Chapter 7
Reporting and Interpreting
Sales Revenue, Receivables, and Cash
Revised: April 27, 2014
ANSWERS TO QUESTIONS
1.
Sales revenue is a gross amount that does not reflect any adjustments. Net sales is sales
revenue adjusted for the following items: (a) sales returns (the sales dollar amount of
goods returned by customers because the goods were either unsatisfactory or not
desired); (b) sales allowances (dollar amounts allowed to customers for unsatisfactory
merchandise) and (c) sales discounts (discounts given to customers for payment of
their accounts within a specified short period of time).
2.
Gross profit or gross margin on sales is the difference between net sales and cost of
sales. It represents the average gross markup realized on the goods sold during the
period. The gross margin ratio is computed by dividing the amount of gross margin by
the amount of net sales. For example, assuming net sales of $100,000 and cost of sales
of $60,000, the gross margin on sales would be $40,000. The gross margin ratio would
be $40,000/$100,000 = 0.40 (40%). This ratio may be interpreted to mean that out of
each $100 of sales, $40 was realized above the amount expended to purchase the
goods that were sold.
3.
A credit card discount is the fee charged by the credit card company for services. When
a company deposits its credit card receipts in the bank, it only receives cash for the
sales amount less the credit card company’s discount. The credit card discount account
either decreases net sales (as a contra-revenue account) or increases selling expense.
4.
A sales discount is a discount given to customers for payment of accounts within a
specified short period of time. Sales discounts arise only when goods are sold on credit
and the seller extends credit terms that provide for a cash discount. For example, the
credit terms may be 1/10, n/30. These terms mean that if the customer pays within 10
days, 1% can be deducted from the invoice price of the goods. Alternatively, if payment
is not made within the 10-day period, no discount is permitted and the total invoice
amount is due within 30 days from the purchase, after which the debt is past due. To
illustrate, assume a $1,000 sale with these terms, if the customer pays within 10 days,
$990 would have been paid. Thus, a sales discount of $10 was granted for early
payment.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-1
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
5.
A sales allowance is an amount allowed to a customer for unsatisfactory merchandise.
A sales allowance reduces the amount the customer must pay, or if already paid, a cash
refund is required. Sales allowances may occur whether the sale was for cash or credit.
In contrast, a sales discount is a cash discount given to a customer who has bought on
credit and made payment within the specified period of time. (Refer to explanation of
sales discount in Question 4 above.)
6.
A trade receivable is an amount owed to the business by a trade customer for
merchandise or services purchased. In contrast, a note receivable is normally a shortterm obligation owed to the company based on a formal written document (this
document specifies the terms of repayment, i.e., maturity date, interest rate, etc.).
7.
In conformity with the matching process, the allowance method records bad debt
expense in the same period in which the credit was granted and the sale was made.
8.
Using the allowance method, bad debt expense is recognized in the period in which the
sale related to the uncollectible account was recorded.
9.
The write-off of bad debts using the allowance method decreases the asset trade
receivables and the contra asset allowance for doubtful accounts by the same amount.
As a consequence, (a) net earnings are unaffected and (b) trade receivables, net, is
unaffected.
10. An increase in the receivables turnover ratio generally indicates faster collection of
receivables. A higher receivables turnover ratio reflects an increase in the number of
times average trade receivables were recorded and collected during the period.
11. Cash includes money and any instrument, such as a cheque, money order, or bank draft
that is normally accepted by banks for deposit and immediate credit to the depositor’s
account. Cash equivalents are short-term, highly liquid investments that are readily
convertible into a known amount of cash, and which are subject to an insignificant risk
of change in value.
12. The primary characteristics of an internal control system for cash are : (a) separation
of the functions of receiving cash from paying cash, (b) separation of cash-receiving
and cash-paying routines, (c) separation of the physical handling of cash from the
accounting function, (d) preparation and monitoring of cash budgets, (e) depositing all
cash receipts and making all cash payments by cheque, (f) requiring separate approval
of all cheques and electronic funds transfers, (g) requiring monthly, independently
prepared reconciliation of bank accounts, and (h) requiring employees to take
vacations and rotate their duties.
13. Trade receivables cannot be considered cash equivalents. They are normally collected
within three months and therefore meet part of the definition of cash equivalents.
However, they are not readily convertible to cash as the conversion to cash depends on
the actions of others (e.g., the customer) and there may be a significant amount of risk
that the value will change in that the collection may not be assured.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-2
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
14. Cash-handling and cash-recording activities should be separated to remove the
opportunity for theft of cash and a cover-up by altering the records. This separation is
accomplished best by assigning the responsibility for cash handling to individuals
other than those who have the responsibility for record keeping. In fact, it is usually
desirable that these two functions be performed in different departments of the
business.
15. The purposes of bank reconciliation are (a) to determine the “true” cash balance, (b) to
provide data to adjust the Cash account to that balance, and (c) to provide control over
the cash account through independent verification. Bank reconciliation involves
reconciling the balance in the Cash account at the end of the period with the balance
shown on the bank statement (which is not the “true” cash balance) at the end of that
same period. Seldom will these two balances be identical because of timing differences
such as deposits in transit; that is deposits that have been made by the company but
not yet entered on the bank statement, and outstanding cheques that have been
written and recorded in the accounts of the company that have not cleared the bank,
hence they have not been deducted from the bank’s balance. Usually, the reconciliation
of the two balances, per books against per bank, requires recording of one or more
items that are reflected on the bank statement but have not been recorded in the
accounting records of the company. An example is the usual bank service charge, which
is included on the bank statement, but has not yet been recorded in the company’s
books.
16. The total amount of cash that should be reported on the statement of financial position
is the sum of (a) the true cash balances in all chequing accounts (verified by a bank
reconciliation of each chequing account), (b) cash held in all “cash on hand” (or “petty
cash”) funds, (c) any cash physically on hand (any cash not transferred to a bank for
deposit) – usually held for change purposes, and (d) the balance in cash equivalent
accounts.
17. (Based on Appendix 7A) The percentage of completion method may be used for longterm construction projects. Companies may use the percentage of completion method
when progress toward completion and costs to complete the contract can be
reasonably estimated, and there is a firm contract that virtually guarantees payment.
18. (Based on Appendix 7B) Under the gross method of recording sales discounts, the
amount of sales discount taken is only recorded at the time the collection of the
account is recorded.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-3
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
Authors' Recommended Solution Time
(Time in minutes)
Exercises
No.
Time
1
5E
2
15 E
3
20 E
4
20 E
5
20 M
6
20 M
7
25 M
8
30 M
9
15 M
10
30 M
11
15 M
12
15 M
13
20 M
14
30 D
15
10 E
16
15 M
17
20 D
18
25 D
19
25 M
20
10 M
21
15 E
22
20 E
23
25 M
24
30 M
25
30 M
26
20 M
E = Easy
Problems
No.
Time
1
25 M
2
35 M
3
30 M
4
30 D
5
50 D
6
40 D
7
40 D
8
30 D
9
25 E
10
35 M
11
35 M
12
45 M
13
25 M
M = Moderate
Alternate
Problems
No.
Time
1
30 M
2
30 M
3
30 M
4
35 D
5
50 D
6
40 D
7
40 D
8
40 D
9
25 E
10
20 M
11
25 M
12
45 M
Cases and
Projects
No.
Time
1
35 M
2
35 M
3
40 M
4
20 M
5
45 D
6
45 D
7
35 D
8
30 M
9
*
D = Difficult
* Due to the nature of these cases and projects, it is very difficult to estimate the amount of
time students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While students
often benefit from the extra effort, we find that some become frustrated by the perceived
difficulty of the task. You can reduce student frustration and anxiety by making your
expectations clear. For example, when our goal is to sharpen research skills, we devote
class time to discussing research strategies. When we want the students to focus on a real
accounting issue, we offer suggestions about possible companies or industries.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-4
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
EXERCISES
E7–1
Transaction
(a) Airline tickets sold by an
airline on a credit card
(b) Computer sold by mail order
company on a credit card
(c) Sale of inventory to a business
customer on open account
Point A
Point of sale
Point B
x Completion of flight
x
Shipment
Delivery
x
Shipment
Collection from customers
E7–2
Req. 1
Sales revenue ($850 + $700 + $450)...........................................................
Less: Sales discount ($850 collected from S. Green x 2%) ................
Net sales .................................................................................................................
$ 2,000
17
$1,983
Req. 2
Jan. 6
Jan 14
Trade receivables – S. Green (+A) ................................................
Sales revenue (+R  +SE)......................................................
850
Cash (+A) ($850 x 98%)...................................................................
Sales discounts (XR  SE) ($850 x 2%) .................................
Trade receivables – S. Green (-A) ........................................
833
17
850
850
E7–3
Req. 1
Sales revenue ($1,000 + $6,000 +$2,000) ................................................
Less: Sales discount ($6,000 collected from Steven x 2%)................
Credit card discount ($1,000 from Rami x 2%)..........................
Net sales .................................................................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-5
$9,000
(120)
(20)
$8,860
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–3 (continued)
Req. 2
July 12
Cash (+A) ($1,000 x 98%) ...............................................................
Credit card discount (+XR  SE) ($1,000 x 2%) .................
Sales revenue (+R  +SE)......................................................
July 15
July 23
980
20
1,000
Trade receivables – Steven (+A) .................................................. 6,000
Sales revenue (+R  +SE)......................................................
6,000
Cash (+A) ($6,000 x 98%) ............................................................... 5,880
Sales discounts (+XR  SE) ($6,000 x 2%) ...........................
120
Trade receivables – Steven (A) ..........................................
6,000
E7–4
Req. 1
Sales revenue ($800 + $5,000 + $6,000) ...................................................
Less: Sales returns and allowances (1/10 x $6,000 from David) .......
Less: Sales discounts (9/10 x $6,000 from David x 2%) ........................
Less: Credit card discounts ($800 from Brigitte x 2%)........................
Net sales .................................................................................................................
$11,800
(600)
(108)
(16)
$11,076
Req. 2
Nov. 20 Cash (+A) ($800 x 98%)...................................................................
Credit card discount (+XR  SE) ($800 x 2%) ....................
Sales revenue (+R  +SE)......................................................
784
16
Nov. 25 Trade receivables – Clara (+A) ..................................................... 5,000
Sales revenue (+R  +SE)......................................................
Dec. 30
Cash (+A) ............................................................................................... 5,000
Trade receivables – Clara (–A) .............................................
800
5,000
5,000
E7–5
Transaction
July 12
July 15
July 20
July 21
Net Sales
+
+
N
–
Gross Profit
+
+
N
–
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-6
Earnings from
Operations
+
+
–
–
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–6
Req. 1
The percentages of (1) cost of sales to net sales and (2) sales returns and allowances to
gross sales are shown in the following table for each of the six quarters.
Quarter
1st quarter, 2014
2nd quarter, 2014
3rd quarter, 2014
4th quarter, 2014
1st quarter, 2015
2nd quarter, 2015
Ratio 1
73%
75%
75%
72%
71%
74%
Ratio 2
4%
5%
6%
8%
9%
11%
Req. 2
The ratio of cost of sales to net sales decreased slightly during the last quarter of 2014 and
the first quarter of 2015. It then increased in the second quarter of 2015. This may indicate
a change in the company’s efficiency in purchasing goods for resale. The changes could also
be related to seasonal variations. It could also mean that the company has been able to
increase its sales prices relative to the cost of the items purchased. Alternatively, the lower
cost of sales may reflect the fact that the company is purchasing lower quality merchandise,
which is costing less than before.
The dollar amount for sales returns and allowances almost quadrupled in amount and
tripled as a percentage of gross sales during the six quarters. Possible reasons for this
increase include: (1) a deterioration in the quality of the merchandise purchased from the
various international suppliers, and/or (2) a liberal policy of sales returns and allowances
that is intended to serve the needs of customers, and to allow them to return any defective
or unwanted merchandise within two months of purchase.
The company should review its sales returns and allowances policy with an attempt to
reduce the maximum length of the period allowed for returns, perhaps from 60 days to 45
days. The company needs to re-examine its sources of supply of merchandise with a view to
improving on the quality of the products purchased and sold so as to reduce the amount of
sales returns and allowances.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-7
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–7
Req. 1
SLATE, INC.
Statement of earnings
For the Year Ended December 31, 2014
Amount
Gross sales ($233,000 + $40,000) ...............................
Less: sales returns and allowances .............................
Net sales revenue ...............................................................
Cost of sales ..........................................................................
Gross margin on sales.......................................................
Operating expenses:
Administrative expense .................................................
Selling expense..................................................................
Bad debt expense .............................................................
Earnings before income tax ...........................................
Income tax expense ($50,600 x 30%) ......................
Net earnings .........................................................................
$273,000
8,000
265,000
146,000
119,000
$20,000
47,200
1,200
Earnings per share ($35,420 ÷ 4,500 shares)
68,400
50,600
15,180
$ 35,420
$7.87
In this case, earnings from operations is the same as earnings before income tax.
Req. 2
Gross profit (gross margin): $265,000 – $146,000 = $119,000.
Gross profit percentage = $119,000 ÷ $265,000 = 0.45 (or 45%).
Gross profit (or gross margin) in dollars is the difference between the sales prices and the
costs of purchasing or manufacturing all goods that were sold during the period
(sometimes called the markup); that is, net revenue minus only one of the expenses – cost
of sales. The gross profit ratio is the amount of each net sales dollar that was gross profit
during the period. For this company, the rate was 45%, which means that $.45 of each net
sales dollar was gross profit (alternatively, 45% of each sales dollar was gross profit for the
period).
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-8
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–8
Req. 1
Statement of Earnings
For the Year Ended December 31, 2014
Revenue ................................................................................
Cost of sales ..........................................................................
Gross profit ..........................................................................
Operating expenses ...........................................................
Earnings from operations ...............................................
Other income (expense):
Finance income (expense), net .................................
Other income ...................................................................
Earnings before income tax ...........................................
Income tax expense ...........................................................
Net earnings .........................................................................
Earnings per share
Number of common shares outstanding (in millions)
Wood Work
Modern Furniture
$1,340,000
748,000
592,000
512,000
80,000
$682,000
399.000
283,000
223,000
60,000
(34,000)
2,500
(31,500)
48,500
15,500
$ 33,000
3,350
-03,350
63,350
12,000
$ 51,350
$0.27
$0.73
120.8 million
70.0 million
Wood Work, earnings per share = $33,000 ÷ 120.8 million shares= $0.27
Modern Furniture, earnings per share = $51,350 ÷ 70.0 million shares = $0.73
Req. 2 (dollars in thousands)
Wood Work:
Gross profit = $592,000
Gross profit percentage: $592,000 ÷ $1,340,000 = 0.442 (or 44.2%).
Modern Furniture:
Gross profit = $283,000
Gross profit percentage: $283,000 ÷ $682,000 = 0.415 (or 41.5%).
Gross profit (or gross margin) is the difference between sales revenue and the cost of sales
during the period (sometimes called the markup). The gross profit percentage measures
how much of every sales dollar is gross profit. It reflects the company’s ability to charge
premium prices and produce goods and services at low cost.
Wood Work sold more merchandise than Modern Furniture, and achieved a higher gross
profit, indicating that Wood Work was able to charge higher prices than Modern Furniture
for the merchandise it sold and/or was able to purchase the merchandise it sold at lower
cost than Modern Furniture.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-9
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–9
Estimated
Estimated
percentage
amount
Aged trade receivables
uncollectible
uncollectible
Not yet due
$25,000 x
2%
=
$ 500
Up to 120 days past due
10,000 x
10%
=
1,000
Over 120 days past due
5,000 x
30%
=
1,500
Estimated ending balance in Allowance for Doubtful Accounts
$3,000
Current balance in Allowance for Doubtful Accounts
600
Bad Debt Expense for the year
$2,400
E7–10
Req. 1 (amounts in millions of Swiss francs, CHF):
Dec. 31, 2012
Allowance for doubtful accounts (XA +A) ....................................
Trade receivables (A) ................................................. ...............
To write off trade receivables determined to be
uncollectible.
95
Trade receivables (+A) ...............................................................................
Allowance for doubtful accounts (+XA A)...... ...............
To reinstate the receivable from a major customer.
15
Cash (+A) ..........................................................................................................
Trade receivables (A) ................................................. ...............
To record collection from a major customer.
15
Bad debt expense (+E SE) .................................................................
Allowance for doubtful accounts (+XA  −A).....................
To record estimated bad debt expense.
310.9
Estimated
percentage
Aged trade receivables
uncollectible
Not past due
CHF10,925 x
1%
Past due 1–30 days
1,356 x
5%
Past due 31–60 days
445 x
10%
Past due 61–90 days
168 x
20%
Past due 91–120 days
95 x
30%
Past due more than 120 days
798 x
40%
Estimated ending balance in Allowance for Doubtful Accounts
Unadjusted balance (372 – 95 + 15)
Bad debt expense for 2012
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-10
95
15
15
310.9
=
=
=
=
=
=
Estimated
amount
uncollectible
CHF109.3
67.8
44.5
33.6
28.5
319.2
CHF602.9
292.0
CHF310.9
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–10 (continued)
Req. 2
Statement of financial position (amounts in millions of Swiss francs, CHF):
Current assets
Trade receivables .......................................................................
CHF13,787.0
Less: Allowance for doubtful accounts ..............................
602.9
Trade receivables, net ..............................................................
CHF13,184.1
E7–11
(Journal entry amounts are in millions of Euro)
Req. 1
Bad debt expense (+E SE) ...........................................................
Allowance for doubtful accounts (+XA  −A)...............
To record estimated bad debt expense.
370
Allowance for doubtful accounts (XA  +A) .............................
Trade receivables (A) ...........................................................
To write off specific bad debts.
235
Trade receivables (+A) ......................................................................
Allowance for doubtful accounts (+XA  –A) ……………
Reinstatement of accounts written off.
132
Cash (+A) ………………………………………………………………………..
Trade receivables (–A) ………………………………………………
Collection on accounts written off.
132
370
235
132
132
Req. 2
It would have no effect because the asset “Trade receivables” and contra-asset “Allowance
for doubtful accounts” would both decline by €10 million. Neither “net receivables” nor
“net earnings” would be affected.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-11
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–12
Req. 1
The percentages of uncollectible accounts for each category of past due receivables are
computed below:
(B)
Amount of
Receivables
(C) = (B) ÷ (A)
Percentage
–
$19,500
–
31 – 60 days
100
5,000
2.0%
61 – 90 days
65
2,300
2.8%
91 – 120 days
985
3,400
29.0%
–
–
–
$1,150
$30,200
Past due accounts
(A)
Impairment
Allowance
Current
$
More than 120 days
The percentage of amounts that are potentially uncollectible increases the longer the
amounts remain uncollected by the Company, which is normal because the likelihood of
collection from delinquent customers become smaller as time passes.
Req. 2
The bad debt expense was determined as follows:
Balance at Beginning of year
$1,200
Losses due to unrecoverable receivables
Known
X
Amounts written off as uncollectible
(1,150)
Known
Balance at end of year
$1,350
Computed above
The unknown amount is $1,350 – ($1,200 – $1,150) = $1,300
Req. 3
Dec. 31, 2014
Allowance for doubtful accounts (XA +A) .................................................. 1,250
Trade receivables (A) .................................................................. ...............
To write off trade receivables determined to be uncollectible.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-12
1,250
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–12 (continued)
Bad debt expense (+E SE) ................................................................................ 1,300
Allowance for doubtful accounts (+XA  −A) ......................................
To record estimated bad debt expense.
1,300
Req. 4
It would have no effect because the asset “Trade Receivables” and contra-asset “Allowance
for Doubtful Accounts” would both decline by $10 thousands. Neither “net trade
receivables” nor “net earnings” would be affected.
E7–13
Req. 1
Allowance for doubtful accounts
Write-offs
56
375
14
Beg. balance
Bad debt exp.
333
End. balance
Bad debt expense increases (is credited to) the allowance. Since we are given the
beginning and ending balances in the allowance, we can solve for write-offs, which
decrease (are debited to) the allowance.
Req. 2
Trade receivables
Beg. balance*
Net sales
13,389
68,643
End. balance **
15,320
56
66,656
Write-offs
Cash collections
* $13,014 + 375
** $14,987 + 333
Trade Receivables is increased (debited) by recording sales made on credit; the account is
decreased (credited) by recording cash collections and write-offs of bad debts. Thus, we
can solve for cash collections as the missing value.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-13
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–14
Req. 1
The allowance for uncollectible accounts is increased (credited) when bad debt expense is
recorded and decreased (debited) when uncollectible accounts are written off. This case
gives the beginning and ending balances of the allowance account and the amount of
uncollectible accounts that were written off. Therefore, the amount of bad debt expense
can be computed as follows (amounts in millions):
(c)
(a)
(b)
(c)
(d)
Allowance for Uncollectible Accounts
17
(a)
42
(d)
9
(b)
34
Beginning balance, given
Ending balance, given
Uncollectible accounts write-off, given
Bad debt expense, inferred amount (to balance)
Req. 2
Working capital is unaffected by the write-off of an uncollectible account when the
allowance method is used. The asset account (Trade Receivables) and the contra- asset
account (Allowance for Uncollectible Accounts) are both reduced by the same amount;
therefore, the net trade receivables is unchanged.
Working capital is decreased when bad debt expense is recorded because the contra–asset
account (Allowance for Uncollectible Accounts) is increased. From requirement (1), we
know that net trade receivables were reduced by $9 million when bad debt expense was
recorded in year 2.
Note that earnings before taxes were reduced by the amount of bad debt expense that was
recorded, therefore Income Tax Expense and Income Tax Payable will decrease. The
decrease in Income Tax Payable caused working capital to increase; accordingly, the net
decrease in working capital was $6.3 million (= $9 million – $9 million x 30%).
Req. 3
The entry to record the write-off of an uncollectible account did not affect any statement of
earnings accounts; therefore, net earnings is unaffected by the $9 million write-off in year
2.
The recording of bad debt expense reduced earnings before taxes in Year 2 by $9 million
and reduced tax expense by $2.7 million (i.e., $9 million x 30%). Therefore, Year 2 net
earnings were reduced by $6.3 million (as computed in Req. 2).
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-14
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–15
Req. 1
Calculations for Current Year:
Receivables turnover
=
Net Sales
=
Average Net Accounts
Receivables
=
365
=
Receivables Turnover
* (6,598 + 6,539) ÷ 2
Average age of
of receivables
$62,071
$6,568.5*
= 9.45times
365 = 39 days (rounded)
9.45
Req. 2
The receivables turnover ratio reflects how many times accounts receivable were recorded
and collected, on average, during the period. The average collection period indicates the
average time it takes a customer to pay the amount due.
E7–16 (in thousands of euros)
Req. 1
Calculations for 2011:
Receivables turnover =
* (798,320 + 889,330) ÷ 2
Average age of
of receivables
=
Net Sales
Average Net Trade
Receivables
= €2,032,341 = 2.41 times
€843,825*
365
=
Receivables Turnover
365 = 151 days (rounded)
2.41
2011: 2.41 times; 151 days
2010: 2.59 times; 141 days
2009: 2.61 times; 140 days
2008: 2.91 times; 125 days
2007: 3.23 times; 113 days
The results indicate a downward trend in the receivables turnover, and an increase in the
average collection period, which increased by more than one month over the five-year
period.
Req. 2
The receivables turnover ratio reflects how many times trade receivables were recorded
and collected, on average, during the period. The average collection period indicates the
average time it takes a customer to pay its accounts.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-15
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–17
Req. 1
a. Receivables turnover = Net sales / Average net trade receivables
Aer Lingus:
WestJet Airlines:
€1,393,284 / [(€29,138 + €42,273) /2] = 39.0 times
$3,427,409 / [($34,122 + $37,576) /2] = 95.6 times
b. Average collection period = 365 / Receivables turnover
Aer Lingus:
WestJet Airlines:
365 / 39.0 = 9 days (rounded)
365 / 95.6 = 4 days (rounded)
Req. 2
WestJet’s trade receivables appear to be the more liquid asset as they are collected every 4
days on average, whereas it takes Aer Lingus 9 days on average to collect from its
passengers or travel agents.
Req. 3
The different currencies do not affect the interpretation of the ratios. Ratios focus on the
relationship of the numbers to each other and are thus not affected by currency.
E7–18
Req. 1
The decrease in the trade receivables balance would increase cash flow from operations for
the current year. This happens because the Company collected more cash from customers
than the credit sales made during the year.
Req. 2
(a) Increasing sales revenue leads to higher trade receivables balances because credit sales
are creating new receivables faster than receivables can be collected.
(b) Cash collections from the prior period's credit sales are lower than the new credit sales
revenue because of the increase in sales revenue. Note that in the next period, cash
collections will also rise. However if credit sales continue to rise, trade receivables will
also continue to increase.
Req. 3
Receivables turnover = Net sales / Average net trade receivables
= $108,429 / [($5,369 + $5,910)/2] = 19.2 times
Average collection period = 365 / Receivables turnover = 365 / 19.2 = 19 days
The computed numbers help investors in assessing how quickly the company collects
receivables from its customers in order to meet its current obligations to suppliers of goods
and services. These numbers can be compared to the average turnover ratio and average
collection period for the industry. The average collection period would also serve as a
check on the company credit policy.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-16
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–19
a. This is not a good practice because the credit manager has the opportunity to
mishandle the cash received from customers while manipulating the customers’
records. For example, he or she may pocket cheques received from customers and
pretend that payments were not received. However, the issuance of periodic
statements to the customers may reveal any mishandling of customers’ payments, if the
customers contact a person other than the credit manager to ask about the difference or
if the statements are reviewed by someone in the accounting department. A more
serious problem would be to pocket the amount received and write the customer’s
account off as uncollectible.
b. The is a very good practice as there will be no cash left in the hands of employees who
may be tempted to use it for their own benefit.
c. This practice is good as it prevents situations that are noted in a) above.
d. This is not a good practice. The invoices should not be stamped “paid” until the cheques
have been issued to the proper party and signed. Otherwise, it is possible for the
treasurer to issue a cheque to another party. Furthermore, it is recommended that the
cheques be signed by two individuals and that the signed cheques be reviewed to
ensure proper payment before the invoice is stamped “paid”.
e. This is not a good practice. The cheques should be pre-numbered in order to keep track
of the cheques that have been issued and to account for the missing cheques.
f. This is not a good practice. The adjusted balances should be equal if the bank
reconciliation is prepared accurately. If the adjusted balances are different, then the
person preparing the bank reconciliation would have made an error that needs to be
identified and corrected.
E7-20
Cash is the most liquid asset for any organization. Safeguarding cash begins with
documentation. Without documentation there is no appropriate way to protect cash from
theft, fraud or loss. The fact that cash receipts for goods sold are only given to those who
ask for them is a weakness in the control for cash. The cashier who receives money from
customers may be a trustworthy family member. But, this practice may lead to the
temptation of pocketing some of the cash received. For this reason, it is recommended that
receipts be given to customers at all times. Furthermore, it is recommended that all cash
receipts be deposited in the bank for safety purposes, and that payments for farm supplies
be made by cheques, by credit card or by debit card instead of keeping large amounts of
cash on hand. It is also important that all invoices received from suppliers of farm products
be kept to document the cash outflow from the business.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-17
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–21
Include:
Cash on hand ($700 + $100 + $200 + $200) ...............................
Petty cash
.................................................................................
Bank accounts:
City Bank
.................................................................................
National Bank (locations A, B, and C) ....................................
Credit Suisse – 3-Month Certificate of Deposit ..........................
Total cash and cash equivalents reported on
2014 statement of financial position ...........................................
Do not include:
Fransabank – 6-month Certificate of
Deposit (report as short-term investment) ................................
$1,200
300
$58,600
5,100
63,700
5,800
$71,000
4,500
Cash equivalents include investments with original maturities (generally) of three months
or less that are readily convertible to cash and whose value is unlikely to change. Under
this definition the 6-month certificate of deposit does not qualify as a cash equivalent.
A more conservative approach would be to recognize only treasury bills and money market
funds as cash equivalents, and exclude the 3-month certificate of deposit. Alternatively if
the 6-month certificate can be cashed early it could be included as a cash equivalent.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-18
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–22
Req. 1
ZOLTAN COMPANY
Bank Reconciliation, June 30, 2015
Company's Books
Bank Statement
Ending balance per Cash
Account ($6,900 + $18,100
– $19,000)……………………………..
Ending balance per bank
statement ……………………………
$6,000
Additions:
Additions:
None
Deposit in transit…………………….
Deductions:
Bank service charge………………
Ending correct cash balance
$6,060
1,900*
7,960
Deductions:
40
$5,960
Outstanding cheques……………
Ending correct cash balance
2,000
$5,960
*$18,100 – $16,200 = $1,900.
Req. 2
Bank service charge expense (+E SE) ..................................................
Cash (A) .................................................................................................
To record deduction from bank account for service charges.
40
40
Req. 3
The balance in the Cash account after the above entry has been posted is the same as the
correct cash balance per the bank reconciliation; $5,960.
Req. 4
Statement of financial position (June 30, 2015):
Current assets:
Cash ($5,960 + $300) ...............................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-19
$6,260
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–23
Req. 1
RUSSELL COMPANY
Bank Reconciliation, September 30, 2014
Company's Books
Ending balance per Cash
account ($6,500 + $28,100 –
$28,900).................................
$5,700
Additions:
$5,770
Additions:
None
Deposit in transit*..........
Deductions:
Bank service charges ....
NSF cheque –
Betty Brown .................
Ending correct cash balance
Bank Statement
Ending balance per bank
statement...............................
1,200*
6,970
Deductions:
$ 60
170
230
$5,470
Outstanding cheques
($28,900 – $27,400) .....
Ending correct cash balance
1,500
$5,470
*$28,100 – $26,900 = $1,200.
Req. 2
(1)
(2)
Bank service charge expense (+E SE) ..............................................
Cash (A) .............................................................................................
To record bank service charges deducted from bank balance.
60
Trade receivables (Betty Brown) (+A) ...................................................
Cash (A) .............................................................................................
To record customer cheque returned due to insufficient funds.
170
60
170
Req. 3
The balance in the Cash account after the above entries have been posted is the same as the
correct cash balance per the bank reconciliation, $5,470.
Req. 4
Statement of financial position (September 30, 2014):
Current assets:
Cash ($5,470 + $400) ...........................................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-20
$5,870
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E724
Req. 1
Cash balance per bank
Add: (1) Deposit in transit
Mini Mart Corporation
Bank Reconciliation
June 30
$1,330
160
1,490
(240)
$1,250
Less: (2) Outstanding cheques
Adjusted cash balance per bank
Cash balance per books
Add: (4) Note collected by bank and interest $40
Less: (3) Bank service charge
(5) NSF Cheque
Adjusted cash balance per books
$ (9)
(80)
$ 499
840
1,339
(89)
$1,250
Req. 2
(1)
(2)
(3)
Cash (+A) .....................................................................................................
Notes receivable (A) ..............................................................
Interest revenue (+R +SE) .................................................
Note receivable and interest collected. (This entry assumes .
that no previous entry was made to accrue interest revenue.)
840
Trade receivables (+A) ..........................................................................
Cash (A) ......................................................................................
Customer's cheque returned; insufficient funds.
80
Bank service charge expense (+E SE) .......................................
Cash (A) ......................................................................................
Bank service charges deducted from bank statement.
9
800
40
80
9
Req. 3
Preparation of a bank reconciliation is important for three reasons: (a) to determine the
“true” cash balance, (b) to provide data to adjust the Cash account to that balance, and (c)
to provide control over the cash account through independent verification.
Req. 4
The amount of cash that should be reported on the statement of financial position is
$1,250.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-21
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–25 (Appendix 7A)
Req. 1
Revenue ....................................................
Expenses ..................................................
Net earnings ............................................
2014
$2,400,000
2,000,000
$ 400,000
2015
$6,000,000
5,000,000
$1,000,000
2016
$3,600,000
3,000,000
$ 600,000
Computations:
2014: ($2,000,000 ÷ $10,000,000) x $12,000,000 = $2,400,000
2015: ($5,000,000 ÷ $10,000,000) x $12,000,000 = $6,000,000
2016: ($3,000,000 ÷ $10,000,000) x $12,000,000 = $3,600,000
Req. 2
If costs cannot be reliably estimated, net earnings would only be recognized when the
project is complete.
2014
2015
2016
Net earnings ............................................
$0
$0
$2,000,000
E7–26 (Appendix 7B)
November 20, 2014
Cash (+A) ..............................................................................................
Credit card discount (+XR SE) ..............................................
Sales revenue (+R +SE)................................................
To record credit card sale.
November 25, 2014:
Trade receivables – Customer Christine (+A) .......................
Sales revenue (+R +SE)................................................
To record a credit sale.
November 28, 2014:
Trade receivables – Customer Daoud (+A) .............................
Sales revenue (+R +SE)................................................
To record a credit sale.
November 30, 2014:
Sales returns and allowances (+XR SE) ............................
Trade receivables – Customer Daoud (–A) ...............
To record return of defective goods $7,200 x 1/12 = $600.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-22
441
9
450
2,800
2,800
7,200
7,200
600
600
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E7–26 (Continued)
December 6, 2014:
Cash (+A) ..............................................................................................
Sales discounts (+XR SE) ........................................................
Trade receivables – Customer Daoud (–A) ...............
To record collection within the discount period,
0.98 × ($7,200 – $600) = $6,498
December 30, 2014:
Cash (+A) ..............................................................................................
Trade receivables – Customer Christine (–A) .........
To record collection after the discount period.
6,468
132
2,800
6,600
2,800
PROBLEMS
P7–1
Case A
Because the fast food restaurant collects cash when the coupon books are sold, cash
collection is not an issue in this case. In order to determine if the revenue has been earned,
the student must be careful in analyzing what the restaurant actually sold. Students who
focus on the sale of the coupon book often conclude that the earning process is complete
with the delivery of the book to the customer. In reality, the restaurant has a significant
additional service to perform; it has to serve a meal. The correct point for revenue
recognition in this case is when the customer uses the coupon or when the coupon expires
and the restaurant has no further obligation.
Case B
In this case there is reason to believe that Quality Builders may default on the contract
because of prior actions. If students believe that Howard Development could sue and
collect on the contract, they will probably argue for revenue recognition at the time of sale.
Given the high risk associated with cash collection, however, many students will properly
argue that revenue should be recognized only as cash is collected.
Case C
While warranty work on some appliances can involve significant amounts of effort and
money, appliance companies are permitted to record revenue at the point of sale. In
accordance with the matching process one should accrue estimated warranty expense at
the time that sales revenue is recorded. Some students may be surprised to learn that costs
that will be incurred in the future should be recorded as an expense in the current
accounting period, but following this practice enhances the quality of the financial
statements.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-23
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–2
Req. 1
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
(m)
Total
Sales
Revenue
+234,000
+11,500
+25,000
N
+26,000
N
N
N
+17,500
N
N
N
N
+$314,000
Sales Discounts
(taken)
N
N
N
N
N
+220*
+2,000**
+500
N
–70
N
N
N
+$2,650
Sales Returns and Bad Debt Expense
Allowances
N
N
N
N
N
N
+500
N
N
N
N
N
N
N
N
N
N
N
+3,500
N
N
N
N
N
N
+980***
+$4,000
+$980
* [($11,500 – 500) x 2%] = $220
** [($98,000 / .98) x .02] = 2,000
*** Balance of Allowance for Doubtful Accounts ($49,500 x 4%)
Balance of account before adjustment ($4,000 – $3,000)........
Bad debt expense .....................................................................................
$1,980
1,000
$ 980
Trade Receivables
Bal., January 1, 2015
115,000
Sale to R. Agostino (b)
11,500
500 Return by R. Agostino (d)
Sale to K. Black (c)
25,000
Sale to B. Assaf (e)
26,000 100,000 Collections within discount period (g)
Sale to R. Fong (i)
17,500
11,000 Collection from R. Agostino (f)
25,000 Collection from K. Black (h)
6,000 Collection from customers (k)
3,000 Write off of uncollectible account (l)
Bal., December 31, 2015
49,500
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-24
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–2 (continued)
Req. 2
Statement of earnings (partial):
Sales revenue ..................................................................................$314,000
Less:
Sales returns and allowances .................................. (4,000)
Sales discounts .............................................................. (2,650)
Net sales revenue ..........................................................................
….
Operating expenses:
Bad debt expense ....................................................................
$307,350
980
P7–3
Statement of Earnings Items
YEAR 1
Note–See below
$160,000*
g.
10,000
e.
150,000
f. (68%*) 102,000
d.
48,000
18,000*
b.
30,000
c.
6,000
a.
$ 24,000
$2.40*
Gross sales revenue ...........................................
Sales returns and allowances ........................
Net sales revenue ...............................................
Cost of sales ..........................................................
Gross profit ...........................................................
Operating expenses ...........................................
Earnings before income taxes .......................
Income tax expense (20%)* ...........................
Net earnings .........................................................
Earnings per share (10,000 shares*) .........
YEAR 2
Note–See below
$232,000*
18,000*
a.
214,000
c.
149,800
b. (30%*) 64,200
d.
44,200
20,000*
e.
4,000
f.
$ 16,000
g.
$1.60
*Amounts given.
Note = Computations in order
a.
b.
c.
d.
e.
f.
g.
Year 1
$2.40 x 10,000 shares = $24,000
$24,000 ÷ (1.00 – 0.20) = $30,000
$30,000 x .20 = $6,000
$30,000 + $18,000 = $48,000
$48,000 ÷ (1.00 – 0.68) = $150,000
$150,000 x .68 = $102,000
$160,000 – $150,000 = $10,000
a.
b.
c.
d.
e.
f.
g.
Year 2
$232,000 – $18,000 = $214,000
$214,000 x .30 = $64,200
$214,000 – $64,200 = $149,800
$64,200 – $20,000 = $44,200
$20,000 x .20 = $4,000
$20,000 – $4,000 = $16,000
$16,000 ÷ 10,000 shares = $1.60
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-25
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–4 (Dollars in thousands)
Req. 1
Bad debt expense (+E SE) ........................................................................ 4
Allowance for doubtful accounts (+XA  –A) .................................
Estimate of end-of-period bad debt expense.
4
There was no write-off of bad debts in Year 1.
Req. 2
Allowance for Year 2
Write-offs
36
Allowance for Year 3
132 Beg. bal.
187 Bad debt exp.
Write-offs
283 Beg. bal.
201 42 Bad debt exp.
283 End. bal.
124 End. Bal.
The solution is facilitated by solving for the missing value in the T-account.
P7–5
Req. 1
Customer
B. Brown……....
D. Di Lella….....
N. Gidda…....…
S. Kavouris……
T. Patel…...…...
Aging Analysis of Trade Receivables
Total
(a)
(b) Up to One
(c) More Than One
Receivables Not Yet Due Year Past Due
Year Past Due
$ 6,000
$6,000
5,000
$ 5,000
7,000
$ 7,000
20,000
4,000
16,000
7,000
7,000
Totals…….……
$45,000
$18,000
$21,000
Percent….…….
100%
40%
46.7%
It is assumed that collections are applied to the oldest invoices first.
$6,000
13.3%
Req. 2
a.
b.
c.
Estimated Amounts Uncollectible
Amount of
Estimated
Age
Receivable
Loss Rate
Not yet due
$18,000
1%
Up to one year past due
21,000
5%
More than one year past due
6,000
30%
Total
$45,000
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-26
Estimated
Uncollectible
$ 180
1,050
1,800
$3,030
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–5 (continued)
Req. 3
Bad debt expense (+E SE) ..........................................................
2,010
Allowance for doubtful accounts (+XA –A) ...............
To adjust for estimated bad debt expense:
Balance needed in the allowance account ....
$3,030
Balance currently in the account .....................
1,020
Adjustment needed, i.e., increase ....................
$2,010
2,010
Req. 4
Statement of Earnings:
Operating expenses:
Bad debt expense .................................................................................
$2,010
Statement of financial position:
Current assets:
Trade receivables .................................................................................
Less: Allowance for doubtful accounts .......................................
Net trade receivables ..........................................................................
$45,000
(3,030)
$41,970
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-27
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–6
Req. 1
April 10
No journal entry as there is no exchange yet.
April 30
Trade receivables (+A) ..................................................................
Sales revenue (+R  +SE) ...................................................
Sold 15 machines to Yuri Inc.
150,000
May 1
Trade receivables (+A) ..................................................................
Sales revenue (+R  +SE) ...................................................
Sold 12 machines to Peter’s Applicances.
120,000
May 5
Cash (+A) ............................................................................................
Sales discounts (+XR –R) [$150,000 x 2%] .......................
Trade receivables (–A) ..........................................................
Collected from Yuri Inc. within the discount period.
147,000
3,000
May 7
Trade receivables (+A) ..................................................................
Sales revenue (+R  +SE) ...................................................
Sold 10 machines to Cheng Ltd.
100,000
May 10
Allowance for doubtful accounts (–XA  +A).......................
Trade receivables (–A) ..........................................................
Write off of uncollectible accounts.
12,000
Cash (+A) ............................................................................................
Sales allowances and returns (+XR  –R) ............................
Trade receivables (–A) ..........................................................
Peter’s Appliances returned two machines and paid the
amount due.
100,000
20,000
June 1
Cash (+A) ............................................................................................
Trade receivables (–A) ..........................................................
Collection from Cheng Ltd. On account.
80,000
June 30
Trade receivables (+A) ..................................................................
Allowance for doubtful accounts (+XA  –A) .............
Reinstatement of accounts written off on May 10.
3,000
Cash (+A) ............................................................................................
Trade receivables (–A) ..........................................................
Collection on accounts written off on May 10.
3,000
May 15
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-28
150,000
120,000
150,000
100,000
12,000
120,000
80,000
3,000
3,000
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–6 (continued)
Req. 2
The following time line shows the various transactions related to trade receivables and
help in preparing the aging of trade receivables schedule.
March 31
April 30
May 1
May 5
May 7
May 10
May 15
June 1
June 30
__|_________|_____ ___|___ ____|_________|_______|______ _|____ ___|________|____
$60,000
$150,000
Balance
Yuri
$120,000 ($150,000)
Peter
Yuri
$100,000 ($12,000) ($20,000) ($80,000) $3,000
($100,000)
($3,000)
Cheng
Write-off
Peter
Cheng Recovery
Age Group
Not yet due
1–30 days past due [$100,000 – $80,000 ]
31–60 days past due
More than 60 days past due
Total
Amount
Receivable
$
0
20,000
0
48,000*
$68,000
Estimated
Percent
Uncollectible
5%
10%
15%
20%
Estimated
Uncollectible
$
0
2,000
0
9,600
$11,600
* $60,000 (beginning balance) – $12,000 (write off)
Allowance for Doubtful Accounts
Beg. bal.
Write-offs
12,000
Recoveries
Bad debt exp.
End. bal.
15,000
3,000
5,600
11,600
Adjusting journal entry:
June 30
Bad debt expense (+E  –SE) ....................................................
Allowance for doubtful accounts (+XA  –A) .............
Recording of estimated bad debt expense for the period.
5,600
5,600
Req. 3
Receivables turnover ratio = Net credit sales / Average net trade receivables
Net credit sales = Credit sales – Sales discounts – Sales returns and allowances
The T-accounts below show the balances of effects of transcations on sales and trade
receivables
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-29
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–6 (continued)
Sales
Balance, March 31
April 30
May 1
May 7
600,000
150,000
120,000
100,000
Balance, June 30
970,000
Trade Receivables
Balance, March 31
April 30
May 1
May 7
June 30
60,000
150,000
120,000
100,000
3,000
Balance, June 30
May 5
May 10
May 15
June 1
June 30
150,000
12,000
120,000
80,000
3,000
68,000
Net credit sales = $970,000 – $3,000 – $20,000 = $947,000
Receivables turnover ratio =$947,000/[($60,000 – $15,000) + ($68,000 – $11,600)]/2]
= $947,000/$50,700 = 18.68
Average collection period = 365/Receivables turnover ratio = 365/18.68 = 19.5 days
The average collection period reflects the average time it takes a customer to pay the
amount due. In this case, the calculation suggests that it takes IceKreme’s customers on
average 19.5 days to pay the amount due.
Req. 4
IceKreme’s customers pay, on average, after 20 days after the purchase date, which is
within the credit of 30 days . They appear to be paying off the amounts due faster than
Pino’s customers, but slower than Julia’s customers.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-30
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–7
Req. 1
Dec. 5
Cash (+A) ............................................................................................
Trade receivables (+A) ..................................................................
Sales revenue (+R  +SE) ...................................................
Sale of merchandise partly cash and the rest on
account, terms 2/10, n/30.
19,000
48,000
Cost of sales (+E  –SE) ................................................................
Merchandise Inventory (–A)...............................................
55,000
Cash (+A) ............................................................................................
Sales discounts (+XR  –R) [$24,000 x 2%] .........................
Trade receivables (–A) ..........................................................
Collected cash for half the credit sales of Dec. 5.
23,520
480
Dec. 20
Cash (+A) ............................................................................................
Trade receivables (–A) ..........................................................
Collection on sales made in November.
90,000
Dec. 26
Allowance for doubtful accounts (–XA  +A).......................
Trade receivables (–A) ..........................................................
Write off of a customer’s uncollectibe account.
3,000
Dec. 12
Req. 2
Amount
Receivable
$42,000
31,500
5,000
6,500
$85,000
Age Group
Current
1–30 days past due
31–60 days past due
More than 60 days past due
Total
67,000
55,000
24,000
Estimated
Percent
Uncollectible
1%
2%
10%
30%
90,000
3,000
Estimated
Uncollectible
$420
630
500
1,950
$3,500
The amount of bad debt expense is the difference in the balance of the Allowance for
Doubtful Accounts before and after the adjustment.
Bad debt expense = $3,500 – ($4,500 – $3,000) = $3,500 – $1,500 = $2,000
Adjusting journal entry:
Dec. 31
Bad debt expense (+E  –SE) ....................................................
Allowance for doubtful accounts (+XA  –A) .............
Recording of estimated bad debt expense for the period.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-31
2,000
2,000
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–7 (continued)
Req. 3
Gross profit percentage = Gross Profit / Net Sales
= (Sales – Sales discount – COS) / (Sales – Sales discount)
= ($67,000 – $480 – $35,000) / ($67,000 – $480)
= $31,520 / $66,520 = 47.38%
This ratio measures how much gross profit is generated from every sales dollar. It reflects
the ability to charge premium prices and purchase or produce goods and services at low
cost.
Receivable turnover ratio = Net credit sales / Average net trade receivables
= $47,520 */ $115,500** = 0.41 times (for December only)
* Net credit sales = Credit sales – Sales discount = $48,000 – $480 =$47,520
** Average net trade receivables = Average of beginning and ending values of net receivables
=[($154,000 – $4,500) + ($85,000 – $3,500)]/2 = $115,500
This ratio measures how many times trade accounts receivable are recorded and collected
during the period. This monthly ratio corresponds to an annual ratio of 4.92 (0.41 x 12),
assuming that the sales and collection activities are typical monthly activities.
P7–8
Req. 1
The beginning balance of trade receivables will increase by the amount of credit sales, and
will decrease when cash is collected from customers or when accounts are written off as
uncollectible. Accordingly, the balance of Trade receivables at December 31, 2015 is
determined as follows:
Beginning balance
+ Credit sales
– Collections from customers
– Write-off of uncollectible accounts
Ending balance
$ 500,000
1,000,000
(1,100,000)
(30,000)
$ 370,000
Req. 2
Allowance for doubtful accounts (XA  +A) .........................
Trade receivables (–A) ............................................................
To record the write-off of trade receivables as uncollectible.
30,000
30,000
27,200
Bad debt expense (+E  SE) .......................................................
27,200
Allowance for doubtful accounts (+XA  A)
To adjust the balance of the Allowance for doubtful accounts and record bad debt
expense for the year.
Ending balance of Allowance account = $370,000 x 6% =
$22,200 Cr
Unadjusted balance of the Allowance account ($25,000 – $30,000) = 5,000 Dr
Amount of adjustment needed =
$27,200 Cr
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-32
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–8 (continued)
Req. 3
Vital Inc.
Partial Statement of Financial Position
As at December 31, 2015
Current Assets
….
Trade receivables
Less: Allowance for doubtful accounts
Net
$370,000
( 22,200)
$347,800
OR
Trade receivables (net of allowance of $22,200)
$347,800
Req. 4
The method being proposed by the bookkeeper is called the direct write-off method. The
reasoning of the bookkeeper is quite appealing in the sense that it saves him and others
time and effort in estimating the amount of receivables that may not be collected in the
future. This simplistic approach would be acceptable if the amounts that are written off
annually are relatively small or if they are close to the amount that would be considered
uncollectible under the allowance method.
The main deficiency of the direct write-off method is its inconsistency with the matching
process which requires that expenses be matched to the related revenues during the same
period. If a trade receivable is written-off in a period that follows the period of sale, then
the matching process would have not been observed. The direct method also results in an
overstatement of trade receivables, which should be reported at their estimated realizable
value. Because most businesses have some amounts that will not be collected, a provision
for uncollectible accounts should be made. For this reason, accountants estimate the
amount that may not be collectible in the future, with full knowledge that the estimated
amount may not be an exact amount. However, the estimated bad debt expense complies
with the matching process. In that respect, it is preferable to be imprecisely right than
precisely wrong.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-33
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–9
Req.1
BUILDERS COMPANY, INC.
Statement of Earnings
For the Year Ended December 31, 2014
Gross sales revenue ....................................................................................
Less: Sales discounts ....................................................................
Sales returns and allowances ........................................
Net sales revenue ........................................................................................
Cost of sales ...............................................................................................
Gross profit ...............................................................................................
Operating expenses:
Selling expenses ................................................................................ $13,600
Administrative expenses ............................................................... 14,400
Bad debt expense .............................................................................
1,600
Earnings before income tax ....................................................................
Income tax expense .........................................................................
Net earnings ..................................................................................................
$145,600
6,400
5,600
133,600
78,400
55,200
Earnings per share: ($17,920 ÷ 10,000 shares) ...........................................................
29,600
25,600
7,680
$17,920
$1.79
In this case earnings from operations is the same as earnings before income tax.
Req. 2
Gross Profit Percentage
=
Gross Profit
Net Sales
=
$55,200
$133,600
= 0.41 (41%)
The gross profit percentage shows the excess of sales prices over the costs to purchase or
produce the goods or services sold, measured as a percentage.
Trade Receivables
Turnover Ratio
=
Net Sales
=
Avg Net Trade
Receivables
$133,600
$15,200
= 8.79
Average net trade receivable = ($16,000 + $14,400) ÷ 2
The trade receivables turnover ratio reflects how many times trade receivables were both
recorded and collected, on average, during the time period. The higher the result is, the
faster the collection of receivables.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-34
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–10
Req. 1
(a)
$50 x 12 months
(b)
$12 x (52 weeks x 5 days per week)
(c), (d) Trade receivables collections ($300 + $800)
Total approximate amount stolen
=
=
=
$ 600
3,120
1,100
$4,820
Req. 2
Basic recommendations:
(1) Install a tight system of internal control, including the following:
a. Approve all sales returns and account write-offs personally and review the
accounts.
b. Use a cash register to record all sales and reconcile the report to the sales
recorded.
c. Deposit all cash daily.
d. Make all payments by cheque. Consider a separate cash-on-hand system for small
expense payments and periodically check the receipts.
e.
Institute a system of spot checks of the employees’ work.
(2) Arrange for an annual independent audit on a continuing basis or a review of the
internal controls that are put in place.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-35
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7-11
Req. 1
Dear Ms. Kostas,
This memo addresses your inquiry about the difference between the balance of the Cash in
Bank account in the company’s records and the balance shown on the bank statement. The
balance in the company’s Cash account is based on the transactions that affected this
account during the month of June. Similarly, the balance of cash shown on the bank
statement reflects the transactions that the bank recorded in the company’s bank account.
It is normal that the balances of these two accounts be different because some of the
cash transactions that affect the company’s bank account may not have been recorded by
the bank as at June 30. For example, an overnight deposit of $1,000 in the bank account on
June 30 will not be recorded by the bank until July 1, but we would have recorded that
deposit in the company’s cash account. This would cause a difference in the account
balances by $1,000 that is only temporary.
Another example is that the bank charges our company specific fees for the services it
provides. The total amount of these service charges is recorded by the bank as they occur.
But, we may not be aware of these charges until we receive the bank statement. We then
record them in the cash account in July, whereas the bank would have recorded them
already in the company’s account in June. These timing differences need to be reviewed on
a regular basis to ensure that there are no errors that have been made inadvertently either
by the bank’s employees or the company’s employees.
Req.2
KOSTAS FASHIONS LTD.
Bank Reconciliation, June 30
Company's Books
Ending balance per Cash
account ...................................
Additions:
Note receivable collected .......
Interest collected .....................
$2,000
80
Deductions:
Bank service charges ($25 + 39) ..................
NSF cheque – Rami Cossette .........................
Correction of amount deposited ..................
Ending correct cash balance ..........................
$ 6,518
Bank Statement
Ending balance per bank
statement ...............................
$10,517
Additions:
2,080
8,598
64
286
90
$8,158
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-36
Deposits in transit .....................
1,145
11,662
Deductions:
Outstanding cheques ................
3,504
Ending correct cash balance ...
$8,158
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–11 (continued)
(1)
Cash in bank (+A).....................................................................................
Note receivable (–A).................................................................
Interest revenue (+R  +SE) ................................................
Note receivable plus interest collected (by bank).
2,080
(2)
Trade receivable (Rami Cossette) (+A) ...........................................
Cash (–A) .......................................................................................
Customer's cheque returned due to insufficient funds.
286
(3)
Trade receivable (Rami Cossette) (+A) .........................................
Cash in bank (–A).......................................................................
Service charges to be collected from the customer.
64
(4)
Cash on hand (+A) ...................................................................................
Cash in bank (–A).......................................................................
Bank deposit of $2,340 recorded incorrectly as $2,430.
90
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-37
2,000
80
286
64
90
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–12
Req. 1
HOPKINS COMPANY
Bank Reconciliation, April 30, 2015
Company's Books
Ending balance per Cash
Account ($23,500
+ $41,500 - $41,100).............
Additions:
Note receivable collected ........
Interest collected ........................
Deductions:
NSF—A.B. Wright .......................
Bank charges ................................
Ending correct cash balance ..
*$41,500 - $36,100 = $5,400.
$23,900
$1,110
70
160
70
Bank Statement
Ending balance per bank
Statement...................................
$23,550
Additions:
1,180
25,080
230
$24,850
Deposits in transit* .....................
Deductions:
Outstanding cheques..................
Ending correct cash balance ...
5,400
28,950
4,100
$24,850
Req. 2
(1)
Cash (+A) .....................................................................................................
Notes receivable (–A)...............................................................
Interest revenue (+R  +SE) ................................................
Note receivable and interest collected. (This entry assumes
that no previous entry was made to accrue interest revenue.)
1,180
(2)
Trade receivable (A. B. Wright) (+A) ...............................................
Cash (–A) .......................................................................................
Customer's cheque returned due to insufficient funds.
160
(3)
Bank service charge expense (+E -SE) ........................................
Cash (–A) .......................................................................................
Bank service charges deducted from bank statement.
70
1,110
70
160
70
These entries are necessary because the changes to the regular Cash account have not yet
been recorded by the company. The bank has already recorded these items in its own
accounts. The Cash account (and the other accounts shown in the above entries) must be
brought up to date for financial statement purposes.
Req. 3
Balance in Cash in bank account, i.e., ending correct cash balance ...........
Balance in Cash on hand account ............................................................................
$24,850
100
Req. 4
Statement of financial position (April 30, 2015):
Current assets:
Cash ($24,850 + $100)..........................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-38
$24,950
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–13 (Appendix 7B)
Req. 1
a.
Cash (+A) ............................................................................................
Sales revenue (+R  +SE) ..................................................
Sold merchandise for cash.
234,000
b.
Trade receivables (+A) .................................................................
Sales revenue (+R  +SE) ..................................................
Sold merchandise to R. Agostino on open account.
11,500
c.
Trade receivables (+A) .................................................................
Sales revenue (+R  +SE) ..................................................
Sold merchandise to K. Black on open account.
25,000
d.
Sales returns and allowances (+XR  –R) .............................
Trade receivables (–A) .........................................................
To record the return of one unit purchased by R. Agostino.
26,000
f.
Cash (+A) ............................................................................................
Sales discounts (+XR  –R) ........................................................
Trade receivables (–A) .........................................................
Collection in full from R. Agostino within the discount
period.
10,780
220
Cash (+A) ............................................................................................
Sales discounts (+XR  –R) ........................................................
Trade receivables (–A) .........................................................
Collections on account within the discount period.
98,000
2,000
Cash (+A) ............................................................................................
Sales discounts (+XR  –R) ........................................................
Trade receivables (–A) .........................................................
Collection from K. Black in full within the discount period.
24,500
500
Trade receivables (+A) .................................................................
Sales revenue (+R  +SE) ..................................................
Sold merchandise to R. Fong on open account.
17,500
i.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-39
25,000
500
Trade receivables (+A) .................................................................
Sales revenue (+R  +SE) ..................................................
Sold merchandise to B. Assaf on open account.
h.
11,500
500
e.
g.
234,000
26,000
11,000
100,000
25,000
17,500
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P7–13 (continued)
Sales returns and allowances (+XR  –R) .............................
Sales discounts (–XR  +R) ..............................................
Cash (–A) ...................................................................................
To record the return of seven defective units by K. Black (7
x $500 x 98%).
3,500
k.
Cash (+A) ............................................................................................
Trade receivables (–A) .........................................................
Collection on account after the discount period.
6,000
l.
Allowance for doubtful accounts (XA  +A) ......................
Trade receivables (–A) .........................................................
To record the write-off of trade receivables as uncollectible.
3,000
j.
m.
70
3,430
6,000
3,000
980
Bad debt expense (+E  SE) ....................................................
980
Allowance for doubtful accounts (+XA  A) ...........
To adjust the balance of the Allowance for doubtful accounts and record bad debt
expense for the year.
Balance of Allowance for Doubtful Accounts ($49,500 x 4%)
Balance of account before adjustment ($4,000 – $3,000)................
Bad debt expense .............................................................................................
$1,980
1,000
$ 980
Trade Receivables
Bal., January 1, 2015
115,000
Sale to R. Agostino (b)
11,500
500 Return by R. Agostino (d)
Sale to K. Black (c)
25,000
Sale to B. Assaf (e)
26,000 100,000 Collections within discount period (g)
Sale to R. Fong (i)
17,500
11,000 Collection from R. Agostino (f)
25,000 Collection from K. Black (h)
6,000 Collection from customers (k)
3,000 Write off of uncollectible account (l)
Bal., December 31, 2015
49,500
Req. 2
Statement of earnings (partial):
Sales revenue ............................................................................................... $314,000
Sales discounts .................................................................................. (2,650)
Sales returns and allowances ...................................................... (4,000)
Net sales revenue ........................................................................................
….
Operating expenses:
Bad debt expense .............................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-40
307,350
980
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
ALTERNATE PROBLEMS
AP7-1
Case A
Revenue should not be recognized until the seller delivers the good or service to the
purchaser. The seller has not yet manufactured the equipment let alone delivered it. The
commitment by the purchaser is not accompanied by payment therefore no cash has been
received. Had cash been received from the purchaser, it should have been recorded as
deferred revenue.
Case B
Revenue should not be recognized unless the seller is reasonably confident that the
purchaser will pay in full. It is clear that many members who sign up do not pay for their
membership. The 10-day delay is known as a “cooling off period” and must be provided by
law, although the time period can be shorter than 10 days. The company can take a
somewhat aggressive approach and recognize a percentage of revenue when members
sign, or a more conservative approach and defer the recognition of revenue until the
cancellation period has expired. Once the cancellation period has ended, Scenic Trails Inc.
can remain somewhat aggressive and recognize the full amount of the membership fee as
revenue or it can be more conservative. The more conservative approach would be to use
either a percentage of revenue or a percentage of trade receivables to create an allowance
for those who will fail to pay the full membership fee during the six-month payment period.
The company should use its experience to choose the appropriate method and the
appropriate percentage that would present fairly the results of its operations to users.
Case C
Educational Toys’ current practice could be based on its experience whereby few
distributors return unsold merchandise and therefore the amount is immaterial. If the
returns are considered as a material amount, then Educational Toys is essentially
recognizing the products delivered to its distributors as if they were sold. In substance,
these products can still be considered inventory for Educational Toys that is located at its
distributors’ warehouses or showrooms. This practice, commonly known as “channeling”,
does not conform to GAAP.
In essence the toys are being sold on consignment and there is little to guide us to
understanding how probable it is that Educational Toys will receive full payment. An
improved approach is for Educational Toys to establish an allowance for sales returns.
Another alternative would be for Educational Toys to not recognize revenue at all until its
distributors have made the sales. Although the correct treatment is a matter of judgement,
it is clear from the facts of this case that there is only a very narrow set of circumstances
under which Educational Toys’ current practice would be acceptable under current
financial reporting standards.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-41
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–2
Req. 1
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
(m)
Total
Sales
Revenue
+228,000
+12,000
+23,600
N
+26,000
N
N
N
N
+18,400
N
N
N
+$308,000
Sales Discounts
(taken)
N
N
N
+120
N
–16
+900*
N
+224
N
N
N
N
+$1,228
Sales Returns and Bad Debt Expense
Allowances
N
N
N
N
N
N
N
N
N
N
+1,600
N
N
N
+1,200
N
N
N
N
N
N
N
N
N
N
+13,620**
+$2,800
+$13,620
* [($89,100/.99) x .01] = $900
**Trade receivables = $116,000 +$228,000 + $12,000 + $23,600 – $12,000 +26,000 –
$90,000 – $1,200 – $22,400 + 18,400 – $26,000 = $272,400
Estimated bad debt expense = $272,400 x 5% = $13,620
Req. 2
Statement of earnings (partial):
Sales revenue .................................................................................. $308,000
Less: Sales discounts ...........................................................
(1,228)
Sales returns and allowances ...............................
(2,800)
Net sales revenue ..........................................................................
….
Operating expenses:
Bad debt expense .................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-42
$303,972
13,620
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–3
Year 1:
Sales discounts
$
3,000
($210,000 – $207,000)
Cost of sales
$124,200
[$207,000 x (1 – 40%)]
Earnings before income taxes
$ 40,000
($207,000 x 40% – $42,800)
Income tax expense
$ 12,000
($40,000 x 30%)
Earnings before discontinued operations $ 28,000
($40,000 – $12,000)
Net earnings
$ 18,000
($28,000 – $10,000)
Earnings per share
$2.25/share ($18,000 ÷ 8,000)
Year 2:
Net sales revenue
$250,000
($255,000 – $5,000)
Gross margin
$100,000
($250,000 x 40%)
Operating expenses
$ 30,000
($100,000 – $70,000)
Income tax expense
$ 21,000
($70,000 x 30%)
Earnings before discontinued operations $ 49,000
($70,000 – $21,000)
Net earnings
$ 51,500
($49,000 + $2,500)
Earnings per share
$6.44/share ($51,500 ÷ 8,000)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-43
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–4 (Dollars in millions)
Req. 1
Balance at
Beginning of
Period
Charged to
Bad Debt
Expense
Write-Offs
Charged to
Allowance
Balance at
End
of Period
$10,364
$2,519
$2,536
$10,347
Year 2
13,554
2,049
5,239
10,364
Year 1
11,305
4,758
2,509
13,554
Allowance for
Doubtful
Accounts
Year 3
Year 1
Allowance for Doubtful Accounts
11,305 Beg. Bal
Write-offs
2,509
4,758 Bad debts expense
13,554 End. bal.
Year 2
Allowance for Doubtful Accounts
13,554 Beg. bal.
Write-offs
5,239
2,049 Bad debts expense
10,364 End. bal.
Year 3
Allowance for Doubtful Accounts
10,364 Beg. bal.
Write-offs
2,536
2,519 Bad debts exp.
10,347 End. bal.
The solution is facilitated by solving for the missing value in the T-account.
Req. 2
Bad debt expense (+E SE) ........................................................................4,758
Allowance for doubtful accounts (+XA  -A)............................
4,758
End of period bad debt expense estimate.
Allowance for doubtful accounts (XA  +A) ......................................... 2,509
Trade receivables (–A) .......................................................................
2,509
Write-off of bad debts.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-44
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–5
Req. 1
Customer
R. Aouad ………..
C. Chronis ………..
D. McClain .……….
T. Skibinski ………
H. Wu ………..…...
Totals……………
Percent …………
Req. 2
a.
b.
c.
d.
Aging Analysis of Trade receivables
(a)
(b)
(c)
Up to
6 to
Total
Not Yet
6 Months
12 Months
Receivable
Due
Past Due
Past Due
$ 2,000
$2,000
6,000
4,000
$ 4,000
14,500
$ 4,500
10,000
13,000
13,000
$39,500
100%
$17,500
44.3%
$14,000
35.4%
$2,000
5.1%
Estimated Amounts Uncollectible
Amount of
Estimated
Age
Receivable
Loss Rate
Not yet due……………………
$17,500
1%
Up to 6 months past due...….
14,000
5%
6 to 12 months past due.….
2,000
20%
More than one year past due
6,000
50%
Total………………………..
$39,500
(d)
More Than
One Year
Past Due
$6,000
$6,000
15.2%
Estimated
Uncollectible
$ 175
700
400
3,000
$4,275
Req. 3
Bad debt expense (+E  SE) ........................................................
5,825
Allowance for doubtful accounts (+XA  A) ................
To adjust for estimated bad debt loss:
Balance needed in the allowance account .......
$4,275 Cr
Balance currently in the account .........................
1,550 Dr
Adjustment needed, i.e., increase ........................
$5,825 Cr
5,825
Req. 4
Statement of earnings:
Operating expenses:
Bad debt expense .................................................................................
Statement of financial position:
Current assets:
Trade receivables .................................................................................
Less: Allowance for doubtful accounts .......................................
Carrying value........................................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-45
$5,825
$39,500
(4,275)
$35,225
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–6
Req. 1
Oct. 8
Nov. 5
Nov. 16
Dec. 20
Allowance for doubtful accounts (XA  +A) ......................
Trade receivables (–A) ..........................................................
Write off of uncollectible accounts.
1,500
Cash (+A) ............................................................................................
Sales discounts (+XR –R) [$7,500 x 2%] .............................
Trade receivables (A) .........................................................
Collected from Machinex within the discount period.
7,350
150
Cash (+A) ............................................................................................
Sales returns and allowances (+XR –R) .............................
Trade receivables (A) .........................................................
Allen Inc. returned two moulds and paid the amount
due.
4,000
1,000
Trade receivables (+A) ..................................................................
Allowance for doubtful accounts (+XA  –A) .............
Reinstatement of accounts written off on October 8.
500
Cash (+A) ............................................................................................
Trade receivables (–A) ..........................................................
Collection on accounts written off on October 8.
500
1,500
7,500
5,000
500
500
Req. 2
The following time line shows the various transactions related to trade receivables and
help in preparing the aging of trade receivables schedule.
Sept 30
Oct 8
Oct 15
Oct 31
Nov 5
Nov 7
Nov 16
Nov 25
Nov 29
Dec 20
__|_______|_____ _|___ ____|_______|_______|_____ _|____ __|_____ |______ |____
$9,500
($1,500)
Balance Write-off
$5,000
Allen
$7,500
($7,500) $10,000 ($1,000) ($1,000) ($5,000) $500
($4,000)
($500)
Machinex Machinex Centra
Allen
Centra Centra Recovery
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-46
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–6 (continued)
Age Group
Not yet due
1–30 days past due ($10,000 – $6,000)
31–60 days past due
More than 60 days past due ($9,500–$1,500)
Total
Amount
Receivable
$
0
4,000
0
8,000
$12,000
Estimated
Percent
Uncollectible
1%
5%
10%
15%
Estimated
Uncollectible
$
0
200
0
1,200
$1,400
Allowance for Doubtful Accounts
Beg. bal.
Write-offs
1,500 Recoveries
Bad debt exp.
End. bal.
1,300
500
1,100
1,400
Adjusting journal entry:
Dec. 31
Bad debt expense (+E  –SE) ....................................................
Allowance for doubtful accounts (+XA  –A) .............
Recording of estimated bad debt expense for the period.
1,100
1,100
Req. 3
Gross profit percentage = Gross Profit / Net Sales
Net sales = $100,000 + (5,000 + 7,500 + 10,000) – (150 + 1,000 + 1,000) = $120,350
Gross profit = Net sales – Cost of sales = $120,350 – $60,000 = $60,350
Gross profit percentage = $60,350 / $120,350 = 50.15%
This ratio measures how much gross profit is generated from every sales dollar. It reflects
the ability to charge premium prices and purchase or produce goods and services at low
cost. The company continue to improve on its gross profit percentage from 35% in 2013 to
50.15% in 2015. It seems that the company is able to increase the sales price for its small
machinery because of the quality of the product and/or it managed to reduce the cost of
production of the machinery by using modern technology or outsourcing the production to
manufacturing facilities in countries where labor cost is relatively low.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-47
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–7
Req. 1
a.
Cash (+A) .............................................................................................
Trade receivables (+A) ..................................................................
Sales revenue (+R  +SE) ...................................................
Sale of merchandise partly cash and the rest on account,
terms n/30.
500,000
4,500,000
Sales returns and allowances (+XR  –R) ...........................
Cash (–A) ....................................................................................
Trade receivables (–A) ..........................................................
To record returns and allowances on sales.
50,000
c.
Cash (+A) .............................................................................................
Trade receivables (–A) ..........................................................
Collection from customers.
4,200,000
d.
Allowance for doubtful accounts (XA  +A) .......................
Trade receivables (–A) ..........................................................
Write off of uncollectibe receivables.
17,000
Trade receivables (+A) ..................................................................
Allowance for doubtful accounts (+XA  –A)..............
Reinstatement of accounts written off previously.
6,000
Cash (+A) .............................................................................................
Trade receivables (–A) ..........................................................
Collection on accounts written off previously.
6,000
b.
e.
5,000,000
5,000
45,000
4,200,000
17,000
6,000
6,000
Req. 2
Rodamex Inc.
Statement of Financial Position (partial)
December 31
2015
Current assets:
:
Trade accounts receivable
Less: Allowance for doubtful accounts
Net realizable value
$938,000 a
23,450 b
$914,550
2014
$700,000
14,000 c
$686,000
a. $700,000 + $4,500,000 – $45,000 – $4,200,000 – $17,000 = $938,000
b. $938,000 x .025 = $23,450.
c. $700,000 x .02 = $14,000.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-48
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–7 (continued)
Req. 3
The amount of bad debt expense is the difference in the balance of the Allowance for
Doubtful Accounts before and after the adjustment.
Bad debt expense = $23,450 – ($14,000 – $17,000 + $6,000) = $20,450
Adjusting journal entry:
Dec. 31
Bad debt expense (+E  –SE) ....................................................
Allowance for doubtful accounts (+XA  –A) .............
Recording of estimated bad debt expense for the period.
20,450
20,450
Req. 4
Receivables turnover ratio = Net credit sales / Average net trade receivables
= ($4,500,000 – $45,000)/ [($686,000 + $914,550)/2]
= 5.57 times
This ratio measures how many times trade accounts receivable are recorded and collected
during the period.
Based on the credit terms, net 30 days, the receivables turnover should equal 365 / 30 =
12.17 times. Rodamex’s ratio is less than half what it should be. As a result, Rodamex’s
management needs to improve its collection efforts so that customers pay the amounts due
in 30 days.
Req. 5
If the cost of sales averages 40 per cent of net sales, then gross profit averages 60 per cent
of net sales.
Gross profit = Net sales x 60% =($5,000,000 – $50,000) x 0.6 = $2,970,000.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-49
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–8
Req. 1
(a)
Trade receivables (+A) ............................................................... 76,000
Sales revenue (+R  +SE)...........................................
To record October sales.
76,000
Cash (+A) .......................................................................................... 39,200
Sales discounts (+XR –R) ......................................................
800
Trade receivables (–A) .................................................
To record collection within the discount period,
(.98 × $40,000 = $39,200)
40,000
Cash (+A) .......................................................................................... 20,000
Trade receivables (–A) ................................................. .
To record collection after the discount period,
($76,000 – $40,000 – $16,000 = $20,000)
(b)
Cash (+A) .......................................................................................... 50,000
Trade receivables (–A) .................................................
To record collection after the discount period.
(c)
Allowance for doubtful accounts (–XA  +A) ...................
Trade receivables (–A) .................................................
Write off of bad debts.
(d)
Inventory (+A) ............................................................................... 40,000
Trade payables (+L) ......................................................
To record purchase of merchandise.
5,000
October 31, 2014:
Trade receivables (Sept. 30).....................................................
Net change in trade receivables during October .............
($76,000 – $40,000 – $20,000 – $50,000 – $5,000)
Trade receivables, October 31 .................................................
Bad debt percentage ....................................................................
Ending balance of Allowance for doubtful accounts .......
20,000
50,000
5,000
40,000
$119,000
(39,000)
$80,000
x 4%
$ 3,200 credit
Balance of the Allowance account before adjustment....
($3,000 cr – $5,000 dr)
2,000 debit
Bad debt expense = $2,000 + $3,200 = $5,200
Bad debt expense (+E  -SE) ..................................................
Allowance for doubtful accounts (+XA  –A) .....
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-50
5,200
5,200
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–8 (continued)
Req. 2
Trade receivables.......................................................................
Less: Allowance for doubtful accounts ..............................
Trade receivables, net ..............................................................
$80,000
(3,200)
$76,800
Req. 3
Dear Mr. Beauregard,
What you are proposing is known as the direct write-off method whereby uncollectible
accounts are written off when we are certain that specific customers will not pay the
amount they owe the company. This approach would be acceptable if the amounts that are
written off annually are relatively small or if they are close to the amount that would be
considered uncollectible under the allowance method.
The main deficiency of the direct write-off method is its inconsistency with the matching
process which requires that expenses be matched to the related revenues during the same
period. If a trade receivable is written-off in a period that follows the period of sale, then
the matching process would have not been observed. Failure to provide an allowance
would also result in an overstatement of the trade receivables on the statement of financial
position. For this reason, accountants estimate the amount that may not be collectible in
the future, with full knowledge that the estimated amount may not be an exact amount. In
this respect, it is preferable to be imprecisely right than precisely wrong. I should note that
both the direct write-off method and the allowance method are likely to produce similar
results if uncollectible amounts are relatively stable over time.
Based on the above, it is preferable that we continue with our past practice of estimating
bad debts during the period of sale and not when we exhaust all means of collection from a
specific customer.
Sincerely,
Carol
Req. 4
Yes, MKI should have obtained the loan from BIT. MKI will have to pay $300 in interest to
BIT, but it will save $400 (= $40,000 x 1%) off the amount owed to Kim & Sons, Ltd.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-51
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–9
Req. 1
PERRY CORPORATION
Statement of Earnings
For the Year Ended December 31, 2015
Net sales revenue ($184,000 – $9,000 – $8,000) .........................
Cost of sales .................................................................................................
Gross profit ..................................................................................................
Operating expenses:
Selling expenses .............................................................................. $17,000
Administrative and general expenses .................................... 18,000
Bad debt expense ...........................................................................
2,000
$ 167,000
98,000
69,000
Total operating expenses .................................................
Earnings before income tax ..................................................................
Income tax expense .......................................................................
Net earnings ................................................................................................
37,000
32,000
10,900
$21,100
Earnings per share:
($21,100 ÷ 10,000 shares) .........................................................................................
$2.11
In this case, earnings from operations is the same as earnings before income tax.
Req. 2
Gross Profit Percentage
=
Gross Profit
Net Sales
=
$69,000 = 0.413 (41.3 %)
$167,000
The gross profit percentage shows the excess of sales prices over the costs to purchase or
produce the goods or services sold, measured as a percentage.
Trade Receivables
Turnover Ratio
* ($16,000 + $18,000) ÷ 2
=
Net Sales
=
Avg Net Trade
Receivables
$167,000
$17,000
= 9.82
The trade receivables turnover ratio reflects how many times trade receivables were both
recorded and collected, on average, during the time period. The higher the result is, the
faster the collection of receivables.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-52
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7-10
Req. 1
The balance of Cash on Hand would be understated by $2,000. The debit to the Sales
returns and allowance account would reduce net sales and net earnings, which reduces the
balance of retained earnings at the end of the month. Hence, net earnings and Retained
Earnings would be understated by $2,000.
Req. 2
Control and safeguarding cash is one of the most important functions of an internal control
system because cash is so vulnerable to theft and fraud. In this case, the weakness in the
system is that Cory is responsible for tasks that are incompatible (i.e. they should be
segregated). Separation of duties is the first step that responsible managers should take to
safeguard cash. This means that the person receiving cash for a transaction should not be
the same person recording receipts of cash and that a third person should be responsible
for depositing and withdrawing cash on behalf of the company.
If this system is in place, a voucher or document is required at every step in the cash
handling process. For example the person receiving cash provides a receipt to the
purchaser and a copy (either electronic or hard copy) is retained by the seller. At the end
of the transaction period, say one day, the total of all sales receipts (less any refunds) must
equal the cash on hand. In this way, companies avoid situations where an employee can
simply take money that belongs to the company and then hide the theft.
When the person handling cash receipts is not the same person handling and recording
payments, there must be collusion between the two before Cory could simply substitute a
purchaser’s cheque for cash stolen. Cory would have had no access to the journal and the
proper journal entry for the PLC cheque would have been made:
Cash (+A)
Trade receivables – PLC Ltd. (–A)
2,000
2,000
When the cash receipts for the day are totaled, the person who deposits this cash should
reconcile the amount deposited to the daily vouchers and this person should neither record
journal entries nor receive cash at the point-of-sale. This means that Cory could not have
taken the cash because a third party would have counted the actual cash on hand and
reconciled it to the receipts for the day. In fact, usually two people are responsible for this
activity and they sign a document verifying the reconciliation.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-53
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–11
Req.1
Sergio Lucas
Bank Reconciliation
August 31
Company's Books
Ending cash balance per
books ...............................................
Additions:
Error recording chq #123 .......
Deductions:
Hydro Bill .......................................
Telus Corp ......................................
Unrecorded withdrawals ........
Bank charges.................................
Ending correct cash balance ..
$12,651.65
27.00
$12,678.65
44.10
55.30
300.00
7.00
Bank Statement
Ending cash balance per bank
statement ........................................ $12,506.60
Additions:
Deposits in transit .......................
Deductions:
Outstanding cheques .................
406.40
$12,272.25
Ending correct cash balance ...
385.00
12,891.60
619.35
$12,272.25
Req. 2
Sergio should first correct the amount of cheque #123 by adding $27.00 to the balance and
reducing the account he debited, and then deduct the hydro bill ($44.10), Telus Corp. bill
($55.30), the bank charges ($7.00) and the withdrawals he made from instant teller
machines ($300).
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-54
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–12
Req. 1
Comparison of deposits listed in the Cash account with deposits listed on the bank
statement reveals a $5,000 deposit in transit on August 31.
Req. 2
Comparison of the cheques cleared on the bank statement with (a) outstanding cheques
from July, and (b) cheques written in August reveals two outstanding cheques at the end of
August ($290 + $550 = $840).
Req. 3
MARTHA COMPANY
Bank Reconciliation, August 31, 2014
Company's Books
Ending balance per Cash
account ..................................
Additions:
Note receivable collected .......
Interest collected .....................
Interest earned .........................
$2,000
180
Deductions:
Bank service charges .......................................
Ending correct cash balance ..........................
$20,280
2,180
80
22,540
10
$22,530
Bank Statement
Ending balance per bank
Statement ...............................
Additions:
Deposits in transit .....................
Deductions:
Outstanding cheques ................
Ending correct cash balance ...
$18,370
5,000
23,370
840
$22,530
Calculation of ending balance per cash account:
$16,520 + $12,000 + $4,000 + $7,000 + $5,000 - $300 - $900 - $290 - $550 - $800 - $400 $21,000 = $20,280.
Req. 4
(1)
Cash in bank (+A)..................................................................................... 2,180
Note receivable (–A).................................................................
Interest revenue (+R  +SE) ................................................
Note receivable plus interest collected (by bank).
(2)
Bank service charge expense (+E  –SE) .....................................
Cash in bank (–A).......................................................................
Service charges deducted from bank balance.
10
(3)
Cash in bank (+A).....................................................................................
Interest Earned (+R  +SE) ..................................................
Interest earned on cash in bank.
80
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-55
2,000
180
10
80
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP7–11 (continued)
These entries are necessary because the changes in the regular Cash account have not yet
been recorded by the company. The bank has already recorded these items in its own
accounts. The Cash account (and the other accounts shown in the above entries) must be
brought up to date for financial statement purposes.
Req. 5
Balance in Cash account, i.e., ending correct cash balance ..................................
Balance in Cash on hand account ...................................................................................
$22,530
$ 200
Req. 6
Statement of Financial Position:
Current assets:
Cash ($22,530 + $200) .........................................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-56
$22,730
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CASES AND PROJECTS
FINDING AND INTERPRETING FINANCIAL INFORMATION
CP7–1
Req. 1
The company discloses its revenue recognition policy in Note 3 – Significant Accounting
Policies. Its recognizes revenue “when the amount can be reliably measured, when it is
probable that future economic benefits will flow to the entity and when specific criteria
have been met for each of the Company’s activities.”
The Company has different sources of revenue including:
(1) Sale of goods, which is recognized when the goods are delivered, less an estimate for
the sales and warranty returns.
(2) Royalties and licence fees, which include licence fees from petroleum agents and
dealers, and royalties from Mark’s and FGL Sports franchisees. Licence fee revenues
are recognized as they are earned in accordance with the substance of the relevant
agreement.
(3) Interest income that is recognized on an accrual basis.
Req. 2
Gross profit percentage = Gross profit / Net sales
2012: $3,497.9 ÷ $11,427.2 = 0.306 (30.6%)
2011: $3,060.7 ÷ $10,387.1 = 0.295 (29.5%)
Canadian Tire’s gross profit percentage increased very slightly in 2012. The increase may
have resulted from higher mark-up on merchandise cost and/or purchase of merchandise
from suppliers at lower cost.
Req. 3
The Company discloses details about its allowance for credit losses in Note 6.3.3 to its
financial statements. The disclosures are as follows:
(in millions of dollars)
2012
Balance, beginning of year
$ 118.7
$ 117.7
265.6
302.0
Recoveries
58.1
50.0
Write-offs
(331.7)
Impairment for credit losses
Balance, end of year
$ 110.7
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-57
2011
(351.0)
$ 118.7
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
The Company reported the bad debt expense, which it labeled as impairment for credit
losses. It aalso reported the amount of receivables that was written off, and the amount the
was recovered from customers, after writing it off.
Req. 4 (in millions of dollars)
Receivables turnover
=
Net Sales
Average Net Trade
Receivables
* [(750.6 + 4,265.7) + (829.3 + 4,081.7)] ÷ 2
=
11,427.2
4,963.7*
= 2.30 times
The receivables turnover for Gildan is 8.62. Canadian Tire’s ratio is much lower than
Gildan’s because of the nature of the products it sells, its credit policy and the speed of
collection from customers. Another possible difference is the amount of credit sales for
each company. The computation of the ratio assumes that all sales are on credit, but this
may not be true.
Req. 5
According to Note 3 the Company defines “cash and cash equivalents” as cash plus highly
liquid and rated certificates of deposit or commercial paper with an original term to
maturity of three months or less. Note 9 lists the items that are considered as Cash and cash
equivalents, including bank indebtedness.
Because cash and cash equivalents are essentially cash, the fair market value is extremely
close to the disclosed amount.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-58
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP7–2
Req. 1
Sales Discounts and Sales Returns and Allowances would likely be subtracted from Sales
Revenue in the computation of Net Sales.
Req. 2
RONA deducts the following expenses: cost of sales, selling, general and administrative
expenses, and gain on disposal of assets. These items are disclosed in Note 5.1 instead of
being reported on the income statement. In addition, RONA’s statement of earnings shows
deductions for goodwill impairment, restructuring costs, impairment of non-financial
assets, finance income, and finance costs in arriving at earnings before income taxes.
On the other hand, Canadian Tire expenses include: cost of producing revenue, distribution
costs, sales and marketing expenses, administrative expenses, finance income and finance
expense to arrive at earnings before income taxes. In summary, any differences in
presentation can be attributed to the preferences of the respective senior management
teams of the two companies.
Req. 3 (in thousands of dollars)
Receivables turnover
=
Net Sales
=
Average Net Trade
Receivables
* ($357,756 + $354,482) ÷ 2
$4,884,016
$356,119*
= 13.71 times
RONA’s receivables turnover implies that RONA’s customers pay the amounts owed within
26.6 days on average (365/13.71). This average collection period is shorter than the actual
average collection period because we assume that all sales are on credit, which is not
realistic since many sales are made for cash (which includes use of debit cards and credit
cards). If we eliminate the cash transactions from the total revenue amount, the numerator
will decrease to reflect the amount of sales on credit. This will decrease the receivables
turnover and increase the average collection period.
Req. 4
Trade receivables decreased from $357,756 in 2011 to 354,482 during 2012. This decrease
indicates that RONA collected more cash from its customers than it had sales. This
increases the net cash inflow from operating activities for 2012.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-59
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP7–3
Req. 1 (in millions of dollars)
Sales
Cost of sales
Gross profit
Percent
RONA
2012
2011
4,884
4,805
3,545
3,437
1,339
1,368
27.3%
28.5%
Canadian Tire
2012
2011
11,427
10,387
7,929
7,326
3,498
3,061
30.6%
29.5%
RONA’s gross profit percentage dropped by 1.2 percent in 2012. But, Canadian Tire’s gross
profit percentage increased by 1.1 percent during the same year. These ratios suggest that
Canadian Tire performed better than RONA in achieving a higher markup on the products it
sells.
Req. 2 (in millions of dollars)
Receivables Turnover Ratio = Net Sales / Average Net Trade Receivables
RONA
2012:
2011:
4,884 / [(357.8 + 354.5) ÷ 2] = 13.71 times
4,805 / [(299.9 + 357.8) ÷ 2] = 14.61 times
RONA’s turnover ratio is relatively stable.
Canadian Tire
2012:
$11,427 / {[(829.3 + 4,081.7) + (750.6 + 4,265.7)] ÷ 2} = 2.30 times
2011:
$10,387 / {[4,725 + (829.3 + 4,081.7)] ÷ 2} = 2.16 times
Canadian Tire’s turnover ratio improved slightly in 2012 while RONA’s dropped during the
same period. Canadian Tire’s relatively low ratio is the result of allowing customers to pay
later by charging their purchases on their Canadian Tire credit cards, and collecting from
customers at some date in the future, particularly when the Company offers them no
payment and no interest for a six-month period.
Req. 3
Receivables Turnover Ratio
Canadian Tire
2.30
RONA
13.32
Industry Average
7.76
The ratio comparison indicates that RONA has performed better than the industry average,
while Canadian Tire’s ratio is much below the industry average. These ratios must be
interpreted properly by taking into consideration the credit policy of the company as well
as the simplifying assumption that all sales are made on account, which is not true.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-60
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
FINANCIAL REPORTING AND ANALYSIS CASES
CP7–4 (Amounts are in thousands of dollars )
Req. 1
The amount of trade receivables that is typically reported on the statement of financial
position is the net realizable value of these receivables, which is the gross amount of the
receivables minus the allowance for doubtful accounts. For Canadian Tire, this amount is
$4,873.7, which is split into a current portion of $4,265.7 and a long-term portion of $608.0.
Canadian Tire reports the first amount as Loans receivable under current assets, and the
second amount as a non-current asset.
Req. 2
(a)
Allowance for credit losses (–XA  +A) ..............................
Loans receivables (–A) .................................................
Write off of bad debts.
331.7
(b)
Loans receivables (+A) ...............................................................
Allowance for credit losses (+XA  –A) ................
Reinstatement of accounts written off previously.
58.1
Cash (+A) ..........................................................................................
Loans receivables (–A) ................................................. .
Collection on accounts written off previously.
58.1
Bad debt expense (+E  –SE) .................................................
Allowance for credit losses (+XA  –A) ................
To record the impairment loss on loans receivable.
265.6
(e)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-61
331.7
58.1
58.1
265.6
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP7–5
Canadian banks usually have fiscal years that end on October 31.
Req. 1 and 2 (millions of dollars)
Fiscal year 2012
Royal Bank
of Canada
Scotiabank
a. Provision for credit losses ............. $ 1,301
$ 1,252
b. Net interest income ......................... 12,498
10,003
Ratio a/b .......................................... 10.4%
12.5%
Canadian Imperial
Bank of Commerce
$ 1,291
7,494
17.2%
Fiscal year 2011
Royal Bank
of Canada
Scotiabank
a. Provision for credit losses ............. $ 1,133
$ 1,076
b. Net interest income ......................... 11,357
9,014
Ratio a/b .......................................... 9.98%
11.94%
Canadian Imperial
Bank of Commerce
$ 1,144
7,062
16.20%
The Canadian Imperial Bank of Commerce has the highest ratio of the three banks in both
years. Notice that the ratios for 2012 increased slightly over their 2011 levels for all banks
because of the increased provisions for loan losses due the slowdown in economic activity.
Req. 3 and 4 (millions of dollars)
Fiscal year 2012
Royal Bank
of Canada Scotiabank
a. Allowance for credit losses ........... $ 1,997
$ 2,969
b. Total loans receivable ..................... 380,241
367,735
Ratio a/b .......................................... 0.53%
0.81%
Fiscal year 2011
Royal Bank
of Canada Scotiabank
a. Allowance for credit losses ........... $ 1,967
$ 2,689
b. Total loans receivable ..................... 347,497
330,262
Ratio a/b .......................................... 0.57%
0.81%
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-62
Canadian Imperial
Bank of Commerce
$ 1,860
244,156
0.76%
Canadian Imperial
Bank of Commerce
$ 1,803
240,758
0.75%
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP7–5 (continued)
Banks lend money to a variety of customers, and classify their loans receivable according to
the following main categories: residential mortgages, personal and credit card loans, and
business and government loans. The quality of the bank’s loans portfolio depends on the
financial health of the individuals and companies that borrow money from the bank. Based
on the ratios above, it appears that Scotiabank risks losing $0.81 for every $100 it has lent
to others whereas Royal Bank of Canada has a better quality loan portfolio than the other
two banks as it risks losing a smaller percentage of its loans to customers.
The ratio increased slightly for the Canadian Imperial Bank of Commerce, remained
unchanges for Scotiabank, and decreased by 4 percentage points for the Royal Bank of
Canada.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-63
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CRITICAL THINKING CASES
CP7–6
Req. 1
The auditor was concerned because of the sequence of events as follows:
(a)
The opening of a new Account Receivable of $2,500 (an unusually large amount and
a “new” customer).
(b)
The write-off of bad debts at year-end rather than during the year.
(c)
The nearness of the creation of the new account receivable of $2,500 to the writeoffs of three accounts of regular customers for a sum of $2,500.
(d)
The accounts written off were for “regular” credit customers (Jones, Blake, and
Sellers). Therefore it is questionable why they would default on payment.
The sequence of events appears to have been:
i.
At completion of the job, $2,500 was collected in cash from the new customer and
pocketed by the clerk-bookkeeper.
ii.
To cover the theft, and yet provide a record of the transaction, a fictitious Account
receivable was debited for the $2,500, instead of Cash.
iii.
When the three regular customers paid their accounts, Cash was debited for a total
of $2,500 and the fictitious Account Receivable credited for the same amount. The
regular customers' accounts were credited as bad debts so that they would neither
be billed nor have reason to call attention to incorrect balances. All the bookkeeper
had to do was find one account, or a combination of account balances, to write off a
total of $2,500. This was done: $800 + $750 + $950 = $2,500.
The auditor has a professional responsibility to report these concerns and findings to the
owner.
Req. 2
Recommendations:
(a)
Report the circumstances to the owner. Do not recommend in respect to the clerkbookkeeper; the owner must make the personnel decisions involved.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-64
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP7–6 (continued)
(b)
Recommendations on internal control measures:
(1)
Separate cash-handling function from the related recordkeeping function.
(2)
Establish a definite routine for handling cash receipts.
(3)
Deposit all cash receipts intact each day.
(4)
Make all payments (except for cash on hand payments) by cheque. Require
that supporting documents be attached to each cheque before signing.
Designate all such documents as PAID, i.e., cancelled, when the cheque is
signed (this will help prevent duplicate payments).
(5)
Establish a cash on hand fund. For control assign it to one person who is not
involved in recordkeeping.
(6)
Exercise strict control of write-offs of uncollectible accounts, including
approval by the owner.
(7)
Continue the annual audit.
CP7–7
Req. 1
While there is some controversy about potential bias induced by prudent valuation of trade
receivables, this case is clear. Prudence refers to the understatement of assets (e.g.
uncollectible accounts) and overstatement of liabilities. In this case, the actual value of
trade receivables was only $5 million and a prudent valuation of the receivables would
have included a realistic provision for bad debt. Both the nominal value and the provision
would have been disclosed. ESB’s experience with collections from customers is a good
basis to determine the amount that is potentially uncollectible in order to report the net
realizable value of the receivables.
Req. 2
Legally it is understandable why BDO Seidman would not want to make public the
provisions of the settlement. It could make this accounting firm a target for future frivolous
law suits that would be very wasteful and costly to defend. Banco Espirito Santo, the
largest bank in Portugal would also prefer to keep any settlement, which was less than the
total amount lost, confidential from shareholders who might accuse the bank of failing to
vigorously defend the rights of the shareholders.
But for the profession in general the question is difficult to answer. Unfortunately when
secrets are kept, people tend to believe that bad news is being concealed. Their logic is that
if the news was good no one would want it to be secret. In legal matters such as this,
however, what is good news for one side would be bad news for the other side; such is the
nature of conflict. BDO Seidman would have done its best to reduce any financial penalty to
preserve the business and the reputation of its accountants. Even a single penny paid out
in penalties could be interpreted as an admission of negligence – and no accounting firm
would willingly make such an admission. To do so would leave the individuals and the firm
itself open to further disciplinary action by the American and Canadian accounting
professional bodies, which may or may not be justified. The tradeoff with respect to the
profession is that incidents such as this affect all major accounting firms and are quickly
forgotten once publicity dies out. Therefore uncertainty about the manner in which the
accounting profession conducts its business benefits from a quick end to public discussion.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-65
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP7–8
Req. 1
Receivables =
Turnover
Net Sales
Average Net Trade
Receivables
Projected change
No change from
beginning of year
$7,015,069 = 8.7
$807,039*
$7,015,069 = 7.3
$963,808
* ($963,808 + $650,270) ÷ 2
Req. 2
Projected decrease in trade receivables = $963,808 – $650,270 = $313,538
A decrease in trade receivables would increase cash by $313,538, all other items held
equal.
Req. 3
An increase in the receivables turnover ratio indicates that there has been an increase in
the number of times average trade receivables were recorded and collected during the
period. All other things equal, this indicates an increase in the rate at which receivables are
collected, which will increase cash flow from operating activities for the period. This can
benefit the company by providing additional liquidity for the company in its day-to-day
operations, reducing the need for additional borrowing and thereby avoiding more interest
costs.
FINANCIAL REPORTING AND ANLYSIS TEAM PROJECT
CP7–9
The solution to this case will depend on the company and/or accounting period selected for
analysis.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
7-66
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.