SHORT-ANSWER QUESTIONS, EXERCISES, AND PROBLEMS
Questions
➢ In view of the difficulty in estimating future events, would you recommend that accountants wait until collections are made from customers before recording sales revenue? Should they wait until known accounts prove to be uncollectible before charging an expense account?
➢ The credit manager of a company has established a policy of seeking to completely eliminate all losses from uncollectible accounts. Is this policy a desirable objective for a company? Explain.
➢ What are the two major purposes of establishing an allowance for uncollectible accounts?
➢ In view of the fact that it is impossible to estimate the exact amount of uncollectible accounts receivable for any one year in advance, what exactly does the Allowance for Uncollectible Accounts account contain after a number of years?
➢ What must be considered before adjusting the allowance for uncollectible accounts under the percentage-of-receivables method?
➢ How might information in an aging schedule prove useful to management for purposes other than estimating the size of the required allowance for uncollectible accounts?
➢ For a company using the allowance method of accounting for uncollectible accounts, which of the following directly affects its reported net income: (1) the establishment of the allowance, (2) the writing off of a specific account, or (3) the recovery of an account previously written off as uncollectible?
➢ Why might a retailer agree to sell by credit card when such a substantial discount is taken by the credit card agency in paying the retailer?
➢ Define liabilities, current liabilities, and long-term liabilities.
➢ What is an operating cycle? Which type of company is likely to have the shortest operating cycle, and which is likely to have the longest operating cycle? Why?
➢ Describe the differences between clearly determinable, estimated, and contingent liabilities. Give one or more examples of each type.
➢ In what instances might a company acquire notes receivable?
➢ How is the maturity value of a note calculated?
➢ What is a dishonored note receivable and how is it reported in the balance sheet?
➢ Under what circumstances does the account Discount on Notes Payable arise? How is it reported in the financial statements? Explain why.
➢ Real world question Refer to “A Broader Perspective: GECS allowance for losses on financing receivables”. What factors are taken into account by the General Electric Company in determining the adjusting entry to establish the desired balance in the Allowance for Losses?
➢ Real world question Refer to “A Broader Perspective: GECS allowance for losses on financing receivables”. Explain how the General Electric Company writes off uncollectibles.
Exercises
Exercise A The accounts of Stackhouse Company as of 2010 December 31, show Accounts Receivable, $ 190,000; Allowance for Uncollectible Accounts, $ 950 (credit balance); Sales, $ 920,000; and Sales Returns and Allowances, $ 12,000. Prepare journal entries to adjust for possible uncollectible accounts under each of the following assumptions:
- Uncollectible accounts are estimated at 1 per cent of net sales.
- The allowance is to be increased to 3 per cent of accounts receivable.
Exercise B Compute the required balance of the Allowance for Uncollectible Accounts for the following receivables:
| Accounts | Age | Probability |
| Receivable | (months) | of Collection |
| $180,000 | Less than 1 | 95% |
| 90,000 | 1-3 | 85 |
| 39,000 | 3-6 | 75 |
| 12,000 | 6-9 | 35 |
| 2,250 | 9-12 | 10 |
Exercise C On 2009 April 1, Kelley Company, which uses the allowance method of accounting for uncollectible accounts, wrote off Bob Dyer’s $ 400 account. On 2009 December 14, the company received a check in that amount from Dyer marked “in full payment of account”. Prepare the necessary entries.
Exercise D Jamestown Furniture Mart, Inc., sold $ 80,000 of furniture in May to customers who used their American Express credit cards. Such sales are subject to a 3 per cent discount by American Express (a nonbank credit card),
- Prepare journal entries to record the sales and the subsequent receipt of cash from the credit card company.
- Do the same as requirement (a), but assume the credit cards used were VISA cards (a bank credit card).
Exercise E Dunwoody Discount Toys, Inc., sells merchandise in a state that has a 5 per cent sales tax. Rather than record sales taxes collected in a separate account, the company records both the sales revenue and the sales taxes in the Sales account. At the end of the first quarter of operations, when it is time to remit the sales taxes to the state taxing agency, the company has $ 420,000 in the Sales account. Determine the correct amount of sales revenue and the amount of sales tax payable.
Exercise F Assume the following note appeared in the annual report of a company:
In 2009, two small retail customers filed separate suits against the company alleging misrepresentation, breach of contract, conspiracy to violate federal laws, and state antitrust violations arising out of their purchase of retail grocery stores through the company from a third party. Damages sought range up to $ 10 million in each suit for actual and treble damages and punitive damages of $ 2 million in one suit and $ 10 million in the other. The company is vigorously defending the actions and management believes there will be no adverse financial effect.
What kind of liability is being reported? Why is it classified this way? Do you think it is possible to calculate a dollar amount for this obligation? How much would the company have to pay if it lost the suit and had to pay the full amount?
Exercise G Determine the maturity date for each of the following notes:
| Issue Date | Life | |
| 2010 January 13 | 30 | days |
| 2010 January 31 | 90 | days |
| 2010 June 4 | 1 | year |
| 2010 December 2 | 1 | month |
Exercise H Crawford, Inc., gave a $ 20,000, 120-day, 12 per cent note to Dunston, Inc., in exchange for merchandise. Crawford uses periodic inventory procedure. Prepare journal entries to record the issuance of the note and the entries needed at maturity for both parties, assuming payment is made.
Exercise I Based on the facts in the previous exercise, prepare the entries that Crawford, Inc., and Dunston, Inc., would make at the maturity date, assuming Crawford defaults.
Exercise J John Wood is negotiating a bank loan for his company, Wood, Inc., of $ 16,000 for 90 days. The bank’s current interest rate is 10 per cent. Prepare Wood’s entries to record the loan under each of the following assumptions:
- Wood signs a note for $ 16,000. Interest is deducted in calculating the proceeds turned over to him.
- Wood signs a note for $ 16,000 and receives that amount. Interest is to be paid at maturity.
Exercise K Based on the previous exercise, prepare the entry or entries that would be made at the maturity date for each alternative, assuming the loan is paid before the end of the accounting period.
Exercise L Pistol Pete provides communication services and products, as well as network equipment and computer systems, to businesses, consumers, communications services providers, and government agencies. The following amounts were included in its 2010 annual report:
| (Millions) | |
| Net sales | $ 79,609 |
| Receivables, net, 2009 December 31 | 29,275 |
| Receivables, net, 2008 December 31 | 28,623 |
Calculate the accounts receivable turnover and the number of days’ sales in accounts receivable. Use net sales instead of net credit sales in the calculation. Comment on the results.
Problems
Problem A As of 2009 December 31, Fargo Company’s accounts prior to adjustment show:
Allowance for uncollectible accounts (credit balance)
| Accounts receivable | $ 40,000 |
| Allowance for uncollectible accounts (credit balance) | 750 |
| Sales | 250,000 |
Fargo Company estimates uncollectible accounts at 1 per cent of sales.
On 2010 February 23, the account of Dan Hall in the amount of $ 300 was considered uncollectible and written off. On 2010 August 12, Hall remitted $ 200 and indicated that he intends to pay the balance due as soon as possible. By 2010 December 31, no further remittance had been received from Hall and no further remittance was expected.
- Prepare journal entries to record all of these transactions and adjusting entries.
- Give the entry necessary as of 2009 December 31, if Fargo Company estimated its uncollectible accounts at 8 per cent of outstanding receivables rather than at 1 per cent of sales.
Problem B At the close of business, Jim’s Restaurant had credit card sales of $ 12,000. Of this amount, $ 4,000 were VISA (bank credit card) sales invoices, which can be deposited in a bank for immediate credit, less a discount of 3 per cent. The balance of $ 8,000 consisted of American Express (nonbank credit card) charges, subject to a 5 per cent service charge. These invoices were mailed to American Express. Shortly thereafter, a check was received.
Prepare journal entries for all these transactions.
Problem C Ruiz Company sells merchandise in a state that has a 5 per cent sales tax. On 2010 January 2, Ruiz sold goods with a sales price of $ 80,000 on credit. Sales taxes collected are recorded in a separate account. Assume that sales for the entire month were $ 900,000. On 2010 January 31, the company remitted the sales taxes collected to the state taxing agency.
- Prepare the general journal entries to record the January 2 sales revenue. Also prepare the entry to show the remittance of the taxes on January 31.
- Now assume that the merchandise sold on January 2 also is subject to federal excise taxes of 12 per cent. The federal excise taxes collected are remitted to the proper agency on January 31. Show the entries on January 2 and January 31.
Problem D Honest Tim’s Auto Company sells used cars and warrants all parts for one year. The average price per car is $ 10,000, and the company sold 900 in 2009. The company expects 30 per cent of the cars to develop defective parts within one year of sale. The estimated average cost of warranty repairs per defective car is $ 600. By the end of the year, 80 cars sold that year had been returned and repaired under warranty. On 2010 January 4, a customer returned a car purchased in 2009 for repairs under warranty. The repairs were made on January 8. The cost of the repairs included parts, $ 400, and labor, $ 210.
- Calculate the amount of the estimated product warranty payable.
- Prepare the entry to record the estimated product warranty payable on 2009 December 31.
- Prepare the entry to record the repairs made on 2010 January 8.
Problem E Celoron Power Boat Company is in the power boat manufacturing business. As of 2010 September 1, the balance in its Notes Receivable account is $ 256,000. The balance in Dishonored Notes Receivable is $ 60,660 (includes the interest of $ 600 and the protest fee of $ 60). A schedule of the notes (including the dishonored note) is as follows:
| Face | Date | Interest | ||
| Amount | Maker | of Note | Life | Rate |
| $ 100,000 |
|
2009/6/01 | 120 days | 12% |
| 72,000 |
|
2009/6/15 | 90 | 8 |
| 84,000 |
|
2009/7/01 | 90 | 10 |
| 60,000 |
|
2009/7/01 | 60 | 6 |
| $316,000 |
Following are Celoron Power Boat Company’s transactions for September:
Sept. 10 Received $ 36,660 from N. Case Company as full settlement of the amount due from it. The company does not charge losses on notes to the Allowance for Uncollectible Accounts account.
? The A. Lamp Company note was collected when due.
? The C. Glass Company note was not paid at maturity.
? C. Wall Company paid its note at maturity.
30 Received a new 60-day, 12 per cent note from C. Glass Company for the total balance due on the dishonored note. The note was dated as of the maturity date of the dishonored note. Celoron Power Boat Company accepted the note in good faith.
Prepare dated journal entries for these transactions.
Problem F Premium Office Equipment, Inc., discounted its own $ 30,000, non interest-bearing, 180-day note on 2009 November 16, at Niagara County Bank at a discount rate of 12 per cent.
Prepare dated journal entries for:
- The original discounting on November 16.
- The adjustment required at the end of the company’s calendar-year accounting period.
- Payment at maturity.
Alternate problems
Alternate problem A The following selected accounts are for Keystone, Inc., a name brand shoe wholesale store, as of 2009 December 31. Prior to closing the accounts and making allowance for uncollectible accounts entries, the $ 5,000 account of Morgan Company is to be written off (this was a credit sale of 2009 February 12).
| Accounts receivable | $ 360,000 |
| Allowance for uncollectible accounts (credit) | 6,000 |
| Sales | 1,680,000 |
| Sales returns and allowances | 30,000 |
- Prepare journal entries to record all of these transactions and the uncollectible accounts expense for the period. Assume the estimated expense is 2 per cent of net sales.
- Give the entry to record the estimated expense for the period if the allowance account is to be adjusted to 5 per cent of outstanding receivables instead of as in (a).
Alternate problem B The cash register at Frank’s Restaurant at the close of business showed cash sales of $ 7,500 and credit card sales of $ 10,000 ($ 6,000 VISA and $ 4,000 American Express). The VISA (bank credit card) invoices were discounted 5 per cent when they were deposited. The American Express (nonbank credit card) charges were mailed to the company and were subject to a 5 per cent service charge. A few days later, Frank received a check for the net amount of the American Express credit card charges.
Prepare journal entries for all of these transactions.
Alternate problem C Beacham Hardware, Inc., sells merchandise in a state that has a 6 per cent sales tax. On 2010 July 1, it sold goods with a sales price of $ 20,000 on credit. Sales taxes collected are recorded in a separate account. Assume that sales for the entire month were $ 400,000. On 2010 July 31, the company remitted the sales taxes collected to the state taxing agency.
- Prepare the general journal entries to record the July 1 sales revenue and sales tax payable. Also prepare the entry to show the remittance of the taxes on July 31.
- Now assume that the merchandise sold also is subject to federal excise taxes of 10 per cent in addition to the 6 per cent sales tax. The company remitted the federal excise taxes collected to the proper agency on July 31. Show the entries on July 1 and July 31.
Alternate problem D Quick Wheels, Inc., sells racing bicycles and warrants all parts for one year. The average price per bicycle is $ 560, and the company sold 4,000 in 2009. The company expects 20 per cent of the bicycles to develop defective parts within one year of sale. The estimated average cost of warranty repairs per defective bicycle is $ 40. By the end of the year, 500 bicycles sold that year had been returned and repaired under warranty. On 2010 January 2, a customer returned a bicycle purchased in 2009 for repairs under warranty. The repairs were made on January 3. The cost of the repairs included parts, $ 25, and labor, $ 15.
- Calculate the amount of the estimated product warranty payable.
- Prepare the entry to record the estimated product warranty payable on 2009 December 31.
- Prepare the entry to record the repairs made on 2010 January 3.
Alternate problem E Vance Commercial Properties, Inc., has an accounting period of one year, ending on July 31. On 2009 July 1, the balances of certain ledger accounts are Notes Receivable, $ 654,000; and Notes Payable, $ 900,000. A schedule of the notes receivable is as follows:
| Face | Date | Interest | ||
| Amount | Maker | of Note | Life | Rate |
| $ 270,000 | Parker Co. | 2009/5/15 | 60 days | 12% |
| 120,000 | Dot Co. | 2009/5/31 | 60 | 12 |
| 264,000 | Fixx Co. | 2009/6/15 | 30 | 10 |
| $654,000 |
The note payable is a 60-day bank loan dated 2009 May 20. Notes Payable—Discount was debited for the discount of $ 6,000. Following are the company’s transactions during July:
July 1 Vance Commercial Properties, Inc., discounted its own $ 90,000, 60-day, non interest-bearing note at Key Bank. The discount rate is 10 per cent, and the note was dated today.
3 Received a 20-day, 12 per cent note, dated today, from Sox Company in settlement of an account receivable of $ 36,000.
6 Purchased merchandise from Link Company, $ 288,000, and issued a 60-day, 12 per cent note, dated today, for the purchase.
8 Sold merchandise to Fan Company, $ 360,000. A 30-day, 12 per cent note, dated today, is received to cover the sale.
14 Received payment on the Parker Company note dated 2009 June 15.
15 Fixx Company sent a $ 120,000, 30-day, 12 per cent note, dated today, and a check to cover the part of the old note not covered by the new note, plus all interest expense incurred on the prior note.
19 The note payable dated 2009 May 20, was paid in full.
23 Sox Company dishonored its note of July 3 and sent a check for the interest on the dishonored note and a new 30-day, 12 per cent note dated 2009 July 23.
30 The Dot Company note dated 2009 May 31, was paid with interest in full.
Prepare dated journal entries for these transactions and necessary July 31 adjusting entries.
Alternate problem F On 2010 November 1, Grand Strand Property Management, Inc., discounted its own $ 50,000, 180-day, non interest-bearing note at its bank at 18 per cent. The note was paid on its maturity date. The company uses a calendar-year accounting period.
Prepare dated journal entries to record (a) the discounting of the note, (b) the year-end adjustment, and (c) the payment of the note.
Beyond the numbers—Critical thinking
Business decision case A Sally Stillwagon owns a hardware store; she sells items for cash and on account. During 2009, which seemed to be a typical year, some of her company’s operating data and other data were as follows:
| Sales: | |
| For cash | $1,200,000 |
| On credit | 2,200,000 |
| Cost of obtaining credit reports on customers | 3,600 |
| Cost incurred in paying a part-time bookkeeper to keep the accounts receivable subsidiary ledger up to date | 12,000 |
| Cost associated with preparing and mailing invoices to customers and other collection activities | 18,000 |
| Uncollectible accounts expense | 45,000 |
| Average outstanding accounts receivable balance (on which Stillwagon estimates she could have earned 10 per cent if it had been invested in other assets) | 180,000 |
A national credit card agency has tried to convince Stillwagon that instead of carrying her own accounts receivable, she should accept only the agency’s credit card for sales on credit. The agency would pay her two days after she submits sales charges, deducting 6 per cent from the amount and paying her 94 per cent.
- Using the data given, prepare an analysis showing whether or not Stillwagon would benefit from switching to the credit card method of selling on credit.
- What other factors should she take into consideration?
Business decision case B Jim Perry operates a large fruit and vegetable stand on the outskirts of a city. In a typical year he sells $ 600,000 of goods to regular customers. His sales are 40 per cent for cash and 60 per cent on credit. He carries all of the credit himself. Only after a customer has a $ 300 unpaid balance on which no payments have been made for two months does he refuse that customer credit for future purchases. His income before taxes is approximately $ 95,000. The total of uncollectible accounts for a given year is $ 48,000.
You are one of Perry’s regular customers. He knows that you are taking a college course in accounting and has asked you to tell him your opinion of several alternatives recommended to him to reduce or eliminate the $ 48,000 per year uncollectible accounts expense. The alternatives are as follows:
- Do not sell on credit.
- Sell on credit by national credit card only.
- Allow customers to charge only until their account balances reach $ 50.
- Allow a bill collector to go after uncollectible accounts and keep half of the amount collected.
Write a report for Perry about the advisability of following any of these alternatives.
Annual report analysis C Visit the Internet site:
Locate the most recent annual reports of The Coca-Cola Company. Calculate accounts receivable turnover and the number of days’ sales in accounts receivable and prepare a written comment on the results.
Group project D In groups of two or three students, write a two-page, double-spaced paper on one of the following topics:
Which is better—the percentage-of-sales method or the percentage-of-receivables method?
Why not eliminate bad debts by selling only for cash?
Why allow customers to use credit cards when credit card expense is so high?
Should banks be required to use 365 days instead of 360 days in interest calculations?
Present your analysis in a convincing manner, without spelling or grammatical errors. Include a cover page with the title and authors’ names.
Group project E “Lapping” of accounts receivable has been used to conceal the fact that payments received on accounts receivable have been “borrowed” and used by an employee for personal use. With one or two other students, research this topic in the library. Write a paper to your instructor describing how this technique works and the steps that can be taken to detect it once it occurs and to prevent it in the future.
Group project F In a group of two or three students, visit a fairly large company in your community to investigate the effectiveness of its management of accounts receivable. Inquire about its credit and sales discount policies, collection policies, and how it establishes the amount for the adjusting entry for uncollectible accounts at year-end. Also ask about how it decides to write off accounts as uncollectible. Calculate its accounts receivable turnover and average collection period for each of the last two years. In view of its credit policies, does its collection period seem reasonable?
Using the Internet—A view of the real world
Visit one of the following Internet sites:
http://www.federatedinvestors.com
Follow some of the other options available at the site. Write a report to your instructor on your experience, describing some of the things you learned at this site. You may want to pretend that you invested in one or more of these funds for the duration of the quarter or semester and see how your investment would have fared during that period. Many investors with a limited amount to invest can have a diversified portfolio by investing in mutual funds. Thus, they spread their risk by investing in a mutual fund that, in turn, invests in many different companies.
Visit Procter & Gamble’s site at:
Procter & Gamble markets more than 250 brands to nearly five billion consumers in over 140 countries. Click on any items that deal with financial news, annual report summary, stock quote, and anything else that looks interesting. Write a memo to your instructor summarizing your findings. Include in your memo some of the financial highlights contained in the annual report summary.
[1]FASB, Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (Stamford, Conn., 1975). Copyright © by Financial Accounting Standards Board, High Ridge Park, Stamford, Connecticut 06905, USA.
[2]AICPA, Accounting Trends & Techniques (New York, 2000), p. 100.