CHAPTER 6: CASH, TEMPORARY INVESTMENTS, ACCOUNTS RECEIVABLE and NOTES RECEIVABLE PROBLEM SOLUTIONS
Assessing Your Recall
6.1Cash:
Probable Future Value – The probable future value in cash is the ability of the cash to be exchanged for goods and services in the future.
Ownership – Ownership is evidenced by possession of currency and by the right to control bank accounts.
Temporary Investments:
Probable Future Value - The probable future value in temporary investments is the cash payments that will be received from the investments in the future. These payments take the form of dividends in the case of shares and interest in the case of debt as well as the ultimate sales price of the securities when they are sold.
Ownership – Ownership is evidenced by share or debt certificates although sometimes these documents are not distributed to the owners but a record is kept by the brokerage house that handles the investments for the company.
Account Receivable:
Probable Future Value – The probable future value in accounts receivable is that they represent the right to receive cash at some (usually fixed) date in the future. The cash, in turn, has value in the ability to be exchanged for goods and services in the future.
Ownership – Ownership is evidenced by contracts either written or implied between the buyer and the seller. Invoices and shipping documents usually provide the necessary evidence of proof that a receivable exits.
Notes Receivable:
Probable Future Value – The probable future value in notes receivable is that they represent the right to receive cash, either upon demand or at some fixed date in the future. The cash, in turn, has value in the ability to be exchanged for goods and services in the future.
Ownership – Ownership is evidenced by a promissory note, or written contract between the maker and the payee.
6.2The unit-of-measure assumption in accounting means that elements of the financial statements are to be measured using a common unit. That unit in Canada is the dollar. In most countries the unit-of-measure is the domestic currency.
6.3Purchasing power risk is present for cash because when cash is held during periods of inflation the purchasing powerofthe dollar decreases. For example, if $100 is held in cash during a year of a price increase of 10% the $100 will buy 10% fewer goods and services at the end of the year, than at the beginning. Inventory, on the other hand, is not fixed in terms of the number of dollars that it represents. The value of the inventory can fluctuate with changing prices. If $100 worth of inventory was held during a year in which prices increased 10% it is possible that the price of the inventory could be raised to $110 to compensate. There may be supply and demand reasons why the price of inventory could not be raised to the full $110. If this is so then the inventory may be subject to some purchasing power risk but not to the same degree as cash.
6.4At the end of every account period the accountant evaluates the cost and the current market value of the temporary investments portfolio. The book value of the portfolio at the end of the period must be the lower of the cost and market value. After this determination is made the carrying value of the portfolio (its cost less the current value in the valuation allowance account) is adjusted upwards or downwards to reflect the proper value at the end of the period. The adjustment is reported as an unrealized loss if the value of the portfolio is written down and an unrealized recovery if the value is written up.
6.5The primary consideration in deciding if an investment should be classified as current or noncurrent is management’s intention. If management intends to hold the investment for more than one year, the investment should be classified as noncurrent. Otherwise, the investment should be classified as current as long as it can be sold.
6.6The direct write-off method recognizes bad debt expense (loss) in the period in which the receivable is determined to be unrecoverable, not necessarily in the period in which the original sale was made. This creates a matching problem. The allowance method estimates and records the bad debt expense in the period of the original sale. This method provides a proper matching of the revenues and expenses (bad debt expense) from the sale and is the method that is most consistent with GAAP. The direct write-off method can be used f the results of applying it are not materially different from the results of applying the allowance method.
6.7Two ratios that measure liquidity are the current ratio and the quick ratio. Both compare current assets to current liabilities, with the current ratio comparing total current assets and the quick ratio comparing total current assets less inventories and prepaid expenses. Both provide information on the ability of the company to pay its current liabilities, with the quick ratio providing more conservative information.
6.8The accounts receivable turnover ratio measures the “turnover” of the accounts receivable in a year. This measures the average number of times the total accounts receivable could have been collected in full during the year. This ratio provides a measure of the efficiency of the collection of the accounts receivable, with larger ratios indicating faster collections, on average.
Applying Your Knowledge
6.9a)
Comet Company
Bank Reconciliation
July 31, 20x2
Balance per bank statement$7,582.45
Add: Outstanding deposit1,532.02
9,114.47
Less: Outstanding cheques
#466$1,250.00
#467520.00
#468360.50
#4701,350.753,481.25
Adjusted cash balance$5,633.22
Balance per general ledger$4,643.22
Add: Collection of note receivable1,015.00
5,658.22
Less: July service charge25.00
Adjusted cash balance$5,633.22
b)At July 31, Comet actually has $5,633.22 in its account.
c)SE-Bank service charges25.00
A-Cash25.00
A-Cash1,015.00
A-Note receivable1,000.00
SE-Interest revenue15.00
6.10a) deducted from cash balance
b) deducted from cash balance
c) deducted from cash balance
d) added to bank balance
e) not included in the bank reconciliation because both Walters and the bank have recorded the transaction
f)deducted from cash balance
g)added to cash balance
h)not included in the bank reconciliation because both Walters and the bank have recorded the transaction
i)deducted from the bank balance
j)
6.11
Peter Hayes
Bank Reconciliation
Balance per bank statement$1,280
Less: Outstanding cheques432
Adjusted cash balance$ 848
Balance per cheque book$ 840
Add: automatic deposit50
890
Less: error in recording cheque$18
NSF cheque1533
857
Less: service charge ($857 - $848)9
Adjusted cash balance$ 848
6.12a)InvestmentCostMarket
Green Company$2,500$2,600
White Company8,0006,400
$10,500$9,000
The investments will be reported at $9,000, the lower of cost and market.
b) On the balance sheet, an account titled valuation allowance for
temporary investments appears as a $1,500 ($10,500 - $9,000) offset to temporary investments. On the income statement, an unrealized loss on the valuation of temporary investments is recognized, also in the amount of $1,500.
6.13a)
Income from operations$45,000
Add: dividend income9001
Deduct: unrealized loss on temporary
investments (1,500)
Net income$44,400
1(100 x $2) + (200 x $3.50) = $900
b)
Return on investments = $900 / $10,500 = 8.57%
Duggan Company did not attain its goal of attaining a 10% annual return on its investments.
6.14 a) No journal entries are required for June 30th or December 31st because on both occasions, the market value of the Meta-Solid shares were higher than the original cost. Note: brokerage fees have been added to (or subtracted from) the cost of the shares purchased (or sold).
March 25 / A-Investment in Meta-Solid / 50,500A-Cash / 50,500
August 15 / A-Dividends receivable / 1,250
SE-Dividend income / 1,250
October 25 / A-Cash / 1,250
A-Dividends receivable / 1,250
February 18 / A-Cash / 12,175
A-Investment in Meta-Solid / 10,100
SE-Gain on sale of temporary
investments / 2,075
b) At December 31, 20x1, the temporary investments would appear on the balance sheet at their original cost of $50,500 (2500 x $20.20 per share)
6.15a)
Dec 31, 20x1 / SE-Unrealized loss on valuation of temporary investments / 40,000XA-Valuation allowance for temporary
Investments / 40,000
Dec 31, 20x2 / XA-Valuation allowance for temporary investments / 20,000
SE-Recovery of unrealized loss on valuation
of temporary investments / 20,000
Dec 31, 20x3 / XA-Valuation allowance for temporary investments / 20,000
SE-Recovery of unrealized loss on valuation
of temporary investments / 20,000
Dec 31, 20x4 / SE-Unrealized loss on valuation of temporary investments / 5,000
XA-Valuation allowance for temporary
investments / 5,000
b)
Dec 31, 20x1$210,000
20x2 280,000
20x3 320,000
20x4 345,000
6.16a) InvestmentCostMarket
Jack$22,500$20,500
Queen15,00019,000
King50,00047,500
$87,500$87,000
Aggregate cost$87,500
Aggregate market value 87,000
Unrealized loss$ 500
At December 31, 2000, the net investments would be reported at the market value of $87,000.
b) On the balance sheet, an account titled valuation allowance for temporary investments appears as a $500 offset to temporary investments. On the income statement, an unrealized loss on the valuation of temporary investments is recognized, also in the amount of $500.
6.17a)
Income from operations$640,000
Add: dividend income12,0001
Deduct: unrealized loss on temporary investments (500)
Net Income$651,500
1 (500 x $5) + (500 x $7) + (500 x $12) = $12,000
b)
Return on investments = $12,000 / $87,500 = 13.71%
Upper Company did not attain its goal of attaining a 20% annual return on its investments.
6.18a)
Mar. 13, 20x1 / A-Temporary Investments / 35,000A-Cash / 35,000
June 24, 20x1 / A-Temporary Investments / 65,000
A-Cash / 65,000
Dec 31, 20x1 / SE-Unrealized loss on valuation of temporary investments / 2,000
XA-Valuation allowance for
temporary investments / 2,000
May 27, 20x2 / A-Cash / 70,000
A-Temporary investments / 65,000
SE-Realized gain on sale of
temporary investments / 5,000
Oct. 8, 20x2 / A-Temporary investments / 95,000
A-Cash / 95,000
Dec 31, 20x2 / XA-Valuation allowance for temporary investments / 2,000
SE-Recovery of unrealized loss on
valuation of temporary
investments / 2,000
Aug 3, 20x3 / A-Temporary investments / 100,000
A-Cash / 100,000
June 30, 20x3 / A-Cash / 105,000
A-Temporary investments / 100,000
SE-Realized gain on sale of temporary investments / 5,000
Dec. 31, 20x3 / SE-Unrealized loss on valuation of temporary investments / 7,000
XA-Valuation allowance for
temporary investments / 7,000
b)
Income Statement
20x1 / 20x2 / 20x3Unrealized loss on valuation of T.I. / (2,000) / 0 / (7,000)
Recovery of unrealized loss on valuation of T.I. / 2,000
Realized gain (loss) on sale of investments / 5,000 / 5,000
Effect on Net Income of Temporary Investments / (2,000) / 7,000 / (2,000)
Balance Sheet
20x1 / 20x2 / 20x3Temporary investments (at cost) / 100,000 / 130,000 / 130,000
Less: valuation allowance / (2,000) / 0 / (7,000)
Temporary investments (LCM) / 98,000 / 130,000 / 123,000
6.19Faun & Faun Inc.
a)
Selling Price$50,000
Add: Loss on Sale 5,650
Cost Price$55,650
Journal Entry for Sales
A-Cash50,000
SE-Loss on Sale of temporary investments5,650
A-Temporary investments55,650
b)
Temporary Investments:
Ending Balance (at cost)$313,000
Less: Purchases during 20x2 85,000
228,000
Add: Sales during 20x2 55,650
Opening Balance (at cost)$283,650
c) Valuation Allowance for Temporary
Ending Balance (20x2)13,000
Less: Unrealized loss on valuation 3,850
Beginning balance 9,150
6.20 a)
20x1 SE-Bad debt expense3,000
XA-Allowance for doubtful accounts3,000
(50,000 / 0.25) x 0.015
20x2XA-Allowance for doubtful accounts500
A-Accounts receivable500
A-Accounts receivable500
XA-Allowance for doubtful accounts500
A-Cash500
A-Accounts receivable500
b)
Accounts receivable in Balance Sheet, December 31, 20x1
Accounts receivable$50,000
Allowance for doubtful accounts (3,000)
$47,000
6.21a)
Allowance for doubtful accounts = $22,500
03 x 750,000
Less: amount written-off (12,000)
Allowance for doubtful accounts $10,500
b)
Accounts receivable$70,000
Less: allowance for doubtful accounts(10,500)
$59,500
c) The balance in the allowance for doubtful accounts might not be reasonable if the collectibility of Dundee’s receivables is not reflective of the industry. This could occur if Dundee’s customers are less reliable, or if Dundee’s policies for checking and extending credit are more lenient. Furthermore, setting up an allowance for doubtful accounts based on a percentage of credit sales is unlikely to result in a close estimate of the accounts that will actually be uncollectible. Instead, basing the allowance for doubtful accounts upon specific customer balances that are overdue (i.e. an aging schedule) might results in a better valuation of accounts receivable.
6.22a)
SE-Bad debt expense172,000
XA-Allowance for doubtful accounts172,000
21,500,000 x 0.8 x 0.01
b)
Accounts receivable$1,348,000
Allowance for doubtful accounts(183,000)
Accounts receivable, net$1,165,000
c) Bad debt expense for year ending October 31, 20x1: $172,000
6.23a)
SE-Bad debt expense31,250
XA-Allowance for doubtful accounts31,250
$1,250,000 x .025 = $31,250
b)
Allowance for doubtful accounts
18,5002% x 925,000
Write off 20x15,650
12,850Balance 20x1
Write off 20x219,20031,25020x2 allowance
24,900Balance 20x2
c)
Accounts receivable, December 31, 20x2$138,000
Allowance for doubtful accounts(24,900)
Accounts receivable, net$113,100
6.24a)
March 12 / A-Note receivable / 10,000A-Accounts receivable / 10,000
August 31 / A-Interest receivable / 550
SE-Interest revenue / 550
$10,000 x .11 x 6/12 = $550
b)
A-Cash 10,825
A-Note receivable10,000
A-Interest receivable 550
SE-Interest revenue 275
$10,000 x .11 x 3/12 = $275
6.25a)
Feb. 1A-Note receivable18,040.00
SE-Sales18,040.00
June 30A-Interest receivable1,052.33
SE-Interest revenue1,052.33
$18,040 x .14 . 5/12 = $1,052.33
Aug. 1A-Cash19,302.80
A-Note receivable18,040.00
A-Interest receivable 1,052.33
SE-Interest revenue 210.47
$18,040 x .14 x 1/12 = $210.47
b)
June 30, 2000 Balance sheet
Note receivable $18,040
Interest receivable 1,052
June 30, 2000 Income statement
Sales $18,040
Interest revenue 1,052
(These amounts have been shown without the cents to simulate the rounding that occurs on financial statements.)
6.26a)
Interest earned at
December 31, 2000= Principal x rate x time
= $2,800 x 9% x 3/12
= $63
Interest earned at
time note is due= Principal x rate x time
= $2,800 x 9% x 4/12
= $84
b)
Dec. 31, 2000 A-Interest receivable63
SE-Interest revenue63
Jan. 30, 2001A-Cash2,884
A-Note receivable2,800
A-Interest receivable 63
SE-Interest revenue 21
6.27a)
Current ratio =25,000 + 70,000 + 10,000 + 210,000 + 30,000
45,000 + 20,000 + 25,000 + 6,000 + 60,000
=345,000
156,000
=2.21
Quick ratio =345,000 - 210,000 - 30,000
156,000
= 0.67
b)The company has been successful in achieving its desired results in terms of the current ratio, but it did not meet its target of 1.0 for the quick ratio.
c)The company could improve its current position through reducing its substantial investment in inventory, so long as the resulting effect on sales is not severe. Reducing the inventory levels would free up some cash, and thus enable the company to better meet its current obligations. In addition, Liquid Company could attempt to reduce its current levels of short-term liabilities, which would also improve its current position.
6.28a)
Faraday Products Company
Balance Sheet
At Year end
Current Assets
Cash$44,000
Accounts receivable62,000
Inventory80,000
Tax refund receivable3,000
Prepaid insurance5,000
Total current assets194,000
Noncurrent Assets
Land45,000
Building and equipment$230,000
Less: accumulated amortization90,000140,000
Trademarks35,000
Total noncurrent assets220,000
Total Assets$414,000
Current Liabilities
Accounts payable$47,000
Wages payable20,000
Taxes payable16,000
Unearned service revenue26,000
Total current liabilities109,000
Noncurrent Liabilities
Bonds payable125,000
Total Liabilities234,000
Shareholders’ Equity
Common shares120,000
Retained earnings60,000
Total shareholders’ equity180,000
Total Liabilities and Shareholders’ Equity$414,000
b)Working capital = $194,000 - $109,000 = $85,000
c) Current ratio, beginning of period = $120,000 / $55,000 = 2.18
Current ratio, end of period = $194,000 / $109,000 = 1.78
The current ratio has declined during the period, since the current assets represent a smaller multiple of the current liabilities at the end of the period than at the beginning of the period.
d) The ending working capital of $85,000 is $20,000 more than the beginning working capital balance of $65,000. While working capital has increased by $20,000, the overall liquidity has declined. The ratio of current assets to current liabilities has declined because current liabilities have increased proportionally more than current assets.
e) Faraday management should prepare a careful analysis of projected cash flows to determine if it needs to take action to avoid future difficulties. In addition, it should compare its current working capital position and overall liquidity to prior years, and to other companies in the same industry.
6.29
Smythe Company
Cash Flow Statement
Year ended December 31, 2000
Operating Activities:
Net income$ 1,635
Add back amortization1,000
Increase in accounts receivable(45)
Increase in inventory(450)
Increase in accounts payable 150
Net cash provided by operating activities2,290
Investing Activities:
Purchase of property, plant and equipment2,200
Increase in cash $ 90
Cash position*, beginning of year
Cash $ 500
Temporary investments 450
$ 950
Cash position, end of year
Cash$ 540
Temporary investments 500
1,040
Increase in cash$ 90
*NOTE: Recall that cash position in the Cash Flow Statement
includes both cash and temporary investments.
Management Perspective Problems
6.30A stock option plan that rewards managers for achieving a certain level of
reported net income has the potential to influence management’s assessment of the collectibility of its accounts receivable. For example, if management determines that the year-end balance of accounts receivable is collectible in full, then no bad debt expense is booked, and the reported net income is higher as a result.
6.31A loan officer is likely to be interested in the market value of temporary
investments because this method provides a better indication of the cash that will be available to settle the loan than the historical cost basis. The use of market value might be preferred over the use of the lower of cost and market method because this method is consistent regarding both upward and downward fluctuations in the market, and reflects the realizable value of the temporary investments at the balance sheet date. On the other hand, the lower of cost and market method results in the minimum realizable amount from selling the temporary investments, and is a more conservative estimate of the cash that will be available for settlement of the loan.
6.32A bank reconciliation is important for the management of cash because it keeps the company up to date in terms of recording all transactions that affect its cash balance. In doing so, the company can assess its need for cash, or perhaps plan short-term investments in order to earn a return on excess cash. A bank reconciliation is also a good internal control over cash because its basic function is to reconcile independent records of the same bank account.
6.33a)
A-Accounts receivable1,250,000
SE-Sales1,250,000
A-Cash1,050,000
A-Accounts receivable1,050,000
SE-Bad debt expense37,500
XA-Allowance for doubtful accounts37,500
XA-Allowance for doubtful accounts18,000
A-Accounts receivable18,000
b)
Balance Sheet, December 31, 2001
Accounts receivable$432,000
Allowance for doubtful accounts(41,500)
Accounts receivable, net$390,500
c) The only information available in evaluating the adequacy of Baltic’s allowance for doubtful accounts at December 31, 2001 is the value of the receivables written-off during 2001, the ending balance in receivables, and prior year-end information. In this case, bad debt expense of $37,500 was recorded and, as of December 31, 2001, $18,000 of accounts have been written-off. It would be very useful to analyze the remaining balance in accounts receivable to arrive at an estimate of the additional amount that is uncollectible. An allowance of $41,500 remains at December 31, 2001, while $22,000 remained at December 31, 2000. Based on the accounts receivable balance at those related points in time, the allowance as a percentage of accounts receivable was 9.6% (2001) and 8.8% (2000), representing approximately a 0.8% increase in the allowance percentage. It appears that the amounts of bad debt expense and allowance for doubtful accounts might be adequate based on the available information. Further analysis might reveal that an adjustment (additional charge) is appropriate.
6.34a) and b)
2001 / 2000 / 1999Allowance for doubtful accounts / $128.9 / $121.9 / $118.0
Total accounts receivable / $1,598.7 / $1,352.5 / $1,162.8
% considered uncollectible / 8.06% / 9.01% / 10.15%
Bad debt expense / $312.4 / $271.5 / $267
Sales / $12,661.8 / $11,367.8 / $10,420
Bad debt expense as a % of sales / 2.47% / 2.39% / 2.56%
c) Although the actual number of write-offs in dollars has fluctuated during the three year period, the highest percentage of accounts written off in relation to either accounts receivable or operating revenues was in 1999. It appears from the following analysis that Lowrate improved considerably in 2000 and is doing roughly the same in 2001:
2001 / 2000 / 1999Accounts written off / sales / 2.45% / 2.38% / 2.85%
Accounts written off / accounts receivable / 19.38% / 19.98% / 25.52%
d) Lowrate Communications records revenue and an account receivable when it bills its customers. Since customers are not liable for calls that were not made by the customers due to car phone theft, cloning, etc., Lowrate removes these charges from the customers’ accounts and must reduce receivables. At the same time, the company must record a reduction in recorded revenue, reduce the allowance for doubtful accounts, or establish an expense account (bad debt). Another option would be to establish one or more separate expense accounts in which these losses are recorded to track them more closely. It is not readily apparent from the financial data presented how Lowrate handles this situation. However, if it is handled through the allowance for doubtful accounts, we would expect the amounts reported as bad debts, the allowance for doubtful accounts, and the amount actually written off to increase.