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# 7.10 7.12 Direct write-off method versus allowance method 7.13 Accounting for Uncollectible Receivables?Percentage of Sales Method 7.14 Comparing the Percentage of Sales and Percentage of Sales 7.15 Ratio Analysis

Recording sales transactions. See attached file for full problem description.

7.10 Aging of Accounts Receivable
Madariaga Company's accounts receivable reveal the following balances:

Operating Activities
Age of Accounts Receivable Balance
Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$840,000
1-30 days past due . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405,000
31-60 days past due . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95,000
61-90 days past due . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
91-120 days past due . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,000

The credit balance in Allowance for Bad Debts is now \$38,000. After a thorough analysis of its collection history, the company estimates that the following percentages of receivables will eventually prove uncollectible:

Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.5%
1-30 days past due . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5
31-60 days past due . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15.0
61-90 days past due . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55.0
91-120 days past due . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94.0

Prepare an aging schedule for the accounts receivable, and give the journal entry for recording the necessary change in the allowance for bad debts account.

In preparing a ageing schedule, we multiply the amount by its respective uncollectible percentage
Amount % uncollectible Amount uncollectible
Current 840,000 0.50% 4,200
1-30 days past due 405,000 3.50% 14,175
31-60 days past due 95,000 15% 14,250
61-90 days past due 60,000 55% 33,000
91-120 days past due 11,000 94% 10,340
Total 75,965
The amount arrived at is what is needed in the allowance account. The allowance account has a balance of
\$38,000. The entry should be for the balance amount
Balance needed 75,965
Prior balance 38,000

The journal entry is
Allowance for bad debts Cr 37,965

1. Compute the appropriate Allowance for Bad Debts as of December 31, 2006.

We first create an ageing schedule
Category Amount Percentage Total Amount Percentage Total
Less then 30 days 122000 2% 2440
31 to 60 days 24000 10% 2400
61 to 90 days 8000 30% 2400
Over 90 days 9000 75% 6750
Total estimated uncollectible accounts 13990
This should be the amount in the allowance for bad debt account

2. Make the journal entry required to record this allowance. Remember that, since this is Harry's first year of operations,
the allowance account at the beginning of the year was \$0.

Since this is the first year of operations, there will not be any existing balance in the allowance account
The value that we have calculated would be the entry
The entry is
Allowance for Bad Debt Account Cr 13,990

3. What is Harry's net accounts receivable balance as of December 31, 2006?

The net receivable balance is Gross Accounts Receivable less the allowance for bad debts
Gross Receivables 163,000 This is the total of all receivables as given in the question
Less Allowance for Bad Debts 13,990
Accounts Receivable, net 149,010

7.12 Direct Write-Off versus Allowance Method
The vice president for Tres Corporation provides you with the following list of accounts receivable written off in the current year.
(These accounts were recognized as bad debt expense at the time they were written off; i.e., the company was using the direct write-off method.)
Date Customer Amount
30-Mar Rasmussen Company \$12,000
31-Jul Dodge Company 7,500
30-Sep Larsen Company 10,000
31-Dec Peterson Company 12,000

Tres Corporation's sales are all on a n/30 credit basis.
Sales for the current year total \$3,600,000,
Analysis indicates uncollectible receivable losses historically approximate 1.5% of sales.

1. Do you agree or disagree with Tres Corporation's policy concerning recognition of bad debt expense? Why or why not?

We disagree with the policy since the method used is direct write off method. This method is not in accordance with the matching principle
since the write off and sale happen in different periods. Also the direct write off method does not provide the correct
picture of net receivables since there is no allowance made

2. If Tres were to use the percentage of sales method for recording bad debt expense, by how much would income before income taxes change for the current year?

The percentage of sale method would mean a bad debt expense of 3,600,000X1.5%= 54,000. The direct write off method results in the
total bad debt expense of 12,000+7,500+10,000+12,000=41,500
If the allowance method is used the bad debt expense will be higher by 54,000-41,500=12,500 and the income before taxes will
be lower by \$12,500

7.13 Accounting for Uncollectible Receivables?Percentage of Sales Method
The trial balance of Marchant's Sporting House, Inc., shows a \$150,000 outstanding balance in Accounts Receivable at the end of 2005. During 2006, 80% of the total credit sales of \$3,500,000 was collected, and no receivables were written off as uncollectible. The company estimated that 2.0% of the credit sales would be uncollectible. During 2007, the account of Prior Sybrowsky, who owed \$4,200, was judged to be uncollectible and was written off. At the end of 2007, the amount previously written off was collected in full from Mr. Sybrowsky.

Prepare the necessary journal entries for recording all the preceding transactions relating to uncollectibles on the books of Marchant's Sporting House, Inc.

The total credit sales are 3,500,000 and the estimate is 2% will be uncollectible. The bad expense for the year will be
3,500,000X2%=70,000. The journal entry will be
Allowance for Bad Debts Cr 70,000
In making the allowance we do not take into account the balance in receivables account. The percentage is applied
to the credit sales figure
In 2007 one account is written off , the entry is
Allowance for Bad Debts Dr 4,200
Accounts Receivable - Sybrowsky Cr 4,200
later this account is collected. The first step is to reinstate the accounts receivable and then to record the cash collected
Accounts Receivable - Sybrowsky Cr 4,200
Allowance for Bad Debts Dr 4,200
(to reinstate the receivable)
Cash Dr 4,200
Accounts Receivable - Sybrowsky Cr 4,200
(to record the collection of the receivable)

7.14 Comparing the Percentage of Sales and the Percentage of
Receivables Methods
Keefer Company uses the percentage of sales method for computing bad debt expense.

As of January 1, 2006:
The balance of Allowance for Bad Debts was \$200,000.
Write-offs of uncollectible accounts during 2006 totaled \$240,000.
Reported bad debt expense for 2006 was \$320,000, computed using the percentage of sales method.

Keith & Harding, the auditors of Keefer's financial statements, compiled an aging accounts receivable analysis of Keefer's accounts at the end of 2006. This analysis has led Keith & Harding to estimate that, of the accounts receivable Keefer has as of the end of 2006, \$700,000 will ultimately prove to be uncollectible.

Given their analysis, Keith & Harding, the auditors, think that Keefer should make an adjustment to it's 2006financial statements. What adjusting journal entry should Keith & Harding suggest?

The balance in the allowance for doubtful account is 200,000+320,000-240,000=280,000 ( opening + new allowance-write off)
This is based on the percentage of sales method
The auditors have gone by the ageing schedule and estimate that the allowance account
should be 700,000.
Keith & Harding need to increase the balance in the allowance account to 700,000. The existing
balance is 280,000 and so an increase of 420,000 is required.
Allowance for Bad Debts Cr 420,000

7.15 Ratio Analysis
The following are summary financial data for Parker Enterprises, Inc., and Boulder, Inc., for three recent years:

Year 3 Year 2 Year 1
Net sales (in millions):
Parker Enterprises, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . \$3,700 \$3,875 \$3,882
Boulder, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,825 16,549 15,242

Net accounts receivable (in millions):
Parker Enterprises, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . 1,400 1,800 1,725
Boulder, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,525 5,800 6,205

1. Using the above data, compute the accounts receivable turnover and average collection period for each company for years 2 and 3.
2. Which company appears to have the better credit management policy?

The formula to use are
Accounts Receivable Turnover = Sales/Average Accounts Receivable
Average Collection Period = 365/Accounts Receivable Turnover
Parker Year 3 Year 2
Accounts Receivable Turnover 2.31 2.20
Average Collection Period 157.84 166.02

Boulder Inc Year 3 Year 2
Accounts Receivable Turnover 3.15 2.76
Average Collection Period 115.95 132.39

Boulder Inc has a better credit management policy since its average collection period is lower indicating
that is collecting its receivables faster than Parker

7.16 Assessing How Well Companies Manage Their Receivables
Assume that Hickory Company has the following data related to its accounts receivable:

2005 2006
Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$1,425,000 \$1,650,000
Net receivables:
Beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375,000 333,500
End of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 420,000 375,000

Use these data to compute accounts receivable turnover ratios and average collection periods for 2005 and 2006.
Based on your analysis, is Hickory Company managing its receivables better or worse in 2006 than it did in 2005?

using the same formula as above
Accounts Receivable Turnover 3.58 4.66
Average Collection Period 101.82 78.36

Hickory is managing its receivables better in 2006 since it has managed to increase the receivable
turnover and reduce the average collection period to 78.3 days from 101.8 days

#### Solution Summary

Worked performed in excel as a guide for your study.

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