Case 5 - 1 Stern Corporation (A)

Accounts receivable Provision for doubtful debts

Direct write-off method: 1,241,558 37,247
Allowance method 1,242,478 37,274

2005 2006
Current ratio 2.54 2.70
Acid-test ratio 1.33 1.48
Days’ cash N/A N/A
Days’ receivables: method (a) 44.14
method (b) or (c) 44.11

Case 5 - 2 Grennel Farm

Delivery method Collection method
Revenue $522,000 $462,400
Gross margin 429,660 380,320
Net income 246,660 197,320
AR 59,600 0
Total assets 593,390 544,050
Retained earnings (Bal. Fig.) 102,890 53,550

Case 5 - 3 Joan Holtz (A)

1) The measurement of revenue is not necessarily straightforward. Estimate actual usage for the part of Dece
2) more conservative approach of counting only $5,000 as revenue in 2006 on the grounds that the service in
3) The agency has substantially performed its earning activities and that the income is reliably measurable. In
4) Typically, firms facing this issue recognize no revenue until harvesting the trees.
5) With fixed‑fee contracts, the critical performance task is spending time, on a project as opposed to deliver
6) The 60 cent reimbursements made in 2006 and the 60 cent reimbursements made in 2007 are an expense o
7) the checks are a great source of interest‑free capital to American Express.
8) Manufacturer A cannot record a sale at all under these circumstances. FASB 49 was issued to address the
9) the $10,000 franchise fee should be recognized as revenue in the year received, as soon as the training cou
10) Tech-Logic should not recognize revenue for these computer systems at shipment or delivery. An alternat
 or doubtful debts Amount transferred from P&L a/c
30,779
30,806

Production method
$614,100
506,370
323,370
151,700
670,100
179,600

sage for the part of December after meters are read and reporting that usage as part of the revenues of that year.
rounds that the service involved is “readiness to serve,” and that this readiness exists equally in each year.
is reliably measurable. Introduction of the possibility of a refund lessens the strength of the argument.

ect as opposed to delivering some end item to the client; they thus record jobs in progress at estimated fee, which would be the sa
in 2007 are an expense of selling tea in 2007.

was issued to address the perceived abuse of treating such temporary title transfers as sales.
s soon as the training course has been completed.
t or delivery. An alternative should be to wait until cash (in the form of hard currency) was received to recognize revenue.
fee, which would be the same as billing rates

recognize revenue.
 Delivery method Instalment method
2011 2012 2013 2011 2012 2013
Balance sheet effect
Cash 36,000 36,000 28,500 36,000 36,000 28,500
Accounts receivable 100,000 140,000 200,000 - - -
Inventory 8,000 23,000 34,000 78,000 123,000 177,800
Rent advance 10,000 10,000 10,000 10,000 10,000 10,000
154,000 209,000 272,500 124,000 169,000 216,300
Accounts payable 25,000 55,000 75,000 25,000 55,000 75,000
Accrued operating exp. 2,500 1,500 2,500 2,500 1,500 2,500
Capital 126,500 152,500 195,000 96,500 1,12,500 1,38,800
154,000 209,000 272,500 124,000 56,500 77,500
Income statement effect
Revenue 160,000 220,000 300,000 60,000 180,000 240,000
Cost of Goods Sold 112,000 165,000 219,000 42,000 135,000 175,200
Gross profit 48,000 55,000 81,000 18,000 45,000 64,800
Operating expenses 21,500 26,000 38,500 21,500 29,000 38,500
Operating profit 26,500 29,000 42,500 (3,500) 16,000 26,300
Gross profit ratio 30% 25% 27% 30% 25% 27%
 Cost recovery first method
2011 2012 2013

36,000 36,000 28,500

- - -
60,000 88,000 113,000
10,000 10,000 10,000
106,000 134,000 151,500
0 55,000 0
0 0 0
0 0 0
- 55,000 -

60,000 180,000 240,000

60,000 152,000 205,000
- 28,000 35,000
21,500 29,000 38,500
(21,500) (1,000) (3,500)
0% 16% 15%
Problem statement
Below is a schedule of monthly credit sales and collections for Yzerman Company. Assuming Yzerman’s cost of g
margin Yzerman will report each month (a) if revenues are recognized when the sale is made and (b) if the installm

Jan. Feb. Mar. Apr. May June Total

Sales $12,000 $8,000 $13,000 $11,000 $9,000 $13,500 $66,500
Collections 11,000 10,000 11,500 10,500 10,500 9,500 $63,000
Delta(AR) $1,000 ($2,000) $1,500 $500 ($1,500) $4,000
Balance in AR $1,000 ($1,000) $500 $1,000 ($500) $3,500
Solution:
Sale Method Jan. Feb. Mar. April May June
Sales $12,000 $8,000 $13,000 $11,000 $9,000 $13,500 $66,500
Cost of goods sold 7,800 5,200 8,450 7,150 5,850 8,775 $43,225
Gross margin $4,200 $2,800 $4,550 $3,850 $3,150 $4,725 $23,275

Installment Method Jan. Feb. Mar. April May June

Sales $11,000 $10,000 $11,500 $10,500 $10,500 $9,500 $63,000
Cost of goods sold 7,150 6,500 7,475 6,825 6,825 6,175 $40,950
$3,850 $3,500 $4,025 $3,675 $3,675 $3,325 $22,050
ming Yzerman’s cost of goods sold is always 65 percent of sales, calculate how much gross
ade and (b) if the installment method is used.
 Problem statement
The Giamatti Construction Company primarily builds houses, and rarely is a house only partially completed as
However, this year Giamatti is also building a motel, which it started in March and expects to complete next Ap
The motel calls for a fee of $5 million. Expected total costs are $4.25 million, and $2.55 million of these had in
Required:
Assume that, excluding the motel project, Giamatti's income before taxes will be $1.25 million both this year a
What will each year's income before taxes be, including the motel project,
(a) if Giamatti uses the completed-contract method and
(b) if it uses the percentage-of-completion method? (Assume actual motel costs in fact turn out to be $4.25 m
Which method should Giamatti use?

Solution:
Completed Contract Percentage of
Completion
This Next This Next
Year Year Year Year
Income excluding motel (000) $1,250 $1,250 $1,250 $1,250
Income from motel project 0 750 450 300
Income before taxes $1,250 $2,000 $1,700 $1,550
house only partially completed as of December 31.
h and expects to complete next April.
and $2.55 million of these had incurred as of December 31.

be $1.25 million both this year and next.

osts in fact turn out to be $4.25 million.)

Problem statement
Alcon Company decided to write off the $3,000 Wordel Corporation receivable as uncollectible.
Subsequently, Wordel makes a $950 payment on the account. Prepare journal entries for these two transactions.

Solution:

$3,000
$3,000
If Alcom uses the allowance method:
dr. Allowance for Doubtful Accou $3,000
cr. Accounts Receivable $3,000

To record the partial payment:

If Alcom uses the direct write-off method:

Cash $950
Bad Debts Recovered $950
(or Bad Debt Expense $950)
If Alcom uses the allowance method:
Either of the above two entries or:
Cash $950
Allowance for doubtful account $950
these two transactions.

Direct write-off method:

Bad debt to be written-off

dr. Bad debt Expense $3,000
cr. Accounts Receivable $3,000
Bad debts recovered is $950 out of $3000
Cash $950
Bad Debts Recovered $950

Allowance method:

Bad debt to be written-off

dr. Allowance for Doubtful Accou $3,000
cr. Accounts Receivable $3,000
Bad debts recovered is $950 out of $3000
Cash $950
Allowance for doubtful account $950
Problem 5-4
Huron Corporation operates in an industry that has a high rate of bad debts.
On December 31, before any year-end adjustments, the balance in Huron's Accounts Receivable account was $750
The year-end balance reported in the statement of financial position for the Allowance for Doubtful Accounts will
Amount Pblty of collection
Less than 16 $450,000 0.99
16 to 30 150,000 0.94
31 to 45 75,000 0.8
46 to 60 45,000 0.65
61 to 75 15,000 0.5
Over 75 15,000 0
$750,000
Required:
a. What is the appropriate balance for the Allowance for Doubtful Accounts on December 31?
b. Show how accounts receivable would be presented on the balance sheet prepared on December 31.
c. What is the dollar effect of the year-end debt adjustment on the before-tax income for the year?

Solution:
(a) The Allowance for Doubtful Accounts should have a balance of $51,750 on December 31. The supporting calculati
Amount outstanding $750,000
Less: Estimated collectible $683,250
Estimated PBDD $66,750

The accounts that have been outstanding over 75 days ($15,000) and have zero probability of collection would be w
not be considered when determining the proper amount of the Allowance for Doubtful Accounts.

(b) Accounts Receivable $735,000

Less: Allowance for Doubtful Accounts 51,750
Net Accounts Receivable $683,250

(c ) The year-end bad debt adjustment would decrease the year’s before-tax income by $29,250, as shown below:

Estimated amount required in the Allowance for Doubtful Accounts 51,750

Balance in the account after write-off of bad accounts but before adjustment 22,500
Required charge to expense $29,250
ounts Receivable account was $750,000 and the Allowance for Doubtful Accounts had a balance of $37,500.
owance for Doubtful Accounts will be based on the aging schedule shown below.
Estimated collectible
$445,500
$141,000
$60,000
$29,250
$7,500
$0
$683,250

December 31?
epared on December 31.
come for the year?

cember 31. The supporting calculations are shown below:

probability of collection would be written off immediately and

oubtful Accounts.

by $29,250, as shown below:

 Green Lawn Chemical Company sells lawn and garden chemicals through several hundred garden supply store
It was Green Lawn's policy to ship goods to these retailers in late winter on a consignment basis.
Periodically, a Green Lawn field representative would count the Green Lawn products on hand at a retailer;
based on this count, the previous count, and intervening shipments, it was determined how many items the reta

Required:
a. Assume Green Lawn shipped goods costing Green Lawn $8,400 and with a wholesale price (i.e., price to the
Prepare journal entries to record this entry (1) on Green Lawn's books and (2) on Carson s books.
b. Later, the field representative's count indicated that Carson's had sold some of these goods, totalling $6,720
Prepare journal entries to reflect these sales (1) on Green Lawn's books and (2) on Carson's books.

solution:
Green Lawn’s books:
dr. Inventory on Consignment 8,400
cr. Finished Goods Inventory 8,400
Note that at this point the $12,600 wholesale price (Green Lawn’s revenue when these goods are sold) is irrelev

Carson’s books:
No entry; the goods are not owned by Carson and hence are not inventory on Carson’s books; similarly, Carso

Green Lawn’s books:

dr. Accounts Receivable 5,040
Cost of Goods Sold 3,360
cr. Sales 5,040
Inventory on Consignment 3,360
(This can be shown as two entries.)

Carson’s books:
dr. Cash or Accounts Receivable 6,720
Cost of Goods Sold 5,040
cr. Sales 6,720
Accounts Payable 5,040
(This also can be shown as two entries.)
 eral hundred garden supply stores and department store garden shops.
consignment basis.
products on hand at a retailer;
ermined how many items the retailer had sold since the previous count, and the retailer was billed for these goods by Green Lawn.

a wholesale price (i.e., price to the retailer, not the end user) of $12.600 to Carson's Garden Shop.
(2) on Carson s books.
e of these goods, totalling $6,720 at retail, $5,040 at wholesale, and $3,360 at Green Lawn's cost.
d (2) on Carson's books.

en these goods are sold) is irrelevant.

n Carson’s books; similarly, Carson does not as yet owe Green Lawn for these goods.
hese goods by Green Lawn.
 Structco Construction Company entered into a long-term construction contract at a fixed contract price of $4,90
Work has proceeded since that time with the following results:

20 x 4 20 x 5 20 x 6
Cost incurred this year $721,000 $1,190,000 $1,715,000
Cost of work to be completed 3,430,000 2,240,000 525,000
(at year end)
Cash collections (this year) 560,000 1,120,000 1,540,000
Year-end percentage complete 20% 50% 95%
Required:
Determine the amount of revenues, expenses, and income for 20x4, 20x5, and 20x6 by using the percentage-of-

solution:

20 x 4 20 x 5 20 x 6
Revenue $980,000 $1,470,000 $2,205,000
Costs 721,000 1,190,000 1,715,000
Income $259,000 $280,000 $490,000
26.4% 19.0% 22.2%
xed contract price of $4,900,000 on September 1, 20x4.

y using the percentage-of-completion method.

Problem 5-7

Dr. Cr.
$38,600
$34,650
1,850
$23,100
231,000
161,700
15,400
Goodwill 38,500
Current portion of bonds payable 7,700
Interest payable 25,000
Inventory, Beginning 46,200
Long-term debt (required to be paid at a rate of $7,700 per year) 192,500
Other expenses 69,300
Plant and equipment, at cost 346,500
Purchase of inventory 184,800
Retained earnings, beginning 46,200
Sales (23% were for cash) 324,400

Required:
(a) Quick and current ratios
(b) number of days' cash on hand
(c) number of days' worth of sales represented by accounts receivable

Solution:
(a) Current assets:
Cash $23,100
Accounts receivable $34,650
Less: Allowance for bad debts 1,850
Net accounts receivable 32,800
Beginning inventory 46,200
Purchases 184,800
Available inventory 231,000
Less: Cost of goods sold 161,700
Ending inventory 69,300
Total current assets $125,200
Current liabilities:
Accounts payable $38,600
Current portion of bonds payable 7,700
Interest payable 25,000
Total current liabilities $71,300
 The above ratios measure GRW’s ability to meet short-term obligations. The current ratio indicates that GRW has
and relatively liquid assets that are expected to be converted to cash in the short run than it has short-run obligation
satisfaction. This ratio does not necessarily mean the amount of current assets is adequate, however. For example, t
and interest payable could be obligations due within the next few days, and it may not be possible to liquidate acco

(b) Cash Expenses:

Cost of goods sold $161,700
Other expenses 69,300
Total cash expenses $231,000

Days’ cash = $23,100 / ($231,000 / 365) = 36.5 days.

This ratio measures how many days of normal operating expenses can be paid without adding to the cash balance. T
that GRW Company has an apparent stockpile of cash. This means GRW is either planning unusual expenditures d
or is not properly managing cash. Cash does not generate a return. There is a trade-off between “instant” liquidity a

Some students may argue that purchases, rather than cost of goods sold, should be used in the calculation. This wou
“steady state” of operations, since it happened that GRW built up its inventory by $23,100 during the year. The arg
on purchases would be stronger if the student explicitly assumes a long-term buildup of inventory each year (to sup
but then, for consistency, some other cash expenses should probably be increased, too, thus resulting in approximat
36.5-day figure. In any event, there is no implication that such ratio calculations are interpretable with great precisi
if calculated for the same company over a period of years.

(c) Days’ receivables = Net receivables / (Credit sales / 365) = $32,800 / ($323,400 x .77 / 365).
= 48 days.

This ratio measures the average collection period of receivables. Although some analysts use total sales (often beca
sales is not disclosed), the above calculation is correct. The result suggests that GRW’s customers are stretching th
o indicates that GRW has 76 percent more cash
it has short-run obligations requiring cash for their
, however. For example, the accounts payable
possible to liquidate accounts receivable and inventories that quickly.

ding to the cash balance. The above ratio indicates

ng unusual expenditures during the next period,
ween “instant” liquidity and the return on marketable securities.

n the calculation. This would not reflect a true

00 during the year. The argument for basing the ratio
nventory each year (to support increasing sales);
us resulting in approximately the same
pretable with great precision. They are most meaningful

use total sales (often because the portion of credit

ustomers are stretching the payment period.