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Chapter 8: Reporting and Analysing Receivables
Kimmel, Weygandt, Kieso, Trenholm
Financial Accounting, Second Canadian Edition
CHAPTER 8
Reporting and Analysing ReceivablesASSIGNMENT CLASSIFICATION TABLE
Study ObjectivesQuestionsBriefExercisesExercisesAProblemsBProblems
1.Identify the different types of receivables.1,21
2.Explain how accounts receivable are recognized in the accounts.3211A, 2A, 6A, 7A, 1B, 2B, 6B, 7B,
3.Describe the method used to account for bad debts.4, 5, 6, 73, 4, 5, 92, 3, 41A, 2A, 3A, 4A, 5A, 7A 1B, 2B, 3B, 4B, 5B, 7B
4.Explain how notes receivable are recognized and valued in the accounts.8, 9, 106, 7, 85, 66A, 8A,
9A 6B, 8B,
9B
5.Explain the statement presentation of receivables.1197, 119A9B
6.Describe the principles of sound accounts receivable management.12, 13108
7.Identify the ratios used to analyse a companys receivables.14, 15, 169, 119, 107A, 10A, 11A7B, 10B, 11B
8.Describe the methods used to accelerate the receipt of cash from receivables.17, 181211, 1211A11B
ASSIGNMENT CHARACTERISTICS TABLE
ProblemNumberDescriptionDifficultyLevelTimeAllotted (min.)
1AJournalize receivables transactions.Moderate20-30
2ADetermine missing amounts.Complex15-20
3AJournalize bad debts transactions.Moderate20-30
4AJournalize bad debts transactionsModerate20-30
5ACalculate bad debt amounts.Moderate20-30
6AJournalize receivables transactions.Moderate20-30
7AJournalize receivables transactions and calculate ratios.Moderate30-40
8AJournalize notes receivables transactions.Moderate20-30
9AJournalize credit card and notes receivable transactions; show balance sheet presentation.Moderate15-20
10ACalculate and interpret ratios.Moderate15-20
11AEvaluate liquidity.Moderate15-20
1BJournalize receivables transactions.Moderate20-30
2BDetermine missing amounts.Complex15-20
3BJournalize bad debts transactions.Moderate20-30
4BJournalize and post bad debts transactionsModerate20-30
5BCalculate bad debt amounts.Moderate20-30
6BJournalize receivables transactions.Moderate20-30
7BJournalize receivables transactions and calculate ratios.Moderate30-40
8BJournalize notes receivables transactions.Moderate20-30
9BJournalize credit card and notes receivable transactions; show balance sheet presentation.Moderate15-20
10BCalculate and interpret ratios.Moderate15-20
11BEvaluate liquidity.Moderate15-20
ANSWERS TO QUESTIONS
1. Accounts receivable are amounts owed by customers on account. They result from the sale of goods and services in the normal course of business operations (i.e., in trade). Notes receivable represent claims that are evidenced by formal instruments of credit. Notes normally extend for periods longer than an account and have a specified interest rate attached.
2. Other receivables include nontrade receivables such as interest receivables, loans to company officers, advances to employees, and income taxes refundable.
3. The sale should be recorded at $10,000 on December 29. If the customer takes the discount it will be recorded on January 8 as a sales discount. If sales discounts covering more than one period of time are material for a company, they should be estimated and recorded in the proper period similar to the allowance for doubtful accounts.
4. The purpose of the allowance for doubtful accounts is to show an estimate of the accounts receivable expected to become uncollectible. The allowance account is used because the amount is only an estimate and we do not know for certain which customers will not pay. The account can be in a debit balance if the amount of actual write-offs exceeds previous provisions for bad debts.
5. Soo Eng should realize that the decrease in net realizable value occurs when estimated uncollectibles are recognized in an adjusting entry. 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.
6. A company should write off an account when all methods of attempting to collect it have failed. Therefore once an account is written off the company should no longer actively attempt collection.
7. Two journal entries are required because the first journal entry has to restore the previously written off accounts receivable and the second journal entry records the actual receipt of payment on the account. This way there is a record that the person did eventually pay for the purpose of future credit decisions.
8. Notes are not recorded at their maturity value because the interest on the note is earned over time. According to the revenue recognition principle, interest is recorded as earned.
9. In total the note will earn $1,250 interest ($30,000 x 5% x 10/12). $1,000 will be recorded for the year ended December 31 8 months interest ($30,000 x 5% x 8/12).
Questions (Continued) 10.
Payee:
Accounts Receivable
xxx
Notes Receivable
xxx
Interest Revenue
xxx
Maker (May Ltd.):
Notes Payable
xxx
Interest Expense
xxx
Accounts Payable
xxx
11.Receivables
Accounts receivable$xxx
Less: Allowance for doubtful accounts xx
Net realizable value xxx
Notes receivable$xxx
Less: Allowance for doubtful accounts xx
Net realizable value xxx12.The steps involved in receivables management are:
(1)Determine to whom to extend credit
(2) Establish a payment period
(3) Monitor collections
(4) Evaluate the liquidity of receivables
(5) Accelerate cash receipts from receivables when necessary
13.A concentration of credit risk exists when a material threat of nonpayment exists, from either a single customer or class of customers, that could adversely affect the companys financial health.
14.An increase in the receivables turnover ratio indicates a faster collection of receivables. The higher the turnover ratio the fewer days it takes to collect the accounts receivable. An increase in the collection period means that it is taking longer for the company to convert sales in to cash.
15.Sales for the period = Receivables Turnover X Average Accounts Receivable
=11.6 X $1,762.5 million
=$20,445 million
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: the receivables turnover, average collection period, inventory turnover and days in inventory ratios.
Questions (Continued)17.Bombardier may sell its receivables to accelerate the receipt of cash. The proceeds from the sale of the receivables could be used to finance operations and reduce the need for the company to rely on other sources of financing such as operating lines of credit. As well, the company may not want to dedicate resources to the time consuming responsibility of billing and collecting from customers. By selling the receivables and passing this responsibility to others, Bombardier is free to concentrate on its core business activities.
18.From its own credit cards, Sears may realize interest revenue from customers who do not pay the balance due within a specified grace period. To account for these transactions the company records a debit to accounts receivable and a credit to sales revenue.
Bank credit cards offer the following advantages:
(1)The credit card issuer makes the credit card investigation of the customer.
(2) The issuer maintains individual customer accounts.
(3) The issuer undertakes the collection process and absorbs any losses from uncollectible accounts.
(4) The retailer receives cash more quickly from the credit card issuer than it would from individual customers.
To record a bank credit card transaction, the seller normally records a debit to cash for the amount of the sale less the service charge required by the credit card company. A debit is made to the service charge expense and a credit is made to sales revenue for the gross amount of the sale.
The advantage of the debit card is that the cash is deducted immediately from the customers account. There are no credit checks or collection concerns so the service charges are normally lower than for a bank credit card.
The entries to record a debit card sale are the same as the entry to record a bank credit card sale.
By using its own credit cards, bank credit cards and debit cards Sears provides more
options to its customers, increases its revenue, and reduces its risk.
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 8-1
(a)Nontrade receivables
(b)Notes receivable
(c)Accounts receivable
(d)Nontrade receivables
BRIEF EXERCISE 8-2
(a)Accounts Receivable
14,000
Sales
14,000
Cost of Goods Sold
10,000
Inventory
10,000
(b)Sales Returns and Allowances
2,400
Accounts Receivable
2,400
Inventory
1,440
Cost of Goods Sold
1,440
(c)Cash ($11,600 - $232)
11,368
Sales Discounts ($11,600 X 2%)
232
Accounts Receivable ($14,000 $2,400)
11,600BRIEF EXERCISE 8-3
(a)Bad Debt Expense
4,500
Allowance for Doubtful Accounts
4,500
(b)The amount to be reported as bad debts expense would be $800 + $7,500 = $8,300.
BRIEF EXERCISE 8-4
(a)
Allowance for Doubtful Accounts
18,000
Accounts Receivable
18,000
(b)
(1)Before Write-Off(2)After Write-Off
Accounts receivable
$700,000
$682,000
Allowance for doubtful accounts
54,000
36,000
Net realizable value
$646,000
$646,000BRIEF EXERCISE 8-5
Accounts Receivable
18,000
Allowance for Doubtful Accounts
18,000
Cash
18,000
Accounts Receivable
18,000BRIEF EXERCISE 8-6
Annual Interest RateTotal Interest
10%
(b) $1,500.00
(a) 8%
$400.00
12%
(c) $1,680.00
BRIEF EXERCISE 8-7
Jan.10Accounts Receivable
12,000
Sales
12,000
Cost of Goods Sold
8,000
Inventory
8,000
Feb.9Notes Receivable
12,000
Accounts Receivable
12,000BRIEF EXERCISE 8-8
(a)
Apr.
1Notes Receivable
10,000
Accounts Receivable
10,000
July
1Cash
10,175
Notes Receivable
10,000
Interest Revenue ($10,000 x 7% x 3/12)
175
(b)
Apr.
1Notes Receivable
10,000
Accounts Receivable
10,000
July
1Accounts Receivable
10,175
Notes Receivable
10,000
Interest Revenue ($10,000 x 7% x 3/12)
175
BRIEF EXERCISE 8-9
(a)Bad Debts Expense
35,000
Allowance for Doubtful Accounts
35,000
(b)Current assets
Cash
$ 90,000
Accounts receivable
$600,000
Less: Allowance for doubtful accounts
35,000565,000
Merchandise inventory
130,000
Prepaid expenses
13,000
$798,000
(c)
Receivables turnover =
Average collection period =
BRIEF EXERCISE 8-10
(a)2.Review company credit ratings
(b)3.Collect information about competitors payment period policies
(c)4.Prepare accounts receivable aging schedule
(d)5.Calculate the receivables turnover and average collection period
(e)1.Accept bank credit cards
BRIEF EXERCISE 8-11
Receivables Turnover ($ in millions):
Average Collection Period:
BRIEF EXERCISE 8-12
Visa card
Cash ($100 $3)
97
Service Charge Expense ($100 X 3%)
3
Sales
100
Nonbank card
Credit Card Receivables
100
Sales
100
Debit card
Cash ($100 $3)
97
Service Charge Expense ($100 X 3%)
3
Sales
100
SOLUTIONS TO EXERCISES
EXERCISE 8-1
Nicklaus Corp.
Jan.6Account ReceivableWatson Inc.
6,000
Sales
6,000
Cost of Goods Sold
3,600
Inventory
3,600
16Cash ($6,000 $120)
5,880
Sales Discounts (2% X $6,000)
120
Accounts ReceivableWatson Inc.
6,000
Watson Inc.
Jan.6Merchandise Inventory.
6,000
Accounts Payable
6,000
16Accounts Payable
6,000
Merchandise Inventory
120
Cash.
5,880
EXERCISE 8-2
(a)Dec. 31Bad Debts Expense
8,200
Allowance for Doubtful Accounts
8,200
(b)Dec. 31Bad Debts Expense
7,500
Allowance for Doubtful Accounts
7,500
EXERCISE 8-3
(a) Age of AccountsAmount % Estimated Uncollectible
0-30 days$65,0002$1,300
31-60 days12,6007882
61-90 days8,500302,550
Over 90 days6,40050 3,200
$7,932
(b)Mar. 31Bad Debts Expense
5,732
Allowance for Doubtful Accounts
5,732
($7,932 $2,200)
(c)The total balance of receivables increased from 2003 to 2004. However, of concern is the fact that each of the three categories of older accounts increased substantially during 2004. That is, customers are taking longer to pay and bad debts are likely to increase. Management needs to investigate the causes of this change.
EXERCISE 8-4
2004
Dec. 31Bad Debts Expense
9,400
Allowance for Doubtful Accounts
9,400
($8,400 + $1,000)
2005
May 11Allowance for Doubtful Accounts
900
Accounts ReceivableWorthy
900
June 12Accounts ReceivableWorthy
900
Allowance for Doubtful Accounts
900
Cash
900
Accounts ReceivableWorthy
900EXERCISE 8-5
Nov.1Notes Receivable
24,000
Cash
24,000
Dec.1Notes Receivable
3,600
Sales
3,600
Cost of Goods Sold
2,500
Inventory
2,500
15Notes Receivable
8,000
Accounts ReceivableB. Barnes
8,000
31Interest Receivable
361
Interest Revenue*
361
*Calculation of interest revenue:
Bouchards note:
$24,000 X 8% X 2/12 = $320
Wrights note:
$3,600 X 6% X 1/12 = .18
Barnes note:
$8,000 X 7% X 15/365=.
23
Total accrued interest
$361
Note: Some students may also calculate interest using part months, rather than days.
EXERCISE 8-6
May1Notes Receivable
6,000
Accounts Receivable Jioux Company
6,000
June30Interest Receivable ($6,000 X 5% X 2/12)
50
Interest Revenue
50
July31Notes Receivable
10,000
Cash
10,000
Oct.31Cash
10,175
Note Receivable
10,000
Interest Revenue ($10,000 X 7% X 3/12)
175
Nov.1Allowance for Doubtful Accounts
6,050
Note Receivable
6,000
Interest Receivable
50
EXERCISE 8-7
DEERE AND COMPANY
Balance Sheet (partial)
October 31, 2002
(in U.S. millions)
Receivables
Trade accounts and notes receivable
$ 2,779.0
Financing receivable
(net of allowance for doubtful accounts $136)
9,068.0
Other receivables
426.4
Total receivables
12,273.4
Less: Allowance for doubtful accounts*
45.0Net receivables
$12,228.4* This presentation assumes that the allowance relates for all receivables. Some students may also assume that it relates solely to accounts receivable.
EXERCISE 8-8
Bombardier has industry risk in that a significant amount of its receivables are concentrated in the transportations and aerospace industry. However, due to the note disclosure, users are now aware of this risk. So long as sales are being made to a variety of customers in the industry, users should not be concerned.
EXERCISE 8-9
(a)
2002Current ratio =
2001
Current ratio =
(b)
2002
Receivables turnover =
Average collection period =
2001
Receivables turnover =
Average collection period =
(c)The accounts receivable represented 62.1% ($722 ( $1,163) of the companys current assets and 11.8% ($722 ( $6,110) of the companys revenue in 2002. It represented 55.4% ($645 ( $1,164) of the companys current assets and 11.4% ($645 ( $5,652) of the companys revenue in 2001. This is a significant portion of the companys liquid assets and its revenue and thus clearly deserves close monitoring.
(d)The receivables turnover ratio and the average collection period seem to indicate that the companys management of receivables has improved. The turnover has improved from 7.4 times in 2001 to 8.1 times in 2002. The average collection period has decreased from 49 days in 2001 to 45 days in 2002. However it appears that overall liquidity has deteriorated as evidenced by the decline in the current ratio from 0.71:1 in 2001 to 0.55:1 in 2002.
EXERCISE 8-10
(a)Decrease
(b)Increase
(c)No effect
(d)Increase
EXERCISE 8-11
(a)
Jan.15Credit Card Receivables
15,000
Sales
15,000
Jan. 20Cash
4,410
Service Charge Expense ($4,500 X 2%)
90
Sales
4,500
Jan. 30Cash
970
Service Charge Expense ($1,000 X 3%)
30
Sales
1,000
Feb.10Cash
12,000
Credit Card Receivables
12,000
Feb.15Interest Receivable ($15,000 - $12,000 X 18% X 1/12)
45
Interest Revenue
45
(b)Service charge expense and interest revenue would be shown in the nonoperating revenues and expense section of the Statement of Earnings
EXERCISE 8-12
One possible reason CN chose to sell may have been to improve its financial ratios. Other reasons include not wanting to deal with the administration of collecting accounts or the desire to accelerate cash receipts.
SOLUTIONS TO PROBLEMS
(a)Accounts Receivable
800,000
Sales
800,000
Cash
743,000
Accounts Receivable
743,000
(b) Allowance for Doubtful Accounts
7,000
Accounts Receivable
7,000
(c)Accounts Receivable
4,000
Allowance for Doubtful Accounts
4,000
Cash
4,000
Accounts Receivable
4,000
(d)Bad Debt Expense
19,000
Allowance for Doubtful Accounts
19,000
Allowance for Doubtful Accounts
W/O 7,000Beg. Bal. 9,000
Recovery 4,000
Bad Debts 19,000
End Bal. 25,000
PROBLEM 8-1A (Continued)(e)
Accounts Receivable
Beg. Bal.200,000
Sales 800,000
Recovery 4,000Collections 743,000
W/O 7,000
Collections 4,000
End Bal. 250,000
Allowance for Doubtful Accounts
W/O 7,000
Beg. Bal. 9,000
Recovery 4,000
Bad Debts 19,000
End Bal. 25,000
(f)Net realizable value of receivables is $225,000 ($250,000 - $25,000)
(a)Allowance for doubtful accounts = $425 (given)
(b)$350 - $150 (b) = $425
(b) = $225
(c)Bad debt expense = Adjustment to allowance for doubtful accounts = $225 (from (b))
(d)Addition to Accounts Receivable = $45,000
(e)Amounts written off = Reductions in the allowance account = $150
(f)(f) + $45,000 - $46,350 - $150 = $4,500
(f) = $6,000
(a)Total estimated bad debts
Number of Days Outstanding
Total0-3031-6061-9091-120Over 120
Accounts
receivable$375,000$220,000$90,000$40,000$10,000$15,000
% uncollectible1%4%8%16%30%
Estimated
bad debts$15,100$2,200$3,600$3,200$1,600$4,500
(b)Bad Debts Expense
25,100
Allowance for Doubtful Accounts
25,100
($15,100 + $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 4% of total accounts receivable rather than aging the individual accounts the allowance at year end, the bad debt expense adjustment would be $25,000 [$15,000 ($375,000 x 4%) + $10,000]. The answers to (c) (d) would not change.
Aging the individual accounts rather than applying a percentage to the total accounts receivable should produce a more accurate allowance and bad debt expense.
(a)
Dec. 31Bad Debts Expense
18,610
Allowance for Doubtful Accounts
18,610
($38,610 $20,000)
(b)
2005
1.Mar.31Allowance for Doubtful Accounts
800
Accounts Receivable
800
2.May31Accounts Receivable
800
Allowance for Doubtful Accounts
800
31Cash
800
Accounts Receivable
800
(c)2005
Dec. 31Bad Debts Expense
6,390
Allowance for Doubtful Accounts
6,390
($38,610 $45,000)
(a)$36,000
(b)$32,000 - $3,000 = $29,000
(c)$32,000 + $3,000 = $35,000
(d)Using the allowance method of reporting bad debt expense provides a better balance sheet valuation for accounts receivable and better matches expenses to the period in which the sale occurs.
Jan.5Accounts ReceivableGeorge Company
16,000
Sales
16,000
Cost of Goods Sold
9,600
Inventory
9,600
20Notes Receivable
16,000
Accounts ReceivableGeorge Company
16,000Feb.18
Notes Receivable
8,000
Sales
8,000
Cost of Goods Sold
5,000
Inventory
5,000Apr. 20
Cash ($16,000 + $360)
16,360
Notes Receivable
16,000
Interest Revenue ($16,000 X 9% X 3/12)
360
30
Cash ($11,000 + $293)
11,293
Notes Receivable
11,000
Interest Revenue ($11,000 X 8% X 4/12)
293May 25
Notes Receivable
6,000
Accounts ReceivableAvery Inc.
6,000Aug.18
Cash ($8,000 + $200)
8,200
Notes Receivable
8,000
Interest Revenue ($8,000 X 5% X 6/12)
200
25Accounts ReceivableAvery Inc.
6,120
($6,000 + $120)
Notes Receivable
6,000
Interest Revenue ($6,000 X 8% X 3/12)
120Sept.1Notes Receivable
10,000
Sales
10,000
Cost of Goods Sold
6,000
Inventory
6,000
(a)1. Accounts Receivable
3,200,000
Sales
3,200,000
2.Sales Returns and Allowances
50,000
Accounts Receivable
50,000
3.Cash
3,000,000
Accounts Receivable
3,000,000
4.Allowance for Doubtful Accounts
90,000
Accounts Receivable
90,000
5.Accounts Receivable
40,000
Allowance for Doubtful Accounts
40,000
Cash
40,000
Accounts Receivable
40,000(b)
Accounts ReceivableAllowance for Doubtful Accounts
Bal. 960,000
(1) 3,200,000
(5) 40,000
(2) 50,000
(3) 3,000,000
(4) 90,000
(5) 40,000(4) 90,000Bal. 70,000
(5) 40,000
Bal. 1,020,000Bal. 20,000
(c)Balance before adjustment [see (b)]
$ 20,000
Balance needed
110,000
Adjustment required
$ 90,000
The journal entry would therefore be as follows:
Bad Debts Expense
90,000
Allowance for Doubtful Accounts
90,000
PROBLEM 8-7A (Continued)
(d)Receivables Turnover
Average Collection Period
Its average collection period is:
(a)July 31
Notes Receivable
50,000
Accounts Receivable
50,000
Aug. 31
Interest Receivable
208
Interest Revenue
208
($50,000 x 5% x 1/12)
Sept. 30
Cash
50,416
Interest Receivable
208
Interest Revenue
(50,000 X 5% X 1/12)
208
Notes Receivable
50,000
(b)Sept. 30
Interest Receivable
208
Interest Revenue
208
($50,000 x 5% x 1/12)
30Accounts Receivable
50,416
Interest Receivable
($208 + $208)
416
Notes Receivable
50,000
(a)Oct.1Cash.8,093.33
Interest Receivable
($8,000 X 7% X 2/12)
93.33
Notes Receivable
8,000.00
7Accounts Receivable
6,900.00
Sales
6,900.00
12Cash ($750 $15)
735.00
Service Charge Expense ($750 X 2%)
15.00
Sales
750.00
21Cash ($1,500 $30)
1,470.00
Service Charge Expense ($1,500 X 2%)
30.00
Sales
1,500.00
31Accounts Receivable
5,260.66
Notes Receivable
5,200.00
Interest Receivable
($5,200 X 7% X 1/12)
30.33
Interest Revenue
($5,200 X 7% X 1/12)
30.33
31Interest Receivable
76.50
Interest Revenue
76.50
($10,200 X 9% X 1/12)
PROBLEM 8-9A (Continued)(b)
Notes ReceivableInterest Receivable
Oct.1 Bal. 23,400.00
Oct. 15 8,000.00
Oct. 25 5,200.00Oct. 1 Bal. 123.66
Oct. 31 76.50
Oct. 1 93.33
Oct. 31 30.33
Oct. 31 Bal. 10,200.00Oct. 31 Bal. 76.50
Accounts Receivable
Oct. 7 6,900.00
Oct. 31 5,260.66
Oct. 31 Bal. 12,160.66
(c)Current assets
Notes receivable
$10,200
Accounts receivable.
12,161
Interest receivable.
77
Total receivables
$22,438
RogersShaw
($ in millions)
Receivables turnover
Average collection period
Shaws receivables turnover was almost 20% higher than Rogers, which means Shaw was more efficient than Rogers in collecting its receivables. However, both companies are still collecting their accounts receivables slower than the industry average of 38 days.
(a)At first glance it appears that Tianjins liquidity had deteriorated over the past year since the companys current ratio has fallen from 1:5:1 to 1:3:1. However, it is taking the company less time to collect its accounts receivable as evidenced by the higher receivables turnover ratio. As well, the company appears to be moving its inventory more quickly as evidenced by the higher inventory turnover ratio. It is possible that the lower current ratio is due to the fact that with improved collections and inventory turnover, the company is carrying fewer current assets and not because the companys liquidity has deteriorated.
(b)Changes in the turnover ratios do not directly affect profitability. However, improvements in turnover generally indicate that the company is better able to convert sales to cash. Improved liquidity could allow the company to better manage it cash flows and therefore, indirectly improve profitability.
(c)There are several steps that Tianjin might have taken to improve its receivables and inventory turnover:
Receivables
The company could limit credit to only the best customers, however, this could negatively affect sales.
The company could initiate the use of a cash discount to encourage early payment of receivables.
The company could more aggressively monitor collections to encourage customers to pay on time.
The company could sell or factor its receivables to accelerate cash receipts.
PROBLEM 8-11A (Continued)
(c) (Continued)
Inventory The company could limit the amount of inventory by improving its purchasing relationships with suppliers. If inventory could be purchased more frequently, required inventory levels could be reduced.
Improvements in production processes could reduce the amount of work in process and thereby reducing inventory and improving the turnover ratio.
Moving to a system whereby inventory is only produced as needed, will reduce the amount of finished goods inventory and improve the turnover ratio. However, there is some risk to this option as sales could be lost if stock-outs occur.
(a)Accounts Receivable
900,000
Sales
900,000
Cash
1,069,000
Accounts Receivable
1,069,000
(b)Allowance for Doubtful Accounts
6,000
Accounts Receivable
6,000
(c)Accounts Receivable
3,000
Allowance for Doubtful Accounts
3,000
Cash
3,000
Accounts Receivable
3,000
(d)Bad Debt Expense
11,000
Allowance for Doubtful Accounts
11,000
Allowance for Doubtful Accounts
W/O 6,000
10,000 Beg. Bal.
3,000 Recovery
11,000 Bad Debts
18,000 End. Bal.
PROBLEM 8-1B (Continued)
(e)
Accounts Receivable
Beg. Bal.400,000
Sales 900,000
Recovery 3,000Collections 1,069,000
W/O 6,000
Collections 3,000
End Bal. 225,000
Allowance for Doubtful Accounts
W/O 6,000
10,000 Beg. Bal.
3,000 Recovery
11,000 Bad Debts
18,000 End Bal.
(f) Net realizable value of receivables is $207,000 ($225,000 - $18,000)
(a)Allowance for doubtful accounts = $930 (given)
(b)$930 - $750 + $105 = $285
(c)Bad debt expense = Adjustment to allowance for doubtful accounts = $285 [from (b)]
(d)Addition to accounts receivable = Sales = $30,000
(e)Amounts written off = Reductions in the allowance account = $105
(f)$8,300 + $30,000 (d) - $32,000 - $105 (e) = $6,195
(a) Total estimated bad debts
Number of Days Outstanding
Total0-3031-6061-9091-120Over 120
Accounts
receivable$260,000$100,000$60,000$50,000$30,000$20,000
% uncollectible1%5%10%20%30%
Estimated
bad debts$21,000$1,000$3,000$5,000$6,000$6,000
(b) Bad Debts Expense
6,000
Allowance for Doubtful Accounts
6,000
[$21,000 - $15,000]
(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) By establishing an allowance at the end of each accounting period the bad debt expense is recorded in the period in which the sales occur. This satisfies the matching principle.
(a)
Dec. 31Bad Debts Expense
16,660
Allowance for Doubtful Accounts
16,660
($35,660 $19,000)
(b)2005
1.Mar.1Allowance for Doubtful Accounts
800
Accounts Receivable
800
2.May1Accounts Receivable
800
Allowance for Doubtful Accounts
800
1Cash
800
Accounts Receivable
800
(c)2005
Dec. 31Bad Debts Expense
4,340
Allowance for Doubtful Accounts
4,340
($35,660 $40,000)
(a)Bad debts written off= $28,000
(b)
$20,000 - $4,000 = $16,000
(c)
$20,000 + $2,000 = $22,000
(d)The advantages of the allowance method are:
1.It attempts to match bad debt expense related to uncollectible accounts receivable with sales revenues on the statement of earnings.
2.It attempts to show the net realizable value of the accounts receivable on the balance sheet.
Jan.
5Accounts ReceivableBrooks Company
6,000
Sales
6,000
Cost of Goods Sold
4,000
Inventory
4,000
Feb.2Notes Receivable
6,000
Accounts ReceivableBrooks Company
6,000
12Notes Receivable
7,800
Sales
7,800
Cost of Goods Sold
5,000
Inventory
5,000
26Accounts ReceivableMathias Co.
5,000
Sales
5,000
Cost of Goods Sold
3,750
Inventory
3,750
Apr.
5Notes Receivable.
5,000
Accounts ReceivableMathias Co.
5,000
12Cash ($7,800 + $78)
7,878
Notes Receivable
7,800
Interest Revenue ($7,800 X 6% X 2/12)
78
PROBLEM 8-6B (Continued)
June2Cash ($6,000 + $80)
6,120
Notes Receivable
6,000
Interest Revenue ($6,000 X 6% X 4/12)
120
July
5Accounts ReceivableMathias Co.
($5,000 + $88)
5,088
Notes Receivable
5,000
Interest Revenue ($5,000 X 7% X 3/12)
88
July 15Notes Receivable
2,000
Sales
2,000
Cost of Goods Sold
1,500
Inventory
1,500
Oct.
15Cash ($2,000 + $35)
2,035
Notes Receivable
2,000
Interest Revenue ($2,000 X 7% X 3/12)
35
(a)1.
Accounts Receivable
2,600,000
Sales
2,600,000
2.Sales Returns and Allowances
40,000
Accounts Receivable
40,000
3.Cash
2,200,000
Accounts Receivable
2,200,000
4.Allowance for Doubtful Accounts
80,000
Accounts Receivable
80,000
5.Accounts Receivable
25,000
Allowance for Doubtful Accounts
25,000
Cash
25,000
Accounts Receivable
25,000
(b)
Accounts ReceivableAllowance for Doubtful Accounts
Bal. 1,000,000
(1) 2,600,000
(5) 25,000
(2) 40,000
(3) 2,200,000
(4) 80,000
(5) 25,000(4) 80,000Bal. 50,000
(5) 25,000
Bal. 1,280,000Bal. 5,000
PROBLEM 8-7B (Continued)
(c)Balance before adjustment [see (b)]
$ 5,000 dr.
Balance needed
70,000 cr.
Adjustment required
$75,000 cr.
The journal entry would therefore be as follows:
Bad Debts Expense
75,000
Allowance for Doubtful Accounts
75,000(d)Receivables Turnover:
The average collection period is:
(a)Nov. 1Notes Receivable
20,000
Accounts Receivable
20,000
30Interest Receivable
($20,000 X 7% X 1/12)
117
Interest Revenue
117
Dec. 31Interest Receivable
117
Interest Revenue
117
Jan. 31Interest Receivable
116
Interest Revenue
116
Feb. 1Cash
20,350
Interest Receivable
350
Notes Receivable
20,000
(b)Feb. 1Accounts Receivable
20,350
Interest Receivable
350
Notes Receivable
20,000
(a)July1Cash
6,060.00
Notes Receivable
6,000.00
Interest Receivable
($6,000 X 6% X 2/12)
60.00
5Accounts Receivable
7,800.00
Sales
7,800.00
14Cash ($700 $21)
679.00
Service Charge Expense ($700 X 3%)
21.00
Sales
700.00
31Allowance For Doubtful Accounts
4,824.00
Notes Receivable
4,800.00
Interest Receivable
($4,800 X 6% x 1/12)
24.00
31Interest Receivable
37.50
Interest Revenue
($9,000 X 5% X 1/12)
37.50
PROBLEM 8-9B (Continued)
(b)
Notes Receivable
Jul. 1 Bal.19,800
Jul. 1 6,000
Jul. 31 4,800
Jul. 31 Bal. 9,000
Interest Receivable
Jul. 1 84.00
Jul. 3 37.50
Jul. 1 Bal. 60.00
Jul. 31 24.00
Jul. 31 Bal. 37.50
Accounts Receivable
Jul. 5 7,800
Jul. 31 Bal. 7,800
(c)Current assets
Notes receivable
$ 9,000
Accounts receivable
7,800
Interest receivable
38
Total receivables
$16,838
(a)
NikeReebok
($ in U.S. millions)
Receivables turnover
Average collection period
Reeboks receivables turnover ratio was higher than Nikes, which means that Reebok was more efficient than Nike in turning receivables into cash. However, both companies are below the industry average in receivables turnover and average collection period.
(a)At first glance it appears that Hawryluks liquidity had improved over the past year since the companys current ratio has increased from 1:5:1 to 1:8:1. However, it is taking the company more time to collect its accounts receivable as evidenced by the lower accounts receivable turnover ratio. As well, the company appears to be moving its inventory less quickly as evidenced by the lower inventory turnover ratio. The cause for these declines should be investigated as part of assessing the companies liquidity.
(b)Changes in the turnover ratios directly affect cash flow. Improvements in the receivables turnover and inventory turnover speed up the cash cycle which provides the company with better cash flow and less need for outside financing.
(c)There are several steps that Hawryluk could consider to improve its receivables and inventory turnover:
Receivables
The company could limit credit to only the best customers, however, this could negatively affect sales.
The company could initiate the use of a cash discount to encourage early payment of receivables
The company could more aggressively monitor collections to encourage customers to pay on time.
The company could sell or factor its receivables to accelerate cash receipts
PROBLEM 8-11B (Continued)
(c) Continued
Inventory The company could limit the amount of inventory by improving its purchasing relationships with suppliers. If inventory could be purchased more frequently, required inventory levels could be reduced.
Improvements in production processes could reduce the amount of work in process and thereby reducing inventory and improving the turnover ratio.
Moving to a system whereby inventory is only produced as needed will reduce the amount of finished goods inventory and improve the turnover ratio. However, there is some risk to this option as sales could be lost if stock-outs occur.
(a)($ in millions)
Receivables turnover
Average collection period
Loblaw has very few credit sales. Given its average collection period of 8.5 days, one can assume that the majority of its sales are cash sales.
(b)Loblaw has a policy of writing off any credit card receivables that has a payment in arrears of greater than 180 days or where the likelihood of collection is considered remote.
(c)Loblaw (through PC Bank) sells a portion of its credit card receivables to an independent Trust through a process called securitization.
(d)Loblaw seems to have a policy of quickly converting its receivables to cash. The company has very few receivables; therefore most of its sales must be on a cash basis. The few receivables owned by the company are quickly sold through securitization allowing the company to quickly turn the receivables into cash.
(a) Most of the receivables owned by the two companies are credit card receivables. However, Sobeys does have some mortgage and loans receivable representing long-term financing to franchisees.
(b) ($ in millions)
Loblaw Sobeys
1.Current ratio
2. Receivables turnover
= 42.9 times= 38.8 times
3.Average collection period
(c)Overall working capital management appear on par with the industry for both Loblaw and Sobeys. The current ratio for Loblaws is around the industry average of 1:1 while Sobeys current ratio is less than the industry average. It appears that Loblaw manages it receivables better than the industry average. Its turnover rate is 42.9 times compared to the average of 40.4. Its average collection period of 8.5 days is slightly better than the industry average of 9 days. Sobeys ratios indicate that it is slightly below the industry average, at 38.8 times for its turnover ratio and 9.4 days for the average collection period.
(a)On the average, Canadians pay off 33% of their credit card balances monthly.
(b)2.6% of balances are overdue by more than 30 days.
(c)3% of uncollectible accounts were written off in the first quarter of 2002
(d)In comparison to Canadians, Americans only pay off 15% of their balances monthly, delinquent accounts (accounts over 30 days) average 5.4% and in the first quarter of 2002 6.4% of uncollectible accounts were written off.
(a)($ in millions)
20022001
Current ratio
Receivables turnover
= 13.7 times= 11.7 times
Average collection period
Suncors liquidity has improved over the past year. Its current ratio has increased to 0.91:1 from 0.80:1 and it is collecting its accounts receivables almost 5 days faster in 2002 versus 2001. The companys current ratio is still under the industry average but they are collecting receivables much faster than the average company in the industry.
(b) By keeping the dollar amount of its allowance for doubtful accounts unchanged over the past few years, the company had a much higher percentage of receivables recognized as doubtful in 2001 versus 2002. It may be more relevant for the company to determine a percentage of receivables that it deems doubtful each year and adjust the balance in the doubtful accounts by recognizing a bad debt expense annually. However, the company may have identified specific accounts that are doubtful, which may be the reason why the balance has not changed from year to year.
(c)By regularly selling its accounts receivable Suncor is able to more quickly convert receivables into cash. The company may have determined that the fees associated with selling the receivables are less than the cost of having to use short term borrowings to finance operations. As well, the company may also not want to bother with the cost and effort required to bill and collect the receivables and would rather sell the receivables and let another company deal with these issues.
(a)Sears sold $8.1 billion of its receivables. This represents 20% ($8.1 ($32.595 + $8.1)) of Sears total receivables. Thus, the sale of receivables by Sears is obviously significant.
Companies sell receivables to raise funds to meet cash needs. As well, Sears may not have wanted to devote resources to the time consuming job of billing and collecting its receivables.
One concern that an investor would have is whether Sears is responsible for these receivables if the receivables go bad. That is, Sears may have to make up any deficiency to the party it sold the receivables to if that party is not able to collect.
(b)The receivables turnover ratio is calculated as net credit sales divided by average gross accounts receivable.
($ in U.S. millions)
2002
= 1.15 times
2001
= 1.51 times
The average collection period is calculated as 365 (the number of days in a year) divided by the receivables turnover ratio. For 2002 and 2001 this is calculated as:
2002
2001
Note that the average collection period for Sears is longer than for many companies because Sears provides instalment financing, allowing its customers to pay over an extended period of time.
BYP 8-5 (Continued)
(c)Both. By providing financing, Sears makes it possible for many of its customers to purchase goods that they dont currently have adequate cash to purchase. Sears allows these customers to pay off their balance in instalment payments, requiring that they pay interest on the outstanding balance. This interest represents a significant portion of Sears' revenue for the year.
(d)The ratio of bad debts expense divided by sales for Sears for 2002 and 2001 is calculated as:
20022001
This ratio gives an indication of the cost of bad debts per dollar of sales. The ratio has gotten worse from 2001 to 2002. It should be monitored over time by management to ensure that the companys credit policies are appropriate and that they are being followed. Too tight a policy and the company will lose too many sales; too loose a policy and the company will incur high bad debts expense.
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 online in the Instructor Resources section of our home page .
(a)
2004 2003 2002
Net credit sales
$500,000$600,000$400,000
Credit and collection expenses
Collection agency fees
$ 2,450
$ 2,500
$ 1,600
Salary of accounts receivable clerk
3,800
3,800
3,800
Uncollectible accounts
8,000
9,600
6,400
Billing and mailing costs
2,500
3,000
2,000
Credit investigation fees
750
900
600
Total
$17,500
$19,800
$14,400
Total expenses as a percentage of
net credit sales
3.5%
3.3%
3.6%(b) Average accounts receivable (5%)
$25,000
$30,000
$20,000
Investment earnings (5%)
$ 1,250
$ 1,500
$ 1,000
Total credit and collection expense per above
$17,500
$19,800
$14,400
Add: Investment earnings*
1,250
1,500
1,000
Net credit and collection expense
$18,750
$21,300
$15,400
Net expenses as a percentage of net sales
3.75%
3.55%
3.85%
*The investment earnings on the cash tied up in accounts receivables is an additional expense of continuing the existing credit policies.
(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 before considering the effect of earnings from other investment opportunities. However, after considering investment earnings, the credit card fee of 3% will be even more attractive to the company. Financially, the company should accept the offer to use the credit cards. However, the decision hinges on (1) the accuracy of the estimates of investment earnings, (2) the expected trend in credit sales, and (3) the effect the new policy will have on sales.
Nonfinancial factors include the effects on customer relationships of the alternative credit policies and whether the Campus Fashions wants to continue with the handling of their own accounts receivable.
Memorandum
To:
Sales Staff
From:Student
Re:Management of the credit function
During the year Toys for Big Boys has experienced a significant increase in sales due to your efforts. However, it is important that the sales staff be aware that, in order for the company to generate the cash it needs to continue operations, it is essential that Toys for Big Boys be able to generate cash from these sales. Cash is needed to pay for the inventory the company has purchased and to cover other operating expenses such as your sales commissions.
Over the past year, the company has noticed a trend whereby the average time to collect accounts receivables has increased from 30 days to 120 days. By allowing you to assume the role of managing the credit function what it is likely is that you have become too focused on sales without considering the quality of the sales and the ability of the customer to pay the receivable within a reasonable period of time.
Given the increase in the average collection period, it is likely that the company has now assumed additional credit risk. The longer a customer takes to pay, the more likely that he will default on the receivable.
The selling staff has been placed in a conflict of interest position. While it is in your best interest to stimulate sales, this may deter you from performing adequate credit checks. To improve this process I would recommend using a separate credit department to evaluate the credit worthiness of all potential credit customers. If the sales staff is opposed to this recommendation, at the very least a set of specific criteria should be developed which would ensure that the selling staff only grant credit to those customers who meet the companys credit standards.
(a)The stakeholders in this situation are:
The president of Shady Corporation
The controller of Shady Corporation
The shareholders of Shady Corporation
(b)The ethical dilemma is whether the controller should issue the credit notes and reinvoice the sale to make the receivable appear to be more current. This way Shady will be able to meet the banks requirements and increase the amount of the operating line of credit.
(c)To proceed with the presidents plan would be fraudulent. If Shady ever defaulted on the loan and it was discovered that the invoices were reissued to manipulate the accounts receivable figures both Shady and potentially the controller could be liable. The controller should point this out to Shadys president and refuse to proceed with the adjustments. If the president still insists that the invoices be reissued, the controller should resign from his position.Legal Notice
Copyright
Copyright 2004 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.
The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.
The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.
EMBED Equation.3
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PROBLEM 8-1A
PROBLEM 8-2A
PROBLEM 8-3A
PROBLEM 8-4A
PROBLEM 8-5A
PROBLEM 8-6A
PROBLEM 8-7A
EMBED Equation.3
PROBLEM 8-8A
PROBLEM 8-9A
PROBLEM 8-10A
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PROBLEM 8-11A
PROBLEM 8-1B
PROBLEM 8-2B
PROBLEM 8-3B
PROBLEM 8-4B
PROBLEM 8-5B
PROBLEM 8-6B
PROBLEM 8-7B
EMBED Equation.3
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PROBLEM 8-8B
PROBLEM 8-9B
PROBLEM 8-10B
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PROBLEM 8-11B
BYP 8-1FINANCIAL REPORTING PROBLEM
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BYP 8-2 COMPARATIVE ANALYSIS PROBLEM
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BYP 8-3 RESEARCH CASE
BYP 8-4 INTERPRETING FINANCIAL STATEMENTS
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BYP 8-5 A GLOBAL FOCUS
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BYP 8-6 FINANCIAL ANALYSIS ON THE WEB
BYP 8-7 COLLABORATIVE LEARNING ACTIVITY
BYP 8-8 COMMUNICATION ACTIVITY
BYP 8-9 ETHICS CASE
Solutions Manual
8-1Chapter 8
Copyright 2004 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.
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