J. C. Penney Company, Inc. Equity Valuation and Analysis As of ...

Net Sales/Unearned Revenue1200Net Sales/Unearned Revenue1000800600400JCPKSSDDSSSISMRT20002002 2003 2004 2005 2006YearWhen evaluating the ratio of net sales to unearned revenue, analysts lookfor unexplained changes in the level of unearned revenue. For instance, if theratio of net sales to unearned revenue increases dramatically, the firm may berecognizing revenue before it is actually earned in an effort to improve earnings.Firms sometimes do this in order to improve sales numbers, when actual salescome in below estimates. This sort of manipulation is cause for concern and is apotential “red flag” indicating fraudulent behavior.Looking at this graph, we see a great deal of variation in the ratiobetween firms. Some of this activity is explainable. For instance, Dillard’s andKohl’s sudden rise in unearned revenue was most likely caused by a change indisclosure. In previous years, Dillard’s and Kohl’s did a poor job of separating itsunearned revenues from its other liabilities. In 2004 and 2006, respectively,Dillard’s and Kohl’s disaggregated their liabilities to reveal unearned revenueliabilities from gift cards, which is a common practice among companies in theretail industry.59