Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition CHAPTER Reporting and Analyzing Receivables ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises A Problems B Problems BYP Identify the types of receivables and record accounts receivable transactions 1, 2, 3, 4, 5, 11, 12 1, 2, 3, 4, 1, 10 1A, 2A, 6A 1B, 2B, 6B 1, 5, Account for bad debts 6, 7, 8, 9, 10 5, 6, 7, 1A, 2A, 3A, 4A, 5A, 8A 1B, 2B, 3B, 4B, 5B, 8B 3, Account for notes 11, 12, receivable 13, 14, 15, 16 Explain the statement presentation of receivables 17, 18, 19 14 Apply the principles of sound accounts receivable management 20, 21, 22, 23 3, 4, 5, 9, 10, 11, 7, 8, 12, 13 15 6A, 7A, 8A 6B, 7B, 8B 10, 11 1A, 2A, 8A, 9A 1B, 2B, 8B, 9B 12, 13 10A, 11A 10B, 11B 1, 2, 4, 6, Solutions Manual 8-1 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Record receivables and bad debts transactions; show statement presentation Moderate 25-35 2A Record receivables and bad debts; show statement presentation Moderate 25-35 3A Determine missing amounts Complex 15-20 4A Prepare aging schedule and record bad debts Moderate 20-30 5A Prepare aging schedule; record bad debts for two years Moderate 25-35 6A Record receivables transactions Moderate 20-30 7A Record notes receivable and payable transactions Moderate 20-30 8A Record notes receivable transactions; show statement presentation Moderate 30-35 9A Prepare assets section Moderate 20-30 10A Calculate and evaluate ratios Moderate 15-20 11A Evaluate liquidity Moderate 15-20 1B Record receivables and bad debts; show statement presentation Moderate 25-35 2B Record receivables and bad debts; show statement presentation Moderate 25-35 3B Determine missing amounts Complex 15-20 4B Prepare aging schedule and record bad debts Moderate 20-30 5B Prepare aging schedule, record bad debts for two years Moderate 25-35 Solutions Manual 8-2 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number Description Difficulty Level Time Allotted (min.) 6B Record receivables transactions Moderate 20-30 7B Record notes receivable and payable transactions Moderate 20-30 8B Record notes receivable transactions; show statement presentation Moderate 30-35 9B Prepare assets section Moderate 20-30 10B Calculate and evaluate ratios Moderate 15-20 11B Evaluate liquidity Moderate 15-20 Solutions Manual 8-3 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition ANSWERS TO QUESTIONS Three types of receivables along with examples follows: (1) (a) Type Accounts receivable (b) Examples Accounts receivable from trade customers (2) Notes receivable Notes receivables 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 Trade receivables are the result of sales transactions while nontrade receivables are the result of transactions other than sales transactions of the business, such as interest receivable, income tax receivable, and similar types of receivables (a) For a service company, a receivable is recorded when service is provided on account as required by the revenue recognition criteria For a merchandising company, a receivable is recorded at the point of sale of merchandise on account as required by the revenue recognition criteria (b) Revenue should be recognized when the performance or sales effort is substantially complete This normally occurs when the service is performed, or when goods are delivered at the point of sale, but not necessarily when cash is received In addition, collection must be reasonably assured Solutions Manual 8-4 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) (a) Nonbank credit cards: From its own company credit card, Canadian Tire realizes interest revenue from customers who not pay the balance due within a specified grace period Bank credit cards: Bank credit cards offer the following advantages: (1) The credit card issuer makes the credit card investigation of the customer (2) The issuer maintains individual customer accounts (3) The issuer undertakes the collection process and absorbs any losses from uncollectible accounts (4) The retailer receives cash more quickly from the credit card issuer than it would from individual customers 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 using its own credit cards, bank credit cards and debit cards, Canadian Tire provides more options to its customers, increases its revenue, and reduces its risk (b) Nonbank credit cards: To record a company credit card transaction, the seller records a debit to Accounts Receivable and a credit to Sales 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 (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 Solutions Manual 8-5 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) (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 (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 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 The write off of an uncollectible account reduces both Accounts Receivable and the Allowance for Doubtful Accounts by the same amount Thus, net realizable value (which is the difference between accounts receivable and allowance for doubtful accounts) does not change Net realizable value 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 10 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 Solutions Manual 8-6 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) 11 (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 net realizable value (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 an entire period 12 (a) (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 12 (b) (1) Accounts Receivable is normally debited for interest 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 interest revenue is accrued, Interest Receivable is debited The Note Receivable account is for the amount of the principal balance of the loan, whereas the interest is recorded and reported separately 13 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 14 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 Solutions Manual 8-7 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) 15 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 16 These notes should be recorded at their net realizable value 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 17 Both the gross amount of receivables and the allowance for doubtful accounts must be reported either in 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 net realizable value and to provide additional information about the allowance in the notes to the statements 18 Current assets Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable Notes receivable (due in three months) Less: Allowance for doubtful notes Net realizable value of short-term notes Sales tax recoverable Income tax receivable Non-current assets Notes receivable (due in two years) 19 (a) Account (1) Sales or Service Revenue (2) Bad Debt Expense (3) Interest Revenue $xxx xxx $xxx $xxx xxx xxx xxx xxx $xxx (b) Classification Revenues Operating expenses Other revenues and expenses 20 The steps involved in receivables management are: (1) Determine who to extend credit to (2) Establish a payment period (3) Monitor collections (4) Evaluate the liquidity of receivables Solutions Manual 8-8 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Answers to Questions (Continued) 21 To help in determining whether Canam Group’s receivables management has improved or worsened the average collection period should be determined Average collection period 2012 365 = 118 days 3.1 2011 365 = 111 days 3.3 Canam’s receivable management has worsened The receivables turnover has decreased from 3.3 times to 3.1 times, indicating a slower collection of receivables The average collection period shows this more clearly; the average time it takes to collect a receivable has risen from 111 days to 118 days 22 (a) An increase in the current ratio does not necessarily mean that the liquidity of a company has improved In order to determine if liquidity has improved, we need to understand why the current ratio rose If it rose because the company has more cash, then the company is more liquid On the other hand if the cash has fallen but inventory has risen by a larger amount because of declining sales, the current ratio will rise but this does not mean that the company is more liquid It simply means that the company has some inventory that it cannot sell and the company has less liquidity The same is true if net accounts receivable increase because of a slowdown in collections not fully adjusted for in the estimate of uncollectible accounts (b) Other ratios that focus on specific current assets rather than current assets in total (as the current ratio does) give us insight into the components of working capital and allow us to understand liquidity in more detail Examples include the receivables turnover ratio and the inventory turnover ratio In general, if these ratios are rising, liquidity is improving because cash is being received more quickly 23 If the receivables turnover is significantly higher than its competitors, it means the company is collecting its receivables faster, indicating it may have an earlier payment due date Customers may move to a competitor that does not collect its receivables as quickly to better manage their cash flow If a company has a receivables turnover that is significantly lower than its competitors, it may be at a competitive disadvantage because it is financing its customers’ purchases for a longer time and delaying the time it takes to receive cash Solutions Manual 8-9 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 (a) (b) (c) (d) (e) (f) (g) Other receivables Other receivables Notes receivable Accounts receivable Accounts receivable Other receivables Notes receivable BRIEF EXERCISE 8-2 (a) (b) (c) (d) July July July Accounts Receivable Sales 42,000 Cost of Goods Sold Merchandise Inventory 30,000 Sales Returns and Allowances Accounts Receivable 7,200 Merchandise Inventory Cost of Goods Sold 4,320 Cash ($34,800 – $696) Sales Discounts ($34,800 × 2%) Accounts Receivable ($42,000 – $7,200) 34,104 696 Aug 31 Accounts Receivable Interest Revenue [($42,000 – $7,200) × 24% × 1/12] 42,000 30,000 7,200 4,320 34,800 696 696 Solutions Manual 8-10 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 8-9B OUTAOUAIS INC Statement of Financial Position (Partial) January 31, 2015 (in thousands) Assets Current assets Accounts receivable Less: Allowance for doubtful accounts Notes receivable Income tax receivable Merchandise inventory Supplies Total current assets Non-current assets Notes receivable Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Goodwill Total assets $2,468 268 $2,200 50 20 3,000 50 5,320 300 $200 $1,000 250 $750 375 750 375 1,325 100 $7,045 Solutions Manual 8-56 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 8-10B (a) Rogers (in millions) Receivables turnover Average collection period (b) Shaw (in millions) $12,486 ($1,693 + $1,665) � � = 7.4 times $4,998 ($472 + $461) � � = 10.7 times 365 = 49 days 7.4 365 = 34 days 10.7 Shaw’s receivables turnover was considerably better than that of Rogers’, which means Shaw was more efficient than Rogers in collecting its receivables While Rogers is collecting their accounts receivable at a similar pace as that of the industry, it remains considerably slower than Shaw’s Solutions Manual 8-57 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 8-11B (a) 2015 Average collection period Days in inventory 365 = 46 days 365 = 61 days 2014 365 = 52 days 365 = 52 days 2013 365 = 61 days 365 = 46 days (b) At first glance it appears that Tianjin’s liquidity had remained stable over the past year since the company’s current ratio has remained at 1.5:1 However, the company is taking less time to collect its accounts receivable as evidenced by the increasing receivables turnover ratio and decreasing collection period In contrast, it appears to be moving its inventory less quickly as evidenced by the lower inventory turnover ratio and increasing days in inventory It is possible that the stable current ratio is due to the fact that the improving collections and deteriorating inventory turnover ratios are offsetting (c) Changes in the turnover ratios indirectly affect profitability Improvements in the receivables turnover and inventory turnover speed up the cash cycle which provides the company with better cash flow and decreases the need for outside financing, thus decreasing interest expense Furthermore, improvements in the receivables turnover usually arise as a direct result of improvements in credit management and better collection efforts These improvements result in fewer defaults and decreases in bad debts expense Improvements in the inventory turnover improve profitability by reducing carrying charges associated with stocking inventory (such as warehousing costs) Improved inventory turnover also reduces the risk of merchandise not selling and becoming obsolete or selling at reduced prices Obsolete inventory lowers profitability because the cost of this type of inventory has to be written off (d) Changes in the turnover ratios directly affect cash flow Improvements in the receivables turnover and inventory turnover speed up the cash cycle which provides the company with better cash flow and less need for outside financing Solutions Manual 8-58 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition PROBLEM 8-11B (Continued) (e) There are several steps that Tianjin might have taken to improve its receivables and inventory turnover: Receivables o The company could establish credit policies and credit limits for certain customers, if it doesn’t already have them o The company could initiate the use of a cash discount to encourage early payment of receivables o The company could more aggressively monitor collections to encourage customers to pay on time Inventory o Tianjin should monitor its inventory levels carefully and only reorder when inventory is selling and additional supplies are required If inventory is not selling (e.g., not in favour or in season), it should mark it down quickly to get rid of it rather than risk it not selling at all and having to pay carrying costs for obsolete inventory o The company could limit the amount of inventory by improving its purchasing relationships with suppliers If inventory could be purchased more frequently, required inventory levels could be reduced o Further, were it possible to move to a system where inventory is only purchased as needed (called “just-in-time”), Tianjin could reduce the amount of inventory it had to carry and improve the turnover ratio However, there is some risk to this option as sales could be lost if stock-outs (which means shortages) occur Solutions Manual 8-59 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-1 FINANCIAL REPORTING (a) Shoppers Drug Mart reports accounts receivable on its 2012 balance sheet (b) ($ in thousands) Receivables turnover Average collection period (c) 2012 $10,781,848 $469,683 + $493,338 365 22.4 2011 = 22.4 times = 16 days $10,458,652 $493,338 + $470,935 365 21.7 = 21.7 times = 17 days Shoppers Drug Mart has exhibited relatively consistent performance in the collection of its accounts receivable It showed a slight improvement in its receivables management in 2012 It should also be noted that an average collection period of less than 30 days is normally an excellent collection period, depending on the terms of sale Solutions Manual 8-60 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-2 COMPARATIVE ANALYSIS (a) ($ in thousands) Current ratio Receivables turnover Average collection period Shoppers Drug Mart $2,764,997 $2,334,917 $10,781,848 $469,683 + $493,338 365 22.4 = Jean Coutu 1.2:1 22.4 = times = 16 days $421,900 $265,300 $2,468,000 $199,600 + $206,500 365 12.2 = 1.6:1 = 12.2 times = 30 days (b) Ratio Current ratio Receivables turnover Average collection period Shoppers 1.2:1 22.4 times 16 days Jean Coutu 1.6:1 12.2 times 30 days Industry 1.6:1 22.4 times 16 days Shoppers Drug Mart demonstrates superior management of accounts receivable as shown by its receivables turnover and average collection period ratios, which are better than those of Jean Coutu and identical to the industry average It should be noted that Jean Coutu’s collection period is still a reasonable one at 30 days, assuming its terms of sale are 30 days On the other hand, Shoppers Drug Mart’s current ratio is below that of Jean Coutu as well as that of the industry average Still it is above 1:1 so given that and its receivables position, its overall liquidity appears to be better than that of Jean Coutu Further investigation as to why Shoppers Drug Mart’s current ratio is lower than that of Jean Coutu and the industry is warranted (for example, is their inventory turnover slower?) before concluding on its liquidity Solutions Manual 8-61 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-3 COMPARING IFRS AND ASPE (a) Both Lava and Flow provide the information on the net realizable value of the trade receivable, 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 receivables, 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 2015 (b) Since Lava follows IFRS, it is required 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 in order to assess credit risk are: • • • • 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 Solutions Manual 8-62 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-4 CRITICAL THINKING 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 2015: 1.6:1 ($10,600,000 ÷ $6,800,000) 2014: 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 2014 2015 write offs 100,000 Bal 2015 500,000 400,000 Notes Receivable Bal 2014 2,000,000 2015 New notes 1,500,000 2015 Collections 800,000 Bal 2015 2,700,000 (c) It is difficult to say whether the Allowance for Doubtful Accounts is adequate or not It is noteworthy that in 2014 the allowance was 10% of the royalties receivable ($500,000 ÷ $5,000,000) In 2015, 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 8-63 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-4 (Continued) (d) Yes, I believe an allowance should be recorded for notes receivable As the notes are due in one year, and all of the notes issued during 2015 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 Debt Expense 1,200,000 Allowance for Doubtful Notes 1,200,000 One could possibly argue that the outstanding notes that were issued in 2015 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 (f) Accounts receivable turnover ratio (calculated using ending balances rather than average balances) 2015: 10.0 times ($60,000,000 ÷ $6,000,000) 2014: 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 2015 while current liabilities are higher While the accounts (royalties) receivables turnover is unchanged in 2015, 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 Solutions Manual 8-64 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-5 ETHICS CASE (a) 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 a product of 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” Solutions Manual 8-65 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-6 “ALL ABOUT YOU” ACTIVITY (a) Solutions Manual 8-66 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-6 (Continued) (b) Answers will vary by student (c) Money obtained from your credit cards is not “free” money Your friend will be responsible for making minimum monthly payments and ultimately paying for the TV Interest will accumulate at a possible average rate of 20% yearly on the monthly balance that is outstanding on his credit card If those minimum monthly payments are not met, then there is a strong likelihood that your friend’s credit score will be impacted Solutions Manual 8-67 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-7 SERIAL CASE (a) Advantages to Koebel’s of reducing credit from 30 to 15 days: • If in fact Coffee Beans can meet these credit terms, 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 wages will be alleviated • Will provide Koebel’s a consistent credit policy that they are able to use When negotiating with Biscuits, for example, they will be able to say that they have a credit policy of 15 days which is the same as what is being offered to their current customers Disadvantages to Koebel’s of reducing credit from 30 to 15 days: • 30 days may be a consistent policy in this industry and Coffee Beans may chose to go elsewhere to purchase their cupcake requirements (as may other customers such as Biscuits) Not only would Koebel’s lose their current contractual commitment but the additional sales they are expecting to earn in the future • Coffee Beans may in fact negotiate a 15 day settlement and still take 45 days to pay The 45 days it is taking Coffee Beans to pay could be a result of their cash flow requirements (b) Implications of the doubling of cupcake requirements on a weekly basis and credit terms remaining at 30 days Natalie, Brian and Janet must carefully consider their cash flow requirements on a weekly basis Inventory requirements to prepare cupcakes will increase There may be a need to hire additional staff (bakers for example) as a result of the planned increase in sales If so, this amount will also have to be considered when determining cash flows Utility costs, such as electricity will also increase and expenditures for more equipment may also be necessary Finally, invoices are now being prepared on a weekly basis Time will have to be spent on ensuring that invoices are appropriately prepared, checked, sent and followed up if they are not paid for on a timely basis Solutions Manual 8-68 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition BYP 8-7 (Continued) (c) Alternatives: • Consider not extending credit Perhaps Coffee Beans would consider payment by using a credit card Some businesses use credit cards to pay for goods purchased Although this is a valid alternative it may not be one that Coffee Beans would consider Many organizations want a consistent alternative when paying for product purchased Coffee Beans may not want to implement this strategy Koebel’s would also have to consider the costs of accepting payment by credit card The issuing credit card company or bank may charge a processing fee This may be more costly than allowing Coffee Beans to pay in 45 days • 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 Koebel’s as the fees charged by a factor can be significant • Consider providing Coffee Beans an incentive or discount to paying quickly, for example a 2% discount Again, a valid alternative but a costly one to Koebel’s This cost should be compared to the cost of credit card fees • No change Consider discussions with Frank to encourage the 30 days payment period instead of 45 Perhaps, arrangements could be made to have the funds transferred from Coffee Beans bank account to Koebel’s bank account This way funds could be transferred on a timely basis Solutions Manual 8-69 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine Financial Accounting, Sixth Canadian Edition Legal Notice Copyright Copyright © 2014 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 (MMXIII xi FI) Solutions Manual 8-70 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... 2/12) 8, 093 Accounts Receivable ($6,000 × 24% × 4/12) Interest Revenue 480 6,000 4,000 13,400 8, 800 8, 000 5,400 4,000 3,000 120 8, 000 13,400 134 8, 000 93 480 Solutions Manual 8- 36 Chapter. .. value Dec 31 2014 May 11 2015 Nov.12 2015 $300,000 16 ,80 0 $ 283 ,200 $2 98, 100 14,900 $ 283 ,200 $2 98, 100 16 ,80 0 $ 281 ,300 Solutions Manual 8- 20 Chapter Copyright © 2014 John Wiley & Sons Canada, Ltd... 84 0 Cash Interest Receivable Notes Receivable Interest Revenue ($ 48, 000 × 7% × 2/12) 49,400 48, 000 32,000 48, 000 84 0 84 0 48, 000 560 Solutions Manual 8- 13 Chapter