CHAPTER 5

REVENUE AND MONETARY ASSETS

Changes from Tenth Edition
The chapter has been updated. The SECs SAB101 Revenue Recognition tests have been added.
Approach
The sequence of transactions for accounts receivable and bad debts often causes difficulty; indeed, the
time that one is sometimes forced to spend on this topic is all out of proportion to its importance. Students
often do not understand why an Allowance for Bad Debts account is necessary at all; they do not grasp
the notion that although we feel reasonably sure that some accounts will go bad, we do not know which
ones they will be. Even when they do understand this, the chain of transactions involved in estimating bad
debts, writing off specific accounts, and booking bad debts recovered, is complicated and not easy to
follow.
If experience is any guide, it is quite likely that at the time this chapter is taught the press will be
describing a company that has gotten into trouble for overstating its revenue or understating its bad debt
or warranty allowance. Discussion of such a situation would be interesting.
Cases
Stern Corporation (A) is a straightforward problem in handling accounts receivable and bad debts.
MacDonalds Farm, by contrast, has few technical calculations but provides an excellent opportunity for
a realistic discussion of alternative ways of measuring revenue and of valuing assets.
Joan Holtz (A) is a different type of case. It is a device for raising several discrete, separable problems
about the subject matter of the chapter, from which the instructor can pick and choose those he or she
wishes to take up in class. (It probably is not feasible to discuss all of them.)
Bausch & Lomb, Inc., is an actual case situation involving revenue recognition.
Boston Automation Systems, Inc. involves a review of the companys revenue recognition practices in the
light of the SECs SAB 101.
Blaine and Mason, LLP, deals with the issue of gross verses net reporting of revenues.

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Problems
Problem 5-1

Sale Method
Jan.
Feb.
Mar.
April
May
June
Sales.........................................................................................................................................................................................
$12,000
$ 8,000
$13,000
$11,000
$9,000
$13,500
Cost of goods sold....................................................................................................................................................................
7,800
5,200
8,450
7,150
5,850
8,775
Gross margin............................................................................................................................................................................
$ 4,200
$2,800
$ 4,550
$ 3,850
$3,150
$ 4,725

Installment Method
Jan.
Feb.
Mar.
April
May
June
Sales.........................................................................................................................................................................................
$11,000
$10,000
$11,500
$10,500
$10,500
$9,500
Cost of goods sold....................................................................................................................................................................
7,150
6,500
4,675
6,825
6,825
6,175
$ 3,850
$ 3,500
$ 6,825
$ 3,675
$ 3,675
$3,325
Problem 5-2

Completed Contract
Percentage of Completion
This Year
Next Year
This Year
Next Year
Income excluding motel (000)..................................................................................................................................................
$1,250
$1,250
$1,250
$1,250
Income from motel project.......................................................................................................................................................
0
750
450
300
Income before taxes.................................................................................................................................................................
$1,250
$2,000
$1,700
$1,550
Problem 5-3
To record the write-off:
If Alcom uses the direct write-off method-Dr. Bad debt Expense.................................................................
Cr. Accounts Receivable........................................................

$3,000
$3,000

If Alcom uses the allowance method:

Dr. Allowance for Doubtful Accounts.......................................
Cr. Accounts Receivable...............................................

$3,000
$3,000

To record the partial payment:

If Alcom uses the direct write-off method:
Cash...........................................................................................
Bad Debts Recovered............................................................
(or Bad Debt Expense............................................................

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$950
$950
$950)

If Alcom uses the allowance method:

Either of the above two entries or:
Cash...........................................................................................
Allowance for doubtful accounts...........................................

$950
$950

Problem 5-4
The Allowance for Doubtful Accounts should have a balance of $51,750 on December 31. The supporting
calculations are shown below:
Days Account
Outstanding
Amount
0-15 days
$450,000
16-30 days
150,000
31-45 days
75,000
46-60 days
45,000
61-75
15,000
Balance for Allowance for Doubtful Accounts

Expected Percentage
Uncollectible*
.01
.06
.20
.35
.50

Estimated
Uncollectible
$ 4,500
9,000
15,000
15,750

7,500
$51,750

*(1-Probability of collection.)
The accounts that have been outstanding over 75 days ($15,000) and have zero probability of collection
would be written off immediately and not be considered when determining the proper amount of the
Allowance for Doubtful Accounts.
b.
Accounts Receivable.......................................................................
Less: Allowance for Doubtful Accounts..........................................
Net Accounts Receivable....................................................

$735,000

51,750
$683,250

c. The year-end bad debt adjustment would decrease the years before-tax income by $29,250, as shown
below:
Estimated amount required in the Allowance for Doubtful
Accounts....................................................................................
Balance in the account after write-off of bad accounts but before
adjustment..................................................................................
Required charge to expense..............................................................

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$51,750
22,500
$29,250

Problem 5-5
Green Lawns books:
Dr. Inventory on Consignment..........................................................
Cr. Finished Goods Inventory......................................................

8,400
8,400

Note that at this point the $12,600 wholesale price (Green Lawns revenue when these goods are sold) is
irrelevant.
Carsons books: No entry; the goods are not owned by Carson and hence are not inventory on Carsons
books; similarly, Carson does not as yet owe Green Lawn for these goods.
Green Lawns books:
Dr. Accounts Receivable..................................................................
Cost of Goods Sold......................................................................
Cr. Sales..................................................................................
Inventory on Consignment..................................................

5,040
3,360
5,040
3,360

(This can be shown as two entries.)

Carsons books:
Dr. Cash or Accounts Receivable.....................................................
Cost of Goods Sold......................................................................
Cr. Sales..................................................................................
Accounts Payable.................................................................
(This also can be shown as two entries.)
Problem 5-6
Revenue.....................
Costs..........................
Income.......................

20 x 1
$980,000

20 x 2
$1,470,000

20 x 3
$2,205,000

721,000
$259,000

1,190,000
$ 280,000

1,715,000
$ 490,000

Revenue equals percentage completed during the year times fixed price.

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6,720
5,040
6,720
5,040

Problem 5-7
The GRW Companys current assets and current liabilities at year-end are shown below.
Current assets:
Cash.........................................................................................
Accounts receivable.................................................................
Less: Allowance for bad debts.................................................
Net accounts receivable............................................................
Beginning inventory.................................................................
Purchases..................................................................................
Available inventory..................................................................
Less: Cost of goods sold...........................................................
Ending inventory......................................................................
Total current assets..............................................................
Current liabilities:
Accounts payable......................................................................
Current portion of bonds payable.............................................
Interest payable.........................................................................
Total current liabilities.........................................................
Current ratio = $125,200 / $71,300 = 1.76
Quick ratio = ($23,100 + $32,800) / $71,300 = .78

$ 23,100
$ 34,650

1,850
32,800
46,200

184,800
231,000

161,700
69,300
$125,200
$38,600
7,700

25,000
$ 71,300

The above ratios measure GRWs ability to meet short-term obligations. The current ratio indicates that
GRW has 76 percent more cash and relatively liquid assets that are expected to be converted to cash in
the short run than it has short-run obligations requiring cash for their satisfaction. This ratio does not
necessarily mean the amount of current assets is adequate, however. For example, the accounts payable
and interest payable could be obligations due within the next few days, and it may not be possible to
liquidate accounts receivable and inventories that quickly.
b.

Cash Expenses:
Cost of goods sold....................................................................
Other expenses.........................................................................
Total cash expenses...............................................................................

$161,700

69,300
$231,000

Days cash = $23,100 / ($231,000 / 365) = 36.5 days.

This ratio measures how many days of normal operating expenses can be paid without adding to the cash
balance. The above ratio indicates that GRW Company has an apparent stockpile of cash. This means
GRW is either planning unusual expenditures during the next period, or is not properly managing cash.
Cash does not generate a return. There is a trade-off between instant liquidity and the return on
marketable securities.
Some students may argue that purchases, rather than cost of goods sold, should be used in the calculation.
This would not reflect a true steady state of operations, since it happened that GRW built up its
inventory by $23,100 during the year. The argument for basing the ratio on purchases would be stronger
if the student explicitly assumes a long-term buildup of inventory each year (to support increasing sales);

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but then, for consistency, some other cash expenses should probably be increased, too, thus resulting in
approximately the same 36.5-day figure. In any event, there is no implication that such ratio calculations
are interpretable with great precision. They are most meaningful if calculated for the same company over
a period of years.
c. Days receivables = Net receivables / (Credit sales / 365) = $32,800 / ($323,400 x .77 / 365).

= 48 days.
This ratio measures the average collection period of receivables. Although some analysts use total sales
(often because the portion of credit sales is not disclosed), the above calculation is correct. The result
suggests that GRWs customers are stretching the payment period.

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