Porter Chapter 7 Solns

CHAPTER 7
Receivables and Investments

OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Learning Outcomes
1. Show that you understand how to account for accounts

receivable, including bad debts.
Exercises
Estimated
Time in
Minutes
Level
1
2
13*
10
25
5
Mod
Mod
Easy
2. Explain how information about sales and receivables can

be combined to evaluate how efficient a company is in
collecting its receivables.
20
Mod
3. Show that you understand how to account for

interest-bearing notes receivable.
15
Mod
4. Explain various techniques that companies use to accelerate

the inflow of cash from sales.
20
Mod
5. Show that you understand the accounting for and disclosure

of various types of investments that companies make.
6
7
8
9
10
13*
15
10
30
30
30
5
Mod
Easy
Mod
Mod
Mod
Easy
6. Explain the effects of transactions involving liquid assets

on the statement of cash flows.
11
12
13*
5
5
5
Easy
Mod
Easy
*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
Learning Outcomes
Problems
and
Alternates
Estimated
Time in
Minutes
Level

1
2
8*
30
15
20
Mod
Mod
Mod
2. Explain how information about sales and receivables

can be combined to evaluate how efficient a company
is in collecting its receivables.
30
Mod

8*
20
Mod

15
Mod

5
6
25
20
Mod
Mod

45
Diff

CHAPTER 7 RECEIVABLES AND INVESTMENTS
Learning Outcomes
Cases
Estimated
Time in
Minutes
7-3
Level

1
2*
4*
30
25
25
Mod
Mod
Mod
2. Explain how information about sales and receivables

can be combined to evaluate how efficient a company
is in collecting its receivables.
25
Mod

25
Mod

4*
25
Mod

2*
25
Mod


7-4
QUESTIONS
1. 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.
2. When bad debts expense is estimated by using the percentage of accounts
receivable 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 approach, however, the emphasis is on the debit to bad debts expense.
The balance in the allowance account before adjustment is ignored.
3. An aging schedule is a refinement of the percentage of accounts receivable
approach 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.
4. 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
granting a customer an open line of credit and does not normally include interest.
5. 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
liability, but a note is required to alert the statement reader of the uncertainty.
6. The first CD should be classified as a cash equivalent because it has an original
maturity of three months or less. The second CD is classified as a short-term
investment. 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
classification as a cash equivalent.
7. Shares of common stock could be classified as either current assets or noncurrent
assets. 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 current assets. Otherwise, the shares should be classified as
noncurrent assets.
8. Any fees or commissions paid to purchase stock in another company should be
added to the cost of the investment.
7-5
BRIEF EXERCISES
BRIEF EXERCISE 7-1 ACCOUNTING FOR BAD DEBTS
LO 1
Bad Debts Expense

Allowance for Doubtful Accounts
To record estimated bad debts:
2% $500,000.
BALANCE SHEET
Assets
Allowance for
Doubtful
Accounts
Liabilities
10,000
10,000
INCOME STATEMENT
+ Stockholders Equity + Revenues Expenses
Bad Debts
Expense
(10,000)
(10,000)
BRIEF EXERCISE 7-2 ACCOUNTS RECEIVABLE TURNOVER
LO 2
$240,000/[($40,000 + $20,000/2] = $240,000/$30,000 = 8 times

BRIEF EXERCISE 7-3 ACCOUNTING FOR NOTES RECEIVABLE
LO 3
2008
Dec. 31
Interest Receivable
Interest Revenue
To record interest earned: $50,000 6% 60/360.
500
500
Note: Solution assumes Gopher accepted the note, not issued the note as shown in the
text.
BALANCE SHEET
Assets
Interest
Receivable
Liabilities
INCOME STATEMENT
Interest Revenue
750
750
7-6
BRIEF EXERCISE 7-4 ACCOUNTING FOR CREDIT CARD SALES
LO 4
July 20
Cash
9,600
Collection Fee Expense
400
Sales Revenue*
*Accounts Receivable if sale was already recorded.
To record credit card sales.
BALANCE SHEET
Assets
Cash
Liabilities
INCOME STATEMENT
9,600
Collection Fee
Expense
Sales Revenue
(400)
10,000
BRIEF EXERCISE 7-5 ACCOUNTING FOR SALE OF STOCK
LO 5
March 5 Cash
Investment in Stock
Gain on Sale of Stock
To record sale of stock at a gain.
BALANCE SHEET
Assets
Cash
Investment
in Stock
LO 6
10,000
=
12,300
Liabilities
12,300
10,100
2,200
INCOME STATEMENT

Gain on Sale
of Stock
2,200
(10,100)
BRIEF EXERCISE 7-6 ACCOUNTS RECEIVABLE ON THE STATEMENT OF CASH

FLOWS
The increase of $40,000 $25,000 or $15,000 in accounts receivable should be

deducted from net income under the indirect method of preparing the statement of cash
flows. Sales increase net income. An increase in accounts receivable is an indication
that sales exceeded cash collections and therefore to arrive at cash from operations a
deduction is needed.
7-7
EXERCISES
EXERCISE 7-1 COMPARISON OF THE DIRECT WRITE-OFF AND ALLOWANCE
METHODS OF ACCOUNTING FOR BAD DEBTS
LO 1
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
effects on net income.
EXERCISE 7-2 ALLOWANCE METHOD OF ACCOUNTING FOR BAD DEBTS

COMPARISON OF THE TWO APPROACHES
LO 1
1. a. Based on 2% of net credit sales:

2008
Dec. 31
Bad Debts Expense

2% $834,000.
BALANCE SHEET
Assets
Allowance for
Doubtful
Accounts
Liabilities
16,680
16,680
INCOME STATEMENT
Bad Debts
Expense
(16,680)
(16,680)
7-8
b. Based on 6% of year-end accounts receivable:

2008
Dec. 31
Bad Debts Expense

Need balance of 6% of $320,100
Balance before adjustment is
Amount of entry must be
16,606
16,606
$19,206 (cr)
2,600 (cr)
$16,606 (cr)
BALANCE SHEET
Assets
Allowance for
Doubtful
Accounts
Liabilities
INCOME STATEMENT
Bad Debts
Expense
(16,606)
(16,606)
2. a. No change.
b. 2008
Dec. 31
Bad Debts Expense

21,806
Need balance of 6% of $320,100
$19,206 (cr)
Balance before adjustment is
(2,600) (dr)
$21,806 (cr)
BALANCE SHEET
Assets
Allowance for
Doubtful
Accounts
LO 2
Liabilities
21,806
INCOME STATEMENT
Bad Debts
Expense
(21,806)
EXERCISE 7-3 ACCOUNTS RECEIVABLE TURNOVER FOR GENERAL MILLS
1. Accounts receivable turnover:

Net credit sales/Average accounts receivable
= $11,640/[($1,076 + $1,034)/2]
= $11,640/$1,055 = 11.03 times
2. Average collection period (assuming 360 days in a year):
Number of days in a year/turnover
= 360/11.03 = 33 days to collect an account receivable
(21,806)
7-9
3. Types of customers General Mills might have:
Grocery wholesalers
Grocery chains
Institutional food services
Whether or not an average of 33 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
period of 33 days may be reasonable, but not if the credit terms are net 10, for
example.
EXERCISE 7-4 NOTES RECEIVABLE
LO 3
1. Rozelle Company is the maker; Dougherty Corporation is the payee.

2. The maturity date is March 1, 2009.
3. 2008
Sept. 1
Notes Receivable
Accounts Receivable
To record receipt of six-month, 7% promissory
note in exchange for open account.
BALANCE SHEET
Assets
Notes
Receivable
Accounts
Receivable
Dec. 31
Liabilities
45,000
INCOME STATEMENT
45,000
(45,000)
Interest Receivable
Interest Revenue
BALANCE SHEET
Assets
Interest
Receivable
45,000
=
1,050
Liabilities
1,050
1,050
INCOME STATEMENT
Interest
Revenue
1,050
7-10
2009
Mar. 1
Cash
Interest Receivable
Interest Revenue
Notes Receivable
To record collection of promissory note:
$45,000 7% 2/12.
BALANCE SHEET
Assets
Cash
Interest
Receivable
Notes
Receivable
LO 4
Liabilities
46,575
1,050
525
45,000
INCOME STATEMENT
46,575
Interest Revenue
525
(1,050)
(45,000)
EXERCISE 7-5 CREDIT CARD SALES
June 12 Cash
Accounts ReceivableAmerican Express
Sales Revenue
To record weekly cash and credit sales.
BALANCE SHEET
Assets
Cash
Accounts
Receivable
American
Express
Liabilities
2,430
3,500
5,930
INCOME STATEMENT
2,430
Sales Revenue
3,500
June 15 Cash
Collection Fee Expense
Accounts ReceivableAmerican Express
To record weekly drafts from credit card company.
BALANCE SHEET
Assets
Cash
Accounts
Receivable
American
Express
5,930
=
3,360
Liabilities
3,360
140
3,500
INCOME STATEMENT
Collection Fee
Expense
(3,500)
The collection fee charged by American Express is $140/$3,500 = 4%.
(140)
7-11
EXERCISE 7-6 CERTIFICATE OF DEPOSIT
LO 5
2008
May 31
Short-Term Investments: CD
Cash
To record purchase of 120-day 9% CD.
BALANCE SHEET
Assets
Liabilities
50,000
50,000
INCOME STATEMENT
Short-Term
Investments:
CD
50,000
Cash
(50,000)
June 30 Interest Receivable

Interest Revenue
BALANCE SHEET
Assets
Interest
Receivable
Liabilities
375
INCOME STATEMENT

Interest Revenue
375
375
Sept. 28 Cash
Interest Receivable
Interest Revenue
Short-Term Investments
To record redemption of $50,000 CD:
$50,000 9% 90/360 = $1,125.
BALANCE SHEET
Assets
Cash
Interest
Receivable
Short-Term
Investments
375
=
51,500
(375)
(50,000)
Liabilities
51,500
375
1,125
50,000
INCOME STATEMENT
Interest Revenue 1,125
7-12
EXERCISE 7-7 CLASSIFICATION OF CASH EQUIVALENTS AND INVESTMENTS ON

A BALANCE SHEET
LO 5
1. STI
6. STI
2. STI
7. STI
3. STI
8. LTI
4. CE
9. STI
5. LTI
10. CE
EXERCISE 7-8 PURCHASE AND SALE OF BONDS
LO 5
1. Journal entries
2008
Jan. 1
Investment in Northern Lights Bonds

Cash
To record purchase of Northern Lights
bonds at 100.
BALANCE SHEET
Assets
Liabilities
100,000
100,000
INCOME STATEMENT
Investment in
Northern Lights
Bonds
100,000
Cash
(100,000)
June 30 Cash
Interest Income
To record interest income on Northern
Lights bonds: $100,000 8% 6/12.
BALANCE SHEET
Assets
Cash
Liabilities
Interest Income
BALANCE SHEET
Cash
INCOME STATEMENT
Cash
Interest Income
To record interest income on Northern
Lights bonds.
Assets
=
4,000
4,000
4,000
Dec. 31
4,000
Liabilities
4,000
4,000
4,000
INCOME STATEMENT
Interest Income
4,000
2009
Jan. 1
Cash
Investment in Northern Lights Bonds
Gain on Sale of Bonds
To record sale of Northern Lights
bonds at 102.
BALANCE SHEET
Assets
Liabilities
7-13
102,000
100,000
2,000
INCOME STATEMENT
Cash
102,000
Investment in
Northern Lights
Bonds
(100,000)
Gain on Sale
of Bonds
2,000
2. Starship was able to sell the bonds for more than the bonds will pay when they
mature because the bonds carry a higher periodic interest than the market rate of
interest that was in effect at the time of the sale.
EXERCISE 7-9 INVESTMENT IN STOCK
LO 5
2008
Oct. 1
Investment in Denver Preferred Stock (BS)

Cash (BS)
To record purchase of stock for cash:
($1,000 $40) + $1,000
BALANCE SHEET
Assets
Liabilities
41,000
41,000
INCOME STATEMENT
Investment in Denver
Preferred
Stock
41,000
Cash
(41,000)
Oct. 20
Cash
1,000
Dividend Income (IS)
1,000
To record $1 per share dividend on dividend declared on investment on
1,000 shares of Denver preferred stock.
BALANCE SHEET
Assets
Cash
=
1,000
Liabilities
INCOME STATEMENT
Dividend Income
1,000
7-14
Nov. 5
Cash (BS)
Investment in Denver Preferred
Stock (BS) (book value)
Gain on Sale of Stock (IS)
To record sale of stock at a gain.
BALANCE SHEET
Assets
Cash
Investment in
Denver
Preferred
Stock
Liabilities
45,000
41,000
4,000
INCOME STATEMENT
45,000
Gain on Sale
of Stock
4,000
(41,000)
EXERCISE 7-10 INVESTMENT IN STOCK
LO 5
2008
Aug. 15
Investment in Sox Common Stock (BS)

Cash (BS)
To record purchase of 5,000 shares of stock for
$15 per share + $1,000 in fees.
BALANCE SHEET
Assets
Liabilities
76,000
76,000
INCOME STATEMENT
Investment in
Sox Common
Stock
76,000
Cash
(76,000)
Oct. 20
Cash (BS)
Loss on Sale of Stock (IS)
Investment in Sox Common Stock (BS)
To record sale of stock at a loss.
50,000*
26,000**
76,000
*5,000 $10
**76,000 50,000
BALANCE SHEET
Assets
Cash
50,000
Investment in
Sox Common
Stock
(76,000)
Liabilities
INCOME STATEMENT
Loss on Sale
of Stock
(26,000)
LO 6
7-15
EXERCISE 7-11 IMPACT OF TRANSACTIONS INVOLVING RECEIVABLES ON

STATEMENT OF CASH FLOWS
Increase in accounts receivableDeducted from net income

Decrease in accounts receivableAdded to net income
Increase in notes receivableDeducted from net income
Decrease in notes receivableAdded to net income
LO 6
EXERCISE 7-12 CASH COLLECTIONSDIRECT METHOD
Cash collections to be reported in the operating activities section of Emily Enterprises

2008 statement of cash flows (direct method):
Accounts receivable, December 31, 2007
Plus sales during 2008
Less cash collections during 2008
Accounts receivable, December 31, 2008
$224,600 + $2,250,000 X = $205,700
X = $2,268,900
$ 224,600
2,250,000
(X
$ 205,700
7-16
M U LTI C O N C E P T E X E R C I S E
LO 1,5,6
EXERCISE 7-13 IMPACT OF TRANSACTIONS INVOLVING CASH, SECURITIES,

AND RECEIVABLES ON STATEMENT OF CASH FLOWS
Purchase of cash equivalentsN

Redemption of cash equivalentsN
Purchase of investmentsI
Sale of investmentsI
Write-off of customer account (under the allowance method)N
7-17
PROBLEMS
PROBLEM 7-1 ALLOWANCE METHOD FOR ACCOUNTING FOR BAD DEBTS
LO 1
1. Accounts Receivable
Cash
Sales Revenue
To record sales for year: $1,050,000 80% = $840,000
credit sales.
BALANCE SHEET
Assets
Accounts
Receivable
Cash
Liabilities

Sales
Revenue
Cash
Accounts Receivable
To record collection of customer accounts.
BALANCE SHEET
Cash
Accounts
Receivable
Liabilities
1,050,000
670,000
670,000
INCOME STATEMENT
670,000
(670,000)

Accounts Receivable
To record write-off of accounts receivable.
BALANCE SHEET
Assets
Allowance for
Doubtful
Accounts
Accounts
Receivable
1,050,000
INCOME STATEMENT
840,000
210,000
Assets
840,000
210,000
4,000
(4,000)
Liabilities
4,000
4,000
INCOME STATEMENT
7-18
PROBLEM 7-1 (Continued)
2.a. Bad Debt Expense

To record estimated bad debt expense:
$840,000 3%.
BALANCE SHEET
Assets
Allowance for
Doubtful
Accounts
Liabilities
25,200
25,200
INCOME STATEMENT
Bad Debt
Expense
2.b. Bad Debt Expense

Accounts receivable at Dec. 31, 2008
($140,000 + $840,000 $670,000 $4,000) = $306,000
Allowance balance needed ($306,000 0.06)
Balance before adjustment:
Beginning balance
$2,350 (cr)
Write-off
4,000 (dr)
BALANCE SHEET
Allowance for
Doubtful
Accounts
Liabilities
20,010
20,010
$18,360 (cr)
1,650 (dr)
$20,010 (cr)

Assets
(25,200)
(25,200)
INCOME STATEMENT
Bad Debt
Expense
(20,010)
(20,010)
3.a. The net realizable value of accounts receivable on December 31, 2008, is
$282,450:
Accounts receivable, Dec. 31 (from Part 2.b.)
Less: Allowance for doubtful accounts, Dec. 31
($2,350 $4,000 + $25,200)
Net realizable value, December 31
$306,000
23,550
$282,450
3.b. The net realizable value of accounts receivable on December 31, 2008, is
$287,640:
Less: Allowance for doubtful accounts, Dec. 31
($2,350 $4,000 + $20,010)
$306,000
18,360
$287,640
7-19
PROBLEM 7-1 (Concluded)
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.
PROBLEM 7-2 AGING SCHEDULE TO ACCOUNT FOR BAD DEBTS
LO 1
1.
Category
Current
Past due:
Less than one month
One to two months
Over two months
Totals
Amount
$200,000
45,000
25,000
10,000
$280,000
2. Journal entry:
2008
Dec. 31 Bad Debts Expense
$35,000 less $12,300 currently in
allowance account.
BALANCE SHEET
Assets
Allowance for
Doubtful
Accounts
Liabilities
Estimated
Percent
Uncollectible
5%
20%
40%
60%
Estimated
Amount
Uncollectible
$10,000
9,000
10,000
6,000
$35,000
22,700
22,700
INCOME STATEMENT
Bad Debts
Expense
(22,700)
3. Partial balance sheet at December 31, 2008:

Current Assets
Accounts receivable
Less: Allowance for doubtful accounts
Net accounts receivable
$280,000
(35,000)
$245,000
(22,700)
7-20
LO 2
PROBLEM 7-3 ACCOUNTS RECEIVABLE TURNOVER FOR COCA-COLA AND

PEPSICO
1. Accounts receivable turnover ratios:

Coca-Cola:
$24,088/[($2,587 + $2,281)/2] = $24,088/$2,434 = 9.90 times
PepsiCo:
$35,137/[($3,725 + $3,261)/2] = $35,137/$3,493 = 10.06 times
2. Average collection period:
Coca-Cola:
360/9.90 = 36.36 days
PepsiCo:
360/10.06 = 35.78 days
Both companies have an average collection period of about 36 days. A collection
period that averages just over one month, appears to be reasonable.
3. The turnover ratios and the average collection periods are very similar for the two
companies. 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 4
PROBLEM 7-4 CREDIT CARD SALES
1. Net selling price

Cost of goods sold
Gross margin
$1.00
0.75
$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.
7-21
PROBLEM 7-5 INVESTMENTS IN BONDS AND STOCK
LO 5
2008
July 1
Investment in Gallatin Bonds

Cash
To record purchase of 6%, Gallatin bonds.
BALANCE SHEET
Assets
Investment in
Gallatin
Bonds
Cash
Oct. 23
Liabilities
Investment
in Eagle
Rock Stock
Cash
Nov. 21
10,000
(10,000)
Investment in Eagle Rock Stock

Cash
To record purchase of 600 shares of
common stock at $20 per share.
=
Liabilities
Investment
in Montana
Stock
Cash
12,000
12,000
INCOME STATEMENT
12,000
(12,000)
Investment in Montana Stock

Cash
preferred stock at $30 per share.
BALANCE SHEET
Assets
10,000
INCOME STATEMENT
BALANCE SHEET
Assets
10,000
6,000
(6,000)
Liabilities
6,000
6,000
INCOME STATEMENT
7-22
Dec. 10
Cash
Dividend Income
To record receipt of dividends on
securities:
Eagle Rock600 $1.50
Montana200 $2.00
1,300
1,300
$ 900
400
$1,300
BALANCE SHEET
Assets
Cash
Liabilities
INCOME STATEMENT
1,300
Dec. 28
Dividend Income
Cash
Investment in Eagle Rock Stock
To record sale of 400 shares of Eagle
Rock stock.
1,300
10,000*
8,000**
2,000
*$400 $25
**$400 $20
BALANCE SHEET
Assets
Cash
Investment
in Eagle
Rock Stock
Dec. 31
Liabilities
10,000
Gain on Sale
of Stock
2,000
(8,000)
Cash (10,000 6% 1/2 year)

Interest Income
To record receipt of interest:
$10,000 6% 6/12.
BALANCE SHEET
Assets
Cash
INCOME STATEMENT
=
300
Liabilities
300
300
INCOME STATEMENT
Interest Income
300
7-23
PROBLEM 7-6 INVESTMENTS IN STOCK
LO 5
2008
Jan. 15
Investment in Sears Stock

Cash
stock at $50 per share, plus $500 in
commissions.
BALANCE SHEET
Assets
Investment in
Sears Stock
Cash
May 23
Liabilities
INCOME STATEMENT
Cash
Dividend Income
To record receipt of dividends of $2 per
share on 200 shares of Sears stock.
BALANCE SHEET
=
Liabilities
Dividend Income
BALANCE SHEET
Investment in
Ford Stock
Cash
Oct. 20
Liabilities
400
7,700
7,700
INCOME STATEMENT
7,700
(7,700)
Cash
Loss on Sale of Stock
Investment in Sears Stock
To record sale of Sears stock:
(200 shares $42) $400 = $8,000.
BALANCE SHEET
Assets
Cash
Investment in
Sears Stock
400
INCOME STATEMENT
Investment in Ford Stock

Cash
commissions.
Assets
400
400
June 1
10,500
10,500
(10,500)
Assets
Cash
10,500
=
8,000
(10,500)
Liabilities
8,000
2,500
10,500
INCOME STATEMENT
Loss on Sale
of Stock
(2,500)
7-24
Dec. 15
Dividends Receivable
Dividend Income
To record notification of the declaration
of $1.50 per share dividend on 100 shares
of Ford stock.
BALANCE SHEET
Assets
Dividends
Receivable
LO 6
Liabilities
150
150
INCOME STATEMENT
Dividend Income
150
PROBLEM 7-7 EFFECTS OF CHANGES IN RECEIVABLE BALANCES ON

1. Statement of cash flows:

STEGNER INC.
FOR THE YEAR ENDED DECEMBER 31, 2008
Net income
Adjustments to reconcile net income to net cash
used by operating activities:
Increase in accounts receivable
Decrease in notes receivable
Cash flows from operating activities
Cash, December 31, 2007
*$223,000 $83,000
**$100,000 $95,000
$ 130,000
$(140,000)*
5,000**
(135,000)
$ (5,000)
110,000
$ 105,000
150
7-25
2. Memorandum to the president:

TO:
Owner of Stegner, Inc.
FROM:
Students name
DATE:
January XX, 2009
SUBJECT: Cash Flows

You recently expressed concern about the decrease in the companys cash balance
in spite of the profitable year that was reported on this years income statement. My
thoughts and a copy of the companys 2008 statement of cash flows follow.
Although net income on an accrual basis was $130,000, the companys cash
balance declined by $5,000 during the year for two reasons. Most importantly, accounts
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.
7-26
M U LTI C O N C E P T P R O B L E M
LO 1,3
PROBLEM 7-8 ACCOUNTS AND NOTES RECEIVABLE
1. Journal entries:
2008
May 15
Accounts Receivable, C. Brown

Sales Revenue
To record sale on credit; terms net 30.
BALANCE SHEET
Assets
Liabilities
INCOME STATEMENT
Sales Revenue

Accounts ReceivableC. Brown
To write off uncollectible account.
BALANCE SHEET
Assets
Allowance
for Doubtful
Accounts
Accounts
Receivable
C. Brown
Dec. 1
Liabilities
5,000
5,000
5,000
INCOME STATEMENT
5,000
(5,000)

To restore account previously written off.
BALANCE SHEET
Assets
Accounts
Receivable
C. Brown
Allowance
for Doubtful
Accounts
5,000
Accounts Receivable,
C. Brown
5,000
Aug. 10
5,000
5,000
(5,000)
Liabilities
5,000
5,000
INCOME STATEMENT
7-27
Dec. 1
Cash
Notes Receivable
To record partial collection on open account
and receipt of two-month 9% note for the balance.
BALANCE SHEET
Assets
Cash
Notes
Receivable
Accounts
Receivable
C. Brown
Dec. 31
Liabilities
INCOME STATEMENT
4,000
(5,000)
Interest Receivable
Interest Revenue
To accrue interest earned:
$4,000 9% 1/12.
30
30
BALANCE SHEET
=
Interest Receivable
Liabilities
INCOME STATEMENT
30
Interest Revenue
Cash
Interest Receivable
Interest Revenue
Notes Receivable
To record collection of note and interest.
BALANCE SHEET
Assets
Cash
Interest
Receivable
Notes
Receivable
5,000
1,000
Assets
2009
Jan. 31
1,000
4,000
=
4,060
Liabilities
30
4,060
30
30
4,000
INCOME STATEMENT

Interest Revenue
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.
7-28
A L T E R N AT E P R O B L E M S
PROBLEM 7-1A ALLOWANCE METHOD FOR ACCOUNTING FOR BAD DEBTS
LO 1
1. Accounts Receivable
Cash
Sales Revenue
To record sales for year: $787,500 80% = $630,000
credit sales.
BALANCE SHEET
Assets
Accounts
Receivable
Cash
Liabilities

Sales Revenue 787,500
630,000
157,500
BALANCE SHEET
Assets
Liabilities
502,500
502,500
INCOME STATEMENT
502,500
(502,500)

Accounts Receivable
To record write-off of accounts receivable.
BALANCE SHEET
Assets
Allowance
for Doubtful
Accounts
Accounts
Receivable
787,500
INCOME STATEMENT
Cash
Accounts Receivable
To record collection of customer accounts.
Cash
Accounts
Receivable
630,000
157,500
3,000
(3,000)
Liabilities
3,000
3,000
INCOME STATEMENT
7-29
PROBLEM 7-1A (Continued)
2.a. Bad Debt Expense

To record estimated bad debt expense.
$630,000 X 3%.
BALANCE SHEET
Assets
Allowance
for Doubtful
Accounts
Liabilities
18,900
18,900
INCOME STATEMENT
Bad Debt
Expense
2.b. Bad Debt Expense

14,820
Accounts receivable at Dec. 31, 2008
($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)
$ 14,820 (cr)
BALANCE SHEET
Assets
Allowance
for Doubtful
Accounts
(18,900)
(18,900)
Liabilities
14,820
INCOME STATEMENT
Bad Debt
Expense
(14,820)
(14,820)
3.a. The net realizable value of accounts receivable on December 31, 2008, is
$211,650.
Less: allowance for doubtful accounts, Dec. 31
($1,950 $3,000 + $18,900)
$229,500
17,850
$211,650
3.b. The net realizable value of accounts receivable on December 31, 2008, is
$215,730.
Less: allowance for doubtful accounts, Dec. 31
($1,950 $3,000 + $14,820)
$229,500
13,770
$215,730
7-30
PROBLEM 7-1A (Concluded)
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 1
PROBLEM 7-2A AGING SCHEDULE TO ACCOUNT FOR BAD DEBTS
1.
Category
Current
Past due:
Less than one month
One to two months
Over two months
Totals
Amount
$200,000
60,300
35,000
45,000
$340,300
Estimated
Percent
Uncollectible
10%
25%
35%
75%
Estimated
Amount
Uncollectible
$20,000
15,075
12,250
33,750
$81,075
2. The controller is primarily responsible for the accuracy of the records, rather than the
collection process. Thus, the controllers main concern should be with the adequacy
of the balance in the allowance account. The amount of the allowance should
probably be increased, given the relatively large amount which is likely to be
uncollectible.
3. Partial balance sheet at December 31, 2008:
Current Assets
Accounts receivable
Less: Allowance for doubtful accounts
Net accounts receivable
LO 2
$340,300
81,075
$259,225
PROBLEM 7-3A ACCOUNTS RECEIVABLE TURNOVER FOR BEST BUY AND

CIRCUIT CITY

Best Buy Co. Inc.:
$35,934/[($548 + $449)/2] = $35,934/$498.5 = 72.08 times
Circuit City Stores, Inc.:
$12,429,754/[($382,555 + $220,869)/2] = $12,429,754/$301,712 = 41.20 times
7-31

Best Buy:
360/72.08 = 4.99 days
Circuit City:
360/41.20 = 8.74 days
Average collection periods of either 5 days or 9 days appear very reasonable
considering the nature of the business.
3. Best Buys accounts receivable turnover ratio is higher than Circuit Citys: 72.08
versus 41.20. However, it would be helpful to measure these statisticsaccounts
receivable turnover ratio and average collection periodwith the same measures for
prior years. It would also be helpful to compare these measures with the industry
averages.
PROBLEM 7-4A CREDIT CARD SALES
LO 4
1. Cost of credit card operation per outlet:

Equipment/phone line
Sales fee:
Credit sales: $800,000 5%
Fee
Total cost
$ 800
$40,000
0.015
600
$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
customers and it does not. The company may find that customer goodwill is
increased by the offer to use a credit card.
PROBLEM 7-5A INVESTMENTS IN BONDS AND STOCK
LO 5
2008
July 1
Investment in Maine Bonds

Cash
To record purchase of 8% Maine bonds.
BALANCE SHEET
Assets
Investment in
Maine Bonds 10,000
Cash
(10,000)
Liabilities
10,000
10,000
INCOME STATEMENT
7-32
PROBLEM 7-5A (Continued)
Oct. 23 Investment in Virginia Stock

Cash
To record purchase of 1,000 shares
of common stock at $15 per share.
BALANCE SHEET
Assets
Liabilities
15,000
15,000
INCOME STATEMENT
Investment in
Virginia Stock 15,000
Cash
(15,000)
Nov. 21
Investment in Carolina Stock

Cash
preferred stock at $8 per share.
BALANCE SHEET
Assets
Liabilities
4,800
4,800
INCOME STATEMENT
Investment in
Carolina Stock 4,800
Cash
(4,800)
Dec. 10
Cash
Dividend Income
To record receipt of dividends:
Virginia1,000 $0.50 = $ 500
Carolina600 $1.00 =
600
$1,100
BALANCE SHEET
Assets
Cash
Liabilities
1,100
INCOME STATEMENT
1,100
Dec. 28
1,100
Dividend Income
Cash
Investment in Virginia Stock
To record sale of 700 shares of Virginia
stock.
1,100
13,300*
10,500**
2,800
*700 $19
**700 $15
BALANCE SHEET
Assets
Cash
13,300
Investment in
Virginia Stock (10,500)
Liabilities
INCOME STATEMENT
Gain on Sale
of Stock
2,800
7-33
Dec. 31
Cash
Interest Income
To record receipt of interest on bonds.
400*
400
*$10,000 8% 1/2 year

BALANCE SHEET
Assets
Cash
Liabilities
INCOME STATEMENT
400
Interest Income
400
PROBLEM 7-6A INVESTMENTS IN STOCK
LO 5
2008
Jan. 15
Investment in IBM Stock

Cash
commissions.
BALANCE SHEET
Assets
Investment in
IBM Stock
Cash
May 23
Liabilities
INCOME STATEMENT
Cash
Dividend Income
To record receipt of dividends of $1 per
share on 100 shares of IBM stock.
BALANCE SHEET
=
Liabilities
Investment in
GM Stock
Cash
100
INCOME STATEMENT
Dividend Income
Investment in GM Stock
Cash
commissions.
BALANCE SHEET
Assets
100
100
June 1
13,250
13,250
(13,250)
Assets
Cash
13,250
=
12,300
(12,300)
Liabilities
100
12,300
12,300
INCOME STATEMENT
7-34
Oct. 20
Cash
Investment in IBM Stock
To record sale of IBM stock:
(100 shares $140) $400.
BALANCE SHEET
Assets
Cash
Investment in
IBM Stock
Liabilities
INCOME STATEMENT
Gain on Sale
of Stock
350
(13,250)
Dividends Receivable
Dividend Income
To record notification of the declaration
of $0.75 per share dividend on 200 shares
of GM stock.
BALANCE SHEET
Assets
LO 6
13,250
350
13,600
Dec. 15
Dividends
Receivable
13,600
Liabilities
150
150
INCOME STATEMENT
Dividend Income
150
PROBLEM 7-7A EFFECTS OF CHANGES IN RECEIVABLE BALANCES ON

1. Statement of cash flows:

ST. CHARLES ANTIQUE MARKET
FOR THE YEAR ENDED DECEMBER 31, 2008
Net loss
Adjustments to reconcile net loss to net cash
provided by operating activities:
Decrease in accounts receivable
Increase in notes receivable
Cash flows from operating activities
*$126,000 $79,000
**$104,800 $112,600
$(6,000)
47,000*
(7,800)**
$33,200
3,100
$36,300
150
7-35
2. Memorandum to the president:

TO:
Owner of St. Charles Antique Market
FROM:
Students name
DATE:
January XX, 2009
SUBJECT: Cash Flows

You recently questioned the increase in the companys cash balance in light of
this years net loss. My thoughts and a copy of the companys 2008 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
2008 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
receivable 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.
7-36
A L T E R N AT E M U L T I C O N C E P T P R O B L E M
LO 1,3
PROBLEM 7-8A ACCOUNTS AND NOTES RECEIVABLE
1. Journal entries:
2008
July 31
Accounts ReceivableP.D. Cat

Sales Revenue
To record sale on credit; terms net 30.
BALANCE SHEET
Assets
Accounts
Receivable
P.D. Cat
Dec. 24
Liabilities
INCOME STATEMENT

To write off uncollectible account.
=
Liabilities
6,000
6,000
INCOME STATEMENT
6,000
(6,000)

To restore account previously written off.
BALANCE SHEET
Assets
Accounts
Receivable
P.D. Cat
Allowance
for Doubtful
Accounts
6,000
6,000
BALANCE SHEET
2009
Jan. 15
6,000
Sales Revenue
Assets
Allowance for
Doubtful
Accounts
Accounts
Receivable
P.D. Cat
6,000
6,000
(6,000)
Liabilities
6,000
6,000
INCOME STATEMENT
7-37
Jan. 15
Cash
Notes Receivable
To record partial collection on open
account and receipt of two-month 8%
note for the balance.
BALANCE SHEET
Assets
Cash
Notes
Receivable
Accounts
Receivable
P.D. Cat
Mar. 15
Liabilities
6,000
INCOME STATEMENT
1,500
4,500
(6,000)
Cash
Interest Revenue
Notes Receivable
To record collection of note and interest:
$4,500 8% 2/12.
BALANCE SHEET
Assets
Cash
Notes
Receivable
1,500
4,500
=
4,560
Liabilities
4,560
60
4,500
INCOME STATEMENT
Interest Revenue
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.
7-38
D E C IS ION C AS E S
READING AND INTERPRETING FINANCIAL STATEMENTS
LO 1
DECISION CASE 7-1 READING APPLES BALANCE SHEET AND NOTES TO THE
STATEMENTS
1. The balance in the Allowance for Doubtful Accounts is $52 million at the end of 2006
and $46 million at the end of 2005.
2. The net realizable value of accounts receivable at the end of 2006 was $1,252
million, and at the end of 2005, $895 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 $17 million for 2006 and $8 million
for 2005.
4. The amount of accounts receivable written off is represented by the line on the table
titled Deductions. This amount is $11 million for 2006 and $9 million for 2005.
5. The increase in the amounts of accounts written off in the last two years could be
due to a number of factors. The company may have loosened its credit policies and
thus is experiencing more bad debts than in the past. The reduction may also be the
result of changes in the economy that have resulted in more companies unable to
pay amounts due to suppliers of credit. It is worth noting that there has also been an
increase in the amounts charged to costs and expenses in the last two years.
Increases in bad debts may be partially a result of increased sales by Apple.
LO 1,6
DECISION CASE 7-2 READING APPLE COMPUTERS STATEMENT OF CASH

FLOWS
1. Apple spent $7,255 million to purchase short-term investments in 2006. This was
$4,215 million less than Apple spent on investments in 2005 but $3,985 million more
than was spent in 2004.
2. Apple received $7,226 million from investments that matured in 2006. This was
$1,383 million less than it received in 2005 and $6,085 more than in 2004.
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.
LO 3
7-39
DECISION CASE 7-3 COMPARING TWO COMPANIES IN THE SAME INDUSTRY:

KELLOGGS AND GENERAL MILLS

Kelloggs:
$10,906.7/[($944.8 + $879.1)/2] = $10,906.7/$911.95 = 11.96 times
General Mills:
$11,640/[($1,076 + $1,034)/2] = $11,640/$1,055 = 11.03 times
Kelloggs:
360/11.96 = 30.10 days
Circuit City:
360/11.03 = 32.64 days
Average collection periods of approximately one month appear reasonable
considering the nature of the business.
3. Kelloggs accounts receivable turnover ratio is slightly higher than General Millss:
11.96 versus 11.03. However, it would be helpful to measure these statistics
accounts receivable turnover ratio and average collection periodwith the same
measures for prior years. It would also be helpful to compare these measures with
the industry averages.
7-40
MAKING FINANCIAL DECISIONS

LO 1,5
DECISION CASE 7-4 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 shortterm 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
considerably between the two companies. On the surface, Oak may appear to be
stronger because it has twice the amount of cash on hand that Maple does. However,
cash is essentially 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.
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
accounts receivable, while Maples percentage is only 1/23, or 4.35%.
In summary, I believe 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 4
DECISION CASE 7-5 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:
7-41
Vice-president
FROM:
Students 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
recommendation 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
whenever possible. The suggested treatment for this sale, however, is a clear
violation of generally accepted accounting principles. The reason for the violation is
straightforward: $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.
REAL WORLD PRACTICE 7.1

According to Apples balance sheet, accounts receivable increased by $1,252 $895 or
$357 million during 2006. Accounts receivable make up $1,252/$14.509, or 8.63%, of
the total current assets at the end of 2006.
REAL WORLD PRACTICE 7.2

The amount of accounts receivable before deducting the balance in the allowance
account is $1,252 + $52 or $1,304 million at the end of 2006. This amount at the end of
2005 is $895 + $46, or $941 million. The gross amount of accounts receivable
increased during 2006 by $1,304 $941, or $363 million. The allowance account
increased during 2006 by $52 $46, or $6 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 account write offs of customers accounts.
7-1

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CHAPTER 7

Receivables and Investments

1. Show that you understand how to account for accounts

2. Explain how information about sales and receivables can

3. Show that you understand how to account for

4. Explain various techniques that companies use to accelerate

5. Show that you understand the accounting for and disclosure

6. Explain the effects of transactions involving liquid assets

*Exercise, problem, or case covers two or more learning outcomes

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

1. Show that you understand how to account for accounts

2. Explain how information about sales and receivables

3. Show that you understand how to account for

4. Explain various techniques that companies use to accelerate

5. Show that you understand the accounting for and disclosure

6. Explain the effects of transactions involving liquid assets

*Exercise, problem, or case covers two or more learning outcomes

CHAPTER 7 RECEIVABLES AND INVESTMENTS

1. Show that you understand how to account for accounts

2. Explain how information about sales and receivables

4. Explain various techniques that companies use to accelerate

5. Show that you understand the accounting for and disclosure

6. Explain the effects of transactions involving liquid assets

3. Show that you understand how to account for

*Exercise, problem, or case covers two or more learning outcomes

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

CHAPTER 7 RECEIVABLES AND INVESTMENTS

Bad Debts Expense

BRIEF EXERCISE 7-2 ACCOUNTS RECEIVABLE TURNOVER

$240,000/[($40,000 + $20,000/2] = $240,000/$30,000 = 8 times

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

BRIEF EXERCISE 7-4 ACCOUNTING FOR CREDIT CARD SALES

BRIEF EXERCISE 7-5 ACCOUNTING FOR SALE OF STOCK

+ Stockholders Equity + Revenues Expenses

BRIEF EXERCISE 7-6 ACCOUNTS RECEIVABLE ON THE STATEMENT OF CASH

The increase of $40,000 $25,000 or $15,000 in accounts receivable should be

CHAPTER 7 RECEIVABLES AND INVESTMENTS

Net income under each of the two alternatives is as follows:

EXERCISE 7-2 ALLOWANCE METHOD OF ACCOUNTING FOR BAD DEBTS

1. a. Based on 2% of net credit sales:

Bad Debts Expense

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

b. Based on 6% of year-end accounts receivable:

Bad Debts Expense

Bad Debts Expense

EXERCISE 7-3 ACCOUNTS RECEIVABLE TURNOVER FOR GENERAL MILLS

1. Accounts receivable turnover:

CHAPTER 7 RECEIVABLES AND INVESTMENTS

3. Types of customers General Mills might have:

Whether or not an average of 33 days to collect an account is reasonable depends

1. Rozelle Company is the maker; Dougherty Corporation is the payee.

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

EXERCISE 7-5 CREDIT CARD SALES

+ Stockholders Equity + Revenues Expenses

The collection fee charged by American Express is $140/$3,500 = 4%.

CHAPTER 7 RECEIVABLES AND INVESTMENTS

EXERCISE 7-6 CERTIFICATE OF DEPOSIT

+ Stockholders Equity + Revenues Expenses

June 30 Interest Receivable

+ Stockholders Equity + Revenues Expenses

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

EXERCISE 7-7 CLASSIFICATION OF CASH EQUIVALENTS AND INVESTMENTS ON

Investment in Northern Lights Bonds