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Chapter 7 Accounts and Notes Receivable QUESTIONS 1. When customers use credit cards, the selling companies can avoid having to directly evaluate the credit standing of their customers. They also avoid the risk of bad debts and often are paid cash from the credit card company more quickly than if customers were granted credit directly. Moreover, they hope to increase sales, and net income, from the added convenience to buyers. 2. Revenues and expenses usually are not matched under the direct write-off method because the revenues recorded from the uncollectible accounts often appear on the income statement of one period while the bad debts expenses of those revenues appear on the income statement of a later period when the account(s) is known to be uncollectible. 3. The accounting constraint of materiality suggests that the requirements of accounting standards can be ignored if their effect on the financial statements is unimportant to their users’ business decisions. 4. Writing off a bad debt against the Allowance account does not reduce the estimated realizable value of a company’s accounts receivable because the write-off reduces the balances of both Accounts Receivable and the Allowance for Doubtful Accounts by equal amounts. This means the difference between them (called estimated realizable value) remains the same. 5. The adjusted balances of Bad Debts Expense and Allowance for Doubtful Accounts are virtually never equal because the expense amount reflects only the events of the current period, and the allowance is the accumulated result of events over a number of prior periods. The only way that they could be equal would be if write-offs during the prior period exactly equaled the beginning balance of the Allowance account. 6. Creditors prefer notes receivable to accounts receivable because the notes can be more easily converted into cash before they are due by discounting (or selling) them to a financial institution. Also, a note represents a clear written acknowledgment by the debtor of both the debt and its amount and terms. 7. Best Buy does not mention uncollectible accounts in its notes to its financial statements, and does not list its receivables as “net” of any allowance for uncollectibles, probably because uncollectible accounts are immaterial. 8. Circuit City uses the allowance method to account for doubtful accounts as evidenced by the receivables being reduced by an allowance on the balance sheet. The realizable value of accounts receivable as of February 28, 2007, is its net amount of $382,555,000. 9. Apple’s gross accounts receivable at September 30, 2006 are ($ millions) $1,252 + $52 = $1,304. Apple believes that the percent of accounts receivable that are uncollectible is $52/$1,304 = 4.0% (rounded) ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 391 QUICK STUDIES Quick Study 7-1 (15 minutes) 1. Cash ............................................................................... 15,360 Credit Card Expense* ................................................... 640 Sales......................................................................... 16,000 To record credit card sales less fees. *$16,000 x 4% Cost of Goods Sold ...................................................... 7,000 Merchandise Inventory ........................................... 7,000 To record cost of sales. 2. Accounts Receivable—Credit Card Cos..................... 17,460 Credit Card Expense* ................................................... 540 Sales......................................................................... 18,000 To record credit card sales less fees. *$18,000 x 3% Cost of Goods Sold ...................................................... 7,800 Merchandise Inventory ........................................... 7,800 To record cost of sales. 5 days later Cash ............................................................................... 17,460 Accounts Receivable—Credit Card Cos............... 17,460 To record cash receipts. Quick Study 7-2 (15 minutes) 1. Oct. 31 Allowance for Doubtful Accounts ........................... Accounts Receivable—D. Elwick ...................... 750 750 To write off account. 2. Dec. 9 Accounts Receivable—D. Elwick* ........................... Allowance for Doubtful Accounts ..................... 400 400 To reinstate a written-off account. *If there is a strong belief that the remaining $350 will be collected soon, then the full $750 balance can be reinstated. 9 Cash ........................................................................... Accounts Receivable—D. Elwick ...................... 400 400 To record payment on a receivable. ©McGraw-Hill Companies, 2009 392 Financial and Managerial Accounting, 3rd Edition Quick Study 7-3 (15 minutes) 1. Dec. 31 Bad Debts Expense ................................................ Allowance for Doubtful Accounts................... 875 875 To record estimate of uncollectibles. Desired balance in allowance = $95,000 x 1.5%= $1,425 cr. Adjustment required = $1,425 cr. - $550 cr. = $875 2. Desired balance in allowance = $1,425 (part 1) Adjustment required = $1,425 cr. + $150 dr. = $1,575 Quick Study 7-4 (10 minutes) Dec. 31 Bad Debts Expense ................................................ 1,750 Allowance for Doubtful Accounts................... 1,750 To record estimate of uncollectibles ($350,000 x 0.5%). Quick Study 7-5 (15 minutes) Aug. 2 Notes Receivable—D. Kissick .......................... Accounts Receivable—D. Kissick ............. 9,000 9,000 To record receipt of note on account. Oct. 31 Maturity date Cash .................................................................... Notes Receivable—D. Kissick ................... Interest Revenue ......................................... 9,135 9,000 135 To record cash received on note plus interest ($9,000 x 6% x 90/360). ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 393 Quick Study 7-6 (15 minutes) Dec. 31 Interest Receivable ............................................ Interest Revenue ......................................... 120 120 To record the year-end adjustment for interest earned ($24,000 x 6% x 30/360). Jan. 15 Maturity date Cash .................................................................... Interest Receivable ..................................... Interest Revenue* ........................................ Notes Receivable ........................................ 24,180 120 60 24,000 To record cash received on note plus interest. * $24,000 x 6% x 15/360 Quick Study 7-7 (10 minutes) Accounts receivable turnover = Net sales Average accounts receivable $910,600 ($138,500 + $153,400) / 2 = 6.2 times Interpretation: An accounts receivable turnover of 6.2 implies that the company’s average accounts receivable balance is converted into cash 6.2 times per year. The 6.2 turnover is about 17% lower than the average turnover of 7.5 for its competitors. The company needs to identify the cause of this poor performance and rectify the situation to at least compete at the average level. ©McGraw-Hill Companies, 2009 394 Financial and Managerial Accounting, 3rd Edition EXERCISES Exercise 7-1 (20 minutes) Apr. 8 Cash ........................................................................ 5,376 Credit Card Expense* ............................................ 224 Sales ................................................................. 5,600 To record credit card sales less 4% fee. *($5,600 x .04) 8 Cost of Goods Sold ...................................................... 4,138 Merchandise Inventory .......................................... 4,138 To record cost of sales. 12 Accounts Receivable—Continental ..................... 5,850 Credit Card Expense*............................................ 150 Sales ................................................................. 6,000 To record credit card sales less 2.5% fee. *($6,000 x .025) 12 Cost of Goods Sold ...................................................... 4,400 Merchandise Inventory .......................................... 4,400 To record cost of sales. 20 Cash ........................................................................ 5,850 Accounts Receivable—Continental ................ 5,850 To record cash received on credit sales less fees. Exercise 7-2 (25 minutes) Part 1 GENERAL LEDGER Accounts Receivable Nov. 5 5,817 Nov. 21 268 10 1,774 13 1,040 30 3,698 Bal. 12,061 Sales Nov. 5 10 13 30 5,817 1,774 1,040 3,698 Sales Returns and Allowances Nov. 21 268 ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 395 Exercise 7-2 (concluded) Part 1—continued ACCOUNTS RECEIVABLE LEDGER Nov. 5 30 Bal. Ski Shop 5,817 3,698 9,515 Welcome Enterprises Nov. 10 1,774 Kit Ronin Nov. 13 1,040 Nov. 21 Bal. 268 772 Part 2 Beachum Company Schedule of Accounts Receivable November 30, 2009 Ski Shop ................................................................................. $ 9,515 Welcome Enterprises ........................................................... 1,774 Kit Ronin ................................................................................ 772 Total ........................................................................................ $12,061 Comparison: The total of the Schedule of Accounts Receivable ($12,061) is proved with the balance of the Accounts Receivable controlling T-account from Part 1 ($12,061). Exercise 7-3 (20 minutes) Dec. 31 Bad Debts Expense ..................................................... 5,148 Allowance for Doubtful Accounts........................ 5,148 To record estimated bad debts expense (.006 x $858,000). Feb. 1 Allowance for Doubtful Accounts.............................. Accounts Receivable—D. Fidel............................ 429 429 To write off an account. June 5 Accounts Receivable—D. Fidel.................................. Allowance for Doubtful Accounts ........................ 429 429 To reinstate an account. June 5 Cash .............................................................................. Accounts Receivable—D. Fidel............................ 429 429 To record cash received on account. ©McGraw-Hill Companies, 2009 396 Financial and Managerial Accounting, 3rd Edition Exercise 7-4 (15 minutes) a. Dec. 31 Bad Debts Expense* ..................................................... 419 Allowance for Doubtful Accounts........................ 419 To record estimated bad debts expense. * Unadjusted balance Estimated balance ($139,500 x .02) Required adjustment = $2,371 = 2,790 = $ 419 credit credit credit b. Dec. 31 Bad Debts Expense** ....................................................3,277 Allowance for Doubtful Accounts........................ 3,277 To record estimated bad debts expense. ** Unadjusted balance Estimated balance ($139,500 x .02) Required adjustment = $ 487 = 2,790 = $3,277 debit credit credit ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 397 Exercise 7-5 (30 minutes) a. Computation of the estimated balance of the allowance for uncollectibles: Not due: 1 to 30: 31 to 60: 61 to 90: Over 90: $66,000 x 0.01 = 15,000 x 0.02 = 6,000 x 0.04 = 3,000 x 0.07 = 5,000 x 0.12 = $ 660 300 240 210 600 $2,010 credit b. Dec. 31 Bad Debts Expense.............................................. Allowance for Doubtful Accounts ................ 2,310 2,310 To record estimated bad debts.* * Unadjusted balance ........................... Estimated balance ............................. $ 300 debit 2,010 credit Required adjustment ......................... $2,310 credit c. Dec. 31 Bad Debts Expense.............................................. Allowance for Doubtful Accounts ................ 1,810 1,810 To record estimated bad debts.* * Unadjusted balance ........................... Estimated balance ............................. $ 200 credit 2,010 credit Required adjustment ......................... $1,810 credit ©McGraw-Hill Companies, 2009 398 Financial and Managerial Accounting, 3rd Edition Exercise 7-6 (25 minutes) a. Computation of the estimated balance of the allowance for uncollectibles: $95,000 x 0.02 = $1,900 credit b. Dec. 31 Bad Debts Expense.............................................. Allowance for Doubtful Accounts ................ 2,200 2,200 To record estimated bad debts.* * Unadjusted balance ........................... Estimated balance ............................. $ 300 debit 1,900 credit Required adjustment ......................... $2,200 credit c. Dec. 31 Bad Debts Expense.............................................. Allowance for Doubtful Accounts ................ To record estimated bad * 1,700 1,700 debts.* Unadjusted balance ........................... Estimated balance ............................. $ 200 credit 1,900 credit Required adjustment ......................... $1,700 credit Exercise 7-7 (20 minutes) Feb. 1 Allowance for Doubtful Accounts.............................. Accounts Receivable—Laguna Co ...................... Accounts Receivable—Malibu Co ....................... 950 200 750 To write off specific accounts. June 5 Accounts Receivable—Laguna .................................. Allowance for Doubtful Accounts ........................ 200 200 To reinstate an account. June 5 Cash .............................................................................. Accounts Receivable—Laguna ............................ 200 200 To record cash received on account. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 399 Exercise 7-8 (25 minutes) a. Expense is 2% of credit sales Dec. 31 Bad Debts Expense............................................... Allowance for Doubtful Accounts ................. 6,000 6,000 To record estimated bad debts [$300,000 x .02]. b. Expense is 1% of total sales Dec. 31 Bad Debts Expense............................................... Allowance for Doubtful Accounts ................. 7,000 7,000 To record estimated bad debts [($300,000 + $400,000) x .01]. c. Allowance is 8% of accounts receivable Dec. 31 Bad Debts Expense............................................... Allowance for Doubtful Accounts ................. To record estimated bad * 6,200 6,200 debts.* Unadjusted balance ........................................................ $1,000 debit. Estimated balance ($65,000 x 8%) ................................ 5,200 credit Required adjustment ...................................................... $6,200 credit ©McGraw-Hill Companies, 2009 400 Financial and Managerial Accounting, 3rd Edition Exercise 7-9 (20 minutes) July 4 Accounts Receivable ............................................ 7,160 Sales ................................................................. 7,160 To record sales on credit. 4 Cost of Goods Sold ...................................................... 4,582 Merchandise Inventory .......................................... 4,582 To record cost of sales. 9 Cash ....................................................................... 19,285 Factoring Fee Expense* ....................................... 1,015 Accounts Receivable ...................................... 20,300 To record sale of receivable. *($20,300 x .05) 17 Cash ....................................................................... 3,938 Accounts Receivable ...................................... 3,938 To record cash received on account. 27 Cash ....................................................................... 11,000 Notes Payable .................................................. 11,000 To record cash from a loan. Note to Financial Statements Accounts receivable in the amount of $14,700 are pledged as security for a $11,000 note payable to Main Bank. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 401 Exercise 7-10 (15 minutes) Nov. 1 Notes Receivable—C. Cruz ............................... Accounts Receivable—C. Cruz ................... 15,000 15,000 To record receipt of note on account. Dec. 31 Interest Receivable ............................................ Interest Revenue .......................................... 175 175 To record interest earned [$15,000 x .07 x 60/360]. Apr. 30 Cash .................................................................... Notes Receivable—C. Cruz ......................... Interest Revenue .......................................... Interest Receivable ...................................... 15,525 15,000 350 175 To record cash received on note plus interest earned [$15,000 x .07 x 120/360]. Exercise 7-11 (20 minutes) Mar. 21 Notes Receivable—J. Penn .................................. 17,200 Accounts Receivable—J. Penn ..................... 17,200 To record receipt of note on account. Sept. 17 Accounts Receivable—J. Penn ........................... 17,802 Interest Revenue ............................................. Notes Receivable—J. Penn ............................ 602 17,200 To record note dishonored plus interest earned [$17,200 x .07 x 180/360 = $602]. Dec. 31 Allowance for Doubtful Accounts ....................... 17,802 Accounts Receivable—J. Penn ..................... 17,802 To write off an account. ©McGraw-Hill Companies, 2009 402 Financial and Managerial Accounting, 3rd Edition Exercise 7-12 (25 minutes) 2008 Dec. 13 Notes Receivable—A. Sumera ............................. 14,000 Accounts Receivable—A. Sumera ................ 14,000 To record receipt of note on account. 31 Interest Receivable ............................................... Interest Revenue ............................................. 63 63 To record interest earned [$14,000 x .09 x 18/360]. 2009 Feb. 11 Cash ....................................................................... 14,210 Interest Revenue ............................................ Interest Receivable ......................................... Notes Receivable—A. Sumera ....................... 147 63 14,000 To record cash received on note plus interest. [$14,000 x .09 x (60-18)/360=$147] Mar. 3 Notes Receivable—Kudak Co. ............................. 10,000 Accounts Receivable—Kudak Co. ................ 10,000 To record receipt of note on account. 17 Notes Receivable—R. Burgess ............................ 9,000 Accounts Receivable—R. Burgess ............... 9,000 To record receipt of note on account. Apr. 16 Accounts Receivable—R. Burgess ..................... 9,060 Interest Revenue ............................................. Notes Receivable—R. Burgess ...................... 60 9,000 To record receivable for dishonored note plus interest [$9,000 x .08 x 30/360]. May 1 Allowance for Doubtful Accounts ....................... 9,060 Accounts Receivable—R. Burgess ............... 9,060 To write off account. June 1 Cash ....................................................................... 10,225 Interest Revenue ............................................. Notes Receivable—Kudak Co ........................ 225 10,000 To record cash received on note with interest [$10,000 x .09 x 90/360]. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 403 Exercise 7-13 (15 minutes) 2008 accounts receivable turnover: $193,000 ($37,200 + $40,500)/2 = 5.0 times 2009 accounts receivable turnover: $262,000 ($40,500 + $42,700)/2 = 6.3 times Analysis: Lucilla Company turned over its accounts receivable 1.3 (5.0 – 6.3) times more in 2009 than in 2008. This can indicate that the company has tightened its credit policy or has improved its collection efforts. However, relative to competitors’ turnover of 7, Lucilla is performing worse than average. ©McGraw-Hill Companies, 2009 404 Financial and Managerial Accounting, 3rd Edition PROBLEM SET A Problem 7-1A (30 minutes) June 4 Accounts Receivable—A. Bullaro ............................ Sales ..................................................................... 700 700 To record sales on credit. 4 Cost of Goods Sold ......................................................... 220 Merchandise Inventory ............................................. 220 To record cost of sales. 5 Cash ............................................................................ Credit card expense* ................................................. Sales ..................................................................... 8,106 294 8,400 To record credit card sales less fee. *($8,400 x .035) 5 Cost of Goods Sold .........................................................4,300 Merchandise Inventory ............................................. 4,300 To record cost of sales. 6 Accounts Receivable—Access ................................ Credit card expense* ................................................. Sales ..................................................................... 5,850 150 6,000 To record credit card sales less fee. *($6,000 x .025) 6 Cost of Goods Sold .........................................................3,680 Merchandise Inventory ............................................. 3,680 To record cost of sales. 8 Accounts Receivable—Access ................................ Credit card expense* ................................................. Sales ..................................................................... 4,368 112 4,480 To record credit card sales less fee. *($4,480 x .025) 8 Cost of Goods Sold .........................................................2,600 Merchandise Inventory ............................................. 2,600 To record cost of sales. 10 No journal entry required. 13 Allowance for Doubtful Accounts ............................ Accounts Receivable—T. Wanek ....................... 467 467 To write off account due. 17 Cash ............................................................................ 10,218 Accounts Receivable—Access .......................... 10,218 To record cash received from credit card co. ($5,850 + $4,368). 18 Cash ............................................................................ Sales Discounts* ....................................................... Accounts Receivable—A. Bullaro ...................... 686 14 700 To record cash received less discount. *($700 x .02) ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 405 Problem 7-2A (35 minutes) 2008 a. Accounts Receivable ......................................... 1,347,700 Sales .............................................................. 1,347,700 To record sales on account. Cost of Goods Sold ...................................................... 982,500 Merchandise Inventory .......................................... 982,500 To record cost of sales. b. Allowance for Doubtful Accounts..................... Accounts Receivable ................................... 20,676 20,676 To write off accounts. c. Cash ..................................................................... Accounts Receivable ................................... 671,100 671,100 To record cash received on account. d. Bad Debts Expense ............................................ Allowance for Doubtful Accounts .............. To record estimated bad * 29,203 29,203 debts.* Beginning receivables ...................... Credit sales ....................................... Collections ........................................ Write-offs ........................................... Ending receivables ........................... Percent uncollectible ........................ Required ending allowance.............. Unadjusted balance .......................... Adjustment to the allowance ........... $ 0 1,347,700 (671,100) (20,676) 655,924 x 1.3% 8,527** 20,676 $ 29,203 Cr. Dr. Cr. ** rounded to nearest dollar ©McGraw-Hill Companies, 2009 406 Financial and Managerial Accounting, 3rd Edition Problem 7-2A (Concluded) 2009 e. Accounts Receivable .............................................. 1,517,800 Sales ................................................................... 1,517,800 To record sales on account. Cost of Goods Sold ...................................................... 1,302,200 Merchandise Inventory .......................................... 1,302,200 To record cost of sales. f. Allowance for Doubtful Accounts ......................... Accounts Receivable ........................................ 32,624 32,624 To record write-off of accounts. g. Cash ......................................................................... 1,118,100 Accounts Receivable ........................................ 1,118,100 To record cash received on account. h. Bad Debts Expense................................................. Allowance for Doubtful Accounts ................... To record estimated bad * 37,396 37,396 debts.* Beginning receivables ............................ Credit sales.............................................. Collections............................................... Write-offs ................................................. Ending receivables ................................. Percent uncollectible .............................. Required ending allowance .................... Unadjusted balance Beginning (Cr.) ...................................... $ 8,527 Write-offs (Dr.) ....................................... 32,624 Adjustment to the allowance .................. $ 655,924 1,517,800 (1,118,100) (32,624) 1,023,000 x 1.3% 13,299 Cr. $ 24,097 37,396 Dr. Cr. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 407 Problem 7-3A (35 minutes) Part 1 a. Expense is 1.5% of credit sales Dec. 31 Bad Debts Expense............................................... 55,800 Allowance for Doubtful Accounts ................. 55,800 To record estimated bad debts [$3,720,000 x .015]. b. Expense is 1% of total sales Dec. 31 Bad Debts Expense............................................... 59,047 Allowance for Doubtful Accounts ................. 59,047 To record estimated bad debts [($2,184,700 + $3,720,000) x .01]. c. Allowance is 3% of accounts receivable Dec. 31 Bad Debts Expense............................................... 62,855 Allowance for Doubtful Accounts ................. 62,855 To record estimated bad debts.* * Unadjusted balance ........................................................ $29,030 debit Estimated balance ($1,127,500 x 3%) ........................... 33,825 credit Required adjustment ...................................................... $62,855 credit Part 2 Current assets Accounts receivable ...........................................$1,127,500 Less allowance for doubtful accounts ............. (26,770)* Or: Accounts receivable (net of $26,770* uncollectible accounts) ................................... $1,100,730 $1,100,730 * Adjustment to the allowance ...................................... $55,800 credit Unadjusted allowance balance .................................. 29,030 debit Adjusted balance ......................................................... $26,770 credit Part 3 Current assets Accounts receivable ...........................................$1,127,500 Less allowance for doubtful accts. ................... (33,825)** Or: Accounts receivable (net of $33,825** uncollectible accounts) ................................... $1,093,675 $1,093,675 ** See computations in Part 1c. ©McGraw-Hill Companies, 2009 408 Financial and Managerial Accounting, 3rd Edition Problem 7-4A (35 minutes) Part 1 Calculation of the estimated balance of the allowance for uncollectibles Not due: 1 to 30: 31 to 60: 61 to 90: Over 90: $784,000 x .0125 = 380,200 x .0200 = 81,800 x .0650 = 52,000 x .3275 = 13,000 x .6800 = $ 9,800 7,604 5,317 17,030 8,840 $48,591 credit Part 2 Dec. 31 Bad Debts Expense.............................................. 25,791 Allowance for Doubtful Accounts ................ To record estimated bad * 25,791 debts.* Unadjusted balance ........................... Estimated balance ............................. $22,800 credit 48,591 credit Required adjustment ......................... $25,791 credit Part 3 Writing off the account receivable in 2010 will not directly affect year 2010 net income. The entry to write off an account involves a debit to Allowance for Doubtful Accounts and a credit to Accounts Receivable, both of which are balance sheet accounts. Net income is affected only by the annual recognition of the estimated bad debts expense, which is journalized as an adjusting entry. Net income for Year 2009 (the year of the original sale) included an estimated expense for write-offs such as this one. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 409 Problem 7-5A (75 minutes) Part 1 2008 Dec. 16 Notes Receivable—A. Bakko.............................. 14,400 Accounts Receivable—A. Bakko ................. 14,400 To record note received on account. 31 Interest Receivable .............................................. Interest Revenue ........................................... 48 48 To record interest earned [$14,400 x .08 x 15/360 = $48]. 2009 Feb. 14 Cash ...................................................................... 14,592 Interest Revenue* .......................................... Interest Receivable........................................ Notes Receivable—A. Bakko........................ 144 48 14,400 To record cash received on note with interest. *[$14,400 x 0.08 x 45/360 = $144] Mar. 2 Notes Receivable—Mayday Co .......................... Accounts Receivable—Mayday Co.............. 8,000 8,000 To record note received on account. 17 Notes Receivable—C. Kadin .............................. Accounts Receivable—C. Kadin .................. 2,200 2,200 To record note received on account. Apr. 16 Accounts Receivable—C. Kadin ........................ Interest Revenue ........................................... Notes Receivable—C. Kadin ........................ 2,211 11 2,200 To record receivable for dishonored note plus interest [$2,200 x 0.06 x 30/360= $11]. June 2 Accounts Receivable—Mayday Co. .................. Interest Revenue* .......................................... Notes Receivable—Mayday Co .................... 8,180 180 8,000 To record receivable for dishonored note [$8,000 x 0.09 x 90/360 = $180]. ©McGraw-Hill Companies, 2009 410 Financial and Managerial Accounting, 3rd Edition Problem 7-5A (Concluded) July 17 Cash ...................................................................... Interest Revenue* .......................................... Accounts Receivable—Mayday Co.............. 8,274 94 8,180 To record cash received on account plus additional interest. *[$8,180 x .09 x 46/360= $94 (rounded)] Aug. 7 Notes Receivable—Trenton Co. ......................... Accounts Receivable—Trenton Co. ........... 8,400 8,400 To record note received on account. Sept. 3 Notes Receivable—C. Marin ............................... Accounts Receivable—C. Marin .................. 3,335 3,335 To record note received on account. Nov. 2 Cash ...................................................................... Interest Revenue* .......................................... Notes Receivable—C. Marin ......................... 3,385 50 3,335 To record cash received on note plus interest *($3,335 x 0.09 x 60/360 = $50) (rounded). 5 Cash ...................................................................... Interest Revenue* .......................................... Notes Receivable—Trenton Co. .................. 8,652 252 8,400 To record cash received on note plus Interest. *($8,400 x .12 x 90/360 = $252) Dec. 1 Allowance for Doubtful Accounts...................... Accounts Receivable—C. Kadin .................. 2,211 2,211 To record write-off of account. Part 2 Analysis Component: When a business pledges its receivables as security for a loan and the loan is still outstanding at period-end, the business must disclose this information in notes to its financial statements. This is a requirement because the business has committed a portion of its assets to cover a specific portion of its liabilities, which means that if the business dishonors its obligations under the loan, the creditor can claim the amount of receivables identified in the pledge as collateral to cover the loan. This arrangement must be disclosed to satisfy the full-disclosure principle. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 411 PROBLEM SET B Problem 7-1B (30 minutes) Aug. 4 Accounts Receivable—K. Carpen ........................... Sales..................................................................... 600 600 To record sales on credit. 10 11 14 15 18 22 25 Cost of Goods Sold ......................................................... 470 Merchandise Inventory .............................................. To record cost of sales. Cash ........................................................................... 5,978 Credit Card Expense* ............................................... 122 Sales..................................................................... To record credit card sales less fee. *($6,100 x .02) Cost of Goods Sold .........................................................5,100 Merchandise Inventory .............................................. To record cost of sales. Accounts Receivable—Aztec ................................... 7,128 Credit card expense* ................................................ 72 Sales..................................................................... To record credit card sales less fee. *($7,200 x .01) Cost of Goods Sold .........................................................6,150 Merchandise Inventory .............................................. To record cost of sales. Cash ........................................................................... 588 Sales Discounts* ....................................................... 12 Accounts Receivable—K. Carpen ..................... To record cash received less discount.*($600 x .02) Accounts Receivable—Aztec ................................... 4,851 Credit Card Expense*(rounded to nearest dollar) ..... 49 Sales...................................................................... To record credit card sales less fee. *($4,900 x .01) Cost of Goods Sold .........................................................3,500 Merchandise Inventory .............................................. To record cost of sales. No journal entry required. Allowance for Doubtful Accounts ........................... 568 Accounts Receivable—Rayvac Co. ................... To write off account due. Cash ........................................................................... 11,979 Accounts Receivable—Aztec ............................. To record cash rec’d from credit card co. ($7,128+$4,851) 470 6,100 5,100 7,200 6,150 600 4,900 3,500 568 11,979 ©McGraw-Hill Companies, 2009 412 Financial and Managerial Accounting, 3rd Edition Problem 7-2B (35 minutes) 2008 a. Accounts Receivable ......................................... 1,346,800 Sales .............................................................. 1,346,800 To record sales on account. Cost of Goods Sold ...................................................... 980,300 Merchandise Inventory .......................................... 980,300 To record cost of sales. b. Cash ..................................................................... Accounts Receivable ................................... 666,300 666,300 To record cash received on account. c. Allowance for Doubtful Accounts..................... Accounts Receivable ................................... 21,000 21,000 To record write-off of accounts. d. Bad Debts Expense ............................................ Allowance for Doubtful Accounts............... To record estimated bad 28,914 28,914 debts.* *Beginning receivables ..................... Credit sales ...................................... Collections ....................................... Write-offs .......................................... Ending receivables .......................... Percent uncollectible ....................... Required ending allowance ............. Unadjusted balance ......................... Adjustment to the allowance........... $ 0 1,346,800 (666,300) (21,000) 659,500 x 1.2% 7,914 21,000 $ 28,914 Cr. Dr. Cr. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 413 Problem 7-2B (Concluded) 2009 e. Accounts Receivable .......................................... 1,562,400 Sales ............................................................... 1,562,400 To record sales on account. Cost of Goods Sold ...................................................... 1,339,300 Merchandise Inventory .......................................... 1,339,300 To record cost of sales. f. Cash ...................................................................... 1,168,400 Accounts Receivable .................................... 1,168,400 To record cash received on account. g. Allowance for Doubtful Accounts...................... Accounts Receivable .................................... 30,400 30,400 To record write-off of accounts. h. Bad Debts Expense ............................................. Allowance for Doubtful Accounts................ To record estimated bad 34,763 34,763 debts.* *Beginning receivables ........................... $ 659,500 Credit sales ............................................ 1,562,400 Collections ............................................. (1,168,400) Write-offs ................................................ (30,400) Ending receivables ................................ 1,023,100 Percent uncollectible ............................. x 1.2% Required ending allowance ................... 12,277 Cr. Unadjusted balance Beginning (credit) ................................ $ 7,914 Write-offs (debit) .................................. 30,400 22,486 Dr. Adjustment to the allowance................. $ 34,763 Cr. ©McGraw-Hill Companies, 2009 414 Financial and Managerial Accounting, 3rd Edition Problem 7-3B (35 minutes) Part 1 a. Expense is 1.2% of credit sales Dec. 31 Bad Debts Expense.............................................. 35,112 Allowance for Doubtful Accounts ................ 35,112 To record estimated bad debts [$2,926,000 x .012]. b. Expense is 0.7% of total sales Dec. 31 Bad Debts Expense............................................ Allowance for Doubtful Accts. .................... 31,682 31,682 To record estimated bad debts [($1,600,000 + $2,926,000) x .007]. c. Allowance is 5% of accounts receivable Dec. 31 Bad Debts Expense.............................................. 42,000 Allowance for Doubtful Accounts ................ 42,000 To record estimated bad debts.* * Estimated balance ($886,000 x 5%) ....... Unadjusted balance ................................ $ 44,300 credit 2,300 credit Required adjustment .............................. $ 42,000 credit Part 2 Current assets Accounts receivable .................................... $886,000 Less allowance for doubtful accounts ...... (37,412)* Or: Accounts receivable (net of $37,412* uncollectible accounts) ............................ * Adjustment to the allowance .................... $ 35,112 Unadjusted allowance balance ................. 2,300 Adjusted balance ....................................... $ 37,412 $848,588 $848,588 credit credit credit Part 3 Current assets Accounts receivable .................................... $886,000 Less allowance for doubtful accounts ...... (44,300)** Or: Accounts receivable (net of $44,300** uncollectible accounts) ............ $841,700 $841,700 ** See computations in Part 1c. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 415 Problem 7-4B (35 minutes) Part 1 Calculation of the estimated balance of the allowance Not due: 1 to 30: 31 to 60: 61 to 90: Over 90: $616,000 x .0090 = $ 5,544 298,000 x .0165 = 4,917 64,000 x .0615 = 3,936 41,000 x .3100 = 12,710 9,200 x .6400 = 5,888 $32,995 Part 2 Dec. 31 Bad Debts Expense........................................... 35,795 Allowance for Doubtful Accounts ............. To record estimated bad * 35,795 debts.* Unadjusted balance .......................... $ 2,800 debit Estimated balance ............................. 32,995 credit Required adjustment ......................... $35,795 credit Part 3 Writing off the account receivable in 2010 will not directly affect Year 2010 net income. The entry to write off an account involves a debit to Allowance for Doubtful Accounts and a credit to Accounts Receivable, both of which are balance sheet accounts. Net income is affected only by the annual recognition of the estimated bad debts expense, which is journalized as an adjusting entry. Net income for Year 2009 (the year of the original sale) included an estimated expense for write-offs such as this one. ©McGraw-Hill Companies, 2009 416 Financial and Managerial Accounting, 3rd Edition Problem 7-5B (75 minutes) Part 1 2008 Nov. 1 Notes Receivable—E. Merklin ................................ 13,560 Accounts Receivable—E. Merklin.................... 13,560 To record note received on account. Dec. 31 Interest Receivable .................................................. Interest Revenue ............................................... 226 226 To record interest earned [$13,560 x .10 x 60/360]. 2009 Jan. 30 Cash .......................................................................... 13,899 Interest Revenue* .............................................. Interest Receivable............................................ Notes Receivable—E. Merklin .......................... 113 226 13,560 To record cash received on note with interest. *[$13,560 x .10 x 30/360] Mar. 1 Notes Receivable—Zada Co. .................................. Accounts Receivable—Zada Co. ..................... 6,000 6,000 To record note received on account. Mar. 2 Notes Receivable—S. Patru ................................... Accounts Receivable—S. Patru ....................... 4,080 4,080 To record note received on account. 31 Accounts Receivable—Zada Co. ........................... Interest Revenue ............................................... Notes Receivable—Zada Co. ............................ 6,040 40 6,000 To record receivable for dishonored note plus interest [$6,000 x .08 x 30/360]. May 1 Cash .......................................................................... Interest Revenue ............................................... Notes Receivable—S. Patru ............................. 4,114 34 4,080 To record cash received on note plus interest ($4,080 x .05 x 60/360 = $34). ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 417 Problem 7-5B (Concluded) June 15 Notes Receivable—M. Braff.................................. Accounts Receivable—M. Braff ..................... 9,000 9,000 To record note received on account. June 21 Notes Receivable—H. Guam ................................ Accounts Receivable—H. Guam .................... 3,160 3,160 To record note received on account. Aug. 14 Cash ........................................................................ Interest Revenue* ............................................ Notes Receivable—M. Braff............................ 9,165 165 9,000 To record cash received on note plus interest. *[$9,000 x .11 x 60/360] (rounded) Sept. 19 Cash ........................................................................ Interest Revenue* ............................................ Notes Receivable—H. Guam .......................... 3,239 79 3,160 To record cash received on note plus interest. *[$3,160 x .10 x 90/360] Nov. 30 Allowance for Doubtful Accounts........................ Accounts Receivable—Zada Co. ................... 6,040 6,040 To record write-off of accounts. Part 2 Analysis Component: When a business pledges its receivables as security for a loan and the loan is still outstanding at period-end, the business must disclose this information in notes to its financial statements. This is a requirement because the business has committed a portion of its assets to cover a specific portion of its liabilities, which means that if the business dishonors its obligations under the loan, the creditor can claim the amount of receivables identified in the pledge as collateral to cover the loan. This arrangement must be disclosed to satisfy the full-disclosure principle. ©McGraw-Hill Companies, 2009 418 Financial and Managerial Accounting, 3rd Edition SERIAL PROBLEM — SP 7 Serial Problem — SP 7, Success Systems (50 minutes) 1. a. Bad debts expense is recorded as 1% of total revenues: $43,853 x .01 = $438.53 which is $439 rounded to nearest dollar. 2010 Mar. 31 Bad Debts Expense ............................................... Allowance for Doubtful Accounts.................. 439 439 To record estimated bad debts. b. Bad debts expense is recorded as 2% of accounts receivable: $22,720 x .02 = $454.40 which is $454 rounded to the nearest dollar. 2010 Mar. 31 Bad Debts Expense ............................................... Allowance for Doubtful Accounts.................. 454 454 To record estimated bad debts. 2. Allowance Balance as of 3/31/10 ................... $454 Cr. Less: Account written off .............................. (100) Dr. Allowance Balance as of 6/30/10 ................... $354 Cr. (before adjustment) Required Balance: $20,250 x 0.02 = $405 Required Adjustment: $405 - $354 = $51 2010 June 30 Bad Debts Expense ............................................... Allowance for Doubtful Accounts.................. 51 51 To record estimated bad debts. 3. Many small business owners use the direct write-off method of recording bad debts expense. The direct method is a simple and straightforward method of accounting for bad debts expense. It can also be justified if the amounts are immaterial. However, when the amounts are material, the direct write-off method can result in accounts receivable overstatements, bad debts expense understatements, and net income overstatements. The method required per GAAP is the allowance method, which will result in the best matching of a period’s expenses to revenues. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 419 Reporting in Action — BTN 7-1 1. Best Buy’s receivables at March 3, 2007, are $548,000,000. 2. Accounts receivable turnover for fiscal 2007 ($ millions) $35,934 ($449 + $548)/2 = 72.1 times 3. Average collection period = 365/ Turnover = 365 / 72.1 = 5.1 days This time period is so short because Best Buy does not generally sell items on credit. Customers use cash or credit cards to pay for their merchandise. It is not likely that all customers pay in about 5 days. It is more likely that credit customers pay in about 30 to 60 days. Since there are so few of them, however, the average is very short. This is because the numerator includes all sales (cash and credit) and the denominator includes only credit sales. 4. Liquid assets as a percent of current liabilities ($ millions) Mar. 3, 2007: $1,205 + $2,588 + $548 $6,301 = 68.9% Feb. 25, 2006: $748 + $3,041 + $449 $6,056 = 70.0% Comments: Current liabilities are obligations that are due to be paid or liquidated within one year or one operating cycle of the business, whichever is longer. Typically, cash provided from the operations of the business during the year along with the existing liquid assets are used to satisfy these obligations. Looking solely at Best Buy’s ability to satisfy current obligations using cash, investment, and receivables assets, the company is in a worse position at March 3, 2007, as compared to February 25, 2006. Best Buy may have some trouble satisfying its current liabilities with these liquid assets. As a benchmark it is preferable to have about 100% in liquid assets to cover current liabilities. 5. Note 1 to Best Buy’s consolidated financial statements reports its significant accounting policies. It reports that: “Cash primarily consists of cash on hand and bank deposits. Cash equivalents primarily consist of money market accounts and other highly liquid investments with an original maturity of three months or less when purchased.” 6. Solution depends on the financial statement information obtained. ©McGraw-Hill Companies, 2009 420 Financial and Managerial Accounting, 3rd Edition Comparative Analysis 1. — BTN 7-2 Accounts Receivable Turnover ($ millions) Best Buy (Current Year): $35,934 ($449 + $548)/2 = 72.1 times Best Buy (Prior Year): $30,848 ($375 + $449)/2 = 74.9 times Circuit City (Current Year): $12,430 ($221 + $383)/2 = 41.2 times Circuit City (Prior Year): $11,514 ($231 + $221)/2 = 50.9 times RadioShack (Current Year): $4,778 ($309 + $248)/2 = 17.2 times RadioShack (Prior Year): $5,082 ($241 + $309)/2 = 18.5 times 2. Average Collection Period (or “Average Days’ Sales Uncollected”) Best Buy (Current Year): 365 days / 72.1 times = 5.1 days Best Buy (Prior Year): 365 days / 74.9 times = 4.9 days Circuit City (Current Year): 365 days / 41.2 times = 8.9 days Circuit City (Prior Year): 365 days / 50.9 times = 7.2 days RadioShack (Current Year):365 days / 17.2 times = 21.2 days RadioShack (Prior Year): 365 days / 18.5 times = 19.7 days ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 421 Comparative Analysis BTN 7-2 (concluded) 2. (concluded) Interpretation: The time periods for Best Buy and Circuit City are so short because neither company sells merchandise on credit very often. Receivables are a small percent of current assets and credit sales are a small percent of total sales. RadioShack, however, has a longer collection period because they sell on credit more often than Best Buy and Circuit City. 3. All of the companies appear efficient in collecting accounts receivable, but Best Buy and Circuit City collects them much more quickly in both years than RadioShack. The differences between Best Buy and Circuit City are not likely material. Ethics Challenge — BTN 7-3 1. If the estimate for bad debts is reduced then less Bad Debts Expense will be recognized on the income statement resulting in a higher net income. It also means that a lower allowance will be shown on the balance sheet, which will result in a higher realizable value for receivables and, therefore, a larger amount of current liquid assets. 2. Accounting procedures often allow for alternate methods or require the use of estimates. Therefore, managers have some leeway in their application of accounting procedures. In this case it seems reasonable to doubt the motivation behind the manager’s recommendation for a lower bad debts expense. There does not appear to be any economic justification for the change in estimate aside from the self-interest of the manager. 3. An informed owner or an effective board of directors will be aware of alternate accounting methods and how estimates can affect the financial statements. The owner or board should review the reasonableness of the manager’s and accountant’s estimate for bad debts expense. Also, if the company is audited, the auditors will review this estimate for reasonableness. ©McGraw-Hill Companies, 2009 422 Financial and Managerial Accounting, 3rd Edition Communicating in Practice — BTN 7-4 TO: Sid Omar FROM: (Your Name) DATE: _______________ SUBJECT: Difference Between Bad Debts Expense and Allowance For Doubtful Accounts In accounting for credit sales and bad debts, we report sales revenue in the period the sales are made, even though some credit sales do not result in collections until the following period. Of course, some credit sales eventually prove to be uncollectible. The fact that some accounts will become uncollectible is what gives rise to bad debts expense and the allowance for doubtful accounts. Determining Bad Debts Expense Bad debts expense represents the estimated amount of the year's sales that will become uncollectible. The reported amount of bad debts expense is determined at the end of the accounting period by multiplying an estimated percent times the annual sales for the period. This year's bad debts expense of $59,000 is calculated as 2% of the annual sales of $2,950,000. Determining Allowance For Doubtful Accounts The Allowance for Doubtful Accounts unadjusted balance at the end of the year is the cumulative result of recording bad debts expense and writing off specific accounts receivable in all past years. The recognition of bad debts expense at the end of each year has the effect of increasing the Allowance for Doubtful Accounts balance. However, when specific accounts receivable are written off, they decrease the Allowance for Doubtful Accounts balance. Prior to this year's bad debts expense calculation, the cumulative total of writing off specific accounts was $16,000 greater than the cumulative total of the past years' bad debts expenses. Therefore, you could say that Allowance for Doubtful Accounts had an "abnormal" balance of $16,000. Then, when this year's bad debts expense of $59,000 is added to Allowance for Doubtful Accounts, the result is an ending balance of $43,000. Sid, I hope this clarifies the matter for you. If you have further questions, please call me. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 423 Taking It to the Net 1. — BTN 7-5 At December 31, 2006, eBay’s ($ thousands) net accounts receivable were $393,195, and at December 31, 2005, its net accounts receivable were $322,788. (These amounts do not reconcile to gross accounts receivable less allowances shown below because eBay subtracts another Allowance for Authorized Credits account.) 2. December 31, ($ thousands) 2006 Gross accounts receivable ....................... $476,060 Allowance for doubtful accounts ............. 68,401 % of uncollectible accounts ..................... 14.4% 3. December 31, 2005 $396,373 62,507 15.8% These percentages seem high compared to other companies, but eBay’s operations are all online, and the risk of fraudulent transactions is likely higher than other companies. eBay’s prior experience has led them to estimate this high amount of uncollectible accounts. Teamwork in Action — BTN 7-6 Instructor note: Computations for the aging schedule are in the Problem 7-4A solution. The check figure for total estimated uncollectibles is $48,591. Adjusting entry Dec. 31 Bad Debts Expense.............................................. 25,791 Allowance for Doubtful Accounts ................ To record estimated bad * 25,791 debts.* Req. allowance balance .................... Unadjusted balance ........................... $48,591 credit 22,800 credit Adj. to the allowance ......................... $25,791 credit December 31, 2009, Balance Sheet Presentation Accounts Receivable ............................................ $1,311,000* Less Allowance for Doubtful Accounts .............. 48,591 1,262,409** * Total of each age category. ** Net Realizable Accounts Receivable. ©McGraw-Hill Companies, 2009 424 Financial and Managerial Accounting, 3rd Edition Entrepreneurial Decision — BTN 7-7 1. Computation of added annual net income or loss a. Added Monthly Net Income or Loss under Plan A Increased sales ............................................................... $250,000 Cost of sales ................................................................... (135,500) Credit card fees ($250,000 x 4.75%) .............................. (11,875) Recordkeeping and shipping ($250,000 x 6%) ............. (15,000) Lost gross profit on store sales ($35,000 x 25%) ........ (8,750) Net income (loss) ............................................................ $ 78,875 b. Added Monthly Net Income or Loss under Plan B Increased sales ............................................................... $500,000 Cost of sales ................................................................... (375,000) Recordkeeping and shipping ($500,000 x 4%) ............. (20,000) Uncollectible accounts ($500,000 x 6.2%) .................... (31,000) Net income (loss) ............................................................ $ 74,000 ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 425 Entrepreneurial Decision — BTN 7-7 continued 2. Plan (A) provides a slightly higher income, so if the company can only pursue one plan now, based purely on the financial aspect, it should choose Plan (A). Plan (A) might expand its product into new markets, and could increase sales over time. However, this is a new distribution method for the company, and it might lack the expertise to do it well. It will need to further assess whether the benefit of additional expansion of online sales over time will be more/less than the cost of lost sales through normal channels. Taking credit cards for these online sales reduces its risk of uncollectible accounts. The credit card company takes the risk of the customer not paying. Plan (B) is a way to expand sales, possibly into more locations. This is an expansion of a distribution method now employed. The company does run some unknown risk associated with having new customers. While the company may understand its current customers, it will need to monitor the new customers to make sure that the uncollectible accounts do not rise beyond acceptable levels. Hitting the Road — BTN 7-8 Telephone calls to VISA and American Express are the source of information for this solution. VISA reports that the average transaction fee it charges merchants is 3%. American Express has a range, depending on volume of business and average price of merchandise sold, which ranges from 2.95% to 4.5%. Some merchants often choose not to accept certain cards because the credit card fees are higher than others. In the case of VISA, compared to American Express, a merchant might have to pay as much as 1.5% more on its American Express transactions. This can be a major part of its net profit margin, especially for businesses such as grocery and hardware stores. ©McGraw-Hill Companies, 2009 426 Financial and Managerial Accounting, 3rd Edition Global Decision — BTN 7-9 1. Accounts Receivable Turnover (£ millions) DSG (Current Year): £7,930 (£370 + £393) / 2 = 20.8 times 2. Average Collection Period (or “Average Days’ Sales Uncollected”) DSG (Current Year): 365 days / 20.8 times = 17.5 days 3. DSG is more like RadioShack than Best Buy or Circuit City in terms of its turnover and collection periods. DSG probably sells on credit more than both Best Buy and Circuit City. ©McGraw-Hill Companies, 2009 Solutions Manual, Chapter 7 427 ©McGraw-Hill Companies, 2009 428 Financial and Managerial Accounting, 3rd Edition