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CHAPTER 7
QUESTIONS
1. (a) A receivable evidenced by a formal,
written promise to pay is classified as a
note receivable; an informal, unsecured
promise to pay is classified as an account receivable or other appropriate
title (e.g., advances to officers).
(b) Receivables arising from the normal
operating activities of a business are
classified as trade receivables; those
from all other sources are nontrade receivables.
(c) All trade receivables and those nontrade receivables expected to be collected within one year (or the normal
operating cycle, whichever is longer)
are reported as Current Assets; all other receivables are noncurrent and are
reported under the Investments or
Other Noncurrent Assets caption,
whichever is appropriate.

3. GAAP requires the allowance method because it provides for a matching of current
revenues with related expenses, and it reports the receivables at their net realizable
value. The direct write-off method is easy to
apply and is objective but does not provide
for proper matching of revenues and expenses nor appropriate valuation of receivables.
4. (a) Adjustments to be made:
Age the receivables (including the dishonored notes) in order to determine
the amount by which to increase Allowance for Bad Debts or to create an allowance balance if none exists. Write
off worthless accounts of $320 as follows:
Allowance for Bad Debts .... 320
Accounts Receivable ......

320
(b) Accounts Receivable should appear on
the balance sheet under Current Assets at $9,572. This balance consists of
the following:
Accounts from sales of
last three months .............. $7,460
Accounts from sales
prior to October 1 .............. 1,312
Dishonored notes
charged back to
customers’ accounts .........
800
$ 9,572

2. (a) Methods for establishing and maintaining an allowance for bad debts account
are as follows:
(1) Allowance for Bad Debts is increased by a certain percentage of
total sales or credit sales.
(2) Allowance for Bad Debts is adjusted to a certain percentage of
receivables.
(3) Allowance for Bad Debts is adjusted to an amount determined by
aging the accounts.
(b) The percentages to use in estimating
uncollectible accounts should be based
on the collection experience of each individual company. Analysis of the past
records can be made to determine the
relationships between write-offs and
sales or receivables. If there has been
no recognizable change in the economic conditions or in the credit policy
of the company, these historical percentages may be used as the best estimate of future uncollectibles. To the

extent that these conditions are changing, the percentages will require appropriate adjustment.

The balance of Allowance for Bad
Debts should be deducted from Accounts Receivable. The credit balances
in customers’ accounts, $1,190, should
be reported as a current liability.
5. Product warranties are obligations that
clearly exist at a balance sheet date, but
the amount to be paid cannot be definitely
determined. The amount of the claim is
therefore estimated. This estimated liability
should normally be recorded on an accrual
basis because the obligation created upon
the sale of a product should be matched
with the revenue received from the sale.

207


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208

6. (a) Accounts receivable turnover is computed by dividing net sales by the average accounts receivable outstanding
for the year.
(b) Average collection period is computed
by dividing average daily sales (net
sales
365) into the average receivables for the year. This measurement
can also be obtained by dividing the
number of days in a year by the accounts receivable turnover.

(c) The accounts receivable turnover
represents the average number of
sales or collection cycles completed by
a firm during a particular year. The
average collection period shows the
average time required to collect receivables.
7. Cash, because it is the standard medium of
exchange, is required to complete almost
all business transactions. Therefore, a certain amount of cash must be kept immediately available for daily transactions. It is
management’s responsibility to see that
sufficient cash, but not an excessive
amount, is available for current operating
purposes. To be productive, any excess of
―idle cash‖ should be invested in temporary
or long-term investments.
8. (a) Cash
(b) Investments, noncurrent receivables, or
other assets (not currently available)
(c) Cash
(d) Other noncurrent assets (will be used
to acquire a noncurrent asset)
(e) Accounts receivable
(f) Accounts receivable
(g) Employees’ accounts or notes receivable
(h) Office supplies
(i) Cash
(j) Notes receivable
(k) Cash
(l) Cash
9. The balance with Bank A should be reported as cash. The overdraft with Bank B

should be reported as a current liability.
Even if the overdraft arose from deposited
checks that did not clear, it would represent
a liability to the bank. The fact that the
overdraft is canceled promptly is not relevant; as of December 31, it would still have
to be regarded as a liability.

Chapter 7

10. Because the compensating balance is legally restricted, the balance should be segregated and reported separately among
the Cash Items in the Current or Noncurrent Assets section of the balance sheet,
depending on the nature of the restrictions.
This will protect financial statement readers
from assuming that the total cash balance
is available to pay current obligations.
11. (a) Differences between depositor and
bank balances typically arise from the
following:
(1) Deposits in transit
(2) Outstanding checks
(3) Bank service charges
(4) Not-sufficient-funds checks
(5) Direct collection by bank of
amounts owed to depositor
(6) Recording errors by the depositor
or the bank
(b) Items (3), (4), and (5) require entries on
the depositor’s books, as well as item
(6) if the error was made by the depositor.
‡

12. The practice of financing accounts receivable has become very popular. In the past
this form of financing was viewed as a last
resort for obtaining funds. Now it is often
seen as a wise and legitimate business tool
that can be used to put the assets of a
company to work. This change in attitude
results from the realization that an available, easy-to-obtain form of financing was
not being used.
‡
13. (a) (1) When receivables are sold, they
are removed from the books of the
seller and a gain or loss is recognized for the difference between
the net proceeds received and the
carrying value of the receivables.
(2) When receivables are used as collateral to secure loans, the receivables remain on the books and a
loan is recorded. The amount of
receivables assigned should be
disclosed in the notes to the financial statements.
(b) (1) The entry to record the sale of receivables without recourse involves
a debit to Cash for the sales price
(less the amount, if any, withheld
by the factor), a debit to Loss from
‡

Relates to Expanded Material.


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Factoring for the charge made by
the factor, a debit to Allowance for
Bad Debts, and a credit to Accounts Receivable for the accounts
sold. If the factor withholds a portion of the sales price pending final
settlement, the amount withheld is
recorded as a debit to Receivable
from Factor. If the receivables are
sold with recourse, the value of the
recourse obligation must be estimated, and the loss on the sale is
increased accordingly.
(2) Accounting for receivables involved
in a secured borrowing involves
making memorandum entries for
data concerning the pledge.
‡

14. According to U.S. GAAP, the following
three conditions must be met in order to
record the transfer of accounts receivable
with recourse as a sale:
(1) The transferred assets must be beyond
the reach of the transferor and its creditors.
(2) The transferees have the right to
pledge or exchange the transferred assets.
(3) The transferor does not maintain effective control over the assets through an
agreement to repurchase them before
their maturity or the ability to cause the
transferee to return specific assets.
‡


15. Under the provisions of IAS 39, a receivable should be derecognized (1) when substantially all of the risks and rewards of
ownership have been transferred or (2) if
the risk and rewards of ownership have not
been transferred but control of the receivable has been transferred.

209

more or less than the fair market value
of the consideration exchanged. However, short-term trade notes may be
recorded at face amount even when
the face amount is not equal to its
present value.
(b) The difference between a note’s face
amount and its present value is initially
recorded as a premium or discount and
amortized over the life of the note. The
amortization procedure is a systematic
allocation of the premium or discount to
Interest Revenue on the books of the
holder of the note and to Interest Expense on the books of the issuer of the
note.
‡

17. An assignment is disclosed in a parenthetical comment or note to the balance sheet,
stating the nature and amount of the
pledged receivables. The receivables continue to be reported as an asset in the balance sheet, and the associated loan is reported as a liability.
‡

18. Imputing a rate of interest is the process of
selecting and applying an interest rate

deemed appropriate under the circumstances. An imputed rate must be determined when no interest rate is stated or
when the stated rate is unreasonable, and
the present value of a note cannot be determined by reference to the note itself or to
the consideration exchanged for the note.
The selection of an appropriate rate is
based on factors such as the credit standing of the issuer of the note, prevailing interest rates for notes with similar terms,
and the rate at which the debtor could obtain financing from other sources at the
time of the transaction.

‡

16. (a) A note receivable should be recorded
at an amount different from its face
amount when the face amount differs
from the present value. Such a difference arises when a note is noninterest-bearing or when the face
amount of an interest-bearing note is

‡

Relates to Expanded Material.


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Chapter 7

PRACTICE EXERCISES
PRACTICE 7–1


SIMPLE CREDIT SALE JOURNAL ENTRIES

Accounts Receivable ..........................................................
Sales ...............................................................................

150,000

Cash .....................................................................................
Accounts Receivable ....................................................

101,000

PRACTICE 7–2

150,000
101,000

SALES DISCOUNTS: GROSS METHOD

Accounts Receivable ..........................................................
Sales ...............................................................................

700

Cash ($300 0.97) ...............................................................
Sales Discounts ..................................................................
Accounts Receivable ....................................................

291
9


Cash .....................................................................................
Accounts Receivable ....................................................

400

PRACTICE 7–3

700

300
400

SALES DISCOUNTS: NET METHOD

Accounts Receivable ($700 0.97) ....................................
Sales ...............................................................................

679

Cash .....................................................................................
Accounts Receivable ($300 0.97) ..............................

291

Cash .....................................................................................
Sales Discounts Not Taken...........................................
Accounts Receivable ($400 0.97) ..............................

400


PRACTICE 7–4

679
291
12
388

SALES RETURNS AND ALLOWANCES

Sales Returns and Allowances ..........................................
Accounts Receivable ....................................................

12,000

Inventory ..............................................................................
Cost of Goods Sold .......................................................

8,400

PRACTICE 7–5

12,000
8,400

BASIC BAD DEBT JOURNAL ENTRIES

Bad Debt Expense ..............................................................
Allowance for Bad Debts ..............................................


12,000

Allowance for Bad Debts ....................................................
Accounts Receivable ....................................................

8,100

12,000
8,100


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211

PRACTICE 7–6

RECOVERY OF AN ACCOUNT PREVIOUSLY WRITTEN OFF

July 23 Allowance for Bad Debts .......................................
Accounts Receivable ........................................

7,500

Nov.

1 Accounts Receivable .............................................
Allowance for Bad Debts..................................


7,500

Cash ........................................................................
Accounts Receivable ........................................

7,500

PRACTICE 7–7

7,500
7,500
7,500

BAD DEBTS: PERCENTAGE-OF-SALES METHOD

Bad Debt Expense ($600,000 0.03) .................................
Allowance for Bad Debts ..............................................

18,000

Allowance for Bad Debts ....................................................
Accounts Receivable ....................................................

19,700

PRACTICE 7–8

18,000
19,700


BAD DEBTS: PERCENTAGE-OF-ACCOUNTS-RECEIVABLE METHOD

Allowance for Bad Debts ....................................................
Accounts Receivable ....................................................

16,600

Bad Debt Expense ..............................................................
Allowance for Bad Debts ..............................................
$200,000 0.14 = $28,000; $28,000 – $900 = $27,100

27,100

PRACTICE 7–9

16,600
27,100

AGING ACCOUNTS RECEIVABLE

Category
Less than 30 days
31 60 days
61 90 days
Over 90 days
Total Allowance for Bad Debts

Amount
$122,000
24,000

8,000
9,000

Percentage
0.02
0.10
0.30
0.75

Total
$ 2,440
2,400
2,400
6,750
$13,990

PRACTICE 7–10 ESTIMATION AND RECOGNITION OF WARRANTY EXPENSE
Warranty Expense ($750,000 0.04) ..................................
Estimated Warranty Liability ........................................

30,000

Estimated Warranty Liability ..............................................
Cash ...............................................................................

37,400

30,000
37,400



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Chapter 7

PRACTICE 7–11 COMPARISON OF ACTUAL AND EXPECTED WARRANTY
EXPENSE
1.

Warranty Liability
0
Actual
repairs

Actual
repairs

3,000

6,500

Beginning—Y1

4,000

Estimated
expense

1,000


Ending—Y1

6,000

Estimated
expense

500

Ending—Y2

2. Compare existing balance with estimated future repairs:
$150,000 0.04 = $6,000; $6,000 6/12 remaining = $3,000
Ending balance of $500 is much less than the estimated remaining repairs
of $3,000.
Compare past estimates with actual experience:
Year 1
Estimated repairs—$100,000 0.04 6/12 = $2,000
Actual repairs—$3,000
Actual repairs were greater than estimated repairs.
Year 2
Estimated repairs—($100,000 0.04 6/12) + ($150,000 0.04
$5,000
Actual repairs—$6,500
Again, actual repairs were greater than estimated repairs.

6/12) =

The balance in the warranty liability account at the end of Year 2 appears to

be much too low. Using the company’s own estimates, the balance should
be $3,000 instead of $500. In addition, in the past two years the company
has significantly underestimated the amount of repairs.
PRACTICE 7–12 AVERAGE COLLECTION PERIOD
1. Average collection period: [($50,000 + $65,000)/2]/($400,000/365) = 52.5 days
2. Average collection period: $65,000/($400,000/365) = 59.3 days


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213

PRACTICE 7–13 COMPUTATION OF CASH BALANCE
Savings account balance ......................................
Coin and currency .................................................
Cash balance ..........................................................

$10,000
2,300
$12,300

Restricted deposits in foreign bank accounts .....
Cash overdraft........................................................
Postdated customer checks .................................

Receivable
Payable
Receivable


PRACTICE 7–14 BANK RECONCILIATION
Balance per bank statement .................................
Add: Deposits in transit .........................................
Deduct: Outstanding checks.................................
Correct balance ......................................................
Balance per books .................................................
Add: Interest earned ..............................................
Deduct: Bank service charge ................................
Correct balance ......................................................

$ 11,500
2,700
$ 14,200
3,900
$ 10,300
$ 10,320
45
$ 10,365
65
$ 10,300

‡

PRACTICE 7–15 SALE OF RECEIVABLES WITHOUT RECOURSE
Cash .....................................................................................
Receivable from Factor ......................................................
Allowance for Bad Debts ....................................................
Loss from Factoring Receivables ......................................
Accounts Receivable ....................................................


50,000
3,000
2,500
4,500
60,000

‡

PRACTICE 7–16 SALE OF RECEIVABLES WITH RECOURSE
Cash .....................................................................................
Receivable from Factor ......................................................
Allowance for Bad Debts ....................................................
Loss from Factoring Receivables ......................................
Accounts Receivable ....................................................
Recourse Obligation .....................................................

‡

Relates to Expanded Material.

50,000
3,000
2,500
5,800
60,000
1,300


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Chapter 7

‡

PRACTICE 7–17 ACCOUNTING FOR A SECURED BORROWING
If the transfer does not satisfy the three conditions contained in FASB ASC
paragraph 860-10-40-5, then it is not accounted for as a sale but is instead
recorded as a secured borrowing, as follows:
Cash .....................................................................................
Loan Payable .................................................................

53,000
53,000

‡

PRACTICE 7–18 JOURNAL ENTRIES FOR INTEREST-BEARING NOTE
Year
Jan.

1 Notes Receivable....................................................
1
Service Revenue ...............................................

6,000

Year 1 Interest Receivable .................................................
Dec. 31
Interest Revenue ($6,000 0.09 12/12) .........


540

Year 2 Cash ........................................................................
June 30
Notes Receivable ..............................................
Interest Receivable ...........................................
Interest Revenue ($6,540 0.09 6/12) ...........

6,834

6,000
540
6,000
540
294

‡

PRACTICE 7–19 JOURNAL ENTRIES FOR NON-INTEREST-BEARING NOTE
Year
Jan.

1 Notes Receivable....................................................
1
Discount on Notes Receivable.........................
Service Revenue ...............................................

1,000


Year 1 Discount on Notes Receivable ..............................
Dec. 31
Interest Revenue ($857 0.08 12/12) ............

69

Year 2 Cash ........................................................................
Dec. 31 Discount on Notes Receivable ..............................
Notes Receivable ..............................................
Interest Revenue [($857 + $69) 0.08 12/12]

1,000
74

143
857
69

1,000
74

‡

PRACTICE 7–20 NOTE EXCHANGED FOR GOODS OR SERVICES
Jan.

‡

1 Notes Receivable....................................................
Loss on Sale of Land .............................................

Land ...................................................................

2,000
450

Dec. 31 Cash ........................................................................
Notes Receivable ..............................................
Interest Revenue ($2,000 0.12 12/12) .........

2,240

Relates to Expanded Material.

2,450
2,000
240


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215

‡

PRACTICE 7–21 EFFECTIVE INTEREST AMORTIZATION METHOD
Year
Jan.

1 Notes Receivable....................................................

1
Discount on Notes Receivable.........................
Service Revenue ...............................................
To compute the present value of the note: FV = $1,000;
N = 3; I = 10%
PV = $751

1,000

Year 1 Discount on Notes Receivable ..............................
Dec. 31
Interest Revenue (see following table) ............

75

Year 2 Discount on Notes Receivable ..............................
Dec. 31
Interest Revenue (see following table) ............

83

Year 3 Cash ........................................................................
Dec. 31 Discount on Notes Receivable ..............................
Notes Receivable ..............................................
Interest Revenue (see following table) ............

1,000
91

(1)

(2)
Face Amount
Before
Current
Unamortized
Installment
Discount

Dec. 31, Year 1
Dec. 31, Year 2
Dec. 31, Year 3

$1,000
1,000
1,000

$249
174
91

249
751

75
83

1,000
91

(3)


(4)

(5)

Net
Amount
(1) – (2)

Discount
Amortization
10% (3)

Payment
Received

$751
826
909

$ 75
83
91
$ 249

$1,000

‡

PRACTICE 7–22 BAD DEBTS AND THE DIRECT METHOD

Change in net accounts receivable balance:
Beginning of year ($13,000 – $3,000) ...........
End of year ($9,500 – $3,100) ........................
Decrease.........................................................

$10,000
6,400
$ 3,600

Cash Flows
Income
Adjustfrom
Statement ments Operations
Sales
Bad debt expense
Cash expenses
Net income

$ 75,000
(2,000)
(53,000)
$ 20,000

$3,600
0
0
$3,600

$ 78,600
(2,000)

(53,000)
$ 23,600

Cash collected from
customers
Cash paid for expenses
Cash from operations

Cash collected from customers ($78,600 – $2,000) ..........
Cash paid for expenses ......................................................
Cash flows from operating activities .................................
‡

Relates to Expanded Material.

$ 76,600
(53,000)
$ 23,600


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Chapter 7

‡

PRACTICE 7–23 BAD DEBTS AND THE INDIRECT METHOD
See the solution to Practice 7–22.
Net income .............................................................

Plus: Decrease in net accounts receivable ..........
Cash flows from operating activities ....................

‡

Relates to Expanded Material.

$ 20,000
3,600
$ 23,600


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217

EXERCISES
7–24.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.


E, cash, current asset
A, D, current asset
D, current asset
A, C, current asset
D, current asset
D, current asset
B, D, noncurrent asset
B, C, current asset
D, current asset
E, prepaid insurance, current asset
E, payable, current liability

7–25.
$74,000 – $31,500 = $42,500 cost of merchandise sold
$42,500 1.6 = $68,000 sales
$68,000 – $53,000 = $15,000 amount that should be in Accounts Receivable
$15,000 – $21,300 = $6,300 overage in Accounts Receivable
7–26.
1.

Cash collected on November 9 ($3,000 0.97).........
Cash collected on December 9 ..................................
Total cash collected ...................................................

2.

November 9
Cash ($3,000 0.97)..............................................
Sales Discounts ($3,000 0.03) ...........................

Accounts Receivable ......................................

2,910
90

December 9
Cash .......................................................................
Accounts Receivable ......................................

4,000

November 9
Cash .......................................................................
Accounts Receivable ......................................

2,910

3.

December 9
Cash .......................................................................
Accounts Receivable ($4,000 0.97) .............
Sales Discounts Not Taken ............................

$2,910
4,000
$6,910

3,000


4,000

2,910
4,000
3,880
120

For the seller, the account Sales Discounts Not Taken is a revenue account
and reflects the implicit interest charge customers pay by not taking cash
discounts. Also, note that with the net method, the original sales amount is
recorded at $6,790 ($7,000 0.97), which assumes that the sales discounts
will be taken.


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Chapter 7

7–27.
1.

July 23
Accounts Receivable............................................
Sales ................................................................
Cost of Goods Sold ..............................................
Inventory ..........................................................

2.


3.

4,500
4,500
3,000
3,000

August 17
Cash .......................................................................
Accounts Receivable ......................................

3,000

August 17
Sales Returns and Allowances ............................
Accounts Receivable ......................................

1,500

Inventory ...............................................................
Cost of Goods Sold .........................................

3,000

1,500
1,000
1,000

4.


Management must ensure that inventory is not recorded in the books
at more than its current value. This lower-of-cost-or-market test would
be especially important in this case because the customer has reported that the inventory does not meet the required specifications.

1.

Bad Debt Expense [0.015 ($3,450,000 – $51,000)] ..
Allowance for Bad Debts .......................................

50,985

Bad Debt Expense [(0.08 $550,000) + $4,500] .........
Allowance for Bad Debts .......................................

48,500

Bad Debt Expense ($41,000 + $4,500) ........................
Allowance for Bad Debts .......................................

45,500

Allowance for Bad Debts ............................................
Accounts Receivable (Phillip Hollister) ................

1,350

Accounts Receivable (Phillip Hollister) .....................
Allowance for Bad Debts .......................................

1,350


Cash ..............................................................................
Accounts Receivable (Phillip Hollister) ................

1,350

7–28.

2.
3.

50,985
48,500
45,500

7–29.
1.
2.

1,350
1,350
1,350


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219

7–30.

1.

Customer
Allison, Inc. ...
Banks Bros. ..
Barker & Co. .
Marrin Co. .....
Ring, Inc. .......
West Corp. ....

Amount
$ 8,795
5,230
7,650
11,285
7,900
4,350
$45,210

2. Total $2,643 (rounded)

3.

Blanchard Company
Analysis of Receivables
December 31, 2013
0–30
31–60
61–90
Days

Days
Days
$ 3,500 $ 5,295
5,000
5,785

$2,650
5,500

$11,080

$8,150

91–120 Over 120
Days
Days
$3,000

$2,230

4,350
$7,350

$2,230

7,900
$16,400
$16,400
11,080
8,150

7,350
2,230

0.007
0.014
0.035
0.102
0.600

= $ 114.80
=
155.12
=
285.25
=
749.70
= 1,338.00
$ 2,642.87

Bad Debt Expense ($2,643 – $2,245) ..............
Allowance for Bad Debts ...........................

398
398

4. a. The percentages applied under the aging method are based on
averages developed from prior experience. Because the number of
accounts is small, the averaging process is not fully applicable.
For example, the Banks Bros. account may be collectible, uncollectible, or partially collectible, but the chances of not collecting
exactly 60% of the $2,230 and 10.2% of the $3,000 seem highly unlikely. Similarly, the West Corp. account will likely be collected in

full, or not at all. To expect to receive 89.8% (100% – 10.2%) is unrealistic. When accounts are few in number, an analysis of each individual receivable’s collectibility will provide a more realistic estimation of uncollectible accounts.
b. Yes. All methods of estimating bad debts are based on averages. An
averaging process requires a sufficient total number of items to
make the estimate accurate. The larger the test population, the less
effect each item in the population has on the average. This helps to
eliminate errors resulting from the use of an item that is uncharacteristic of the trend being estimated.


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7–31.

Chapter 7

1.

2011
Beginning allowance balance................. $ 44,600
Estimated uncollectibles (2% of sales) ..
57,000
Total allowance before write-offs ........... $101,600
Ending allowance balance ......................
61,600
Accounts written off ................................ $ 40,000

2012
$ 61,600
72,000
$133,600

82,800
$ 50,800

2013
$ 82,800
78,800
$161,600
123,000
$ 38,600

2. Aging of accounts receivable would indicate whether the increase in the
allowance is justified.
7–32.

1.

2012 Warranty Expense ($700,000 0.11) ..............
Estimated Liability under Warranties ........

77,000

Estimated Liability under Warranties.............
Cash, Inventory, etc. ...................................

18,500

2013 Warranty Expense ($850,000 0.11) ..............
Estimated Liability under Warranties ........

93,500


Estimated Liability under Warranties .............
Cash, Inventory, etc. ...................................

30,750

77,000
18,500
93,500

2. 2012 sales still under warranty for 6 months
($700,000 1/2 0.07)(a) ..........................................................
2013 sales still under warranty for 18 months
($850,000 0.07) + ($850,000 1/2 0.04)(a) ..........................
Ending balance in liability accounts .......................................
Predicted future warranty repairs ...........................................
Difference ..................................................................................

30,750
$ 24,500
76,500
$101,000
$121,250 (b)
101,000
$ 20,250

This difference is fairly large. The estimates from the manufacturer may
need to be adjusted.
EXPLANATIONS
(a)

Because sales are made evenly during the year, one-half of warranty
costs associated with one calendar year are actually incurred in the
following calendar year.
(b)

Balance in liability account at end of 2012
($77,000 – $18,500) ............................................................
Increase in liability account during 2013
($93,500 – $30,750) ............................................................
Balance in liability account at end of 2013 .........................

$ 58,500
62,750
$121,250


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7–33.

221

2012 Cash ..........................................................................
Unearned Revenue from Service Contracts........
To record cash received from sale of
service contracts: 380 $75 = $28,500.

28,500


Unearned Revenue from Service Contracts ..........
Revenue from Service Contracts .........................
To record estimated revenue earned
from service contracts:
(1/2 0.32) $28,500 = $4,560.

4,560

Cost of Servicing Television Contracts .................
Cash, Inventory, etc. .............................................
To record repairs actually made during
the year.

4,240

28,500

4,560

2013 Cash ..........................................................................
31,500
Unearned Revenue from Service Contracts........
To record cash received from sale of service
contracts; 420 $75 = $31,500.
Unearned Revenue from Service Contracts ..........
15,300
Revenue from Service Contracts .........................
To record the estimated revenue earned from
service contracts.
*2012: [(1/2 0.40)(a) $28,500(b)] + [(1/2 0.32) $28,500] .........

*2013: (1/2 0.32) $31,500(c) ........................................................

4,240

31,500

15,300*

$10,260
5,040
$15,300

EXPLANATIONS
(a)
Because sales are made evenly during the year, one-half of 2012
estimated repairs and one-half of 2013 estimated repairs are realized in 2013.
(b)
380 contracts sold in 2012 at $75 each.
(c)
420 contracts sold in 2013 at $75 each.
Cost of Servicing Television Service Contracts ....
8,250
Cash, Inventory, etc. ............................................
To record the repairs actually made during the year.
Total revenue from service contracts in 2013 ..................
Total actual expenses relating to service contracts ........
Profit from service contracts in 2013 ................................

8,250
$15,300

8,250
$ 7,050


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222

Chapter 7

7–34.

1. Net sales ..................................................................
$2,145,000
2013 net receivables................................................
223,000
2012 net receivables................................................
202,000
Average net receivables
[($223,000 + $202,000) ÷ 2] ..................................
212,500
Accounts receivable turnover: $2,145,000 ÷ $212,500 = 10.09 times
2. $2,145,000 ÷ 365 = $5,876.71
$212,500/$5,876.71 = 36.16 days

7–35.

1.

(1)
(2)

(3)
(4)
(5)
(6)
(7)

(e)
(a)
(c)
(a)
(a)
(b)
(f)

(8)
(9)
(10)
(11)
(12)
(13)
(14)

(d)
(d)
(d)
(a)
(d)
(a)—the $16 portion
(a)


2. Checking account at Second Security..............................
Payroll account ...................................................................
Sales tax account ...............................................................
Traveler’s check .................................................................
Cash in petty cash fund .....................................................
Money order ........................................................................
Total ...............................................................................

$350
100
150
50
16
36
$702

The other items are restricted or are not acceptable for deposit at face value by a bank. Also, two of the above items (i.e., the payroll account and the
sales tax account) might be reported separately if considered material because they are restricted in terms of their use.
7–36.

1.

Restricted Cash .......................................................... 7,450,000
Revenue Received in Advance ............................
7,450,000

2. Restricted Cash would be shown as a current asset separate from Cash.
The asset is current because it relates to an obligation (to provide vacations), which presumably will be satisfied within one year. Revenue Received in Advance would be shown as a current liability. The nature of
the cash restriction would also probably be disclosed in the notes to the
financial statements.

7–37.

Cash is $1,669,500 ($29,500 + $1,375,000 + $265,000). The $225,000 compensating balance amount should be included in Cash, but the nature of
the agreement should be disclosed in the notes to the financial statements.
The $2,500,000 restricted time deposits would be shown as Restricted Cash
in the Current Assets section.


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7–38.

223

Balance per bank statement ............................................................
Add: Deposits in transit ....................................................................

$32,346
3,689
$36,035
6,530
$29,505

Deduct: Outstanding checks............................................................
Correct balance .................................................................................

The service charge, interest, and recording error are all items that were
handled correctly by the bank.
7–39.


Balance per Lewiston’s books ....................................
Add: Unrecorded check received but not yet deposited
Deduct: Service charge ..............................................
NSF check .....................................................
Correct balance ............................................................

$7,842
275
$8,117
$110
350

460
$7,657

The deposits in transit and outstanding checks have already been handled
properly by Lewiston.
7–40.

1.

Clegg Auto
Bank Reconciliation
September 30

Balance per bank statement ...................................
Add: Deposits in transit ....................................
Check charged incorrectly .......................
Deduct: Outstanding checks .............................

Corrected bank balance ..........................................
Balance per books ...................................................
Add: Collection of note ......................................
Deduct: Bank service charge ...........................
Transposition error .............................
Corrected book balance ..........................................

$18,972.67
$3,251.42
713.18

3,964.60
(4,163.51)
$18,773.76
$16,697.76
2,150.00

$

2. Journal entry to correct Clegg Auto’s books:
Miscellaneous Expense ............................................
Sales ($1,682 – $1,628)..............................................
Cash [$2,150 – ($20 + $54)] .......................................
Notes Receivable ....................................................
Interest Revenue.....................................................

20.00
54.00

(74.00)

$18,773.76

20
54
2,076
2,100
50


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224

Chapter 7

7–41.

Determination of checks issued during June:
All cash credits during June ...........................................
Less: Service charge of May recorded in June .............
Checks issued during June .............................................
Determination of checks cashed during June:
Checks and charges recorded during June ...................
Less: NSF check returned in June .................................
June service charge ..............................................
Checks cashed during June ............................................

7–42.

‡


‡

235
$16,085
$21,675
16,085

Outstanding checks at the end of June ............................
Less: Excess of checks issued over checks cashed .......
Outstanding checks at the beginning of June ..................

$11,470
5,590
$ 5,880

1.

$ 5,590

Cash .............................................................................
Receivable from Factor ..............................................
Allowance for Bad Debts ...........................................
Loss from Factoring Receivables .............................
Accounts Receivable ............................................

675,000
75,000
120,000
30,000


Cash .............................................................................
Receivable from Factor ........................................

75,000

900,000
75,000

COMPUTATIONS:
FV = $10,000, N = 3, I = 12%

PV = $7,118
$10,000 – $7,118 = $2,882 discount
$8,000 – $7,118 = $882 loss on sale

Notes Receivable ...........................................................
Loss on Sale of Equipment...........................................
Equipment (net)........................................................
Discount on Notes Receivable ................................
End of First Year
Discount on Notes Receivable .....................................
Interest Revenue ......................................................
($10,000 – $2,882 = $7,118 0.12 = $854)

‡

$16,320
$200
35


Checks issued during June ...............................................
Checks cashed during June ..............................................
Excess of checks issued over checks cashed
during June ........................................................................

2.

7–43.

$21,705
30
$21,675

Relates to Expanded Material.

10,000
882
8,000
2,882
854
854


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225

7–43. ‡ (Concluded)
End of Second Year

Discount on Notes Receivable .....................................
Interest Revenue ......................................................
($7,118 + $854 = $7,972 0.12 = $957)
End of Third Year
Discount on Notes Receivable .....................................
Interest Revenue ......................................................
($7,972 + $957 = $8,929 0.12 = $1,071)

957
957

1,071
1,071

Although not required by the exercise, the entry to record the receipt of final payment on the note would be:
Cash ...............................................................................
Notes Receivable .....................................................

10,000
10,000

The discount on notes receivable would be fully amortized by this time
($854 + $957 + $1,071 = $2,882).
7–44.‡

1.
2.

3.
4.


5.

‡

Inventory .....................................................................
Accounts Payable .................................................

95,000

Accounts Payable .......................................................
Inventory ................................................................
Cash .......................................................................
($95,000 0.03 = $2,850 cash discount)

95,000

Cash .............................................................................
Notes Payable .......................................................

75,000

Interest Expense .........................................................
Cash .......................................................................
($75,000 0.08 1/12 = $500)

500

Interest Expense .........................................................
Notes Payable .............................................................

Cash .......................................................................

500
75,000

Relates to Expanded Material.

95,000
2,850
92,150

75,000
500

75,500


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226

Chapter 7

7–45. ‡
Cash Flows
from
Income
Adjust- Operating
Statement ments Activities
Sales
Bad debt expense

Cash expenses
Net income

$800,000 $(40,000) $ 760,000
(24,000)
0
(24,000)
(681,000)
0
(681,000)
$ 95,000 $(40,000) $ 55,000

Cash collected from
customers
Cash paid for expenses
Cash from operations

1. Cash collected from customers ($760,000 – $24,000)
Cash expenses ................................................................
Cash flow from operating activities ..............................

$ 736,000
(681,000)
$ 55,000

2. Net income ......................................................................
Less: Increase in Accounts Receivable ........................
Cash flow from operating activities........................

$ 95,000

(40,000)
$ 55,000

(Note: When computing cash flow from operations, both the bad debt expense and any write-off of uncollectibles can be ignored when using the indirect method and net receivable balances.)

‡

Relates to Expanded Material.


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227

PROBLEMS
7–46.
1.

2.

Cash...........................................................................................
Accounts Receivable ...............................................................
Sales ....................................................................................

310,270
380,780

Cash...........................................................................................
Sales Discounts ........................................................................

Accounts Receivable ..........................................................
*$303,800 ÷ 0.96 = $316,458; $316,458 – $303,800 = $12,658

303,800
12,658*

691,050

316,458

Allowance for Bad Debts .........................................................
Accounts Receivable ..........................................................

5,250

Sales Returns and Allowances ................................................
Accounts Receivable ..........................................................

83,800

Sales Returns and Allowances ................................................
Cash .....................................................................................

13,318

Accounts Receivable ...............................................................
Allowance for Bad Debts ....................................................

8,290


Cash...........................................................................................
Accounts Receivable ..........................................................

8,290

5,250
83,800
13,318
8,290
8,290

Bad Debt Expense ....................................................................
4,265*
Allowance for Bad Debts ....................................................
4,265
*$380,780 – $83,800 – $12,658 = $284,322; $284,322 0.015 = $4,265 (rounded)

7–47.
1.

2.

3.

Gross method:
Accounts Receivable ..........................................................
Sales ...............................................................................

70,000


Net method:
Accounts Receivable ..........................................................
Sales ...............................................................................

68,600

Gross method:
Cash .....................................................................................
Sales Discounts ..................................................................
Accounts Receivable ....................................................

68,600
1,400

Net method:
Cash .....................................................................................
Accounts Receivable ....................................................

68,600

70,000

68,600

70,000

68,600


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228

7–47.
4.

Chapter 7

(Concluded)
Gross method:
Cash .....................................................................................
Accounts Receivable ....................................................

70,000
70,000

Net method:
Cash .....................................................................................
70,000
Accounts Receivable ....................................................
68,600
Sales Discounts Not Taken...........................................
1,400
For the seller, the account Sales Discounts Not Taken is a revenue account
and reflects the implicit interest charge customers pay by not taking cash discounts.
5.

The net method is theoretically more correct because the cash value of the
transaction is $68,600—if the customer were to pay in cash, the price would be
$68,600. Any amount paid above that is, at least implicitly, a finance or interest
charge.

The net method is not used in practice because the bookkeeping involved is
more difficult. Particularly tricky are the necessary adjusting entries at yearend to reflect the amount of Sales Discounts Not Taken on credit sales that are
past the discount period but that have not been paid. In addition, in most
cases, the operating results derived using the gross method and the net
method will not differ materially. A material difference would result if many
customers neglected to take cash discounts. The gross method categorizes
this extra revenue as part of net sales and thus part of operating income. The
net method categorizes this extra revenue as interest revenue. Also, billings
are usually at gross, and the accounting records should reflect the billing
amount.

7–48.
1.

2.

Bad Debt Expense ....................................................................
7,410*
Allowance for Bad Debts ....................................................
7,410
*$247,000 0.03 = $7,410. Because the percentage-of-gross-sales method is
being used, the full amount is recognized as bad debt expense.
Allowance for Bad Debts .........................................................
620*
Bad Debt Expense ..............................................................
620
*$83,000 0.06 = $4,980; $5,600 – $4,980 = $620. Because the percentage-ofreceivables method is being used, the allowance account must be adjusted to
the proper ending balance.



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7–48.
3.

229

(Concluded)
The percentage-of-receivables method reflects more accurately the net realizable value of receivables. The total amount expected to be received is the total
receivables less the estimate of uncollectible receivables. Whatever balance is
in the allowance account must be used to arrive at the desired valuation basis.
With the percentage-of-sales method, the valuation of receivables is not considered; only the matching of a certain percentage of bad debts against sales
of the period is considered.

7–49.
Uncollectible Loss Percentage
Year
2012
2011
2010
2009
2008
Average

0–30 Days
0.30%
0.50
0.40
0.40

0.20
1.80%
0.36%

Age of Accounts
0–30 days
31–60 days
61–90 days
91–120 days
Over 120 days

31–60 Days
0.90%
0.80
1.10
1.00
1.10
4.90%
0.98%

Amount
$478,600
172,300
79,200
21,300
8,300
$759,700

61–90 Days
8.70%

9.00
9.50
9.90
8.90
46.00%
9.20%
Average Loss
Percentage
0.36%
0.98
9.20
51.24
82.02

91–120 Days
52.10%
49.20
53.70
51.30
49.90
256.20%
51.24%

Over 120
Days
84.10%
80.30
82.00
78.50
85.20

410.10%
82.02%

Estimated
Uncollectible
$ 1,723
1,689
7,286
10,914
Correct
6,808
Balance:
$28,420

Adjusting entry:
Bad Debt Expense ....................................................................
Allowance for Bad Debts ($25,124 – $28,420) ...................

3,296
3,296


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Chapter 7

7–50.
2012 Cash (1,290 $950)................................................................... 1,225,500
Sales ....................................................................................

1,225,500
Warranty Expense (1,290 $55) ..............................................
Estimated Liability under Warranties ................................

70,950
70,950

2013 Cash (1,100 $980)................................................................... 1,078,000
Sales ....................................................................................
1,078,000
Warranty Expense (1,100 $55) ..............................................
Estimated Liability under Warranties ................................

60,500

Estimated Liability under Warranties ......................................
Cash, Inventories, etc. .......................................................

28,500

2014 Estimated Liability under Warranties ......................................
Cash, Inventories, etc. .......................................................

66,000

Ending balance in liability account .........................................
Predicted warranty expense (2013 sales still under warranty
12 months—1,100 $55 0.60) ..............................................
Difference ..................................................................................


60,500
28,500
66,000
$ 36,950*

$

36,300
650

*Balance in liability account at end of 2012 .............................

$70,950

Increase in liability account during 2013
($60,500 – $28,500) ..................................................................
Decrease in liability account during 2014...............................
Balance in liability account at end of 2014 .............................

32,000
(66,000)
$36,950

The difference is relatively small, indicating an accurate estimate of warranty
expense. Sound Portal Corporation should continue to use the current estimates until experience indicates otherwise.


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231

7–51.
Computation of Estimated Loss on Returns on Sales Warranties
Subsequent to June 30, 2013
Percentage of
Total
Percentage
Estimated
Estimated
of
Total
Returns Sub- Returns SubEstimated Estimated
sequent to
sequent to
Month
Sales
Returns
Returns
6/30/2013
6/30/2013
January ........... $4,200,000
7%
$294,000
10%
$ 29,400
February ......... 4,700,000
7
329,000
20

65,800
March .............. 3,900,000
7
273,000
30
81,900
April ................ 3,250,000
7
227,500
50
113,750
May ................. 2,400,000
10
240,000
70
168,000
June ................ 1,900,000
10
190,000
100
190,000
$648,850
Total estimated returns .......... $648,850
Required liability balance ....
Loss percentage on returns...
65%* Less balance, 6/30/2013 .......
Total estimated loss on returns $421,753
Required adjustment to
liability account ..................


$421,753
120,400
$301,353

*Estimated loss on component replacement (in percentage of sales price):
Cost of unit replacement ...............................................................
70%
Add freight charges on return and replacement .........................
5
75%
Deduct salvage value of components returned ...........................
10
Net loss on components returned ................................................
65%
Adjusting Entry
Warranty Expense ...............................................................................
Estimated Liability for Product Warranty .....................................

301,353
301,353