework of financial statements—balance sheet and profit/loss statement—to identify what these hidden liabilities might be.

The Balance Sheet

Assets are usually good covers for hidden liabilities.

Accounts Receivable is a strategic asset from which cash resources are derived. We need to recognize that not all customers will fulfill their obligation to pay. Changes in the book industry must be considered when reporting the worth of our receivables. A reserve or allowance for bad debt should be established.

Inventory is another large asset behind which a large liability might be hidden. It is valuated based on manufacturing cost, early in the life of a book, when outlooks are rosy and assurances of selling all copies are still ringing in our ears.

But after three years, or five years, if stocks remain unsold in the warehouse, that so-called asset of an inventory is no longer an asset. It is a liability, because there is no way you can justify that old value assigned to the inventory when the title first appeared. The book has run its life. It will no longer sell. Therefore its value as an asset has diminished.

The books must be written off, or at least written down. There should be a systematic way to write down inventory values to ensure that no surprises occur. Some presses write down over five years, and that is fine, if done consistently. Others are more strict with themselves and recognize that certain types of books, if they don't sell after two years, are worth nothing.

Work in Process is an asset that usually does not hide liabilities because most book projects that appear in the accounting radar screen end up in inventory or in plant assets. Most projects are completed and launched as finished products, but every now and then a project that has already been launched and for which manufacturing costs have been incurred is suddenly aborted or suspended for some reason. If a project is cancelled, then the work-in-process asset should be written off. This happens so seldom that I know of no organization that creates a reserve for this possibility.

Computer Assets are another place where hidden liabilities may lurk. There are probably two kinds of presses in the AAUP: those who record important assets like computers as assets and those who don’t, but who simply record them as expenses at the time they are purchased. Whichever kind of press we classify ourselves as, we need to recognize just how fast computers are becoming obsolete.

After three years, much hardware and software is useless. We need to be realistic in our depreciation schedules and, being forewarned, should consider setting aside an amount of money every year in a "computer reserve" to pay for new technologies. This applies even to those presses who believe that if a computer is doing the job, don’t change it just because a new version is available; run it until it can run no more. A press caught without resources to buy new computers when it is absolutely necessary to do so will grind to a halt. Liabilities will then quickly mount.

Royalty Advances are assets that are relatively new to many in the university press world. During the last 10 years, because of the quick expansion among many unversity presses and because of the escalated competition for manuscripts to publish, it has become necessary to pay authors an advance for a book that may be only in the conceptualization stage. Royalty advances are assets much like a work in process. If the author does not come across with an acceptable manuscript, or if the manuscript is published but the book does not sell through and is not able to earn the full amount of the advance, the unearned balance needs to be written off.

The solution to all the above problems can be found in establishing reserves for specific purposes. (See D-4, "Reserves and Allowances.")

The Profit/Loss Statement

There is one large item in the profit and loss statement—sales—that could hide liabilities in two ways. During the budgeting process, sales figures could be so grossly overstated or understated that liabilities or damage to the program could result.

When overly optimistic sales estimates are plugged into the budget, it creates a situation where departments are unwittingly encouraged to budget larger expenses and overspend. When the over-optimism is recognized early during a given fiscal year, the budget can be revised. But there are certain types of expenses that could lock in early in the fiscal year and be impossible or at least very difficult to reverse.

On the other hand, very pessimistic estimates of sales could douse creativity and or could even kill programs and initiatives unecessarily. In the long term, this could be a liability the press would have to shoulder. (See B-1, "Sales Forecasting.")

Likewise, returns on sales could be underreported, as in periods of sustained and ever-increasing returns. At the end of the fiscal year, some presses have started to create a reserve to handle these unprecedented and continuing returns in order to reflect reality better in the profit and loss statement and to prevent over-optimism in net sales projections in the future. (See D-4, "Reserves and Allowances.")

Liabilities and the Nature of the Business of Publishing

Certain liabilities could arise because of the specific nature of the publishing business. We could be sued for copyright infringement or for hurting the reputation of others. This reality has not been brought to the attention of many small and medium-sized presses until very recently. When presses were doing a lot of monographs and scholarly books, the opportunities for copyright infringement and hurting others were not as many as when many presses started to pick up more "jazzy" trade books that touch on contemporary issues.

If a judgement were brought against us in these areas, would we have the money to pay for damages? Often, when lawyers get involved in our behalf, a monetary settlement is a very attractive alternative compared to the costs involved in prolonged litigation. Are we ready for these costs?

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