Solution manual intermediate accounting 15e by stice ch07

a Methods for establishing and maintaining an allowance for bad debts account are as follows: 1 Allowance for Bad Debts is increased by a certain percentage of total sales or credit sale

CHAPTER 7 QUESTIONS

1 (a) A receivable evidenced by a formal,

written promise to pay is classified as

a note receivable; an informal,

unsecured promise to pay is classified

as an account receivable or other

appropriate title (e.g., advances to

officers)

(b) Receivables arising from the normal

operating activities of a business are

classified as trade receivables; those

from all other sources are nontrade

receivables

(c) All trade receivables and those

nontrade receivables expected to be

collected within 1 year (or the normal

operating cycle, whichever is longer)

are reported as Current Assets; all

other receivables are noncurrent and

are reported under the Investments or

Other Noncurrent Assets caption,

whichever is appropriate

2 (a) Methods for establishing and

maintaining an allowance for bad

debts account are as follows:

(1) Allowance for Bad Debts is

increased by a certain percentage

of total sales or credit sales

(2) Allowance for Bad Debts is

adjusted to a certain percentage

of receivables

(3) Allowance for Bad Debts is

adjusted to an amount determined

by aging the accounts

(b) The percentages to use in estimating

uncollectible accounts should be

based on the collection experience of

each individual company Analysis of

the past records can be made to

determine the relationships between

write-offs and sales or receivables If

there has been no recognizable

change in the economic conditions or

in the credit policy of the company,

these historical percentages may be

used as the best estimate of future

uncollectibles To the extent that these

conditions are changing, the

percentages will require appropriate

adjustment

3 GAAP requires the allowance method

because it provides for a matching ofcurrent revenues with related expenses,and it reports the receivables at their netrealizable value The direct write-offmethod is easy to apply and is objectivebut does not provide for proper matching

of revenues and expenses nor appropriatevaluation of receivables

4 (a) Adjustments to be made:

Age the receivables (including thedishonored notes) in order todetermine the amount by which toincrease Allowance for Bad Debts or tocreate an allowance balance if noneexists Write off worthless accounts of

$320 as follows:

Allowance for Bad Debts 320Accounts Receivable 320

(b) Accounts Receivable should appear

on the balance sheet under CurrentAssets at $9,572 This balanceconsists of the following:

Accounts from sales of the last three months $7,460Accounts from sales

prior to October 1 1,312Dishonored notes

charged back to customers’ accounts 800

$9,572The balance of Allowance for BadDebts should be deducted fromAccounts Receivable The creditbalances in customers’ accounts,

$1,190, should be reported as acurrent liability

5 Product warranties are obligations that

clearly exist at a balance sheet date, butthe amount to be paid cannot be definitelydetermined The amount of the claim istherefore estimated This estimatedliability should normally be recorded on anaccrual basis because the obligationcreated upon the sale of a product should

be matched with the revenue receivedfrom the sale

6 (a) Accounts receivable turnover is

computed by dividing net sales by the

average accounts receivable

outstanding for the year

(b) Average collection period is computed

by dividing average daily sales (net

sales ÷ 365) into the average

receivables for the year This

measurement can also be obtained by

dividing the number of days in a year

by the accounts receivable turnover

(c) The accounts receivable turnover

represents the average number of

sales or collection cycles completed

by a firm during a particular year The

average collection period shows the

average time required to collect

receivables

7 Cash, because it is the standard medium

of exchange, is required to complete

almost all business transactions

Therefore, a certain amount of cash must

be kept immediately available for daily

transactions It is management’s

responsibility to see that sufficient cash,

but not an excessive amount, is available

for current operating purposes To be

productive, any excess of “idle cash”

should be invested in temporary or

long-term investments

8 (a) Cash

(b) Investments, noncurrent receivables,

or other assets (not currently

available)

(c) Cash

(d) Other noncurrent assets (will be used

to acquire a noncurrent asset)

(e) Accounts receivable

9. The balance with Bank A should be

reported as cash The overdraft with Bank

B should be reported as a current liability

Even if the overdraft arose from deposited

checks that did not clear, it would

represent a liability to the bank The fact

that the overdraft is canceled

promptly is not

* Relates to Expanded Material

relevant; as of December 31, it would still have

to be regarded as a liability

10 Because the compensating balance is

legally restricted, the balance should be

segregated and reported separately

among the Cash Items in the current or

noncurrent asset section of the balance

sheet, depending on the nature of the

restrictions This will protect financial

statement readers from assuming that the

total cash balance is available to pay

current obligations

11 (a) Differences between depositor and

bank balances typically arise from the

(5) Direct collection by bank of

amounts owed to depositor

(6) Recording errors by the depositor

or the bank

(b) Items (3), (4), and (5) require entries

on the depositor’s books, as well as

item (6) if the error was made by the

depositor

12.* The practice of financing accounts

receivable has become very popular In

the past this form of financing was viewed

as a last resort for obtaining funds Now it

is often seen as a wise and legitimate

business tool that can be used to put the

assets of a company to work This change

in attitude results from the realization that

an available, easy-to-obtain form of

financing was not being used

13.* (a) (1) When receivables are sold, they

are removed from the books of the

seller and a gain or loss is

recognized for the difference

between the net proceeds

received and the carrying value of

the receivables

(2) When receivables are used as

collateral to secure loans, the

receivables remain on the books

and a loan is recorded The

amount of receivables assigned

should be disclosed in the notes to

the financial statements

(b) (1) The entry to record the sale of

receivables without recourseinvolves a debit to Cash for thesales price (less the amount, ifany, withheld by the factor), adebit to Loss from Factoring forthe charge made by the factor, adebit to Allowance for Bad Debts,and a credit to AccountsReceivable for the accounts sold

If the factor withholds a portion ofthe sales price pending finalsettlement, the amount withheld isrecorded as a debit to Receivablefrom Factor If the receivables aresold with recourse, the value ofthe recourse obligation must beestimated, and the loss on thesale is increased accordingly.(2) Accounting for receivablesinvolved in a secured borrowinginvolves making memorandumentries for data concerning thepledge

14.* According to FASB Statement No 140, the

following three conditions must be met inorder to record the transfer of accountsreceivable with recourse as a sale:

(1) The transferred assets must bebeyond the reach of the transferor andits creditors

(2) The transferees have the right topledge or exchange the transferred assets

(3) The transferor does not maintaineffective control over the assetsthrough an agreement to repurchasethem before their maturity or the ability

to cause the transferee to returnspecific assets

15.* (a) A note receivable should be recorded

at an amount different from its faceamount when face amount differs frompresent value Such a differencearises

when a note is noninterest bearing or

when the face amount of an

interest-bearing note is more or less than the

fair market value of the consideration

exchanged However, short-term trade

notes may be recorded at face amount

even when the face amount is not

equal to its present value

(b) The difference between a note’s face

amount and its present value is

initially recorded as a premium or

discount and amortized over the life of

the note The amortization procedure

is a systematic allocation of the

premium or discount to Interest

Revenue on the books of the holder of

the note and to Interest Expense on

the books of the issuer of the note

16.* An assignment is disclosed in a

parenthetical comment or note to the

balance sheet, stating the nature and

amount of the pledged receivables The

receivables continue to be reported as an

balance sheet, and the associated loan is reported as a liability

17.* Imputing a rate of interest is the process of

selecting and applying an interest ratedeemed appropriate under thecircumstances An imputed rate must bedetermined when no interest rate is stated

or when the stated rate is unreasonable,and the present value of a note cannot bedetermined by reference to the note itself

or to the consideration exchanged for thenote The selection of an appropriate rate

is based on factors such as the creditstanding of the issuer of the note,prevailing interest rates for notes withsimilar terms, and the rate at which thedebtor could obtain financing fromother sources at the time of thetransaction

PRACTICE EXERCISES PRACTICE 7−1 SIMPLE CREDIT SALE JOURNAL ENTRIES

Accounts Receivable 100,000

Sales 100,000 Cash 88,000

Accounts Receivable 88,000

PRACTICE 7−2 SALES DISCOUNTS: GROSS METHOD

Accounts Receivable 500

Sales 500

Cash ($200 × 0.97) 194

Sales Discounts 6

Accounts Receivable 200

Cash 300

Accounts Receivable 300

PRACTICE 7−3 SALES DISCOUNTS: NET METHOD Accounts Receivable ($500 × 0.97) 485

Sales 485

Cash 194

Accounts Receivable ($200 × 0.97) 194 Cash 300

Sales Discounts Not Taken 9 Accounts Receivable ($300 × 0.97) 291

PRACTICE 7−4 SALES RETURNS AND ALLOWANCES

Sales Returns and Allowances 10,000

Accounts Receivable 10,000 Inventory 7,000

Cost of Goods Sold 7,000

PRACTICE 7−5 BASIC BAD DEBT JOURNAL ENTRIES

Bad Debt Expense 8,000

Allowance for Bad Debts 8,000

Allowance for Bad Debts 7,300

Accounts Receivable 7,300

PRACTICE 7−6 RECOVERY OF AN ACCOUNT PREVIOUSLY WRITTEN OFF

July 23 Allowance for Bad Debts 7,500

Accounts Receivable 7,500

Nov 1 Accounts Receivable 7,500

Allowance for Bad Debts 7,500Cash 7,500

Accounts Receivable 7,500

PRACTICE 7−7 BAD DEBTS: PERCENTAGE OF SALES METHOD

Bad Debt Expense ($500,000 × 0.03) 15,000

Allowance for Bad Debts 15,000Allowance for Bad Debts 13,700

Accounts Receivable 13,700

PRACTICE 7−8 BAD DEBTS: PERCENTAGE OF ACCOUNTS RECEIVABLE METHOD

Bad Debt Expense 11,300

Allowance for Bad Debts 11,300

$100,000 × 0.12 = $12,000; $12,000 – $700 = $11,300

Allowance for Bad Debts 14,700

Accounts Receivable 14,700

PRACTICE 7−9 AGING ACCOUNTS RECEIVABLE

PRACTICE 7−10 ESTIMATION AND RECOGNITION OF WARRANTY EXPENSE

Warranty Expense ($500,000 × 0.06) 30,000

Estimated Warranty Liability 30,000Estimated Warranty Liability 32,000

Cash 32,000

PRACTICE 7−11 COMPARISON OF ACTUAL AND EXPECTED WARRANTY EXPENSE

Compare existing balance with estimated future repairs:

$150,000 × 0.04 = $6,000; $6,000 × 6/12 remaining = $3,000

Ending balance of $500 is much less than the estimated remaining repairs of $3,000

Compare past estimates with actual experience:

Again, actual repairs were greater than estimated repairs

The balance in the warranty liability account at the end of Year 2 appears to be much toolow Using the company’s own estimates, the balance should be $3,000 instead of $500 Inaddition, in the past two years the company has significantly underestimated the amount ofrepairs

PRACTICE 7−12 AVERAGE COLLECTION PERIOD

1 Average collection period: [($50,000 + $65,000)/2]/($400,000/365) = 52.5 days

2 Average collection period: $65,000/($400,000/365) = 59.3 days

PRACTICE 7−13 COMPUTATION OF CASH BALANCE

Savings account balance $10,000

Coin and currency 2,300

Cash balance $12,300

Restricted deposits in foreign bank accounts Receivable

Cash overdraft Payable

Post-dated customer checks Receivable

PRACTICE 7−14 BANK RECONCILIATION

Balance per bank statement $ 8,000

Add: Deposits in transit 3,600

$11,600Deduct: Outstanding checks 6,500

Correct balance $ 5,100

Balance per books $ 5,125

Add: Interest earned 30

$ 5,155Deduct: Bank service charge 55

Correct balance $ 5,100

PRACTICE 7−15 SALE OF RECEIVABLES WITHOUT RECOURSE

Cash 50,000

Receivable from Factor 3,000

Allowance for Bad Debts 2,500

Loss from Factoring Receivables 4,500

Accounts Receivable 60,000

PRACTICE 7−16 SALE OF RECEIVABLES WITH RECOURSE

Cash 50,000

Receivable from Factor 3,000

Allowance for Bad Debts 2,500

Loss from Factoring Receivables 5,800

Accounts Receivable 60,000Recourse Obligation 1,300

PRACTICE 7−17 ACCOUNTING FOR A SECURED BORROWING

If the transfer does not satisfy the three conditions contained in SFAS No 140, then it is not

accounted for as a sale but is instead recorded as a secured borrowing, as follows:

Cash 53,000

Loan Payable 53,000

PRACTICE 7−18 JOURNAL ENTRIES FOR INTEREST-BEARING NOTE

Year 1 Notes Receivable 1,000

Jan 1 Service Revenue 1,000

Year 1 Interest Receivable 80

Dec 31 Interest Revenue ($1,000 × 0.08 × 12/12) 80

Year 2 Cash 1,123

June 30 Notes Receivable 1,000

Interest Receivable 80Interest Revenue ($1,080 × 0.08 × 6/12) 43

PRACTICE 7−19 JOURNAL ENTRIES FOR NONINTEREST-BEARING NOTE

Year 1 Notes Receivable 1,000

Jan 1 Discount on Notes Receivable 143

Service Revenue 857Year 1 Discount on Notes Receivable 69

Dec 31 Interest Revenue ($857 × 0.08 × 12/12) 69

Year 2 Cash 1,000

Dec 31 Discount on Notes Receivable 74

Notes Receivable 1,000Interest Revenue [($857 + 69) × 0.08 × 12/12] 74

PRACTICE 7−20 NOTE EXCHANGED FOR GOODS OR SERVICES

Jan 1 Notes Receivable 1,000

Loss on Sale of Land 260

Land 1,260Dec 31 Cash 1,130

Notes Receivable 1,000Interest Revenue ($1,000 × 0.13 × 12/12) 130

PRACTICE 7−21 EFFECTIVE INTEREST AMORTIZATION METHOD

Year 1 Notes Receivable 1,000

Jan 1 Discount on Notes Receivable 249

Service Revenue 751

To compute the present value of the note: FV = $1,000; N = 3; I = 10% → PV = $751

Year 1 Discount on Notes Receivable 75

Dec 31 Interest Revenue (see following table) 75

Year 2 Discount on Notes Receivable 83

Dec 31 Interest Revenue (see following table) 83

Year 3 Cash 1,000

Dec 31 Discount on Notes Receivable 91

Notes Receivable 1,000Interest Revenue (see following table) 91

PRACTICE 7−22 BAD DEBTS AND THE DIRECT METHOD

Change in net accounts receivable balance:

Beginning of year ($12,000 − $2,500) $9,500End of year ($10,000 − $2,900) 7,100Decrease $2,400

Cash Flows Income StatementAdjustmentsfrom Operations

Cash expenses (44,000) 0 (44,000) Cash paid for expenses

Net income $ 5,000 $2,400 $ 7,400 Cash from operations

Cash collected from customers ($52,400 − $1,000) $ 51,400

Cash paid for expenses (44,000)

Cash flows from operating activities $ 7,400

PRACTICE 7−23 BAD DEBTS AND THE INDIRECT METHOD

See the solution to Practice 7−22

Cash collected from customers

Net income $5,000

Plus: Decrease in net accounts receivable 2,400

Cash flows from operating activities $7,400

10 E, prepaid insurance, current asset

11 E, payable, current liability

7–25 $98,000 – $23,500 = $74,500 cost of merchandise sold

$74,500 × 1.5 = $111,750 sales

$111,750 – $72,000 = $39,750 amount that should be in Accounts Receivable

$39,750 – $33,500 = $6,250 shortage in Accounts Receivable

7–26.

1 Cash collected on November 9 ($2,000 × 0.97) $1,940

Cash collected on December 9 3,000

Total cash collected $4,940

2 November 9

Cash ($2,000 × 0.97) 1,940

Sales Discounts ($2,000 × 0.03) 60

Accounts Receivable 2,000 December 9

Cash 3,000

Accounts Receivable ($3,000 × 0.97) 2,910 Sales Discounts Not Taken 90 For the seller, the account Sales Discounts Not Taken is a revenue account and reflects the implicit interest charge customers pay by not taking cash discounts Also, note that with the net method, the original sales amount is recorded at $4,850 ($5,000 × 0.97), which assumes that the sales discounts will

be taken.

7–27.

1 July 23

Accounts Receivable 4,500

Sales 4,500 Cost of Goods Sold 3,000

Cost of Goods Sold 1,000

4 Management must ensure that inventory is not recorded in the books at more

than its current value This lower-of-cost-or-market test would be especially important in this case because the customer has reported that the inventory does not meet the required specifications.

7–28 1 Bad Debt Expense [0.015 × ($1,690,000 – $14,000)] 25,140

Allowance for Bad Debts 25,140

2 Bad Debt Expense [(0.03 × $300,000) + $4,200] 13,200

Allowance for Bad Debts 13,200

3 Bad Debt Expense ($11,000 + $4,200) 15,200

Allowance for Bad Debts 15,200

7–29 1 Allowance for Bad Debts 1,350

Accounts Receivable (Phillip Hollister) 1,350

2 Accounts Receivable (Phillip Hollister) 1,350

Allowance for Bad Debts 1,350 Cash 1,350

Accounts Receivable (Phillip Hollister) 1,350

7–30 1 Blanchard Company

Analysis of Receivables December 31, 2005 0–30 31–60 61–90 91–120 Over 120

Customer Amount Days Days Days Days Days Allison, Inc $ 8,795 $ 3,500 $ 5,295

2 Total $2,643 (rounded) $16,400 × 0.007 = $ 114.80

11,080 × 0.014 = 155.12 8,150 × 0.035 = 285.25 7,350 × 0.102 = 749.70 2,230 × 0.600 = 1,338.00

$ 2,642.87

3 Bad Debt Expense ($2,643 – $2,245) 398

Allowance for Bad Debts 398

4 a The percentages applied under the aging method are based on

averages developed from prior experience Because the number of accounts are few, the averaging process is not fully applicable For example, the Banks Bros account may be collectible, uncollectible, or partially collectible, but the chances of not collecting

exactly 60% of the $2,230 and 10.2% of the $3,000 seem highly unlikely Similarly, the West Corp account will likely be collected in full, or not at all To expect to receive 89.8% (100% – 10.2%) is unrealistic When accounts are few in number, an analysis of each individual receivable’s collectibility will provide a more realistic estimation of uncollectible accounts.

b Yes All methods of estimating bad debts are based on averages.

An averaging process requires a sufficient total number of items to make the estimate accurate The larger the test population, the less effect each item in the population has on the average This helps to eliminate errors resulting from the use of an item that is uncharacteristic of the trend being estimated.

7–31 1 2003 2004 2005

Beginning allowance balance $21,500 $35,500 $50,000 Estimated uncollectibles (2% of sales) 39,500 50,000 47,000 Total allowance before write-offs $61,000 $85,500 $97,000 Ending allowance balance 35,500 50,000 66,000 Accounts written off $25,500 $35,500 $31,000

2 Aging of accounts receivable would indicate whether the increase in the allowance is justified.

Cash, Inventory, etc 22,450

2 2004 sales still under warranty for 6 months

($500,000 × 1/2 × 0.09)(a) $ 22,500

2005 sales still under warranty for 18 months ($625,000 × 0.09) + ($625,000 × 1/2 × 0.03)(a) 65,625

$ 88,125 Ending balance in liability accounts $101,950 (b)

Predicted future warranty repairs 88,125 Difference $ 13,825 This difference is fairly large The estimates from the manufacturer may need to be adjusted.

EXPLANATIONS

(a) Because sales are made evenly during the year, one-half of warranty costs associated with one calendar year are actually incurred in the following calendar year.

(b) Balance in liability account at end of 2004 ($60,000 – $10,600) $ 49,400 Increase in liability account during 2005

($75,000 – $22,450) 52,550 Balance in liability account at end of 2005 $101,950

7–33 2004 Cash 18,000

Unearned Revenue from Service Contracts 18,000

To record cash received from sale of

Unearned Revenue from Service Contracts 21,000

To record cash received from sale of service

EXPLANATIONS

(a)Because sales are made evenly during the year, one-half of 2004 estimated repairs and one-half of 2005 estimated repairs are realized in 2005.

(b)300 contracts sold in 2004 at $60 each.

(c)350 contracts sold in 2005 at $60 each.

Cost of Servicing Television Service Contracts 9,630 Cash, Inventory, etc 9,630

To record the repairs actually made during the year.

Total revenue from service contracts in 2005 $ 11,040 Total actual expenses relating to service contracts 9,630 Profit from service contracts in 2005 $ 1,410

7–34 1 Net sales $1,430,000

2005 net receivables 223,000

2004 net receivables 202,000 Average net receivables

[($223,000 + $202,000) ÷ 2] 212,500 Accounts receivable turnover: $1,430,000 ÷ $212,500 = 6.73 times

2 $1,430,000 ÷ 365 = $3,917.81

$212,500/$3,917.81 = 54.24 days

(2) (a) (9) (d) (3) (c) (10) (d) (4) (a) (11) (a) (5) (a) (12) (d) (6) (b) (13) (a)—the $16 portion (7) (f) (14) (a)

2 Checking account at Second Security $350

Payroll account 100

Sales tax account 150

Traveler’s check 50

Cash in petty cash fund 16

Money order 36

Total $ 702 The other items are restricted or are not acceptable for deposit at face value by a bank Also, two of the above items (i.e., the payroll account and the sales tax account) might be reported separately if considered material because they are restricted in terms of their use.

7–36 1 Restricted Cash 6,000,000

Revenue Received in Advance 6,000,000

2 Restricted Cash would be shown as a current asset separate from Cash The asset is current because it relates to an obligation (to provide vacations), which presumably will be satisfied within 1 year Revenue Received in Advance would be shown as a current liability The nature of the cash restriction would also probably be disclosed in the notes to the financial statements.

7–37 Cash is $1,755,000 ($35,000 + $1,450,000 + $270,000) The $150,000

compensating balance amount should be included in Cash, but the nature

of the agreement should be disclosed in the notes to the financial statements The $3,000,000 restricted time deposits would be shown as Restricted Cash in the Current Asset section.

7–38 Balance per bank statement $28,046

Add: Deposits in transit 3,689

$31,735 Deduct: Outstanding checks 6,530 Correct balance $25,205 The service charge, interest, and recording error are all items that were handled correctly by the bank.

7–39 Balance per Letterman’s books $9,213

Add: Unrecorded check received but not yet deposited 350

$9,563 Deduct: Service charge $130

NSF check 400 530 Correct balance $9,033 The deposits in transit and outstanding checks have already been handled properly by Letterman.

Bank Reconciliation September 30 Balance per bank statement $15,496.91 Add: Deposits in transit $2,615.23

Check charged incorrectly 617 .08 3,232.31 Deduct: Outstanding checks (3,079.51) Corrected bank balance $15,649 71 Balance per books $14,692.71 Add: Collection of note 1,045.00 Deduct: Bank service charge $ 25.00

Transposition error 63 .00 (88.00) Corrected book balance $15,649 71

2 Journal entry to correct Thalman Auto’s books:

Miscellaneous Expense 25 Sales ($1,792 – $1,729) 63 Cash [$1,045 – ($25 + $63)] 957 Notes Receivable 1,000 Interest Revenue 45

7–41 Determination of checks issued during June:

All cash credits during June $19,802 Less: Service charge of May recorded in June 20 Checks issued during June $19,782 Determination of checks cashed during June:

Checks and charges recorded during June $17,210 Less: NSF check returned in June $100

June service charge 30 130 Checks cashed during June $17,080 Checks issued during June $19,782 Checks cashed during June 17,080 Excess of checks issued over checks cashed

during June $ 2,702 Outstanding checks at the end of June $

13,260 Less: Excess of checks issued over checks cashed 2,702 Outstanding checks at the beginning of June $

2 Cash 50,000

Receivable from Factor 50,000

‡Relates to Expanded Material.

7–43.‡ COMPUTATIONS:

FV = $10,000, N = 3, I = 12% → PV = $7,118

$10,000 – $7,118 = $2,882 discount

$8,000 – $7,118 = $882 loss on sale Notes Receivable 10,000 Loss on Sale of Equipment 882 Equipment (net) 8,000 Discount on Notes Receivable 2,882

End of First Year

Discount on Notes Receivable 854 Interest Revenue 854

End of Second Year

Discount on Notes Receivable 957 Interest Revenue 957

End of Third Year

Discount on Notes Receivable 1,071 Interest Revenue 1,071

Although not required by the exercise, the entry to record the receipt of final payment on the note would be:

Cash 10,000 Notes Receivable 10,000 The discount on notes receivable would be fully amortized by this time ($854 + $957 + $1,071 = $2,882).

7–44.‡ 1 Inventory 50,000

Accounts Payable 50,000

2 Accounts Payable 50,000

Inventory 2,500 Cash 47,500

Income Statement Adjustments Cash Flow from Operating Activities

Bad debt expense (24,000) 0 (24,000)

Cash expenses (681,000) 0 (681,000) Cash paid for expenses Net income $ 95,000 $(40,000) $ 55,000 Cash from operations

1 Cash collected from customers ($760,000 – $24,000) $ 736,000

Cash expenses (681,000)

Cash flow from operating activities 55,000 $

2 Net Income $ 95,000

Less: Increase in Accounts Receivable (40,000)

Cash flow from operating activities 55,000 $

(Note: When computing cash flow from operations, both the bad debt

expense and any write-off of uncollectibles can be ignored when using the indirect method and net receivable balances.)

Cash collected from customers

PROBLEMS 7–46.

1 Cash 210,270

Accounts Receivable 380,780

Sales 591,050 Cash 303,800

Accounts Receivable 63,800 Sales Returns and Allowances 13,318

Cash 13,318 Accounts Receivable 8,290

Allowance for Bad Debts 8,290 Cash 8,290

Accounts Receivable 8,290

2 Bad Debt Expense 4,565*

Allowance for Bad Debts 4,565

*$380,780 – $63,800 – $12,658 = $304,322; $304,322 × 0.015 = $4,565 (rounded) 7–47.

Cash 49,000

Accounts Receivable 49,000

7–47 (Concluded)

4 Gross method:

Cash 50,000

Accounts Receivable 50,000 Net method:

Cash 50,000

Accounts Receivable 49,000 Sales Discounts Not Taken 1,000 For the seller, the account Sales Discounts Not Taken is a revenue account and reflects the implicit interest charge customers pay by not taking cash discounts.

5 The net method is theoretically more correct because the cash value of the

transaction is $49,000—if the customer were to pay in cash, the price would be

$49,000 Any amount paid above that is, at least implicitly, a finance or interest charge.

The net method is not used in practice because the bookkeeping involved is more difficult Particularly tricky are the necessary adjusting entries at year- end to reflect the amount of Sales Discounts Not Taken on credit sales that are past the discount period but that have not been paid In addition, in most

cases, the operating results derived using the gross method and the net

method will not differ materially A material difference would result if many customers neglected to take cash discounts The gross method categorizes this extra revenue as part of net sales and thus part of operating income The net method categorizes this extra revenue as interest revenue Also, billings are usually at gross, and the accounting records should reflect the billing amount.

7–48.

1 Bad Debt Expense 7,410*

Allowance for Bad Debts 7,410

*$247,000 × 0.03 = $7,410 Because the percentage-of-gross-sales method is being used, the full amount is recognized as bad debt expense.

2 Allowance for Bad Debts 620*

Bad Debt Expense 620

*$83,000 × 0.06 = $4,980; $5,600 – $4,980 = $620 Because the receivables method is being used, the allowance account must be adjusted to the proper ending balance.

percentage-of-3 The percentage-of-receivables method reflects more accurately the net

realizable value of receivables The total amount expected to be received is the total receivables less the estimate of uncollectible receivables Whatever balance is in the allowance account must be used to arrive at the desired valuation basis With the percentage-of-sales method, the valuation of receivables is not considered; only the matching of a certain percentage of bad debts against sales of the period is considered.

Uncollectible Loss Percentage

Over 120 Year 0–30 Days 31–60 Days 61–90 Days 91–120 Days Days

Average .48% 0 .04% 1 10 .04% 50 .70% 78 .12%

Allowance for Bad Debts ($32,796 – $30,490) 2,306

Bad Debt Expense 2,306 7–50.

2004 Cash (1,050 × $900) 945,000

Sales 945,000 Warranty Expense (1,050 × $45) 47,250

Estimated Liability under Warranties 47,250

2005 Cash (900 × $925) 832,500

Sales 832,500 Warranty Expense (900 × $45) 40,500

Estimated Liability under Warranties 40,500 Estimated Liability under Warranties 18,300

Cash, Inventories, etc 18,300

2006 Estimated Liability under Warranties 44,600

Cash, Inventories, etc 44,600