LESSON 6
Suggested solutions
Question 1 (30 marks)
Multiple choice (1 mark each)
a. 3)
Although 1 and 2 are important parts of an internal control system for cash, the
segregation of the duties of cash handling from cash accounting is the most important
internal control over cash.
b. 3)
The cash held in the sinking fund is not available for current use. Therefore, it would be
recorded as a non-current asset on the balance sheet. Note that while petty cash normally
has its own G/L account, it would usually be part of cash reported on the balance sheet.
c. 4)
The direct write-off method of accounting for bad debts expense violates the matching
principle because the expense is recorded in the period when the account is written off,
which may not be in the period the related sale was made.
d. 2)
Both assignment of accounts receivable and factoring of accounts receivable mean that
accounts receivable are converted to cash prior to their normal collection time.
e. 1)
When accounts receivable are sold to a factor without recourse it means that the factor is
responsible for any uncollectible accounts.
f. 2)
The cost of the first computer will be €4,000. Since the note payable carries the market
rate of interest, no discounting is required. To get the cost of the second computer, the
cash payments must be discounted at 8%. The only cash payment is the payment of
€4,320 at the end of one year. The present value factor for a single sum to be paid at the
end of one period, discounted at 8% is 0.9259. €4,320  0.9259 = €4,000.
g. 3)
The fact that the maker of the note is experiencing financial difficulty does not
necessarily mean that payment won’t be made as scheduled. When the payee determines
it is probable that the recoverable value of the note is less than its carrying value,
impairment has occurred.
Financial Accounting: Assets
Suggested solutions 6  1
h. 2)
The bank account and the petty cash fund are two separate cash accounts and should be
added together to get the total cash to be reported on the balance sheet.
i. 4)
The bank balance is too low compared to the cash general ledger balance because of
deposits in transit. Therefore, deposits in transit need to be added to the balance per bank.
j. 3)
The bank reconciliation is designed to reconcile both the unadjusted cash balance per the
books and the unadjusted cash balance per the bank to the correct cash balance that
should be reported on the balance sheet.
(2 marks each)
k. 3)
€40,000 + €20,000 – €4,000
Or, you might notice that both reconciling items are adjustments to the bank balance.
That means the general ledger balance for cash is the correct final balance.
l. 2)
€164 + €34 = €198
This means that cash is short by €2. Since there is only €34 of cash left, €166 of cash
must be added to the petty cash box.
m. 2)
€97,850 + €10,000 – €13,000
n. 3)
€1,840 + €36,750 – €36,200
o. 3)
€1,000 – €200
p. 1)
X + €3,800 + €160 – €3,000 = €2,500
X = €2,500 – €3,800 – €160 + €3,000
q. 2)
€800,000 – €62,500
r. 4)
€40,000 – €3,400
Financial Accounting: Assets
Suggested solutions 6  2
s. 1)
€30,000 + (€30,000  4.3553)
4.3553 is the present value factor for a six-period annuity at a discount rate of 10%.
t. 4)
You could calculate the carrying value at December 31, year 2 (€120,000) and compare it
with the recoverable amount. However, since annual interest payments are expected to be
made each year to maturity, and the stated interest rate is equal to the market rate of
interest, it should be obvious that the present value of the future payments is still equal to
€120,000. If you are not sure, calculate it!
Question 2 (6 marks)
Requirement 1 (3 marks)
Factoring without recourse means that when Desperado sells its receivables to the factor,
it is the factor that assumes the risk for any accounts receivable that cannot be collected
in the future. If the factor is unable to collect certain accounts receivable, it has no
recourse to Desperado. Factoring with recourse means that when Desperado sells it
receivables to the factor, it is Desperado who retains some (or all) of the risk of
uncollectible accounts. If the factor is unable to collect a particular receivable, it has the
right to come back to Desperado for payment of that amount. Desperado will likely get
more cash if it sells its accounts receivables on a with recourse basis. Since the risk of
non-payment remains with Desperado under a with recourse agreement, the factor will be
willing to pay more.
Requirement 2 (3 marks)
When receivables are sold without recourse, the transaction is normally recorded as a
sale. The accounts receivable are removed from the books of Desperado and an expense
equal to the difference between the price paid by the factor and the book value of the
receivables is recognized.
When receivables are sold with recourse, the funds received from the factor are normally
recorded as a loan from the factor rather than as sales proceeds. This is because there
really has not been a transfer of risk from the seller to the factor. As the customers make
payments and funds are collected by the factor, the loan is reduced.
Question 3 (14 marks)
Requirement 1 (4 marks)
Deposits in transit, November 30
Plus Deposits made by Rutnip in December
(€11,820 – €90 error correction)
Deposits that could have been received by bank in December
Deposits actually recorded by bank in December
Deposits in transit at December 31 (deposit recorded
by the company but not yet recorded by the bank)
Financial Accounting: Assets
€ 3,080
11,730
14,810
10,000
€ 4,810
Suggested solutions 6  3
€ 4,000
6,400
10,400
8,200
Outstanding cheques, November 30
Plus cheques written by Rutnip in December
Cheques that could have cleared bank in December
Cheques actually cleared by bank in December
Outstanding cheques at December 31 (cheques written
by the company but not yet recorded by the bank)
€ 2,200
Requirement 2 (5 marks)
RUTNIP INC.
Bank Reconciliation
December 31, 20X5
Cash balance per books, December 31, 20X5
Add:
Note receivable collected by bank
Deduct:
NSF cheque
December bank charge
December interest on bank loan
Error correction on deposit (€320 – €230)
Adjusted cash balance per books, December 31
€ 18,770
1,800
€ 270
30
470
90
(860)
€ 19,710
€ 17,100
Cash balance per bank statement, December 31, 20X5
Add:
Deposits in transit (from Requirement 1)
Deduct:
Outstanding cheques (from Requirement 1)
Adjusted cash balance per bank statement, December 31
4,810
(2,200)
€ 19,710
Requirement 3 (5 marks)
Journal entries from bank reconciliation:
a. Cash ................................................................................ 1,800
Notes receivable.........................................................
1,800
To record collection of note receivable made by bank on behalf of Rutnip.
b. Accounts receivable, Smythe...........................................
270
Cash ...........................................................................
270
To re-establish the account receivable from Smythe since their cheque was no good.
c. Bank service charge expense ...........................................
Cash ...........................................................................
To record the monthly bank charge.
30
d. Interest expense ...............................................................
Cash ...........................................................................
To record monthly interest on bank loan.
470
Financial Accounting: Assets
30
470
Suggested solutions 6  4
e. Accounts receivable .........................................................
90
Cash ...........................................................................
90
To correct error on cash deposit originally recorded as €320, which should have been
€230.
Question 4 (20 marks)
Requirement 1 (4 marks)
Allowance for doubtful accounts ........................................... 2,400
Accounts receivable .........................................................
2,400
There is no effect on total current assets as a result of the accounts receivable write off
entry because both accounts receivable and the related contra account are reduced by the
same amount.
Requirement 2 (4 marks)
Accounts receivable ............................................................... 5,000
Allowance for doubtful accounts .....................................
To re-establish the account receivable that was previously written off.
5,000
Note: the collection of this €5,000 is included in the €210,000 of customer payments for
the year.
Requirement 3 (4 marks)
The balance in the accounts receivable account at December 31, 20X6, before the
recording of the 20X6 bad debt expense is €194,600 as derived below:
Bal. January 1
Sales on account
Accounts receivable
162,000 Cash collected
240,000 AR written off
Re-establish AR
previously written off
Bal. December 31
210,000
2,400
5,000
194,600
The balance in the Allowance for doubtful accounts at December 31, 20X6 before the
recording of the 20X6 bad debt expense is €6,000 as derived below:
Allowance for doubtful accounts
AR written off
2,400 Bal. January 1
Reestablish AR
previously
written off
Bal. Dec. 31
Financial Accounting: Assets
3,400
5,000
6,000
Suggested solutions 6  5
Requirement 4 (4 marks)
a. To calculate bad debt expense based on the credit sales method, the expected
uncollectible rate of 2% is applied to the credit sales for the period of €240,000.
2% of €240,000 = €4,800
The journal entry would be
Bad debt expense ............................................................. 4,800
Allowance for doubtful accounts ...............................
4,800
b. To calculate bad debt expense based on the accounts receivable method, the required
allowance at December 31, 20X6 (€5,400) is compared to the balance in the
Allowance for doubtful accounts prior to the adjustment for bad debts (€6,000) and
an entry is made to adjust to the required amount (€5,400 – €6,000 = (€600)). The
journal entry would be
Allowance for doubtful accounts .....................................
Bad debt expense .......................................................
600
600
The reason for the negative bad debt expense is that there must have been an
overestimation of the expense in prior periods.
Requirement 5 (4 marks)
Credit sales method
Current assets
Accounts receivable
Less: Allowance for
doubtful accounts
Accounts receivable method
€ 194,600
€ 194,600
(1) 10,800
€ 183,800
(2) 5,400
€ 189,200
(1) €6,000 + €4,800
(2) €6,000 – €600
Question 5 (10 marks)
Requirement 1 (4 marks)
The present value of the €750,000 non-interest bearing note would be
€250,000  2.48691 = €621,725
1
The present value factor of an annuity for three periods at 10% (Table 2, Appendix A
Lesson 5)
Therefore, the €750,000 face value note would be recorded as
Face value of note
Less: Discount on note receivable
Present value of note receivable
Financial Accounting: Assets
€ 750,000
128,275
€ 621,275
Suggested solutions 6  6
The entry to record the sale of the equipment by XTL on January 1, 20X5 would be
Cash ...................................................................................... 250,000
Note receivable ...................................................................... 750,000
Discount on notes receivable ...........................................
128,725
Equipment ........................................................................
600,000
Gain on sale of equipment ...............................................
271,275
Requirement 2 (2 marks)
The entries to record the interest revenue and the first repayment of the note at
December 31, 20X6 would be as follows:
Discount on notes receivable .................................................
Interest revenue ................................................................
1
(€750,000 – €128,725)  0.10
62,1271
62,127
Cash ...................................................................................... 250,000
Notes receivable...............................................................
250,000
Requirement 3 (4 marks)
At December 31, 20X6, it is necessary to compare the carrying value of the note
receivable to its recoverable amount to determine if there is an impairment that requires a
write-down.
Carrying value of note receivable at
December 31, 20X6
Present value of €500,000 to be received
in three years
Amount of impairment
1
2
€ 433,8521
375,6502
€ 58,202
€500,000 – (€128,275 – €62,127)
€500,000  0.7513 (the present value of a single sum to be received in three years,
discounted at 10%)
Note: there would be no recognition of interest revenue in 20X6 because of the
impairment of the loan. Once a loan becomes impaired, accrual of interest ceases. If
interest had been accrued to December 31, 20X6, it would just make the amount of the
write-off larger, to offset the interest that had been accrued.
The entry to record the impairment of the loan would be
Charge for loan impairment ...................................................
Allowance for loan impairment .......................................
Financial Accounting: Assets
58,202
52,202
Suggested solutions 6  7
Question 6 (20 marks)
Requirement 1 (12 marks)
The present value of the three year, 4%, €240,000 note payable would be
Present value of €240,000 to be received
in three years, discounted at 8% is
Present value of €9,600 annuity for three
years, discounted at 8%
€240,000  0.7938
€ 190,512
€9,600  2.5771
24,740
€ 215,252
The journal entries to record the purchase of the land and the subsequent interest expense
and principal repayment would be as follows:
January 1, 20X5
Land ...................................................................................... 215,252
Discount on notes payable ..................................................... 24,748
Notes payable...................................................................
To record purchase of land and issuance of note payable.
240,000
December 31, 20X5
Interest expense ..................................................................... 17,2201
Discount on notes payable ...............................................
7,6203
Cash .................................................................................
9,6002
To record annual interest payment, interest expense, and amortization of discount on
notes payable.
1
2
3
€215,252  0.08
€240,000  0.04
€17,220 – €9,600
December 31, 20X6
Interest expense ..................................................................... 17,8301
Discount on notes payable ...............................................
8,2303
Cash .................................................................................
9,6002
To record annual interest payment, interest expense, and amortization of discount on
notes payable.
1
2
3
(€215,252 + €7,620)  0.08
€240,000  0.04
€17,830 – €9,600
Financial Accounting: Assets
Suggested solutions 6  8
December 31, 20X7
Interest expense ..................................................................... 18,4881
Discount on notes payable ...............................................
8,8883
Cash .................................................................................
9,6002
To record annual interest payment, interest expense, and amortization of discount on
notes payable.
1
2
3
(€215,252 + €7,620 + €8,230)  0.08
€240,000  0.04
€18,488 – €9,600
Note that, due to rounding, there is still a €10 balance (€24,748 – €7,620 – €8,230 –
€8,888) in the Discount on notes payable account.
To get rid of this balance, we make the following entry:
Interest expense .....................................................................
Discount on notes payable ...............................................
To bring balance in Discount account to zero.
10
10
December 31, 20X7
Notes payable......................................................................... 240,000
Cash .................................................................................
To record repayment of principal amount of note payable.
240,000
Requirement 2 (8 marks)
The present value of the two-year, non-interest bearing €14,000 note receivable would be
Present value of €140,000 to be received in
two years, discounted at 8% is
€14,000  0.8573
€ 12,002
The journal entries to record the sale of the goods, the recognition of interest revenue and
the subsequent collection of the note receivable would be as follows:
January 1, 20X5
Note receivable ......................................................................
Discount on notes receivable ...........................................
Sales ................................................................................
To record sale of goods.
14,000
1,998
12,002
December 31, 20X5
Discount on notes receivable .................................................
9611
Interest revenue ................................................................
961
To record interest revenue and amortization of discount on note receivable.
1
€12,002  0.08
December 31, 20X6
Financial Accounting: Assets
Suggested solutions 6  9
Discount on notes receivable .................................................
1,0371
Cash ....................................................................................... 14,000
Notes receivable...............................................................
14,000
Interest revenue ................................................................
1,037
To record interest revenue and amortization of discount on note receivable and collection
of note receivable.
1
[(€12,002 + €961)  0.08]
100
Financial Accounting: Assets
Suggested solutions 6  10