ACCOUNTING FOR NOTES RECEIVABLE
2. Entries to record the $9,000 in accounts receivable that were subsequently collected
3. The adjusting entry required at December 31, 2011, to increase the Allowance for Doubt- ful Accounts to $75,000.
b. Notice that the Allowance for Doubtful Accounts was only $40,000 at the end of 2010, but uncollectible accounts during 2011 totaled $106,000 ($115,000 less the $9,000 reinstated). Do these relationships appear reasonable, or was the Allowance for Doubtful Accounts greatly understated at the end of 2010? Explain.
At December 31, 2010, Westport Manufacturing Co. owned the following investments in the capi- tal stock of publicly owned companies (all classified as available-for-sale securities):
Current
Market
Cost Value Lamb Computer, Inc. (1,000 shares: cost,
$30 per share; market value, $50) . . . $30,000 $50,000 Dry Foods (5,000 shares: cost, $9
per share; market value, $8) . . . 45,000 40,000 Totals . . . $75,000 $90,000
In 2011, Westport engaged in the following two transactions:
Apr. 6 Sold 100 shares of its investment in Lamb Computer at a price of $55 per share, less a brokerage commission of $20.
Apr. 20 Sold 2,500 shares of its Dry Foods stock at a price of $7 per share, less a brokerage commission of $20.
At December 31, 2011, the market values of these stocks were: Lamb Computer, $40 per share;
Dry Foods, $7.
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Problem Set B 333
Instructions
a. Illustrate the presentation of marketable securities and the unrealized holding gain or loss in Westport’s balance sheet at December 31, 2010. Include a caption indicating the section of the balance sheet in which each of these accounts appears.
b. Prepare journal entries to record the transactions on April 6 and April 20.
c. Prior to making a fair value adjustment at the end of 2011, determine the unadjusted balance in the Marketable Securities controlling account and the Unrealized Holding Gain (or Loss) on Investments account. (Assume that no unrealized gains or losses have been recognized since last year.)
d. Prepare a schedule showing the cost and market values of securities owned at the end of 2011.
(Use the same format as the schedule illustrated above.)
e. Prepare the fair value adjusting entry required at December 31, 2011.
f. Illustrate the presentation of the marketable securities and unrealized holding gain (or loss) in the balance sheet at December 31, 2011. (Follow the same format as in part a. )
g. Illustrate the presentation of the net realized gains (or losses) in the 2011 income statement.
Assume a multiple-step income statement and show the caption identifying the section in which this amount would appear.
h. Explain how both the realized and the unrealized gains and losses will affect the company’s 2011 income tax return.
Southern Supply sells a variety of merchandise to retail stores on account, but it insists that any customer who fails to pay an invoice when due must replace their account receivable with an interest-bearing note. The company adjusts and closes its accounts at December 31. Among the transactions relating to notes receivable were the following:
Nov. 1 Received from a customer (LCC) a nine-month, 12 percent note for $60,000 in settlement of an account receivable due today.
Aug. 1 Collected in full the nine-month, 12 percent note receivable from LCC, including interest.
Instructions
a. Prepare journal entries (in general journal form) to record: (1) the receipt of the note on November 1; (2) the adjustment for interest on December 31; and (3) the collection of principal and interest on August 1. (To better illustrate the allocation of interest revenue between accounting periods, we will assume Southern Supply makes adjusting entries only at year-end. )
b. Assume that instead of paying the note on August 1, the customer (LCC) had defaulted. Give the journal entry by Southern Supply to record the default. Assume that LCC has sufficient resources that the note eventually will be collected.
c. Explain why the company insists that any customer who fails to pay an invoice when due must replace it with an interest-bearing note.
Data Management, Inc., provided the following information at December 31, 2011:
Bank Reconciliation
General ledger cash Bank statement balance,
balance, 12/31/11 . . . $44,637 12/31/11. . . $37,960 Bank service charge . . . (125) Deposits in transit . . . 18,800 Returned customer checks Outstanding checks. . . (15,560) marked NSF . . . (2,350)
Error in recording of office
supplies . . . (962)
Adjusted cash balance, Adjusted cash balance,
12/31/11 . . . $41,200 12/31/11. . . $41,200 PROBLEM 7.6B
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Marketable Securities
The company invested $75,000 in a portfolio of marketable securities on December 9, 2011. The portfolio’s market value on December 31, 2011, had decreased in value to $68,000.
Notes Receivable
On October 1, 2011, Data Management sold 50 laptop computers to the Mifflinburg School District for $74,500. The school district paid $2,500 at the point of sale and issued a one-year,
$72,000, 6 percent note for the remaining balance. The note, plus accrued interest, is due in full on September 30, 2012. Data Management adjusts for accrued interest revenue monthly.
Accounts Receivable
Data Management uses a balance sheet approach to account for uncollectible accounts expense.
Outstanding accounts receivable on December 31, 2011, total $900,000. After aging these accounts, the company estimates that their net realizable value is $860,000. Prior to making any adjustment to record uncollectible accounts expense, Data Management’s Allowance for Doubtful Accounts has a debit balance of $9,000.
Instructions
a. Prepare the journal entry necessary to update the company’s accounts immediately after per- forming its bank reconciliation on December 31, 2011.
b. Prepare the journal entry necessary to adjust the company’s marketable securities to market value at December 31, 2011.
c. Prepare the journal entry necessary to accrue interest revenue in December 2011.
d. Prepare the journal entry necessary to report the company’s accounts receivable at their net realizable value at December 31, 2011.
e. Discuss briefly why the company’s Allowance for Doubtful Accounts had a debit balance prior to the adjustment made in part d. How might the company change the percentages it applies to the accounts receivable aging categories to avoid future debit balances in its Allowance for Doubtful Accounts?
The Cash account in the general ledger of Ciavarella Corporation shows a balance of $112,000 at December 31, 2011 (prior to performing a bank reconciliation). The company’s bank statement shows a balance of $104,100 at the same date. An examination of the bank statement reveals the following:
1. Deposits in transit amount to $16,800.
2. Bank service charges total $100.
3. Outstanding checks total $12,400.
4. A $2,500 check marked “NSF” from Needham Company (one of Ciavarella’s customers) was returned to Ciavarella Corporation by the bank. This was the only NSF check that Ciavarella received during 2011.
5. Check no. 550 was actually written by Ciavarella in the amount of $3,200 for computer equip- ment but was incorrectly recorded in the general ledger as a debit to Computer Equipment of
$2,300, and a credit to Cash of $2,300.
In addition to the above information, Ciavarella owns the following assets at December 31, 2011:
(1) money market accounts totaling $150,000, (2) $5,000 of high-grade, 60-day commercial paper, and (3) highly liquid stock investments valued at $245,000 at December 31, 2011 (these investments originally cost Ciavarella $225,000).
On December 1, 2011, Ciavarella sold a used truck to Ritter Industries for $18,000.
Ciavarella accepted a three-month, $18,000, 9 percent note receivable from Ritter. The note, plus accrued interest, is due in full on March 1, 2012. Ciavarella adjusts for accrued interest revenue monthly.
Ciavarella uses the income statement approach to compute uncollectible accounts expense. The general ledger had reported Accounts Receivable of $540,000 at January 1, 2011. At that time, the Allowance for Doubtful Accounts had a credit balance of $12,000. Throughout 2011, the company PROBLEM 7.8B
Short Comprehensive Problem
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Critical Thinking Cases 335
Critical Thinking Cases
In each of the situations described below, indicate the accounting principles or concepts, if any, that have been violated and explain briefly the nature of the violation. If you believe the prac- tice is in accord with generally accepted accounting principles, state this as your position and defend it.
a. A small business in which credit sales fluctuate greatly from year to year uses the direct write- off method both for income tax purposes and in its financial statements.
b. Computer Systems often sells merchandise in exchange for interest-bearing notes receivable, maturing in 6, 12, or 24 months. The company records these sales transactions by debiting Notes Receivable for the maturity value of the notes, crediting Sales for the sales price of the merchandise, and crediting Interest Revenue for the balance of the maturity value of the note.
The cost of goods sold also is recorded.
c. A company has $400,000 in unrestricted cash, $1 million in a bank account specifically earmarked for the construction of a new factory, and $2 million in cash equivalents. In the balance sheet, these amounts are combined and shown as “Cash and cash equivalents . . .
$3.4 million.”
Rock, Inc., sells stereo equipment. Traditionally, the company’s sales have been in the follow- ing categories: cash sales, 25 percent; customers using national credit cards, 35 percent; sales on account (due in 30 days), 40 percent. With these policies, the company earned a modest profit, and monthly cash receipts exceeded monthly cash payments by a comfortable margin. Uncollectible accounts expense was approximately 1 percent of net sales. (The company uses the direct write-off method in accounting for uncollectible accounts receivable.)
Two months ago, the company initiated a new credit policy, which it calls “Double Zero.”
Customers may purchase merchandise on account, with no down payment and no interest charges.
The accounts are collected in 12 monthly installments of equal amounts.
The plan has proven quite popular with customers, and monthly sales have increased dramatically. Despite the increase in sales, however, Rock is experiencing cash flow problems—
it hasn’t been generating enough cash to pay its suppliers, most of which require payment within 30 days.
The company’s bookkeeper has prepared the following analysis of monthly operating results:
CASE 7.1
Accounting Principles C
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wrote off actual accounts receivable of $14,000 and collected $5,252,500 on account from credit customers (this amount includes the $2,500 NSF check received from Needham Company). Credit sales for the year ended December 31, 2011, totaled $6,480,000. Of these credit sales, 1 percent were estimated to eventually become uncollectible.
Instructions
a. Prepare Ciavarella’s bank reconciliation dated December 31, 2011, and provide the journal entry necessary to update the company’s general ledger balances.
b. Compute cash and cash equivalents to be reported in Ciavarella’s balance sheet dated December 31, 2011.
c. Prepare the adjusting entry necessary to account for the note receivable from Ritter Industries at December 31, 2011.
d. Determine the net realizable value of Ciavarella’s accounts receivable at December 31, 2011.
e. Determine the total dollar amount of financial assets to be reported in Ciavarella’s balance sheet dated December 31, 2011.
f. Assume that it is normal for firms similar to Ciavarella to take an average of 60 days to collect an outstanding receivable. Is Ciavarella Corporation’s collection performance above or below this average?
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Before Last
Sales Double Zero Month
Cash . . . $12,500 $ 5,000 National credit card . . . 17,500 10,000 30-day accounts . . . 20,000 – 0 – Double Zero accounts . . . – 0 – 75,000 Total monthly sales . . . $50,000 $ 90,000 Cost of goods sold and expenses. . . 40,000 65,000 Net income . . . $10,000 $ 25,000 Cash receipts
Cash sales . . . $12,500 $ 5,000 National credit card companies. . . 17,500 10,000 30-day accounts . . . 19,500 – 0 – Double Zero accounts . . . – 0 – 11,250 Total monthly cash receipts. . . $49,500 $ 26,250 Accounts written off as uncollectible. . . $ 500 $ –-0-– Accounts receivable at month-end . . . $20,000 $135,000
The bookkeeper offered the following assessment: “Double Zero is killing us. Since we started that plan, our accounts receivable have increased nearly sevenfold, and they’re still growing. We can’t afford to carry such a large nonproductive asset on our books. Our cash receipts are down to nearly half of what they used to be. If we don’t go back to more cash sales and receivables that can be collected more quickly, we’ll become insolvent.”
In reply Maxwell “Rock” Swartz, founder and chief executive officer, shouted out: “Why do you say that our accounts receivable are nonproductive? They’re the most productive asset we have! Since we started Double Zero, our sales have nearly doubled, our profits have more than doubled, and our bad debt expense has dropped to nothing!”
Instructions
a. Is it logical that the Double Zero plan is causing sales and profits to increase while also causing a decline in cash receipts? Explain.
b. Why has the uncollectible accounts expense dropped to zero? What would you expect to hap- pen to the company’s uncollectible accounts expense in the future—say, next year? Why?
c. Do you think that the reduction in monthly cash receipts is permanent or temporary? Explain.
d. In what sense are the company’s accounts receivable a “nonproductive” asset?
e. Suggest several ways that Rock may be able to generate the cash it needs to pay its bills with- out terminating the Double Zero plan.
f. Would you recommend that the company continue offering Double Zero financing, or should it return to the use of 30-day accounts? Explain the reasons for your answer, and identify any unresolved factors that might cause you to change this opinion in the future.
Affections manufactures candy and sells only to retailers. It is not a publicly owned company and its financial statements are not audited. But the company frequently must borrow money. Its creditors insist that the company provide them with unaudited financial statements at the end of each quarter.
In October, management met to discuss the fiscal year ending next December 31. Due to a sluggish economy, Affections was having difficulty collecting its accounts receivable, and its cash position was unusually low. Management knew that if the December 31 balance sheet did not look good, the company would have difficulty borrowing the money it would need to boost production for Valentine’s Day.
Thus the purpose of the meeting was to explore ways in which Affections might improve its December 31 balance sheet. Some of the ideas discussed are as follows:
CASE 7.3
“Improving” the Balance Sheet
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Critical Thinking Cases 337
1. Offer customers purchasing Christmas candy a 10 percent discount if they make payment within 30 days.
2. Allow a 30-day grace period on all accounts receivable overdue at the end of the year. As these accounts will no longer be overdue, the company will not need an allowance for overdue accounts.
3. For purposes of balance sheet presentation, combine all forms of cash, including cash equiva- lents, compensating balances, and unused lines of credit.
4. Require officers who have borrowed money from the company to repay the amounts owed at December 31. This would convert into cash the “notes receivable from officers,” which now appear in the balance sheet as noncurrent assets. The loans could be renewed immediately after year-end.
5. Present investments in marketable securities at their market value, rather than at cost.
6. Treat inventory as a financial asset and show it at current sales value.
7. On December 31, draw a large check against one of the company’s bank accounts and deposit it in another of the company’s accounts in a different bank. The check won’t clear the first bank until after year-end. This will substantially increase the amount of cash in bank accounts at year-end.
Instructions
a. Separately evaluate each of these proposals. Consider ethical issues as well as accounting issues.
b. Do you consider it ethical for management to hold this meeting in the first place? That is, should management plan in advance how to improve financial statements that will be distrib- uted to creditors and investors?
Prudent cash management is an important function in any business. Large amounts of cash sitting idle in non-interest-bearing checking accounts can cost a company thousands—even millions—of dollars annually in foregone revenue. Thus, many businesses invest large amounts of idle cash in Treasury bills, certificates of deposit (CDs), and money market accounts.
Visit the Bankrate.com home page at the following address:
www.bankrate.com
Search the site for information on CDs, money market accounts, and other interest-bearing products. Look for links under the “Compare Rates” menu.
Instructions
a. Prepare a table showing the current interest rates on Treasury bills, various CDs, and money market accounts.
b. If you were in charge of investing $1 million among the cash equivalents identified in part a, how would you make your allocation? Defend your answer.
Internet sites are time and date sensitive. It is the purpose of these exercises to have you explore the Internet. You may need to use the Yahoo! search engine http://www.yahoo.com (or another favorite search engine) to find a company’s current Web address.
Answers to Self-Test Questions
1. b 2. c 3. a 4. c 5. a 6. b 7. a 8. d 9. c 10. b ($300,000 12% 6⁄12) 11. a
INTERNET CASE 7.4
Returns on Idle Cash from Various Cash Equivalents IN
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Inventories and the Cost of Goods Sold
A F T E R S T U D Y I N G T H I S C H A P T E R , Y O U S H O U L D B E A B L E TO :
In a perpetual inventory system, determine the cost of goods sold using (a) specific identification, (b) average cost, (c) FIFO, and (d) LIFO. Discuss the advantages and shortcomings of each method.
Explain the need for taking a physical inventory.
Record shrinkage losses and other year-end adjustments to inventory.
In a periodic inventory system, determine the ending inventory and the cost of goods sold using (a) specific identification, (b) average cost, (c) FIFO, and (d) LIFO.
Explain the effects on the income statement of errors in inventory valuation.
Estimate the cost of goods sold and ending inventory by the gross profit method and by the retail method.
Compute the inventory turnover and explain its uses.
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Having the right merchandise available at the right time and in the right place is critically important to all companies that sell products to their customers.
These businesses include chain stores such as grocery stores, drugstores, and department stores.
Consider the case of Kroger Co.—a giant retailer that spans many states with store formats that include grocery and multidepartment stores, convenience stores, and mall jewelry stores. Kroger operates under nearly two dozen banners or names and is one of the country’s largest grocery retailers with 2,468 grocery retail stores and 2009 sales of $76.7 million.
Kroger also operates food-processing or manufacturing facilities that produce private-label products, supermarket fuel centers, and pharmacies located in its combination food and drugstores. Imagine the challenges this complex retailer faces in having product at the right place, at the right time, and in the needed quantities. To meet these objectives, a company’s inventory is constantly changing.
Accounting for the movement of inventory into and out of a company like Kroger also presents a significant challenge. Inventory is often one of the largest assets in a company’s statement of financial position (balance sheet), one of its most important determinants of the results of its operation (income statement), and one of its most significant cash flows (statement of cash flows). ■