friedlan4e sm ch06

8/10/2019 Friedlan4e SM Ch06

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CHAPTER 6

Cash, Receivables, and the Time Value of Money

QUET!"#

Q6-1.Internal controls are the policies and procedures that management implements to protect an

entitys assets and ensure the integrity of the accounting information system. Strong internal

controls provide assurance to stakeholders that the entitys assets cant be stolen, used

inappropriately, or used ithout proper authori!ation, and that the information produced by the

accounting system can be relied on. Strong internal controls are e"tremely important because

ithout them actions that could be very detrimental to the profitability and survival of the entity

could occur. #or e"ample, theft by employees and customers can cost a company a large amount

of money.

Q6-$.

Segregation of duties means that people ho handle an asset shouldnt also be responsible for

record keeping for that asset. If duties arent segregated, an employee may be able to steal cash

and cover up the theft by making fictitious entries to the accounting records. %he idea is that an

employee shouldnt be in a position to steal or misuse an asset and be able to cover up the theft

or misuse through access to the accounting records. If the same employee maintains custody of

an asset and maintains the accounting records, that person can steal assets and modify the records

such that the theft cant easily be discovered.

Q6-&.'ash is an unproductive asset because the return earned on cash by depositing it in the bank is

much less than the cost of financing cash. %hat is particularly so for businesses that receive little

or no interest on cash balances in che(uing accounts but must pay at least &) to *) interest on

borroed funds. +eople invest cash in businesses to earn a return that is larger than hat they

ould receive from a bank investment. oever, an ade(uate reserve of cash is crucial to

provide li(uidity.

Q6-*.

If an entity has more cash than is re(uired either for operating purposes or for planned

investments in productive assets then the oners ould be better off if the cash as returned tothem so that they could invest it in productive assets. %he reason is that cash is an unproductive

asset because it doesnt earn a reasonable return to the investor. crucial decision for

management is determining hat the appropriate amount of cash the entity should have.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-1Solutions /anual

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Q6-5.

nless there has been a period of !ero or negative inflation, you are orse off no in the sense

that you have less purchasing poer than hen the money as misplaced. lso, you have

foregone the interest that you ould have earned had you invested all or part of the 75 during

the four-year period. 8ou also delayed en9oying the 75 for four years.

Q6-6.

nominal dollar is a dollar that isnt ad9usted for changes in the purchasing poer. %he use of

the nominal dollar ignores purchasing poer gains and losses. %hat means that hile the absolute

:nominal; number of dollars stays the same, the (uantity of goods a dollar ill purchase changes

over time. If there is inflation and an entity has a liability that must be paid in money, it costs the

entity less to repay the debt in terms of the purchasing poer that is sacrificed. %he fact that less

is sacrificed in terms of purchasing poer isnt captured by I#3S.

3estricted cash is cash that is set aside for a particular purpose and not available for general use

by the entity. %his could be because of a legal or contractual obligation to use it in a particular

ay. %he implication is that hen assessing an entitys li(uidity its necessary to ignore restricted

cash because it isnt available for general use.

Q6-?.

%here are several reasons for a preference for money no. %here is an opportunity to earn a

return on the money, there is a risk that the future payment may not occur, and there is a loss of

purchasing poer unless there is !ero inflation or deflation. lso, having money no allos youto spend it sooner, hich means that you get satisfaction of some form sooner :a vacation today

is probably more attractive than the same one a year later;.

Q6-@.

Simple interest is paid only on the principal hile compound interest is paid on the principal and

interest earned in previous periods. 2iven the same interest rate, you earn more interest ith

compound interest, because ith compound interest the interest is calculated on a larger amount.

Q6-1.

%he present value of future cash flos is the value today of amounts that ill be received in the

future. #uture value is the amount that ill be received in the future by investing today. Ahen

estimating the value of a lottery that ill pay 7$5, each year for 1 years, present value is

appropriate. #uture value is the amount e ill have in the bank at retirement if e deposit

71, in the bank today at 6) per year until retirement. :Bther e"amples are appropriate as

ell.;

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-$Solutions /anual



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Q6-11.

receivable is an amount oed to the entity. 3eceivables can be classified as current or non-

current assets, depending on hen they are e"pected to be collected :current if they ill be

collected ithin one year or one operating cycle;. 3eceivables are valued at C3D :net reali!able

value;Ethe estimated amount that ill be collected. 'ommon types of receivables are accounts

receivable :amounts due from customers;, notes receivable :a more formal receivable, often from

customers;, interest receivable, and receivables from shareholders :amounts due from

shareholders;.

Q6-1$.

Ahen revenue is recogni!ed earlier, the balance in accounts receivable is larger and the firm

reports more current assets. s a result, balance sheet measures of li(uidity such as the current

and (uick ratios indicate a more li(uid entity hen revenue is recogni!ed earlier. %here is no real

impact on economic li(uidity using different revenue recognition methods since the ability to

meet obligations depends on cash availability, not the timing of revenue recognition. %he sameconclusion is true if cash is received before or at the same time as revenue is recogni!ed.

3ecognition of revenue improves measured li(uidity in this case because current liabilities

:unearned revenue; decrease.

Q6-1&.

Ahen revenue is recogni!ed before cash is collected accounts receivable are reported on the

balance sheet. %hus recognition of revenue gives rise to receivables. %he revenue recognition

criteria determine hen receivables are reported.

Q6-1*.%he benefit is that the business is able to sell merchandise to customers ho dont ish to pay

cash at the time of sale, and almost certainly obtains sales that otherise ould go to

competitors. %he draback is that the company must ait for the receivable to be collected and

there is a risk that the money ill never be collected. Indeed, its almost a certainty that some

percentage of credit sales ont be collected. company ould prefer to collect the cash at the

time of the sale, unless there is a very high interest rate on the amount oing. #or e"ample,

credit card companies earn significant amounts of money hen customers dont pay

immediately. Bther than for retail businesses most transactions are carried out ith credit terms,

ith suppliers sending invoices to customers for payment.

Q6-15.

%he amount reported on the balance sheet is usually less than the sum of individual receivables

because the reported amount is net of an alloance for an estimated amount that ont be

collected. ccounts receivable are reported at net reali!able value, hich is the amount that ill

be reali!ed in cash. If an entity sells on credit its highly likely that some customers ont pay so

its necessary to reflect the fact that all the money people promised to pay ont be collected. In

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-&Solutions /anual



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addition to uncollectable amounts, estimated returns and discounts are deducted from gross

accounts receivable, hich reduces the C3D and increases the difference beteen the gross and

net amount of accounts receivable.

Q6-16.

%he oners decision criteria for riting off receivables needs to be e"plained. %he oner may

ait too long to rite off receivables :thus leaving assets and net income overstated; or that he

rites off receivables in an arbitrary manner :potentially at times hen it is convenient for him;.

Its possible that since the oner is seeking a loan, he may delay riting off bad debts to make

his financial statements appear stronger. s a result the bank manager may not be receiving the

information he needs to make a good decision :the amount of cash that ill be received;. s a

bank manager I ould ask to see an aging schedule and information on the collectability of

receivables before approving the loan re(uest.

Q6-1>.Ahen the percentage-of-receivables or percentage-of-credit-sales method is used the e"pense is

accrued hen financial statements are prepared. %he amount accrued recogni!es that some

receivables ouldnt be collected, but it isnt knon hich ones. %he decision to rite off a

receivable is recognition that a specific receivable ont be collected. So part of the estimate is

converted into a knon amount :the actual customer;. %he 9ournal entry to record the rite-off

ould reduce the alloance :the general recognition; and the receivable :the specific customer;,

hich has no effect on the income statement as these are both balance sheet accounts.

Q6-1?.

%he direct rite-off method results in both an income statement that doesnt match e"penses torelated revenues and a balance sheet that reports accounts receivable at an amount that e"ceeds

the net reali!able value. In accrual accounting all costs incurred to earn revenue in a period

should be e"pensed in that period. %he direct rite-off method recogni!es the cost of

uncollectible amounts hen an amount is determined to be uncollectible, hich may occur in a

period other than hen the related revenue as recogni!ed.

Q6-1@.

%he percentage-of-credit-sales method estimates the amount of credit sales recogni!ed in a

period that isnt collectible and recogni!e an e"pense for that amount in the period. %he amount

of the e"pense is added to the alloance account. Fecause the percentage-of-credit-sales method

focusses on credit sales, hich is an income statement account, its considered an income

statement approach. In the percentage-of-receivables method the focus is on getting the amount

of receivables reported on the balance sheet to reflect the net reali!able value :C3D; of the

receivables. ere the focus is on the balance sheet. %he amount of the e"pense is simply the

amount re(uired to get the alloance to the desired amount. Fecause of the focus on amount of

accounts receivable on the balance sheet its considered a balance sheet approach.

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Q6-$.

If the percentage is too lo, income ill be overstated, as ill the net balance in accounts

receivable :because the alloance is too small;. Bver time net receivables could become

significantly overstated if the underestimation of bad debts isnt noticed because the

underestimate each year ill build up in the alloance account. If the e"pense is consistently too

high, income ill be understated, as ill the net balance in accounts receivable :because the

alloance is too large;. Bver time net receivables could become significantly understated if the

overestimation of bad debts isnt noticed because the overestimate each year ill build up in the

alloance account.

Q6-$1.

n aging schedule classifies accounts receivable according to the time they have been

outstanding. Its useful for assessing the bad debt e"pense and the collectability of receivables

because the longer a receivable is outstanding and overdue, the less likely it is the amount ill becollected.

Q6-$$.

%he decision is a combination of past e"perience and a consideration of trends in the economy in

general and the specific industry and entities ho oe money. Some of the analysis is ob9ective

but the 9udgment of management is also informed by sub9ective assessments. %he process is

sub9ective because its a prediction. %he actual outcome depends on uncertain future events that

ont be knon ith certainty hen the estimate is made.

Q6-$&.%here are a variety of circumstances that may cause a manager to rite off an account receivable.

%he company that oes the money may have declared bankruptcy, efforts to collect the money

may have been unsuccessful, or the debtor may have informed the creditor that they have no

intention or ability to pay. Such decisions are often sub9ective ith respect to the timing of the

rite off, but there are ob9ective criteria such as the length of time that has passed ithout

payment of any part of the debt. %here is alays some probability that a ritten off account

receivable ill be collected. %he timing of rite offs ont have any immediate effect on the

accrual methods because the effect of the rite off is to shift the effect from the alloance

account to the specific account receivable. %he timing may affect future estimates of bad debts

though.

If the direct rite off approach is used the timing and 9udgement e"ercised by management ill

have an immediate effect on the income statement and balance sheet. Geciding to rite off a

receivable during a period :as opposed to another; ill reduce net income and the balance in

accounts receivable by the amount of the rite off. %he decision to defer a rite off ould

increase net income and receivables in the period relative to if a receivable as ritten off.




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Q6-$*.

%he amount of the revenue should be reported at the present value of the future payment or at the

fair value of the merchandise :the cash selling price;. %his is the effect of the time value of

moneyEa dollar today is orth more than one received to years in the future. Fy deferring

collection to years the amount of revenue is less than if it ere collected immediately. %he

difference beteen the amount collected in to years and the amount recogni!ed as revenue

today should be treated as interest revenue over the to years. Fy recogni!ing the full 71,

as revenue upon delivery, Derlo has overstated revenue in the current period as the interest

revenue hasnt yet been earned.

Q6-$5

lloing customers to return product indicates that at company stands behind their merchandise

giving their customers confidence in purchases. s a result sales may be higher. oever,

alloing returns comes at a cost to the company including the cost of restocking, record keepingand the reselling of items :perhaps at a discount;. 3eturns should be accrued at the end of a

period by estimating the amount that ill be returned. 3eturns are reflected on the income

statement as a contra revenue account ith a corresponding entry on the balance sheet as a contra

asset account :contra accounts receivableEalloance for returns :if a credit sale;; or an accrued

liability :if a cash sale;.

Q6-$6

%he benefits of giving a discount to customers are to give the customer an incentive to pay

earlier rather than later. %his may reduce the risk of default and give the company providing the

discount (uicker access to cash it can use to meet its obligations. %he challenge accountants faceith respect to discounts is estimating the amount that ill be taken by customers :the proportion

of receivables eligible for discounts at the end of the period that ill be claimed;. +ractically this

isnt a big problem because the actual amount ill usually be knon ithin a fe days of the

end of the period :the discount period is usually short;.

Q6-$>.

idden reserves are accounting estimates that management uses to manage earnings. hidden

reserve allos management to increase or decrease revenues or e"penses in a period and thereby

shift income among periods to achieve a reporting ob9ective. idden reserves are made possible

by inade(uate accounting disclosureEentities dont disclose all the estimates they make or the

underlying assumptions. idden reserves create a problem for users of financial statements

because they distort income and related measures and they arent observable or identifiable by

stakeholders. s a result the measures affected by hidden reserves cant be interpreted

effectively.

Q6-$?.




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%he (uick ratio is cash, cash e(uivalents, temporary investments, and receivables :really assets

that ill or can be converted to cash (uickly; divided by current liabilities. %he ratio provides an

indication of li(uidity by using only current assets that are cash or ill be reali!ed in cash very

soon. %he ratio e"cludes inventory, prepaid assets and other current assets from the numerator of

the current ratio because generally these assets are less li(uid. %he inventory of a 9eellery store

cant be sold (uicklyEits not very li(uidEso the current ratio may not be as good an indication

of li(uidity. #or the gold mine, inventory is very li(uid because gold bullion can be sold at any

time on the open market, so the current ratio provides a very good indication of the mines ability

to meet its financial obligations.

Q6-$@.

The accounts $eceivable tu$nove$ $atio is useful fo$ evaluatin% li&uidity because it '$ovides

insi%ht into ho( &uic)ly $eceivables a$e conve$ted into cash* The hi%he$ the $atio, the

faste$ $eceivables a$e bein% collected and the mo$e &uic)ly the entity collects cash

f$om its custome$s, (hich sho$tens the cash la%*

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6->Solutions /anual



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E+ERC!E

=6-1.

'ash is money on hand and cash e(uivalents are short-term investments easily and (uickly

converted into a knon amount of cash.

a. 'ash in the office should be included in cash and cash e(uivalents because its money on

hand.

b. 'ash in a bank savings account should be included in cash and cash e(uivalents because

its money on hand and readily available for use.

c. ncashed che(ues should be classified as cash because a che(ue is e(uivalent to cash

:although there is some uncertainty since the debtor might not have the funds to cover the

che(ue;.

d. %he amount oed by an e"ecutive is a receivable, not cash. %he amount isnt money on

hand or available and it isnt a short-term investment easily and (uickly converted into a

knon amount of cash :its not even clear if or hen the amount ill be repaid;.

e. %he investment certificate should be classified as cash and cash e(uivalents because its

easily convertible to a knon amount of cash. %he certificate can be cashed at any time

for its face value plus interest so the amount of cash is knon.

f. %he amount borroed is cash :only borroed amount;. %he unborroed portion of theline isnt included in cash and cash e(uivalents.

g. %his item shouldnt be considered as cash and cash e(uivalents because its being held by

a foreign government and not available for use. %he amount is similar to restricted cash.

h. %he post-dated che(ues shouldnt be included in cash and cash e(uivalents because they

cant be converted to cash until #ebruary $1. Bn the balance sheet date :Gecember &1,

$1>; they dont represent cash thats available or an investment. If the che(ues represent

payments from the customers they ould be classified as receivables until they are

cashed or become cashable.

i. %he amount held by the layer shouldnt be included in cash and cash e(uivalents. Since

the cash is held by the layer for a specific and restricted purpose it should be classified

as restricted cash. 3estricted cash isnt readily available for use. %he restricted cash

ould be disclosed separately on the financial statements.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-?Solutions /anual



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9. %he Fritish pounds should be included in cash and cash e(uivalents. Ahile the pounds

cant be converted into a knon amount of 'anadian cash, they can be converted (uickly

and easily and are readily available for use. lso, if the pounds are used to pay

obligations denominated in pounds, e"change isnt an issue.

k. %hese items shouldnt be included in cash and cash e(uivalents because the value of

publicly traded shares fluctuates daily. Its uncertain ho much cash ould be received

for the shares until they ere sold.

=6-$.

#uture Dalue amount invested

a. #D H :1.*;6 71, H 71$6,5&1.@

b. #DH :1.$;1$ 71, H 71$6,?$*.1?

c. #DH :1.1;$* 71, H 71$6,@>&.*6

d. #DH :1.&&&&&;>$ 71, H 71$>,>*.1@

=6-&.

#uture Dalue amount invested

a. #D H :1.&;? 75, H 76,&&&.?5

b. #DH :1.$5;$* 7>, H 71$6,61.?$

c. #DH :1.?;* 71, H 71&6,*?.@

d. #DH :1.;6 7$5, H 7$5,

=6-*.

+DH

a. +D H 7$,5,6&$.??

c. +D H J71,?>.&5

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-@Solutions /anual



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11/60

=6-5.

+DH

a. +D H 7$,6.6*.If 7$, is to be paid in the future revenue should be 715,?>> ith ?) recorded as

interest revenue each year.

b. +D H 7*,

8es, the present value of the future cash flos is higher than the 7>, investment.

c. +DH 75,*&.$$

8ou should pay no more than 7>*&.$$ for the bond because thats hat 75, to be

received in tenty years is e(uivalent to.

d. +D H 76,


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c. 1

%he present value of the annuity and lump sum is 7$,1@$.>> today. %his is the ma"imum

amount you ould pay for the investment.

=6->.a. #uture DalueM 75, P :1.*;1H 7>,*1.$$ ill be the maturity value.

b. 'omparing +resent values to 71M

Bption 1M

+D H 7$,551.*5 ill be the amount oing on the loan.

e. Students may approach from +D or #D in their solutionM

sing +D M

:i; +D H 715:ii; +D H 715sing #DM

:i; #D H 71 " :1.1;&H 71,&&1.:ii; #D H 71 " :1.15;&H 71,5$.??

Foth methods yield the same choice, at 1) it is a better option to take the 71,5 in thefuture hile at 15) it is better to take the 71 no.

f. +resent value of an annuityM

1


13/60

=6-?.

a. Gr. 'ash 1>5,Gr. ccounts receivable 6$5,

'r. Sales ?,

b. Gr. 'ash *5,'r. ccounts receivable *5,

c. Gr. Fad debt e"pense &1,$5'r. lloance for bad debts &1,$5

d. Gr. lloance for bad debts &*,'r. ccounts receivable &*,

=6-@.

a. Gr. 'ash $,5Gr. ccounts receivable >,

'r. Sales @,5

b. Gr. lloance for bad debts >,'r. ccounts receivable >,

c. Gr. 'ash >,'r. lloance for bad debts >,

=6-1.

a. Gr. Fad debt e"pense 5,'r. ccounts receivable 5,

%he effect of this entry on net income ould be to decrease it by 75,.

b. Gr. lloance for bad debts 5,'r. ccounts receivable 5,

%his entry has no effect on net income. %he effect on net income occurs hen the baddebt e"pense is recorded at the end of the period, based on the amount of credit salesmade during the period.

c. lloance for bad debts 5,ccounts receivable 5,

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-1&Solutions /anual



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%his entry has no effect on net income. %he effect on net income occurs hen the baddebt e"pense is recorded at the end of the period, based on the amount of ending accountsreceivable that is estimated not to be collectable.

d. /alagash decided to rite off the account receivable because collectability as no longer

reasonably assured. %he company e"ercised 9udgment by deciding to rite off the amountimmediately. %his is a conservative approach, avoiding overstating assets. #rom anob9ectives standpoint the ritedon could have served to loer income currently, therebyavoiding a reduction in the future.

=6-11a. 7*,, L 7*,,:1.1*;-1L 7*,, :1.1*;-$L 7*,, :1.1*;-&

H 71&,$?6,5$?.11Br use the +D of an annuityM

,

1+D -mount to be received or paid in each period

:1 ;

1 1H 1 -mount to be received or paid in each period

:1 ;

n rn

n

r

r r

=

+

+

H 7*,, L :1


15/60

4ong-term receivable &,>>,?>.11

Interest revenue @$$,1$@.?@

$$ 'ash *,,.

4ong-term receivable &,5?,>>1.@&

Interest revenue *@1,$$?.>

c.

Total $eceivable -on%.te$m Cu$$ent 'o$tion

May 81,/019 7 @,$?6,5$?.11 7 5,>>>,>56 7 &,5?,>>$

May 81,/012 7 6,5?6,6*$.* 7 &,>>,?> 7 &,5?,>>$

May 81,/01: 7 &,5?,>>1.@& 7 - 7 &,5?,>>$

May 81,/0/0 7 - 7 - 7 -

#or each year, the amount of the long-term receivable reported on the balance sheet is the

present value of the remaining payments. Since 7*,, is paid each year the amount

reported as current on the /ay &1, balance sheet each year is the present value of

7*,,. %he remainder is long-term.

d. It ould be misleading to users of the financial statements if Gebden recogni!ed the full

716,, immediately since income is overstated. If the time value of money is

ignored, stakeholders might get the impression that the sale as more profitable than it

actually as. In addition, stakeholders ouldnt reali!e that Gebden isnt only selling

land, but is also financing the purchase, hich has cash flo implications. Gebdens

management ould favour this approach if it anted to increase income in the current

period, perhaps because of a bonus plan or an interest in impressing e"ternal stakeholders

ith higher income.




16/60

=6-1$.

'ash ccounts

receivable

lloance

foruncollectable

accounts

3evenu

e

Fad

debte"pense

Feginnin

g

balances

>5,? :&,;

&5, &5,

&>5, :&>5,;

:&,5; :&,5;

48,/007 &,$

=nding

balances

>,6. Guring $1? 7&,$ as

ritten off from accounts receivable.




17/60

=6-1&.

'ash ccounts

receivable

lloance

for

uncollectableaccounts

nearned

revenue

3evenue Fad debt

e"pense

Feginning

balances

1&*,>5 :>,6$; 56,11$, :?*>,;

:@,1&; :@,1&;

:>,*?; >,*?

=nding

balances

?>?,$* 1?$,$> :?,>1$; *,* @*@,& :@,1&;1$ :this is done by calculating that amount fromthe other three pieces of information about the unearned revenue account. Aith the amount ofunearned revenue recogni!ed its then possible to calculate the increase in accounts receivablefor the period :the information gives revenue for the period so the increase in accounts receivableis revenue O the decrease in unearned revenue. %he other amounts then flo from there.

=6-1*.

lloance for doubtful accounts Gecember &1, $16 7&?,15

4essM ccounts ritten of during $1> :&@,6;

+re-closing alloance for doubtful accounts Gecember &1,

$1> :1,*5;

'redit sales during $1> $,$6$,5

verage percentage of credit sales uncollectible $)

Fad debts e"pense for $1> *5,$5

+re-closing alloance for doubtful accounts Gecember &1,

$1> :1,*5;

lloance for doubtful accounts Gecember &1, $1> 7*&,?

Fad debt e"pense *5,$5

lloance for bad debts *5,$5

%o record bad debt e"pense for $1>

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=6-15.a.

C$edit Pe$cent 3ad ebt

;ea$ ales Uncollected E


19/60

=6-16.

a. Fad debt e"pense H 7@*, 5 :71,5>5, 6); O 711,$5 H 7?&,$5

lloance for doubtful accounts H 71,5>5, 6) H 7@*,5

Fad debt e"pense :@*,5 O 11,$5; ?&,$5

lloance for doubtful accounts ?&,$5

b. Fad debt e"pense H 7@,&61,5 1.5); H 71*,*$$.5

lloance for doubtful accounts H 71*,*$$.5 L 711,$5 H 7151,6>$.5

Fad debt e"pense 1*,*$$.5

lloance for doubtful accounts 1*,*$$.5

c. Fad debt e"pense H 7@*, 5 :71,5>5, 6); L 711,$5 H 715,>5

lloance for doubtful accounts H 71,5>5, 6) H 7@*,5

Fad debt e"pense :@*,5 L 11,$5; 15,>5

lloance for doubtful accounts 15,>5

Fad debt e"pense H 7@,&61,5 1.5) H 71*,*$$.5

lloance for doubtful accounts H 71*,*$$.5 O 711,$5 H 71$@,1>$.5

Fad debt e"pense 1*,*$$.5

lloance for doubtful accounts 1*,*$$.5

debit balance in alloance for doubtful accounts indicates that the estimate of

bad debts as too lo. nder the percentage of receivables method, the focus is onreporting receivables at their net reali!able value. %his means that the alloance must

reflect the amount of receivables estimated to be uncollectible. %herefore the bad debt

e"pense must be debited an additional 711,$5, resulting in a higher bad debts e"pense.

nder the percentage of credit sales method, the focus is to report an accurate bad

debt e"pense. It follos that the bad debt e"pense for the period ont be changed

because of the balance in the alloance account. oever, the alloance for doubtful

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-1@Solutions /anual



20/60

accounts ill be 711,$5 loer, and accounts receivable ont be stated at their estimated

net reali!able value on the balance sheet. Aith the percentage credit sales method its

possible for the alloance balance to become unrepresentative of the amount of

receivables that ont be collected if there is an error that persists in one direction :i.e.

the bad debt e"pense is continually overstated or understated;.

=6-1>.

Pe$cent Amount

Account A%e 3alance

Uncollectibl

e Uncollectible

'urrent 7>, $.5) 71>,5

1-& days $??, 1) $?,?

&1-@ days 1$?,* $5) &$,1

@ days 5?,? 6) &5,$?

%otal 71,1>5,$ 711&,6?

lloance ccount

+re-closing balance 71,?

3e(uired balance :11&,6?;

3e(uired

ad9ustment 4=1/5,5207

a. %he amount of closing accounts receivable that is estimated to be uncollectible is

711&,6?.

b.

Fad debt e"pense 1$*,*?

lloance for doubtful accounts 1$*,*?

%o record bad debt e"pense for the period

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-$Solutions /anual



21/60

=6-1?.

a.

verage accounts receivable H

:5$, L *>5,;

$

H *@>,5

ccounts receivable turnover

ratio H

'redit sales

verage accounts

receivable

H

*,15,

*@>,5

H 2*85

b.

verage collection period of accounts receivable H

&65

?.&*

H 58*96 days

c. %he reasonableness of the collection period cant be determined ith the information

provided. Fenchmarks are re(uired, such as the collection period in prior years, creditterms offered to customers, economic conditions, amount for comparable firms, etc.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-$1Solutions /anual



22/60

=6-1@.

a. lloance for doubtful accounts 5&,

Fad debt e"pense 5&,

b. %he effect of making estimates of bad debts that ere higher than the actual amount as

to understate net income in each year by the e"cess of the estimate over the actual

amount. %he ad9usting entry increases net income by 75&, in the year of the

correction, hich reverses the cumulative effect of the high estimates over the past three

years. In other ords, net income in the current year ill be 75&, higher after the

ad9ustment than it otherise ould have been, but in the previous three years :taken

together; net income ould have been 75&, loer than it should have been.

c. %he error and ad9usting entry could mislead financial statement users if its material. Cetincome in each of the previous three years has been understated hich may cause users to

underestimate %rilbys future cash flos. In addition, the large decrease in bad debt

e"pense due to the ad9usting entry ill overstate the current years net income. %his could

cause users to overestimate %rilbys future cash flos :especially if these ad9ustments and

misestimates arent disclosed;. lso, the balance sheets of all the affected periods

ouldnt reflect the net reali!able value of accounts receivable. %his could affect the

decisions of creditors since decision criteria such as current assets, current ratio, (uick

ratio, etc., ill be misleading. Stakeholders may have made decisions that erent

optimal for them versus the ones they ould have made if they had obtained more

accurate information.

=6-$

a. Sales 3eturns and lloances 1,

:contra sales;

lloance for 3eturns 1,

:contra accounts receivable;

%his assumes no beginning balances in the contra accounts.

b. ccounts 3eceivable balance ould be 7515, :5$5, O 1,; and net sales ouldbe 7*,115, :*,1$5, O 1,;.

c. lloance for 3eturns $,

ccounts 3eceivable $,

Inventory PPP

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-$$Solutions /anual



23/60

'ost of Sales PPP

=6-$1a. Sales Giscounts :&) " 1$, " $); >$

:contra sales;

lloance for %rade Giscount >$:contra accounts receivable;

b. ccounts 3eceivable balance ould be 7$>*,$? :$>5, O >$; and net sales ould be

71,@6*,$? :1,@65, O >$;.

c. 'ash @?

lloance for %rade Giscount $

ccounts 3eceivable 1

=6-$$

Account A%e 3alance Uncollectible Uncollectible

'urrent 71?, $.) 7&,6

p to 6 days *, $) 7?,

6 days 15, 5) 7>,5

%otal 7$&5, 71@,1

a. Fad Gebt ="pense 1@,1

lloance for doubtful accounts 1@,1

Sales Giscounts :71$, " *) " $); @6

lloance for sales discounts :


24/60

=6-$&.a. %his item shouldnt be included hen calculating the (uick ratio because prepaids arent

li(uid assets :they represent cash flos that have already occurred;.

b. %his item should be included in calculating the (uick ratio because it represents the currentportion of interest that is receivable ithin the period. 'onsideration should be given to hen

the interest is due to be paid.

c. %his item should be included hen calculating the (uick ratio because the maturity date is

very soon, one month.

d. %his item shouldnt be included hen calculating the (uick ratio because it is a long-term

receivable that cant be (uickly converted to cash.

e. %his item should be included in the (uick ratio because the current portion of long term

receivable is collectible ithin the operating cycle in the form of cash.

f. %his item shouldnt be included hen calculating the (uick ratio because long term assets

cant be (uickly converted to cash.

g. %his item shouldnt be included in the calculation of the (uick ratio because it cant be

converted into cash to cover current liabilities prior to maturity.

h. %his item should be included in the calculation of the (uick ratio because gold can be (uicklyconverted into cash.

i. %his item shouldnt be included hen calculating the (uick ratio because restricted cash isnt

available for general purpose use.

9. %his item shouldnt be included in the (uick ratio because it cant be converted to cash

(uickly.

k. %his item should be included hen calculating the (uick ratio because post-dated che(ues

pertain to receivables, hich are included in (uick assets.

l. %his item should be included in the (uick ratio as it ill be converted to cash in a very short

period of time.

m. Shares in privately oned corporations are often not very li(uid :there is no ready market,

sales are often restricted; so these shouldnt be considered (uick assets.

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=6-$*.

a.

'urrent ratio H'urrent assets

'urrent liabilities

$1>H

51&,>5

*1,$5

H 1*/2

$1?H

6$>,>5

&*$,5

H 1*28

Quick ratio HQuick assets

'urrent liabilities

$1>H

$5,

*1,$5

H 0*6/

$1?H

&&$,5

&*$,5

H 0*:9

Quic) Assets /012 /019

'ash and cash e(uivalents 7 @5, 715,ccounts receivable $&>,5 1*5,

%otal (uick assets &&$,5 $5,

b. Foth Seahorses current and (uick ratios increased from $1> to $1?. %his indicates that

Seahorse has improved its ability to meet its current obligations. lso, the current ratio of

1.?& at the end of $1? suggests that its li(uidity position is solid. It should be noted,

hoever, that the current ratio includes current non-li(uid assets :such as prepaids;,hich arent readily available to meet current obligations. lso, both the current and

(uick ratios include items, hich may or may not convert into cash that ill be available

to satisfy current obligations. %his includes such items as accounts receivable and

inventory. Ahether or not these items represent resources that ill be available to meet

current obligations depends on ho (uickly they get converted to cash.




26/60

c. Bne scenario in hich a significant increase in the (uick ratio could be an indicator of a

deteriorating li(uidity position is hen there is a large increase in accounts receivable but

the receivables arent collectable. %his could indicate that the entity is having difficulty

converting its accounts receivable into cash. In this situation, accounts receivable

ouldnt be as li(uid as e"pected because their collectability is in doubt. %his analysis

presumes that management didnt properly account for the collectability problem by

recording an ade(uate alloance for doubtful accounts and bad debt e"pense.

=6-$5.ssume all sales are on creditM

ccounts receivable turnover ratio H'redit sales

verage accounts receivable

*.@$H1,5@$,


verage accounts receivable H1,5@$,

*.@$

H =&$&,5>>

verage collection period H&65

ccounts receivable turnover ratio

H &65

*.@$

H >*.1@




27/60

=6-$6.

verage collection period H &65

ccounts receivable turnover

ratio

*> H &65


ccounts receivable turnover ratio H &65

*>

H >.>>



>.>> H1$5,1$5,


verage accounts receivable H 1$5,1$5,

>.>>

H 16,111,@?6

ccounts receivable at the end of $1@

H :3end $1?L 3end $1@;H716,111,@?6

$

H :3end $1?L 1.1$N3end $1?;H716,111,@?6

$

H$.1$N 3end $1?H7$N16,111,@?6 H 7&$,$$&,@>$

3end $1?H 715,1@@,@?6

H 3end $1@ H 1.1$N3end $1?H 71>,$&,@?*

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29/60


30/60

=6-$?.

ssume all sales are on credit.

%he folloing formulas ere used to calculate ansersM



verage accounts receivable H Bpening $ 71,*$*,$5 71,>6,>

Bpening ccounts 3eceivable 165,6$* 1$$,$?& @&,11&

=nding ccounts 3eceivable $61,? 165,6$* 1$$,$?&

verage ccounts 3eceivable $1&,>1$ 1*&,@5* 1>,6@?


:3%B; @. @.?@ 1.

verage collection period *.5> &6.?@ &6.51

s a bank manager I am a bit concerned that the 3%B is decreasing and the averagecollection period is increasing. %he company is taking a longer period of time to collecton its receivables. In $16 and $1> the company as collecting on its receivables almostithin their specified period of & days :9ust under &> days; but in $1? the collectionperiod increased almost four days. It is important that ggassi! maintains control overreceivables by folloing up on overdue accounts and ensure that credit is only offered tocustomers ith acceptable credit ratings. %o properly assess ggasi!s situation I ouldre(uire more information such as industry standards for these ratios, an aging schedulefor receivables, a full balance sheet, income statement, and a cash flo statement.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-&Solutions /anual



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PR"3-EM

+6-1.

It costs li" 1) per year to borro from the line of credit. %herefore if li" borros 71,from the line of credit to pay their supplier on day 1 and subse(uently pays off the line of credit

on day &, the amount of interest that li" ill pay is for a $ day period.

71, N :$


32/60

+6-&.

%he eakness in this scenario is the lack of verification of e"penses claimed by the trustees.="penses charged to the cards only re(uire e"planation if the staff person re(uests it, and eventhen if the trustee has a suitable e"planation then the e"pense is approved. %his system could

easily allo trustees to charge items to the card that arent employment related. %o improve thiscontrol, trustees should be re(uired to submit receipts for all e"penses and also provide astatement e"plaining hat the item purchased as as ell as hy it as re(uired. dditionally,there appears to be no verification regarding the amount of kilometres driven. trustee couldclaim the distance travelled as for employment reasons, hoever ithout verification thetrustee could easily claim distances travelled for personal reasons. better control ould be tore(uire the trustee to note the reason for the travel, their starting point and destination as ell assubmit a calculation that provides the kilometres driven :for e"ample, a print out from a mappingebsite such as /ap Quest or 2oogle /aps;. %he e"penses should be approved by a manager orchair of the board. dditionally, the travel e"penses should be submitted more fre(uently so thatthere are feer e"penses to verify ith each submission.

P6.5*

%he eakness in this scenario is the lack of separation of duties. %he person hired by the park tocollect the cash could steal some of it and give the rest to the park manager at the end of the day.%his kind of theft is difficult to detect. better system is to have one person collect the cash fromcustomers, and a separate person record the sales and issue receipts, ith each person separatelyturning in the cash and receipts at the end of the day. %his could be done by having a separateperson sell tickets for the rides and have the ride operator only collect tickets from customers. Ineither case it ould be possible to give free rides to people. In the latter case rides could be soldto people for cash on the side. %his behaviour could be checked by having someone observe the

operator from time to time.

+6-5.

3etail businesses have large amounts of inventory that are included in the calculation of thecurrent ratio but not the (uick ratio. #or retail businesses inventory is usually by far the largestcurrent asset and often the largest asset category on the balance sheet so the impact of leaving outinventory hen calculating the (uick ratio ill be significant. %he denominator, currentliabilities, is the same for both ratios and current liabilities includes amounts oing for inventoryhile inventory isnt classified as a (uick asset.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-&$Solutions /anual



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+6-6.

a. 715, L 7$$,5,5.

%he purpose of this report is to provide an analysis of the recent credit policy change at /agundy

Inc. #our issues are covered in the report. %hese are the bad debt e"pense for $1>, the accounts

receivable turnover ratio, the effect of the change on /agundys li(uidity, and an assessment of

the policy. =ach issue is discussed belo.

a. %he ne aggressive policy and the old conservative policy are opposite e"tremes. %he

estimated percentage-of-credit-sales uncollectible amount should be ad9usted toreflect this change. 2iven that ne customers ho are granted credit ill pose morerisk, meaning there ill likely be an increase in uncollected amounts, the rate shouldbe modified ith the ne sales policy in mind. %he e"act ne percentage that shouldbe used ill re(uire an assessment of the customers. oever, the ne percentageshould be higher than $).

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-&&Solutions /anual



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b. %he ne credit policies allo customers more time to pay and provides credit to morerisky customers, hich implies that /agundys accounts receivable balance ill gromore (uickly than sales. s a result the average accounts receivable balance illincrease, hich ill cause /agundys accounts receivable turnover to decrease.

c. /agundys ne credit strategy ill reduce the li(uidity of the company. %he loosercredit terms means that cash ill be collected more sloly, hich means more cashill be tied up. %his is indicated by the decreasing accounts receivable turnover. Inaddition, the increased sales ill likely re(uire additional inventory and that illre(uire more cash investment as ell. Bn the other hand, cash flo increase becausethe company is selling more merchandise :this assumes that the changed credit policyis beneficial;.

d. Ahether or not the policy is good or bad also depends on the outcome. %he increasein sales is a good thing but costs also increase. %he attractiveness of the strategydepends on hether the benefits e"ceed the costs. Ahile sales are rising as a result of

the ne strategy there ill be additional costs from bad debts, collection, andfinancing. %he certain measures of li(uidity ill also likely decline ith theassociated conse(uences.

+6-?.

Aooler Inc.s profit margin to start off is lo, roughly 11) of sales for years $1* and $15 ithall sales on a cash basis. In $16 and $1> it declined to 9ust over ?). ccepting credit cardscomes at a transaction cost of &.5) of sales. Aooler accepting credit cards increased businesshoever the result of flat profits as a result of their e"isting customers paying ith credit cardsalso. #rom $16 to $1> credit sales ent from 61) to ?1) of total sales. Simply put, if cash

sales yielded an 11) margin, then 1) credit sales ould only yield a >.5) :11-&.5; margin. Itappears that most customers are taking advantage of using credit cards at a cost of &.5) toAooler. s a result of e"isting customers paying on credit the over margin reduced on eachtransaction resulting if flat profitsEthe gain in profits from increased sales as offset by theadded cost of credit, hich applied to ne and e"isting sales.

+6-@.

a.

i. 7?*,

ii. 1.5) :?,*>, ?5); H 71>,@@$.5

iii. @.5) :1,$$,; H 7115,@

115,@ O :@6, O ?*,; H 71&,@

b.

i. 7 :%here is no alloance for doubtful accounts under the direct method;ii. 7@6, O 7?*, L 71>,@@$.5 H 711@,@@$.5

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-&*Solutions /anual



35/60

iii. 7115,@

c.

i. Fad debt e"pense ?*,

ccounts receivable ?*,

%o record the bad debt e"pense under the direct-rite-off method.

ii. Fad debt e"pense 1>,@@$.5

lloance for doubtful accounts 1>,@@$.5

%o record the bad debt e"pense under the percentage-of-credit-sales method.

iii. Fad debt e"pense 1&,@

lloance for doubtful accounts 1&,@

%o record the bad debt e"pense under the percentage-of-receivables method.

d.

i. 75, O ?*, H 7*16,ii. 75, O 1>,@@$.5H 7&@$,>.5iii. 75, O1&,@ H 7&@6,1

e. %he differences arise because each method of determining bad debts has a different focus.nder the direct method bad debts are charged to income as they occur, hich meansmatching doesnt occur. nder the percentage-of-credit-sales method, the focus is toreport a reasonably accurate bad debt e"pense. nder the percentage-of-receivablesmethod the focus is to report accounts receivable reasonably close to their net reali!able

value. If the estimates using the latter to methods arent correct year after yeardifferences in the methods ill occur because the percentage-of-receivables methodad9usts the balance in the alloance account to ensure that the net accounts receivableappro"imates its C3D. %he percentage-of-credit-sales method doesnt consider the C3Dof accounts receivable, only the e"pense for the period. In principle, the percentage-of-credit sales and percentage-of-receivables should provide the same result. oever, themethods ill diverge, even if they are set up to yield the same result, once estimates andactuals are different in a year.

f. Bf the to accrual methods they to ays of achieving the same end. Co method is

inherently better or orse, each one involves a trade-off. %he direct method provides

accurate information about the amount of bad debts, but doesnt match the e"pense to the

revenue it helped generate, hich is hy its not used under accrual accounting. %he

percentage-of-credit-sales method matches the e"pense to the revenue it helped generate,

but is an estimate, not an actual indication of hat ont be collected. %he percentage-of-

receivables method also matches the e"pense to the revenue and provides an

appro"imation of the receivables net reali!able value, but the amount of bad debts may be

even less accurate than the percentage-of-credit-sales method. It must be stressed that if

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-&5Solutions /anual



36/60

the estimates are unbiased :over time estimation errors average to !ero; the methods

should yield similar results. Gifferences among the methods are caused by errors in

estimating bad debts. %hese methods, it should be remembered, are means to an endT to

provide an appropriate valuation for accounts receivable and to determine an appropriate

e"pense for the calculation of net income.

+6-1.

a.

i. 71?,

ii. $.5) :>5, ?5); H 715,@&>.5

iii. 1) :1*5,; H 71*,5

1*,5 O :1&,5 O 1?,; H 71@,

b.

i. 7 :%here is no alloance for doubtful accounts under the direct method;ii. 1&,5 O 1?, L 15,@&>.5 H 711,*&>.5iii. 71*,5

c.

i. Fad debt e"pense 1?,

ccounts receivable 1?,

%o record the bad debt e"pense under the direct-rite-off method.

ii. Fad debt e"pense 15,@&>.5

lloance for doubtful accounts 15,@&>.5

%o record the bad debt e"pense under the percentage-of-credit-sales method.

iii. Fad debt e"pense 1@,

lloance for doubtful accounts 1@,

%o record the bad debt e"pense under the percentage-of-receivables method.

d.

i. 7*5, O 1?, H 7$>,ii. 7*5, O 15,@&>.5 H 7$@,6$.5iii. 7*5, O 1@, H 7$6,

e. %he differences arise because each method of determining bad debts has a different focus.nder the direct method bad debts are charged to income as they occur, hich meansmatching doesnt occur. nder the percentage-of-credit-sales method, the focus is toreport a reasonably accurate bad debt e"pense. nder the percentage-of-receivablesmethod the focus is to report accounts receivable reasonably close to their net reali!able

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-&6Solutions /anual



37/60

value. If the estimates using the latter to methods arent correct year after yeardifferences in the methods ill occur because the percentage-of-receivables methodad9usts the balance in the alloance account to ensure that the net accounts receivableappro"imates its C3D. %he percentage-of-credit-sales method doesnt consider the C3Dof accounts receivable, only the e"pense for the period. In principle, the percentage-of-

credit sales and percentage-of-receivables should provide the same result. oever, themethods ill diverge, even if they are set up to yield the same result, once estimates andactuals are different in a year.

f. Bf the to accrual methods they to ays of achieving the same end. Co method is

inherently better or orse, each one involves a trade-off. %he direct method provides

accurate information about the amount of bad debts, but doesnt match the e"pense to the

revenue it helped generate, hich is hy its not used under accrual accounting. %he

percentage-of-credit-sales method matches the e"pense to the revenue it helped generate,

but is an estimate, not an actual indication of hat ont be collected. %he percentage-of-

receivables method also matches the e"pense to the revenue and provides anappro"imation of the receivables net reali!able value, but the amount of bad debts may be

even less accurate than the percentage-of-credit-sales method. It must be stressed that if

the estimates are unbiased :over time estimation errors average to !ero; the methods

should yield similar results. Gifferences among the methods are caused by errors in

estimating bad debts. %hese methods, it should be remembered, are means to an endT to

provide an appropriate valuation for accounts receivable and to determine an appropriate

e"pense for the calculation of net income.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-&>Solutions /anual



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+6-11.

a.

8ear 'redit Sales

)

ncollectible

Fad Gebt

="pense

$1& 7 &,&>5, &) 7 11,$5$1* &,>1$,5 &) 111,&>5

$15 *,1?5, &) 1$5,55

$16 *,>$5, &) 1*1,>5

$1> 5,&>>,5 &) 161,&$5

$1? 5,?5, &) 1>5,5

b.

;ea$ "'enin% balance >$ite.offs

3ad debt

e


39/60

e"pectation is that $) of sales ill go uncollected hereas &) is being e"pensed, net

income is, on average, being understated each year by 1) of credit sales.

e. %he net amount of accounts receivable on alkirks balance sheet on Gecember &1, $1?

ill be 71,*61,@$5 :71,?1&,5 O 7&51,5>5;;. %he balance doesnt reflect the net

reali!able value of the accounts receivable. %he amount is understated by the cumulative

e"cess of bad debts e"pense from $1& to $1?.

f. Fad debt e"pense calculated as $) of credit sales, beginning in $15M

;ea$ C$edit ales Uncollectible 3ad ebt E$ite.offs 3ad debt e


40/60

conclude that the 7$1,&>5 as part of ongoing earnings. oever, users ont be

misled hen determining future cash flos from accounts receivable as they are no

stated at net reali!able value.

+6-1$.




verage accounts receivable H Bpening 6&.6* *?.> *>.?*

'omparing the to companies, Sturgis has a better accounts receivable turnover ratio,hich means its more effective at collecting its debts. Sturgis is collecting its debts 15days faster than %adoussac. Bn the surface at least Sturgis is better at managing its cashflos and has better controls in place to ensure collection. dditional useful informationregarding the receivables of the companies includes the period each company alloscustomers to pay :the difference beteen the to might not be meaningful if %adoussacoffers more time;, any incentives for early payment :discount for prompt payment;, andinformation on the risk profile of the customers :are conditions each company facesdifferent regarding its customers;.

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+6-1&

'urrent

3atio

Quick 3atio ccounts 3eceivable %urnover

3atio

verage 'ollection +eriod

of

ccounts 3eceivable

1 Increase Increase Increase Gecrease

$ Co effect Co effect Co effect Co effect

& Increase Increase Co effect Co effect

* Gecrease Gecrease Gecrease Increase

5 Co effect Co effect Co effect Co effect

6 Co effect Co effect Co effect Co effect

>N Co effect Co =ffect Co effect Co effect

%he credit sale increases 3%B because the impact on the denominator is less than the

effect on the numerator. In the denominator the beginning accounts receivable isnt

affected by the credit sale, only ending receivables is. %he opposite logic applies to hen

there are decreases as in item *.

N ssumes that an accrual method for bad debts is used :rite-off has no effect on net

accounts receivable;. If the direct rite-off approach is used the anser ould be

decrease, decrease, increase, decrease.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-*1Solutions /anual



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+6-1*.

'urrent

3atio

Quick

3atio

ccounts 3eceivable

%urnover 3atio

verage 'ollection

+eriod of ccounts

3eceivable

1 Gecrease Gecrease Increase Gecrease

$ Co effect Co effect Increase Gecrease

& Gecrease Gecrease Co effect Co effect

* Gecrease Gecrease Co effect Co effect

5 Increase Increase Co effect Co effect

6 Gecrease Gecrease Increase Gecrease

+6-15.

Cote that amounts calculated by students may vary slightly depending on ho much roundingthey do.Items to be solved are shon in grey.

'urrent assets on Gecember &1, $1> 71,5$&,>5

'urrent ratio on Gecember &1, $1> 1.15

'urrent liabilities on Gecember &1, $1> 71,&$5,

Quick assets on Gecember &1, $1> 7?5,

Quick ratio on Gecember &1, $1> .6*

ccounts receivable on Gecember &1, $1> 7$>5,1@$

ccounts receivable on Gecember &1, $16 7$>,

3evenues :all on credit; during $1> 7$,>5,

verage collection period of accounts receivable for $1> &$ days

ccounts receivable turnover ratio for $1> 11.*1

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-*$Solutions /anual



43/60

+6-16.

Cote that amounts calculated by students may vary slightly depending on ho much roundingthey do. Items to be solved are shon in bold.

'urrent assets on Gecember &1, $1? 7$>5,'urrent ratio on Gecember &1, $1? 1.$5

'urrent liabilities on Gecember &1, $1? 7$$,

Quick assets on Gecember &1, $1? 71?>,

Quick ratio on Gecember &1, $1? .?5

ccounts receivable on Gecember &1, $1? 755,

ccounts receivable on Gecember &1, $1> 7*5,

3evenues :all on credit; during $1? 7$?>,5

verage collection period of accounts receivable for $1? 6&.*?

ccounts receivable turnover ratio for $1? 5.>5

+6-1>.

Cu$$ent

$atio Quic) $atio

Accounts

$eceivable

tu$nove$

$atio

Ave$a%e

collection

'e$iod of

accounts

$eceivable

ebt.to.

e&uity $atio

P$ofit

ma$%in $atio

Ariteoff of

an account

receivable1Co =ffect Co =ffect Co =ffect Co =ffect Co =ffect Co =ffect

3ecording

the

alloance

for

discounts$

Gecrease Gecrease Increase Gecrease Increase Gecrease

3ecording

the bad debt

e"pense&Gecrease Gecrease Increase Gecrease Increase Gecrease

Sale of

merchandiseon creditT

payment

due in three

years*

Gecrease

:less

inventory;

Co =ffect Increase Gecrease Gecrease Increase

1Ariteoff of an account receivable reduces the alloance and a specific receivable account. %heres no effect

on current assets or the income statement.$Gebit SalesEalloance for discounts :contra sales;, 'redit lloance for discounts :contra accounts

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-*&Solutions /anual



44/60

receivable;&Gebit Fad debt e"pense :e"pense;, 'redit lloance for uncollectables :contra accounts receivable;*Gebit 4ong-term accounts receivable, 'redit SalesT Gebit 'ost of goods sold, 'redit inventory

N ssume that alloance for returns has been 9ournali!ed.

+6-1?.

Cu$$ent

$atio Quic) $atio

Accounts

$eceivable

tu$nove$

$atio

Ave$a%e

collection

'e$iod of

accounts

$eceivable

ebt.to.

e&uity $atio

P$ofit

ma$%in

$atio

3ecording the

alloance for

returns1Gecrease Gecrease Increase Gecrease Increase Gecrease

'ollection of a

previously

ritten off

account

receivable$

Co =ffect Co =ffect Increase Gecrease Co =ffect Co =ffect

Sale of

merchandise

on creditT

payment due in

& days&

Increase Increase Increase Gecrease Gecrease Increase

'ollection of

an accountreceivable*

Co =ffect Co =ffect Increase Gecrease Co =ffect Co =ffect

1Gebit SalesEalloance for return :contra sales;, 'redit lloance for returns :contra accounts receivable;$Gebit ccounts receivable, 'redit lloance for uncollectables, Gebit 'ash, 'redit ccounts receivable&Gebit ccounts receivable, 'redit SalesT the increase in sales is greater than the increase in average accounts

receivable.*Gebit 'ash, 'redit ccounts receivable.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-**Solutions /anual



45/60

+6-1@.

ccounts receivable turnover ratio H&65

verage collection period

H &65

6$

H 5.?@

verage accounts receivable H'redit Sales


H $,*56,

5.?@

H *16,@>?

verage accounts receivable H Feg. ?

$

Feginning


46/60

ccounts receivable turnover ratioH $,5?1, H 5.&?

*>@,*>?

verage collection periodH &65 H 6? days

5.&?

e. n additional bad debt e"pense of 75, ould cause average accounts receivable to

decrease by 7$,5.

ccounts receivable turnover ratioH $,*56, H 5.@$

*1*,*>?

verage collection periodH &65 H 61.6 days

5.@$

f. n alloance for sales returns of 7>,5 ould cause average accounts receivable todecrease by 7&,>5 but reduce net sales by the entire amount.

ccounts receivable turnover ratioH $,**?,5 H 5.@&

*1&,$$?

verage collection periodH &65 H 61.6 days

5.@&

+6-$.

a. %he amount of revenue that Fellburn should recogni!e is the present value of the long-

term receivableM

75,,


47/60

c. #or fiscal $1> Fellburn ould report 7*1&,$$&:7*,1&$,$&1N 1); of interest revenue.

Bn /arch &1, $1> Fellburn ould report a long-term receivable of 7*,5*5,*55. %he

receivable is still long-term because as its not due to be collected until pril $1?, hich

is more than one year aay.

%he 9ournal entry to record the interest revenue isM

4ong-term receivable *1&,$$&

Interest revenue *1&,$$&

Fellburn should record 7*5*,5*6 of interest revenue in fiscal $1?. %he receivable ould

appear on the balance sheet at its present value of 75,,. It ould be classified as a

current asset because the cash ill be received ithin one year.

%he 9ournal entry to record the interest revenue isM

4ong-term receivable :current asset; *5*,5*6

Interest revenue *5*,5*6

d. 'ash 5,,

4ong-term receivable 5,,

e. Fellburn should recogni!e 75,, in revenue. %he interest payments should be

recogni!ed as interest revenue in the periods in hich they are paid.

+6-$1.a.

Account A%e 3alance

Pe$cent

Uncollectible

Amount

Uncollectible

'urrent 7$??, 1) 7$,??

1-& days 11$, 5) 5,6

&1-6 days 6, 15) @,

61-1$ days *, *) 16,

1$ days 6, >5) *5,

%otal 756, 7>?,*?

%he amount of closing accounts receivable estimated to be uncollectible is 7>?,*?.

b.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-*>Solutions /anual



48/60

Bpening alloance :76>,?;

mount ritten-off 5?,

+re-closing alloance :@,?;

3e(uired balance :>?,*?;

3e(uired ad9ustment 4=62,6207

Fad debt e"pense 6?,6?

lloance for uncollectible accounts 6?,6?

c. Bne possible e"planation is that management has revised its percentage of accounts

receivable estimated to be uncollectible resulting in a higher alloance. nother

e"planation is that the company had more sales, and thus a greater amount of accounts

receivable, meaning more ould be uncollectible. third possibility is that the

composition of the accounts changed and there are relatively older accounts receivable

than in $1>. %his too ould increase the alloance. fourth possibility is that the

company may have changed its credit policies making it easier for prospective customers

to get credit.

+6-$$.

a. lloance for uncollectible accounts 5&,

Fad debt e"pense 5&,

b. %he effect of estimating the bad debts higher than they actually ere in each of the years

as to decrease net income in each period by the e"cess of the estimate over the actualbad debts. %he ad9usting entry ill have the effect of increasing net income in the year

the ad9ustment is made by 75&,, hich is the cumulative e"cess of the estimate over

the actual bad debts for the past three years. In other ords, net income ill be 75&,

higher after the ad9ustment than it otherise ould have been :to offset income being too

lo in the previous three years;. oever, over the four years net income in total ould

have been the same. Ahat differs is the allocation of income over the four years. lso, it

might be argued that a higher e"pense in the first three years as conservative

accounting, but the effect of that conservatism in the fourth year results in higher income,

hich could be misleading to users.

c. %he error and ad9usting entry could mislead financial statement users. Cet income in each

of the previous three years has been understated, hich may cause users to underestimate

%rilbys future cash flos. In addition, the large decrease in bad debt e"pense due to the

ad9usting entry ill overstate net income for the current year. %his could cause users of

the financial statements to overestimate %rilbys future cash flos. %he financial

statements ould be even more confusing if this ad9ustment asnt clearly disclosed.

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-*?Solutions /anual



49/60

sers might conclude that the 75&, as part of ongoing earnings. In addition, the

balance sheets of the previous three years ont reflect the net reali!able value of

accounts receivable. %his could affect the decisions of creditors since decision criteria

such as current assets, current ratio, (uick ratio, etc., ill be misleading.

+6-$&.a, b.

ssume all sales on credit.




verage accounts receivable H Bpening


50/60

verage

ccounts

3eceivable $&$,16? $$5,??* $1@,611 $11,?&*

3%B @.>$ @.*& @.&$ @.$1

verage

collectionperiod &>.5* &?.>$ &@.15 &@.65

c. istorically Ilderton has done a better 9ob of managing its receivables despite more

stringent payment terms. It has reduced the number of days it takes to collect over the

period from &@.> days to &>.5 days, a reduction of about to days. %rua" ith more

lenient terms seems to be losing control of collecting receivables. %he time it takes to

collect has increased over the period from *@.> days to 5&.6 days, an increase of about

four days. Feing able to collect faster and having a higher turnover indicates better

management of accounts receivable and cash inflo by Ilderton over %rua".




51/60

+6-$*.

'ompany 'ompany F 'ompany '

'urrent 3atio 1.1* 1.1* 1.1*

Quick 3atio .6> .>5 .5&

3anking in order of li(uidity position :strongest to poorest;M

1; 'ompany F$; 'ompany &; 'ompany '

Ahile all three companies have the same current ratio it doesnt mean that they can alays haveenough cash to meet their current obligations. #or this reason e must look at the (uick ratio tobreak the tie. Ahile none of the companies appear to have enough li(uid asset to meet currentobligations :Quick 3atioU1; 'ompany F is in the best position of the three ith the highest (uickratio. In addition, F has the most cash, hich enhances its ability to meet its obligations. Btherfactors that may affect ranking outside of the ratios could be the nature of inventory on handsince certain types of inventory like commodities maybe more li(uid than others :i.e.'omputers;.

+6-$5.a. i.



;ea$

C$edit ales

3ad ebts

1*@0

$1* 75,5*, 7>5,?1

$15 6,&1>,5 @*,>6&

$16 >,$65,1$6 1?,@>>

$1> ?,5>$,?*? 1$?,5@&

$1? @,?5?,>>* 1*>,??$


52/60

ii.

iii.

;ea$ 3e%* 3alance >$ite."ffs

3ad ebt

1*@0 End* 3alance76&, :76&,; 7>5,?1 7>5,?1

>5,?1 :>5,?1; @*,>6$ @*,>6&

@*,>6& :@*,>6&; 1?,@>> 1?,@>>

1?,@>> :1?,@>>; 1$?,5@& 1$?,5@&

1$?,5@& :1$?,5@&; 1*>,??$ 1*>,??$

3e%* 3alance

>$ite."ffs

3ad ebt

1*9@

End* 3alance

76&, :76&,; 7??,**5 7??,**5??,**5 :>5,?1; 11,556 1$&,1@1

1$&,1@1 :@*,>6$; 1$>,1* 155,56@

155,56@ :1?,@>6; 15,$5 1@6,61?

1@6,61? :1$?,5@$; 1>$,5$@ $*,555

iv.

#! 3efo$e

3ad ebts

3ad ebts

1*@0

;ea$ #!

$1* 7*6*,@6? 7>5,?1 7&?@,15?$15 6&1,>5 7@*,>6& 5&6,@?>

$16 6@,1?6 71?,@>> 5?1,$@

$1> >@>,$>* 71$?,5@& 66?,6?1

$1? ??>,$@ 71*>,??$ >&@,*?

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-5$Solutions /anual


;ea$

C$edit ales

3ad ebts

1*9@

$1* 75,5*, 7??,**5

$15 6,&1>,5 11,556

$16 >,$65,1$6 1$>,1*

$1> ?,5>$,?*? 15,$5

$1? @,?5?,>>* 1>$,5$@


53/60

#! 3efo$e

3ad ebts

3ad ebts

1*9@

;ea$ #!

$1* 7*6*,@6? 7??,**5 7&>6,5$&

$15 6&1,>5 711,556 5$1,1@*

$16 6@,1?6 71$>,1* 56&,*6

$1> >@>,$>* 715,$5 6*>,$*@

$1? ??>,$@ 71>$,5$@ >1*,>61

b. %he president could cite the increasing rite-offs each year to 9ustify the .$5) increase.

oever, the increased rite-offs are more likely caused by the increasing sales. %he

president could also cite poor economic conditions. gain, this is a eak argument since

rapidly increasing sales indicate favourable economic conditions. %he president could

also support the increase ith information about accounts receivable, for instance a lo

turnover ratio and long collection period combined ith many overdue accounts ould

lend strong support to his argument. %he president could also contend that he&

%o correct error in estimating bad debt e"pense for $1* to $1?

ii. %his entry ould increase net income by 7@$,6>& by loering e"penses by

7@$,6>&.

d. idden reserves are an abuse of accounting information and they undermine the

relevance and reliability of financial statements. ccounting re(uires many sub9ective

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-5&Solutions /anual



54/60

estimates, many of hich are made by management and arent fully disclosed in the

financial statements. sers of financial statements ho arent aare of these estimates

are in danger of being misled by them and making inappropriate decisions. sing hidden

reserves to smooth earnings or shift earnings to achieve certain reporting ob9ectives

makes earnings less informative to users. I#3S re(uires disclosure of significant

estimates so for these companies at least stakeholders can e"pect information that might

e"pose hidden reserves.

+6-$6.

a.

4oan loss

provision

H =nding

balance

- Feginning

balance

L 4oan

losses

- 4oss

recoveries

$15 7$,>1?, H 7$1,&$*, - 7$$,1*, L 76,66, - 7$,5&$,$16 75,&$$, H 7$1,1&?, - 7$1,&$*, L 7>,@5, - 7$,**$,

$1> 75,$6?, H 7$1,, - 7$1,1&?, L 7>,?&, - 7$,*$*,

b. #rom the information provided the balance in the loan loss account has decreased overthe three years shon. oever, the loan loss provision itself increased significantly in$16 :although the smaller loan loss provision in $15 may have been the result ofhaving to reduce the balance in the alloance account;. %he decreasing balance in thealloance account suggests that e"pected losses are declining :assuming a steady orincreasing loan portfolio;. %he information from alloance account shos that the loanlosses associated ith consumer loans and international commercial loans have increased

significantly, suggesting that these loans are becoming more risky :assuming that amountof loans has remained stable;. Bn the other hand, the losses associated ith 'anadiancommercial loans have decreased from $15 to $1>.

c. 'onsumer loans are by far the most risky as seen from the folloing tableM

4oan losses as a

percentage of loans

outstanding at year

end

4oan losses less loan

loss recoveries as a

percentage of loans

outstanding at year end'onsumer loans 1.*6) 1.16)

'anadian commercial loans .$*) .)

International commercial loans .$&) .1*)

%otal .>?) .5*)

'onsumer loan losses as a percentage of consumer loans outstanding are significantly higherthan the same ratio for the other categories of loans. Fecause a particular loan category is riskier

ohn #riedlan,Financial Accounting: A Critical Approach, *thedition +age 6-5*Solutions /anual



55/60

than others, it doesnt necessary make that category bad business. 3emaining in consumer loansmay still be profitable even if the loss rate is higher. %he bank ill be able to compensate for thehigher risk by charging a higher interest rate on consumer loans. lso, by being in consumerloans Vbara! ill be able to have a larger pool of loans in its portfolio. 'onsumer loans representover **) of the loans. It may not be possible for Vbara! to replace these loans ith those in the

less risky categories. aving more commercial loans may actually increase risk because the loanpool ould have more similar types of loans, hich means that hen things get bad in a sectorthe risk of losses is actually higher.

d. /ore information about the pool of loans gives the stakeholder the ability to do moreanalysis of the banks lending practices. Aith detailed information about the loan portfolio astakeholder could assess the lending strategy of the bank and the riskiness of the loans beingmade. /y key concern as a stakeholder of the bank :keeping in mind of course that differentstakeholders have different interests and different information needs; ould be to evaluate therisk of and return on the portfolio. Information about the distribution of loans :regions of thecountry, industries, foreign countries, etc.; ould give insight into the risk of the portfolio :the

more diversified the portfolio the less risky it is;. Information about interest rates, duration ofloans, and other terms ould give insight into the returns that could be earned on the portfolioand help in making predictions about future cash flos.




56/60

U!# B!#A#C!A- TATEME#TU!# B!#A#C!A- TATEME#T

#S6-1.

:in millions of dollars;

a. 'ash and e(uivalents on /arch &1, $1$ O 7$?>.&b. Cet amount of accounts receivable on /arch &1, $1$ O 7&?.*c. 2ross amount of accounts receivable on /arch &1, $1$ O 7&16d. lloance for doubtful accounts on /arch &1, $1$ O 7>.6e. mount of trade receivables past due on /arch &1 ,$1$ O 7>?.>f. 'ash from operations for $1$ O 7$&&.@g. 3evenue for $1$ O 71,?$1.$

#S6-$

:amounts in millions of dollars;

'= reports accounts receivable as 7&?.* on its balance sheet. %his number represents theamount of money that '= estimates it can collect from its customers ho havenWt yet paid forthe goods and services received. %his figure is loer than the amount that customers actuallyoed to the company because '= has reduced it by the amount that '= estimates customersont pay :even though the customer oes money, some may never pay their bills;. 'ustomersactually oe 7&16 hen uncollectible amounts arent taken into consideration. %his amountincludes amounts not oed by customers. %he amount oed by customers is 11&.$. Cote 5shos a bad debt e"pense of 7>.6.

#S6-&:amounts in millions of dollars;

4i(uidity can be e"amined in a number of ays. '=s cash position has increased slightly from$11, though its belo the $1 level. %he current ratio is 1.&, hich unchanged from $11and slightly higher than $1. %he (uick ratio :including cash and cash e(uivalents and accountsreceivable; has decreased slightly from .>1 to .6>. In $1 the (uick ratio as also .>1. nimportant message from these measures is their stability. Aorking capital has increased by over7$5 from 7$&@.1 to 7$6*.>%he companys li(uidity has been steady over three years as measuredby the current and (uick ratios. 'ash from operations has also been steady over to years,suggesting a reliable flo of cash coming in from operations.

#S6-*.in millions of dollars as of /arch &1, /01/ /011

'ash and cash e(uivalents 7$?>.& 7$>6.*

5>&.$




57/60

%otal current assets 11*?.1 1*@.$

%otal current liabilities ??&.* ?1.1

Quick ratio .6> .>1

:Quick assets < current liabilities;

'urrent ratio 1.& 1.&

:'urrent assets < current liabilities;

Aorking capital $6*.> $&@.1

#rom $11 to $1$ the (uick ratio has slightly declined indicating that their li(uidity position hasorsened but given the small change it could be caused by timing. Ahile a further look into theindustry is re(uired for comparison it does not look like the company is in a very strong li(uidityposition to start out ith since current liabilities are higher than (uick assets. %he current ratio

has remained unchanged beteen the to years but over all there is an increase in orkingcapital. %his can be taken as a sign of improvement in li(uidity hoever items such as theincrease in inventories for a company that provides primarily services maybe alarming. #rom thestatement of cash flos, there is an improvement in '#B. Bverall there is an increase in cash andcash e(uivalents in $1$ but this is more than offset by the additional debt the company hastaken on.

#S6-5.%he ma"imum amount '= can receive under the program of selling their accounts receivable is715 million. %he benefit of selling accounts receivable is that it improves the companys cashposition and maintain its li(uidity position ithout incurring additional borroings. company

buying the receivables ould make money by buying the receivable for loer than their facevalue, ith the difference being profit.

#S6-6.%he note on estimates is included to make stakeholders aare that estimates have been used inthe preparation of the financial statements. lthough the estimates are supposed to representmanagements best guessR regarding uncertainties at the financial statement date, stakeholdersare cautioned that the actual results may differ from the estimates. Its important thatstakeholders are aare of these estimates so they can appropriately evaluate the companysperformance and take into consideration managements motivation in making estimates. It alsoensures that stakeholders are aare of the presence of uncertainty hen financial statement

numbers are being relied upon to make a decision. %hat said, estimates are needed under accrualaccounting to prepare financial statements because there are uncert

friedlan4e sm ch06

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