Friedlan4e SM Ch06

CHAPTER 6
Cash, Receivables, and the Time Value of Money

QUESTIONS
Q6-1.
Internal controls are the policies and procedures that management implements to protect an
entitys assets and ensure the integrity of the accounting information system. Strong internal
controls provide assurance to stakeholders that the entitys assets cant be stolen, used
inappropriately, or used without proper authorization, and that the information produced by the
accounting system can be relied on. Strong internal controls are extremely important because
without them actions that could be very detrimental to the profitability and survival of the entity
could occur. For example, theft by employees and customers can cost a company a large amount
of money.
Q6-2.
Segregation of duties means that people who handle an asset shouldnt also be responsible for
record keeping for that asset. If duties arent segregated, an employee may be able to steal cash
and cover up the theft by making fictitious entries to the accounting records. The idea is that an
employee shouldnt be in a position to steal or misuse an asset and be able to cover up the theft
or misuse through access to the accounting records. If the same employee maintains custody of
an asset and maintains the accounting records, that person can steal assets and modify the records
such that the theft cant easily be discovered.
Q6-3.
Cash is an unproductive asset because the return earned on cash by depositing it in the bank is
much less than the cost of financing cash. That is particularly so for businesses that receive little
or no interest on cash balances in chequing accounts but must pay at least 3% to 4% interest on
borrowed funds. People invest cash in businesses to earn a return that is larger than what they
would receive from a bank investment. However, an adequate reserve of cash is crucial to
provide liquidity.
Q6-4.
If an entity has more cash than is required either for operating purposes or for planned
investments in productive assets then the owners would be better off if the cash was returned to
them so that they could invest it in productive assets. The reason is that cash is an unproductive
asset because it doesnt earn a reasonable return to the investor. A crucial decision for
management is determining what the appropriate amount of cash the entity should have.
John Friedlan, Financial Accounting: A Critical Approach, 4th edition

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Copyright 2013 McGraw-Hill Ryerson Ltd.
Q6-5.
Unless there has been a period of zero or negative inflation, you are worse off now in the sense
that you have less purchasing power than when the money was misplaced. Also, you have
foregone the interest that you would have earned had you invested all or part of the $500 during
the four-year period. You also delayed enjoying the $500 for four years.
Q6-6.
A nominal dollar is a dollar that isnt adjusted for changes in the purchasing power. The use of
the nominal dollar ignores purchasing power gains and losses. That means that while the absolute
(nominal) number of dollars stays the same, the quantity of goods a dollar will purchase changes
over time. If there is inflation and an entity has a liability that must be paid in money, it costs the
entity less to repay the debt in terms of the purchasing power that is sacrificed. The fact that less
is sacrificed in terms of purchasing power isnt captured by IFRS/ASPE accounting.
Q6-7.
Restricted cash is cash that is set aside for a particular purpose and not available for general use
by the entity. This could be because of a legal or contractual obligation to use it in a particular
way. The implication is that when assessing an entitys liquidity its necessary to ignore restricted
cash because it isnt available for general use.
Q6-8.
There are several reasons for a preference for money now. There is an opportunity to earn a
return on the money, there is a risk that the future payment may not occur, and there is a loss of
purchasing power unless there is zero inflation or deflation. Also, having money now allows you
to spend it sooner, which means that you get satisfaction of some form sooner (a vacation today
is probably more attractive than the same one a year later).
Q6-9.
Simple interest is paid only on the principal while compound interest is paid on the principal and
interest earned in previous periods. Given the same interest rate, you earn more interest with
compound interest, because with compound interest the interest is calculated on a larger amount.
Q6-10.
The present value of future cash flows is the value today of amounts that will be received in the
future. Future value is the amount that will be received in the future by investing today. When
estimating the value of a lottery that will pay $25,000 each year for 10 years, present value is
appropriate. Future value is the amount we will have in the bank at retirement if we deposit
$10,000 in the bank today at 6% per year until retirement. (Other examples are appropriate as
well.)
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Q6-11.
A receivable is an amount owed to the entity. Receivables can be classified as current or noncurrent assets, depending on when they are expected to be collected (current if they will be
collected within one year or one operating cycle). Receivables are valued at NRV (net realizable
value)the estimated amount that will be collected. Common types of receivables are accounts
receivable (amounts due from customers), notes receivable (a more formal receivable, often from
customers), interest receivable, and receivables from shareholders (amounts due from
shareholders).
Q6-12.
When revenue is recognized earlier, the balance in accounts receivable is larger and the firm
reports more current assets. As a result, balance sheet measures of liquidity such as the current
and quick ratios indicate a more liquid entity when revenue is recognized earlier. There is no real
impact on economic liquidity using different revenue recognition methods since the ability to
meet obligations depends on cash availability, not the timing of revenue recognition. The same
conclusion is true if cash is received before or at the same time as revenue is recognized.
Recognition of revenue improves measured liquidity in this case because current liabilities
(unearned revenue) decrease.
Q6-13.
When revenue is recognized before cash is collected accounts receivable are reported on the
balance sheet. Thus recognition of revenue gives rise to receivables. The revenue recognition
criteria determine when receivables are reported.
Q6-14.
The benefit is that the business is able to sell merchandise to customers who dont wish to pay
cash at the time of sale, and almost certainly obtains sales that otherwise would go to
competitors. The drawback is that the company must wait for the receivable to be collected and
there is a risk that the money will never be collected. Indeed, its almost a certainty that some
percentage of credit sales wont be collected. A company would prefer to collect the cash at the
time of the sale, unless there is a very high interest rate on the amount owing. For example,
credit card companies earn significant amounts of money when customers dont pay
immediately. Other than for retail businesses most transactions are carried out with credit terms,
with suppliers sending invoices to customers for payment.
Q6-15.
The amount reported on the balance sheet is usually less than the sum of individual receivables
because the reported amount is net of an allowance for an estimated amount that wont be
collected. Accounts receivable are reported at net realizable value, which is the amount that will
be realized in cash. If an entity sells on credit its highly likely that some customers wont pay so
its necessary to reflect the fact that all the money people promised to pay wont be collected. In
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addition to uncollectable amounts, estimated returns and discounts are deducted from gross
accounts receivable, which reduces the NRV and increases the difference between the gross and
net amount of accounts receivable.
Q6-16.
The owners decision criteria for writing off receivables needs to be explained. The owner may
wait too long to write off receivables (thus leaving assets and net income overstated) or that he
writes off receivables in an arbitrary manner (potentially at times when it is convenient for him).
Its possible that since the owner is seeking a loan, he may delay writing off bad debts to make
his financial statements appear stronger. As a result the bank manager may not be receiving the
information he needs to make a good decision (the amount of cash that will be received). As a
bank manager I would ask to see an aging schedule and information on the collectability of
receivables before approving the loan request.
Q6-17.
When the percentage-of-receivables or percentage-of-credit-sales method is used the expense is
accrued when financial statements are prepared. The amount accrued recognizes that some
receivables wouldnt be collected, but it isnt known which ones. The decision to write off a
receivable is recognition that a specific receivable wont be collected. So part of the estimate is
converted into a known amount (the actual customer). The journal entry to record the write-off
would reduce the allowance (the general recognition) and the receivable (the specific customer),
which has no effect on the income statement as these are both balance sheet accounts.
Q6-18.
The direct write-off method results in both an income statement that doesnt match expenses to
related revenues and a balance sheet that reports accounts receivable at an amount that exceeds
the net realizable value. In accrual accounting all costs incurred to earn revenue in a period
should be expensed in that period. The direct write-off method recognizes the cost of
uncollectible amounts when an amount is determined to be uncollectible, which may occur in a
period other than when the related revenue was recognized.
Q6-19.
The percentage-of-credit-sales method estimates the amount of credit sales recognized in a
period that isnt collectible and recognize an expense for that amount in the period. The amount
of the expense is added to the allowance account. Because the percentage-of-credit-sales method
focusses on credit sales, which is an income statement account, its considered an income
statement approach. In the percentage-of-receivables method the focus is on getting the amount
of receivables reported on the balance sheet to reflect the net realizable value (NRV) of the
receivables. Here the focus is on the balance sheet. The amount of the expense is simply the
amount required to get the allowance to the desired amount. Because of the focus on amount of
accounts receivable on the balance sheet its considered a balance sheet approach.
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Q6-20.
If the percentage is too low, income will be overstated, as will the net balance in accounts
receivable (because the allowance is too small). Over time net receivables could become
significantly overstated if the underestimation of bad debts isnt noticed because the
underestimate each year will build up in the allowance account. If the expense is consistently too
high, income will be understated, as will the net balance in accounts receivable (because the
allowance is too large). Over time net receivables could become significantly understated if the
overestimation of bad debts isnt noticed because the overestimate each year will build up in the
allowance account.
Q6-21.
An aging schedule classifies accounts receivable according to the time they have been
outstanding. Its useful for assessing the bad debt expense and the collectability of receivables
because the longer a receivable is outstanding and overdue, the less likely it is the amount will be
collected.
Q6-22.
The decision is a combination of past experience and a consideration of trends in the economy in
general and the specific industry and entities who owe money. Some of the analysis is objective
but the judgment of management is also informed by subjective assessments. The process is
subjective because its a prediction. The actual outcome depends on uncertain future events that
wont be known with certainty when the estimate is made.
Q6-23.
There are a variety of circumstances that may cause a manager to write off an account receivable.
The company that owes the money may have declared bankruptcy, efforts to collect the money
may have been unsuccessful, or the debtor may have informed the creditor that they have no
intention or ability to pay. Such decisions are often subjective with respect to the timing of the
write off, but there are objective criteria such as the length of time that has passed without
payment of any part of the debt. There is always some probability that a written off account
receivable will be collected. The timing of write offs wont have any immediate effect on the
accrual methods because the effect of the write off is to shift the effect from the allowance
account to the specific account receivable. The timing may affect future estimates of bad debts
though.
If the direct write off approach is used the timing and judgement exercised by management will
have an immediate effect on the income statement and balance sheet. Deciding to write off a
receivable during a period (as opposed to another) will reduce net income and the balance in
accounts receivable by the amount of the write off. The decision to defer a write off would
increase net income and receivables in the period relative to if a receivable was written off.
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Q6-24.
The amount of the revenue should be reported at the present value of the future payment or at the
fair value of the merchandise (the cash selling price). This is the effect of the time value of
moneya dollar today is worth more than one received two years in the future. By deferring
collection two years the amount of revenue is less than if it were collected immediately. The
difference between the amount collected in two years and the amount recognized as revenue
today should be treated as interest revenue over the two years. By recognizing the full $100,000
as revenue upon delivery, Verlo has overstated revenue in the current period as the interest
revenue hasnt yet been earned.
Q6-25
Allowing customers to return product indicates that at company stands behind their merchandise
giving their customers confidence in purchases. As a result sales may be higher. However,
allowing returns comes at a cost to the company including the cost of restocking, record keeping
and the reselling of items (perhaps at a discount). Returns should be accrued at the end of a
period by estimating the amount that will be returned. Returns are reflected on the income
statement as a contra revenue account with a corresponding entry on the balance sheet as a contra
asset account (contra accounts receivableallowance for returns (if a credit sale)) or an accrued
liability (if a cash sale).
Q6-26
The benefits of giving a discount to customers are to give the customer an incentive to pay
earlier rather than later. This may reduce the risk of default and give the company providing the
discount quicker access to cash it can use to meet its obligations. The challenge accountants face
with respect to discounts is estimating the amount that will be taken by customers (the proportion
of receivables eligible for discounts at the end of the period that will be claimed). Practically this
isnt a big problem because the actual amount will usually be known within a few days of the
end of the period (the discount period is usually short).
Q6-27.
Hidden reserves are accounting estimates that management uses to manage earnings. A hidden
reserve allows management to increase or decrease revenues or expenses in a period and thereby
shift income among periods to achieve a reporting objective. Hidden reserves are made possible
by inadequate accounting disclosureentities dont disclose all the estimates they make or the
underlying assumptions. Hidden reserves create a problem for users of financial statements
because they distort income and related measures and they arent observable or identifiable by
stakeholders. As a result the measures affected by hidden reserves cant be interpreted
effectively.
Q6-28.
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The quick ratio is cash, cash equivalents, temporary investments, and receivables (really assets
that will or can be converted to cash quickly) divided by current liabilities. The ratio provides an
indication of liquidity by using only current assets that are cash or will be realized in cash very
soon. The ratio excludes inventory, prepaid assets and other current assets from the numerator of
the current ratio because generally these assets are less liquid. The inventory of a jewellery store
cant be sold quicklyits not very liquidso the current ratio may not be as good an indication
of liquidity. For the gold mine, inventory is very liquid because gold bullion can be sold at any
time on the open market, so the current ratio provides a very good indication of the mines ability
to meet its financial obligations.
Q6-29.
The accounts receivable turnover ratio is useful for evaluating liquidity because it provides
insight into how quickly receivables are converted into cash. The higher the ratio, the
faster receivables are being collected and the more quickly the entity collects cash
from its customers, which shortens the cash lag.

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EXERCISES
E6-1.
Cash is money on hand and cash equivalents are short-term investments easily and quickly
converted into a known amount of cash.
a.
Cash in the office should be included in cash and cash equivalents because its money on
hand.
b.
Cash in a bank savings account should be included in cash and cash equivalents because
its money on hand and readily available for use.
c.
Uncashed cheques should be classified as cash because a cheque is equivalent to cash

(although there is some uncertainty since the debtor might not have the funds to cover the
cheque).
d.
The amount owed by an executive is a receivable, not cash. The amount isnt money on
hand or available and it isnt a short-term investment easily and quickly converted into a
known amount of cash (its not even clear if or when the amount will be repaid).
e.
The investment certificate should be classified as cash and cash equivalents because its
easily convertible to a known amount of cash. The certificate can be cashed at any time
for its face value plus interest so the amount of cash is known.
f.
The amount borrowed is cash (only borrowed amount). The unborrowed portion of the
line isnt included in cash and cash equivalents.
g.
This item shouldnt be considered as cash and cash equivalents because its being held by
a foreign government and not available for use. The amount is similar to restricted cash.
h.
The post-dated cheques shouldnt be included in cash and cash equivalents because they
cant be converted to cash until February 21. On the balance sheet date (December 31,
2017) they dont represent cash thats available or an investment. If the cheques represent
payments from the customers they would be classified as receivables until they are
cashed or become cashable.
i.
The amount held by the lawyer shouldnt be included in cash and cash equivalents. Since
the cash is held by the lawyer for a specific and restricted purpose it should be classified
as restricted cash. Restricted cash isnt readily available for use. The restricted cash
would be disclosed separately on the financial statements.

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j.
The British pounds should be included in cash and cash equivalents. While the pounds
cant be converted into a known amount of Canadian cash, they can be converted quickly
and easily and are readily available for use. Also, if the pounds are used to pay
obligations denominated in pounds, exchange isnt an issue.
k.
These items shouldnt be included in cash and cash equivalents because the value of
publicly traded shares fluctuates daily. Its uncertain how much cash would be received
for the shares until they were sold.
E6-2.
Future Value
amount invested
a. FV = (1.04)6 $100,000 = $126,531.90

b. FV= (1.02)12 $100,000 = $126,824.18
c. FV= (1.01)24 $100,000 = $126,973.46
d. FV= (1.0033333)72 $100,000 = $127,074.19
E6-3.
Future Value
amount invested
a. FV = (1.03)8 $5,000 = $6,333.85

b. FV= (1.025)24 $70,000 = $126,610.82
c. FV= (1.08)4 $100,000 = $136,048.90
d. FV= (1.00)6 $25,000 = $25,000
E6-4.
PV=
a. PV = $200,000/(1.14)10 = $53,949
b. PV = [$50,000/(1.06)1] + [$25,000/(1.06)3] + [$10,000/(1.06)5]
= $47,169.81 + $20,990.48 + $7,472.58
= $75,632.88
c. PV = [$10,000/(1.06)1] + [$25,000/(1.06)3] + [$50,000/(1.06)5]
= $9433.96 + $20,990.48 + $37,362.91
= $67,787.35
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E6-5.
PV=
a.
PV = $20,000/(1.08)3 = $15,876.64.
If $20,000 is to be paid in the future revenue should be $15,877 with 8% recorded as
interest revenue each year.
b.
PV
c.
PV= $5,000/(1.10)20 = $743.22

You should pay no more than $743.22 for the bond because thats what $5,000 to be
received in twenty years is equivalent to.
d.
PV
e.
PV =$15,000/(1.10)5 =$9,313.82
Choosing $10,000 today is a better option since $15,000 in five years is only worth
$9,313.82 today.
= $4,000/(1.12) + $3,000/(1.12)2 + $2,000/(1.12)3

= $3,571.43 +
$2,391.58 + $1,423.56
= $7,386.57
Yes, the present value of the future cash flows is higher than the $7,000 investment.
= $6,000/(1.08) + $4,000/(1.08)2 + $8,000/(1.08)3

= $5,555.56 +
$3,429.36 + $6,350.66
= $15,335.57
You should pay no more than $15,335.57 for the investment as that the present value of
the amount that will be received.
E6-6.
The solutions are calculated using the equation from the text:
a.
1/.08*[1 1/(1 + .08)25] x $40,000= $426,991.05.

The real value of the prize is $426,991 given the present value of the annuity.
b.
1/.12*[1 1/(1 + .12)15] x $250,000 = $1,702,716.12

Since the $250,000 annuity is worth only $1,702,716.12 today, you would prefer to
receive $2,000,000 now.

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c.
1/.01*[1 1/(1 + .01)36] x $50 + $200

=$1,505 + $200
=$1,705 would be the equivalent cash prize today
d.
1/.10*[1 1/(1 + .10)10] x $200 + $2500/(1.10)10= $2,192.77

The present value of the annuity and lump sum is $2,192.77 today. This is the maximum
amount you would pay for the investment.
E6-7.
a.
Future Value: $5,000 X (1.04)10 = $7,401.22 will be the maturity value.
b.
Comparing Present values to $1000:

Option 1:
PV
= $2,500/(1.10)5 = $1,552.30
Option 2:
PV
= $500/(1.10)1 + $650/1.102 +$800/1.103 +$200/1.104 +$100/1.105
= $1,791.48
Option 3:
PVannuity = 1/.10*[1 1/(1 + .10)5] x $400 = $1,516.31
Option 2 has the highest present value and would be the best investment.
c.
PVannuity = 1/.07*[1 1/(1 + .07)20] x $10,000 = $105,940.14

She would pay $105,940.14 for the annuity.
d.
Future Value = $50,000(1.09)3 = $64,751.45 will be the amount owing on the loan.
e.
Students may approach from PV or FV in their solution:

Using PV :
(i)
PV = $1500/(1.10)3 = $1,126.97
(ii)
PV = $1500/(1.15)3 = $986.27
Using FV:
(i)
FV = $1000 x (1.10)3 = $1,331.00
(ii)
FV = $1000 x (1.15)3 = $1,520.88
Both methods yield the same choice, at 10% it is a better option to take the $1,500 in the
future while at 15% it is better to take the $1000 now.
f.
Present value of an annuity:

1/.08*[1 1/(1 + .08)25] x $2,000,000 = $21,349,552
The real value of the prize is $21,349,552.38

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E6-8.
a.
b.
c.
d.
Dr. Cash
Dr. Accounts receivable
Cr. Sales
175,000
625,000
Dr. Cash
Cr. Accounts receivable
405,000
Dr. Bad debt expense

Cr. Allowance for bad debts
31,250
Dr. Allowance for bad debts

34,000
Dr. Cash
Dr. Accounts receivable
Cr. Sales
2,500
7,000

7,000
Dr. Cash
Cr. Allowance for bad debts
7,000

50,000
800,000
405,000
31,250
34,000
E6-9.
a.
b.
c.
9,500
7,000
7,000
E6-10.
a.
50,000
The effect of this entry on net income would be to decrease it by $50,000.

b.

50,000
50,000
This entry has no effect on net income. The effect on net income occurs when the bad
debt expense is recorded at the end of the period, based on the amount of credit sales
made during the period.
c.
Allowance for bad debts

Accounts receivable

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50,000
50,000
Page 6-13
This entry has no effect on net income. The effect on net income occurs when the bad
debt expense is recorded at the end of the period, based on the amount of ending accounts
receivable that is estimated not to be collectable.
d.
Malagash decided to write off the account receivable because collectability was no longer
reasonably assured. The company exercised judgment by deciding to write off the amount
immediately. This is a conservative approach, avoiding overstating assets. From an
objectives standpoint the writedown could have served to lower income currently, thereby
avoiding a reduction in the future.
E6-11
a.
$4,000,000 + $4,000,000(1.14)-1 + $4,000,000 (1.14)-2 + $4,000,000 (1.14)-3
= $13,286,528.11
Or use the PV of an annuity:
PVn,r
Amount to be received or paid in each period

(1 r )
1
1
= 1
Amount to be received or paid in each period
r
(1 r ) n
n
= $4,000,000 + (1/.14*[1 1/(1 + .14)3] x $4,000,000)

= $13,286,528.11
Dr. Cash
Dr. Long-term Receivables
Cr. Revenue
4,000,000.00
9,286,528.11
13,286,528.11
b.
Debden Ltd.
Long-term Receivable Schedule 2018-2020
2018
2019
2020
Beginning balance
in long-term
receivable account
$9,286,528.11
6,586,642.04
3,508,771 .93
Cash
Payment
$4,000,000
4,000,000
4,000,000
Interest
revenue
(Bal. X 14%)
$1,300,113.94
922,129.89
491,228.07
Reduction in
long-term
receivable
(Pmt-Interest)
$2,699,886.06
3,077,870.11
3,508,771.93
Ending balance in
long-term
receivable account
$6,586,642.04
3,508,771.93
0
*numbers may vary due to rounding

2018
Cash
4,000,000.00
Long-term receivable
Interest revenue
2019
Cash

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2,699,886.06
1,300,113.94
4,000,000.00
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Interest revenue
2020
3,077,870.11
922,129.89
Cash
4,000,000.00
Interest revenue
3,508,771.93
491,228.07
c.
May 31,2017
May 31,2018
May 31,2019
May 31,2020
Total receivable
$
9,286,528.11
$
6,586,642.04
$
3,508,771.93
$
-
Long-term
$
5,777,756
$
3,077,870
$
$
-
Current portion
$
3,508,772
$
3,508,772
$
3,508,772
$
For each year, the amount of the long-term receivable reported on the balance sheet is the
present value of the remaining payments. Since $4,000,000 is paid each year the amount
reported as current on the May 31, balance sheet each year is the present value of
$4,000,000. The remainder is long-term.
d.
It would be misleading to users of the financial statements if Debden recognized the full
$16,000,000 immediately since income is overstated. If the time value of money is
ignored, stakeholders might get the impression that the sale was more profitable than it
actually was. In addition, stakeholders wouldnt realize that Debden isnt only selling
land, but is also financing the purchase, which has cash flow implications. Debdens
management would favour this approach if it wanted to increase income in the current
period, perhaps because of a bonus plan or an interest in impressing external stakeholders
with higher income.

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E6-12.
Cash
Beginnin
g
balances
7/31/17
Accounts
receivable
75,800
Allowance
for
uncollectable
accounts
(3,000)
350,000
Ending
balances
7/31/18
375,000
(375,000)
375,000
(3,200)
47,600
Revenu
e
Bad
debt
expense
350,000
(3,500)
3,200
(3,300)
(3,500)
350,000
(3,500)
Note: The ending balance in accounts receivable on July 31, 2018 was $47,600. During 2018 $3,200 was
written off from accounts receivable.

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E6-13.
Cash
Beginning
balances
12/31/2016
31,240
847,000
Ending
balances
12/31/2017
878,240
Accounts
receivable
Allowance
for
uncollectable
accounts
Unearned
revenue
Revenue
134,750
902,000
(7,062)
56,100
(47,300)
31,240
Bad debt
expense
949,300
(847,000)
(7,480)
(9,130)
7,480
182,270
(8,712)
(9,130)
40,040
949,300
(9,130)
Amounts that have to be calculated are shown in grey. Its necessary to calculate the amount of
the unearned revenue that was recognized in 2017 (this is done by calculating that amount from
the other three pieces of information about the unearned revenue account. With the amount of
unearned revenue recognized its then possible to calculate the increase in accounts receivable
for the period (the information gives revenue for the period so the increase in accounts receivable
is revenue the decrease in unearned revenue. The other amounts then flow from there.
E6-14.
Allowance for doubtful accounts December 31, 2016
Less: Accounts written of during 2017
Pre-closing allowance for doubtful accounts December 31,
2017
$38,150
(39,600)
Credit sales during 2017

Average percentage of credit sales uncollectible
Bad debts expense for 2017
Pre-closing allowance for doubtful accounts December 31,
2017
Allowance for doubtful accounts December 31, 2017
2,262,500
2%
45,250
Bad debt expense

To record bad debt expense for 2017
Solutions Manual
(1,450)
(1,450)
$43,800
45,250
45,250
Page 6-17
E6-15.
a.
Year
2014
2015
2016
2017
2018
b.
Credit
Sales
$500,000
500,000
500,000
500,000
500,000
Percent
Uncollected
2%
2%
2%
2%
2.3%
Bad Debt
Expense
$10,000
10,000
10,000
10,000
11,500
By only recording a bad debt expense of $10,000 when in fact bad debts were $11,500,
net income was overstated by $1,500 for each of the years 2014 to 2017. The company
corrected addressed the issue in 2018 so it recorded an appropriate expense in 2018, in
addition to correcting the error.
c.
Credited To
Allowance
Debited To
Allowance
Allowance
Year
Balance
Open
$(11,500)
2014
$(10,000)
$11,500
$(10,000)
2015
(10,000)
11,500
(8,500)
2016
(10,000)
11,500
(7,000)
2017
(10,000)
11,500
(5,500)
2018
(11,500)
11,500
(5,500)
2018
(6,000)*
(11,500)
*Adjustment to correct understatement from 2014-2017 (part e)
The impact is that net accounts receivable are overstated because the allowance is understated.
d.
The correction is needed to catch up with the expense understatement made in 2014
through 2017. The result is that the allowance and the bad debt expense will be correct
at the end of 2018. From 2014 through 2017 the bad debt expense was understated by
$1,500 each year so the correction would require an additional bad debt expense of
$6,000 ($1,500
e.
4).
Bad debt expense

Allowance for doubtful accounts

Solutions Manual
6,000
6,000
Page 6-18
E6-16.
a.
Bad debt expense = $94, 500 ($1,575,000
6%) $11,250 = $83,250
Allowance for doubtful accounts = $1,575,000

Bad debt expense (94,500 11,250)
b.
Bad debt expense = $9,361,500
6% = $94,500
83,250
83,250
1.5%) = $140,422.50
Allowance for doubtful accounts = $140,422.50 + $11,250 = $151,672.50

Bad debt expense
c.
Bad debt expense = $94, 500 ($1,575,000
140,422.50
140,422.50
6%) + $11,250 = $105,750
Allowance for doubtful accounts = $1,575,000

Bad debt expense (94,500 + 11,250)
Bad debt expense = $9,361,500
6% = $94,500
105,750
105,750
1.5% = $140,422.50
Allowance for doubtful accounts = $140,422.50 $11,250 = $129,172.50

Bad debt expense
140,422.50
140,422.50
A debit balance in allowance for doubtful accounts indicates that the estimate of
bad debts was too low. Under the percentage of receivables method, the focus is on
reporting receivables at their net realizable value. This means that the allowance must
reflect the amount of receivables estimated to be uncollectible. Therefore the bad debt
expense must be debited an additional $11,250, resulting in a higher bad debts expense.
Under the percentage of credit sales method, the focus is to report an accurate bad
debt expense. It follows that the bad debt expense for the period wont be changed
because of the balance in the allowance account. However, the allowance for doubtful
Solutions Manual
Page 6-19
accounts will be $11,250 lower, and accounts receivable wont be stated at their estimated
net realizable value on the balance sheet. With the percentage credit sales method its
possible for the allowance balance to become unrepresentative of the amount of
receivables that wont be collected if there is an error that persists in one direction (i.e.
the bad debt expense is continually overstated or understated).
E6-17.
Account Age
Current
1-30 days
31-90 days
> 90 days
Total
Balance
$700,000
288,000
Percent
Uncollectibl
e
2.50%
10%
Uncollectible
$17,500
28,800
128,400
25%
32,100
58,800
$1,175,200
60%
35,280
$113,680
Allowance Account
Pre-closing balance
Required balance
Required
adjustment
a.
Amount
$10,800
(113,680)
($124,480)
The amount of closing accounts receivable that is estimated to be uncollectible is

$113,680.
b.
Bad debt expense
To record bad debt expense for the period

Solutions Manual
124,480
124,480
Page 6-20
E6-18.
a.
Average accounts receivable
Accounts receivable turnover

ratio
(520,000 + 475,000)
2
497,500
Credit sales
Average accounts
receivable
4,150,000
497,500
8.34
b.
Average collection period of accounts receivable
365
8.34
= 43.76 days
c.
The reasonableness of the collection period cant be determined with the information
provided. Benchmarks are required, such as the collection period in prior years, credit
terms offered to customers, economic conditions, amount for comparable firms, etc.

Solutions Manual
Page 6-21
E6-19.
a.

Bad debt expense
53,000
53,000
b.
The effect of making estimates of bad debts that were higher than the actual amount was
to understate net income in each year by the excess of the estimate over the actual
amount. The adjusting entry increases net income by $53,000 in the year of the
correction, which reverses the cumulative effect of the high estimates over the past three
years. In other words, net income in the current year will be $53,000 higher after the
adjustment than it otherwise would have been, but in the previous three years (taken
together) net income would have been $53,000 lower than it should have been.
c.
The error and adjusting entry could mislead financial statement users if its material. Net
income in each of the previous three years has been understated which may cause users to
underestimate Trilbys future cash flows. In addition, the large decrease in bad debt
expense due to the adjusting entry will overstate the current years net income. This could
cause users to overestimate Trilbys future cash flows (especially if these adjustments and
misestimates arent disclosed). Also, the balance sheets of all the affected periods
wouldnt reflect the net realizable value of accounts receivable. This could affect the
decisions of creditors since decision criteria such as current assets, current ratio, quick
ratio, etc., will be misleading. Stakeholders may have made decisions that werent
optimal for them versus the ones they would have made if they had obtained more
accurate information.
E6-20
a.
Sales Returns and Allowances

10,000
(contra sales)
Allowance for Returns
(contra accounts receivable)
This assumes no beginning balances in the contra accounts.
10,000
b.
Accounts Receivable balance would be $515,000 (525,000 10,000) and net sales would
be $4,115,000 (4,125,000 10,000).
c.
Allowance for Returns

Accounts Receivable
2,000
Inventory
XXX

Solutions Manual
2,000
Page 6-22
Cost of Sales
XXX
E6-21
a.
Sales Discounts (30% x 120,000 x 2%)
(contra sales)
Allowance for Trade Discount
(contra accounts receivable)
720
720
b.
Accounts Receivable balance would be $274,280 (275,000 720) and net sales would be
$1,964,280 (1,965,000 720).
c.
Cash
Allowance for Trade Discount
Accounts Receivable
980
20
1000
E6-22
Account Age
Current
Up to 60 days
>60 days
Total
a.
Balance
$180,000
40,000
15,000
$235,000
Uncollectible
2.00%
20%
50%
Uncollectible
$3,600
$8,000
$7,500
$19,100
Bad Debt Expense

Sales Discounts ($120,000 x 40% x 2%)
Allowance for sales discounts (A/R)
Sales Returns and Allowances
Allowance for sales returns (A/R)
19,100
19,100
960
960
12,000
12,000
b.
Accounts Receivable balance would be $202,940 (235,000 19,100 960 12,000).
c.
The amount of net sales recorded for the year is $1,887,040 ( 1,900,000 960 12,000).
Bad debts would be reported as an expense.
d.
A stakeholder should be concerned with the estimates made by management, especially

in the first year of operations as there is an absence of historical data to base the
estimates.

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Page 6-23
E6-23.
a. This item shouldnt be included when calculating the quick ratio because prepaids arent
liquid assets (they represent cash flows that have already occurred).
b. This item should be included in calculating the quick ratio because it represents the current
portion of interest that is receivable within the period. Consideration should be given to when
the interest is due to be paid.
c.
This item should be included when calculating the quick ratio because the maturity date is
very soon, one month.
d. This item shouldnt be included when calculating the quick ratio because it is a long-term
receivable that cant be quickly converted to cash.
e. This item should be included in the quick ratio because the current portion of long term
receivable is collectible within the operating cycle in the form of cash.
f. This item shouldnt be included when calculating the quick ratio because long term assets
cant be quickly converted to cash.
g. This item shouldnt be included in the calculation of the quick ratio because it cant be
converted into cash to cover current liabilities prior to maturity.
h. This item should be included in the calculation of the quick ratio because gold can be quickly
converted into cash.
i. This item shouldnt be included when calculating the quick ratio because restricted cash isnt
available for general purpose use.
j. This item shouldnt be included in the quick ratio because it cant be converted to cash
quickly.
k. This item should be included when calculating the quick ratio because post-dated cheques
pertain to receivables, which are included in quick assets.
l. This item should be included in the quick ratio as it will be converted to cash in a very short
period of time.
m. Shares in privately owned corporations are often not very liquid (there is no ready market,
sales are often restricted) so these shouldnt be considered quick assets.
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Page 6-24
E6-24.
a.
Current ratio
2017
2018
Quick ratio
2017
2018
Quick Assets
Cash and cash equivalents
Accounts receivable
Total quick assets
b.
Current assets
Current liabilities
513,750
401,250
1.28
627,750
342,500
1.83
Quick assets
Current liabilities
250,000
401,250
0.62
332,500
342,500
0.97
2018
2017
$ 95,000 $105,000
237,500 145,000
332,500 250,000
Both Seahorses current and quick ratios increased from 2017 to 2018. This indicates that
Seahorse has improved its ability to meet its current obligations. Also, the current ratio of
1.83 at the end of 2018 suggests that its liquidity position is solid. It should be noted,
however, that the current ratio includes current non-liquid assets (such as prepaids),
which arent readily available to meet current obligations. Also, both the current and
quick ratios include items, which may or may not convert into cash that will be available
to satisfy current obligations. This includes such items as accounts receivable and
inventory. Whether or not these items represent resources that will be available to meet
current obligations depends on how quickly they get converted to cash.

Solutions Manual
Page 6-25
c.
One scenario in which a significant increase in the quick ratio could be an indicator of a
deteriorating liquidity position is when there is a large increase in accounts receivable but
the receivables arent collectable. This could indicate that the entity is having difficulty
converting its accounts receivable into cash. In this situation, accounts receivable
wouldnt be as liquid as expected because their collectability is in doubt. This analysis
presumes that management didnt properly account for the collectability problem by
recording an adequate allowance for doubtful accounts and bad debt expense.
E6-25.
Assume all sales are on credit:
Accounts receivable turnover ratio =
Credit sales
4.92 =
1,592,000
Average collection period
1,592,000
4.92
$323,577
365
Accounts receivable turnover ratio
365
4.92
74.19

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Page 6-26
E6-26.
365
ratio
47
365
365
47
7.77
Credit sales
7.77 =
125,125,000
125,125,000
7.77
16,111,986
Accounts receivable at the end of 2019

= (ARend 2018 + ARend 2019) =$16,111,986
2
= (ARend 2018 + 1.12*ARend 2018) =$16,111,986
2
=2.12* ARend 2018 =$2*16,111,986 = $32,223,972
ARend 2018 = $15,199,986
= ARend 2019 = 1.12*ARend 2018 = $17,023,984

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Page 6-27
E6-27.
Assume all sales are on credit:
2017
$275,200
Accounts receivable
Allowance for uncollectable
amounts
Net accounts receivable
Sales
2016
$249,800
2015
$244,900
8,256
8,243
266,944
241,557
1,845,000 1,552,000
7,837
237,063
The following formulas were used to calculate answers:

Credit sales
= Opening A/R + Closing A/R

2
365
= Accounts receivable turnover
ratio
2016
ratio
2017
ratio
Credit sales
1,552,000
(241,557+237,063)/2
6.49
Credit sales
1,845,000
(266,944+241,557)/2
7.26

Solutions Manual
Page 6-28
2016
365
ratio
365
6.49
56.3
2017
365
365
7.26
50.3
Accounts receivable turnover measures the number of times during a period an entity collects its
receivable. The average collection period is the number of days it takes to collect receivables (on
average). Accounts receivable turned over more often in 2017 (7.26 times) than in 2016 (6.49
times), indicating the company has improved in their collection practices year over year. This is
reflected in the number of days it takes for the company to collect. It took on average 56.3 days
to collect in 2016 versus 50.3 days in 2017.

Solutions Manual
Page 6-29
E6-28.
Assume all sales are on credit.
Credit Sales
Opening Accounts Receivable
Ending Accounts Receivable
Average Accounts Receivable
(ARTO)
Credit sales

2
365
ratio
2018
$1,922,720
2017
$1,424,250
2016
$1,076,700
165,624
261,800
213,712
122,283
165,624
143,954
93,113
122,283
107,698
9.00
40.57
9.89
36.89
10.00
36.51
As a bank manager I am a bit concerned that the ARTO is decreasing and the average
collection period is increasing. The company is taking a longer period of time to collect
on its receivables. In 2016 and 2017 the company was collecting on its receivables almost
within their specified period of 30 days (just under 37 days) but in 2018 the collection
period increased almost four days. It is important that Aggassiz maintains control over
receivables by following up on overdue accounts and ensure that credit is only offered to
customers with acceptable credit ratings. To properly assess Aggasizs situation I would
require more information such as industry standards for these ratios, an aging schedule
for receivables, a full balance sheet, income statement, and a cash flow statement.

Solutions Manual
Page 6-30
PROBLEMS
P6-1.
It costs Alix 10% per year to borrow from the line of credit. Therefore if Alix borrows $1,000
from the line of credit to pay their supplier on day 10 and subsequently pays off the line of credit
on day 30, the amount of interest that Alix will pay is for a 20 day period.
$1,000 * (20/365) * 10% = $5.48 in interest
The savings that Alix realized from paying early was $20.00
$20 $5.48 = $14.52 net savings
Alix should immediately change their policy to pay their suppliers early whenever possible even
if it means using the line of credit. Another way to look at this question can be to compare the
interest rates.
365/20 = 18.25 , therefore there are 18.25 cycles in a year
2% * 18.25 = 36.5%
Therefore suppliers are providing an equivalent of 36.5% discount per year for early payment
while it only cost 10% interest to borrow.
P6-2.
The main weakness in this scenario is the lack of physical safeguards over cash. Due to the
location of the cash, and the fact that the drawer is unlocked, anyone could easily steal the cash.
The cash should be kept in a more secure location, in a locked drawer or safe. The cash should be
taken to the bank on a more timely basis could use night deposit. There is also a lack of
separation of duties. The volunteer treasurer could take some of the cash and deposit the rest in
the bank and no one would be aware of it. One volunteer should keep records of cash donations,
and a second volunteer should have to sign for receiving the cash when he or she takes it to the
bank for deposit.

Solutions Manual
Page 6-31
P6-3.
The weakness in this scenario is the lack of verification of expenses claimed by the trustees.
Expenses charged to the cards only require explanation if the staff person requests it, and even
then if the trustee has a suitable explanation then the expense is approved. This system could
easily allow trustees to charge items to the card that arent employment related. To improve this
control, trustees should be required to submit receipts for all expenses and also provide a
statement explaining what the item purchased was as well as why it was required. Additionally,
there appears to be no verification regarding the amount of kilometres driven. A trustee could
claim the distance travelled was for employment reasons, however without verification the
trustee could easily claim distances travelled for personal reasons. A better control would be to
require the trustee to note the reason for the travel, their starting point and destination as well as
submit a calculation that provides the kilometres driven (for example, a print out from a mapping
website such as Map Quest or Google Maps). The expenses should be approved by a manager or
chair of the board. Additionally, the travel expenses should be submitted more frequently so that
there are fewer expenses to verify with each submission.
P6-4.
The weakness in this scenario is the lack of separation of duties. The person hired by the park to
collect the cash could steal some of it and give the rest to the park manager at the end of the day.
This kind of theft is difficult to detect. A better system is to have one person collect the cash from
customers, and a separate person record the sales and issue receipts, with each person separately
turning in the cash and receipts at the end of the day. This could be done by having a separate
person sell tickets for the rides and have the ride operator only collect tickets from customers. In
either case it would be possible to give free rides to people. In the latter case rides could be sold
to people for cash on the side. This behaviour could be checked by having someone observe the
operator from time to time.
P6-5.
Retail businesses have large amounts of inventory that are included in the calculation of the
current ratio but not the quick ratio. For retail businesses inventory is usually by far the largest
current asset and often the largest asset category on the balance sheet so the impact of leaving out
inventory when calculating the quick ratio will be significant. The denominator, current
liabilities, is the same for both ratios and current liabilities includes amounts owing for inventory
while inventory isnt classified as a quick asset.

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Page 6-32
P6-6.
a.
$15,000 + $22,500/(1.10)1 + $37,500/(1.10)2 = $66,446.28
b.
$50,000 (1.05)18 = $120,330.96
c.
$1/.08*[1 1/(1 + .08)12]
$25,000 = $188,401.95
The maximum amount the investor should pay is $188,401.95

d.
The company will have to repay the original amount of the loan, $500,000 plus interest.
The amount that must be repaid is the future value of $500,000 with interest compounded
at 9% per year for five years. Its assumed that interest owing is compounded each year.
$500,000 (1.09)4 = $705,790.08
e.
$30,000 today = $30,000

$50,000 (1.10)5 = $31,046.07
$1/.10
[1 1/(1 + .10)5] x $8,000 = $30,326.29
Of the three alternatives, the $50,000 to be received in 5 years has the highest present
value and so is the preferred option.
P6-7.
The purpose of this report is to provide an analysis of the recent credit policy change at Magundy
Inc. Four issues are covered in the report. These are the bad debt expense for 2017, the accounts
receivable turnover ratio, the effect of the change on Magundys liquidity, and an assessment of
the policy. Each issue is discussed below.
a.
The new aggressive policy and the old conservative policy are opposite extremes. The
estimated percentage-of-credit-sales uncollectible amount should be adjusted to
reflect this change. Given that new customers who are granted credit will pose more
risk, meaning there will likely be an increase in uncollected amounts, the rate should
be modified with the new sales policy in mind. The exact new percentage that should
be used will require an assessment of the customers. However, the new percentage
should be higher than 2%.

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Page 6-33
b.
The new credit policies allow customers more time to pay and provides credit to more
risky customers, which implies that Magundys accounts receivable balance will grow
more quickly than sales. As a result the average accounts receivable balance will
increase, which will cause Magundys accounts receivable turnover to decrease.
c.
Magundys new credit strategy will reduce the liquidity of the company. The looser
credit terms means that cash will be collected more slowly, which means more cash
will be tied up. This is indicated by the decreasing accounts receivable turnover. In
addition, the increased sales will likely require additional inventory and that will
require more cash investment as well. On the other hand, cash flow increase because
the company is selling more merchandise (this assumes that the changed credit policy
is beneficial).
d.
Whether or not the policy is good or bad also depends on the outcome. The increase
in sales is a good thing but costs also increase. The attractiveness of the strategy
depends on whether the benefits exceed the costs. While sales are rising as a result of
the new strategy there will be additional costs from bad debts, collection, and
financing. The certain measures of liquidity will also likely decline with the
associated consequences.
P6-8.
Wooler Inc.s profit margin to start off is low, roughly 11% of sales for years 2014 and 2015 with
all sales on a cash basis. In 2016 and 2017 it declined to just over 8%. Accepting credit cards
comes at a transaction cost of 3.5% of sales. Wooler accepting credit cards increased business
however the result of flat profits was a result of their existing customers paying with credit cards
also. From 2016 to 2017 credit sales went from 61% to 81% of total sales. Simply put, if cash
sales yielded an 11% margin, then 100% credit sales would only yield a 7.5% (11-3.5) margin. It
appears that most customers are taking advantage of using credit cards at a cost of 3.5% to
Wooler. As a result of existing customers paying on credit the over margin reduced on each
transaction resulting if flat profitsthe gain in profits from increased sales was offset by the
added cost of credit, which applied to new and existing sales.
P6-9.
a.
i.
ii.
$84,000
1.5% (8,470,000
iii.
9.5%
85%) = $107,992.50
(1,220,000) = $115,900
115,900 (96,000 84,000) = $103,900

b.
i.
ii.
$0 (There is no allowance for doubtful accounts under the direct method)

$96,000 $84,000 + $107,992.50 = $119,992.50

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Page 6-34
iii.
$115,900
c.
i.
Bad debt expense

84,000
Accounts receivable
84,000
To record the bad debt expense under the direct-write-off method.
ii.
Bad debt expense

107,992.50
107,992.50
To record the bad debt expense under the percentage-of-credit-sales method.
iii.
Bad debt expense

103,900
103,900
To record the bad debt expense under the percentage-of-receivables method.
d.
i.
ii.
iii.
$500,000 84,000 = $416,000

$500,000 107,992.50= $392,007.50
$500,000 103,900 = $396,100
e.
The differences arise because each method of determining bad debts has a different focus.
Under the direct method bad debts are charged to income as they occur, which means
matching doesnt occur. Under the percentage-of-credit-sales method, the focus is to
report a reasonably accurate bad debt expense. Under the percentage-of-receivables
method the focus is to report accounts receivable reasonably close to their net realizable
value. If the estimates using the latter two methods arent correct year after year
differences in the methods will occur because the percentage-of-receivables method
adjusts the balance in the allowance account to ensure that the net accounts receivable
approximates its NRV. The percentage-of-credit-sales method doesnt consider the NRV
of accounts receivable, only the expense for the period. In principle, the percentage-ofcredit sales and percentage-of-receivables should provide the same result. However, the
methods will diverge, even if they are set up to yield the same result, once estimates and
actuals are different in a year.
f.
Of the two accrual methods they to ways of achieving the same end. No method is
inherently better or worse, each one involves a trade-off. The direct method provides
accurate information about the amount of bad debts, but doesnt match the expense to the
revenue it helped generate, which is why its not used under accrual accounting. The
percentage-of-credit-sales method matches the expense to the revenue it helped generate,
but is an estimate, not an actual indication of what wont be collected. The percentage-ofreceivables method also matches the expense to the revenue and provides an
approximation of the receivables net realizable value, but the amount of bad debts may be
even less accurate than the percentage-of-credit-sales method. It must be stressed that if

Solutions Manual
Page 6-35
the estimates are unbiased (over time estimation errors average to zero) the methods
should yield similar results. Differences among the methods are caused by errors in
estimating bad debts. These methods, it should be remembered, are means to an end; to
provide an appropriate valuation for accounts receivable and to determine an appropriate
expense for the calculation of net income.
P6-10.
a.
i.
ii.
$18,000
2.5% (750,000
iii.
10%
85%) = $15,937.50
(145,000) = $14,500
14,500 (13,500 18,000) = $19,000

b.
i.
ii.
iii.
$0 (There is no allowance for doubtful accounts under the direct method)

13,500 18,000 + 15,937.5 = $11,437.5
$14,500
c.
i.
Bad debt expense

18,000
Accounts receivable
18,000
To record the bad debt expense under the direct-write-off method.
ii.
Bad debt expense

15,937.50
15,937.50
To record the bad debt expense under the percentage-of-credit-sales method.
iii.
Bad debt expense

19,000
19,000
To record the bad debt expense under the percentage-of-receivables method.
d.
i. $45,000 18,000 = $27,000
ii. $45,000 15,937.5 = $29,062.50
iii. $45,000 19,000 = $26,000
e.
The differences arise because each method of determining bad debts has a different focus.
Under the direct method bad debts are charged to income as they occur, which means
matching doesnt occur. Under the percentage-of-credit-sales method, the focus is to
report a reasonably accurate bad debt expense. Under the percentage-of-receivables
method the focus is to report accounts receivable reasonably close to their net realizable

Solutions Manual
Page 6-36
value. If the estimates using the latter two methods arent correct year after year
differences in the methods will occur because the percentage-of-receivables method
adjusts the balance in the allowance account to ensure that the net accounts receivable
approximates its NRV. The percentage-of-credit-sales method doesnt consider the NRV
of accounts receivable, only the expense for the period. In principle, the percentage-ofcredit sales and percentage-of-receivables should provide the same result. However, the
methods will diverge, even if they are set up to yield the same result, once estimates and
actuals are different in a year.
f.
Of the two accrual methods they to ways of achieving the same end. No method is
inherently better or worse, each one involves a trade-off. The direct method provides
accurate information about the amount of bad debts, but doesnt match the expense to the
revenue it helped generate, which is why its not used under accrual accounting. The
percentage-of-credit-sales method matches the expense to the revenue it helped generate,
but is an estimate, not an actual indication of what wont be collected. The percentage-ofreceivables method also matches the expense to the revenue and provides an
approximation of the receivables net realizable value, but the amount of bad debts may be
even less accurate than the percentage-of-credit-sales method. It must be stressed that if
the estimates are unbiased (over time estimation errors average to zero) the methods
should yield similar results. Differences among the methods are caused by errors in
estimating bad debts. These methods, it should be remembered, are means to an end; to
provide an appropriate valuation for accounts receivable and to determine an appropriate
expense for the calculation of net income.

Solutions Manual
Page 6-37
P6-11.
a.
Year
2013
2014
2015
2016
2017
2018
Credit Sales
$ 3,375,000
3,712,500
4,185,000
4,725,000
5,377,500
5,850,000
%
Uncollectible
3%
3%
3%
3%
3%
3%
Bad Debt
Expense
$ 101,250
111,375
125,550
141,750
161,325
175,500
b.
Year Opening balance
Write-offs
2013
$ 90,000
$ 88,200
2014
103,050
101,475
2015
112,950
80,438
2016
158,062
74,016
2017
225,796
103,496
2018
283,625
107,550
c.
Accounts
receivable
Bad debt
expense
Ending balance
$101,250
$103,050
111,375
112,950
125,550
158,062
141,750
225,796
161,325
283,625
175,500
351,575
Year
Ending allowance
balance
2013
$103,050
$1,183,500
8.71%
2014
112,950
1,264,500
8.93%
2015
158,062
1,381,500
11.44%
2016
225,796
1,512,000
14.93%
2017
283,625
1,692,000
16.76%
2018
351,575
1,813,500
19.39%
% of A/R
The allowance account is growing rapidly relative to gross accounts receivable. This is occurring
because the bad debt expense is being consistently overstated. Since the percentage-of-creditsales method focuses on the income statement, the overstatement of the bad debt expense results
in a buildup in the allowance account. The errors are accumulating and the increase in the
allowance is due to the increase in sales and the error buildup.
d.
In general, overestimating the bad debt expense will cause net income to be understated
because too much of credit sales is being expensed as uncollectible. Since the

Solutions Manual
Page 6-38
expectation is that 2% of sales will go uncollected whereas 3% is being expensed, net

income is, on average, being understated each year by 1% of credit sales.
e.
The net amount of accounts receivable on Halkirks balance sheet on December 31, 2018
will be $1,461,925 ($1,813,500 $351,575)). The balance doesnt reflect the net
realizable value of the accounts receivable. The amount is understated by the cumulative
excess of bad debts expense from 2013 to 2018.
f.
Bad debt expense calculated as 2% of credit sales, beginning in 2015:
Year
Credit Sales % Uncollectible
Bad Debt Expense
2013 $ 3,375,000
3%
$101,250
2014
3,712,500
3%
111,375
2015
4,185,000
2%
83,700
2016
4,725,000
2%
94,500
2017
5,377,500
2%
107,550
2018
5,850,000
2%
117,000
Total
27,225,000
615,375
Year Opening balance Write-offs Bad debt expense Ending balance
2013
$90,000
$88,200
$101,250
$103,050
2014
103,050
101,475
111,375
112,950
2015
112,950
80,438
83,700
116,212
2016
116,212
74,016
94,500
136,696
2017
136,696
103,496
107,550
140,750
2018
140,750
107,550
117,000
150,200
The allowance on December 31, 2018 would be $150,200 if the percentage had been adjusted in
2015.
g.

Bad debt expense
201,375
201,375
The entry serves to increase income in 2018 by $201,375. This would have a very
significant effect on net income for that year. (If all Halkirks sales are on credit and the
company has a profit margin of 10% the adjustment would serve to increase income by
almost 34%. This entry might give the impression on the financial statements that the
companys bad debt expense is lower than it actually is. This could mislead users when
they are attempting to gauge future net income (flow of wealth). The financial statements
would be even more confusing if this adjustment wasnt disclosed separately. Users might
Solutions Manual
Page 6-39
conclude that the $201,375 was part of ongoing earnings. However, users wont be
misled when determining future cash flows from accounts receivable as they are now
stated at net realizable value.
P6-12.
Credit sales

2
365
ratio
Tadoussac Inc.
2018
2017
Accounts receivable
turnover
Average Collection Period
5.85
62.37
5.74
63.64
Sturgis Ltd.
2018
2017
7.59
48.07
7.63
47.84
Comparing the two companies, Sturgis has a better accounts receivable turnover ratio,
which means its more effective at collecting its debts. Sturgis is collecting its debts 15
days faster than Tadoussac. On the surface at least Sturgis is better at managing its cash
flows and has better controls in place to ensure collection. Additional useful information
regarding the receivables of the companies includes the period each company allows
customers to pay (the difference between the two might not be meaningful if Tadoussac
offers more time), any incentives for early payment (discount for prompt payment), and
information on the risk profile of the customers (are conditions each company faces
different regarding its customers).

Solutions Manual
Page 6-40
P6-13
Current
Ratio
Quick Ratio
Accounts Receivable Turnover

Ratio
Increase
Increase
Increase
Average Collection Period

of
Accounts Receivable
Decrease
No effect
No effect
No effect
No effect
Increase
Increase
No effect
No effect
Decrease
Decrease
Decrease
Increase
No effect
No effect
No effect
No effect
No effect
No effect
No effect
No effect
7*
No effect
No Effect
No effect
No effect
The credit sale increases ARTO because the impact on the denominator is less than the
effect on the numerator. In the denominator the beginning accounts receivable isnt
affected by the credit sale, only ending receivables is. The opposite logic applies to when
there are decreases as in item 4.
Assumes that an accrual method for bad debts is used (write-off has no effect on net
accounts receivable). If the direct write-off approach is used the answer would be
decrease, decrease, increase, decrease.

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Page 6-41
P6-14.
Current
Ratio
Quick
Ratio
Accounts Receivable
Turnover Ratio
Average Collection
Period of Accounts
Receivable
Decrease
Decrease
Increase
Decrease
No effect
No effect
Increase
Decrease
Decrease
Decrease
No effect
No effect
Decrease
Decrease
No effect
No effect
Increase
Increase
No effect
No effect
Decrease
Decrease
Increase
Decrease
P6-15.
Note that amounts calculated by students may vary slightly depending on how much rounding
they do. Items to be solved are shown in grey.
Current assets on December 31, 2017

Current ratio on December 31, 2017
Current liabilities on December 31, 2017
Quick assets on December 31, 2017
Quick ratio on December 31, 2017
Accounts receivable on December 31, 2017
Revenues (all on credit) during 2017
Average collection period of accounts receivable for 2017
Accounts receivable turnover ratio for 2017

Solutions Manual
$1,523,750
1.15
$1,325,000
$850,000
0.64
$275,192
$207,000
$2,750,000
32 days
11.41
Page 6-42
P6-16.
Note that amounts calculated by students may vary slightly depending on how much rounding
they do. Items to be solved are shown in bold.
Current assets on December 31, 2018
Current ratio on December 31, 2018
Current liabilities on December 31, 2018
Quick assets on December 31, 2018
Quick ratio on December 31, 2018
Revenues (all on credit) during 2018
Average collection period of accounts receivable for 2018
Accounts receivable turnover ratio for 2018
$275,000
1.25
$220,000
$187,000
0.85
$55,000
$45,000
$287,500
63.48
5.75
P6-17.
Current
ratio
Accounts
receivable
turnover
ratio
Average
collection
period of
accounts
receivable
Debt-toequity ratio
Profit
margin ratio
Quick ratio
Writeoff of
an account
No Effect
No Effect
No Effect
No Effect
No Effect
No Effect
1
receivable
Recording
the
allowance
Decrease
Decrease
Increase
Decrease
Increase
Decrease
for
discounts2
Recording
the bad debt
Decrease
Decrease
Increase
Decrease
Increase
Decrease
expense3
Sale of
merchandise
Decrease
on credit;
(less
No Effect
Increase
Decrease
Decrease
Increase
payment
inventory)
due in three
years4
1
Writeoff of an account receivable reduces the allowance and a specific receivable account. Theres no effect
on current assets or the income statement.
2
Debit Salesallowance for discounts (contra sales), Credit Allowance for discounts (contra accounts
Solutions Manual
Page 6-43
receivable)
3
Debit Bad debt expense (expense), Credit Allowance for uncollectables (contra accounts receivable)
4
Debit Long-term accounts receivable, Credit Sales; Debit Cost of goods sold, Credit inventory
* Assume that allowance for returns has been journalized.
P6-18.
Current
ratio
Accounts
receivable
turnover
ratio
Average
collection
period of
accounts
receivable
Debt-toequity ratio
Profit
margin
ratio
Quick ratio
Recording the
allowance for
Decrease
Decrease
Increase
Decrease
Increase
Decrease
1
returns
Collection of a
previously
written off
No Effect
No Effect
Increase
Decrease
No Effect
No Effect
account
receivable2
Sale of
merchandise
on credit;
Increase
Increase
Increase
Decrease
Decrease
Increase
payment due in
30 days3
Collection of
an account
No Effect
No Effect
Increase
Decrease
No Effect
No Effect
receivable4
1
Debit Salesallowance for return (contra sales), Credit Allowance for returns (contra accounts receivable)
2
Debit Accounts receivable, Credit Allowance for uncollectables, Debit Cash, Credit Accounts receivable
3
Debit Accounts receivable, Credit Sales; the increase in sales is greater than the increase in average accounts
receivable.
4
Debit Cash, Credit Accounts receivable.

Solutions Manual
Page 6-44
P6-19.
=
=
365
365
62
5.89
Credit Sales
2,456,000
5.89
416,978
= Beg. A/R+420,000
= 416,978
2
Beginning A/R
= 413,956
a.
No effect because a write-off of accounts receivable doesnt affect net receivables so the
calculation isnt affected.
b.
Collection of an additional $80,000 of accounts receivable causes average accounts

receivable to decrease by $40,000.
Accounts receivable turnover ratio=
Average collection period=
2,456,000
376,978
6.51
365
6.51
56 days
c.
No effect because the transaction was a cash sale.
d.
Additional credit revenue means the numerator of the equation increases by $125,000.
Since it is a credit sale average accounts receivable would also increase, by $62,500

Solutions Manual
Page 6-45
e.
365
5.38
5.38
= 68 days
An additional bad debt expense of $5,000 would cause average accounts receivable to
decrease by $2,500.
f.
2,581,000
479,478
2,456,000
414,478
365
5.92
5.92
= 61.6 days
An allowance for sales returns of $7,500 would cause average accounts receivable to
decrease by $3,750 but reduce net sales by the entire amount.
2,448,500
413,228
365
5.93
5.93
= 61.6 days
P6-20.
a.
The amount of revenue that Bellburn should recognize is the present value of the longterm receivable:
$5,000,000/(1.1)2 = $4,132,231
The entry to record the sale is:
Revenue
b.
4,132,231
4,132,231
On March, 31, 2016 Bellburns balance sheet would show a long-term receivable of
$4,132,231. It would be classified as a long-term (non-current) asset since the cash
wouldnt be received within one year/one operating cycle.

Solutions Manual
Page 6-46
c.
For fiscal 2017 Bellburn would report $413,223($4,132,231* 10%) of interest revenue.
On March 31, 2017 Bellburn would report a long-term receivable of $4,545,455. The
receivable is still long-term because as its not due to be collected until April 2018, which
is more than one year away.
The journal entry to record the interest revenue is:
Interest revenue
413,223
413,223
Bellburn should record $454,546 of interest revenue in fiscal 2018. The receivable would
appear on the balance sheet at its present value of $5,000,000. It would be classified as a
current asset because the cash will be received within one year.
The journal entry to record the interest revenue is:
d.
Long-term receivable (current asset)

Interest revenue
454,546
454,546
Cash
5,000,000
5,000,000
e.
Bellburn should recognize $5,000,000 in revenue. The interest payments should be

recognized as interest revenue in the periods in which they are paid.
P6-21.
a.
Account Age
Current
1-30 days
31-60 days
61-120 days
> 120 days
Total
Balance
$288,000
112,000
60,000
40,000
60,000
$560,000
Percent
Amount
Uncollectible Uncollectible
1%
$2,880
5%
5,600
15%
9,000
40%
16,000
75%
45,000
$78,480
The amount of closing accounts receivable estimated to be uncollectible is $78,480.

b.
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Page 6-47
Opening allowance
Amount written-off
Pre-closing allowance
Required balance
Required adjustment
($67,800)
58,000
(9,800)
(78,480)
($68,680)
Bad debt expense

Allowance for uncollectible accounts
c.
68,680
68,680
One possible explanation is that management has revised its percentage of accounts
receivable estimated to be uncollectible resulting in a higher allowance. Another
explanation is that the company had more sales, and thus a greater amount of accounts
receivable, meaning more would be uncollectible. A third possibility is that the
composition of the accounts changed and there are relatively older accounts receivable
than in 2017. This too would increase the allowance. A fourth possibility is that the
company may have changed its credit policies making it easier for prospective customers
to get credit.
P6-22.
a.

Bad debt expense
53,000
53,000
b.
The effect of estimating the bad debts higher than they actually were in each of the years
was to decrease net income in each period by the excess of the estimate over the actual
bad debts. The adjusting entry will have the effect of increasing net income in the year
the adjustment is made by $53,000, which is the cumulative excess of the estimate over
the actual bad debts for the past three years. In other words, net income will be $53,000
higher after the adjustment than it otherwise would have been (to offset income being too
low in the previous three years). However, over the four years net income in total would
have been the same. What differs is the allocation of income over the four years. Also, it
might be argued that a higher expense in the first three years was conservative
accounting, but the effect of that conservatism in the fourth year results in higher income,
which could be misleading to users.
c.
The error and adjusting entry could mislead financial statement users. Net income in each
of the previous three years has been understated, which may cause users to underestimate
Trilbys future cash flows. In addition, the large decrease in bad debt expense due to the
adjusting entry will overstate net income for the current year. This could cause users of
the financial statements to overestimate Trilbys future cash flows. The financial
statements would be even more confusing if this adjustment wasnt clearly disclosed.

Solutions Manual
Page 6-48
Users might conclude that the $53,000 was part of ongoing earnings. In addition, the
balance sheets of the previous three years wont reflect the net realizable value of
accounts receivable. This could affect the decisions of creditors since decision criteria
such as current assets, current ratio, quick ratio, etc., will be misleading.
P6-23.
a, b.
Assume all sales on credit.
Credit sales

2
=
365
Truax Inc.
Revenue
Accounts
receivable at
year-end
Opening
Accounts
Receivable
Average
Accounts
Receivable
ARTO
Average
collection
period
2018
2017
2016
2015
$2,604,420 $2,480,400 $2,340,000 $2,250,000
Ilderton Ltd.
Revenue
Accounts
receivable at
year-end
Opening
Accounts
Receivable
2018
2017
2016
2015
$2,257,164 $2,129,400 $2,047,500 $1,950,000
400,680
364,765
334,286
310,345
364,765
334,286
310,345
302,100
382,723
6.80
349,526
7.10
322,316
7.26
306,223
7.35
53.64
51.43
50.28
49.68
235,121
229,214
222,554
216,667
229,214
222,554
216,667
207,000

Solutions Manual
2014
302,100
2014
207,000
Page 6-49
Average
Accounts
Receivable
ARTO
Average
collection
period
c.
232,168
9.72
225,884
9.43
219,611
9.32
211,834
9.21
37.54
38.72
39.15
39.65
Historically Ilderton has done a better job of managing its receivables despite more
stringent payment terms. It has reduced the number of days it takes to collect over the
period from 39.7 days to 37.5 days, a reduction of about two days. Truax with more
lenient terms seems to be losing control of collecting receivables. The time it takes to
collect has increased over the period from 49.7 days to 53.6 days, an increase of about
four days. Being able to collect faster and having a higher turnover indicates better
management of accounts receivable and cash inflow by Ilderton over Truax.

Solutions Manual
Page 6-50
P6-24.
Current Ratio
Quick Ratio
Company A Company B Company C

1.14
1.14
1.14
0.67
0.75
0.53
Ranking in order of liquidity position (strongest to poorest):

1) Company B
2) Company A
3) Company C
While all three companies have the same current ratio it doesnt mean that they can always have
enough cash to meet their current obligations. For this reason we must look at the quick ratio to
break the tie. While none of the companies appear to have enough liquid asset to meet current
obligations (Quick Ratio<1) Company B is in the best position of the three with the highest quick
ratio. In addition, B has the most cash, which enhances its ability to meet its obligations. Other
factors that may affect ranking outside of the ratios could be the nature of inventory on hand
since certain types of inventory like commodities maybe more liquid than others (i.e.
Computers).
P6-25.
a.
i.
Year
2014
2015
2016
2017
2018
Credit Sales
$5,054,000
6,317,500
7,265,126
8,572,848
9,858,774
Bad Debts
1.50%
$75,810
94,763
108,977
128,593
147,882

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Page 6-51
ii.
Year
2014
2015
2016
2017
2018
Credit Sales
$5,054,000
6,317,500
7,265,126
8,572,848
9,858,774
Bad Debts
1.75%
$88,445
110,556
127,140
150,025
172,529
iii.
Year
Beg. Balance
$63,000
75,810
94,763
108,977
128,593
Beg. Balance
$63,000
88,445
123,191
155,569
196,618
Write-Offs
($63,000)
(75,810)
(94,763)
(108,977)
(128,593)
Bad Debt
1.50%
$75,810
94,762
108,977
128,593
147,882
Bad Debt
Write-Offs 1.75%
($63,000)
$88,445
(75,810)
110,556
(94,762)
127,140
(108,976)
150,025
(128,592)
172,529
End. Balance
$75,810
94,763
108,977
128,593
147,882
End. Balance
$88,445
123,191
155,569
196,618
240,555
iv.
Year
2014
2015
2016
2017
2018
NI Before
Bad Debts
$464,968
631,750
690,186
797,274
887,290
Bad Debts
1.50%
$75,810
$94,763
$108,977
$128,593
$147,882
NI
$389,158
536,987
581,209
668,681
739,408

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Page 6-52
Year
2014
2015
2016
2017
2018
b.
NI Before
Bad Debts
$464,968
631,750
690,186
797,274
887,290
Bad Debts
1.75%
$88,445
$110,556
$127,140
$150,025
$172,529
NI
$376,523
521,194
563,046
647,249
714,761
The president could cite the increasing write-offs each year to justify the 0.25% increase.
However, the increased write-offs are more likely caused by the increasing sales. The
president could also cite poor economic conditions. Again, this is a weak argument since
rapidly increasing sales indicate favourable economic conditions. The president could
also support the increase with information about accounts receivable, for instance a low
turnover ratio and long collection period combined with many overdue accounts would
lend strong support to his argument. The president could also contend that he/she is being
conservative. Two things to note however, its very difficult to question an estimate that
falls into a reasonable range. Management could easily make a plausible case for this
change. Over time it would be possible to observe whether there was in fact a bias in the
estimates. If, for example there was a persistent error in one direction. However, this
would take a number of periods to detect.
c.
i.
Opening bad debt balance $240,555
Required opening bad debt 147,882
Adjustment
92,673

92,673
Bad debt expense
To correct error in estimating bad debt expense for 2014 to 2018
92,673
ii.
This entry would increase net income by $92,673 by lowering expenses by
$92,673.
d.
Hidden reserves are an abuse of accounting information and they undermine the
relevance and reliability of financial statements. Accounting requires many subjective

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Page 6-53
estimates, many of which are made by management and arent fully disclosed in the
financial statements. Users of financial statements who arent aware of these estimates
are in danger of being misled by them and making inappropriate decisions. Using hidden
reserves to smooth earnings or shift earnings to achieve certain reporting objectives
makes earnings less informative to users. IFRS requires disclosure of significant
estimates so for these companies at least stakeholders can expect information that might
expose hidden reserves.
P6-26.
a.
Loan loss
provision
2015 $2,718,000
2016 $5,322,000
2017 $5,268,000
= Ending
balance
= $21,324,000
= $21,138,000
= $21,000,000
- Beginning
balance
- $22,140,000
- $21,324,000
- $21,138,000
+ Loan
losses
+ $6,066,000
+ $7,950,000
+ $7,830,000
- Loss
recoveries
- $2,532,000
- $2,442,000
- $2,424,000
b.
From the information provided the balance in the loan loss account has decreased over
the three years shown. However, the loan loss provision itself increased significantly in
2016 (although the smaller loan loss provision in 2015 may have been the result of
having to reduce the balance in the allowance account). The decreasing balance in the
allowance account suggests that expected losses are declining (assuming a steady or
increasing loan portfolio). The information from allowance account shows that the loan
losses associated with consumer loans and international commercial loans have increased
significantly, suggesting that these loans are becoming more risky (assuming that amount
of loans has remained stable). On the other hand, the losses associated with Canadian
commercial loans have decreased from 2015 to 2017.
c.
Consumer loans are by far the most risky as seen from the following table:
Consumer loans
Canadian commercial loans
International commercial loans
Total
Loan losses as a
percentage of loans
outstanding at year
end
1.46%
0.24%
0.23%
0.78%
Loan losses less loan

loss recoveries as a
percentage of loans
outstanding at year end
1.16%
0.00%
0.14%
0.54%
Consumer loan losses as a percentage of consumer loans outstanding are significantly higher
than the same ratio for the other categories of loans. Because a particular loan category is riskier
Solutions Manual
Page 6-54
than others, it doesnt necessary make that category bad business. Remaining in consumer loans
may still be profitable even if the loss rate is higher. The bank will be able to compensate for the
higher risk by charging a higher interest rate on consumer loans. Also, by being in consumer
loans Zbaraz will be able to have a larger pool of loans in its portfolio. Consumer loans represent
over 44% of the loans. It may not be possible for Zbaraz to replace these loans with those in the
less risky categories. Having more commercial loans may actually increase risk because the loan
pool would have more similar types of loans, which means that when things get bad in a sector
the risk of losses is actually higher.
d.
More information about the pool of loans gives the stakeholder the ability to do more
analysis of the banks lending practices. With detailed information about the loan portfolio a
stakeholder could assess the lending strategy of the bank and the riskiness of the loans being
made. My key concern as a stakeholder of the bank (keeping in mind of course that different
stakeholders have different interests and different information needs) would be to evaluate the
risk of and return on the portfolio. Information about the distribution of loans (regions of the
country, industries, foreign countries, etc.) would give insight into the risk of the portfolio (the
more diversified the portfolio the less risky it is). Information about interest rates, duration of
loans, and other terms would give insight into the returns that could be earned on the portfolio
and help in making predictions about future cash flows.

Solutions Manual
Page 6-55
USING FINANCIAL STATEMENTS

USING FINANCIAL STATEMENTS
FS6-1.
(in millions of dollars)
a.
b.
c.
d.
e.
f.
g.
Cash and equivalents on March 31, 2012 $287.3

Net amount of accounts receivable on March 31, 2012 $308.4
Gross amount of accounts receivable on March 31, 2012 $316
Allowance for doubtful accounts on March 31, 2012 $7.6
Amount of trade receivables past due on March 31 ,2012 $78.7
Cash from operations for 2012 $233.9
Revenue for 2012 $1,821.2
FS6-2
(amounts in millions of dollars)
CAE reports accounts receivable as $308.4 on its balance sheet. This number represents the
amount of money that CAE estimates it can collect from its customers who haven't yet paid for
the goods and services received. This figure is lower than the amount that customers actually
owed to the company because CAE has reduced it by the amount that CAE estimates customers
wont pay (even though the customer owes money, some may never pay their bills). Customers
actually owe $316 when uncollectible amounts arent taken into consideration. This amount
includes amounts not owed by customers. The amount owed by customers is 113.2. Note 5
shows a bad debt expense of $7.6.
FS6-3
(amounts in millions of dollars)
Liquidity can be examined in a number of ways. CAEs cash position has increased slightly from
2011, though its below the 2010 level. The current ratio is 1.30, which unchanged from 2011
and slightly higher than 2010. The quick ratio (including cash and cash equivalents and accounts
receivable) has decreased slightly from 0.71 to 0.67. In 2010 the quick ratio was also 0.71. An
important message from these measures is their stability. Working capital has increased by over
$25 from $239.1 to $264.7The companys liquidity has been steady over three years as measured
by the current and quick ratios. Cash from operations has also been steady over two years,
suggesting a reliable flow of cash coming in from operations.
FS6-4.
in millions of dollars as of March 31,
2012
2011
Cash and cash equivalents
$287.3
$276.4
A/R
308.4
296.8
Total quick assets
595.7
573.2

Solutions Manual
Page 6-56
Total current assets

Total current liabilities
Quick ratio
1148.1
1049.2
883.4
810.1
0.67
0.71
1.30
1.30
264.7
239.1
(Quick assets / current liabilities)

Current ratio
(Current assets / current liabilities)
Working capital
From 2011 to 2012 the quick ratio has slightly declined indicating that their liquidity position has
worsened but given the small change it could be caused by timing. While a further look into the
industry is required for comparison it does not look like the company is in a very strong liquidity
position to start out with since current liabilities are higher than quick assets. The current ratio
has remained unchanged between the two years but over all there is an increase in working
capital. This can be taken as a sign of improvement in liquidity however items such as the
increase in inventories for a company that provides primarily services maybe alarming. From the
statement of cash flows, there is an improvement in CFO. Overall there is an increase in cash and
cash equivalents in 2012 but this is more than offset by the additional debt the company has
taken on.
FS6-5.
The maximum amount CAE can receive under the program of selling their accounts receivable is
$150 million. The benefit of selling accounts receivable is that it improves the companys cash
position and maintain its liquidity position without incurring additional borrowings. A company
buying the receivables would make money by buying the receivable for lower than their face
value, with the difference being profit.
FS6-6.
The note on estimates is included to make stakeholders aware that estimates have been used in
the preparation of the financial statements. Although the estimates are supposed to represent
managements best guess regarding uncertainties at the financial statement date, stakeholders
are cautioned that the actual results may differ from the estimates. Its important that
stakeholders are aware of these estimates so they can appropriately evaluate the companys
performance and take into consideration managements motivation in making estimates. It also
ensures that stakeholders are aware of the presence of uncertainty when financial statement
numbers are being relied upon to make a decision. That said, estimates are needed under accrual
accounting to prepare financial statements because there are uncertainties that depend on future
events (such as how much of receivables wont be collected). The only way to avoid estimates
would be to delay accounting recognition until no uncertainty remained. This would impair the
usefulness of financial statement information because information would be provided to
stakeholders much later. Estimates may be difficult to make because it is hard to predict the
future and to be free from management bias.
Solutions Manual
Page 6-57
FS6-7.
The other amounts used to calculate accounts receivables include: Allowance for doubtful
accounts, accrued receivables, along with receivables from related parties and other receivables.
The portion of these other balances to the total accounts receivable is ($116.5/$308.4) 38% of the
total receivables. Accounts receivables and trade receivables are one and the same however
accrued receivables are amounts that are from outstanding contracts that have not been billed
while receivables from related parties are amounts due from stakeholders such as managers and
major shareholders. Allowance for doubtful account is a contra asset account under accounts
receivable which represents and estimates of uncollectable amounts. Knowing the amount of
different receivables provides information to the users of the financial statements to assess the
source of the receivables. In this case majority or the receivables are trade receivables but there
are amounts included for accrued receivables and related parties that carries material balances.
FS6-8.
in millions of dollars
2012
2011
A/R
$308.4
$296.8 $238.2
Sales
1,821.2 1,630.8
302.6
267.5
6.02
6.10
60.6
59.9
2010

(Credit sales / average accounts
receivable)
Average collection period for a/r
(365 / accounts receivable turnover ratio)
CAEs accounts receivable turnover ratio and average collection period are virtually unchanged
from 2011 to 2012. On average it now takes just over 60 days to collect receivables. Since the
ratios are unchanged its difficult to comment on how well receivables are being managed. We
would need more information about credit terms to provide more insight. For example, our
assessment of the collection period would be affected by the credit terms CAE offers its
customers.

Solutions Manual
Page 6-58
FS6-9.
In millions of dollars
2012
2011
Not overdue
$113.2
$114.8
$90.6
Past due three months or less
47.4
67.1
41.2
Past due for more than three months
31.3
15.2
20.6
191.9
197.1
152.4
Not overdue
58.99%
58.24%
59.45%
Past due three months or less
24.70%
34.04%
27.03%
Past due for more than three months
16.31%
7.71%
13.52%
Total Trade receivables
Total Trade receivables
2010
100.00% 100.00% 100.00%
Trade receivables that arent overdue has remained stable compared to total trade receivables for
all three years. However, overdue accounts past 90 days has more than doubled from 2011 to
2012 indicating the CAE despite improvements from 2010 to 2011 is having problems with
collections. On the other hand past due accounts in the three month range has improved over the
three time frame. The amount past due three months or less has decreased but it seems that much
of that decrease has gone to receivables past due more than three months.
FS6-10.
The aging schedule indicates how effective CAE is at collecting receivables. The lower the
percentage of past due account the better the company is at managing its credit. However in the
case of CAE it may be distorted given its ability to factor its receivables. By separating the past
due amounts into different categories users of the financial statement can assess the riskiness of
collectability of outstanding balances. The longer an amount is overdue the less likely it is to be
collected. Therefore estimates used for doubtful accounts would like increase as the proportion
of aged accounts increase. If the amount of past due accounts increased significantly the
allowance would likely increase as well since more overdue accounts implies fewer collections.
FS6-11.
Allowance for doubtful accounts (AFDA) increased by $1.6 million. The amounts changed as a
result of additions to the allowance in the amount of $6.2 million while reversals, amounts
charged off and exchange differences netted out to the $1.6 million increase. The journal entry
for the increase in AFDA is
$6,200,000
Cr. Allowance for doubtful accounts
$6,200,000
The journal entry to write-off the amount owing per the financial statement of amounts charge
Solutions Manual
Page 6-59
off of $2.4 million is as follows:

Cr. Accounts Receivable
Dr. Allowance for doubtful accounts
$2,400,000
$2,400,000
FS6-12.
CAE is exposed to credit risk from multiple sources: accounts receivable default, cash and cash
equivalents treasury activities (losses on investments) and performance of derivative financial
instruments. The steps that CAE has taken to minimize credit risk include: scanning of market
conditions; engaging in contracts with A-rated or better credit scores; and doing business with
established companies. The markets are uncertain while it is possible to reduce those risks by
entering into low risk investments it can never be completely eliminated given market
uncertainty. Currently CAE accounts for credit risk of trade receivable by setting up an
allowance for doubtful accounts that represents the maximum exposure the company has
associated with that

Solutions Manual
Page 6-60

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CHAPTER 6

Cash, Receivables, and the Time Value of Money

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Uncashed cheques should be classified as cash because a cheque is equivalent to cash

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

a. FV = (1.04)6 $100,000 = $126,531.90

a. FV = (1.03)8 $5,000 = $6,333.85

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

PV= $5,000/(1.10)20 = $743.22

= $4,000/(1.12) + $3,000/(1.12)2 + $2,000/(1.12)3

= $6,000/(1.08) + $4,000/(1.08)2 + $8,000/(1.08)3

1/.08*[1 1/(1 + .08)25] x $40,000= $426,991.05.

1/.12*[1 1/(1 + .12)15] x $250,000 = $1,702,716.12

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

1/.01*[1 1/(1 + .01)36] x $50 + $200

1/.10*[1 1/(1 + .10)10] x $200 + $2500/(1.10)10= $2,192.77

Comparing Present values to $1000:

PVannuity = 1/.07*[1 1/(1 + .07)20] x $10,000 = $105,940.14

Students may approach from PV or FV in their solution:

Present value of an annuity:

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Dr. Bad debt expense

Dr. Allowance for bad debts

Dr. Allowance for bad debts

Dr. Bad debt expense

The effect of this entry on net income would be to decrease it by $50,000.

Dr. Allowance for bad debts

Allowance for bad debts

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Amount to be received or paid in each period

= $4,000,000 + (1/.14*[1 1/(1 + .14)3] x $4,000,000)

*numbers may vary due to rounding

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Credit sales during 2017

Bad debt expense

Bad debt expense

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Bad debt expense = $94, 500 ($1,575,000

6%) $11,250 = $83,250

Allowance for doubtful accounts = $1,575,000

Bad debt expense = $9,361,500

Allowance for doubtful accounts = $140,422.50 + $11,250 = $151,672.50

Bad debt expense = $94, 500 ($1,575,000

Allowance for doubtful accounts = $1,575,000

Allowance for doubtful accounts = $140,422.50 $11,250 = $129,172.50

The amount of closing accounts receivable that is estimated to be uncollectible is

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Accounts receivable turnover

Average collection period of accounts receivable

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Allowance for doubtful accounts

Sales Returns and Allowances

Allowance for Returns

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Bad Debt Expense

Accounts Receivable balance would be $202,940 (235,000 19,100 960 12,000).

A stakeholder should be concerned with the estimates made by management, especially

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Average accounts receivable

Average collection period