E6-4 Accounting for cash discounts
On May 1, 2012, Crab Cove Fishing Company sold Maine lobster on account
for a gross price of $30,000. On May 5, the company sold cod on account for
a gross price of $20,000. the terms of both sales were 3/10, n/30. Crab Cove
received payment for the first sale on May 6, 2012, and the payment for the
second sale on May 31,2012. Provide all necessary journal entries.
a. Assume the Gross Method.
P6-2 Cash Discounts-Gross
During March the following credit sales and collections occurred. Company prepares quarterly financials.
March 3 Sold goods to AAA for a gross price of $1,400. Terms 2/10, n/30.
March 8 Sold goods to BBB for a gross price of $800. Terms 2/10, n/30.
March 11
Received full payment from AAA.
March 28
Received full payment from BBB.
March 29
Sold goods to CCC for a gross price of $1,800. Terms 2/10, n/30.
March 31
CCC returned goods $1,800.
E6-4 Accounting for cash discounts
On May 1, 2012, Crab Cove Fishing Company sold Maine lobster on account
for a gross price of $30,000. On May 5, the company sold cod on account for
a gross price of $20,000. the terms of both sales were 3/10, n/30. Crab Cove
received payment for the first sale on May 6, 2012, and the payment for the
second sale on May 31,2012. Provide all necessary journal entries.
b.
Assume the Net Method.
P6-2 Cash Discounts-Net
During March the following credit sales and collections occurred. Company prepares quarterly financials.
March 3 Sold goods to AAA for a gross price of $1,400. Terms 2/10, n/30.
March 8 Sold goods to BBB for a gross price of $800. Terms 2/10, n/30.
March 11
Received full payment from AAA.
March 28
Received full payment from BBB.
March 29
Sold goods to CCC for a gross price of $1,800. Terms 2/10, n/30.
March 31
CCC returned goods $1,800.
BE6-1 Analysis of AR:
The following information was taken from the 2009 Annual report of Emerson
Electric Co. Balance Sheet (in millions):
Receivables were in 2009 $3,623 and in 2008 $4,618; less allowance for
uncollectibles of $93 and $90, respectively.
a. Compute total AR as of the end of 2009 and 2008, and compute the bad debt
allowance as a % of total AR. Did the % increase or decrease?
b.
The bad debt expense reported on Emerson’s 2009 income statement did not
equal $93. Explain why.
Liquidity Ratios
• Working Capital =CA-CL
• Current Ratio = CA/CL
• Quick Ratio or Acid Test Ratio =
(CA-Inv & Prepaids)/CL
How are these ratios affected by the journal entries you
will learn this chapter?
Sale on Account:
Cash Collection:
AR Writeoff:
AR Recovery:
Bad Debt AJE:
Allowance for Doubtful Accts.
(T-account)
Allowance for Doubtful Accts.
Beginning
Balance
Recover write-off
Write-off of
accounts
receivable
Accounts Receivable
Recover write
off
Ending Bal.
AJE estimates
bad debt expense
AJE estimates bad debt
expense
Ending
Balance
Beginning Bal.
Credit sales
Bad Debts Expense
Customer pays
AR Write-off
The AJE to record the estimate of
uncollectibles. Aging calculates the
expense amount necessary to
achieve the “desired ending
balance” in the allowance account.
OR % of Sales is the Expense and
then compute EB in Allowance
account.
E6-5 Bad debts under the allowance method.
Arlington Cycle Company began
operations on 1/1/11. The
company reported the following
on its 2011 financials:
Gross sales in 2012 $1,400,000
and $1,500,000 in 2011.
AR in 2012 $600,000 and
$650,000 in 2011.
Actual bad debt write-offs in
2012 $22,000 and $10,000 in
2011.
Arlington estimates bad debts at
2% of gross sales.
Analyze the activity in the
allowance for doubtful accounts Taccount, and comment on
whether the bad debt estimate
has been sufficient to cover the
writeoffs.
P6-3 Bad Debts over time
Credit sales
Actual bad debt write-offs
Allowance for doubtful
accounts
2012
2011
2010
$205,000
$200,000
$180,000
11,000
10,000
6,000
?
?
?
The company estimates bad debts for financial reporting purposes at 3% of credit sales.
The balance in the Allowance for Doubtful Accounts as of 1/1/2010 was $10,000.
a.
Provide the journal entries related to Allowance for Doubtful Accounts for
2010, 2011, and 2012.
b.
Compute the balance in the Allowance for Doubtful Accounts as of
12/31/2012.
c.
Comment on the sufficiency of bad debt expense and allowance over the
three-year period. How did you come to your conclusion?
P6-4 Uncollectibles over Two Periods
Glacier Ice Company uses a percentage-of-net-sales method to account for estimated bad debts.
Historically, 3% of net sales have proven to be uncollectible. During 2011 and 2012, the company
reported the following:
Gross sales
Sales discounts
Sales returns
2012
2011
$1,500,000
$1,800,000
100,000
130,000
50,000
20,000
a.
Prepare the AJE on 12/31/11, to record the estimated bad debt expense for the period.
b.
Assume 1/1/11 balance in allowance for doubtful accounts was $65,000(credit) and that
$70,000 were written-off during the year. What is the 12/31/11 balance after adjustments?
c.
Prepare the AJE on 12/31/12 to record the estimated bad debt expense for the period.
d.
What is the 12/31/12 balance in allowance for doubtful accounts? Assume that $85,000 in
bad debts were written off the books during 2012.
E6-8 Reconstructing journal entries
The 2012 annual report of Johnson Services reveals the following (dollar
amounts are year-end balances):
2012
2011
$75,300
$61,500
Accounts receivable
9,400
9,200
Allowance for doubtful accounts
1,300
1,000
55
70
Credit sales
Bad debt recoveries
Johnson estimates bad debts each year at 2% of credit sales.
a. Compute the actual amount of write-offs during 2012.
b.
Infer the journal entries that explain the activity in accounts receivable
and the related allowance account during 2012.
E6-7 Accounting for Bad Debts: Allowance Method
The following were extracted from the 2008 financial records of
Cummins, Inc. (dollars in millions):
Allowance for doubtful accounts $12 (cr.)
During the following year, the company wrote-off $11 of AR as
uncollectible and then estimated $9 of the year’s receivables to be
uncollectible. No recoveries of any previously written-off accounts.
a. Prepare the entry to record the bad debt expense.
b. Compute the final balance in the Allowance for Doubtful
Accounts.
Aging of AR
Emory Company uses the accounts receivable aging method to estimate uncollectible accounts. At the
beginning of the year, the balance of the Accounts Receivable account was a debit of $90,430, and the balance
of Allowance for Uncollectible Accounts as a credit of $8,100. During the year, the company had sales on account
of $475,000, sales returns and allowances of $6,200, worthless accounts written off of $8,800, and collections
from customers of $452,730. At the end of year (December 31, 2012), a junior accountant for Emory Company
was preparing an aging analysis of accounts receivable.
At the top of page 5 of the report, the following totals appeared:
Customer
Account
Total
Balance Forward $89,640
Not Yet Due
1–30 Days Past
Due
31–60 Days Past
Due
61–90 Days Past
Due
Over 90 Days Past
Due
$49,030
$24,110
$9,210
$3,990
$3,300
To finish the analysis, the following accounts need to be classified:
From past experience, the company has found that the following rates are realistic for estimating uncollectible accounts:
Time
Percentage Considered Uncollectible
Not yet due
2
1–30 days past due
5
31–60 days past due
15
61–90 days past due
25
Over 90 days past due
50
Required
Complete the aging analysis of accounts receivable.
Compute the end-of-year balances (before adjustments) of Accounts Receivable and
Allowance for Uncollectible Accounts.
Prepare an analysis computing the estimated uncollectible accounts.
Calculate Garcia Company's estimated uncollectible accounts expense for the year (round
the amount to the nearest whole dollar).
What role do estimates play in applying the aging analysis? What factors might affect these
estimates?
P6-7 Ignoring Potential Bad Debts
Income Statement
Sales
Cost of goods sold
2011 Balance Sheet
$200,000 Cash
102,000 Accounts receivable
Gross profit
98,000 Other assets
Expenses
65,000 Total assets
Net income
$33,000 Current liabilities
2011
$5,000
85,000
40,000
$130,000
13,000
Long-term NP
80,000
SHE
37,000
Total L + SHE
$130,000
The above financial information is for the Hadley Company’s first year of operation.
The income statement was not adjusted for bad debt expense. A large percentage
of sales were to 3 customers, one of which, Litzenberger Supply is in questionable
financial health, although still in business. Litzenberger owes Hadley $50,000 as
of the end of 2011.
P6-7 continued
Required:
a. Adjust the financial statements of Hadley Company to reflect a more conservative
reporting with respect to bad debts, i.e. set up a provision. Recompute net
income. How does this adjustment affect your assessment of Hadley’s first year
of operations?
b.
Why would auditors probably require that Hadley choose the more conservative
reporting?
c.
Hadley’s CFO claims that no bad debt expense should be recorded because
Litzenberger is still conducting operations as of the end of 2011. How would you
respond to this claim?
During 2010, Omega Company had net sales of $11,400,000. Most of the sales were on credit. At the end
of 2010, the balance of Accounts Receivable was $1,400,000, and Allowance for Uncollectible Accounts
had a debit balance of $48,000.
Omega Company's management uses two methods of estimating uncollectible accounts expense: the
percentage of net sales method and the accounts receivable aging method. The percentage of
uncollectible sales is 1.5 percent of net sales, and based on an aging of accounts receivable, the end-ofyear uncollectible accounts total $140,000.
1. Prepare the end-of-year adjusting entry to record the uncollectible accounts expense under each
method.
2. What will the balance of Allowance for Uncollectible Accounts be after each adjustment?
Anatomy of Merchandise Inventory
Cost of Goods Sold:
Account/Computation
BE7-1 Inventory
In its 2008 annual report, Hewlett-Packard reported beginning
inventory of $8.0 billion, ending inventory of $7.9 billion on its
balance sheet, and cost of goods sold of $69.3 billion on the
income statement. Compute the inventory purchases made by
HP during 2008.
E7-4 Compute the missing values
Compute the missing information from the following information
extracted from 3M (dollars in millions) income statements:
2008
2007
2006
?
?
$2,162
13,540
?
12,152
Goods Available for Sale
?
?
14,314
Ending inventory
?
2,852
?
$13,379
$12,735
$11,713
Beginning inventory
Purchases
Cost of Goods Sold
E7-5
The following information comes from the records of Telly’s Supply:
Beginning inventory $32,000
Inventory purchases $85,000
Transportation-in $4,300
An inventory count taken at year-end indicates that inventory with a cost f $50,000 is
on hand as of December 31, 2011.
Assume that inventory purchases and transportation-in are both reflected in the
inventory account, which shows and ending balance of $52,000. Compute cost of
goods sold along with any adjusting entries required at the end of the period.
E7-2 Purchases under Perpetual
Using Gross Method, what are the journal entries?
• Nick’s Fish Market purchased Maine lobster on account
on October 10, 2011, for a gross price of $76,000. Terms:
2/15, n/30
• Nick also purchased Alaskan king crab on account on
October 11, 2011, for a gross price of $36,000. Terms:
2/15, n/30
• Nick paid for the lobster on October 20, 2011.
• Nick paid for the crab on October 30, 2011.
E7-2 Purchases under Periodic
Using Gross Method, what are the journal entries?
• Nick’s Fish Market purchased Maine lobster on account
on October 10, 2011, for a gross price of $76,000. Terms:
2/15, n/30
• Nick also purchased Alaskan king crab on account on
October 11, 2011, for a gross price of $36,000. Terms:
2/15, n/30
• Nick paid for the lobster on October 20, 2011.
• Nick paid for the crab on October 30, 2011.
E7-10 Inventory Cost Flows
Watkins Corporation began operations on January 1, 2010. The 2010 and
2011 schedules of inventory purchases and sales are as follows:
2010:
Purchase 1
10 units @ $10
$100
Purchase 2
20 units @ $12
$240
Total Purchases
$340
Sales
15 units @ $30
$450
2011:
Purchase 1
Purchase 2
Total Purchases
Sales
10 units @ $13
15 units @ $15
20 units @ $35
$130
$225
$355
$700
Compare the COGS, Gross profit, and Ending inventory 2010 and 2011
results when using FIFO, Weighted Average, or LIFO periodic.
E7-10 Periodic Recap
Inventory
Costing
Method
Revenue
Cost of Goods
Sold
Gross Margin
Balance Sheet
Inventory
Revenue
Cost of Goods
Sold
Gross Margin
Balance Sheet
Inventory
Weighted
Average
FIFO
LIFO
Inventory
Costing
Method
Weighted
Average
FIFO
LIFO
E7-10 Inventory Cost Flows
Watkins Corporation began operations on January 1, 2010. The
2010 and 2011 schedules of inventory purchases and sales are
as follows:
2010:
Purchase 1
10 units @ $10
$100
Sales
5 units @ $30
Purchase 2
20 units @ $12
$240
Sales
10 units @ $30
2011:
Purchase 1
10 units @ $13
$130
Sales
10 units @ $35
Purchase 2
15 units @ $15
$225
Sales
10 units @ $35
Compare the COGS, Gross profit, and Ending inventory 2010
and 2011 results when using FIFO, or LIFO perpetual.
E7-10 Perpetual Recap
Inventory
Costing
Method
Revenue
Cost of Goods
Sold
Gross Margin
Balance Sheet
Inventory
Revenue
Cost of Goods
Sold
Gross Margin
Balance Sheet
Inventory
FIFO
LIFO
Inventory
Costing
Method
FIFO
LIFO
BE7-3 FIFO V. LIFO
General Electric uses LIFO inventory cost flow
assumption, reporting inventories on its 2008
balance sheet of $13.7 billion and a LIFO reserve
of approximately $706 million.
What would be GE’s 2008 inventory balance if it
used FIFO assumption instead?
Why is disclosure of the LIFO reserve useful to
financial statement users?
ID7-4 LCOM and Recognition of Loss/Income
TII Industries makes over-voltage protectors, power systems, and electronic
products primarily for the communications industry. Several years ago, the
company reported that it took “a substantial inventory write-down,” resulting in a
loss for its third quarter ending June 24. The write-down was estimated to be $12
million and stems from customers’ changes in product specifications.
a. Provide the journal entry to record the write-down.
b.
Assume the original cost of the inventory was $52 million and that it was
written down to its market value of $40 million. If TII sells it for $48 million
cash in the following period, what journal entries would be recorded?
Assume that TII uses the perpetual inventory method.
c.
Applying the lower-of-cost-or-market rule in this case would cause TII to
recognize a loss in the period of the write-down and income in the
subsequent period. Does such recognition seem appropriate? Why or why
not?
ID7-3 LIFO Liquidation and Hidden Reserves
In the early 1980s, an oil glut caused Texaco, a
LIFO user, to delay drilling, which cut it oil
inventory levels by 16%. The LIFO cushion (i.e.,
the difference between LIFO and FIFO inventory
values) that was built into those barrels over the
year amounted to $454 million and transformed
what would have been a drop in net income to a
modest gain.
Explain how using LIFO could be interpreted as
building “hidden reserves.”
P7-10 Avoiding LIFO Liquidations
IBT has used the LIFO inventory cost flow assumption for five years. As of
December 31, 2010, IBT had 700 items in its inventory, and the $9,000 inventory
dollar amount reported on the balance sheet consisted of the following costs:
When
purchased
Number of
items
Cost per item
Total
2007
500
$12
$6,000
2009
200
$15
$3,000
Total
700
$9,000
During 2011, IBT sold 900 items for $75 each and purchased 350 items at $30
each. Expenses other than cost of goods sold totaled $20,000, and the federal
income tax rate is 30% of taxable income.
a. Prepare the 2011 income statement.
b. Assume that IBT purchased an additional 550 items on December 20, 2011
for $30 each. Prepare the 2011 income statement.
c. Compare the two income statements. Discuss the advantages to the
12.20.11 purchase. Discuss the disadvantages of such a strategy.
P7-3 Inventory errors and financial statements
The following information was taken from Eli
Lilly (dollars in millions). Compute the corrected
COGS and Net income for 2006, 2007, 2008
assuming that ending inventory was overstated
by $500 in 2006, understated by $150 in 2007,
and overstated by $320 in 2008.
Sales
Cost of Goods Sold
Gross profit
Expenses
Net income (loss)
2008
2007
2006
$20,378
$18,634
$15,691
4,383
4,249
3,547
$15,995
$14,385
$12,144
18,067
11,432
9,481
$(2,072)
$2,953
$2,663
P7-3 Financial statement effects of inventory errors
Sales
Cost of Goods
Sold (COGS):
BB
Purchases
COGAS
Less: EB
COGS
Gross Profit
2007
$18,634
2006
$ 15,691
$
$
$
$
$
4,249
14,385
3,547
$ 12,144
P7-3 Financial statement effects of inventory errors
Sales
Cost of Goods
Sold (COGS):
BB
Purchases
COGAS
Less: EB
COGS
Gross Profit
2008
$20,378
2007
$ 18,634
$
$
$
$
$
4,383
15,995
4,249
$ 14,385
E7-6 Financial statement effects of inventory errors
Sales
Cost of Goods
Sold (COGS):
BB
Purchases
COGAS
Less: EB
COGS
Gross Profit
2008
$1,262
$268
857
$1,125
239
2007
$1,277
$287
887
$1,174
268
886
$376
906
$371
E7-6
a. Assume that counting errors caused the ending
inventory (EB) in 2007 to be understated by
$50 and the ending inventory in 2008 to be
overstated by $50.
Compute the impact of these errors on cost of
goods sold for the year ended December 31, 2007
and on the inventory balance as of December 31,
2007.
E7-6
b. Compute the impact of these errors on cost of goods
sold for the year ended December 31, 2008 and on the
inventory balance as of December 31, 2008.
c. What is the impact of these errors on cost of goods
sold over the two-year period ended December 31,
2008?
c. Answer
2007
2008
Original COGS
$906
$886
Corrected COGS
$856
$986