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1. Receivables are normally classified as (1) accounts receivable, (2) notes receivable, or(3) other receivables.
2. Dan’s Hardware should use the direct write-off method because it is a small business that has a relatively small number and volume of accounts receivable.
3. Contra asset, credit balance
4. The accounts receivable and provision for doubtful accounts may be reported at a net amount of $661,500 ($673,400 – $11,900) in the Current Assets section of the statement offinancial position. In this case, the amount of the provision for doubtful accounts should be shown separately in a note to the financial statements or in parentheses on the statement of financial position. Alternatively, the accounts receivable may be shown at the gross amount of $673,400 less the amount of the provision for doubtful accounts of $11,900, thus yielding net accounts receivable of $661,500.
5. (1) The percentage rate used is excessive in relationship to the accounts written off asuncollectible; hence, the balance in the allowance is excessive.
(2) A substantial volume of old uncollectible accounts is still being carried in the accounts receivable account.
6. An estimate based on analysis of receivables provides the most accurate estimate of the current net realizable value.
7. a. Sailfish Companyb. Notes Receivable
8. The interest will amount to $5,100 ($85,000 × 6%) only if the note is payable one year fromthe date it was created. The usual practice is to state the interest rate in terms of an annualrate, rather than in terms of the period covered by the note.
9. Debit Accounts Receivable for $243,600Credit Notes Receivable for $240,000Credit Interest Revenue for $3,600
11 Trade receivable is two one example of items in the loans and receivables category. From the perspective of accounting treatment, the IFRS for loans and receivables follows the nature of debt securities. Under this framework, IAS 39 requires loans and receivables to be measured initially at fair value. Valuation changesafter the initial purchase are accounted for at amortized cost using the effective interest method.
12 Classification for measurement is a foundation for accounting standards. Based on this principle and theissues from IAS 39, IFRS 9 Financial Instruments classifies financial assets by measurement methods. Inparticular, IFRS 9 classifies financial assets into two categories on the basis of measurement methods—amortized cost and fair value. This classification by itself refers to the measurement method, further clarifying the measurement methods for financial assets.
13 The primary difference between IAS 39 and IFRS 9 is in the classfication of financial instruments. The classification under IAS 39 is not based wholly on the measurement methods. Instead, the classification mixes a firm’s business models of financial instruments and measurement methods, creating confusions to accounting for financial instruments. In contrast, IFRS 9 classifies financial instruments by mmeasurement methods. In particular, IFRS 9 classifies financial instruments into the categories of fair value and amortized cost method.
14 IAS 39 classifies financial instruments into the four categories: (1) Financial assets at fair value through profit or loss (FVTPL), (2) Available-for-sale financial assets (AFS), (3) Loans andreceivables (LR), and (4) Held-to-maturity investments (HTM).IFRS 9 Financial Instruments classifies financial assets by measurement methods. Inparticular, IFRS 9 classifies financial assets into two categories on the basis of measurement methods—amortized cost and fair value. This classification by itself refers to the measurement method, further clarifying the measurement methods for financial assets.
15 According to IAS 39 and IFRS 9, loans and receivables are measured at amortized cost using effectiveinterest rate method. The effective interest rate is the implied discount rate under which the discounted valueof estimated future cash payments or receipts is equal to the net carrying amount.
Ex. 8–1Accounts receivable from the U.S. government are significantly different from receivables from commercial aircraft carriers such as Delta and United. Thus,Boeing should report each type of receivable separately. In its filing with theSecurities and Exchange Commission, Boeing reports the receivables togetheron the statement of financial position, but discloses each receivable separately in a note to the financial statements.
b. Johnson & Johnson: 3.4% ($340,000,000 ÷ $10,114,000,000)
c. Casino operations experience greater bad debt risk, since it is difficult to control the creditworthiness of customers entering the casino. In addition, individuals who may have adequate creditworthiness could overextend themselves and lose more than they can afford if they get caught up in the excitement of gambling. In contrast, Johnson & Johnson’s customers are primarily other businesses such as grocery store chains.
Balance Percent AmountNot past due $ 740,000 0.5% $ 3,7001–30 days past due 390,000 2% 7,800 31–60 days past due 85,000 4% 3,40061–90 days past due 28,000 14% 3,92091–180 days past due 42,000 32% 13,440Over 180 days past due 15,000 80% 12,000
Total $1,300,000 $44,260
Ex. 8–11
2014 Dec. 31 Bad Debt Expense 47,635
Allowance for Doubtful Accounts 47,635Uncollectible accounts estimate
c. Net profit would have been $9,375 higher in 2014 under the direct write-off method, because bad debt expense would have been $9,375 higher under the allowance method ($39,375 expense under the allowance method vs. $30,000 expense under the direct write-off method).
Net sales…………………………Accounts receivable……………Average accts. receivable………
Accts. receivable turnover……
Average daily sales………………
Days’ sales in receivables……
c. The accounts receivable turnover indicates an increase in the efficiency of collecting accounts receivable by increasing from 9.4 to 10.5, a favorable trend. The days’ salesin receivables also indicates an increase in the efficiency of collecting accounts receivable by decreasing from 39.0 to 34.8, which is a favorable trend. However,before reaching a final conclusion, the ratios should be compared with industryaverages and similar firms.
Ex. 8–24a. and b.
Net sales…………………………Accounts receivable……………Average accts. receivable………
Accts. receivable turnover……
Average daily sales………………
Days’ sales in receivables……
c. The accounts receivable turnover indicates a decrease in the efficiency of collecting accounts receivable by decreasing from 9.5 to 9.3, an unfavorable trend. The number of days’ sales in receivables increased from 38.6 to 39.4 days, also indicating an unfavorable trend in collections of receivables. These unfavorable trends are consistent with the economic downturn that occurred worldwide in Year 1 and Year 2. However, before reaching a final conclusion, both ratios should be compared with those of past years, industry averages, and similar firms.
$1,155,185 $1,108,567.5
Year 2 Year 1$10,706,588 $10,494,983$1,265,032 $1,045,338
Net sales…………………………Accounts receivable……………Average accts. receivable……
Accts. receivable turnover……
Average daily sales……………
Days’ sales in receivables……
c. The accounts receivable turnover indicates an increase in the efficiency of collecting accounts receivable by increasing from 30.7 to 37.3, a favorable trend.The days’ sales in receivables indicates an increase in the efficiency of collecting accounts receivable by decreasing from 11.9 to 9.8, also indicating a favorable trend. Before reaching a conclusion, however, the ratios should be compared with industry averages and similar firms.
Note: For computations of the individual ratios, see Ex. 8–27 and Ex. 8–28.
b. The Limited Brands has the higher average accounts receivable turnover ratio.
c. The Limited Brands operates a specialty retail chain of stores that sell directly to individual consumers. Many of these consumers (retail customers) pay with MasterCards or VISAs that are recorded as cash sales. In contrast, H.J. Heinz manufactures processed foods that are sold to food wholesalers, grocery store chains, and other food distributors that eventually sell Heinz products to individual consumers. Accordingly, because of the extended distribution chain, we would expect Heinz to have more accounts receivable than The Limited Brands. In addition, we would expect Heinz’s business customers to take a longer period to pay their receivables. Thus, we wouldexpect Heinz’s average accounts receivable turnover ratio to be lower thanThe Limited Brands, as shown in (a).
CustomerAdams Sports & FliesBlue Dun FliesCicada Fish Co.Deschutes SportsGreen River Sports 54 days (23 + 31)Smith River Co. 33 days (2 + 31)Western Trout Company 24 daysWolfe Sports
5. On the statement of financial position, assets would be overstated by $124,600, since the provision for doubtful accounts would be understated by $124,600. In addition, the equity (retained earnings) account would be overstated by $124,600, since bad debt expense would be understated and net profit overstated by $124,600 on the statement of comprehensive income.
2. Yes. The actual write-offs of accounts originating in the first two years are reasonably close to the expense that would have been charged to those years on the basis of 1% of sales. The total write-off of receivables originating in the first year amounted to $8,500 ($4,500 + $3,000 + $1,000), as compared with bad debt expense, based on the percentage of sales, of $9,000 ($900,000 × 1%). Forthe second year, the comparable amounts were $11,800 ($6,600 + $3,700 + $1,500)and $12,500 ($1,250,000 × 1%).
5. On the statement of financial position, assets would be overstated by $115,860, since the provision for doubtful accounts would be understated by $115,860. In addition, the equity (retained earnings) account would be overstated by $115,860, since bad debt expense would be understated and net profit overstated by $115,860 on the statement of comprehensive income.
2. Yes. The actual write-offs of accounts originating in the first two years are reasonably close to the expense that would have been charged to those years onthe basis of 1/4% of sales. The total write-off of receivables originating in the firstyear amounted to $30,600 ($18,000 + $9,000 + $3,600), as compared with bad debtexpense based on the percentage of sales, of $31,250 ($12,500,000 × 0.0025). For thesecond year, the comparable amounts were $35,600 ($21,200 + $9,300 + $5,100) and $37,000 ($14,800,000 × 0.0025).
CP 8–1By computing interest using a 365-day year for depository accounts (liabilities), Bev is minimizing interest expense to the bank. By computing interest using a 360-day year for loans (assets), Bev is maximizing interest revenue to the bank. However, federal legislation (Truth in Lending Act) requires banks to computeinterest on a 365-day year. Hence, Bev is behaving in an unprofessional manner.
CP 8–21. a. b.
Addition to Provision Accounts Writtenfor Doubtful Accounts Off During Year
2. a. The estimate of 1/2 of 1% of credit sales may be too large, since the provisionfor doubtful accounts has steadily increased each year. The increasing balanceof the provision for doubtful accounts may also be due to the failure to writeoff a large number of uncollectible accounts. These possibilities could be evaluated by examining the accounts in the accounts receivable subsidiaryledger for collectibility and comparing the result with the balance in theprovision for doubtful accounts.
Note to Instructors: Since the provision for doubtful accounts increased by 188% [($14,400 – $5,000) ÷ $5,000], while sales have increased by 27.5% [($5,100,000 – $4,000,000) ÷ $4,000,000], the increase cannot be explained by an expanding volume of sales.
CP 8–2 (Concluded)b. The balance of Allowance for Doubtful Accounts that should exist at
December 31, 2014, can only be determined after all attempts have been made to collect the receivables on hand at December 31, 2014. However, the account balances at December 31, 2014, could be analyzed, perhapsusing an aging schedule, to determine a reasonable amount of allowance and to determine accounts that should be written off. Also, past write-offs of uncollectible accounts could be analyzed in depth in order to develop a reasonable percentage for future adjusting entries, based on past history. Caution, however, must be exercised in using historical percentages. Specifically, inquiries should be made to determine whether any significant changes between prior years and the current year may have occurred, which might reduce the accuracy of the historical data. For example, a recent change in credit-granting policies or changes in the general economy (entering a recessionary period, for example) could reduce the usefulness of analyzing historical data.
Based on the preceding analyses, a recommendation to decrease the annual rate charged as an expense may be in order (perhaps Xtreme Co. is experiencing a lower rate of uncollectibles than is the industry average), or perhaps a change to the “estimate based on analysis of receivables” method may be appropriate.
CP 8–31. and 2.
Net sales…………………………Accounts receivable…………Average accts. receivable……
Accts. receivable turnover……
Average daily sales……………
Days’ sales in receivables……
3. The accounts receivable turnover indicates a decrease in the efficiency of collecting accounts receivable by decreasing from 25.6 to 23.0, an unfavorable trend. The days’ sales in receivables increased from 14.3 days to 15.9, an unfavorable trend. Thus, based on (1) and (2), Best Buy has decreased its efficiency in the collection of receivables.
CP 8–3 (Concluded)4. We assumed that the percentage of credit sales to total sales remains constant
from one period to the next and no major changes in operations occurred between years. For example, if the percentage of credit sales to total sales is not similar or if the percentage changes between years, then the ratios would be distorted and, thus, not comparable. Also, any major changes in operations could distort the comparison between years.
3. The accounts receivable turnover indicates a slight decrease in the efficiency of collecting accounts receivable by decreasing from 14.8 to 14.7, an unfavorable trend. The days’ sales in receivables increased from 24.6 days to 24.8, an unfavorable trend. Before reaching a more definitive conclusion, the ratios should be compared with industry averages and similar firms.
Net sales………………………………Accounts receivable…………………Average accts. receivable…………
Accts. receivable turnover…………
Average daily sales…………………
Days’ sales in receivables…………
3. The accounts receivable turnover indicates a decrease in the efficiency of collecting accounts receivable by decreasing from 64.5 to 61.7, an unfavorable trend. The days’ sales in receivables increased from 5.7 days to 5.9 days, an unfavorable trend. Before reaching a more definitive conclusion, the ratios should be compared with industry averages and similar firms.
4. Costco’s accounts receivable turnover would normally be higher than that of atypical manufacturing company such as H.J. Heinz Company. This is becausemany of Costco’s customers charge their purchases to American Express cardsor pay with checks or cash. In contrast, the customers of H.J. Heinz Company are other businesses that pay their accounts receivable on a less timely basis. Fora recent year, the accounts receivable turnover ratio for H.J. Heinz was 9.3(see Ex. 8–24).
Note: Costco does not accept MasterCard or Visa, but only American Express.
CP 8–61. Note to Instructors: The turnover ratios will vary over time. Recently, the
various turnover ratios (rounded to one decimal place) were as follows:
Alcoa Inc. ……………………………… 10.3AutoZone, Inc. ………………………… 58.4Barnes & Noble, Inc. ………………… 54.5Caterpillar ……………………………… 2.6The Coca-Cola Company …………… 8.6Delta Air Lines ………………………… 18.0The Home Depot ……………………… 66.4IBM ……………………………………… 3.4Kroger …………………………………… 93.7Procter & Gamble …………………… 12.0Walmart ………………………………… 91.4Whirlpool Corporation ……………… 7.0
Based on the above, the companies can be categorized as follows:
Alcoa Inc. AutoZone, Inc.Caterpillar Barnes & Noble, Inc.The Coca-Cola Company Delta Air LinesIBM The Home DepotProcter & Gamble KrogerWhirlpool Corporation Walmart
2. The companies with accounts receivable turnover ratios above 15 are all companiesselling primarily to individual consumers. In contrast, companies with turnoverratios below 15 are companies selling primarily to other businesses. Generally, wewould expect companies selling to individual consumers to have higher turnoverratios, since many customers will charge their purchases on credit cards. In contrast,companies selling to other businesses normally allow a credit period of at least 30days or longer.
Below 15 Above 15Accounts Receivable Turnover Ratio