Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CHAPTER REPORTING AND ANALYZING RECEIVABLES LEARNING OBJECTIVES Identify the types of receivables and record accounts receivable transactions Account for bad debts Account for notes receivable Explain the statement presentation of receivables Apply the principles of sound accounts receivable management SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO BT Item LO BT Item LO BT Questions Item LO BT Item LO BT 1 C K 11 C 16 C 21 K C C 12 1,3 C 17 C 22 C C C 13 1,3 C 18 K 23 C C C 14 C 19 C 24 C C 10 C 15 K 20 K Brief Exercises 1 K AP AP 10 1,3 AP 13 AP AP AP AP 11 AP 14 AN AP AP AP 12 AP 15 AN 1 AP AP AP 10 AP 13 AN AN AP AP 11 AN AP AP AP 12 AN Exercises Problems: Set A and B 1,2,4 AP AP AP 10 AN 1,2,4 AP AN AP 2,3,4 AP 11 AN 1,3 AP AP Accounting Cycle Review 1,2,3,4 AP Cases 1,5 AN 2,4 E C AN 2,3,5 E E Legend: The following abbreviations will appear throughout the solutions manual file Solutions Manual 8-1 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition LO Learning objective BT Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty S Simple M Moderate C Complex Estimated time to prepare in minutes Difficulty: Time: AACSB CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006 Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech Diversity Diversity Reflective Thinking Reflec Thinking CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation Solutions Manual 8-2 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ANSWERS TO QUESTIONS Three types of receivables along with examples follow: (a) Type (1) Accounts receivable (b) Examples Accounts receivable from trade customers (2) Notes receivable Notes receivable from trade customers Notes receivable obtained when selling property (3) Other receivables Interest receivable, loans to company officers, advances to employees, sales tax recoverable, and income tax receivable LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Trade receivables are the result of sales transactions while nontrade receivables are the result of transactions other than sales (or service revenue in a non-merchandising business) transactions of the business, such as interest receivable, income tax receivable, and similar types of receivables LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 8-3 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley (a) Financial Accounting, Seventh Canadian Edition For a service company, a receivable is recorded when the revenue is considered to be earned, which occurs when the service is provided In a merchandising company, a receivable is recorded when revenue is considered to be earned, which occurs when the merchandise is sold (normally at the point of sale) (b) The five-step process used to measure and report revenue: Identify the contract with the client or customer Identify the performance obligations in the contract Determine the transaction price Allocate the transaction price to the performance obligations in the contract Recognize revenue when (or as) the company satisfies the performance obligations The timing of the recognition of revenue will determine the point at which the account receivable will be recognized in the accounts LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 8-4 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition (a) The advantages of accepting credit cards are: (1) (2) (3) (4) (5) (6) The credit card issuer makes the credit card investigation of the customer The issuer maintains individual customer accounts The issuer undertakes the collection process and absorbs any losses from uncollectible accounts The retailer receives cash more quickly from the credit card issuer than it would from individual customers It allows the company to remain competitive (as competitors accept credit cards) It increases sales as customers are able to make purchases when they don’t have the required cash Debit cards: The advantage of the debit card is that the cash is deducted immediately from the customer’s account There are no credit checks or collection concerns so the service charges are normally lower than for a bank credit card By accepting credit cards and debit cards, Canadian Tire provides more options to its customers, increases its revenue, and reduces its risk (b) Bank credit cards: To record a bank credit card transaction, the seller records a debit to Cash and a credit to Sales Debit cards: To record a debit card transaction, the seller records a debit to Cash and a credit to Sales Bank charges expense for debit card and bank credit card fees must also be recorded, usually as part of the bank reconciliation process LO BT: C Difficulty: C Time: 20 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 8-5 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition (a) Using an accounts receivable subsidiary ledger makes it possible to determine the balance owed by an individual customer at any point in time This makes it easier to manage receivables, answer customer inquiries, follow up on payments, and decide if additional credit should be granted (b) The general ledger control account should agree with the total of the individual accounts in the subsidiary ledger LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting (a) An aging schedule shows the receivables in various stages outstanding; 0–30 days, 31–60 days, 61–90 days, and so on, as long as required (b) The aging schedule is used to apply percentages to outstanding receivables in each age category, to determine the total estimated uncollectible accounts LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting (a) The purpose of the account Allowance for Doubtful Accounts is to show an estimate of the accounts receivable expected to become uncollectible The allowance account is used because the amount is only an estimate and we not know for certain which customers will not pay, so we cannot reduce specific customer accounts in the subsidiary ledger or the related accounts receivable control account in the general ledger Instead we increase the allowance account balance (b) The account can be in a debit balance if the amount of actual write offs exceeds previous provisions for bad debts A debit balance will arise during the period when these write offs are recorded, but by the end of the reporting period, adjusting entries will be made that will bring the balance in the allowance account back into a credit position The credit entry to this account is offset with a debit to Bad Debts Expense LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 8-6 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Debit balances in the Allowance for Doubtful Account occur during the year when the amounts recorded for bad debt write offs exceed the opening balance in the Allowance for Doubtful Accounts Since the amount arrived at for the adjusted balance in the Allowance for Doubtful Accounts at the end of the previous period is based on estimates, it is possible that this situation could occur The excess amount of write offs beyond the opening balance of the allowance account could relate to accounts receivable that were outstanding at the end of the previous period To the extent that this is the case, the financial statements of the previous period had an understatement in the Bad Debts Expense account as well as an understatement of Allowance for Doubtful Accounts balance, and therefore overstatement of net accounts receivable This situation is treated as a change in estimate and is not considered an error in the previous period financial statements LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting The Bad Debts Expense account reflects only the current year’s estimates while the Allowance for Doubtful Accounts is a cumulative result of estimates, write offs, and subsequent recoveries from the current and prior periods LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 10 The write off of an uncollectible account reduces both Accounts Receivable and the Allowance for Doubtful Accounts by the same amount Thus, net carrying amount (which is the difference between accounts receivable and allowance for doubtful accounts) does not change The carrying amount will change, however, when an adjusting entry is made to record the estimate of uncollectible accounts, because only the Allowance account is affected in this entry LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 8-7 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 11 Financial Accounting, Seventh Canadian Edition Two journal entries are required because the first journal entry has to restore the previously written off accounts receivable and the second journal entry records the actual receipt of payment on the account This way, there is a record that the person did eventually pay, and that may affect future credit decisions Furthermore, the date on which the determination that the receivable is actually collectible and the date it is actually collected may be different and this would necessitate the separate recording of these events LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 12 (a) The similarities between accounts receivable and notes receivable are that they are both credit instruments, both can be sold, and both are valued at their carrying amount (b) Differences between accounts receivable and notes receivable include the following An accounts receivable is an informal promise to pay, while a note receivable is a written promise giving the payee a stronger legal claim A note receivable is a negotiated instrument that can be transferred to another party An account receivable arises from credit sales, while a note receivable can arise for a number of reasons such as the financing of a purchase, lending money, or extending the terms of an account receivable An account receivable is usually due within a short period of time, while a note receivable can extend for longer periods of time (which is why it bears interest) An account receivable does not incur interest unless the account is overdue, while a note usually bears interest for the entire period LO 1,3 BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 8-8 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 13 (a) (b) Financial Accounting, Seventh Canadian Edition (1) Interest is normally recorded for an account receivable if a customer does not pay in full within a specified period of time (usually 30 days) The invoice will specifically state the amount or percentage of interest due on overdue accounts (2) In the case of notes receivable, the amount of interest accrues starting from the date of the issuance of the note and continues to the maturity date of the note Interest earned is recorded when accrued at the end of each accounting period or when collected, whichever comes first (1) Accounts Receivable is normally debited for interest accrued on overdue balances This accomplishes two goals: updating a particular customer’s balance in the subsidiary ledger to allow management to decide if additional credit should be granted if overdue balances are not yet paid; it also allows the company to easily send a statement of transactions to the customer that includes interest charges so that the customer will be aware of them (2) In the case of notes receivable, when accrued, Interest Revenue is credited and Interest Receivable is debited The Note Receivable account is for the principal balance of the loan, whereas the interest is recorded and reported separately LO 1,3 BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 14 Notes are not recorded at their maturity value (which would include interest) because the interest on the note is not receivable when the note is first recorded The interest is earned over time and is recorded when earned LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 15 Cobden Inc., as the party making the promise to pay, is the maker of the note It would record a note payable Scotiabank, as the party who will be paid, is the payee It would record a note receivable LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 8-9 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 16 Financial Accounting, Seventh Canadian Edition When a note receivable is honoured at maturity it is paid in full, while a dishonoured note is not paid in full at maturity A dishonoured note receivable is no longer negotiable The payee still has a claim against the maker of the note and, if eventual collection is expected, an accounts receivable is recorded LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 17 These notes should be reported at their carrying amount An entry should be made to debit Bad Debts Expense for the 10% expected to be uncollectible and to credit Allowance for Doubtful Notes for the same amount LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 18 Both the gross amount of receivables and the allowance for doubtful accounts must be reported either on the statement of financial position or in the notes to the financial statements It is usual to report the receivables on the statement of financial position at their carrying amount and to provide additional information about the allowance in the notes to the statements LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting 19 Current assets Accounts receivable Less: Allowance for doubtful accounts Carrying amount of accounts receivable Notes receivable (due in three months) Less: Allowance for doubtful notes Carrying amount of short-term notes $xxx xxx $xxx $xxx xxx Sales tax recoverable Income tax receivable Non-current assets Notes receivable (due in two years) xxx xxx xxx $xxx LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 8-10 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR8-1 (CONTINUED) Adjusting journal entries (AJE) Jan 31 31 31 31 31 Depreciation Expense Accumulated Depreciation—Equipment ($1,560,000 ÷ 10 x 1/12) 13,000 Insurance Expense Prepaid Insurance ($14,000 ÷ 8) 1,750 Salaries Expense Salaries Payable 36,000 Interest Receivable Interest Revenue ($20,000 x 9% x 5/12) 75 Income Tax Expense Income Tax Payable 24,000 13,000 1,750 36,000 75 24,000 Solutions Manual 8-83 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR8-1 (CONTINUED) (f) DITURI DESIGNS LTD Adjusted Trial Balance January 31, 2018 Cash Accounts receivable Allowance for doubtful accounts Notes receivable Inventory Prepaid insurance Interest receivable Equipment Accumulated depreciation—equipment Accounts payable Income tax payable Salaries payable Unearned revenue Bank loan payable Common shares Retained earnings Sales Sales returns and allowances Cost of goods sold Depreciation expense Salaries expense Insurance expense Bad debts expense Bank charges expense Interest revenue Interest expense Income tax expense Debit 265,772 482,100 Credit 16,900 20,000 2,769,400 12,250 75 1,560,000 985,000 419,000 24,000 36,000 34,000 785,000 600,000 2,128,900 382,000 4,000 197,600 13,000 46,000 1,750 12,900 128 175 2,000 24,000 $5,410,975 $5,410,975 Solutions Manual 8-84 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR8-1 (CONTINUED) (g) (1) DITURI DESIGNS LTD Income Statement Month ended January 31, 2018 Sales Less: Sales returns and allowances Net sales Cost of goods sold Gross profit Operating expenses Salaries expense Depreciation expense Bad debts expense Insurance expense Bank charges expense Total operating expenses Income from operations Other expenses and revenues Interest revenue Interest expense Income before income tax Income tax expense Net income $382,000 4,000 378,000 197,600 180,400 $46,000 13,000 12,900 1,750 128 73,778 106,622 ($175) 2,000 1,825 104,797 24,000 $ 80,797 (g) (2) DITURI DESIGNS LTD Statement of Changes in Equity Month ended January 31, 2018 Balance, January Net income Balance, January 31 Common Shares $600,000 0000 000 $600,000 Retained Earnings $2,128,900 80,797 $2,209,697 Total Equity $2,728,900 80,797 $2,809,697 Solutions Manual 8-85 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR8-1 (CONTINUED) (g) (3) DITURI DESIGNS LTD Statement of Financial Position January 31, 2018 Assets Current assets Cash Accounts receivable $482,100 Less: Allowance for doubtful accounts 16,900 Notes receivable Interest receivable Inventory Prepaid insurance Total current assets Property, plant and equipment Equipment $1,560,000 Less: Accumulated depreciation 985,000 Total assets Liabilities and Shareholders’ Equity Current Liabilities Accounts payable Salaries payable Income tax payable Unearned revenue Current portion of bank loan payable* Total current liabilities Bank loan payable Total Liabilities Shareholders’ equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity *$15,000 x 12 months = $180,000 $ 265,772 465,200 20,000 75 2,769,400 12,250 3,532,697 575,000 $4,107,697 $ 419,000 36,000 24,000 34,000 180,000 693,000 605,000 1,298,000 $ 600,000 2,209,697 2,809,697 $4,107,697 LO 1,2,3,4 BT: AP Difficulty: M Time: 80 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 8-86 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT8-1 (a) Financial Accounting, Seventh Canadian Edition FINANCIAL REPORTING CASE The North West Company Inc reports $79,373,000 accounts receivable on its January 31, 2016 balance sheet From note 5, we can see that this amount is made up of: Trade accounts receivable Corporate and other accounts receivable Less: Allowance for doubtful accounts $78,190,000 13,566,000 (12,383,000) $79,373,000 (b) ($ in thousands) Receivables turnover 2016 $1,796,035 $79,373 + $72,506 Average collection period (c) 365 23.7 2015 = 23.7 times = 15 days $1,624,400 $72,506 + $70,527 365 22.7 Net credit sales ÷ Average net accounts receivable = Accounts receivable turnover Days in year ÷ Accounts receivable turnover = Average collection period in days = 22.7 times = 16 days North West has exhibited relatively consistent performance in the collection of its accounts receivable It showed an improvement in its receivables management in 2016 It should also be noted that an average collection period of less than 30 days is normally an excellent collection period, depending on the terms of sale LO 1,5 BT: AN Difficulty: M Time: 20 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 8-87 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT8-2 (a) ($ in thousands) Current ratio Average collection period FINANCIAL REPORTING CASE North West ($ in thousands) $335,581 $155,501 Receivables turnover Financial Accounting, Seventh Canadian Edition $1,796,035 $79,373 + $72,506 365 23.7 (b) Ratio Current ratio Receivables turnover Average collection period = 2.2:1 23.7 = times = 15 days North West 2.2:1 23.7 times 15 days Sobeys ($ in millions) $2,581.4 $2,707.4 = $24,618.8 $489.4 + $499.7 365 49.8 Sobeys 1.0:1 49.8 times days = 1.0:1 49.8 times = days Industry 1.18:1 24.2 times 15 days Sobeys demonstrates superior management of accounts receivable as shown by its receivables turnover and average collection period ratios, which are better than those of North West and the industry average It should be noted that North West sells appliances and other household items, which Sobeys and other industry competitors not The credit terms granted to customers on these purchases may be longer, explaining why their average collection period is also longer On the other hand, Sobeys’ current ratio is less than half that of North West and below the industry average Further investigation as to why Sobeys’ current ratio is so low is warranted (for example, is their inventory turnover slower?) before drawing a conclusion about its liquidity LO BT: AN Difficulty: M Time: 20 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 8-88 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT8-3 Financial Accounting, Seventh Canadian Edition FINANCIAL REPORTING CASE (a) Both Lava and Flow provide the information on the carrying amount of the trade receivables, but Lava provides disclosure of the amount of the allowance for doubtful accounts Lava also provides more detail as to the aging of its accounts receivable, which is useful in assessing credit risk The analyst can see that over 70% ($1,322 ÷ $1,854) of Lava’s receivables are current in 2018 (b) Since Lava is a publicly traded company with many shareholders and creditors, it is to its benefit to provide more information for the users of the financial statements to help them to assess credit and collection risks and management’s policies with respect to accounts receivable (c) Big Bank would want an aging analysis of Flow In addition, here are some examples of additional information Big Bank would need to assess credit risk: • • • • Normal payment terms for the company and industry; An analysis by major customers; Details on how creditworthiness is evaluated; and Details on how Lava and Flow follow up on receivables that are past due for a significant amount of time LO 2,4 BT: E Difficulty: M Time: 20 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 8-89 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT8-4 Financial Accounting, Seventh Canadian Edition FINANCIAL ANALYSIS CASE Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS (a) Current ratio 2018: 1.6:1 ($10,600,000 ÷ $6,800,000) 2017: 2.1:1 ($10,500,000 ÷ $5,100,000) Yes, the current ratio exceeds the bank’s requirement of a current ratio of 1.5:1 in both years (b) Allowance for Doubtful Accounts Bal 2017 2018 write offs 100,000 Bal 2018 500,000 400,000 Notes Receivable Bal 2017 2,000,000 2018 New notes 1,500,000 2018 Collections 800,000 Bal 2018 2,700,000 (c) It is difficult to say whether the Allowance for Doubtful Accounts is adequate or not It is noteworthy that in 2017 the allowance was 10% of the royalties receivable ($500,000 ÷ $5,000,000) In 2018, after the write off, the allowance is 6.7% of the royalties receivable ($400,000 ÷ $6,000,000) It is quite likely, given the increase in sales from $50 million to $60 million and the increase in receivables from $5 million to $6 million, that the allowance should also increase proportionately unless there is evidence to the contrary HHL should prepare an aging of its accounts (royalty) receivable and monitor its collection history so that it can ensure that it provides for the appropriate level of allowance Solutions Manual 8-90 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT8-4 (CONTINUED) (d) Yes, I believe an allowance should be recorded for notes receivable As the notes are due in one year, and all the notes issued during 2018, which amounted to $1.5 million, are still outstanding at the end of the year, we need to determine what happened to the $2 million of notes that were outstanding at the beginning of the year Since $800,000 of these notes has been collected, the remaining $1.2 million ($2,700,000 − $1,500,000) must have been dishonoured An argument can be made for an allowance being recorded for the full amount of the $1.2 million dishonoured notes as past experience indicates that they will probably not be collected To record this, the following journal entry would be required: Bad Debts Expense Allowance for Doubtful Notes 1,200,000 1,200,000 One could possibly argue that the outstanding notes that were issued in 2018 amounting to $1.5 million should have an allowance provided for them but, at this time, it may be difficult to quantify this (e) If an Allowance for Doubtful Notes of $1.2 million is recorded, this would lower current assets to $9.4 million ($10.6 million − $1.2 million) and the current ratio would now be 1.4:1 ($9.4 million ÷ $6.8 million) This would violate the terms on the bank loan Solutions Manual 8-91 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT8-4 (CONTINUED) (f) Accounts receivable turnover ratio (calculated using ending balances rather than average balances) 2018: 10.0 times ($60,000,000 ÷ $6,000,000) 2017: 10.0 times ($50,000,000 ÷ $5,000,000) The liquidity of the company has deteriorated based on the decline in the current ratio calculated in (a) The cash balance is lower in 2018 while current liabilities are higher While the accounts (royalties) receivable turnover is unchanged in 2018, the collectability of the accounts receivable as well as the notes receivable arising from dishonoured notes is suspect because of the reluctance of the vice-president to write off dishonoured notes LO 2,3,5 BT: E Difficulty: C Time: 30 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 8-92 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT8-5 (a) Financial Accounting, Seventh Canadian Edition ETHICS CASE The stakeholders in this situation are: The controller of Encounter Limited, Sam Wong The president of Encounter Limited, Suzanne Chen The company’s bank The shareholders of this publicly traded company Any other parties who rely upon the company’s financial statements (b) The president of the company likely made the request to improve the current ratio to show that the company is more liquid than it really is, for the benefit of the bank In this way, the bank’s expectations will be met (c) Yes The controller has an ethical dilemma—should Sam follow the president's “suggestion” and prepare misleading financial statements by understating the allowance for doubtful accounts and bad debt expense or should Sam attempt to stand up to and possibly anger the president by preparing a fair (realistic) statement of financial position (d) No Encounter’s liquidity should be measured using fair financial statements The controller should not prepare financial statements with the objective of achieving or sustaining a predetermined level of liquidity The current ratio should be a product of proper estimates made by management and operating results, not of “creative accounting.” LO BT: C Difficulty: M Time: 20 AACSB: Ethics CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics Solutions Manual 8-93 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT8-6 (a) Financial Accounting, Seventh Canadian Edition SERIAL CASE Software Solutions is currently adhering to ABC’s credit terms of 30 days but have asked for an increase to 60 days Several major clients, however, have extended their payment period to 45 days Advantages to Anthony Business Company (ABC) of enforcing credit terms of 30 days for its clients: • Cash flow will increase and the stress of ensuring that there are adequate funds on hand to purchase additional inventory and pay for salaries and salary related costs will be alleviated with respect to those clients currently taking longer than 30 days to pay • Will provide ABC with a consistent credit policy When negotiating terms with new customers it may wish to offer credit to, it will be able to say that it has a credit policy that is consistent with what is being offered to current customers—whether major or not Disadvantages to ABC of enforcing credit terms of 30 days for clients: • Software Solutions and other major clients wishing a payment period of longer than 30 days may choose to go elsewhere Not only would ABC lose its current contractual commitment but also the additional revenues it expects to earn from these clients in the future • (b) Since some clients have been delaying payment to 45 days in the past without any consequences, enforcing a 30-day payment period may be problematic If ABC feels that a particular client in this situation is loyal and is a major source of its profitability and growth, it may have to consider whether the cost equals the benefits of enforcing credit terms of 30 days I not believe that ABC should reduce its credit terms to 15 days Because ABC is a young growing company, it should be very careful about its customer relations For existing customers, particularly Software Solutions, ABC should not disturb their current terms In the case of ABC, 15 day terms are not likely standard in its industry and would likely turn new customers away ABC should consider the delays in collection as a cost of doing business and arrange for the proper financing of the cash flow demands of the future It is better to incur interest costs and retain clients than pay staff who are not assigned billable work Solutions Manual 8-94 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT8-6 (CONTINUED) (b) (continued) Advantages to (ABC) of reducing credit from 30 to 15 days: • If in fact clients can meet these credit terms, cash flow will increase • Will provide ABC with a consistent credit policy • If ABC needs to borrow money, it can demonstrate to its creditor that it has good control over the collection of accounts receivable Disadvantages to ABC of reducing credit from 30 to 15 days: • 30 days may be a consistent policy in this industry ABC should check this out before making any change (c) • Some clients may in fact agree to a 15-day payment period and still take 45 days to pay ABC will have to be clear on what the penalty is for late payment (interest, for example) and what enforcement measures it is prepared to take • ABC may experience down time (or not as productive performance) from its employees through loss of customers • ABC may experience a loss of reputation ABC may be perceived as being cash strapped and consequently customers may incorrectly conclude that ABC is not a reliable source of service Implications of the doubling services for Software Solutions on operations and cash flows Doug, Bev, and Emily must carefully consider the company’s cash flow requirements ABC will need to hire additional staff as a result of the planned increase in services These additional costs will have to be considered when determining cash flows All employee related costs will increase as a consequence of the additional staff For example, electricity costs will increase and expenditures for more equipment may be necessary Payments for payroll and related costs cannot be delayed Since ABC is selling services and not inventory to Software Solutions, it cannot pass on to its own suppliers, delays in payment Solutions Manual 8-95 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT8-6 (CONTINUED) (d) Alternatives: • Consider not extending credit for the purchase of goods Perhaps clients might consider payment by using a corporate credit card Although this is an alternative for the sale of goods, it may not be one that clients would accept, considering some are currently taking 45 days to pay their ABC invoices In addition, not all clients may have a corporate credit card nor wish to acquire one It is not as common as a personal credit card ABC would also have to consider the costs of accepting payment by credit card The issuing credit card company or bank will charge a processing fee This may be more costly than allowing selected clients to pay in 45 days • Consider providing clients an incentive or discount to paying quickly, for example a 1% discount Again, a valid alternative but might be a costly one to ABC This cost should be compared to the cost of credit card fees and potential interest paid if cash was borrowed by ABC to finance operations • Consider the sale of receivables to an organization that will collect the receivable (a factor) Although a valid alternative, this one may be a costly one to ABC, as the fees charged by a factor can be significant and likely far more significant than any savings it would occur from receiving the collection of an account 15 days (45 days – 30 days) earlier In addition, it may make ABC look desperate and could lead clients to the perception that ABC has a poor financial position LO BT: E Difficulty: C Time: 45 AACSB: Communication CPA: cpa-t001, cpa-t005, cpa-e003 CM: Reporting, Finance and Comm Solutions Manual 8-96 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legal Notice Copyright © 2017 by John Wiley & Sons Canada, Ltd or related companies All rights reserved The data contained in these files are protected by copyright This manual is furnished under licence and may be used only in accordance with the terms of such licence The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd (MMXVII vi F2) Solutions Manual 8-97 Chapter Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... ($23,680 – $3,600) Allowance for Doubtful Accounts 20 ,080 Bad Debts Expense ($23,680 + $5,400) Allowance for Doubtful Accounts 29 ,080 20 ,080 29 ,080 LO BT: AP Difficulty: M Time:... and Decision- Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting. .. allowance for doubtful accounts must be reported either on the statement of financial position or in the notes to the financial statements It is usual to report the receivables on the statement of financial