CHAPTER 8
Accounts Receivable
QUESTIONS
1. Accounts receivable are an asset and are 10. Assuming an allowance method is used, the
generally presented in the current asset section write-off of an account receivable reduces
of the balance sheet. gross accounts receivable but has no effect on
2. Gross receivables represent the total amounts net income, net accounts receivable, total
owed to a company without regard to potential assets, or the current ratio.
uncollectible accounts. Net receivables equal 11. The aging method emphasizes the valuation of
gross receivables less the estimated uncollect- accounts receivable in the balance sheet. The
ible accounts represented in the allowance for ending balance in the allowance for doubtful
doubtful accounts. accounts corresponds to the expected
3. The percentage of gross receivables not expected uncollectible receivables on the balance sheet.
to be collected is computed by dividing the The percent-of-sales method emphasizes the
allowance for uncollectible accounts by the gross relationship between the current period sales
amount of accounts receivable. and the expected bad debts resulting from
their sales. Its theoretical underpinning is the
4. Bad debt expense appears in general and
matching principle.
administrative expenses in the income
statement. 12. Since GAAP accounting for bad debts ignores
interest, it overstates the value of the receiva-
5. The three parts to the economic value of
bles relative to their true economic value.
accounts receivable are: 1) the nominal amount
Therefore, the market-to-book value will be
owed by customers, 2) the allowance for bad
less than 1.
debts, representing the nominal amount that is
expected not to be collected, and 3) the 13. Because the percentage of sales method
discounted expected future cash collections of adjusts the percentage used if the actual
the accounts receivable (i.e., the time value of experience is better or worse than estimates,
money). bad debt expense is smoothed over time. If the
balance in the allowance grows too large, the
6. GAAP revenue recognition criteria include: 1)
percentage of sales is lowered. If the balance
an earnings process must be substantially
is too small, the percentage is increased.
complete, 2) an exchange takes place, and 3)
collection is reasonably assured. 14. The aging method focuses directly on the
balance of accounts receivable at the balance
7. GAAP for accounts receivable ignore interest
sheet date. The “bad debt expense” is the
because the time period involved in the
difference between the existing balance before
collection of a receivable is relatively short.
the adjusting entry is made and the desired
Therefore, the “interest” component is viewed
ending balance in the allowance for doubtful
as being immaterial.
accounts.
8. Account Financial
Theoretically, since a careful analysis of existing
name Type statement accounts receivable has been made, the net
Bad debt Operating Income receivables should be a close approximation of
expense expense statement the value of the receivables at year end.
Accounts Current Balance
receivable asset sheet
Allowance for Contra- Balance
doubtful asset sheet
accounts
9. “Written-off” means that a specific customer’s
account receivable has been taken off the books
and no longer is represented as an asset.
260
Accounts Receivable 261
15. Sometimes management’s incentives for 18. If management overstates uncollectible accounts
accurate estimates of uncollectible accounts in a given accounting period, subsequent
are suspect. When the expectations of collections are likely to exceed the net book
uncollectibles that are built into the book value value of the receivables. This will result in a
differ substantially from those used to deter- gain from the collection experience, which will
mine economic values, market-to-book ratios be recognized by lowering the bad debt
will differ significantly from one. expense in future periods. In years of high
16. Factoring is when organizations raise cash by profits, management may overstate bad debt
selling their accounts receivable. expense so that it can be understated in future
periods when profits may be lower.
17. Factoring without recourse means that the
19. The days receivables outstanding equals 365
purchaser of the accounts receivable bears all
days divided by the receivables turnover, so on
the risk of uncollectibles.
average an account must have been outstand-
ing for 365/4.6 or 79 days.
262 Chapter 8
EXERCISES
E8-1
a. Accounts receivable 100,000
Sales revenue 100,000
(To recognize revenue and to anticipate collection of receivables)
Cash 60,000
Accounts receivable 60,000
(To recognize collection of cash from companies owing Alerin Corp. from 2003
sales)
Allowance for doubtful accounts 4,000
Accounts receivable 4,000
(To write off accounts that will not be collected)
Bad debt expense 12,000
Allowance for doubtful accounts 12,000
(To record bad debt expense based on an estimate that $8,000 of accounts
receivable will not be collectible. Before the adjustment, the allowance account
has a debit balance of $4,000.)
b. Net accounts receivable:
Accounts receivable balance ($100,000 – 60,000 – 4,000) $36,000
Allowance for doubtful accounts balance ($12,000 – 4,000) 8,000
Net accounts receivable $28,000
Bad debt expense: $12,000
E8-2
a. Accounts receivable 100,000
Sales revenue 100,000
(To recognize revenue and to anticipate collection of receivables)
Cash 60,000
Accounts receivable 60,000
(To recognize collection of cash from companies owing Alerin Corp. from 2003
sales)
Allowance for doubtful accounts 4,000
Accounts receivable 4,000
Accounts Receivable 263
(To write off accounts that will not be collected)
Bad debt expense 8,000
Allowance for doubtful accounts 8,000
(To record bad debt expense based on an estimate that 8 percent of credit sales
will not be collectible)
Net accounts receivable:
Accounts receivable balance ($100,000 – 60,000 – 4,000) $36,000
Allowance for doubtful accounts balance ($8,000 – 4,000) 4,000
Net accounts receivable $32,000
Bad debt expense: $8,000
b. Under the direct write-off method, the entry to write off the uncollectible
accounts would be:
Bad debt expense 4,000
Accounts receivable 4,000
There would be no entry debiting bad debt expense and crediting allowance for
doubtful accounts to estimate potential uncollectible accounts.
E8-3
Estimated uncollectible accounts, per aging schedule:
Estimated Percentage
Days Outstanding Amount Uncollectible Amount
0-60 $120,000 1% $ 1,200
61-120 90,000 2% 1,800
Over 120 120,000 6% 7,200
$330,000 $10,200
Bad debt expense is $5,200. ($12,000 Beginning balance – $7,000 written off +
$5,200 bad debt expense equals desired ending balance of $10,200.)
Net accounts receivable would be $330,000 – $10,200 = $319,800
264 Chapter 8
E8-4
a. Receivables turnover:
2001 2002
Net sales $22,419.3 $30,382.3
= 12.55 = 13.37
Average net receivables ($1,612.2 + $1,960) ($2,583.7 + $1,960)
2 2
Days receivables outstanding:
365 365 = 29.08 365
= 27.3
Receivables turnover 12.55 13.37
Percentage of receivables not expected to be collected:
1998 1999
Allowances $83.7 $181.5
= .041 = .066
Ending accounts receivable $2,048.7 $2,765.2
b. McKesson’s ratios indicate an improved performance in the collection of
accounts receivable. The company collected receivables almost 2 days faster on
average in 2002 compared to 2001.
E8-5
a. Allowance for doubtful accounts 4,250
Accounts receivable—Alissa Corp. 4,250
(To write off Alissa Corporation’s accounts receivable)
b. The net accounts receivable will not change as the result of the write-off:
Accounts receivable $295,750
Allowance for doubtful accounts (11,032 )
Net accounts receivable $284,718
c. The write-off has no effect on Erin’s 2004 net income.
E8-6
a. Bad debt expense 90,000
Allowance for doubtful accounts 90,000
(To record bad debt expense estimated at 1.5% of net credit sales)
Accounts Receivable 265
b. Bad debt expense 82,000
Allowance for doubtful accounts 82,000
(To record bad debt expense with bad debts estimated to be 9% of accounts
receivable. .09 × $950,000 = $85,500; $85,500 – $3,500 = $82,000)
c. Net value of accounts receivable:
Bad debts estimated at 1.5% of net credit sales:
Accounts receivable $950,000
Allowance for doubtful accounts ($3,500 + $90,000) (93,500 )
Net value $856,500
Bad debts estimated at 9% of accounts receivable
Accounts receivable $950,000
Allowance for doubtful accounts ($3,500 + 82,000) (85,500 )
Net value $864,500
E8-7
a. Bad debt expense 90,000
Allowance for doubtful accounts 90,000
(To record bad debt expense estimated at 1.5% of net credit sales)
b. Bad debt expense 90,500
Allowance for doubtful accounts 90,500
(To record bad debt expense with bad debts estimated to be 9% of accounts
receivable. $85,500 + $5,000 = $90,500)
c. Net value of accounts receivable:
Bad debts estimated at 1.5% of net credit sales:
Accounts receivable $950,000
Allowance for doubtful accounts ($–5,000 + $90,000) (85,000 )
Net value $865,000
Bad debts estimated at 9% of accounts receivable
Accounts receivable $950,000
Allowance for doubtful accounts ($–5,000 + 90,500) (85,500 )
Net value $864,500
266 Chapter 8
PROBLEMS
P8-1
a. 1) Rogal’s bad debt expense for 2004 will be $9,960.
Percent Estimated
Age in days Amount Uncollectible Amount
0-10 $296,000 1 $ 2,960
11-60 42,000 5 2,100
61-180 34,000 15 5,100
Over 180 12,000 30 3,600
TOTAL $384,000 $13,760
Amount estimated uncollectible $13,760
Existing credit balance in allowance for doubtful accounts (3,800 )
Bad debt expense $ 9,960
2) The write-off does not affect 2005’s income before taxes.
3) Balance before Balance after
write-off write-off
Accounts receivable $384,000 $374,000
Allowance for doubtful accounts (13,760 ) (3,760 )
Net accounts receivable $370,240 $370,240
b. Bad debt expense: $1,200,000 (.005) = $6,000
Balance in allowance for doubtful accounts:
Balance before adjustment $3,800 CR
Bad debt expense 6,000
Balance after adjustment $9,800 CR
c. Direct write-off is not preferred GAAP. It fails to include the bad debt
expense in the period in which sales revenue is recognized, violating the
matching principle.
Accounts Receivable 267
P8-2
a. Accounts receivable 2,600,000
Sales revenue 2,600,000
(To recognize revenue and to anticipate collection of receivables)
Cash 2,400,000
Accounts receivable 2,400,000
(To recognize collection of cash from companies owing Boyce Corp. from 2004
sales)
Allowance for doubtful accounts 150,000
Accounts receivable 150,000
(To write off accounts that will not be collected)
Accounts receivable 1,200
Allowance for doubtful accounts 1,200
(To reverse the write-off of accounts written off in previous years that were
collected in 2004)
Cash 1,200
Accounts receivable 1,200
(To record collection of accounts written off in previous years)
Bad debt expense 156,000
Allowance for doubtful accounts 156,000
(To record bad debt expense based on an estimate that 6 percent of credit sales
will not be collectible)
b. Bad debt expense will be $156,000
c. Net accounts receivable:
Accounts receivable balance
($2,000,000 + 2,600,000 – 2,400,000 –
150,000 + 1,200 – 1,200) $2,050,000
Allowance for doubtful accounts balance
($140,000 – 150,000 + 1,200 + 156,000) (147,200 )
Net accounts receivable $1,902,800
d. If Boyce only experiences a 5% loss instead of a 6% loss, the company will have
a “gain” from the collection experience. This gain is most often recognized by
slightly reducing the bad debt expense percentage going forward.
268 Chapter 8
P8-3
a. Accounts receivable 2,600,000
Sales revenue 2,600,000
(To recognize revenue and to anticipate collection of receivables)
Cash 2,400,000
Accounts receivable 2,400,000
(To recognize collection of cash from companies owing Boyce Corp. from 2004
sales)
Allowance for doubtful accounts 150,000
Accounts receivable 150,000
(To write off accounts that will not be collected)
Accounts receivable 1,200
Allowance for doubtful accounts 1,200
(To reverse the write-off of accounts written off in previous years that were
collected in 2004)
Cash 1,200
Accounts receivable 1,200
(To record collection of accounts written off in previous years)
Bad debt expense 111,300
Allowance for doubtful accounts 111,300
(To record bad debt expense based on an estimate that 5% of accounts
receivable will not be collectible)
Accounts receivable balance:
($2,000,000 + 2,600,000 – 2,400,000 –
150,000 + 1,200 – 1,200) $2,050,000
Required balance in allowance for doubtful accounts:
$2,050,000(.05) $102,500
Balance in allowance before adjustment:
($140,000 – 150,000 + 1,200) 8,800 DR
Bad debt expense $111,300
b. Bad debt expense will be $111,300
Accounts Receivable 269
c. Net accounts receivable:
Accounts receivable balance ($2,000,000 + 2,600,000 –
2,400,000 – 150,000 + 1,200 – 1,200) $2,050,000
Allowance for doubtful accounts balance
($140,000 – 150,000 + 1,200 + 111,300) (102,500 )
Net accounts receivable $1,947,500
P8-4
a. Although a write-off of accounts receivable has no effect on net income, Sears’
new policy will require the company to increase its estimates of potential uncol-
lectible accounts resulting from sales in 1998 and 1999. This will have the effect
of increasing the estimated bad debt expense, resulting in higher loan loss
reserves (bad debt expense) being recognized in 1998 and 1999, the years the
system is being changed over.
The Wall Street Journal reported:
“The impact of the change began to appear in Sears’ 1998 fourth-quarter
earnings report. A group of credit card accounts, representing about 12% of the
business, which had already been converted to the new system, showed a 10.1%
delinquency rate, a 43.6% jump from the 7.03% rate recorded in the fourth quar-
ter of 1997 for the whole portfolio.”
b. If the potential uncollectible accounts are overestimated in 1998 and 1999, net
income for those years will be understated. The “gain” from the collection period
would be recognized in the years 2000 and after, by reducing the estimated
uncollectible accounts expense. This would overstate 2000’s income relative to
what it otherwise would have been.
P8-5
a. Uncollectible accounts expense 1,287,000,000
Allowance (provision) for uncollectible
accounts 1,287,000,000
(To record bad debt expense based on estimated uncollectible accounts)
b. Allowance (provision) for uncollectible
accounts 2,040,000,000
Accounts receivable 2,040,000,000
(To write off uncollectible accounts receivable)
c. Entry a. reduces net income by $1,287,000,000. Entry b. has no effect on net
income.
270 Chapter 8
d. The provision for uncollectible accounts is added back to net income because it
is an expense that reduces Sears’ net income, but does not use any cash. The
provision estimates potential future bad debts related to current years’ sales.
However, it is a noncash expense similar to depreciation and amortization that
did not require any cash outlay on the part of the company.
P8-6
a. Economic value of accounts receivable:
$235,000,000 – $23,000,000 = $205,825,240
1.03
Receivable turnover is 4.05, or once every 90 days (3 months); so interest for 90
days is 0.12/4 = .03.
b. Generally Accepted Accounting Principles ignore interest because accounts
receivable are usually outstanding for only a short period of time. Therefore,
book values and returns on equity will be fairly close to their economic values.
c. Market-to-book value ratio:
Economic value of accounts receivable $205,825,240 = .971
Book value of accounts receivable $212,000,000
d. Since potential uncollectible accounts represent estimates by a company’s
management, there are times when those estimates can be suspect. If the
expectations that are built into the book value are substantially different from
those used to determine economic value, the market-to-book value ratio can
differ significantly from one.
P8-7
a. There is a significant negative trend beginning in 2001. Gross accounts
receivable declined 43 percent from 7/31/00 to 4/27/03. This would be attributa-
ble to the economic downturn that affected the entire technology sector begin-
ning in 2001.
Accounts Receivable 271
b. 7/31/99 7/31/00 7/28/01 4/27/02
Accounts receivable $1,269 $2,342 $1,75 $1,336
Allowance for doubtful accounts 27 43 288 346
Net accounts receivable $1,242 $2,299 $1,466 $990
Allowance as a % of
gross accounts receivable 2.1% 1.8% 16.4% 25.9%
The trend is very alarming. Cisco’s allowance for doubtful accounts has grown
from around 2 percent of accounts receivable in 1999 and 2000 to nearly 13
times that level, or 26 percent, in 2002. At 4/27/02, the company expects that one
out of every four dollars owed to it will not be collected.
c. In an economic downturn, it is expected that doubtful accounts will increase. As
sales decline, it would also be expected that total accounts receivable will
decline. However, note the dramatic percentage increase in the allowance for
doubtful accounts compared to 1999, when accounts receivable were only about
5 percent less than in 2002. At that time, the allowance for doubtful accounts
was only 2 percent of total accounts receivable. The allowance reported in 2002
is greater than in any previous year, both in absolute dollars and as a percentage
of gross accounts receivable. In 2002, it had risen to more than one quarter of
the total accounts receivable. This raises doubt about the quality of revenues
reported in 2001 and 2002. It could also raise doubts as to the future business
prospects of Cisco. It implies that many of Cisco’s customers are having difficul-
ty paying their bills. If these customers file for bankruptcy, potential future
growth at Cisco is at risk. In addition, increasing bad debts in the future will also
negatively impact Cisco’s operating margins.
d. If Cisco has overstated its bad debt expense in 2002, the company will “make
up” the difference in 2003. This might result in lower operating expenses and
higher operating income in 2003. It would make 2003’s results appear even
better, especially if compared with 2002.
Source: Cisco Sytem’s annual reports and 10-Q, Reuters, May 29, 2002.
P8-8
a. Beginning accounts receivable $9,450,000
Sales 105,900,000
less writeoffs –4,426,000
less cash collections ?
Equals ending accounts receivable $ 11,735,000
Cash collections = $103,189,000
272 Chapter 8
b. Age of receivable Amount of receivable % Uncollectible Amount
0-30 days $8,000,000 1% $80,000
31-60 days $3,000,000 6% 180,000
61-90 days $600,000 14% 84,000
91-120 days $115,000 30% 34,500
more than 120 days $20,000 50% 10,000
Total $11,735,000 $388,500
Balance in Allowance for Doubtful Accounts 1/1/04: $330,750 CR
Accounts written off during 2004: 426,000 DR
Balance at 12/31/04 before adjustment 95,250 DR
Required balance per aging: 388,500 CR
Bad debt expense for 2004: $483,750
c. Bad debt expense 483,750
Allowance for doubtful accounts 483,750
d. Accounts receivable balance at 12/31/04: $11,735,000
Allowance for doubtful accounts at 12/31/04: (388,500)
Net accounts receivable at 12/31/04: $11,346,500
e. Sebago uses a balance sheet approach, since the company estimates the
potential uncollectible accounts based on an aging of accounts receivable. The
ending balance in the allowance for doubtful accounts is a function of this
aging; the bad debt expense is a “plug” based on the beginning balance in the
allowance, any accounts written off during the year and the required ending
balance based on the aging.
P8-9
a. Sales $105,900,000
Percent estimated uncollectible .005
Bad debt expense: $ 529,500
b. Allowance for doubtful accounts 426,000
Accounts receivable 426,000
c. Bad debt expense 529,500
Allowance for doubtful accounts 529,500
Accounts Receivable 273
d. Beginning balance $330,750
Additions 529,500
Write-offs (426,000)
Ending balance $434,250
e. The write-off has no effect on the income statement or balance sheet.
f. The adjusting entry increases operating expenses, reduces net income, reduces
assets and reduces equity.
g. Accounts receivable balance at 12/31/04: $11,735,000
Allowance for doubtful accounts at 12/31/04: (434,250)
Net accounts receivable at 12/31/04: $11,300,750
h. Sebago’s approach represents an income statement approach. Bad debts are
recognized as a percentage of sales. The ending balance in the allowance for
doubtful accounts will be a result of the percentage used and the amount of
receivables written off during the year.
274 Chapter 8
CASES
C8-1 Cascade Communications
a. Days sales outstanding are computed by dividing 365 by the company’s
accounts receivable turnover. With days sales outstanding of 70, Cascade
turned its receivables 5.2 times in the fourth quarter of 1996 compared to 7.8
times in the previous quarter.
b. Analysts could be concerned for a number of reasons. The slowdown in
collection could mean that customers are unhappy with the product that they
have received and are withholding payment. It could also mean that the compa-
ny had significant “last minute” sales, essentially borrowing from the following
quarter to hit sales goals in the fourth quarter. Sometimes, a significant slow-
down in the receivable turnover can be attributed to aggressive accounting
tactics, where management is booking sales prematurely, but customers are not
paying bills related to these sales. In Cascade’s case, analysts were concerned
that sales growth for the high technology company was slowing significantly.
The Wall Street Journal stated that the increase in days sales outstanding “sug-
gests Cascade raced to book more orders at the end of the fourth quarter to
meet expectations, perhaps sapping business from coming quarters.” (The Wall
Street Journal, January 1997)
C8-2 Bad Debt Accounting
a. The method of accounting for bad debts does not affect expected collections, so
all three firms have the same expected collections:
80 + ½ * (15 + (½ * 5 + ½ * 0)) + ½ * (10 + (½ * 10 + ½ * 0))
= 80 + ½ * (15 + 2.5) + ½ * (10 + 5)
= 80 + 8.75 + 7.5
= 96.25
We can state this in terms of expected uncollectibles by noting that there is a ½
chance that there will be no uncollectibles, a ¼ chance that there will be $5 of
uncollectibles, and a ¼ chance that there will be $10 of uncollectibles. Expected
uncollectibles at time 0 are then:
½ * 0 + ¼ * 5 + ¼ * 10 = 1.25 + 2.5 = $3.75.
The expected amount to be collected is:
$100 – 3.75 = $96.25.
Accounts Receivable 275
b. Direct Method:
No entry
% Sales:
Bad Debts Expense 3.75
Allowance for Doubtful Accounts 3.75
Aging:
Bad Debts Expense 3.75
Allowance for Doubtful Accounts 3.75
c. Direct Method:
Time 1:
No entry
Time 2:
No entry
Time 3:
No entry
% Sales:
Time 1:
No entry
Time 2:
No entry
Time 3:
Allowance for Doubtful Accounts 3.75
Gain on Favorable Collection Experience 3.75
Aging:
Time 1:
No entry
276 Chapter 8
Time 2:
Allowance for Doubtful Accounts 1.25
Gain on Favorable Collection Experience 1.25
This entry reflects the fact that the balance in accounts receivable is $5, ½ of
which is expected to be uncollectible. Before adjustment, the balance in the
allowance for doubtful accounts was 1.25. This adjustment brings the balance in
the allowance for doubtful accounts down to $2.50.
Time 3:
Allowance for Doubtful Accounts 2.50
Gain on Favorable Collection Experience 2.50
d. Direct Method:
Time 1:
No entry
Time 2:
No entry
Time 3:
Bad Debts Expense 5.0
Accounts Receivable 5.0
To write off the uncollectible amount.
% Sales:
Time 1:
No entry
Time 2:
No entry
Accounts Receivable 277
Time 3:
Allowance for Doubtful Accounts 3.75
Bad Debts Expense 1.25
Accounts Receivable 5.0
To write off the uncollectible amount, we first debit the Allowance, then must
record additional bad debt expense because the allowance is insufficient.
Aging:
Time 1:
No entry
Time 2:
Allowance for Doubtful Accounts 1.25
Gain on Favorable Collection Experience 1.25
This entry reflects the fact that the balance in accounts receivable is $5, ½ of
which is expected to be uncollectible.
Time 3:
Allowance for Doubtful Accounts 2.5
Bad Debts Expense 2.5
Accounts Receivable 5.0
e. Direct Method:
Time 1:
No entry
Time 2:
No entry
Time 3:
No entry
% Sales:
Time 1:
No entry
278 Chapter 8
Time 2:
No entry
Time 3:
Allowance for Doubtful Accounts 3.75
Gain on Favorable Collection Experience 3.75
Aging:
Time 1:
No entry
Time 2:
Bad Debts Expense 1.25
Allowance for Doubtful Accounts 1.25
This entry reflects the fact that the balance in accounts receivable is $10, ½ of
which is expected to be uncollectible.
Time 3:
Allowance for Doubtful Accounts 5.0
Gain on Favorable Collection Experience 5.0
f. Direct method:
Time 1:
No entry
Time 2:
No entry
Time 3:
Bad Debts Expense 10.0
Accounts Receivable 10.0
To write off the uncollectible amount.
% Sales:
Time 1:
No entry
Accounts Receivable 279
Time 2:
No entry
Time 3:
Allowance for Doubtful Accounts 3.75
Bad Debts Expense 6.25
Accounts Receivable 10.0
To write off the uncollectible amount, we first debit the Allowance, then we must
record additional bad debt expense because the allowance is insufficient.
Aging:
Time 1:
No entry
Time 2:
Bad Debts Expense 1.25
Allowance for Doubtful Accounts 1.25
This entry reflects the fact that the balance in accounts receivable is $10, ½ of
which is expected to be uncollectible. The balance in the allowance for doubtful
accounts is only 3.75, so this adjustment provides the 1.25 increase necessary
to bring it to $5.00.
Time 3:
Allowance for Doubtful Accounts 5.0
Bad Debts Expense 5.0
Accounts Receivable 10.0
g. Yes, because all three methods keep the same gross accounts receivable on the
books. All record the total receivable, and all write off bad debts. The only differ-
ence is the allowance for doubtful accounts, which is the cumulative bad debt
expense less write-offs. Because write-offs are the same for all three methods,
the only difference is the cumulative amount of expense recognized.
h. Aging, because it makes estimates of expected uncollectibles at each balance
sheet date.
i. Some say aging again does the best job. Others like % of Sales. Aging makes
bad debts expense a function of information about collectibility, while % of Sales
just matches bad debts expense to current sales. If the accrual process is aimed
at generating balance sheets that reflect the best estimates of economic value at
280 Chapter 8
the time, then aging is the better accrual method. If the accrual process is more
aimed at showing expenses that are tied to the sales recognized in the period,
then aging reflects too much information. It is hard to see how reflecting too
much information can hurt, however, and accrual is increasingly thought of as a
process of measuring value, not matching.
j. None of the methods takes into account the time value of money.
k. Sales would be recorded at the amount that is expected to be collected. This
would make bad debts a contra-revenue, instead of an expense. Interest would
be imputed on the expected collections. Changes in the expected collections
would be reflected in gains and losses shown on the income statement. The
amount shown on any balance sheet for accounts receivable would be the net
present value of the expected collection.
See Chapter 7 of Antle and Garstka.
l. Yes. For example, if collections follow Path 4, before adjustment the allowance
under the % of Sales method is a negative $6.25. It means that information has
come out that past bad debts expenses has been too small relative to the write-
offs actually experienced.
m. Aging is probably the most informative, since it tries to keep the balance sheets
reflecting good information about expected uncollectibles. Aging will, however,
tend to make reported income more volatile, because it records gains and losses
as information becomes available. Some companies might want smoother
reported earnings, and might choose % of Sales. (See Figure 5.7 in Chapter 5. If
you don’t have Figure 5.7, you are relying on an old version of Chapter 5. Down-
load the new version from the WebBoard.)
There is probably information in a company’s choice of Aging or % of Sales, but
nothing general is known about what that information might be.
233 Chapter 8
Accounts Receivable
C 8-3 Typical Company: Bad Debt Accounting
a. and b.
Cash Accounts Rec. Allow for Dbtfl Accounts Inventory
12/31/2002 1,000.0 12/31/2002 – – 12/31/2002 12/31/2002 –
90.0 03we 03sales 1,000.0 200.0 03bde 03purch 300.0 300.0 03cgs
300.0 03purch 12/31/2003 1,000.0 200.0 12/31/2003 12/31/2003 –
12/31/2003 610.0 04 sales 1,000.0 800.0 04coll 04wa 200.0 200.0 04purch 300.0 300.0 04cgs
04coll 800.0 300.0 04purch 200.0 04wo 200.0 12/31/2004 12/31/2004 –
90.0 04we 12/31/2004 1,000.0 05wo 200.0 200.0 04bde 05puech 300.0 300.0 05cgs
12/31/2004 1,020.0 05sales 1,000.0 800.0 05coll 200.0 12/31/2005 12/31/2005 –
05coll 800.0 300.0 05purch 200.0 05wo 06wo 200.0 200.0 05bde 06purch 300.0 300.0 06cgs
90.0 05we 12/31/2005 1,000.0 200.0 12/31/2006 –
12/31/2005 1,430.0 06sales 1,000.0 800.0 06coll
06coll 800.0 300.0 06purch 200.0 06wo
90.0 06we 12/31/2006 1,000.0 Accumulated Depreciation Common Stock
12/31/2006 1,840.0 – 12/31/2002 2,640.0 12/31/2002
410.0 03de 2,640.0 12/31/2002
Retained Earnings PP&E 410.0 12/31/2003 2,640.0 12/31/2004
– 12/31/2002 12/31/2002 1,640.0 410.0 04de 2,640.0 12/31/2005
– 12/31/2003 12/31/2003 1,640.0 820.0 12/31/2004 2,640.0 12/31/2006
– 12/31/2004 12/31/2004 1,640.0 410.0 05de
– 12/31/2005 12/31/2005 1,640.0 1,230.0 12/31/2005
– 12/31/2006 12/31/2006 1,640.0 410.0 06de
1,640.0 12/31/2006
Sales Depreciation Exp
03c1 1,000.0 1,000.0 03sales 03de 410.0 410.0 03c5 Bad Debt Expense
04c1 1,000.0 1,000.0 04sales 04de 410.0 410.0 04c5 03bde 200.0 200.0 03c4
05c1 1,000.0 1,000.0 05sales 05de 410.0 410.0 05c5 04bde 200.0 200.0 04c4 Income Summary
06c1 1,000.0 1,000.0 06sales 06de 410.0 410.0 06c5 05bde 200.0 200.0 05c4 03c2 90.0 1,000.0 03c1
06bde 200.0 200.0 06c4 03c3 300.0
03c4 200.0
Cost of Goods Sold Wages Expense 03c5 410.0
03cgs 300.0 300.0 03c3 03we 90.0 90.0 03c2 04c2 90.0 1,000.0 04c1
04cgs 300.0 300.0 04c3 04we 90.0 90.0 04c2 04c3 300.0
05cgs 300.0 300.0 05c3 05we 90.0 90.0 05c2 04c4 200.0
06cgs 300.0 300.0 06c3 06we 90.0 90.0 06c2 04c5 410.0
05c2 90.0 1,000.0 05c1
Using the % of sales, bad debts expense = 20% of sales – 20% of $100,000 each year. 05c3 300.0
Using aging, the ending balance for doubtful accounts = 20% of ending accounts receivable. 05c4 200.0
When everything goes as expected, if the percentage of sales and the percentages used in aging are properly aligned, you get 05c5 410.0
all the same accounting statements. 06c2 90.0 1,000.0 06c1
06c3 300.0
06c4 200.0
06c5 410.0
281
282 Chapter 8
a. and b.
Typical Company
Balance Sheets
as of 12/31
2003 2004 2005 2006 .
Cash $ 610.0 $ 1,020.0 $ 1,430.0 $ 1,840.0
Accounts Receivable, net 800.0 800.0 800.0 800.0
Total Current Assets $ 1,410.0 $ 1,820.0 $ 2,230.0 $ 2,640.0
Buildings & Machinery $ 1,640.0 $ 1,640.0 $ 1,640.0 $ 1,640.0
Less: Accumulated Depreciation (410.0) (820.0) (1,230.0) (1,640.0)
Buildings & Machinery, net $ 1,230.0 $ 820.0 $410.0 $ –
Total Non-current Assets $ 1,230.0 $ 820.0 $410.0 $ –
Total Assets $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Shareholders’ Equity
Common Stock $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Retained Earnings – – – –
Total Shareholders’ Equity $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Total Liabilities &
Shareholders’ Equity $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Market value of Typical Company $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Mkt Value/Book Value 1.00 1.00 1.00 1.00
Econ ROE 0.0% 0.0% 0.0% 0.0%
Acctg ROE 0.0% 0.0% 0.0% 0.0%
Econ ROE = (Change in mkt value + Dividends)/Beginning Mkt value
06c1
Typical Company
Income Statements
for Years Ended
12/31/2003 12/31/2004 12/31/2005 12/31/2006
Sales $ 1,000.0 $ 1,000.0 $ 1,000.0 $ 1,000.0
Cost of Goods Sold (300.0) (300.0) (300.0) (300.0)
Gross Margin $ 700.0 $ 700.0 $ 700.0 $ 700.0
Other Expenses:
Wages (90.0) (90.0) (90.0) (90.0)
Depreciation (410.0) (410.0) (410.0) (410.0)
Bad debts expense (200.0) (200.0) (200.0) (200.0)
Net Income $ – $ – $ – $ –
Accounts Receivable 283
Typical Co.
Cash Flow Statements
for Years Ended 12/31
2003 2004 2005 2006
Operations:
Net Income $ – $ – $ – $ –
Addbacks:
Depreciation 410.0 410.0 410.0 410.0
Changes in accounts that
require additions:
Accounts Receivable, net (800.0) – – –
Cash flow from operations $ (390.0) $ 410.0 $ 410.0 $ 410.0
Cash flows for investing $ – $ – $ – $ –
Cash flows from financing $ – $ – $ – $ –
Change in Cash $ (390.0) $ 410.0 $ 410.0 $ 410.0
236 Chapter 8
284
c. (% Sales)
Cash Accounts Rec. Allow. for Dbtfl Accounts Inventory
12/31/2002 1,000.0 12/31/2002 – – 12/31/2002 12/31/2002 –
90.0 03we 03 sales 1,000.0 200.0 03bde 03purch 300.0 300.0 03cgs
300.0 03purch 12/31/2003 1,000.0 200.0 12/31/2003 12/31/2003 –
12/31/2003 610.0 04sales 1,000.0 500.0 04coll 04wo 300.0 200.0 04bde 04purch 300.0 300.0 04CGS
04coll 500.0 300.0 04purch 300.0 04WO 100.0 12/31/2004 12/31/2004 –
90.0 04we 12/31/2004 1,200.0 05wo 200.0 200.0 05bde 05purch 300.0 300.0 05cgs
12/31/2004 720.0 05sales 1,000.0 1,000.0 05coll 100.0 12/31/2005 12/31/2005 –
05coll 1,000.0 300.0 05purch 200.0 05wo 05wo 200.0 200.0 05bde 06purch 300.0 300.0 06cgs
90.0 05we 12/31/2005 1,000.0 100.0 12/31/2006 –
12/31/2005 1,330.0 0 6sales 1,000.0 800.0 06c0ll
06coll 800.0 300.0 06purch 200.0 05wo
90.0 06we 12/31/2006 1,000.0 Accumulated Depreciation Common Stock
12/31/2006 1,740.0 – 12/31/2002 2,640.0
410.0 03de 2,640.0
Retained Earnings PP&E 410.0 12/31/2003 2,640.0
– 12/31/2002 12/31/2002 1,640.0 410.0 04de 2,640.0
– 12/31/2003 12/31/2003 1,640.0 820.0 12/31/2004 2,640.0
– 12/31/2004 12/31/2004 1,640.0 410.0 05de
– 12/31/2005 12/31/2005 1,640.0 1,230.0 12/31/2005
– 12/31/2006 12/31/2006 1,640.0 410.0 6de
1,640.0 12/31/2006
Sales Depreciation Exp.
03c1 1,000.0 1,000.0 03sales 03de 410.0 410.0 03c5 Bad Debts Expense
04c1 1,000.0 1.000.0 04sales 04de 410.0 410.0 04c5 03bde 200.0 200.0 03c4
05c1 1,000.0 1,000.0 05sales 05de 4100 410.0 05c5 04bde 200.0 200.0 04c4 Income Summary
06c1 1.000.0 1,000.0 06sales 06de 410.0 410.0 06c5 05bde 200.0 200.0 05c4 03c2 90.0 1,000.0 03c1
06bde 200.0 200.0 06c4 03c3 300.0
03c4 200.0
Cost of Goods Sold Wages Expense 03c5 410.0
03cgs 300.0 300.0 03c3 03we 90.0 90.0 03c2 04c2 90.0 1,000.0 04c1
04cgs 300.0 300.0 04c3 04we 90.0 90.0 04c2 04c3 300.0
05cgs 300.0 300.0 05c3 05we 90.0 90.0 05c2 04c4 200.0
06cgs 300.0 300.0 06c3 06we 90.0 90.0 06c2 04c5 410.0
05c2 90.0 1,000.0 05c1
05c3 300.0
05c4 200.0
05c5 410.0
06c2 90.0 1,000.0 06c1
Chapter 8
06c3 300.0
06c4 200.0
06c5 410.0
285 Chapter 8
c. (% Sales)
Typical Company
Balance Sheets
as of 12/31
2003 2004 2005 2006
Cash $ 610.0 $ 720.0 $ 1,330.0 $ 1,740.0
Accounts Receivable, net 800.0 1,100.0 900.0 900.0
Total Current Assets $ 1,410.0 $1,820.0 $2,230.0 $2,640.0
Buildings & Machinery $ 1,640.0 $ 1,640.0 $ 1,640.0 $ 1,640.0
Less: Accumulated Depreciation (410.0) (820.0) (1,230.0) (1,640.0)
Buildings & Machinery, net $ 1,230.0 $820.0 $410.0 $–
Total Non-current Assets $ 1,230.0 $820.0 $410.0 $–
Total Assets $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Shareholders’ Equity
Common Stock $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Retained Earnings – – – –
Total Shareholders’ Equity $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Total Liabilities & Shareholders’ Equity $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Market Value of Typical Company $ 2,640.0 $ 2,540.0 $ 2,540.0 $ 2,540.0
Mkt Value/Book Value 1.00 0.96 0.96 0.96
Econ ROE 0.00% (3.79%) 0.00% 0.00%
Acctg ROE 0.00% 0.00% 0.00% 0.00%
Econ ROE = (Change in mkt value + Dividends)/Beginning Mkt value
06c1
Note how MV/BV stays away from 1. The only way to bring this back to 1 change the
percentage.
286 Chapter 8
(% Sales)
Typical Company
Income Statements
for Years Ended
12/31/2003 12/31/2004 12/31/2005 12/31/2006
Sales $ 1,000.0 $ 1,000.0 $ 1,000.0 $ 1,000.0
Cost of Goods Sold (300.0) (300.0) (300.0) (300.0)
Gross Margin $700.0 $700.0 $700.0 $700.0
Other Expenses:
Wages (90.0) (90.0) (90.0) (90.0)
Depreciation (410.0) (410.0) (410.0) (410.0)
Bad debts expense (200.0) (200.0) (200.0) (200.0)
Net Income $ – $ – $ – $ – .
Note how the income statement fails to reflect the unfavorable collection experience.
(% Sales)
Typical Co.
Cash Flow Statements
for Years Ended 12/31
2003 2004 2005 2006
Operations:
Net Income $ – $ – $ –$ –
Addbacks:
Depreciation 410.0 410.0 410.0 410.0
Changes in accounts that require additions:
Accounts Receivable, net (800.0) (300.0) 200.0 –
Cash flow from operations $(390.0) $ 110.0 $ 610.0 $ 410.0
Cash flows for investing $ – $ – $ – $ –
Cash flows from financing $ – $ – $ – $ –
Change in Cash $(390.0) $ 110.0 $ 610.0 $ 410.0
239 Chapter 8
Accounts Receivable
c. (Aging)
Cash Accounts Rec. Allow. for Debit Accounts Inventory
12/31/2002 1,000.0 12/31/2002 – – 12/31/2002 12/31/2002 –
90.0 03we 03sales 1,000.0 200.0 03bde 03purch 300.0 300.0 03cgs
300.0 03purch 12/31/2003 1,000.0 200.0 12/31/2003 12/31/2003 –
12/31/2003 610.0 04sales 1,000.0 500.0 04coll 04wo 300.0 500.0 04bde 04purch 300.0 300.0 04cgs
04coll 500.0 300.0 04purch 300.0 04wo 400.0 12/31/2004 12/31/2004 –
90.0 04we 12/31/2004 1,200.0 05wo 200.0 – 05bde 05purch 300.0 300.0 05cgs
12/31/2004 720.0 05sales 1,000.0 1,000.0 05coll 200.0 12/31/2005 12/31/2005 –
05coll 1,000.0 300.0 05purch 200.0 05wo 05wo 200.0 200.0 05bde 06purch 300.0 300.0 06cgs
90.0 05we 12/31/2005 1,000.0 200.0 12/31/2006 –
12/31/2005 1,330.0 06sales 1,000.0 800.0 06coll
06coll 800.0 300.0 06purch 200.0 06wo
90.0 06we 12/31/2006 1,000.0 Accumulated Depreciation Common Stock
12/31/2006 1,740.0 – 12/31/2002 2,640.0
410.0 03de 2,640.0
Retained Earnings PP&E 410.0 12/31/2003 2,640.0
– 12/31/2002 12/31/2002 1,640.0 410.0 04de 2,640.0
– 12/31/2003 12/31/2003 1,640.0 820.0 12/31/2004 2,640.0
04c6 300.0 – 12/31/2004 1,640.0 410.0 05de
12/31/2004 300.0 12/31/2005 1,640.0 1,230.0 12/31/2005
200.0 05c1 12/31/2006 1,640.0 410.0 06de
12/31/2005 100.0 1,640.0 12/31/2006
12/31/2006 100.0 –
Depreciation Exp.
03de 410.0 410.0 03c5 Bad Debts Expense Income Summary
04de 410.0 410.0 04c5 03bde 200.0 200.0 03c4 03c2 90.0 1,000.0 03c1
05de 410.0 410.0 05c5 04bde 500.0 500.0 04c4 03c3 300.0
06c1 06de 410.0 410.0 06c5 05bde – – 05c4 03c4 500.0
06bde 200.0 200.0 06c4 03c5 410.0
Sales 04c2 90.0 1,000.0 04c1
03c1 1,000.0 1,000.0 03sales Wages Expense 04c3 300.0
04c1 1,000.0 1,000.0 04sales 03we 90.0 90.0 03c2 04c4 500.0
05c1 1,000.0 1,000.0 05sales 04we 90.0 90.0 04c2 04c5 410.0 300.0 04c6
06c1 1,000.0 1,000.0 06sales 05we 90.0 90.0 05c2 05c2 90.0 1,000.0 05c1
06we 90.0 90.0 06c2 05c3 300.0
Cost of Goods Sold 05c4 –
03cgs 300.0 300.0 03c3 05c5 410.0
04cgs 300.0 300.0 04c3 05c6 200.0
05cgs 300.0 300.0 05c3 06c2 90.0 1,000.0 06c1
06cgs 300.0 300.0 06c3 06c3 300.0
06c4 200.0
06c5 410.0
287
288 Chapter 8
c. (Aging)
Typical Company
Balance Sheets
as of 12/31
2003 2004 2005 2006 .
Cash $ 610.0 $ 720.0 $ 1,330.0 $ 1,740.0
Accounts Receivable, net 800.0 800.0 800.0 800.0
Total Current Assets $ 1,410.0 $ 1,520.0 $ 2,130.0 $ 2,540.0
Buildings & Machinery $ 1,640.0 $ 1,640.0 $ 1,640.0 $ 1,640.0
Less: Accumulated Depreciation (410.0) (820.0) (1,230.0) (1,640.0)
Buildings & Machinery, net $ 1,230.0 $ 820.0 $ 410.0 $ –
Total Non-current Assets $ 1,230.0 $ 820.0 $ 410.0 $ –
Total Assets $ 2,640.0 $ 2,340.0 $ 2,540.0 $ 2,540.0
Shareholders’ Equity
Common Stock $ 2,640.0 $ 2,640.0 $ 2,640.0 $ 2,640.0
Retained Earnings – (300.0) (100.0) (100.0)
Total Shareholders’ Equity $ 2,640.0 $ 2,340.0 $ 2,540.0 $ 2,540.0
Total Liabilities & Shareholders’ Equity $ 2,640.0 $ 2,340.0 $ 2,540.0 $ 2,540.0
Market value of Typical Company $ 2,640.0 $ 2,540.0 $ 2,540.0 $ 2,540.0
Mkt Value/Book Value 1.00 1.09 1.00 1.00
Econ ROE 0.0% (3.79%) 0.0% 0.0%
Acctg ROE 0.0% (11.4%) 8.5% 0.0%
Econ ROE = (Change in mkt value + Dividends)/Beginning Mkt value
06c1
Note how MV/BV goes back to 1. Aging has a self-correcting mechanism.
Accounts Receivable 289
(Aging)
Typical Company
Income Statements
for Years Ended
12/31/2003 12/31/2004 12/31/2005 12/31/2006
Sales $ 1,000.0 $ 1,000.0 $ 1,000.0 $ 1,000.0
Cost of Goods Sold (300.0) (300.0) (300.0) (300.0)
Gross Margin $ 700.0 $ 700.0 $ 700.0 $ 700.0
Other Expenses:
Wages (90.0) (90.0) (90.0) (90.0)
Depreciation (410.0) (410.0) (410.0) (410.0)
Bad debts expense (200.0) (500.0) – (200.0)
Net Income $ – $ (300.0) $ 200.0 $ –
(Aging)
Typical Co.
Cash Flow Statements
for Years Ended 12/31
2003 2004 2005 2006
Operations:
Net Income $ – $ (300.0) $ 200.0 $ –
Addbacks:
Depreciation 410.0 410.0 410.0 410.0
Changes in accounts that require additions:
Accounts Receivable, net (800.0) – – –
Cash flow from operations $ (390.0) $ 110.0 $ 610.0 $ 410.0
Cash flows for investing $ – $ – $ – $ –
Cash flows from financing $ – $ – $ – $ –
Change in Cash $ (390.0) $ 110.0 $ 610.0 $ 410.0
d. Note how income under aging reflects the unfavorable $100 loss in collections.
It doesn’t get things right, because the $100 is the total over two periods: 2004
and 2005.
290 Chapter 8
C8-4 Mechanical Technology Incorporated
a. The accounts are shown below:
Accounts Receivable (gross)
Beginning balance 5,058
Sales 12,885 13,916 Collections (PLUG)
62 Write-offs
Ending balance 3,965
Allowance for Doubtful Accounts
99 Beginning balance
Write-offs 62 76 Expense for the period
113 Ending balance
Now, the account, Accounts receivable (net) appears as follows:
Accounts Receivable (net)
Beginning balance 4,959
Sales 12,885 13,916 Collections
76 Expense
Ending balance 3,852
Accounts Receivable 291
b. MECHANICAL TECHNOLOGY INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Years Ended September 30, 1999 and 1998
(Dollars in thousands)
1999 1998
OPERATING ACTIVITIES
(Loss) income from continuing operations $ (10,729) $ (2,031)
Adjustments to reconcile net (loss) income to net cash
provided (used) by continuing operations:
Depreciation and amortization 581 323
Unrealized loss on marketable securities (5)
Equity in losses of Plug Power 9,363 3,806
Loss on sale of fixed assets 28 9
Deferred income taxes and other credits (10) 13
Stock option compensation 55 -
Changes in operating assets and liabilities net
of effects from discontinued operations:
Accounts receivable (net) 1,107 (1,064)
Accounts receivable—related parties (18) -
Inventories (4) (362)
Prepaid expenses and other current assets (174) (346)
Accounts payable (1,450) 788
Income taxes (7) (76)
Accrued liabilities (1,085) (519)
___ ___ _____
Net cash (used) provided by continuing operations (2,348) 541
ACCOUNTS RECEIVABLE RESERVE, and ACCOUNTS RECEIVABLE in the cash flow
statement should be replaced with one line, ACCOUNTS RECEIVABLE (NET) . . .
$1,107 ($4,959 – $3,852), the amount by which the net accounts receivable decreased
in 1999. Note that this is also $1,093 + $14.
292 Chapter 8
c. Complete the following table (assume all sales are on account):
1999 1998
Bad debt expense 76 95
(Bde)
Sales 12,885 21,028
Bde/sales .0059 .0045
Ending accounts 3,965 5,058
receivable balance
(Earb)
Bde/Earb .019 .019
In light of the above table, it is more likely that Mechanical Technology uses the
aging method to determine bad debt expense, since Bde/Earb is more stable
than Bde/Sales.
C8-5 Mentor Corporation
a. 1999
Bad Debt Expense 960
Allowance for Doubtful Accounts 960
Allowance for Doubtful Accounts 494
Accounts receivable 494
2000
Bad Debt Expense 1,888
Allowance for Doubtful Accounts 1,888
Allowance for Doubtful Accounts 984
Accounts receivable 984
b. Ratio of bad debt expense to net sales revenue:
(A) (Bad Debt Expense) / (Net Sales)
1998 1999 2000
(933/180,267) = .0052 (960/202,788) = .0047 (1,888/247,344) = .0076
(B) Ratio of allowance for doubtful accounts to gross accounts receivable:
(Allowance for Doubtful Accounts)/(Gross A/R)
1998 1999 2000
(1,606/33,274) = .048 (2,072)/(37,431 + 2,072) = .052 (2,976)/(48,286) =.062
Accounts Receivable 293
(A) is likely to be very stable if the % of Sales method is used unless split
between cash and A/R varies.
(B) is very small (consistent with the statement “bad debts have been mini-
mal”).
(A) varies too much so accounting must have been based upon (B), Aging.
c. Accounts receivable turnover = (Net Sales)/(Average A/R)
1999
(202,783)/((37,431 + 31,668)/2) = (202,783/34,549.5) = 5.8693
2000
(247,344)/((45,310 + 37,431)/2) = (247,344/41,370.5) = 5.97875
1999
(365)/(5.8693) = 62.19 days
2000
(365)/(5.97875) = 61.05 days
Caveats:
Cyclic: Could over- or understate
Could use average of ending quarterly values
Should use sales on account (vs. total sales)
We assumed all sales were accounts receivable sales
Turns would be fewer if numerator is lower
Days outstanding would be higher
d. Look at year 2000. If A/R turns double =~ (247,344)/x) = 5.97875(2) = 11.9575
x = 20,685.26 on average (A/R balance)
vs: 41,370.5, i.e., would decrease by half
... 20,685,260 x.10 = 2.07 million dollars opportunity cost/year
e. Accrued sales returns: products returned
Allowances: discounts for prompt payment
Gross sales computation:
Net Sales $247,344
+ Change in Allowance for Sales Returns 1,275
$248,619
294 Chapter 8
f. No effect on cash flows. Accounts receivable are decreased and so is the allow-
ance account. The net effect is zero.
g. Usual analysis:
A/R (Gross)
Beginning balance 39,503
Sales 247,344 984 write-offs
237,577 plug
48,286
If you consider returns and allowances (more accurate)
A/R Gross
Beginning balance 39,503
Sales 247,344 + 1,275 984 write-offs
0 deductions for
returns
238,852 plug
48,286
So cash inflow is somewhere in the neighborhood of $238,252. This assumes
warranty expense is not netted out from sales to arrive at net sales-only sales
returns and allowances are.