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Porter solutions chapter 7TRANSCRIPT
Chapter 7: Investments and Receivables
7-40Financial accounting solutions manual
chapter 7 Receivables and investments7-41
CHAPTER 7Receivables and InvestmentsOVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Estimated
Time in
Learning OutcomesExercisesMinutesLevel
1.Show that you understand how to account for accounts110Mod
receivable, including bad debts.225Mod
13*5Easy
2.Explain how information about sales and receivables can320Mod
be combined to evaluate how efficient a company is in
collecting its receivables.
3.Show that you understand how to account for 415Mod
interest-bearing notes receivable.
4.Explain various techniques that companies use to accelerate520Mod
the inflow of cash from sales.
5.Show that you understand the accounting for and disclosure615Mod
of various types of investments that companies make.710Easy
830Mod
930Mod
1030Mod
13*5Easy
6.Explain the effects of transactions involving liquid assets115Easy
on the statement of cash flows.125Mod
13*5Easy
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
ProblemsEstimated
andTime in
Learning OutcomesAlternatesMinutesLevel
1.Show that you understand how to account for accounts130Mod
receivable, including bad debts.215Mod
8*20Mod
2.Explain how information about sales and receivables330Mod
can be combined to evaluate how efficient a company
is in collecting its receivables.
3.Show that you understand how to account for 8*20Mod
interest-bearing notes receivable.
4.Explain various techniques that companies use to accelerate415Mod
the inflow of cash from sales.
5.Show that you understand the accounting for and disclosure525Mod
of various types of investments that companies make.620Mod
6.Explain the effects of transactions involving liquid assets 745Diff
on the statement of cash flows.*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
Estimated
Time in
Learning OutcomesCasesMinutesLevel
1.Show that you understand how to account for accounts130Mod
receivable, including bad debts.2*25Mod
4*25Mod
2.Explain how information about sales and receivables325Mod
can be combined to evaluate how efficient a company
is in collecting its receivables.
3.Show that you understand how to account for
interest-bearing notes receivable.
4.Explain various techniques that companies use to accelerate525Mod
the inflow of cash from sales.
5.Show that you understand the accounting for and disclosure4*25Mod
of various types of investments that companies make.
6.Explain the effects of transactions involving liquid assets 2*25Mod
on the statement of cash flows.
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)questions 1.The allowance method of accounting for bad debts tries to match one of the costs associated with granting credit, i.e., uncollectible accounts, with the revenue of the period. Under the matching principle, an estimate of bad debts is made on the basis of either the sales of the period or the accounts receivable at the end of the period, and an expense is recognized.
2.When bad debts expense is estimated by using the percentage of accounts receivable approach, the balance already in the allowance account must be considered. For example, if the estimate of the accounts receivable that will prove to be uncollectible is $20,000 and the allowance account has a balance of $3,000 before adjustment, only $17,000 has to be added to it. Under the percentage of net credit sales approach, however, the emphasis is on the debit to bad debts expense. The balance in the allowance account before adjustment is ignored.
3.An aging schedule is a refinement of the percentage of accounts receivable approach to estimating bad debts. The accountant categorizes the various receivables by the length of time they are outstanding. The estimate of the percent uncollectible increases as the age of the accounts go up.
4.A note receivable arises from a written promise by someone to pay a specific amount of money in the future with interest. An account receivable arises from granting a customer an open line of credit and does not normally include interest.
5.When a note receivable is discounted with recourse, it means that if the customer fails to pay the bank the total amount due on the maturity date, the company that sold the note to the bank is liable to the bank for the full amount. Therefore, during the time a discounted note is outstanding, the seller of the note is contingently liable. Accounting standards do not require the seller to recognize the contingency as a liability, but a note is required to alert the statement reader of the uncertainty.
6.The first CD should be classified as a cash equivalent because it has an original maturity of three months or less. The second CD is classified as a short-term investment. It is a current asset because it will be converted into cash within the next year, even though its original maturity of more than three months disqualifies it from classification as a cash equivalent.
7.Shares of common stock could be classified as either current assets or noncurrent assets. The intent of the company determines the proper classification. If Stanzel purchases the IBM shares with the intent of selling them in the near term, they should be classified as current assets. Otherwise, the shares should be classified as noncurrent assets.
8.Any fees or commissions paid to purchase stock in another company should be added to the cost of the investment.BRIEF exercisesLO 1BRIEF EXERCISE 7-1 ACCOUNTING FOR BAD DEBTS
Bad Debts Expense10,000
Allowance for Doubtful Accounts
10,000
To record estimated bad debts:
2% $500,000.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Bad Debts
Doubtful
Expense(10,000)
Accounts(10,000)
LO 2BRIEF EXERCISE 7-2 ACCOUNTS RECEIVABLE TURNOVER
$240,000/[($40,000 + $20,000/2] = $240,000/$30,000 = 8 timesLO 3BRIEF EXERCISE 7-3 ACCOUNTING FOR NOTES RECEIVABLE
2008
Dec. 31Interest Receivable500
Interest Revenue
500
To record interest earned: $50,000 6% 60/360.Note: Solution assumes Gopher accepted the note, not issued the note as shown in the
text.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Interest
Interest Revenue750
Receivable750
LO 4BRIEF EXERCISE 7-4 ACCOUNTING FOR CREDIT CARD SALES
July 20Cash9,600
Collection Fee Expense400
Sales Revenue*
10,000
*Accounts Receivable if sale was already recorded.
To record credit card sales.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
9,600
Collection Fee
Expense(400)
Sales Revenue10,000
LO 5BRIEF EXERCISE 7-5 ACCOUNTING FOR SALE OF STOCK
March 5Cash 12,300
Investment in Stock
10,100
Gain on Sale of Stock
2,200
To record sale of stock at a gain.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
12,300
Gain on Sale
Investment
of Stock 2,200
in Stock(10,100)
LO 6BRIEF EXERCISE 7-6 ACCOUNTS RECEIVABLE ON THE STATEMENT OF CASH FLOWS
The increase of $40,000 $25,000 or $15,000 in accounts receivable should be deducted from net income under the indirect method of preparing the statement of cash flows. Sales increase net income. An increase in accounts receivable is an indication that sales exceeded cash collections and therefore to arrive at cash from operations a deduction is needed.exercisesLO 1EXERCISE 7-1 COMPARISON OF THE DIRECT WRITE-OFF AND ALLOWANCE METHODS OF ACCOUNTING FOR BAD DEBTS
Net income under each of the two alternatives is as follows:
Direct write-off method: $145,000 $10,500 = $134,500
Allowance method: $145,000 (2% $650,000) = $145,000 $13,000 = $132,000Conclusion: The direct write-off method would result in a lesser amount of expense and therefore in a higher net income. However, under current accounting standards, if bad debts are material in amount, the allowance method must be used. In addition, it is not acceptable for a company to choose accounting methods on the basis of their effects on net income.
LO 1EXERCISE 7-2 ALLOWANCE METHOD OF ACCOUNTING FOR BAD DEBTSCOMPARISON OF THE TWO APPROACHES
1.a.Based on 2% of net credit sales:
2008
Dec. 31Bad Debts Expense16,680
Allowance for Doubtful Accounts
16,680
To record estimated bad debts:
2% $834,000.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Bad Debts
Doubtful
Expense(16,680)
Accounts(16,680)
b.Based on 6% of year-end accounts receivable:
2008
Dec. 31Bad Debts Expense16,606
Allowance for Doubtful Accounts
16,606
To record estimated bad debts:
Need balance of 6% of $320,100$19,206 (cr)
Balance before adjustment is
2,600 (cr)
Amount of entry must be$16,606 (cr)
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Bad Debts
Doubtful
Expense(16,606)
Accounts(16,606)
2.a.No change.
b.2008
Dec. 31Bad Debts Expense21,806
Allowance for Doubtful Accounts
21,806
To record estimated bad debts:
Need balance of 6% of $320,100$19,206 (cr)
Balance before adjustment is
(2,600) (dr)
Amount of entry must be$21,806 (cr)
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Bad Debts
Doubtful
Expense(21,806)
Accounts(21,806)LO 2EXERCISE 7-3 ACCOUNTS RECEIVABLE TURNOVER FOR GENERAL MILLS
1.Accounts receivable turnover:
Net credit sales/Average accounts receivable
= $11,640/[($1,076 + $1,034)/2]
= $11,640/$1,055 = 11.03 times
2.Average collection period (assuming 360 days in a year):
Number of days in a year/turnover
= 360/11.03 = 33 days to collect an account receivable
3.Types of customers General Mills might have:
Grocery wholesalersGrocery chainsInstitutional food services
Whether or not an average of 33 days to collect an account is reasonable depends on several factors. For example, how does this compare with other companies in the same industry as General Mills? How does it compare with prior years? What are General Mills credit terms? If its credit terms are 2/10, net 30, an average collection period of 33 days may be reasonable, but not if the credit terms are net 10, for example.
LO 3EXERCISE 7-4 NOTES RECEIVABLE
1.Rozelle Company is the maker; Dougherty Corporation is the payee.
2.The maturity date is March 1, 2009.
3.2008
Sept. 1Notes Receivable45,000
Accounts Receivable
45,000
To record receipt of six-month, 7% promissory
note in exchange for open account.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Notes
Receivable45,000
Accounts
Receivable(45,000)
Dec. 31Interest Receivable1,050
Interest Revenue
1,050
To record interest earned: $45,000 7% 4/12.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Interest
Interest
Receivable1,050
Revenue1,050
2009
Mar. 1Cash46,575
Interest Receivable
1,050
Interest Revenue
525
Notes Receivable
45,000
To record collection of promissory note:
$45,000 7% 2/12.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
46,575
Interest Revenue525 Interest
Receivable(1,050)Notes
Receivable(45,000)LO 4EXERCISE 7-5 CREDIT CARD SALES
June 12Cash2,430
Accounts ReceivableAmerican Express3,500
Sales Revenue
5,930
To record weekly cash and credit sales.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
2,430
Sales Revenue5,930
Accounts
Receivable
American
Express3,500
June 15Cash3,360
Collection Fee Expense140
Accounts ReceivableAmerican Express
3,500
To record weekly drafts from credit card company.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
3,360
Collection FeeAccounts
Expense(140)
Receivable
American
Express(3,500)The collection fee charged by American Express is $140/$3,500 = 4%.
LO 5EXERCISE 7-6 CERTIFICATE OF DEPOSIT
2008May 31Short-Term Investments: CD50,000
Cash
50,000
To record purchase of 120-day 9% CD.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Short-Term
Investments:
CD
50,000
Cash
(50,000)
June 30Interest Receivable375
Interest Revenue
375
To record interest earned: $50,000 9% 30/360.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Interest
Interest Revenue375
Receivable375Sept. 28Cash
51,500
Interest Receivable
375
Interest Revenue
1,125
Short-Term Investments
50,000
To record redemption of $50,000 CD:
$50,000 9% 90/360 = $1,125.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
51,500
Interest Revenue1,125Interest
Receivable(375)
Short-Term
Investments(50,000)
LO 5EXERCISE 7-7 CLASSIFICATION OF CASH EQUIVALENTS AND INVESTMENTS ON A BALANCE SHEET
1.STI6.STI
2.STI7.STI
3.STI8.LTI
4.CE9.STI
5.LTI10.CE
LO 5EXERCISE 7-8 PURCHASE AND SALE OF BONDS
1.Journal entries
2008
Jan. 1Investment in Northern Lights Bonds100,000
Cash
100,000
To record purchase of Northern Lights
bonds at 100.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
Northern Lights
Bonds100,000
Cash
(100,000)
June 30Cash4,000
Interest Income
4,000
To record interest income on Northern
Lights bonds: $100,000 8% 6/12.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
4,000
Interest Income4,000
Dec. 31Cash4,000
Interest Income
4,000
To record interest income on Northern
Lights bonds.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
4,000
Interest Income4,000
2009
Jan. 1Cash102,000
Investment in Northern Lights Bonds
100,000
Gain on Sale of Bonds
2,000
To record sale of Northern Lights
bonds at 102.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
102,000
Gain on SaleInvestment in
of Bonds2,000
Northern Lights
Bonds(100,000)
2.Starship was able to sell the bonds for more than the bonds will pay when they mature because the bonds carry a higher periodic interest than the market rate of interest that was in effect at the time of the sale.
LO 5EXERCISE 7-9 INVESTMENT IN STOCK
2008
Oct. 1Investment in Denver Preferred Stock (BS)41,000
Cash (BS)
41,000
To record purchase of stock for cash:
($1,000 $40) + $1,000
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in Denver
Preferred
Stock41,000Cash
(41,000)
Oct. 20Cash1,000
Dividend Income (IS)
1,000
To record $1 per share dividend on dividend declared on investment on
1,000 shares of Denver preferred stock.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
1,000
Dividend Income1,000
Nov. 5Cash (BS)45,000
Investment in Denver Preferred
Stock (BS) (book value)
41,000
Gain on Sale of Stock (IS)
4,000
To record sale of stock at a gain.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
45,000
Gain on SaleInvestment in
of Stock4,000
Denver
Preferred
Stock(41,000)LO 5EXERCISE 7-10 INVESTMENT IN STOCK
2008
Aug. 15Investment in Sox Common Stock (BS)76,000
Cash (BS)
76,000
To record purchase of 5,000 shares of stock for
$15 per share + $1,000 in fees.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
Sox Common
Stock76,000
Cash
(76,000)
Oct. 20Cash (BS)50,000*
Loss on Sale of Stock (IS)26,000**
Investment in Sox Common Stock (BS)
76,000
To record sale of stock at a loss.
*5,000 $10
**76,000 50,000
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
50,000
Loss on Sale
Investment in
of Stock(26,000)
Sox Common
Stock(76,000)
LO 6EXERCISE 7-11 IMPACT OF TRANSACTIONS INVOLVING RECEIVABLES ONSTATEMENT OF CASH FLOWS
Increase in accounts receivableDeducted from net incomeDecrease in accounts receivableAdded to net incomeIncrease in notes receivableDeducted from net incomeDecrease in notes receivableAdded to net income
LO 6EXERCISE 7-12 CASH COLLECTIONSDIRECT METHOD
Cash collections to be reported in the operating activities section of Emily Enterprises 2008 statement of cash flows (direct method):
Accounts receivable, December 31, 2007$224,600
Plus sales during 20082,250,000
Less cash collections during 2008
(X)
Accounts receivable, December 31, 2008$205,700
$224,600 + $2,250,000 X = $205,700
X = $2,268,900MULTICONCEPT EXERCISELO 1,5,6EXERCISE 7-13 IMPACT OF TRANSACTIONS INVOLVING CASH, SECURITIES, AND RECEIVABLES ON STATEMENT OF CASH FLOWS
Purchase of cash equivalentsN
Redemption of cash equivalentsN
Purchase of investmentsI
Sale of investmentsI
Write-off of customer account (under the allowance method)NproblemsLO 1PROBLEM 7-1 ALLOWANCE METHOD FOR ACCOUNTING FOR BAD DEBTS
1.Accounts Receivable840,000
Cash
210,000
Sales Revenue
1,050,000
To record sales for year: $1,050,000 80% = $840,000
credit sales.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Accounts
Sales
Receivable840,000
Revenue1,050,000
Cash
210,000
Cash
670,000
Accounts Receivable
670,000
To record collection of customer accounts.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
670,000
Accounts
Receivable(670,000)
Allowance for Doubtful Accounts4,000
Accounts Receivable
4,000
To record write-off of accounts receivable.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Doubtful
Accounts4,000
Accounts
Receivable(4,000)PROBLEM 7-1 (Continued)2.a.Bad Debt Expense25,200
Allowance for Doubtful Accounts
25,200
To record estimated bad debt expense:
$840,000 3%.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Bad Debt
Doubtful
Expense(25,200)
Accounts(25,200)
2.b.Bad Debt Expense20,010
Allowance for Doubtful Accounts
20,010
To record estimated bad debt expense:
Accounts receivable at Dec. 31, 2008
($140,000 + $840,000 $670,000 $4,000) = $306,000
Allowance balance needed ($306,000 0.06)
$18,360 (cr)
Balance before adjustment:
Beginning balance$2,350 (cr)
Write-off
4,000 (dr)
1,650 (dr)
Amount of entry must be
$20,010 (cr)
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Bad Debt
Doubtful
Expense(20,010)
Accounts(20,010)
3.a.The net realizable value of accounts receivable on December 31, 2008, is $282,450:
Accounts receivable, Dec. 31 (from Part 2.b.)
$306,000
Less: Allowance for doubtful accounts, Dec. 31
($2,350 $4,000 + $25,200)
23,550
Net realizable value, December 31
$282,4503.b.The net realizable value of accounts receivable on December 31, 2008, is $287,640:
Accounts receivable, Dec. 31 (from Part 2.b.)
$306,000
Less: Allowance for doubtful accounts, Dec. 31
($2,350 $4,000 + $20,010)
18,360
Net realizable value, December 31
$287,640PROBLEM 7-1 (Concluded)
4.The recognition of bad debt expense reduces the net realizable value by the amount recorded in bad debt expense and the allowance for doubtful accounts. The write-off of accounts has no effect on the net realizable value.
LO 1PROBLEM 7-2 AGING SCHEDULE TO ACCOUNT FOR BAD DEBTS
1.
EstimatedEstimated
PercentAmount
CategoryAmountUncollectibleUncollectible
Current$200,0005%$10,000
Past due:
Less than one month45,00020%9,000
One to two months25,00040%10,000
Over two months
10,00060%
6,000
Totals
$280,000
$35,000
2.Journal entry:
2008
Dec. 31Bad Debts Expense22,700
Allowance for Doubtful Accounts
22,700
To record estimated bad debts:
$35,000 less $12,300 currently in
allowance account.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Bad Debts
Doubtful
Expense(22,700)
Accounts(22,700)
3.Partial balance sheet at December 31, 2008:
Current Assets
Accounts receivable$280,000
Less: Allowance for doubtful accounts
(35,000)
Net accounts receivable
$245,000
LO 2PROBLEM 7-3 ACCOUNTS RECEIVABLE TURNOVER FOR COCA-COLA AND PEPSICO
1.
Accounts receivable turnover ratios:
Coca-Cola:
$24,088/[($2,587 + $2,281)/2] = $24,088/$2,434 = 9.90 times
PepsiCo:
$35,137/[($3,725 + $3,261)/2] = $35,137/$3,493 = 10.06 times
2.Average collection period:
Coca-Cola:
360/9.90 = 36.36 days
PepsiCo:
360/10.06 = 35.78 days
Both companies have an average collection period of about 36 days. A collection period that averages just over one month, appears to be reasonable.
3.The turnover ratios and the average collection periods are very similar for the two companies. It would be especially helpful to measure these statistics, accounts receivable turnover ratio and average collection period, with the same measures for prior years. It would also be helpful to compare these measures with the industry averages.
LO 4PROBLEM 7-4 CREDIT CARD SALES
1.Net selling price$1.00
Cost of goods sold
0.75
Gross margin$0.25
The owner must net $1 per gallon on the selling price. The amount per gallon he would have to charge credit card customers is
X 0.02X=1.00
0.98X=1.00
X=$1.02 per gallon
(It is worth noting that not all gas companies charge a higher price for credit card purchases.)
2.If his normal charge is $1.02 to credit card customers, he can offer a $0.02 discount to cash customers and still maintain his gross margin.
LO 5PROBLEM 7-5 INVESTMENTS IN BONDS AND STOCK
2008
July 1Investment in Gallatin Bonds10,000
Cash
10,000
To record purchase of 6%, Gallatin bonds.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
Gallatin
Bonds10,000
Cash
(10,000)
Oct. 23Investment in Eagle Rock Stock12,000
Cash
12,000
To record purchase of 600 shares of
common stock at $20 per share.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment
in Eagle
Rock Stock12,000
Cash
(12,000)
Nov. 21Investment in Montana Stock6,000
Cash
6,000
To record purchase of 200 shares of
preferred stock at $30 per share.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment
in Montana
Stock6,000
Cash
(6,000)PROBLEM 7-5 (Concluded)
Dec. 10Cash1,300
Dividend Income
1,300
To record receipt of dividends on
securities:
Eagle Rock600 $1.50$900
Montana200 $2.00
400
$1,300
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
1,300
Dividend Income1,300
Dec. 28Cash10,000*
Investment in Eagle Rock Stock
8,000**
Gain on Sale of Stock
2,000
To record sale of 400 shares of Eagle
Rock stock.
*$400 $25
**$400 $20
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
10,000
Gain on SaleInvestment
of Stock2,000
in Eagle
Rock Stock(8,000)
Dec. 31Cash (10,000 6% 1/2 year)300
Interest Income
300
To record receipt of interest:
$10,000 6% 6/12.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
300
Interest Income300
LO 5PROBLEM 7-6 INVESTMENTS IN STOCK
2008
Jan. 15Investment in Sears Stock10,500
Cash
10,500
To record purchase of 200 shares of
stock at $50 per share, plus $500 in
commissions.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
Sears Stock10,500
Cash
(10,500)
May 23Cash400
Dividend Income
400
To record receipt of dividends of $2 per
share on 200 shares of Sears stock.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
400
Dividend Income400
June 1Investment in Ford Stock7,700
Cash
7,700
To record purchase of 100 shares of
stock at $74 per share, plus $300 in
commissions.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
Ford Stock7,700
Cash
(7,700)
Oct. 20Cash8,000
Loss on Sale of Stock2,500
Investment in Sears Stock
10,500
To record sale of Sears stock:
(200 shares $42) $400 = $8,000.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
8,000
Loss on Sale
Investment in
of Stock(2,500)
Sears Stock(10,500)PROBLEM 7-6 (Concluded)
Dec. 15Dividends Receivable150
Dividend Income
150
To record notification of the declaration
of $1.50 per share dividend on 100 shares
of Ford stock.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Dividends
Dividend Income150
Receivable150
LO 6PROBLEM 7-7 EFFECTS OF CHANGES IN RECEIVABLE BALANCES ON STATEMENT OF CASH FLOWS
1.Statement of cash flows:
STEGNER INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2008
Net income
$130,000
Adjustments to reconcile net income to net cash
used by operating activities:
Increase in accounts receivable$(140,000)*
Decrease in notes receivable
5,000**
(135,000)
Cash flows from operating activities
$(5,000)
Cash, December 31, 2007
110,000
Cash, December 31, 2008
$105,000
*$223,000 $83,000
**$100,000 $95,000
PROBLEM 7-7 (Concluded)
2.Memorandum to the president:
TO:Owner of Stegner, Inc.
FROM:Students name
DATE:January XX, 2009
SUBJECT:Cash Flows
You recently expressed concern about the decrease in the companys cash balance in spite of the profitable year that was reported on this years income statement. My thoughts and a copy of the companys 2008 statement of cash flows follow.
Although net income on an accrual basis was $130,000, the companys cash balance declined by $5,000 during the year for two reasons. Most importantly, accounts receivable increased by $140,000 during the year from $83,000 to $223,000; we did not collect amounts due from our customers as sales were made. This drain on cash was partially offset by a $5,000 decrease in notes receivable during the year, from $100,000 to $95,000.
We can better manage our cash flow by increasing our collection efforts.
MULTICONCEPT PROBLEMLO 1,3PROBLEM 7-8 ACCOUNTS AND NOTES RECEIVABLE
1.Journal entries:
2008
May 15Accounts Receivable, C. Brown5,000
Sales Revenue
5,000
To record sale on credit; terms net 30.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Accounts Receivable,
Sales Revenue5,000
C. Brown5,000
Aug. 10Allowance for Doubtful Accounts5,000
Accounts ReceivableC. Brown
5,000
To write off uncollectible account.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance
for Doubtful
Accounts5,000
Accounts
Receivable
C. Brown(5,000)
Dec. 1Accounts ReceivableC. Brown5,000
Allowance for Doubtful Accounts
5,000
To restore account previously written off.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Accounts
Receivable
C. Brown5,000
Allowance
for Doubtful
Accounts(5,000)PROBLEM 7-8 (Concluded)
Dec. 1Cash1,000
Notes Receivable4,000
Accounts ReceivableC. Brown
5,000
To record partial collection on open account
and receipt of two-month 9% note for the balance.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
1,000
Notes
Receivable4,000
Accounts
Receivable
C. Brown(5,000)
Dec. 31Interest Receivable30
Interest Revenue
30
To accrue interest earned:
$4,000 9% 1/12.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Interest Receivable30
Interest Revenue30
2009
Jan. 31Cash4,060
Interest Receivable
30
Interest Revenue
30
Notes Receivable
4,000
To record collection of note and interest.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
4,060
Interest Revenue30
Interest
Receivable(30)Notes
Receivable(4,000)
2.Brown is interested in reestablishing a good credit standing with its supplier, Linus, and for this reason has sent the check and signed a note for the balance.alternate problemsLO 1PROBLEM 7-1A ALLOWANCE METHOD FOR ACCOUNTING FOR BAD DEBTS
1.Accounts Receivable630,000
Cash
157,500
Sales Revenue
787,500
To record sales for year: $787,500 80% = $630,000
credit sales.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Accounts
Sales Revenue787,500
Receivable630,000Cash
157,500
Cash
502,500
Accounts Receivable
502,500
To record collection of customer accounts.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
502,500
Accounts
Receivable(502,500)
Allowance for Doubtful Accounts3,000
Accounts Receivable
3,000
To record write-off of accounts receivable.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance
for Doubtful
Accounts3,000
Accounts
Receivable(3,000)PROBLEM 7-1A (Continued)2.a.Bad Debt Expense18,900
Allowance for Doubtful Accounts
18,900
To record estimated bad debt expense.
$630,000 X 3%.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance
Bad Debt
for Doubtful
Expense(18,900)
Accounts(18,900)
2.b.Bad Debt Expense14,820
Allowance for Doubtful Accounts
14,820
To record estimated bad debt expense:
Accounts receivable at Dec. 31, 2008
($105,000 + $630,000 $502,500 $3,000) =$229,500
0.06
Allowance balance needed$13,770 (cr)
Balance before adjustment:
Beginning balance$1,950 (cr)
Write-off
3,000 (dr)
1,050 (dr)
Amount of entry must be$14,820 (cr)
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance
Bad Debt
for Doubtful
Expense(14,820)
Accounts(14,820)
3.a.The net realizable value of accounts receivable on December 31, 2008, is $211,650.
Accounts receivable, Dec. 31 (from Part 2.b.)
$229,500
Less: allowance for doubtful accounts, Dec. 31
($1,950 $3,000 + $18,900)
17,850
Net realizable value, December 31
$211,6503.b.The net realizable value of accounts receivable on December 31, 2008, is $215,730.
Accounts receivable, Dec. 31 (from Part 2.b.)
$229,500
Less: allowance for doubtful accounts, Dec. 31
($1,950 $3,000 + $14,820)
13,770
Net realizable value, December 31
$215,730
PROBLEM 7-1A (Concluded)
4.The recognition of bad debt expense reduces the net realizable value by the amount recorded in bad debt expense and the allowance for doubtful accounts. The write-off of accounts has no effect on the net realizable value.
LO 1PROBLEM 7-2A AGING SCHEDULE TO ACCOUNT FOR BAD DEBTS
1.
EstimatedEstimated
PercentAmount
CategoryAmountUncollectibleUncollectible
Current$200,00010%$20,000
Past due:
Less than one month60,30025%15,075
One to two months35,00035%12,250
Over two months
45,00075%
33,750
Totals$340,300
$81,075
2.The controller is primarily responsible for the accuracy of the records, rather than the collection process. Thus, the controllers main concern should be with the adequacy of the balance in the allowance account. The amount of the allowance should probably be increased, given the relatively large amount which is likely to be uncollectible.
3.Partial balance sheet at December 31, 2008:
Current Assets
Accounts receivable$340,300
Less: Allowance for doubtful accounts
81,075
Net accounts receivable
$259,225
LO 2PROBLEM 7-3A ACCOUNTS RECEIVABLE TURNOVER FOR BEST BUY AND CIRCUIT CITY
1.Accounts receivable turnover ratios:
Best Buy Co. Inc.:
$35,934/[($548 + $449)/2] = $35,934/$498.5 = 72.08 times
Circuit City Stores, Inc.:
$12,429,754/[($382,555 + $220,869)/2] = $12,429,754/$301,712 = 41.20 times
PROBLEM 7-3A (Concluded)
2.Average collection period:
Best Buy:
360/72.08 = 4.99 days
Circuit City:
360/41.20 = 8.74 days
Average collection periods of either 5 days or 9 days appear very reasonable considering the nature of the business.
3.Best Buys accounts receivable turnover ratio is higher than Circuit Citys: 72.08 versus 41.20. However, it would be helpful to measure these statisticsaccounts receivable turnover ratio and average collection periodwith the same measures for prior years. It would also be helpful to compare these measures with the industry averages.
LO 4PROBLEM 7-4A CREDIT CARD SALES
1.Cost of credit card operation per outlet:
Equipment/phone line
$800
Sales fee:
Credit sales: $800,000 5%$40,000
Fee0.015
600
Total cost
$1,400
Conclusion: To cover the cost of the new equipment in the first year, new sales would need to net $1,400 per outlet.
2.The company should also consider competition in its decision on the use of credit cards. It may in fact suffer a loss of sales if its competitors start offering credit to customers and it does not. The company may find that customer goodwill is increased by the offer to use a credit card.
LO 5PROBLEM 7-5A INVESTMENTS IN BONDS AND STOCK
2008
July 1Investment in Maine Bonds10,000
Cash
10,000
To record purchase of 8% Maine bonds.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
Maine Bonds10,000
Cash
(10,000)PROBLEM 7-5A (Continued)
Oct. 23Investment in Virginia Stock15,000
Cash
15,000
To record purchase of 1,000 shares
of common stock at $15 per share.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
Virginia Stock15,000
Cash
(15,000)
Nov. 21Investment in Carolina Stock4,800
Cash
4,800
To record purchase of 600 shares of
preferred stock at $8 per share.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
Carolina Stock4,800Cash
(4,800)
Dec. 10Cash1,100
Dividend Income
1,100
To record receipt of dividends:
Virginia1,000 $0.50 =$500
Carolina600 $1.00 =
600
$1,100
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
1,100
Dividend Income1,100
Dec. 28Cash13,300*
Investment in Virginia Stock
10,500**
Gain on Sale of Stock
2,800
To record sale of 700 shares of Virginia
stock.
*700 $19
**700 $15
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
13,300
Gain on SaleInvestment in
of Stock2,800
Virginia Stock(10,500)
PROBLEM 7-5A (Concluded)
Dec. 31Cash400*
Interest Income
400
To record receipt of interest on bonds.
*$10,000 8% 1/2 year
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
400
Interest Income400
LO 5PROBLEM 7-6A INVESTMENTS IN STOCK
2008
Jan. 15Investment in IBM Stock13,250
Cash
13,250
To record purchase of 100 shares of
stock at $130 per share, plus $250 in
commissions.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
IBM Stock13,250
Cash
(13,250)
May 23Cash100
Dividend Income
100
To record receipt of dividends of $1 per
share on 100 shares of IBM stock.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
100
Dividend Income100
June 1Investment in GM Stock12,300
Cash
12,300
To record purchase of 200 shares of
stock at $60 per share, plus $300 in
commissions.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Investment in
GM Stock12,300
Cash
(12,300)PROBLEM 7-6A (Concluded)
Oct. 20Cash13,600
Investment in IBM Stock
13,250
Gain on Sale of Stock
350
To record sale of IBM stock:
(100 shares $140) $400.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
13,600
Gain on SaleInvestment in
of Stock350
IBM Stock(13,250)
Dec. 15Dividends Receivable150
Dividend Income
150
To record notification of the declaration
of $0.75 per share dividend on 200 shares
of GM stock.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Dividends
Dividend Income150
Receivable150
LO 6PROBLEM 7-7A EFFECTS OF CHANGES IN RECEIVABLE BALANCES ON STATEMENT OF CASH FLOWS
1.Statement of cash flows:
ST. CHARLES ANTIQUE MARKET
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2008
Net loss
$(6,000)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Decrease in accounts receivable
47,000*
Increase in notes receivable
(7,800)**
Cash flows from operating activities
$33,200
Cash, December 31, 2007
3,100
Cash, December 31, 2008
$36,300
*$126,000 $79,000
**$104,800 $112,600PROBLEM 7-7A (Concluded)
2.Memorandum to the president:
TO:Owner of St. Charles Antique Market
FROM:Students name
DATE:January XX, 2009
SUBJECT:Cash Flows
You recently questioned the increase in the companys cash balance in light of this years net loss. My thoughts and a copy of the companys 2008 statement of cash flows follow.
St. Charles Antique Market was able to generate a significant amount of cash from operations even though the company incurred an accrual basis net loss during 2008 of $6,000. Most importantly, the amount of accounts receivable decreased by $47,000 during the year from $126,000 to $79,000; collections of accounts receivable generated cash for the company. This cash flow was partially offset by a $7,800 increase in notes receivable during the year, from $104,800 to $112,600.
ALTERNATE MULTICONCEPT PROBLEMLO 1,3PROBLEM 7-8A ACCOUNTS AND NOTES RECEIVABLE
1.Journal entries:
2008
July 31Accounts ReceivableP.D. Cat6,000
Sales Revenue
6,000
To record sale on credit; terms net 30.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Accounts
Sales Revenue6,000
Receivable
P.D. Cat6,000
Dec. 24Allowance for Doubtful Accounts6,000
Accounts ReceivableP.D. Cat
6,000
To write off uncollectible account.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Allowance for
Doubtful
Accounts6,000
Accounts
Receivable
P.D. Cat(6,000)
2009
Jan. 15Accounts ReceivableP.D. Cat6,000
Allowance for Doubtful Accounts
6,000
To restore account previously written off.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Accounts
Receivable
P.D. Cat6,000Allowance
for Doubtful
Accounts(6,000)PROBLEM 7-8A (Concluded)
Jan. 15Cash1,500
Notes Receivable4,500
Accounts ReceivableP.D. Cat
6,000
To record partial collection on open
account and receipt of two-month 8%
note for the balance.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
1,500
Notes
Receivable4,500
Accounts
Receivable
P.D. Cat(6,000)
Mar. 15Cash4,560
Interest Revenue
60
Notes Receivable
4,500
To record collection of note and interest:
$4,500 8% 2/12.
Balance Sheet
Income Statement
Assets=Liabilities+Stockholders Equity+ Revenues Expenses
Cash
4,560
Interest Revenue60
Notes
Receivable(4,500)
2.P.D. Cat is interested in reestablishing a good credit standing with its supplier, Tweety, and for this reason has sent the check and signed a note for the balance.
decision CASESREADING AND INTERPRETING FINANCIAL STATEMENTS
LO 1DECISION CASE 7-1 READING APPLES BALANCE SHEET AND NOTES TO THE STATEMENTS
1.
The balance in the Allowance for Doubtful Accounts is $52 million at the end of 2006 and $46 million at the end of 2005.
2.The net realizable value of accounts receivable at the end of 2006 was $1,252 million, and at the end of 2005, $895 million.
3.The amount of bad debts expense is represented by the line on the table titled Charged to costs and expenses. This amount is $17 million for 2006 and $8 million for 2005.
4.The amount of accounts receivable written off is represented by the line on the table titled Deductions. This amount is $11 million for 2006 and $9 million for 2005.
5.The increase in the amounts of accounts written off in the last two years could be due to a number of factors. The company may have loosened its credit policies and thus is experiencing more bad debts than in the past. The reduction may also be the result of changes in the economy that have resulted in more companies unable to pay amounts due to suppliers of credit. It is worth noting that there has also been an increase in the amounts charged to costs and expenses in the last two years. Increases in bad debts may be partially a result of increased sales by Apple.LO 1,6DECISION CASE 7-2 Reading Apple Computers Statement of Cash Flows
1.
Apple spent $7,255 million to purchase short-term investments in 2006. This was $4,215 million less than Apple spent on investments in 2005 but $3,985 million more than was spent in 2004.
2.Apple received $7,226 million from investments that matured in 2006. This was $1,383 million less than it received in 2005 and $6,085 more than in 2004.
3.Bonds mature, but stocks have no maturity date. Therefore, if a company holds bonds until their maturity date, they will receive proceeds on that date. Bonds can be sold on a date before they mature as well. Because stocks do not have a maturity date, any proceeds are received on the date they are sold.LO 3DECISION CASE 7-3 COMPARING TWO COMPANIES IN THE SAME INDUSTRY: KELLOGGS AND GENERAL MILLS
1.
Accounts receivable turnover ratios:
Kelloggs:
$10,906.7/[($944.8 + $879.1)/2] = $10,906.7/$911.95 = 11.96 times
General Mills:
$11,640/[($1,076 + $1,034)/2] = $11,640/$1,055 = 11.03 times
2.Average collection period:
Kelloggs:
360/11.96 = 30.10 days
Circuit City:
360/11.03 = 32.64 days
Average collection periods of approximately one month appear reasonable considering the nature of the business.
3.Kelloggs accounts receivable turnover ratio is slightly higher than General Millss: 11.96 versus 11.03. However, it would be helpful to measure these statisticsaccounts receivable turnover ratio and average collection periodwith the same measures for prior years. It would also be helpful to compare these measures with the industry averages. MAKING FINANCIAL DECISIONS
LO 1,5DECISION CASE 7-4 LIQUIDITY
TO:The President of FNB of Verona HeightsFROM:Joe Smith, Loan OfficerDATE:X/X/XXSUBJECT:Loan proposals
I have reviewed the loan proposals recently submitted by Oak and Maple and would like to summarize for you my findings. Because of limited resources available for short-term loans, my recommendation is that we make a six-month $10 million loan to Maple only.
The total current asset positions of the two companies are identical. Each has $33 million in current assets. However, the composition of the current assets differs considerably between the two companies. On the surface, Oak may appear to be stronger because it has twice the amount of cash on hand that Maple does. However, cash is essentially a non-earning asset, and I am skeptical as to why Oak feels it necessary to maintain that much cash on hand, and consequently, why it feels as if it needs to borrow an additional $10 million.
The accounts receivable for Maple is significantly larger than that for Oak. Assuming that the estimates of bad debts are reasonably reliable, Oak has a bigger problem with uncollectibles than does Maple. Oak has an allowance that is 1/15, or 6.67% of accounts receivable, while Maples percentage is only 1/23, or 4.35%.
In summary, I believe that Maple is a better candidate at the present time for a loan. I recommend that we make a six-month $10 million loan to Maple at the current market rate of interest. Please call if you need any further details in connection with these two loan requests.
ETHICAL DECISION MAKING
LO 4DECISION CASE 7-5 NOTES RECEIVABLE
1.The entry to record the sale of the property violates two principles: the revenue recognition principle and the historical cost principle. Revenue is recognized at the appropriate time, when a sale takes place, but for the wrong amount. The fair value of the property, $7.5 million, should be used as a measure of the amount of revenue to be recognized, rather than the face value of the note.
2.TO:Vice-president
FROM:Students name
DATE:12/31/XX
SUBJECT:Land sale
This is in response to your suggestion about the proper accounting for the recent sale of our 100-acre tract for the new shopping center. I have considered your recommendation that we recognize revenue in the amount of $10 million, which is equivalent to the $2 million installments on the note over each of the next five years.
Please understand my interest in maximizing profits to our shareholders whenever possible. The suggested treatment for this sale, however, is a clear violation of generally accepted accounting principles. The reason for the violation is straightforward: $10 million is not the value of the asset we sacrificed in exchange for the five-year note. The property was recently appraised at a fair market value of $7.5 million. The difference between the $10 million in face value of the note and the $7.5 million fair value of the property represents the interest we will earn over the next five years as we collect on the note. We will, in fact, recognize this difference of $2.5 million as income, but only over the life of the note, and as interest income rather than sales revenue. For now the amount of revenue we should recognize is $7.5 million.
Please call me at any time if you would like to discuss this matter further.
REAL WORLD PRACTICE 7.1
According to Apples balance sheet, accounts receivable increased by $1,252 $895 or $357 million during 2006. Accounts receivable make up $1,252/$14.509, or 8.63%, of the total current assets at the end of 2006.
REAL WORLD PRACTICE 7.2
The amount of accounts receivable before deducting the balance in the allowance account is $1,252 + $52 or $1,304 million at the end of 2006. This amount at the end of 2005 is $895 + $46, or $941 million. The gross amount of accounts receivable increased during 2006 by $1,304 $941, or $363 million. The allowance account increased during 2006 by $52 $46, or $6 million. Changes in the allowance during the year are a result of adding additional amounts to it for the estimated bad debts and removing from the account write offs of customers accounts.
7-1