Professional Documents
Culture Documents
Chapter 8 Solutions
Receivables
Exercises
Exercises
E8-1. Account analysis
(AICPA adapted)
To find the amount of gross sales, start by determining credit sales. We can
do this with the accounts receivable T-account below.
Beginning AR
Credit sales
Ending AR
Accounts Receivable
$80,000
$1,000
Accounts written off
X
35,000
Cash collected
$74,000
$30,000
30,000
$60,000
$10,000
$10,000
$40,000
$40,000
Based on the two entries above, the balance in the allowance for doubtful
accounts at the end of the year was $30,000. The amount of accounts
receivable before the allowance for doubtful accounts that should appear on
the balance sheet is calculated as:
Net accounts receivable
Allowance for doubtful accounts
Gross accounts receivable
$250,000
30,000
$280,000
8-2
$1,000
500
$1,500
Payments
Interest
Income
Reduction
of Principal
1/1/01
12/31/01
12/31/02
12/31/03
12/31/04
12/31/05
$200,000
200,000
200,000
200,000
200,000
$75,8201
63,402
49,742
34,716
18,120*
$124,180
136,598
150,258
165,284
181,880
Net Installments
Due
$758,200
634,020
497,422
347,164
181,880
0
$60,000
$3,600
Next, find the present value of these amounts, discounted at 15% for one-half
year.
Maturity value of the note
$63,600
Less: bank discount ($63,600 .15 1/2)
4,770
Cash proceeds received from the bank
$58,830
E8-7. Note receivable carrying amount
(AICPA adapted)
Requirement 1:
D R Cash
D R Note receivable
CR Interest revenue
$5,000
3,100
$8,100
8-3
Requirement 2:
The account increases the carrying amount of the note receivable which will
ultimately total $100,000.
E8-8. Aging Analysis
(AICPA adapted)
The estimated uncollectible accounts at December 31, 2001 total:
0-30 days
31-60 days
Over 60 days
$60,000 x 5%
4,000 x 10%
2,000 x 70%
=
=
=
$3,000
400
1,400
$4,800
8-4
As reported Adjustment
Cash
$ 70,000
-0Accounts receivable
120,000
- $26,000
Inventories
60,000
+ 20,000
$250,000
Correct total
$ 70,000
94,000
80,000
$244,000
8-5
$10,500
$10,500
$29,750
3. Notes receivable
CR Sales revenue
$56,349
$56,349
DR Notes receivable
CR Interest income
Year
10/31/02
10/31/03
10/31/04
Balance
$ 56,349
61,984
68,182
$ 29,750
$ 5,635
$ 5,635
Rate
10%
10%
10%
4. DR Accounts receivable
CR Sales revenue
Income
$ 5,635
6,198
6,818
Balance
$ 61,984
68,182
75,000
$395,000
$395,000
DR Cash
CR Accounts receivable
5. DR Cash
DR Interest expense (45,000 x 9%)
CR Accounts receivable
8-6
$355,000
$355,000
$ 40,950
4,050
$ 45,000
Writeoffs
$ 31,750
$ 31,750
Allowance for
Uncollectible
Accounts
$33,000
$29,750
3,250
31,750
$35,000
Beginning balance
Required adjustment
(plugged number)
Required balance
Requirement 2:
Balance sheet presentation at October 31, 2002
Notes receivable
Accounts receivable
Less: Allowance for
Uncollectible accounts
Beginning balance
Sales on account
Ending balance
Sale by note
Imputed interest
Ending balance
$ 61,984
333,750
(35,000)
$360,734
Accounts Receivable
$379,000
$ 10,500 Returns
29,750 Write-offs
395,000
355,000 Collections
45,000 Factoring
$333,750
Notes Receivable
$56,349
5,635
$61,984
8-7
Amount
$30,000
10,000
5,000
Expected
Bad Debt
5%
11%
30%
Dollar
Amount
$1,500
1,100
1,500
$4,100
Direction of effect
Dollar amount of effect
Assets
600
Liabilities
NE
$600
$600
Net
Income
600
Cash Flow
from
Operations
NE
The journal entries for the other transactions are provided below:
January 1, 2002
No journal entry is recorded since the ultimate resolution of the account
receivable is still uncertain.
March 1, 2002
D R Allowance for uncollectibles
CR Accounts receivable
$800
$800
Direction of effect
Dollar amount of effect
Assets
NE
Liabilities
NE
8-8
Net
Income
NE
Cash Flow
from
Operations
NE
Since write-offs are typically realizations of events that have already been
anticipated (through the bad debt provision), they do not affect the assets
or the net income.
May 7, 2002
D R Cash
CR Accounts receivable
Direction of effect
Dollar amount of effect
$1,200
$1,200
Assets
NE
Liabilities
NE
Cash Flow
from
Operations
+
1,200
Net
Income
NE
Requirement 2:
Based on the aging schedule, the ending balance in the allowance for
doubtful accounts is calculated as follows:
Age of Receivables
Zero to 30 days old
31 days to 90 days old
Over 90 days old
Amount
$30,000
10,000
5,000
Expected
Bad Debt
3%
8%
22%
Dollar
Amount
$ 900
800
1,100
$2,800
Since the company has a larger balance than what is required by the aging
schedule, the company should decrease its bad debt expense by $700
($3,500 - $2,800).
December 31, 2001
D R Allowance for uncollectibles
CR Bad debt expense
Direction of effect
Dollar amount of effect
Assets
+
700
Liabilities
NE
$700
$700
Net
Income
+
700
8-9
Cash Flow
From
Operations
NE
Accounts Receivable
$ 850,000
$7,975,000 Collections
8,200,000
85,000 Current period write-offs
$ 990,000
Journal Entries:
DR Accounts receivable
CR Sales revenue
To record 2002 credit sales
DR Cash
CR Accounts receivable
To record 2002 cash collections
DR Allowance for uncollectibles
CR Accounts receivable
To record write-off of accounts
receivable during 2002
$8,200,000
$8,200,000
$7,975,000
$7,975,000
$85,000
$85,000
Requirement 2:
Oettinger Corporation
Accounts Receivable Aging Schedule
December 31, 2002
Age
0-30 days
31-60 days
61-90 days
91-120 days
120 days or more
Total
Accounts Receivable
Aging %
Balance
20.0%
$ 198,000
40.0%
396,000
35.0%
346,500
3.0%
29,700
2.0%
19,800
$ 990,000
8-10
Uncollectibles
Percentage
Amount
2.0% $ 3,960
5.0%
19,800
15.0%
51,975
25.0%
7,425
50.0%
9,900
$ 93,060
2002 write-offs
Allowance for
Uncollectible Accounts
$85,000
$25,000 Beginning balance
82,000 Provided based on 1% of sales
22,000
71,060 Required adjustment
$93,060 Ending balance,
per aging schedule
Requirement 3:
The journal entries affecting the allowance for uncollectible accounts are:
DR
$85,000
DR
$990,000
(93,060)
$896,940
$4
X
$56
8-11
Solving for X:
$30 - 4 + X = $56
X = $30
Now divide bad debt expense by charge sales.
$30/$1,000 = 3%
Bad debt expense = 3% of charge sales
Next, repeat the computation with the 2002 allowance for doubtful accounts:
2002
Allowance for Doubtful Accounts
$47
Beginning balance
Accounts written-off
$50
X
$30
Solving for X:
$47 - $50 + X = $30
X = $33
Now divide bad debt expense by charge sales.
$33/$1,100 = 3%
Bad debt expense = 3% of charge sales, just as in 2003.
Since we know that there has been no change in method during the three
years shown, we can apply this ratio to 2001.
2001
Allowance for Doubtful Accounts
Y Beginning balance
Accounts written-off
$2
X
8-12
$100,000
$100,000
$92,000
$9,000
$9,000
Accounts receivable
Beginning balance
Credit sales
Cash collections
Bad debts written-off
Ending balance
Aging Information
> 90 days past due
3190 days past due
Current (plug number)
Total from gross A/R T-account
$92,000
DR
$20,000
100,000
______
$19,000
Book Value
$2,000
7,000
10,000
$19,000
CR
$92,000
9,000
$9,000
CR
$2,000
10,000
_____
$3,000
To record entry for bad debt expense (from the allowance account)
D R Bad debt expense
$10,000
CR Allowance for uncollectibles
$10,000
Requirement 2:
Balance sheet presentation
Accounts receivable (gross)
Less: allowance for uncollectibles
Accounts receivable (net)
$19,000
(3,000)
$16,000
Requirement 3:
The bad debt expense for 2001 can be broken down into the following three
components:
Breakdown of bad debt expense
Current years actual bad debts
$ 5,000
(bad debts written off from this years sales)
Current years expected bad debts
(ending balance in the allowance account)
3,000
Excess of 2000s actual over expected bad debts
($4,000 minus $2,000)
2,000
$10,000
The learning objective for this requirement is to enable students to
understand how and when expected and realized bad debts affect the bad
debt expense. One component arises from sales made and settled during the
current year. Another component comprises the expected bad debts due to
sales made during the current year that are yet to be settled. The final
component is the result of an error made in the previous years estimate of
bad debts on outstanding accounts receivable.
A second aspect of the problem is to highlight how much of the information is
publicly available in the financial statements. This problem is specifically
constructed with breakdowns provided on collections and bad debts grouped
by the year of sale. However, in a typical annual report, it will not be possible
to see these components without additional disclosures in the management
discussion and analysis section.
8-14
(b) = (a)x
(c)
11.12%
Receivable
Cash
Ending
A/R
December 31
A/R
(given)
Interest
Revenue
Collected
(given)
Received
1996
1997
1998
1999
2000
2001
$63,930
43,206
27,310
15,751
8,572
13
$7,109
4,805
3,037
1,752
953
1
$20,724
15,896
11,559
7,179
8,559
13
$27,833
20,701
14,596
8,931
9,512
14
12/31/96:
D R Cash
CR Accounts receivable
CR Interest revenue
12/31/97:
D R Cash
CR Accounts receivable
CR Interest revenue
12/31/98:
D R Cash
CR Accounts receivable
CR Interest revenue
12/31/99:
D R Cash
CR Accounts receivable
CR Interest revenue
12/31/00:
D R Cash
CR Accounts receivable
CR Interest revenue
12/31/01:
D R Cash
CR Accounts receivable
CR Interest revenue
8-15
$43,206
27,310
15,751
8,572
13
0
$27,833
$20,724
7,109
$20,701
$15,896
4,805
$14,596
$11,559
3,037
$8,931
$7,179
1,752
$9,512
$8,559
953
$14
$13
1
CR
$ 35,000
150,631
$105,771
$ 79,860
$ 210,758
2,218,139
$105,771
1,997,897
$ 325,229
D R Accounts receivable
CR Revenues
$2,218,139
$2,218,139
$150,631
$105,771
$150,631
$105,771
D R Cash
CR Accounts receivable
$1,997,897
$1,997,897
CR
$ 79,860
20,585
0
$100,445
$ 325,229
2,175,475
0
$2,146,981
$ 353,723
8-16
D R Accounts receivable
CR Revenues
$2,175,475
$2,175,475
$20,585
$20,585
0
0
$2,146,981
$2,146,981
Requirement 2:
The answer provided below discusses a set of plausible events that is
consistent with the allowance and write-off activity reported over the period
1994 to 1996. The managements actual explanation for the changes in
provision for doubtful accounts is also provided below.
Provision for doubtful
accounts/revenue
Allowance for doubtful accounts/
Gross accounts receivable
1996
0.95%
1995
6.79%
1994
4.32%
28.40%
24.56%
16.61%
1994 to 1995
Provision for doubtful accounts has increased probably due to higher than
expected customer defaults. This is reflected in the higher ratio of allowance
for doubtful accounts to gross accounts receivable at the end of 1995 when
compared to 1994.
1995 to 1996
Provision for doubtful accounts for 1996 is at a historically low figure as a
percentage of revenues. However, the allowance for doubtful accounts as a
percentage of gross accounts receivable has increased further to 28.4% in
1996 from 24.56% in 1995. Note that the provision for doubtful accounts for
1996 equals the change in allowance for doubtful accounts over this period
indicating that no accounts receivable were written off during the year. It
appears that provision for doubtful accounts entirely represents anticipated
or expected bad debts for revenues not yet collected. In addition, during
1996, it seems that the company may be continuing to pursue claims against
its customers for whom it has already reported provision for doubtful
accounts during 1995. In such cases, the company will not yet write off these
accounts until a final resolution of the claims. This appears to have resulted
8-17
$45,000
$45,000
1/9/01:
To record receipt of payment:
D R Cash
D R Cash discount
CR Accounts receivable
$21,825
675
$22,500
Note: The credit terms 3/10, n/30 means that the customer gets a 3% cash
discount for payment made within 10 days. However, the entire amount is due
within 30 days. Since the customers settled half of the receivables within 10
days, they are entitled to a 3% cash discount ($45,000 0.50 0.03 = $675).
1/15/01:
To record return of beer from customers:
D R Allowance for sales returns
CR Accounts receivable
$2,000
$2,000
Note: This reflects the actual return of goods that was anticipated earlier.
1/28/01:
To record receipt of payment:
D R Cash
CR Accounts receivable
$20,500
$20,500
Note: Balance due is $22,500 ($45,000 0.50) minus $2,000 of sales return.
Since the payment was received after the 10th day, no cash discount is given
to the customers.
D R Allowance for sales returns
CR Sales returns
$250
$250
Note: Recall that expected sales returns of $2,250 were recorded on January
1, 2001. However, since the actual sales returns were only $2,000, we
reverse the 1/1/01 journal entry to the extent of $250.
Requirement 2:
Journal entries prior to January 15, 2001 are unaffected.
1/15/01:
To record return of beer from customers:
D R Allowance for sales returns
D R Sales returns
CR Accounts receivable
$2,250
750
$3,000
Note: This reflects the actual return of goods to the extent it was anticipated
earlier ($2,250). For goods returned in excess of expected sales returns
8-19
($3,000 - $2,250), we decrease the net revenue by debiting sales returns and
decreasing accounts receivable further by $750.
1/28/01:
To record receipt of payment:
D R Cash
CR Accounts receivable
$19,500
$19,500
Note: Balance due is $22,500 ($45,000 0.50) minus $3,000 of sales returns.
Since the payment was received after the 10th day, no cash discount is given
to the customers.
Requirement 3:
1/1/01:
To record sale of beer:
D R Accounts receivable
CR Sales revenue
$45,000
$45,000
1/9/01:
To record receipt of payment:
D R Cash
D R Cash discount
CR Accounts receivable
$21,825
675
$22,500
Note: The credit terms 3/10, n/30 mean that the customer gets a 3% cash
discount for payment made within 10 days. However, the entire amount is due
within 30 days. Since customers settled half of the receivables within 10 days,
they are entitled to a 3% cash discount ($45,000 0.50 0.03 = $675).
1/15/01:
To record return of beer from the customers:
D R Sales returns
CR Accounts receivable
$2,000
$2,000
Note: Since expected sales returns were not recorded, actual returns
decrease net revenue by a debit to sales returns.
1/28/01:
To record receipt of payment:
D R Cash
CR Accounts receivable
$20,500
$20,500
Note: Balance due is $22,500 ($45,000 0.50) minus $2,000 of sales returns.
Since the payment was received after the 10th day, no cash discount is given
to the customers.
8-20
Requirement 4:
Assuming the company uses the calendar year as its fiscal year, all
transactions pertaining to the sale of beer took place within one accounting
period (sale of goods, return of goods, and collection of cash). However, if
sales revenue is recorded in one accounting period and actual sales returns
are recorded in the following period, then the matching principle is likely to be
violated. This problem is mitigated by recording expected sales returns in the
same period as when sales revenue is recorded. A second advantage is that
the users of the financial statements might receive more information under
the expected sales return approach since material deviations from
expectations will affect future financial statements (See Requirement 3). If
disclosed, this might provide evidence of the managers ability to forecast
sales returns. However, in some companies, estimated sales returns may not
be materially different from actual sales returns, in which case, firms might
minimize their bookkeeping costs by recording sales returns when goods are
actually returned.
Requirement 5:
If the customer decides to take advantage of the cash discount, the optimal
time to do this is on the tenth day (i.e., the customer does not obtain any
benefit by paying any sooner). If the customer decides not to take the cash
discount, the full amount is due on the 30th day. (Once again, the customer
does not obtain any benefit by paying any sooner.) Consequently, to take
advantage of the cash discount, the customer pays 20 days sooner than it
would otherwise.
Given that its incremental borrowing rate is 18%, the customer could borrow
$21,825 and pay interest for 20 days (i.e., $21,825 18% 20/365 = $215)
i.e., it has to pay $22,040 ($21,825 + $215) on the borrowing. However, if it
had waited for the entire credit period of 30 days, then it would have to pay
$22,500 to Hillock Brewing. Consequently, by taking advantage of the cash
discount through borrowing, the customer is better off to the extent of $460
($22,500 minus $22,040). The $460 also represents the difference between
the cash discount ($675) and the interest cost on the borrowing ($215). In
summary, the customer is better off taking advantage of the cash discount.
Another way to answer the question is to view the cash discount ($675) as the
return on investment in accounts receivable ($21,825) for 20 days. This
converts into an annualized rate of return of 56.4% ($675/$21,825 365/20
100) when compared to the incremental borrowing rate of 18%.
8-21
(a)
104,000
6,500
110,500
80,000
80,000
250
250
30,500
250
9,200
50
8-22
40,000
40,000
(30,800)
9,200
Requirement 2:
August 31 balance sheet
Mik-Gen would disclose either in a note or on the face of the balance sheet:
Accounts receivable include assigned receivables of $50,000.
Note to instructor: This amount comprises the initial balance of $130,000
less August collections of $80,000.
Liabilities would include a loan payable of $30,500 (initial balance of $110,500
less August collections of $80,000) and interest payable of $250.
P8-10. Factoring receivables
Note to the instructor: When receivables are transferred with recourse, the
cash received from the factor is treated as an operating or a financing cash
inflow depending on whether the transfer of receivables receive the sale or
loan treatment under the GAAP. To highlight this aspect, the solution also
indicates the effects of each cash transaction on the statement of cash flows
for all parts of the problem.
Requirement 1:
a) To record the sale of receivables to the factor:
Calculation of the proceeds from the factor
Gross accounts receivable factored
(-) Interest for one month
(200,000 0.12 1/12)
(-) Factoring fee (6% of $200,000)
(-) Holdback for returns (5% of $200,000)
Net proceeds
DR
DR
DR
DR
$200,000
(2,000)
(12,000)
(10,000)
$176,000
$4,000
176,000
10,000
10,000
$200,000
Since the factor is responsible for all the bad debts on the factored
receivables, the allowance for uncollectibles with respect to these
receivables should be eliminated (by debiting the allowance account). The
loss on sale of receivables can be broken down into three components as
follows:
8-23
Interest expense
Factoring fee
(-) Elimination of allowance
Loss on sale of receivables
$2,000
12,000
(4,000)
$10,000
$4,000
176,000
2,000
12,000
10,000
$4,000
200,000
The debit to the allowance for uncollectibles and the credit to the bad debt
expense represent the reversal of the journal entry for bad debt expense
on the $200,000 of the factored receivables. The intuition behind this is
that the factoring fee is expected to include a compensation for the credit
risk (bad debts) borne by the factor. Consequently, by not reversing the
bad debt expense, we will be double counting.
The loss on sale of receivables in the original journal entry is now
decomposed into two debits (to interest expense and factoring fee) and a
credit (bad debt expense reversal). However, the net effect on the income
statement ($2,000 + $12,000 - $4,000 = $10,000) is identical.
8-24
$3,000
$7,000
$3,000
$7,000
Requirement 2:
a) To record the sale of receivables to the factor:
Calculation of the proceeds from the factor
Gross accounts receivable factored
(-) Interest for one month
(200,000 0.12 1/12)
(-) Factoring fee (2.5% of $200,000)
(-) Holdback (7% of $200,000)
Net proceeds
D R Loss on sale of receivables
D R Cash
CR Accounts receivable
$200,000
(2,000)
(5,000)
(14,000)
$179,000
7,000
179,000
$186,000
$2,000
5,000
$7,000
$3,000
$3,000
c) To record bad debts written off on the transferred receivables. Recall that
Atherton had anticipated only $4,000 of bad debts, and, consequently, the
excess write-offs increase bad debt expense.
D R Bad debt expense
D R Allowance for doubtful accounts
CR Accounts receivable
8-26
$1,500
4,000
$5,500
d) To record the collection from the customers and pay off to the factor.
Since the transfer was treated as a sale, only the net proceeds (i.e., the
difference between the collections and the payoff) is recorded in the books.
Face value of receivables
(-) Sales returns
(-) Bad debts written off
Cash collected from customers
(-) Due to the factor
= Net proceeds
D R Cash
CR Accounts receivable
$200,000
(3,000)
(5,500)
$191,500
(186,000)
$5,500
$5,500
$5,500
$179,000
2,000
5,000
$186,000
8-27
$3,000
c) To record bad debts written off on the transferred receivables. Recall that
Atherton had anticipated only $4,000 of bad debts, and consequently, the
excess write-offs increase bad debt expense.
D R Bad debt expense
D R Allowance for doubtful accounts
CR Accounts receivable
$1,500
4,000
$5,500
$200,000
(3,000)
(5,500)
$191,500
$191,500
$191,500
$186,000
$186,000
8-28
CR
$4,955,000
5,846,000
$6,876,000
Ending balance
$3,925,000
$31,651,000
137,002,000
$6,876,000
134,833,000
$26,944,000
$137,002,00
$137,002,000
$5,846,000
$6,876,000
D R Cash
CR Gross accounts receivable
$134,833,00
8-29
$5,846,000
$6,876,000
$134,833,000
Requirement 2:
Provision for doubtful accounts
as % of revenue
Revised provision for Year 3 using the Year 2
percentage ($137,002,000 5.98%)
Year 3
Year 2
Year 1
4.27%
5.98%
6.30%
$8,192,720
DR
CR
$4,955,000
8,192,720
$6,271,720
Year 3
$6,900,000
5,846,000
8,192,720
$4,553,280
-34.01%
Note that the operating income would have decreased by 34% if Ramsay had
reported the Year 3 bad debts at the same percentage of revenue as it did in
Year 2. Although Ramsay probably has good reasons for the lower provision
for doubtful accounts, it is important for an analyst to follow up with Ramsays
management for information regarding this decline.
8-30
Requirement 3:
Year 3
Allowance for doubtful accounts as a % of gross A/R 14.57%
Revised balance in allowance account
($26,944,000 15.66%)
Year 2
15.66%
$4,218,114
DR
CR
$4,955,000
6,139,114
$6,876,000
$4,218,114
Year 3
$6,900,000
5,846,000
(6,139,114)
$6,606,886
-4.25%
end of Year 3 also, then what would have been the balance in gross accounts
receivable?
Year 3
$26,944,000
31,798,164
($4,854,164)
The above table suggests that Ramsay would have reported almost $5 million
of additional receivables at the end of Year 3 if the receivables balance
continued to be 23.21% of revenue. This suggests that the substantial
difference in the answers to Requirements 2 and 3 appears to be due to
substantial improvement in the quality of Ramsays accounts receivable, i.e.,
improved collections and lower write-offs.
The intertemporal pattern of the bad debt expense is also consistent with this
intuition:
Provision for doubtful accounts as
% of Revenue
Year 3
Year 2
Year 1
4.27%
5.98%
6.30%
Requirement 2:
Restructuring of note receivable by taking cash and new note receivable in
exchange for original note receivable:
$ 45,000
3,600
48,600
January 1, 2004:
DR Cash
DR Restructured note receivable
DR Loss on receivable restructuring
CR Note receivable
CR Interest receivable
$ 5,000
40,589
3,011
$45,000
3,600
8-33
$ 4,200
$
953
3,247
$ 4,200
$ 1,029
3,171
$ 4,200
$ 1,111
3,089
8-34
$14,000
$14,000
$48,000
2,400
$20,000
14,000
16,400
$20,000
14,000
16,400
$48,000
2,400
Requirement 2:
Warren Companies
1/1/01: To record the modified sum:
D R Note payable
D R Interest payable
CR Restructured note payable
$48,000
2,400
$50,400
(1 + r) = (1.1429)1/3 = 1.0455
Restructured
note amount
Present value of
future flows @ 5%
$50,400.0
$57,600
x .86384
$49,757.0
$806.4
$1,449.4
Then,
$ 806.4
= .556
$1, 449.4
$2,296
$2,296
$2,401
$2,401
$2,503
rounded
$57,600
$49,757
643
$57,600
$48,000
2,400
Note: The restructured note is valued at $49,757, being the present value of
$57,600 to be received in three years discounted at 5%. The factor is .86384.
12/31/01: To record interest receivable:
D R Restructured note receivable
CR Interest income
($49,757 5% = $2,488)
12/31/02: To record interest receivable:
D R Restructured note receivable
CR Interest income
[($49,757 + $2,488) 5% = $2,612]
12/31/03: To record interest receivable:
D R Restructured note receivable
CR Interest income
[($49,757 + $2,488 + $2,612) 5% = $2,743]
8-36
$2,488
$2,488
$2,612
$2,612
$2,743
$2,743
$57,600
Requirement 3:
Warren Companies
1/1/01: To record the modified sum:
D R Note payable
D R Interest payable
CR Restructured note payable
CR Extraordinary gain on debt
$48,000
2,400
$48,000
$41,464
8,936
$57,600
$48,000
2,400
$48,000
$48,000
2,400
Note: The restructured note is valued at $41,464, being the present value of
$48,000 to be received in three years discounted at 5%. The factor is .86384.
12/31/01: To record interest receivable:
D R Restructured note receivable
CR Interest income
($41,464 5% = $2,073)
12/31/02: To record interest receivable:
D R Restructured note receivable
CR Interest income
[($41,464 + $2,073) 5% = $2,177]
12/31/03: To record interest receivable:
D R Restructured note receivable
CR Interest income
[($41,464 + $2,073 + $2,177) 5% = $2,286]
12/31/03: To record receipt of amount due:
D R Cash
CR Restructured note receivable
8-37
$2,073
$2,073
$2,177
$2,177
$2,286
$2,286
$48,000
$48,000
Moto-Lite Company
Summary of Overstatements
Accounts
Description
Receivable
Sales
Originally recorded:
($6000 x 19 engines)
$ 114,000
Collections (6 engines)
(36,000)
78,000
$ 114,000
114,000
Should be recorded:
($6000 x 9 engines)
Collections (6 engines)
Amount overstated
54,000
(36,000)
18,000
60,000
54,000
54,000
60,000
Gross Profit
(35% of sales)
$
39,900
39,900
18,900
18,900
21,000
Having a written fixed commitment and specific written delivery terms from
the buyer;
The critical event has taken place, the production of the required materials
in accordance with the buyers written instructions, so that the earning
process appears to be complete except for delivery of the goods;
Material destined for Bostian is completely segregated and not subject to
being used to fill other orders;
Material destined for Bostian is complete and ready for shipment.
However, Aurora should not include the Bostian transaction as a receivable
and sale in calendar year 2001 for the following reasons:
1. Aurora maintained risk of ownership.
2. Bostian did not request the bill and hold arrangement. Aurora did this
unilaterally.
3. Aurora accepted Bostians purchase order and delivery terms. Bostian
was unable to take delivery of the material early.
It appears that Aurora improperly included this transaction in 2001
business and if the amount were material, an adjustment would be
required to correctly report this as 2002 business.
8-40
$26.7 Beginning
balance
B Beginning
balance
$24.8 Ending
balance
C Ending
balance
1997:
End. balance = beg. balance
$24.8
$26.7
$3.1
A = $5.0
8-41
1998:
B = Beginning balance in 1998 = ending balance in 1997
= $24.8
$24.8
$3.9
4.2
C = $24.5
1999:
D = Beginning balance in 1999 = ending balance in 1998 = $24.5
End. balance = beg. balance
$24.5
$24.5
- $8.3
E = $8.3
Requirements 2 & 3:
Allowance method
1997 DR
DR
1998 DR
DR
1999 DR
DR
Direct write-off
$5.0
$5.0
NO ENTRY
$4.2
$4.2
NO ENTRY
DR
$8.3
$8.3
8-42
NO ENTRY
$5.0
$5.0
$4.2
$4.2
$8.3
$8.3
Requirement 4:
The allowance method is consistent with the matching principle underlying
the accrual accounting model, whereas the direct write-off method is not.
Requirement 5:
The cumulative income difference is equal to the change in the balance of the
allowance account from 1997 to 1999.
Allow. for doubtful accounts end of 1999:
Allow. for doubtful accounts beg. of 1997:
Income difference (cumulative)
$24.5
26.7
$ 2.2
(1.9)
(0.3)
(-0-)
($2.2)
($3.1 - $5.0)
1998
(3.9 - 4.2)
1999
(8.3 - 8.3)
Total
($ 2.2)
Requirement 6:
If the firm wanted to be conservative, the initial provision could be increased
by the entire $6 million. If the firm wanted to be optimistic, the initial provision
would not be increased at all. Perhaps, the best recommendation to make is
to take a middle ground and accrue a portion of the $6 million. For example,
management could be asked to make an estimate of the probability that the
customer will go bankrupt (e.g., 35.0%), and then the initial provision could be
increased by this probability times the $6 million (i.e., $2.1 million).
8-43
Requirement 9:
Managing a financial statement item suggests the ability to influence net
income and the pattern of net income growth from year to year. Smoothing
income and taking big-bath charge-offs are examples.
Other items that can potentially be managed include:
a) Depreciation method choice.
b) Useful lives for tangible and intangible assets.
c) Estimates of future warranty expense by firms that offer product warranties
(e.g., car makers like GM and Ford).
d) The timing and amounts for special charges/write-downs, restructurings,
asset sales, etc.
e) Inventory method choice.
f)
Some students may feel more comfortable seeing the solution in amortization
table form. The following table provides details of the present value
calculation as well as the amortization of the notes receivable:
Beginning
Payment of Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Interest
Revenue
$1,676,5911
1,785,570
1,901,632
1,886,300
1,869,972
1,852,583
1,834,063
1,814,340
1,793,334
1,770,964
1,747,139
1,721,765
1,694,742
1,665,963
1,635,313
1,602,671
1,567,907
1,530,884
1,491,454
1,449,461
1,404,738
1,357,109
1,306,383
1,252,361
1,194,827
1,133,553
1,068,296
998,798
924,782
845,956
762,005
672,598
577,380
475,972
367,973
252,953
130,458
$49,018,791
Cash
Received
Change in
Receivable
$1,676,591
1,785,570
$2,137,500
(235,868)
2,137,500
(251,200)
2,137,500
(267,528)
2,137,500
(284,917)
2,137,500
(303,437)
2,137,500
(323,160)
2,137,500
(344,166)
2,137,500
(366,536)
2,137,500
(390,361)
2,137,500
(415,735)
2,137,500
(442,758)
2,137,500
(471,537)
2,137,500
(502,187)
2,137,500
(534,829)
2,137,500
(569,593)
2,137,500
(606,616)
2,137,500
(646,046)
2,137,500
(688,039)
2,137,500
(732,762)
2,137,500
(780,391)
2,137,500
(831,117)
2,137,500
(885,139)
2,137,500
(942,673)
2,137,500
(1,003,947)
2,137,500
(1,069,204)
2,137,500
(1,138,702)
2,137,500
(1,212,718)
2,137,500
(1,291,544)
2,137,500
(1,375,495)
2,137,500
(1,464,902)
2,137,500
(1,560,120)
2,137,500
(1,661,528)
2,137,500
(1,769,527)
2,137,500
(1,884,547)
2,137,500
(2,007,042)
$74,812,500 $(25,793,709)
Balance of
Notes
Receivable
$25,793,709
27,470,300
29,255,870
29,020,002
28,768,802
28,501,274
28,216,357
27,912,920
27,589,760
27,245,594
26,879,058
26,488,696
26,072,961
25,630,204
25,158,667
24,656,481
24,121,652
23,552,059
22,945,443
22,299,397
21,611,358
20,878,596
20,098,205
19,267,088
18,381,949
17,439,275
16,435,328
15,366,125
14,227,423
13,014,705
11,723,161
10,347,666
8,882,765
7,322,645
5,661,116
3,891,589
2,007,042
0
Present Value
at 1/1/69
$1,769,527
1,661,528
1,560,120
1,464,902
1,375,495
1,291,544
1,212,718
1,138,702
1,069,204
1,003,947
942,673
885,139
831,117
780,391
732,762
688,039
646,046
606,616
569,593
534,829
502,187
471,537
442,758
415,735
390,361
366,536
344,166
323,160
303,437
284,917
267,528
251,200
235,868
221,473
207,956
$25,793,709
Discount Discounting
Factor
Time
0.8278
0.7773
0.7299
0.6853
0.6435
0.6042
0.5674
0.5327
0.5002
0.4697
0.4410
0.4141
0.3888
0.3651
0.3428
0.3219
0.3022
0.2838
0.2665
0.2502
0.2349
0.2206
0.2071
0.1945
0.1826
0.1715
0.1610
0.1512
0.1420
0.1333
0.1252
0.1175
0.1103
0.1036
0.0973
= Total PV
Interest revenue of $1,676,591 is calculated by multiplying the 1969 beginning of year balance in notes
receivable ($25,793,709) by 6.5%.
8-46
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
$2,000,000
3,412,500
25,793,709
$31,206,209
$5,412,500
25,793,709
$22,000,000
9,206,209
CR Gain on sale
Requirement 2:
This requirement illustrates the effects of a difference between the stated rate
and the prevailing market interest rate. Contracts might specify different
stated rates to manage the contracting parties cash flow streams. For
example, zero-coupon bonds have no periodic interest payments even
though the effective interest rate is positive. However, for valuation purposes,
what matters is the present value of current and future cash flows discounted
at a rate commensurate with the riskiness of the future cash flows (referred to
as the effective interest rate).
The 35 payments of $2,137,500 viewed as an ordinary annuity from 1/1/71
are:
$2,137,500 9.644158973 = $20,614,389
Discounted back to 1/1/69:
$20,614,389 .82644628 = $17,036,686
Thus, the present value of the note at January 1, 1969 at 10% would be
$17,036,686.
8-47
The following table provides details of the present value calculation as well as
the amortization of the note receivable using a discount rate of 10%:
Beginning
Payment of Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Interest
Revenue
$1,703,669
1,874,035
2,061,439
2,053,833
2,045,466
2,036,263
2,026,139
2,015,003
2,002,753
1,989,279
1,974,456
1,958,152
1,940,217
1,920,489
1,898,788
1,874,917
1,848,658
1,819,774
1,788,002
1,753,052
1,714,607
1,672,318
1,625,799
1,574,629
1,518,342
1,456,427
1,388,319
1,313,401
1,230,991
1,140,340
1,040,625
930,937
810,281
677,559
531,565
370,971
194,318
$57,775,814
Cash
Received
Change in
Receivable
- $1,703,669
1,874,035
$2,137,500
(76,061)
2,137,500
(83,667)
2,137,500
(92,034)
2,137,500
(101,237)
2,137,500
(111,361)
2,137,500
(122,497)
2,137,500
(134,747)
2,137,500
(148,221)
2,137,500
(163,044)
2,137,500
(179,348)
2,137,500
(197,283)
2,137,500
(217,011)
2,137,500
(238,712)
2,137,500
(262,583)
2,137,500
(288,842)
2,137,500
(317,726)
2,137,500
(349,498)
2,137,500
(384,448)
2,137,500
(422,893)
2,137,500
(465,182)
2,137,500
(511,701)
2,137,500
(562,871)
2,137,500
(619,158)
2,137,500
(681,073)
2,137,500
(749,181)
2,137,500
(824,099)
2,137,500
(906,509)
2,137,500
(997,160)
2,137,500 (1,096,875)
2,137,500 (1,206,563)
2,137,500 (1,327,219)
2,137,500 (1,459,941)
2,137,500 (1,605,935)
2,137,500 (1,766,529)
2,137,500 (1,943,182)
$74,812,500 $(17,036,66)
Balance of
Notes
Receivable
$17,036,686
18,740,354
20,614,390
20,538,329
20,454,662
20,362,628
20,261,391
20,150,030
20,027,533
19,892,786
19,744,564
19,581,521
19,402,173
19,204,890
18,987,879
18,749,167
18,486,584
18,197,742
17,880,017
17,530,518
17,146,070
16,723,177
16,257,995
15,746,294
15,183,424
14,564,266
13,883,193
13,134,012
12,309,913
11,403,405
10,406,245
9,309,370
8,102,807
6,775,587
5,315,646
3,709,711
1,943,182
0
Present Value
at 1/1/69
$1,605,935
1,459,941
1,327,219
1,206,563
1,096,875
997,160
906,509
824,099
749,181
681,073
619,158
562,871
511,701
465,182
422,893
384,448
349,498
317,726
288,842
262,583
238,712
217,011
197,283
179,348
163,044
148,221
134,747
122,497
111,361
101,237
92,034
83,667
76,061
69,146
62,860
$17,036,686
$ 2,000,000
3,412,500
17,036,686
$22,449,186
Discount Discounting
Factor
Time
0.7513
0.6830
0.6209
0.5645
0.5132
0.4665
0.4241
0.3855
0.3505
0.3186
0.2897
0.2633
0.2394
0.2176
0.1978
0.1799
0.1635
0.1486
0.1351
0.1228
0.1117
0.1015
0.0923
0.0839
0.0763
0.0693
0.0630
0.0573
0.0521
0.0474
0.0431
0.0391
0.0356
0.0323
0.0294
= Total PV
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
$2,137,500
8-49
1995
6.63%
-34.04%
-31.77%
1994
15.81%
12.74%
12.09%
I am not sure whether you used gross or net receivables in your calculations.
However, the inferences are very similar either way. Consequently, unless it
impacts my analysis, I will use gross and net receivables interchangeably.
I have also been able to verify your receivables turnover calculations:
Net sales
Receivables, net (from bal. sheet)
Average receivables
1995
$2,886,225
742,480
934,104
1994
$2,706,791
1,125,728
1,062,127
3.09
118
2.55
143
1993
$2,337,235
998,525
The collection period has indeed decreased from 143 days to less than 120
days. However, the decline appears to be primarily due to increased usage of
factored receivables rather than faster payments by customers. One
approach to examining the effect of factoring is to estimate the receivables
turnover assuming that Spiegel does not factor any of the receivables. This
would give us a better estimate of how fast Spiegels customers are paying off
their debt.
To perform this analysis, we first have to figure out what the receivables
balance would have been without any factoring. These numbers are provided
under receivables generated from operations, which Spiegel calls
receivables serviced. Note that receivables owned represents those
receivables that are included in Spiegels balance sheet under net
receivables. Over the last 3 years, the proportion of the factored receivables
(receivables sold) has continuously increased:
Receivables sold
Receivables owned
Total receivables generated
from operations
Receivables sold
Receivables owned
Total receivables generated
from operations
1995
$1,180,000
821,081
1994
1993
$ 480,000 $ 330,000
1,203,444
1,073,618
$2,001,081
$1,683,444
$1,403,618
1995
58.97%
41.03%
1994
28.51%
71.49%
1993
23.51%
76.49%
100.00%
100.00%
100.00%
8-50
1995
$2,886,225
1994
$2,706,791
1993
$2,337,235
2,001,081
1,842,263
1.57
233
1,683,444
1,543,531
1.75
208
1,403,618
These calculations suggest that the customers are, in fact, taking a longer
time to pay off their debt (233 days in 1995 versus 208 days in 1994).
However, Spiegels receivables turnover improved because a
substantial portion of its receivables are off the balance sheet due to
increased factoring.
One consideration we have to keep in mind is that Spiegel has sold its
receivables without recourse for bad debt risk. Consequently, whether the
cash is received from the factor or directly from the customer may not be of
much concern to an analyst. However, the long-run implications of the
factoring are not clear. Can Spiegel continue to factor almost 60% of
receivables in the near future? Since the true collection period has indeed
deteriorated, it might have implications for future factoring agreements. For
instance, the factors might demand a larger factoring fee due to the extended
collection time. Alternatively, the factors might accept only transfers of
receivables with recourse to avoid bearing any increased bad debt risk from
slower collection.
The second issue relates to the accounting for sale of receivables. To get
better intuition on this, let us first try to understand the journal entry recorded
by Spiegel when it factors its receivables. Recall that Spiegel is still
responsible for sales returns although the investors in the securitized
receivables bear the bad debt risk. Consequently, while an allowance for
returns on the factored receivables must continue to be maintained in
Spiegels books, the allowance for uncollectibles on those receivables is
eliminated. Let me draw your attention to the following information that you
provided to me earlier:
8-51
1995
$49,954
91,612
(33,600)
1994
$46,855
79,183
(6,300)
(67,134)
$40,832
(69,784)
$49,954
1993
$37,231
69,160
(1,609)
695
(58,622)
$46,855
1995
$1,180,000
1994
$480,000
1993
$330,000
1995
$700,000
33,600
1994
$150,000
6,300
1993
$330,000
1,609
Now lets try to reconstruct the journal entry for the sale of receivables during
1995:
D R Cash (plug number)
$685,037
D R Allowance for doubtful accounts (+A)
33,600
CR Receivables
CR Gain on sale of receivables (from footnote)
$700,000
18,637
Note that the gain on sale of receivables is included under other revenue.
Since $700,000 of receivables have been removed from the books, Spiegel
cannot continue to show the corresponding allowance for returns as a contra
asset account (Note: It appears that the investors in the factored receivables
are not holding back any funds for expected sales returns). Instead, Spiegel
seems to reclassify the allowance for returns on the factored receivables as
a liability. This explains why a portion of the allowance for sales returns
is disclosed under accrued liabilities. Recall that Spiegel continues to be
responsible for sales returns, so the allowance for returns cannot be
eliminated altogether.
If Spiegel is selling receivables with a present value of expected net cash
flows of only $666,400 ($700,000 minus $33,600), why are the investors
paying $685,037 for these receivables? Why the $18,637 disparity exists is
not readily apparent. One possibility is that the interest rate on the customer
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receivables is higher than the rate of return earned by the investors on the
receivables. If so, the gain on sale represents a brokerage fee retained by
Spiegel for obtaining financing for its customers; i.e., it is too costly for the
customers to obtain outside financing and too costly for the investors in
receivables to independently evaluate the quality of receivables.
Consequently, Spiegel earns a brokerage fee for acting as an intermediary.
A second possibility is that market interest rates have decreased from the
time the receivables were first created to the time the receivables were sold
to the investors. If this is true, the higher cash received represents the lower
prevailing discount rate at the time of the sale of receivables. In any case, it
is important to understand the reasons for the gain on sale of receivables to
evaluate the quality of Spiegels earnings.
C8-4. Thompson Traders (KR): Bad-debt analysis
Tony Barclays calculation:
The following table provides the necessary calculations to support Tony
Barclays analysis.
Year
1997
1998
1999
2000
2001
Revenue
$30,000
40,000
60,000
80,000
90,000
Bad Debts
Written-off
$ 600
1,000
1,500
2,400
3,000
%
2.00%
2.50%
2.50%
3.00%
3.33%
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Revenue
$30,000
40,000
60,000
80,000
90,000
3.00%
3.00%
3.00%
3.00%
2.44%
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The following table summarizes the actual transactions in the allowance for
uncollectibles account:
Beginning balance
(+) Bad debt expense
(-) Bad debts written-off
Ending balance
2000
$800
(275)
$525
$2,700
525
$3,225
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The following table summarizes the actual transactions in the allowance for
uncollectibles account through 2001:
Allowance for Uncollectibles
Beginning balance
(+) Bad debt expense
(-) Bad debts written off
Ending balance
1997
1998
1999
2000
2001
- $ 225 $ 325 $ 475 $ 275
$825
1,100
1,650
2,200
3,225
(600) (1,000) (1,500) (2,400) (3,000)
$225 $ 325 $ 475 $ 275 $ 500
Journal Entry:
D R Bad debt expense
CR Allowance for uncollectibles
$3,225
$3,225
Note that the change in the bad debt formula will impact the bad debt expense
of the future years also. Therefore, under GAAP, the company should
disclose the impact of the change in this accounting estimate on its income
statement for 2001 (i.e., $90,000 0.25% = $225). Notice that 0.25% is simply
3% minus 2.75%.
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C8-5. The Software Toolworks, Inc. (KR): Account reconciliation and analysis
Requirement 1:
DR
Allowance for returns
Beginning balance
Provision for returns
Actual returns (plug number)
Ending balance
CR
$6,363,000
10,942,000
$12,041,000
$5,264,000
$4,151,000
946,000
$1,527,000
$3,570,000
DR
Accounts receivable (gross)
Beginning balance
Revenues (see below)
Actual returns (from allowance for returns
Bad debts written-off (from allowance for
Cash collected (plug number)
Ending balance
CR
$ 34,754,000
130,540,000
$12,041,000
1,527,000
12,831,000
$ 38,895,000
Revenues are calculated after adding back the provision for returns to the
revenues reported in the financial statements.
1993
1992
Revenues (net of provision for returns)
$119,598,000 $102,646,000
Provision for returns
10,942,000
8,863,000
Gross revenues
$130,540,000 $111,509,000
While provision for returns is contra to the revenue account, provision for
doubtful accounts is an expense account.
The company actually includes sales returns and allowances as well as
allowance to distributors for advertising in the T-account allowance for
returns. Consequently, a portion of the provision for returns is treated as a
contra sales account, and the remainder is treated as an expense. This fine
distinction is ignored in the case to keep it simple.
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Requirement 2
The receivables are analyzed using the following approaches:
Examining the trend in provision for doubtful accounts as a percentage of
revenues
Comparing the growth in revenues to the growth in receivables
Comparing allowance for doubtful accounts as a percentage of gross
accounts receivable with the provision for doubtful accounts as a
percentage of revenues
First, let us focus on the provision for doubtful accounts as a percentage of
revenues.
Revenues (net of provision for returns)
Provision for doubtful accounts
Provision for DA as % of revenues
1993
1992
$119,598,000 $102,646,000
946,000
3,673,000
0.79%
3.58%
Note that the revenue figure used is net of provision for returns. This is
because bad debts are likely to be related only to inventory sales that are not
expected to be returned by the customers. If gross revenue figures are used,
then variations in Provision for doubtful accounts as a percentage of revenue
could be due to variations in expected sales returns rather than changes in
expected bad debts.
The companys provision for doubtful accounts has decreased substantially
from about 3.6% of Revenue to less than 1%. In general, changes in this ratio
can indicate changes either in the quality of receivables or earnings
management. In this case, it appears that the 1992 higher provision is more
likely due to temporarily higher bad debts. Note that the company experienced
higher than expected bad debts in 1992 due to a customer bankruptcy and
an arbitration case. This information provided in the case was obtained from
the management discussion and analysis section. Let us recalculate the
ratios after excluding these potentially transitory items:
Provision for doubtful accounts
(-) Chapter 11 customer
(-) Receivable in arbitration
Provision for doubtful accounts (adjusted)
Provision for d.a. (adj.) as % of revenues
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1993
$946,000
_______
$946,000
0.79%
1992
$3,673,000
(2,167,000)
(583,000)
$ 923,000
0.90%
Notice that the current year provision is much more comparable to that of last
years after excluding the two specific bad debts. Without any further
information, it appears that the company has not substantially revised its bad
debt provision during the year. One caveat here is that the change from
0.90% to 0.79% may have a material impact on the bottom line of the
company. If profit figures were available, we could calculate the impact on the
1993 net income if the company had maintained the provision at 0.90% as in
1992.
Similar to provision for doubtful accounts, we can also examine the trend in
provision for returns:
1993
$119,598,000
10,942,000
$130,540,000
8.38%
1992
$102,646,000
8,863,000
$111,509,000
7.95%
17.07%
16.52%
19.88%
Consequently, when there are large write-offs taking place in a year, you
would notice a less than proportionate growth in gross receivables. This is
actually what happened for the company.
Write-offs as % of allowance for DA
($1,527,000/$946,000)
Actual returns as % of allowance for returns
($12,041,000/$10,942,000)
161.42
110.04
Since write-offs were 60% more than the provision for doubtful accounts, the
growth in gross receivables appears to be much lower than the growth in
sales. However, the change in net receivables (24%) is higher than the
growth in gross or net sales. As an analyst, one should conduct further
analysis or follow up with the management. Before investigating further, it may
be fruitful to get a handle on the materiality of any build-up in receivables, i.e.,
we should estimate the level of abnormal accounts receivable.
Balances as of March 31
1993
1992
$ 30,061,000 $24,240,000
28,603,200
$ 1,457,800
For instance, based on the growth in sales, we might project that the
receivables should have grown by around 18%, which is a rough average of
the three percentages changes computed above: 17.07%, 16.52%, and
19.88%. Using this assumption, the estimated abnormal receivable is
$1,457,800. Depending on whether this amount is material or not, additional
follow-up action may be taken.
A third approach is to compare the provision for doubtful accounts as a
percentage of revenue with the allowance for doubtful accounts as a
percentage of receivables.
Provision for d.a. (Adj.) as % of revenues
Allowance for d.a. as % of (A/R - returns)
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1993
1992
0.79%
0.90%
10.62% 14.62%
Obviously, one would expect the allowance percentage to be higher than the
provision percentage since more of the delinquent customers are likely to be
included in the year-end receivables. The evidence is quite consistent with
this conjecture. Moreover, we see a drop in the allowance balance as a
percentage of receivables, which is consistent with the larger write-offs
experienced during 1993 as a result of higher than usual bad debt provision
in 1992.
The following table provides a similar comparison for sales returns:
Prov. for returns as % of gross revenues
Allowance for returns as % of A/R
1993
1992
8.38% 7.95%
13.53% 18.31%
Unlike bad debts, there is no reason why we should expect larger sales
returns on year-end receivables unless the fourth quarter sales have
different return privileges compared to the other period sales. Consequently,
the larger allowance percentage compared to the provision percentage
needs further scrutiny.
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