ACCT1101 ACCOUNTING FOR DECISION MAKING

Case: Decision making problem

After meeting with their accountant Brianna, Jeff and Pam have a much better understanding of the
transaction recording and the compliance they must meet. Brianna analyzed their financial statements and
explained that even though the business was generating good profit they were heading towards a cash
shortage as their capital was reducing. Brianna identified inventory as the key area of concern as the gross
margin was falling. Brianna has asked you to go to Pam’s Party Supplies for a day to observe what is
happening in the store.

During that day you saw that the inventory deliveries were not being counted and Jeff admitted that they
had lots of deliveries because he was buying extra inventory so they didn’t ‘run out’. He couldn’t see any
reason to check the incoming purchases against the supplier’s invoice and therefore had his staff put it on
display or despatched to customers immediately. There did not appear to be any inventory records.

You were very surprised at the level of discounting with corporate customers and the casual approach to
payment. Pam said they were building their corporate business and that they had allowed staff to offer very
favourable discounts and payment terms to their corporate customers because it was good business to do
that.

Following your observations at Pam’s Party Supplies, what recommendations will you be making to
Brianna?

Identify the problem
Identify the alternatives
Evaluate the alternatives
1. The inventory levels are rising causing the inventory to fall and
margins are decreasing. Having a negative impact on cash flows.
2. It was observed that there were no inventory records kept and
incoming stock was not matched against the suppliers invoice
3. It was observed that there was random discounting with corporate
sales and undefined payment terms
• Determine minimum and maximum inventory levels for all stock items;
identify slow moving items and replace with new lines
• Write a procedure for the receipt of incoming stock to verify its receipt;
Establish a perpetual inventory system to know the stockholding and
turnover of each inventory item
• Write a policy and guideline, approved by Jeff & Pam for discounts
and a clear credit policy e.g. Credit checks, payment terms, to be
followed by all staff. Any exceptions to be approved by Jeff and Pam
• Continue without making any changes
1. Determining the stock levels for inventory will ensure efficient ordering,
holding of stock and monitoring inventory turnover. This will result in
Jeff making informed decisions about the stock he really needs to
order - both slow moving and fast-moving lines- resulting in improved
margins and cash flows.

An inventory record system is an internal control that assists in

controlling and reporting on inventory holdings and movements. This
system will allow Jeff to set the minimum and maximum stock levels
so that there is sufficient stock to meet regular selling needs, ensure
that excess stock is not held and prevent theft.

Without a policy and guideline for discounts, the profit is eroded as is

the cash received for a sale. There can also an opportunity created for
staff to discount stock to friends. Jeff & Pam should be the ones the
state the level of discounts that can be given. A policy on customer
credit terms reduces the risk of customers not paying their bills and
having to write them off as back debts. It also ensures that the cash
from sales in flowing into the business in a timely manner
 ACCT1101 ACCOUNTING FOR DECISION MAKING
2. To do nothing can lead the business into a cash crisis that will require
Jeff and Pam to put more money in. Without some form of inventory
control the will be stock outs, overstocking and increased obsolete
stock. No control over discounts and customers’ account will result in
increased bad debts and diminished profits. All of which will result in a
negative impact on the working capital and margins.

Make a decision Students must justify their decisions.

 ACCT1101 ACCOUNTING FOR DECISION MAKING

In-class Practice Questions

The following questions have been adapted from Attrill, Peter, McLaney, E. J., and Harvey,
David "Accounting: Information for Business Students", 1st edition, Pearson Australia

Question 1
Bombo Ltd has $12 300 000 in accounts receivable as at 31 December 2021. On the basis of past
experience, the managers and accountants have determined the amount of debt that will not be collectable
for particular periods for which the amounts have been owing to the organisation. The age of the various
amounts owing, and estimates of their ‘uncollectability’, are as follows:

Period Outstanding Amount Owing Percentage of Debt that

will not be collected
1–30 days $8 000 000 1%
31–60 days $3 000 000 3%
61–90 days $900 000 10%
More than 90 days $400 000 25%
$12 300 000

Required:
You are required to calculate the estimated amount for the allowance for doubtful debts.

Solution:

Using the above information, we can calculate the Allowance for Doubtful Debts as follows:

1–30 days 31–60 days 61–90 days More than 90 Total

days
Amount owing $8 000 000 $3 000 000 $900 000 $400 000 $12 300 000
Percentage not 1% 3% 10% 25%
expected to be
collected
Doubtful Debt $80 000 $90 000 $90 000 $100 000 $360 000
amount

The total amount of doubtful debts therefore would be $360 000.

The information about accounts receivable would be disclosed in the financial statements as follows:

Accounts Receivable $12 300 000

Less: Allowance for doubtful debts ($360 000)
Net Accounts receivable $11 940 000
 ACCT1101 ACCOUNTING FOR DECISION MAKING

Question 2
Dixon Supplies Co. has recently prepared draft financial statements for the most recent year. A profit for
the year of $290,000 was reported. Subsequent investigation found that one item of inventories (IXL 205)
had been valued using the LIFO basis, whereas the policy of the business is to use the FIFO basis for all
inventories. The business had the following transactions for this item during the year.

Units Cost/unit
1 Jan Opening Inventories 1500 $20
5 May Bought 2800 $25
21 Sept Bought 1100 $31
5400
11 Nov Sold 3700

It was also discovered, after the draft financial statements were prepared, that the net
realisable value of inventories of item IXL 205 was $27,500

Required:
Calculate the revised profit for the year after the inventories for item IXL 205 have been
appropriately valued.

Solution:

The cost of sales is too high.

3700 units have been charged to cost of sales using LIFO, which means:
1,100 @ $31 = $34,100
+ 2,600 @ $25 = $65,000
$99,100

Should have been charged using FIFO

1,500 @ $20 = $30,000
+ 2,200 @ $25 = $55,000
$85,000

So profit understated by $14,100 ($99,100 - $85,000)

In correcting the cost of sales we also correct the closing inventory, so the closing inventory is valued
using FIFO which means
1,100 @ $31 = $34,100
+ 600 @ $25 = $15,000
$49,100

Stock should be valued at the lower of cost or realisable value of $27,500, which means
that there will be a further write-off of $49,100 - $27,500 = $21,600

So the revised profit figure is $290,000 + $14,100 - $21,600 = $282,500.

 ACCT1101 ACCOUNTING FOR DECISION MAKING

Question 3
Calculate depreciation expense for each asset group for the year ended 30 June 2017.

Asset Delivery trucks Building

Acquisition cost $250,000 $300,000
Useful life/units (km for trucks, years for the rest) 200,000 30
Estimated residual value $45,000 $45,000
Depreciation method Units of production Straight-line
Depreciation expense for the year ? ?

Note: The trucks were driven 24,500 kilometres during the year.

Solution:

Asset Delivery trucks Building

250,000 – 45,000 300,000 – 45,000

Depreciable amount = $205,000 = $255,000
205,000/200,000 255,000/30
Depreciation rate = $1.025/km = 8,500
kms for trucks, year for equip & building,
24,500 km 1 year
beg NBV for computers
Depreciation expense $25,113 $8,500