Porter Chapter 7 solns

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


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




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


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




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


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


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


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


16,680


2% $834,000.

Balance Sheet

Income Statement


Allowance for

Bad Debts

Doubtful

Expense(16,680)

Accounts(16,680)

b.Based on 6% of year-end accounts receivable:

2008



16,606


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


Allowance for

Bad Debts

Doubtful

Expense(16,606)

Accounts(16,606)

2.a.No change.

b.2008



21,806


Need balance of 6% of $320,100$19,206 (cr)

Balance before adjustment is

(2,600) (dr)


Balance Sheet

Income Statement


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


Cash

45,000


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


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


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


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


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


Allowance for

Doubtful

Accounts4,000

Accounts

Receivable(4,000)PROBLEM 7-1 (Continued)2.a.Bad Debt Expense25,200


25,200

To record estimated bad debt expense:

$840,000 3%.

Balance Sheet

Income Statement


Allowance for

Bad Debt

Doubtful

Expense(25,200)

Accounts(25,200)

2.b.Bad Debt Expense20,010


20,010


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


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:


$306,000

Less: Allowance for doubtful accounts, Dec. 31

($2,350 $4,000 + $20,010)

18,360


$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



22,700


$35,000 less $12,300 currently in

allowance account.

Balance Sheet

Income Statement


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


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


Investment

in Eagle

Rock Stock12,000

Cash

(12,000)

Nov. 21Investment in Montana Stock6,000

Cash

6,000


preferred stock at $30 per share.

Balance Sheet

Income Statement


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


Cash

1,300


Dec. 28Cash10,000*

Investment in Eagle Rock Stock

8,000**


2,000

To record sale of 400 shares of Eagle

Rock stock.

*$400 $25

**$400 $20

Balance Sheet

Income Statement


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


Cash

300

Interest Income300

LO 5PROBLEM 7-6 INVESTMENTS IN STOCK

2008

Jan. 15Investment in Sears Stock10,500

Cash

10,500


stock at $50 per share, plus $500 in

commissions.

Balance Sheet

Income Statement


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


Cash

400

Dividend Income400

June 1Investment in Ford Stock7,700

Cash

7,700



commissions.

Balance Sheet

Income Statement


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


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


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


$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


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


Allowance

for Doubtful

Accounts5,000

Accounts

Receivable

C. Brown(5,000)

Dec. 1Accounts ReceivableC. Brown5,000


5,000

To restore account previously written off.

Balance Sheet

Income Statement


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


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


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


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


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


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


Allowance

for Doubtful

Accounts3,000

Accounts

Receivable(3,000)PROBLEM 7-1A (Continued)2.a.Bad Debt Expense18,900


18,900

To record estimated bad debt expense.

$630,000 X 3%.

Balance Sheet

Income Statement


Allowance

Bad Debt

for Doubtful

Expense(18,900)

Accounts(18,900)

2.b.Bad Debt Expense14,820


14,820


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)


Balance Sheet

Income Statement


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.


$229,500

Less: allowance for doubtful accounts, Dec. 31

($1,950 $3,000 + $18,900)

17,850


$211,6503.b.The net realizable value of accounts receivable on December 31, 2008, is $215,730.


$229,500

Less: allowance for doubtful accounts, Dec. 31

($1,950 $3,000 + $14,820)

13,770


$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



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


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


Investment in

Virginia Stock15,000

Cash

(15,000)

Nov. 21Investment in Carolina Stock4,800

Cash

4,800


preferred stock at $8 per share.

Balance Sheet

Income Statement


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


Cash

1,100


Dec. 28Cash13,300*

Investment in Virginia Stock

10,500**


2,800

To record sale of 700 shares of Virginia

stock.

*700 $19

**700 $15

Balance Sheet

Income Statement


Cash

13,300


of Stock2,800

Virginia Stock(10,500)


Dec. 31Cash400*

Interest Income

400

To record receipt of interest on bonds.

*$10,000 8% 1/2 year

Balance Sheet

Income Statement


Cash

400

Interest Income400

LO 5PROBLEM 7-6A INVESTMENTS IN STOCK

2008

Jan. 15Investment in IBM Stock13,250

Cash

13,250



commissions.

Balance Sheet

Income Statement


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


Cash

100

Dividend Income100

June 1Investment in GM Stock12,300

Cash

12,300



commissions.

Balance Sheet

Income Statement


Investment in

GM Stock12,300

Cash

(12,300)PROBLEM 7-6A (Concluded)

Oct. 20Cash13,600

Investment in IBM Stock

13,250


350

To record sale of IBM stock:

(100 shares $140) $400.

Balance Sheet

Income Statement


Cash

13,600


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


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


3,100


$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


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


Allowance for

Doubtful

Accounts6,000

Accounts

Receivable

P.D. Cat(6,000)

2009

Jan. 15Accounts ReceivableP.D. Cat6,000


6,000

To restore account previously written off.

Balance Sheet

Income Statement


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


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


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


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

Porter Chapter 7 solns

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