Chapter 10

CHAPTER 10

10-1. Q: Distinguish between tests of details of balances and tests of transactions for the sales and collection cycle. Explain how the tests of transactions affect the tests of details. A: Tests of details of financial balances are designed to determine the reasonableness of the balances in sales, accounts receivable, and other account balances which are affected by the sales and collection cycle. Such tests include confirmation of accounts receivable, and examining documents supporting the balance in these accounts.

Tests of transactions for the sales and collection cycle are intended to determine the effectiveness of internal control structure and to test the substance of the transactions which are produced by this cycle. Such tests would consist of examining sales invoices in support of entries in the sales journal, reconciling cash receipts, or reviewing the approval of credit.

The results of the tests of transactions will be used to affect the procedures, sample size, timing and particular items selected for the tests of details of financial balances (i.e., an effective internal control structure will result in reduced testing when compared to the tests of details required in the case of an inadequate internal control structure).

10-2. Q:

Distinguish between a positive and a negative confirmation and state the

circumstances in which each should be used. Why do CPA firms frequently use a combination of positive and negative confirmations on the same audit? A:

There are two common types of confirmations used for confirming accounts

receivable:

“positive” confirmations and “negative” confirmations.

A positive

confirmation is a communication addressed to the debtor requesting him to confirm directly whether the balance as stated on the confirmation request is correct or incorrect.

A negative confirmation is also a communication addressed to the debtor, but it requests a response only when the debtor disagrees with the stated amount.

A positive confirmation is more reliable evidence because the auditor can perform follow-up procedures if a response is not received from the debtor. With a negative confirmation, failure to reply must be regarded as a correct response even though the debtor may have ignored the confirmation request.

Offsetting the reliability disadvantage, negative confirmations are less expensive to send than positive confirmations, and thus more of them can be distributed for the same total cost. The determination of which type of confirmation to be sent is an auditor’s decision and it should be based on the facts in the audit. The following are the most important circumstances where positive confirmations should be used: 1.

There are a small number of large accounts which account for a significant portion of total accounts receivable.

2.

There are suspected conditions of dispute, inaccuracy, or irregularity. This would be the case when internal controls are considered inadequate or if prior year’s audit test results are unsatisfactory.

3.

The rules of certain regulatory agencies require them. This is the case for brokers and dealers in securities.

When the above conditions do not exist, it is acceptable to use negative confirmations, but negative confirmations should not be used if the auditor believes the customer is likely to ignore the confirmation. Typically, when negative confirmations are used, the auditor is using a reduced control risk assessment in the audit of accounts receivable. It is also common to use negative confirmations for audits of hospitals, retail stores, and other industries where the receivables are due from the general public. In these cases, far more assurance is obtained from tests of internal control than from confirmations.

It is also common to use a combination of negative and positive confirmations by sending the positives to accounts with large balances and negatives to those with small balances.

10-3. Q: Under what circumstances is it acceptable to confirm accounts receivable prior to the statement of financial position date? A: It is acceptable to confirm accounts receivable prior to the statement of financial position if the internal control structure is adequate and can provide reasonable assurance that sale, cash receipts and other credits are properly recorded between the date of the confirmation and the end of the accounting period. Other factors the auditor is likely to consider in making the decision are the materiality of accounts receivable and the auditor’s experience in prior years.

If the decision is made to confirm accounts

receivable prior to year end, it is necessary to test the transactions occurring between the confirmation date and the statement of financial position by examining internal documents and performing analytical procedures at year end.

10-4. Q: During the audit of South Technologies, Inc., the auditors sent confirmation request to customers whose accounts had been written off as uncollectible during the year under audit. An executive of South protested, saying: “You people should be verifying that the receivables on the books are collectible. We know the ones we wrote off are no good.” REQUIRED: a. What purpose, if any, is served by this audit procedure? b. Does the South executive’s statement suggest some misunderstanding of audit objectives? Explain.

A: (a) When confirmation requests are mailed to debtors whose accounts were written off as uncollectible, the auditors’ purpose is to determine that the receivables were genuine when they were first recorded in the accounts. In some fraud cases, fictitious

accounts receivable have been created to cover up a shortage. Eventually these fictitious receivables must be disposed of; one method is to write off the fictitious accounts as uncollectible.

(b) The South executive appears to believe the auditors are solely concerned with the collectability of accounts and notes receivable. In fact, the confirmation process is primarily intended to establish that the receivables are genuine and that the customers (or makers of notes) exist.

Other audit procedures are followed to determine

collectability. 10-5. Q: During preliminary conversations with a new staff assistant you instruct her to send out confirmation request for both accounts receivable and notes receivable. She asks whether the confirmation requests should go to the makers of the notes or to the holders of the notes in the case of notes that have been discounted. Provide an answer to her question and give reasons for you answer. A: The confirmation requests should go to the makers of the notes regardless of whether the notes have been discounted. The act of discounting a note receivable does not reduce the importance of the note being genuine and collectible. A company which discounts its notes receivable remains in a position of sustaining a loss if the makers of the notes fail to make payment at the maturity dates.

10-6. Q: What are the implications to the auditors if, during their examination of account receivable, some of a client’s customers do not respond to the auditors’ request for positive confirmation of their accounts receivable? What procedures should the auditors perform if there is no response to a second request for a positive confirmation? A: (a) When customers fail to respond to positive confirmation requests the CPAs may not assume with confidence that these customers reviewed the requests and found no disagreement and therefore did not reply. Some busy customers will not take the time

to review confirmation requests and will not respond; hence, obvious exceptions may exist without being reported to the CPAs.

(b) If there is no response to a second request, the CPAs may mail a third request and possibly make telephone calls in an effort to get a reply directly from the customer. When it becomes apparent that the confirmation program will not produce further evidence, the CPAs should consider each remaining customer as to the size, nature, and age of the balance and the apparent reason for the lack of a reply before they decide what additional work is necessary in the circumstances. The CPAs should carry out the alternative audit procedures of examining customers’ purchase orders or contracts, shipping documents and sales invoices of the client, and remittances by nonconfirming customers received by the client subsequent to the statement of financial position. The auditors may also verify the existence, location, and credit standings of the nonconfirming customers by reference to credit agencies or other sources independent of the client.

10-7. Q: Your regular annual audit of North, Inc., included the confirmation of accounts receivable. You decided to use the positive form of confirmation request. Satisfactory replies were received from all but one of the large accounts. You sent a second and third request to this customer, but received no reply. At this point an employee for the full amount of the receivable. Would you regard this as a satisfactory disposition of the matter? Explain. A: No, the matter remains unresolved. First, oral evidence from the client is never in itself sufficient; the auditors must follow up to determine the reliability of the oral evidence. Second, payment of an account receivable is not confirmation; the account might be fictitious, and the “payment” could have been made by a dishonest employee who had created the fictitious account to conceal a cash shortage. The auditors must examine the customer purchase order or contract, and copies of the sales invoice and shipping document, in support of the unconfirmed receivable.

They should also

determine the genuineness of the customer by reference to the telephone directory or to credit agency reports.

10-8. Q: AUDIT OF ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

Annette dela Cruz of Cruz and Cabrera, CPAs, has been assigned to the Monty’s Meat, Inc., audit for the fiscal year ended October 31. She currently is completing the audit of accounts receivable by reviewing returned accounts receivable confirmations and evaluating the adequacy of the allowance for doubtful accounts. Monty’s Meat buys beef, pork, and poultry from local slaughterhouses, processes it, and sells it to area grocery retailers and restaurants. As of October 31, the company had 450 customer accounts with a combined balance of ₱ 350, 000. Annette stratified the population of accounts so that all balances equal to or greater than ₱ 2, 000 were selected for confirmation. From the remaining 420 accounts, she drew a random sample of 50 accounts. Annette then mailed positive confirmation requests to the 80 customers. Working paper 1 summarizes the confirmation replies.

REQUIRED: a. Comment on the adequacy of Annette’s work paper as presented in Working Paper 1. b. Assuming all amounts are considered material, draft any audit adjustments that you consider necessary. Include journal explanations. (Assume that Monty’s Meat maintains perpetual inventory records.) c. Working papers 2 and 3 reproduce the audit work papers for the “accounts receivable aging analysis” and “allowance for uncollectible accounts” respectively: 1. Using two separate sheets of paper reproduce on the first work paper the last line of working paper 2, which represents the aged totals of Monty’s Meat’s accounts receivable. On the second work paper, reproduce the last line of working paper 3, the October 31 general ledger balance in allowance for

doubtful accounts. Add an audit legend describing how Annette obtained the ₱ 365, 000 balance in accounts receivable. 2. Post your adjustments from question (b) to the two work papers. 3. Record subsequent collections on the aging analysis, assuming the following cash receipts for the period 11/1/2015 through 11/27/2015: Current

₱ 210, 113

1-30 days past due TOTAL

13, 353 ₱ 223, 466

4. Add an audit legend describing the procedures you would apply to the subsequent collections. 5. Calculate estimated uncollectible accounts receivable on the aging analysis, assuming that the following percentages adjusted for current observable data on collectability of records are used by Monty’s Meat, and have been agreed to by the auditors: Current

10%

Past due: 1-30 days

25%

31-60 days

70%

Over 60 days

100%

6. Evaluate the adequacy of the allowance for doubtful accounts and record any necessary audit adjustment on the allowance for doubtful accounts work paper. 7. Add an audit legend presenting your conclusion regarding the adequacy of the allowance for doubtful accounts.

A: a. The work paper does not include a description of the auditing procedures performed in confirming the accounts. The work paper is also incomplete in the following respects:

1)

The work paper does not state whether the auditor traced the ABC Grocery remittance of P3, 000 to November cash receipts.

2)

The work paper does not state whether the auditor examined the November 2 credit memo issued to Sari-Sari Store.

3)

The work paper does not state whether the auditor traced the Lucena’s Meat Market remittance to November cash receipts.

4)

The work paper does not state whether and how the auditor obtained satisfaction regarding confirmation requests not returned.

5)

The work paper does not state whether the auditor examined documentation for the Diana’s Supper Club order returned and received on October 31.

6)

Rather than summarizing the confirmations returned without exception, as was done at the bottom of Working Paper 1, these confirmations should have been listed separately.

b. 1) Sales

P11, 100

Accounts receivable

Inventory

P11, 100

8,600

Cost of goods sold

8,600

To reverse 2016 sale recorded in 2015.

2) Allowance for uncollectible accounts Accounts receivable To write off uncollectible account.

1,277 1,277

3) Sales returns and allowances

3,634

Accounts receivable

3,634

To record return of spoiled meat and recognize loss in period in which incurred. Meat not restored to inventory, inasmuch as it was spoiled.

4) Sales

13,000

Accounts receivable

13,000

To correct error in recording customer remittance as a sale.

5) Sales Returns

334

Accounts receivable

Inventory

334

250

Cost of goods sold

250

To record return and restore meat to inventory because meat returned in good condition. c. (See completed Exhibits 1.1 and 1.2 reproduced below and on the following page.) Exhibit 1.1

Monty’s Meat, Inc. Accounts Receivable - Trade Aging Analysis October 31, 2015

Conf.

Past Due (Days)

No.

Customer

Balance

Current

1060

Culley’s Meats

P 1,330

P

1061

Jolly Roger Restaurant

466

1064

ABC Grocery

4,256

3,000

1,256

(Other)

329,433

280,763

33,467

1602

Rudy’s Deli

378

1603

General Foods Grocers

13,468

13,000

1607

Kim’s Fresh Meats

2,334

1,074

1608

Dill’s Discount Grocery

12,469

12,469

1612

Diana’s Supper Club

866

334

10/31

Balance per ledger

P365,000

P 311,970 P 36,449 P13,234

Audit Adjustments

P

P

P(1,277

(29,345)

(28,068)

)

P335,655

P 283,902 P 36,449 P13,234

10/31

Audited balance

1-30

31-60

Over 60

1,330 P

466

P12,324

P 2,879

378 468 1,260

532 P 3,347

P 2,070

# Cash

receipts

11/1

–

P(210,113) P (13,353) P

0 P

0&

11/27

11/27

Outstanding

Estimated

percent

P 73,789 P 23,096 P13,234

P 2,070

10%

100%

25%

70%

uncollectible

10/31

Estimated uncollectible

P 24,487

P

7,379 P 5,774 P 9,264

&

Traced subsequent collections to November remittance advices.

#

Obtained balances from subsidiary ledger after agreeing to general ledger control account.

Prepared by: Initial Date

Reviewed by: Initial

Date

Exhibit 1.2

Monty’s Meat, Inc. Accounts Receivable - Trade Allowance for Doubtful Accounts October 31, 2015

11/1/15

Balance per general ledger

P28,000 #

P 2,070

11/1 - 10/31

Monthly provision

11/1 - 10/31

Write-offs

10/31/16

Balance per general ledger

AJE 2

24,000 & (37,000) @ P15,000

(1,277) P13,723

10/31/16

AJE 6

P10,777

Audited balance

P24,500 ^

AJE 6

Bad debts expense

P10,777

Allowance for doubtful accounts

P10,777

To adjust allowance for doubtful accounts to amount considered reasonable in the circumstances.

# Traced to last year’s WTB - audited balance &

Traced to standard journal entries

@

Examined documentation and discussed with credit manager and legal

counsel ^ In light of aging analysis, the above balance, as adjusted, appears to be adequate.

Prepared by:

Reviewed by:

Initial

Date

Initial

Date

10-9. Q: ACCOUNTS RECEIVABLE CONFIRMATION FOLLOW-UP You have been assigned to the first examination of the accounts of the Makati Company for the year ending March 31, 2015. Accounts receivable were confirmed on December 31, 2014, and at that date the receivables consisted of approximately two hundred accounts with balances totalling ₱ 956, 750. Seventy-five of these accounts with balances totalling ₱ 650, 725 were selected for confirmation. All but 20 of the confirmation requests have been returned; thirty were signed without comments, 14 had minor differences which have been cleared satisfactorily, while 11 confirmations had the following comments: 1. We are sorry but we cannot answer your request for confirmation of our account as 2. 3. 4. 5.

the PDQ Company uses an accounts payable voucher system. The balance of ₱ 1, 050 was paid on December 23, 2015. The balance of ₱ 7, 750 was paid on January 5, 2015. The balance noted above has been paid. We do not owe you anything at December 31, 2014, as the goods, represented by your invoice date December 30, 2014, number 25050, in the amount of ₱ 11, 550 were

received on January 5, 2015, on FOB destination terms. 6. An advance payment of ₱ 2, 500 made by us in November 2014 should cover the two invoices totalling ₱ 1, 350 shown on the statement attached. 7. We never received these goods. 8. We are contesting the property of this ₱ 12, 525 charges. We think the charge is excessive. 9. Amount okay. As the goods have been shipped to us on consignment, we will remit payment upon selling the goods. 10. The ₱ 10, 000 representing a deposit under a lease, will be applied against the rent due to us during 2016, the last year of the lease.

11. Your credit memo dated December 5, 2014 in the amount of ₱ 440 cancels the balance above. REQUIRED: What steps would you take to clear satisfactorily each of the above 11 comments? A: For all of the exceptions, the auditor is concerned about four principal things. (a) Whether there is a client error. Many times the confirmation response differences are due to timing differences for deposits in the mail and inventory in transit to the customer. Sometimes customers misunderstand the confirmation or the information requested. The auditor must distinguish between those and client errors. (b) The amount of the client error if any. (c) The cause of the error. It would be intentional, a misunderstanding of the proper way to record a transaction, or a breakdown of internal control. (d) Potential errors in the sample not tested. The auditor must estimate the error in the untested population, based on the results of the tests of the sample.

Suggested steps to clear each of the comments satisfactorily are: 1. (a) Examine supporting documents, including the sales invoices and applicable sales and shipping orders, for propriety and valuation of the sales. (b)Review the cash receipts books for the period after December 31, 2014, and note any collections from the PDQ Company. The degree of internal control over cash receipts should be an important consideration in determining the reliance that can be placed on the cash receipts entries. In addition, as there is no assurance that collections after December 31 represent the payment of invoices supporting the December 31 trial balance, consideration should be given to requesting a confirmation from the PDQ Company of the invoices paid by their checks.

2. (a) The cause should be investigated thoroughly. If the credit was posted to the wrong account, it may indicate merely a clerical error. On the other hand, posting to the wrong account may indicate lapping. (b) Such a comment may also indicate a delay in posting and depositing of receipts. If upon investigation such is the case, the company should be informed immediately so that it can take corrective steps. 3. This is a confirmation of the balance with an additional comment. Since the customer has given us the data, it is preferable to check to see that the information agrees with the company’s records.

Such a procedure may disclose misposting or delay in

recording receipts. 4. This incomplete comment should raise an immediate question: does the customer mean paid before or paid after December 31? Because the customer’s intent is unknown, this account should be reconfirmed and the customer asked to state the exact date. Upon receipt of the second confirmation, the information thereon should be traced to the cash receipts book. 5. The auditor should first evaluate how long it takes to ship goods to the customer in question. If it ordinarily takes more than five days, there is no indication of error. A comment of this type may indicate that the company may be recording sales before an actual sale has taken place. The auditor should examine the invoice and review with the appropriate officials the company’s policies. Sales, cost of sales, inventories and accounts receivable may have to be adjusted if title has not passed to the buyer as of December 31, 2014. 6.

(a) Determine if such advance payment has been received and that it has been properly recorded. A review should be made of other advance payments to ascertain that charges against such advances have been properly handled. (b)If the advance payment was to cover these invoices, the auditor should propose a reclassification of the P1,350, debiting the advance payment account and crediting accounts receivable--trade.

7.

(a) Examine the shipping order for indications that the goods were shipped and, if available, carrier’s invoice and/or bill of lading for receipt of the goods. (b)If it appears that goods were shipped, send all available information to the customer and ask the customer to reconfirm. If the customer still insists that goods were never received, all data should be presented to an appropriate company official for a complete explanation. This may indicate that accounting for shipments is inadequate and consideration should be given to reviewing the procedures to determine if improvements can be made. (c)

If the goods were not shipped, the auditor should recommend an adjustment reducing sales, cost of sales, and accounts receivable, and increasing inventories.

8. This should be discussed with the appropriate officials and correspondence with the customer should be reviewed to allow determination whether an adjustment should be made in the amount receivable or if an allowance for doubtful accounts should be set up. 9. As title on any goods shipped on consignment does not pass until those goods are sold, the sales entry should be reversed, inventory charged, and cost of sales credited if it is actually a consignment sale. Other so-called sales should be reviewed and company officials queried to determine if other sales actual represent consignment shipments; if so, the adjustment set forth in the preceding sentence should be made for all consignment shipments. 10. This is a noncurrent asset and should be reclassified to either deposit or prepaid rent. A review of other accounts, especially those with round numbers, may disclose other accounts that should be so reclassified. 11. This may indicate a misposting of the credit or a delay in posting the credit. Comments under 2 above would also apply to credits.

10-10. Q: PREPARATION OF ACCOUNTS RECEIVABLE AGING SCHEDULE AND ANALYSIS OF ALLOWANCE OF DOUBTFUL ACCOUNTS

Ken Company sells office equipment and supplies on many organizations in the city and surrounding area on contract terms of 2/10, n/30. In the past, over 75% of the credit customers have taken advantage of the discount by paying within 10 days of invoice date. The number of customers taking the full 30 days to pay has increased within the last year. Current indications are that less than 60% of the customers are now taking the discount. Past due accounts have been observed to be on the rise. The controller has responded to a request for more information on the deterioration in collections of accounts receivable with the report reproduced below. Ken Company Finance Committee Report Accounts Receivable Collections May 31, 2015 The fact that some credit accounts will prove uncollectible is normal. Annual bad debt write-offs have been increasing over the past 5 years. The current Accounts Receivable balance is ₱ 1.2 million. The condition of this balance in terms of age and probability of collection is as follows: PROPORTION OF TOTAL

AGE CATEGORIES

PROBABILITY OF

COLLECTION 68%

not yet due

99%

15%

less than 30 days past due

96 ½ %

8%

30 to 60 days past due

95%

5%

61 to 120 days past due

91%

2 ½%

121 to 180 days

60%

1½%

over 180 days past due

10%

The allowance for doubtful accounts had a credit balance of ₱ 30, 250 on June 1, 2014. Ken has provided for a monthly bad debts expense accrual during the current fiscal year based on the assumption that four percent of gross credit sales will be uncollectible. Total gross credit sales

for the 2014-2015 fiscal year amounted to ₱3 million. Write-offs of bad accounts during the year totalled ₱ 108, 750. REQUIRED: a. Prepare an accounts receivable aging schedule for the Ken Company using the age categories identified in the controller’s report to the Finance Committee showing: 1. The amount of accounts receivable outstanding for each age category and in total. 2. The estimated amount that is uncollectible for each category and in total. b. Compute the amount of the year-end adjustment necessary to bring Allowance for Doubtful Accounts to the balance indicated by the age analysis. Then prepare the necessary journal entry to adjust the accounting records. c. First assume a recessionary environment with tight credit and high interest rates. Then 1. Identify steps Ken Company might consider to improve the accounts receivable situation. 2. Evaluate each step identified in terms of the risks and costs involved. A: Requirement (a) Ken Company Accounts Receivable Aging Schedule May 31, 2015

Age Category

Proportion

Amount

of

in

Total

Category

Probability of

Estimated Uncollectibl e Amount

NonCollection

Not yet due

.680

P 816,000

.010

P 8,160

Less than 30 days past

.150

180,000

.035

6,300

30 to 60 days past due

.080

96,000

.050

4,800

61 to 120 days past due

.050

60,000

.090

5,400

121 to 180 days past due

.025

30,000

.400

12,000

Over 180 days past due

.015

18,000

.900

16,200

1.000

P1,200,000

due

P52,860

Requirement (b) Ken Company Analysis of Allowance for Doubtful Accounts May 31, 2015 June 1, 2014 balance

P 30,250

Bad debt expense accrual (3,000,000 x .04)

120,000

Balance before write-offs of bad accounts

P150,250

Write-offs of bad accounts

108,750

Balance before year-end adjustment

P 41,500

Estimated uncollectible amount

52,860

Additional allowance needed

Debit

P 11,360

Credit

Bad Debts Expense

11,360

Allowance for Doubtful Accounts

11,360

Requirement (c) 1.

Steps to Improve the

2.

Risks and Costs

Accounts Receivable Situation

Involved

Establish more selective credit-granting This policy could result in lost sales and policies, such as more restrictive credit increased costs of credit evaluation. Ken requirements or more thorough credit may be all but forced to adhere to the rating investigation.

prevailing credit-granting policies of the office equipment and supplies industry.

Establish a more rigorous collection This

policy

may

offend

current

policy either through external collection customers and thus risk future sales. agencies or by Ken’s own personal.

Increased collection costs could result from this policy.

Charge interest on overdue accounts.

This

policy

may

offend

current

customers and thus risk future sales. Insist on cash on delivery (COD) or cash This policy could result in lost sales and on order (COO) for new customers or increased administrative costs. poorer credit risks.

10-11. Q:

ANALYSIS

OF

ACCOUNTS

RECEIVABLE

AND

ALLOWANCE

FOR

DOUBTFUL ACCOUNTS You are examining the financial statements of Demo Inc., for the year ended December 31, 2014. During the audit of the accounts receivable and other related accounts, certain information was obtained. From this information you are to prepare: a. Audit work papers for the accounts receivable and the allowance for doubtful accounts as of December 31, 2014. b. Proposed audit adjustments. The December 31, 2014 debit balance in the Accounts Receivable control account is ₱ 197, 000. The only entries in the Bad Debts expense account were: A credit for ₱ 324 on December 1, 2014 because company A remitted in full for the accounts charged off October 31, 2014, and a debit on December 31 for the amount of the credit of the Allowance for Doubtful Accounts. (Insert Allowance for Doubtful Accounts schedule here)

There is a credit balance in one account receivable (0-1 month) of ₱ 2, 000; it represents an advance on a sales contract. Also, there is a credit balance in one of the 103 months accounts receivable of ₱500 for which merchandise will be accepted by the customer. The ledger accounts have not been close as of December 31, 2014. The Accounts Receivable control account is not in agreement with the subsidiary ledger. The difference cannot be located, and the auditor decides to adjust the control to the sum of the subsidiaries after corrections are made. A: Requirement (a) DEMO INC. Accounts Receivable 12-31-14 Balance Per

AGING DISTRIBUTION Per

Months Outstanding

General Ledger

Subsidiar

0-1

1-3

3-6

over 6

y Unadjusted Balances

P197,00 0

P198,24 P93,240 P76,820

P22,180

P6,000

0

Add (Deduct) Adjustments: AJE (2)

to correct

understatement of accounts written off on October 31. (200) (3) to write off definitely uncollectible accounts

(1,000)

(1,000)

(1,000)

(4) to reclassify advances from customers

2,000

2,000

500

500

1,44

_______

2,000

(5) to reclassify accounts with credit balances

500

(6) to adjust general ledger balance to agree with subsidiary balance

Balances as adjusted

______

______

______

_

_

_

P199,74 P95,240 P77,320

P22,180

0 P199,74 0

______

P5,000

0

DEMO INC. Allowance for Doubtful Accounts 12-31-14 Balance per Ledger

P12,000.00

Add (Deduct) Adjustments: AJE(1)to correct error in recording bad debts recovery

324.00

(2)to correct understatement of accounts written off

(

(3)to write off definitely uncollectible accounts

( 1,000.00)

(4)to adjust allowance to required balance (Schedule 1)

( 6,359.80)

Balance as adjusted

200.00)

P 4,764.20

Schedule 1: Computation of Required Allowance Adjusted

Required

Allowance

Account Classification

Total

%

Amount

P 95,240

1

P 952.40

1-3 months outstanding

77,320

2

1,546.40

3-6 months outstanding

22,180

3

665.40

5,000

P2,000-

0-1 month outstanding

over

6

months

outstanding

50% _______

P3,00020%

Totals

Requirement (b)

(1)

0

0

Adjusting Journal Entries 12-31-14

Bad Debts

324.00

Allowance for Doubtful Accounts

324.00 200.00

Allowance for Doubtful Accounts

200.00 1,000.00

Accounts Receivable (4)

Accounts Receivable

1,000.00 2,000.00

Advances from Customers (5)

0 P4,764.2

Accounts Receivable (3)

600.0

P199,74

Allowance for Doubtful Accounts (2)

1,000.00

Accounts Receivable

2,000.00 500.00

Customers’ accounts with credit

500.00

balances (6)

Accounts Receivable

1,440.00

Sales (7)

Allowance for Doubtful Accounts

1,440.00 6,359.80

Bad Debts Expense

6,359.80

10-12. Q: CLASSIFICATION OF RECEIVABLES When examining the accounts of Tripoli Company, you ascertain that balances relating to both receivables and payables are included in a single controlling account (called receivables), which has a ₱ 23, 050 debit balance. An analysis of the details of this account revealed the following: ITEMS Accounts receivable – customers Accounts receivable – officers (current collection expected) Debit balances – creditors

DEBIT

CREDIT

₱ 40, 000 2, 500 450

Expense advances to salespersons

1, 000

Share capital subscriptions receivable

4, 600

Accounts payable for merchandise

₱ 19, 250

Unpaid salaries

3, 300

Credit balance in customer accounts

2, 000

Cash received in advance from customers for goods not yet shipped

450

Expected bad debts, cumulative

500

REQUIRED: 1. Give the journal entry to eliminate the above account and to set up the appropriate accounts to replace it. 2. How should the items be reported on Tripoli Company’s statement of financial position?

A: Requirement (1)

Accounts receivable, trade...............................

40,000

Advances to suppliers.......................................

450

Due from officers.............................................

2,500

Subscriptions receivable – share capital...........

4,600

Expense advances to salespeople.....................

1,000

Accounts payable, trade (P19,250 –

19,250

P450)*.............................................................. Advances

from

customers

on

sales

450

contracts........................................................... Salaries payable..........................................

3,300

Allowance for doubtful accounts...............

500

Receivables (to close permanently)............

23,050

Customers’ credit balances.........................

2,000

Requirement (2)

Current assets: Accounts receivable, trade.........................

40,000

Less allowance for doubtful accounts........

500

P39,500

Creditors’ debit balances............................

450

Due from officers**...................................

2,500

Subscriptions

4,600

receivable

–

ordinary

shares**............................................................ Expense advances to salespeople...............

1,000

Current liabilities: Accounts payable, trade.............................

19,250

Customers’ credit balances.........................

2,000

Cash advances from customers on sales

*

(not yet shipped)......................................

450

Salaries payable..........................................

3,300

These amounts are netted against normal balances to reflect control balances; but if material in amount, they should be reported separately on the statement of financial position as indicated in Requirement 2.

** Considered as current assets only if currently collectible. All items are assumed to be material in amount.

10-13. Q: ANALYSIS OF BAD DEBTS EXPENSE AND ALLOWANCE FOR BAD DEBTS In 2015, 3 years after it began operations, the Pearl Corporation decided to change from the direct write-off method of recording bad debts to estimating bad debts. (Insert figure here.) A: 1.

Estimated bad debt percentage based on year-end accounts receivable: 28.5%# 2012

2013

2014

2015

Actual bad debts

P 3,300a

P 5,700c

P 7,800e

P 16,800

Credit Sales

P90,000

P158,000

P210,000

P459,000

P 9,500b

P 19,900d

P 29,500f

P 58,900

0.347

0.286

0.264

Outstanding receivables (year-end) Percentage of outstanding receivables

a

P2,500 + P500 + P300 = P3,300

b

0 + P90,000 - P78,000 - P2,500 = P9,500

0.285#

c

P4,600 + P700 + P400 = P5,700

d

P9,500 + P158,000 - P8,500 - P134,000 - P500 - P4,600 = P19,900

e

Estimated. The bad debts written off in the third year following the sale have averaged about 7.8% [(P300 + P400)  (P3,300 + P5,700)] of the total actual bad debts in the previous 2 years. Therefore, the bad debts on 2014 sales of P6,200 and P1,000 are about 92.2% of the total bad debts expected on 2014 sales.

f

2.

P19,900 + P210,000 - P200 - P14,200 - P178,800 - P300 - P700 - P6,200 = P29,500 Bad debts estimated as a percentage of year-end accounts receivable P29,500 + P235,000 - P300 - P19,500 - P400 - P1,000 - P200,000 = P43,300 P43,300 x 0.285 = P12,340.50, or approximately P12,300.

Criteria for

recognition of bad debts or impairment of receivables under PAS 39 should be applied.

10-14. Q: ANALYSIS OF ALLOWANCE FOR DOUBTFUL ACCOUNTS From inception of operations to December 31, 2014 Flores Corporation provided for uncollectible accounts receivable under the allowance method: provisions were made monthly at 2% of credit sales; bad debts written off were charged to the allowance account; recoveries of bad debts previously written off were credited to the allowance account; and no year-end adjustments to the allocation account were made. Flores’s usual credit terms are net 30 days. The balance in the allowance for doubtful accounts was ₱ 130, 000 at January 1, 2015. During 2015 credit sales totalled ₱ 9, 000, 000 interim provisions for doubtful accounts were made at 2% of credit sales, ₱ 90, 000 of bad debts were written off, and recoveries of accounts previously written off amounted to ₱ 15, 000. Flores installed a computer facility in November 2015 and an aging of accounts receivable was prepared for the first time as of December 31, 2015. (Insert summary of aging here)

Based on the review of collectability of the account balances in the “prior to 1/1/2015” aging category, additional receivables totalling ₱ 60, 000 were written off as of December 31, 2015. Effective with the year ended December 31, 2015. Flores adopted the revised accounting standards in recognizing bad debts.

REQUIRED: 1. Prepare schedule analyzing the changes in the allowance for doubtful account for the year ended December 31, 2015. Show supporting computations in good form. 2. Prepare the journal entry for the year end adjustment to the allowance for doubtful accounts balance as of December 31, 2015.

A: Requirement (1) Flores Corporation Analysis of Changes in the Allowance for Doubtful Accounts For the Year Ended December 31, 2015

Balance at January 1, 2015

P130,00 0

Provision for doubtful accounts (P9,000,000 x 2%) Recovery in 2011 of bad debts written off previously

180,000 15,00 0 P325,00 0

Deduct write-offs for (P90,000 + P60,000)

150,00 0

Balance at December 31, 2015, before additional impairment loss

P175,00

0 Increase in estimated uncollectible accounts during 2015 (P235,300 -

60,30

P175,000)

0

Balance at December 31, 2015, adjusted (Schedule 1)

P235,30 0

Schedule 1: Computation of Allowance for Doubtful Accounts

Aging category November-December 2015

at December 31, 2015 Balance Percent

Doubtful accounts

P1,140,000

2

P 22,800

July-October

600,000

10

60,000

January-June

400,000

25

100,000

75

52,500

70,000 a

Prior to 1/1/15

P235,300 a

P130,000 - P60,000

Requirement (2) Flores Corporation Journal Entry December 31, 2015

Bad Debt Expense Allowance for Doubtful Accounts To increase the allowance for doubtful accounts at December 31, 2015, resulting from evaluation of collectibility of remaining receivables.

60,300 60,300

10-15. Analysis of Accounts Receivable and Allowance of Doubtful Accounts The following are the balances of selected accounts taken from the December 31, 2014 statement of financial position of Visayas Company; Accounts receivable

P546,400

Allowance for doubtful accounts

16,392

The following transactions (in summary) affecting the Accounts Receivable account occurred during the year ended December 31, 2015. Sales- all on account

P2,622,832

Cash received from customers

2,857,960

The corporation’s credit terms were 2/10, n/30 and customers paying P2,009,842 of the above stated cash took advantage of the discount. Accounts receivable written off as worthless

P18,700

Credit memoranda issued for returned sales and allowances

37,000

REQUIRED: a. Current balance of Accounts Receivable as of December 31, 2015. b. Adjusting journal entry for estimated bad debts on December 31, 2015. The corporation adjusts its allowance account to a percentage of outstanding receivable. The credit experience of the corporation indicates that the percentage rate to be used on December 31, 2015 will be 2/3 of that used on December 31, 2014. Requirement (a) Visayas Company

Accounts Receivable 12.31.15

Balance, 12.31.14

P 546,400

Add: Sales on account for the year

2,622,832

Total

P3,169,232

Less: Collections during the year - with discount (1)

P2,050,859

- without discount (2)

848,118

Accounts written off

18,700

Credit memo for sales returns & allowances

37,000

Balance, 12.31.15

Total collections Less: Accts paid w/ discount

2,954,677 P 214,555

P2,857,960 2,009,842 ( 98% = P2,050,859) (1)

Accts paid by customers w/o discount

P 848,118 (2)

Requirement (b) AJE (1)

Doubtful accounts expense

6,599

Allowance for doubtful accounts

6,599

Supporting Analysis:

% allowance to AR 12.31.14

P 16,392 = P546,400

Required % allowance to

3%

AR 12.31.15

2/3 x 3% = 2 %

Required allowance 12.31.15 2% x P214,555

P4,291

Allowance for doubtful accounts balance, 12.31.14 P 16,392 Less: Accounts written off

18,700 P( 2,308)

Required balance, 12.31.15 Estimated bad debts expense for 12.31.15

4,291 P 6,599