2100 Solutions - CH8

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)


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


18,000

Cash

18,000

Accounts Receivable


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


(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


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


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


8,200

(b)Dec. 31Bad Debts Expense

7,500


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


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


9,400

($8,400 + $1,000)

2005

May 11Allowance for Doubtful Accounts

900

Accounts ReceivableWorthy

900

June 12Accounts ReceivableWorthy

900


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



2001



(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


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


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


4,000

Cash

4,000

Accounts Receivable

4,000

(d)Bad Debt Expense

19,000


19,000


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


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


25,100

($15,100 + $10,000)

(c)Allowance for Doubtful Accounts

5,000

Accounts Receivable

5,000

(d)Accounts Receivable

5,000


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)


18,610


18,610

($38,610 $20,000)

(b)

2005

1.Mar.31Allowance for Doubtful Accounts

800

Accounts Receivable

800

2.May31Accounts Receivable

800


800

31Cash

800

Accounts Receivable

800

(c)2005


6,390


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


360

30

Cash ($11,000 + $293)

11,293

Notes Receivable

11,000


293May 25

Notes Receivable

6,000

Accounts ReceivableAvery Inc.

6,000Aug.18

Cash ($8,000 + $200)

8,200

Notes Receivable

8,000


200

25Accounts ReceivableAvery Inc.

6,120

($6,000 + $120)

Notes Receivable

6,000


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


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


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)


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


6,900.00

Sales

6,900.00

12Cash ($750 $15)

735.00


15.00

Sales

750.00

21Cash ($1,500 $30)

1,470.00


30.00

Sales

1,500.00


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


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.


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


3,000

Cash

3,000

Accounts Receivable

3,000

(d)Bad Debt Expense

11,000


11,000


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


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


6,000

[$21,000 - $15,000]

(c) Allowance for Doubtful Accounts

2,000

Accounts Receivable

2,000

(d) Accounts Receivable

1,000


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)


16,660


16,660

($35,660 $19,000)

(b)2005

1.Mar.1Allowance for Doubtful Accounts

800

Accounts Receivable

800

2.May1Accounts Receivable

800


800

1Cash

800

Accounts Receivable

800

(c)2005


4,340


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


78


June2Cash ($6,000 + $80)

6,120

Notes Receivable

6,000


120

July

5Accounts ReceivableMathias Co.

($5,000 + $88)

5,088

Notes Receivable

5,000


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


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


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


(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


75,000(d)Receivables Turnover:

The average collection period is:

(a)Nov. 1Notes Receivable

20,000

Accounts Receivable

20,000


($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


7,800.00

Sales

7,800.00

14Cash ($700 $21)

679.00


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


37.50

Interest Revenue

($9,000 X 5% X 1/12)

37.50


(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)



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


(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)



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


= 13.7 times= 11.7 times


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.

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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

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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

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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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