CHAPTER 6

6-1 If eventual payment on the contract is reasonably certain, $10

million should be recognized as revenue each year. For a
government contract, this is generally the preferred method. In
contrast, if there is concern about realization of the payment
from a non-governmental customer, all $50 million might be
deferred and not recognized until the time of receipt of
payments as the contract is completed.

6-2 Some accounts will never be collected. Therefore, the average

amount collected on credit sales is less than the total amount
of the sales. For cash sales, the total amount of the sale is
collected.

6-3 The seller of an item recognizes a sales return (allowance),

which is deducted from sales revenue. The buyer of an item
receives a purchase return (allowance), which is deducted from
the amount spent for an item.

6-4 Trade discounts are traditional ways of determining net sales

prices. The method begins with a gross, or list, price and
applies specified reductions thereto. Trade discounts often
reward high volume customers by giving them lower unit
costs. Cash discounts are relatively small reductions of selling
prices that are intended to spur prompt payment.

6-5 Trade discounts are used to arrive at invoice prices, which are
then routinely recorded as purchases and sales occur.
Reports to shareholders do not ordinarily show trade
discounts, but reports to managers often do if the information
is deemed helpful.

232
6-6 Retailers do pay their banks a small percentage of revenue
when a credit card is used. However, offering such a credit
service can increase sales. If retailers offer their own credit
they bear the cost of running a credit department and also
forfeit some revenue through bad debts. The fees paid to Visa
or MasterCard by a merchant may be much less than the costs
of running a dedicated “store” credit card.

6-7 Cash equivalents are highly liquid short-term investments that

can be converted easily into cash with little delay. Money
market funds and treasury bills are examples.

6-8 True. If a compensating balance is required, a borrower does

not have use of the entire amount borrowed. For example,
borrowing $1,000 at 12% interest with a required 10%
compensating balance means that only $900 can be withdrawn
for use. Interest of $120 is paid for $900 of usable funds, an
effective rate of 120 ÷ 900 = 13.3%.

6-9 Although the cash balance may be small, the cash flow for
most companies is large. Good cash management may
indeed be very important to the generation of profits. In
addition, cash is especially attractive to thieves and
embezzlers. Safeguards are generally worth more than
companies spend to develop and implement them.
6-10 Good internal control requires that transactions be rung into
the register so that register totals can be compared to cash
levels. These practices engage the customers as "auditors" to
assure the transaction is recorded.

Chapter 6 Accounting for Sales 233

6-11 Often book and bank balances disagree, generally due to
differences in timing. For example, deposits may have been
recorded in the books but still be in transit to the bank. Or
checks may have been written and deducted on the books but
not yet received and paid by the bank. Or the bank may have
charged a service charge that is not yet recorded on the
books.
6-12 Internal control procedures used to safeguard cash include:
• Reconcile bank statements regularly on a timely basis.
• Different individuals should receive and disburse cash.
• Individuals handling cash should not have access to
accounting records.
• Cash receipts should be immediately recorded and
deposited.
• Disbursements should be on serially numbered checks.
• Disbursements should be authorized by someone other
than the check writer.

6-13 No. Although internal controls do guard against dishonest

actions, they also help ensure accurate accounting records.
Good controls can help uncover honest accounting errors as
well as dishonest actions.
6-14 If the gross margin increase resulting from additional sales
exceeds the costs of offering credit, the company is well
advised to offer credit. For a company to manage credit
internally, costs include the cost of creating and operating a
credit department, training sales staff to sell on credit, and
losses due to non-payment. For a company to accept bank
credit cards, costs include training, plus a fee paid per
transaction, occasional losses due to clerical error, and
possibly some special equipment.

234
6-15 Often the fee charged by credit card companies drops as
volume increases, so dealing with one card on higher volume
is less expensive. Also, some cards charge higher fees to
stores than others. American Express is an expensive card.
But American Express also has a higher income level
cardholding population and more corporate accounts. Higher
priced establishments or restaurants catering to business
patrons are more likely to accept American Express. Finally,
coverage and acceptance vary from nation to nation.

6-16 The allowance method uses estimates of bad debt expenses

during the period of sale. In contrast, the specific write-off
method does not recognize bad debt expense until actual
write-offs occur.

6-17 Correct entry:

Allowance for uncollectible accounts 14,321
Accounts receivable 14,321
Correcting entry:
Allowance for uncollectible accounts 14,321
Bad debts expense 14,321
6-18 The Allowance for Uncollectible Accounts has no subsidiary
ledger because the individual uncollectible accounts are
unknown. It is a reduction of the total amount receivable.
6-19 Three popular ways to estimate bad debt expense are (a)
percentage of sales, (b) percentage of ending accounts
receivable, and (c) aging of accounts.
6-20 Aging is an analysis of the elements of individual accounts
receivable according to the time elapsed after the dates of
billing.

Chapter 6 Accounting for Sales 235

6-21 A write-off should be reversed so that the customer can more
likely restore his otherwise poor credit rating with the company.
Without a reversal of the write-off, the customer's individual
subsidiary account receivable will not show the ultimate
payment.
6-22 The average collection period is calculated by dividing 365 by
the accounts receivable turnover.
6-23 The percentage of sales approach focuses on historical
experience to estimate bad debt expense; the balance in the
allowance account is a byproduct. The aging of accounts
receivable approach uses historical experience to estimate the
proper balance in the allowance account and bad debt
expense is a byproduct.
6-24 Administrative controls emphasize management planning and
evaluation. Accounting controls comprise the methods and
procedures that are largely concerned with the authorization of
transactions, the safeguarding of assets, and the accuracy of
the financial records.
6-25 Outside auditors may advise and check, but management has
primary responsibility for the design and operation of an
organization's internal control system.
6-26 The primary responsibility of the audit committee is fiscal
vigilance, including the overseeing of accounting controls and
policies.

236
6-27 Checklist for judging the effectiveness of internal control:

1. Reliable personnel with clear 6 Physical safeguards.

responsibilities.
2. Separation of duties. 7. Bonding, vacations, and rotation
of duties.
3. Proper authorization. 8. Independent check.
4. Adequate documents. 9. Cost-benefit analysis.
5. Proper procedures.

6-28 Incompetent or dishonest individuals can undermine a system,

no matter how strong its other characteristics.

6-29 No one should have complete control of both the physical and
record keeping aspects of a transaction.

6-30 The revenue for the special promotion should have been
spread over four months, not two. This calls the profit
calculation into question. While there may be collection
concerns for a free newspaper, the $70,000 of A/R does not
seem excessive if measured at the end of the second month
of business. It is quite reasonable for there to be something
like a month of revenue in receivables, depending on standard
payment terms.

6-31 A classified income statement can provide a measure of gross

profit and could be constructed to give results separately for
various product lines. In general, if we drop prices, sales will
increase and the gross profit percentage will fall. Total profits
may rise or fall depending on the relationship between the
increase in sales and the decrease in the gross margin
percentage. Preparing a classified income statement with
separate revenue and gross profit for different product lines
helps us learn whether individual managers are making good
decisions.

Chapter 6 Accounting for Sales 237

6-32 Delivery to the customer means the selling company has
completed its responsibility, but the customer must still pay.
For accounting purposes, we recognize revenue if ultimate
payment is likely, and we use the allowance account to reduce
accounts receivable for our expectations about the dollar
amounts that will ultimately prove to be uncollectible bad debts.

6-33 Both cash-collection and accrual-basis sales levels are

relevant in evaluating our sales staff. We do not want higher
sales unless they can be collected. We generally integrate the
concepts by focusing on growth in accrual-basis sales while
assuring that accounts receivable balances grow only
proportionally (not faster). This is equivalent to saying that the
frequency of bad debt expense or uncollectibles per dollar of
sales remains constant.

6-34 (16-20 min.)

1. (a) There would be no entry on July 17. The criteria for

revenue recognition were not yet met.

(b) 8/12 – Delivery

Accounts receivable 40,000
Sales revenue 40,000
To record sales of 1,000
books @ $40 each

238
6-34 (continued)

(c) 9/10 – Payment

The cash discount was
2% x $40,000 = $800.
Cash 39,200
Cash discount on sales 800
Accounts receivable 40,000
To record cash payments received

(d) 12/18 – Returns

This entry differs slightly from the one in the text because
payment has already been made. Instead of decreasing
accounts receivable for the merchandise returned, a cash
refund equal to the amount actually paid for the books,
$2,400 – (2% x $2,400) = $2,352, is made.

Sales returns and allowances 2,352

Cash 2,352
To record the cash refund on the
return of 60 books @ $40 each, net
of discounts

2. Gross sales $40,000

Deduct:
Sales returns and allowances $2,352
Cash discount on sales 800 3,152
Net sales $36,848

Chapter 6 Accounting for Sales 239

6-35 (10 min.)

1. If there is a significant chance that payment on the contract will

not be received, the realization test has not been met.
Recognition of revenue should be delayed until there is a high
probability of receiving the payment. This may mean
recognizing all $11 million of revenue at completion of the
contract, and recognizing all of the expenses on the contract at
the same time.

It is reasonable to ask whether the contract should be

accepted in this instance. It is reasonable to suggest that the
contract be altered to require progress payments as
milestones are reached.

2. Revenue should be recognized as it is earned:

20X0 3/10 x $11 million = $3.3 million

20X1 3/10 x $11 million = $3.3 million
20X2 4/10 x $11 million = $4.4 million
$11.0

240
6-36 (10 min.) Amounts are in British pounds (£).

1. Accounts Receivable, or Trade Accounts Receivable

2. Trade debtors 100,000

Turnover 100,000
To record sales of £100,000
of chocolates to Harrod’s.

6-37 (10-15 min.)

1. Gemini is not able to use $10,000 of the $100,000 loan because

it must be kept in its account at First Bank. Therefore, the loan
generates only $90,000 of usable cash.

2. The interest is 9% of $100,000, or $9,000 annually. Because

usable funds are only $90,000, the real interest rate is $9,000 ÷
$90,000 = 10%, not 9%.

3. "Of the $45,000 cash balance, $10,000 must be maintained in a

checking account at First Bank as a compensating balance for
a $100,000 loan."

Chapter 6 Accounting for Sales 241

6-38 (10-15 min.)
A = L + SE

 Increase   Increase 
Sales on credit +900,000  Accounts  = +900,000
 Re ceivable   Sales 
 

 Increase 
 Decrease   
Returns and  Accounts  – 40,000  Sales
Returns and 
– 40,000 =
Allowances  Receivable   Allowances 
 
 

 Increase 
 Decrease   Cash 
Cash discounts – 30,000  Accounts  = – 30,000  Discounts 
 Receivable   on Sales 
   

The revenue section of the income statement would be:

Gross sales $900,000

Deduct:
Sales returns and allowances $40,000
Cash discounts on sales 30,000 70,000
Net sales $830,000

Journal entries:

Accounts receivable 900,000

Sales 900,000

Sales returns and allowances 40,000

Accounts receivable 40,000

Cash 830,000
Cash discounts on sales 30,000
Accounts receivable 860,000

242
6-39 (10-15 min.)

1. Gross sales $700,000

Deduct:
Sales returns and allowances $40,000
Cash discounts on sales 20,000 60,000
Net sales $640,000

2. (a) Accounts receivable 700,000

Sales revenue 700,000

(b) Sales returns and allowances 40,000

Accounts receivable 40,000
(c) Cash 640,000
Cash discounts on sales 20,000
Accounts receivable 660,000

Chapter 6 Accounting for Sales 243

6-40 (6-10 min.)

A = L + SE

1. Sell on terms +300,000  Accounts

Increase 
 = +300,000  Increase 
of 2 / 10, N / 30  Receivable   Sales 
 

 Increase 
2. Collection +294,000  Cash 
 
=
 Increase 
 Decrease   
–300,000  Accounts  – 6,000  Cash 
 Receivable  Discounts
 on Sales 
 
 

Journal Entries:
Accounts receivable 300,000
Sales 300,000

Cash 294,000
Cash discounts on sales 6,000
Accounts receivable 300,000

244
6-41 (10 min.)
Except for the entry of July 12, these entries are
straightforward.
June 9 Accounts receivable 30,000
Sales 30,000
June 11 Accounts receivable 10,000
Sales 10,000
June 18 Cash 29,400
Cash discounts on sales 600
Accounts receivable 30,000
June 26 Sales returns and allowances 1,000
Accounts receivable 1,000
July 10 Cash 9,000
Accounts receivable 9,000
No cash discount was available
but the $1,000 return on
June 26 reduced the amount
due
July 12 Sales returns and allowances 100
Cash 98
Cash discounts on sales 2
The amount actually paid on
June 18 was $98, not $100.
Accordingly, this entry adjusts
the cash discount account.
Alternatively:
Sales returns and allowances 98
Cash 98

Chapter 6 Accounting for Sales 245

6-42 (10-15 min.)
1. n/30 indicates that the gross invoice amount, which is the list
price net of trade discounts (n means net of trade discounts,
not net of cash discounts), should be received by the vendor
by 30 days after the date of the invoice.
EOM means the gross invoice amount should be received by
the end of the month of the invoice.
15, EOM means the gross amount should be received by the
fifteenth day after the end of the month of the invoice.
1/10, n/30 means that a discount of 1 percent of the gross
amount may be deducted if the remainder is received by the
vendor by the tenth day after the date of the invoice.
Otherwise, the gross amount should be received by the vendor
by 30 days after the date of the invoice.
2/10, n/30 means the same as the preceding terms, except that
the cash discount is 2%.
2. You should borrow and use the cash to take advantage of the
discounts offered by both vendors. The equivalent annual
interest rates for "borrowing" from the vendors are 18% for
John’s Fisheries and 36% for Garcia, as compared with the
bank rate of 16%.
When the discount applies for ten days and the invoice price is
due anyway by the 30th day, failure to take the discount
provides only a 20 day delay or borrowing period.
1/10, n/30 is 1% for 20 days, or 18% for 360 days (that is, 1% x
18 periods of 20 days each).
2/10, n/30 is 2% for 20 days, or 36% for 360 days (that is, 2% x
18 periods of 20 days each).

246
6-43 (16-20 min.)

1. A = L + SE

Sale using bank card + 192  Increase  =

 + 200 Increase 

 Cash   Sales 

 Increase 
 Cash 
= – 8 Discounts 
 for 
 Bank Card 
 

Accountants disagree as to where the discount belongs on the

income statement. In strict theory, the discount should appear
as an immediate offset to gross revenue (like other cash
discounts). However, bad debts, collection expenses, and
administrative expenses now appear as operating expenses.
Inasmuch as most managers regard such expenses as being
replaced by the amount of bankcard discounts, most
companies classify the discounts as operating expenses.

2. The past results are recast as follows:

Bank
Cash Card Total
Sales $400,000 $400,000 $800,000
Cash discounts for
bank cards @ 4% − 16,000 16,000
Net effect $400,000 $384,000 $784,000

Chapter 6 Accounting for Sales 247

6-43 (continued)

The credit costs are $16,000 rather than $15,000. This example
shows that diverting regular cash sales to bankcard sales is a
danger that a manager must ponder seriously when deciding
whether the entity should accept bankcards. If sales do not
increase, profit will fall by $16,000 – $15,000 = $1,000.

3. Total sales would be 1.1 x $800,000 = $880,000, and total cash

receipts would be $880,000 − (4% x $440,000) = $862,400.
Without the credit card, cash receipts were $800,000 − $15,000
= $785,000. Therefore, use of the cards generates an extra
$862,400 − $785,000 = $77,400 of cash receipts. So if
incremental cost-of-goods sold are less than $77,400, adopt
the card.

The revised results are recast as follows:

Bank
Cash Card Total
Sales $440,000 $440,000
$880,000
Cash discounts for
bank cards @ 4% − 17,600
17,600
Net effect $440,000 $422,400
$862,400

The credit costs increase by $17,600 – $15,000 = $2,600. Only

if the extra $80,000 of sales have a margin (that is, sales – added
costs) greater than $2,600 is the change worthwhile. If the added
cost for the extra sales is less than $80,000 – $2,600 = $77,400,
profits will increase if VISA is adopted.

248
6-44 (15 min.)

As much of the price reduction as possible should be assigned

to the discount. Since a trade-in does not lower sales tax, the initial
tax will be .07 x $20,000 = $1,400 for a total cash cost to Nagata of
$14,400. Alternatively, we could base the sales tax on the sales
price after a 15% discount. Shown below this reduces the tax to
$1,190 saving $210.

15% No
Discount Discount
Gross sales price $20,000 $20,000
Discount 3,000 –
Taxable sales price 17,000 20,000
Sales tax (7%) 1,190 1,400
Total 18,190 21,400
Less trade-in 4,000* 7,000
*
Total cash price $14,190 $14,400

* The trade-in “value” is the difference between the sales price

and the cash payment. When the dealer offers a “discount” the
amount of the discount reduces the sales price and thus reduces
the “value” assigned to the trade-in. Trade in values are $7,000 –
$3,000 and $7,000 – $0 respectively.

Mr. Nagata would pay $1,400 – $1,190 = $210 more sales tax if no
explicit discount is included in the deal. This is 7% of the discount.

Chapter 6 Accounting for Sales 249

6-45 (16-20 min.)

1. The allowance method is preferable because the revenue

earned in 20X8 is really $784,000 on the accrual basis, not
$800,000. The .02 x $800,000 = $16,000 of expected bad
debts should be matched to 20X8 revenue.

A = L+ SE
a. Specific Write-off Method

 Increase 
20X8 Sales + 800,000  Accounts  = + 800,000  Increase
Sales 

 Receivable   
 

 Decrease   Increase 
20X9 Write-off – 14,000  Accounts  = – 14,000  Bad Debts 
 Receivable   Expense 
   

b. Allowance Method

 Increase 
20X8 Sales + 800,000  Accounts  = + 800,000  Increase
Sales 

 Receivable   
 

 Increase   Increase 
 Allowance for 
20X8 Allowance– 16,000  Uncollecti ble  = – 16,000 Bad Debts 
 Accounts   Expense 
   

 Decrease 
 for 
20X9 Write-off + 14,000  Allowance
Uncollecti ble 
 Accounts 
 
=
 Decrease 
– 14,000  Accounts 
Receivable 
 

250
6-45 (continued)
2. a. 20X8 Accounts receivable 800,000
Sales 800,000
20X9 Bad debts expense 14,000
Accounts receivable 14,000
b. 20X8 Accounts receivable 800,000
Sales 800,000
20X8 Bad debts expense 16,000
Allowance for uncollectible
accounts 16,000
20X8 Allowance for uncollectible
accounts 14,000
Accounts receivable 14,000

Chapter 6 Accounting for Sales 251

6-46 (10 min.) Amounts in millions

1. The journal entry for the write-off would be:

Allowance for uncollectible accounts 8,000
Accounts receivable 8,000
The balance sheet total would be unchanged. The only
change would be a reduced allowance amount disclosed
in the footnotes of $671,000. Of course, the gross
amount of accounts receivable would also decrease by
$8,000 to $21,985,819.
2. No allowance account would be deducted from the gross
receivable, which was $21,993,819 + $679,000.
Accounts receivable 22,672,819
Though not required, it may be useful to point out that,
after the write-off, the January 2 balance sheet under the
specific write-off method would be reduced by $8,000.
Accounts receivable 22,664,819
The write-off reduces the balance sheet amount under the
specific write-off method, but it does not affect the net
balance sheet amount under the allowance method.

252
6-47 (10 min.)
Receivables from patients 2,500,000
Patient billings (or revenue) 2,500,000
Bad debt expense 375,000
Allowance for doubtful receivables 375,000
Allowance for doubtful receivables 360,000
Receivables from patients 360,000

This problem does not use the beginning balances. As a class

exercise you may wish to extend the problem. You can use the data
to calculate the 12/31/X2 allowance as $50,000 + $375,000 –
$360,000 = $65,000. The allowance balance has increased by
$15,000 during 20X2.

You could assume end of year receivables at $250,000 and

calculate cash collections as $200,000 + $2,500,000 – $360,000 –
$250,000 = $2,090,000. It is easy to forget the fact that gross
receivables are reduced by write-offs even though net receivables
are not. Students may find this concept challenging.

Chapter 6 Accounting for Sales 253

6-48 (15 min.)
1. Cash 400,000
Accounts receivable 600,000
Sales 1,000,000
To record sales
Cash 560,000
Accounts receivable 560,000
To record collections
Bad debt expense 12,000
Allowance for bad debts 12,000
To record bad debt expense
Allowance for bad debts 10,000
Accounts receivable 10,000
To record write-offs
2. December 31
20X8 20X7
Accounts receivable $120,000* $90,000
Allowance for bad debts 10,000** 8,000
Book value $110,000 $82,000
* $90,000 + $600,000 – $560,000 – 10,000
** $8,000 + $12,000 – $10,000
3. The central question is whether the current balance of
Allowance for Bad Debts is adequate. While receivables rose
by 33% from 90,000 to 120,000, the allowance changed by
about 25%. This relationship seems reasonable. Write-offs
were similar to the bad debt expense. Additional questions
could be asked to refine this decision. What is the collectibility
of the $120,000 gross balance of receivables? What is the
composition of the receivables? Were there many new
customers? How old are the balances in relation to the ages in
previous years?
254
6-49 (10 min.)

Allowance for uncollectible accounts 25,000

Accounts receivable 25,000

Accounts receivable 6,000

Allowance for uncollectible accounts 6,000

Cash 6,000
Accounts receivable 6,000

Note: Although the last two entries could be summarized in a

single entry debiting Cash for $6,000 and crediting the allowance
account, two entries would usually be made. The debit and credit to
Accounts Receivable would be posted also to the customer's
account, which would then contain useful information for possible
credit decisions in the future.

Chapter 6 Accounting for Sales 255

6-50 (10-15 min.)

1.

GENERAL LEDGER SUBSIDIARY LEDGER

Accounts Receivable Schumacher

Credit Collec- 720,00 20X4 5,000
0
sales tions
during
20X4 800,00
0
Bal. 80,000
12/31/X4
Cerruti

Allowance for Uncollectible Accounts 20X4 7,000 20X4 5,00

0
20X4 16,000 Bal. 2,000
12/31/X4

Others
Bad Debts Expense 20X4 788,00 20X4 715,000
0 *
20X4 16,000 Bal. 73,000
12/31/X
4
* Total collections of $720,000 less Cerruti's
$5,000.

Accounts Receivable, December 31,

20X4

Schumacher $ 5,000
Cerruti 2,000
Others 73,000
Total $80,000

256
2. Allowance for uncollectible accounts 5,000
Accounts receivable 5,000

Chapter 6 Accounting for Sales 257

6-50 (continued)

Stress that the 20X5 write-off does not change collectible A/R.

Pre Write-off Post-Write-off

Accounts receivable $80,000 $75,000
Allowance for uncollectible accounts 16,000 11,000
Net receivables $ 64,000 $64,000

Students could be informed that the total balances in the

subsidiary ledger are usually checked against the general ledger
balance at least once a month.

Students are usually familiar with several types of subsidiary

ledgers: the customer statements received from their university
bursar, their gas and electric company, and their bank cards and the
depositor statements received from their banks (which are really
subsidiary accounts to Deposits Payable).

6-51 (10 min.) Dollar amounts are in millions.

Vulcan’s accounts receivable turnover is:

$2,700÷ [1/2 x $334 + $343)] = 7.98

The average collection period is:

365 ÷ 7.98 = 45.74 days

258
6-52 (10 min.)
a. Internal audits should be routinely scheduled, they should
not be at the discretion of department managers. Internal
auditors should have access to top management and to
the audit committee of the board of directors, instead of
just presenting reports to the managers involved. Finally,
input from the internal auditors helps external auditors
assess internal controls. Without such information, the
external auditors may not be able to rely as much on
internal controls and the audit will be more costly because
of the need to use larger sample sizes.
The role of the internal audit staff should be redefined. It
should make regular reports to top management and to
the audit committee of the board. All parts of the
organization should be subject to internal audit on a
rotating basis. The internal auditors should be instructed
to provide whatever assistance possible to the external
auditors.
b. A new employee, who has yet to prove his reliability, has
been given a great deal of independent authority.
However, most important is the lack of appropriate
authorization for significant transactions. The policy of
general authorization is not explicit. An exact limit on the
size of loans Howell is authorized to approve should be
established. Further, the policy of specific authorization
for large loans is not being followed. It is important for the
president to enforce internal control procedures.

Chapter 6 Accounting for Sales 259

6-52 (continued)
This situation is similar to one that caused the ruin of the
largest bank in the Pacific Northwest. A very profitable
energy industry loan division was allowed to violate
internal controls. When the bottom fell out of oil prices,
extensive loan losses in the division far exceeded the
profits in the rest of the bank.
During the 1990s many cases emerged where managers
were allowed to continue to undertake very large
transactions when they were profitable. As interest rates
began to rise, highly leveraged positions or risky
derivative positions created huge losses. Examples
include: the Orange County bankruptcy in California and
huge losses on derivatives by Procter & Gamble and
Gibson Greeting Cards. The two latter cases led to
lawsuits against Banker's Trust, which created the
derivative contracts.
c. Two weaknesses combine to provide a serious lack of
internal control. First, duties are not appropriately
separated. Grant could place a fictitious order, fill out
receiving documents as if merchandise were received,
and authorize payment into his own (or a confederate's)
account. However, sometimes the benefits of
specialization are great. Grant may have special expertise
in watches and know more about the suppliers than
others in the company. One way to aid internal control
without complete separation of duties is to provide proper
supervision. Blumberg apparently realized this when
setting up its internal control procedures. However, some
manager has overridden the procedures by not hiring a
purchasing supervisor. This may be a case where an
emphasis on short-term operating results has caused a
manager to sacrifice long-run controls.
260
6-53 10-20 min.)

Financial Officer A B C D
1. P
2. P
3. P
4. P
5. P
6. P
7. P P
8. P P
9. P
10. P

Other combinations would, of course, be appropriate. In fact,

all of the assignments to employees A, B, C, and D are arbitrary – but
the patterns of linking tasks to a particular employee capture the
issues of what tasks should go together.

Note that the first two routines are closely associated and can
therefore be performed by a single employee. Routines 7 and 8
should be handled jointly by at least two employees. They should
sign the daily reports of money received. It is especially important
that employees having access to cash should not have access also
to accounting documents and records. A smaller organization
could not spread the duties as widely as in this case.

Chapter 6 Accounting for Sales 261

6-54 (10-15 min.)
1. Bank Reconciliation
July 31
Balance per books $47,000
Deduct:
Bank service charge $ 120
NSF checks 11,000 11,120
Corrected balance per books $35,880

Balance per bank $32,880

Add: Deposit in transit 9,000
Subtotal $41,880
Deduct: Outstanding checks 6,000
Corrected balance per bank $35,880

2. Patient receivables 11,000

Bank service charge expense 120
Cash in bank 11,120
To record reductions in cash per July 31
bank reconciliation.

262
6-55 (20-30 min.) Amounts are in thousands.
1. The reserve for loan/lease losses is the estimated amount of
outstanding loans and leases that will never be collected. It is
similar to an allowance for uncollectible accounts. The
provision charged to operations is the amount recorded as
expense and added to the reserve (allowance) account based
on loans made and an up-to-date assessment of the
probability of default of existing loans. The provision is the
amount included in the income statement. Loan/leases
charged off are amounts written off as specific loans and
leases are recognized as uncollectible.
2.
Reserve for loan/lease losses 1,721
Loan/lease receivables
(specific customers) 1,721

Loans/lease receivables (specific customers) 484

Reserve for loan/lease losses 484

Cash 484
Loan/lease receivables 484

Provision charged to operations 2,235

Reserve for loan/lease losses 2,235

3. The provision would need to be $1,704 smaller ($11,704 −

$10,000), resulting in a reduction in the provision of $1,704
(assuming that the $2,235 has already been charged):
Reserve for loan/lease losses 1,704
Provision charged to operations 1,704

Chapter 6 Accounting for Sales 263

 This results in a net provision charged to operations of $531
for 2002.

264
6-55 (continued)
4. Because the provision expense would be $1,704 less, the profit
would be $1,704 more, or $34,340 + $1,704 = $36,044. Students
may ask why we chose to ignore income taxes. We do not
want to introduce details about the differences between
accounting for bad debts for financial reporting and for taxes at
this stage of the course.

6-56 (16-20 min.)

1-30 31-60 61-90 Over

Name Total days days days 90 days
Ng $ 20,000 $15,000 $5,000
Michael's 8,000 $ 2,000 $ 6,000
Shoven 12,000 4,800 7,200
Bonner 20,000 20,000
Hjortshoj 4,000 3,000 1,000
Other accounts 80,000 40,000 24,000 12,000 4,000
Totals $144,000 $65,000 $34,800 $35,200 $9,000
Bad debt percentages .2% .8% 10% 80%
Bad debt allowance
to be provided $ 11,128 $ 130 $ 278 $ 3,520 $7,200

The ending balance in the allowance account should be

$11,128, which happens to be 7.7% of the total balance in accounts
receivable. In all likelihood, this is an alarming figure. The Ng and
Shoven accounts deserve concentrated attention.

Chapter 6 Accounting for Sales 265

6-57 (16-20 min.)
Accounts Bad Debts
Receivable Written Off During
at End of Year Subsequent
Years
20X1 $ 210,000 $ 8,000
20X2 170,000 6,000
20X3 195,000 7,000
20X4 230,000 9,000
20X5 275,000 13,000
20X6 240,000 9,800
Six-year total $1,320,000 $52,800
Average (divide by 6) $ 220,000 $ 8,800

Note that the bad debts written off should be only those related
to year-end receivable balances. Thus, the $8,000 of write-offs
associated with 20X1 occurred in 20X2. Other write-offs of 20X2
sales occurring during 20X2 are irrelevant to the calculation of the
historical relation.
The 20X7 addition to the Allowance for Uncollectible Accounts
would be computed as follows:
1. Determine the average net loss as a percentage of the average
ending balance of Accounts Receivable: Average net bad
debt losses would be $8,800. Divide $8,800 by $220,000 to
obtain 4%.
Note the same result is obtained by using the six-year totals:
$52,800 ÷ $1,320,000.
2. Apply the percentage to the ending Accounts Receivable
balance to determine the balance that should be in the
Allowance account at the end of the year: 4.0% x $250,000
receivables at the end of 20X7 is $10,000.

266
6-57 (continued)
3. Prepare an adjusting entry to bring the Allowance to the
appropriate amount. Then the bad debt expense for 20X7 is
$10,000 – $600, or $9,400. The journal entry would be:
Bad debt expense 9,400
Allowance for uncollectible accounts 9,400
To bring the Allowance to the level
justified by bad debt experience during
the past six years

6-58 (20 min.)

Note that the data provide four years of experience to use in

calculating the proper percentage. Sales and ending accounts
receivable from 20X1 through 20X4 are matched with write-offs for
20X2 through 20X5.

1. Bad debt write-offs as a percentage of sales provides the

amount to be added to the allowance account. Bad debt write-
offs as a percentage of sales are:

($12,500 + $14,000 + $16,500 + $17,600)/($680,000 + $750,000 +

$750,000 + $850,000) = $60,600/$3,030,000 = 2%

Bad debt expense, 20X5 = 2% x $840,000 = $16,800

Ending balance, allowance for uncollectible accounts

= Beginning balance + bad debt expense – bad debts written
off
= $15,900 + $16,800 – $17,600
= $15,100

Chapter 6 Accounting for Sales 267

6-58 (continued)

Use of T-accounts might help:

Allowance for Uncollectible Accounts

Written off 17,600 Beg. Bal. 15,900
Expense 16,800
End. Bal. 15,100

2. The percentage of ending accounts receivable method

provides the desired balance in the allowance account. The
allowance account balance, as a percentage of ending
accounts receivable, should be calculated as follows:

($12,500 + $14,000 + $16,500 + $17,600)/($90,000 + $97,000 +

$103,000 + $114,000) = $60,600/$404,000 = 15%

Ending balance, allowance for uncollectible accounts, 20X5 =

15% x $110,000 = $16,500

Beginning + bad debt – bad debt = Ending balance

balance expense write offs

$15,900 + bad debt – $17,600 = $16,500

expense

Bad debt expense = $16,500 + $17,600 – $15,900 = $18,200

The critical issue is to realize the allowance balance before the

bad debt expense entry is the beginning balance of $15,900
less the write-offs of $17,600; a debit balance of $1,700. The
expense must bring this balance to zero and then create the
required $16,500 credit balance

268
6-58 (continued)

Note: If both problems 6-57 and 6-58 are assigned, you should
realize that the tables are constructed differently. Both are
explicit about timing, but the structure of the solutions make
different assumptions. In 6-57 the write-offs are related to the
A/R in the same row. In 6-58 the write-offs are listed for the year
in which they were written off, not in the year in which the sale
arose.

Using the T-account for the percentage of ending accounts

receivable method:

Allowance for Uncollectible Accounts

Written off 17,600 Beg. Bal. 15,900
Expense 18,200
End. Bal. 16,500

6-59 (30 min.)

1. The bad debt expense is .014 x $6,000,000 = $84,000.
Accounts receivable $470,000
Less: Allowance for bad debts
(84,000 – 1,200) 82,800
Net accounts receivable $387,200
Journal entry:
Bad debt expense 84,000
Allowance for bad debts 84,000
To recognize bad debt expenses for 20X7

Chapter 6 Accounting for Sales 269

6-59 (continued)

2. The ending balance in the allowance for bad debts account

should be .18 x $470,000 = $84,600.
Accounts receivable $470,000
Less: Allowance for bad debts 84,600
Net accounts receivable $385,400
Journal entry:
Bad debt expense 85,800
Allowance for bad debts 85,800
To recognize bad debt expenses for 20X7
The entry of $85,800 is to create a balance of $84,600. It must
also offset the existing $1,200 debit balance.
3. The percentage of ending accounts receivable is usually more
accurate. It focuses specifically on accounts that are still
outstanding at the end of the year. (The aging method would
go a step further by looking at the length of time each ending
account receivable has been outstanding.)
It appears that the collection experience on Teton’s sales early
in 20X7 has been slightly worse than usual. The balance in the
allowance account based on ending accounts receivable is
more than that based on a percentage of sales.

270
6-60 (6-10 min.)

This problem illustrates the use of financial ratios.

365
Days to collect A/R =
Accounts Receivable Turnover

AverageAccountsReceivable
= x 365
Credit Sales

1/2 ($185,000 + $190,000)

For 20X7 = x 365
.80($2,500,000)

$187,500
= x 365 = 34.2 days
$2,000,000

1/2 ($190,000 + $175,000)

For 20X8 = x 365
.80($2,000 ,000)

$182,500
= x 365 = 41.6 days
$1,600,000

The increase in the average collection period was 41.6 − 34.2, or

7.4 days, a significant rise. An increase is sometimes attributed to a
deliberate loosening of credit to encourage sales. However, sales
dropped 20% in this case while receivables dropped only 8%. The
management and the auditors should be especially careful in
investigating the collectibility of the $175,000 of receivables.

Chapter 6 Accounting for Sales 271

6-61 (10-15 min.)

1. Cash 588.00
Cash discounts for bank cards 12.00
Sales 600.00

2. a. Receivable from cardholder's bank 591.00

Deposits 588.00
Revenue from processing bank cards 3.00

b. Cash 591.00
Receivable from cardholder's bank 591.00

3. Receivable from cardholder 600.00

Cash 591.00
Revenue from processing bank cards 9.00

4. The bulk of the revenue comes from interest earned from

cardholders who elect to defer their payments, not from the
processing fees illustrated in this problem. Banks earn more
than $7 a month in interest payments for an average
cardholder who uses the card's revolving-charge privileges.
The interest rates charged on continuing balances (often 15 –
19%) far exceed rates banks pay on deposits.

$600 $591.00 $588.00

Customer → Card Issuing → Merchant’s → Merchant
Bank Bank

272
6-62 (16-20 min.) Amounts are in thousands.
1. The allowance for uncollectible accounts as a percentage of
ending receivables:
Year 1 Year 2
Federal programs 2,793/30,905 = 9.0% 2,378/33,109 = 7.2%
University funds 337/4,748 = 7.1% 271/4,999 = 5.4%
The university apparently believes that loans under the federal
program are less likely to be repaid than are loans with
university funds because the allowance is a larger percentage
of the outstanding loans. The quality of both types of loans is
deemed to be better at the end of year 2 than at the end of year
1.
2. In year two, university fund loan balances would rise from 4,999
to 5,199. Assuming their quality was equivalent to existing
loans, a reserve of 5.4% would be appropriate, so the reserve
balance would rise by .054 x $200,000 = $10,800 to $281,800.
This assumes that the default risk on new loans is the same as
that on existing loans.
Note that tabulated values were in thousands.

Chapter 6 Accounting for Sales 273

6-63 (15 min.)
1. The $60,829,000 relates to medical industry practice. Many
"third party" payers reimburse hospitals at rates different from
(lower than) the billing rate.
As many students will know and many will not know, medical
institutions are usually heavily dependent on being paid by
third parties such as government agencies and insurance
companies. The contractual allowances are offsets to revenue
which are related to adjustments of amounts billed.
An actual EquiMed footnote read:
Net revenues are recorded at established rates reduced by
allowances for contractual adjustments. Contractual
adjustments arise due to the difference between the
Company’s established rates for services and the
amounts allowed for such services by government
sponsored healthcare programs and by others.

2. Receivables (classified by type) 159,944,000

Operating revenues 159,944,000

Provisions for contractual

allowances 60,829,000
Allowance for contractual
adjustments 60,829,000

Note: EquiMed is not doing well. The shares are trading for less
than 1¢ in late 2004 and the last SEC filings were in 1998.
Those last filings basically related to why 1997-year end
results could not be calculated.

274
6-64 (16-25 min.)

1. Amounts are in millions.

2002
(a) Customer receivables 1,670.3 + 66.4 = $1,736.7
(b) Allowance 66.4
Ratio of (b) to (a) 3.8%
Among the possible reasons for a worsening in the ratio from
1995 to 1998 are the following: a larger percentage of ending
accounts receivable had been outstanding for a long time;
default on debts had become more common; and credit was
granted to more marginal customers.
In 2002 the ratio is significantly improved and better than in
1995. Possible explanations include a reversal of the proposed
negative features during the prior 3 years.
2. The journal entry would be:
Allowance for doubtful items 100,000
Accounts receivable 100,000

Chapter 6 Accounting for Sales 275

6-65 (16-20 min.) Amounts are in millions of dollars.

1. a. A = L + SE
 Increase   Increase
 
2003 Allowance –33  Allowance  = –33  Bad 
for Doubtful
 Accounts   Debts 
   Expense

 Decrease 
2003 Write-off +25.5  for
Allowance  =
 Doubtful
 Accounts 

 Decrease 
 
–25.5  Accounts 
Receivable 
 

b. Bad debts expense 33

Allowance for doubtful accounts 33
Allowance for doubtful accounts 25.5
Accounts receivable 25.5

2. 87.9 – 33 + 25.5 = 80.4

3. a. A = L + SE
 Decrease   Increase
 
2003 Write-off – 25.5  Accounts  = – 25.5  Bad 
 Receivable   Debts 
   Expense

b. Bad debts expense 25.5

Accounts receivable 25.5

4. No allowance would be present. The net receivables would be

higher by $87.9. The new balance would be $2,101.1 + $87.9 =
$2,189.0.
276
6-66 (16-20 min.) (Amounts in millions)

1. a. Write-offs = Beginning Balance + Bad Debt Expense – Ending

Balance
= 413 + 128 – 376
= $165
The T-account entries are:

Allowance for Doubtful Accounts

Write-offs 165 Beg. Bal. 413
Expense 128
End. Bal. 376

b. A = L + SE

 Increase   Increase 
 Allowance   
2003 Allowance –128  for Doubtful = –128  Bad 
Debts
 Accounts   Expense
 
 

 Decrease 
 
2003 Write-off +165  Allowance 
 for Doubtful 
 
 Accounts 
=
 Decrease 
 
–165  Trade 
 Receivables 
 

c. Bad debts expense 128

Allowance for doubtful
accounts 128

Allowance for doubtful accounts 165

Trade receivables 165
Chapter 6 Accounting for Sales 277
6-67 (20-25 min.) Amounts are in millions of dollars.

1. Bad debt expense 3.0

Allowance for credit losses 3.0
To record bad debt expense
2. Allowance for credit losses 2.4
Finance receivables 2.4
To record net write-offs

Alternatively, this transaction could be accomplished in two steps:

Allowance for credit losses 2.9

Finance receivables 2.9
Finance receivables .5
Allowance for credit losses .5

3. Allowance for credit losses .2

Finance receivables .2
To record other adjustments to allowance for
doubtful accounts.

Note: This problem provides a springboard for discussion of

the richness of detailed disclosure in the 10-K. It shows explicit
links between end-of-year balances and activity during the
year.

278
6-68 (15 min.)

1. Normally accounts receivable and sales should grow at

approximately the same pace. Exceptions may occur when a
company changes its credit or collection policies. More liberal
credit policies or more lenient collection policies would cause
accounts receivable to grow faster than sales, and vice versa.

2. One action that would make sales grow faster than accounts
receivable is recording bogus sales. There would be no
customer from whom to collect a receivable for the sale.
Therefore, sales would be recorded without a related receivable
and either expenses or assets would be misstated.

If sales are recorded well before a bill is sent to a customer,

accounts receivable would grow faster than sales. Customers
would continue to pay their bills 30 days or so after receiving
them, but the receivables would be on the books much longer
because the company would record them well before the
customer received the bill.

Also, expanding sales and accounts receivable by the same

amount – e.g. recording bogus sales with receivables that will
never be collected – would make the accounts receivable
increase by a larger percentage than sales.

3. Comptronix had a large increase in sales with little increase in

accounts receivable. Therefore, one might suspect that it was
recording bogus sales. This is not certain; there are possible
legitimate reasons for the difference between the increase in
sales and accounts receivable. But a good analyst would see
the “red flag” raised by this and would look for explanations,
including the explanation of bogus sales.

Chapter 6 Accounting for Sales 279

6-68 (continued)

Postscript: Comptronix admitted that bogus sales had been

reported. Yet, the company had enough strengths to survive.
Under new management, the company grew until 1993. The
financial statements for 1990 and 1991 were revised: sales in 1990
were actually $63.4 million instead of $70.2 million and in 1991 sales
were $88.8 million instead of $102.0 million. Sales in 1992 and 1993
were $139.1 million and $184.1 million, respectively. A footnote to
the financial statements stated that 1990 and 1991 statements were
“restated to reflect corrections of improper accounting and financial
reporting practices that occurred since 1989.” After 1993, fortunes
reversed. By 1995 sales were only $92.2 million, and in 1996 the
company declared bankruptcy.

6-69 (20-30 min.)

(a) Board of Audit 1245 Independent
Directors Committee 678 Auditors

6 8 3 4
Finance 3 Internal
Vice President Auditing

Note that solid lines are used to indicate direct responsibility

between the audit committee and the internal and external
auditors, in order to reflect the relationships required by the
court decision. Thus, item 3 appears on a dashed line.

b. Reliable personnel with clear responsibilities, separation

of duties, and independent check.

280
6-70 (20-30 min.)

1. Customers should be alerted to such thefts by the absence of

appropriate credits on their monthly statements received from
Braxton Company. However, the president's assistant, who
processes all outgoing mail, could conceal the theft by
destroying the monthly statements prepared by the
bookkeeper and substituting false statements to reflect
appropriate credits for the customers' remittances that had
been stolen. Precautions: The bookkeeper should send the
monthly statements directly to the president for mailing.
Regular audits should be made by independent accountants
who would follow the standard audit procedure of obtaining
confirmations of customers' accounts by direct
correspondence with the customers.

2. The bank balance would not reconcile with the balance of cash
in bank shown on the books of Braxton Company. However,
the president's assistant, who processes all incoming mail,
could alter the bank statements to falsely reflect deposits of the
stolen checks. Although the president might detect such
alterations by comparing deposit entries on the altered bank
statements with his copies of bank deposit tickets, the
president should take the precaution of personally obtaining
the bank statement each month from the bank. In addition,
regular audits should be made by independent accountants,
who would follow the standard audit procedure of obtaining
confirmation of bank balances directly from banks.

Chapter 6 Accounting for Sales 281

6-71 (6-10 min.)

Many problems could be considered. Here are some. Go into

the background and references of all personnel hired, especially
drivers (who handle cash) and those in the office who handle cash.
Establish control records daily over the amount of cash to be picked
up, and reconcile this daily when drivers check back to turn in the
cash collected. Assign duties and responsibilities at the office as
much as possible, to pinpoint responsibility, maintain quality of work,
and get work done on time. It is probably best to control all
purchasing of supplies, cash payments, and payroll yourself.
Review the payroll time records carefully, possibly daily. Assign one
person the duty of computing the amount due on each film order;
review his or her work periodically to make sure few if any errors
occur. Deposit each day's receipts that day or the next day, at the
latest. Make all payments by pre-numbered check. Keep unused
checks under lock and key. Establish work hours and see that they
are observed. Establish some controls over supplies and access to
them. If a petty cash fund is kept, keep it small and review its activity
often. It might be advisable to bond the drivers and your cashier, if
one is designated. Make sure regular vacations are taken. The firm
may be too small for an audit by an outside CPA, but if outside help
is sought in preparing tax returns, ask that accountant to note any
areas that might need better controls. Keep locks on all doors;
issue keys to as few employees as you consider necessary. Set a
policy of locking doors and windows at the end of the day, assigning
it to one person in your absence. Verify the mileage of each driver's
route, to make sure his or her mileage reports are correct and
possibly set a maximum mileage for each route, assuming each
driver always follows the same route.

282
6-72 (10-15 min.)

Our first reaction was to laugh. The purpose of this question

is to focus on a major criterion for appraising an internal control
system -- cost and benefit. The news story generates a suspicion
that a simple system plus petty theft may be less costly than a
complex system plus zero theft.

A similar example is the toleration by many companies of

petty theft of office supplies and small tools and parts by employees.
This is viewed as less costly than any elaborate perpetual inventory
systems. In one case, a company decided to crack down on thefts
of tools by factory workers. Physical inspections of lunch boxes and
packages were conducted as workers left the plant. The new
system was short-lived. The company detected worker resentment
that would have more far-reaching cost implications than the loss of
some small tools.

Chapter 6 Accounting for Sales 283

6-73 (10-20 min.)
All of the items on the checklist seem important, but
separation of duties, proper authorization, and physical safeguards
seem most prominent.
According to the Wall Street Journal, "...slot-machine meters
were rigged to falsely indicate on Argent records that they were
paying customers one-third more than they actually were." When
the slot machines were emptied at the Stardust, one of Argent’s
casinos, the coins were taken to the counting room where an
electronic scale used to weigh the coins had been fixed to under
weigh by about a third. At times as much as $20,000 was skimmed
in one day and not recorded on Argent's books. To remove that
much coinage, "auxiliary banks" were placed around the casino,
and change clerks were instructed to purchase coins for resale to
patrons from these auxiliary banks. This maneuver enabled
conversion of the extra coins into bills of large denomination for
easier removal from the hotel.
Each gambling establishment has safeguard procedures to
thwart the theft of revenues; however, a key procedure of having an
auditor compare the coin count weight with the wrapped coin weight
was avoided when the Stardust manager excluded the auditor from
the counting room until after the coins were wrapped. Later the
auditor was required to sign forms saying that he had verified that
the weighed and wrapped total agreed. An auditor who complained
to the manager and later to the hotel's treasurer was "put off" by
both.
After the skimmed coins were converted to bills, the gaming
report indicated, the slot managers at each casino would place the
money in large envelopes and deliver these to the manager at the
Stardust. According to the news story, he delivered these to
another individual, who presumably had the money flown back to
Chicago.

284
6-73 (continued)

Twice accountants from Argent's independent auditors, J.H.

Cohn & Co., made surprise visits to the Stardust counting room and
found the scale was under weighing from 33% to as much as 75%.
They were told the scale was broken and an order had been placed
to have it repaired. In their memos, both accountants "underscored
that the scales were not accurate" but the senior partners of J.H.
Cohn said they had not noticed these warning signals.
So many casino employees knew that money was being
skimmed, that eventually word got out to the Nevada gaming control
board. When the chief of the audit division and two agents paid a
surprise visit to the Stardust they found more than $7,200 in
quarters in one auxiliary bank and $3,500 in cash in another. The
manager fled to Mexico.
Managers of the Fremont Casino, alerted to the "raid" by the
Stardust's management, hastily dismantled their auxiliary bank and
stored the parts in the hotel basement, and their operation was not
discovered until revealed by employees several days later.
Some months after the Stardust and Fremont casino
operations were revealed, the law-enforcement group located the
missing manager, who was using an alias. Dispatching his 27-year
old son with a message that the manager would be given immunity
from prosecution if he would cooperate in their investigation, the
law-enforcement agency persuaded him to return to the U.S.
Shortly after his return, the son was murdered. The manager fled
again, this time to Costa Rica, where evidence indicates that he, too,
was murdered -- presumably to keep him from testifying about the
Las Vegas skimming operations.

Chapter 6 Accounting for Sales 285

6-74 (15 min.)
Some controls are listed. Others are certainly possible.
(a) Mail W2 forms directly to a home address; have separate
individuals verify time cards and distribute payroll checks;
require personnel department authorization for adding or
deleting employees from the payroll; periodically
supervise the procedure for punching time cards.
(b) Periodically send people to pose as customers to see if
cash is handled properly; statistically analyze cash
receipts for periods of time that various employees are in
charge; enforce use of a cash register for all sales.
(c) Rotation of duties; forced vacations; documentation of
competitive bids.

6-75 (20-25 min.)

a. The first weakness is the system used to hire and train
Rodney Williams. He was not hired for his capabilities,
and one week of training seems inadequate for the
responsibilities he was given. A second weakness is lack
of separation of duties. When one person both handles
the cash and makes the accounting entries, it is possible
for that person to pocket cash and cover it up by making
false journal entries.
b. The labor policy is not one to attract capable and reliable
personnel. With high turnover of clerks, Sanchez must
be putting confidence in employees about whom he
knows very little. Convenience stores are a prime target
of employee theft, so money saved on wages may be
more than offset by losses due to employee theft or
incompetence.

286
 c. Two weaknesses in internal control are lack of immediate
recording of sales (especially cash sales) and less secure
location for storage of cash. Neither of these controls is
completely lacking, but they are less effective than using
a cash register inside the station. McGuire has
considered physical safeguards by using a locked cash
box. Nevertheless, robbery would be easier with cash
being kept at the pumps instead of in the station. A help
would be to transfer cash inside more often than once a
day. They should also reconcile cash and credit slips with
meter readings on the pumps.

The lack of immediate recording of sales in a cash

register is partially offset by the fact that the gas pumps
keep a running total of the sales value of the gas
pumped. This allows a day-by-day check of total receipts
via cash, credit card, checks, etc. versus the total sales
value registered on the pumps. Shortages can be
identified, but little information is provided about potential
sources of the shortages.

d. Bonding employees does not show lack of trust; it is

simply good business policy. Money saved by ceasing
the purchase of fidelity bonds may be small compared to
potential losses from dishonest employees. Making
short-term budgets by taking long-term risks may not be
wise.

Chapter 6 Accounting for Sales 287

6-76 (30 min.)

Most of the items have many possible explanations. The

following is one possible set:

1) Revenue was recorded after rendering services even though

the customer is having financial problems and may be unable
to pay the bill.

2) Credit sales and debit accounts receivable, even though the

lease may be terminated at any time and the "receivable" not
collected.

3) Inflating the physical count of inventories in a periodic

inventory system decreases the cost of goods sold, hence
increasing income: cost of goods sold = beginning inventory +
purchases - ending inventory. The larger the ending inventory,
the smaller the cost of goods sold.

4) Sales for 20X2 might be recorded in 20X1, or vice versa. This

moves income from one period to another. When 20X1 is a
bad year, income is essentially borrowed from 20X2 by
recording in December 20X1 sales that belong in January
20X2.

5) Cost of goods sold can be manipulated by choosing what LIFO

layer to write off. For example, if income needs a boost, write
off an old LIFO inventory layer even if that layer of inventory
was not depleted.

6) Credit sales and debit receivables for phantom sales. You

might hope that conditions are better next year so that you can
reverse the entry (i.e., debit sales, credit receivables) so no one
will ever know what was done.

288
6-76 (continued)

7) You can avoid crediting inventories and debiting a loss

account when the market value of inventories falls below cost;
similarly with marketable securities. This is difficult to detect
because it is an error of omission rather than an error of
commission.

8) A growing company can change from accelerated to straight

line depreciation when income needs a boost; depreciation
expense will fall, increasing income.

9) Costs, for example advertising costs, might not be recorded

until a later year. For example, McCormick Company, in a well-
publicized case, did not account for advertising expenses until
long after the related services were rendered. The income for
the period the services were performed is overstated.

10) Part of the company might be sold at a gain. Including the gain
in operating income gives a false picture of the profitability of
ongoing operations.

Chapter 6 Accounting for Sales 289

6-77 (26-35 min.)
1. 3/6 Deposits 9,000
Cash 9,000
3/10 Cash 12,000
Deposits 12,000
2. 3/1 Accounts payable 11,000
Cash 11,000
3/6 Accounts payable 9,000
Cash 9,000
3/10 Cash 12,000
Taxes receivable 12,000
3/14 Equipment 14,000
Cash 14,000

3/17 Cash 16,000

Fees receivable 16,000

3/28 Accounts payable 8,000

Cash 8,000

3/30 Interest expense

(or interest payable) 21,000
Cash 21,000

3/31 Cash 25,000

Taxes receivable 25,000

290
6-77 (continued)

3. City’s books:

Cash in Bank (receivable from bank)

20X1 20X1
2/28 Balance 30,000 3/1 11,000
3/10 12,000 3/6 9,000
3/17 16,000 3/14 14,000
3/31 25,000 3/28 8,000
3/30 21,000
83,000 63,000
3/31 Balance 20,000

Bank's books:

Deposits (payables)
20X1 20X1
3/1 11,000 2/28 Balance 30,000
3/6 9,000 3/10 12,000
3/14 14,000 3/17 16,000
3/31 100* ______
34,100 58,000
3/31 Balance 23,900

*Miscellaneous service charges

Chapter 6 Accounting for Sales 291

6-77 (continued)

4. CITY OF ROYALTON
Bank Reconciliation
March 31, 20X1

Balance per books $20,000

Deduct: Bank service charges for
March not recorded 100
Adjusted balance per books $19,900

Balance per bank statement $23,900

Add: Deposit of 3/31 not recorded by bank 25,000
Total $48,900
Deduct: Outstanding checks:
3/28 #264 $ 8,000
3/30 #265 21,000 29,000
Adjusted balance per bank $19,900

The adjusting entry:

3/31 Bank service charges (expense) 100

Cash 100
To record bank's charges for
miscellaneous services.

5. $20,000 minus the service charge of $100 = $19,900

292
6-78 (20-30 min.)

1. SYLVIA NELSON
Bank Reconciliation
October 31, 20X1
Balance per books $ 375
Additions:
Unrecorded automatic deposit
of weekly payroll, October 31 $800
Unrecorded automatic loan by
bank to cover overdraft 100 900
Subtotal $1,275
Deductions:
Gambling debt returned check $475
Miscellaneous fees (10 + 15) 25 500
Adjusted (corrected) balance per books $ 775

Balance per bank statement $ 805

Additions:
Unrecorded deposit of October 31 400
Subtotal $1,205
Deductions:
Outstanding checks:
#341 $ 90
#342 340 430
Adjusted (corrected) balance per bank $ 775
2. Cash in bank 400
Receivable from gambler 475
Bank service charge expense 25
Note payable to bank 100
Salary revenue 800
To update and correct balances in various accounts
as indicated by monthly bank reconciliation.

Chapter 6 Accounting for Sales 293

6-79 (20 min.)

1. Balance per books $16,610

Add: Additional deposit to correct $270 error 270
Deduct: NSF check (3,000)
Deduct: Bank service charge for August (30)
Adjusted balance per books $13,850

Balance per bank $16,500

Add: Deposits in transit 4,600
Total 21,100
Deduct: Outstanding checks (9,850)
Adjusted balance per bank $11,250

The two adjusted balances are not equal; therefore, the

books do not reconcile. The difference is $2,600.

2. Balance per books $16,610

Add: Additional deposit to correct $270 error 270
Deduct: NSF check (3,000)
Deduct: Bank service charge for August (30)
Adjusted balance per books $13,850

Balance per bank $16,500

Add: Deposits in transit 7,200
Total 23,700
Deduct: Outstanding checks (9,850)
Adjusted balance per bank $13,850

The new information from Ms. Ratelli makes the two

adjusted balances equal, so the book statement reconciles
with the bank statement.

294
6-79 (continued)
3. Small organizations often have a problem with internal control
because it is difficult to achieve appropriate separation of
duties. In this case, Ms. Ratelli both writes checks and records
the transactions, duties that should be separated to achieve
good internal control.
Although you cannot be certain from the information given, it
appears that Ms. Ratelli may have written an unauthorized
check and is now trying to cover it up. Suppose she had
written the $2,600 unauthorized check but had not recorded it
in the Chamber’s books. The book balance would be
overstated by $2,600 compared with the bank balance,
creating a need to add $2,600 to the bank balance to make
them reconcile. Adding $2,600 to the deposits in transit
accomplishes this. If this is indeed what happened, it could be
confirmed several ways.
When September’s book and bank statements are reconciled
we may learn that the supposed deposit in transit was never
recorded by the bank. If an unrecorded check was written, a
careful audit of checks on the books with checks clearing the
bank would uncover this fact. The bank would show an extra
$2,600 check.
Given that you report to Ms. Ratelli, it is likely that she has
previously had the bank reconciliation responsibility and the
ability to conceal misappropriations.
4. Since this is the first week on the job, it seems appropriate to
watch for further developments. If the additional $2,600
deposit appears on next months statement, all is well.

Chapter 6 Accounting for Sales 295

6-79 (continued)
5. Ethical standards state that accountants should not condone
unethical acts by others in the organization. In general, such
acts should be brought to the attention of one’s immediate
supervisor. However, when the unethical act is committed by
the immediate supervisor, there is an obligation to discuss the
matter with someone at a higher level of authority.
In this case, there is a strong suspicion, although no proof, that
Ms. Ratelli has committed an unethical act. Since it is now mid-
September, the deposit should be in the bank and could be
confirmed with a telephone call. The accounting assistant
could: 1) make the phone call and proceed based on what is
learned, 2) approach someone at a higher level of authority in
the Chamber, or 3) confront Ms. Ratelli directly, not accusing
her but asking for clarification. We favor the third action. If
there is a logical explanation, the matter can be dropped. If not,
the accounting assistant must be prepared to go to a higher
authority in the Chamber.

296
6-80 (90 min. or more)

The purpose of this exercise is to see how revenue recognition

differs across industries. Issues that are important in one industry
are unimportant in others.
Each student will research a particular industry. This will
require learning something about the industry and about companies
in the industry, as well as learning where to find information about
the companies. This individual research effort is an important
learning experience.
When the individual research is complete, the group members
will share their information. The industries selected for this exercise
have interesting revenue recognition differences. Students will find
out that what they learned about their particular industry is different
from what the other group members found.
Important issues to consider in revenue recognition are whether
revenue recognition precedes or follows the receipt of cash, whether
revenue is recognized before, at, or after formal billing of customers,
whether collectability of receipts is sufficiently uncertain to delay
revenue recognition, and when the revenue is really earned.

6-81 (30-50 min.)

Each solution will be unique and will change each year. The
purpose of this problem is to recognize variations in accounts
receivable turnover and days to collect receivables. Instructors may
wish to encourage the use of 10-K data, which typically provides
more details than the annual report.

Chapter 6 Accounting for Sales 297

6-82 (30-45 min.)
1. From Starbucks’ annual report we learn that “[t]he company
considers all highly liquid instruments with a maturity of three
months or less at the time of purchase to be cash
equivalents.” Money market funds and treasury bills are
examples. You may wish to point out that other companies
allow instruments to become cash equivalents when they are
within three months of maturity even if they were initially longer-
term instruments classified as short-term investments.
2. Average Collection Period
= 365 days ÷ Accounts receivable turnover
= 365 days ÷ [(Credit Sales) ÷ Average Accounts Receivable]
= 365 ÷ [$4,075,522 ÷ (($114,448 + $97,573) ÷ 2)]
= 365 ÷ [($4,075,522 ÷ $106,101.5]
= 365 ÷ 38.4 = 9.5 days
A case could be made for focusing on specialty sales only
(since they are the sales most likely to be on account), in which
case the calculation is:
365 ÷ ($625,898 ÷ $106,010.5) = 61.9 days

298
6-83 (30-60 min.)

NOTE TO INSTRUCTOR. This solution is based on the web site as it

was in late 2004. Be sure to examine the current web site and 10-K
before assigning this problem, as the information there may have
changed.

1. Oracle says: “We develop, manufacture, market, distribute,

and service database software and infrastructure software, including
application server, collaborative software, and development tools,
that help our customers manage and grow their businesses and
operations. We also offer an integrated suite of business
applications software.”

2. There are several places where R&D is discussed, but the

coverage of accounting policies is the most clear and relevant: “All
research and development costs are expensed as incurred.” Costs
eligible for capitalization under SFAS 86 were not material. R&D is a
distinct line item in the earnings statement and represents 13% of
sales.

3. Oracle has a financing division, and in fiscal 2004 $356.6

million or 10% of software license revenue was financed through that
division. The resulting receivables are generally sold to third parties.

4. From the balance sheet it is clear that an allowance for bad

debts is used. The balance is net of allowances. From the notes we
learn that Oracle uses a specific review of invoices mixed with an
aging of accounts receivable to set the balance in the allowance
account.

Chapter 6 Accounting for Sales 299