Chap 007 Cash and Receivables

Chapter 7

Cash and Receivables

AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning skills: Questions

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Exercises (cont.)

AACSB Tags

7–1 7–2 7–3 7–4 7–5 7–6 7–7 7–8 7–9 7–10 7–11 7–12 7–13 7–14 7–15 7–16 7–17 7–18 7–19 7–20

Reflective thinking Reflective thinking Reflective thinking Reflective thinking, Communications Diversity, Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking, Communications Reflective thinking Diversity, Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking Reflective thinking, Communications Reflective thinking Reflective thinking Reflective thinking Reflective thinking, Communications Diversity, Reflective thinking

7–3 7–4 7–5 7–6 7–7 7–8 7–9 7–10 7–11 7–12 7–13 7–14 7–15 7–16 7–17 7–18 7–19 7–20 7–21 7–22 7–23 7–24 7–25 7–26 7–27 7–28 7–29 7–30 7–31

Communications Analytic Analytic Analytic Analytic Analytic Communications Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic

Brief Exercises 7–1 7–2 7–3 7–4 7–5 7–6 7–7 7–8 7–9 7–10 7–11 7–12 7–13 7–14 7–15 7–16 7–17

Reflective thinking Reflective thinking Reflective thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking Analytic Analytic Analytic

Exercises 7–1 7–2

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Analytic Analytic

CPA/CMA 1 2 3 4 5 6 7 8 9 10 1 2

Analytic Analytic Reflective thinking Analytic Analytic Analytic Analytic Diversity, Analytic Diversity, Reflective thinking Diversity, Reflective thinking Reflective thinking Analytic © The McGraw-Hill Companies, Inc., 2013 7–1

CPA/CMA cont.

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Analytic

Problems 7–1 7–2 7–3 7–4 7–5 7–6 7–7 7–8 7–9 7–10 7–11 7–12 7–13 7–14 7–15

Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Diversity, Analytic Analytic Analytic Analytic Analytic Analytic Analytic

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Intermediate Accounting, 7/e

Questions for Review of Key Topics Question 7–1

Cash equivalents usually include negotiable instruments as well as highly liquid investments that have a maturity date no longer than three months from date of purchase. Question 7–2

Internal control procedures involving accounting functions are intended to improve the accuracy and reliability of accounting information and to safeguard the company’s assets. The separation of duties means that employees involved in recordkeeping should not also have physical responsibility for assets. Question 7–3

Management must document the company’s internal controls and assess their adequacy. The auditors must provide an opinion on management’s assessment. The Public Company Accounting Oversight Board’s Auditing Standard No. 5, which supersedes Auditing Standard No. 2, further requires the auditor to express its own opinion on whether the company has maintained effective internal control over financial reporting. Question 7–4

A compensating balance is an amount of cash a depositor (debtor) must leave on deposit in an account at a bank (creditor) as security for a loan or a commitment to lend. The classification and disclosure of a compensating balance depends on the nature of the restriction and the classification of the related debt. If the restriction is legally binding, then the cash will be classified as either current or noncurrent (investments and funds or other assets) depending on the classification of the related debt. In either case, note disclosure is appropriate. If the compensating balance arrangement is informal and no contractual agreement restricts the use of cash, note disclosure of the arrangement including amounts involved is appropriate. The compensating balance can be included in the cash and cash equivalents category of current assets. Question 7–5

Yes, IFRS and U.S. GAAP differ in how bank overdrafts are treated. Under IFRS, overdrafts can be offset against other cash accounts. Under U.S. GAAP, overdrafts must be treated as liabilities.

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Answers to Questions (continued) Question 7–6

Trade discounts are reductions below a list price and are used to establish a final price for a transaction. The reduced price is the starting point for initial valuation of the transaction. A cash discount is a reduction, not in the selling price of a good or service, but in the amount to be paid by a credit customer if the receivable is paid within a specified period of time. Question 7–7

The gross method of accounting for cash discounts considers discounts not taken as part of sales revenue. The net method considers discounts not taken as interest revenue, because they are viewed as compensation to the seller for allowing the buyer to defer payment. Question 7–8

When returns are material and a company can make reasonable estimates of future returns, an allowance for sales returns is established. At a financial reporting date, this provides an estimate of the amount of future returns for prior sales, and involves a debit to sales returns and a credit to allowance for sales returns for the estimated amount. Allowance for sales returns is a contra account to accounts receivable. When returns actually occur in the future reporting period, the allowance for sales returns is debited. Question 7–9

Even when specific customer accounts haven’t been proven uncollectible by the end of the reporting period, bad debt expense properly should be matched with sales revenue on the income statement for that period. Likewise, since it’s not expected that all accounts receivable will be collected, the balance sheet should report only the expected net realizable value of that asset. So, to record the bad debt expense and the related reduction of accounts receivable when the amount hasn’t been determined, an estimate is needed. In an adjusting entry, we record bad debt expense and reduce accounts receivable for an estimate of the amount that eventually will prove uncollectible. If uncollectible accounts are immaterial or not anticipated, or it’s not possible to reliably estimate uncollectible accounts, an allowance for uncollectible accounts is not appropriate. In these few cases, any bad debts that do arise simply are written off as bad debt expense at the time they prove uncollectible.

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Intermediate Accounting, 7/e

Answers to Questions (continued) Question 7–10

The income statement approach to estimating bad debts determines bad debt expense directly by relating uncollectible amounts to credit sales. The balance sheet approach to estimating future bad debts indirectly determines bad debt expense by estimating the net realizable value for accounts receivable that exist at the end of the period. In other words, the allowance for uncollectible accounts at the end of the period is estimated and then bad debt expense is determined by adjusting the allowance account to reflect net realizable value. Question 7–11

A company has to separately disclose trade receivables and receivables from related parties under U.S. GAAP, but not under IFRS. Question 7–12

The assignment of all accounts receivable in general as collateral for debt requires no special accounting treatment other than note disclosure of the agreement. Question 7–13

The accounting treatment of receivables factored with recourse depends on whether certain criteria are met. If the criteria are met, the factoring is accounted for as a sale. If they are not met, the factoring is accounted for as a loan. In addition, note disclosure may be required. Accounts receivable factored without recourse are accounted for as the sale of an asset. The difference between the book value and the fair value of proceeds received is recognized as a gain or a loss. Question 7–14

U.S. GAAP focuses on whether control of assets has shifted from the transferor to the transferee. In contrast, IFRS focuses on whether the company has transferred “substantially all of the risks and rewards of ownership,” as well as whether the company has transferred control. Under IFRS: 1. If the company transfers substantially all of the risks and rewards of ownership, the transfer is treated as a sale. 2. If the company retains substantially all of the risks and rewards of ownership, the transfer is treated as a secured borrowing. 3. If neither conditions 1 or 2 hold, the company accounts for the transaction as a sale if it has transferred control, and as a secured borrowing if it has retained control.

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Answers to Questions (continued) Question 7–15

When a note is discounted, a financial institution, usually a bank, accepts the note and gives the seller cash equal to the maturity value of the note reduced by a discount. The discount is computed by applying a discount rate to the maturity value and represents the financing fee the bank charges for the transaction. The four-step process used to account for a discounted note receivable is as follows: 1. Accrue any interest revenue earned since the last payment date (or date of the note). 2. Compute the maturity value. 3. Subtract the discount the bank requires (discount rate times maturity value times the remaining length of time from date of discounting to maturity date) from the maturity value to compute the proceeds to be received from the bank (maturity value less discount). 4. Compute the difference between the proceeds and the book value of the note and related interest receivable. The treatment of the difference will depend on whether the discounting is accounted for as a sale or as a loan. If it’s a sale, the difference is recorded as a loss or gain on the sale; if it’s a loan, the difference is viewed as interest expense or interest revenue. Question 7–16

A company’s investment in receivables is influenced by several related variables, to include the level of sales, the nature of the product or service, and credit and collection policies. The receivables turnover and average collection period ratios are designed to monitor receivables. Question 7–17

The items necessary to adjust the bank balance might include deposits outstanding (including undeposited cash), outstanding checks, and any bank errors discovered during the reconciliation process. The items necessary to adjust the book balance might include collections made by the bank on the company’s behalf, service and other charges made by the bank, NSF (nonsufficient funds) check charges, and any company errors discovered during the reconciliation process.

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Intermediate Accounting, 7/e

Answers to Questions (concluded) Question 7–18

A petty cash fund is established by transferring a specified amount of cash from the company’s general checking account to an employee designated as the petty cash custodian. The fund is replenished by writing a check to the petty cash custodian for the sum of the bills paid with petty cash. The appropriate expense accounts are recorded from petty cash vouchers at the time the fund is replenished. Question 7–19 When a creditor’s investment in a receivable becomes impaired, due to a troubled debt restructuring or for any other reason, the receivable is remeasured based on the discounted present value of currently expected cash flows discounted at the loan’s original effective rate (regardless of the extent to which expected cash receipts have been reduced). The extent of the impairment is the difference between the carrying amount of the receivable (the present value of the receivable’s cash flows prior to the restructuring) and the present value of the revised cash flows discounted at the loan’s original effective rate. This difference is recorded as bad debt expense or as an impairment loss at the time the receivable is reduced. Question 7–20

No. Under both U.S. GAAP and IFRS, a company can recognize in net income the recovery of impairment losses of accounts and notes receivable.

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BRIEF EXERCISES

Brief Exercise 7–1 The company could improve its internal control procedure for cash receipts by segregating the duties of recordkeeping and the handling of cash. Jim Seymour, responsible for recordkeeping, should not also be responsible for depositing customer checks.

Brief Exercise 7–2 Under IFRS the cash balance would be $245,000, because they could offset the two accounts. Under U.S. GAAP the balance would be $250,000, because they could not offset the two accounts.

Brief Exercise 7–3 All of these items would be included as cash and cash equivalents except the U.S. Treasury bills, which would be included in the current asset section of the balance sheet as short-term investments.

Brief Exercise 7–4 Income before tax in 2014 will be reduced by $2,500, the amount of the cash discounts. $25,000 x 10 = $250,000 x 1% = $2,500

Brief Exercise 7–5 Income before tax in 2013 will be reduced by $2,500, the anticipated amount of cash discounts. $25,000 x 10 = $250,000 x 1% = $2,500

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Intermediate Accounting, 7/e

Brief Exercise 7–6 Estimated returns = $10,600,000 x 8% = $848,000 Less: Actual returns (720,000) Remaining estimated returns $128,000

Sales returns .................................................................... 128,000 Allowance for sales returns ....................................... 128,000 Inventory—estimated returns ........................................ Cost of goods sold ($128,000 x 60%) ...........................

76,800 76,800

Brief Exercise 7–7 Singletary cannot combine the two types of receivables under U.S. GAAP, as the director is a related party. Under IFRS a combined presentation would be allowed.

Brief Exercise 7–8 (1) Bad debt expense = $1,500,000 x 2% = $30,000 (2) Allowance for uncollectible accounts: Beginning balance $25,000 Add: Bad debt expense 30,000 Deduct: Write-offs (16,000) Ending balance $39,000

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Brief Exercise 7–9 (1) Allowance for uncollectible accounts: Beginning balance $ 25,000 Deduct: Write-offs (16,000) Required allowance (33,400)* Bad debt expense $24,400 (2) Required allowance = $334,000** x 10% = $33,400* Accounts receivable: Beginning balance Add: Credit sales Deduct: Cash collections Write-offs Ending balance

$ 300,000 1,500,000 (1,450,000) (16,000) $ 334,000**

Brief Exercise 7–10 Allowance for uncollectible accounts: Beginning balance Add: Bad debt expense Deduct: Required allowance Write-offs

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$30,000 40,000 (38,000) $32,000

Intermediate Accounting, 7/e

Brief Exercise 7–11 Credit sales Deduct: Cash collections Write-offs Year-end balance in A/R Beginning balance in A/R

$8,200,000 (7,950,000) (32,000)* (2,000,000) $1,782,000

*Allowance for uncollectible accounts: Beginning balance $30,000 Add: Bad debt expense 40,000 Deduct: Required allowance (38,000) Write-offs $32,000

Brief Exercise 7–12 2013 interest revenue: $20,000 x 6% x 1/12 = $100 2014 interest revenue: $20,000 x 6% x 2/12 = $200

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Brief Exercise 7–13 Assets decrease by $7,000: Cash increases by $100,000 x 85% = Receivable from factor increases by ($11,000 – 3,000 fee) Accounts receivable decrease Net decrease in assets

$ 85,000 8,000 (100,000) $ (7,000)

Liabilities would not change as a result of this transaction. Income before income taxes decreases by $7,000 (the loss on sales of receivables) The journal entry to record the transaction is as follows: Cash (85% x $100,000) ....................................................... Loss on sale of receivables (to balance) ............................ Receivable from factor ($11,000 fair value – 3,000 fee) ....... Accounts receivable (balance sold) ................................

85,000 7,000 8,000 100,000

Brief Exercise 7–14 Logitech would account for the transfer as a secured borrowing. The receivables remain on the company’s books and a liability is recorded for the amount borrowed plus the bank’s fee.

Brief Exercise 7–15 Under IFRS Huling would treat this transaction as a secured borrowing, because it retains substantially all of the risks and rewards of ownership. Under U.S. GAAP Huling would treat this transaction as a sale, because it has transferred control. Note, however, that in practice we would typically expect for the entity that has the risks and rewards of ownership to also have control over the assets, so we would expect these criteria to usually lead to the same accounting.

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Intermediate Accounting, 7/e

Brief Exercise 7–16 $30,000 450 30,450 (406) $30,044

Face amount Interest to maturity ($30,000 x 6% x 3/12) Maturity value Discount ($30,450 x 8% x 2/12) Cash proceeds

Brief Exercise 7–17 Receivables turnover =

$320,000 = 5.33 times $60,000*

($50,000 + $70,000)  2 = $60,000* Average collection period

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=

365 = 68 days 5.33

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EXERCISES

Exercise 7–1 Requirement 1 Cash and cash equivalents includes: a. Balance in checking account Balance in savings account b. Undeposited customer checks c. Currency and coins on hand f. U.S. treasury bills with 2-month maturity Total

$13,500 22,100 5,200 580 15,000 $56,380

Requirement 2 d. The $400,000 savings account will be used for future plant expansion and therefore should be classified as a noncurrent asset, either in other assets or investments. e. The $20,000 in the checking account is a compensating balance for a longterm loan and should be classified as a noncurrent asset, either in other assets or investments. f. The $20,000 in 7-month treasury bills should be classified as a current asset along with other temporary investments.

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Intermediate Accounting, 7/e

Exercise 7–2 Requirement 1 Cash and cash equivalents includes: Cash in bank—checking account U.S. treasury bills Cash on hand Undeposited customer checks Total

$22,500 5,000 1,350 1,840 $30,690

Requirement 2 The $10,000 in 6-month treasury bills should be classified as a current asset along with other temporary investments.

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Exercise 7–3 The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. Accounts receivables from related parties should be shown separately from trade receivables: FASB ACS 210–10–S99–1: “Balance Sheet—Overall—SEC Materials—General.” Also appears under ACS 310–10–45–13: “Receivables— Overall—Other Presentation Matters—Receivables from Officers, Employees or Affiliates, ” and under ASC 850–10–50–2: "Related Party Disclosures— Overall—Disclosure" 2. Definition of Cash Equivalents: FASB ACS 305–10–20: “Cash and Cash Equivalents—Overall—Glossary.” 3. Notes exchanged for cash are valued at the cash proceeds: FASB ACS 310– 10–30–2: “Receivables—Overall—Initial Measurement—Notes Exchanged for Cash.” 4. The two conditions that must be met to accrue a loss on an account receivable: FASB ASC 310–10–35–8: "Receivables—Overall—Subsequent Measurement."

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Intermediate Accounting, 7/e

Exercise 7–4 Requirement 1: U.S. GAAP Current Assets: Cash

$175,000

Current Liabilities: Bank overdrafts

$ 15,000

Requirement 2: IFRS Current Assets: Cash

$160,000

(No current liabilities with respect to overdrafts.)

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Exercise 7–5 Requirement 1 Sales price = 100 units x $600 = $60,000 x 70% = $42,000 November 17, 2013 Accounts receivable ........................................................ Sales revenue...............................................................

42,000

November 26, 2013 Cash (98% x $42,000)......................................................... Sales discounts (2% x $42,000).......................................... Accounts receivable ....................................................

41,160 840

42,000

42,000

Requirement 2 November 17, 2013 Accounts receivable ........................................................ Sales revenue...............................................................

42,000

December 15, 2013 Cash ................................................................................. Accounts receivable ....................................................

42,000

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42,000

42,000

Intermediate Accounting, 7/e

Exercise 7–5 (concluded)

Requirement 3 Requirement 1, using the net method: November 17, 2013 Accounts receivable........................................................ Sales revenue (98% x $42,000) ......................................

41,160

November 26, 2013 Cash ................................................................................ Accounts receivable....................................................

41,160

41,160

41,160

Requirement 2, using the net method: November 17, 2013 Accounts receivable........................................................ Sales revenue (98% x $42,000) ......................................

December 15, 2013 Cash ................................................................................ Accounts receivable.................................................... Interest revenue...........................................................

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41,160 41,160

42,000 41,160 840

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Exercise 7–6 Requirement 1 Sales price = 1,000 units x $50 = $50,000 July 15, 2013 Accounts receivable ........................................................ Sales revenue...............................................................

50,000

July 23, 2013 Cash (98% x $50,000)......................................................... Sales discounts (2% x $50,000).......................................... Accounts receivable ....................................................

49,000 1,000

50,000

50,000

Requirement 2

July 15, 2013 Accounts receivable ........................................................ Sales revenue...............................................................

50,000

Aug. 15, 2013 Cash ................................................................................. Accounts receivable ....................................................

50,000

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50,000

50,000

Intermediate Accounting, 7/e

Exercise 7–7 Requirement 1

July 15, 2013 Accounts receivable........................................................ Sales revenue (98% x $50,000) ......................................

49,000

July 23, 2013 Cash ................................................................................ Accounts receivable....................................................

49,000

49,000

49,000

Requirement 2 July 15, 2013 Accounts receivable........................................................ Sales revenue (98% x $50,000) ......................................

August 15, 2013 Cash ................................................................................ Accounts receivable.................................................... Interest revenue...........................................................

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49,000 49,000

50,000 49,000 1,000

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Exercise 7–8 Requirement 1 Estimated returns = 4% x $11,500,000 = Less: Actual returns Remaining estimated returns

$460,000 (450,000) $10,000

To record the actual sales returns Sales returns .................................................................... 450,000 Accounts receivable .................................................... 450,000 Inventory—estimated returns ......................................... 292,500 Cost of goods sold ($450,000 x 65%) ............................ 292,500 December 31, 2013 To record the estimated sales returns Sales returns .................................................................... 10,000 Allowance for sales returns ........................................ Inventory—estimated returns ......................................... Cost of goods sold ($10,000 x 65%) ..............................

10,000

6,500 6,500

Note: another series of journal entries that produce the same end result would be: To record the actual sales returns Allowance for sales returns ............................................. 450,000 Accounts receivable .................................................... 450,000 December 31, 2013 To record the estimated sales returns Sales returns (4% x $11,500,000)........................................ 460,000 Allowance for sales returns ........................................ 460,000 Inventory—estimated returns ......................................... 299,000 Cost of goods sold (65% x $460,000) ............................. 299,000

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Intermediate Accounting, 7/e

Exercise 7–8 (continued)

Requirement 2 Beginning balance in allowance account Add: Year-end estimate Less: Actual returns Ending balance in allowance account

$300,000 460,000 (450,000) $310,000

Exercise 7–9 Requirement 1 The specific citation that specifies these disclosure policies is FASB ACS 310–10– 50–9: “Receivables—Overall—Disclosure—Accounting Policies for Credit Losses and Doubtful Accounts.” Requirement 2 FASB ACS 310–10–50–9 reads as follows: “In addition to disclosures required by this Subsection and Subtopic 450-20, an entity shall disclose a description of the accounting policies and methodology the entity used to estimate its allowance for loan losses, allowance for doubtful accounts, and any liability for off-balance-sheet credit losses and related charges for loan, trade receivable or other credit losses in the notes to the financial statements. Such a description shall identify the factors that influenced management’s judgment (for example, historical losses and existing economic conditions) and may also include discussion of risk elements relevant to particular categories of financial instruments.”

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Exercise 7–10 Requirement 1 Bad debt expense = $67,500 (1.5% x $4,500,000) Requirement 2 Allowance for uncollectible accounts Balance, beginning of year Add: Bad debt expense for 2013 (1.5% x $4,500,000) Less: End-of-year balance Accounts receivable written off

$42,000 67,500 (40,000) $69,500

Requirement 3 $69,500 — the amount of accounts receivable written off.

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Intermediate Accounting, 7/e

Exercise 7–11 Requirement 1 To record the write-off of receivables: Allowance for uncollectible accounts ............................ Accounts receivable....................................................

21,000 21,000

To reinstate an account previously written off and to record the collection: Accounts receivable........................................................ Allowance for uncollectible accounts ........................

1,200

Cash ................................................................................ Accounts receivable....................................................

1,200

1,200

1,200

Allowance for uncollectible accounts: Balance, beginning of year Deduct: Receivables written off Add: Collection of receivable previously written off Balance, before adjusting entry for 2013 bad debts

$32,000 (21,000) 1,200 12,200

Required allowance: 10% x $625,000 Bad debt expense

(62,500) $50,300

To record bad debt expense for the year: Bad debt expense ............................................................ Allowance for uncollectible accounts ........................

50,300 50,300

Requirement 2 Current assets: Accounts receivable, net of $62,500 allowance for uncollectible accounts Solutions Manual, Vol.1, Chapter 7

$562,500 © The McGraw-Hill Companies, Inc., 2013 7–25

Exercise 7–12 Using the direct write-off method, bad debt expense is equal to actual write-offs. Collections of previously written-off receivables are recorded as revenue. Allowance for uncollectible accounts: Balance, beginning of year Deduct: Receivables written off Add: Collection of receivables previously written off Less: End of year balance Bad debt expense for the year 2013

$17,280 (17,100) 2,200 (22,410) $20,030

Exercise 7–13 ($ in millions) Allowance for uncollectible accounts: Balance, beginning of year Add: Bad debt expense Less: End of year balance Write-offs during the year

Allowance

$15.8 12.7 (16.3) $ 12.2*

15.8 12.7 writeoffs

16.3

Accounts receivable analysis: Balance, beginning of year

$ 1,057.4

($1,041.6 + 15.8)

Add: Credit sales Less: Write-offs* Less: Balance, end of year

1,057.4

14,880.2 (12.2) (1,178.6)

($1,162.3 + 16.3)

Cash collections

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Gross A/R

14,880.2

12.2 collections

1,178.6

$14,746.8

Intermediate Accounting, 7/e

Exercise 7–14 Requirement 1

June 30, 2013 Note receivable ............................................................... Sales revenue ..............................................................

30,000

December 31, 2013 Interest receivable ........................................................... Interest revenue ($30,000 x 6% x 6/12) ...........................

900

March 31, 2014 Cash [$30,000 + ($30,000 x 6% x 9/12)] ................................ Interest revenue ($30,000 x 6% x 3/12) ........................... Interest receivable (accrued at December 31) .................. Note receivable ..........................................................

30,000

900

31,350 450 900 30,000

Requirement 2 2013 income before income taxes would be understated by $900 2014 income before income taxes would be overstated by $900.

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Exercise 7–15 Requirement 1 June 30, 2013 Note receivable (face amount)............................................ Discount on note receivable ($30,000 x 8% x 9/12)......... Sales revenue (difference)..............................................

30,000 1,800 28,200

December 31, 2013 Discount on note receivable ........................................... Interest revenue ($30,000 x 8% x 6/12) ............................

1,200

March 31, 2014 Discount on note receivable ........................................... Interest revenue ($30,000 x 8% x 3/12) ............................

600

Cash ................................................................................ Note receivable (face amount) .......................................

Requirement 2 $ 1,800 ÷ $28,200 = 6.383% 12/9 x _______ = 8.511%

1,200

600 30,000 30,000

interest for 9 months sales price rate for 9 months to annualize the rate effective interest rate

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Intermediate Accounting, 7/e

Exercise 7–16 Requirement 1 Book value of stock Plus gain on sale of stock = Note receivable Interest reported for the year

$16,000 6,000 $22,000 $ 2,200 =

Divided by value of note

10% rate

$ 22,000

Requirement 2 To record sale of stock in exchange for note receivable: January 1, 2013 Note receivable ............................................................... Investments ................................................................. Gain on sale of investments........................................

22,000 16,000 6,000

To accrue interest on note receivable for twelve months: December 31, 2013 Interest receivable ........................................................... Interest revenue ($22,000 x 10%) ..................................

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2,200 2,200

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Exercise 7–17 Cash (difference)................................................................ 439,200 Finance charge expense (1.8% x $600,000)........................ 10,800 Liability—financing arrangement .............................. 450,000

Exercise 7–18 Cash (90% x $60,000)......................................................... Loss on sale of receivables (to balance) ............................ Receivable from factor ($5,000 fair value – [2% x $60,000]) Accounts receivable (balance sold) ................................

54,000 2,200 3,800 60,000

Exercise 7–19 Cash ([90% – 2%] x $60,000) .............................................. Loss on sale of receivables (to balance) ............................ Receivable from factor ($5,000 fair value) ......................... Recourse liability ....................................................... Accounts receivable (balance sold) ................................

52,800 5,200 5,000 3,000 60,000

Exercise 7–20 Mountain High retains significant risks and rewards and therefore must treat the transfer as a secured borrowing. The accounts receivable stay on the balance sheet of Mountain High, and they must record a liability.

Cash ([90% – 2%] x $60,000) .............................................. Finance charge expense (2% x $60,000) ............................ Liability ...................................................................... © The McGraw-Hill Companies, Inc., 2013 7–30

52,800 1,200 54,000

Intermediate Accounting, 7/e

Exercise 7–21 Step 1: Accrue interest earned. February 28, 2013 Interest receivable ........................................................... Interest revenue ($15,000 x 10% x 2/12)..........................

250 250

Step 2: Add interest to maturity to calculate maturity value. Step 3: Deduct discount to calculate cash proceeds. $15,000 750 15,750 (630) $15,120

Face amount Interest to maturity ($15,000 x 10% x 6/12) Maturity value Discount ($15,750 x 12% x 4/12) Cash proceeds

Step 4: Record a loss for the difference between the cash proceeds and the note’s book value. February 28, 2013 Cash (proceeds determined above)........................................ Loss on sale of note receivable (difference) ..................... Note receivable (face amount) ....................................... Interest receivable (accrued interest determined above) ....

Solutions Manual, Vol.1, Chapter 7

15,120 130 15,000 250

© The McGraw-Hill Companies, Inc., 2013 7–31

Exercise 7–22 List A c 1. Internal control j 2. Trade discount g 3. Cash equivalents h 4. Allowance for uncollectibles i 5. Cash discount l 6. Balance sheet approach d 7. Income statement approach k 8. Net method a 9. Compensating balance m 10. Discounting b 11. Gross method e 12. Direct write-off method f

13. Factoring

© The McGraw-Hill Companies, Inc., 2013 7–32

List B a. b. c. d. e. f. g. h. i. j. k. l.

Restriction on cash. Cash discount not taken is sales revenue. Includes separation of duties. Bad debt expense a % of credit sales. Recognizes bad debts as they occur. Sale of receivables to a financial institution. Include highly liquid investments. Estimate of bad debts. Reduction in amount paid by credit customer. Reduction below list price. Cash discount not taken is interest revenue. Bad debt expense determined by estimating realizable value. m. Sale of note receivable to a financial institution.

Intermediate Accounting, 7/e

Exercise 7–23 Requirement 1 March 17, 2013 Allowance for uncollectible accounts ............................ Accounts receivable....................................................

1,700

March 30, 2013 Note receivable ............................................................... Cash ............................................................................

20,000

1,700

20,000

Step 1: Accrue interest earned for two months on note receivable. May 30, 2013 Interest receivable ........................................................... Interest revenue ($20,000 x 7% x 2/12)............................

233 233

Step 2: Add interest to maturity to calculate maturity value. Step 3: Deduct discount to calculate cash proceeds.

$20,000 1,400 21,400 (1,427) $19,973

Solutions Manual, Vol.1, Chapter 7

Face amount Interest to maturity ($20,000 x 7%) Maturity value Discount ($21,400 x 8% x 10/12) Cash proceeds

© The McGraw-Hill Companies, Inc., 2013 7–33

Exercise 7–23 (continued) Step 4: Record a loss for the difference between the cash proceeds and the note’s book value.

May 30, 2013 Cash (proceeds determined above) ........................................ Loss on sale of note receivable (difference) ...................... Interest receivable (from adjusting entry) ........................ Note receivable (face amount) .......................................

19,973 260 233 20,000

June 30, 2013 Accounts receivable ........................................................ Sales revenue...............................................................

12,000

July 8, 2013 Cash ($12,000 x 98%)......................................................... Sales discounts ($12,000 x 2%) .......................................... Accounts receivable ....................................................

11,760 240

August 31, 2013 Notes receivable (face amount) .......................................... Discount on note receivable ($6,000 x 8% x 6/12) .......... Investments (book value) ............................................... Gain on sale of investments (difference) .......................

December 31, 2013 Bad debt expense ($700,000 x 2%) .................................... Allowance for uncollectible accounts .........................

© The McGraw-Hill Companies, Inc., 2013 7–34

12,000

12,000

6,000 240 5,000 760

14,000 14,000

Intermediate Accounting, 7/e

Exercise 7–23 (concluded)

Requirement 2 To accrue interest earned on note receivable: December 31, 2013 Discount on note receivable ........................................... Interest revenue ($6,000 x 8% x 4/12) .............................

160 160

Exercise 7–24 Second quarter: Receivables turnover =

Average collection period

=

Third quarter: Receivables turnover =

Average collection period

Solutions Manual, Vol.1, Chapter 7

=

$19,953 $11,260

= 1.772 times

91 = 51.35 days 1.772

$16,428 = 1.43 times $11,453.5 91 = 63.64 days 1.43

© The McGraw-Hill Companies, Inc., 2013 7–35

Exercise 7–25 Average collection period

= 365 ÷ Accounts receivable turnover = 50 days

Accounts receivable turnover

= 365 ÷ 50 = 7.3

Average accounts receivable

= ($400,000 + 300,000) ÷ 2 = $350,000

Accounts receivable turnover 7.3

= Net sales ÷ Average accounts receivable = Net sales ÷ $350,000

Net sales = 7.3 x $350,000

= $2,555,000

Exercise 7–26 To establish the petty cash fund:

October 2, 2013 Petty Cash........................................................... Cash (checking account) ................................

200 200

To replenish the petty cash fund: October 31, 2013 Office supplies expense ..................................... Entertainment expense ....................................... Postage expense ................................................. Miscellaneous expense ....................................... Cash (checking account) ................................

© The McGraw-Hill Companies, Inc., 2013 7–36

76 48 20 19 163

Intermediate Accounting, 7/e

Exercise 7–27 September 30, 2013 To replenish the petty cash fund Delivery expense ............................................... 16 Office supplies expense ..................................... 19 Receivable from employee ................................ 25 Postage expense ................................................. 32 Cash (checking account)................................

92

Exercise 7–28 Compute balance per bank statement: Balance per books Deduct: Deposits outstanding Add: Checks outstanding Deduct: Bank service charges Balance per bank Step 1:

Bank Balance to Corrected Balance

Balance per bank statement Add: Deposits outstanding Deduct: Checks outstanding Corrected cash balance Step 2:

$23,820 (2,340) 1,890 (38) $23,332

$23,332 2,340 (1,890) $23,782

Book Balance to Corrected Balance

Balance per books Deduct: Service charges Corrected cash balance

Solutions Manual, Vol.1, Chapter 7

$23,820 (38) $23,782

© The McGraw-Hill Companies, Inc., 2013 7–37

Exercise 7–29 Requirement 1 Step 1: Bank Balance to Corrected Balance Balance per bank statement Add: Deposits outstanding Deduct: Checks outstanding Add: Bank error in recording check Corrected cash balance

$38,018 6,300 (8,420) 270 $36,168

Step 2: Book Balance to Corrected Balance Balance per books Add: Error in recording cash receipt ($2,000 – 200) Deduct: Service charges NSF checks Automatic monthly loan payment Corrected cash balance

$38,918 1,800 (30) (1,200) (3,320) $36,168

Requirement 2 To correct error in recording cash receipt from credit customer: Cash .................................................................... Accounts receivable .......................................

1,800 1,800

To record credits to cash revealed by the bank reconciliation: Miscellaneous expense (bank service charges) . Accounts receivable (NSF checks) .................... Interest expense .................................................. Note payable....................................................... Cash ................................................................

30 1,200 320 3,000 4,550

Note: Each of the adjustments to the book balance required journal entries. None of the adjustments to the bank balance require entries. © The McGraw-Hill Companies, Inc., 2013 7–38

Intermediate Accounting, 7/e

Exercise 7–30 ANALYSIS

Previous Value:

Accrued 2012 interest (10% x $12,000,000) Principal Carrying amount of the receivable

$ 1,200,000 12,000,000 $13,200,000

New Value:

Interest $1 million x 1.73554 * Principal $11 million x 0.82645 ** Present value of the receivable

= =

$1,735,540 9,090,950

Loss: * present value of an ordinary annuity of $1: n = 2, i =10% (from Table 4) ** present value of $1: n = 2, i =10% (from Table 2)

(10,826,490) $ 2,373,510

JOURNAL ENTRIES

January 1, 2013 Loss on troubled debt restructuring (to balance) ......... Accrued interest receivable (account balance) ........ Note receivable ($12,000,000 – 10,826,490) ..........

2,373,510 1,200,000 1,173,510

December 31, 2013 Cash (required by new agreement) .................. ........... Note receivable (to balance) ........................….. ....... Interest revenue (10% x $10,826,490) ........ ...........

1,000,000 82,649

December 31, 2014 Cash (required by new agreement) .................. ........... Note receivable (to balance) ............................ ........... Interest revenue (10% x [$10,826,490 + 82,649]) ..

1,000,000 90,861

1,082,649

1,090,861*

Cash (required by new agreement) .................. ........... 11,000,000 Note receivable (balance) ............................ ........... 11,000,000 * rounded to amortize the note to $11,000,000 (per schedule below)

Solutions Manual, Vol.1, Chapter 7

© The McGraw-Hill Companies, Inc., 2013 7–39

Exercise 7–30 (concluded) Amortization Schedule – Not required Cash Interest by agreement

1 2

1,000,000 1,000,000 2,000,000

Effective Increase in Interest Balance 10% x Outstanding Balance Discount Reduction .10 (10,826,490) = 1,082,649 .10 (10,909,139) = 1,090,861*

2,173,510

82,649 90,861 173,510

Outstanding Balance

10,826,490 10,909,139 11,000,000

* rounded

© The McGraw-Hill Companies, Inc., 2013 7–40

Intermediate Accounting, 7/e

Exercise 7–31 ANALYSIS

Previous Value:

Accrued 2012 interest (10% x $240,000) Principal Carrying amount of the receivable

$ 24,000 240,000 $264,000

New Value:

$11,555 + 11,555 + 11,555 + 240,000 = $274,665 $274,665 x 0.82645 * = Loss: * present value of $1: n = 2, i = 10% (from Table 2)

(226,997) $ 37,003

JOURNAL ENTRIES

January 1, 2013 Loss on troubled debt restructuring (to balance) ......... Accrued interest receivable (10% x $240,000) ....... Note receivable ($240,000 – 226,997) ........ ...........

37,003 24,000 13,003

December 31, 2013 Note receivable (to balance) ............................ ........... Interest revenue (10% x $226,997) ............. ...........

22,700

December 31, 2014 Note receivable (to balance) ............................ ........... Interest revenue (10% x [$226,997 + 22,700]) .......

24,968

22,700

24,968*

Cash (required by new agreement) .................. ........... 274,665 Note receivable (balance) ............................ ........... * rounded to amortize the note to $274,665 (per schedule below)

Solutions Manual, Vol.1, Chapter 7

274,665

© The McGraw-Hill Companies, Inc., 2013 7–41

Exercise 7–31 (concluded) Amortization Schedule – Not required Cash Interest by agreement

1 2

0 0

Effective Interest 10% x Outstanding Balance .10 (226,997) = 22,700 .10 (249,697) = 24,968*

47,668

Increase in Outstanding Balance Balance Discount Reduction

22,700 24,968 47,668

226,997 249,697 274,665

* rounded

© The McGraw-Hill Companies, Inc., 2013 7–42

Intermediate Accounting, 7/e

CPA / CMA REVIEW QUESTIONS

CPA Exam Questions 1. a. Allowance for uncollectible accounts, beginning balance Add: Bad debt expense (2% x $9,000,000) Less: Write-offs Allowance for uncollectible accounts, ending balance 2. a. Accounts receivable, beginning balance Add: Credit sales Less: Write-offs Less: Accounts receivable, ending balance Cash collections

$260,000 180,000 (325,000) $115,000 $ 600 3,200 (200) (500) $3,100

3. c. The reinstatement of a previously written off account increases the allowance account. The collection of the reinstated account does not affect the allowance account. The net effect of the reinstatement and collection is an increase in the allowance account. Neither the reinstatement nor the subsequent collection of the account has any effect on the expense. 4. b. Accounts receivable, beginning balance Add: Credit sales Less: Sales returns Less: Write-offs Less: Cash collections Accounts receivable, ending balance

$ 650,000 2,700,000 (75,000) (40,000) (2,150,000) $1,085,000

5. c. The key phrase is "without recourse" which means that Gar Co. has transferred the collection risk to Ross Bank. Ross does not have any recourse against Gar Co. if the accounts are not collected. Thus, Gar has sold the accounts receivable to Ross Bank and has also transferred the risk associated with collection.

Solutions Manual, Vol.1, Chapter 7

© The McGraw-Hill Companies, Inc., 2013 7–43

CPA Exam Questions (concluded) 6. a. The aging method is a balance sheet approach that calculates the required ending balance in the allowance for uncollectible accounts. The calculation is as follows: Estimated %

Required

Uncollectible

x

Amount

=

Balance

1%

x

$120,000

=

$1,200

2%

x

$ 90,000

=

1,800

6%

x

$100,000

=

6,000

Total required balance

$9,000

7. a. The estimate using the income statement approach is: $1,750,000 x 2% = $35,000 The estimate using the balance sheet approach is: Required ending balance ($900,000 x 5%) Less: Allowance for uncollectible accounts before recording bad debt expense Bad debt expense

$45,000 (16,000) $29,000

8. b. IFRS allows overdrafts to be offset with positive cash balances if the overdrafts are payable on demand and which fluctuate as part of its cash management program. 9. c. IAS No. 39 allows receivables to be accounted for as “available for sale” investments if that approach is elected upon initial recognition of the receivable. 10. d. Under IFRS, measurement of an impairment of a receivable is required if there is objective evidence that a loss event has occurred that has an impact on the future cash flows to be collected and that can be estimated reliably. © The McGraw-Hill Companies, Inc., 2013 7–44

Intermediate Accounting, 7/e

CMA Exam Questions 1. c. The allowance method records bad debt expense systematically as a percentage of either credit sales or the level of accounts receivable. The latter calculation considers the amount already existing in the allowance account. The credit is to a contra asset or allowance account. As accounts receivable are written off, they are charged to the allowance account. 2. d. If a company uses the allowance method, the write-off of a receivable has no effect on total assets. The journal entry involves a debit to the allowance account and a credit to accounts receivable. The net effect is that the asset section is both debited and credited for the same amount. Thus, there will be no effect on either total assets or net income. 3. c. The entry is to debit bad debt expense and credit the allowance account. Net credit sales were $1,500,000 ($1,800,000 – $125,000 of discounts – $175,000 of returns). Thus, the expected bad debt expense is $22,500 (1.5% x $1,500,000). This amount is recorded regardless of the balance remaining in the allowance account from previous periods. The net effect is that the allowance account is increased by $22,500.

Solutions Manual, Vol.1, Chapter 7

© The McGraw-Hill Companies, Inc., 2013 7–45

PROBLEMS Problem 7–1 Requirement 1 Monthly bad debt expense accrual summary. Bad debt expense (3% x $2,620,000).................................. Allowance for uncollectible accounts .........................

78,600 78,600

To record year 2013 accounts receivable write-offs: Allowance for uncollectible accounts ............................. Accounts receivable ....................................................

68,000 68,000

Requirement 2 Bad debt expense ........................................................... Allowance for uncollectible accounts (below) .............

4,300 4,300

Year-end required allowance for uncollectible accounts: Summary Age Group 0–60 days 61–90 days 91–120 days Over 120 days Totals

Amount $430,000 98,000 60,000 55,000 $643,000

© The McGraw-Hill Companies, Inc., 2013 7–46

Percent Uncollectible 4% 15% 25% 40%

Estimated Allowance $17,200 14,700 15,000 22,000 $68,900

Intermediate Accounting, 7/e

Problem 7–1 (concluded)

Allowance for uncollectible accounts: Beginning balance Add: Monthly bad debt accruals Deduct: Write-offs Balance before year-end adjustment Required allowance (determined above) Required year-end increase in allowance

$54,000 78,600 (68,000) 64,600 68,900 $ 4,300

Requirement 3 Bad debt expense for 2013: Monthly accruals Year-end adjustment Total

$78,600 4,300 $82,900

Balance sheet: Current assets: Accounts receivable, net of $68,900 allowance for uncollectible accounts

Solutions Manual, Vol.1, Chapter 7

$574,100

© The McGraw-Hill Companies, Inc., 2013 7–47

Problem 7–2 Requirement 1 (a) Accounts receivable analysis ($ in thousands): Balance, beginning of year ($580,640 + 6,590) Add: Credit sales Less: Cash collections Less: Balance end of year ($504,944 + 5,042) Accounts receivable written off during year

$ 587,230 2,158,755 (2,230,065) (509,986) $ 5,934

(b) Allowance for uncollectible accounts analysis ($ in thousands): Beginning balance Less: Write-offs (from above) Less: Year-end balance Bad debt expense for the current year

$6,590 (5,934) (5,042) $4,386

(c) $4,386 of bad debt expense divided by $2,158,755 in credit sales equals .2% (.002). Requirement 2 (a) ($ in thousands) Current assets: Receivables

Current year

Previous year

$509,986

$587,230

(b) ($ in thousands) Bad debt expense would be equal to actual receivables written off of $5,934.

© The McGraw-Hill Companies, Inc., 2013 7–48

Intermediate Accounting, 7/e

Problem 7–3 Requirement 1 2011

2010

($ in thousands)

Accounts receivable, net Add: Allowances Accounts receivable, gross

$39,098 421 $39,519

$23,963 488 $24,451

Requirement 2 ($ in thousands)

The answers to this question require an analysis of both gross accounts receivable and the allowance for uncollectible accounts for 2011. First of all, 2011 sales of $369,571 plus the increase in receivables reported in the statement of cash flows indicates cash received from customers of $354,436 ($369,571 – 15,135). The activity in gross accounts receivable would be: Gross Accounts Receivable ________________________________________ ($ in thousands)

Beg. Bal. Sales

24,451 369,571

End. Bal.

354,436 67 _________________ 39,519

Collections Write-offs

The journal entry to record write-offs would be: Allowance for Uncollectible Accounts ........... ........................ 67 Accounts Receivable ................................... ............................

Solutions Manual, Vol.1, Chapter 7

67

© The McGraw-Hill Companies, Inc., 2013 7–49

Problem 7–3 (continued)

Considering the allowance for uncollectible accounts in light of these write-offs allows us to solve for bad debt expense:

Allowance for Uncollectible Accounts ________________________________________ ($ in thousands)

488

Beg. Bal.

Write-offs 67 0 Bad Debt Expense _________________ 421 End. Bal. Cirrus recognized zero bad debt expense during 2011.

© The McGraw-Hill Companies, Inc., 2013 7–50

Intermediate Accounting, 7/e

Problem 7–4 Requirement 1 To record accounts receivable written off during the year 2013: Allowance for uncollectible accounts ............................ Accounts receivable....................................................

35,000 35,000

To record collection of account receivable previously written off: Accounts receivable........................................................ Allowance for uncollectible accounts ........................

3,000

Cash ................................................................................ Accounts receivable....................................................

3,000

3,000

3,000

Requirement 2 (a) December 31, 2013 Bad debt expense (3% x $1,750,000) ................................. Allowance for uncollectible accounts ........................

52,500 52,500

(b) December 31, 2013 Bad debt expense ............................................................ Allowance for uncollectible accounts (below).............

Solutions Manual, Vol.1, Chapter 7

36,700 36,700

© The McGraw-Hill Companies, Inc., 2013 7–51

Problem 7–4 (continued)

Accounts receivable analysis: Beginning balance Add: Credit sales Less: Write-offs Less: Cash collections Ending balance

$ 462,000 1,750,000 (35,000) (1,830,000) $ 347,000

$347,000 x 10% = $34,700 = Required allowance for uncollectible accounts Allowance for uncollectible accounts analysis: Beginning balance Add: Collection of receivable previously written off Less: Write-offs Balance before adjustment Required allowance (determined above) Bad debt expense adjustment

$30,000 3,000 (35,000) (2,000) debit balance 34,700 $36,700

(c) December 31, 2013 Bad debt expense ............................................................ Allowance for uncollectible accounts (below) .............

37,047 37,047

Required allowance:

Age Group 0–60 days 61–90 days 91–120 days Over 120 days Totals

Amount $225,550 69,400 34,700 17,350 $347,000

© The McGraw-Hill Companies, Inc., 2013 7–52

Percent Uncollectible 4% 15% 25% 40%

Estimated Allowance $ 9,022 10,410 8,675 6,940 $35,047

Intermediate Accounting, 7/e

Problem 7–4 (concluded)

Allowance for uncollectible accounts analysis: Beginning balance Add: Collection of receivable previously written off Less: Write-offs Balance before adjustment Required allowance Bad debt expense adjustment Requirement 3 Accounts receivable

–

Year-end allowance

$30,000 3,000 (35,000) (2,000) debit balance 35,047 $37,047

(a)

$347,000

–

[(2,000) + 52,500]

= $296,500

(b)

$347,000

–

34,700

= $312,300

(c)

$347,000

–

35,047

= $311,953

Solutions Manual, Vol.1, Chapter 7

© The McGraw-Hill Companies, Inc., 2013 7–53

Problem 7–5 Requirement 1 ($ in millions)

Accounts receivable, net Add: Allowances Accounts receivable, gross

2009 $837,010 20,991 $858,001

2008 $758,200 23,314 $781,514

Requirement 2 ($ in millions)

Analysis of allowance for doubtful accounts Balance, beginning of year Add: Bad debt expense Less: Balance end of year Write-offs

$8,915 1,500 (8,863) $1,552

Requirement 3 ($ in millions)

Analysis of allowance for sales returns Balance, end of year Add: Actual returns Less: Balance beginning of year Estimated sales returns

$12,128 3,155 (14,399) $ 884

Gross sales for the year equal net sales of $6,149,800 + estimated sales returns of $884 = $6,150,684 thousand. Requirement 4 ($ in millions) Accounts receivable analysis: Balance, beginning of year Add: Credit sales Less: Bad debt write-offs Less: Actual sales returns Less: Balance end of year Cash collections

© The McGraw-Hill Companies, Inc., 2013 7–54

$ 781,514 6,150,684 (1,552) (3,155) (858,001) $6,069,490

Intermediate Accounting, 7/e

Problem 7–6 Requirement 1 Total face value of notes = $300,000 + 150,000 + 200,000 = Balance sheet carrying value = Difference is the remaining discount on note 3

$650,000 645,000 $ 5,000

Note 3 is a 6-month note, with three months remaining. Therefore, $5,000 represents one-half of the total discount of $10,000. $10,000 ÷ $200,000 = 5% x 12/6 = 10% discount rate.

Requirement 2 Total accrued interest receivable Less: Interest accrued on note 1: $300,000 x 10% x 4/12 =

Interest accrued on note 2

$16,000 (10,000) $ 6,000

$6,000 ÷ $150,000 = 4% x 12/6 = 8% Requirement 3 Note 1 Note 2 Note 3 ($200,000 x 10% x 3/12) Total interest revenue

Solutions Manual, Vol.1, Chapter 7

$10,000 6,000 5,000 $21,000

© The McGraw-Hill Companies, Inc., 2013 7–55

Problem 7–7 Requirement 1 Alternative a: To record the borrowing of $500,000 and signing of a note payable: July 1, 2013 Cash ................................................................................. 500,000 Note payable ............................................................... 500,000 Alternative b: To record the transfer of receivables: July 1, 2013 Cash ($550,000 x 98%) ....................................................... 539,000 Loss on transfer of receivables (2% x $550,000) ............... 11,000 Accounts receivable .................................................... 550,000 Requirement 2 Alternative a: July, 2013 Cash (80% x $780,000) ....................................................... 624,000 Accounts receivable .................................................... 624,000 July 31, 2013 Interest expense ($500,000 x 12% x 1/12) ............................ 5,000 Note payable.................................................................... 500,000 Cash ............................................................................. 505,000

© The McGraw-Hill Companies, Inc., 2013 7–56

Intermediate Accounting, 7/e

Problem 7–7 (concluded)

Alternative b: $550 of accounts receivable are now held by the bank, and presumably the bank has collected .8 x $550 = $440 during July. Lonergan still holds accounts receivable of ($780 – 550 = $230), so should have collected .8 x $230 = $184 during July. July 31, 2013 Cash [80% x ($780,000 – 550,000)] ..................................... 184,000 Accounts receivable.................................................... 184,000 Requirement 3 Alternative a. –

Alternative b. –

Note disclosure is required for the assignment of accounts receivable as collateral for the $500,000 note. No disclosure is required since the transfer of receivables was made without recourse.

Problem 7–8 Cash (90% x $800,000) ...................................................... 720,000 Loss on sale of receivables (to balance)............................ 52,000 Receivable from factor ($60,000 fair value – [4% x $800,000]) 28,000 Accounts receivable (balance sold) ............................... 800,000

Solutions Manual, Vol.1, Chapter 7

© The McGraw-Hill Companies, Inc., 2013 7–57

Problem 7–9 WALKEN COMPANY Balance Sheet December 31, 2013 Current Assets Casha Accounts receivable (net)b

€35,000 60,000

a

Walken would net the €40,000 and (€5000) cash balances, yielding a balance of €35,000. b

Net accounts receivable would be affected as follows: Beginning balance: € 25,000 Credit sales 85,000 Cash collections (30,000) Receivables factored with Reliable (20,000) c Receivables factored with Dependable -0Total €60,000

c

The receivables factored with Dependable don’t qualify for sales treatment, as substantially all risks and rewards of ownership are retained by Walken.

© The McGraw-Hill Companies, Inc., 2013 7–58

Intermediate Accounting, 7/e

Problem 7–10 Requirement 1 February 28, 2013 Note receivable ............................................................... Sales revenue ..............................................................

March 31, 2013 Note receivable (face amount) ........................................... Discount ($8,000 x 10%) ............................................... Sales revenue (difference) .............................................

10,000 10,000

8,000 800 7,200

April 3, 2013 Accounts receivable........................................................ Sales revenue ..............................................................

7,000

April 11, 2013 Cash (98% x $7,000) .......................................................... Sales discounts (2% x $7,000) ........................................... Accounts receivable....................................................

$6,860 140

April 17, 2013 Sales returns .................................................................... Accounts receivable....................................................

5,000

Inventory ......................................................................... Cost of goods sold ......................................................

Solutions Manual, Vol.1, Chapter 7

7,000

7,000

5,000 3,200 3,200

© The McGraw-Hill Companies, Inc., 2013 7–59

Problem 7–10 (continued)

April 30, 2013 Cash (99% x $50,000) ......................................................... Loss on sale of receivables (1% x $50,000) ....................... Accounts receivable ....................................................

49,500 500 50,000

To accrue interest on note receivable for four months: June 30, 2013 Interest receivable ........................................................... Interest revenue ($10,000 x 10% x 4/12) ..........................

333 333

To record discounting of note receivable: June 30, 2013 Cash (proceeds determined below)........................................ Loss on sale of note receivable (to balance) ...................... Interest receivable (from adjusting entry) ........................ Note receivable (face amount)........................................

$10,000 583 10,583 (317) $10,266

10,266 67 333 10,000

Face amount Interest to maturity ($10,000 x 10% x 7/12) Maturity value Discount ($10,583 x 12% x 3/12) Cash proceeds

August 31, 2013 — NO ENTRY REQUIRED

© The McGraw-Hill Companies, Inc., 2013 7–60

Intermediate Accounting, 7/e

Problem 7–10 (concluded)

Requirement 2 To accrue nine months’ interest on the Maddox Co. note receivable: Discount ......................................................................... Interest revenue ($8,000 x 10% x 9/12) ...........................

600 600

Requirement 3 Date February 28 March 31 April 3 April 11 April 17 April 17 April 30 June 30 June 30 December 31 Total effect

Solutions Manual, Vol.1, Chapter 7

Income increase (decrease) $10,000 7,200 7,000 (140) (5,000) 3,200 (500) 333 (67) 600 $22,626

© The McGraw-Hill Companies, Inc., 2013 7–61

Problem 7–11 Note

Note Face Value

Date of Note

Interest Rate

Date Discounted

Discount Rate

Proceeds Received

1

$50,000

3-31-11

8%

6-30-11

10%

$50,350 (1)

2

50,000

3-31-11

8%

9-30-11

10%

51,675 (2)

3

50,000

3-31-11

8%

9-30-11

12%

51,410 (3)

4

80,000

6-30-11

6%

10-31-11

10%

81,027 (4)

5

80,000

6-30-11

6%

10-31-11

12%

80,752 (5)

6

80,000

6-30-11

6%

11-30-11

10%

81,713 (6)

(1) $50,000 3,000 53,000 (2,650) $50,350

Face amount Interest to maturity ($50,000 x 8% x 9/12) Maturity value Discount ($53,000 x 10% x 6/12) Cash proceeds

$50,000 3,000 53,000 (1,325) $51,675

Face amount Interest to maturity ($50,000 x 8% x 9/12) Maturity value Discount ($53,000 x 10% x 3/12) Cash proceeds

(2)

© The McGraw-Hill Companies, Inc., 2013 7–62

Intermediate Accounting, 7/e

Problem 7–11 (concluded)

(3) $50,000 3,000 53,000 (1,590) $51,410

Face amount Interest to maturity ($50,000 x 8% x 9/12) Maturity value Discount ($53,000 x 12% x 3/12) Cash proceeds

$80,000 2,400 82,400 (1,373) $81,027

Face amount Interest to maturity ($80,000 x 6% x 6/12) Maturity value Discount ($82,400 x 10% x 2/12) Cash proceeds

$80,000 2,400 82,400 (1,648) $80,752

Face amount Interest to maturity ($80,000 x 6% x 6/12) Maturity value Discount ($82,400 x 12% x 2/12) Cash proceeds

$80,000 2,400 82,400 (687) $81,713

Face amount Interest to maturity ($80,000 x 6% x 6/12) Maturity value Discount ($82,400 x 10% x 1/12) Cash proceeds

(4)

(5)

(6)

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© The McGraw-Hill Companies, Inc., 2013 7–63

Problem 7–12 Requirement 1 In addition to sales revenue of $1,340,000, the 2014 income statement will include (1) interest revenue, (2) bad debts expense, and (3) loss on sale of note receivable. Interest revenue $200,000 note: $200,000 x 6% x 3/12 = $60,000 note: $ 60,000 x 8%(1) x 10/12 = Total interest revenue

$3,000 4,000 $7,000

(1)

The interest rate on the $60,000 note can be determined as follows: Interest receivable in 12/31/2013 balance sheet = $6,800 Less: Interest on $200,000 note: $200,000 x 6% x 6/12 = (6,000) Interest on $60,000 note $ 800 $800 represents interest for two months (November and December of 2013) or $400 per month. Annual interest is $400 x 12 = $4,800. $4,800  $60,000 = 8% interest rate. Bad debt expense Analysis of accounts receivable Beginning accounts receivable ($218,000 + 24,000) Add: Credit sales Less: Cash collections Less: Write-offs Ending accounts receivable

$ 242,000 1,340,000 (1,280,000) (22,000) $ 280,000

Analysis of allowance for uncollectible accounts Beginning allowance Add: Bad debt expense Less: Write-offs Ending allowance(2)

$24,000 ? (22,000) $28,000

Therefore bad debt expense is $26,000 ($24,000 – 22,000 – 28,000) (2)

$280,000 x 10% = $28,000

© The McGraw-Hill Companies, Inc., 2013 7–64

Intermediate Accounting, 7/e

Problem 7–12 (concluded)

Loss on sale of note receivable Interest accrued on the $200,000 note for nine months (6/30/2013 to 3/31/2014): $200,000 x 6% x 9/12 = $9,000 Calculation of cash proceeds received from discounting note: $200,000 12,000 212,000 (4,240) $207,760

Face amount Interest to maturity ($200,000 x 6%) Maturity value Discount ($212,000 x 8% x 3/12) Cash proceeds

Carrying value of note Less: Cash proceeds Loss on sale of note receivable

$209,000 ($200,000 + 9,000 interest receivable) (207,760) $ 1,240

Requirement 2 Accounts receivable, net of $28,000 in allowance for uncollectible accounts

$252,000

Requirement 3 Accounts receivable turnover ratio: $1,340,000 ------------- = 5.7 times $235,000(3) ($218,000 + 252,000)  2 = $235,000

(3)

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Problem 7–13 Requirement 1 Computation of balance per books: Balance per bank statement Add: Deposits outstanding Deduct: Checks outstanding Error in recording rent check Add: Automatic mortgage payment Add: Bank service charges Deduct: Deposit credit to company’s account in error Add: NSF check charge Balance per books

Step 1:

(875.00) 85.00 $13,542.87

Bank Balance to Corrected Balance

Balance per bank statement Add: Deposits outstanding Deduct: Bank error—deposit incorrectly credited to company account Checks outstanding Corrected cash balance Step 2:

$14,632.12 575.00 (1,320.25) (18.00) 450.00 14.00

$14,632.12 575.00

(875.00) (1,320.25) $13,011.87

Book Balance to Corrected Balance

Balance per books Add: Error in recording rent check Deduct: Automatic mortgage note payment Service charges NSF checks Corrected cash balance

© The McGraw-Hill Companies, Inc., 2013 7–66

$13,542.87 18.00 (450.00) (14.00) (85.00) $13,011.87

Intermediate Accounting, 7/e

Problem 7–13 (concluded)

Requirement 2 To correct error in recording cash disbursement for rent: Cash ................................................................... Rent expense ..................................................

18 18

To record credits to cash revealed by the bank reconciliation: Interest expense ................................................. Mortgage note payable ...................................... Miscellaneous expense (bank service charges) . Accounts receivable (NSF checks).................... Cash ............................................................... Requirement 3 Checking account balance Petty cash U.S. treasury bills Total cash and cash equivalents

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350 100 14 85 549

$13,011.87 200.00 5,000.00 $18,211.87

© The McGraw-Hill Companies, Inc., 2013 7–67

Problem 7–14 Requirement 1 Step 1:

Bank Balance to Corrected Balance

Balance per bank statement Add: Deposits outstanding Deduct: Bank error—deposit incorrectly credited to company account Outstanding checks Corrected cash balance Step 2:

$3,851 2,150 (1)

(1,300) (831) (2) $3,870

Book Balance to Corrected Balance

Balance per books Deduct: Error in recording check #411 Service charges NSF checks Corrected book balance (1) Receipts Less: December receipts deposited: Bank deposits $43,000 Less: Deposit error (1,300) Less: Prior month’s deposits outstanding (1,200) Deposits outstanding, Dec. 31 (2) Dec. disbursements Error in recording check #411 Less: December checks cleared: Total checks cleared $41,918 Prior month's checks: #363 $123 #380 56 #381 86 #382 340 (605) December checks outstanding Add: check # 365 Total checks outstanding, Dec. 31

© The McGraw-Hill Companies, Inc., 2013 7–68

$4,422 (90) (22) (440) $3,870 $42,650

40,500 $ 2,150 $41,853 90

(41,313) 630 201 $ 831

Intermediate Accounting, 7/e

Problem 7–14 (concluded)

Requirement 2 To record credits to cash revealed by the bank reconciliation: Advertising expense .......................................... Miscellaneous expense (bank service charges) . Accounts receivable (NSF checks).................... Cash ...............................................................

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90 22 440 552

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Problem 7–15 Requirement 1 ($ in millions)

Land................................................................. .........................16 Loss on debt restructuring ............................... ...........................6 Note receivable ........................................... ............................. Accrued interest receivable ......................... .............................

20 2

Requirement 2 ANALYSIS

Previous Value: Accrued 2012 interest (10% x $20,000,000) Principal Carrying amount of the receivable New Value: Interest $1 million x 3.16987 * = Principal $15 million x 0.68301 ** = Present value of the receivable Loss:

$ 2,000,000 20,000,000 $22,000,000 $ 3,169,870 10,245,150 (13,415,020) $ 8,584,980

* Present value of an ordinary annuity of $1: n = 4, i = 10% (from Table 4) ** Present value of $1: n = 4, i = 10% (from Table 2) JOURNAL ENTRIES

January 1, 2013 Loss on troubled debt restructuring (to balance) .............. Accrued interest receivable (10% x $20,000,000) ........ Note receivable ($20,000,000 – 13,415,020).............. December 31, 2013 Cash (required by new agreement)……………………… Note receivable (to balance)…………………………….. Interest revenue (10% x $13,415,020) ........ .................

8,584,980 2,000,000 6,584,980 1,000,000 341,502 1,341,502

December 31, 2014 Cash (required by new agreement)……………………… 1,000,000 Note receivable (to balance)……………………………… 375,652 Interest revenue (10% x $13,756,522) ........ ................. 1,375,652 © The McGraw-Hill Companies, Inc., 2013 7–70

Intermediate Accounting, 7/e

Problem 7–15 (continued) December 31, 2015 Cash (required by new agreement) .................. .1,000,000 Note receivable (to balance) ............................ ....413,217 Interest revenue (10% x $14,132,174) ........ .................

1,413,217

December 31, 2016 Cash (required by new agreement) .................. .1,000,000 Note receivable (to balance) ............................ ....454,609 Interest revenue (10% x $14,545,391) ........ .................

1,454,609*

Cash (required by new agreement) ..................15,000,000 Note receivable (balance) ............................ ................. 15,000,000 * rounded to amortize the note to $15,000,000 (per schedule below)

Amortization Schedule – Not required Cash Interest by agreement

1 2 3 4

1,000,000 1,000,000 1,000,000 1,000,000 4,000,000

Effective Interest 10% x Outstanding Balance .10(13,415,020) = 1,341,502 .10(13,756,522) = 1,375,652 .10(14,132,174) = 1,413,217 .10(14,545,391) = 1,454,609*

5,584,980

Increase in Balance Discount Reduction

341,502 375,652 413,217 454,609 1,584,980

Outstanding Balance

13,415,020 13,756,522 14,132,174 14,545,391 15,000,000

* rounded

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Problem 7–15 (continued) Requirement 3 ANALYSIS

Previous Value: Accrued interest (10% x $20,000,000) Principal Carrying amount of the receivable New Value: $27,775,000 x 0.68301 * = Loss:

$ 2,000,000 20,000,000 $22,000,000 (18,970,603) $ 3,029,397

* Present value of $1: n = 4, i = 10% (from Table 2) JOURNAL ENTRIES

January 1, 2013 .... Loss on troubled debt restructuring (to balance) .............. Accrued interest receivable (10% x $20,000,000) ........ Note receivable ($20,000,000 – 18,970,603)................

3,029,397 2,000,000 1,029,397

December 31, 2013 .... Note receivable (to balance)…………………………… . Interest revenue (10% x $18,970,603) ........ .................

1,897,060

December 31, 2014 .... Note receivable (to balance)…………………………….. Interest revenue (10% x [$18,970,603 + 1,897,060]) ...

2,086,766

December 31, 2015 .... Note receivable (to balance)……………………………. Interest revenue (10% x balance [see schedule]) ..........

2,295,443

December 31, 2016 .... Note receivable (to balance)…………………………….. Interest revenue (10% x balance [see schedule]) ..........

2,525,128

1,897,060

2,086,766

2,295,443

2,525,128*

Cash (required by new agreement)………………………. 27,775,000 Note receivable (balance)............................ ................. 27,775,000 * rounded to amortize the note to $27,775,000 (per schedule below)

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Intermediate Accounting, 7/e

Problem 7–15 (concluded) Amortization Schedule – Not required Cash Interest by agreement

1 2 3 4

0 0 0 0

Effective Increase in Interest Balance 10% x Outstanding Balance Discount Reduction .10 (18,970,603) .10 (20,867,663) .10 (22,954,429) .10 (25,249,872)

= 1,897,060 = 2,086,766 = 2,295,443 = 2,525,128* 8,804,397

1,897,060 2,086,766 2,295,443 2,525,128 8,804,397

Outstanding Balance

18,970,603 20,867,663 22,954,429 25,249,872 27,775,000

* rounded

Solutions Manual, Vol.1, Chapter 7

© The McGraw-Hill Companies, Inc., 2013 7–73

CASES Judgment Case 7–1 Requirement 1 To account for the accounts receivable factored on April 1, 2013, Magrath should decrease accounts receivable by the amount of accounts receivable factored, increase cash by the amount received from the factor, and record a loss equal to the difference. The loss should be reported in the income statement. Factoring of accounts receivable without recourse is equivalent to a sale. Requirement 2 Magrath should account for the collection of the accounts previously written off as uncollectible as follows: • Increase both accounts receivable and the allowance for uncollectible accounts. • Increase cash and decrease accounts receivable. Requirement 3 One approach estimates uncollectible accounts based on credit sales. This approach focuses on income determination by attempting to match uncollectible accounts expense with the revenues generated. The other approach estimates uncollectible accounts based on the balance in receivables or on an aging of receivables. The approach focuses on asset valuation by attempting to report receivables at net realizable value.

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Intermediate Accounting, 7/e

Communication Case 7–2 Suggested Grading Concepts and Grading Scheme: Content (70%) ______ 40 Explains the difference between the allowance method and the direct write-off method. ____ Direct write-off is more objective. ____ Direct write-off has potential to violate the matching principle. ______ 15 Even if uncollectibles are fairly stable, when significant variations do occur, profit will be overstated in one period and understated in another period. ______ 15 Even if uncollectibles remain constant, the direct write-off method will result in an overstatement of accounts receivable in the balance sheet. ____ ______ 70 points Writing (30%) ______ 6 Terminology and tone appropriate to the audience of a company president. ______ 12 Organization permits ease of understanding. ____ Introduction that states purpose. ____ Paragraphs that separate main points. ______ 12 English ____ Sentences grammatically clear and well organized, concise. ____ Word selection. ____ Spelling. ____ Grammar and punctuation. ____ ______ 30 points

Solutions Manual, Vol.1, Chapter 7

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Judgment Case 7–3 Requirement 1 a. Hogan should account for the sales discounts at the date of sale using the net method by recording accounts receivable and sales revenue at the amount of sales less the sales discounts available. Revenues should be recorded at the cash equivalent price at the date of sale. Under the net method, the sale is recorded at an amount that represents the cash equivalent price at the date of exchange (sale). b. There is no effect on Hogan’s sales revenues when customers do not take the sales discounts. Hogan’s net income is increased by the amount of interest earned when customers do not take the sales discounts. Requirement 2 Trade discounts are neither recorded in the accounts nor reported in the financial statements. Therefore, the amount recorded as sales revenues and accounts receivable is net of trade discounts and represents the cash equivalent price of the asset sold. Requirement 3 To account for the accounts receivable factored on August 1, 2013, Hogan should decrease accounts receivable by the amount of the accounts receivable factored, increase cash by the amount received from the factor, and record a loss. Factoring of accounts receivable without recourse is equivalent to a sale. The difference between the cash received and the carrying amount of the receivables is a loss. Requirement 4 Hogan should report the face amount of the interest-bearing notes receivable and the related interest receivable for the period from October 1 through December 31 on its balance sheet as current assets. Both assets are due on September 30, 2014, which is less than one year from the date of the balance sheet. Hogan should report interest revenue from the notes receivable on its income statement for the year ended December 31, 2013. Interest revenue is equal to the amount accrued on the notes receivable at the appropriate interest rate. Interest revenue is realized with the passage of time. Accordingly, interest revenue should be accounted for as an element of income over the life of the notes receivable.

© The McGraw-Hill Companies, Inc., 2013 7–76

Intermediate Accounting, 7/e

Real World Case 7–4 Requirement 2 a. Sales returns reserve is a contra-asset account, serving to reduce the carrying value of accounts receivable for the estimated amount of sales returns. Green Mountain is using the term “reserve” rather than “allowance,” but the account serves the same purpose. b. Sales Returns Reserve ________________________________________ 3,809 Beg. Bal. 31 Acquisition 40,139 charged to cost and expense Deductions 31,237 _________________ 12,742 End. Bal. c. Sales returns (a contra-revenue account)......... ................. 40,139 Sales returns reserve .................................... ............................ 40,139 This journal entry reduces revenue for $40,139 of estimated sales returns and increases the reserve by that amount. Note: They refer to this as “amount charged to cost and expense,” but it actually is an amount charged to a contra-revenue account which has the same effect on income as an expense. Sales returns reserve ........................................ ................. 31,237 Accounts receivable..................................... ............................ 31,237 This journal entry recognizes that returns of $31,237 occurred during the period, reducing both the sales returns reserve and accounts receivable.

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Real World Case 7–4 (continued)

d. In the operations section of the statement of cash flows, $40,139 is added back to net income because it is an amount that reduces net income (by being subtracted from revenue) but does not in itself use any cash. The $31,237 reduction in accounts receivable is included in the overall change in receivables of ($102,297). Requirement 3 a. Sales Returns Reserve ________________________________________ 12,742 Beg. bal. 27,521 charged to cost and expense (from Antar) Deductions assumed to be 0 _________________ 40,263 End. bal. b. Sales Returns Reserve ________________________________________ 40,263 Beg. bal. Recovery (from Antar) 22,259 Deductions assumed to be 0 _________________ 18,004 End. bal. c. Sales returns reserve........................................ ..................22,259 Recovery of sales returns (increasing revenue) ........................ 22,259 This journal entry increases revenue by $22,259, the amount by which the sales returns reserve is being reduced.

© The McGraw-Hill Companies, Inc., 2013 7–78

Intermediate Accounting, 7/e

Real World Case 7–4 (concluded)

d. It could be that Green Mountain unintentionally overestimated returns in Q1 by a very large amount, and then experienced lower than expected returns and so had to reduce their allowance to correct their estimate. On the other hand, Green Mountain could have intentionally overestimated returns in Q1 as a way to shift income from Q1 to Q2, since income would be reduced by the estimated returns in Q1 and increased by the recovery in Q2.

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© The McGraw-Hill Companies, Inc., 2013 7–79

Ethics Case 7–5 Requirement 1 Required allowance Revised allowance Increase in income before taxes of proposed change

$180,000 135,000 $ 45,000

Requirement 2 Discussion should include these elements. Ethical Dilemma: You, as the assistant controller, have a responsibility to follow GAAP and make a reasonably accurate estimate of the net realizable value of receivables. Is your responsibility to fairly present Stanton Industries’ financial statements to external users greater than your obligation to improve the financial position of your employer? Alternative actions and consequences include: 1. Refuse to comply with the controller’s request to change the aging category of the large account. Positive consequences: a. Preservation of your honesty and integrity. b. Fair presentation of the net realizable value of receivables. Negative consequences: a. Possible loss of your job. b. Lower net income for Stanton Industries. c. A devalued stock price for Stanton Industries. 2. Comply with the controller's suggestion to report the allowance for uncollectible accounts at $135,000. Positive consequences: a. Retention of your job. b. A more favorable net income for Stanton Industries. c. A more favorable position with unknowing creditors, financial analysts, current investors, and future investors. Negative consequences: a. Endure guilt feelings. b. A lack of trust in you by other managers and employees. c. Possible litigation from investors and creditors. © The McGraw-Hill Companies, Inc., 2013 7–80

Intermediate Accounting, 7/e

Case 7–5 (concluded)

3. Report the controller’s suggestion to a higher level of management, the audit committee, or the auditors. If one of these parties corrects the controller and compels fair reporting of the allowance account, the consequences would be the same as in alternative 1 when you refuse to make the adjustment. Your job may still be in jeopardy due to the fact that management may consider whistle blowing as indicative of employee disloyalty. If the reportee parties agree with the controller and report the incorrect amount of $135,000, the consequences will be similar to those for the second alternative in 2, except that you run an even greater risk of losing your job. 4. Refuse to comply with the controller’s request and resign as assistant controller. If you report the controller’s suggestion to higher management, the audit committee, or the auditor, the positive and negative considerations are the same as for alternative 3. If you do not report the controller’s request, then the consequences are the same as for alternative 2. In either case, your job is not an issue since you have already resigned.

Solutions Manual, Vol.1, Chapter 7

© The McGraw-Hill Companies, Inc., 2013 7–81

Judgment Case 7–6 1. A weakness is created by the fact that John need only submit a list of accounts and amounts to be charged to replenish the petty cash fund. The supporting documentation for the petty cash disbursements also should be submitted with John’s list and reviewed by someone else. Surprise counts of the fund also should be made to ensure that the fund is being maintained on an imprest basis, that is, to ensure that cash and/or receipts equal $200 at all times. 2. The internal control system for disbursements does not contain sufficient separation of duties. Dean Leiser approves the vouchers, signs the checks, maintains the disbursement records, and reconciles the bank account. There should be at least one other person involved in these activities to ensure accuracy and to safeguard cash from expropriation. 3. The internal control system for receipts does not contain sufficient separation of duties. Fran Jones has physical control of the deposits and also maintains the subsidiary ledger for accounts receivable. These duties should be separated. In addition, the company should require that customers pay their bills via check and that cash not be used.

© The McGraw-Hill Companies, Inc., 2013 7–82

Intermediate Accounting, 7/e

Real World Case 7–7 Requirement 3 Avon Products, Inc., information from 2010 2010 Net sales: $10,731.3 2010 net accounts receivable: $826.3 (allowance $232) 2009 net accounts receivable: $765.7 (allowance $165.1) Provision for doubtful accounts (bad debt expense) from cash flow statement: $215.7 Answers will, of course, vary depending on the year. The following were reported in the financial statements for the year ended December 31, 2010 ($ in millions): a. Net trade accounts receivable + Allowance for doubtful accounts = Gross accounts receivable $826.3 + 232 = $ 1,058.3 b. The statement of cash flows indicates bad debt expense (provision for doubtful accounts) of $215.7 c. Beginning allowance for doubtful accounts + Bad debt expense – Bad debt write-offs = Ending allowance for doubtful accounts $165.1 + 215.7 – Write-offs = $232.0 Write-offs = $148.8 d. Beginning trade accounts receivable + Credit sales – Bad debt write-offs – Cash collected = Ending trade accounts receivable Beginning trade accounts receivable = $765.7+ 165.1= $930.8 $930.8 + 10,731.3 – 148.8 – Cash collections = $1,058.3 Cash collections = $10,455

Solutions Manual, Vol.1, Chapter 7

© The McGraw-Hill Companies, Inc., 2013 7–83

Integrating Case 7–8 McLaughlin's underestimation of bad debts is treated as a change in accounting estimate. Changes in estimates are accounted for prospectively. When a company revises a previous estimate, prior financial statements are not restated. Instead, the company merely incorporates the new estimate in any related accounting determinations from then on. In this case, bad debt expense for 2014 will be higher than it would have been had not the underestimation occurred. A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per share amounts for 2014.

© The McGraw-Hill Companies, Inc., 2013 7–84

Intermediate Accounting, 7/e

Analysis Case 7–9 Requirement 1 These methods can be described by one of two basic arrangements: 1. A secured borrowing, or 2. A sale of receivables. When a company chooses between a borrowing and a sale, the critical element is the extent to which it (the transferor) is willing to surrender control over the assets transferred. Specifically, the transferor is determined to have surrendered control over the receivables if and only if three sale conditions are met. Secured borrowings usually take the form of an assignment of receivables. An assignment of receivables is a promise by the borrower (the owner of the receivables) that any failure to repay debt owed to the lender in accordance with the debt agreement will cause the proceeds from collecting the receivables to go directly toward repayment of the debt. This arrangement is no different from the use of a building as collateral for a mortgage loan. The assignor (borrower) assigns the assignee (lender) the rights to specific receivables as collateral for a loan. A variation of assigning specific receivables is when trade receivables in general rather than specific receivables are pledged as collateral. The responsibility of collection of the receivables remains solely with the company. This variation is referred to as a pledging of accounts receivable. Two popular arrangements used for the sale of receivables are factoring and securitization. A factor is a financial institution that buys receivables for cash, handles the billing and collection of the receivables, and charges a fee for this service. Actually, credit cards like VISA and Mastercard are forms of factoring arrangements. The seller relinquishes all rights to the future cash receipts in exchange for cash from the buyer (the factor). Another popular arrangement used to sell receivables is a securitization. In a typical accounts receivable securitization, the company creates a Special Purpose Entity (SPE), usually a trust or a subsidiary. The SPE buys a pool of trade receivables, credit card receivables, or loans from the company, and then sells related securities, for example bonds or commercial paper, that are backed (collateralized) by the receivables. Similar to accounts receivable, a note receivable can be used to obtain immediate cash from a financial institution either by pledging the note as collateral for a loan or by selling the note. The transfer of a note is referred to as discounting.

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Case 7–9 (concluded)

Requirement 2 In an assignment of specific receivables, usually the amount borrowed is less than the amount of receivables assigned. The difference provides some protection for the lender to allow for possible uncollectible accounts. Also, the assignee (transferee) usually charges the assignor an up-front finance charge in addition to stated interest on the collateralized loan. The borrower, assignor, records the loan liability, the finance fee expense, and the cash borrowed. No special accounting treatment is needed for an assignment of receivables in general, and the arrangement is simply described in a disclosure note. The specific accounting treatment for the sale of receivables using factoring and securitization arrangements depends on the amount of risk the factor assumes, in particular whether it buys the receivables without recourse or with recourse. When a company sells accounts receivable without recourse, the buyer assumes the risk of uncollectibility. This means the buyer has no recourse to the seller if customers don’t pay the receivables. In that case, the seller simply accounts for the transaction as a sale of an asset. The buyer charges a fee for providing this service, usually a percentage of the book value of receivables. Because the fee reduces the proceeds the seller receives from selling the asset, the seller records a loss on sale of assets. The typical factoring arrangement is made without recourse. When a company sells accounts receivable with recourse, the seller retains the risk of uncollectibility. In effect, the seller guarantees that the buyer will be paid even if some receivables prove to be uncollectible. Even if receivables are sold with recourse, as long as the three conditions for sale treatment are met, the transferor would still account for the transfer as a sale. The only difference would be the additional requirement that the transferor record the estimated fair value of the recourse obligation as a liability. The recourse obligation is the estimated amount that the transferor will have to pay the transferee as a reimbursement for uncollectible receivables.

© The McGraw-Hill Companies, Inc., 2013 7–86

Intermediate Accounting, 7/e

Real World Case 7–10 Requirement 1 Sanofi-Aventis uses the terms “provision for impairment” and “impairment” for “allowance for bad debts.” The (€126) is the allowance necessary to adjust gross accounts receivable for estimated bad debts. Requirement 2 Sanofi-Aventis does not factor or securitize its receivables. We know this because note D.10 states, “Group policy is to retain receivables until maturity, and hence not to use receivables securitization programs.” Requirement 3 a. Accounts receivable would be reduced in the period of change, as SanofiAventis would collect outstanding receivables and immediately securitize new receivables. b. Cash flow from operations would be increased in the period of change, as Sanofi-Aventis would show cash inflows both from collecting outstanding receivables and from immediately securitizing new receivables. c. Accounts receivable would be stable at a relatively low level, as SanofiAventis would immediately securitize new receivables. d. Cash flow from operations would return to approximately its former level, as Sanofi-Aventis would show cash inflows only from immediately securitizing new receivables. Requirement 4 The answers to requirement 3 highlight that decisions to increase or decrease the extent of securitization create one-time changes in receivables and cash flows in the period in which the company transitions to the new level. For example, increasing securitization will boost cash flow in the period of change. However, the increased cash flow is only temporary—in future periods cash flow will revert to former levels unless the company increases the extent of securitization yet further.

Solutions Manual, Vol.1, Chapter 7

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Research Case 7–11 Requirement 1 When a company sells accounts receivable without recourse, the buyer assumes the risk of uncollectibility. This means the buyer cannot pursue collection from the seller (has no recourse) if customers don’t pay the receivables. Requirement 2 FASB ASC 860–10–40–5: “Transfers and Servicing—Overall—Derecognition— Criteria for a Sale of Financial Assets.” The transferor is determined to have surrendered control over the receivables if and only if all of the following conditions are met: a. The transferred assets have been isolated from the transferor—put presumptively beyond the reach of the transferor and its creditors—even in bankruptcy or other receivership. b. Each transferee has the right to pledge or exchange the assets it received. c. The transferor does not maintain effective control over the transferred assets through either (1) an agreement that the transferor repurchase or redeem them before their maturity or (2) the ability to cause the transferee to return specific assets. (These criteria were included in Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" subsequently modified by SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140.” (The above conditions can be found in paragraph 9 of the standard.)

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Intermediate Accounting, 7/e

Case 7–11 (concluded)

Requirement 3

Cash (90% x $400,000) ...................................................... 360,000 Loss on sale of receivables (to balance)............................ 31,000 Receivable from factor ($25,000 fair value – [4% x $400,000]) 9,000 Accounts receivable (balance sold) ............................... 400,000 Requirement 4

FASB ACS 860–10–40–24: “Transfers and Servicing—Overall—Derecognition – Effective Control Through Both a Right and an Obligation (previously paragraph 47 of SFAS No. 140) lists the following conditions: a. The assets to be repurchased or redeemed are the same or substantially the same as those transferred. b. The transferor is able to repurchase or redeem them on substantially the agreed terms, even in the event of default by the transferee. c. The agreement is to repurchase or redeem them before maturity, at a fixed or determinable price. d. The agreement is entered into concurrently with the transfer.

Solutions Manual, Vol.1, Chapter 7

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Analysis Case 7–12 Requirement 1 Del Monte Receivables turnover

=

Average collection period

=

3,627 205.95

= 17.61 times

365 = 20.73 days 17.61

Smithfield 12,202.7 = 18.33 times 665.55 365 18.33

= 19.91 days

The receivable turnover ratios are in a close range with one another. This is not surprising since the companies operate in the same industry, selling similar products with similar terms and customers. Requirement 2 The objective of this requirement is to motivate students to obtain hands-on familiarity with actual annual reports and to apply the techniques learned in the chapter. You may wish to provide students with multiple copies of the same annual reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective.

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Intermediate Accounting, 7/e

Analysis Case 7–13 Requirement 1 Note 1 indicates “Cash and Cash Equivalents—All highly liquid investments, including credit card receivables due from banks, with original maturities of three months or less at date of purchase, are reported at fair value and are considered to be cash equivalents. All other investments not considered to be cash equivalents are separately categorized as investments.” Requirement 2 $13,913 (in millions)—from the balance sheet. Requirement 3 ($ in millions, from Note 12)

Net receivables Add: Allowance Gross receivables

Solutions Manual, Vol.1, Chapter 7

2011 $6,493 96 $6,589

2010 $5,837 115 $5,952

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Air France–KLM Case Requirement 1 AF indicates the following: 3.10.1 Valuation of trade receivables and noncurrent financial assets Trade receivables, loans and other noncurrent financial assets are considered to be assets issued by the Group and are recorded at fair value then, subsequently, using the amortized cost method less impairment losses, if any. The purchases and sales of financial assets are accounted for as of the transaction date. This approach is consistent with U.S. GAAP. The receivables are recorded initially at their fair value (their value when the sales transaction occurs). If they are discounted for the time value of money, the amount of any discount is amortized to interest revenue over the life of the receivable. And, an allowance for bad debts is set up to account for uncollectible accounts (per note 24, they call that allowance a “valuation allowance”), which they refer to as “impairment losses” in the footnote. Requirement 2 Valuation Allowance for Trade Accounts Receivable ________________________________________ 89 Beg. Bal. 14 bad debt expense write-offs 15 currency translation adj. 1 reclassification 4 _________________ 83 End. Bal. Requirement 3 AF has bank overdrafts of €129 as of March 31, 2011. Under IFRS, those overdrafts would be netted against AF’s total cash and cash equivalents of €3,717 if the overdrafts are payable on demand and are part of the AF’s normal cash management process. Instead, the overdrafts are shown as a current liability, consistent with U.S. GAAP and suggesting that the overdrafts don’t meet IFRS’s requirements for netting against the cash balance. © The McGraw-Hill Companies, Inc., 2013 7–92

Intermediate Accounting, 7/e