Chap 007

Question 7-1Cash equivalents usually include negotiable instruments as well as highly liquid

investments that have a maturity date no longer than three months from date of purchase.

Question 7-2Internal control procedures involving accounting functions are intended to

improve the accuracy and reliability of accounting information and to safeguard the company’s assets. The separation of duties means that employees involved in recordkeeping should not also have physical responsibility for assets.

Question 7-3 Management must document the company’s internal controls and assess their

adequacy. The auditors must provide an opinion on management’s assessment. The Public Company Accounting Oversight Board’s Auditing Standard No. 5, which supersedes Auditing Standard No. 2, further requires the auditor to express its own opinion on whether the company has maintained effective internal control over financial reporting.

Question 7-4 A compensating balance is an amount of cash a depositor (debtor) must leave on

deposit in an account at a bank (creditor) as security for a loan or a commitment to lend. The classification and disclosure of a compensating balance depends on the nature of the restriction and the classification of the related debt. If the restriction is legally binding, then the cash will be classified as either current or noncurrent (investments and funds or other assets) depending on the classification of the related debt. In either case, note disclosure is appropriate. If the compensating balance arrangement is informal and no contractual agreement restricts the use of cash, note disclosure of the arrangement including amounts involved is appropriate. The compensating balance can be included in the cash and cash equivalents category of current assets.

Chapter 7 Cash and Receivables

QUESTIONS FOR REVIEW OF KEY TOPICS

7-1

Chapter 07 - Cash and Receivables

Question 7-5 Yes, IFRS and U.S. GAAP differ in how bank overdrafts are treated. Under

IFRS, overdrafts can be offset against other cash accounts. Under U.S. GAAP overdrafts must be treated as liabilities.

7-2


Answers to Questions (continued)

Question 7-6 Trade discounts are reductions below a list price and are used to establish a final

price for a transaction. The reduced price is the starting point for initial valuation of the transaction. A cash discount is a reduction, not in the selling price of a good or service, but in the amount to be paid by a credit customer if the receivable is paid within a specified period of time.

Question 7-7 The gross method of accounting for cash discounts considers discounts not taken

as part of sales revenue. The net method considers discounts not taken as interest revenue, because they are viewed as compensation to the seller for allowing the buyer to defer payment.

Question 7-8When returns are material and a company can make reasonable estimates of

future returns, an allowance for sales returns is established. At a financial reporting date, this provides an estimate of the amount of future returns for prior sales, and involves a debit to sales returns and a credit to allowance for sales returns for the estimated amount. Allowance for sales returns is a contra account to accounts receivable. When returns actually occur in the future reporting period, the allowance for sales returns is debited.

Question 7-9Even when specific customer accounts haven’t been proven uncollectible by the

end of the reporting period, bad debt expense properly should be matched with sales revenue on the income statement for that period. Likewise, since it’s not expected that all accounts receivable will be collected, the balance sheet should report only the expected net realizable value of that asset. So, to record the bad debt expense and the related reduction of accounts receivable when the amount hasn’t been determined, an estimate is needed. In an adjusting entry, we record bad debt expense and reduce accounts receivable for an estimate of the amount that eventually will prove uncollectible.

If uncollectible accounts are immaterial or not anticipated, or it’s not possible to reliably estimate uncollectible accounts, an allowance for uncollectible accounts is not appropriate. In these few cases, any bad debts that do arise simply are written off as bad debt expense at the time they prove uncollectible.

7-3



Question 7-10 The income statement approach to estimating bad debts determines bad debt

expense directly by relating uncollectible amounts to credit sales. The balance sheet approach to estimating future bad debts indirectly determines bad debt expense by estimating the net realizable value for accounts receivable that exist at the end of the period. In other words, the allowance for uncollectible accounts at the end of the period is estimated and then bad debt expense is determined by adjusting the allowance account to reflect net realizable value.

Question 7-11 A company has to separately disclose trade receivables and receivables from

related parties under U.S. GAAP, but not under IFRS.

Question 7-12 The assignment of all accounts receivable in general as collateral for debt

requires no special accounting treatment other than note disclosure of the agreement.

Question 7-13 The accounting treatment of receivables factored with recourse depends on

whether certain criteria are met. If the criteria are met, the factoring is accounted for as a sale. If they are not met, the factoring is accounted for as a loan. In addition, note disclosure may be required. Accounts receivable factored without recourse are accounted for as the sale of an asset. The difference between the book value and the fair value of proceeds received is recognized as a gain or a loss.

Question 7-14 U.S. GAAP focuses on whether control of assets has shifted from the transferor

to the transferee. In contrast, IFRS focuses on whether the company has transferred “substantially all of the risks and rewards of ownership,” as well as whether the company has transferred control. Under IFRS:

If the company transfers substantially all of the risks and rewards of ownership, the transfer is treated as a sale.

If the company retains substantially all of the risks and rewards of ownership, the transfer is treated as a secured borrowing.

If neither conditions 1 or 2 hold, the company accounts for the transaction as a sale if it has transferred control, and as a secured borrowing if it has retained control.

7-4



Question 7-15 When a note is discounted, a financial institution, usually a bank, accepts the note

and gives the seller cash equal to the maturity value of the note reduced by a discount. The discount is computed by applying a discount rate to the maturity value and represents the financing fee the bank charges for the transaction.

The four-step process used to account for a discounted note receivable is as follows:

1. Accrue any interest revenue earned since the last payment date (or date of the note).

2. Compute the maturity value.3. Subtract the discount the bank requires (discount rate times maturity value

times the remaining length of time from date of discounting to maturity date) from the maturity value to compute the proceeds to be received from the bank (maturity value less discount).

4. Compute the difference between the proceeds and the book value of the note and related interest receivable. The treatment of the difference will depend on whether the discounting is accounted for as a sale or as a loan. If it’s a sale the difference is recorded as a loss or gain on the sale; if it’s a loan the difference is viewed as interest expense or interest revenue.

Question 7-16 A company’s investment in receivables is influenced by several related variables,

to include the level of sales, the nature of the product or service, and credit and collection policies. The receivables turnover and average collection period ratios are designed to monitor receivables.

Question 7-17 The items necessary to adjust the bank balance might include deposits

outstanding (including undeposited cash), outstanding checks, and any bank errors discovered during the reconciliation process. The items necessary to adjust the book balance might include collections made by the bank on the company’s behalf, service and other charges made by the bank, NSF (nonsufficient funds) check charges, and any company errors discovered during the reconciliation process.

7-5


Answers to Questions (concluded)

Question 7-18 A petty cash fund is established by transferring a specified amount of cash from

the company’s general checking account to an employee designated as the petty cash custodian. The fund is replenished by writing a check to the petty cash custodian for the sum of the bills paid with petty cash. The appropriate expense accounts are recorded from petty cash vouchers at the time the fund is replenished.

Question 7-19When a creditor’s investment in a receivable becomes impaired, due to a troubled

debt restructuring or for any other reason, the receivable is re-measured based on the discounted present value of currently expected cash flows at the loan’s original effective rate (regardless of the extent to which expected cash receipts have been reduced). The extent of the impairment is the difference between the carrying amount of the receivable (the present value of the receivable’s cash flows prior to the restructuring) and the present value of the revised cash flows discounted at the loan’s original effective rate. This difference is recorded as a loss at the time the receivable is reduced.

Question 7-20 No. Under both U.S. GAAP and IFRS, a company can recognize in net income

the recovery of impairment losses of accounts and notes receivable.

7-6


The company could improve its internal control procedure for cash receipts by segregating the duties of recordkeeping and the handling of cash. Jim Seymour,

responsible for recordkeeping, should not also be responsible for depositing customer checks.

Under IFRS the cash balance would be $245,000, because they could offset the two accounts. Under U.S. GAAP the balance would be $250,000, because they could

not offset the two accounts.All of these items would be included as cash and cash

equivalents except the U.S. Treasury bills, which would be included in the current asset section of the balance sheet as

short-term investments.Income before tax in 2012 will be reduced by $2,500, the

amount of the cash discounts.

$25,000 x 10 = $250,000 x 1% = $2,500Income before tax in 2011 will be reduced by $2,500, the

anticipated amount of cash discounts.

$25,000 x 10 = $250,000 x 1% = $2,500

BRIEF EXERCISES

Brief Exercise 7-1

Brief Exercise 7-2

Brief Exercise 7-3

Brief Exercise 7-4

Brief Exercise 7-5

7-7


Estimated returns = $10,600,000 x 8% = $848,000Less: Actual returns (720,000) Remaining estimated returns $128,000

Sales returns.................................................................... 128,000Allowance for sales returns ....................................... 128,000

Inventory – estimated returns ........................................ 76,800Cost of goods sold ($128,000 x 60%) ............................ 76,800

(1) Bad debt expense = $1,500,000 x 2% = $30,000

(2) Allowance for uncollectible accounts: Beginning balance $25,000 Add: Bad debt expense 30,000 Deduct: Write-offs (16,000) Ending balance $39,000

Brief Exercise 7-6

Brief Exercise 7-7Singletary cannot combine the two types of receivables under U.S. GAAP, as the director is a related party. Under IFRS a combined presentation would be allowed.

Brief Exercise 7-8

7-8


(1)Allowance for uncollectible accounts:Beginning balance $ 25,000 Deduct: Write-offs (16,000) Required allowance (33,400)*Bad debt expense $24,400

(2) Required allowance = $334,000** x 10% = $33,400*

Accounts receivable:Beginning balance $ 300,000 Add: Credit sales 1,500,000 Deduct: Cash collections (1,450,000) Write-offs (16,000)Ending balance $ 334,000**

Allowance for uncollectible accounts:Beginning balance $30,000 Add: Bad debt expense 40,000 Deduct: Required allowance (38,000)Write-offs $32,000

Brief Exercise 7-9

Brief Exercise 7-10

7-9


Credit sales $8,200,000Deduct: Cash collections (7,950,000) Write-offs (32,000)* Year-end balance in A/R (2,000,000)Beginning balance in A/R $1,782,000

*Allowance for uncollectible accounts: Beginning balance $30,000 Add: Bad debt expense 40,000 Deduct: Required allowance (38,000) Write-offs $32,000

2011 interest revenue:$20,000 x 6% x 1/12 = $100

2012 interest revenue:$20,000 x 6% x 2/12 = $200

Assets decrease by $7,000:

Cash increases by $100,000 x 85% = $ 85,000 Receivable from factor increases by ($11,000 – $3,000 fee) 8,000 Accounts receivable decrease (100,000) Net decrease in assets $ (7,000)

Liabilities would not change as a result of this transaction.

Income before income taxes decreases by $7,000 (the loss on sales of receivables)

Brief Exercise 7-11

Brief Exercise 7-12

Brief Exercise 7-13

7-10


The journal entry to record the transaction is as follows:

Cash (85% x $100,000)....................................................... 85,000Loss on sale of receivables (to balance)............................ 7,000Receivable from factor ($11,000 fair value – $3,000 fee)..... 8,000

Accounts receivable (balance sold)............................... 100,000

Logitech would account for the transfer as a secured borrowing. The receivables remain on the company’s books and a liability is recorded for the amount borrowed plus the

bank’s fee.

Under IFRS, Huling would treat this transaction as a secured borrowing, because they retain substantially all of the risks and rewards of ownership. Under U.S. GAAP, Huling would treat this transaction as a sale, because they have transferred control. Note, however, that in practice we would typically expect for the entity that has the risks and rewards of ownership to also have control over the assets, so we would expect these criteria to usually lead to the same accounting.

$30,000 Face amount 450 Interest to maturity ($30,000 x 6% x 3/12)30,450 Maturity value

(406 ) Discount ($30,450 x 8% x 2/12)$30,044 Cash proceeds

Receivables turnover = $320,000 = 5.33 $60,000*

Brief Exercise 7-14

Brief Exercise 7-15

Brief Exercise 7-16

Brief Exercise 7-17

7-11


($50,000 + 70,000) 2 = $60,000*

Average collection = 365 = 68 days period 5.33

7-12


Requirement 1Cash and cash equivalents includes:

a. Balance in checking account $13,500Balance in savings account 22,100

b. Undeposited customer checks 5,200c. Currency and coins on hand 580f. U.S. treasury bills with 2-month maturity 15,000

Total $56,380

Requirement 2

d. The $400,000 savings account will be used for future plant expansion and therefore should be classified as a noncurrent asset, either in other assets or investments.

e. The $20,000 in the checking account is a compensating balance for a long-term loan and should be classified as a noncurrent asset, either in other assets or investments.

f. The $20,000 in 7-month treasury bills should be classified as a current asset along with other temporary investments.

Requirement 1Cash and cash equivalents includes:

Cash in bank – checking account $22,500U.S. treasury bills 5,000Cash on hand 1,350Undeposited customer checks 1,840

Total $30,690

Requirement 2

EXERCISES

Exercise 7-1

Exercise 7-2

7-13


The $10,000 in 6-month treasury bills should be classified as a current asset along with other temporary investments.

7-14


Requirement 1: U.S. GAAP

Requirement 2: IFRS

Requirement 1

Sales price = 100 units x $600 = $60,000 x 70% = $42,000

November 17, 2011Accounts receivable........................................................ 42,000

Sales revenue.............................................................. 42,000

November 26, 2011

Exercise 7-3

Current Assets:

Cash $175,000

Current Liabilities:

Bank Overdrafts $ 15,000

Current Assets:

Cash $160,000

(No current liabilities with respect to overdrafts.)

Exercise 7-4

7-15


Cash (98% x $42,000)........................................................ 41,160Sales discounts (2% x $42,000)......................................... 840

Accounts receivable.................................................... 42,000

Requirement 2


Sales revenue.............................................................. 42,000

December 15, 2011Cash................................................................................ 42,000


7-16


Exercise 7-4 (concluded)

Requirement 3

Requirement 1, using the net method:


Sales revenue (98% x $42,000)...................................... 41,160

November 26, 2011Cash................................................................................ 41,160


Requirement 2, using the net method:


Sales revenue (98% x $42,000)...................................... 41,160

December 15, 2011Cash................................................................................ 42,000

Accounts receivable.................................................... 41,160Interest revenue........................................................... 840

7-17


Exercise 7-5Requirement 1

Sales price = 1,000 units x $50 = $50,000

July 15, 2011Accounts receivable........................................................ 50,000

Sales revenue.............................................................. 50,000

July 23, 2011Cash (98% x $50,000)........................................................ 49,000Sales discounts (2% x $50,000)......................................... 1,000


Requirement 2


Sales revenue.............................................................. 50,000

Aug. 15, 2011Cash................................................................................ 50,000


7-18




Sales revenue (98% x $50,000)...................................... 49,000

July 23, 2011Cash................................................................................ 49,000


Requirement 2


Sales revenue (98% x $50,000)...................................... 49,000

August 15, 2011Cash................................................................................ 50,000

Accounts receivable.................................................... 49,000Interest revenue........................................................... 1,000

Requirement 1

Estimated returns = 4% x $11,500,000 = $460,000Less: Actual returns (450,000) Remaining estimated returns $10,000

To record the actual sales returns

Exercise 7-7

7-19


Sales returns.................................................................... 450,000Accounts receivable.................................................... 450,000

Inventory – estimated returns ........................................ 292,500Cost of goods sold ($450,000 x 65%) ............................ 292,500

December 31, 2011 To record the estimated sales returnsSales returns.................................................................... 10,000

Allowance for sales returns ....................................... 10,000

Inventory – estimated returns ........................................ 6,500Cost of goods sold ($10,000 x 65%) ............................. 6,500

Note: another series of journal entries that produce the same end result would be:

To record the actual sales returnsAllowance for sales returns............................................ 450,000


December 31, 2011 To record the estimated sales returnsSales returns (4% x $11,500,000)....................................... 460,000

Allowance for sales returns ....................................... 460,000

Inventory-estimated returns ........................................... 299,000Cost of goods sold (65% x $460,000)............................. 299,000

7-20


Exercise 7-7 (continued)

Requirement 2Beginning balance in allowance account $300,000 Add: Year-end estimate 460,000 Less: Actual returns (450,000)Ending balance in allowance account $310,000

Requirement 1Bad debt expense = $67,500 (1.5% x $4,500,000)

Requirement 2Allowance for uncollectible accounts

Balance, beginning of year $42,000Add: Bad debt expense for 2011 (1.5% x $4,500,000) 67,500Less: End-of-year balance (40,000) Accounts receivable written off $69,500

Requirement 3$69,500 — the amount of accounts receivable written off.

Exercise 7-8

7-21



To record the write-off of receivables.

Allowance for uncollectible accounts............................. 21,000Accounts receivable.................................................... 21,000

To reinstate an account previously written off and to record the collection.

Accounts receivable........................................................ 1,200Allowance for uncollectible accounts......................... 1,200

Cash................................................................................ 1,200Accounts receivable.................................................... 1,200

Allowance for uncollectible accounts:Balance, beginning of year $32,000Deduct: Receivables written off (21,000)Add: Collection of receivable previously written off 1,200Balance, before adjusting entry for 2011 bad debts 12,200

Required allowance: 10% x $625,000 (62,500)Bad debt expense $50,300

To record bad debt expense for the year.

Bad debt expense............................................................ 50,300Allowance for uncollectible accounts......................... 50,300

Requirement 2

Current assets:Accounts receivable, net of $62,500 allowance for uncollectible accounts $562,500

7-22


Using the direct write-off method, bad debt expense is equal to actual write-offs. Collections of previously written-off receivables are recorded as revenue.

Allowance for uncollectible accounts:

Balance, beginning of year $17,280Deduct: Receivables written off (17,100)Add: Collection of receivables previously written off 2,200Less: End of year balance (22,410)Bad debt expense for the year 2011 $20,030

($ in millions)


Balance, beginning of year $16Add: Bad debt expense 14Less: End of year balance (18) Write-offs during the year $ 12 *

Accounts receivable analysis:

Balance, beginning of year ($1,084 + 16) $ 1,100Add: Credit sales 4,271Less: Write-offs* (12)Less: Balance end of year ($953 + 18) (971)Cash collections $4,388

Exercise 7-10

Exercise 7-11

7-23


Requirement 1

June 30, 2011Note receivable............................................................... 30,000

Sales revenue.............................................................. 30,000

December 31, 2011Interest receivable........................................................... 900

Interest revenue ($30,000 x 6% x 6/12)............................ 900

March 31, 2012Cash [$30,000 + ($30,000 x 6% x 9/12)]................................ 31,350

Interest revenue ($30,000 x 6% x 3/12)............................ 450Interest receivable (accrued at December 31).................. 900Note receivable .......................................................... 30,000

Requirement 22011 income before income taxes would be understated by $9002012 income before income taxes would be overstated by $900.

Exercise 7-12

7-24



June 30, 2011Note receivable (face amount)........................................... 30,000

Discount on note receivable ($30,000 x 8% x 9/12)........ 1,800Sales revenue (difference)............................................. 28,200

December 31, 2011Discount on note receivable ........................................... 1,200

Interest revenue ($30,000 x 8% x 6/12)............................ 1,200

March 31, 2012Discount on note receivable ........................................... 600


Cash ................................................................................ 30,000Note receivable (face amount)....................................... 30,000

Requirement 2$ 1,800 interest for 9 months

÷ $28,200 sales price= 6.383% rate for 9 months

x 12/9 to annualize the rate_______

= 8.511% effective interest rate

7-25



Book value of stock $16,000Plus gain on sale of stock 6,000 = Note receivable $22,000

Interest reported for the year $ 2,200 = 10% rate

Divided by value of note $ 22,000

Requirement 2To record sale of stock in exchange for note receivable.

January 1, 2011Note receivable............................................................... 22,000

Investments................................................................. 16,000Gain on sale of investments........................................ 6,000

To accrue interest on note receivable for twelve months.

December 31, 2011Interest receivable........................................................... 2,200

Interest revenue ($22,000 x 10%)................................... 2,200

Cash (difference)............................................................... 439,200Finance charge expense (1.8% x $600,000)....................... 10,800

Liability – financing arrangement ............................. 450,000

Cash (90% x $60,000)........................................................ 54,000Loss on sale of receivables (to balance)............................ 2,200

Exercise 7-15

Exercise 7-16

7-26


Receivable from factor ($5,000 fair value – [2% x $60,000]) 3,800Accounts receivable (balance sold)............................... 60,000

Cash ([90% - 2%] x $60,000)............................................... 52,800Loss on sale of receivables (to balance)............................ 5,200Receivable from factor ($5,000 fair value)......................... 5,000

Recourse liability ....................................................... 3,000Accounts receivable (balance sold)............................... 60,000

Mountain High retains significant risks and rewards and therefore must treat the transfer as a secured borrowing. The accounts receivable stay on the balance sheet of Mountain High, and they must record a liability.

Cash ([90% - 2%] x $60,000)............................................... 52,800Finance charge expense (2% x $60,000)............................ 1,200

Liability ...................................................................... 54,000

Step 1: Accrue interest earned.

February 28, 2011Interest receivable........................................................... 250

Interest revenue ($15,000 x 10% x 2/12).......................... 250

Step 2: Add interest to maturity to calculate maturity value.Step 3: Deduct discount to calculate cash proceeds.


Exercise 7-17

Exercise 7-18

Exercise 7-19

7-27



Step 4: To record a loss for the difference between the cash proceeds and the note’s book value.

February 28, 2011Cash (proceeds determined above)........................................ 15,120Loss on sale of note receivable (difference)...................... 130

Note receivable (face amount)....................................... 15,000Interest receivable (accrued interest determined above)..... 250

7-28


List A List B

c 1. Internal control a. Restriction on cash. j 2. Trade discount b. Cash discount not taken is sales revenue. g 3. Cash equivalents c. Includes separation of duties. h 4. Allowance for uncollectibles d. Bad debt expense a % of credit sales. i 5. Cash discount e. Recognizes bad debts as they occur. l 6. Balance sheet approach f. Sale of receivables to a financial institution. d 7. Income statement approach g. Include highly liquid investments. k 8. Net method h. Estimate of bad debts. a 9. Compensating balance i. Reduction in amount paid by credit customer. m 10. Discounting j. Reduction below list price. b 11. Gross method k. Cash discount not taken is interest revenue. e 12. Direct write-off method l. Bad debt expense determined by estimating realizable

value. f 13. Factoring m. Sale of note receivable to a financial institution.

Exercise 7-20

7-29



March 17, 2011Allowance for uncollectible accounts............................. 1,700


March 30, 2011Note receivable............................................................... 20,000

Cash............................................................................ 20,000

Step 1: To accrue interest earned for two months on note receivable

May 30, 2011Interest receivable........................................................... 233


Step 2: Add interest to maturity to calculate maturity value.Step 3: Deduct discount to calculate cash proceeds.

$20,000 Face amount 1,400 Interest to maturity ($20,000 x 7%)21,400 Maturity value

(1,427 ) Discount ($21,400 x 8% x 10/12)$19,973 Cash proceeds

7-30


Exercise 7-21 (continued)

Step 4: To record a loss for the difference between the cash proceeds and the note’s book value.

May 30, 2011Cash (proceeds determined above)........................................ 19,973Loss on sale of note receivable (difference)...................... 260

Interest receivable (from adjusting entry)........................ 233Note receivable (face amount)....................................... 20,000

June 30, 2011Accounts receivable........................................................ 12,000

Sales revenue.............................................................. 12,000

July 8, 2011Cash ($12,000 x 98%)........................................................ 11,760Sales discounts ($12,000 x 2%).......................................... 240


August 31, 2011Notes receivable (face amount).......................................... 6,000

Discount on note receivable ($6,000 x 8% x 6/12).......... 240Investments (book value)............................................... 5,000Gain on sale of investments (difference)....................... 760

December 31, 2011Bad debt expense ($700,000 x 2%).................................... 14,000

Allowance for uncollectible accounts......................... 14,000

7-31



Requirement 2To accrue interest earned on note receivable.

December 31, 2011Discount on note receivable............................................ 160

Interest revenue ($6,000 x 8% x 4/12)............................. 160

Second quarter:Receivables turnover = $16,629 = 1.62

$10,244


Third quarter:Receivables turnover = $13,648 = 1.36

$10,068


Average collection period = 365 ÷ Accounts receivable turnover = 50 days

Accounts receivable turnover = 365 ÷ 50 = 7.3

Average accounts receivable = ($400,000 + 300,000) ÷ 2 = $350,000

Exercise 7-22

Exercise 7-23

7-32


Accounts receivable turnover = Net sales ÷ Average accounts receivable 7.3 = Net sales ÷ $350,000

Net sales = 7.3 x $350,000 = $2,555,000

To establish the petty cash fund.

October 2, 2011Petty Cash.......................................................... 200

Cash (checking account)................................ 200

To replenish the petty cash fund.

October 31, 2011Office supplies expense..................................... 76Entertainment expense....................................... 48Postage expense................................................. 20Miscellaneous expense....................................... 19


Exercise 7-24

7-33


September 30, 2011 To replenish the petty cash fundDelivery expense................................................ 16Office supplies expense..................................... 19Receivable from employee................................ 25Postage expense................................................. 32


Exercise 7-25

7-34


Requirement 1

Exercise 7-26Compute balance per bank statement:

Balance per books $23,820Deduct: Deposits outstanding (2,340)Add: Checks outstanding 1,890Deduct: Bank service charges (38) Balance per bank $23,332

Step 1: Bank Balance to Corrected Balance

Balance per bank statement $23,332Add: Deposits outstanding 2,340Deduct: Checks outstanding (1,890)Corrected cash balance $23,782

Step 2: Book Balance to Corrected Balance

Balance per books $23,820Deduct: Service charges (38)Corrected cash balance $23,782

Exercise 7-27

7-35


Requirement 2

To correct error in recording cash receipt from credit customer.

Cash.................................................................... 1,800Accounts receivable....................................... 1,800

To record credits to cash revealed by the bank reconciliation.

Miscellaneous expense (bank service charges).. 30Accounts receivable (NSF checks).................... 1,200Interest expense.................................................. 320Note payable...................................................... 3,000

Cash................................................................ 4,550


Balance per bank statement $38,018Add: Deposits outstanding 6,300Deduct: Checks outstanding (8,420)Add: Bank error in recording check 270Corrected cash balance $36,168


Balance per books $38,918Add: Error in recording cash receipt ($2,000 - 200) 1,800Deduct:

Service charges (30)NSF checks (1,200)Automatic monthly loan payment (3,320)

Corrected cash balance $36,168

7-36


Note: Each of the adjustments to the book balance required journal entries. None of the adjustments to the bank balance require entries.

7-37


Exercise 7-28ANALYSIS

Previous Value:Accrued 2010 interest (10% x $12,000,000) $ 1,200,000Principal 12,000,000 Carrying amount of the receivable $13,200,000New Value:Interest $1 million x 1.73554 * = $1,735,540Principal $11 million x 0.82645 ** = 9,090,950 Present value of the receivable (10,826,490 ) Loss: $ 2,373,510 * present value of an ordinary annuity of $1: n=2, i=10% (from Table 4)** present value of $1: n=2, i=10% (from Table 2)

JOURNAL ENTRIES

January 1, 2011 Loss on troubled debt restructuring (to balance).......... 2,373,510

Accrued interest receivable (account balance)......... 1,200,000Note receivable ($12,000,000 - 10,826,490)............ 1,173,510

December 31, 2011Cash (required by new agreement).............................. 1,000,000Note receivable (to balance)........................….. ........ 82,649

Interest revenue (10% x $10,826,490).................... 1,082,649

December 31, 2012Cash (required by new agreement).............................. 1,000,000Note receivable (to balance)........................................ 90,861

Interest revenue (10% x [$10,826,490 + 82,649]). . . 1,090,861*

Cash (required by new agreement).............................. 11,000,000Note receivable (balance)........................................ 11,000,000

* rounded to amortize the note to $11,000,000 (per schedule below)

7-38



Amortization Schedule – Not required

Cash Effective Increase in OutstandingInterest Interest Balance Balance

by agreement 10% x Outstanding Balance Discount Reduction10,826,490

1 1,000,000 .10 (10,826,490) = 1,082,649 82,649 10,909,1392 1,000,000 .10 (10,909,139) = 1,090,861* 90,861 11,000,000

2,000,000 2,173,510 173,510* rounded

7-39


Exercise 7-29ANALYSIS

Previous Value:Accrued 2010 interest (10% x $240,000) $ 24,000Principal 240,000 Carrying amount of the receivable $264,000New Value:$11,555 + 11,555 + 11,555 + 240,000 = $274,665

$274,665 x 0.82645 * = (226,997 ) Loss: $ 37,003 * present value of $1: n=2, i=10% (from Table 2)

JOURNAL ENTRIES

January 1, 2011Loss on troubled debt restructuring (to balance).......... 37,003

Accrued interest receivable (10% x $240,000)........ 24,000Note receivable ($240,000 - 226,997)..................... 13,003

December 31, 2011Note receivable (to balance)........................................ 22,700

Interest revenue (10% x $226,997)......................... 22,700

December 31, 2012Note receivable (to balance)........................................ 24,968

Interest revenue (10% x [$226,997 + 22,700])........ 24,968*

Cash (required by new agreement).............................. 274,665Note receivable (balance)........................................ 274,665

* rounded to amortize the note to $274,665 (per schedule below)

7-40





by agreement 10% x Outstanding Balance Discount Reduction226,997

1 0 .10 (226,997) = 22,700 22,700 249,6972 0 .10 (249,697) = 24,968* 24,968 274,665

47,668 47,668* rounded

7-41


Exercise 7-30

Requirement 1

The specific citation that specifies these disclosure policies is FASB ACS 310–10–50–9: “Receivables—Overall—Disclosure—Accounting Policies for Credit Losses and Doubtful Accounts.”

Requirement 2

FASB ACS 310–10–50–9 reads as follows:

“In addition to disclosures required by this Subsection and Subtopic 450-20, an entity shall disclose a description of the accounting policies and methodology the entity used to estimate its allowance for loan losses, allowance for doubtful accounts, and any liability for off-balance-sheet credit losses and related charges for loan, trade receivable or other credit losses in the notes to the financial statements. Such a description shall identify the factors that influenced management's judgment (for example, historical losses and existing economic conditions) and may also include discussion of risk elements relevant to particular categories of financial instruments.”

7-42


http://asc.fasb.org/link&sourceid=SL2242617-111524&objid=6567777

Exercise 7-31

The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is:

1. Accounts receivables from related parties should be shown separately from trade receivables: FASB ACS 210–10–S99–1: “Balance Sheet—Overall—SEC Materials—General.” Also appears under ACS 310–10–45–13: “Receivables—Overall—Other Presentation Matters—Receivables from Officers, Employees or Affiliates, ” and under ASC 850–10–50–2: "Related Party Disclosures—Overall—Disclosure"

2. Definition of Cash Equivalents: FASB ACS 305–10–20: “Cash and Cash Equivalents—Overall—Glossary.”

3. Notes exchanged for cash are valued at the cash proceeds: FASB ACS 310–10–30–2: “Receivables—Overall—Initial Measurement—Notes Exchanged for Cash.”

4. The two conditions that must be met to accrue a loss on an account receivable: FASB ASC 310-10-35-8: "Receivables—Overall—Subsequent Measurement."

7-43


CPA / CMA REVIEW QUESTIONSCPA Exam Questions

1. a. Allowance for uncollectible accounts, beginning balance $260,000Add: Bad debt expense (2% × $9,000,000) 180,000Less: Write-offs (325,000)Allowance for uncollectible accounts, ending balance $115,000

2. a. Accounts receivable, beginning balance $ 600Add: Credit sales 3,200Less: Write-offs (200)Less: Accounts receivable, ending balance (500)Cash collections $3,100

3. c. The reinstatement of a previously written off account increases the allowance account. The collection of the reinstated account does not affect the allowance account. The net effect of the reinstatement and collection is an increase in the allowance account. Neither the reinstatement nor the subsequent collection of the account has any effect on the expense.

4. b. Accounts receivable, beginning balance $ 650,000Add: Credit sales 2,700,000Less: Sales returns (75,000)Less: Write-offs (40,000)Less: Cash collections (2,150,000)Accounts receivable, ending balance $1,085,000

5. c. The key phrase is "without recourse" which means that Gar Co. has transferred the collection risk to Ross Bank. Ross does not have any recourse against Gar Co. if the accounts are not collected. Thus, Gar has sold the accounts receivable to Ross Bank and has also transferred the risk associated with collection.

7-44


7-45


CPA Exam Questions (concluded)

6. a. The aging method is a balance sheet approach that calculates the required ending balance in the allowance for uncollectible accounts. The calculation is as follows:

7. a. The estimate using the income statement approach is:$1,750,000 x 2% = $35,000

The estimate using the balance sheet approach is:

Required ending balance ($900,000 x 5%) $45,000Less: Allowance for uncollectible accounts before recording bad debt expense (16,000)Bad debt expense $29,000

7-46


7-47


Requirement 1Monthly bad debt expense accrual summary.

Bad debt expense (3% x $2,620,000)................................. 78,600Allowance for uncollectible accounts......................... 78,600

To record year 2011 accounts receivable write-offs.


Requirement 2

CMA Exam Questions1. c. The allowance method records bad debt expense systematically as a percentage of either credit sales or the level of accounts receivable. The latter calculation considers the amount already existing in the allowance account. The credit is to a contra asset or allowance account. As accounts receivable are written off, they are charged to the allowance account.

2. d. If a company uses the allowance method, the write-off of a receivable has no effect on total assets. The journal entry involves a debit to the allowance account and a credit to accounts receivable. The net effect is that the asset section is both debited and credited for the same amount. Thus, there will be no effect on either total assets or net income.

3. c. The entry is to debit bad debt expense and credit the allowance account. Net credit sales were $1,500,000 ($1,800,000 - $125,000 of discounts - $175,000 of returns). Thus, the expected bad debt expense is $22,500 (1.5% x $1,500,000). This amount is recorded regardless of the balance remaining in the allowance account from previous periods. The net effect is that the allowance account is increased by $22,500.

PROBLEMS Problem 7-1

7-48


Bad debt expense ........................................................... 4,300Allowance for uncollectible accounts (below)............. 4,300

Year-end required allowance for uncollectible accounts:

SummaryPercent Estimated

Age Group Amount Uncollectible Allowance0-60 days $430,000 4% $17,20061-90 days 98,000 15% 14,70091-120 days 60,000 25% 15,000Over 120 days 55,000 40% 22,000 Totals $643,000 $68,900

7-49


Problem 7-1 (concluded)


Beginning balance $54,000Add: Monthly bad debt accruals 78,600Deduct: Write-offs (68,000)Balance before year-end adjustment 64,600Required allowance (determined above) 68,900Required year-end increase in allowance $ 4,300

Requirement 3Bad debt expense for 2011:

Monthly accruals $78,600Year-end adjustment 4,300 Total $82,900

Balance sheet:

Current assets: Accounts receivable, net of $68,900 allowance for uncollectible accounts $574,100

7-50


Problem 7-2Requirement 1

(a)

Accounts receivable analysis ($ in thousands):

Balance, beginning of year ($580,640 + 6,590) $ 587,230Add: Credit sales 2,158,755Less: Cash collections (2,230,065)Less: Balance end of year ($504,944 + 5,042) (509,986)Accounts receivable written off during year $ 5,934

(b)

Allowance for uncollectible accounts analysis ($ in thousands):

Beginning balance $6,590Less: Write-offs (from above) (5,934)Less: Year-end balance (5,042)Bad debt expense for the current year $4,386

(c)

$4,386 of bad debt expense divided by $2,158,755 in credit sales equals .2% (.002).

Requirement 2(a) ($ in thousands)

Current year Previous yearCurrent assets: Receivables $509,986 $587,230

(b) ($ in thousands)

Bad debt expense would be equal to actual receivables written offof $5,934.

7-51


Requirement 1

2009 2008 ($ in thousands)

Accounts receivable, net $13,306 $22,652Add: Allowances 451 404 Accounts receivable, gross $13,757 $23,056

Requirement 2($ in thousands)The answers to this question require an analysis of both gross accounts receivable

and the allowance for uncollectible accounts for 2009. First of all, 2009 sales of $174,642 plus the decrease in receivables reported in the statement of cash flows indicates cash received from customers of $183,988 ($174,642+ 9,346).

The activity in gross accounts receivable would be:

Gross Accounts Receivable__________________________________________

($ in thousands)Beg. Bal. 23,056Sales 174,642

183,988 CollectionsWriteoffs 47

_________________End. Bal. 13,757

Note that, to make the T-account balance, this solution debits accounts receivable for writeoffs. Rather than decreasing A/R by writing off accounts, Cirrus must be reinstating some previously written off accounts after determining that those accounts are now collectible, making the journal entry:

Accounts Receivable................................................................47Allowance for Uncollectible Accounts.................................... 47

Problem 7-3

7-52


Problem 7-3 (continued)

Considering the Allowance for Uncollectible Accounts in light of these “negative writeoffs” leads to the conclusion that Cirrus had no bad debt expense:

Allowance for Uncollectible Accounts__________________________________________

($ in thousands) 404 Beg. Bal. 47 Reinstated A/R

-0- Bad Debt Expense

_________________ 451 End. Bal.

7-53



To record accounts receivable written off during the year 2011.


To record collection of account receivable previously written off.

Accounts receivable........................................................ 3,000Allowance for uncollectible accounts......................... 3,000

Cash................................................................................ 3,000Accounts receivable.................................................... 3,000

Requirement 2(a)

December 31, 2011Bad debt expense (3% x $1,750,000)................................. 52,500

Allowance for uncollectible accounts......................... 52,500

(b)

December 31, 2011Bad debt expense............................................................ 36,700

Allowance for uncollectible accounts (below)............. 36,700

7-54



Accounts receivable analysis:Beginning balance $ 462,000 Add: Credit sales 1,750,000 Less: Write-offs (35,000) Less: Cash collections (1,830,000)Ending balance $ 347,000

$347,000 x 10% = $34,700 = Required allowance for uncollectible accounts

Allowance for uncollectible accounts analysis:Beginning balance $30,000 Add: Collection of receivable previously written off 3,000 Less: Write-offs (35,000)Balance before adjustment (2,000) debit balanceRequired allowance (determined above) 34,700Bad debt expense adjustment $36,700

(c)

December 31, 2011Bad debt expense............................................................ 37,047

Allowance for uncollectible accounts (below)............. 37,047

Required allowance:

Age Group AmountPercent

uncollectibleEstimated allowance

0-60 days $225,550 4% $ 9,02261-90 days 69,400 15% 10,41091-120 days 34,700 25% 8,675Over 120 days 17,350 40% 6,940 Totals $347,000 $35,047

7-55



Allowance for uncollectible accounts analysis:Beginning balance $30,000 Add: Collection of receivable previously written off 3,000 Less: Write-offs (35,000)Balance before adjustment (2,000) debit balanceRequired allowance 35,047Bad debt expense adjustment $37,047

Requirement 3Accounts receivable - Year-end allowance

(a) $347,000 - [$(2,000) + 52,500] = $296,500

(b) $347,000 - 34,700 = $312,300

(c) $347,000 - 35,047 = $311,953

Requirement 1 ($ in millions)

2009 2008Accounts receivable, net $837,010 $758,200 Add: Allowances 20,991 23,314Accounts receivable, gross $858,001 $781,514

Requirement 2($ in millions)

Analysis of allowance for doubtful accounts Balance, beginning of year $8,915 Add: Bad debt expense 1,500 Less: Balance end of year (8,863 ) Write offs $1,552


Analysis of allowance for sales returnsBalance, end of year $12,128 Add: Actual returns 3,155

Problem 7-5

7-56


Less: Balance beginning of year (14,399 ) Estimated sales returns $ 884

Gross sales for the year equal net sales of $6,149,800 + estimated sales returns of $884 = $6,150,684 thousand.


Accounts receivable analysis: Balance, beginning of year $ 781,514 Add: Credit sales 6,150,684 Less: Bad debt write-offs (1,552) Less: Actual sales returns (3,155) Less: Balance end of year (858,001)Cash collections $6,069,490

7-57



Total face value of notes = $300,000 + 150,000 + 200,000 = $650,000Balance sheet carrying value = 645,000Difference is the remaining discount on note 3 $ 5,000

Note 3 is a 6-month note, with three months remaining. Therefore, $5,000 represents one-half of the total discount of $10,000.$10,000 ÷ $200,000 = 5% x 12/6 = 10% discount rate.

Requirement 2Total accrued interest receivable $16,000

Less: Interest accrued on note 1: $300,000 x 10% x 4/12 = (10,000)

Interest accrued on note 2 $ 6,000

$6,000 ÷ $150,000 = 4% x 12/6 = 8%

Requirement 3Note 1 $10,000Note 2 6,000Note 3 ($200,000 x 10% x 3/12) 5,000 Total interest revenue $21,000

7-58



Alternative a:

To record the borrowing of $500,000 and signing of a note payable.

July 1, 2011Cash................................................................................ 500,000

Note payable............................................................... 500,000

Alternative b:

To record the transfer of receivables.

July 1, 2011Cash ($550,000 x 98%)....................................................... 539,000Loss on transfer of receivables (2% x $550,000)............... 11,000


Requirement 2

Alternative a:

July, 2011Cash (80% x $780,000)....................................................... 624,000


July 31, 2011Interest expense ($500,000 x 12% x 1/12)............................ 5,000Note payable................................................................... 500,000

Cash............................................................................ 505,000

7-59



Alternative b:

$550 of accounts receivable are now held by the bank, and presumably the bank has collected .8 x $550 = $440 during July. Lonergan still holds accounts receivable of ($780 – $550 = $230), so should have collected .8 x $230 = $184 during July.

July 31, 2011Cash [80% x ($780,000 - $550,000)]..................................... 184,000


Requirement 3Alternative a. – Note disclosure is required for the assignment of accounts

receivable as collateral for the $500,000 note.

Alternative b. – No disclosure is required since the transfer of receivables was made without recourse.

Cash (90% x $800,000)....................................................... 720,000Loss on sale of receivables (to balance)............................ 52,000Receivable from factor ($60,000 fair value – [4% x $800,000]) 28,000


Problem 7-8

7-60


Problem 7-9

Walken CompanyBalance SheetDecember 31, 2011

Current Assets

Casha €35,000

Accounts Receivable (net)b 60,000

aWalken would net the €40,000 and (€5000) cash balances, yielding a balance of €35,000.

bNet Accounts Receivable would be affected as follows:Beginning balance: € 25,000Credit sales 85,000Cash collections (30,000)Receivables factored with Reliable (20,000)Receivables factored with Dependablec -0-

Total €60,000

cThe receivables factored with Dependable don’t qualify for sales treatment, as sub-stantially all risks and rewards of ownership are retained by Walken.

7-61



February 28, 2011Note receivable............................................................... 10,000

Sales revenue.............................................................. 10,000

March 31, 2011Note receivable (face amount)........................................... 8,000

Discount ($8,000 x 10%)............................................... 800Sales revenue (difference)............................................. 7,200

April 3, 2011Accounts receivable........................................................ 7,000

Sales revenue.............................................................. 7,000

April 11, 2011Cash (98% x $7,000).......................................................... $6,860Sales discounts (2% x $7,000)........................................... 140


April 17, 2011Sales returns.................................................................... 5,000


Inventory......................................................................... 3,200Cost of goods sold...................................................... 3,200

7-62



April 30, 2011Cash (99% x $50,000)......................................................... 49,500Loss on sale of receivables (1% x $50,000)....................... 500


To accrue interest on note receivable for four months.

June 30, 2011Interest receivable........................................................... 333

Interest revenue ($10,000 x 10% x 4/12).......................... 333

To record discounting of note receivable.

June 30, 2011Cash (proceeds determined below)....................................... 10,266Loss on sale of note receivable (to balance)...................... 67

Interest receivable (from adjusting entry)........................ 333Note receivable (face amount)....................................... 10,000



August 31, 2011 — NO ENTRY REQUIRED

7-63



Requirement 2

To accrue nine months' interest on the Maddox Co. note receivable.

Discount ......................................................................... 600Interest revenue ($8,000 x 10% x 9/12)............................ 600

Requirement 3Income

Date increase (decrease)February 28 $10,000March 31 7,200April 3 7,000April 11 (140)April 17 (5,000)April 17 3,200April 30 (500)June 30 333June 30 (67)December 31 600 Total effect $22,626

7-64


Problem 7-11

NoteNote Face

ValueDate of

NoteInterest

RateDate

DiscountedDiscount

RateProceeds Received

1 $50,000 3-31-11 8% 6-30-11 10% $50,350 (1)

2 50,000 3-31-11 8% 9-30-11 10% 51,675 (2)

3 50,000 3-31-11 8% 9-30-11 12% 51,410 (3)

4 80,000 6-30-11 6% 10-31-11 10% 81,027 (4)

5 80,000 6-30-11 6% 10-31-11 12% 80,752 (5)

6 80,000 6-30-11 6% 11-30-11 10% 81,713 (6)

(1)$50,000 Face amount 3,000 Interest to maturity ($50,000 x 8% x 9/12)53,000 Maturity value




7-65











7-66



In addition to sales revenue of $1,340,000, the 2012 income statement will include (1) interest revenue, (2) bad debts expense, and (3) loss on sale of note receivable.

Interest revenue$200,000 note: $200,000 x 6% x 3/12 = $3,000$60,000 note: $ 60,000 x 8%(1) x 10/12 = 4,000 Total interest revenue $7,000

(1) The interest rate on the $60,000 note can be determined as follows:Interest receivable in 12/31/11 balance sheet = $6,800Less: Interest on $200,000 note: $200,000 x 6% x 6/12 = (6,000) Interest on $60,000 note $ 800

$800 represents interest for two months (November and December of 2011) or $400 per month. Annual interest is $400 x 12 = $4,800. $4,800 $60,000 = 8% interest rate.

Bad debt expenseAnalysis of accounts receivable Beginning accounts receivable ($218,000 + 24,000) $ 242,000 Add: Credit sales 1,340,000 Less: Cash collections (1,280,000) Less: Write-offs (22,000 ) Ending accounts receivable $ 280,000

Analysis of allowance for uncollectible accounts Beginning allowance $24,000 Add: Bad debt expense ? Less: Write-offs (22,000)Ending allowance(2) $28,000

Therefore bad debt expense is $26,000 ($24,000 – 22,000 – 28,000)

(2)$280,000 x 10% = $28,000

7-67



Loss on sale of note receivableInterest accrued on the $200,000 note for nine months (6/30/11 to 3/31/12):$200,000 x 6% x 9/12 = $9,000Calculation of cash proceeds received from discounting note:

$200,000 Face amount 12,000 Interest to maturity ($200,000 x 6%)212,000 Maturity value (4,240 ) Discount ($212,000 x 8% x 3/12)$207,760 Cash proceeds

Carrying value of note $209,000 ($200,000 + $9,000 interest receivable) Less: Cash proceeds (207,760)

Loss on sale of note receivable $ 1,240

Requirement 2Accounts receivable, net of $28,000 in allowance for uncollectible accounts $252,000

Requirement 3Accounts receivable turnover ratio:

$1,340,000------------- = 5.7 $235,000(3)

(3)($218,000 + 252,000) 2 = $235,000

7-68


Problem 7-13Requirement 1Computation of balance per books:

Balance per bank statement $14,632.12Add: Deposits outstanding 575.00Deduct: Checks outstanding (1,320.25)

Error in recording rent check (18.00)Add: Automatic mortgage payment 450.00Add: Bank service charges 14.00Deduct: Deposit credit to company’s

account in error (875.00)Add: NSF check charge 85 .00

Balance per books $13,542 .87


Balance per bank statement $14,632.12Add: Deposits outstanding 575.00Deduct:

Bank error - deposit incorrectly credited to company account (875.00)Checks outstanding (1,320 .25 )

Corrected cash balance $13,011 .87


Balance per books $13,542.87Add: Error in recording rent check 18.00Deduct:

Automatic mortgage note payment (450.00)Service charges (14.00)NSF checks (85 .00 )

Corrected cash balance $13,011 .87

7-69



Requirement 2

To correct error in recording cash disbursement for rent.

Cash.................................................................... 18Rent expense.................................................. 18


Interest expense.................................................. 350Mortgage note payable....................................... 100Miscellaneous expense (bank service charges).. 14Accounts receivable (NSF checks).................... 85

Cash................................................................ 549

Requirement 3Checking account balance $13,011.87Petty cash 200.00U.S. treasury bills 5,000 .00 Total cash and cash equivalents $18,211 .87

7-70


7-71


Requirement 1Problem 7-14


Balance per bank statement $3,851Add: Deposits outstanding 2,150 (1)Deduct:

Bank error - deposit incorrectly credited to company account (1,300)Outstanding checks (831) (2)

Corrected cash balance $3,870


Balance per books $4,422Deduct:

Error in recording check #411 (90)Service charges (22)NSF checks (440)

Corrected book balance $3,870

(1) Receipts $42,650 Less: December receipts deposited:

Bank deposits $43,000Less: Deposit error (1,300)Less: Prior month's deposits outstanding (1,200 ) 40,500

Deposits outstanding, Dec. 31 $ 2,150

(2) Dec. disbursements $41,853 Error in recording check #411 90

Less: December checks cleared:Total checks cleared $41,918Prior month's checks:

#363 $123#380 56#381 86#382 340 (605) (41,313)

December checks outstanding 630 Add: check # 365 201Total checks outstanding, Dec. 31 $ 831

7-72



Requirement 2


Advertising expense........................................... 90Miscellaneous expense (bank service charges).. 22Accounts receivable (NSF checks).................... 440

Cash................................................................ 552

7-73


Requirement 1 ($ in millions)

Land..........................................................................................16Loss on debt restructuring..........................................................6

Note receivable......................................................................... 20Accrued interest receivable...................................................... 2

Requirement 2 ANALYSIS

Previous Value:Accrued 2010 interest (10% x $20,000,000) $ 2,000,000

Problem 7-15

7-74


Principal 20,000,000 Carrying amount of the receivable $22,000,000New Value:Interest $1 million x 3.16987 * = $ 3,169,870Principal $15 million x 0.68301 ** = 10,245,150 Present value of the receivable (13,415,020 ) Loss: $ 8,584,980 * present value of an ordinary annuity of $1: n=4, i=10% (from Table 4)** present value of $1: n=4, i=10% (from Table 2)

JOURNAL ENTRIES

January 1, 2011Loss on troubled debt restructuring (to balance)............... 8,584,980

Accrued interest receivable (10% x $20,000,000)........ 2,000,000Note receivable ($20,000,000 - $13,415,020).............. 6,584,980

December 31, 2011 Cash (required by new agreement)....................1,000,000Note receivable (to balance).................................341,502

Interest revenue (10% x $13,415,020).......................... 1,341,502



7-75





December 31, 2014Cash (required by new agreement)....................1,000,000Note receivable (to balance).................................454,609

Interest revenue (10% x $14,545,391).......................... 1,454,609*

Cash (required by new agreement)..................15,000,000Note receivable (balance).............................................. 15,000,000





1 1,000,000 .10(13,415,020) = 1,341,502 341,502 13,756,5222 1,000,000 .10(13,756,522) = 1,375,652 375,652 14,132,1743 1,000,000 .10(14,132,174) = 1,413,217 413,217 14,545,3914 1,000,000 .10(14,545,391) = 1,454,609* 454,609 15,000,000

4,000,000 5,584,980 1,584,980* rounded

7-76



Requirement 3 ANALYSIS

Previous Value:Accrued interest (10% x $20,000,000) $ 2,000,000Principal 20,000,000 Carrying amount of the receivable $22,000,000New Value:

$27,775,000 x 0.68301 * = (18,970,603 ) Loss: $ 3,029,397 * present value of $1: n=4, i=10% (from Table 2)

JOURNAL ENTRIES

January 1, 2011 ..... Loss on troubled debt restructuring (to balance)............... 3,029,397

Accrued interest receivable (10% x $20,000,000)........ 2,000,000Note receivable ($20,000,000 - 18,970,603)................. 1,029,397

December 31, 2011 ..... Note receivable (to balance)..............................1,897,060



Interest revenue (10% x [$18,970,603 + 1,897,060]). . . 2,086,766


Interest revenue (10% x balance [see schedule]).......... 2,295,443


Interest revenue (10% x balance [see schedule]).......... 2,525,128*

Cash (required by new agreement)..................27,775,000Note receivable (balance).............................................. 27,775,000


7-77






1 0 .10 (18,970,603) = 1,897,060 1,897,060 20,867,6632 0 .10 (20,867,663) = 2,086,766 2,086,766 22,954,4293 0 .10 (22,954,429) = 2,295,443 2,295,443 25,249,8724 0 .10 (25,249,872) = 2,525,128* 2,525,128 27,775,000

8,804,397 8,804,397* rounded

7-78


Requirement 1To account for the accounts receivable factored on April 1, 2011, Magrath should

decrease accounts receivable by the amount of accounts receivable factored, increase cash by the amount received from the factor, and record a loss equal to the difference. The loss should be reported in the income statement. Factoring of accounts receivable without recourse is equivalent to a sale.

Requirement 2Magrath should account for the collection of the accounts previously written off

as uncollectible as follows:

Increase both accounts receivable and the allowance for uncollectible accounts. Increase cash and decrease accounts receivable.

Requirement 3One approach estimates uncollectible accounts based on credit sales. This

approach focuses on income determination by attempting to match uncollectible accounts expense with the revenues generated.

The other approach estimates uncollectible accounts based on the balance in receivables or on an aging of receivables. The approach focuses on asset valuation by attempting to report receivables at realizable value.

CASES

Judgment Case 7-1

7-79


Communication Case 7-2Suggested Grading Concepts and Grading Scheme:

Content (70%)_______ 40 Explains the difference between the allowance method and the

direct write-off method.______ Direct write-off more objective.______ Direct write-off has potential to violate the matching

principle.

_______ 15 Even if uncollectibles are fairly stable, when significant variations do occur, profit will be overstated in one periodand understated in another period.

_______ 15 Even if uncollectibles remain constant, the direct write-off method will result in an overstatement of accounts receivablein the balance sheet.

_____________ 70 points

Writing (30%)_______ 6 Terminology and tone appropriate to the audience of a

company president.

_______ 12 Organization permits ease of understanding.______ Introduction that states purpose.______ Paragraphs that separate main points.

_______ 12 English______ Sentences grammatically clear and well organized,

concise.______ Word selection.______ Spelling.______ Grammar and punctuation.

_____________ 30 points

7-80


Judgment Case 7-3Requirement 1

a. Hogan should account for the sales discounts at the date of sale using the net method by recording accounts receivable and sales revenue at the amount of sales less the sales discounts available.Revenues should be recorded at the cash equivalent price at the date of sale. Under the net method, the sale is recorded at an amount that represents the cash equivalent price at the date of exchange (sale).

b. There is no effect on Hogan’s sales revenues when customers do not take the sales discounts. Hogan’s net income is increased by the amount of interest earned when customers do not take the sales discounts.

Requirement 2Trade discounts are neither recorded in the accounts nor reported in the financial

statements. Therefore, the amount recorded as sales revenues and accounts receivable is net of trade discounts and represents the cash equivalent price of the asset sold.

Requirement 3To account for the accounts receivable factored on August 1, 2011, Hogan should

decrease accounts receivable by the amount of the accounts receivable factored, increase cash by the amount received from the factor, and record a loss. Factoring of accounts receivable without recourse is equivalent to a sale. The difference between the cash received and the carrying amount of the receivables is a loss.

Requirement 4Hogan should report the face amount of the interest-bearing notes receivable and

the related interest receivable for the period from October 1 through December 31 on its balance sheet as current assets. Both assets are due on September 30, 2012, which is less than one year from the date of the balance sheet.

Hogan should report interest revenue from the notes receivable on its income statement for the year ended December 31, 2011. Interest revenue is equal to the amount accrued on the notes receivable at the appropriate interest rate.

Interest revenue is realized with the passage of time. Accordingly, interest revenue should be accounted for as an element of income over the life of the notes receivable.

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Requirement 1Required allowance $180,000Revised allowance 135,000Increase in income before taxes of proposed change $ 45,000

Requirement 2Discussion should include these elements.

Ethical Dilemma:You as the assistant controller have a responsibility to follow GAAP and make a

reasonably accurate estimate of the net realizable value of receivables. Is your responsibility to fairly present Stanton Industries' financial statements to external users greater than your obligation to improve the financial position of your employer?

Alternative actions and consequences include:

1. Refuse to comply with the controller's request to change the aging category of the large account.Positive consequences:

a. Preservation of your honesty and integrity.b. Fair presentation of the net realizable value of receivables.

Negative consequences:a. Possible loss of your job.b. Lower net income for Stanton Industries.c. A devalued stock price for Stanton Industries.

2. Comply with the controller's suggestion to report the allowance for uncollectible accounts at $135,000.Positive consequences:

a. Retention of your job.b. A more favorable net income for Stanton Industries.c. A more favorable position with unknowing creditors, financial analysts,

current investors, and future investors.Negative consequences:

a. Endure guilt feelings.b. A lack of trust in you by other managers and employees.c. Possible litigation from investors and creditors.

Ethics Case 7-4

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Case 7-4 (concluded)

3. Report the controller's suggestion to a higher level of management, the audit committee, or the auditors. If one of these parties corrects the controller and compels fair reporting of the allowance account, the consequences would be the same as in alternative 1 when you refuse to make the adjustment. Your job may still be in jeopardy due to the fact that management may consider whistle blowing as indicative of employee disloyalty. If the reportee parties agree with the controller and report the incorrect amount of $135,000, the consequences will be similar to those for the second alternative in 2, except that you run an even greater risk of losing your job.

4. Refuse to comply with the controller's request and resign as assistant controller. If you report the controller's suggestion to higher management, the audit committee, or the auditor, the positive and negative considerations are the same as for alternative 3. If you do not report the controller's request, then the consequences are the same as for alternative 2. In either case your job is not an issue since you have already resigned.

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Judgment Case 7-51. A weakness is created by the fact that John need only submit a list of accounts and

amounts to be charged to replenish the petty cash fund. The supporting documentation for the petty cash disbursements also should be submitted with John’s list and reviewed by someone else. Surprise counts of the fund also should be made to ensure that the fund is being maintained on an imprest basis, that is, to ensure that cash and/or receipts equal $200 at all times.

2. The internal control system for disbursements does not contain sufficient separation of duties. Dean Leiser approves the vouchers, signs the checks, maintains the disbursement records, and reconciles the bank account. There should be at least one other person involved in these activities to ensure accuracy and to safeguard cash from expropriation.

3. The internal control system for receipts does not contain sufficient separation of duties. Fran Jones has physical control of the deposits and also maintains the subsidiary ledger for accounts receivable. These duties should be separated. In addition, the company should require that customers pay their bills via check and that cash not be used.

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Real World Case 7-6Requirement 3

Answers will, of course, vary depending on the year. The following were reported in the financial statements for the year ended December 31, 2008 ($ in millions):

a. Net trade accounts receivable + Allowance for doubtful accounts = Grossaccounts receivable$687.8 + 127.9 = $815.7

b. The statement of cash flows indicates bad debt expense (provision for doubtful accounts) of $195.5

c. Beginning allowance for doubtful accounts + Bad debt expense - Bad debt write-offs = Ending allowance for doubtful accounts$141.1 + 195.5 - Write-offs = $127.9Write-offs = $208.7

d. Beginning trade accounts receivable + Credit sales - Bad debt write-offs - Cash collected = Ending trade accounts receivableBeginning trade accounts receivable = $795.0+ 141.1 = $936.1$936.1 + 10,588.9– 208.7 – Cash collections = $815.7Cash collections = $10,500.6

McLaughlin's underestimation of bad debts is treated as a change in accounting estimate. Changes in estimates are accounted for prospectively. When a company revises

a previous estimate, prior financial statements are not restated. Instead, the company merely incorporates the new estimate in any related accounting determinations from then on. In this case, bad debt expense for 2012 will be higher than it would have been had not the underestimation occurred. A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for 2012.

Integrating Case 7-7

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Analysis Case 7-8Requirement 1

These methods can be described by one of two basic arrangements:1. A secured borrowing, or2. A sale of receivables.

When a company chooses between a borrowing and a sale, the critical element is the extent to which it (the transferor) is willing to surrender control over the assets transferred. Specifically, the transferor is determined to have surrendered control over the receivables if and only if three sale conditions are met.

Secured borrowings usually take the form of an assignment of receivables. An assignment of receivables is a promise by the borrower (the owner of the receivables) that any failure to repay debt owed to the lender in accordance with the debt agreement, will cause the proceeds from collecting the receivables to go directly toward repayment of the debt. This arrangement is no different from the use of a building as collateral for a mortgage loan. The assignor (borrower) assigns the assignee (lender) the rights to specific receivables as collateral for a loan. A variation of assigning specific receivables is when trade receivables in general rather than specific receivables are pledged as collateral. The responsibility of collection of the receivables remains solely with the company. This variation is referred to as a pledging of accounts receivable.

Two popular arrangements used for the sale of receivables are factoring and securitization. A factor is a financial institution that buys receivables for cash, handles the billing and collection of the receivables, and charges a fee for this service. Actually, credit cards like VISA and Mastercard are forms of factoring arrangements. The seller relinquishes all rights to the future cash receipts in exchange for cash from the buyer (the factor).

Another popular arrangement used to sell receivables is a securitization. In a typical accounts receivable securitization, the company creates a Special Purpose Entity (SPE), usually a trust or a subsidiary. The SPE buys a pool of trade receivables, credit card receivables, or loans from the company, and then sells related securities, for example bonds or commercial paper, that are backed (collateralized) by the receivables.

Similar to accounts receivable, a note receivable can be used to obtain immediate cash from a financial institution either by pledging the note as collateral for a loan or by selling the note. The transfer of a note is referred to as discounting.

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Case 7-8 (concluded)Requirement 2

In an assignment of specific receivables, usually the amount borrowed is less than the amount of receivables assigned. The difference provides some protection for the lender to allow for possible uncollectible accounts. Also, the assignee (transferee) usually charges the assignor an up-front finance charge in addition to stated interest on the collateralized loan. The borrower, assignor, records the loan liability, the finance fee expense, and the cash borrowed.

No special accounting treatment is needed for an assignment of receivables in general, and the arrangement is simply described in a disclosure note.

The specific accounting treatment for the sale of receivables using factoring and securitization arrangements depends on the amount of risk the factor assumes, in particular whether it buys the receivables without recourse or with recourse.

When a company sells accounts receivable without recourse, the buyer assumes the risk of uncollectibility. This means the buyer has no recourse to the seller if customers don’t pay the receivables. In that case, the seller simply accounts for the transaction as a sale of an asset. The buyer charges a fee for providing this service, usually a percentage of the book value of receivables. Because the fee reduces the proceeds the seller receives from selling the asset, the seller records a loss on sale of assets. The typical factoring arrangement is made without recourse.

When a company sells accounts receivable with recourse, the seller retains the risk of uncollectibility. In effect, the seller guarantees that the buyer will be paid even if some receivables prove to be uncollectible. Even if receivables are sold with recourse, as long as the three conditions for sale treatment are met, the transferor would still account for the transfer as a sale. The only difference would be the additional requirement that the transferor record the estimated fair value of the recourse obligation as a liability. The recourse obligation is the estimated amount that the transferor will have to pay the transferee as a reimbursement for uncollectible receivables.

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Real World Case 7-9Requirement 1

Sanofi-Aventis uses the terms “provision for impairment” and “impairment”for “allowance for bad debts”. The (€88) is the allowance necessary to adjust gross accounts receivable for estimated bad debts.

Requirement 2

Sanofi-Aventis does not factor or securitize its receivables. We know this because note D.10 states “Group policy is to retain receivables until maturity, and hence not to use receivables securitization programs.”

Requirement 3

a. Accounts receivable would be reduced in the period of change, as Sanofi-Aventis would collect outstanding receivables and immediately securitize new receivables.

b. Cash flow from operations would be increased in the period of change, as Sanofi-Aventis would show cash inflows both from collecting outstanding receivables and from immediately securitizing new receivables.

c. Accounts receivable would be stable at a relatively low level, as Sanofi-Aventis would immediately securitize new receivables.

d. Cash flow from operations would return to approximately its former level, as Sanofi-Aventis would show cash inflows only from immediately securitizing new receivables.

Requirement 4

The answers to requirement 3 highlight that decisions to increase or decrease the extent of securitization create one-time changes in receivables and cash flows in the period in which the company transitions to the new level. For example, increasing securitization will boost cash flow in the period of change. However, the increased cash flow is only temporary – in future periods cash flow will revert to former levels unless the company increases the extent of securitization yet further.

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Research Case 7-10Requirement 1

When a company sells accounts receivable without recourse, the buyer assumes the risk of uncollectibility. This means the buyer cannot pursue collection from the seller (has no recourse) if customers don’t pay the receivables.

Requirement 2

FASB ASC 860–10–40–5: “Transfers and Servicing—Overall—Derecognition—Criteria for a Sale of Financial Assets.”

The transferor is determined to have surrendered control over the receivables if and only if all of the following conditions are met:

a. The transferred assets have been isolated from the transferor - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.

b. Each transferee has the right to pledge or exchange the assets it received.c. The transferor does not maintain effective control over the transferred assets

through either (1) an agreement that the transferor repurchase or redeem them before their maturity or (2) the ability to cause the transferee to return specific assets.

(These criteria were included in Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" subsequently modified by SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140”. The above conditions can be found in paragraph 9 of the standard.)

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Case 7-10 (concluded)

Requirement 3

Cash (90% x $400,000)....................................................... 360,000Loss on sale of receivables (to balance)............................ 31,000Receivable from factor ($25,000 fair value – [4% x $400,000]) 9,000


Requirement 4

FASB ACS 860–10–40–24: “Transfers and Servicing—Overall—Derecognition – Effective Control Through Both a Right and an Obligation (previously paragraph 47 of SFAS No. 140) lists the following conditions:

a. The assets to be repurchased or redeemed are the same or substantially the same as those transferred.

b. The transferor is able to repurchase or redeem them on substantially the agreed terms, even in the event of default by the transferee.

c. The agreement is to repurchase or redeem them before maturity, at a fixed or determinable price.

d. The agreement is entered into concurrently with the transfer.

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Analysis Case 7-11Requirement 1

Del Monte Smithfield

Receivables turnover = 3,627 = 15.6 12,488 = 18.7 233 667

Average collection = 365 = 23.4 days 365 = 19.5 days period 15.6 18.7

The receivable turnover ratios are in a close range with one another. This is not surprising since the companies operate in the same industry, selling similar products with similar terms and customers.

Requirement 2The objective of this requirement is to motivate students to obtain hands-on

familiarity with actual annual reports and to apply the techniques learned in the chapter. You may wish to provide students with multiple copies of the same annual reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective.

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Analysis Case 7-12Requirement 1Note 1 indicates “Cash and Cash Equivalents —All highly liquid investments, including credit card receivables due from banks, with original maturities of three months or less at date of purchase are carried at cost and are considered to be cash equivalents. All other investments not considered to be cash equivalents are separately categorized as investments.”

Requirement 2$8,352 (in millions) – from the Balance Sheet.

Requirement 3($ in millions, from Note 12) 2009 2008Net receivables $4,731 $5,961Add: Allowance 112 103 Gross receivables $4,843 $6,064

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British Airways Case

BA indicates “unused amounts reversed” and “exchange movement on revaluation”, both of which may appear unusual from the perspective of U.S. GAAP. “Unused amounts reversed” appear to capture that BA did not use the entire balance in the allowance account. Under U.S. GAAP it likewise would only add an amount to the balance necessary to account for additional bad debts. “Exchange movement on revaluation” relates to changes in currency exchange rates, which is not a topic dealt with in this text.

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