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Chapter 7

Cash and Receivables

AACSB assurance of learning standards in accounting and business education require


documentation of outcomes assessment. Although schools, departments, and faculty may approach
assessment and its documentation differently, one approach is to provide specific questions on
exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each
question, exercise and problem in Intermediate Accounting, 6e with the following AACSB learning
skills:
Questions
7-1
7-2
7-3
7-4
7-5
7-6
7-7
7-8
7-9

AACSBTags
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking, Communications
Diversity, Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking, Communications

Exercises(cont.)
7-11
7-12
7-13
7-14
7-15
7-16
7-17
7-18
7-19

AACSBTags
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Diversity, Analytic

7-10
7-11
7-12
7-13
7-14
7-15
716
717
718
719
720

Reflective thinking
Diversity, Reflective thinking
Reflective thinking
Reflective thinking
Diversity, Reflective thinking
Reflective thinking, Communications
Reflective thinking
Reflective thinking
Reflective thinking
Reflective thinking, Communications
Diversity, Reflective thinking

7-20
7-21
7-22
7-23
7-24
7-25
7-26
7-27
7-28
7-29
7-30

Reflective thinking
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Reflective thinking,
Communications
Reflective thinking,
Communications

BriefExercises

7-31

Analytic

7-1
7-2
7-3
7-4
7-5
7-6
7-7
7-8

Reflective thinking
Diversity, Reflective thinking
Reflective thinking
Analytic
Analytic
Analytic
Diversity, Reflective thinking
Analytic

CPA/CMA
7-1
7-2
7-3
7-4
7-5
7-6
7-7

Analytic
Analytic
Reflective thinking
Analytic
Analytic
Analytic

7-9
7-10
7-11

Analytic
Analytic
Analytic

7-1
7-2
7-3

Reflective thinking
Analytic
Analytic

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Analytic

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7-1

7-12

Analytic

7-13
7-14
7-15
7-16
7-17
Exercises
7-1
7-2
7-3
7-4
7-5
7-6
7-7
7-8
7-9
7-10

Analytic
Reflective thinking
Diversity, Reflective thinking
Analytic
Analytic
Analytic
Analytic
Diversity, Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic

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7-2

Problems
7-1
7-2
7-3
7-4
7-5
7-6
7-7
7-8
7-9
7-10
7-11
7-12
7-13
7-14
7-15

Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Diversity, Analytic
Analytic
Analytic
Analytic
Analytic
Analytic
Analytic

Intermediate Accounting, 6/e

QUESTIONS FOR REVIEW OF KEY TOPICS


Question 7-1
Cash equivalents usually include negotiable instruments as well as highly liquid
investments that have a maturity date no longer than three months from date of
purchase.
Question 7-2
Internal control procedures involving accounting functions are intended to
improve the accuracy and reliability of accounting information and to safeguard the
companys assets. The separation of duties means that employees involved in
recordkeeping should not also have physical responsibility for assets.
Question 7-3
Management must document the companys internal controls and assess their
adequacy. The auditors must provide an opinion on managements assessment. The
Public Company Accounting Oversight Boards Auditing Standard No. 5, which
supersedes Auditing Standard No. 2, further requires the auditor to express its own
opinion on whether the company has maintained effective internal control over
financial reporting.
Question 7-4
A compensating balance is an amount of cash a depositor (debtor) must leave on
deposit in an account at a bank (creditor) as security for a loan or a commitment to
lend. The classification and disclosure of a compensating balance depends on the
nature of the restriction and the classification of the related debt. If the restriction is
legally binding, then the cash will be classified as either current or noncurrent
(investments and funds or other assets) depending on the classification of the related
debt. In either case, note disclosure is appropriate. If the compensating balance
arrangement is informal and no contractual agreement restricts the use of cash, note
disclosure of the arrangement including amounts involved is appropriate. The
compensating balance can be included in the cash and cash equivalents category of
current assets.
Question 7-5
Yes, IFRS and U.S. GAAP differ in how bank overdrafts are treated. Under
IFRS, overdrafts can be offset against other cash accounts. Under U.S. GAAP
overdrafts must be treated as liabilities.
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Intermediate Accounting, 6/e

Answers to Questions (continued)


Question 7-6
Trade discounts are reductions below a list price and are used to establish a final
price for a transaction. The reduced price is the starting point for initial valuation of
the transaction. A cash discount is a reduction, not in the selling price of a good or
service, but in the amount to be paid by a credit customer if the receivable is paid
within a specified period of time.
Question 7-7
The gross method of accounting for cash discounts considers discounts not taken
as part of sales revenue. The net method considers discounts not taken as interest
revenue, because they are viewed as compensation to the seller for allowing the buyer
to defer payment.
Question 7-8
When returns are material and a company can make reasonable estimates of
future returns, an allowance for sales returns is established. At a financial reporting
date, this provides an estimate of the amount of future returns for prior sales, and
involves a debit to sales returns and a credit to allowance for sales returns for the
estimated amount. Allowance for sales returns is a contra account to accounts
receivable. When returns actually occur in the future reporting period, the allowance
for sales returns is debited.
Question 7-9
Even when specific customer accounts havent been proven uncollectible by the
end of the reporting period, bad debt expense properly should be matched with sales
revenue on the income statement for that period. Likewise, since its not expected
that all accounts receivable will be collected, the balance sheet should report only the
expected net realizable value of that asset. So, to record the bad debt expense and the
related reduction of accounts receivable when the amount hasnt been determined, an
estimate is needed. In an adjusting entry, we record bad debt expense and reduce
accounts receivable for an estimate of the amount that eventually will prove
uncollectible.
If uncollectible accounts are immaterial or not anticipated, or its not possible to
reliably estimate uncollectible accounts, an allowance for uncollectible accounts is not
appropriate. In these few cases, any bad debts that do arise simply are written off as
bad debt expense at the time they prove uncollectible.

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7-5

Answers to Questions (continued)


Question 7-10
The income statement approach to estimating bad debts determines bad debt
expense directly by relating uncollectible amounts to credit sales. The balance sheet
approach to estimating future bad debts indirectly determines bad debt expense by
estimating the net realizable value for accounts receivable that exist at the end of the
period. In other words, the allowance for uncollectible accounts at the end of the
period is estimated and then bad debt expense is determined by adjusting the
allowance account to reflect net realizable value.
Question 7-11
A company has to separately disclose trade receivables and receivables from
related parties under U.S. GAAP, but not under IFRS.
Question 7-12
The assignment of all accounts receivable in general as collateral for debt
requires no special accounting treatment other than note disclosure of the agreement.
Question 7-13
The accounting treatment of receivables factored with recourse depends on
whether certain criteria are met. If the criteria are met, the factoring is accounted for
as a sale. If they are not met, the factoring is accounted for as a loan. In addition,
note disclosure may be required. Accounts receivable factored without recourse are
accounted for as the sale of an asset. The difference between the book value and the
fair value of proceeds received is recognized as a gain or a loss.
Question 7-14
U.S. GAAP focuses on whether control of assets has shifted from the transferor
to the transferee. In contrast, IFRS focuses on whether the company has transferred
substantially all of the risks and rewards of ownership, as well as whether the
company has transferred control. Under IFRS:
If the company transfers substantially all of the risks and rewards of ownership,
the transfer is treated as a sale.
If the company retains substantially all of the risks and rewards of ownership, the
transfer is treated as a secured borrowing.
If neither conditions 1 or 2 hold, the company accounts for the transaction as a
sale if it has transferred control, and as a secured borrowing if it has retained control.

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Intermediate Accounting, 6/e

Answers to Questions (continued)


Question 7-15
When a note is discounted, a financial institution, usually a bank, accepts the note
and gives the seller cash equal to the maturity value of the note reduced by a discount.
The discount is computed by applying a discount rate to the maturity value and
represents the financing fee the bank charges for the transaction.
The four-step process used to account for a discounted note receivable is as
follows:
1. Accrue any interest revenue earned since the last payment date (or date of the
note).
2. Compute the maturity value.
3. Subtract the discount the bank requires (discount rate times maturity value
times the remaining length of time from date of discounting to maturity date)
from the maturity value to compute the proceeds to be received from the bank
(maturity value less discount).
4. Compute the difference between the proceeds and the book value of the
note and related interest receivable. The treatment of the difference will
depend on whether the discounting is accounted for as a sale or as a loan.
If its a sale the difference is recorded as a loss or gain on the sale; if its a
loan the difference is viewed as interest expense or interest revenue.
Question 7-16
A companys investment in receivables is influenced by several related variables,
to include the level of sales, the nature of the product or service, and credit and
collection policies. The receivables turnover and average collection period ratios are
designed to monitor receivables.
Question 7-17
The items necessary to adjust the bank balance might include deposits
outstanding (including undeposited cash), outstanding checks, and any bank errors
discovered during the reconciliation process. The items necessary to adjust the book
balance might include collections made by the bank on the companys behalf, service
and other charges made by the bank, NSF (nonsufficient funds) check charges, and
any company errors discovered during the reconciliation process.

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7-7

Answers to Questions (concluded)


Question 7-18
A petty cash fund is established by transferring a specified amount of cash from
the companys general checking account to an employee designated as the petty cash
custodian. The fund is replenished by writing a check to the petty cash custodian for
the sum of the bills paid with petty cash. The appropriate expense accounts are
recorded from petty cash vouchers at the time the fund is replenished.
Question 7-19
When a creditors investment in a receivable becomes impaired, due to a troubled
debt restructuring or for any other reason, the receivable is re-measured based on the
discounted present value of currently expected cash flows at the loans original
effective rate (regardless of the extent to which expected cash receipts have been
reduced). The extent of the impairment is the difference between the carrying amount
of the receivable (the present value of the receivables cash flows prior to the
restructuring) and the present value of the revised cash flows discounted at the loans
original effective rate. This difference is recorded as a loss at the time the receivable
is reduced.
Question 7-20
No. Under both U.S. GAAP and IFRS, a company can recognize in net income
the recovery of impairment losses of accounts and notes receivable.

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Intermediate Accounting, 6/e

BRIEF EXERCISES
The company could improve its internal control
Brief Exercise 7-1procedure for cash receipts by segregating the duties of
recordkeeping and the handling of cash. Jim Seymour,
responsible for recordkeeping, should not also be responsible for depositing customer
checks.
Under IFRS the cash balance would be $245,000,
Brief Exercise 7-2because they could offset the two accounts. Under U.S.
GAAP the balance would be $250,000, because they could
not offset the two accounts.
All of these items would be included as cash and cash
Brief Exercise 7-3equivalents except the U.S. Treasury bills, which would be
included in the current asset section of the balance sheet as
short-term investments.
Income before tax in 2012 will be reduced by $2,500, the
Brief Exercise 7-4amount of the cash discounts.
$25,000 x 10 = $250,000 x 1% = $2,500
Income before tax in 2011 will be reduced by $2,500, the
Brief Exercise 7-5anticipated amount of cash discounts.
$25,000 x 10 = $250,000 x 1% = $2,500

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Brief Exercise 7-6

Estimated returns = $10,600,000 x 8% =


Less: Actual returns(720,000)
Remaining estimated returns
$128,000

$848,000

Sales returns............................................................... 128,000


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

Brief Exercise 7-7

Singletary cannot combine the two types of receivables under U.S. GAAP, as the
director is a related party. Under IFRS a combined presentation would be
(1) Bad debtallowed.
expense
=
$1,500,000 x
2%
=
Brief Exercise 7-8
$30,000
(2) Allowance for uncollectible accounts:
Beginning balance
$25,000
Add: Bad debt expense
30,000
Deduct: Write-offs
(16,000)
Ending balance
$39,000

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Intermediate Accounting, 6/e

Brief Exercise 7-9

(1)Allowance for uncollectible accounts:


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

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


Accounts receivable:
Beginning balance
Add: Credit sales
Deduct: Cash collections
Write-offs
Ending balance

$ 300,000
1,500,000
(1,450,000)
(16,000)
$ 334,000**

Brief Exercise 7-10

Allowance for uncollectible accounts:


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

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Brief Exercise 7-11

Credit sales $8,200,000


Deduct: Cash collections (7,950,000)
Write-offs
(32,000)*
Year-end balance in A/R
(2,000,000)
Beginning balance in A/R
$1,782,000
*Allowance for uncollectible accounts:
Beginning balance
$30,000
Add: Bad debt expense
40,000
Deduct: Required allowance
(38,000)
Write-offs
$32,000

Brief Exercise 7-12

2011 interest revenue:


$20,000 x 6% x 1/12 = $100

2012 interest revenue:


$20,000 x 6% x 2/12 = $200

Assets decrease by $7,000:


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

Brief Exercise 7-13

Liabilities would not change as a result of this transaction.


Income before income taxes decreases by $7,000
(the loss on sales of receivables)
The journal entry to record the transaction is as follows:

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Intermediate Accounting, 6/e

Cash (85% x $100,000)..................................................


Loss on sale of receivables (to balance)........................
Receivable from factor ($11,000 fair value $3,000 fee).
...............................Accounts receivable (balance sold)
.......................................................................100,000

Brief Exercise

85,000
7,000
8,000

Logitech would account for the transfer as a secured


7-14borrowing. The receivables remain on the companys books
and a liability is recorded for the amount borrowed plus the

banks fee.

Brief Exercise 7-15

Under IFRS, Huling would treat this transaction as a


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

Brief Exercise 7-16


$30,000
450
30,450
(406)
$30,044

Brief Exercise 7-17

Face amount
Interest to maturity ($30,000 x 6% x 3/12)
Maturity value
Discount ($30,450 x 8% x 2/12)
Cash proceeds

Receivables turnover =
$60,000*

$320,000 = 5.33

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

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7-13

Average collection
period

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7-14

365 = 68 days
5.33

Intermediate Accounting, 6/e

EXERCISES
Exercise 7-1Requirement 1

Cash and cash equivalents includes:

a. Balance in checking account


Balance in savings account
b. Undeposited customer checks
c. Currency and coins on hand
f. U.S. treasury bills with 2-month maturity
Total

$13,500
22,100
5,200
580
15,000
$56,380

Requirement 2
d. The $400,000 savings account will be used for future plant expansion and
therefore should be classified as a noncurrent asset, either in other assets or
investments.
e. The $20,000 in the checking account is a compensating balance for a longterm loan and should be classified as a noncurrent asset, either in other
assets or investments.
f. The $20,000 in 7-month treasury bills should be classified as a current asset
along with other temporary investments.

Exercise 7-2Requirement 1

Cash and cash equivalents includes:

Cash in bank checking account


U.S. treasury bills
Cash on hand
Undeposited customer checks
Total

$22,500
5,000
1,350
1,840
$30,690

Requirement 2

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7-15

The $10,000 in 6-month treasury bills should be classified as a current asset


along with other temporary investments.

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Intermediate Accounting, 6/e

Exercise 7-3Requirement 1: U.S. GAAP


Current Assets:
Cash

Requirement 2: IFRS
$175,000

Current Assets:
Cash

$160,000

Current Liabilities:
Bank Overdrafts

$ 15,000
(No current liabilities with respect to overdrafts.)

Exercise 7-4
Requirement 1
Sales price = 100 units x $600 = $60,000 x 70% = $42,000
November 17, 2011
Accounts receivable...................................................
..............................................................Sales revenue
.........................................................................42,000

November 26, 2011


Cash (98% x $42,000)....................................................
Sales discounts (2% x $42,000).....................................
...................................................Accounts receivable
.........................................................................42,000

42,000

41,160
840

Requirement 2

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November 17, 2011


Accounts receivable...................................................
..............................................................Sales revenue
.........................................................................42,000

December 15, 2011


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

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7-18

42,000

42,000

Intermediate Accounting, 6/e

Exercise 7-4 (concluded)


Requirement 3
Requirement 1, using the net method:
November 17, 2011
Accounts receivable................................................... 41,160
........................................................Sales revenue (98% x $42,000)
.................................................................................... 41,160

November 26, 2011


Cash............................................................................
...................................................Accounts receivable
.........................................................................41,160

41,160

Requirement 2, using the net method:


November 17, 2011
Accounts receivable................................................... 41,160
........................................................Sales revenue (98% x $42,000)
.................................................................................... 41,160

December 15, 2011


Cash............................................................................
...................................................Accounts receivable
.........................................................................41,160

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42,000

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7-19

..........................................................Interest revenue
..............................................................................840

Exercise 7-5Requirement 1
Sales price = 1,000 units x $50 = $50,000
July 15, 2011
Accounts receivable...................................................
..............................................................Sales revenue
.........................................................................50,000

July 23, 2011


Cash (98% x $50,000)....................................................
Sales discounts (2% x $50,000).....................................
...................................................Accounts receivable
.........................................................................50,000

50,000

49,000
1,000

Requirement 2
July 15, 2011
Accounts receivable...................................................
..............................................................Sales revenue
.........................................................................50,000

50,000

Aug. 15, 2011

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7-20

Intermediate Accounting, 6/e

Cash............................................................................
...................................................Accounts receivable
.........................................................................50,000

50,000

Exercise 7-6Requirement 1
July 15, 2011
Accounts receivable................................................... 49,000
........................................................Sales revenue (98% x $50,000)
.................................................................................... 49,000

July 23, 2011


Cash............................................................................
...................................................Accounts receivable
.........................................................................49,000

49,000

Requirement 2
July 15, 2011
Accounts receivable................................................... 49,000
........................................................Sales revenue (98% x $50,000)
.................................................................................... 49,000

August 15, 2011


Cash............................................................................
...................................................Accounts receivable
.........................................................................49,000

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50,000

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7-21

..........................................................Interest revenue
...........................................................................1,000

Requirement 1
Estimated returns = 4% x $11,500,000 =
Less: Actual returns
(450,000)
Remaining estimated returns
$10,000

Exercise 7-7

$460,000

To record the actual sales returns


Sales returns............................................................... 450,000
...................................................Accounts receivable
.......................................................................450,000
Inventory estimated returns .................................... 292,500
.......................................Cost of goods sold ($450,000 x 65%)
.......................................................................292,500
December 31, 2011 To record the estimated sales returns
Sales returns............................................................... 10,000
.......................................Allowance for sales returns
.........................................................................10,000
Inventory estimated returns ....................................
6,500
.........................................Cost of goods sold ($10,000 x 65%)
...........................................................................6,500

Note: another series of journal entries that produce the same end result would be:
To record the actual sales returns
Allowance for sales returns........................................ 450,000

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Intermediate Accounting, 6/e

...................................................Accounts receivable
.......................................................................450,000
December 31, 2011 To record the estimated sales returns
Sales returns (4% x $11,500,000)................................... 460,000
.......................................Allowance for sales returns
.......................................................................460,000
Inventory-estimated returns ....................................... 299,000
................................................Cost of goods sold (65% x $460,000)
.................................................................................... 299,000

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Exercise 7-7 (continued)


Requirement 2
Beginning balance in allowance account
Add: Year-end estimate
Less: Actual returns
Ending balance in allowance account

$300,000
460,000
(450,000)
$310,000

Exercise 7-8Requirement 1

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

Requirement 2
Allowance for uncollectible accounts
Balance, beginning of year
Add: Bad debt expense for 2011 (1.5% x $4,500,000)
Less: End-of-year balance
Accounts receivable written off

$42,000
67,500
(40,000)
$69,500

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

Exercise 7-9Requirement 1
To record the write-off of receivables.
Allowance for uncollectible accounts........................
...................................................Accounts receivable
.........................................................................21,000

21,000

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


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

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7-24

1,200

Intermediate Accounting, 6/e

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

1,200

Allowance for uncollectible accounts:


Balance, beginning of year
Deduct: Receivables written off
Add: Collection of receivable previously written off
Balance, before adjusting entry for 2011 bad debts

$32,000
(21,000)
1,200
12,200

Required allowance: 10% x $625,000


Bad debt expense

(62,500)
$50,300

To record bad debt expense for the year.


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

50,300

Requirement 2
Current assets:
Accounts receivable, net of $62,500 allowance
for uncollectible accounts
$562,500
Using the direct write-off method, bad debt expense is equal to
Exercise 7-10actual write-offs. Collections of previously written-off receivables
are recorded as revenue.
Allowance for uncollectible accounts:
Balance, beginning of year
Deduct: Receivables written off
Add: Collection of receivables previously written off
Less: End of year balance
Solutions Manual, Vol.1, Chapter 7

$17,280
(17,100)
2,200
(22,410)

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7-25

Bad debt expense for the year 2011

Exercise 7-11
Balance, beginning of year
Add: Bad debt expense
Less: End of year balance
Write-offs during the year

$20,030
($ in millions)
Allowance for uncollectible accounts:
$16
14
(18)
$ 12*

Accounts receivable analysis:


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

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7-26

$ 1,100
4,271
(12)
(971)
$4,388

Intermediate Accounting, 6/e

Exercise 7-12Requirement 1
June 30, 2011
Note receivable...........................................................
..............................................................Sales revenue
.........................................................................30,000

30,000

December 31, 2011


Interest receivable.......................................................
900
.............................................Interest revenue ($30,000 x 6% x 6/12)
......................................................................................................................
900
March 31, 2012
Cash [$30,000 + ($30,000 x 6% x 9/12)]............................

31,350

.............................................Interest revenue ($30,000 x 6% x 3/12)


......................................................................................................................
450
...................Interest receivable (accrued at December 31)
..............................................................................900
..........................................................Note receivable
.........................................................................30,000

Requirement 2
2011 income before income taxes would be understated by $900
2012 income before income taxes would be overstated by $900.

Exercise 7-13Requirement 1
June 30, 2011

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7-27

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


..........................Discount on note receivable ($30,000 x 8% x 9/12)
....................................................................................
1,800
.............................................Sales revenue (difference)
.........................................................................28,200
December 31, 2011
Discount on note receivable ......................................
1,200
.............................................Interest revenue ($30,000 x 8% x 6/12)
....................................................................................
1,200
March 31, 2012
Discount on note receivable ......................................
600
.............................................Interest revenue ($30,000 x 8% x 3/12)
....................................................................................
600
Cash ...........................................................................
.......................................Note receivable (face amount)
.........................................................................30,000

Requirement 2
$ 1,800
$28,200
= 6.383%
12/
x
9
_______
= 8.511%

30,000

interest for 9 months


sales price
rate for 9 months
to annualize the rate
effective interest rate

Exercise 7-14Requirement 1

Book value of stock


Plus gain on sale of stock
6,000
= Note receivable
$22,000
Interest reported for the year

$16,000

$ 2,200
=

The McGraw-Hill Companies, Inc., 2011


7-28

10% rate
Intermediate Accounting, 6/e

Divided by value of note

$ 22,000

Requirement 2
To record sale of stock in exchange for note receivable.
January 1, 2011
Note receivable...........................................................
.................................................................Investments
.........................................................................16,000
.......................................Gain on sale of investments
...........................................................................6,000

22,000

To accrue interest on note receivable for twelve months.


December 31, 2011
Interest receivable.......................................................
2,200
.............................................Interest revenue ($22,000 x 10%)
...........................................................................2,200

Exercise 7-15

Cash (difference)............................. 439,200


Finance charge expense (1.8% x $600,000)................... 10,800
.............................Liability financing arrangement
.......................................................................450,000

Exercise 7-16

Cash (90% x $60,000)...................... 54,000


Loss on sale of receivables (to balance)........................
2,200
Receivable from factor ($5,000 fair value [2% x $60,000])
3,800
...............................Accounts receivable (balance sold)
.........................................................................60,000

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7-29

Exercise 7-17

Cash ([90% - 2%] x $60,000).............


Loss on sale of receivables (to balance)........................
Receivable from factor ($5,000 fair value)....................
.......................................................Recourse liability
...........................................................................3,000
...............................Accounts receivable (balance sold)
.........................................................................60,000

52,800
5,200
5,000

Mountain High retains significant risks and rewards and therefore


The accounts
receivable stay on the balance sheet of Mountain High, and they
must record a liability.

Exercise 7-18must treat the transfer as a secured borrowing.

Cash ([90% - 2%] x $60,000)..........................................


Finance charge expense (2% x $60,000).......................
.....................................................................Liability
.........................................................................54,000

Exercise 7-19

52,800
1,200

Step 1: Accrue interest earned.

February 28, 2011


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

Step 2: Add interest to maturity to calculate maturity value.


Step 3: Deduct discount to calculate cash proceeds.
$15,000
750
15,750
(630)

Face amount
Interest to maturity ($15,000 x 10% x 6/12)
Maturity value
Discount ($15,750 x 12% x 4/12)

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7-30

Intermediate Accounting, 6/e

$15,120

Cash proceeds

Step 4: To record a loss for the difference between the cash proceeds and the
notes book value.
February 28, 2011
Cash (proceeds determined above)...................................
Loss on sale of note receivable (difference).................
.......................................Note receivable (face amount)
.........................................................................15,000
....Interest receivable (accrued interest determined above)
..............................................................................250

Exercise 7-20
c 1. Internal control
j
2. Trade discount
g 3. Cash equivalents
h 4. Allowance for uncollectibles
i
5. Cash discount
l
6. Balance sheet approach
d 7. Income statement approach
k 8. Net method
a 9. Compensating balance
m 10. Discounting
b 11. Gross method
e 12. Direct write-off method
f

13. Factoring

15,120
130

List A List B
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.

Restriction on cash.
Cash discount not taken is sales revenue.
Includes separation of duties.
Bad debt expense a % of credit sales.
Recognizes bad debts as they occur.
Sale of receivables to a financial institution.
Include highly liquid investments.
Estimate of bad debts.
Reduction in amount paid by credit customer.
Reduction below list price.
Cash discount not taken is interest revenue.
Bad debt expense determined by estimating realizable
value.
m. Sale of note receivable to a financial institution.

Exercise 7-21Requirement 1
March 17, 2011
Allowance for uncollectible accounts........................
...................................................Accounts receivable
...........................................................................1,700

Solutions Manual, Vol.1, Chapter 7

1,700

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7-31

March 30, 2011


Note receivable...........................................................
............................................................................Cash
.........................................................................20,000

20,000

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


May 30, 2011
Interest receivable.......................................................
233
.............................................Interest revenue ($20,000 x 7% x 2/12)
....................................................................................
233

Step 2: Add interest to maturity to calculate maturity value.


Step 3: Deduct discount to calculate cash proceeds.

$20,000
1,400
21,400
(1,427)
$19,973

Face amount
Interest to maturity ($20,000 x 7%)
Maturity value
Discount ($21,400 x 8% x 10/12)
Cash proceeds

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7-32

Intermediate Accounting, 6/e

Exercise 7-21 (continued)


Step 4: To record a loss for the difference between the cash proceeds and the
notes book value.
May 30, 2011
Cash (proceeds determined above)...................................
Loss on sale of note receivable (difference).................
.......................Interest receivable (from adjusting entry)
..............................................................................233
.......................................Note receivable (face amount)
.........................................................................20,000

June 30, 2011


Accounts receivable...................................................
..............................................................Sales revenue
.........................................................................12,000

July 8, 2011
Cash ($12,000 x 98%)....................................................
Sales discounts ($12,000 x 2%).....................................
...................................................Accounts receivable
.........................................................................12,000

19,973
260

12,000

11,760
240

August 31, 2011

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7-33

Notes receivable (face amount).....................................


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

December 31, 2011


Bad debt expense ($700,000 x 2%)................................
........................Allowance for uncollectible accounts
.........................................................................14,000

The McGraw-Hill Companies, Inc., 2011


7-34

14,000

Intermediate Accounting, 6/e

Exercise 7-21 (concluded)


Requirement 2
To accrue interest earned on note receivable.
December 31, 2011
Discount on note receivable.......................................
160
...............................................Interest revenue ($6,000 x 8% x 4/12)
....................................................................................
160

Second quarter:
Receivables turnover =
$10,244
Exercise 7-22
Average collection
=
91 = 56 days
period
1.62
Third quarter:
Receivables turnover =

Average collection
period

$13,648
$10,068

$16,629 = 1.62

= 1.36

91 = 67 days
1.36

Average collection period


receivable turnover = 50 days

Exercise 7-23

Accounts receivable turnover

= 365 Accounts
= 365 50 = 7.3

Average accounts receivable

= ($400,000 + 300,000) 2 = $350,000

Accounts receivable turnover


7.3

= Net sales Average accounts receivable


= Net sales $350,000

Net sales = 7.3 x $350,000

= $2,555,000

Exercise 7-24
Solutions Manual, Vol.1, Chapter 7

To establish the petty cash fund.


The McGraw-Hill Companies, Inc., 2011
7-35

October 2, 2011
Petty Cash......................................................
................................Cash (checking account)

200
200

To replenish the petty cash fund.


October 31, 2011
Office supplies expense.................................
Entertainment expense...................................
Postage expense.............................................
Miscellaneous expense..................................
................................Cash (checking account)

76
48
20
19
163

Exercise 7-25
September 30, 2011 To replenish the petty cash fund
Delivery expense...........................................
16
Office supplies expense.................................
19
Receivable from employee............................
25
Postage expense.............................................
32
................................Cash (checking account)

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7-36

92

Intermediate Accounting, 6/e

Compute balance per bank statement:


Exercise
Balance
per books 7-26Exercise 7-27
Deduct: Deposits outstanding
Add: Checks outstanding
Deduct: Bank service charges
Balance per bank
Step 1:

Bank Balance to Corrected Balance

Balance per bank statement


Add: Deposits outstanding
Deduct: Checks outstanding
Corrected cash balance
Step 2:

$23,820
(2,340)
1,890
(38)
$23,332

$23,332
2,340
(1,890)
$23,782

Book Balance to Corrected Balance

Balance per books


Deduct: Service charges
Corrected cash balance

$23,820
(38)
$23,782

Requirement 1

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7-37

Step 1: Bank Balance to Corrected Balance


Balance per bank statement
Add: Deposits outstanding
Deduct: Checks outstanding
Add: Bank error in recording check
Corrected cash balance

$38,018
6,300
(8,420)
270
$36,168

Step 2: Book Balance to Corrected Balance


Balance per books
Add: Error in recording cash
receipt ($2,000 - 200)
Deduct:
Service charges
NSF checks
Automatic monthly loan payment
Corrected cash balance

$38,918
1,800
(30)
(1,200)
(3,320)
$36,168

Requirement 2

To correct error in recording cash receipt from credit customer.


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

1,800

To record credits to cash revealed by the bank reconciliation.


Miscellaneous expense (bank service charges)
Accounts receivable (NSF checks)................ 1,200
Interest expense.............................................
320

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7-38

30

Intermediate Accounting, 6/e

Note payable..................................................
...............................................................Cash
..............................................................4,550

3,000

Note: Each of the adjustments to the book balance required journal entries.
Noneoftheadjustmentstothebankbalancerequireentries.

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7-39

Exercise 7-28
ANALYSIS

Previous Value:

Accrued 2010 interest (10% x $12,000,000)


Principal
Carrying amount of the receivable

$ 1,200,000
12,000,000
$13,200,000

New Value:

Interest
$1 million
x 1.73554 *
Principal $11 million
x 0.82645 **
Present value of the receivable

=
=

$1,735,540
9,090,950

Loss:

(10,826,490)
$ 2,373,510

* present value of an ordinary annuity of $1: n=2, i=10% (from Table 4)


** present value of $1: n=2, i=10% (from Table 2)
JOURNALENTRIES

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7-40

Intermediate Accounting, 6/e

January 1, 2011
Loss on troubled debt restructuring (to balance)..........
Accrued interest receivable (account balance).........
Note receivable ($12,000,000 - 10,826,490)............

2,373,510
1,200,000
1,173,510

December 31, 2011


Cash (required by new agreement)..............................
Note receivable (to balance).......................... ........
Interest revenue (10% x $10,826,490)....................

1,000,000
82,649
1,082,649

December 31, 2012


Cash (required by new agreement)..............................
Note receivable (to balance)........................................
Interest revenue (10% x [$10,826,490 + 82,649])...

1,000,000
90,861

Cash (required by new agreement)..............................


Note receivable (balance)........................................

11,000,000

1,090,861*
11,000,000

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

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7-41

Exercise 12-28 (concluded)


Amortization Schedule Not required

Cash
Interest
by agreement

1
2

1,000,000
1,000,000
2,000,000

Effective
Increase in
Interest
Balance
10% x Outstanding Balance Discount Reduction
.10 (10,826,490) = 1,082,649
.10 (10,909,139) = 1,090,861*

2,173,510

82,649
90,861
173,510

Outstanding
Balance

10,826,490
10,909,139
11,000,000

* rounded

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7-42

Intermediate Accounting, 6/e

Exercise 7-29
ANALYSIS

Previous Value:

Accrued 2010 interest


(10% x $240,000)
Principal
Carrying amount of the receivable

$ 24,000
240,000
$264,000

New Value:

$11,555 + 11,555 + 11,555 + 240,000 = $274,665


$274,665 x 0.82645 * =
Loss:
*

(226,997)
$ 37,003

present value of $1: n=2, i=10% (from Table 2)


JOURNALENTRIES

January 1, 2011
Loss on troubled debt restructuring (to balance)..........
Accrued interest receivable (10% x $240,000)........
Note receivable ($240,000 - 226,997).....................

37,003
24,000
13,003

December 31, 2011


Note receivable (to balance)........................................
Interest revenue (10% x $226,997).........................

22,700
22,700

December 31, 2012


Note receivable (to balance)........................................
Interest revenue (10% x [$226,997 + 22,700])........

24,968

Cash (required by new agreement)..............................


Note receivable (balance)........................................

274,665

24,968*
274,665

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

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7-43

Exercise 7-29 (concluded)


Amortization Schedule Not required
Cash
Interest
by agreement

1
2

0
0

Effective
Interest
10% x Outstanding Balance
.10 (226,997) = 22,700
.10 (249,697) = 24,968*

47,668

Increase in
Outstanding
Balance
Balance
Discount Reduction

22,700
24,968
47,668

226,997
249,697
274,665

* rounded

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7-44

Intermediate Accounting, 6/e

Exercise 7-30
Requirement 1
The specific citation that specifies these disclosure policies is FASB ACS 31010
509: ReceivablesOverallDisclosureAccounting Policies for Credit Losses
and Doubtful Accounts.
Requirement 2
FASB ACS 31010509 reads as follows:
In addition to disclosures required by this Subsection and Subtopic 450-20, an entity
shall disclose a description of the accounting policies and methodology the entity used
to estimate its allowance for loan losses, allowance for doubtful accounts, and any
liability for off-balance-sheet credit losses and related charges for loan, trade
receivable or other credit losses in the notes to the financial statements. Such a
description shall identify the factors that influenced management's judgment (for
example, historical losses and existing economic conditions) and may also include
discussion of risk elements relevant to particular categories of financial instruments.

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7-45

Exercise 7-31
The FASB Accounting Standards Codification represents the single source of
authoritative U.S. generally accepted accounting principles. The specific citation for
each of the following items is:
1.Accountsreceivablesfromrelatedpartiesshouldbeshownseparately
fromtradereceivables:FASBACS21010S991:BalanceSheet
OverallSECMaterialsGeneral.AlsoappearsunderACS3101045
13:ReceivablesOverallOtherPresentationMattersReceivables
fromOfficers,EmployeesorAffiliates,andunderASC85010502:
"RelatedPartyDisclosuresOverallDisclosure"

2.DefinitionofCashEquivalents:FASBACS3051020:CashandCash
EquivalentsOverallGlossary.
3. Notes exchanged for cash are valued at the cash proceeds: FASB ACS 310
10302: ReceivablesOverallInitial MeasurementNotes Exchanged for
Cash.
4. The two conditions that must be met to accrue a loss on an account
receivable: FASB ASC 310-10-35-8: "ReceivablesOverallSubsequent
Measurement."

The McGraw-Hill Companies, Inc., 2011


7-46

Intermediate Accounting, 6/e

CPA / CMA REVIEW QUESTIONS


CPA Exam Questions
1. a. Allowance for uncollectible accounts, beginning balance
Add: Bad debt expense (2% $9,000,000)
Less: Write-offs
Allowance for uncollectible accounts, ending balance
2. a. Accounts receivable, beginning balance
Add: Credit sales
Less: Write-offs
Less: Accounts receivable, ending balance
Cash collections

$260,000
180,000
(325,000)
$115,000
$ 600
3,200
(200)
(500)
$3,100

3. c. The reinstatement of a previously written off account increases the


allowance account. The collection of the reinstated account does not
affect the allowance account. The net effect of the reinstatement and
collection is an increase in the allowance account. Neither the
reinstatement nor the subsequent collection of the account has any
effect on the expense.
4. b. Accounts receivable, beginning balance
Add: Credit sales
Less: Sales returns
Less: Write-offs
Less: Cash collections
Accounts receivable, ending balance

$ 650,000
2,700,000
(75,000)
(40,000)
(2,150,000)
$1,085,000

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

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7-47

CPA Exam Questions (concluded)


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

7. a. The estimate using the income statement approach is:


$1,750,000 x 2% = $35,000
The estimate using the balance sheet approach is:
Required ending balance ($900,000 x 5%)
Less: Allowance for uncollectible accounts
before recording bad debt expense
Bad debt expense

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7-48

$45,000
(16,000)
$29,000

Intermediate Accounting, 6/e

CMA Exam Questions


1. c. The allowance method records bad debt expense systematically as a
percentage of either credit sales or the level of accounts receivable.
The latter calculation considers the amount already existing in the
allowance account. The credit is to a contra asset or allowance
account. As accounts receivable are written off, they are charged to
the allowance account.
2. d. If a company uses the allowance method, the write-off of a receivable
has no effect on total assets. The journal entry involves a debit to the
allowance account and a credit to accounts receivable. The net effect
is that the asset section is both debited and credited for the same
amount. Thus, there will be no effect on either total assets or net
income.
3. c. The entry is to debit bad debt expense and credit the allowance
account. Net credit sales were $1,500,000 ($1,800,000 - $125,000 of
discounts - $175,000 of returns). Thus, the expected bad debt expense
is $22,500 (1.5% x $1,500,000). This amount is recorded regardless
of the balance remaining in the allowance account from previous
periods. The net effect is that the allowance account is increased by
$22,500.

1
PROBLEMS Requirement
Monthly bad debt expense accrual summary.

Problem 7-1

Bad debt expense (3% x $2,620,000)


........................Allowance for uncollectible accounts
.........................................................................78,600

Solutions Manual, Vol.1, Chapter 7

78,600

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7-49

To record year 2011 accounts receivable write-offs.


Allowance for uncollectible accounts........................
...................................................Accounts receivable
.........................................................................68,000

68,000

Requirement 2
Bad debt expense .......................................................
.............Allowance for uncollectible accounts (below)
...........................................................................4,300

4,300

Year-end required allowance for uncollectible accounts:


Summary
Age Group
0-60 days
61-90 days
91-120 days
Over 120 days
Totals

Amount
$430,000
98,000
60,000
55,000
$643,000

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7-50

Percent
Uncollectible
4%
15%
25%
40%

Estimated
Allowance
$17,200
14,700
15,000
22,000
$68,900

Intermediate Accounting, 6/e

Problem 7-1 (concluded)


Allowance for uncollectible accounts:
Beginning balance
Add: Monthly bad debt accruals
Deduct: Write-offs
Balance before year-end adjustment
Required allowance (determined above)
Required year-end increase in allowance

$54,000
78,600
(68,000)
64,600
68,900
$ 4,300

Requirement 3
Bad debt expense for 2011:
Monthly accruals
Year-end adjustment
Total

$78,600
4,300
$82,900

Balance sheet:
Current assets:
Accounts receivable, net of $68,900
allowance for uncollectible accounts

$574,100

Problem 7-2Requirement 1
(a)

Accounts receivable analysis ($ in thousands):


Balance, beginning of year ($580,640 + 6,590)
Add: Credit sales
Less: Cash collections
Less: Balance end of year ($504,944 + 5,042)
Accounts receivable written off during year

$ 587,230
2,158,755
(2,230,065)
(509,986)
$
5,934

(b)
Allowance for uncollectible accounts analysis ($ in thousands):
Beginning balance
Solutions Manual, Vol.1, Chapter 7

$6,590
The McGraw-Hill Companies, Inc., 2011
7-51

Less: Write-offs (from above)


Less: Year-end balance
Bad debt expense for the current year

(5,934)
(5,042)
$4,386

(c)
$4,386 of bad debt expense divided by $2,158,755 in credit sales
equals .2% (.002).
Requirement 2
(a) ($ in thousands)
Current year

Previous year

$509,986

$587,230

Current assets:
Receivables
(b) ($ in thousands)

Bad debt expense would be equal to actual receivables written off


of $5,934.

Problem 7-3Requirement 1

2009

2008

($ in thousands)

Accounts receivable, net


Add: Allowances
Accounts receivable, gross

$13,306
451
$13,757

$22,652
404
$23,056

Requirement 2
($ in thousands)

The answers to this question require an analysis of both gross accounts receivable
and the allowance for uncollectible accounts for 2009. First of all, 2009 sales of
$174,642 plus the decrease in receivables reported in the statement of cash flows
indicates cash received from customers of $183,988 ($174,642+ 9,346).
The activity in gross accounts receivable would be:
Gross Accounts Receivable
__________________________________________
The McGraw-Hill Companies, Inc., 2011
7-52

Intermediate Accounting, 6/e

($ in thousands)

Beg. Bal.
Sales

23,056
174,642
183,988

Writeoffs
End. Bal.

Collections

47
_________________
13,757

Note that, to make the T-account balance, this solution debits accounts receivable
for writeoffs. Rather than decreasing A/R by writing off accounts, Cirrus must be
reinstating some previously written off accounts after determining that those accounts
are now collectible, making the journal entry:
Accounts Receivable................................................................47
Allowance for Uncollectible Accounts....................................

Solutions Manual, Vol.1, Chapter 7

47

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7-53

Problem 7-3 (continued)


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

Allowance for Uncollectible Accounts


__________________________________________
($ in thousands)

404
47
-0_________________
451

Beg. Bal.
Reinstated A/R
Bad Debt Expense
End. Bal.

Problem 7-4Requirement 1

To record accounts receivable written off during the year 2011.

Allowance for uncollectible accounts........................


...................................................Accounts receivable
.........................................................................35,000

35,000

To record collection of account receivable previously written off.


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

3,000

Cash............................................................................

3,000

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Intermediate Accounting, 6/e

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

Requirement 2
(a)
December 31, 2011
Bad debt expense (3% x $1,750,000).............................
........................Allowance for uncollectible accounts
.........................................................................52,500

52,500

(b)
December 31, 2011
Bad debt expense........................................................
.............Allowance for uncollectible accounts (below)
.........................................................................36,700

Solutions Manual, Vol.1, Chapter 7

36,700

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7-55

Problem 7-4 (continued)


Accounts receivable analysis:
Beginning balance
Add: Credit sales
Less: Write-offs
Less: Cash collections
Ending balance

$ 462,000
1,750,000
(35,000)
(1,830,000)
$ 347,000

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


Allowance for uncollectible accounts analysis:
Beginning balance
Add: Collection of receivable previously written off
Less: Write-offs
Balance before adjustment
Required allowance (determined above)
Bad debt expense adjustment

$30,000
3,000
(35,000)
(2,000) debit balance
34,700
$36,700

(c)
December 31, 2011
Bad debt expense........................................................
.............Allowance for uncollectible accounts (below)
.........................................................................37,047

37,047

Required allowance:

Age Group
0-60 days
61-90 days
91-120 days
Over 120 days
Totals

Amount
$225,550
69,400
34,700
17,350
$347,000

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7-56

Percent
uncollectible
4%
15%
25%
40%

Estimated
allowance
$ 9,022
10,410
8,675
6,940
$35,047

Intermediate Accounting, 6/e

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Problem 7-4 (concluded)


Allowance for uncollectible accounts analysis:
Beginning balance
Add: Collection of receivable previously written off
Less: Write-offs
Balance before adjustment
Required allowance
Bad debt expense adjustment
Requirement 3
Accounts receivable

Year-end allowance

$30,000
3,000
(35,000)
(2,000) debit balance
35,047
$37,047

(a)

$347,000

[$(2,000) + 52,500]

= $296,500

(b)

$347,000

34,700

= $312,300

(c)

$347,000

35,047

= $311,953

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Intermediate Accounting, 6/e

Problem 7-5Requirement 1
Accounts receivable, net
Add: Allowances
Accounts receivable, gross

($ in millions)

2009
$837,010
20,991
$858,001

2008
$758,200
23,314
$781,514

Requirement 2
($ in millions)

Analysis of allowance for doubtful accounts


Balance, beginning of year
Add: Bad debt expense
Less: Balance end of year
Write offs

$8,915
1,500
(8,863)
$1,552

Requirement 3
($ in millions)

Analysis of allowance for sales returns


Balance, end of year
Add: Actual returns
Less: Balance beginning of year
Estimated sales returns

$12,128
3,155
(14,399)
$ 884

Gross sales for the year equal net sales of $6,149,800 + estimated sales returns of
$884 = $6,150,684 thousand.
Requirement 4
($ in millions)
Accounts receivable analysis:
Balance, beginning of year
Add: Credit sales
Less: Bad debt write-offs
Less: Actual sales returns
Less: Balance end of year
Cash collections

$ 781,514
6,150,684
(1,552)
(3,155)
(858,001)
$6,069,490

Problem 7-6Requirement 1

Total face value of notes = $300,000 + 150,000 + 200,000 =

$650,000
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7-59

Balance sheet carrying value =


Difference is the remaining discount on note 3

645,000
$ 5,000

Note 3 is a 6-month note, with three months remaining. Therefore,


$5,000 represents one-half of the total discount of $10,000.
$10,000 $200,000 = 5% x 12/6 = 10% discount rate.
Requirement 2
Total accrued interest receivable
Less: Interest accrued on note 1:
$300,000 x 10% x 4/12 =
Interest accrued on note 2

$16,000
(10,000)
$ 6,000

$6,000 $150,000 = 4% x 12/6 = 8%


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

$10,000
6,000
5,000
$21,000

Problem 7-7Requirement 1

Alternative a:

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


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

Alternative b:
To record the transfer of receivables.

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Intermediate Accounting, 6/e

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

Requirement 2
Alternative a:
July, 2011
Cash (80% x $780,000).................................................. 624,000
...................................................Accounts receivable
.......................................................................624,000
July 31, 2011
Interest expense ($500,000 x 12% x 1/12)........................
5,000
Note payable............................................................... 500,000
............................................................................Cash
.......................................................................505,000

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Problem 7-7 (concluded)


Alternative b:
$550 of accounts receivable are now held by the bank, and presumably the bank
has collected .8 x $550 = $440 during July. Lonergan still holds accounts receivable
of ($780 $550 = $230), so should have collected .8 x $230 = $184 during July.
July 31, 2011
Cash [80% x ($780,000 - $550,000)]................................ 184,000
...................................................Accounts receivable
.......................................................................184,000

Requirement 3
Alternative a.
Alternative b.

Note disclosure is required for the assignment of accounts


receivable as collateral for the $500,000 note.
No disclosure is required since the transfer of receivables
was made without recourse.

Problem 7-8

Cash (90% x $800,000)....................... 720,000


Loss on sale of receivables (to balance)........................ 52,000
Receivable from factor ($60,000 fair value [4% x $800,000])28,000
...............................Accounts receivable (balance sold)
.......................................................................800,000

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Intermediate Accounting, 6/e

Problem 7-9Walken Company


Balance Sheet
December 31, 2011
Current Assets
Casha
Accounts Receivable (net)b

35,000
60,000

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

Net Accounts Receivable would be affected as follows:


Beginning balance:
25,000
Credit sales
85,000
Cash collections
(30,000)
Receivables factored with Reliable
(20,000)
c
Receivables factored with Dependable
-0Total
60,000

The receivables factored with Dependable dont qualify for sales treatment, as substantially all risks and rewards of ownership are retained by Walken.

Problem 7-10Requirement 1
February 28, 2011
Note receivable...........................................................
..............................................................Sales revenue
.........................................................................10,000

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10,000

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March 31, 2011


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

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

April 11, 2011


Cash (98% x $7,000)......................................................
Sales discounts (2% x $7,000).......................................
...................................................Accounts receivable
...........................................................................7,000

April 17, 2011


Sales returns...............................................................
...................................................Accounts receivable
...........................................................................5,000
Inventory....................................................................
......................................................Cost of goods sold
...........................................................................3,200

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7-64

7,000

$6,860
140

5,000

3,200

Intermediate Accounting, 6/e

Problem 7-10 (continued)


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

49,500
500

To accrue interest on note receivable for four months.


June 30, 2011
Interest receivable.......................................................
333
.............................................Interest revenue ($10,000 x 10% x 4/12)
....................................................................................
333

To record discounting of note receivable.


June 30, 2011
Cash (proceeds determined below)...................................
Loss on sale of note receivable (to balance).................
........................Interest receivable (from adjusting entry)
..............................................................................333
.......................................Note receivable (face amount)
.........................................................................10,000

$10,000
583
10,583
(317)
Solutions Manual, Vol.1, Chapter 7

10,266
67

Face amount
Interest to maturity ($10,000 x 10% x 7/12)
Maturity value
Discount ($10,583 x 12% x 3/12)
The McGraw-Hill Companies, Inc., 2011
7-65

$10,266

Cash proceeds

August 31, 2011 NO ENTRY REQUIRED

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Intermediate Accounting, 6/e

Problem 7-10 (concluded)


Requirement 2
To accrue nine months' interest on the Maddox Co. note receivable.
Discount ....................................................................
600
...............................................Interest revenue ($8,000 x 10% x 9/12)
....................................................................................
600

Requirement 3
Income
increase (decrease)
$10,000
7,200
7,000
(140)
(5,000)
3,200
(500)
333
(67)
600
$22,626

Date
February 28
March 31
April 3
April 11
April 17
April 17
April 30
June 30
June 30
December 31
Total effect

Problem 7-11
Note

Note Face
Value

Date of
Note

Interest
Rate

Date
Discounted

Discount
Rate

Proceeds
Received

$50,000

3-31-11

8%

6-30-11

10%

$50,350 (1)

50,000

3-31-11

8%

9-30-11

10%

51,675 (2)

50,000

3-31-11

8%

9-30-11

12%

51,410 (3)

80,000

6-30-11

6%

10-31-11

10%

81,027 (4)

80,000

6-30-11

6%

10-31-11

12%

80,752 (5)

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80,000

6-30-11

6%

11-30-11

10%

81,713 (6)

(1)
$50,000
3,000
53,000
(2,650)
$50,350

Face amount
Interest to maturity ($50,000 x 8% x 9/12)
Maturity value
Discount ($53,000 x 10% x 6/12)
Cash proceeds

$50,000
3,000
53,000
(1,325)
$51,675

Face amount
Interest to maturity ($50,000 x 8% x 9/12)
Maturity value
Discount ($53,000 x 10% x 3/12)
Cash proceeds

(2)

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Intermediate Accounting, 6/e

Problem 7-11 (concluded)


(3)
$50,000
3,000
53,000
(1,590)
$51,410

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

$80,000
2,400
82,400
(1,373)
$81,027

Face amount
Interest to maturity ($80,000 x 6% x 6/12)
Maturity value
Discount ($82,400 x 10% x 2/12)
Cash proceeds

$80,000
2,400
82,400
(1,648)
$80,752

Face amount
Interest to maturity ($80,000 x 6% x 6/12)
Maturity value
Discount ($82,400 x 12% x 2/12)
Cash proceeds

$80,000
2,400
82,400
(687)
$81,713

Face amount
Interest to maturity ($80,000 x 6% x 6/12)
Maturity value
Discount ($82,400 x 10% x 1/12)
Cash proceeds

(4)

(5)

(6)

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Requirement 1
Problem 7-12
In addition to sales revenue of $1,340,000, the 2012 income
statement will include (1) interest revenue, (2) bad debts expense,
and (3) loss on sale of note receivable.
Interest revenue
$200,000 note: $200,000 x 6% x 3/12 =
$60,000 note:
$ 60,000 x 8%(1) x 10/12 =
Total interest revenue

$3,000
4,000
$7,000

The interest rate on the $60,000 note can be determined as follows:


Interest receivable in 12/31/11 balance sheet =
$6,800
Less: Interest on $200,000 note: $200,000 x 6% x 6/12 = (6,000)
Interest on $60,000 note
$ 800
(1)

$800 represents interest for two months (November and December of 2011) or
$400 per month. Annual interest is $400 x 12 = $4,800.
$4,800 $60,000 = 8% interest rate.
Bad debt expense
Analysis of accounts receivable
Beginning accounts receivable ($218,000 + 24,000)
Add: Credit sales
Less: Cash collections
Less: Write-offs
Ending accounts receivable

$ 242,000
1,340,000
(1,280,000)
(22,000)
$ 280,000

Analysis of allowance for uncollectible accounts


Beginning allowance
Add: Bad debt expense
Less: Write-offs
Ending allowance(2)

$24,000
?
(22,000)
$28,000

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


$280,000 x 10% = $28,000

(2)

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Intermediate Accounting, 6/e

Problem 7-12 (concluded)


Loss on sale of note receivable
Interest accrued on the $200,000 note for nine months (6/30/11 to 3/31/12):
$200,000 x 6% x 9/12 = $9,000
Calculation of cash proceeds received from discounting note:
$200,000
12,000
212,000
(4,240)
$207,760

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

Carrying value of note


Less: Cash proceeds
Loss on sale of note receivable

$209,000 ($200,000 + $9,000 interest receivable)


(207,760)
$ 1,240

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

$252,000

Requirement 3
Accounts receivable turnover ratio:
$1,340,000
------------$235,000(3)

= 5.7

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

(3)

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Problem 7-13
Computation
of balance per books:
Balance per bank statement
Add: Deposits outstanding
Deduct: Checks outstanding
Error in recording rent check
Add: Automatic mortgage payment
Add: Bank service charges
Deduct: Deposit credit to companys
account in error
Add: NSF check charge
Balance per books
Step 1:

(875.00)
85.00
$13,542.87

Bank Balance to Corrected Balance

Balance per bank statement


Add: Deposits outstanding
Deduct:
Bank error - deposit incorrectly
credited to company account
Checks outstanding
Corrected cash balance
Step 2:

$14,632.12
575.00
(1,320.25)
(18.00)
450.00
14.00

$14,632.12
575.00
(875.00)
(1,320.25)
$13,011.87

Book Balance to Corrected Balance

Balance per books


Add: Error in recording rent check
Deduct:
Automatic mortgage note payment
Service charges
NSF checks
Corrected cash balance

$13,542.87
18.00
(450.00)
(14.00)
(85.00)
$13,011.87

Requirement 1
Problem 7-13 (concluded)
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Intermediate Accounting, 6/e

Requirement 2

To correct error in recording cash disbursement for rent.


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

18
18

To record credits to cash revealed by the bank reconciliation.


Interest expense.............................................
Mortgage note payable..................................
Miscellaneous expense (bank service charges)
Accounts receivable (NSF checks)................
...............................................................Cash

Requirement 3
Checking account balance
Petty cash
U.S. treasury bills
Total cash and cash equivalents

Solutions Manual, Vol.1, Chapter 7

350
100
14
85
549

$13,011.87
200.00
5,000.00
$18,211.87

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7-73

Problem 7-14
Requirement 1

The McGraw-Hill Companies, Inc., 2011


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Intermediate Accounting, 6/e

Step 1:

Bank Balance to Corrected Balance

Balance per bank statement


Add: Deposits outstanding
Deduct:
Bank error - deposit incorrectly
credited to company account
Outstanding checks
Corrected cash balance
Step 2:

$3,851
2,150 (1)
(1,300)
(831) (2)
$3,870

Book Balance to Corrected Balance

Balance per books


Deduct:
Error in recording check #411
Service charges
NSF checks
Corrected book balance

$4,422
(90)
(22)
(440)
$3,870

(1) Receipts
Less: December receipts deposited:
Bank deposits
$43,000
Less: Deposit error
(1,300)
Less: Prior month's
deposits outstanding
(1,200)
Deposits outstanding, Dec. 31

$42,650

(2) Dec. disbursements


Error in recording check #411
Less: December checks cleared:
Total checks cleared
$41,918
Prior month's checks:
#363
$123
#380
56
#381
86
#382
340
(605)
December checks outstanding
Add: check # 365
Total checks outstanding, Dec. 31

$41,853
90

40,500
$ 2,150

(41,313)
630
201
$ 831

Problem 7-14 (concluded)


Requirement 2
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7-75

To record credits to cash revealed by the bank reconciliation.


Advertising expense......................................
Miscellaneous expense (bank service charges)
Accounts receivable (NSF checks)................
...............................................................Cash

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7-76

90
22
440
552

Intermediate Accounting, 6/e

Problem 7-15Requirement 1

($inmillions)

Land..........................................................................................16
Loss on debt restructuring..........................................................6
Note receivable.........................................................................
Accrued interest receivable......................................................

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20
2

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7-77

Requirement 2

ANALYSIS

Previous Value:
Accrued 2010 interest (10% x $20,000,000)
Principal
Carrying amount of the receivable
New Value:
Interest
$1 million x 3.16987 * =
Principal $15 million x 0.68301 ** =
Present value of the receivable
Loss:

$ 2,000,000
20,000,000
$22,000,000
$ 3,169,870
10,245,150
(13,415,020)
$ 8,584,980

* present value of an ordinary annuity of $1: n=4, i=10% (from Table 4)


** present value of $1: n=4, i=10% (from Table 2)
JOURNALENTRIES

January 1, 2011
Loss on troubled debt restructuring (to balance)...............
Accrued interest receivable (10% x $20,000,000)........
Note receivable ($20,000,000 - $13,415,020)..............

8,584,980
2,000,000
6,584,980

December 31, 2011


Cash (required by new agreement)....................1,000,000
Note receivable (to balance).................................341,502
Interest revenue (10% x $13,415,020)..........................

1,341,502

December 31, 2012


Cash (required by new agreement)....................1,000,000
Note receivable (to balance).................................375,652
Interest revenue (10% x $13,756,522)..........................

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1,375,652

Intermediate Accounting, 6/e

Problem 7-15 (continued)


December 31, 2013
Cash (required by new agreement)....................1,000,000
Note receivable (to balance).................................413,217
Interest revenue (10% x $14,132,174)..........................

1,413,217

December 31, 2014


Cash (required by new agreement)....................1,000,000
Note receivable (to balance).................................454,609
Interest revenue (10% x $14,545,391)..........................

1,454,609*

Cash (required by new agreement)..................15,000,000


Note receivable (balance).............................................. 15,000,000
* rounded to amortize the note to $15,000,000 (per schedule below)

Amortization Schedule Not required

Cash
Interest
by agreement

1
2
3
4

1,000,000
1,000,000
1,000,000
1,000,000
4,000,000

Effective
Interest
10% x Outstanding Balance
.10(13,415,020) = 1,341,502
.10(13,756,522) = 1,375,652
.10(14,132,174) = 1,413,217
.10(14,545,391) = 1,454,609*

5,584,980

Increase in
Balance
Discount Reduction

341,502
375,652
413,217
454,609
1,584,980

Outstanding
Balance

13,415,020
13,756,522
14,132,174
14,545,391
15,000,000

* rounded

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7-79

Problem 7-15 (continued)


Requirement 3

ANALYSIS

Previous Value:
Accrued interest (10% x $20,000,000)
Principal
Carrying amount of the receivable
New Value:
$27,775,000 x 0.68301 * =
Loss:

$ 2,000,000
20,000,000
$22,000,000
(18,970,603)
$ 3,029,397

* present value of $1: n=4, i=10% (from Table 2)


JOURNALENTRIES

January 1, 2011

.....

Loss on troubled debt restructuring (to balance)...............


Accrued interest receivable (10% x $20,000,000)........
Note receivable ($20,000,000 - 18,970,603).................
December 31, 2011

2,086,766

.....

Note receivable (to balance)..............................2,295,443


Interest revenue (10% x balance [see schedule])..........

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7-80

1,897,060

.....

Note receivable (to balance)..............................2,086,766


Interest revenue (10% x [$18,970,603 + 1,897,060]). . .
December 31, 2013

2,000,000
1,029,397

.....

Note receivable (to balance)..............................1,897,060


Interest revenue (10% x $18,970,603)..........................
December 31, 2012

3,029,397

2,295,443

Intermediate Accounting, 6/e

December 31, 2014

.....

Note receivable (to balance)..............................2,525,128


Interest revenue (10% x balance [see schedule])..........
2,525,128*
Cash (required by new agreement)..................27,775,000
Note receivable (balance).............................................. 27,775,000
* rounded to amortize the note to $27,775,000 (per schedule below)

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Problem 7-15 (concluded)


Amortization Schedule Not required

Cash
Interest
by agreement

1
2
3
4

0
0
0
0

Effective
Increase in
Interest
Balance
10% x Outstanding Balance Discount Reduction
.10 (18,970,603) = 1,897,060
.10 (20,867,663) = 2,086,766
.10 (22,954,429) = 2,295,443
.10 (25,249,872) = 2,525,128*

8,804,397

1,897,060
2,086,766
2,295,443
2,525,128
8,804,397

Outstanding
Balance

18,970,603
20,867,663
22,954,429
25,249,872
27,775,000

* rounded

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Intermediate Accounting, 6/e

CASES
Judgment Case 7-1Requirement 1

To account for the accounts receivable factored on


April 1, 2011, Magrath should decrease accounts receivable by the amount of
accounts receivable factored, increase cash by the amount received from the factor,
and record a loss equal to the difference. The loss should be reported in the income
statement. Factoring of accounts receivable without recourse is equivalent to a sale.
Requirement 2
Magrath should account for the collection of the accounts previously written off
as uncollectible as follows:
Increase both accounts receivable and the allowance for uncollectible accounts.
Increase cash and decrease accounts receivable.

Requirement 3
One approach estimates uncollectible accounts based on credit sales. This
approach focuses on income determination by attempting to match uncollectible
accounts expense with the revenues generated.
The other approach estimates uncollectible accounts based on the balance in
receivables or on an aging of receivables. The approach focuses on asset valuation by
attempting to report receivables at realizable value.
Suggested Grading Concepts and Grading
Communication Case 7-2Scheme:
Content (70%)
_______ 40 Explains the difference between the allowance method and the
direct write-off method.
______ Direct write-off more objective.
______ Direct write-off has potential to violate the matching
principle.
_______ 15 Even if uncollectibles are fairly stable, when significant
variations do occur, profit will be overstated in one period
and understated in another period.
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_______ 15 Even if uncollectibles remain constant, the direct write-off


method will result in an overstatement of accounts receivable
in the balance sheet.
______
_______ 70 points
Writing (30%)
_______ 6 Terminology and tone appropriate to the audience of a
company president.
_______ 12 Organization permits ease of understanding.
______ Introduction that states purpose.
______ Paragraphs that separate main points.
_______ 12 English
______ Sentences grammatically clear and well organized,
concise.
______ Word selection.
______ Spelling.
______ Grammar and punctuation.
______
_______ 30 points

Judgment Case 7-3Requirement 1

a. Hogan should account for the sales discounts at the


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

b. There is no effect on Hogans sales revenues when customers do not take the
sales discounts. Hogans net income is increased by the amount of interest
earned when customers do not take the sales discounts.
Requirement 2
Trade discounts are neither recorded in the accounts nor reported in the financial
statements. Therefore, the amount recorded as sales revenues and accounts receivable
is net of trade discounts and represents the cash equivalent price of the asset sold.
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Requirement 3
To account for the accounts receivable factored on August 1, 2011, Hogan should
decrease accounts receivable by the amount of the accounts receivable factored,
increase cash by the amount received from the factor, and record a loss. Factoring of
accounts receivable without recourse is equivalent to a sale. The difference between
the cash received and the carrying amount of the receivables is a loss.
Requirement 4
Hogan should report the face amount of the interest-bearing notes receivable and
the related interest receivable for the period from October 1 through December 31 on
its balance sheet as current assets. Both assets are due on September 30, 2012, which
is less than one year from the date of the balance sheet.
Hogan should report interest revenue from the notes receivable on its income
statement for the year ended December 31, 2011. Interest revenue is equal to the
amount accrued on the notes receivable at the appropriate interest rate.
Interest revenue is realized with the passage of time. Accordingly, interest
revenue should be accounted for as an element of income over the life of the notes
receivable.

Ethics Case 7-4Requirement 1


$180,000
Revised allowance
Increase in income before taxes of proposed change

Required allowance
135,000
$ 45,000

Requirement 2
Discussion should include these elements.
Ethical Dilemma:
You as the assistant controller have a responsibility to follow GAAP and make a
reasonably accurate estimate of the net realizable value of receivables. Is your
responsibility to fairly present Stanton Industries' financial statements to external
users greater than your obligation to improve the financial position of your employer?
Alternative actions and consequences include:
1. Refuse to comply with the controller's request to change the aging category of the
large account.
Positive consequences:
a. Preservation of your honesty and integrity.
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b. Fair presentation of the net realizable value of receivables.


Negative consequences:
a. Possible loss of your job.
b. Lower net income for Stanton Industries.
c. A devalued stock price for Stanton Industries.
2. Comply with the controller's suggestion to report the allowance for uncollectible
accounts at $135,000.
Positive consequences:
a. Retention of your job.
b. A more favorable net income for Stanton Industries.
c. A more favorable position with unknowing creditors, financial analysts,
current investors, and future investors.
Negative consequences:
a. Endure guilt feelings.
b. A lack of trust in you by other managers and employees.
c. Possible litigation from investors and creditors.

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Case 7-4 (concluded)


3. Report the controller's suggestion to a higher level of management, the audit
committee, or the auditors. If one of these parties corrects the controller and
compels fair reporting of the allowance account, the consequences would be the
same as in alternative 1 when you refuse to make the adjustment. Your job may
still be in jeopardy due to the fact that management may consider whistle blowing
as indicative of employee disloyalty. If the reportee parties agree with the
controller and report the incorrect amount of $135,000, the consequences will be
similar to those for the second alternative in 2, except that you run an even greater
risk of losing your job.
4. Refuse to comply with the controller's request and resign as assistant controller. If
you report the controller's suggestion to higher management, the audit committee,
or the auditor, the positive and negative considerations are the same as for
alternative 3. If you do not report the controller's request, then the consequences
are the same as for alternative 2. In either case your job is not an issue since you
have already resigned.
1. A weakness is created by the fact that John need only
Judgment Case 7-5 submit a list of accounts and amounts to be charged to
replenish the petty cash fund.
The supporting
documentation for the petty cash disbursements also should be submitted with
Johns list and reviewed by someone else. Surprise counts of the fund also should
be made to ensure that the fund is being maintained on an imprest basis, that is, to
ensure that cash and/or receipts equal $200 at all times.
2. The internal control system for disbursements does not contain sufficient
separation of duties. Dean Leiser approves the vouchers, signs the checks,
maintains the disbursement records, and reconciles the bank account. There should
be at least one other person involved in these activities to ensure accuracy and to
safeguard cash from expropriation.
3. The internal control system for receipts does not contain sufficient separation of
duties. Fran Jones has physical control of the deposits and also maintains the
subsidiary ledger for accounts receivable. These duties should be separated. In
addition, the company should require that customers pay their bills via check and
that cash not be used.

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Requirement 3
Real World Case 7-6
Answers will, of course, vary depending on the year.
The following were reported in the financial statements
for the year ended December 31, 2008 ($ in millions):
a. Net trade accounts receivable + Allowance for doubtful accounts = Gross
accounts receivable
$687.8 + 127.9 = $815.7
b. The statement of cash flows indicates bad debt expense (provision for
doubtful accounts) of $195.5
c. Beginning allowance for doubtful accounts + Bad debt expense - Bad debt
write-offs = Ending allowance for doubtful accounts
$141.1 + 195.5 - Write-offs = $127.9
Write-offs = $208.7
d. Beginning trade accounts receivable + Credit sales - Bad debt write-offs Cash collected = Ending trade accounts receivable
Beginning trade accounts receivable = $795.0+ 141.1 = $936.1
$936.1 + 10,588.9 208.7 Cash collections = $815.7
Cash collections = $10,500.6
McLaughlin's underestimation of bad debts is treated
Integrating Case 7-7as a change in accounting estimate. Changes in estimates
are accounted for prospectively. When a company revises
a previous estimate, prior financial statements are not restated. Instead, the company
merely incorporates the new estimate in any related accounting determinations from
then on. In this case, bad debt expense for 2012 will be higher than it would have
been had not the underestimation occurred. A disclosure note should describe the
effect of a change in estimate on income before extraordinary items, net income, and
related per-share amounts for 2012.

Analysis Case 7-8Requirement 1


These methods can be described by one of two basic arrangements:
1. Asecuredborrowing,or
2. Asaleofreceivables.
When a company chooses between a borrowing and a sale, the critical element is
the extent to which it (the transferor) is willing to surrender control over the assets
transferred. Specifically, the transferor is determined to have surrendered control over
the receivables if and only if three sale conditions are met.
Secured borrowings usually take the form of an assignment of receivables. An
assignment of receivables is a promise by the borrower (the owner of the receivables)
that any failure to repay debt owed to the lender in accordance with the debt
agreement, will cause the proceeds from collecting the receivables to go directly
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toward repayment of the debt. This arrangement is no different from the use of a
building as collateral for a mortgage loan. The assignor (borrower) assigns the
assignee (lender) the rights to specific receivables as collateral for a loan. A variation
of assigning specific receivables is when trade receivables in general rather than
specific receivables are pledged as collateral. The responsibility of collection of the
receivables remains solely with the company. This variation is referred to as a
pledging of accounts receivable.
Two popular arrangements used for the sale of receivables are factoring and
securitization. A factor is a financial institution that buys receivables for cash,
handles the billing and collection of the receivables, and charges a fee for this service.
Actually, credit cards like VISA and Mastercard are forms of factoring arrangements.
The seller relinquishes all rights to the future cash receipts in exchange for cash from
the buyer (the factor).
Another popular arrangement used to sell receivables is a securitization. In a
typical accounts receivable securitization, the company creates a Special Purpose
Entity (SPE), usually a trust or a subsidiary. The SPE buys a pool of trade
receivables, credit card receivables, or loans from the company, and then sells related
securities, for example bonds or commercial paper, that are backed (collateralized) by
the receivables.
Similar to accounts receivable, a note receivable can be used to obtain immediate
cash from a financial institution either by pledging the note as collateral for a loan or
by selling the note. The transfer of a note is referred to as discounting.

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Case 7-8 (concluded)


Requirement 2
In an assignment of specific receivables, usually the amount borrowed is less
than the amount of receivables assigned. The difference provides some protection for
the lender to allow for possible uncollectible accounts. Also, the assignee (transferee)
usually charges the assignor an up-front finance charge in addition to stated interest on
the collateralized loan. The borrower, assignor, records the loan liability, the finance
fee expense, and the cash borrowed.
No special accounting treatment is needed for an assignment of receivables in
general, and the arrangement is simply described in a disclosure note.
The specific accounting treatment for the sale of receivables using factoring and
securitization arrangements depends on the amount of risk the factor assumes, in
particular whether it buys the receivables without recourse or with recourse.
When a company sells accounts receivable without recourse, the buyer assumes
the risk of uncollectibility. This means the buyer has no recourse to the seller if
customers dont pay the receivables. In that case, the seller simply accounts for the
transaction as a sale of an asset. The buyer charges a fee for providing this service,
usually a percentage of the book value of receivables. Because the fee reduces the
proceeds the seller receives from selling the asset, the seller records a loss on sale of
assets. The typical factoring arrangement is made without recourse.
When a company sells accounts receivable with recourse, the seller retains the
risk of uncollectibility. In effect, the seller guarantees that the buyer will be paid even
if some receivables prove to be uncollectible. Even if receivables are sold with
recourse, as long as the three conditions for sale treatment are met, the transferor
would still account for the transfer as a sale. The only difference would be the
additional requirement that the transferor record the estimated fair value of the
recourse obligation as a liability. The recourse obligation is the estimated amount that
the transferor will have to pay the transferee as a reimbursement for uncollectible
receivables.

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Real World Case 7-9

Requirement 1

Sanofi-Aventis uses the terms provision for


impairment and impairmentfor allowance for bad debts. The (88) is the
allowance necessary to adjust gross accounts receivable for estimated bad debts.
Requirement 2
Sanofi-Aventis does not factor or securitize its receivables. We know this
because note D.10 states Group policy is to retain receivables until maturity, and
hence not to use receivables securitization programs.
Requirement 3
a. Accounts receivable would be reduced in the period of change, as SanofiAventis would collect outstanding receivables and immediately securitize
new receivables.
b. Cash flow from operations would be increased in the period of change, as
Sanofi-Aventis would show cash inflows both from collecting outstanding
receivables and from immediately securitizing new receivables.
c. Accounts receivable would be stable at a relatively low level, as SanofiAventis would immediately securitize new receivables.
d. Cash flow from operations would return to approximately its former level,
as Sanofi-Aventis would show cash inflows only from immediately
securitizing new receivables.
Requirement 4
The answers to requirement 3 highlight that decisions to increase or decrease the
extent of securitization create one-time changes in receivables and cash flows in the
period in which the company transitions to the new level. For example, increasing
securitization will boost cash flow in the period of change. However, the increased
cash flow is only temporary in future periods cash flow will revert to former levels
unless the company increases the extent of securitization yet further.

Research Case 7-10Requirement 1

When a company sells accounts receivable without


recourse, the buyer assumes the risk of uncollectibility. This means the buyer cannot
pursue collection from the seller (has no recourse) if customers dont pay the
receivables.
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Requirement 2
FASB ASC 86010405: Transfers and ServicingOverallDerecognition
Criteria for a Sale of Financial Assets.
The transferor is determined to have surrendered control over the receivables if
and only if all of the following conditions are met:
a. The transferred assets have been isolated from the transferor - put presumptively
beyond the reach of the transferor and its creditors, even in bankruptcy or other
receivership.
b. Each transferee has the right to pledge or exchange the assets it received.
c. The transferor does not maintain effective control over the transferred assets
through either (1) an agreement that the transferor repurchase or redeem them
before their maturity or (2) the ability to cause the transferee to return specific
assets.
(These criteria were included in Statement of Financial Accounting Standards
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" subsequently modified by SFAS No. 166,
Accounting for Transfers of Financial Assets, an amendment of FASB Statement No.
140. The above conditions can be found in paragraph 9 of the standard.)

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Requirement 3
Cash (90% x $400,000).................................................. 360,000
Loss on sale of receivables (to balance)........................ 31,000
Receivable from factor ($25,000 fair value [4% x $400,000])9,000
...............................Accounts receivable (balance sold)
.......................................................................400,000

Requirement 4
FASB ACS 860104024: Transfers and ServicingOverallDerecognition
Effective Control Through Both a Right and an Obligation (previously paragraph 47 of
SFAS No. 140) lists the following conditions:
a. The assets to be repurchased or redeemed are the same or substantially the same
as those transferred.
b. The transferor is able to repurchase or redeem them on substantially the agreed
terms, even in the event of default by the transferee.
c. The agreement is to repurchase or redeem them before maturity, at a fixed or
determinable price.
d. The agreement is entered into concurrently with the transfer.

Analysis Case 7-11Requirement 1


Del Monte
Receivables turnover

3,627
233

Average collection
period

365
15.6

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= 15.6

= 23.4 days

Smithfield
12,488
667
365
18.7

= 18.7

= 19.5 days

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The receivable turnover ratios are in a close range with one another. This is not
surprising since the companies operate in the same industry, selling similar products
with similar terms and customers.
Requirement 2
The objective of this requirement is to motivate students to obtain hands-on
familiarity with actual annual reports and to apply the techniques learned in the
chapter. You may wish to provide students with multiple copies of the same annual
reports and compare responses. Another approach is to divide the class into teams
who evaluate reports from a group perspective.

Analysis Case 7-12Requirement 1

Note 1 indicates Cash and Cash Equivalents All highly


liquid investments, including credit card receivables due from banks, with original
maturities of three months or less at date of purchase are carried at cost and are
considered to be cash equivalents. All other investments not considered to be cash
equivalents are separately categorized as investments.
Requirement 2
$8,352 (in millions) from the Balance Sheet.
Requirement 3
($ in millions, from Note 12)

Net receivables
Add: Allowance
Gross receivables

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2009
$4,731
112
$4,843

2008
$5,961
103
$6,064

Intermediate Accounting, 6/e

British Airways Case


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

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