B6001 – Accounting 1 – Financial Accounting

Problem Set #6

Instructions

1. All homework assignments are type B1 assignments. You may discuss the assigned questions
with your classmates, but you must write up the answers yourself. Submitting answers that
are not your own, which includes copying someone else’s answer file, is an honor code
violation.

2. Answers to homework assignments must be submitted to Canvas electronically in pdf-

format. You may create your original write-up using any word-processing and/or spreadsheet
software of your choice, or writing by hand, but you must convert your write-up to a pdf-file
before uploading.

3. Check your answer file for spelling and formatting. Have pity on the graders, unreadable
submissions are not graded.

4. Label the steps in your calculations clearly and show enough detail so that an informed and
competent reader can understand your derivations and arguments.

You may only share these materials with current term students.
Question 1: Hook the Crook
Question 2: Almost Symmetric Corporation

Question 1: Hook the Crook

At a January 2019 meeting, the president of the “Hook the Crook” Company announced that the
credit evaluation department was being disbanded because it had restricted the company’s
growth. The sales staff would now make credit decisions.
By the end of the year, Hook the Crook had generated significant gains in sales and the president
was very pleased. The accounting department provided the following data:

2019 2018
Sales (all are on credit) $24,000,000 $8,000,000
Cost Of Goods Sold 21,000,000 7,000,000
Accounts Receivable 13,000,000 1,000,000
Allowance for bad debt, 12/31 ? 30,000

The $13,000,000 receivables balance was aged as follows:

Percentage expected
Age of receivable Amount
to be collected
Under 31 days $4,000,000 95%
31-60 days $3,500,000 90%
61-90 days $3,000,000 75%
Over 90 days $2,500,000 50%

$30,000 was written off during 2019, and the remaining balance of accounts receivable (from
December 31, 2018) was collected. No accounts were written off related to 2019 credit sales.

Required:
a. Estimate the amount of uncollectible accounts as of December 31, 2019, and compute the
bad debt expense for 2019. Record the transaction related to the bad debt expense.

Percentage
Age of
Amount expected to be Uncollectable Uncollectable
receivable
collected percentage amount
Under 31
4,000,000 95%
days 5% 200000
 31-60 days 3,500,000 90% 10% 350000
61-90 days 3,000,000 75% 25% 750000
Over 90
2,500,000 50%
days 50% 1250000
Total 2,550,000

DR Bad debt expense 2,550,000

CR Allowance for doubtful accounts 2,550,000

b. Why should a company record a bad debt expense during the current year, when it is
going to realize a specific account is uncollectible only in the future (say next year)?

The matching principle says that costs should be recognized at the time of revenue
generation. The cost of potential default is part of the business risk that arises when a credit
sale is made, and therefore it should be recorded at the same time as the sale is recorded.

c. Compute the amount the company expects to collect (also known as net-realizable-value)
as a percentage of the respective year-end receivable balances, at the end of 2019 and
2018.

2019 2018
Accounts receivable 24,000,000 1,000,000
Uncollectable amount 2,550,000 30,000
Net Realizable Value (NRV) 21,450,000 970,000
NRV as % of accounts receivable 89.38% 97.00%

d. Assume the increase in sales was due only to the change in credit policy. Was the
president’s decision justifiable?

No, the decision was not justifiable. In 2018, only 3% of the accounts receivable was not
recovered, and 97% was recovered. In 2019, there is large provision of 10.62% for bad
debt, and the actual amount of bad debt may be even larger than this. Considering the high
 COGS, this situation may lead to losses overall due to high unrealizable accounts
receivable.

Question 2: Almost Symmetric Corporation

The Almost Symmetric Corporation (ASC) has two almost identical products: Uris and Warren.
The plans for 2020 are to produce and sell 1,000 units of each, Uris at $75 per unit and Warren at
$60 per unit. Both products require labor (at $10 per hour) and machine time (at $20 per hour).
In particular, production of one unit of Uris requires one labor hour and two machine hours,
while a unit of Warren requires two labor hours and one machine hour. Overhead for the year
(set-up of production batches and quality control) is estimated at $33,000. Assume that both
labor and machine costs are direct costs (not included in overhead) and thus are allocated in all
cases directly to Uris and Warren.

Required:
a. Assume the overhead is allocated based on labor dollars. What is the overhead allocation
rate? The per-unit cost and gross margin for each of the products? Any recommendation
to ASC based on your findings?

Total allocation basis = total labor hours per year = (1*1000)+(2*1000) = 3000

Total overhead = 33,000

Overhead allocation rate = 33000/3000 = $11 per labor hour

For Uris:

Per-unit cost = 10 + 20*2 + 11 = $61

Gross margin = 75 – 61 = $14

For Warren:

Per-unit cost = 20 + 20 + 2*11 = $62

Gross margin = 60 – 62 = - $2

Based on these findings, ASC should increase the price for Warren as it loses 2 dollars per
unit sold or consider not selling it, and focus more on selling Uris.
 b. Assume the overhead is allocated based on machine hours. What is the overhead
allocation rate? The-per unit cost and gross margin for each of the products? Any
recommendation to ASC based on your findings?

Total allocation basis = total machine hours per year = (1*1000)+(2*1000) = 3000

Total overhead = 33,000

Overhead allocation rate = 33000/3000 = $11 per machine hour

For Uris:

Per-unit cost = 10 + 20*2 + 2*11 = $72

Gross margin = 75 – 72 = $3

For Warren:

Per-unit cost = 20 + 20 + 11 = $51

Gross margin = 60 – 51 = $9

Based on these findings, ASC should focus on selling more of Warren as it has higher gross
margin than Uris.

c. An expensive consultant, MacK-ABC, was hired and after a long investigation suggested
ASC uses an ABC costing system. Further analysis revealed that all overhead should be
classified as a batch level cost, and that Uris is planned to be produced in 100 batches while
Warren is planned to be produced in 10 batches. Given ABC is implemented, what is the per-
unit cost and gross margin for each of the products? Any recommendation to ASC based on
your findings?

Total batches = 100 + 10 = 110

Total Overhead = 33,000
Overhead allocation rate = 33000/110 = 300 per batch
For Uris:
Batch cost = (10+40)*10 + 300 = 800
Unit cost = 800/10 = $80
Gross margin = 75 – 80 = -$5
For Warren:
Batch cost = (20+20)*100 + 300 = 4300
Unit cost = 4300/100 = $43
Gross margin = 60 – 43 = $17
Based on these findings, ASC should focus on selling more of Warren as it has higher gross
margin than Uris. Uris should be discontinued because of negative margin, or the price
should be increased if the demand curve supports a higher price.