Chapter 5 Problem Session Exercise - Receivables and Sales

Problem I: Indicate whether each of the following statements is true (T) or false (F).

Item Statement
a. The “Sales Discounts”, “Sales Returns, and “Sales Allowances” accounts are examples
F of expense accounts.

b. T “Net Sales Revenue” is calculated by subtracting the sales discounts, sales returns, and
sales allowances account balances from the total sales revenue account balance.

c. F The “Allowance for Uncollectible Accounts” account is best described as a contra-

liability.

d. F “Net Accounts Receivable” is determined by adding together the balances in the

“Accounts Receivable” and “Allowance for Uncollectible Accounts” accounts.

e. T The “Allowance Method” of accounting for bad debts requires companies to record an
estimate of bad debt expense arising from uncollectible sales on account in the same year
the sales revenue is recorded rather than in the year the bad debt expense is known with
certainty.

f. T The “Allowance Method” of accounting for bad debts is an application of GAAP

whereas the “Direct Write-Off Method” is not.

g. T If a company’s receivables turnover ratio is decreasing from one year to the next, it can
infer customers are paying off their accounts receivable more quickly than in the past.

h. T As a company’s receivables turnover ratio decreases, the average collection period in

terms of days should be decreasing.

i. F Before the year-end journal entry to record bad debts, if the “Allowance for
Uncollectible Accounts” account has a debit balance, we can infer the estimate of
uncollectible accounts at the beginning of the year was too high.

j. t When preparing an aging report, most companies should expect that the longer a
particular customer’s account has been outstanding, the more likely it is to become
uncollectible.

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Problem II: As each of the following account balances increases in 20X1, indicate the effect, if any, the
increase will have on the company’s gross profit (also known as gross margin) and net income in 20X1.
Gross margin or gross profit is defined as the subtotal on the multi-step income statement determined by
taking the difference between net sales and cost of goods sold. The first two have been done as examples.

Item As the following account Effect on Effect on Effect on

balance increases in 20X1: Net Sales Revenue Gross Profit Net Income
Ex. Salaries Expense No effect No effect Decrease
Ex. Dividends No effect No effect No effect
a. Sales Revenue Increases Increases Increases

b. Sales Discounts Decreases Decreases Decreases

c. Sales Returns and Decreases Decreases Decreases

Allowances

d. Bad Debt Expense No effect No effect Decreases

e. Interest Revenue No effect No effect Increases

f. Note Receivable No effect No effect No effect

g. Cost of Goods Sold No effect Decreases Decreases

Problem III: Triad Inc. was incorporated on 10/1/X1 to provide landscaping services in the Raleigh area.
During October, the following transactions occurred with respect to services provided to its first customer.
Date Description
10/1/X1: Triad provided services worth $25,000 on account, terms 2/10, n/30.
10/6/X1: Triad granted the customer a $2,000 sales allowance.
10/11/X1: Triad’s customer paid off their account in full.

Required: Record the above transactions in the general journal below.

Date Account Names Debit Credit
10/1/X1 Accounts Receivable $25,000
Service Revenue $25,000

10/6/X1 Sales Allowance $2000

Accounts Receivable $2000

10/11/X1 Cash $22540

Sales Allowance $460
Accounts Receivable $23,000

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Problem IV: On October 1, 20X1, Chavez Corp. provided services worth $65,000 on account to one of its
longtime customers. At that time, Chavez debited their “Accounts Receivable” account and credited their
“Service Revenue” account for $65,000.
On November 1, 20X1, Chavez agreed to convert the account receivable to a one-year, 12%, note receivable.
The customer will pay Chavez $65,000 plus accrued interest on November 1, 20X2. Note: Round all interest
calculations to the nearest whole month.
A. How much total interest will Chavez eventually earn on the Note Receivable? Answer: $7,800

B. Assuming Chavez has a calendar year-end, prepare in the general journal below the following three
journal entries:
 The entry to record the conversion of the account receivable to a note receivable on Nov 1, 20X1
 The entry to record accrued interest revenue on December 31, 20X1
 The entry to record the collection of the note’s face value plus accrued interest on Nov 1, 20X2.

Date Account Name Debit Credit

11/1/X1 Note Receivable $65,000
Accounts Receivable $65,000

12/31/X1 Interest Receivable $1300

Interest Revenue $1300

11/1/X2 Cash $$72800

Note receivable $65,000
Interest receivable $3000
Interest Revenue $6500

C. Accounting Check √ There should not be any receivable balances left after the last entry since the note and its related
interest have been collected. Are your receivables balances equal to zero? In addition, the sum of your credits to the “Interest
Revenue” account should equal your answer to part “A”. Are your sums equal to that answer? If your answer is “no” to either
question, please go back and check your calculations and/or entries.

D. If the note had been a nine-month, 12%, note instead of a one-year note, what would be the entries for
12/31/X1 and 8/1/X2 (the new maturity date)?

Date Account Name Debit Credit

12/31/X1 Interest receivable 1300
Interest Revenue 1300

8/1/X2 Cash 70850

Note Receivable 65000
Interest Receivable 1300
Interest Revenue 4550

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Problem V:
Alling Inc.’s trial balance indicates the following select account balances at the end of 20X1 before the year-
end adjustment to record bad debts:

Alling Inc.
Trial Balance (partial)
12/31/X1
Account Name Debit Credit
Accounts Receivable – 12/31/X1 $ 850,000
Allowance for Uncollectible Accounts – 12/31/X1 $ 24,000
Sales Revenue 9,000,000
Bad Debts Expense – 1/1/X1 0

A. Assume at the end of 20X1, Alling’s management estimates 4% of its ending gross Accounts Receivable
account balance will be uncollectible.

Required: Prepare the 12/31/X1 journal entry to record bad debts for 20X1.

Date Account Name Debit Credit

12/31/X1 Bad Debt Expense $10,000
Allowance for Uncollectable Accounts $10,000

B. Assume that on January 8th of the following year (20X2), Alling is notified that one of its customers has
filed for bankruptcy. As a consequence, $2,000 of the Accounts Receivable balance is deemed to be
uncollectible and will be specifically written off.
Required: Prepare the specific write-off journal entry to record this uncollectible account.

Date Account Name Debit Credit

1/8/X2 Allowance for Uncollectable Accounts $2,000
Accounts Receivable $2,000

C. How should a specific write-off journal entry (see letter “B” above) affect a company’s net accounts
receivable balance? In other words, what will be the difference between the company’s net accounts
receivable amount immediately before and after the specific write-off?

No effect

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Problem VI:

Gavin Corp. has the following select balance sheet and income statement account balances for the years
ending 12/31/X2 and 12/31/X1:

Note: Account balances are shown in absolute value.

Account Name 12/31/X2 12/31/X1

Accounts Receivable $178,000 500,000
Allowance for Uncollectible Accounts 8,000 20,000
Sales Revenue (all on credit) 5,200,000 4,900,000
Sales Discounts and Sales Allowances 200,000 175,000

A. Compute Gavin’s accounts receivable turnover and number of days in receivables (average collection
period) for 20X2 assuming a 365-day year. Note: When computing the average accounts receivable
balance, use the “net” accounts receivable balance at the beginning and end of the year. Round to three
decimal places.

Net Credit sales / Average Accounts Receivable

ART = $5,000,000 / [(480,000/170,000)/2]

365/15.385 = 23.7 Days

B. Assume Gavin has a policy which requires its customers to pay their account balance off within 15 days.
Compare their policy against how their customers are behaving based on the average collection period
from part “A”. What advice would you give Gavin with respect to its receivables and its policies?

Raise the limit and allow more time for your customers to pay on credit in order to earn more revenue.