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Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition
CHAPTER 8
Reporting and Analyzing Receivables
Brief A B
Study Objectives Questions Exercises Exercises Problems Problems BYP
3. Account for notes 11, 12, 9, 10, 11, 7, 8, 9 6A, 7A, 8A 6B, 7B, 4
receivable. 13, 14, 12, 13 8B
15, 16
5A Prepare aging schedule; record bad debts for two Moderate 25-35
years.
5B Prepare aging schedule, record bad debts for two Moderate 25-35
years.
ANSWERS TO QUESTIONS
1. Three types of receivables along with examples follows:
2. Trade receivables are the result of sales transactions while nontrade receivables are the
result of transactions other than sales transactions of the business, such as interest
receivable, income tax receivable, and similar types of receivables.
(b) Revenue should be recognized when the performance or sales effort is substantially
complete. This normally occurs when the service is performed, or when goods are
delivered at the point of sale, but not necessarily when cash is received. In addition,
collection must be reasonably assured.
Bank credit cards: 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.
Debit cards: The advantage of the debit card is that the cash is deducted
immediately from the customer’s account. There are no credit checks or collection
concerns so the service charges are normally lower than for a bank credit card.
By using its own credit cards, bank credit cards and debit cards, Canadian Tire
provides more options to its customers, increases its revenue, and reduces its risk.
4. (b) Nonbank credit cards: To record a company credit card transaction, the seller
records a debit to Accounts Receivable and a credit to Sales.
Bank credit cards: To record a bank credit card transaction, the seller records a debit
to Cash and a credit to Sales.
Debit cards: To record a debit card transaction, the seller records a debit to Cash
and a credit to Sales.
Bank charges expense for debit card and bank credit card fees must also be
recorded, usually as part of the bank reconciliation process.
5. (a) Using an accounts receivable subsidiary ledger makes it possible to determine the
balance owed by an individual customer at any point in time. This makes it easier to
manage receivables, answer customer inquiries, follow up on payments and decide if
additional credit should be granted.
(b) The general ledger control account should agree with the total of the individual
accounts in the subsidiary ledger.
(b) The aging schedule is used to apply percentages to outstanding receivables in each
age category to determine the total estimated uncollectible accounts.
7. (a) The purpose of the account 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, so we cannot reduce specific customer accounts in the
subsidiary ledger or the related accounts receivable control account in the general
ledger. Instead we increase the allowance account balance.
(b) The account can be in a debit balance if the amount of actual write offs exceeds
previous provisions for bad debts. A debit balance will arise during the period when
these write offs are recorded, but by the end of the reporting period adjusting entries
will be made that will bring the balance in the allowance account back into a credit
position. The credit entry to this account is offset with a debit to Bad Debts Expense.
8. The Bad Debts Expense account reflects only the current year’s estimates while the
Allowance for Doubtful Accounts is a cumulative result of estimates, write offs, and
subsequent recoveries from the current and prior periods.
9. 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 (which
is the difference between accounts receivable and allowance for doubtful accounts) does
not change. Net realizable value will change, however, when an adjusting entry is made
to record the estimate of uncollectible accounts because only the Allowance account is
affected in this entry.
10. 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, and that may affect future credit decisions. Furthermore, the date on
which the determination that the receivable is actually collectible and the date it is
actually collected may be different and this would necessitate the separate recording of
these events.
(b) Differences between accounts receivable and notes receivable include the following.
An accounts receivable is an informal promise to pay, while a note receivable is a
written promise giving the payee a stronger legal claim. A note receivable is a
negotiated instrument that can be transferred to another party. An account receivable
arises from credit sales, while a note receivable can arise for a number of reasons
such as the financing of a purchase, lending money, or extending the terms of an
account receivable. An account receivable is usually due within a short period of time,
while a note receivable can extend for longer periods of time (which is why it bears
interest). An account receivable does not incur interest unless the account is overdue
while a note usually bears interest for an entire period.
12. (a) (1) Interest is normally recorded for an account receivable if a customer does not
pay in full within a specified period of time (usually 30 days). The invoice will
specifically state the amount or percentage of interest due on overdue accounts.
(2) In the case of notes receivable, the amount of interest accrues starting from the
date of the issuance of the note and continues to the maturity date of the note.
Interest earned is recorded when accrued at the end of each accounting period
or when collected, whichever comes first.
12. (b) (1) Accounts Receivable is normally debited for interest on overdue balances. This
accomplishes two goals: updating a particular customer’s balance in the
subsidiary ledger to allow management to decide if additional credit should be
granted if overdue balances are not yet paid; it also allows the company to
easily send a statement of transactions to the customer that includes interest
charges so that the customer will be aware of them.
(2) In the case of notes receivable when interest revenue is accrued, Interest
Receivable is debited. The Note Receivable account is for the amount of the
principal balance of the loan, whereas the interest is recorded and reported
separately.
13. Notes are not recorded at their maturity value (which would include interest) because the
interest on the note is not receivable when the note is first recorded. The interest is
earned over time and is recorded when earned.
14. Cobden Inc., as the party making the promise to pay, is the maker of the note. It would
record a note payable. Scotiabank, as the party who will be paid, is the payee. It would
record a note receivable.
16. These notes should be recorded at their net realizable value. An entry should be made to
debit Bad Debts Expense for the 10% expected to be uncollectible and to credit
Allowance for Doubtful Notes for the same amount.
17. Both the gross amount of receivables and the allowance for doubtful accounts must be
reported either in the statement of financial position or in the notes to the financial
statements. It is usual to report the receivables on the statement of financial position at
their net realizable value and to provide additional information about the allowance in the
notes to the statements.
Non-current assets
Notes receivable (due in two years) $xxx
2012 2011
Average collection period 365 = 118 days 365 = 111 days
3.1 3.3
22. (a) An increase in the current ratio does not necessarily mean that the liquidity of a
company has improved. In order to determine if liquidity has improved, we need to
understand why the current ratio rose. If it rose because the company has more cash,
then the company is more liquid. On the other hand if the cash has fallen but
inventory has risen by a larger amount because of declining sales, the current ratio
will rise but this does not mean that the company is more liquid. It simply means that
the company has some inventory that it cannot sell and the company has less
liquidity. The same is true if net accounts receivable increase because of a slowdown
in collections not fully adjusted for in the estimate of uncollectible accounts.
(b) Other ratios that focus on specific current assets rather than current assets in total
(as the current ratio does) give us insight into the components of working capital and
allow us to understand liquidity in more detail. Examples include the receivables
turnover ratio and the inventory turnover ratio. In general, if these ratios are rising,
liquidity is improving because cash is being received more quickly.
23. If the receivables turnover is significantly higher than its competitors, it means the
company is collecting its receivables faster, indicating it may have an earlier payment
due date. Customers may move to a competitor that does not collect its receivables as
quickly to better manage their cash flow.
If a company has a receivables turnover that is significantly lower than its competitors, it
may be at a competitive disadvantage because it is financing its customers’ purchases
for a longer time and delaying the time it takes to receive cash.
(a)
Visa card
Cash ........................................................................................ 100
Sales ............................................................................... 100
(b)
Nonbank credit card
Accounts Receivable ................................................................ 100
Sales ............................................................................... 100
Because VISA is sponsored by a bank, it is appropriate to record a debit to cash in the first
entry. In the second entry, because a nonbank credit card is used, the company bears the
entire risk of collecting the amount, so it is recorded in accounts receivable. In addition, there
are normally no bank charges incurred with respect to the use of a company credit card.
Lewis Corp.
Jan. 23 3,700 Jan. 29 3,700
Jan. 31 Bal. 0
Accounts Receivable
Jan. 31 11,500 Jan. 31 6,400
Jan. 31Bal. 5,100
(b)
Dec. 31 Bad Debts Expense ($23,680 – $3,600).......................... 20,080
Allowance for Doubtful Accounts........................... 20,080
2014
April 1 Notes Receivable ........................................................... 10,000
Sales ...................................................................... 10,000
2015
Mar 31 Cash ............................................................................... 10,900
Interest Receivable ................................................. 675
Notes Receivable ................................................... 10,000
Interest Revenue ($10,000 × 9% × 3/12)................ 225
2014
Apr. 1 Merchandise Inventory................................................. 10,000
Notes Payable..................................................... 10,000
2015
Mar. 31 Interest Expense ($10,000 × 9% × 6/12) .................... 450
Interest Payable ........................................................... 450
Notes Payable.............................................................. 10,000
Cash ................................................................... 10,900
(a)
Apr. 1 Notes Receivable ......................................................... 40,000
Accounts Receivable .......................................... 40,000
(b)
Apr. 1 Notes Receivable ......................................................... 40,000
Accounts Receivable .......................................... 40,000
(c)
Apr. 1 Notes Receivable ......................................................... 40,000
Accounts Receivable .......................................... 40,000
Note that no interest revenue is recorded in (c) because it is unlikely that it will be
collected.
NIAS CORPORATION
Statement of Financial Position (Partial)
February 28, 2015
Assets
Current assets
Cash ........................................................................ $ 150,000
Trading investments................................................. 330,000
Accounts receivable ................................................. $470,000
Less: Allowance for doubtful accounts ..................... 30,000 440,000
Notes receivable (due Nov. 1, 2015)........................ 300,000
Sales tax recoverable .............................................. 38,000
Merchandise inventory ............................................. 380,000
Prepaid rent ............................................................. 8,000
Total current assets ................................................. $1,646,000
(a)
(b)
The receivables turnover is better in 2012 and the average collection period is generally
unchanged in 2012 (when rounded to the nearest day).
SOLUTIONS TO EXERCISES
EXERCISE 8-1
EXERCISE 8-2
(a)
Accounts Receivable
Feb. 2 1,140 Feb. 4 140
5 760 14 760
10 920 28 1,000
17 696
22 1,738
Feb. 28 Bal. 3,354
EXERCISE 8-3
EXERCISE 8-4
(c) The net realizable value of the accounts receivable at March 31 is as follows:
EXERCISE 8-5
(a)
2014
2015
(b)
Dec. 31 May 11 Nov.12
2014 2015 2015
EXERCISE 8-6
(a)
Accounts Receivable
March 1 Balance 30,000
Sales 40,000
Collections 35,000
Write offs (1)
March 31 Balance 32,000
EXERCISE 8-7
EXERCISE 8-8
EXERCISE 8-9
EXERCISE 8-10
Assets
Current assets
Receivables
Trade accounts and notes receivable............................. $3,799.1
Less: Allowance for doubtful trade and notes receivables 66.0 $ 3,733.1
Financing receivables .................................................... $22,159.1
Less: Allowance for doubtful financing receivables ........ 177.0 21,982.1
Other receivables .............................................................................. 1,790.9
Total receivables ............................................................................... $27,506.1
EXERCISE 8-11
(a) (b)
SFP or
IS Classification
Accounts payable $22,600 SFP
Accounts receivable 18,200 SFP
Advances to employees 2,900 SFP
Allowance for doubtful accounts 1,300 SFP
Allowance for doubtful notes (current) 5,000 SFP
Bad debts expense 2,000 IS Operating expense
Cash 7,500 SFP
Interest expense 2,400 IS Non-operating expense
Interest revenue 6,000 IS Non-operating revenue
Merchandise inventory 26,400 SFP
Notes receivable (current) 25,000 SFP
Notes receivable (non-current) 75,000 SFP
Prepaid insurance 1,500 SFP
Sales 370,000 IS Operating revenue
Sales discounts 12,000 IS Contra operating revenue
Sales tax recoverable 3,150 SFP
(c)
APOLLO CORPORATION
Statement of Financial Position (partial)
November 30, 2015
Assets
Current assets
Cash .............................................................................. $ 7,500
Accounts receivable ....................................................... $18,200
Less: Allowance for doubtful accounts ........................... 1,300 16,900
Notes receivable ........................................................... $25,000
Less: Allowance for doubtful notes ................................. 5,000 20,000
Advances to employees ....................................................................... 2,900
Sales tax recoverable ........................................................................... 3,150
Merchandise inventory ......................................................................... 26,400
Prepaid insurance ................................................................................ 1,500
Total current assets ................................................................... $78,350
EXERCISE 8-12
(a) ($ in millions)
2012
Current ratio = $1,869 = 0.8 : 1
$2,203
2011
Current ratio = $1,848 = 1.1 : 1
$1,715
(b) In 2012, accounts receivable increased 0.6% [($841 − $836) ÷ $836] while revenues
increased 9.9% [($9,920 − $9,028) ÷ $9,028]. CN is doing a better job of collecting its
accounts receivable. The receivables turnover ratio and the average collection period
indicate that the company’s management of receivables has improved. The turnover
has improved from 11.1 times in 2011 to 11.8 times in 2012. The average collection
period has decreased from 33 days in 2011 to 31 days in 2012 so cash is being
collected sooner.
The current ratio has declined from 1.1:1 in 2011 to 0.8:1 in 2012. However, this
decrease is not due to slow-collection of receivables (or slow moving inventory). This
decrease can be attributed to the 28% [($2,203 – $1,715) ÷ $1,715] increase in current
liabilities compared to the modest increase in current assets of 1% [($1,869 – $1,848)
÷ $1,848].
EXERCISE 8-13
(a) At first glance, the increase in the current ratio might lead to the conclusion that Lin’s
liquidity has improved in 2015. When looking further and noting a deterioration in the
receivables and inventory turnover ratios in the same period, one must conclude that
the increase in the current ratio does not mean that Lin’s liquidity has improved. In this
case, total current assets have increased in comparison to current liabilities because
of increases in accounts receivable and inventory.
(b) Lin must determine the source of the deterioration of both the receivables and
inventory turnover ratios. If the deterioration is a result of specific policy changes in the
way in which Lin is managing its accounts receivable, by for example extending its
credit terms, the result of the deterioration of the accounts receivable turnover is not a
surprising result. Similarly, if the deterioration of the inventory turnover is a result of a
management strategy to improve sales and profitability, the outcome is also not a
surprise to management. On the other hand, if Lin establishes that there have been no
direct causes to the change that can be readily explained through the actions of
management, specific measures to improve the management of its accounts
receivable and inventory must be undertaken immediately.
SOLUTIONS TO PROBLEMS
PROBLEM 8-1A
(d)
UNDERWOOD IMPORTS INC.
Statement of Financial Position (partial)
December 31, 2015
Assets
Current assets
Accounts receivable .................................................... $1,960,000
Less: Allowance for doubtful accounts ........................ 100,000 $1,860,000
(e)
UNDERWOOD IMPORTS INC.
Income Statement (partial)
Year Ended December 31, 2015
PROBLEM 8-2A
(e)
Before bad debts expense was recorded, the Allowance account had a debit balance of
$20,000 ($88,000 – $116,000 + $8,000). To adjust this to $72,000 requires a credit to this
account of $92,000 with an offsetting debit to Bad Debts Expense.
PROBLEM 8-3A
Accounts Receivable
Beg. bal. 18,000
55,000
(a) 78,000 (b) 1,000
End. bal. (c) 40,000
Sales
78,000
(b) Write offs of accounts receivable obtained from reduction of allowance for doubtful
accounts $1,000
(c) $18,000 + $78,000 (a) – $1,000 (b) – $55,000 = $40,000, the ending balance
(d) $1,800 – $1,000 + (d) = $2,000 (e); (d) = $1,200 and this represents the credit side of
the bad debts expense entry.
(f) Bad debts expense = Adjustment to allowance for doubtful accounts = $1,200 [from
(d)]
PROBLEM 8-4A
Estimated Estimated
Number of Days Accounts Percentage Uncollectible
Outstanding Receivable Uncollectible Accounts
0-30 days $240,000 1% $ 2,400
31-60 days 120,000 5% 6,000
61-90 days 100,000 10% 10,000
Over 90 days 60,000 25% 5,000
Total $520,000 $33,400
(b) (1)
Bad Debts Expense ................................................................ 13,400
Allowance for Doubtful Accounts....................................... 13,400
[$33,400 – $20,000]
(2) If the allowance for doubtful accounts had an unadjusted debit balance of $20,000,
the bad debts expense in the entry above would be $53,400 ($33,400 + $20,000)
(e) Part (a): The total estimated allowance for doubtful accounts = $520,000 × 6% =
$31,200.
Part (b): (1) The journal entry would record bad debts expense of $11,200
($31,200 – $20,000)
(2) If the allowance for doubtful accounts had an unadjusted debit balance
of $20,000, the bad debts expense in the entry above would be $51,200
($31,200 + $20,000)
PROBLEM 8-5A
Estimated Estimated
Number of Days Accounts Percentage Uncollectible
Outstanding Receivable Uncollectible Accounts
0-30 days $320,000 3% $ 9,600
31-60 days 114,000 6% 6,840
61-90 days 76,000 12% 9,120
Over 90 days 50,000 24% 12,000
Total $560,000 $37,560
Estimated Estimated
Number of Days Accounts Percentage Uncollectible
Outstanding Receivable Uncollectible Accounts
0-30 days $300,000 3% $ 9,000
31-60 days 64,000 6% 3,840
61-90 days 86,000 12% 10,320
Over 90 days 130,000 24% 31,200
Total $580,000 $54,360
Total accounts receivable increased slightly from 2014 to 2015. However, estimated
allowance balance increased significantly. Amounts outstanding over 90 days more
than doubled while amounts less than 60 days decreased significantly. This implies the
receivables are less likely to be collected because they are increasing in age.
PROBLEM 8-6A
PROBLEM 8-7A
PROBLEM 8-8A
(a) Notes receivable total $61,000 and interest receivable $603 at September 30, 2015:
(d)
TARDIF CORPORATION
Balance Sheet (partial)
October 31, 2015
_________________________________________________________________________
Assets
Current assets
Notes receivable .......................................................... $38,000
Less: Allowance for doubtful notes .............................. 17,500 $20,500
Interest receivable ....................................................... 143
PROBLEM 8-9A
CANADIANA CORPORATION
Statement of Financial Position (Partial)
December 31, 2015
(in thousands)
Assets
Current assets
Cash $ 592
Trading investments 196
Accounts receivable $1,630
Less: Allowance for doubtful accounts 32 1,598
Notes receivable 2,481
Income tax receivable 99
Merchandise inventory 1,902
Supplies 85
Total current assets 6,953
Non-current assets
Notes receivable 101
Property, plant, and equipment
Land $ 1,077
Buildings $2,734
Less: Accumulated depreciation 960 1,774
Equipment $737
Less: Accumulated depreciation 488 249 3,100
Total assets $10,154
PROBLEM 8-10A
(a)
Nike Adidas
(in US $ millions) (in euro millions)
$24,128 €13,344
Receivables turnover ($3,212+$3,330) (€1,794+€1,858)
� � � �
2 2
=7.4 times =7.3 times
365 365
Average collection period = 49 days = 50 days
7.4 7.3
(b) Both companies’ collection experiences are very close to each other and to the industry.
Nike’s receivables turnover ratio and collection period are practically identical to the
industry average, whereas Adidas’ is slightly below that of Nike and the industry.
Adidas’ collection experience is marginally but not notably weaker (meaning that it
collects its receivables slower).
PROBLEM 8-11A
(b) At first glance, it appears that Pampered Pets’ liquidity has improved over the last two
years since the company’s current ratio has increased from 2.1:1 to 2.6:1. The current
ratio aggregates all current assets together. To get a better understanding of why this
increase in the current ratio occurred, we need to analyze specific accounts that are
included in this ratio. To do this, we can examine the receivables and inventory
turnover ratios. The increase in the receivables turnover ratio indicates that the
company is collecting its receivables faster and this improves cash flow and liquidity.
As well, the company appears to be moving its inventory more quickly as evidenced by
the higher inventory turnover ratio and this also improves cash flow and liquidity.
Therefore, it does appear that the company’s overall liquidity is improving.
(c) Changes in the turnover ratios indirectly affect profitability. Improvements in the
receivables turnover and inventory turnover speed up the cash cycle which provides
the company with better cash flow and decreases the need for outside financing , thus
decreasing interest expense. Furthermore, improvements in the receivables turnover
usually arise as a direct result of improvements in credit management and better
collection efforts. These improvements result in fewer defaults and decreases in bad
debts expense. Improvements in the inventory turnover improve profitability by
reducing carrying charges associated with stocking inventory (such as warehousing
costs). Improved inventory turnover also reduces the risk of merchandise not selling
and becoming obsolete or selling at reduced prices. Obsolete inventory lowers
profitability because the cost of this type of inventory has to be written off.
(d) 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.
(e) There are several steps that Pampered Pets could consider to improve its receivables
and inventory turnover:
Receivables
o The company could establish credit policies and credit limits for certain
customers, if it doesn’t already have them.
o The company could initiate the use of a cash discount to encourage early
payment of receivables
Inventory
o Pampered Pets should monitor its inventory levels carefully and only reorder
when inventory is selling and additional supplies are required. If inventory is not
selling (e.g., not in favour or in season), it should mark it down quickly to get rid
of it rather than risk it not selling at all and having to pay carrying costs for
obsolete inventory.
o The company could limit the amount of inventory by improving its purchasing
relationships with suppliers. If inventory could be purchased more frequently,
high levels of inventory will not have to be carried and stored.
PROBLEM 8-1B
(b)
(d)
BORDEAUX INC.
Statement of Financial Position (partial)
December 31, 2015
Assets
Current assets
Accounts receivable .................................................. $410,000
Less: Allowance for doubtful accounts ...................... 25,000 $385,000
(e)
BORDEAUX INC.
Income Statement (partial)
Year Ended December 31, 2015
PROBLEM 8-2B
(e)
Accounts Receivable
Beg. Bal. 200,000
Sales 800,000 Collections 723,000
Recovery 3,500 Write off 21,000
Collections 3,500
End Bal. 256,000
Before bad debts expense was recorded, the balance in the Allowance account was a debit
$3,500 ($14,000 – $21,000 + $3,500). To move this balance to a credit of $16,000 requires a
credit to the Allowance of $19,500 with an offsetting debit to Bad Debts Expense.
(f)
HUANG LTD.
Statement of Financial Position (partial)
Assets
Current assets
Accounts receivable .............................................................. $256,000
Less: Allowance for doubtful accounts ................................... 16,000
Net realizable value ................................................................ 240,000
PROBLEM 8-3B
Accounts Receivable
Beg. bal. (a) 27,750
(b) 250
225,000 230,000
End. bal. 22,500
Sales
(e) 225,000
(a) Solving for the opening Accounts Receivable balance (a) we get:
(a) + $225,000 – $230,000 – $250 (b) = $22,500
(a) = $27,750
(b) Write offs of accounts receivable obtained from reduction of allowance for doubtful
accounts $250.
(c) This amount represents the increase in the Allowance for Doubtful Accounts caused
by recorded bad debt expense:
Unadjusted balance $750 + (c) = $1,150 (we know the $1,150 balance (d) – it was
given) (c) = $400
(f) Bad debts expense = Adjustment to allowance for doubtful accounts = $400 (from (c))
PROBLEM 8-4B
(a) Total estimated allowance for doubtful accounts:
Estimated Estimated
Number of Days Accounts Percentage Uncollectible
Outstanding Receivable Uncollectible Accounts
0-30 days $110,000 1% $1,100
31-60 days 50,000 5% 2,500
61-90 days 20,000 10% 2,000
Over 90 days 12,500 20% 2,500
Total $192,500 $8,100
(b) (1)
Bad Debts Expense .................................................................. 13,100
Allowance for Doubtful Accounts....................................... 13,100
($8,100 + $5,000 = $13,100)
(2)
If the allowance for doubtful accounts had an unadjusted credit balance of
$5,000, the bad debts expense in the entry above would be $3,100
($8,100 – $5,000)
(e) If Imagine used 4% of total accounts receivable rather than aging the individual
accounts to determine the allowance at year end, the bad debts expense adjustment
would be $12,700 [$7,700 ($192,500 × 4%) + $5,000]. If the allowance for doubtful
accounts had an unadjusted credit balance of $5,000, the bad debts expense in the
entry above would be $2,700. The answers to (c) – (d) would not change.
(f) Aging the individual accounts should produce a more accurate estimate of the net
realizable value of the accounts receivable. As the receivables get older, a higher
percentage is applied to them when calculating the uncollectable accounts. This is
more accurate because older receivables have a greater probability of not being
collected.
PROBLEM 8-5B
Estimated Estimated
Number of Days Accounts Percentage Uncollectible
Outstanding Receivable Uncollectible Accounts
0-30 days $220,000 3% $ 6,600
31-60 days 86,000 6% 5,160
61-90 days 52,000 12% 6,240
Over 90 days 22,000 20% 4,400
Total $380,000 $22,400
Estimated Estimated
Number of Days Accounts Percentage Uncollectible
Outstanding Receivable Uncollectible Accounts
0-30 days $240,000 3% $ 7,200
31-60 days 104,000 6% 6,240
61-90 days 62,000 12% 7,440
Over 90 days 34,000 20% 6,800
Total $440,000 $27,680
Accounts receivable has increased and so has the allowance balance. The increase in the
accounts receivable appears to be spread throughout the aging analysis and is not
concentrated in any of the aging categories. Thus, the increase in the allowance is
attributable to a general increase in accounts receivable rather than to increased age.
PROBLEM 8-6B
PROBLEM 8-7B
PROBLEM 8-8B
(a) Total notes receivable are $58,000 and total interest receivable $918 at November 30,
2015:
(d)
KITIMAT CORPORATION
Balance Sheet (partial)
December 31, 2015
_________________________________________________________________________
Assets
Current assets
Notes receivable .......................................................... $35,000
Less: Allowance for doubtful notes .............................. 20,000 $15,000
Interest receivable ....................................................... 133
PROBLEM 8-9B
OUTAOUAIS INC.
Statement of Financial Position (Partial)
January 31, 2015
(in thousands)
Assets
Current assets
Accounts receivable $2,468
Less: Allowance for doubtful accounts 268 $2,200
Notes receivable 50
Income tax receivable 20
Merchandise inventory 3,000
Supplies 50
Total current assets 5,320
Non-current assets
Notes receivable 300
Property, plant, and equipment
Land $200
Buildings $1,000
Less: Accumulated depreciation 250 750
Equipment $750
Less: Accumulated depreciation 375 375 1,325
Goodwill 100
PROBLEM 8-10B
(a)
Rogers Shaw
(in millions) (in millions)
$12,486 $4,998
Receivables turnover ($1,693 + $1,665) ($472 + $461)
� � � �
2 2
= 7.4 times = 10.7 times
365 365
Average collection period = 49 days = 34 days
7.4 10.7
(b) Shaw’s receivables turnover was considerably better than that of Rogers’, which means
Shaw was more efficient than Rogers in collecting its receivables. While Rogers is
collecting their accounts receivable at a similar pace as that of the industry, it remains
considerably slower than Shaw’s.
PROBLEM 8-11B
(b) At first glance it appears that Tianjin’s liquidity had remained stable over the past year
since the company’s current ratio has remained at 1.5:1. However, the company is
taking less time to collect its accounts receivable as evidenced by the increasing
receivables turnover ratio and decreasing collection period. In contrast, it appears to
be moving its inventory less quickly as evidenced by the lower inventory turnover ratio
and increasing days in inventory. It is possible that the stable current ratio is due to the
fact that the improving collections and deteriorating inventory turnover ratios are
offsetting.
(c) Changes in the turnover ratios indirectly affect profitability. Improvements in the
receivables turnover and inventory turnover speed up the cash cycle which provides
the company with better cash flow and decreases the need for outside financing, thus
decreasing interest expense. Furthermore, improvements in the receivables turnover
usually arise as a direct result of improvements in credit management and better
collection efforts. These improvements result in fewer defaults and decreases in bad
debts expense. Improvements in the inventory turnover improve profitability by
reducing carrying charges associated with stocking inventory (such as warehousing
costs). Improved inventory turnover also reduces the risk of merchandise not selling
and becoming obsolete or selling at reduced prices. Obsolete inventory lowers
profitability because the cost of this type of inventory has to be written off.
(d) 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.
(e) There are several steps that Tianjin might have taken to improve its receivables and
inventory turnover:
Receivables
o The company could establish credit policies and credit limits for certain
customers, if it doesn’t already have them.
o The company could initiate the use of a cash discount to encourage early
payment of receivables.
Inventory
o Tianjin should monitor its inventory levels carefully and only reorder when
inventory is selling and additional supplies are required. If inventory is not
selling (e.g., not in favour or in season), it should mark it down quickly to get rid
of it rather than risk it not selling at all and having to pay carrying costs for
obsolete inventory.
o 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.
(a) Shoppers Drug Mart reports accounts receivable on its 2012 balance sheet.
(b)
(c) Shoppers Drug Mart has exhibited relatively consistent performance in the collection
of its accounts receivable. It showed a slight improvement in its receivables
management in 2012. It should also be noted that an average collection period of less
than 30 days is normally an excellent collection period, depending on the terms of
sale.
(a)
($ in
thousands) Shoppers Drug Mart Jean Coutu
(b)
Ratio Shoppers Jean Coutu Industry
Current ratio 1.2:1 1.6:1 1.6:1
Receivables turnover 22.4 times 12.2 times 22.4 times
Average collection period 16 days 30 days 16 days
On the other hand, Shoppers Drug Mart’s current ratio is below that of Jean Coutu as
well as that of the industry average. Still it is above 1:1 so given that and its receivables
position, its overall liquidity appears to be better than that of Jean Coutu. Further
investigation as to why Shoppers Drug Mart’s current ratio is lower than that of Jean
Coutu and the industry is warranted (for example, is their inventory turnover slower?)
before concluding on its liquidity.
(a) Both Lava and Flow provide the information on the net realizable value of the trade
receivable, but Lava provides disclosure of the amount of the allowance for doubtful
accounts. Lava also provides more detail as to the aging of its accounts receivables,
which is useful in assessing credit risk. The analyst can see that over 70% ($1,322 ÷
$1,854) of Lava’s receivables are current in 2015.
(b) Since Lava follows IFRS, it is required to provide more information for the users of the
financial statements to help them to assess credit and collection risks and
management’s policies with respect to accounts receivable.
(c) Big Bank would want an aging analysis of Flow. In addition, here are some examples of
additional information Big Bank would need in order to assess credit risk are:
Note to instructors: All of the material supplementing this group activity, including a
suggested solution, can be found in the Collaborative Learning section of the Instructor
Resource site accompanying this textbook as well as in the Prepare and Present section of
WileyPLUS.
Yes, the current ratio exceeds the bank’s requirement of a current ratio of 1.5:1 in both
years.
(b)
Notes Receivable
Bal. 2014 2,000,000
2015 New notes 1,500,000 2015 Collections 800,000
Bal. 2015 2,700,000
(c) It is difficult to say whether the Allowance for Doubtful Accounts is adequate or not. It is
noteworthy that in 2014 the allowance was 10% of the royalties receivable ($500,000 ÷
$5,000,000). In 2015, after the write-off, the allowance is 6.7% of the royalties receivable
($400,000 ÷ $6,000,000). It is quite likely, given the increase in sales from $50 million to
$60 million and the increase in receivables from $5 million to $6 million, that the
allowance should also increase proportionately unless there is evidence to the contrary.
HHL should prepare an aging of its accounts (royalty) receivable and monitor its
collection history so that it can ensure that it provides for the appropriate level of
allowance.
(d) Yes, I believe an allowance should be recorded for notes receivable. As the notes are
due in one year, and all of the notes issued during 2015 which amounted to $1.5 million,
are still outstanding at the end of the year, we need to determine what happened to the
$2 million of notes that were outstanding at the beginning of the year. Since $800,000 of
these notes has been collected, the remaining $1.2 million ($2,700,000 − $1,500,000)
must have been dishonoured.
An argument can be made for an allowance being recorded for the full amount of the
$1.2 million dishonoured notes as past experience indicates that they will probably not
be collected. To record this, the following journal entry would be required:
One could possibly argue that the outstanding notes that were issued in 2015 amounting
to $1.5 million should have an allowance provided for them but at this time it may be
difficult to quantify this.
(e) If an Allowance for Doubtful Notes of $1.2 million is recorded, this would lower current
assets to $9.4 million ($10.6 million − $1.2 million) and the current ratio would now be
1.4:1 ($9.4 million ÷ $6.8 million). This would violate the terms on the bank loan.
(f) Accounts receivable turnover ratio (calculated using ending balances rather than
average balances)
The liquidity of the company has deteriorated based on the decline in the current ratio
calculated in (a). The cash balance is lower in 2015 while current liabilities are higher.
While the accounts (royalties) receivables turnover is unchanged in 2015, the
collectability of the accounts receivable as well as the notes receivable arising from
dishonoured notes is suspect because of the reluctance of the vice president to write off
dishonoured notes.
(b) The president of the company likely made the request to improve the current ratio to
show that the company is more liquid than it really is for the benefit of the bank. In this
way, the bank’s expectations will be met.
(c) Yes. The controller has an ethical dilemma—should Sam follow the president's
“suggestion” and prepare misleading financial statements by understating the allowance
for doubtful accounts and bad debt expense or should Sam attempt to stand up to and
possibly anger the president by preparing a fair (realistic) statement of financial
position.
(d) No. Encounter’s liquidity should be a product of fair financial statements. The controller
should not prepare financial statements with the objective of achieving or sustaining a
predetermined level of liquidity. The current ratio should be a product of proper
estimates made by management and operating results, not of “creative accounting”.
(a)
(c) Money obtained from your credit cards is not “free” money. Your friend will be
responsible for making minimum monthly payments and ultimately paying for the TV.
Interest will accumulate at a possible average rate of 20% yearly on the monthly balance
that is outstanding on his credit card. If those minimum monthly payments are not met,
then there is a strong likelihood that your friend’s credit score will be impacted.
• If in fact Coffee Beans can meet these credit terms, cash flow will increase and the
stress of ensuring that there are adequate funds on hand to purchase additional
inventory and pay for salaries and wages will be alleviated.
• Will provide Koebel’s a consistent credit policy that they are able to use. When
negotiating with Biscuits, for example, they will be able to say that they have a credit
policy of 15 days which is the same as what is being offered to their current
customers.
• 30 days may be a consistent policy in this industry and Coffee Beans may chose to go
elsewhere to purchase their cupcake requirements (as may other customers such as
Biscuits). Not only would Koebel’s lose their current contractual commitment but the
additional sales they are expecting to earn in the future.
• Coffee Beans may in fact negotiate a 15 day settlement and still take 45 days to pay.
The 45 days it is taking Coffee Beans to pay could be a result of their cash flow
requirements.
(b) Implications of the doubling of cupcake requirements on a weekly basis and credit terms
remaining at 30 days
Natalie, Brian and Janet must carefully consider their cash flow requirements on a weekly
basis. Inventory requirements to prepare cupcakes will increase. There may be a need to
hire additional staff (bakers for example) as a result of the planned increase in sales. If so,
this amount will also have to be considered when determining cash flows. Utility costs,
such as electricity will also increase and expenditures for more equipment may also be
necessary. Finally, invoices are now being prepared on a weekly basis. Time will have to
be spent on ensuring that invoices are appropriately prepared, checked, sent and followed
up if they are not paid for on a timely basis.
• Consider not extending credit. Perhaps Coffee Beans would consider payment by
using a credit card. Some businesses do use credit cards to pay for goods purchased.
Although this is a valid alternative it may not be one that Coffee Beans would consider.
Many organizations want a consistent alternative when paying for product purchased.
Coffee Beans may not want to implement this strategy. Koebel’s would also have to
consider the costs of accepting payment by credit card. The issuing credit card
company or bank may charge a processing fee. This may be more costly than allowing
Coffee Beans to pay in 45 days.
• Consider the sale of receivables to an organization that will collect the receivable (a
factor). Although a valid alternative, this one may be a costly one to Koebel’s as the
fees charged by a factor can be significant.
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