Professional Documents
Culture Documents
Chapter 7
Reporting and Interpreting
Sales Revenue, Receivables, and Cash
Revised: April 27, 2014
ANSWERS TO QUESTIONS
1. Sales revenue is a gross amount that does not reflect any adjustments. Net sales is sales
revenue adjusted for the following items: (a) sales returns (the sales dollar amount of
goods returned by customers because the goods were either unsatisfactory or not
desired); (b) sales allowances (dollar amounts allowed to customers for unsatisfactory
merchandise) and (c) sales discounts (discounts given to customers for payment of
their accounts within a specified short period of time).
2. Gross profit or gross margin on sales is the difference between net sales and cost of
sales. It represents the average gross markup realized on the goods sold during the
period. The gross margin ratio is computed by dividing the amount of gross margin by
the amount of net sales. For example, assuming net sales of $100,000 and cost of sales
of $60,000, the gross margin on sales would be $40,000. The gross margin ratio would
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7-1
be $40,000/$100,000 = 0.40 (40%). This ratio may be interpreted to mean that out of
each $100 of sales, $40 was realized above the amount expended to purchase the
goods that were sold.
3. A credit card discount is the fee charged by the credit card company for services. When
a company deposits its credit card receipts in the bank, it only receives cash for the
sales amount less the credit card company’s discount. The credit card discount account
either decreases net sales (as a contra-revenue account) or increases selling expense.
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7-2
5. A sales allowance is an amount allowed to a customer for unsatisfactory merchandise.
A sales allowance reduces the amount the customer must pay, or if already paid, a cash
refund is required. Sales allowances may occur whether the sale was for cash or credit.
In contrast, a sales discount is a cash discount given to a customer who has bought on
credit and made payment within the specified period of time. (Refer to explanation of
sales discount in Question 4 above.)
7. In conformity with the matching process, the allowance method records bad debt
expense in the same period in which the credit was granted and the sale was made.
8. Using the allowance method, bad debt expense is recognized in the period in which the
sale related to the uncollectible account was recorded.
9. The write-off of bad debts using the allowance method decreases the asset trade
receivables and the contra asset allowance for doubtful accounts by the same amount.
As a consequence, (a) net earnings are unaffected and (b) trade receivables, net, is
unaffected.
10. An increase in the receivables turnover ratio generally indicates faster collection of
receivables. A higher receivables turnover ratio reflects an increase in the number of
times average trade receivables were recorded and collected during the period.
11. Cash includes money and any instrument, such as a cheque, money order, or bank draft
that is normally accepted by banks for deposit and immediate credit to the depositor’s
account. Cash equivalents are short-term, highly liquid investments that are readily
convertible into a known amount of cash, and which are subject to an insignificant risk
of change in value.
12. The primary characteristics of an internal control system for cash are : (a) separation
of the functions of receiving cash from paying cash, (b) separation of cash-receiving
and cash-paying routines, (c) separation of the physical handling of cash from the
accounting function, (d) preparation and monitoring of cash budgets, (e) depositing all
cash receipts and making all cash payments by cheque, (f) requiring separate approval
of all cheques and electronic funds transfers, (g) requiring monthly, independently
prepared reconciliation of bank accounts, and (h) requiring employees to take
vacations and rotate their duties.
13. Trade receivables cannot be considered cash equivalents. They are normally collected
within three months and therefore meet part of the definition of cash equivalents.
However, they are not readily convertible to cash as the conversion to cash depends on
the actions of others (e.g., the customer) and there may be a significant amount of risk
that the value will change in that the collection may not be assured.
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7-3
14. Cash-handling and cash-recording activities should be separated to remove the
opportunity for theft of cash and a cover-up by altering the records. This separation is
accomplished best by assigning the responsibility for cash handling to individuals
other than those who have the responsibility for record keeping. In fact, it is usually
desirable that these two functions be performed in different departments of the
business.
15. The purposes of bank reconciliation are (a) to determine the “true” cash balance, (b) to
provide data to adjust the Cash account to that balance, and (c) to provide control over
the cash account through independent verification. Bank reconciliation involves
reconciling the balance in the Cash account at the end of the period with the balance
shown on the bank statement (which is not the “true” cash balance) at the end of that
same period. Seldom will these two balances be identical because of timing differences
such as deposits in transit; that is deposits that have been made by the company but
not yet entered on the bank statement, and outstanding cheques that have been
written and recorded in the accounts of the company that have not cleared the bank,
hence they have not been deducted from the bank’s balance. Usually, the reconciliation
of the two balances, per books against per bank, requires recording of one or more
items that are reflected on the bank statement but have not been recorded in the
accounting records of the company. An example is the usual bank service charge, which
is included on the bank statement, but has not yet been recorded in the company’s
books.
16. The total amount of cash that should be reported on the statement of financial position
is the sum of (a) the true cash balances in all chequing accounts (verified by a bank
reconciliation of each chequing account), (b) cash held in all “cash on hand” (or “petty
cash”) funds, (c) any cash physically on hand (any cash not transferred to a bank for
deposit) – usually held for change purposes, and (d) the balance in cash equivalent
accounts.
17. (Based on Appendix 7A) The percentage of completion method may be used for long-
term construction projects. Companies may use the percentage of completion method
when progress toward completion and costs to complete the contract can be
reasonably estimated, and there is a firm contract that virtually guarantees payment.
18. (Based on Appendix 7B) Under the gross method of recording sales discounts, the
amount of sales discount taken is only recorded at the time the collection of the
account is recorded.
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7-4
Authors' Recommended Solution Time
(Time in minutes)
* Due to the nature of these cases and projects, it is very difficult to estimate the amount of
time students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While students
often benefit from the extra effort, we find that some become frustrated by the perceived
difficulty of the task. You can reduce student frustration and anxiety by making your
expectations clear. For example, when our goal is to sharpen research skills, we devote
class time to discussing research strategies. When we want the students to focus on a real
accounting issue, we offer suggestions about possible companies or industries.
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7-5
EXERCISES
E7–1
Transaction Point A Point B
(a) Airline tickets sold by an
airline on a credit card Point of sale x Completion of flight
(b) Computer sold by mail order
company on a credit card x Shipment Delivery
(c) Sale of inventory to a business
customer on open account x Shipment Collection from customers
E7–2
Req. 1
Req. 2
E7–3
Req. 1
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7-6
E7–3 (continued)
Req. 2
E7–4
Req. 1
Req. 2
E7–5
Earnings from
Transaction Net Sales Gross Profit Operations
July 12 + + +
July 15 + + +
July 20 N N –
July 21 – – –
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7-7
E7–6
Req. 1
The percentages of (1) cost of sales to net sales and (2) sales returns and allowances to
gross sales are shown in the following table for each of the six quarters.
Req. 2
The ratio of cost of sales to net sales decreased slightly during the last quarter of 2014 and
the first quarter of 2015. It then increased in the second quarter of 2015. This may indicate
a change in the company’s efficiency in purchasing goods for resale. The changes could also
be related to seasonal variations. It could also mean that the company has been able to
increase its sales prices relative to the cost of the items purchased. Alternatively, the lower
cost of sales may reflect the fact that the company is purchasing lower quality merchandise,
which is costing less than before.
The dollar amount for sales returns and allowances almost quadrupled in amount and
tripled as a percentage of gross sales during the six quarters. Possible reasons for this
increase include: (1) a deterioration in the quality of the merchandise purchased from the
various international suppliers, and/or (2) a liberal policy of sales returns and allowances
that is intended to serve the needs of customers, and to allow them to return any defective
or unwanted merchandise within two months of purchase.
The company should review its sales returns and allowances policy with an attempt to
reduce the maximum length of the period allowed for returns, perhaps from 60 days to 45
days. The company needs to re-examine its sources of supply of merchandise with a view to
improving on the quality of the products purchased and sold so as to reduce the amount of
sales returns and allowances.
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7-8
E7–7
Req. 1
SLATE, INC.
Statement of earnings
For the Year Ended December 31, 2014
Amount
In this case, earnings from operations is the same as earnings before income tax.
Req. 2
Gross profit (or gross margin) in dollars is the difference between the sales prices and the
costs of purchasing or manufacturing all goods that were sold during the period
(sometimes called the markup); that is, net revenue minus only one of the expenses – cost
of sales. The gross profit ratio is the amount of each net sales dollar that was gross profit
during the period. For this company, the rate was 45%, which means that $.45 of each net
sales dollar was gross profit (alternatively, 45% of each sales dollar was gross profit for the
period).
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7-9
E7–8
Req. 1
Statement of Earnings
For the Year Ended December 31, 2014
Number of common shares outstanding (in millions) 120.8 million 70.0 million
Wood Work, earnings per share = $33,000 ÷ 120.8 million shares= $0.27
Modern Furniture, earnings per share = $51,350 ÷ 70.0 million shares = $0.73
Wood Work:
Gross profit = $592,000
Gross profit percentage: $592,000 ÷ $1,340,000 = 0.442 (or 44.2%).
Modern Furniture:
Gross profit = $283,000
Gross profit percentage: $283,000 ÷ $682,000 = 0.415 (or 41.5%).
Gross profit (or gross margin) is the difference between sales revenue and the cost of sales
during the period (sometimes called the markup). The gross profit percentage measures
how much of every sales dollar is gross profit. It reflects the company’s ability to charge
premium prices and produce goods and services at low cost.
Wood Work sold more merchandise than Modern Furniture, and achieved a higher gross
profit, indicating that Wood Work was able to charge higher prices than Modern Furniture
for the merchandise it sold and/or was able to purchase the merchandise it sold at lower
cost than Modern Furniture.
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7-10
E7–9
Estimated Estimated
percentage amount
Aged trade receivables uncollectible uncollectible
Not yet due $25,000 x 2% = $ 500
Up to 120 days past due 10,000 x 10% = 1,000
Over 120 days past due 5,000 x 30% = 1,500
Estimated ending balance in Allowance for Doubtful Accounts $3,000
Current balance in Allowance for Doubtful Accounts 600
Bad Debt Expense for the year $2,400
E7–10
Estimated Estimated
percentage amount
Aged trade receivables uncollectible uncollectible
Not past due CHF10,925 x 1% = CHF109.3
Past due 1–30 days 1,356 x 5% = 67.8
Past due 31–60 days 445 x 10% = 44.5
Past due 61–90 days 168 x 20% = 33.6
Past due 91–120 days 95 x 30% = 28.5
Past due more than 120 days 798 x 40% = 319.2
Estimated ending balance in Allowance for Doubtful Accounts CHF602.9
Unadjusted balance (372 – 95 + 15) 292.0
Bad debt expense for 2012 CHF310.9
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7-11
E7–10 (continued)
Req. 2
E7–11
Req. 1
Req. 2
It would have no effect because the asset “Trade receivables” and contra-asset “Allowance
for doubtful accounts” would both decline by €10 million. Neither “net receivables” nor
“net earnings” would be affected.
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7-12
E7–12
Req. 1
The percentages of uncollectible accounts for each category of past due receivables are
computed below:
(A) (B)
Impairment Amount of (C) = (B) ÷ (A)
Past due accounts Allowance Receivables Percentage
Current $ – $19,500 –
31 – 60 days 100 5,000 2.0%
61 – 90 days 65 2,300 2.8%
91 – 120 days 985 3,400 29.0%
More than 120 days – – –
$1,150 $30,200
The percentage of amounts that are potentially uncollectible increases the longer the
amounts remain uncollected by the Company, which is normal because the likelihood of
collection from delinquent customers become smaller as time passes.
Req. 2
Req. 3
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7-13
E7–12 (continued)
Req. 4
It would have no effect because the asset “Trade Receivables” and contra-asset “Allowance
for Doubtful Accounts” would both decline by $10 thousands. Neither “net trade
receivables” nor “net earnings” would be affected.
E7–13
Req. 1
Allowance for doubtful accounts
375 Beg. balance
Write-offs 56 14 Bad debt exp.
333 End. balance
Bad debt expense increases (is credited to) the allowance. Since we are given the
beginning and ending balances in the allowance, we can solve for write-offs, which
decrease (are debited to) the allowance.
Req. 2
Trade receivables
Beg. balance* 13,389 56 Write-offs
Net sales 68,643 66,656 Cash collections
End. balance ** 15,320
* $13,014 + 375
** $14,987 + 333
Trade Receivables is increased (debited) by recording sales made on credit; the account is
decreased (credited) by recording cash collections and write-offs of bad debts. Thus, we
can solve for cash collections as the missing value.
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7-14
E7–14
Req. 1
The allowance for uncollectible accounts is increased (credited) when bad debt expense is
recorded and decreased (debited) when uncollectible accounts are written off. This case
gives the beginning and ending balances of the allowance account and the amount of
uncollectible accounts that were written off. Therefore, the amount of bad debt expense
can be computed as follows (amounts in millions):
Req. 2
Working capital is unaffected by the write-off of an uncollectible account when the
allowance method is used. The asset account (Trade Receivables) and the contra- asset
account (Allowance for Uncollectible Accounts) are both reduced by the same amount;
therefore, the net trade receivables is unchanged.
Working capital is decreased when bad debt expense is recorded because the contra–asset
account (Allowance for Uncollectible Accounts) is increased. From requirement (1), we
know that net trade receivables were reduced by $9 million when bad debt expense was
recorded in year 2.
Note that earnings before taxes were reduced by the amount of bad debt expense that was
recorded, therefore Income Tax Expense and Income Tax Payable will decrease. The
decrease in Income Tax Payable caused working capital to increase; accordingly, the net
decrease in working capital was $6.3 million (= $9 million – $9 million x 30%).
Req. 3
The entry to record the write-off of an uncollectible account did not affect any statement of
earnings accounts; therefore, net earnings is unaffected by the $17 million write-off in year
2.
The recording of bad debt expense reduced earnings before taxes in Year 2 by $9 million
and reduced tax expense by $2.7 million (i.e., $9 million x 30%). Therefore, Year 2 net
earnings were reduced by $6.3 million (as computed in Req. 2).
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7-15
E7–15
Req. 1
Calculations for Current Year:
Req. 2
The receivables turnover ratio reflects how many times accounts receivable were recorded
and collected, on average, during the period. The average collection period indicates the
average time it takes a customer to pay the amount due.
The results indicate a downward trend in the receivables turnover, and an increase in the
average collection period, which increased by more than one month over the five-year
period.
Req. 2
The receivables turnover ratio reflects how many times trade receivables were recorded
and collected, on average, during the period. The average collection period indicates the
average time it takes a customer to pay its accounts.
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7-16
E7–17
Req. 1
a. Receivables turnover = Net sales / Average net trade receivables
Aer Lingus: €1,393,284 / [(€29,138 + €42,273) /2] = 39.0 times
WestJet Airlines: $3,427,409 / [($34,122 + $37,576) /2] = 95.6 times
b. Average collection period = 365 / Receivables turnover
Aer Lingus: 365 / 39.0 = 9 days (rounded)
WestJet Airlines: 365 / 95.6 = 4 days (rounded)
Req. 2
WestJet’s trade receivables appear to be the more liquid asset as they are collected every 4
days on average, whereas it takes Aer Lingus 9 days on average to collect from its
passengers or travel agents.
Req. 3
The different currencies do not affect the interpretation of the ratios. Ratios focus on the
relationship of the numbers to each other and are thus not affected by currency.
E7–18
Req. 1
The decrease in the trade receivables balance would increase cash flow from operations for
the current year. This happens because the Company collected more cash from customers
than the credit sales made during the year.
Req. 2
(a) Increasing sales revenue leads to higher trade receivables balances because credit sales
are creating new receivables faster than receivables can be collected.
(b) Cash collections from the prior period's credit sales are lower than the new credit sales
revenue because of the increase in sales revenue. Note that in the next period, cash
collections will also rise. However if credit sales continue to rise, trade receivables will
also continue to increase.
Req. 3
Receivables turnover = Net sales / Average net trade receivables
= $108,429 / [($5,369 + $5,910)/2] = 19.2 times
Average collection period = 365 / Receivables turnover = 365 / 19.2 = 19 days
The computed numbers help investors in assessing how quickly the company collects
receivables from its customers in order to meet its current obligations to suppliers of goods
and services. These numbers can be compared to the average turnover ratio and average
collection period for the industry. The average collection period would also serve as a
check on the company credit policy.
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7-17
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7-18
E7–19
a. This is not a good practice because the credit manager has the opportunity to
mishandle the cash received from customers while manipulating the customers’
records. For example, he or she may pocket cheques received from customers and
pretend that payments were not received. However, the issuance of periodic
statements to the customers may reveal any mishandling of customers’ payments, if the
customers contact a person other than the credit manager to ask about the difference or
if the statements are reviewed by someone in the accounting department. A more
serious problem would be to pocket the amount received and write the customer’s
account off as uncollectible.
b. The is a very good practice as there will be no cash left in the hands of employees who
may be tempted to use it for their own benefit.
d. This is not a good practice. The invoices should not be stamped “paid” until the cheques
have been issued to the proper party and signed. Otherwise, it is possible for the
treasurer to issue a cheque to another party. Furthermore, it is recommended that the
cheques be signed by two individuals and that the signed cheques be reviewed to
ensure proper payment before the invoice is stamped “paid”.
e. This is not a good practice. The cheques should be pre-numbered in order to keep track
of the cheques that have been issued and to account for the missing cheques.
f. This is not a good practice. The adjusted balances should be equal if the bank
reconciliation is prepared accurately. If the adjusted balances are different, then the
person preparing the bank reconciliation would have made an error that needs to be
identified and corrected.
E7-20
Cash is the most liquid asset for any organization. Safeguarding cash begins with
documentation. Without documentation there is no appropriate way to protect cash from
theft, fraud or loss. The fact that cash receipts for goods sold are only given to those who
ask for them is a weakness in the control for cash. The cashier who receives money from
customers may be a trustworthy family member. But, this practice may lead to the
temptation of pocketing some of the cash received. For this reason, it is recommended that
receipts be given to customers at all times. Furthermore, it is recommended that all cash
receipts be deposited in the bank for safety purposes, and that payments for farm supplies
be made by cheques, by credit card or by debit card instead of keeping large amounts of
cash on hand. It is also important that all invoices received from suppliers of farm products
be kept to document the cash outflow from the business.
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7-19
E7–21
Include:
Cash on hand ($700 + $100 + $200 + $200) ............................... $1,200
Petty cash ................................................................................. 300
Bank accounts:
City Bank ................................................................................. $58,600
National Bank (locations A, B, and C) .................................... 5,100 63,700
Credit Suisse – 3-Month Certificate of Deposit .......................... 5,800
Total cash and cash equivalents reported on
2014 statement of financial position ........................................... $71,000
Do not include:
Fransabank – 6-month Certificate of
Deposit (report as short-term investment) ................................ 4,500
Cash equivalents include investments with original maturities (generally) of three months
or less that are readily convertible to cash and whose value is unlikely to change. Under
this definition the 6-month certificate of deposit does not qualify as a cash equivalent.
A more conservative approach would be to recognize only treasury bills and money market
funds as cash equivalents, and exclude the 3-month certificate of deposit. Alternatively if
the 6-month certificate can be cashed early it could be included as a cash equivalent.
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7-20
E7–22
Req. 1
ZOLTAN COMPANY
Bank Reconciliation, June 30, 2015
Additions: Additions:
Req. 2
Req. 3
The balance in the Cash account after the above entry has been posted is the same as the
correct cash balance per the bank reconciliation; $5,960.
Req. 4
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7-21
E7–23
Req. 1
RUSSELL COMPANY
Bank Reconciliation, September 30, 2014
Additions: Additions:
Req. 2
Req. 3
The balance in the Cash account after the above entries have been posted is the same as the
correct cash balance per the bank reconciliation, $5,470.
Req. 4
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7-22
E7−24
Req. 1
Mini Mart Corporation
Bank Reconciliation
June 30
Cash balance per bank $1,330
Add: (1) Deposit in transit 160
1,490
Less: (2) Outstanding cheques (240)
Adjusted cash balance per bank $1,250
Req. 2
Req. 3
Preparation of a bank reconciliation is important for three reasons: (a) to determine the
“true” cash balance, (b) to provide data to adjust the Cash account to that balance, and (c)
to provide control over the cash account through independent verification.
Req. 4
The amount of cash that should be reported on the statement of financial position is
$1,250.
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7-23
E7–25 (Appendix 7A)
Req. 1
2014 2015 2016
Revenue .................................................... $2,400,000 $6,000,000 $3,600,000
Expenses ................................................... 2,000,000 5,000,000 3,000,000
Net earnings ............................................ $ 400,000 $1,000,000 $ 600,000
Computations:
2014: ($2,000,000 ÷ $10,000,000) x $12,000,000 = $2,400,000
2015: ($5,000,000 ÷ $10,000,000) x $12,000,000 = $6,000,000
2016: ($3,000,000 ÷ $10,000,000) x $12,000,000 = $3,600,000
Req. 2
If costs cannot be reliably estimated, net earnings would only be recognized when the
project is complete.
2014 2015 2016
Net earnings ............................................ $0 $0 $2,000,000
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7-24
E7–26 (Continued)
December 6, 2014:
Cash (+A) .............................................................................................. 6,468
Sales discounts (+XR→ −SE) ........................................................ 132
Trade receivables – Customer Daoud (–A)............... 6,600
To record collection within the discount period,
0.98 × ($7,200 – $600) = $6,498
PROBLEMS
P7–1
Case A
Because the fast food restaurant collects cash when the coupon books are sold, cash
collection is not an issue in this case. In order to determine if the revenue has been earned,
the student must be careful in analyzing what the restaurant actually sold. Students who
focus on the sale of the coupon book often conclude that the earning process is complete
with the delivery of the book to the customer. In reality, the restaurant has a significant
additional service to perform; it has to serve a meal. The correct point for revenue
recognition in this case is when the customer uses the coupon or when the coupon expires
and the restaurant has no further obligation.
Case B
In this case there is reason to believe that Quality Builders may default on the contract
because of prior actions. If students believe that Howard Development could sue and
collect on the contract, they will probably argue for revenue recognition at the time of sale.
Given the high risk associated with cash collection, however, many students will properly
argue that revenue should be recognized only as cash is collected.
Case C
While warranty work on some appliances can involve significant amounts of effort and
money, appliance companies are permitted to record revenue at the point of sale. In
accordance with the matching process one should accrue estimated warranty expense at
the time that sales revenue is recorded. Some students may be surprised to learn that costs
that will be incurred in the future should be recorded as an expense in the current
accounting period, but following this practice enhances the quality of the financial
statements.
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7-25
P7–2
Req. 1
Trade Receivables
Bal., January 1, 2015 115,000
Sale to R. Agostino (b) 11,500 500 Return by R. Agostino (d)
Sale to K. Black (c) 25,000 11,000 Collection from R. Agostino (f)
Sale to B. Assaf (e) 26,000 100,000 Collections within discount period (g)
Sale to R. Fong (i) 17,500 25,000 Collection from K. Black (h)
6,000 Collection from customers (k)
3,000 Write off of uncollectible account (l)
Bal., December 31, 2015 49,500
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7-26
P7–2 (continued)
Req. 2
P7–3
Year 1
a. $2.40 x 10,000 shares = $24,000
b. $24,000 ÷ (1.00 – 0.20) = $30,000
c. $30,000 x .20 = $6,000
d. $30,000 + $18,000 = $48,000
e. $48,000 ÷ (1.00 – 0.68) = $150,000
f. $150,000 x .68 = $102,000
g. $160,000 – $150,000 = $10,000
Year 2
a. $232,000 – $18,000 = $214,000
b. $214,000 x .30 = $64,200
c. $214,000 – $64,200 = $149,800
d. $64,200 – $20,000 = $44,200
e. $20,000 x .20 = $4,000
f. $20,000 – $4,000 = $16,000
g. $16,000 ÷ 10,000 shares = $1.60
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing © 2014 McGraw-Hill Ryerson Limited. All rights reserved.
7-27
P7–4 (Dollars in thousands)
Req. 1
Bad debt expense (+E→ −SE) ........................................................................ 4
Allowance for doubtful accounts (+XA → –A) ................................. 4
Estimate of end-of-period bad debt expense.
Req. 2
Allowance for Year 2 Allowance for Year 3
132 Beg. bal. 283 Beg. bal.
Write-offs 36 187 Bad debt exp. Write-offs 201 42 Bad debt exp.
283 End. bal. 124 End. Bal.
The solution is facilitated by solving for the missing value in the T-account.
P7–5
Req. 1
Aging Analysis of Trade Receivables
Total (a) (b) Up to One (c) More Than One
Customer Receivables Not Yet Due Year Past Due Year Past Due
B. Brown…….... $ 6,000 $6,000
D. Di Lella…..... 5,000 $ 5,000
N. Gidda…....… 7,000 $ 7,000
S. Kavouris…… 20,000 4,000 16,000
T. Patel…...…... 7,000 7,000
Totals…….…… $45,000 $18,000 $21,000 $6,000
Percent….……. 100% 40% 46.7% 13.3%
It is assumed that collections are applied to the oldest invoices first.
Req. 2
Estimated Amounts Uncollectible
Amount of Estimated Estimated
Age Receivable Loss Rate Uncollectible
a. Not yet due $18,000 1% $ 180
b. Up to one year past due 21,000 5% 1,050
c. More than one year past due 6,000 30% 1,800
Total $45,000 $3,030
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7-28
P7–5 (continued)
Req. 3
Bad debt expense (+E→ −SE) .......................................................... 2,010
Allowance for doubtful accounts (+XA→ –A) ............... 2,010
To adjust for estimated bad debt expense:
Balance needed in the allowance account .... $3,030
Balance currently in the account ..................... 1,020
Adjustment needed, i.e., increase..................... $2,010
Req. 4
Statement of Earnings:
Operating expenses:
Bad debt expense ................................................................................. $2,010
Statement of financial position:
Current assets:
Trade receivables ................................................................................. $45,000
Less: Allowance for doubtful accounts ....................................... (3,030)
Net trade receivables .......................................................................... $41,970
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7-29
P7–6
Req. 1
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7-30
June 1 Cash (+A) 80,000
...............................................................................................................
Trade receivables (–A) 80,000
...............................................................................................................
Collection from Cheng Ltd. On account.
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7-31
P7–6 (continued)
Req. 2
The following time line shows the various transactions related to trade receivables and
help in preparing the aging of trade receivables schedule.
Estimated
Amount Percent Estimated
Age Group Receivable Uncollectible Uncollectible
Not yet due $ 0 5% $ 0
1–30 days past due [$100,000 – $80,000 ] 20,000 10% 2,000
31–60 days past due 0 15% 0
More than 60 days past due 48,000* 20% 9,600
Total $68,000 $11,600
* $60,000 (beginning balance) – $12,000 (write off)
Req. 3
Receivables turnover ratio = Net credit sales / Average net trade receivables
Net credit sales = Credit sales – Sales discounts – Sales returns and allowances
The T-accounts below show the balances of effects of transcations on sales and trade
receivables
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7-32
P7–6 (continued)
Sales
Balance, March 31 600,000
April 30 150,000
May 1 120,000
May 7 100,000
Balance, June 30 970,000
Trade Receivables
Balance, March 31 60,000
April 30 150,000 May 5 150,000
May 1 120,000 May 10 12,000
May 7 100,000 May 15 120,000
June 30 3,000 June 1 80,000
June 30 3,000
Balance, June 30 68,000
The average collection period reflects the average time it takes a customer to pay the
amount due. In this case, the calculation suggests that it takes IceKreme’s customers on
average 19.5 days to pay the amount due.
Req. 4
IceKreme’s customers pay, on average, after 20 days after the purchase date, which is
within the credit of 30 days . They appear to be paying off the amounts due faster than
Pino’s customers, but slower than Julia’s customers.
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7-33
P7–7
Req. 1
Req. 2
Estimated
Amount Percent Estimated
Age Group Receivable Uncollectible Uncollectible
Current $42,000 1% $420
1–30 days past due 31,500 2% 630
31–60 days past due 5,000 10% 500
More than 60 days past due 6,500 30% 1,950
Total $85,000 $3,500
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7-34
The amount of bad debt expense is the difference in the balance of the Allowance for
Doubtful Accounts before and after the adjustment.
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7-35
P7–7 (continued)
Req. 3
Gross profit percentage = Gross Profit / Net Sales
= (Sales – Sales discount – COS) / (Sales – Sales discount)
= ($67,000 – $480 – $35,000) / ($67,000 – $480)
= $31,520 / $66,520 = 47.38%
This ratio measures how much gross profit is generated from every sales dollar. It reflects
the ability to charge premium prices and purchase or produce goods and services at low
cost.
Receivable turnover ratio = Net credit sales / Average net trade receivables
= $47,520 */ $115,500** = 0.41 times (for December only)
* Net credit sales = Credit sales – Sales discount = $48,000 – $480 =$47,520
** Average net trade receivables = Average of beginning and ending values of net receivables
=[($154,000 – $4,500) + ($85,000 – $3,500)]/2 = $115,500
This ratio measures how many times trade accounts receivable are recorded and collected
during the period. This monthly ratio corresponds to an annual ratio of 4.92 (0.41 x 12),
assuming that the sales and collection activities are typical monthly activities.
P7–8
Req. 1
The beginning balance of trade receivables will increase by the amount of credit sales, and
will decrease when cash is collected from customers or when accounts are written off as
uncollectible. Accordingly, the balance of Trade receivables at December 31, 2015 is
determined as follows:
Beginning balance $ 500,000
+ Credit sales 1,000,000
– Collections from customers (1,100,000)
– Write-off of uncollectible accounts (30,000)
Ending balance $ 370,000
Req. 2
Allowance for doubtful accounts (−XA → +A) ......................... 30,000
Trade receivables (–A) ............................................................ 30,000
To record the write-off of trade receivables as uncollectible.
Bad debt expense (+E → −SE) ....................................................... 27,200
Allowance for doubtful accounts (+XA → −A) 27,200
To adjust the balance of the Allowance for doubtful accounts and record bad debt
expense for the year.
Ending balance of Allowance account = $370,000 x 6% = $22,200 Cr
Unadjusted balance of the Allowance account ($25,000 – $30,000) = 5,000 Dr
Amount of adjustment needed = $27,200 Cr
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7-36
P7–8 (continued)
Req. 3
Vital Inc.
Partial Statement of Financial Position
As at December 31, 2015
Current Assets
….
Trade receivables $370,000
Less: Allowance for doubtful accounts ( 22,200)
Net $347,800
OR
Req. 4
The method being proposed by the bookkeeper is called the direct write-off method. The
reasoning of the bookkeeper is quite appealing in the sense that it saves him and others
time and effort in estimating the amount of receivables that may not be collected in the
future. This simplistic approach would be acceptable if the amounts that are written off
annually are relatively small or if they are close to the amount that would be considered
uncollectible under the allowance method.
The main deficiency of the direct write-off method is its inconsistency with the matching
process which requires that expenses be matched to the related revenues during the same
period. If a trade receivable is written-off in a period that follows the period of sale, then
the matching process would have not been observed. The direct method also results in an
overstatement of trade receivables, which should be reported at their estimated realizable
value. Because most businesses have some amounts that will not be collected, a provision
for uncollectible accounts should be made. For this reason, accountants estimate the
amount that may not be collectible in the future, with full knowledge that the estimated
amount may not be an exact amount. However, the estimated bad debt expense complies
with the matching process. In that respect, it is preferable to be imprecisely right than
precisely wrong.
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7-37
P7–9
Req.1
BUILDERS COMPANY, INC.
Statement of Earnings
For the Year Ended December 31, 2014
Gross sales revenue .................................................................................... $145,600
Less: Sales discounts .................................................................... 6,400
Sales returns and allowances ........................................ 5,600
Net sales revenue ........................................................................................ 133,600
Cost of sales ............................................................................................... 78,400
Gross profit ............................................................................................... 55,200
Operating expenses:
Selling expenses ................................................................................ $13,600
Administrative expenses ............................................................... 14,400
Bad debt expense ............................................................................. 1,600 29,600
Earnings before income tax .................................................................... 25,600
Income tax expense ......................................................................... 7,680
Net earnings .................................................................................................. $17,920
Earnings per share: ($17,920 ÷ 10,000 shares) ........................................................... $1.79
In this case earnings from operations is the same as earnings before income tax.
Req. 2
The gross profit percentage shows the excess of sales prices over the costs to purchase or
produce the goods or services sold, measured as a percentage.
The trade receivables turnover ratio reflects how many times trade receivables were both
recorded and collected, on average, during the time period. The higher the result is, the
faster the collection of receivables.
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7-38
P7–10
Req. 1
Req. 2
Basic recommendations:
(2) Arrange for an annual independent audit on a continuing basis or a review of the
internal controls that are put in place.
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7-39
P7-11
Req. 1
This memo addresses your inquiry about the difference between the balance of the Cash in
Bank account in the company’s records and the balance shown on the bank statement. The
balance in the company’s Cash account is based on the transactions that affected this
account during the month of June. Similarly, the balance of cash shown on the bank
statement reflects the transactions that the bank recorded in the company’s bank account.
It is normal that the balances of these two accounts be different because some of the
cash transactions that affect the company’s bank account may not have been recorded by
the bank as at June 30. For example, an overnight deposit of $1,000 in the bank account on
June 30 will not be recorded by the bank until July 1, but we would have recorded that
deposit in the company’s cash account. This would cause a difference in the account
balances by $1,000 that is only temporary.
Another example is that the bank charges our company specific fees for the services it
provides. The total amount of these service charges is recorded by the bank as they occur.
But, we may not be aware of these charges until we receive the bank statement. We then
record them in the cash account in July, whereas the bank would have recorded them
already in the company’s account in June. These timing differences need to be reviewed on
a regular basis to ensure that there are no errors that have been made inadvertently either
by the bank’s employees or the company’s employees.
Req.2
Additions: Additions:
Note receivable collected........ $2,000
Interest collected ...................... 80 2,080 Deposits in transit .................... 1,145
8,598 11,662
Deductions: Deductions:
Bank service charges ($25 + 39) .................. 64 Outstanding cheques ............... 3,504
NSF cheque – Rami Cossette ......................... 286
Correction of amount deposited .................. 90
Ending correct cash balance ......................... $8,158 Ending correct cash balance .. $8,158
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7-40
P7–11 (continued)
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7-41
P7–12
Req. 1
HOPKINS COMPANY
Bank Reconciliation, April 30, 2015
Company's Books Bank Statement
Ending balance per Cash Ending balance per bank
Account ($23,500 Statement ................................... $23,550
+ $41,500 - $41,100) ............. $23,900
Additions: Additions:
Note receivable collected......... $1,110
Interest collected ........................ 70 1,180 Deposits in transit* ..................... 5,400
25,080 28,950
Deductions: Deductions:
NSF—A.B. Wright........................ 160 Outstanding cheques .................. 4,100
Bank charges ................................. 70 230
Ending correct cash balance... $24,850 Ending correct cash balance.... $24,850
*$41,500 - $36,100 = $5,400.
Req. 2
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7-42
P7–13 (Appendix 7B)
Req. 1
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7-43
P7–13 (continued)
Trade Receivables
Bal., January 1, 2015 115,000
Sale to R. Agostino (b) 11,500 500 Return by R. Agostino (d)
Sale to K. Black (c) 25,000 11,000 Collection from R. Agostino (f)
Sale to B. Assaf (e) 26,000 100,000 Collections within discount period (g)
Sale to R. Fong (i) 17,500 25,000 Collection from K. Black (h)
6,000 Collection from customers (k)
3,000 Write off of uncollectible account (l)
Bal., December 31, 2015 49,500
Req. 2
Case A
Revenue should not be recognized until the seller delivers the good or service to the
purchaser. The seller has not yet manufactured the equipment let alone delivered it. The
commitment by the purchaser is not accompanied by payment therefore no cash has been
received. Had cash been received from the purchaser, it should have been recorded as
deferred revenue.
Case B
Revenue should not be recognized unless the seller is reasonably confident that the
purchaser will pay in full. It is clear that many members who sign up do not pay for their
membership. The 10-day delay is known as a “cooling off period” and must be provided by
law, although the time period can be shorter than 10 days. The company can take a
somewhat aggressive approach and recognize a percentage of revenue when members
sign, or a more conservative approach and defer the recognition of revenue until the
cancellation period has expired. Once the cancellation period has ended, Scenic Trails Inc.
can remain somewhat aggressive and recognize the full amount of the membership fee as
revenue or it can be more conservative. The more conservative approach would be to use
either a percentage of revenue or a percentage of trade receivables to create an allowance
for those who will fail to pay the full membership fee during the six-month payment period.
The company should use its experience to choose the appropriate method and the
appropriate percentage that would present fairly the results of its operations to users.
Case C
Educational Toys’ current practice could be based on its experience whereby few
distributors return unsold merchandise and therefore the amount is immaterial. If the
returns are considered as a material amount, then Educational Toys is essentially
recognizing the products delivered to its distributors as if they were sold. In substance,
these products can still be considered inventory for Educational Toys that is located at its
distributors’ warehouses or showrooms. This practice, commonly known as “channeling”,
does not conform to GAAP.
In essence the toys are being sold on consignment and there is little to guide us to
understanding how probable it is that Educational Toys will receive full payment. An
improved approach is for Educational Toys to establish an allowance for sales returns.
Another alternative would be for Educational Toys to not recognize revenue at all until its
distributors have made the sales. Although the correct treatment is a matter of judgement,
it is clear from the facts of this case that there is only a very narrow set of circumstances
under which Educational Toys’ current practice would be acceptable under current
financial reporting standards.
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7-45
AP7–2
Req. 1
Sales Sales Discounts Sales Returns and Bad Debt Expense
Revenue (taken) Allowances
(a) +228,000 N N N
(b) +12,000 N N N
(c) +23,600 N N N
(d) N +120 N N
(e) +26,000 N N N
(f) N –16 +1,600 N
(g) N +900* N N
(h) N N +1,200 N
(i) N +224 N N
(j) +18,400 N N N
(k) N N N N
(l) N N N N
(m) N N N +13,620**
Total +$308,000 +$1,228 +$2,800 +$13,620
Req. 2
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7-46
AP7–3
Year 1:
Year 2:
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7-47
AP7–4 (Dollars in millions)
Req. 1
The solution is facilitated by solving for the missing value in the T-account.
Req. 2
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7-48
AP7–5
Req. 1
Aging Analysis of Trade receivables
(a) (b) (c) (d)
Up to 6 to More Than
Total Not Yet 6 Months 12 Months One Year
Customer Receivable Due Past Due Past Due Past Due
R. Aouad ……….. $ 2,000 $2,000
C. Chronis ……….. 6,000 $6,000
D. McClain .………. 4,000 $ 4,000
T. Skibinski ……… 14,500 $ 4,500 10,000
H. Wu ………..…... 13,000 13,000
Totals…………… $39,500 $17,500 $14,000 $2,000 $6,000
Percent ………… 100% 44.3% 35.4% 5.1% 15.2%
Req. 2
Estimated Amounts Uncollectible
Amount of Estimated Estimated
Age Receivable Loss Rate Uncollectible
a. Not yet due…………………… $17,500 1% $ 175
b. Up to 6 months past due...…. 14,000 5% 700
c. 6 to 12 months past due.…. 2,000 20% 400
d. More than one year past due 6,000 50% 3,000
Total……………………….. $39,500 $4,275
Req. 3
Bad debt expense (+E → −SE) ........................................................ 5,825
Allowance for doubtful accounts (+XA → −A) ................ 5,825
To adjust for estimated bad debt loss:
Balance needed in the allowance account ....... $4,275 Cr
Balance currently in the account ......................... 1,550 Dr
Adjustment needed, i.e., increase ........................ $5,825 Cr
Req. 4
Statement of earnings:
Operating expenses:
Bad debt expense ................................................................................. $5,825
Statement of financial position:
Current assets:
Trade receivables ................................................................................. $39,500
Less: Allowance for doubtful accounts ....................................... (4,275)
Carrying value........................................................................................ $35,225
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7-49
AP7–6
Req. 1
Req. 2
The following time line shows the various transactions related to trade receivables and
help in preparing the aging of trade receivables schedule.
Sept 30 Oct 8 Oct 15 Oct 31 Nov 5 Nov 7 Nov 16 Nov 25 Nov 29 Dec 20
__|_______|_____ _|___ ____|_______|_______|_____ _|____ __|_____ |______ |____
$9,500 ($1,500) $5,000 $7,500 ($7,500) $10,000 ($1,000) ($1,000) ($5,000) $500
($4,000) ($500)
Balance Write-off Allen Machinex Machinex Centra Allen Centra Centra Recovery
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7-50
AP7–6 (continued)
Estimated
Amount Percent Estimated
Age Group Receivable Uncollectible Uncollectible
Not yet due $ 0 1% $ 0
1–30 days past due ($10,000 – $6,000) 4,000 5% 200
31–60 days past due 0 10% 0
More than 60 days past due ($9,500–$1,500) 8,000 15% 1,200
Total $12,000 $1,400
Req. 3
Gross profit percentage = Gross Profit / Net Sales
Net sales = $100,000 + (5,000 + 7,500 + 10,000) – (150 + 1,000 + 1,000) = $120,350
Gross profit = Net sales – Cost of sales = $120,350 – $60,000 = $60,350
Gross profit percentage = $60,350 / $120,350 = 50.15%
This ratio measures how much gross profit is generated from every sales dollar. It reflects
the ability to charge premium prices and purchase or produce goods and services at low
cost. The company continue to improve on its gross profit percentage from 35% in 2013 to
50.15% in 2015. It seems that the company is able to increase the sales price for its small
machinery because of the quality of the product and/or it managed to reduce the cost of
production of the machinery by using modern technology or outsourcing the production to
manufacturing facilities in countries where labor cost is relatively low.
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7-51
AP7–7
Req. 1
Req. 2
Rodamex Inc.
Statement of Financial Position (partial)
December 31
2015 2014
Current assets:
:
Trade accounts receivable $938,000 a $700,000
Less: Allowance for doubtful accounts 23,450 b 14,000 c
Net realizable value $914,550 $686,000
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7-52
AP7–7 (continued)
Req. 3
The amount of bad debt expense is the difference in the balance of the Allowance for
Doubtful Accounts before and after the adjustment.
Req. 4
Receivables turnover ratio = Net credit sales / Average net trade receivables
= ($4,500,000 – $45,000)/ [($686,000 + $914,550)/2]
= 5.57 times
This ratio measures how many times trade accounts receivable are recorded and collected
during the period.
Based on the credit terms, net 30 days, the receivables turnover should equal 365 / 30 =
12.17 times. Rodamex’s ratio is less than half what it should be. As a result, Rodamex’s
management needs to improve its collection efforts so that customers pay the amounts due
in 30 days.
Req. 5
If the cost of sales averages 40 per cent of net sales, then gross profit averages 60 per cent
of net sales.
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7-53
AP7–8
Req. 1
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7-54
AP7–8 (continued)
Req. 2
Req. 3
What you are proposing is known as the direct write-off method whereby uncollectible
accounts are written off when we are certain that specific customers will not pay the
amount they owe the company. This approach would be acceptable if the amounts that are
written off annually are relatively small or if they are close to the amount that would be
considered uncollectible under the allowance method.
The main deficiency of the direct write-off method is its inconsistency with the matching
process which requires that expenses be matched to the related revenues during the same
period. If a trade receivable is written-off in a period that follows the period of sale, then
the matching process would have not been observed. Failure to provide an allowance
would also result in an overstatement of the trade receivables on the statement of financial
position. For this reason, accountants estimate the amount that may not be collectible in
the future, with full knowledge that the estimated amount may not be an exact amount. In
this respect, it is preferable to be imprecisely right than precisely wrong. I should note that
both the direct write-off method and the allowance method are likely to produce similar
results if uncollectible amounts are relatively stable over time.
Based on the above, it is preferable that we continue with our past practice of estimating
bad debts during the period of sale and not when we exhaust all means of collection from a
specific customer.
Sincerely,
Carol
Req. 4
Yes, MKI should have obtained the loan from BIT. MKI will have to pay $300 in interest to
BIT, but it will save $400 (= $40,000 x 1%) off the amount owed to Kim & Sons, Ltd.
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7-55
AP7–9
Req. 1
PERRY CORPORATION
Statement of Earnings
For the Year Ended December 31, 2015
In this case, earnings from operations is the same as earnings before income tax.
Req. 2
The gross profit percentage shows the excess of sales prices over the costs to purchase or
produce the goods or services sold, measured as a percentage.
The trade receivables turnover ratio reflects how many times trade receivables were both
recorded and collected, on average, during the time period. The higher the result is, the
faster the collection of receivables.
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7-56
AP7-10
Req. 1
The balance of Cash on Hand would be understated by $2,000. The debit to the Sales
returns and allowance account would reduce net sales and net earnings, which reduces the
balance of retained earnings at the end of the month. Hence, net earnings and Retained
Earnings would be understated by $2,000.
Req. 2
Control and safeguarding cash is one of the most important functions of an internal control
system because cash is so vulnerable to theft and fraud. In this case, the weakness in the
system is that Cory is responsible for tasks that are incompatible (i.e. they should be
segregated). Separation of duties is the first step that responsible managers should take to
safeguard cash. This means that the person receiving cash for a transaction should not be
the same person recording receipts of cash and that a third person should be responsible
for depositing and withdrawing cash on behalf of the company.
If this system is in place, a voucher or document is required at every step in the cash
handling process. For example the person receiving cash provides a receipt to the
purchaser and a copy (either electronic or hard copy) is retained by the seller. At the end
of the transaction period, say one day, the total of all sales receipts (less any refunds) must
equal the cash on hand. In this way, companies avoid situations where an employee can
simply take money that belongs to the company and then hide the theft.
When the person handling cash receipts is not the same person handling and recording
payments, there must be collusion between the two before Cory could simply substitute a
purchaser’s cheque for cash stolen. Cory would have had no access to the journal and the
proper journal entry for the PLC cheque would have been made:
When the cash receipts for the day are totaled, the person who deposits this cash should
reconcile the amount deposited to the daily vouchers and this person should neither record
journal entries nor receive cash at the point-of-sale. This means that Cory could not have
taken the cash because a third party would have counted the actual cash on hand and
reconciled it to the receipts for the day. In fact, usually two people are responsible for this
activity and they sign a document verifying the reconciliation.
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AP7–11
Req.1
Sergio Lucas
Bank Reconciliation
August 31
Additions: Additions:
Error recording chq #123 ....... 27.00
$12,678.65 Deposits in transit ....................... 385.00
12,891.60
Deductions: Deductions:
Hydro Bill ....................................... 44.10 Outstanding cheques .................. 619.35
Telus Corp ...................................... 55.30
Unrecorded withdrawals ......... 300.00
Bank charges ................................. 7.00 406.40
Ending correct cash balance ... $12,272.25 Ending correct cash balance ... $12,272.25
Req. 2
Sergio should first correct the amount of cheque #123 by adding $27.00 to the balance and
reducing the account he debited, and then deduct the hydro bill ($44.10), Telus Corp. bill
($55.30), the bank charges ($7.00) and the withdrawals he made from instant teller
machines ($300).
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AP7–12
Req. 1
Comparison of deposits listed in the Cash account with deposits listed on the bank
statement reveals a $5,000 deposit in transit on August 31.
Req. 2
Comparison of the cheques cleared on the bank statement with (a) outstanding cheques
from July, and (b) cheques written in August reveals two outstanding cheques at the end of
August ($290 + $550 = $840).
Req. 3
MARTHA COMPANY
Bank Reconciliation, August 31, 2014
Company's Books Bank Statement
Ending balance per Cash Ending balance per bank
account ................................... $20,280 Statement............................... $18,370
Additions: Additions:
Note receivable collected........ $2,000 Deposits in transit .................... 5,000
Interest collected ...................... 180 2,180 23,370
Interest earned.......................... 80
22,540
Deductions: Deductions:
Bank service charges ...................................... 10 Outstanding cheques ............... 840
Ending correct cash balance ......................... $22,530 Ending correct cash balance .. $22,530
Req. 4
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AP7–11 (continued)
These entries are necessary because the changes in the regular Cash account have not yet
been recorded by the company. The bank has already recorded these items in its own
accounts. The Cash account (and the other accounts shown in the above entries) must be
brought up to date for financial statement purposes.
Req. 5
Balance in Cash account, i.e., ending correct cash balance .................................. $22,530
Balance in Cash on hand account ................................................................................... $ 200
Req. 6
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CASES AND PROJECTS
CP7–1
Req. 1
The company discloses its revenue recognition policy in Note 3 – Significant Accounting
Policies. Its recognizes revenue “when the amount can be reliably measured, when it is
probable that future economic benefits will flow to the entity and when specific criteria
have been met for each of the Company’s activities.”
Req. 2
Gross profit percentage = Gross profit / Net sales
2012: $3,497.9 ÷ $11,427.2 = 0.306 (30.6%)
2011: $3,060.7 ÷ $10,387.1 = 0.295 (29.5%)
Canadian Tire’s gross profit percentage increased very slightly in 2012. The increase may
have resulted from higher mark-up on merchandise cost and/or purchase of merchandise
from suppliers at lower cost.
Req. 3
The Company discloses details about its allowance for credit losses in Note 6.3.3 to its
financial statements. The disclosures are as follows:
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The Company reported the bad debt expense, which it labeled as impairment for credit
losses. It aalso reported the amount of receivables that was written off, and the amount the
was recovered from customers, after writing it off.
The receivables turnover for Gildan is 8.62. Canadian Tire’s ratio is much lower than
Gildan’s because of the nature of the products it sells, its credit policy and the speed of
collection from customers. Another possible difference is the amount of credit sales for
each company. The computation of the ratio assumes that all sales are on credit, but this
may not be true.
Req. 5
According to Note 3 the Company defines “cash and cash equivalents” as cash plus highly
liquid and rated certificates of deposit or commercial paper with an original term to
maturity of three months or less. Note 9 lists the items that are considered as Cash and cash
equivalents, including bank indebtedness.
Because cash and cash equivalents are essentially cash, the fair market value is extremely
close to the disclosed amount.
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CP7–2
Req. 1
Sales Discounts and Sales Returns and Allowances would likely be subtracted from Sales
Revenue in the computation of Net Sales.
Req. 2
RONA deducts the following expenses: cost of sales, selling, general and administrative
expenses, and gain on disposal of assets. These items are disclosed in Note 5.1 instead of
being reported on the income statement. In addition, RONA’s statement of earnings shows
deductions for goodwill impairment, restructuring costs, impairment of non-financial
assets, finance income, and finance costs in arriving at earnings before income taxes.
On the other hand, Canadian Tire expenses include: cost of producing revenue, distribution
costs, sales and marketing expenses, administrative expenses, finance income and finance
expense to arrive at earnings before income taxes. In summary, any differences in
presentation can be attributed to the preferences of the respective senior management
teams of the two companies.
RONA’s receivables turnover implies that RONA’s customers pay the amounts owed within
26.6 days on average (365/13.71). This average collection period is shorter than the actual
average collection period because we assume that all sales are on credit, which is not
realistic since many sales are made for cash (which includes use of debit cards and credit
cards). If we eliminate the cash transactions from the total revenue amount, the numerator
will decrease to reflect the amount of sales on credit. This will decrease the receivables
turnover and increase the average collection period.
Req. 4
Trade receivables decreased from $357,756 in 2011 to 354,482 during 2012. This decrease
indicates that RONA collected more cash from its customers than it had sales. This
increases the net cash inflow from operating activities for 2012.
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CP7–3
RONA’s gross profit percentage dropped by 1.2 percent in 2012. But, Canadian Tire’s gross
profit percentage increased by 1.1 percent during the same year. These ratios suggest that
Canadian Tire performed better than RONA in achieving a higher markup on the products it
sells.
RONA
2012: 4,884 / [(357.8 + 354.5) ÷ 2] = 13.71 times
2011: 4,805 / [(299.9 + 357.8) ÷ 2] = 14.61 times
Canadian Tire
2012: $11,427 / {[(829.3 + 4,081.7) + (750.6 + 4,265.7)] ÷ 2} = 2.30 times
2011: $10,387 / {[4,725 + (829.3 + 4,081.7)] ÷ 2} = 2.16 times
Canadian Tire’s turnover ratio improved slightly in 2012 while RONA’s dropped during the
same period. Canadian Tire’s relatively low ratio is the result of allowing customers to pay
later by charging their purchases on their Canadian Tire credit cards, and collecting from
customers at some date in the future, particularly when the Company offers them no
payment and no interest for a six-month period.
Req. 3
The ratio comparison indicates that RONA has performed better than the industry average,
while Canadian Tire’s ratio is much below the industry average. These ratios must be
interpreted properly by taking into consideration the credit policy of the company as well
as the simplifying assumption that all sales are made on account, which is not true.
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FINANCIAL REPORTING AND ANALYSIS CASES
Req. 1
The amount of trade receivables that is typically reported on the statement of financial
position is the net realizable value of these receivables, which is the gross amount of the
receivables minus the allowance for doubtful accounts. For Canadian Tire, this amount is
$4,873.7, which is split into a current portion of $4,265.7 and a long-term portion of
$608.0. Canadian Tire reports the first amount as Loans receivable under current assets,
and the second amount as a non-current asset.
Req. 2
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CP7–5
Canadian banks usually have fiscal years that end on October 31.
The Canadian Imperial Bank of Commerce has the highest ratio of the three banks in both
years. Notice that the ratios for 2012 increased slightly over their 2011 levels for all banks
because of the increased provisions for loan losses due the slowdown in economic activity.
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CP7–5 (continued)
Banks lend money to a variety of customers, and classify their loans receivable according to
the following main categories: residential mortgages, personal and credit card loans, and
business and government loans. The quality of the bank’s loans portfolio depends on the
financial health of the individuals and companies that borrow money from the bank. Based
on the ratios above, it appears that Scotiabank risks losing $0.81 for every $100 it has lent
to others whereas Royal Bank of Canada has a better quality loan portfolio than the other
two banks as it risks losing a smaller percentage of its loans to customers.
The ratio increased slightly for the Canadian Imperial Bank of Commerce, remained
unchanges for Scotiabank, and decreased by 4 percentage points for the Royal Bank of
Canada.
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CRITICAL THINKING CASES
CP7–6
Req. 1
(a) The opening of a new Account Receivable of $2,500 (an unusually large amount and
a “new” customer).
(b) The write-off of bad debts at year-end rather than during the year.
(c) The nearness of the creation of the new account receivable of $2,500 to the write-
offs of three accounts of regular customers for a sum of $2,500.
(d) The accounts written off were for “regular” credit customers (Jones, Blake, and
Sellers). Therefore it is questionable why they would default on payment.
i. At completion of the job, $2,500 was collected in cash from the new customer and
pocketed by the clerk-bookkeeper.
ii. To cover the theft, and yet provide a record of the transaction, a fictitious Account
receivable was debited for the $2,500, instead of Cash.
iii. When the three regular customers paid their accounts, Cash was debited for a total
of $2,500 and the fictitious Account Receivable credited for the same amount. The
regular customers' accounts were credited as bad debts so that they would neither
be billed nor have reason to call attention to incorrect balances. All the bookkeeper
had to do was find one account, or a combination of account balances, to write off a
total of $2,500. This was done: $800 + $750 + $950 = $2,500.
The auditor has a professional responsibility to report these concerns and findings to the
owner.
Req. 2
Recommendations:
(a) Report the circumstances to the owner. Do not recommend in respect to the clerk-
bookkeeper; the owner must make the personnel decisions involved.
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CP7–6 (continued)
(b) Recommendations on internal control measures:
(1) Separate cash-handling function from the related recordkeeping function.
(2) Establish a definite routine for handling cash receipts.
(3) Deposit all cash receipts intact each day.
(4) Make all payments (except for cash on hand payments) by cheque. Require
that supporting documents be attached to each cheque before signing.
Designate all such documents as PAID, i.e., cancelled, when the cheque is
signed (this will help prevent duplicate payments).
(5) Establish a cash on hand fund. For control assign it to one person who is not
involved in recordkeeping.
(6) Exercise strict control of write-offs of uncollectible accounts, including
approval by the owner.
(7) Continue the annual audit.
CP7–7
Req. 1
While there is some controversy about potential bias induced by prudent valuation of trade
receivables, this case is clear. Prudence refers to the understatement of assets (e.g.
uncollectible accounts) and overstatement of liabilities. In this case, the actual value of
trade receivables was only $5 million and a prudent valuation of the receivables would
have included a realistic provision for bad debt. Both the nominal value and the provision
would have been disclosed. ESB’s experience with collections from customers is a good
basis to determine the amount that is potentially uncollectible in order to report the net
realizable value of the receivables.
Req. 2
Legally it is understandable why BDO Seidman would not want to make public the
provisions of the settlement. It could make this accounting firm a target for future
frivolous law suits that would be very wasteful and costly to defend. Banco Espirito Santo,
the largest bank in Portugal would also prefer to keep any settlement, which was less than
the total amount lost, confidential from shareholders who might accuse the bank of failing
to vigorously defend the rights of the shareholders.
But for the profession in general the question is difficult to answer. Unfortunately when
secrets are kept, people tend to believe that bad news is being concealed. Their logic is that
if the news was good no one would want it to be secret. In legal matters such as this,
however, what is good news for one side would be bad news for the other side; such is the
nature of conflict. BDO Seidman would have done its best to reduce any financial penalty to
preserve the business and the reputation of its accountants. Even a single penny paid out
in penalties could be interpreted as an admission of negligence – and no accounting firm
would willingly make such an admission. To do so would leave the individuals and the firm
itself open to further disciplinary action by the American and Canadian accounting
professional bodies, which may or may not be justified. The tradeoff with respect to the
profession is that incidents such as this affect all major accounting firms and are quickly
forgotten once publicity dies out. Therefore uncertainty about the manner in which the
accounting profession conducts its business benefits from a quick end to public discussion.
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CP7–8
Req. 1
No change from
Projected change beginning of year
* ($963,808 + $650,270) ÷ 2
Req. 2
A decrease in trade receivables would increase cash by $313,538, all other items held
equal.
Req. 3
An increase in the receivables turnover ratio indicates that there has been an increase in
the number of times average trade receivables were recorded and collected during the
period. All other things equal, this indicates an increase in the rate at which receivables are
collected, which will increase cash flow from operating activities for the period. This can
benefit the company by providing additional liquidity for the company in its day-to-day
operations, reducing the need for additional borrowing and thereby avoiding more interest
costs.
CP7–9
The solution to this case will depend on the company and/or accounting period selected for
analysis.
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