Chapter 7 Solution of fundamental of financial accouting by EDMONDS (4th edition)

ANSWERS TO QUESTIONS - CHAPTER 7

1. Accounts receivable are the expected future receipts when a company permits one of its customers to buy now and pay later. The amounts are usually small with a short term to maturity. Notes Receivable have longer terms to maturity and are usually for larger amounts. The note specifies the maturity date, interest rate, and other credit terms.

2. The net realizable value is the amount expected to be collected from accounts receivable. It is the face amount of receivables less an allowance for uncollectible accounts.

3. The going concern assumption is based upon the premise that since companies believe that they will continue to operate, they assume that they will be responsible for paying the full balance of their obligations. Accordingly, receivables are carried at net realizable value and payables at full value on the balance sheet.

4. The allowance method is a method of accounting for bad debts where bad debts are estimated and expensed in the same period in which the corresponding sales are recognized. The receivables are reported at net realizable value in the financial statements. The direct write-off method is the practice of recognizing bad debt expense only when accounts are determined to be uncollectible.

5. The most common format for reporting accounts receivable on the balance sheet is gross receivables less the allowance for doubtful accounts. This format allows the users to see both the total amount owed by the customers and the amount the company expects to collect.

6. Estimating bad debts expense improves the accuracy of financial statements by (1) reporting expected realizable value of receivables (i.e., future cash flows) and (2) presenting a better matching of expenses with related revenues. This provides a better measure of managerial performance.

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7. The practice of reestablishing a previously written off account, then recording its collection as a payment on account, reflects a complete record of account activity. Such a record provides an accurate picture of the source of cash flows and improves the customer’s credit history.

8. Factors for use in estimating bad debts include:(1) the percentage of uncollectible accounts from years' past.(2) adjustment for new circumstances that are anticipated to be experienced in the future.(3) industry averages or experiences of similar businesses.(4) examination of current accounts and company credit

policies.

9. Recognizing bad debts expense reduces accounts receivable on the asset side and reduces the retained earnings on the equity side.

10. A write-off of an uncollectible account when the allowance method is used has no effect on the accounting equation because the allowance account, a contra asset account, is reduced and the accounts receivable account, also on the asset side, is reduced.

When the direct method is used, a write-off of an uncollectible account reduces assets (accounts receivable) and reduces retained earnings (increases bad debts expense).

11. The recovery of a bad debt when the allowance method is used does not affect the income statement. Only accounts receivable, cash, and allowance for doubtful accounts are affected. Cash flow from operations increases as a result of the collection.

12. The advantage of using the allowance method is that it improves the accuracy of the financial statements; the advantage of using the direct write-off method is that it is convenient to use.

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13. The direct write-off method is not GAAP, but is allowed if the amount of uncollectible accounts is immaterial (i.e., insignificant).

14. It is generally beneficial to accept major credit cards because the business then avoids the risk of bad debts as well as the cost of maintaining credit records. It may also attract more customers.

15. The acceptance of major credit cards enables a business to avoid the cost of uncollectible accounts and the clerical costs of maintaining accounts receivable records. In addition, the business avoids the implicit cost of lost opportunities due to delayed cash flows.

16. Warranty - a promise to correct a deficiency or dissatisfaction in quality, quantity, or performance.

17. The recognition of warranty expense reduces the amount of retained earnings shown on the balance sheet and reduces net income on the income statement. It also increases the amount of liabilities on the balance sheet.

18. Warranty cost is shown on the statement of cash flows when the actual cost is incurred (i.e., paid).

19. At maturity, the amount due on an interest-bearing note is the face amount plus accrued interest. Discount notes have the interest included in the face value of the note.

20. The carrying value of a discount note is computed by subtracting the amount of unamortized interest held in the discount on notes payable account from the face value amount shown in the notes payable account.

21. The effective rate of interest is higher on the discounted note because the actual amount of interest paid is more than the amount of the discount rate applied to the amount of cash received at issue. The amount received when making discount notes is less than that of interest-bearing notes because the interest portion is subtracted.

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Discounted Interest Bearing

Face Value $10,000$10,000Less: Discount ($10,000 x .12) (1,200) -0- Proceeds $ 8,800 $10,000

Effective Interest Rate:Discounted Note: $1,200 $8,800 = 13.6%Interest-Bearing Note: $1,200 $10,000 = 12.0%

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22. Amortization of discount reduces net income on the income statement, increases the carrying value of notes payable on the balance sheet, and does not affect the statement of cash flows.

23. Event Effect on Accounting Equation

Issuing Discount Note Increase in Cash (asset); Increase in Notes Payable (liability); Increase in Discount on Notes Payable (contra liability)

Amortization of Discount Decrease in Discount on Notes Payable (contra liability); Decrease in Retained Earnings (equity)

Payment of Note at MaturityDecrease in Cash (asset); Decrease in Notes Payable (liability)

24. Discount on Notes Payable is a contra-liability account that is subtracted from the face value of the note to determine the carrying value of the liability.

25. AccountsReceivable = Sales Turnover Accounts Receivable

The A/R turnover tells how many times during the year on average accounts receivable is collected (i.e., converted to cash).

26. Average Daysto Collect = 365 Accounts Receivable Accounts Receivable Turnover

This ratio tells the user how many days it takes a company to collect its accounts receivable.

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27. No, accounting terminology is not even standard in English-speaking countries. In the U.K. sales is called “turnover,” inventory is “stocks,” and the “gearing ratio” refers to the debt-to-assets ratio. Knowing this terminology is important for companies involved in international trade.

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SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 7

EXERCISE 7-1Aa. and c.

Stateline Auto ServiceT-Accounts

Assets = Liabilities + Stockholders’ Equity

Cash Retained Earnings2004 20042. 18,000 cl 19,800Bal.

18,000 Bal.

19,800

20053. 19,000 Service RevenueBal.

37,000 2004

cl 20,000

1. 20,000

Accounts Receivable Bal.

-0-

2004 20051. 20,000 2. 18,000 2. 22,000Bal.

2,000 Bal.

22,000

20052. 22,000 1. 160 Bad Debts Expense

3. 19,000 2004

Bal.

4,840 3. 200 cl 200

Bal.

-0-

Allow. For Bad Debts 2005

2004 4. 220 3. 200 Bal

.220

Bal.

200

20051. 160 4. 220

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Bal.

260

Note: Closing entries for 2005 were not made because they were not necessary to answer the questions.

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EXERCISE 7-1 (cont.)

b. (1) Net Income for 2004: $19,800 ($20,000 $200)(2) Net Cash Flow from Operating Activities:$18,000(3) Balance of Accounts Receivable, 12/31/2004: $2,000(4) Net Realizable Value of Accounts Receivable,

12/31/2004: $1,800 ($2,000 $200)

c. (1) Net Income for 2005: $21,780 ($22,000 $220)(2) Net Cash Flow from Operating Activities:$19,000(3) Balance of Accounts Receivable, 12/31/2004:

$4,840(4) Net Realizable Value of Accounts Receivable,

12/31/2004: $4,580 ($4,840 $260)

7-9

EXERCISE 7-2A

Event

Assets

=Liab.

+ S. Equity

Rev.

– Exp.

= Net Inc.

Cash Flow

1. + NA + + NA + NA2. +/ NA NA NA NA NA + OA3. NA NA + NA4. +/ NA NA NA NA NA NA

7-10

EXERCISE 7-3A

a. Analyze the Accounts Receivable account:

Accounts Receivable

Beginning Balance $ 2,000

Plus: Revenue on Account 9,000Less: Write-off (110)Less: Ending Balance (2,200

)Collections of Accounts Rec.

$ 8,690

b. Analyze the Allowance for Doubtful Accounts account:

Allowance for Doubtful Accounts

Beginning Balance $100Less: Write-off (110)Less: Ending Balance (170)Bad Debts Expense $180

Note to Instructor: This information can also be shown in T-Account format.

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EXERCISE 7-4A

Selected T-Accounts:

Cash Allowance for Doubt Acct.

Sales Revenue

2007 12/31/06 20072. 920 Bal. 3,200 3.

204,0004.197,000 2007

1. 3,400 2. 920Accounts Receivable 5. 4,080 Bad Debts Expense

12/31/06 Bal. 4,800 2007Bal.

97,0005. 4,080

20072. 920 1. 3,4003.204,000 2. 920

4.197,000

Bal.100,600

2007 transactions:1. Bad accounts written off: $3,4002. Collected previously written off accounts: 9203. Sales on account: 204,0004. Collections of accounts receivable: 197,0005. Bad Debts Expense (204,000 x 2%):

4,080

a. 1. Allowance for Doubtful Accounts, 12/31/07:$ 4,8002. Accounts Receivable, 12/31/07: 100,6003. Net Realizable Value ($100,600 – $4,800): 95,800

b. Bad Debts Expense 2007 ($204,000 x 2%): $4,080

c. The recovery of previously written off accounts will cause two asset exchange transactions. First, reinstate the accounts receivable; + Accounts Receivable, +Allowance

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for Doubtful Accounts. Second, record the collection of the accounts receivable; +Cash, – Accounts Receivable.

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EXERCISE 7-5A

Accounts Receivable Allowance for Doubt. Accts.Cr. Sales 352,000 Coll. 320,000 Chg. Off 320 Est. 3,520

Chg. Off 320 Bal. 3,200

Bal. 31,680

a. 1. $31,680 (see above)

2. $3,200

3. $3,520 ($352,000 x 1%)

4. $31,680 $3,200 = $28,480

b.1. $31,680 (same as above)

2. $320 (the amount charged off)

3. $31,680 (the balance of accounts receivable)

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EXERCISE 7-6Aa.

Ben’s Repair ShopHorizontal Statements Model

Balance Sheet Income Statement Statement ofEvent

Assets = Liab.

+ S. Equity

Rev. – Exp. = Net Inc.

Cash Flows

Cash + Acct. Rec.

= + Ret. Ear.

20061. 12,000 + NA = NA + 12,000 12,00

0 NA = 12,000 12,000 OA

2. NA + 1,500 = NA + 1,500 1,500 NA = 1,500 NA3. (8,200) + NA = NA + (8,200) NA 8,200 = (8,200) (8,200) OABal. 3,800 + 1,500 = NA + 5,300 13,50

0 8,200 = 5,300 3,800 NC

20074. NA + (50) = NA + (50) NA 50 = (50) NABal. 3,800 + 1,450 = NA + 5,250 -0- 50 = (50) NA

b. Net Income for 2006: $5,300

7-15

EXERCISE 7-6A (cont.)c.

Ben’s Repair ShopGeneral Journal

Date Account Titles Debit Credit

20061. Cash 12,000

Sales Revenue 12,000

2. Accounts Receivable 1,500Sales Revenue 1,500

3. Operating Expenses 8,200Cash 8,200

20074. Bad Debts Expense 50

Accounts Receivable 50

7-16

EXERCISE 7-7Aa.

Big Elk Hunting LodgeHorizontal Statements Model

Balance Sheet Income Statement Statement of

Assets = Liab.

+ S. Equity

Rev. Exp. = Net Inc.

Cash Flows

Event

Cash + Acc. Rec. = + Ret. Ear

1. + 76,800 = NA + 76,800 80,000 3,200

= 76,800 NA

2. 76,800

+ ( 76,800) = NA + NA NA NA = NA 76,800 OA

b. 1. Total assets: Cash $ 76,800

2. Revenue recognized: $ 80,000

3. Cash Flow from Operating Activities:$ 76,800

4. By accepting credit cards rather than allowing customers to purchase goods on account, Big Elk Hunting Lodge avoids the risk of bad debts as well as the expense of maintaining and collecting accounts receivable.

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EXERCISE 7-8A

a. & b.Event

Account Title Debit Credit

a. Accounts Receivable 3,346.50Credit Card Expense ($3,450 x 3%)

103.50

Sales Revenue 3,450.00

b. Cash 3,346.50Accounts Receivable 3,346.50

c. Net Income Sales $3,450.00Credit Card Expense (103 .50) Net Income $3,346 .50

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EXERCISE 7-9ANote: T-Accounts are provided for the use of the instructor.


Cash Warranties Payable

Sales Revenue

Sales110,000

Pur.75,000

Pd. 320 Est. 5,500 Sales 110,000

Pd. 320 Bal. 5,180Bal.34,680

Cost of Goods Sold

Sold75,000

Mdse. InventoryPur.75,000

Sold75,000

Warranty Expense

Bal. -0- Est. 5,500

Taylor’s ComputersFinancial Statements

Income Statement

Sales Revenue $110,000

Cost of Goods Sold (75,000)

Gross Margin 35,000

Warranty Expense (5,500)

Net Income $ 29,500

Statement of Cash Flows

Cash Flows From Operating Activities:Inflow from Customers $110,00

0Outflow for Inventory (75,000)Outflow for Warranty Expense (320)

Net Cash Flow from Operating Activities $34,680

Cash Flows From Investing Activities -0-

Cash Flows From Financing Activities -0-

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Net Change in Cash 34,680Plus: Beginning Cash Balance -0-Ending Cash Balance $34,680

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EXERCISE 7-9A (cont.)

The difference between net income and cash flows from operating activities is the difference in the amount of warranty expense accrued and the amount actually paid. The estimated warranty expense based on a percent of sales amounted to $5,500, but only $320 of that amount was actually paid.

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EXERCISE 7-10Aa.

Event

Assets

= Liab.

+ S. Equity

Rev.

Exp.

= Net Inc.

Cash Flow

Est. NA = + + NA + = NAPd. = + NA NA NA = NA OA

Event Account Titles Debit Credit

b.Est. Warranty Expense 900

Warranties Payable 900

c.Payment


Cash 315

d. Companies can match the warranty expense with the revenue that will produce the repairs. This concept follows the matching principle.

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EXERCISE 7-11A

Cash Notes Payable Service Revenue1. 44,0001 1. 50,000 2.

36,8002.36,800 Bal.

50,000Bal.36,800

Bal.80,800

Disc. on Notes Pay. Interest Expense1. 6,000 3. 5,000 3. 5,0002

Bal. 1,000 Bal.5,000

1$50,000 x 12% = $6,000; $50,000 $6,000 = $44,0002$6,000 x 10/12 = $5,000

a. Total Liabilities:Notes Payable $50,000Less: Discount on Notes Payable

(1,000)

Total Liabilities $ 49,000

b. Income Reported on the Income Statement:Service Revenue $36,800Less: Interest Expense (5,000)Net Income $31,800

c. Cash Flows From Operating Activities:Inflow from Customers $36,800

7-23

EXERCISE 7-11A (cont.)d.

Barnes General Journal


3/1/06 Cash 44,000Discount on Notes Payable 6,000

Notes Payable 50,000

12/31/06

Interest Expense 5,000

Discount on Notes Payable 5,000

2/28/07 Interest Expense 1,000Discount on Notes Payable 1,000

2/28/07 Notes Payable 50,000Cash 50,000

7-24

EXERCISE 7-12Aa.


Event

Assets

= Liabilities + S. Equity


Cash Flows

Cash = Notes Pay. Disc. on NP

+ Ret. Ear.

1. 17,600

= 20,000 2,400 + NA NA NA = NA 17,600 FA


Event

Assets



Cash Flows

Cash = Notes Pay. + Int. Pay. + Ret. Ear.

2. 20,000

= 20,000 + NA + NA NA NA = NA 20,000 FA

b. Discount Note: 20,000 x 12% = $2,400Interest-beraing Note: 20,000 x 12% = $2,400

c. Discount Note: Principal $17,600Interest-bearing Note: Principal $20,000

d. Effective Interest Rate = Interest Paid Principal Amount

Discount Note: $2,400 $17,600 = 13.64%

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Interest-bearing Note: $2,400 $20,000 = 12%

The effective interest rate is higher for the discount note. Both notes paid the same amount of interest, but only $17,600 of cash was received from the loan for the discount note.

7-26

EXERCISE 7-13A

Ray CoGeneral Journal


a.6/1/06 Cash 27,000

Discount on Notes Payable 3,000Notes Payable 30,000

b.12/31/06

Interest Expense* 1,750


c.5/31/07 Interest Expense** 1,250



*$3,000 x 7/12 = $1,750**$3,000 x 5/12 = $1,250

7-27

EXERCISE 7-14A a.A-1 Steel Co. T-Accounts, 2007


Cash Accounts Payable Common StockBal. 3,000 Bal.

7,500Bal.12,000

1. 5,000 7. 1,100 10. 52,000 2. 47,000 1. 5,0006. 7,280 8. 9,600 Bal. 2,500 Bal.

17,0009. 75,000 10.

52,00011. 2,000 Warranties Payable Retained Earnings

Bal.25,580

7. 1,100 4. 3,280 Bal.18,700

Bal. 2,180Dividends

Accounts Receivable 11. 2,000Bal.

15,000Notes Payable Bal. 2,000

3a. 82,000

5. 600 6. 8,000

9. 75,000 Bal. 8,000

Sales Revenue

Bal. 21,400

3a. 82,000

Discount on Notes Pay.

Bal. 82,000

Allow. for Doubt. Acct.

6. 720 13. 240

Bal. 800 Bal. 480 Cost of Goods Sold5. 600 3b. 46,000

12. 820 Bal.46,000Bal. 1,020

Warranty ExpenseMerchandise

Inventory4. 3,280

Bal.21,000

Bal. 3,280

2. 47,000 3b.46,000

Bal.22,000

Salaries Expense

8. 9,600

7-28

Bal. 9,600

Bad Debts Expense12. 820Bal. 820

Interest Expense13. 240Bal. 240

4: $82,000 x 4% = $3,280 6: $8,000 x 9% = $72012: $82,000 x 1% = $82013: $720 x 4/12 = $240EXERCISE 7-14A (cont.)

b.A-1 Steel Company

Financial StatementsFor the Year Ended December 31, 2007

Income Statement

Sales Revenue $ 82,000


Gross Margin 36,000

Operating ExpensesSalaries Expense $ 9,600Warranty Expense 3,280Bad Debts Expense 820

Total Operating Expenses (13,700)

Operating Income 22,300Interest Expense (240)

Net Income $22,060

Statement of Changes in Stockholders’ Equity

Beginning Common Stock

$12,000

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Plus: Stock Issued 5,000Ending Common Stock $17,000

Beginning Retained Earnings

18,700

Plus: Net Income 22,060Less: Dividends (2,000)Ending Retained Earnings 38,760

Total Stockholders’ Equity $55,760

7-30

EXERCISE 7-14A b. (cont.)

A-1 Steel CompanyBalance Sheet

As of December 31, 2007

AssetsCash $

25,580Accounts Receivable $21,400Less: Allowance for Doubtful

Accounts(1,020) 20,380

Merchandise Inventory 22,000Total Assets $ 67,960

LiabilitiesAccounts Payable $ 2,500Warranties Payable 2,180Notes Payable $ 8,000Less: Discount on Notes Payable (480) 7,520

Total Liabilities 12,200

Stockholders’ EquityCommon Stock 17,000Retained Earnings 38,760

Total Stockholders’ Equity 55,760

Total Liabilities and Stockholders’ Equity

$ 67,960

7-31

EXERCISE 7-14A b. (cont.)

A-1 Steel CompanyStatement of Cash Flows

For the Year Ended December 31, 2007

Cash Flows From Operating Activities:

Inflow from Customers $ 75,000Outflow for Inventory (52,000)Outflow for Expenses (10,700)

Net Cash Flow from Operating Activities

$12,300

Cash Flows From Investing Activities

-0-

Cash Flows From Financing Activities:

Inflow from Stock Issue 5,000Outflow for Dividend (2,000)Inflow from Loan 7,280

Net Cash Flow from Financing Activities

10,280

Net Change in Cash 22,580Plus: Beginning Cash Balance 3,000Ending Cash Balance $25,58

0

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SOLUTIONS TO PROBLEMS - SERIES A - CHAPTER 7

PROBLEM 7-15Aa.

Event Number

Type of Transaction

20061. Asset Source2. Asset Exchange3. Asset Use

20071. Asset Source2. Asset Exchange3. Asset Exchange4a. Asset Exchange4b. Asset Exchange5. Asset Use6. Asset Use

b. 2006 and 2007Effect of Transactions on Financial Statements

No. Assets = Liab. + S. Equity

Rev. Exp. =Net Inc. Cash Flows

2006 1. + NA + + NA + NA 2. + NA NA NA NA NA + OA 3. NA NA + NA

2007 1. + NA + + NA + NA 2. + NA NA NA NA NA + OA 3. + NA NA NA NA NA NA 4a.* + NA NA NA NA NA NA 4b. + NA NA NA NA NA + OA 5. NA NA + OA 6. NA NA + NA

*4a. is reinstatement of the previously charged off receivable; 4b is the collection of the account.

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PROBLEM 7-15A (cont.)

c.

Durm’s Consulting


20061. Accounts Receivable 40,000

Service Revenue 40,000

2. Cash 34,000Accounts Receivable 34,000

3. Bad Debts Expense* 800Allowance for Doubtful

Accounts800

*$40,000 x 2% = $800

Durm’s Consulting T-Accounts 2006

Assets = Stockholders’ Equity

Cash Accounts Receivable

Service Revenue

2. 34,000 1. 40,000 2.34,000

1. 40,000

Bal. 34,000

Bal. 6,000

Bal. 40,000

Allow. For Doubtful Accounts

Bad Debts Expense

3. 800 3. 800Bal. 800 Bal. 800

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7-35

PROBLEM 7-15A (cont.)d.

Durm’s ConsultingFinancial Statements

For the Year Ended 2006

Income Statement

Service Revenue $40,000

Bad Debts Expense (800)

Net Income $39,200



$ -0-

Plus: Stock Issued -0-Ending Common Stock $ -0-


-0-

Plus: Net Income 39,200Ending Retained Earnings

39,200

Total Stockholders’ Equity

$39,200

7-36

PROBLEM 7-15A d. (cont.)


Balance Sheet As of December 31, 2006

AssetsCash $34,000Accounts Receivable $ 6,000Less: Allowance for Doubtful

Accounts(800) 5,200

Total Assets $39,200

Liabilities $ -0-

Stockholders’ EquityCommon Stock $ -0-Retained Earnings 39,200



$39,200

Statement of Cash FlowsFor the Year Ended 2006


Inflow from Customers $34,000Net Cash Flow from Operating Activities

$34,000


-0-

Cash Flows From Financing Activities

-0-

Net Change in Cash 34,000

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Plus: Beginning Cash Balance -0-Ending Cash Balance $34,000

7-38

PROBLEM 7-15A e. (cont.)

Durm’s Consulting


2006 Closing Entries1. Service Revenue 40,000

Retained Earnings 40,000

2. Retained Earnings 800Bad Debts Expense 800

Durm’s ConsultingT-Accounts 2006 Closing Entries



Retained Earnings

Bal.34,000

Bal. 6,000 2. 800 1. 40,000

Bal39,200

Allowance for Doubtful Accounts Service Revenue

Bal. 800 1.40,000

Bal.40,000Bal. -0-

Bad Debts Expense

Bal. 800 2. 800Bal. -0-

Durm’s ConsultingAfter Closing Trial Balance

December 31, 2006


Cash $34,000Accounts Receivable 6,000

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$ 800


Totals $40,000 $40,000


c. (2007)

Durm’s Consulting





3. Allowance for Doubtful Accounts

150

Accounts Receivable 150

4a. Accounts Receivable 12Allowance for Doubtful

Accounts12

4b. Cash 12Accounts Receivable 12


6. Bad Debts Expense* 515Allowance for Doubtful

Accounts515

*$51,500 x 1% = $515

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PROBLEM 7-15A c. (cont.)

2007Durm’s ConsultingT-Accounts 2007



Retained Earnings

Bal.34,000

Bal. 6,000

Bal.39,200

2. 47,500 5.36,500

1. 51,500 2.47,500

4b. 12 4a. 12 3. 150 Service RevenueBal.45,012

4b. 12 1. 51,500

Bal. 9,850 Bal. 51,500


Bad Debts Expense

Bal. 800 6. 5153. 150 4a. 12 Bal. 515

6. 515Bal.

1,177Operating Expenses

5. 36,500Bal.

36,500

7-41

PROBLEM 7-15A

d. (2007)Durm’s Consulting

Financial StatementsFor the Year Ended 2007

Income Statement


ExpensesOperating Expenses $36,500Bad Debts Expense 515

Total Expenses (37,015)

Net Income $14,485



$ -0-



39,200


53,685


$53,685

7-42

PROBLEM 7-15A d. (cont.)2007


Balance Sheet As December 31, 2007

AssetsCash $45,012Accounts Receivable $ 9,850Less, Allowance for Doubtful

Accounts(1,177) 8,673


Liabilities $ -0-




$53,685

Statement of Cash FlowsFor the Year Ended 2007


Inflow from Customers $47,512Outflow for Expenses (36,500)


$11,012


-0-


-0-

Net Change in Cash 11,012

7-43

Plus: Beginning Cash Balance 34,000Ending Cash Balance $45,012

7-44

PROBLEM 7-15A (cont.) e. (2007)

Durm’s Consulting




2. Retained Earnings 37,015Operating Expenses 36,500Bad Debts Expense 515

Durm’s Consulting T-Accounts 2007 Closing Entries


Cash Accounts Receivable Retained EarningsBal.45,012 Bal. 9,850 Bal. 39,200

2. 37,015 1. 51,500Bal. 53,685

Allow. For Doubtful Accounts Service Revenue

Bal.1,177 1. 51,500 Bal. 51,500Bal. -0-

Bad Debts ExpenseBal. 515 2. 515Bal. -0-

Operating ExpensesBal.36,500 2. 36,500Bal. -0-

7-45

PROBLEM 7-15A e. (cont.)2007

Durm’s ConsultingAfter Closing Trial Balance

December 31, 2007


Cash $ 45,012Accounts Receivable 9,850Allowance for Doubtful Accounts

$ 1,177


Totals $ 54,862 $ 54,862

7-46

PROBLEM 7-16A

Accounts Receivable Allowance for Doubtful Accounts

1/1 172,800

Col 1,284,860

Bad A/C 4,500

1/1 5,184

Sales 1,269,800

Bad A/C 4,500 Est. 6,349

Bal. 153,240 Bal. 7,033

a. 1. $1,269,800 x .5% = $6,349

2. Accounts Receivable Balance, 12/31/07 $153,240Less: Allowance for Doubtful Accounts,

12/31/07 (7,033 )

Net Realizable Value $146,207

b.Hill Cabinet CompanyGeneral Journal, 2007

Event


1a. Accounts Receivable 1,269,800Sales Revenue 1,269,800

1b. Cost of Goods Sold 800,000Inventory 800,000

2. Cash 1,284,860Accounts Receivable 1,284,860


4,500

Accounts Receivable 4,500

4. Bad Debts Expense 6,349Allowance for Doubtful

Accounts6,349

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c. Bad debts expense is an estimate of current receivables that may eventually be uncollectible. The amount written off as uncollectible is the actual amount that was determined in the current accounting period to be uncollectible.

7-48

PROBLEM 7-17Aa.

Effect of Transactions on Financial Statements



2004 1. + NA + NA NA NA + FA 2. + NA NA NA NA NA OA 3a. + NA + + NA + + OA 3b. + NA + + + + NA 3c. + NA + + NA + NA 3d. NA NA + NA 4. + NA NA NA NA NA + OA 5. + NA NA NA NA NA + OA 6. NA NA + NA 7. NA + NA + NA 8. NA NA + OA

Legend:3a. Cash Sales3b.Credit Card Sales (remember that credit card expense is recorded).3c. Sales on Account3d.Cost of Sales

7-49


b.Brigg’s Supply Co.

General Journal, 2004

Date

Account Titles Debit Credit

1. Cash 70,000Common Stock 70,000

2. Merchandise Inventory 240,000Cash 240,000

3a. Cash 100,000Sales Revenue 100,000

3b. Accounts Receivable - Credit Card Co.

242,500

Credit Card Expense 7,500Sales Revenue 250,000

3c. Accounts Receivable 20,000Sales Revenue 20,000

3d. Cost of Goods Sold 190,000Merchandise Inventory 190,000

4. Cash 242,500Accounts Receivable - Credit

Card Co.242,500


6. Bad Debts Expense 240Accounts Receivable 240

7. Warranty Expense 650Warranties Payable 650

8. Selling and Administrative Exp. 53,000

7-50

Cash 53,000

PROBLEM 7-17A b. (cont.)

Brigg’s Supply Co. T-Accounts


Cash Warranties Payable Common Stock1. 70,000 2.

240,0007. 650 1. 70,000

3a.100,000

8. 53,000 Bal. 650 Bal. 70,000

4. 242,5005. 16,000 Sales RevenueBal.

135,5003a.

100,0003b.

250,000Accounts Receivable 3c. 20,000

3b.242,500 4.242,500

Bal.370,000

3c. 20,000 5. 16,0006. 240 Cost of Goods Sold

Bal. 3,760 3d.190,000

Bal.190,000

Merchandise Inventory

2. 240,000 3d.190,000

Bad Debts Expense

Bal.50,000 6. 240Bal. 240

Credit Card Expense3b. 7,500Bal. 7,500

Warranty Expense7. 650Bal. 650

Selling & Adm.

7-51

Expense8. 53,000Bal. 53,000

7-52


c.Brigg’s Supply Co.


Income Statement



Gross Margin 180,000

Operating ExpensesBad Debts Expense $ 240Credit Card Expense 7,500Warranty Expense 650Selling & Adm. Expense 53,000

Total Operating Expenses

(61,390)

Net Income $118,610



$ -0-

Plus: Stock Issued 70,000Ending Common Stock $ 70,000


-0-


118,610


$188,610

7-53


Brigg’s Supply Co.Balance Sheet

As of the End of the Year 2004

AssetsCash $135,500Accounts Receivable 3,760Merchandise Inventory 50,000


LiabilitiesWarranties Payable $ 650

Stockholders’ EquityCommon Stock $ 70,000Retained Earnings 118,610



$189,260

7-54


Brigg’s Supply Co.Statement of Cash FlowsFor the Year Ended 2004


Inflow from Customers $358,500Outflow for Inventory (240,000

)Outflow for Expenses (53,000)


$ 65,500


-0-


Cash Inflow from Stock Issued 70,000Net Cash Flow from Financing Activities

70,000


0

7-55

PROBLEM 7-18A

a.City Corp.




2001 1. + + NA NA NA NA + FA 2. NA NA + OA 3. + NA + + NA + + OA 4. NA + NA + NA

2002 1. + NA + + NA + + OA 2. NA NA + OA 3a. NA + NA + NA 3b. NA NA NA NA OA,FA

7-56

PROBLEM 7-18A b. (cont.)City Corp.

General Journal 2001 and 2002

Date Account Titles Debit Credit20011. Cash 36,400


2. Selling and Adm. Expenses 118,000Cash 118,000

3. Cash 176,000Service Revenue 176,000

4. Interest Expense* 2,700Discount on Notes Payable 2,700

Closing Entries

5. cl Service Revenue 176,000Selling and Adm. Expenses 118,000Interest Expense 2,700Retained Earnings 55,300

20021. Cash 292,000


2. Selling and Adm. Expenses 198,000Cash 198,000

3a. Interest Expense* 900Discount on Notes Payable 900

3b. Notes Payable 40,000Cash 40,000

*2001: $3,600 x 9/12 = $2,700 2002: $3,600 x 3/12 = $900PROBLEM 7-18A b. (cont.)

7-57

City Corp.General Journal, 2001 and 2002

2002 Closing Entries

4. cl Service Revenue 292,000Selling and Adm. Expenses 198,000Interest Expense 900Retained Earnings 93,100

7-58

PROBLEM 7-18A b. (cont.)

City Corp. T-Accounts


Cash Notes Payable Retained Earnings2001 2001 20011. 36,400 2.

118,0001. 40,000 cl 55,300

3. 176,000 Bal.40,000

Bal.55,300

Bal.94,400 2002 20022002 3b. 40,000 cl 93,1001. 292,000 2.

198,000Bal. -0- Bal.

148,4003b.40,000

Bal.148,400


Service Revenue

2001 20011. 3,600 4. 2,700 cl176,000 3. 176,000Bal. 900 Bal. -0-2002 2002

3a. 900 cl 292,000 1.292,000

Bal. -0- Bal. -0-

Selling and Adm. Exp.

20012. 118,000 cl

118,000Bal. -0-20022. 198,000 cl 198,000Bal. -0-

Interest Expense20014. 2,700 cl 2,700Bal. -0-20023a. 900 cl 900

7-59

Bal. -0-

7-60

PROBLEM 7-18A (cont.) c.

City Corp.Financial Statements

Income Statements

2001 2002

Service Revenue $176,000 $292,000

ExpensesSelling and Adm.

Expenses118,000 198,000

Interest Expense 2,700 900

Total Expenses (120,700) (198,900)

Net Income $ 55,300 $ 93,100

Statements of Changes in Stockholders’ Equity

2001 2002


$ -0- $ -0-

Plus: Stock Issued -0- -0-Ending Common Stock -0- -0-


-0- 55,300

Plus: Net Income 55,300 93,100Ending Retained Earnings

55,300 148,400


$ 55,300 $148,400

7-61


City Corp.Financial Statements

Balance Sheets

2001 2002

AssetsCash $94,400 $148,40

0Total Assets $94,400 $148,40

0

LiabilitiesNotes Payable $40,000 $ -0-Less: Discount on Notes Payable (900) -0-

Total Liabilities 39,100 -0-

Stockholders’ EquityCommon Stock -0- -0-Retained Earnings 55,300 148,400

Total Stockholders’ Equity 55,300 148,400


$94,400 $148,400

7-62


City Corp. Statements of Cash Flows

2001 2002


Inflow from Customers $176,000 $292,000Outflow for Expenses (118,000

)(198,000

)Ouflow for Interest -0- (3,600)


58,000 90,400


-0- -0-


Cash Inflow from Loan 36,400Cash Ouflow to Repay Loan (36,400)

Net Cash Flow From Financing Activities

36,400 (36,400)

Net Change in Cash 94,400 54,000Plus: Beginning Cash Balance -0- 94,400Ending Cash Balance $ 94,400 $148,400

7-63

PROBLEM 7-19A

Event

Type of

EventAssets Liabilitie

s

Common Stock

Retained

Earnings

Net Incom

e

Cash Flow

a. AS + NA NA + + +b. AU NA NA c. AS + NA NA + + NAd. AU NA NA NAe. AE + NA NA NA NA +f. AS + NA NA + + +g. AE + NA NA NA NA h. CE NA + NA NAi. AS + NA NA + + NAj. AS + NA NA + + +k. AU NA NA NA l. AE + NA NA NA NA +m. AS + + NA NA NA +n. AU NA NA NA o. CE NA + NA NA

7-64

PROBLEM 7-20ABelmont Equipment Co.

Balance SheetAs of December 31, 2003

AssetsCurrent Assets

Cash $ 17,800Accounts Receivable $90,000Less: Allow. for Doubtful Accounts (4,000) 86,000Merchandise Inventory 122,800Interest Receivable 500Prepaid Rent 9,600Supplies 1,600Notes Receivable 12,000

Total Current Assets $250,300

Property, Plant and EquipmentEquipment 60,000Less: Accumulated Depreciation (30,000) 30,000Land 36,000

Total Property, Plant and Equipment

66,000


Liabilities and Stockholders’ EquityCurrent Liabilities

Accounts Payable $ 46,000Unearned Revenue 52,600Warranties Payable 1,300Interest Payable 1,800Salaries Payable 9,200

Total Current Liabilities $110,900

Long-Term LiabilitiesNotes Payable 106,000Less: Discount on Notes Payable (2,400)

Total Long-Term Liabilities 103,600


Stockholders’ EquityCommon Stock 40,000Retained Earnings 61,800*



$316,300

7-65

*Must be computed: $10,400 + $59,400 $8,000 = $61,800

7-66


Belmont Equipment Co.Income Statement

For the Year Ending December 31, 2003




Operating ExpensesSalaries Expense $96,000Operating Expenses 70,000Warranty Expense 3,400Bad Debts Expense 10,800


Operating Income 72,800

Non-Operating ItemsInterest Revenue 4,200Interest Expense (24,000)Gain on Sale of Equipment 6,400

Total Non-Operating Items (13,400)

Net Income $ 59,400

7-67

PROBLEM 7-21A

T-Accounts provided for the use of the instructor.

Accounts ReceivableBal. 30,000Chg. Sales 240,000 Write-Off 1,600

Coll 240,400End. Bal. 28,000

Allowance for Doubtful AccountsBal. 2,000

Write-Off 1,600 Exp. 1,400End. Bal. 1,800

Notes PayableBal. 40,000End. Bal. 40,000

Discount on Notes PayableBal. 2,400

Exp. 800End. Bal. 1,600

Warranties PayableBal. 3,600

Paid 1,700 Exp. 1,100End. Bal. 3,000

a. Cash collected: $240,400Bad Debts Expense: $1,400Net Realizable Value: $28,000 $1,800 = $26,200

b. Cash paid for warranties: $1,700

c. Interest recognized for the period: $800Cash paid for interest: $-0-Book Value of Discount Note: $40,000 $1,600= $38,400

7-68

PROBLEM 7-22A

Water Way Sales & ServiceGeneral Journal


1. Merchandise Inventory 390,000Accounts Payable 390,000

2a. Accounts Receivable 522,000Sales Revenue 522,000

2b. Cost of Goods Sold 364,000Merchandise Inventory 364,000


4a. Accounts Receivable - Credit Card Co.

25,080




6. Accounts Payable 396,000Cash 396,000

7. Selling and Administrative Expenses

150,000

Cash 150,000

8. Cash 25,080Accounts Receivable - Cr.

Card Co.25,080

9. Cash 55,200Discount on Notes Payable 4,800


10. Bad Debts Expense 450

7-69

Accounts Receivable 450PROBLEM 7-22A (cont.)

Water Way Sales & ServiceGeneral Journal


Adjusting Entries

11a. Interest Expense* 1,200Discount on Notes Payable 1,200

11b. Warranty Expense 3,090Warranties Payable 3,090

*$4,800 x 3/12 = $1,200

7-70


Water Way Sales & ServiceT-Accounts



44,000Bal. 90,000

3. 44,000 6. 396,000 6. 396,000 1. 390,000

5. 504,000 7. 150,000

Bal.38,000

Retained Earnings

8. 25,080 Bal. 65,5009. 55,200 Warranties Payable Bal. 65,500Bal.

169,38011b.

3,090Bal. 3,090 Sales Revenue

Accounts Receivable 2a. 522,000

Bal. 17,800

Disc. on Notes Pay. 4a. 26,400

2a. 522,000

5. 504,000

9. 4,800 11a. 1,200

Bal. 548,400

4a. 25,080

8. 25,080 Bal. 3,600

10. 450 Service RevenueBal. 35,350 Notes Payable 3. 44,000

9. 60,000 Bal. 44,000Merchandise Inventory Bal.

60,000Bal. 94,600 Cost of Goods Sold1. 390,000 2b.

364,0002b.364,000

4b. 18,600

4b. 18,600

Bal.102,000 Bal.382,600

Credit Card Expense4a. 1,320Bal. 1,320

Selling & Adm. Exp.7. 150,000Bal.

150,000

Bad Debts Expense

7-71

10. 450Bal. 450

Warranty Expense11b. 3,090Bal. 3,090

Interest Expense11a. 1,200Bal. 1,200

7-72


Water Way Sales and ServiceFinancial Statements


Income Statement

Revenue Sales Revenue $548,400 Service Revenue 44,000Total Revenue $592,40

0

Costs and Expenses Cost of Goods Sold 382,600 Bad Debts Expense 450 Credit Card Expense 1,320 Warranty Expense 3,090 Selling & Adm. Expenses

150,000


(537,460)


Non Operating Items Interest Expense (1,200)

Net Income $ 53,740



$90,000

Plus: Stock Issued -0-Ending Common Stock $ 90,000


65,500

7-73


119,240


$209,240


Water Way Sales and ServiceBalance Sheet


AssetsCash $169,38

0Accounts Receivable 35,350Merchandise Inventory 102,000


LiabilitiesAccounts Payable $38,000Warranties Payable 3,090Notes Payable $ 60,000Less, Discount on Note (3,600) 56,400




Total Liab. and Stockholders’ Equity

$306,730

7-74


Water Way Sales and ServiceStatement of Cash Flows



Cash Receipts from Revenue $573,080Cash Payment for Inventory (396,000)Cash Payments for Expenses (150,000)


$ 27,080


-0-


Cash Inflow from Note 55,200Net Cash Flow from Financing Activities

55,200


7-75

SOLUTIONS TO EXERCISES - SERIES B - CHAPTER 7

EXERCISE 7-1Ba. and c.

Smith Dry CleaningT-Accounts


Cash Retained Earnings2003 20032. 8,000 cl 9,900Bal.

8,000 Bal.

9,900

20043. 10,000 Service RevenueBal.

18,000 2003

cl 10,000

1. 10,000

Accounts Receivable Bal.

-0-

2003 20041. 10,000 2. 8,000 2. 12,000Bal.

2,000 Bal.

12,000

20042. 12,000 1. 80 Bad Debts Expense

3. 10,000 2003

Bal.

3,920 3. 100 cl 100

Bal.

-0-

Allow. For Bad Debts 2004

2003 4. 120 3. 100 Bal

.120

Bal.

100

2004

7-76

1. 80 4. 120 Bal.

140

Year 2004 closing entries are not shown. They are not needed to answer the questions

7-77

EXERCISE 7-1B (cont.)

b. (1) Net Income for 2003: $9,900 ($10,000 $100)(2) Net Cash Flow from Operating Activities:$8,000(3) Balance of Accounts Receivable, 12/31/2003:


12/31/2003: $1,900($2,000 $100)

c. (1) Net Income for 2004: $11,880 ($12,000 $120)(2) Net Cash Flow from Operating Activities:

$10,000(3) Balance of Accounts Receivable, 12/31/2004:


12/31/2004: $3,780 ($3,920 $140)

7-78

EXERCISE 7-2B

Event Assets = Liab.

+ Stk. Equity


Cash Flow

Cash A. Rec.

All for DA

= + Ret. Earn.

1. NA + NA = NA + + + NA = + NA2. + NA = NA + NA NA NA = NA + OA3. NA = NA + NA NA NA = NA NA4. NA NA + = NA + NA + = NA

7-79

EXERCISE 7-3B

a. Analyze the Accounts Receivable account:

Accounts Receivable

Beginning Balance $ 1,500

Plus: Revenue on Account 7,000Less: Write-off (80)Less: Ending Balance (2,000

)Collections of Accounts Rec.

$ 6,420

b. Analyze the Allowance for Doubtful Accounts account:


Beginning Balance $150Less: Write-off (80)Less: Ending Balance (175)Bad Debts Expense $105

Note to Instructor: This information can also be shown in T-Account format.

7-80

EXERCISE 7-4B

Selected T-Accounts:

Cash Allowance for Doubt Acct.

Sales Revenue

2008 12/31/07 20082. 900 Bal. 3,000 3.

200,0004.190,000 2008

1. 3,500 2. 900Accounts Receivable 5. 4,000 Bad Debts Expense

12/31/07 Bal. 4,400 2008Bal.

80,0005. 4,000

20082. 900 1. 3,5003.200,000 2. 900

4.190,000

Bal.86,500

2008 transactions:1. Bad accounts written off: $3,5002a. Reinstated previously written-off accounts: 9002b. Collected previously written off accounts: 9003. Sales on account: 200,0004. Collections of accounts receivable: 190,0005. Bad Debts Expense; (200,000 x 2%)

4,000

a. 1. Allowance for Doubtful Accounts, 12/31/08:$ 4,4002. Accounts Receivable, 12/31/08: 86,5003. Net Realizable Value ($86,500 – $4,400): 82,100

b. Bad Debts Expense 2008 ($200,000 x 2%): $4,000

c. The recovery of the previously written off accounts will not affect the income statement. The transaction is an

7-81

asset exchange transaction. The income statement is only affected when bad debts expense is recognized.

7-82

EXERCISE 7-5B

Accounts Receivable Allowance for Doubt. Accts.Cr. Sales 300,000 Coll. 260,000 Chg. Off 250 Est. 3,000

Chg. Off 250 Bal. 2,750

Bal. 39,750

a. 1. $39,750 (see above)

2. $2,750

3. $3,000 ($300,000 x 1%)

4. $39,750 $2,750 = $37,000

b.1. $39,750 (same as above)

2. $250 (the amount charged off)

3. $39,750 (the balance of accounts receivable)

7-83

EXERCISE 7-6Ba.

Valley Service Co.Horizontal Statements Model

Balance Sheet Income Statement Statement ofEvent

Assets = Liab.

+ S. Equity


Cash Flows

Cash + Acct. Rec.

= + Ret. Ear.

20051. 10,000 + NA = NA + 10,000 10,00

0 NA = 10,000 10,000 OA

2. NA + 2,000 = NA + 2,000 2,000 NA = 2,000 NA3. (8,000) + NA = NA + (8,000) NA 8,000 = (8,000) (8,000) OA4. NA + (70) = NA + (70) NA 70 = (70) NABal. 2,000 + 1,930 = NA + 3,930 12,00

0 8,070 = 3,930 2,000

b. Net Income for 2005: $3,930

7-84

EXERCISE 7-6B (cont.)c.

Valley Service Co.General Journal


20051. Cash 10,000

Sales Revenue 10,000

2. Accounts Receivable 2,000Sales Revenue 2,000


4. Bad Debts Expense 70Accounts Receivable 70

7-85

EXERCISE 7-7Ba.

Denver One-Day SpaHorizontal Statements Model


Assets = Liab.

+ S. Equity


Cash Flows

Event

Cash + Acct. Rec.

= + Ret. Ear

1. NA + 114,000 = NA + 114,000

120,000

6,000

= 114,000

NA

2. 114,000

+ (114,000)

= NA + NA NA NA = NA 114,000 OA

b. 1. Total assets: Cash $114,000

2. Revenue recognized: $120,000

3. Cash Flow from Operating Activities:$114,000

4. If a business maintains its own accounts receivable, i.e. it sells goods on account, it must incur the cost of investigating customers in order to extend credit. Then, the customer must be sent bills each month. If a customer is slow paying, collection notices must be sent, and finally other collection expense and bad debt charge off may occur. If a business uses credit cards for its credit business, the only expense is the fee charged by the credit card company.

7-86

7-87

EXERCISE 7-8B

a. & b.Event


a. Accounts Receivable 2,880Credit Card Expense ($3,000 x 4%)

120

Sales Revenue 3,000

b. Cash 2,880Accounts Receivable 2,880

c. Net Income Sales $3,000Credit Card Expense (120 ) Net Income $2,880

7-88

EXERCISE 7-9BNote: T-Accounts are provided for the use of the instructor.


Cash Warranties Payable

Sales Revenue

Sales140,000

Pur.95,000

Pd. 200 Est. 8,400 Sales 140,000

Pd. 200 Bal. 8,200Bal.44,800

Cost of Goods Sold

Sold95,000

Mdse. InventoryPur.95,000

Sold95,000

Warranty Expense

Bal. -0- Est. 8,400

Long’s StereosFinancial Statements

Income Statement



Gross Margin 45,000

Warranty Expense (8,400)

Net Income $ 36,600

Statement of Cash Flows

Cash Flows From Operating Activities:Inflow from Customers $140,00

0Outflow for Inventory (95,000)Outflow for Warranty Expense (200)


$44,800

Cash Flows From Investing Activities -0-

Cash Flows From Financing Activities -0-

7-89


7-90


Total warranties liabilities at the end of the period is $8,200, the balance of the Warranties Payable account.

7-91

EXERCISE 7-10Ba.

Event

Assets

=Liab.

+ S. Equity

Rev.

Exp.

= Net Inc.

Cash Flow

Est. NA = + + NA + = NAPd. = + NA NA NA = NA OA

Event Account Titles Debit Credit

b.Est. Warranty Expense 1,400

Warranties Payable 1,400

c.Payment


Cash 596

d. Warranty obligations may be uncertain, but they usually represent legal liabilities that must be recognized in the accounts.

7-92

EXERCISE 7-11B

Cash Notes Payable Service Revenue1.

180,0001. 200,000 2. 55,000

2. 55,000 Bal.200,000

Bal.55,000

Bal.235,000

Disc. on Notes Pay. Interest Expense1. 20,000 3. 15,000 3. 15,000*

Bal. 5,000 Bal.15,000

* $20,000 x 9/12 = $15,000

a. Total Liabilities:Notes Payable $200,000Less: Discount on Notes Payable

(5,000)

Total Liabilities $195,000

b. Income Reported on the Income Statement:Service Revenue $55,000Less: Interest Expense (15,000)Net Income $40,000

c. Cash Flows From Operating Activities:Inflow from Customers $55,000

7-93

EXERCISE 7-11B (cont.)d.

Davis General Journal


4/1/04 Cash 180,000Discount on Notes Payable 20,000


12/31/04

Interest Expense 15,000


3/31/05 Interest Expense 5,000Discount on Notes Payable 5,000


7-94

EXERCISE 7-12Ba.


Event

Assets



Cash Flows

Cash = Notes Pay.

Disc. on NP

+ Ret. Ear.

1. 27,000

= 30,000 3,000 + NA NA NA = NA 27,000 FA


Event

Assets


Rev. Exp. = Net Inc. Cash Flows

Cash = Notes Pay.

+ Int. Pay. + Ret. Ear.

2. 30,000

= 30,000 + NA + NA NA NA = NA 30,000 FA

b. Discount Note: 30,000 x 10% = $3,000Interest-bearing Note: 30,000 x 10% = $3,000

c. Discount Note: Principal $27,000Interest-bearing Note: Principal $30,000

d. Effective Interest Rate = Interest Paid Principal Amount

Discount Note: $3,000 $27,000 = 11.11%

7-95

Interest-bearing Note: $3,000 $30,000 = 10%

The effective interest rate is higher for the discount note. Both notes paid the same amount of interest, but only $27,000 of cash was received from the loan for the discount note.

7-96

EXERCISE 7-13B

Lewis Co.General Journal


a.7/1/05 Cash 35,200


b.12/31/05

Interest Expense* 2,400


c.6/30/06 Interest Expense** 2,400



*$4,800 x 6/12 = $2,400**$4,800 x 6/12 = $2,400

7-97

EXERCISE 7-14Ba.

Phillips Metal Co. T-Accounts, 2005



10,000Bal.20,000

1. 4,000 7. 2,000 10.68,000

2. 80,000 1. 4,000

6. 9,100 8. 16,000 Bal.22,000

Bal.24,000

9.133,200

10.68,00011. 2,000 Warranties Payable Retained Earnings

Bal.62,300

7. 2,000 4. 6,400 Bal.33,000

Bal. 4,400Accounts Receivable Dividends

Bal.20,000

11. 2,000

3a. 128,000

5. 800 Notes Payable Bal. 2,000

9.133,200

6. 10,000

Bal. 14,000

Bal.10,000

Sales Revenue

3a.128,000

Allow. For Doubt. Acct.


Bal.128,000

Bal.1,000 6. 900 13. 3005. 800 12. 1,280 Bal. 600 Cost of Goods Sold

Bal.1,480 3b. 76,000Bal.76,000


Bal.40,000

Warranty Expense

2. 80,000 3b.76,000

4. 6,400

Bal.44,000

Bal. 6,400

Operating Expenses

7-98

8. 16,000Bal.16,000

Bad Debts Expense12. 1,280Bal. 1,280

Interest Expense13. 300Bal. 300

4: $128,000 x 5% = $6,4006: $10,000 x 9% = $90012: $128,000 x 1% =$1,28013: $900 x 4/12 = $300

7-99


b.Phillips Metal CompanyFinancial Statements


Income Statement



Gross Margin 52,000

Operating ExpensesOperating Expenses $16,000Warranty Expense 6,400Bad Debts Expense 1,280


Operating Income 28,320Interest Expense (300)

Net Income $28,020



$20,000Plus: Stock Issued 4,000Ending Common Stock $24,000


33,000

Plus: Net Income 28,020Less: Dividends (2,000)Ending Retained Earnings 59,020

Total Stockholders’ Equity $83,020

7-100

7-101

EXERCISE 7-14B b. (cont.)

Phillips Metal Co.Balance Sheet


AssetsCash $


Accounts(1,480) 12,520

Merchandise Inventory 44,000Total Assets $118,82

0

LiabilitiesAccounts Payable $

22,000Warranties Payable 4,400Notes Payable $10,000Less: Discount on Notes Payable (600) 9,400





$118,820

7-102

EXERCISE 7-14B b. (cont.)

Phillips Metal Co.Statement of Cash Flows



Inflow from Customers $133,200

Outflow for Inventory (68,000)Outflow for Expenses (18,000)


$47,200


-0-


Inflow from Stock Issue 4,000Outflow for Dividend (2,000)Inflow from Loan 9,100

Net Cash Flow from Financing Activities

11,100


0

7-103

SOLUTIONS TO PROBLEMS - SERIES B - CHAPTER 7

PROBLEM 7-15Ba.

Event Number

Type of Transaction

20051. Asset Source2. Asset Exchange3. Asset Use

20061. Asset Source2. Asset Exchange3. Asset Exchange4a. Asset Exchange4b. Asset Exchange5. Asset Use6. Asset Use

b. 2005 and 2006Effect of Transactions on Financial Statements



2005 1. + NA + + NA + NA 2. + NA NA NA NA NA + OA 3. NA NA + NA

2006 1. + NA + + NA + NA 2. + NA NA NA NA NA + OA 3. + NA NA NA NA NA NA 4a.* + NA NA NA NA NA NA 4b. + NA NA NA NA NA + OA 5. NA NA + OA 6. NA NA + NA

*Transaction 4a is the reinstatement of the previously written-off account; 4b is the collection of the account.

7-104

PROBLEM 7-15B (cont.)

c.

J & J Company






4. Bad Debts Expense* 2,550Allowance for Doubtful

Accounts2,550

*$255,000 x 1% = $2,550

J & J Company T-Accounts 2005



Service Revenue

2. 159,000 3.150,000

1. 255,000 2.159,000

1. 255,000

Bal. 9,000 Bal.96,000 Bal. 255,000


Bad Debts Expense

4. 2,550 4. 2,550

Bal.2,550 Bal. 2,550

Operating

7-105

Expenses3.

150,000Bal.

150,000

7-106

PROBLEM 7-15B (cont.)d.

J & J CompanyFinancial Statements


Income Statement


ExpensesOperating Expenses 150,000Bad Debts Expense 2,550

Total Expenses 152,550

Net Income $102,450



$ -0-



-0-


102,450


$102,450

7-107

PROBLEM 7-15B d. (cont.)


Balance Sheet As of December 31, 2005

AssetsCash $


Accounts(2,550) 93,450


Liabilities $ -0-




$102,450

Statement of Cash FlowsFor the Year Ended December 31, 2005


Inflow from Customers $159,000Outflow for Expense (150,000)


$9,000


-0-

Cash Flows From Financing -0-

7-108

Activities


7-109

PROBLEM 7-15B (cont.) e.

J & J Company




2. Retained Earnings 152,550Operating Expenses 150,000Bad Debts Expense 2,550

J & J CompanyT-Accounts 2005 Closing Entries



Retained Earnings

Bal. 9,000 Bal.96,000 2. 152,550 1. 255,000Bal.102,450

Allowance for Doubtful Accounts Service Revenue

Bal.2,550 1. 255,000 Bal.255,000Bal. -0-

Operating Expenses

Bal.150,000

2.150,000

Bal. -0-

Bad Debts Expense

Bal. 2,550 2. 2,550

Bal. -0-

7-110

PROBLEM 7-15B e. (cont.)J & J Company

After Closing Trial BalanceDecember 31, 2005


Cash $ 9,000Accounts Receivable 96,000Allowance for Doubtful Accounts

$ 2,550


Totals $105,000 $105,000

7-111


c. (2006)

J & J Company






1,800


4a. Accounts Receivable 600Allowance for Doubtful

Accounts600

4b. Cash 600Accounts Receivable 600


6. Bad Debts Expense* 2,040Allowance for Doubtful

Accounts2,040

*$408,000 x .5% = $2,040

7-112

PROBLEM 7-15B c. (cont.)

2006J & J Company

T-Accounts 2006



Retained Earnings

Bal. 9,000 Bal.96,000 Bal.102,450

2. 411,000 5.126,000

1. 408,000 2.411,000

4b. 600 4a. 600 3. 1,800 Service RevenueBal.

294,6004b. 600 1. 408,000

Bal. 91,200

Bal.408,000


Bad Debts Expense

Bal.2,550 6. 2,040

3. 1,800 4a. 600 Bal. 2,0406. 2,040

Bal.3,390 Operating Expenses

5. 126,000

Bal.126,000

7-113

PROBLEM 7-15B

d. (2006)J & J Company


Income Statement


ExpensesOperating Expenses $126,000Bad Debts Expense 2,040

Total Expenses (128,040)

Net Income $279,960



$ -0-



102,450


382,410


$382,410

7-114

PROBLEM 7-15B d. (cont.)2006


Balance Sheet As December 31, 2006

AssetsCash $294,60

0Accounts Receivable $ 91,200Less: Allowance for Doubtful

Accounts(3,390) 87,810


Liabilities $ -0-

Stockholders’ EquityCommon Stock $ -

0-Retained Earnings 382,410



$382,410

Statement of Cash FlowsFor the Year Ended December 31, 2006


Inflow from Customers $411,600Outflow for Expenses (126,000

)Net Cash Flow from Operating Activities

$285,600


-0-

7-115


-0-


0

7-116

PROBLEM 7-15B (cont.) e. (2006)

J & J Company




2. Retained Earnings 128,040Operating Expenses 126,000Bad Debts Expense 2,040

J & J CompanyT-Accounts 2006 Closing Entries


Cash Accounts Receivable Retained EarningsBal.

294,600Bal.91,200 Bal.

102,4502. 128,040 1. 408,000

Bal.382,410

Allow. For Doubtful Accounts Service Revenue

Bal.3,390 1. 408,000 Bal.408,000Bal. -0-

Bad Debts ExpenseBal. 2,040 2. 2,040Bal. -0-

Operating ExpensesBal.

126,0002. 126,000

Bal. -0-

7-117

PROBLEM 7-15B e. (cont.)2006

J & J CompanyAfter Closing Trial Balance

December 31, 2006


Cash $294,600Accounts Receivable 91,200Allowance for Doubtful Accounts

$ 3,390


Totals $385,800 $385,800

7-118

PROBLEM 7-16Ba.

Sales on Account $300,000

Less: Ending Balance of Accounts Receivable

(58,000)

Collections of Accounts Receivable $242,000

b. Credit Sales $300,000 x 1% = $3,000 of Bad Debts Expense

c.ACE Appliance


Event


1. Accounts Receivable 300,000Service Revenue 300,000


3. Bad Debts Expense 3,000Allowance for Doubtful

Accounts3,000

d. Accounts Receivable Ending Balance $58,000Less: Allowance for Doubtful Accounts (3,000)Net Realizable Value of Accounts

Receivable$55,000

7-119

PROBLEM 7-16B (cont.)e.

ACE Appliance Effect of Events on Financial Statements

Event Assets = Liab + S. Equity Rev. Exp. = Net Inc. Cash FlowsCash + Acct.

Rec. Allow. = NA + Ret.

Earn.1. NA +300,000 NA = NA + 300,000 300,00

0 NA =300,000 NA

2. 242,000 +(242,000)

NA = NA + NA NA NA = NA 242,000 OA

3. NA + NA 3,000 = NA + (3,000) NA 3,000= (3,000) NATotals 242,000 + 58,000 3,000 = -0- + 297,000 300,00

0 3,00

0=297,000 242,000

7-120

PROBLEM 7-17Ba.


No. Assets = Liabilities

+ S. Equity


2005 1. + NA + NA NA NA + FA 2. + NA NA NA NA NA OA 3a. + NA + + NA + + OA 3b. + NA + + + + NA 3c. + NA + + NA + NA 3d. NA NA + NA 4. + NA NA NA NA NA + OA 5. + NA NA NA NA NA + OA 6. NA NA + NA 7. NA + NA + NA 8. NA NA + OA

Legend:3a. Cash Sales3b.Credit Card Sales (remember that the credit card expense is recorded)3c. Sales on Account3d.Cost of Sales

7-121


b.Byrd Company



1. Cash 500,000Common Stock 500,000

2. Merchandise Inventory 1,200,000

Cash 1,200,000


3b. Accounts Receivable - Credit Card Co.

480,000


3c. Accounts Receivable 500,000Sales Revenue 500,000

3d. Cost of Goods Sold 900,000Merchandise Inventory 900,000

4. Cash 480,000Accounts Receivable - Credit

Card Co.480,000


6. Bad Debts Expense 5,000Accounts Receivable 5,000

7. Warranty Expense 4,500Warranties Payable 4,500

8. Selling and Administrative Exp. 100,000

7-122

Cash 100,000

PROBLEM 7-17B b. (cont.)

Byrd Company T-Accounts


Cash Warranties Payable Common Stock1. 500,000 2.

1,200,000

7. 4,500 1. 500,000

3a.600,000

8. 100,000 Bal.4,500 Bal. 500,000

4. 480,0005. 400,000 Sales RevenueBal.

680,0003a. 600,000

3b. 500,000Accounts Receivable 3c. 500,000

3b.480,000 4. 480,000 Bal. 1,600,000

3c.500,000 5. 400,0006. 5,000 Cost of Goods Sold

Bal.95,000 3d. 900,000Bal.900,000


2.1,200,000

3d.900,000

Bad Debts Expense

Bal.300,000

6. 5,000

Bal. 5,000

Credit Card Expense3b. 20,000Bal. 20,000

Warranty Expense7. 4,500Bal. 4,500

Selling & Adm. Expenses

8. 100,000

7-123

Bal.100,000

7-124

PROBLEM 7-17B (cont.)c.

Byrd CompanyFinancial Statements


Income Statement

Sales Revenue $1,600,000



Operating ExpensesBad Debts Expense $ 5,000Credit Card Expense 20,000Warranty Expense 4,500Selling & Adm. Expenses 100,000


Net Income $ 570,500


Beginning Common Stock $ -0-Plus: Stock Issued 500,000Ending Common Stock $

500,000


-0-

Plus: Net Income 570,500Ending Retained Earnings 570,500

Total Stockholders’ Equity $1,070,500

7-125


Byrd CompanyBalance Sheet


AssetsCash $680,000Accounts Receivable 95,000Merchandise Inventory 300,000

Total Assets $1,075,000

LiabilitiesWarranties Payable $ 4,500

Stockholders’ EquityCommon Stock $500,000Retained Earnings 570,500

Total Stockholders’ Equity 1,070,500


$1,075,000

7-126


Byrd CompanyStatement of Cash Flows



Inflow from Customers $1,480,000

Outflow for Inventory (1,200,000)

Outflow for Expenses (100,000)Net Cash Flow from Operating Activities

$180,000


-0-


Cash Inflow from Stock Issue 500,000Net Cash Flow from Financing Activities

500,000


0

7-127

PROBLEM 7-18B

a.White & Company




2006 1 + + NA NA NA NA + FA 2. + NA + + NA + + OA 3. NA NA + OA 4. NA + NA + NA

2007 1. + NA + + NA + + OA 2. NA NA + OA 3a. NA + NA + NA 3b. NA NA NA NA OA,FA

7-128

PROBLEM 7-18B (cont.) b.White & Company

General Journal 2006 and 2007

Date Account Titles Debit Credit20061. Cash 180,000




4. Interest Expense1 10,000Discount on Notes Payable 10,000

Closing Entries

5. cl. Service Revenue 336,000Retained Earnings 336,000

cl. Retained Earnings 142,000Operating Expenses 132,000Interest Expense 10,000

20071. Cash 984,000



3a. Interest Expense2 10,000Discount on Notes Payable 10,000

3b. Notes Payable 200,000Cash 200,000

1$20,000 x 6/12 = $10,0002$20,000 x 6/12 = $10,000


7-129

White & CompanyGeneral Journal 2006 and 2007


2007 Closing Entries

4. cl Service Revenue 984,000Retained Earnings 984,000

cl Retained Earnings 426,000Operating Expenses 416,000Interest Expense 10,000

7-130


White & CompanyT-Accounts


Cash Notes Payable Retained Earnings2006 2006 20061. 180,000 3. 132,000 1. 200,000 cl142,000 cl 336,0002. 336,000 Bal.

200,000Bal.194,000

Bal.384,000

2007 2007

2007 3b.200,000

cl426,000 cl 984,000

1. 984,000 2. 416,000 Bal. -0- Bal.752,000

3b.200,000

Bal.752,000 Discount on Notes Pay.

Service Revenue

2006 20061. 20,000 4. 10,000 cl336,000 2. 336,000Bal.

10,000Bal. -0-

2007 20073a. 10,000 cl984,000 1. 984,000

Bal. -0- Bal. -0-

Operating Expenses20063.132,000 cl 132,000Bal. -0-20072.416,000 cl 416,000Bal. -0-

Interest Expense20064. 10,000 cl 10,000Bal. -0-20073a.10,000 cl 10,000Bal. -0-

7-131

7-132

PROBLEM 7-18B (cont.) c.

White & CompanyFinancial Statements

Income Statements

2006 2007

Service Revenue$336,000

$984,000

ExpensesOperating Expenses 132,000 416,000Interest Expense 10,000 10,000

Total Expenses (142,000) (426,000)

Net Income $194,000 $558,000

Statements of Changes in Stockholders’ Equity

2006 2007

Beginning Common Stock $ -0- $ -0-Plus: Stock Issued -0- -0-Ending Common Stock -0- -0-


-0- 194,000

Plus: Net Income 194,000 558,000Ending Retained Earnings 194,000 752,000


$194,000 $752,000

7-133


White & CompanyBalance Sheets

2006 2007

AssetsCash $384,000 $752,000

Total Assets $384,000 $752,000

LiabilitiesNotes Payable $200,000 $ -0-Less: Discount on Notes Payable (10,000) -0-

Total Liabilities 190,000 -0-

Stockholders’ EquityCommon Stock -0- -0-Retained Earnings 194,000 752,000

Total Stockholders’ Equity 194,000 752,000


$384,000 $752,000

7-134


White & CompanyStatements of Cash Flows

2006 2007


Inflow from Customers $336,000 $984,000

Outflow for Expenses (132,000) (416,000)

Ouflow for Interest -0- (20,000)Net Cash Flow from Operating Activities

204,000 548,000


-0- -0-


Cash Inflow from Loan 180,000Cash Outflow to Repay Loan (180,00

0)Net Cash Flow From Financing Activities

180,000 (180,000)

Net Change in Cash 384,000 368,000Plus: Beginning Cash Balance -0- 384,000Ending Cash Balance $384,000 $752,00

0

7-135

PROBLEM 7-19B

Event

Type of

EventAssets Liabilitie

s

Common Stock

Retained

Earnings

Net Incom

e

Cash Flow

a. AE + NA NA NA NA b. AS + NA NA + + NAc. AE + NA NA NA NA +d. AS/AE +(+) NA NA + + +e. AS + NA NA + + +f. AU NA NA NA g. AU NA NA h. AS + NA NA + + +i. AU NA NA NA j. AS + + NA NA NA +k. AS + NA NA + + NAl. AU NA NA NAm. CE NA + NA NAn. AE + NA NA NA NA +o. CE NA + NA NA

7-136

PROBLEM 7-20BDaniels Company

Balance SheetAs of December 31, 2004

AssetsCurrent Assets

Cash $ 23,000Accounts Receivable $113,000Less: Allow. for Doubtful

Accounts(7,000) 106,000

Merchandise Inventory 154,000Interest Receivable 800Prepaid Rent 14,000Supplies 3,000Notes Receivable 17,000Total Current Assets $317,800

Property, Plant and EquipmentEquipment 77,000Less: Accumulated Depreciation (38,000) 39,000Land 50,000Total Property, Plant and

Equipment89,000


Liabilities and Stockholders’ EquityCurrent Liabilities

Accounts Payable $ 60,000Unearned Revenue 58,000Warranties Payable 2,000Interest Payable 3,000Salaries Payable 12,000Total Current Liabilities $135,000

Long-Term LiabilitiesNotes Payable 133,000Less: Discount on Notes Payable (4,000)Total Long-Term Liabilities 129,000


Stockholders’ EquityCommon Stock 52,000Retained Earnings 90,800*



$406,800

7-137

*Must be computed: ($28,800 + $74,000 $12,000 = $90,800)

7-138


Daniels CompanyIncome Statement





Operating ExpensesSalaries Expense $122,000Operating Expenses 90,000Warranty Expense 5,000Bad Debts Expense 14,000



Non-Operating ItemsInterest Revenue 6,000Interest Expense (32,000)Gain on Sale of Equipment 10,000

Total Non-Operating Items (16,000)

Net Income $ 74,000

7-139

PROBLEM 7-21Ba. T-Accounts provided for the use of the instructor.

Accounts ReceivableBal. 30,000Chg. Sales 170,000 Write-off 1,400

Coll 164,600End. Bal. 34,000

Allowance for Doubtful AccountsBal. 1,800

Write-off 1,400 Exp. 1,300End. Bal. 1,700

Cash collected: $164,600Bad Debts Expense: $1,300Net Realizable Value: $34,000 $1,700 = $32,300

b. Note: T-Accounts provided for the use of the instuctor.

Warranties PayableBal. 4,000

Cash Paid 4,600 Exp. 3,600End. Bal. 3,000

Cash paid for warranties: $4,600

c. Note: T-Accounts provided for the use of the instructor.

Note PayableBal. 40,000End. Bal. 40,000

Discount on Note PayableBal. 1,200

Exp. 400End. Bal. 800

Interest recognized for the period: $400Cash paid for interest: $-0-Book Value of Discount Note: $40,000 $800= $39,200

7-140

PROBLEM 7-22Ba.

The Sport ShopGeneral Journal


1. Merchandise Inventory 420,000Accounts Payable 420,000

2a. Accounts Receivable 480,000Sales Revenue 480,000




4a. Accounts Receivable - Credit Card Co.

172,800




6. Accounts Payable 540,000Cash 540,000

7. Selling and Administrative Expenses

134,000

Cash 134,000

8. Cash 172,800Accounts Receivable - Cr.

Card Co172,800

7-141

PROBLEM 722B a. (cont.)

The Sport ShopGeneral Journal


9. Cash 43,200Discount on Notes Payable 4,800



7,200


Adjusting Entries

11a. Bad Debts Expense1 4,800Allowance for Doubtful

Accounts4,800

11b. Interest Expense2 2,800Discount on Notes Payable 2,800

11c. Warranty Expense 1,800Warranties Payable 1,800

1$480,000 x 1% = $4,8002$4,800 x 7/12 = $2,800

7-142

PROBLEM 7-22B a. (cont.)

The Sport ShopT-Accounts


Cash Accounts Payable Common StockBal.

118,000Bal.

142,000Bal.720,000

3a.240,000

6.540,000

6.540,000

1. 420,000

5. 526,000 7.134,000

Bal. 22,000 Retained Earnings

8. 172,800 Bal.108,000

9. 43,200 Warranties PayableBal.

426,00011c. 1,800 Sales Revenue

Bal. 1,800 2a.480,000

Accounts Receivable 3a.240,000

Bal.172,000


4a.180,000

2a.480,000

5.526,000

9. 4,800 11b. 2,800 Bal.900,000

4a.172,800

8.172,800

Bal. 2,000

10. 7,200 Cost of Goods SoldBal.

118,800Notes Payable 2b.

288,0009. 48,000 3b.

144,000Allow. for Doubt.

Acc.Bal.

48,0004b.

108,000Bal.10,000

Bal.540,000

10. 7,200 11a.4,800Bal. 7,600 Credit Card Expense

4a. 7,200Merchandise

InventoryBal. 7,200

Bal.690,000

7-143

1. 420,000 2b.288,000

Selling & Adm. Exp.

3b.144,000

7. 134,000

4b.108,000

Bal.134,000

Bal.570,000

Bad Debts Expense11a. 4,800Bal. 4,800

Warranty Expense11c. 1,800Bal. 1,800

Interest Expense11b. 2,800Bal. 2,800

7-144


The Sport ShopFinancial Statements


Income Statement




Operating ExpensesBad Debts Expense $ 4,800Credit Card Expense 7,200Warranty Expense 1,800Selling and Admin.

Expenses134,000


(147,800)


Less: Nonoperating Expense

Interest Expense (2,800)

Net Income $209,400



$720,000

Plus: Stock Issued -0-Ending Common Stock $ 720,000


108,000


317,400


$1,037,400

7-145


The Sport ShopBalance Sheet


AssetsCash $426,000Accounts Receivable $118,800Less: Allowance for Doubtful

Accounts(7,600) 111,200

Merchandise Inventory 570,000

Total Assets $1,107,200

LiabilitiesAccounts Payable $ 22,000Warranties Payable 1,800Notes Payable $ 48,000Less: Discount on Notes Payable (2,000) 46,000



Total Stockholders’ Equity 1,037,400


$1,107,200

7-146


The Sport ShopStatement of Cash Flows



Inflow from Customers $938,800Outflow for Inventory (540,000

)Outflow for Expenses (134,000

)Net Cash Flow from Operating Activities

$264,800


-0-


Cash Inflow from Loan 43,200Net Cash Flow From Financing Activities

43,200


0

b. Net Realizable Value: $111,200 ($118,800 $7,600).

c. Bad Debts Expense using Direct Write-off Method: $7,200

7-147

ATC 7-1Financial Statement Analysis

a. First, calculate the accounts receivable turnover ratio:

$31,888÷$2,895=11.0 times

Next, calculate the average days to collect accounts receivable:

365 days÷11.0=33 days

b. Note 9, page 42, reports “allowances” of $69 (million).

Allow. for doubtful accts. ÷ Acct. Rec. = Uncollectible %

$69÷$2,964=2.3%

c. $2,895÷$9,491=30.5%

d. Note 9, page 42, reports warranty obligations of $467 (million).

7-148

ATC 7-2 a. 1.Bell Card Zore

Total Sales $125,000 $210,000 $195,000Cash Sales 85,000 26,000 120,000Credit Sales 40,000 184,000 75,000Accounts Receivable, 1/1/08 6,200 42,000 8,100Accounts Receivable, 12/31/08 5,600 48,000 7,500Allowance for Doubtful Acct, 1/1/08 186 1,840 405Allowance for Doubtful Acct, 12/31/08 224 1,680 435Bad Debts Expense, 2008 242 1,200 395Uncollectible accounts charged off, 2008 204 1,360 365Collections of accounts receivable, 2008 40,396 176,640 75,235

2. Uncollectible AccountsBell - 2007: $186 $6,200 = .03 or 3%Bell - 2008: $224 $5,600 = .04 or 4%

Card - 2007: $1,840 $42,000 = .044 or 4.4%Card - 2008: $1,680 $48,000 = .035 or 3.5%

Zore - 2007: $405 $8,100 = .05 or 5%Zore - 2008: $435 $7,500 = .058 or 5.8%

3. Credit SalesBell: $40,000 $125,000 = 32%Card: $184,000 $210,000 = 87.6%

Zore: $75,000 $195,000 = 38.5%

4. Accounts Receivable TurnoverBell: $40,000 $5,600 = 7.14Card: $184,000 $48,000 = 3.83Zore: $75,000 $7,500 = 10

c. Card has the highest percentage of sales that are credit sales with 87.6%.

d. Zore appears to be doing the best job of collecting it accounts receivable with just .5% of its charge sales being charged off during the year.A company can screen its charge customers and use aggressive collection policies to keep uncollectible accounts to a minimum.

7-149

ATC 7-3Thinking About the Numbers -- Explaining the Time Needed to Collect Accounts Receivable

a. Retail furniture stores, such as Haverty’s, sell their products directly to consumers. Because furniture purchases represent relatively large dollar amounts for many individuals, they often “finance” these purchases. This is the reason Haverty’s takes about three months on average to collect its receivables; it allows customers a long time to pay, but it charges interest on their accounts receivable during this time.

Ford, by contrast, sells to car dealers, not to the ultimate consumer, so it gets its money relatively fast. Ford also has a “car financing” operation, but that is a separate operation from the manufacturing of cars.

b. The rather short collection period for Boeing will surprise many students. They may suggest that Boeing collects its receivables soon after each airplane is manufactured because it has been “made to order.” This, of course, is only partly true. Boeing bills and collects payments from customers as their airplanes are being produced. If Boeing waited until its airplanes were completed before being paid, it would need to borrow (or get from some other source) a lot of additional money to finance the long production period that airplanes require. Boeing’s workers and suppliers want to be paid as they provide services to Boeing, not after each airplane is completed.

Colgate Palmolive, by contrast, has a rather traditional accounts receivable arrangement with its distributors. The length of time they are given to repay Colgate probably is approximately the same length of time they are expected to need to sell the products to their customers.

7-150

ATC 7-4

a. Accounts Receivable Turnover:

Company Sales Accounts Receivable

Shafer $920,000 $80,000 = 11.5 times

Burgess $450,000 $50,000 = 9.0 times

Average Days to Collect Accounts Receivable:

Company 365 Acct. Rec. Turnover

Shager 365 11.5 = 31.7 days to coll.

Burgess 365 9.0 = 40.56 days to coll.

b. Burgess is more likely to incur a larger cost from the extension of credit because it takes longer to collect from customers.

c. Costs associated with the extension of credit:

1. Cost of credit approval.2. Recording and billing costs of accounts receivable.3. Costs associated with lost opportunities to invest the

cash to produce a return on the investment.4. Salaries, equipment, and supplies that are used in the

collection process.

d. A company may be more willing to extend credit:

1. Because more goods and services can be sold when credit is allowed.

2. To be more competitive with other companies.

7-151

3. To give the buying company time to generate the cash to pay for the goods purchased.

7-152

ATC 7-5

a. First the companies' gross margins must be calculated. Playfair Pigpen

Sales $650,000 $1,000,000 Cost of goods sold 475,000 630,000 Gross margin $175,000 $ 370,000

Gross margin %:Playfair: $175,000 ÷ $650,000 = 26.9%Pigpen: $370,000 ÷ $1,000,000 = 37.0%

Average days to collect receivables:

First, calculate the net realizable value of each company's accounts receivable:

Playfair Pigpen Accounts receivable $105,000 $260,000 Allow. for doubtful accts. 5,000 10,000 Net realizable value $100,000 $250,000

Second, calculate the accounts receivable turnover ratio:Playfair: $650,000 ÷ $100,000 = 6.5 timesPigpen: $1,000,000 ÷ $250,000 = 4.0 times

Finally, calculate the average days to collect accounts receivable:

Playfair: 365 days÷ 6.5 = 56 daysPigpen: 365 days÷ 4.0 = 91 days

b. Pigpen is charging more in relation to cost of goods sold.Gross Margin %:

Playfair: $175,000$650,000=26.9%Pigpen: $370,000$1,000,000=37.0%

c. Pigpen has the larger absolute balance of accounts receivable and it takes a longer time to collect its accounts receivable. Therefore, it will incur the greater financing cost associated with accounts receivable.

7-153

ATC 7-5 (cont.)

d. Based only on the information provided, Playfair probably has the more restrictive credit policies. It is collecting its receivables faster than Pigpen. This suggests Playfair requires repayment more quickly than Pigpen, or that it only grants credit to customers who have a history of paying on time, or both. Of course there are many other factors, such as industry trends, that might explain the difference in average collection periods, but this information is not available to us. In a "real-world" situation, a prudent decision maker would try to obtain more information before making a judgment.

7-154

ATC 7-6

This assignment is designed to test both analytical skills and writing skills.In the memo, students should explain the conceptual difference in the two types of notes. Some points that can be made include:

Interest-bearing note:interest is paid at maturity;the amount of cash proceeds equals the amount of the principal of the note; interest is computed by multiplying the principal of the note by the interest rate.

Discount note:interest is paid in advance;the amount of the cash proceeds equals the face amount of the note less the amount of discount that is deducted;the amount of the discount is determined by multiplying the face amount of the note by the discount rate.

The effective interest rate for each of the notes is computed as follows:

Interest-bearing note: $50,000 x 10% = $5,000 amount of interest$5,000 $50,000 = 10% effective interest rate

Discount note: $50,000 x 9.5% = $4,750 amount of discount$50,000 $4,750 = $45,250 cash proceeds$4,750 $45,250 = 10.5% effective interest rate

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ATC 7-7

a. The direct write-off would affect the accounting equation as follows:

Stockholders’Assets = Liabilities + Equity(45,000) (45,000)

The entry to record the expense would be:

Debit CreditBad Debts Expense 45,000


Net income would be reduced by the recognition of the $45,000 of bad debts expense. Ending retained earnings would be reduced on the statement of changes in equity. Assets (i.e., accounts receivable) and equity (i.e., retained earnings) would be reduced on the balance sheet. The statement of cash flows would not be affected.

b. The ethical thing to do would be to advise the bank. Because Saunders had knowledge of the uncollectible account, he could not legally attest to the quality of the receivables. If he lies to the bank, he is engaging in criminal fraud and may be subject to prosecution. Remember always, it is best to avoid unethical or illegal behavior at the earliest possible time.

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ATC 7-8Using the EDGAR DatabaseNOTE: This solution was accurate as of December 19, 2001. However, the EDGAR

database is subject to update at any time, so this solution will likely be “dated” at the time you assign this case to your students.

These data are from the December 31, 2000 financial statements and dollar amounts are in thousands.

a. Sales ÷ Accounts Rec. = A/R Turnover$4,247,504 ÷ $538,403 = 7.9 times

365 ÷ 7.9 = 46 days

b. The balance of total accounts receivable was $559,999. (This is the sum of net receivables [$538,403] and the balance in the “allowance” account [$21,596]).

$21,596 ÷ $559,999 = 3.9% of receivables that are not expected to be collected.

c. The liability for warranties was $59,563 (from the footnote for accrued liabilities).

d. Maytag manufactures products under the names of Jenn-Air, Magic Chef, Admiral, Norge and Hoover.

e. Maytag’s financial statements do not disclose the amount of warranty expense, but the footnotes do disclose the amount of warranties that are included in accrued liabilities. Comparing the balance in the warranties liability to the amount of sales reveals that warranty costs appeared to change little from 1999 to 2000. The supporting computations are:

Warranties liability sales;1999 $62,459 $4,323,673 = 1.445%2000 $59,563 $4,247,504= 1.402%Difference: 0.043%

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Documents

Chapter 7 Solution of fundamental of financial accouting by EDMONDS (4th edition)