SURVEY OF ACCOUNTING 7TH EDITION WARREN
SOLUTIONS MANUAL
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CHAPTER 6
RECEIVABLES AND INVENTORIES
CLASS DISCUSSION QUESTIONS
1. Receivables are normally classified as (1)
accounts receivable, (2) notes receivable, or
(3) other receivables.
2. Transactions in which merchandise is sold or
services are provided on credit generate
accounts receivable.
3. a. Current Assets
b. Investments
4. Examples of other receivables include
interest receivable, taxes receivable, and
receivables from officers or employees.
5. Carter’s should use the direct write-off
method because it is a small business that
has a relatively small number and volume of
accounts receivable.
6. The allowance method
7. Contra asset
8. The accounts receivable and allowance for
doubtful accounts may be reported at a net
amount of $428,200 ($475,000 – $46,800) in
the Current Assets section of the balance
sheet. In this case, the amount of the
allowance for doubtful accounts should be
shown separately in a note to the financial
statements or in parentheses on the balance
sheet. Alternatively, the accounts receivable
may be shown at the gross amount of
$475,000 less the amount of the allowance
for doubtful accounts of $46,800, thus
yielding net accounts receivable of $428,200.
9. (1) The percentage rate used is excessive in
relationship to the volume of accounts
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written off as uncollectible; hence, the
balance in the allowance is excessive.
(2) A substantial volume of old uncollectible
accounts is still being carried in the
accounts receivable account.
10. Manufacturing firms must accumulate the
costs for making product. The costs for
making product include materials, which are
included in materials inventory. Additional
costs, such as direct labor and factory
overhead, must be added to materials during
production. The work-in-process inventory
account accumulates these costs during
production. At the completion of production,
the work-in-process costs are transferred to
the finished goods inventory account. Upon
sale, the finished goods costs are transferred
to cost of goods sold, to be matched against
the revenue from sale. Since
merchandisers only purchase goods for
resale, they use a single inventory account,
Merchandise Inventory. Upon sale, the
merchandise inventory costs are transferred
to cost of merchandise sold, to be matched
against the revenue from sale. Thus,
accounting for the sale of completed goods is
similar for both types of firms.
11. No, they are not techniques for determining
physical quantities. The terms refer to cost
flow assumptions, which affect the determi-
nation of the cost prices assigned to items in
the inventory.
 12. No, the term refers to the flow of costs rather analyst will adjust earnings to what they
than the items remaining in the inventory. would have been under FIFO. This is
The inventory cost is composed of the because the liquidation of a LIFO reserve
earliest acquisitions costs rather than the abnormally inflates gross profit and net
most recent acquisitions costs. income.
13. a. FIFO c. FIFO 17. Current Assets
b. LIFO d. LIFO 18. Net realizable value (estimated selling price
14. FIFO less any direct cost of disposition, such as
sales commissions).
15. LIFO. In periods of rising prices, the use of
LIFO will result in the lowest taxable income 19. By a notation next to “merchandise inventory”
and thus the lowest income tax expense. on the balance sheet or in a note to the
financial statements.
16. The LIFO reserve is the difference between
the FIFO and LIFO inventory valuation. The
EXERCISES

E6–1

Accounts receivable from the U.S. government are significantly different from
receivables from commercial aircraft carriers such as Delta and United. Thus, Boeing
should report each type of receivable separately. In a recent filing with the Securities
and Exchange Commission, Boeing reports the receivables together on the balance
sheet, but discloses each receivable separately in a note to the financial statements.

E6–2

Due Date Interest Due at Maturity

a. Feb. 20 $450 [$40,000 × 0.09 × (45/360)]
b. May 22 $150 [$9,000 × 0.10 × (60/360)]
c. Aug. 28 $360 [$12,000 × 0.12 × (90/360)]
d. Dec. 28 $600 [$18,000 × 0.10 × (120/360)]
e. Nov. 30 $140 [$10,500 × 0.08 × (60/360)]

E6–3

a. MGM: 17.1% ($101,207,000 ÷ $592,937,000)

b. IBM: 2.2% ($256,000,000 ÷ $11,435,000,000)

c. Casino operations experience greater bad debt risk, since it is difficult to

control the creditworthiness of customers entering the casino. In addition,
individuals who may have adequate creditworthiness could overextend themselves
and lose more than they can afford if they get caught up in the excitement of

2
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 gambling. In contrast, IBM’s customers are primarily other businesses such as
aircraft manufacturers and retail store chains.

Note to Instructors: In a separate note in its 10-K SEC filing, MGM disclosed that its
casino accounts receivables of $347,679,000 have an estimated allowance for
doubtful accounts of $94,800,000, which as a percentage of casino receivables is
27.3% ($94,800,000 ÷ $347,679,000). The remaining receivables of MGM are primarily
related to its hotel operations.

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E6–4

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Statement
Cash + Receivable
Feb. 14. 9,000 –9,000

Statement of Cash Flows

Feb. 14. Operating 9,000

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Retained Statement
Accounts Receivable = Earnings
Feb. 14. –45,000 –45,000 Feb. 14.

Income Statement
Feb. 14. Bad debt
expense –45,000

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Retained Statement
Accounts Receivable = Earnings
Dec. 23. 45,000 45,000 Dec. 23.

Income Statement
Dec. 23. Bad debt
expense 45,000

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E6–4, Concluded

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Statement
Cash + Receivable
Dec. 23. 45,000 –45,000

Statement of Cash Flows

Dec. 23. Operating 45,000

E6–5

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Statement
Cash + Receivable
Jan. 31. 8,000 –8,000

Statement of Cash Flows

Jan. 31. Operating 8,000

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Allowance for Statement
Receivable – Doubtful Accounts
Jan. 31. –32,000 32,000

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E6–5, Concluded

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Allowance for Statement
Receivable – Doubtful Accounts
Nov. 2. 32,000 –32,000

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Statement
Cash + Receivable
Nov. 2. 32,000 –32,000

Statement of Cash Flows

Nov. 2. Operating 32,000

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E6–6

a.

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Retained Statement
Receivable = Earnings
–11,575 –11,575

Income Statement
Bad debt
expense –11,575

b.

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accts. Allowance for Statement
Rec. – Doubtful Accounts
–11,575 +11,575

E6–7

Estimated balance of Allowance for Doubtful Accounts: $73,500

Computed as shown below.

Estimated
Uncollectible Accounts
Age Interval Balance Percent Amount
Not past due ............................................... $1,350,000 2% $27,000
1–30 days past due .................................... 600,000 3 18,000
31–60 days past due .................................. 90,000 5 4,500
61–90 days past due .................................. 40,000 15 6,000
91–180 days past due ................................ 20,000 50 10,000
Over 180 days past due ............................. 10,000 80 8,000
Total ....................................................... $2,110,000 $73,500

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E6–8

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows – Allowance for Retained Statement
Doubtful Accounts = Earnings
Dec. 31. –62,200 –62,200 Dec.31.

Income Statement
Dec. 31. Bad debt
expense –62,200

Note: $62,200 = $73,500 – $11,300

E6–9

a. $108,000 ($21,600,000 × 0.005) c. $162,000 ($21,600,000 × 0.0075)

b. $125,000 ($145,000 – $20,000) d. $148,000 ($130,000 + $18,000)

E6–10

$516,250 [$590,000 + $40,000 – ($6,500,000 × 1¾%)]

E6–11

a. $579,000 [$625,000 + $80,000 – ($7,200,000 × 1¾%)]

b. $119,750 [($113,750 – $40,000) + ($126,000 – $80,000)]

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E6–12

a. The three different inventories accumulate manufacturing costs as the product is

being produced. Costs flow through these accounts until the product is sold, and
the cost is matched on the income statement as cost of goods sold, shown as
follows:
Materials Work-in-Process Finished Goods Cost of
Inventory Inventory Inventory Goods Sold

b. The materials inventory includes the cost of purchased parts and materials needed
to manufacture wireless communication devices. Work-in-process inventory
accumulates direct materials, direct labor, and factory overhead costs that are
incurred during production. The finished goods inventory includes the direct
labor, direct materials, and factory overhead costs for completed product.

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E6–13

a. The asset categories reflect the life cycle of a film. The initial “In development” costs
are associated with efforts to develop a new film. These costs would include the
salaries of writers and other creative people to develop film concepts and
ideas. Once a film is accepted for production, the costs are reclassified as “In
production” (in process). Additional production costs, including salaries for actors
and actresses, are now accumulated. Once a film is released (completed), the costs
are transferred to the “In release” category.

b. The description above sounds similar to a manufacturing firm. Raw materials (in
development) are transferred to work in process (in process), then to finished goods
(completed). Thus, the reclassification of costs through different asset categories
as the film becomes more complete is similar to a manufacturing firm. However,
with manufactured product, once the product is sold the costs are shown on the
income statement as cost of goods sold. In other words, all of the costs are matched
against the revenue. For DreamWorks, when a film is released, the costs of the
completed film do not all immediately flow to the income statement. Rather, the
costs are classified as an asset, termed “released,” and amortized over a short time
period (around three years). This reflects the belief that films can generate revenue
longer than the year in which they are first released. This application of the matching
principle is reasonable since such films earn revenues on television, in foreign
markets, and in DVD sales.

E6–14

a. $148,500 (90 units at $1,650)

b. $114,480 [(54 units × $1,200) + (36 units × $1,380)] = $64,800 + $49,680
c. $133,920 (90 units at $1,488; $595,200 ÷ 400 units = $1,488)
Cost of merchandise available for sale:
54 units at $1,200 ..................................................... $ 64,800
108 units at $1,380 ..................................................... 149,040
126 units at $1,560 ..................................................... 196,560
112 units at $1,650 ..................................................... 184,800
400 units (at average cost of $1,488) ....................... $595,200

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E6–15

Cost
Merchandise Merchandise
Inventory Method Inventory Sold
a. FIFO ..................... $7,728 $21,522
b. LIFO ..................... 6,660 22,590
c. Average cost ....... 7,215 22,035
Cost of merchandise available for sale:
42 units at $180 ........................................................ $ 7,560
58 units at $195 ........................................................ 11,310
20 units at $204 ........................................................ 4,080
30 units at $210 ........................................................ 6,300
150 units (at average cost of $195) .......................... $29,250
a. First-in, first-out:
Merchandise inventory:
30 units at $210 ........................................................ $ 6,300
7 units at $204 ........................................................ 1,428
37 units ..................................................................... $ 7,728
Merchandise sold:
$29,250 – $7,728 ....................................................... $21,522
b. Last-in, first-out:
Merchandise inventory:
37 units at $180 ........................................................ $ 6,660
Merchandise sold:
$29,250 – $6,660 ....................................................... $22,590
c. Average cost:
Merchandise inventory:
37 units at $195 ($29,250/150 units) ....................... $ 7,215
Merchandise sold:
$29,250 – $7,215 ....................................................... $22,035

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E6–16

1. a. FIFO inventory > (greater than) LIFO inventory

b. FIFO cost of goods sold < (less than) LIFO cost of goods sold
c. FIFO net income > (greater than) LIFO net income
d. FIFO income tax > (greater than) LIFO income tax

2. In periods of rising prices, the income shown on the company’s tax return would be
lower than if FIFO were used; thus, there is a tax advantage of using LIFO.

Note to Instructors: The federal tax laws require that if LIFO is used for tax purposes,
LIFO also must be used for financial reporting purposes. This is known as the LIFO
conformity rule. Thus, selecting LIFO for tax purposes means that the company’s
reported income also will be lower than if FIFO had been used. Companies using LIFO
believe the tax advantages from using LIFO outweigh any negative impact of reporting
a lower income to shareholders.

E6–17

1. The interest receivable should be reported separately as a current asset. It should

not be deducted from notes receivable.

2. The allowance for doubtful accounts should be deducted from accounts receivable.

A corrected partial balance sheet would be as follows:

ZABEL COMPANY
Balance Sheet
December 31, 20Y4
Assets
Current assets:
Cash ............................................................................ $ 75,000
Notes receivable ........................................................ 115,000
Accounts receivable .................................................. $475,000
Less allowance for doubtful accounts ............... 11,150 463,850
Interest receivable ..................................................... 9,000

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E6–18

A B C D E F G
1 Unit Unit Total
2 Inventory Cost Market
3 Commodity Quantity Price Price Cost Market LCM
4 Buffalo 35 $115 $120 $ 4,025 $ 4,200 $ 4,025
5 Dakota 67 90 75 6,030 5,025 5,025
6 Frontier 8 300 280 2,400 2,240 2,240
7 Midwest 83 40 30 3,320 2,490 2,490
8 Rainbow 100 90 94 9,000 9,400 9,000
9 Total $ 24,775 $ 23,355 $ 22,780

E6–19

The merchandise inventory would appear in the Current Assets section, as follows:
Merchandise inventory—at lower of cost (FIFO) or market ........ $22,780
Alternatively, the details of the method of determining cost and the method of valuation
could be presented in a note.

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 PROBLEMS

P6–1

1.
A B C D E F G H
1 Aging-of-Receivables Schedule
2 December 31, 20Y7
3 Days Past Due
Not Past Over
4 Customer Balance Due 1–30 31–60 61–90 91–120 120
5 AAA Beauty 19,500 19,500
6 Amelia’s Wigs 8,000 8,000

30 Zim’s Beauty 6,100 6,100

31 Totals 880,000 575,000 140,500 82,700 36,000 25,000 20,800
32 Percent uncollectible 1% 2% 8% 15% 35% 80%
Estimate of
33 uncollectible accounts 45,966 5,750 2,810 6,616 5,400 8,750 16,640

2.

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows – Allowance for Retained Statement
Doubtful Accounts = Earnings
20Y7 20Y7
Dec. 31. –42,466* –42,466 Dec. 31.

Income Statement
20Y7 Bad debt
Dec. 31. expense –42,466

*$42,466 = $45,966 – $3,500

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 P6–1, Continued

3.

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows – Allowance for Retained Statement
Doubtful Accounts = Earnings
20Y7 20Y7
Dec. 31. –62,500* –62,500 Dec. 31.

Income Statement
20Y7 Bad debt
Dec. 31. expense –62,500

*$62,500 = $5,000,000 × 1.25%

4.

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Allowance for Statement
Receivable – Doubtful Accounts
20Y8
Mar. 4. –4,350 4,350

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 P6–1, Continued

5.

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Allowance for Statement
Receivable – Doubtful Accounts
20Y8
Aug. 17. 4,350 –4,350

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Statement
Cash + Receivable
20Y8
Aug. 17. 4,350 –4,350

Statement of Cash Flows

20Y8
Aug. 17. Operating 4,350

6. a.

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Retained Statement
Accounts Receivable = Earnings
20Y8 20Y8
Mar. 4. –4,350 –4,350 Mar. 4.

Income Statement

20Y8 Bad debt

Mar. 4. expense –4,350

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 P6–1, Concluded

6. b.

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Retained Statement
Accounts Receivable = Earnings
20Y8 20Y8
Aug. 17. 4,350 4,350 Aug. 17.

Income Statement
20Y8 Bad debt
Aug. 17. expense 4,350

Balance Sheet
Statement of Assets = Liabilities + Stockholders’ Equity Income
Cash Flows Accounts Statement
Cash + Receivable
20Y8
Aug. 17. 4,350 –4,350

Statement of Cash Flows

20Y8
Aug. 17. Operating 4,350

7. Amazon.com uses the allowance method of accounting for uncollectible

accounts receivable. Generally accepted accounting principles require that
companies with a large amount of receivables use the allowance method.

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 P6–2

1.
a. b.
Addition to Allowance Accounts Written
Year for Doubtful Accounts Off During Year

20Y2 $31,250 ($12,500,000 × 0.0025) $18,450 ($31,250 – $12,800)

20Y3 31,500 ($12,600,000 × 0.0025) 21,300 ($12,800 + $31,500 – $23,000)
20Y4 32,000 ($12,800,000 × 0.0025) 21,000 ($23,000 + $32,000 – $34,000)
20Y5 32,500 ($13,000,000 × 0.0025) 17,500 ($34,000 + $32,500 – $49,000)
2. a. The estimate of ¼ of 1% of credit sales may be too large, since the
allowance for doubtful accounts has steadily increased each year. The
increasing balance of the allowance for doubtful accounts also may be due
to the failure to write off a large number of uncollectible accounts. These
possibilities could be evaluated by examining the accounts in the
subsidiary ledger for collectibility and comparing the result with the
balance in the allowance for doubtful accounts.
Note to Instructors: Since the amount of credit sales has been fairly uniform over
the years, the increase cannot be explained by an expanding volume of sales.

b. The balance of Allowance for Doubtful Accounts that should exist at

December 31, 20Y5, can only be determined after all attempts have been
made to collect the receivables on hand at December 31, 20Y5. However,
the account balances at December 31, 20Y5, could be analyzed, perhaps
using an aging schedule, to determine a reasonable amount of allowance
and to determine accounts that should be written off. Also, past write-offs
of uncollectible accounts could be analyzed in depth in order to develop a
reasonable percentage for future adjusting entries, based on past history.
Caution must be exercised, however, in using historical percentages.
Specifically, inquiries should be made to determine whether any significant
changes between prior years and the current year may have
occurred, which might reduce the accuracy of the historical data. For
example, a recent change in credit-granting policies or changes in the
general economy (entering a recessionary period, for example) could
reduce the usefulness of analyzing historical data.
Based on the preceding analyses, a recommendation to decrease the
annual rate charged as an expense may be in order (perhaps EquiPrime
Co. is experiencing a lower rate of uncollectibles than is the industry
average), or perhaps a change to the “estimate based on analysis of
receivables” method may be appropriate.

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 P6–3

1. Bad Debt Expense

Increase Balance of
Expense Expense (Decrease) Allowance
Actually Based on in Amount Account,
Year Reported Estimate* of Expense End of Year
1 $ 5,000 $ 11,500 $ 6,500 $ 6,500
2 9,000 23,750 14,750 21,250
3 23,000 45,000 22,000 43,250
4 37,500 48,000 10,500 53,750

*Determined by multiplying sales by 0.005 as follows:

Year 1: $11,500 = $2,300,000 × 0.005
Year 2: $23,750 = $4,750,000 × 0.005
Year 3: $45,000 = $9,000,000 × 0.005
Year 4: $48,000 = $9,600,000 × 0.005

2. Yes. The actual write-offs of accounts originating in the first two years are
reasonably close to the expense that would have been charged to those years
on the basis of ½% of sales. The total write-off of receivables originating in the
first year amounted to $11,000 ($5,000 + $4,000 + $2,000), as compared with
bad debt expense, based on the percentage of sales, of $11,500. For the second
year, the comparable amounts were $22,500 ($5,000 + $12,000 + $5,500) and
$23,750.

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 P6–4

1. First-In, First-Out Method

Model Quantity Unit Cost Total Cost
101Sx 6 $225 $ 1,350
3 222 666
256Br 4 140 560
4 130 520
378Wh 4 317 1,268
590Pm 2 535 1,070
2 530 1,060
661Qu 6 542 3,252
1 549 549
828Ts 2 232 464
913Vn 12 39 468
Total ................................................................. $11,227

2. Last-In, First-Out Method

Model Quantity Unit Cost Total Cost
101Sx 9 $213 $ 1,917
256Br 8 120 960
378Wh 4 305 1,220
590Pm 2 520 1,040
2 527 1,054
661Qu 6 520 3,120
1 531 531
828Ts 2 222 444
913Vn 8 35 280
4 36 144
Total ................................................................. $10,710

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 P6–4, Concluded

3. Average Cost Method

Model Quantity Unit Cost* Total Cost
101Sx 9 $218 $ 1,962
256Br 8 126 1,008
378Wh 4 311 1,244
590Pm 4 528 2,112
661Qu 7 534 3,738
828Ts 2 227 454
913Vn 12 37 444
Total ................................................................. $10,962

*Computations of unit costs:

101Sx: $218 = [(9 × $213) + (7 × $215) + (6 × $222) + (6 × $225)] ÷ (9 + 7 + 6 + 6)
256Br: $126 = [(20 × $120) + (12 × $130) + (4 × $130) + (4 × $140)] ÷ (20 + 12 + 4 + 4)
378Wh: $311 = [(6 × $305) + (3 × $310) + (3 × $316) + (4 × $317)] ÷ (6 + 3 + 3 + 4)
590Pm: $528 = [(2 × $520) + (2 × $527) + (2 × $530) + (2 × $535)] ÷ (2 + 2 + 2 + 2)
661Qu $534 = [(6 × $520) + (8 × $531) + (4 × $549) + (6 × $542)] ÷ (6 + 8 + 4 + 6)
828Ts: $227 = [(4 × $222) + (4 × $232)] ÷ (4 + 4)
913Vn: $37 = [(8 × $35) + (12 × $36) + (16 × $37) + (14 × $39)] ÷ (8 + 12 + 16 + 14)

4. a. During periods of rising prices, the LIFO method will result in a lesser
amount of inventory, a greater amount of the cost of merchandise sold, and
a lesser amount of net income than the other two methods. For
Icelander Appliances, the LIFO method would be preferred for the current
year, since it would result in a lesser amount of income tax.
b. During periods of declining prices, the FIFO method will result in a lesser
amount of net income and would be preferred for income tax purposes.

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 P6–5
Inventory Sheet
December 31, 20Y9
Unit Unit Total
Inventory Cost Market
Description Quantity Price Price Cost Market LCM
112Aa 38 25 $ 80 $ 83 $ 2,000 $2,075
13 78 1,014 1,079
3,014 3,154 $ 3,014
B300t 33 118 115 3,894 3,795 3,795
C39f 41 20 66 64 1,320 1,280
21 70 1,470 1,344
2,790 2,624 2,624
Echo9 125 25 26 3,125 3,250 3,125
F900w 18 10 565 550 5,650 5,500
8 560 4,480 4,400
10,130 9,900 9,900
H687 60 15 15 900 900 900
J023 5 385 390 1,925 1,950 1,925
L33y 375 6 6 2,250 2,250 2,250
R66b 90 80 22 18 1,760 1,440
10 21 210 180
1,970 1,620 1,620
S77x 6 5 250 235 1,250 1,175
1 260 260 235
1,510 1,410 1,410
T882m 130 100 20 18 2,000 1,800
30 19 570 540
2,570 2,340 2,340
Z55p 12 9 750 746 6,750 6,714
3 749 2,247 2,238
8,997 8,952 8,952
Totals $43,075 $42,145 $41,855

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 FINANCIAL ANALYSIS

FA6–1

1. Year 2 Year 1
Accounts receivable turnover:
$62,071 ÷ $9,970 ............................ 6.2
$61,494 ÷ $9,340 ............................ 6.6

2. Number of days’ sales in receivables:

365 days ÷ 6.2 ................................ 58.9 days
365 days ÷ 6.6 ................................ 55.3 days

3. Inventory turnover:
$48,260 ÷ $1,353 ............................ 35.7
$50,098 ÷ $1,176 ............................ 42.6

4. Number of days’ sales in inventory:

365 days ÷ 35.7 .............................. 10.2 days
365 days ÷ 42.6 .............................. 8.6 days

5. Dell Inc.’s management of both receivables and inventory has declined from
Year 1 to Year 2. Dell is collecting its accounts receivable slower in Year 2. Its
accounts receivable turnover declined from 6.6 in Year 1 to 6.2 in Year 2, while
its number of days’ sales in receivables increased from 55.3 days in Year 1 to
58.9 days in Year 2. Likewise, Dell is selling its inventory at a slower rate. Its
inventory turnover declined from 42.6 in Year 1 to 35.7 in Year 2, while its
number of days’ sales in inventory increased from 8.6 days in Year 1 to 10.2
days in Year 2. These declines may be due to depressed economic conditions
or symptoms of underlying problems that need to be corrected. A comparison
with competitors’ results would be useful in answering this later question.

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 FA6–2

1. Year 2 Year 1
Accounts receivable turnover:
$120,357 ÷ $20,523 ........................ 5.9
$127,245 ÷ $21,427 ........................ 5.9

2. Number of days’ sales in receivables:

365 days ÷ 5.9 ................................ 61.9 days
365 days ÷ 5.9 ................................ 61.9 days

3. Inventory turnover:
$92,385 ÷ $6,904 ............................ 13.4
$97,418 ÷ $6,978 ............................ 14.0

4. Number of days’ sales in inventory:

365 days ÷ 13.4 .............................. 27.2 days
365 days ÷ 14.0 .............................. 26.1 days

5. Hewlett-Packard Company’s management of receivables has remained the

same from Year 1 to Year 2. Its accounts receivable turnover is 5.9 in Years 1
and 2. Thus, the number of days’ sales in receivables is 61.9 days in Years 1
and 2. However, Hewlett-Packard is selling its inventory at a slightly slower
rate. Its inventory turnover declined from 14.0 in Year 1 to 13.4 in Year 2, while
its number of days’ sales in inventory increased from 26.1 days in Year 1 to
27.2 days in Year 2.

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 FA6–3

The results of FA6–1 and FA6–2 for Dell and Hewlett-Packard are summarized
below.
Dell Inc. Hewlett-Packard
Year 2 Year 1 Year 2 Year 1
Accounts receivable turnover ................ 6.2 6.6 5.9 5.9
Number of days’ sales in receivables.... 58.9 55.3 61.9 61.9
Inventory turnover................................... 35.7 42.6 13.4 14.0
Number of days’ sales in inventory ....... 10.2 8.6 27.2 26.1

Dell’s accounts receivable turnover and number of days’ sales in receivables are
slightly better than Hewlett-Packard’s. The major difference between the two
companies is the management of inventory. Dell has a much higher inventory
turnover and a lower number of days’ sales in inventory than does Hewlett-
Packard. This may be due to the fact that Hewlett-Packard sells more of its products
through retailers such as Best Buy than does Dell, which often sells directly to
consumers based upon their specific orders.

FA6–4

1. Year 2 Year 1
Accounts receivable turnover:
$65,030 ÷ $12,568 .......................... 5.2
$61,587 ÷ $12,219 .......................... 5.0

2. Number of days’ sales in receivables:

365 days ÷ 5.2 ................................ 70.2 days
365 days ÷ 5.0 ................................ 73.0 days

3. Inventory turnover:
$20,350 ÷ $5,832 ............................ 3.5
$18,792 ÷ $5,279 ............................ 3.6

4. Number of days’ sales in inventory:

365 days ÷ 3.5 ................................ 104.3 days
365 days ÷ 3.6 ................................ 101.4 days

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 FA6–4, Concluded

5. Johnson & Johnson is collecting its accounts receivable slightly faster in Year
2. Its accounts receivable turnover increased from 5.0 in Year 1 to 5.2 in Year
2, while its number of days’ sales in receivables decreased from 73.0 days in
Year 1 to 70.2 days in Year 2. However, Johnson & Johnson is selling its
inventory at a slightly slower rate. Its inventory turnover declined from 3.6 in
Year 1 to 3.5 in Year 2, while its number of days’ sales in inventory increased
from 101.4 days in Year 1 to 104.3 days in Year 2. Overall, the managing of
receivables and inventories remained approximately the same in Years 1 and
2.

FA6–5

1. International
Paper Walmart
Accounts receivable turnover:
$26,034 ÷ [($3,378 + $3,782) ÷ 2] .. 7.3
$446,950 ÷ [($5,089 + $5,937) ÷ 2] 81.1

2. Number of days’ sales in receivables:

365 days ÷ 7.3 ................................ 50.0 days
365 days ÷ 81.1 .............................. 4.5 days

3. Inventory turnover:
$18,960 ÷ [($2,347 + $2,320) ÷ 2] .. 8.1
$335,127 ÷ [($36,437 + $40,714) ÷ 2] 8.7

4. Number of days’ sales in inventory:

365 days ÷ 8.1 ................................ 45.1 days
365 days ÷ 8.7 ................................ 42.0 days

5. International Paper’s accounts receivable turnover of 7.3 is significantly less

than Walmart’s 81.1 accounts receivable turnover. Likewise, International
Paper’s number of days’ sales in receivables of 50.0 is significantly more than
Walmart’s 4.5 number of days’ sales in receivables. These differences are likely
due to Walmart selling directly to consumers who use cash or credit cards. In
contrast, International Paper sells primarily to other companies. The inventory
turnover and number of days’ sales in inventory are similar for the two
companies even though their operations differ significantly.

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 CASES

Case 6–1

By computing interest using a 365-day year for depository accounts (payables),

Sybil is minimizing interest expense to the bank. By computing interest using a
360-day year for loans (receivables), Sybil is maximizing interest revenue to the
bank. However, federal legislation (Truth in Lending Act) requires banks to
compute interest on a 365-day year. Hence, Sybil is behaving in an unprofessional
manner.

Case 6–2

Because of the size and number of customers’ accounts, it is probably

unreasonable for Northern Construction Supplies Co. not to allow credit to
contractors and to require cash or credit card payment. To do so, as Janet points
out, would probably cost Northern most of its contractor customers. Thus,
Northern is faced with having to allow credit to its contracting customers.
Many building contractors obtain construction loans from local financial
institutions. They are then allowed to draw upon (withdraw) these funds as portions
of the construction are completed. Most of the time, a representative of the financial
institution granting the construction loan must approve the disbursement based
upon an observation of the work to verify that it was actually performed. Building
contractors are, of course, charged interest on the balances withdrawn from their
construction loans. Thus, building contractors have an incentive to delay payment
of construction bills as long as possible. At the same time, it is unreasonable to
expect payment from the contractors until the representative of the financial
institution has approved payment. Thus, it is probably reasonable to expect that
accounts will remain open for 30–45 days after the contractor has received the
materials.

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 Case 6–2, Concluded

The primary problem that Northern Construction Supplies Co. is facing is that
some contractors are apparently abusing Northern’s liberal credit policy. One
alternative would be for Northern to allow a discount for payment within 30 days.
For example, Northern might allow a 2% discount if the bill is paid within 30 days.
Credit then might be discontinued for any contractor with a bill outstanding more
than 60 days. This would provide the contractors an incentive to pay their bills
early. That is, a 2% discount for payment 30 days early (the bill must be paid within
60 days) is equivalent to an annual interest rate of 24% (2% × 360 ÷ 30). This
discount rate would easily exceed most interest rates on construction loans. Such
a payment policy would give contractors a “positive” incentive to pay early. Before
initiating such a policy, Northern should consider its effect on profits. Does the
discount offered compensate for the faster collection of accounts
receivable? For example, earlier payments would allow Northern to earn interest
(profit) on the monies received from the contractors.
Note: Statement of activity indicates most contractors pay their receivables, but
they just take their time.
An alternative approach would be to charge contractors interest on past due
accounts. For example, Northern might charge accounts over 60 days past due
interest at 1½% per month (equivalent to approximately 18% per year). This
approach would be more of a “negative” approach to motivating contractors to pay
earlier.
Finally, yet another approach would be to stop extending credit to contractors who
routinely abuse Northern’s liberal credit policy. However, this approach is more
extreme than the preceding two approaches. It might be more appropriate for
contractors who continue to abuse the credit policy after one of the preceding
approaches has been implemented.
Regardless of the approach chosen, exceptions probably should be allowed for
good customers who suffer unusual situations. For example, a contractor’s bill
might be past due because of unforeseen construction problems, such as bad
weather, disagreement on contract specifications, etc.

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 Case 6–3

Since the title to merchandise shipped FOB shipping point passes to the buyer
when the merchandise is shipped, the shipments made before midnight, December
31, 20Y1, should properly be recorded as sales for the fiscal year ending
December 31, 20Y1. Hence, Gene Lumpkin is behaving in a professional manner.
However, Gene should realize that recording these sales in 20Y1 precludes them
from being recognized as sales in 20Y2. Thus, accelerating the shipment of
orders to increase sales of one period will have the effect of decreasing sales of
the next period.

Case 6–4

In developing a response to Evan’s concerns, you should probably first emphasize

the practical need for an assumption concerning the flow of cost of goods
purchased and sold. That is, when identical goods are frequently purchased, it may
not be practical to specifically identify each item of inventory. If all the identical
goods were purchased at the same price, it wouldn’t make any difference for
financial reporting purposes which goods we assumed were sold first, second, etc.
However, in most cases, goods are purchased over time at different prices, and,
hence, a need arises to determine which goods are sold so that the price (cost) of
those goods can be matched against the revenues to determine operating income.
Next, you should emphasize that accounting principles allow for the fact that the
physical flow of the goods may differ from the flow of costs. Specifically,
accounting principles allow for three cost flow assumptions: first-in, first-out; last-
in, first-out; and average cost. Each of these methods has advantages and
disadvantages. One primary advantage of the last-in, first-out method is that it
better matches current costs (the cost of goods purchased last) with current
revenues. Therefore, the reported operating income is more reflective of current
operations and what might be expected in the future. Another reason that the last-
in, first-out method is often used is that it tends to minimize taxes during periods
of price increases. Since for most businesses prices tend to increase, the LIFO
method will generate lower taxes than will the alternative cost flow methods.
The preceding explanation should help Evan better understand LIFO and its impact
on the financial statements and taxes.

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