CHAPTER 9 Accounting for Receivables

CHAPTER 9 Accounting for Receivables ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises Problems Set A Problems Set B 1. Identify and distinguish between the different types of receivables. 2. Show how accounts receivable are recognized in the accounts. 1, 2 1 3 2 1 1, 6, 7, 8 1, 6, 7, 8 3. Describe and use the methods and bases used to value accounts receivable. 4, 5, 6, 7, 8 3, 4, 5, 6, 11 2, 3, 4 1, 2, 3, 4, 5, 6 1, 2, 3, 4, 5, 6 4. Determine the entries to record the disposition of accounts receivable. 5. Determine the interest on notes receivable. 6. Show how notes receivable are recognized in the accounts. 7. Demonstrate how notes receivable are valued. 8. Determine the entries to record the disposition of notes receivable. 9. Illustrate the statement presentation of receivables. 9, 10, 11 7 5, 6, 10 8, 9 8, 9 12 8, 10 7, 8, 9 8, 9 8, 9 13 9, 10 7, 8 8, 9 8, 9 8, 9 8, 9 14 10 9 8, 9 8, 9 15 3, 11 10, 11 7, 9 7, 9 10. Evaluate short-term liquidity. 16, 17 12 12 10 10 9-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Prepare journal entries related to bad debts expense. Simple 20-30 2A Calculate bad debts amounts using various methods. Simple 15-25 3A 4A 5A 6A 7A Journalize transactions related to bad debts using ageing schedule. Calculate bad debts and journalize transactions using an ageing schedule. Journalize transactions related to bad debts using percentage of sales. Analyse accounts and prepare journal entries for receivables and bad debts. Determine missing amounts related to sales and accounts receivable. Moderate 20-30 Moderate 15-25 Moderate 15-25 Complex 15-25 Complex 15-25 8A Prepare entries for various receivables transactions. Moderate 35-45 9A Prepare entries for various notes receivable transactions. Show balance sheet presentation. Moderate 35-45 10A Calculate ratios to evaluate short-term liquidity. Moderate 15-25 1B Prepare journal entries related to bad debts expense. Simple 20-30 2B Calculate bad debts amounts using various methods. Simple 15-25 3B 4B 5B 6B 7B Journalize transactions related to bad debts using ageing schedule. Calculate bad debts and journalize transactions using an ageing schedule. Journalize transactions related to bad debts using percentage of receivables. Analyse accounts and prepare journal entries for receivables and bad debts. Determine missing amounts related to sales and accounts receivable. Moderate 20-30 Moderate 15-25 Moderate 15-25 Complex 15-25 Complex 15-25 8B Prepare entries for various receivables transactions. Moderate 35-45 9B Prepare entries for various notes receivable transactions. Show balance sheet presentation. Moderate 35-45 10B Calculate ratios to evaluate short-term liquidity. Moderate 15-25 9-2

BLOOM S TAXONOMY TABLE Correlation Chart between Bloom s Taxonomy, Study Objectives and End-of-Chapter Material Study Objective Knowledge Comprehension Application Analysis Synthesis Evaluation 1. Identify and distinguish between the different types of receivables. Q9-2 BE9-1 Q9-1 2. Show how accounts receivable are recognized in the accounts. 3. Describe and use the methods and bases used to value accounts receivable. 4. Determine the entries to record the disposition of accounts receivable. Q9-5 Q9-4 Q9-6 Q9-7 Q9-10 Q9-9 Q9-11 E9-6 Q9-3 BE9-2 E9-1 P9-1A P9-8A P9-1B P9-8B Q9-8 BE9-3 BE9-4 BE9-5 BE9-6 BE9-11 E9-2 E9-3 E9-4 BE9-7 E9-5 E9-10 P9-8A P9-1A P9-2A P9-3A P9-4A P9-5A P9-1B P9-2B P9-3B P9-4B P9-5B P9-9A P9-8B P9-9B P9-6A P9-7A P9-6B P9-7B P9-6A P9-6B 5. Determine the interest on notes receivable. 6. Show how notes receivable are recognized in the accounts. 7. Demonstrate how notes receivable are valued. 8. Determine the entries to record the disposition of notes receivable. Q9-12 BE9-10 E9-7 E9-8 E9-9 Q9-13 BE9-9 BE9-10 E9-7 E9-8 P9-8A P9-8A P9-9A P9-8B P9-9B Q9-14 BE9-10 E9-9 P9-8A P9-8A P9-9A P9-8B P9-9B P9-9A P9-8B P9-9B P9-9A P9-8B P9-9B BE9-8 9. Illustrate the statement presentation of receivables. 10. Evaluate short-term liquidity. Broadening Your Perspective Q9-15 BE9-11 E9-10 E9-11 P9-9A P9-9B Q9-16 Q9-17 BE9-12 BYP9-2 BYP9-3 P9-7A P9-7B E9-12 P9-10A P9-10B BYP9-1 BYP9-4 BYP9-5 BYP9-6 9-3

ANSWERS TO QUESTIONS 01. The three major types and classification of receivables are as follows: Type Classification (1) Accounts receivable Current asset (2) Notes receivable Current or noncurrent asset depending on due date (3) Other receivables Current or noncurrent asset depending on due date 02. Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable. 03. Accounts Receivable... 50 Interest Revenue... 50 04. Under the direct write-off method, bad debt losses are not estimated and no allowance account is used. When an account is determined to be uncollectible, the loss is debited to Bad Debts Expense. The direct write-off method makes no attempt to match bad debts expense to sales revenues, or to show the net realizable value of the receivables in the balance sheet. The disadvantages are that it may not match expenses with revenue and it does not accurately reflect the collectible value of the accounts receivable on the balance sheet. 5. The essential features of the allowance method of accounting for bad debts are: (1) Uncollectible accounts receivable are estimated in advance, in order to match the cost of the bad debts against sales in the same accounting period in which the sale occurred. (2) Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. (3) Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time a specific account is written off.0 9-4

Questions Chapter 9 (Continued) 6. Net realizable value is the difference between Accounts Receivable (normal debit balance) and the Allowance for Doubtful Accounts (normal credit balance). Soo Eng should realize that the decrease in net realizable value occurs when estimated uncollectibles are recognized in an adjusting entry (debit Bad Debt Expense; credit Allowance for Doubtful Accounts). The write-off of an uncollectible account reduces both accounts receivable and the allowance for doubtful accounts by the same amount. Thus, net realizable value does not change. 7. The two bases of estimating uncollectibles under the allowance method are (1) percentage of sales (income statement method) and (2) percentage of receivables (balance sheet method). The percentage of sales basis establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. This method emphasizes the matching of expenses with revenues. Under the percentage of receivables basis, the balance in the allowance for doubtful accounts is derived either (a) by applying a percentage estimate of bad debts to total receivables or (b) from an analysis of individual customer accounts. This method emphasizes net realizable value. 8. The adjusting entry under the percentage of sales basis is: Bad Debts Expense... 4,100 Allowance for Doubtful Accounts... 4,100 The adjusting entry under the percentage of receivables basis is: Bad Debts Expense... 2,300 Allowance for Doubtful Accounts ($5,800 $3,500) 2,300 9. The first entry is made to reverse write-off of the account receivable. The second entry records the collection of the account. 9-5

Questions Chapter 9 (Continued) 10. The reasons companies sometimes sell their receivables are: (1) For competitive reasons, sellers often must provide financing to purchasers of their goods for extended periods. Selling receivables provides a more current source of cash to help finance operations. (2) Receivables may be sold because they may be the only reasonable source of cash readily at hand. (3) Billing and collection are often time-consuming and costly. As a result, it is often easier for a retailer to sell the receivable to another party who has expertise in billing and collection matters. This will also speed up the collection of cash. 11. By using both its own credit cards, bank credit cards, and debit cards, Sears provides more options to its customers, increases its revenue, and reduces its risk. The journal entries for each type of card follow: Sears card: Dr. Accounts Receivable Cr. Sales Revenue Bank credit card or debit card: Dr. Cash Dr. Credit / Debit Card Expense Cr. Sales Revenue 12. (a) Principal = $12,000 [($360 x 12/4) 9%] (b) Interest = $5,400 [$30,000 x 6% x 3] (c) Interest rate = 8.33% [($2,500 x 12/6) $60,000] (d) Time = 3 months [$875 ($50,000 x 7%) 12] 9-6

Questions Chapter 9 (Continued) 13. Accounts receivable are amounts owed by customers on account, resulting from the sale of goods and services in the normal course of business operations (i.e., in trade). Interest is not normally charged on accounts receivable unless they are overdue. Accounts receivable are normally collected within 30 or so days. Notes receivable represent claims that are evidenced by formal instruments of credit. A promissory note gives the holder a stronger legal claim than one on an account receivable. As a result, it is easier to sell to another party. Promissory notes are negotiable instruments, which means they can be transferred to another party by endorsement. Interest is normally charged on notes receivable for the entire maturity period. Notes receivable can extend for any period of time, from 30 days to a number of years. 14. Payee Accounts Receivable... Notes Receivable... Interest Revenue... Maker May Company Notes Payable... Interest Expense... Accounts Payable... xxx xxx xxx xxx xxx xxx 15. Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. Both the gross amount of receivables and the allowance for doubtful accounts / notes should be reported. If collectible within a year or the operating cycle, whichever is longer, these receivables are reported as current assets immediately below temporary investments. 16. An increase in the current ratio normally indicates an improvement in short-term liquidity. This may not always be the case because the composition of current assets may vary. In order to determine if the increase is an improvement in financial health, other ratios that should be considered include: Receivable turnover and collection period and inventory turnover and days sales in inventory ratios. 9-7

Questions Chapter 9 (Continued) 17. Receivables turnover = Net credit sales Average accounts receivable Net credit sales = Receivables turnover x Average accounts receivable Net credit sales = 8.0583 x $4,542,500 Net credit sales = $36,604,828 9-8

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 (a) Other receivables (b) Notes receivable (c) Accounts receivable BRIEF EXERCISE 9-2 July 1 Accounts Receivable... 14,000 Sales... 14,000 8 Sales Returns and Allowances... 3,800 Accounts Receivable... 3,800 31 Cash... 10,200 Accounts Receivable ($14,000 $3,800)... 10,200 BRIEF EXERCISE 9-3 April 30 Bad Debt Expense [($800,000 $50,000) X 2%]... 15,000 Allowance for Doubtful Accounts... 15,000 BRIEF EXERCISE 9-4 (a) Dec. 31 Bad Debts Expense [($400,000 X 1%) $3,000] 1,000 Allowance for Doubtful Accounts... 1,000 (b) Dec. 31 Bad Debts Expense [($400,000 X 1%) + $800]. 4,800 Allowance for Doubtful Accounts... 4,800 9-9

BRIEF EXERCISE 9-5 (a) Jan. 24 Allowance for Doubtful Accounts... 7,000 Accounts Receivable... 7,000 (b) Accounts receivable Allowance for doubtful accounts Net realizable value (1) Before Write-Off (2) After Write-Off $700,000 0054,000 $646,000 $693,000 0047,000 $646,000 BRIEF EXERCISE 9-6 March 4 Accounts Receivable... 7,000 Allowance for Doubtful Accounts... 7,000 Cash... 7,000 Accounts Receivable... 7,000 BRIEF EXERCISE 9-7 Bank credit card: July 27 Cash ($75 $2.62)... 72.38 Credit Card Expense ($75 X 3.5%)... 2.62 Sales... 75.00 (a) Debit card: The above entry would not change unless the fee is different, except that the account used to record the fee is called Debit Card Expense. (b) Nonbank card: July 27 Accounts Receivable ($75 $2.62)... 72.38 Credit Card Expense ($75 X 3.5%)... 2.62 Sales... 75.00 9-10

BRIEF EXERCISE 9-8 (a) Total Interest = $15,000 [$900,000 x 10% x 2/12] (b) Interest Rate = 8% [($526.67 x 12) $79,000] (c) Principal = $56,000 [($1,680 x 12/6) 6%] BRIEF EXERCISE 9-9 Jan. 10 Accounts Receivable Opal... 9,000 Sales... 9,000 Feb. 9 Notes Receivable Opal... 9,000 Accounts Receivable Opal... 9,000 BRIEF EXERCISE 9-10 (a) Apr. 1 Notes Receivable... 10,000 Accounts Receivable... 10,000 July 1 Cash... 10,175 Notes Receivable... 10,000 Interest Revenue ($10,000 x 7% x 3/12)... 175 (b) Apr. 1 Notes Receivable... 10,000 Accounts Receivable... 10,000 July 1 Accounts Receivable... 10,175 Notes Receivable... 10,000 Interest Revenue ($10,000 x 7% x 3/12)... 175 (c) Apr. 1 Notes Receivable... 10,000 Accounts Receivable... 10,000 July 1 Allowance for Doubtful Notes... 10,000 Notes Receivable... 10,000 9-11

BRIEF EXERCISE 9-11 (a) Feb. 28 Bad Debts Expense... 36,000 Allowance for Doubtful Accounts... 36,000 (b) WENDY COMPANY Balance Sheet (Partial) February 28, 2003 Assets Current assets Cash $090,000 Accounts receivable... $600,000 Less: Allowance for doubtful accounts... 36,000 564,000 Merchandise inventory... 130,000 Prepaid expenses... 13,000 Total current assets... $797,000 BRIEF EXERCISE 9-12 Receivables turnover $11,006 [($420 + $380) 2] = 27.52 times Collection period 365 days 27.52 = 13.27 days 9-12

SOLUTIONS TO EXERCISES EXERCISE 9-1 1. Jan. 6 Accounts Receivable Watson.... 5,000 Sales... 5,000 Feb. 5 Cash... 5,000 Accounts Receivable Watson... 5,000 2. Jan. 10 Accounts Receivable Giger... 11,000 Sales... 11,000 Feb. 12 Cash... 6,000 Accounts Receivable Giger... 6,000 Mar. 10 Accounts Receivable Giger... 100 Interest Revenue... 100 [2% X ($11,000 $6,000)] EXERCISE 9-2 (a) (1) Dec. 31 Bad Debts Expense... 8,000 [($840,000 $40,000) X 1%] Allowance for Doubtful Accounts... 8,000 (2) Dec. 31 Bad Debts Expense... 8,500 Allowance for Doubtful Accounts... 8,500 [($110,000 X 10%) $2,500] (b) (1) Dec. 31 Bad Debts Expense... 4,000 [($840,000 $40,000) X 0.5%] Allowance for Doubtful Accounts... 4,000 (2) Dec. 31 Bad Debts Expense... 6,000 Allowance for Doubtful Accounts... 6,000 [($110,000 X 5%) + $500] 9-13

EXERCISE 9-3 (a) Accounts Receivable Amount % 0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding $65,000 017,600 008,500 006,400 2 10 30 50 Estimated Uncollectible $1,300 01,760 02,550 03,200 $8,810 (b) Mar. 31 Bad Debts Expense... 7,010 Allowance for Doubtful Accounts... 7,010 ($8,810 $1,800) EXERCISE 9-4 2002 Dec. 31 Bad Debts Expense (2% X $400,000)... 8,000 Allowance for Doubtful Accounts... 8,000 2003 May 11 Allowance for Doubtful Accounts... 1,100 Accounts Receivable Worthy... 1,100 June 12 Accounts Receivable Worthy... 1,100 Allowance for Doubtful Accounts... 1,100 12 Cash... 1,100 Accounts Receivable Worthy... 1,100 9-14

EXERCISE 9-5 (a) Dec. 15 Cash ($250 - $7.50)... 242.50 Credit Card Expense ($250 x 3%)... 7.50 Sales... 250.00 (b) Apr. 2 Accounts Receivable Zachos... 1,300.00 Sales... 1,300.00 May 3 Cash... 700.00 Accounts Receivable Zachos... 700.00 June 1 Accounts Receivable Zachos... 14.40 Interest Revenue... 14.40 [28.8% X ($1,300 $700) x 1/12 ] EXERCISE 9-6 One possible reason CN sold its receivables may have been to provide it with a source of current financing. Other possible reasons include not wanting to deal with the administration of collecting accounts, the desire to accelerate cash receipts, or to improve its financial ratios (e.g., receivables turnover). 9-15

EXERCISE 9-7 Nov. 1 Notes Receivable A. Morgan... 18,000 Cash... 18,000 Dec. 1 Notes Receivable Wright.... 3,600 Sales... 3,600 16 Notes Receivable Barnes... 4,000 Accounts Receivable Barnes... 4,000 31 Interest Receivable... 331 Interest Revenue*... 331 *Calculation of interest revenue: Morgan: $18,000 X 10% X 2/12... $300 Wright: $3,600 X 6% X 1/12... 18 Barnes: $4,000 X 8% X 0.5/12... 13 Total accrued interest... $331 EXERCISE 9-8 2002 May 1 Notes Receivable Jones... 10,500 Accounts Receivable Jones... 10,500 Dec. 31 Interest Receivable... 700 Interest Revenue ($10,500 X 10% X 8/12)... 700 2003 May 1 Cash... 11,550 Notes Receivable Jones... 10,500 Interest Receivable... 700 Interest Revenue ($10,500 X 10% X 4/12)... 350 9-16

EXERCISE 9-9 (a) Nov. 1 Accounts Receivable Fein... 4,200 Notes Receivable Fein... 4,000 Interest Revenue... 200 ($4,000 X 10% X 6/12) To record the dishonour of Fein Inc. note, with expectation of future collection. (b) Nov. 1 Allowance for Doubtful Notes... 4,000 Notes Receivable Fein... 4,000 To record the dishonour of Fein Inc. note, with no expectation of collection. EXERCISE 9-10 (a) Jan. 15 Accounts Receivable... 15,000 Sales... 15,000 20 Cash ($4,500 $225)... 4,275 Credit Card Expense ($4,500 X 5%)... 225 Sales... 4,500 30 Cash ($1,000 - $30)... 970 Debit Card Expense ($1,000 X 3%)... 30 Sales... 1,000 Feb. 10 Cash... 12,000 Accounts Receivable... 12,000 15 Accounts Receivable ($3,000 X 18% x 1/12)... 45 Interest Revenue... 45 (b) Interest Revenue is reported under other revenues and gains. The Credit Card Expense and Debit Card Expense accounts are usually categorized as selling expenses. 9-17

EXERCISE 9-11 DROST COMPANY Balance Sheet (Partial) October 31, 2003 (In millions) Assets Current assets Accounts receivable... $2,907 Less: Allowance for doubtful accounts... 31 $2,876 Advances to employees... 5 Notes receivable... 228 HST recoverable... 25 Total current assets... $3,134 EXERCISE 9-12 Nike Receivables Turnover $8,995.1 $1,569.4 = 5.73 times 365 days 5.73 = 63.7 days Reebok $2,899.9 $417.4 = 6.95 times 365 days 6.95 = 52.5 days Nike s receivable turnover and collection period are not as good as Reebok s or the industry average. Reebok s ratios are slightly better than the industry average. 9-18

SOLUTIONS TO PROBLEMS PROBLEM 9-1A (a) 1. Accounts Receivable... 3,300,000 Sales... 3,300,000 (b) 2. Sales Returns and Allowances... 50,000 Accounts Receivable... 50,000 3. Cash... 2,800,000 Accounts Receivable... 2,800,000 4. Allowance for Doubtful Accounts... 90,000 Accounts Receivable... 90,000 5. Accounts Receivable... 25,000 Allowance for Doubtful Accounts... 25,000 Cash... 25,000 Accounts Receivable... 25,000 Accounts Receivable Bal. 960,000 (1) 3,300,000 (5) 25,000 (2) 50,000 (3) 2,800,000 (4) 90,000 (5) 25,000 Allowance for Doubtful Accounts (4) 90,000 Bal. 70,000 (5) 25,000 Bal. 1,320,000 Bal. 5,000 9-19

PROBLEM 9-1A (Continued) (c) Balance before adjustment [see (b)]... $ 5,000 Balance needed... 125,000 Adjustment required... $120,000 The journal entry would therefore be as follows: March 31 Bad Debts Expense... 120,000 Allowance for Doubtful Accounts... 120,000 9-20

PROBLEM 9-2A (a) $38,000 (b) $63,000 ($2,100,000 X 3%) The balance in the Allowance for Doubtful Accounts is irrelevant. (c) $47,400 [($840,000 X 6%) $3,000] (d) $53,400 [($840,000 X 6%) + $3,000] (e) The weaknesses of the direct write-off method are two-fold. First, it does not match expenses with revenues. Second, the accounts receivable are not stated at their estimated net realizable value at the balance sheet date. 9-21

PROBLEM 9-3A (a) Dec. 31 Bad Debts Expense... 16,050 Allowance for Doubtful Accounts... 16,050 Estimated bad debts $25,050 Less: Unadjusted balance 9,000 Adjustment required $16,050 (a) and (b) Bad Debts Expense Date Explanation Ref. Debit Credit Balance 2002 Dec. 31 Adjusting entry 16,050 16,050 Allowance for Doubtful Accounts Date Explanation Ref. Debit Credit Balance 2002 Dec. 31 31 2003 Mar. 1 May 1 Balance Adjusting entry ƒ 1,000 16,050 00,1,000 09,000 25,050 24,050 25,050 9-22

PROBLEM 9-3A (Continued) (b) 1. Mar. 1 Allowance for Doubtful Accounts... 1,000 Accounts Receivable... 1,000 2. May 1 Accounts Receivable... 1,000 Allowance for Doubtful Accounts... 1,000 1 Cash... 1,000 Accounts Receivable... 1,000 (c) Dec. 31 Bad Debts Expense... 12,050 Allowance for Doubtful Accounts... 12,050 ($37,100 - $25,050) 9-23

PROBLEM 9-4A (a) Accounts Receivable Amount % 0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding $100,000 60,000 50,000 30,000 1 5 10 25 Estimated Uncollectible $ 1,000 3,000 5,000 7,500 $16,500 (b) Bad Debts Expense... 6,500 Allowance for Doubtful Accounts ($16,500 $10,000) 6,500 (c) Allowance for Doubtful Accounts... 2,000 Accounts Receivable... 2,000 (d) Accounts Receivable... 1,000 Allowance for Doubtful Accounts... 1,000 Cash... 1,000 Accounts Receivable... 1,000 (e) When an allowance is established, an estimate is made of the accounts receivable or credit sales that will not be collected. An entry is made to record this estimate in the period in which the sale occurred. This matches the estimated expense with the revenue it generated. 9-24

PROBLEM 9-5A (a) Bad Debts Expense (3% X $1,000,000)... 30,000 Allowance for Doubtful Accounts... 30,000 (b) Allowance for Doubtful Accounts... 37,000 Accounts Receivable... 37,000 (c) Accounts Receivable... 5,000 Allowance for Doubtful Accounts... 5,000 Cash... 5,000 Accounts Receivable... 5,000 (d) Beginning balance... $09,000 Add: Bad debt expense... 30,000 Recovery of account... 5,000 Deduct: Write-off of uncollectible accounts... (37,000) Ending balance... $ 7,000 (e) When the percentage of sales (income statement) method is used to estimate bad debts, recoveries of accounts previously written off do not directly affect the bad debts expense (They may have an indirect effect, by influencing the estimator s judgment regarding the appropriate percentage of sales to use). If the percentage of receivables (balance sheet) method of providing for bad debts was used, the recovery would have a direct effect by increasing the balance is the allowance account and therefore reducing the expense to be recorded in the year-end adjustment. 9-25

PROBLEM 9-6A Accounts Receivable Yr. 1 Balance 8,300,000 Sales 28,500,000 Write-offs 105,000 Collections 27,195,000 Yr. 2 Balance 9,500,000 Allowance for Doubtful Accounts Yr. 1 Balance 750,000 Bad debts 285,000 Write-offs 105,000 Yr. 2 Balance 930,000 Year 2 Bad Debts Expense... 285,000 Allowance for Doubtful Accounts... 285,000 Accounts Receivable... 28,500,000 Sales... 28,500,000 ($285,000 = 1% of sales; Therefore sales = $28,500,000) Allowance for Doubtful Accounts... 105,000 Accounts Receivable... 105,000 ($750,000 + $285,000 $930,000 = $105,000) Cash..... 27,195,000 Accounts Receivable... 27,195,000 ($8,300,000 + $28,500,000 $105,000 $9,500,000 = $27,195,000) 9-26

PROBLEM 9-7A (a) Merchandise inventory at beginning of year... $36,000 Add: Purchases... 60,000 Goods available for sale... 96,000 Less: Merchandise inventory at end of year... 32,000 Cost of goods sold... 64,000 Add: Gross profit... 27,000 Total sales... 91,000 Less: Cash sales... 15,000 Credit sales... $76,000 (b) Accounts receivable at beginning of year... $24,000 Add: Credit sales... 76,000 100,000 Less: Accounts collected during the year... $61,000 Accounts written off during the year... 1,000 62,000 Accounts receivable at end of year... $38,000 Accounts Receivable Beg. balance 24,000 Credit sales 76,000 Write-offs 1,000 Collections 61,000 End. balance 38,000 9-27

PROBLEM 9-8A Jan. 5 Accounts Receivable Brooks Company... 7,000 Sales... 7,000 Feb. 2 Notes Receivable Brooks Company... 7,000 Accounts Receivable Brooks Company... 7,000 12 Notes Receivable Gage Company... 7,800 Sales... 7,800 26 Accounts Receivable Mathias Co.... 4,000 Sales... 4,000 Apr. 5 Notes Receivable Mathias Co... 4,000 Accounts Receivable Mathias Co... 4,000 12 Cash ($7,800 + $130)... 7,930 Notes Receivable Gage Company... 7,800 Interest Revenue... 130 ($7,800 X 10% X 2/12) June 2 Cash ($7,000 + $187)... 7,187 Notes Receivable Brooks Company... 7,000 Interest Revenue... 187 ($7,000 X 8% X 4/12) July 4 Accounts Receivable Mathias Co.... 4,080 ($4,000 + $80) Notes Receivable Mathias Co.... 4,000 Interest Revenue ($4,000 X 8% X 3/12)... 80 15 Notes Receivable Tritt Inc... 5,000 Sales... 5,000 Oct. 13 Allowance for Doubtful Notes... 5,000 Notes Receivable Tritt Inc.... 5,000 Dec. 31 No entry required 9-28

PROBLEM 9-9A (a) Oct. 1 Cash... 8,080 Notes Receivable Foran... 8,000 Interest Receivable... 80 ($8,000 X 6% X 2/12) 7 Accounts Receivable... 6,900 Sales... 6,900 12 Cash ($750 $26.25)... 723.75 Credit Card Expense ($750 X 3.5%)... 26.25 Sales... 750.00 15 Accounts Receivable... 485 Interest Revenue... 485 31 Accounts Receivable Drexler... 8,160 Notes Receivable Drexler... 8,000 Interest Receivable... 80 ($8,000 X 12% X 1/12) Interest Revenue... 80 ($8,000 X 12% X 1/12) 31 Interest Receivable... 90 ($12,000 X 9% X 1/12) Interest Revenue... 90 9-29

PROBLEM 9-9A (Continued) (b) Notes Receivable Date Explanation Ref. Debit Credit Balance Oct. 1 1 31 Balance 8,000 8,000 28,000 20,000 12,000 Accounts Receivable Date Explanation Ref. Debit Credit Balance Oct. 7 15 31 6,900 0,485 8,160 06,900 07,385 15,545 Interest Receivable Date Explanation Ref. Debit Credit Balance Oct. 1 1 31 31 Balance 90 80 80 61.55 160 80 0 90 (c) TARDIF COMPANY Balance Sheet (partial) October 31, 2003 Assets Current assets Notes receivable... $12,000 Accounts receivable... 15,545 Interest receivable... 90 Total current assets... $27,635 9-30

PROBLEM 9-9A (Continued) (d) Oct. 31 Allowance for Doubtful Notes... 8,080 Notes Receivable Drexler... 8,000 Interest Receivable... 80 Note that the interest previously accrued on this note should be written off, as well as the note itself. Also, no interest would be accrued for October. 9-31

PROBLEM 9-10A (a) 2000 1999 Current ratio $1,125 $1,903 = 0.6:1 $1,527 $1,777 = 0.9:1 Acid test ratio $756 $1,903 = 0.4:1 $1,110 $1,777 = 0.6:1 (b) 2000 1999 Receivables turnover $5,446 $770 = 7.1x $5,261 $603.5 = 8.7x Collection period 365 days 7.1 = 51.4 days 365 days 8.7 = 42.0 days (c) CN s short-term liquidity has deteriorated. The current and acid test ratios both declined. The receivables turnover is less and the average collection period is longer. 9-32

PROBLEM 9-1B (a) 1. Accounts Receivable... 2,600,000 Sales... 2,600,000 2. Sales Returns and Allowances... 40,000 Accounts Receivable... 40,000 3. Cash... 2,300,000 Accounts Receivable... 2,300,000 4. Allowance for Doubtful Accounts... 65,000 Accounts Receivable... 65,000 5. Accounts Receivable... 25,000 Allowance for Doubtful Accounts... 25,000 Cash... 25,000 Accounts Receivable... 25,000 (b) Bad Debts Expense... 51,200 Allowance for Doubtful Accounts... 51,200 [($2,600,000 - $40,000) X 2%] (c) Accounts Receivable Bal. 1,000,000 (1) 2,600,000 (5) 25,000 (2) 40,000 (3) 2,300,000 (4) 65,000 (5) 25,000 Allowance for Doubtful Accounts (4) 65,000 Bal. 60,000 (5) 25,000 51,200 Bal. 1,195,000 Bal. 71,200 9-33

PROBLEM 9-2B (a) $24,000 (b) $45,000 ($1,500,000 X 3%) (c) $27,000 [($600,000 X 5%) $3,000] (d) $32,000 [($600,000 X 5%) + $2,000] (e) The direct write-off method of reporting bad debts expense is not in accordance with generally accepted accounting principles because it does not match expenses with the associated revenues. In addition, the accounts receivable are not stated at their net realizable value at the balance sheet date. (f) The answer will vary depending on which method the student prefers. Example: Although either method is acceptable, I prefer the percentage of receivables (ageing) basis because I believe it results in a better estimate. It also may lead to better accounts receivable management because of the focus on the age of individual accounts and evaluation of loss percentages in each age category. Often, I find it helpful to use both methods together to help check the reasonableness of the estimate. 9-34

PROBLEM 9-3B (a) Dec. 31 Bad Debts Expense... 18,950 Allowance for Doubtful Accounts... 18,950 ($28,950 $10,000) (b) 1. Mar. 31 Allowance for Doubtful Accounts... 800 Accounts Receivable... 800 2. May 31 Accounts Receivable... 800 Allowance for Doubtful Accounts... 800 31 Cash... 800 Accounts Receivable... 800 Bad Debts Expense Date Explanation Ref. Debit Credit Balance 2002 Dec. 31 Adjusting 18,950 18,950 Allowance for Doubtful Accounts Date Explanation Ref. Debit Credit Balance 2002 Dec. 31 31 2003 Mar. 31 May 31 Balance Adjusting 800 18,950 800 10,000 28,950 28,150 28,950 (c) Dec. 31 Bad Debts Expense... 2,970 Allowance for Doubtful Accounts... 2,970 ($40,000 - $37,030) 9-35

PROBLEM 9-4B (a) Total estimated bad debts Number of Days Past Due Total 0-30 31-60 61-90 Over 90 Accounts receivable $375,000 $220,000 $90,000 $40,000 $25,000 % uncollectible 1% 4% 5% 10% Estimated bad debts $10,300 $2,200 $3,600 $2,000 $2,500 (b) Bad Debts Expense... 20,300 Allowance for Doubtful Accounts... 20,300 [$10,300 + $10,000] (c) Allowance for Doubtful Accounts... 5,000 Accounts Receivable... 5,000 (d) Accounts Receivable... 5,000 Allowance for Doubtful Accounts... 5,000 Cash... 5,000 Accounts Receivable... 5,000 (e) If Image.com used 3% of accounts receivable rather than ageing the accounts the allowance at year-end, the adjustment would be $21,250 [($375,000 x 3%) + $10,000]. The remaining entries would remain unchanged. (f) Ageing the accounts rather than applying a percentage to the total accounts receivable should produce a more accurate allowance and bad debt expense when the ageing of the accounts change. It also focuses management attention on the receivables and the loss percentages, which can result in better receivables management. 9-36

PROBLEM 9-5B (a) Accounts Receivable... 1,300,000 Sales... 1,300,000 (b) Allowance for Doubtful Accounts... 41,000 Accounts Receivable... 41,000 (c) Accounts Receivable... 5,200 Allowance for Doubtful Accounts... 5,200 Cash... 5,200 Accounts Receivable... 5,200 (d) Accounts receivable: Beginning balance... $ 150,000 Add: Credit sales... 1,300,000 1,450,000 Deduct: Collections on account... $1,225,000 Write-off of uncollectible accounts... 41,000 1,266,000 Unadjusted balance... $ 184,000 Allowance for doubtful accounts: Beginning balance... $10,000 Add: Recovery of account... 5,200 Deduct: Write-off of uncollectible accounts... 41,000 Unadjusted balance... $25,800 Debit (e) Bad Debts Expense [(12% X $184,000) + $25,800) 47,880 Allowance for Doubtful Accounts... 47,880 9-37

PROBLEM 9-5B (Continued) (f) Accounts receivable: Beginning balance... $ 150,000 Add: Credit sales... 1,300,000 1,450,000 Deduct: Collections on account... $1,225,000 Write-off of uncollectible accounts... 41,000 1,266,000 Ending balance... $ 184,000 Allowance for doubtful accounts: Beginning balance... $10,000 Add: Recovery of account... 5,200 Bad debts expense... 47,880 63,080 Deduct: Write-off of uncollectible accounts... 41,000 Ending balance... $22,080 9-38

PROBLEM 9-6B Accounts Receivable Yr. 1 Balance 4,100,000 Sales 22,500,000 Write-offs 150,000 Collections 21,650,000 Yr. 2 Balance 4,800,000 Allowance for Doubtful Accounts Yr. 1 Balance 350,000 Bad debts 225,000 Write-offs 150,000 Yr. 2 Balance 425,000 Allowance for Doubtful Accounts... 150,000 Accounts Receivable... 150,000 Bad Debts Expense... 225,000 Allowance for Doubtful Accounts... 225,000 ($350,000 $150,000 $425,000 = $225,000) Accounts Receivable... 22,500,000 Sales... 22,500,000 ($225,000 = 1% of sales; Therefore sales = $22,500,000) Cash..... 21,650,000 Accounts Receivable... 21,650,000 ($4,100,000 + $22,500,000 $150,000 $4,800,000 = $21,650,000) 9-39

PROBLEM 9-7B (a) Sales? Cost of goods sold 66,000 Gross profit on sales 31,000 Total sales = $97,000 ($31,000 + $66,000) Cash sales = 18,000 Credit sales = $79,000 (b) Accounts receivable at December 31 is $24,500, as shown below: Accounts Receivable Beg. balance 27,000 Credit sales 79,000 Write-offs 1,500 Collections 80,000 End. balance 24,500 9-40

(a) PROBLEM 9-8B Jan. 5 Accounts Receivable George Company... 18,000 Sales... 18,000 20 Notes Receivable George Company... 18,000 Accounts Receivable George Company 18,000 Feb. 18 Notes Receivable Swaim Company... 8,000 Sales... 8,000 Apr. 20 Cash ($18,000 + $405)... 18,405 Notes Receivable George Company... 18,000 Interest Revenue... 405 ($18,000 X 9% X 3/12) 30 Cash ($15,000 + $400)... 15,400 Notes Receivable Annabelle Company.. 15,000 Interest Revenue... 400 ($15,000 X 8% X 4/12) May 25 Notes Receivable Avery Inc... 6,000 Accounts Receivable Avery Inc... 6,000 Aug. 18 Cash ($8,000 + $400)... 8,400 Notes Receivable Swaim Company... 8,000 Interest Revenue... 400 ($8,000 X 10% X 6/12) 23 Allowance for Doubtful Notes... 6,000 Notes Receivable Avery Inc.... 6,000 Sept. 1 Notes Receivable Young Company... 12,000 Sales... 12,000 9-41

PROBLEM 9-8B (Continued) Nov. 22 There would probably be no entry made on November 22. Since financial statements are prepared only at year-end, Dot.com Company would probably wait until December 31 before making a decision regarding whether the note should be written off. Dec. 31 Interest Receivable... 400 Interest Revenue... 400 ($12,000 x 10% X 4/12) The company would evaluate the information available on Young Company and may decide to write off the note and not accrue the interest. If they decide that a write-off is appropriate, the above entry would not be made and the following entry would be made: Dec. 31 Allowance for Doubtful Notes... 12,000 Notes Receivable... 12,000 (b) Interest should not be accrued if it is unlikely to be collected. In addition, consideration would have to be given to whether the note should be written off. At the very least, an allowance should be created with respect to the Young Company note, based upon the estimated probability of collection. 9-42

PROBLEM 9-9B (a) Don Co. $6,000 X 12% X 2/12 = $120 Jean Co. $4,800 X 11% X 1/12 = 44 Total $164 (b) July 1 Cash ($6,000 + $120)... 6,120 Notes Receivable Don Co... 6,000 Interest Receivable... 120 ($6,000 X 12% X 2/12) 5 Accounts Receivable... 6,200 Sales... 6,200 14 Cash ($700 $21)... 679 Credit Card Expense ($700 X 3%)... 21 Sales... 700 16 Accounts Receivable... 415 Interest Revenue... 415 31 Accounts Receivable Jean Co... 4,888 Notes Receivable Jean Co... 4,800 Interest Receivable... 44 ($4,800 X 11% X 1/12) Interest Revenue... 44 ($4,800 X 11% X 1/12) 31 Interest Receivable... 75 ($10,000 X 9% X 1/12) Interest Revenue... 75 9-43

PROBLEM 9-9B (Continued) (c) Notes Receivable Date Explanation Ref. Debit Credit Balance July 1 1 31 Balance T 6,000 4,800 20,800 14,800 10,000 Accounts Receivable Date Explanation Ref. Debit Credit Balance July 5 16 31 6,200 415 4,888 6,200 6,615 11,503 Interest Receivable Date Explanation Ref. Debit Credit Balance July 1 1 31 31 Balance Adjusting entry T 75 120 44 164 44 0 75 (d) OUELLETTE CO. Balance Sheet (partial) July 31, 2003 Assets Current assets Notes receivable... $10,000 Accounts receivable... 11,503 Interest receivable... 75 Total current assets... $21,578 9-44

PROBLEM 9-9B (Continued) (e) Interest should not be accrued if it is unlikely to be collected. In addition, consideration would have to be given to whether the note should be written off. At the very least, an allowance should be created with respect to the Jean Company note, based upon the estimated probability of collection. 9-45

PROBLEM 9-10B (a) 2000 1999 Current ratio $782,878 $899,684 = 0.9:1 Acid test $690,612 $899,684 = 0.8:1 $1,133,906 $1,874,643 = 0.6:1 $1,048,279 $1,874,643 = 0.6:1 (b) 2000 1999 Receivables turnover $4,210,313 $858,257 = 4.9 x $4,160,167 $675,706 = 6.2 x Collection period 365 days 4.9 = 74.4 days 365 days 6.2 = 58.9 days (c) Becker Milk s short-term liquidity has improved slightly. The current and acid test ratios both increased. However, the receivables turnover is lower and the collection period is longer. This could be the reason the current and acid test ratios look artificially better. Further investigation is warranted before one should conclude on Becker Milk s liquidity. 9-46

BYP 9-1 FINANCIAL REPORTING PROBLEM (a) ($ in thousands) 2000 1999 Acid test ratio $1,446 + $2,294 = 0.6:1 $6,405 Receivables turnover $20,844 [$2,294 + $2,494) 2] = 8.7 x $20,942 + $2,494 = 3.6:1 $6,451 $21,465 [($2,494 + $7,196) 2] = 4.4 x Collection period 365 days = 41.9 days 8.7 365 days = 82.9 days 4.4 (b) The acid test ratio decreased significantly from 1999 to 2000. The receivables turnover increased substantially, and the average collection period decreased correspondingly, from 1999 to 2000. 9-47

BYP 9-2 INTERPRETING FINANCIAL STATEMENTS (a) ($ in thousands) 1999 1998 Current ratio $95,746 $56,862 = 1.7:1 $113,797 $71,817 = 1.6:1 Acid test ratio $37,429 $56,862 = 0.7:1 $31,135 $71,817 = 0.4:1 (b) ($ in thousands) 1999 1998 Receivables turnover $302,392 [$29,955 + $30,776) 2] = 9.9 x $291,655 [$30,776 + $23,379) 2] = 10.8 x Collection period 365 days 9.9 = 36.9 days 365 days 10.8 = 33.8 days (c) High Liner Foods does an adequate job of managing its receivables. However, it appears the management s performance has deteriorated in 1999 compared to the previous year. Its average collection period of 34 days in 1998 and 37 days in 1999 is longer than its credit terms of 7 to 30 days. (d) The same allowance for doubtful accounts appears reasonable. If there was a significant difference in credit risk in the separate locations, this should have been disclosed in the notes to the financial statements. 9-48

BYP 9-3 ACCOUNTING ON THE WEB Due to the frequency of change with regard to information available on the world wide web, the Accounting on the Web cases are updated as required. Their suggested solutions are also updated whenever necessary, and can be found on-line in the Instructor Resources section of our home page [www.wiley.com/canada/weygandt2]. 9-49

BYP 9-4 COLLABORATIVE LEARNING ACTIVITY (a) Net credit sales... 2003 2002 2001 $500,000 $600,000 $400,000 Credit and collection expenses Collection agency fees... Salary of accounts receivable clerk.. Uncollectible accounts (1.6%)... Billing and mailing costs (0.5%)... Credit investigation fees (0.15%)... Total... $ 02,450 3,800 8,000 2,500 750 $ 17,500 $ 02,500 3,800 9,600 3,000 0 900 $ 19,800 $ 2,400 3,800 6,400 2,000 0,600 $ 15,200 Total expenses as a percentage of net credit sales... 3.5% 3.3% 3.8% (b) Average accounts receivable (5%)... $25,000 $30,000 $20,000 Investment income (8%)... $ 2,000 $ 2,400 $ 1,600 Total credit and collection expenses per above... Add: Investment income*... Net credit and collection expense... $17,500 0002,000 $19,500 $19,800 2,400 $22,200 $15,200 0 1,600 $16,800 Net expenses as a percentage of net credit sales... 3.9% 3.7% 4.2% * The lost investment income on the cash tied up in accounts receivable is an additional expense of continuing the existing credit policies (an opportunity cost). 9-50

BYP 9-4 (Continued) (c) The analysis shows that the credit card fee of 3% of net credit sales will be lower than the percentage cost of credit and collection expenses in each year. This is true both before and after considering the effect of income from other investment opportunities. It would be cheaper for Campus Fashions to accept bank credit cards rather than only their own credit card. However, the decision hinges on (1) the accuracy of the estimate of investment income, (2) the expected trend in credit sales, and (3) the effect the new policy will have on sales. Non-financial factors include the effects on customer relationships of the alternative credit policies, and whether the Berkvoms want to continue with the problems of handling their own accounts receivable. Note that the case mentions that the company has lost some sales as a result of its refusal to accept credit cards. If credit cards are accepted, the extra sales will generate extra profits; operating expenses might also be affected. These should be estimated and taken into consideration as well. 9-51

BYP 9-5 COMMUNICATION ACTIVITY Dear Lois, The methods you asked about are methods of dealing with uncollectible accounts receivables. Allowance versus direct write-off methods: The allowance method estimates uncollectible amounts and matches the estimated bad debts expense against revenues generated in the year of the sale. Estimated uncollectible accounts are recorded in a contra account to accounts receivable, called Allowance for Doubtful Accounts. The direct write-off method does not estimate bad debts expenses in advance and an allowance account is not used. Instead, when an account is determined to be uncollectible, it is written off directly to expense. Unless bad debt losses are insignificant, this method is not acceptable for financial reporting purposes. Allowance method Percentage of sales and percentage of receivables methods: The percentage of sales and percentage of receivables methods are both acceptable methods used to estimate the amount uncollectible under the allowance" method. Under the percentage of sales basis, management establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. This is based on past experience and anticipated credit policy. The percentage is then applied to either total credit sales or net credit sales of the current year. This basis of estimating emphasizes the matching of expenses with revenues, and is therefore deemed an income statement approach. 9-52

BYP 9-5 (Continued) Under the percentage of receivables basis, management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts. This percentage can be applied to total accounts receivable or to aged classes of receivables in which customer accounts are classified by the length of time they have been unpaid. This basis emphasizes net realizable value of receivables and is therefore deemed a "balance sheet" approach. I hope that this answers your questions. Please do not hesitate to contact me if you require any further information. Sincerely, 9-53

BYP 9-6 ETHICS CASE (a) The stakeholders in this situation are: The president of Shirt Co. The controller of Shirt Co. The parent company, Clothes Corp. Any other parties who rely upon the company s financial statements. (b) Yes. The controller is posed with an ethical dilemma should he/she follow the president's suggestion and prepare misleading financial statements (understated net income) or should he/she attempt to stand up to and possibly anger the president by preparing a fair (realistic) income statement. (c) Shirt Co.'s growth rate should be a product of fair and accurate financial statements. One should not prepare financial statements with the objective of achieving or sustaining a predetermined growth rate. The growth rate should be a product of management and operating results, not of creative accounting. 9-54