Investments and Receivables

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					                                       CHAPTER 7

                  Investments and Receivables
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
                                                                                 Estimated
                                                                                  Time in
Learning Outcomes                                                    Exercises    Minutes    Level
1. Show that you understand the accounting and disclosure                 1          15      Mod
   of various types of investments companies make.                        2          10      Easy
                                                                         15*          5      Easy

2. Show that you understand how to account for accounts                   3          10      Mod
   receivable, including bad debts.                                       4          25      Mod
                                                                         15*          5      Easy

3. Explain how information about sales and receivables can                5          20      Mod
   be combined to evaluate how efficient a company is in
   collecting its receivables.

4. Show that you understand how to account for                            6          15      Mod
   interest-bearing notes receivable.

5. Explain various techniques that companies use to accelerate            7          20      Mod
   the inflow of cash from sales.

6. Explain the effects of transactions involving liquid assets            8           5      Easy
   on the statement of cash flows.                                        9           5      Mod
                                                                         15*          5      Easy

7. Show that you understand the accounting for and disclosure of         10          10      Mod
   investments in the stocks and bonds of other companies.               11          10      Mod
   (Appendix)                                                            12          30      Mod
                                                                         13          30      Mod
                                                                         14          30      Mod

*Exercise, problem, or case covers two or more learning outcomes
 Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)




                                                                                                 7-1
7-2     FINANCIAL ACCOUNTING SOLUTIONS MANUAL



                                                                     Problems     Estimated
                                                                        and        Time in
Learning Outcomes                                                    Alternates    Minutes    Level
1. Show that you understand the accounting and disclosure
   of various types of investments companies make.

2. Show that you understand how to account for accounts                   1           30      Mod
   receivable, including bad debts.                                       2           15      Mod
                                                                          8*          20      Mod

3. Explain how information about sales and receivables                    3           30      Mod
   can be combined to evaluate how efficient a company
   is in collecting its receivables.

4. Show that you understand how to account for                            5           45      Diff
   interest-bearing notes receivable.                                     6           25      Mod
                                                                          7           20      Mod
                                                                          8*          20      Mod

5. Explain various techniques that companies use to accelerate            4           15      Mod
   the inflow of cash from sales.

6. Explain the effects of transactions involving liquid assets            5           25      Mod
   on the statement of cash flows.

7. Show that you understand the accounting for and                        6           30      Mod
   disclosure of investments in the stocks and bonds                      7           30      Mod
   of other companies. (Appendix)

*Exercise, problem, or case covers two or more learning outcomes
 Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
                                                                 CHAPTER 7 • INVESTMENTS AND RECEIVABLES     7-3

                                                                                          Estimated
                                                                                           Time in
Learning Outcomes                                                              Cases       Minutes     Level
1. Show that you understand the accounting and disclosure                          2*         25           Mod
   of various types of investments companies make.                                 3*         25           Mod

2. Show that you understand how to account for accounts                            1          30           Mod
   receivable, including bad debts.                                                3*         25           Mod

3. Explain how information about sales and receivables
   can be combined to evaluate how efficient a company
   is in collecting its receivables.

4. Show that you understand how to account for
   interest-bearing notes receivable.

5. Explain various techniques that companies use to accelerate                     4          25           Mod
   the inflow of cash from sales.

6. Explain the effects of transactions involving liquid assets                     2*         25           Mod
   on the statement of cash flows.                                                 7          30           Mod

7. Show that you understand the accounting for and disclosure                      5          25           Mod
   of investments in the stocks and bonds of other companies.
   (Appendix)

*Exercise, problem, or case covers two or more learning outcomes
 Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
7-4   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




                                         QUESTIONS


1. The first CD should be classified as a cash equivalent because it has an original ma-
   turity of three months or less. The second CD is classified as a short-term invest-
   ment. It is a current asset because it will be converted into cash within the next year,
   even though its original maturity of more than three months disqualifies it from clas-
   sification as a cash equivalent.
2. The allowance method of accounting for bad debts tries to match one of the costs
   associated with granting credit, i.e. uncollectible accounts, with the revenue of the
   period. Under the matching principle, an estimate of bad debts is made on the basis
   of either the sales of the period or the accounts receivable at the end of the period,
   and an expense is recognized.
3. When bad debts expense is estimated by using the percentage of accounts receiva-
   ble approach, the balance already in the allowance account must be considered. For
   example, if the estimate of the accounts receivable that will prove to be uncollectible
   is $20,000 and the allowance account has a balance of $3,000 before adjustment,
   only $17,000 has to be added to it. Under the percentage of net credit sales ap-
   proach, however, the emphasis is on the debit to bad debts expense. The balance in
   the allowance account before adjustment is ignored.
4. An aging schedule is a refinement of the percentage of accounts receivable ap-
   proach to estimating bad debts. The accountant categorizes the various receivables
   by the length of time they are outstanding. The estimate of the percent uncollectible
   increases as the age of the accounts go up.
5. A note receivable arises from a written promise by someone to pay a specific
   amount of money in the future with interest. An account receivable arises from grant-
   ing a customer an open line of credit and does not normally include interest.
6. When a note receivable is discounted with recourse, it means that if the customer
   fails to pay the bank the total amount due on the maturity date, the company that
   sold the note to the bank is liable to the bank for the full amount. Therefore, during
   the time a discounted note is outstanding, the seller of the note is contingently liable.
   Accounting standards do not require the seller to recognize the contingency as a lia-
   bility, but a note is required to alert the statement reader of the uncertainty.
7. Shares of common stock could be classified as either trading or available-for-sale
   securities. The intent of the company determines the proper classification. If Stanzel
   purchases the IBM shares with the intent of selling them in the near term, they
   should be classified as trading securities. Otherwise, the shares should be classified
   as available-for-sale securities.
8. The accounting requirements for trading securities and available-for-sale securities
   are similar. The primary difference is in the treatment of unrealized gains and losses
   from changes in the market value of the securities. For trading securities, the gains
   and losses are reported on the income statement in the period when they occur. For
                                                      CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-5


   available-for-sale securities, the fluctuations in value are reported as a separate
   component of stockholders’ equity rather than on the income statement. The differ-
   ent treatment is justified on the grounds that the inclusion in income of fluctuations in
   value of securities that will not necessarily be sold in the near future (available-for-
   sale securities) could lead to unnecessary volatility in reported earnings.
9. Fluctuations in the value of trading securities are reported as gains and losses on
   the income statement. These gains and losses are considered unrealized, however,
   because the securities have not been sold.


                                     EXERCISES


LO 1      EXERCISE 7-1 CERTIFICATE OF DEPOSIT


2007
May 31    Short-Term Investments: CD                                       50,000
             Cash                                                                           50,000
          To record purchase of 120-day 9% CD.
                Assets          =       Liabilities          +       Owners’ Equity
               +50,000
               –50,000
June 30 Interest Receivable                                                    375
            Interest Revenue                                                                    375
        To record interest earned: $50,000 × 9% × 30/360.
                Assets          =       Liabilities          +       Owners’ Equity
                 +375                                                    +375
Sept. 28 Cash                                                              51,500
            Interest Receivable                                                                375
            Interest Revenue                                                                 1,125
            Short-Term Investments                                                          50,000
         To record redemption of $50,000 CD:
         $50,000 × 9% × 90/360 = $1,125.
                Assets          =       Liabilities          +       Owners’ Equity
               +51,500                                                  +1,125
                  –375
               –50,000
7-6      FINANCIAL ACCOUNTING SOLUTIONS MANUAL




LO 1         EXERCISE 7-2 CLASSIFICATION OF CASH EQUIVALENTS AND INVESTMENTS ON
             A BALANCE SHEET

1. STI                                                  6. STI
2. STI                                                  7. STI
3. STI                                                  8. LTI
4. CE                                                   9. STI
5. LTI                                                10. CE


LO 2         EXERCISE 7-3 COMPARISON OF THE DIRECT WRITE-OFF AND ALLOWANCE
             METHODS OF ACCOUNTING FOR BAD DEBTS

Net income under each of the two alternatives is as follows:
      Direct write-off method: $145,000 – $10,500 = $134,500
      Allowance method: $145,000 – (2% × $650,000) = $145,000 – $13,000 = $132,000

Conclusion: The direct write-off method would result in a lesser amount of expense
and therefore in a higher net income. However, under current accounting standards, if
bad debts are material in amount, the allowance method must be used. In addition, it is
not acceptable for a company to choose accounting methods on the basis of their ef-
fects on net income.


LO 2         EXERCISE 7-4 ALLOWANCE METHOD OF ACCOUNTING FOR BAD DEBTS—
             COMPARISON OF THE TWO APPROACHES

1. a. Based on 2% of net credit sales:
         2007
         Dec. 31     Bad Debts Expense                                  16,680
                        Allowance for Doubtful Accounts                               16,680
                     To record estimated bad debts:
                     2% × $834,000.
                    Assets             =         Liabilities     +   Owners’ Equity
                   –16,680                                             –16,680
                                                     CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-7


  b. Based on 6% of year-end accounts receivable:
       2007
       Dec. 31    Bad Debts Expense                                       16,606
                     Allowance for Doubtful Accounts                                       16,606
                  To record estimated bad debts:
                  Need balance of 6% of $320,100            $19,206 (cr)
                  Balance before adjustment is                2,600 (cr)
                  Amount of entry must be                   $16,606 (cr)
                  Assets         =     Liabilities          +       Owners’ Equity
                 –16,606                                              –16,606

2. a. No change.
  b. 2007
     Dec. 31      Bad Debts Expense                               21,806
                       Allowance for Doubtful Accounts                                     21,806
                  To record estimated bad debts:
                  Need balance of 6% of $320,100       $19,206 (cr)
                  Balance before adjustment is          (2,600) (dr)
                  Amount of entry must be              $21,806 (cr)
                  Assets         =     Liabilities          +       Owners’ Equity
                 –21,806                                              –21,806


LO 3       EXERCISE 7-5 ACCOUNTS RECEIVABLE TURNOVER FOR GENERAL MILLS


1. Accounts receivable turnover:
       Net credit sales/Average accounts receivable
       = $11,070/[($980 + $1,010)/2]
       = $11,070/$995 = 11.13 times
2. Average collection period (assuming 360 days in a year):
       Number of days in a year/turnover
       = 360/11.13 = 32 days to collect an account receivable
3. Types of customers General Mills might have:
   •   Grocery wholesalers
   •   Grocery chains
   •   Institutional food services
   Whether or not an average of 32 days to collect an account is reasonable depends
   on several factors. For example, how does this compare with other companies in the
   same industry as General Mills? How does it compare with prior years? What are
   General Mills’ credit terms? If its credit terms are 2/10, net 30, an average collection
7-8      FINANCIAL ACCOUNTING SOLUTIONS MANUAL




      period of 32 days may be reasonable, but not if the credit terms are net 10, for ex-
      ample.


LO 4           EXERCISE 7-6 NOTES RECEIVABLE


1. Rozelle Company is the maker; Dougherty Corporation is the payee.
2. The maturity date is March 1, 2008.
3. 2007
   Sept. 1       Notes Receivable                                     45,000
                    Accounts Receivable                                             45,000
                 To record receipt of six-month, 7% promissory
                 note in exchange for open account.
                    Assets             =         Liabilities   +   Owners’ Equity
                   +45,000
                   –45,000
      Dec. 31    Interest Receivable                                    1,050
                     Interest Revenue                                                1,050
                 To record interest earned: $45,000 × 7% × 4/12.
                     Assets            =         Liabilities   +   Owners’ Equity
                     +1,050                                           +1,050

      2008
      Mar. 1     Cash                                                 46,575
                    Interest Receivable                                              1,050
                    Interest Revenue                                                   525
                    Notes Receivable                                                45,000
                 To record collection of promissory note:
                 $45,000 × 7% × 2/12.
                    Assets             =         Liabilities   +   Owners’ Equity
                   +46,575                                             +525
                    –1,050
                   –45,000
                                                     CHAPTER 7 • INVESTMENTS AND RECEIVABLES     7-9


LO 5      EXERCISE 7-7 CREDIT CARD SALES


   June 12 Cash                                                             2,430
           Accounts Receivable—American Express                             3,500
              Sales Revenue                                                                    5,930
           To record weekly cash and credit sales.
                Assets         =       Liabilities          +       Owners’ Equity
                +2,430                                                 +5,930
                +3,500
   June 15 Cash                                                             3,360
           Collection Fee Expense                                             140
              Accounts Receivable—American Express                                             3,500
           To record weekly drafts from credit card company.
                Assets         =       Liabilities          +       Owners’ Equity
                +3,360                                                  –140
                –3,500
The collection fee charged by American Express is $140/$3,500 = 4%.


LO 6      EXERCISE 7-8 IMPACT OF TRANSACTIONS INVOLVING RECEIVABLES ON
          STATEMENT OF CASH FLOWS

Increase in accounts receivable—Deducted from net income
Decrease in accounts receivable—Added to net income
Increase in notes receivable—Deducted from net income
Decrease in notes receivable—Added to net income


LO 6      EXERCISE 7-9 CASH COLLECTIONS—DIRECT METHOD


Cash collections to be reported in the operating activities section of Emily Enterprises’
2007 statement of cash flows (direct method):

   Accounts receivable, December 31, 2006                                             $ 224,600
   Plus sales during 2007                                                              2,250,000
   Less cash collections during 2007                                                          (X)
   Accounts receivable, December 31, 2007                                             $ 205,700
   $224,600 + $2,250,000 – X = $205,700
   X = $2,268,900
7-10    FINANCIAL ACCOUNTING SOLUTIONS MANUAL




LO 7        EXERCISE 7-10 CLASSIFICATION OF INVESTMENTS (Appendix)


1. T                                                   4. S
2. E                                                   5. AS
3. AS


LO 7        EXERCISE 7-11 CLASSIFICATION OF INVESTMENTS (Appendix)


1. AS                                                  4. T
2. HM                                                  5. AS
3. T


LO 7        EXERCISE 7-12 PURCHASE AND SALE OF BONDS (Appendix)


1. Journal entries
   2007
   Jan. 1       Investment in Northern Lights Bonds                  100,000
                   Cash                                                             100,000
                To record purchase of Northern Lights
                bonds at 100.
                   Assets             =         Liabilities    +   Owners’ Equity
                 +100,000
                 –100,000
   June 30 Cash                                                         4,000
              Interest Income                                                         4,000
           To record interest income on Northern
           Lights bonds: $100,000 × 8% × 6/12.
                    Assets            =         Liabilities    +   Owners’ Equity
                    +4,000                                            +4,000
   Dec. 31      Cash                                                    4,000
                   Interest Income                                                    4,000
                To record interest income on Northern
                Lights bonds.
                    Assets            =         Liabilities    +   Owners’ Equity
                    +4,000                                            +4,000
                                                     CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-11


   2008
   Jan. 1     Cash                                                      102,000
                 Investment in Northern Lights Bonds                                      100,000
                 Gain on Sale of Bonds                                                      2,000
              To record sale of Northern Lights
              bonds at 102.
                 Assets         =      Liabilities          +       Owners’ Equity
               +102,000                                                +2,000
               –100,000


2. Starship was able to sell the bonds for more than the bonds will pay when they ma-
   ture because the bonds carry a higher periodic interest than the market rate of inter-
   est that was in effect at the time of the sale.


LO 7        EXERCISE 7-13 INVESTMENT IN STOCK (Appendix)


1. Chicago should classify its investment in Denver stock as trading securities because
   it plans to hold the stock for a short time and profit from an increase in its market
   price.
2. Journal entries:
   2007
   Dec. 1     Investment in Denver Preferred Stock (BS)                   40,000
                  Cash (BS)                                                                40,000
              To record purchase of trading securities
              for cash.
                 Assets         =      Liabilities          +       Owners’ Equity
                +40,000
                –40,000
   Dec. 20    Dividends Receivable (BS)                                     1,000
                  Dividend Income (IS)                                                         1,000
              To record receivable for $1 per share
              dividend declared on investment on
              1,000 shares of Denver preferred stock.
                 Assets         =      Liabilities          +       Owners’ Equity
                 +1,000                                                +1,000
7-12   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




   Dec. 31     Investment in Denver Preferred Stock (BS)                 2,000
                  Unrealized Gain—Trading Securities (IS)                              2,000
               To adjust trading securities to fair value:
               Fair value: 1,000 shares × $42
                  per share                           $42,000
               Cost: 1,000 shares × $40 per
                  share                                40,000
               Unrealized gain                        $ 2,000
                   Assets            =         Liabilities   +     Owners’ Equity
                   +2,000                                             +2,000

   2008
   Jan. 15     Cash (BS)                                                 1,000
                  Dividends Receivable (BS)                                            1,000
               To record receipt of dividend.
                   Assets            =         Liabilities   +     Owners’ Equity
                   +1,000
                   –1,000
   Feb. 12     Cash (BS)                                                45,000
                  Investment in Denver Preferred
                     Stock (BS) (book value)                                          42,000
                  Gain on Sale of Stock (IS)                                           3,000
               To record sale of stock at a gain:
               1,000 × $45 = $45,000.
                  Assets             =         Liabilities   +     Owners’ Equity
                 +45,000                                              +3,000
                 –42,000

3. Chicago should classify its investment on its December 31 balance sheet as a cur-
   rent asset.


LO 7       EXERCISE 7-14 INVESTMENT IN STOCK (Appendix)


1. Cubs should classify its investment in Sox stock as available-for-sale because it
   plans to hold the stock indefinitely rather than as a part of its active trading portfolio.
   Only bonds can qualify as held-to-maturity securities.
                                                    CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-13


2. Journal entries:
   2007
   Aug. 15   Investment in Sox Common Stock (BS)                         76,000
                Cash (BS)                                                                 76,000
             To record purchase of available-for-sale
             securities for cash: 5,000 shares × $15
             per share + $1,000 fees.
                Assets         =      Liabilities          +       Owners’ Equity
               +76,000
               –76,000
   Dec. 31   Unrealized Gain/Loss—Available-for-
                 Sale Securities (BS)                                    11,000
                 Investment in Sox Common
                     Stock (BS)                                                           11,000
             To adjust available-for-sale securities
             to fair value:
             Cost                                  $76,000
             Fair value: 5,000 shares × $13         65,000
             Unrealized loss                       $11,000
                Assets         =      Liabilities          +       Owners’ Equity
               –11,000                                               –11,000

   2008
   July 8    Cash (BS)                                                   50,000*
             Loss on Sale of Stock (IS)                                  26,000**
                Investment in Sox Common Stock (BS)                                       65,000***
                Unrealized Gain/Loss—Available-for-
                   Sale Securities (BS)                                                   11,000
             To record sale of stock at a loss.
               *5,000 × $10
              **76,000 – 50,000
             ***76,000 – 11,000
                Assets         =      Liabilities          +       Owners’ Equity
               +50,000                                               –26,000
               –65,000                                               +11,000

3. Cubs should classify its investment on its December 31 balance sheet according to
   its intent at that point in time. The exercise indicates that Cubs plans to hold the
   stock indefinitely. Thus, the stock should probably be classified as a noncurrent as-
   set at December 31, even though Cubs does sell the stock in the following year.
7-14   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




                                  MULTI-CONCEPT EXERCISE

LO 1,2,6       EXERCISE 7-15 IMPACT OF TRANSACTIONS INVOLVING CASH, SECURITIES,
               AND RECEIVABLES ON STATEMENT OF CASH FLOWS

Purchase of cash equivalents—N
Redemption of cash equivalents—N
Purchase of investments—I
Sale of investments—I
Write-off of customer account (under the allowance method)—N



                                           PROBLEMS


LO 2       PROBLEM 7-1 ALLOWANCE METHOD FOR ACCOUNTING FOR BAD DEBTS


1. Accounts Receivable                                             840,000
   Cash                                                            210,000
      Sales Revenue                                                           1,050,000
   To record sales for year: $1,050,000 × 80% = $840,000
   credit sales.
                  Assets             =         Liabilities   +   Owners’ Equity
                +840,000                                         +1,050,000
                +210,000
   Cash                                                            670,000
      Accounts Receivable                                                         670,000
   To record collection of customer accounts.
                  Assets             =         Liabilities   +   Owners’ Equity
                +670,000
                –670,000
   Allowance for Doubtful Accounts                                    4,000
       Accounts Receivable                                                          4,000
   To record write-off of accounts receivable.
                   Assets            =         Liabilities   +   Owners’ Equity
                   +4,000
                   –4,000
                                                    CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-15


2.a. Bad Debt Expense                                                    25,200
        Allowance for Doubtful Accounts                                                   25,200
     To record estimated bad debt expense:
     $840,000 × 3%.
                Assets        =       Liabilities          +       Owners’ Equity
               –25,200                                               –25,200

2.b. Bad Debt Expense                                                    20,010
        Allowance for Doubtful Accounts                                                   20,010
     To record estimated bad debt expense:
     Accounts receivable at Dec. 31, 2007
     ($140,000 + $840,000 – $670,000 – $4,000) $306,000

    Allowance balance needed ($306,000 × 0.06)                         $18,360 (cr)
    Balance before adjustment:
        Beginning balance                      $2,350 (cr)
        Write-off                               4,000 (dr)
                                                                         1,650 (dr)
    Amount of entry must be                                            $20,010 (cr)
                Assets        =       Liabilities          +       Owners’ Equity
               –20,010                                               –20,010

3.a. The net realizable value of accounts receivable on December 31, 2007, is
     $282,450:
        Accounts receivable, Dec. 31 (from Part 2.b.)                                  $306,000
        Less: Allowance for doubtful accounts, Dec. 31
           ($2,350 – $4,000 + $25,200)                                                   23,550
        Net realizable value, December 31                                              $282,450

3.b. The net realizable value of accounts receivable on December 31, 2007, is
     $287,640:
    Accounts receivable, Dec. 31 (from Part 2.b.)                                      $306,000
    Less: Allowance for doubtful accounts, Dec. 31
       ($2,350 – $4,000 + $20,010)                                                       18,360
    Net realizable value, December 31                                                  $287,640

4. The recognition of bad debt expense reduces the net realizable value by the amount
   recorded in bad debt expense and the allowance for doubtful accounts. The write-
   off of accounts has no effect on the net realizable value.
7-16    FINANCIAL ACCOUNTING SOLUTIONS MANUAL




LO 2        PROBLEM 7-2 AGING SCHEDULE TO ACCOUNT FOR BAD DEBTS


1.                                                             Estimated         Estimated
                                                                Percent           Amount
               Category                         Amount        Uncollectible     Uncollectible
        Current                                 $200,000           5%            $10,000
        Past due:
           Less than one month                    45,000            20%             9,000
           One to two months                      25,000            40%            10,000
           Over two months                        10,000            60%             6,000
        Totals                                  $280,000                          $35,000

2. Journal entry:
   2007
   Dec. 31 Bad Debts Expense                                                22,700
                 Allowance for Doubtful Accounts                                         22,700
             To record estimated bad debts:
             $35,000 less $12,300 currently in
             allowance account.
                   Assets             =         Liabilities     +       Owners’ Equity
                  –22,700                                                 –22,700

3. Partial balance sheet at December 31, 2007:
     Current Assets
     Accounts receivable                                            $280,000
     Less: Allowance for doubtful accounts                           (35,000)
     Net accounts receivable                                                    $245,000


LO 3        PROBLEM 7-3 ACCOUNTS RECEIVABLE TURNOVER FOR WHIRLPOOL AND
            MAYTAG

1. Accounts receivable turnover ratios:
        Whirlpool:
          $13,220/[($2,032 + $1,913)/2] = $13,220/$1,972.5 = 6.70 times
        Maytag:
          $4,721,538/[($629,901 + $596,832)/2] = $4,721,538/$613,366.5 = 7.70 times
                                                  CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-17


2. Average collection period:
        Whirlpool:
          360/6.70 = 53.73 days
        Maytag:
          360/7.70 = 46.75 days
   An average collection period of 54 days, or almost two months, appears to be rea-
   sonable. However, Maytag’s average collection period of about 47 days is even bet-
   ter.
3. Maytag’s accounts receivable turnover ratio is slightly higher than Whirlpool’s: 7.70
   versus 6.70. It takes Maytag an average of 46.75 days to collect its receivables;
   Whirlpool requires an average of 53.73 days.
       It would be especially helpful to measure these statistics, accounts receivable
   turnover ratio and average collection period, with the same measures for prior years.
   It would also be helpful to compare these measures with the industry averages.


LO 5       PROBLEM 7-4 CREDIT CARD SALES


1. Net selling price                  $1.00
   Cost of goods sold                  0.75
   Gross margin                       $0.25

   The owner must net $1 per gallon on the selling price. The amount per gallon he
   would have to charge credit card customers is
       X – 0.02X = 1.00
           0.98X = 1.00
               X = $1.02 per gallon
   (It is worth noting that not all gas companies charge a higher price for credit card
   purchases.)

2. If his normal charge is $1.02 to credit card customers, he can offer a $0.02 discount
   to cash customers and still maintain his gross margin.
7-18    FINANCIAL ACCOUNTING SOLUTIONS MANUAL




LO 6        PROBLEM 7-5 EFFECTS OF CHANGES IN RECEIVABLE BALANCES ON STATE-
            MENT OF CASH FLOWS

1. Statement of cash flows:
                                    STEGNER INC.
                             STATEMENT OF CASH FLOWS
                        FOR THE YEAR ENDED DECEMBER 31, 2007
   Net income                                                         $ 130,000
   Adjustments to reconcile net income to net cash
      used by operating activities:
          Increase in accounts receivable               $(140,000)*
          Decrease in notes receivable                      5,000**    (135,000)
   Cash flows from operating activities                               $ (5,000)
   Cash, December 31, 2006                                              110,000
   Cash, December 31, 2007                                            $ 105,000
    *$223,000 – $83,000
   **$100,000 – $95,000

2. Memorandum to the president:
TO:           Owner of Stegner, Inc.
FROM:         Student’s name
DATE:         January XX, 2008
SUBJECT: Cash Flows
      You recently expressed concern about the decrease in the company’s cash bal-
   ance in spite of the profitable year that was reported on this year’s income state-
   ment. My thoughts and a copy of the company’s 2007 statement of cash flows fol-
   low.
      Although net income on an accrual basis was $130,000, the company’s cash
   balance declined by $5,000 during the year for two reasons. Most importantly, ac-
   counts receivable increased by $140,000 during the year from $83,000 to $223,000;
   we did not collect amounts due from our customers as sales were made. This drain
   on cash was partially offset by a $5,000 decrease in notes receivable during the
   year, from $100,000 to $95,000.
      We can better manage our cash flow by increasing our collection efforts.
                                                     CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-19


LO 7        PROBLEM 7-6 INVESTMENTS IN BONDS AND STOCK (Appendix)


1. Journal entries:
   2007
   July 1     Investment in Gallatin Bonds                                10,000
                 Cash                                                                      10,000
              To record purchase of 6%, Gallatin bonds.
                 Assets         =      Liabilities          +       Owners’ Equity
                +10,000
                –10,000
   Oct. 23    Investment in Eagle Rock Stock                              12,000
                 Cash                                                                      12,000
              To record purchase of 600 shares of
              common stock at $20 per share.
                 Assets         =      Liabilities          +       Owners’ Equity
                +12,000
                –12,000
   Nov. 21    Investment in Montana Stock                                   6,000
                 Cash                                                                          6,000
              To record purchase of 200 shares of
              preferred stock at $30 per share.
                 Assets         =      Liabilities          +       Owners’ Equity
                 +6,000
                 –6,000
   Dec. 10    Cash                                                          1,300
                  Dividend Income                                                              1,300
              To record receipt of dividends on
              trading securities:
              Eagle Rock—600 × $1.50                 $ 900
              Montana—200 × $2.00                       400
                                                     $1,300
                 Assets         =      Liabilities          +       Owners’ Equity
                 +1,300                                                +1,300
7-20   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




   Dec. 28     Cash                                                      10,000*
                  Investment in Eagle Rock Stock                                       8,000**
                  Gain on Sale of Stock                                                2,000
               To record sale of 400 shares of Eagle
               Rock stock.
                *$400 × $25
               **$400 × $20
                  Assets             =         Liabilities     +    Owners’ Equity
                 +10,000                                               +2,000
                  –8,000
   Dec. 31     Cash (10,000 × 6% × 1/2 year)                                  300
                  Interest Income                                                       300
               To record receipt of interest:
               $10,000 × 6% × 6/12.
                   Assets            =         Liabilities     +    Owners’ Equity
                    +300                                                +300
   Dec. 31     Investment in Eagle Rock Stock                                1,800
                  Investment in Montana Stock                                            800
                  Unrealized Gain—Trading Securities                                   1,000
               To adjust trading securities to fair value:
                              Total               Total Fair Value Gain
               Security       Cost                  at 12/31/07    (Loss)
               Eagle Rock $     4,000              $     5,800     $1,800
                          (200* × $20)              (200 × $29)
               Montana          6,000                    5,200       (800)
                           (200 × $30)              (200 × $26)
                          $    10,000              $    11,000     $1,000
               *600 original purchase less 400 sold on December 28
                   Assets            =         Liabilities     +    Owners’ Equity
                   +1,800                                              +1,000
                     –800

2. Partial balance sheet at December 31, 2007:
   Current assets:
      Investment in trading securities, at fair value                                $11,000
   Long-term assets:
      Investment in bonds                                                            $10,000
                                                     CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-21


3. Items on the 2007 income statement:
       Dividend income                                           $1,300
       Interest income                                              300
       Gain on sale of stock                                      2,000
       Unrealized gain on trading securities                      1,000


LO 7        PROBLEM 7-7 INVESTMENTS IN STOCK (Appendix)


1. Journal entries:
   2007
   Jan. 15    Investment in Sears Stock                                   10,500
                 Cash                                                                      10,500
              To record purchase of 200 shares of
              stock at $50 per share, plus $500 in
              commissions.
                 Assets         =      Liabilities          +       Owners’ Equity
                +10,500
                –10,500
   May 23     Cash                                                            400
                 Dividend Income                                                                400
              To record receipt of dividends of $2 per
              share on 200 shares of Sears stock.
                 Assets         =      Liabilities          +       Owners’ Equity
                  +400                                                  +400
   June 1     Investment in Ford Stock                                      7,700
                 Cash                                                                          7,700
              To record purchase of 100 shares of
              stock at $74 per share, plus $300 in
              commissions.
                 Assets         =      Liabilities          +       Owners’ Equity
                 +7,700
                 –7,700
   Oct. 20    Cash                                                          8,000
              Loss on Sale of Stock                                         2,500
                 Investment in Sears Stock                                                 10,500
              To record sale of Sears stock:
              (200 shares × $42) – $400 = $8,000.
                 Assets         =      Liabilities          +       Owners’ Equity
                 +8,000                                                –2,500
                –10,500
7-22   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




   Dec. 15     Dividends Receivable                                         150
                   Dividend Income                                                         150
               To record notification of the declaration
               of $1.50 per share dividend on 100 shares
               of Ford stock.
                   Assets            =         Liabilities    +     Owners’ Equity
                    +150                                                +150
   Dec. 31     Investment in Ford Stock                                     800
                  Unrealized Gain/Loss: Available-
                     for-Sale Securities                                                   800
               To adjust Ford stock to fair value.
               Total Cost             Total Fair Value       Gain (Loss)
                $7,700                    $8,500                $800
                                        (100 × $85)
                   Assets            =         Liabilities    +     Owners’ Equity
                    +800                                                +800

2. Total income from investments during 2007:
       Dividend income on Sears stock                                          $ 400
       Loss on sale of Sears stock                                              (2,500)
       Dividend income on Ford stock                                               150
          Total income (loss)                                                  $(1,950)
   Note: The unrealized gain from the increase in market value of the Ford stock is not
   recognized in income but rather as an adjustment to stockholders’ equity because
   the securities are classified as available-for-sale.

3. If Atlas categorizes its securities as trading securities, an additional $800 of income
   would be recognized in 2007, resulting in a net loss from the investments of $1,950
   – $800, or $1,150. Increases and decreases in the value of trading securities are
   recognized on the income statement but not those of available-for-sale securities.

                                  MULTI-CONCEPT PROBLEM

LO 2,4       PROBLEM 7-8 ACCOUNTS AND NOTES RECEIVABLE


1. Journal entries:

   2007
   May 15      Accounts Receivable, C. Brown                               5,000
                  Sales Revenue                                                           5,000
               To record sale on credit; terms net 30.
                   Assets            =         Liabilities    +     Owners’ Equity
                   +5,000                                              +5,000
                                                     CHAPTER 7 • INVESTMENTS AND RECEIVABLES    7-23


   Aug. 10   Allowance for Doubtful Accounts                                5,000
                 Accounts Receivable—C. Brown                                                  5,000
             To write off uncollectible account.
                Assets         =       Liabilities          +       Owners’ Equity
                +5,000
                –5,000
   Dec. 1    Accounts Receivable—C. Brown                                   5,000
                Allowance for Doubtful Accounts                                                5,000
             To restore account previously written off.
                Assets         =       Liabilities          +       Owners’ Equity
                +5,000
                –5,000
   Dec. 1    Cash                                                           1,000
             Notes Receivable                                               4,000
                Accounts Receivable—C. Brown                                                   5,000
             To record partial collection on open account
             and receipt of two-month 9% note for the balance.
                Assets         =       Liabilities          +       Owners’ Equity
                +1,000
                +4,000
                –5,000
   Dec. 31   Interest Receivable                                                30
                 Interest Revenue                                                                    30
             To accrue interest earned:
             $4,000 × 9% × 1/12.
                Assets         =       Liabilities          +       Owners’ Equity
                  +30                                                     +30

   2008
   Jan. 31   Cash                                                           4,060
                Interest Receivable                                                               30
                Interest Revenue                                                                  30
                Notes Receivable                                                               4,000
             To record collection of note and interest.
                Assets         =       Liabilities          +       Owners’ Equity
                +4,060                                                                         +30
                   –30
                –4,000

2. Brown is interested in reestablishing a good credit standing with its supplier, Linus,
   and for this reason has sent the check and signed a note for the balance.
7-24   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




                                ALTERNATE PROBLEMS


LO 2       PROBLEM 7-1A ALLOWANCE METHOD FOR ACCOUNTING FOR BAD DEBTS


1. Accounts Receivable                                             630,000
   Cash                                                            157,500
      Sales Revenue                                                               787,500
   To record sales for year: $787,500 × 80% = $630,000
   credit sales.
                  Assets             =         Liabilities   +   Owners’ Equity
                +630,000                                          +787,500
                +157,500
   Cash                                                            502,500
      Accounts Receivable                                                         502,500
   To record collection of customer accounts.
                  Assets             =         Liabilities   +   Owners’ Equity
                +502,500
                –502,500
   Allowance for Doubtful Accounts                                    3,000
       Accounts Receivable                                                          3,000
   To record write-off of accounts receivable.
                   Assets            =         Liabilities   +   Owners’ Equity
                   +3,000
                   –3,000

2.a. Bad Debt Expense                                               18,900
        Allowance for Doubtful Accounts                                            18,900
     To record estimated bad debt expense.
     $630,000 X 3%.
                  Assets             =         Liabilities   +   Owners’ Equity
                 –18,900                                           –18,900
                                                    CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-25


2.b. Bad Debt Expense                                          14,820
        Allowance for Doubtful Accounts                                                   14,820
     To record estimated bad debt expense:
     Accounts receivable at Dec. 31, 2007
        ($105,000 + $630,000 – $502,500 – $3,000) $229,500
                                                   ×   0.06
        Allowance balance needed                   $ 13,770 (cr)
        Balance before adjustment:
            Beginning balance          $1,950 (cr)
            Write-off                   3,000 (dr)
                                                      1,050 (dr)
        Amount of entry must be                    $ 14,820 (cr)
                Assets         =      Liabilities          +       Owners’ Equity
               –14,820                                               –14,820

3.a. The net realizable value of accounts receivable on December 31, 2007, is
     $211,650.
         Accounts receivable, Dec. 31 (from Part 2.b.)                                 $229,500
         Less: allowance for doubtful accounts, Dec. 31
            ($1,950 – $3,000 + $18,900)                                                  17,850
         Net realizable value, December 31                                             $211,650

3.b. The net realizable value of accounts receivable on December 31, 2007, is
     $215,730.
         Accounts receivable, Dec. 31 (from Part 2.b.)                                 $229,500
         Less: allowance for doubtful accounts, Dec. 31
            ($1,950 – $3,000 + $14,820)                                                  13,770
         Net realizable value, December 31                                             $215,730

4. The recognition of bad debt expense reduces the net realizable value by the amount
   recorded in bad debt expense and the allowance for doubtful accounts. The write-
   off of accounts has no effect on the net realizable value.


LO 2       PROBLEM 7-2A AGING SCHEDULE TO ACCOUNT FOR BAD DEBTS


1.                                                       Estimated            Estimated
                                                          Percent              Amount
            Category           Amount                   Uncollectible        Uncollectible
     Current                   $200,000                    10%                $20,000
     Past due:
        Less than one month      60,300                        25%               15,075
        One to two months        35,000                        35%               12,250
        Over two months          45,000                        75%               33,750
     Totals                    $340,300                                         $81,075
7-26   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




2. The controller is primarily responsible for the accuracy of the records, rather than the
   collection process. Thus, the controller’s main concern should be with the adequacy
   of the balance in the allowance account. The amount of the allowance should prob-
   ably be increased, given the relatively large amount which is likely to be uncollecti-
   ble.
3. Partial balance sheet at December 31, 2007:
       Current Assets
       Accounts receivable                                  $340,300
       Less: Allowance for doubtful accounts                  81,075
       Net accounts receivable                                            $259,225


LO 3       PROBLEM 7-3A ACCOUNTS RECEIVABLE TURNOVER FOR BEST BUY AND
           CIRCUIT CITY

1. Accounts receivable turnover ratios:
   Best Buy Co. Inc.:
     $24,547/[($343 + $312)/2] = $24,547/$327.5 = 74.95 times
   Circuit City Stores, Inc.:
      $9,745,445/[($154,039 + $140,385)/2] = $9,745,445/$147,212 = 66.20 times
2. Average collection period:
   Best Buy:
     360/74.95 = 4.80 days
   Circuit City:
      360/66.20 = 5.44 days
   Average collection periods of 5 days appear very reasonable considering the nature
   of the business.
3. Best Buy’s accounts receivable turnover ratio is higher than Circuit City’s: 74.95 ver-
   sus 66.20. However, for both it takes only about five days to collect their receivables.
       It would be helpful to measure these statistics—accounts receivable turnover ra-
   tio and average collection period—with the same measures for prior years. It would
   also be helpful to compare these measures with the industry averages.
                                                       CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-27


LO 5       PROBLEM 7-4A CREDIT CARD SALES


1. Cost of credit card operation per outlet:
       Equipment/phone line                                                          $ 800
       Sales fee:
          Credit sales: $800,000 × 5%                             $40,000
       × Fee                                                      × 0.015               600
       Total cost                                                                    $1,400

   Conclusion: To cover the cost of the new equipment in the first year, new sales
   would need to net $1,400 per outlet.
2. The company should also consider competition in its decision on the use of credit
   cards. It may in fact suffer a loss of sales if its competitors start offering credit to cus-
   tomers and it does not. The company may find that customer goodwill is increased
   by the offer to use a credit card.


LO 6       PROBLEM 7-5A EFFECTS OF CHANGES IN RECEIVABLE BALANCES ON STATE-
           MENT OF CASH FLOWS

1. Statement of cash flows:


                          ST. CHARLES ANTIQUE MARKET
                           STATEMENT OF CASH FLOWS
                     FOR THE YEAR ENDED DECEMBER 31, 2007
   Net loss                                                                         $ (6,000)
   Adjustments to reconcile net loss to net cash
   provided by operating activities:
      Decrease in accounts receivable                                               47,000*
      Increase in notes receivable                                                  (7,800)**
   Cash flows from operating activities                                            $33,200
   Cash, December 31, 2006                                                           3,100
   Cash, December 31, 2007                                                         $36,300
    *$126,000 – $79,000
   **$104,800 – $112,600
7-28   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




2. Memorandum to the president:
   TO:           Owner of St. Charles Antique Market
   FROM:         Student’s name
   DATE:         January XX, 2008
   SUBJECT: Cash Flows
       You recently questioned the increase in the company’s cash balance in light of
   this year’s net loss. My thoughts and a copy of the company’s 2007 statement of
   cash flows follow.
       St. Charles Antique Market was able to generate a significant amount of cash
   from operations even though the company incurred an accrual basis net loss during
   2007 of $6,000. Most importantly, the amount of accounts receivable decreased by
   $47,000 during the year from $126,000 to $79,000; collections of accounts receiva-
   ble generated cash for the company. This cash flow was partially offset by a $7,800
   increase in notes receivable during the year, from $104,800 to $112,600.



LO 7        PROBLEM 7-6A INVESTMENTS IN BONDS AND STOCK (Appendix)


1. Journal entries:
   2007
   July 1    Investment in Maine Bonds                              10,000
                Cash                                                              10,000
             To record purchase of 8% Maine bonds.
                  Assets             =         Liabilities   +   Owners’ Equity
                 +10,000
                 –10,000
   Oct. 23 Investment in Virginia Stock                             15,000
               Cash                                                               15,000
           To record purchase of 1,000 shares
           of common stock at $15 per share.
                  Assets             =         Liabilities   +   Owners’ Equity
                 +15,000
                 –15,000
                                                    CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-29


Nov. 21   Investment in Carolina Stock                                     4,800
             Cash                                                                             4,800
          To record purchase of 600 shares of
          preferred stock at $8 per share.
              Assets          =      Liabilities           +       Owners’ Equity
              +4,800
              –4,800
Dec. 10   Cash                                                             1,100
             Dividend Income                                                                  1,100
          To record receipt of dividends on trading
          securities:
             Virginia—1,000 × $0.50 =        $                               500
             Carolina—600 × $1.00 =       600
                                       $1,100
              Assets          =      Liabilities           +       Owners’ Equity
              +1,100                                                  +1,100
Dec. 28   Cash                                                           13,300*
             Investment in Virginia Stock                                                 10,500**
             Gain on Sale of Stock                                                         2,800
          To record sale of 700 shares of Virginia
          stock.
           *700 × $19
          **700 × $15
              Assets          =      Liabilities           +       Owners’ Equity
             +13,300                                                  +2,800
             –10,500
Dec. 31   Cash                                                               400*
             Interest Income                                                                   400
          To record receipt of interest on bonds.
           *$10,000 × 8% × 1/2 year
          **($10,700 – $10,000)/3.5 years × 1/2 year
              Assets          =      Liabilities           +       Owners’ Equity
               +400                                                    +400
7-30   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




 Dec. 31     Investment in Virginia Stock                                   1,500
             Investment in Carolina Stock                                   1,800
                Unrealized Gain—Trading Securities                                     3,300
             To adjust trading securities to fair value:
                                    Total         Total Fair Value Gain
               Security             Cost            at 12/31/07    (Loss)
               Virginia         $     4,500        $     6,000     $1,500
                                (300* × $15)        (300 × $20)
               Carolina               4,800              6,600      1,800
                                  (600 × $8)        (600 × $11)
                                $     9,300        $    12,600     $3,300
             *1,000 original purchase less 700 sold on December 28.
                   Assets            =         Liabilities     +    Owners’ Equity
                   +1,500                                              +3,300
                   +1,800

2. Partial balance sheet at December 31, 2007:
       Current assets:
          Investment in trading securities, at fair value                            $12,600
       Long-term assets:
          Investment in bonds                                                        $10,000

3. Items on the 2007 income statement:
       Dividend income                                                                $1,100
       Interest income                                                                   400
       Gain on sale of stock                                                           2,800
       Unrealized gain on trading securities                                           3,300


LO 7       PROBLEM 7-7A INVESTMENTS IN STOCK (Appendix)


1. Journal entries:
   2007
   Jan. 15     Investment in IBM Stock                                  13,250
                  Cash                                                                13,250
               To record purchase of 100 shares of
               stock at $130 per share, plus $250 in
               commissions.
                  Assets             =         Liabilities     +    Owners’ Equity
                 +13,250
                 –13,250
                                                 CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-31


May 23    Cash                                                            100
             Dividend Income                                                                100
          To record receipt of dividends of $1 per
          share on 100 shares of IBM stock.
             Assets         =      Liabilities          +       Owners’ Equity
              +100                                                  +100
June 1    Investment in GM Stock                                      12,300
             Cash                                                                      12,300
          To record purchase of 200 shares of
          stock at $60 per share, plus $300 in
          commissions.
            Assets          =      Liabilities          +       Owners’ Equity
           +12,300
           –12,300
Oct. 20   Cash                                                        13,600
             Investment in IBM Stock                                                   13,250
             Gain on Sale of Stock                                                        350
          To record sale of IBM stock:
          (100 shares × $140) – $400.
            Assets          =      Liabilities          +       Owners’ Equity
           +13,600                                                  +350
           –13,250
Dec. 15   Dividends Receivable                                            150
              Dividend Income                                                               150
          To record notification of the declaration
          of $0.75 per share dividend on 200 shares
          of GM stock.
             Assets         =      Liabilities          +       Owners’ Equity
              +150                                                  +150
Dec. 31   Unrealized Gain/Loss—Available-for-
             Sale Securities                                            3,300
                Investment in GM Stock                                                     3,300
          To adjust GM stock to fair value:
           Total Cost        Total Fair Value         Gain (Loss)
            $12,300              $9,000                $(3,300)
                               (200 × $45)
             Assets         =      Liabilities          +       Owners’ Equity
             –3,300                                                –3,300
7-32   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




2. Total income from investments during 2007:
       Dividend income on IBM stock                                               $100
       Gain on sale of IBM stock                                                   350
       Dividend income on GM stock                                                 150
          Total income                                                            $600
   Note: The unrealized loss from the decrease in market value of the GM stock is not
   recognized in income but rather as an adjustment to stockholders’ equity because
   the securities are classified as available-for-sale.
3. If Trendy categorizes its securities as trading securities, a loss of $3,300 would be
   recognized in 2007, resulting in a net loss from the investments of $3,300 – $1,100,
   or $2,200. Increases and decreases in the value of trading securities are recognized
   on the income statement, but not those of available-for-sale securities.


                         ALTERNATE MULTI-CONCEPT PROBLEM

LO 2,4       PROBLEM 7-8A ACCOUNTS AND NOTES RECEIVABLE


1. Journal entries:
   2007
   July 31     Accounts Receivable—P.D. Cat                           6,000
                  Sales Revenue                                                   6,000
               To record sale on credit; terms net 30.
                   Assets            =         Liabilities   +   Owners’ Equity
                   +6,000                                           +6,000
   Dec. 24     Allowance for Doubtful Accounts                        6,000
                   Accounts Receivable—P.D. Cat                                   6,000
               To write off uncollectible account.
                   Assets            =         Liabilities   +   Owners’ Equity
                   +6,000
                   –6,000
   2008
   Jan. 15     Accounts Receivable—P.D. Cat                           6,000
                  Allowance for Doubtful Accounts                                 6,000
               To restore account previously written off.
                   Assets            =         Liabilities   +   Owners’ Equity
                   +6,000
                   –6,000
                                                     CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-33


   Jan. 15   Cash                                                           1,500
             Notes Receivable                                               4,500
                Accounts Receivable—P.D. Cat                                                   6,000
             To record partial collection on open
             account and receipt of two-month 8%
             note for the balance.
                Assets         =       Liabilities          +       Owners’ Equity
                +1,500
                +4,500
                –6,000
   Mar. 15   Cash                                                           4,560
                Interest Revenue                                                                  60
                Notes Receivable                                                               4,500
             To record collection of note and interest:
             $4,500 × 8% × 2/12.
                Assets         =       Liabilities          +       Owners’ Equity
                +4,560                                                    +60
                –4,500

2. P.D. Cat is interested in reestablishing a good credit standing with its supplier,
   Tweety, and for this reason has sent the check and signed a note for the balance.



                               DECISION CASES


             READING AND INTERPRETING FINANCIAL STATEMENTS

LO 2      DECISION CASE 7-1 READING APPLE’S BALANCE SHEET AND NOTES TO THE
          STATEMENTS

1. The balance in the Allowance for Doubtful Accounts is $47 million at the end of 2004
   and $49 million at the end of 2003.
2. The net realizable value of accounts receivable at the end of 2004 was $774 million,
   and at the end of 2003, $766 million.
3. The amount of bad debts expense is represented by the line on the table titled
   “Charged to costs and expenses.” This amount is $3 million for 2004 and $4 million
   for 2003.
4. The amount of accounts receivable written off is represented by the line on the table
   titled “Deductions.” This amount is $5 million for 2004 and $6 million for 2003.
7-34    FINANCIAL ACCOUNTING SOLUTIONS MANUAL




5. The reduction in the amounts of accounts written off in the last two years could be
   due to a number of factors. The company may have tightened its credit policies and
   thus is not experiencing as many bad debts as in the past. The reduction may also
   be the result of an increased effort to collect outstanding receivables. It is worth not-
   ing that there has been a similar decrease in the amounts charged to costs and ex-
   penses in the last two years.



LO 1,6        DECISION CASE 7-2 READING APPLE COMPUTER’S STATEMENT OF CASH
              FLOWS

1. Apple spent $3,270 million to purchase short-term investments in 2004. This was
   $622 million more than Apple spent on investments in 2003 but $874 million less
   than was spent in 2002.
2. Apple received $1,141 million from investments that matured in 2004. This was
   $1,305 million less than it received in 2003 and $1,705 less than in 2002.
3. Bonds mature, but stocks have no maturity date. Therefore, if a company holds
   bonds until their maturity date, they will receive proceeds on that date. Bonds can
   be sold on a date before they mature as well. Because stocks do not have a maturity
   date, any proceeds are received on the date they are sold.


                                MAKING FINANCIAL DECISIONS

LO 1,2        DECISION CASE 7-3 LIQUIDITY


TO:           The President of FNB of Verona Heights
FROM:         Joe Smith, Loan Officer
DATE:         X/X/XX
SUBJECT: Loan proposals

    I have reviewed the loan proposals recently submitted by Oak and Maple and would
like to summarize for you my findings. Because of limited resources available for short-
term loans, my recommendation is that we make a six-month $10 million loan to Maple
only.
    The total current asset positions of the two companies are identical. Each has $33
million in current assets. However, the composition of the current assets differs consid-
erably between the two companies. On the surface, Oak may appear to be stronger be-
cause it has twice the amount of cash on hand that Maple does. However, cash is es-
sentially a non-earning asset, and I am skeptical as to why Oak feels it necessary to
maintain that much cash on hand, and consequently, why it feels as if it needs to borrow
an additional $10 million.
                                                    CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-35


    The accounts receivable for Maple is significantly larger than that for Oak. Assuming
that the estimates of bad debts are reasonably reliable, Oak has a bigger problem with
uncollectibles than does Maple. Oak has an allowance that is 1/15, or 6.67% of ac-
counts receivable, while Maple’s percentage is only 1/23, or 4.35%.
    In summary, I feel that Maple is a better candidate at the present time for a loan. I
recommend that we make a six-month $10 million loan to Maple at the current market
rate of interest. Please call if you need any further details in connection with these two
loan requests.


                             ETHICAL DECISION MAKING

LO 5       DECISION CASE 7-4 NOTES RECEIVABLE


1. The entry to record the sale of the property violates two principles: the revenue
   recognition principle and the historical cost principle. Revenue is recognized at the
   appropriate time, when a sale takes place, but for the wrong amount. The fair value
   of the property, $7.5 million, should be used as a measure of the amount of revenue
   to be recognized, rather than the face value of the note.

2. TO:         Vice-president
   FROM:       Student’s name
   DATE:       12/31/XX
   SUBJECT: Land sale

       This is in response to your suggestion about the proper accounting for the recent
   sale of our 100-acre tract for the new shopping center. I have considered your rec-
   ommendation that we recognize revenue in the amount of $10 million, which is
   equivalent to the $2 million installments on the note over each of the next five years.
       Please understand my interest in maximizing profits to our shareholders when-
   ever possible. The suggested treatment for this sale, however, is a clear violation of
   generally accepted accounting principles. The reason for the violation is straightfor-
   ward: $10 million is not the value of the asset we sacrificed in exchange for the five-
   year note. The property was recently appraised at a fair market value of $7.5 million.
   The difference between the $10 million in face value of the note and the $7.5 million
   fair value of the property represents the interest we will earn over the next five years
   as we collect on the note. We will, in fact, recognize this difference of $2.5 million as
   income, but only over the life of the note, and as interest income rather than sales
   revenue. For now the amount of revenue we should recognize is $7.5 million.
       Please call me at any time if you would like to discuss this matter further.
7-36   FINANCIAL ACCOUNTING SOLUTIONS MANUAL




LO 7       DECISION CASE 7-5 FAIR MARKET VALUES FOR INVESTMENTS (Appendix)


1. Net income under two different assumptions:
  (a) Stock is classified as a trading security:
       Net income before adjustment                                              $ 400,000
       Unrealized loss                                                            (250,000)*
       Net income                                                                $ 150,000
       *10,000 shares × ($100 – $75).
  (b) Stock is classified as an available-for-sale security:
       Net income                                                                 $400,000
       (Any unrealized gains or losses on available-for-sale securities are reported as a
       component of stockholders’ equity and are not reported on the income state-
       ment.)
2. The proper classification of the Clean Air stock is a matter of judgment. Given the
   circumstances, however, it seems most appropriate to classify the stock as trading
   securities. The case indicates that Kennedy regularly holds stocks of various com-
   panies in a trading securities portfolio. There is nothing in the case to suggest that
   the objective in holding the Clean Air stock is any different.
3. The treasurer’s advice presents the controller with a clear ethical dilemma. Should
   the proper classification of an investment for financial reporting purposes be dictat-
   ed, or at least influenced, by the effect of the classification on net income? The
   treasurer is accurate in stating that regardless of this decision, the stock will be re-
   ported on the balance sheet at fair value. Accounting standards, however, call for
   the recognition of a loss on the income statement for declines in value of trading se-
   curities. If the controller is not able to differentiate the Clean Air stock from the other
   securities in the company’s trading securities portfolio, he or she should demand that
   the stock be classified as a trading security.


REAL WORLD PRACTICE 7.1

According to Apple’s balance sheet, accounts receivable increased by $774 – $766 or
$8 million during 2004. Accounts receivable make up $774/$7,055, or 11%, of the total
current assets at the end of 2004.


REAL WORLD PRACTICE 7.2

The amount of accounts receivable before deducting the balance in the allowance ac-
count is $774 + $47, or $821, million at the end of 2004. This amount at the end of 2003
is $766 + $49, or $815 million. The gross amount of accounts receivable increased dur-
                                                CHAPTER 7 • INVESTMENTS AND RECEIVABLES   7-37


ing 2004 by $821 – $815, or $6 million. The allowance account decreased during 2004
by $47 – $49, or $2 million. Changes in the allowance during the year are a result of
adding additional amounts to it for the estimated bad debts and removing from the ac-
count write offs of customers’ accounts.

				
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