Spiceland SM 7eCh07

7/25/2019 Spiceland SM 7eCh07

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The McGraw-Hill Companies, Inc., 2007Solutions Manual, Vol.1, Chapter 7 7-1

Question 7-1Cash equivalents usually include negotiable instruments as well as highly liquid investments

that have a maturity date no longer than three months from date of purchase.

Question 7-2Internal control procedures involving accounting functions are intended to improve the

accuracy and reliability of accounting information and to safeguard the companys assets. Theseparation of duties means that employees involved in recordkeeping should not also have physicalresponsibility for assets.

Question 7-3Management must document the companys internal controls and assess their adequacy. The

auditors must provide an opinion on managements assessment. The Public Company AccountingOversight Boards Auditing Standard No. 2 further requires the auditor to express its own opinion onwhether the company has maintained effective internal control over financial reporting

Question 7-4A compensating balance is an amount of cash a depositor (debtor) must leave on deposit in an

account at a bank (creditor) as security for a loan or a commitment to lend. The classification anddisclosure of a compensating balance depends on the nature of the restriction and the classificationof the related debt. If the restriction is legally binding, then the cash will be classified as eithercurrent or noncurrent depending on the classification of the related debt. In either case, notedisclosure is appropriate. If the compensating balance arrangement is informal and no contractualagreement restricts the use of cash, note disclosure of the arrangement including amounts involved isappropriate. The compensating balance can be included in the cash and cash equivalents category ofcurrent assets.

Question 7-5Trade discounts are reductions below a list price and are used to establish a final price for a

transaction. The reduced price is the starting point for initial valuation of the transaction. A cashdiscount is a reduction, not in the selling price of a good or service, but in the amount to be paid by acredit customer if the receivable is paid within a specified period of time.

Question 7-6The gross method of accounting for cash discounts considers discounts not taken as part of

sales revenue. The net method considers discounts not taken as interest revenue, because they areviewed as compensation to the seller for allowing the buyer to defer payment.

Chapter 7 Cash and Receivables

QUESTIONS FOR REVIEW OF KEY TOPICS
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The McGraw-Hill Companies, Inc., 20077-2 Intermediate Accounting, 4/e

Answers to Questions (continued)

Question 7-7When returns are material and a company can make reasonable estimates of future returns, an

allowance for sales returns is established. At a financial reporting date, this provides an estimate ofthe amount of future returns for prior sales, and involves a debit to sales returns and a credit toallowance for sales returns for the estimated amount. Allowance for sales returns is a contra accountto accounts receivable. When returns actually occur in the future reporting period, the allowance forsales returns is debited.

Question 7-8Even when specific customer accounts havent been proven uncollectible by the end of the

reporting period, bad debt expense properly should be matched with sales revenue on the incomestatement for that period. Likewise, since its not expected that all accounts receivable will becollected, the balance sheet should report only the expected net realizable value of that asset. So, to

record the bad debt expense and the related reduction of accounts receivable when the amount hasnt been determined, an estimate is needed. In an adjusting entry, we record bad debt expense andreduce accounts receivable for an estimate of the amount that eventually will prove uncollectible.

If uncollectible accounts are immaterial or not anticipated, or its not possible to reliablyestimate uncollectible accounts, an allowance for uncollectible accounts is not appropriate. In thesefew cases, any bad debts that do arise simply are written off as bad debt expense.

Question 7-9The income statement approach to estimating bad debts determines bad debt expense directly

by relating uncollectible amounts to credit sales. The balance sheet approach to estimating future bad debts indirectly determines bad debt expense by estimating the net realizable value for accounts

receivable that exist at the end of the period. In other words, the allowance for uncollectibleaccounts at the end of the period is estimated and then bad debt expense is determined by adjustingthe allowance account to reflect net realizable value.

Question 7-10The assignment of all accounts receivable in general as collateral for debt requires no special

accounting treatment other than note disclosure of the agreement.

Question 7-11Accounts receivable factored without recourse are accounted for as the sale of an asset. The

difference between the book value and the proceeds received is recognized as a gain or a loss. The

accounting treatment of receivables factored with recourse depends on whether certain criteria aremet. If the criteria are met, the factoring is accounted for as a sale. If they are not met, the factoringis accounted for as a loan. In addition, note disclosure may be required.


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Answers to Questions (concluded)

Question 7-12When a note is discounted, a financial institution, usually a bank, accepts the note and gives the

seller cash equal to the maturity value of the note reduced by a discount. The discount is computed by applying a discount rate to the maturity value and represents the financing fee the bank chargesfor the transaction.

The four-step process used to account for a discounted note receivable is as follows:1. Accrue any interest revenue earned since the last payment date (or date of the note).2. Compute the maturity value.3. Subtract the discount the bank requires (discount rate times maturity value times the length

of time from date of discounting to maturity date) from the maturity value to compute the proceeds to be received from the bank (maturity value less discount).

4. Compute the difference between the proceeds and the book value of the note and relatedinterest receivable. The treatment of the difference will depend on whether the discounting

is accounted for as a sale or as a loan . If its a sale the difference is recorded as a loss orgain on the sale; if its a loan the difference is viewed as interest expense or interestrevenue.

Question 7-13A companys investment in receivables is influenced by several related variables, to include

the level of sales, the nature of the product or service, and credit and collection policies. Thereceivables turnover and average collection period ratios are designed to monitor receivables.

Question 7-14The items necessary to adjust the bank balance might include deposits outstanding (including

undeposited cash), outstanding checks, and any bank errors discovered during the reconciliation process. The items necessary to adjust the book balance might include collections made by the bankon the companys behalf, service and other charges made by the bank, NSF (nonsufficient funds)check charges, and any company errors discovered during the reconciliation process.

Question 7-15A petty cash fund is established by transferring a specified amount of cash from the companys

general checking account to an employee designated as the petty cash custodian. The fund isreplenished by writing a check to the petty cash custodian for the sum of the bills paid with pettycash. The appropriate expense accounts are recorded from petty cash vouchers at the time the fundis replenished.


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Brief Exercise 7-1The company could improve its internal control procedure for cash receipts by

segregating the duties of recordkeeping and the handling of cash. Jim Seymour,responsible for recordkeeping, should not also be responsible for depositing customerchecks.

Brief Exercise 7-2All of these items would be included as cash and cash equivalents except the U.S.

Treasury bills, which would be included in the current asset section of the balancesheet as short-term investments.

Brief Exercise 7-3Income before tax in 2007 will be reduced by $2,500, the amount of the cash

discounts.

$25,000 x 10 = $250,000 x 1% = $2,500

Brief Exercise 7-4Income before tax in 2006 will be reduced by $2,500, the anticipated amount of

cash discounts.

$25,000 x 10 = $250,000 x 1% = $2,500

BRIEF EXERCISES


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Brief Exercise 7-5

Estimated returns = $10,600,000 x 8% = $848,000Less: Actual returns (720,000)

Remaining estimated returns $128,000

Sales returns .................................................................. 128,000Allowance for sales returns ...................................... 128,000

Inventory ...................................................................... 76,800Cost of goods sold ($128,000 x 60%) ........................... 76,800

Brief Exercise 7-6

(1) Bad debt expense = $1,500,000 x 2% = $30,000

(2) Allowance for uncollectible accounts:Beginning balance $25,000Add: Bad debt expense 30,000Deduct: Write-offs (16,000 )

Ending balance $39,000


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Brief Exercise 7-7

(1) Allowance for uncollectible accounts:Beginning balance $ 25,000

Deduct: Write-offs (16,000)Required allowance (33,400)*Bad debt expense $24,400

(2) Required allowance = $334,000** x 10% = $33,400 *

Accounts receivable:Beginning balance $ 300,000

Add: Credit sales 1,500,000Deduct: Cash collections (1,450,000)

Write-offs (16,000)Ending balance $ 334,000**

Brief Exercise 7-8

Allowance for uncollectible accounts:Beginning balance $30,000

Add: Bad debt expense 40,000Deduct: Required allowance (38,000)

Write-offs $32,000


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Brief Exercise 7-9

Credit sales $8,200,000Deduct: Cash collections (7,950,000)

Write-offs (32,000)*Year-end balance in A/R (2,000,000 )Beginning balance in A/R $1,782,000

*Allowance for uncollectible accounts:Beginning balance $30,000Add: Bad debt expense 40,000Deduct: Required allowance (38,000 )

Write-offs $32,000

Brief Exercise 7-10

2006 interest revenue:$20,000 x 6% x 1/12 = $100

2007 interest revenue:$20,000 x 6% x 2/12 = $200


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Brief Exercise 7-11Assets decrease by $3,000:Cash increases by $100,000 x 85% = $ 85,000Receivable from factor increases by

([15% x $100,000] $3,000 fee) 12,000Accounts receivable decrease (100,000)

Net decrease in assets $ (3,000)

Liabilities would not change as a result of this transaction.

Income before income taxes decreases by $3,000 , the amount of the factors fee.($100,000 x 3%)

The journal entry to record the transaction is as follows:

Cash (85% x $100,000) ..................................................... 85,000Loss on sale of receivables (3% x $100,000) ..................... 3,000Receivable from factor ([15% x $100,000] $3,000 fee) ..... 12,000

Accounts receivable (balance sold) ............................... 100,000

Brief Exercise 7-12Logitech would account for the transfer as a secured borrowing. The receivables

would remain on the companys books and a liability is recorded for the amount

borrowed plus the banks fee.


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Brief Exercise 7-13

$30,000 Face amount450 Interest to maturity ($30,000 x 6% x 3/12)

30,450 Maturity value (406) Discount ($30,450 x 8% x 2/12)

$30,044 Cash proceeds

Brief Exercise 7-14

Receivables turnover = $320,000 = 5.33 $60,000*

($50,000 + 70,000) 2 = $60,000*

Average collection = 365 = 68 days period 5.33


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Exercise 7-1

Requirement 1Cash and cash equivalents includes:

a. Balance in checking account $13,500Balance in savings account 22,100

b. Undeposited customer checks 5,200c. Currency and coins on hand 580f. U.S. treasury bills with 2-month maturity 15,000

Total $56,380

Requirement 2

d. The $400,000 savings account will be used for future plant expansion andtherefore should be classified as a noncurrent asset, either in other assets orinvestments .

e. The $20,000 in the checking account is a compensating balance for a long-term loan and should be classified as a noncurrent asset, either in otherassets or investments .

f. The $20,000 in 7-month treasury bills should be classified as a current assetalong with other temporary investments.

EXERCISES


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Exercise 7-2

Requirement 1Cash and cash equivalents includes:

Cash in bank checking account $22,500U.S. treasury bills 5,000Cash on hand 1,350Undeposited customer checks 1,840

Total $30,690

Requirement 2

The $10,000 in 6-month treasury bills should be classified as a current assetalong with other temporary investments.


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Exercise 7-3

Requirement 1

Sales price = 100 units x $600 = $60,000 x 70% = $42,000

November 17, 2006 Accounts receivable ...................................................... 42,000

Sales revenue............................................................. 42,000

November 26, 2006 Cash (98% x $42,000) ....................................................... 41,160Sales discounts (2% x $42,000) ........................................ 840

Accounts receivable .................................................. 42,000

Requirement 2


Sales revenue............................................................. 42,000

December 15, 2006 Cash .............................................................................. 42,000



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Exercise 7-3 (concluded)

Requirement 3

Requirement 1:


Sales revenue (98% x $42,000) ..................................... 41,160

November 26, 2006 Cash .............................................................................. 41,160


Requirement 2:


Sales revenue (98% x $35,000) ..................................... 41,160

December 15, 2006 Cash .............................................................................. 42,000

Accounts receivable .................................................. 41,160Interest revenue ......................................................... 840


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Exercise 7-4

Requirement 1

Sales price = 1,000 units x $50 = $50,000

July 15, 2006 Accounts receivable ...................................................... 50,000

Sales revenue............................................................. 50,000

July 23, 2006 Cash (98% x $50,000) ....................................................... 49,000Sales discounts (2% x $50,000) ........................................ 1,000


Requirement 2

July 15, 2006

Accounts receivable ...................................................... 50,000Sales revenue............................................................. 50,000

Aug. 15, 2006 Cash .............................................................................. 50,000



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Exercise 7-5

Requirement 1


Sales revenue (98% x $50,000) ..................................... 49,000

July 23, 2006 Cash .............................................................................. 49,000


Requirement 2


Sales revenue (98% x $50,000) ..................................... 49,000

August 15, 2006 Cash .............................................................................. 50,000

Accounts receivable .................................................. 49,000Interest revenue ......................................................... 1,000


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Exercise 7-6

Requirement 1$67,500 (1.5% x $4,500,000)

Requirement 2 Allowance for uncollectible accounts

Balance, beginning of year $42,000Add: Bad debt expense for 2006 (1.5% x $4,500,000) 67,500Less: End-of-year balance (40,000)

Accounts receivable written off $69,500

Requirement 3 $69,500 the amount of accounts receivable written off.


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Exercise 7-7Requirement 1

To record the write-off of receivables.

Allowance for uncollectible accounts ............................ 21,000Accounts receivable .................................................. 21,000

To record the collection of a receivable previously written off.

Accounts receivable ...................................................... 1,200Allowance for uncollectible accounts ........................ 1,200

Cash .............................................................................. 1,200Accounts receivable .................................................. 1,200

Allowance for uncollectible accounts: Balance, beginning of year $32,000Deduct: Receivables written off (21,000)Add: Collection of receivable previously written off 1,200Balance, before adjusting entry for 2006 bad debts 12,200

Required allowance: 10% x $625,000 (62,500 )Bad debt expense $50,300

To record bad debt expense for the year.

Bad debt expense .......................................................... 50,300Allowance for uncollectible accounts ........................ 50,300

Requirement 2

Current assets: Accounts receivable, net of $62,500 in allowance

for uncollectible accounts $562,500


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Exercise 7-8Using the direct write-off method, bad debt expense is equal to actual write-offs.

Collections of previously written-off receivables are recorded as revenue.

Allowance for uncollectible accounts:

Balance, beginning of year $17,280Deduct: Receivables written off (17,100)Add: Collection of receivables previously written off 2,200Less: End of year balance (22,410)Bad debt expense for the year 2006 $20,030

Exercise 7-9($ in millions)


Balance, beginning of year $242Add: Bad debt expense 44Less: End of year balance (166)Write-offs during the year $120*

Accounts receivable analysis:

Balance, beginning of year ($5,196 + 242) $ 5,438Add: Credit sales 36,835Less:Write-offs* (120)Less: Balance end of year ($5,890 + 166) (6,056 )Cash collections $36,097


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Exercise 7-10

Requirement 1

June 30, 2006 Note receivable ............................................................. 30,000

Sales revenue............................................................. 30,000

December 31, 2006 Interest receivable ......................................................... 900

Interest revenue ($30,000 x 6% x 6/12

) ........................... 900

March 31, 2007 Cash [$30,000 + ($30,000 x 6% x 9/12)] ............................... 31,350

Interest revenue ($30,000 x 6% x 3/12) ........................... 450Interest receivable (accrued at December 31) .................. 900

Note receivable ......................................................... 30,000

Requirement 22006 income before income taxes would be understated by $9002007 income before income taxes would be overstated by $900.


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Exercise 7-11

Requirement 1

June 30, 2006 Note receivable (face amount) .......................................... 30,000

Discount on note receivable ($30,000 x 8% x 9/12) ........ 1,800Sales revenue (difference) ............................................ 28,200

December 31, 2006 Discount on note receivable ......................................... 1,200

Interest revenue ($30,000 x 8% x 6/12) ........................... 1,200

March 31, 2007 Discount on note receivable ......................................... 600

Interest revenue ($30,000 x 8% x 3/12) ........................... 600

Cash ............................................................................. 30,000 Note receivable (face amount) ...................................... 30,000

Requirement 2$ 1,800 interest for 9 months

$28,200 sales price= 6.38% rate for 9 monthsx 12/9 to annualize the rate _______

= 8.51% effective interest rate


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Exercise 7-12

Requirement 1Book value of stock $16,000Plus gain on sale of stock 6,000

= Note receivable $22,000

Interest reported for the year $ 2,200= 10% rate

Divided by value of note $ 22,000

Requirement 2To record sale of stock in exchange for note receivable.

January 1, 2006 Note receivable ............................................................. 22,000

Investments ............................................................... 16,000Gain on sale of investments....................................... 6,000

To accrue interest on note receivable for twelve months.

December 31, 2006 Interest receivable ......................................................... 2,200

Interest revenue ($22,000 x 10%) .................................. 2,200

Exercise 7-131. a2. a3. a4. a


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Exercise 7-14

Cash (difference) ............................................................. 439,200Finance charge expense (1.8% x $600,000) ....................... 10,800

Liability financing arrangement ............................. 450,000

Exercise 7-15

Cash (90% x $60,000) ....................................................... 54,000Loss on sale of receivables (2% x $60,000) ...................... 1,200

Receivable from factor ([10% x $60,000] $1,200 fee) ....... 4,800Accounts receivable (balance sold) ............................... 60,000

Exercise 7-16

Cash (90% x $60,000) ....................................................... 54,000Loss on sale of receivables ([2% x $60,000] + $3,000) ....... 4,200Receivable from factor ([10% x $60,000] $1,200 fee) ...... 4,800

Recourse liability ..................................................... 3,000Accounts receivable (balance sold) ............................... 60,000


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Exercise 7-17Step 1: Accrue interest earned.

February 28, 2006 Interest receivable ......................................................... 250

Interest revenue ($15,000 x 10% x 2/12) ......................... 250

Step 2: Add interest to maturity to calculate maturity value.Step 3: Deduct discount to calculate cash proceeds.




Step 4: To record a loss for the difference between the cash proceeds and thenotes book value.

February 28, 2006 Cash (proceeds determined above) ....................................... 15,120Loss on sale of note receivable (difference) ..................... 130

Note receivable (face amount) ...................................... 15,000Interest receivable (accrued interest determined above) ..... 250

Exercise 7-181. d2. c


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Exercise 7-19

List A List B

c 1. Internal control a. Restriction on cash. j 2. Trade discount b. Cash discount not taken is sales revenue.g 3. Cash equivalents c. Includes separation of duties.h 4. Allowance for uncollectibles d. Bad debt expense a % of credit sales.i 5. Cash discount e. Recognizes bad debts as they occur.l 6. Balance sheet approach f. Sale of receivables to a financial institution.d 7. Income statement approach g. Include highly liquid investments.k 8. Net method h. Estimate of bad debts.a 9. Compensating balance i. Reduction in amount paid by credit customer.m 10. Discounting j. Reduction below list price. b 11. Gross method k. Cash discount not taken is interest revenue.e 12. Direct write-off method l. Bad debt expense determined by estimating realizable

value.f 13. Factoring m. Sale of note receivable to a financial institution.


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Exercise 7-20

Requirement 1

March 17, 2006 Allowance for uncollectible accounts ............................ 1,700


March 30, 2006 Note receivable ............................................................. 20,000

Cash .......................................................................... 20,000

Step 1: To accrue interest earned for two months on note receivable

May 30, 2006 Interest receivable ......................................................... 233

Interest revenue ($20,000 x 7% x 2/12) ........................... 233

Step 2: Add interest to maturity to calculate maturity value.Step 3: Deduct discount to calculate cash proceeds.

$20,000 Face amount1,400 Interest to maturity ($20,000 x 7%)

21,400 Maturity value (1,427) Discount ($21,400 x 8% x 10/12)



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Exercise 7-20 (continued)

Step 4: To record a loss for the difference between the cash proceeds and thenotes book value.

May 30, 2006 Cash (proceeds determined above) ...................................... 19,973Loss on sale of note receivable (difference) ..................... 260

Interest receivable (from adjusting entry) ....................... 233 Note receivable (face amount) ...................................... 20,000

June 30, 2006 Accounts receivable ...................................................... 12,000

Sales revenue............................................................. 12,000

July 8, 2006 Cash ($12,000 x 98%) ....................................................... 11,760Sales discounts ($12,000 x 2%) ........................................ 240


August 31, 2006 Notes receivable (face amount) ......................................... 6,000

Discount on note receivable ($6,000 x 8% x 6/12) .......... 240Investments (book value) .............................................. 5,000Gain on sale of investments (difference) ...................... 760

December 31, 2006 Bad debt expense ($700,000 x 2%) ................................... 14,000

Allowance for uncollectible accounts ........................ 14,000


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Exercise 7-20 (concluded)

Requirement 2To accrue interest earned on note receivable.

December 31, 2006 Discount on note receivable .......................................... 160

Interest revenue ($6,000 x 8% x 4/12)............................. 160

Exercise 7-21

Second quarter:Receivables turnover = 5,398 = 3.15

1,714


Third quarter:Receivables turnover = 5,620 = 3.14

1,790



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Exercise 7-22Average collection period = 365 Accounts receivable turnover = 50 days

Accounts receivable turnover = 365 50 = 7.3

Average accounts receivable = ($400,000 + 300,000) 2 = $350,000

Accounts receivable turnover = Net sales Average accounts receivable7.3 = Net sales $350,000

Net sales = 7.3 x $350,000 = $2,555,000

Exercise 7-23

1. c. The allowance method records bad debt expense systematically as a percentageof either sales or the level of accounts receivable. The latter calculationconsiders the amount already existing in the allowance account. The credit is toa contra asset or allowance account. As accounts receivable are written off,they are charged to the allowance account.

2. d. If a company uses the allowance method, the write-off of a receivable has noeffect on total assets. The journal entry involves a debit to the allowanceaccount and a credit to accounts receivable. The net effect is that the assetsection is both debited and credited for the same amount. Thus, there will be noeffect on either total assets or net income.

3. c. The entry is to debit bad debt expense and credit the allowance account. Netcredit sales were $1,500,000 ($1,800,000 - $125,000 of discounts - $175,000 ofreturns). Thus, the expected bad debt expense is $22,500 (1.5% x $1,500,000).This amount is recorded regardless of the balance remaining in the allowanceaccount from previous periods. The net effect is that the allowance account isincreased by $22,500.


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Exercise 7-24To establish the petty cash fund.

October 2, 2006Petty Cash ........................................................ 200

Cash (checking account)............................... 200

To replenish the petty cash fund.

October 31, 2006Office supplies expense.................................... 76

Entertainment expense ..................................... 48Postage expense ............................................... 20Miscellaneous expense..................................... 19

Cash (checking account)............................... 163

Exercise 7-25Compute balance per bank statement:

Balance per books $23,820Deduct: Deposits outstanding (2,340)Add: Checks outstanding 1,890Deduct: Bank service charges (38)

Balance per bank $23,332

Step 1: Bank Balance to Corrected Balance

Balance per bank statement $23,332Add: Deposits outstanding 2,340

Deduct: Checks outstanding (1,890)Corrected cash balance $23,782

Step 2: Book Balance to Corrected Balance

Balance per books $23,820Deduct: Service charges (38 )Corrected cash balance $23,782


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Exercise 7-26Requirement 1

Requirement 2To correct error in recording cash receipt from credit customer.

Cash ................................................................. 1,800Accounts receivable ..................................... 1,800

To record credits to cash revealed by the bank reconciliation.

Miscellaneous expense (bank service charges) . 30Accounts receivable (NSF checks)................... 1,200

Interest expense................................................ 320 Note payable .................................................... 3,000

Cash ............................................................. 4,550

Note: Each of the adjustments to the book balance required journal entries. None of the adjustments to the bank balance require entries.


Balance per bank statement $38,018Add: Deposits outstanding 6,300Deduct: Checks outstanding (8,420)Add: Bank error in recording check 270Corrected cash balance $36,168


Balance per books $38,918Add: Error in recording cash

receipt ($2,000 - 200) 1,800Deduct:

Service charges (30) NSF checks (1,200)Automatic monthly loan payment (3,320)

Corrected cash balance $36,168


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Problem 7-1

Requirement 1Monthly bad debt expense accrual summary.

Bad debt expense (3% x $2,620,000) ................................ 78,600Allowance for uncollectible accounts ........................ 78,600

To record year 2006 accounts receivable write-offs.


Requirement 2

Bad debt expense ......................................................... 4,300Allowance for uncollectible accounts (below) ............. 4,300

Year-end required allowance for uncollectible accounts:

PROBLEMS

Summary Percent Estimated

Age Group Amount Uncollectible Allowance0-60 days $430,000 4% $17,20061-90 days 98,000 15% 14,70091-120 days 60,000 25% 15,000

Over 120 days 55,000 40% 22,000Totals $643,000 $68,900


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Problem 7-1 (concluded)


Beginning balance $54,000Add: Monthly bad debt accruals 78,600Deduct: Write-offs (68,000)Balance before year-end adjustment 64,600Required allowance (determined above) 68,900Required year-end increase in allowance $ 4,300

Requirement 3 Bad debt expense for 2006:

Monthly accruals $78,600Year-end adjustment 4,300Total $82,900

Balance sheet:

Current assets:Accounts receivable, net of $68,900 in

allowance for uncollectible accounts $574,100


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Problem 7-2

Requirement 1(a)

Accounts receivable analysis:

Balance, beginning of year ($580,640 + 6,590) $ 587,230Add: Credit sales 2,158,755Less: Cash collections (2,230,065)Less: Balance end of year ($504,944 + 5,042) (509,986 )Accounts receivable written off during year $ 5,934

(b)

Allowance for uncollectible accounts analysis:

Beginning balance $6,590Less: Write-offs (from above) (5,934)Less: Year-end balance (5,042)Bad debt expense for the current year $4,386

(c)

$4,386 of bad debt expense divided by $2,158,755 in credit salesequals .2% (.002).

Requirement 2(a)

Current year Previous yearCurrent assets:

Receivables $509,986 $587,230

(b)

Bad debt expense would be equal to actual receivables written offof $5,934.


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Problem 7-3

Requirement 1To record accounts receivable written off during the year 2006.


To record collection of account receivable previously written off.

Accounts receivable ...................................................... 3,000Allowance for uncollectible accounts ........................ 3,000

Cash .............................................................................. 3,000Accounts receivable .................................................. 3,000

Requirement 2(a)

December 31, 2006 Bad debt expense (3% x $1,750,000) ................................ 52,500

Allowance for uncollectible accounts ........................ 52,500

(b)

December 31, 2006 Bad debt expense .......................................................... 36,700

Allowance for uncollectible accounts (below) ............. 36,700


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Problem 7-3 (continued)

Accounts receivable analysis: Beginning balance $ 462,000

Add: Credit sales 1,750,000Less: Write-offs (35,000)Less: Cash collections (1,830,000)

Ending balance $ 347,000

$347,000 x 10% = $34,700 = Required allowance for uncollectible accounts

Allowance for uncollectible accounts analysis: Beginning balance $30,000

Add: Collection of receivable previously written off 3,000Less: Write-offs (35,000)

Balance before adjustment (2,000) debit balanceRequired allowance (determined above) 34,700Bad debt expense adjustment $36,700

(c)

December 31, 2006 Bad debt expense .......................................................... 37,047

Allowance for uncollectible accounts (below) ............. 37,047

Required allowance:

Age Group AmountPercent

uncollectibleEstimatedallowance

0-60 days $225,550 4% $ 9,02261-90 days 69,400 15% 10,41091-120 days 34,700 25% 8,675Over 120 days 17,350 40% 6,940

Totals $347,000 $35,047


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Allowance for uncollectible accounts analysis: Beginning balance $30,000

Add: Collection of receivable previously written off 3,000Less: Write-offs (35,000)

Balance before adjustment (2,000) debit balanceRequired allowance 35,047Bad debt expense adjustment $37,047

Requirement 3Accounts receivable - Year-end allowance

(a) $347,000 - [$(2,000) + 52,500] = $296,500

(b) $347,000 - 34,700 = $312,300

(c) $347,000 - 35,047 = $311,953


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Problem 7-4

Requirement 1Total face value of notes = $300,000 + 150,000 + 200,000 = $650,000Balance sheet carrying value = 645,000Difference is the remaining discount on note 3 $ 5,000

Note 3 is a 6-month note, with three months remaining. Therefore,$5,000 represents one-half of the total discount of $10,000.$10,000 $200,000 = 5% x 12/6 = 10% discount rate .

Requirement 2Total accrued interest receivable $16,000

Less: Interest accrued on note 1:$300,000 x 10% x 4/12 = (10,000)

Interest accrued on note 2 $ 6,000

$6,000 $150,000 = 4% x 12/6 = 8%

Requirement 3 Note 1 $10,000 Note 2 6,000 Note 3 ($200,000 x 10% x 3/12) 5,000

Total interest revenue $21,000


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Problem 7-5

Requirement 1 Alternative a:

To record the borrowing of $500,000 and signing of a note payable.

July 1, 2006 Cash .............................................................................. 500,000

Note payable ............................................................. 500,000

Alternative b:

To record the transfer of receivables.

July 1, 2006 Cash ($550,000 x 98%) ..................................................... 539,000Loss on transfer of receivables (2% x $550,000) ............... 11,000


Requirement 2

Alternative a:

July, 2006Cash (80% x $780,000) ..................................................... 624,000


July 31, 2006 Interest expense ($500,000 x 12% x 1/12) ........................... 5,000 Note payable ................................................................. 500,000

Cash .......................................................................... 505,000


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Alternative b:

The amount collected by the bank in excess of the receivables transferred isremitted to Lonergan.

July 31, 2006 Cash [(80% x $780,000) - $550,000] ................................... 74,000


Requirement 3Alternative a. Note disclosure is required for the assignment of accounts

receivable as collateral for the $500,000 note.

Alternative b. No disclosure is required since the transfer of receivableswas made without recourse.

Problem 7-6

Cash (90% x $800,000) ..................................................... 720,000Loss on sale of receivables (4% x $800,000) ..................... 32,000Receivable from factor ([10% x $800,000] $32,000 fee) ... 48,000



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Problem 7-7

Requirement 1

February 28, 2006 Note receivable ............................................................. 10,000

Sales revenue............................................................. 10,000

March 31, 2006 Note receivable (face amount) .......................................... 8,000

Discount ($8,000 x 10%) .............................................. 800Sales revenue (difference) ............................................ 7,200

April 3, 2006 Accounts receivable ...................................................... 7,000

Sales revenue............................................................. 7,000

April 11, 2006 Cash (98% x $7,000) ........................................................ $6,860Sales discounts (2% x $7,000) .......................................... 140


April 17, 2006 Sales returns .................................................................. 5,000


Inventory....................................................................... 3,200Cost of goods sold..................................................... 3,200


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Problem 7-7 (continued)

April 30, 2006 Cash (99% x $50,000) ....................................................... 49,500Loss on sale of receivables (1% x $50,000) ...................... 500


To accrue interest on note receivable for four months.

June 30, 2006 Interest receivable ......................................................... 333

Interest revenue ($10,000 x 10% x 4/12) ......................... 333

To record discounting of note receivable.

June 30, 2006 Cash (proceeds determined below) ...................................... 10,266Loss on sale of note receivable (difference) ..................... 67

Interest receivable (from adjusting entry) ....................... 333 Note receivable (face amount) ...................................... 10,000




August 31, 2006 NO ENTRY REQUIRED


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Requirement 2

To accrue nine months' interest on the Maddox Co. note receivable.

Discount ....................................................................... 600Interest revenue ($8,000 x 10% x 9/12) ........................... 600

Requirement 3Income

Date increase (decrease)

February 28 $10,000March 31 7,200April 3 7,000April 11 (140)April 17 (5,000)April 17 3,200April 30 (500)June 30 333June 30 (67)December 31 600

Total effect $22,626


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Problem 7-8

Note

Note Face

Value

Date of

Note

Interest

Rate

Date

Discounted

Discount

Rate

Proceeds

Received

1 $50,000 3-31-06 8% 6-30-06 10% $50,350 (1)

2 50,000 3-31-06 8% 9-30-06 10% 51,675 (2)

3 50,000 3-31-06 8% 9-30-06 12% 51,410 (3)

4 80,000 6-30-06 6% 10-31-06 10% 81,027 (4)

5 80,000 6-30-06 6% 10-31-06 12% 80,752 (5)

6 80,000 6-30-06 6% 11-30-06 10% 81,713 (6)

(1)

$50,000 Face amount3,000 Interest to maturity ($50,000 x 8% x 9/12)



(2)





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(3)




(4)

$80,000 Face amount

2,400 Interest to maturity ($80,000 x 6% x6/12)82,400 Maturity value

(1,373) Discount ($82,400 x 10% x 2/12)$81,027 Cash proceeds

(5)




(6)


82,400 Maturity value

(687) Discount ($82,400 x 10% x 1/12)$81,713 Cash proceeds


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Problem 7-9

Requirement 1Computation of balance per books:

Balance per bank statement $14,632.12Add: Deposits outstanding 575.00Deduct: Checks outstanding (1,320.25)

Error in recording rent check (18.00)Add: Automatic mortgage payment 450.00Add: Bank service charges 14.00Deduct: Deposit credit to companys

account in error (875.00)Add: NSF check charge 85.00

Balance per books $13,542.87


Balance per bank statement $14,632.12Add: Deposits outstanding 575.00Deduct:

Bank error - deposit incorrectlycredited to company account (875.00)

Checks outstanding (1,320.25)Corrected cash balance $13,011.87


Balance per books $13,542.87Add: Error in recording rent check 18.00Deduct:

Automatic mortgage note payment (450.00)

Service charges (14.00) NSF checks (85.00 )Corrected cash balance $13,011.87


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Requirement 2To correct error in recording cash disbursement for rent.

Cash ................................................................. 18Rent expense ................................................ 18


Interest expense................................................ 350Mortgage note payable ..................................... 100Miscellaneous expense (bank service charges) . 14Accounts receivable (NSF checks)................... 85

Cash ............................................................. 549

Requirement 3Checking account balance $13,011.87Petty cash 200.00U.S. treasury bills 5,000.00

Total cash and cash equivalents $18,211.87

Problem 7-10

Requirement 1


Balance per bank statement $3,851Add: Deposits outstanding 2,150 (1) Deduct:

Bank error - deposit incorrectlycredited to company account (1,300)

Outstanding checks (831) (2) Corrected cash balance $3,870


Balance per books $4,422


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Requirement 2


Advertising expense ......................................... 90Miscellaneous expense (bank service charges) . 22Accounts receivable (NSF checks)................... 440

Cash ............................................................. 552


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Judgment Case 7-1

Requirement 1To account for the accounts receivable factored on April 1, 2006, Magrath should

decrease accounts receivable by the amount of accounts receivable factored, increasecash by the amount received from the factor, and record a loss equal to the difference.The loss should be reported in the income statement. Factoring of accounts receivablewithout recourse is equivalent to a sale.

Requirement 2Magrath should account for the collection of the accounts previously written off

as uncollectible as follows:

Increase both accounts receivable and the allowance for uncollectible accounts.Increase cash and decrease accounts receivable.

Requirement 3One approach estimates uncollectible accounts based on credit sales. This

approach focuses on income determination by attempting to match uncollectibleaccounts expense with the revenues generated.

The other approach estimates uncollectible accounts based on the balance inreceivables or on an aging of receivables. The approach focuses on asset valuation byattempting to report receivables at realizable value.

CASES


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Communication Case 7-2Suggested Grading Concepts and Grading Scheme:

Content (70%) ______ 40 Explains the difference between the allowance method and the

direct write-off method. ____ Direct write-off more objective. ____ Direct write-off has potential to violate the matching

principle.

______ 15 Even if uncollectibles are fairly stable, when significantvariations do occur, profit will be overstated in one periodand understated in another period.

______ 15 Even if uncollectibles remain constant, the direct write-offmethod will result in an overstatement of accounts receivableon the balance sheet.

_____ ______ 70 points

Writing (30%) ______ 6 Terminology and tone appropriate to the audience of a

company president. ______ 12 Organization permits ease of understanding.

____ Introduction that states purpose. ____ Paragraphs that separate main points.

______ 12 English ____ Sentences grammatically clear and well organized,

concise. ____ Word selection. ____ Spelling. ____ Grammar and punctuation.

_____ ______ 30 points


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Judgment Case 7-3

Requirement 1a. Hogan should account for the sales discounts at the date of sale using the net

method by recording accounts receivable and sales revenue at the amount ofsales less the sales discounts available.Revenues should be recorded at the cash equivalent price at the date of sale.Under the net method, the sale is recorded at an amount that represents thecash equivalent price at the date of exchange (sale).

b. There is no effect on Hogans sales revenues when customers do not take thesales discounts. Hogans net income is increased by the amount of interestearned when customers do not take the sales discounts.

Requirement 2Trade discounts are neither recorded in the accounts nor reported in the financial

statements. Therefore, the amount recorded as sales revenues and accounts receivableis net of trade discounts and represents the cash equivalent price of the asset sold.

Requirement 3To account for the accounts receivable factored on August 1, 2006, Hogan should

decrease accounts receivable by the amount of the accounts receivable factored,increase cash by the amount received from the factor, and record a loss. Factoring of

accounts receivable without recourse is equivalent to a sale. The difference betweenthe cash received and the carrying amount of the receivables is a loss.

Requirement 4Hogan should report the face amount of the interest-bearing notes receivable and

the related interest receivable for the period from October 1 through December 31 onits balance sheet as current assets. Both assets are due on September 30, 2007, whichis less than one year from the date of the balance sheet.

Hogan should report interest revenue from the notes receivable on its incomestatement for the year ended December 31, 2006. Interest revenue is equal to the

amount accrued on the notes receivable at the appropriate interest rate.Interest revenue is realized with the passage of time. Accordingly, interest

revenue should be accounted for as an element of income over the life of the notesreceivable.


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Ethics Case 7-4

Requirement 1Required allowance $180,000Revised allowance 135,000

Increase in income before taxes of proposed change $ 45,000

Requirement 2Discussion should include these elements.

Ethical Dilemma:You as the assistant controller have a responsibility to follow GAAP and make a

reasonably accurate estimate of the net realizable value of receivables. Is yourresponsibility to fairly present Stanton Industries' financial statements to external

users greater than your obligation to improve the financial position of your employer?

Alternative actions and consequences include:

1. Refuse to comply with the controller's request to change the aging category of thelarge account.Positive consequences:

a. Preservation of your honesty and integrity. b. Fair presentation of the net realizable value of receivables.

Negative consequences:a. Possible loss of your job.

b. Lower net income for Stanton Industries.c. A devalued stock price for Stanton Industries.

2. Comply with the controller's suggestion to report the allowance for uncollectibleaccounts at $135,000.Positive consequences:

a. Retention of your job. b. A more favorable net income for Stanton Industries.

c. A more favorable position with unknowing creditors, financial analysts,current investors, and future investors. Negative consequences:

a. Endure guilt feelings. b. A lack of trust in you by other managers and employees.c. Possible litigation from investors and creditors.


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Case 7-4 (concluded)

3. Report the controller's suggestion to a higher level of management, the auditcommittee, or the auditors. If one of these parties corrects the controller andcompels fair reporting of the allowance account, the consequences would be thesame as in alternative 1 when you refuse to make the adjustment. Your job maystill be in jeopardy due to the fact that management may consider whistle blowingas indicative of employee disloyalty. If the reportee parties agree with thecontroller and report the incorrect amount of $135,000, the consequences will besimilar to those for the second alternative in 2, except that you run an even greaterrisk of losing your job.

4. Refuse to comply with the controller's request and resign as assistant controller. If

you report the controller's suggestion to higher management, the audit committee,or the auditor, the positive and negative considerations are the same as foralternative 3. If you do not report the controller's request, then the consequencesare the same as for alternative 2. In either case your job is not an issue since youhave already resigned.


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Judgment Case 7-51. A weakness is created by the fact that John need only submit a list of accounts and

amounts to be charged to replenish the petty cash fund. The supportingdocumentation for the petty cash disbursements also should be submitted withJohns list and reviewed by someone else. Surprise counts of the fund also should

be made to ensure that the fund is being maintained on an imprest basis, that is, toensure that cash and/or receipts equal $200 at all times.

2. The internal control system for disbursements does not contain sufficientseparation of duties. Dean Leiser approves the vouchers, signs the checks,maintains the disbursement records, and reconciles the bank account. There should

be at least one other person involved in these activities to ensure accuracy and tosafeguard cash from expropriation.

3. The internal control system for receipts does not contain sufficient separation ofduties. Fran Jones has physical control of the deposits and also maintains thesubsidiary ledger for accounts receivable. These duties should be separated. Inaddition, the company should require that customers pay their bills via check andthat cash not be used.


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Real World Case 7-6

Requirement 12004 2003

($ in thousands) Accounts receivable, net $19,804 $22,712Add: Allowances 696 977

Accounts receivable, gross $20,500 $23,689

Requirement 2($ in thousands)The answers to this question require an analysis of both accounts receivable and

the allowance for uncollectible accounts for 2004. First of all, 2004 sales of $196,338 plus the decrease in receivables reported in the statement of cash flows indicates cashreceived from customers of $199,246 ($196,338 + 2,908).

Analysis of accounts receivable ($ in thousands) Beginning accounts receivable $ 23,689Add: Credit sales 196,338Less: Cash collections (199,246)Less: Write-offs ?Ending accounts receivable $ 20,500

Therefore, bad debt write-offs must have been $281 .

($23,689 + 196,338 199,246 20,500 = $281)

Analysis of allowance for uncollectible accountsBeginning allowance $977Add: Bad debt expense ?Less: Write-offs (281 )Ending allowance $696

Therefore, bad debt expense must have been $0 , indicating that the allowanceaccount from prior years was sufficient to cover future anticipated write-offs on year-

end accounts receivable. ($977 281 696 = $0)


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Real World Case 7-7

Requirement 3Answers will, of course, vary. The following were reported in the financial

statements for the year ended December 31, 2003 ($ in millions): a. Net trade accounts receivable + Allowance for doubtful accounts = Gross

accounts receivable$599.8 + 63.1 = $662.9

b. The statement of cash flows indicates bad debt expense (provision fordoubtful accounts) of $124.8

c. Beginning allowance for doubtful accounts + Bad debt expense - Bad debtwrite-offs = Ending allowance for doubtful accounts$49.5 + 124.8 - Write-offs = $63.1

Write-offs = $111.2 d. Beginning trade accounts receivable + Credit sales - Bad debt write-offs -Cash collected = Ending trade accounts receivableBeginning trade accounts receivable = $555.4 + 49.5 = $604.9$604.9 + 6,804.6 111.2 Cash collections = $662.9Cash collections = $6,635.4

Integrating Case 7-8McLaughlin's underestimation of bad debts is treated as a change in accounting

estimate. Changes in estimates are accounted for prospectively. When a companyrevises a previous estimate, prior financial statements are not restated. Instead, thecompany merely incorporates the new estimate in any related accountingdeterminations from then on. In this case, bad debt expense for 2007 will be higherthan it would have been had not the underestimation occurred. A disclosure noteshould describe the effect of a change in estimate on income before extraordinaryitems, net income, and related per-share amounts for 2007.


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Analysis Case 7-9Requirement 1

These methods can be described by one of two basic arrangements:1. A secured borrowing, or 2. A sale of receivables.

When a company chooses between a borrowing and a sale, the critical element isthe extent to which it (the transferor) is willing to surrender control over the assetstransferred . Specifically, the transferor is determined to have surrendered control overthe receivables if and only if three sale conditions are met.

Secured borrowings usually take the form of an assignment of receivables. Anassignment of receivables is a promise by the borrower (the owner of the receivables)that any failure to repay debt owed to the lender in accordance with the debtagreement, will cause the proceeds from collecting the receivables to go directly

toward repayment of the debt. This arrangement is no different from the use of a building as collateral for a mortgage loan. The assignor (borrower) assigns theassignee (lender) the rights to specific receivables as collateral for a loan. A variationof assigning specific receivables is when trade receivables in general rather thanspecific receivables are pledged as collateral. The responsibility of collection of thereceivables remains solely with the company. This variation is referred to as apledging of accounts receivable.

Two popular arrangements used for the sale of receivables are factoring and securitization . A factor is a financial institution that buys receivables for cash,handles the billing and collection of the receivables, and charges a fee for this service.Actually, credit cards like VISA and Mastercard are forms of factoring arrangements.The seller relinquishes all rights to the future cash receipts in exchange for cash fromthe buyer (the factor ).

Another popular arrangement used to sell receivables is a securitization . In atypical accounts receivable securitization, the company creates a Special PurposeEntity (SPE), usually a trust or a subsidiary. The SPE buys a pool of tradereceivables, credit card receivables, or loans from the company, and then sells relatedsecurities, for example bonds or commercial paper, that are backed (collateralized) bythe receivables.

Similar to accounts receivable, a note receivable can be used to obtain immediatecash from a financial institution either by pledging the note as collateral for a loan or by selling the note. The transfer of a note is referred to as discounting .


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Requirement 2In an assignment of specific receivables, usually the amount borrowed is less

than the amount of receivables assigned. The difference provides some protection forthe lender to allow for possible uncollectible accounts. Also, the assignee (transferee)usually charges the assignor an up-front finance charge in addition to stated interest onthe collateralized loan. The borrower, assignor, records the loan liability, the financefee expense, and the cash borrowed.

No special accounting treatment is needed for an assignment of receivables ingeneral, and the arrangement is simply described in a disclosure note.

The specific accounting treatment for the sale of receivables using factoring andsecuritization arrangements depends on the amount of risk the factor assumes, in

particular whether it buys the receivables without recourse or with recourse .

When a company sells accounts receivable without recourse, the buyer assumesthe risk of uncollectibility. This means the buyer has no recourse to the seller ifcustomers dont pay the receivables. In that case, the seller simply accounts for thetransaction as a sale of an asset. The buyer charges a fee for providing this service,usually a percentage of the book value of receivables. Because the fee reduces the

proceeds the seller receives from selling the asset, the seller records a loss on sale ofassets. The typical factoring arrangement is made without recourse.

When a company sells accounts receivable with recourse, the seller retains therisk of uncollectibility. In effect, the seller guarantees that the buyer will be paid evenif some receivables prove to be uncollectible. Even if receivables are sold withrecourse, as long as the three conditions for sale treatment are met, the transferorwould still account for the transfer as a sale. The only difference would be theadditional requirement that the transferor record the estimated fair value of therecourse obligation as a liability. The recourse obligation is the estimated amount thatthe transferor will have to pay the transferee as a reimbursement for uncollectiblereceivables.


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Research Case 7-10

Requirement 1When a company sells accounts receivable without recourse, the buyer assumes

the risk of uncollectibility. This means the buyer has no recourse to the seller ifcustomers dont pay the receivables.

Requirement 3The transferor is determined to have surrendered control over the receivables if

and only if all of the following conditions are met:

a. The transferred assets have been isolated from the transferor - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or otherreceivership.

b. Each transferee has the right to pledge or exchange the assets it received.c. The transferor does not maintain effective control over the transferred assets

through either (1) an agreement that the transferor repurchase or redeem them before their maturity or (2) the ability to cause the transferee to return specificassets.

Statement of Financial Accounting Standards No. 140, "Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities," provides theauthoritative guidance in this area. The above conditions can be found in paragraph 9of the standard.

Requirement 4

Cash (90% x $400,000) ..................................................... 360,000Loss on sale of receivables (4% x $400,000) ..................... 16,000Receivable from factor (10% x $400,000 16,000 fee) ........ 24,000



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Requirement 5Paragraph 47 of SFAS 140 states lists the following conditions:

a. The assets to be repurchased or redeemed are the same or substantially the sameas those transferred.

b. The transferor is able to repurchase or redeem them on substantially the agreedterms, even in the event of default by the transferee.

c. The agreement is to repurchase or redeem them before maturity, at a fixed ordeterminable price.

d. The agreement is entered into concurrently with the transfer.


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Analysis Case 7-11

Requirement 1

Sara Lee Tyson Foods

Receivables turnover = 19,566 = 10.3 26,441 = 211,893 1,260

Average collection = 365 = 35 days 365 = 17 days period 10.3 21

Tyson Foods collects its receivables, on average, 18 days faster than does SaraLee. Assuming similar customer credit policies, this indicates that Tyson does a better

job in managing its investment in receivables.

Requirement 2The objective of this requirement is to motivate students to obtain hands-on

familiarity with actual annual reports and to apply the techniques learned in thechapter. You may wish to provide students with multiple copies of the same annualreports and compare responses. Another approach is to divide the class into teams

who evaluate reports from a group perspective.


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Analysis Case 7-12

Requirement 1 Note 1 indicates that cash equivalents are investments in short-term, interest-

bearing instruments with maturities of three months or less at the date of purchase.

Requirement 2($ in millions) 2004 2003

Net receivables $3,027 $2,627Add: Allowances 151 149Gross receivables $3,178 $2,776

Requirement 3($ in millions) Allowances:Beginning of year $ 149Add: Bad debt expense (provision for uncollectible

accounts - from statement of cash flows) 106Less: Ending balance (151 )Amount written off as uncollectible $104

Spiceland SM 7eCh07

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