CHAPTER 9 Accounting for Receivables

Solutions

Complete the following: Questions #1,2 (p444) ; Brief Exercise #1 (p445) 01. The three major types and classification of receivables are as follows: Type Classification (1) Accounts receivable Current asset (2) Notes receivable Current or noncurrent asset

depending on due date (3) Other receivables Current or noncurrent asset

depending on due date 02. Other receivables include nontrade receivables such as interest receivable, loans to

company officers, advances to employees, and income taxes refundable. BRIEF EXERCISE 9-1 (a) Other receivables (b) Notes receivable (c) Accounts receivable

Complete the following: Questions #4, 5, 6, 7 (p444); Brief Exercises #3, 4, 5, 6 (p445); Exercises

#2, 3, 4 (p446-7); Problems #2, 4, 5 (p. 447-9) 04. Under the direct write-off method, bad debt losses are not estimated and no allowance account is

used. When an account is determined to be uncollectible, the loss is debited to Bad Debts Expense. The direct write-off method makes no attempt to match bad debts expense to sales revenues, or to show the net realizable value of the receivables in the balance sheet. The disadvantages are that it may not match expenses with revenue and it does not accurately reflect the collectible value of the accounts receivable on the balance sheet.

5. The essential features of the allowance method of accounting for bad debts are:

(1) Uncollectible accounts receivable are estimated in advance, in order to match the cost of the bad debts against sales in the same accounting period in which the sale occurred.

(2) Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts through an adjusting entry at the end of each period.

(3) Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time a specific account is written off.0

6. Net realizable value is the difference between Accounts Receivable (normal debit balance) and

the Allowance for Doubtful Accounts (normal credit balance). Soo Eng should realize that the decrease in net realizable value occurs when estimated uncollectibles are recognized in an adjusting entry (debit Bad Debt Expense; credit Allowance for Doubtful Accounts). The write-off of an uncollectible account reduces both accounts receivable and the allowance for doubtful accounts by the same amount. Thus, net realizable value does not change.

7. The two bases of estimating uncollectibles under the allowance method are (1) percentage of

sales (income statement method) and (2) percentage of receivables (balance sheet method). The percentage of sales basis establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. This method emphasizes the matching of expenses with revenues. Under the percentage of receivables basis, the balance in the allow-

ance for doubtful accounts is derived either (a) by applying a percentage estimate of bad debts to total receivables or (b) from an analysis of individual customer accounts. This method emphasizes net realizable value.

BRIEF EXERCISE 9-3 April 30Bad Debt Expense [($800,000 – $50,000) X 2%] ............................................................ 15,000

Allowance for Doubtful Accounts..................................................................... 15,000 BRIEF EXERCISE 9-4 (a) Dec. 31 Bad Debts Expense [($400,000 X 1%) – $3,000] ................................. 1,000

Allowance for Doubtful Accounts ...................................................... 1,000 (b) Dec. 31 Bad Debts Expense [($400,000 X 1%) + $800]............................................. 4,800

Allowance for Doubtful Accounts ...................................................... 4,800 BRIEF EXERCISE 9-5 (a) Jan. 24 Allowance for Doubtful Accounts..................................................................... 7,000

Accounts Receivable ............................................................................ 7,000 (b)

(1) Before Write-Off

(2) After Write-Off Accounts receivable Allowance for doubtful accounts Net realizable value

$700,000 0054,000 $646,000

$693,000 0047,000 $646,000

BRIEF EXERCISE 9-6 March 4 Accounts Receivable.............................................................................................. 7,000

Allowance for Doubtful Accounts ................................................................. 7,000 Cash ............................................................................................................ 7,000

Accounts Receivable ................................................................................... 7,000 EXERCISE 9-2 (a) (1) Dec. 31Bad Debts Expense....................................................................................... 8,000

[($840,000 – $40,000) X 1%] Allowance for Doubtful Accounts .......................................... 8,000

(2) Dec. 31Bad Debts Expense....................................................................................... 8,500

Allowance for Doubtful Accounts .......................................... 8,500 [($110,000 X 10%) – $2,500]

(b) (1) Dec. 31Bad Debts Expense....................................................................................... 4,000

[($840,000 – $40,000) X 0.5%] Allowance for Doubtful Accounts .......................................... 4,000

(2) Dec. 31Bad Debts Expense....................................................................................... 6,000

Allowance for Doubtful Accounts .......................................... 6,000 [($110,000 X 5%) + $500]

EXERCISE 9-3 (a)

Accounts Receivable

Amount

%

Estimated Uncollectible

0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding

$65,000 017,600 008,500 006,400

2

103050

$1,300 01,760 02,550 03,200 $8,810

(b) Mar. 31Bad Debts Expense................................................................................................... 7,010 Allowance for Doubtful Accounts ...................................................... 7,010

($8,810 – $1,800)

EXERCISE 9-4 2002

Dec. 31 Bad Debts Expense (2% X $400,000).................................................................... 8,000 Allowance for Doubtful Accounts ................................................................. 8,000

2003

May 11 Allowance for Doubtful Accounts............................................................................ 1,100 Accounts Receivable–Worthy...................................................................... 1,100

June 12 Accounts Receivable–Worthy ................................................................................ 1,100

Allowance for Doubtful Accounts ................................................................. 1,100

12 Cash ............................................................................................................ 1,100 Accounts Receivable–Worthy...................................................................... 1,100

PROBLEM 9-2A

(a) $38,000 (b) $63,000 ($2,100,000 X 3%) The balance in the Allowance for Doubtful Accounts is irrelevant. (c) $47,400 [($840,000 X 6%) – $3,000] (d) $53,400 [($840,000 X 6%) + $3,000] (e) The weaknesses of the direct write-off method are two-fold. First, it does not match expenses

with revenues. Second, the accounts receivable are not stated at their estimated net realizable value at the balance sheet date.

PROBLEM 9-4A

(a)

Accounts Receivable

Amount

%

Estimated Uncollectible

0-30 days outstanding 31-60 days outstanding 61-90 days outstanding Over 90 days outstanding

$100,000

60,00050,00030,000

15

1025

$ 1,000

3,000 5,000

7,500 $16,500

(b) Bad Debts Expense ............................................................................................ 6,500

Allowance for Doubtful Accounts ($16,500 – $10,000)............................................. 6,500

(c) Allowance for Doubtful Accounts .............................................................................. 2,000 Accounts Receivable ................................................................................................ 2,000 (d) Accounts Receivable ............................................................................................ 1,000

Allowance for Doubtful Accounts.............................................................................. 1,000

Cash ................................................................................................................ 1,000 Accounts Receivable ................................................................................................ 1,000

(e) When an allowance is established, an estimate is made of the accounts receivable or credit sales that will not be collected. An entry is made to record this estimate in the period in which the sale occurred. This matches the estimated expense with the revenue it generated.

PROBLEM 9-5A

(a) Bad Debts Expense (3% X $1,000,000) ........................................................................ 30,000

Allowance for Doubtful Accounts ....................................................................... 30,000 (b) Allowance for Doubtful Accounts ................................................................................... 37,000

Accounts Receivable.......................................................................................... 37,000 (c) Accounts Receivable ..................................................................................................... 5,000

Allowance for Doubtful Accounts ....................................................................... 5,000

Cash ...................................................................................................................5,000 Accounts Receivable.......................................................................................... 5,000

(d) Beginning balance ......................................................................................................... $09,000

Add: Bad debt expense .................................................................................... 30,000 Recovery of account ................................................................................ 5,000

Deduct: Write-off of uncollectible accounts .................................................................... (37,000) Ending balance .............................................................................................................. $ 7,000

(e) When the percentage of sales (income statement) method is used to estimate bad debts,

recoveries of accounts previously written off do not directly affect the bad debts expense (They may have an indirect effect, by influencing the estimator’s judgment regarding the appropriate percentage of sales to use).

If the percentage of receivables (balance sheet) method of providing for bad debts was used, the recovery would have a direct effect by increasing the balance is the allowance account and therefore reducing the expense to be recorded in the year-end adjustment.

Complete the following: Question #12 (p444);

Brief Exercise #8 (p445); Exercises #7, 8 (p 447)

12. (a) Principal = $12,000 [($360 x 12/4) ÷ 9%]

(b) Interest = $5,400 [$30,000 x 6% x 3] (c) Interest rate = 8.33% [($2,500 x 12/6) ÷ $60,000] (d) Time = 3 months [$875 ÷ ($50,000 x 7%) ÷ 12]

BRIEF EXERCISE 9-8 (a) Total Interest = $15,000 [$900,000 x 10% x 2/12] (b) Interest Rate = 8% [($526.67 x 12) ÷ $79,000] (c) Principal = $56,000 [($1,680 x 12/6) ÷ 6%] EXERCISE 9-7 Nov. 1Notes Receivable–A. Morgan ........................................ 18,000

Cash.............................................................. 18,000

Dec. 1 Notes Receivable–Wright. ............................................... 3,600

Sales ............................................................. 3,600

16 Notes Receivable–Barnes .................................... 4,000 Accounts Receivable–Barnes ....................... 4,000

31 Interest Receivable ............................................... 331 Interest Revenue*.......................................... 331

*Calculation of interest revenue:

Morgan: $18,000 X 10% X 2/12 ...................................... $300 Wright: $3,600 X 6% X 1/12 ........................................... 18 Barnes: $4,000 X 8% X 0.5/12 ....................................... 13

Total accrued interest .................................................. $331

EXERCISE 9-8 2002 May 1 Notes Receivable–Jones.............................................................. 10,500

Accounts Receivable—Jones ............................................. 10,500 Dec. 31 Interest Receivable................................................................................ 700

Interest Revenue ($10,500 X 10% X 8/12) ......................... 700

2003 May 1 Cash ............................................................................................ 11,550

Notes Receivable–Jones .................................................... 10,500 Interest Receivable ............................................................. 700 Interest Revenue ($10,500 X 10% X 4/12) ......................... 350

Complete the following: Question #13 (p444) ; Brief Exercise #9 (p445) 13. Accounts receivable are amounts owed by customers on account, resulting from the sale of

goods and services in the normal course of business operations (i.e., in trade). Interest is not normally charged on accounts receivable unless they are overdue. Accounts receivable are normally collected within 30 or so days.

Notes receivable represent claims that are evidenced by formal instruments of credit. A promissory note gives the holder a stronger legal claim than one on an account receivable. As a result, it is easier to sell to another party. Promissory notes are negotiable instruments, which means they can be transferred to another party by endorsement. Interest is normally charged on notes receivable for the entire maturity period. Notes receivable can extend for any period of time, from 30 days to a number of years.

BRIEF EXERCISE 9-9 Jan. 10 Accounts Receivable–Opal .................................................................................... 9,000

Sales .......................................................................................................... 9,000 Feb. 9 Notes Receivable–Opal.......................................................................................... 9,000

Accounts Receivable–Opal ........................................................................ 9,000

Complete the following: Questions #16, 17 (p444) ; Brief Exercise #12 (p445); Exercise #12 (p448); Problem #10 (p451)

16. An increase in the current ratio normally indicates an improvement in short-term liquidity. This may not always be the case because the composition of current assets may vary. In order to determine if the increase is an improvement in financial health, other ratios that should be considered include: Receivable turnover and collection period and inventory turnover and days sales in inventory ratios.

17. Receivables turnover = Net credit sales ÷ Average accounts receivable Net credit sales = Receivables turnover x Average accounts receivable Net credit sales = 8.0583 x $4,542,500 Net credit sales = $36,604,828

BRIEF EXERCISE 9-12 Receivables turnover $11,006 ÷ [($420 + $380) ÷ 2] = 27.52 times Collection period 365 days ÷ 27.52 = 13.27 days EXERCISE 9-12 Nike Receivables Turnover $8,995.1 ÷ $1,569.4 = 5.73 times 365 days ÷ 5.73 = 63.7 days Reebok $2,899.9 ÷ $417.4 = 6.95 times 365 days ÷ 6.95 = 52.5 days Nike’s receivable turnover and collection period are not as good as Reebok’s or the industry average. Reebok’s ratios are slightly better than the industry average.

PROBLEM 9-10A

(a) 2000 1999 Current ratio $1,125 ÷ $1,903 = 0.6:1

$1,527 ÷ $1,777 = 0.9:1

Acid test ratio $756 ÷ $1,903 = 0.4:1

$1,110 ÷ $1,777 = 0.6:1

(b) 2000 1999 Receivables turnover $5,446 ÷ $770 = 7.1x $5,261 ÷ $603.5 = 8.7x Collection period 365 days ÷ 7.1

= 51.4 days 365 days ÷ 8.7 = 42.0 days

(c) CN’s short-term liquidity has deteriorated. The current and acid test ratios both declined. The

receivables turnover is less and the average collection period is longer.