Copyright © 2013 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 7/e, Solutions Manual (For Instructor Use Only) 8-1 CHAPTER 8 Reporting and Analyzing Receivables ANSWERS TO QUESTIONS 1. Accounts receivable are amounts customers owe on account. They result from the sale of goods and services (i.e., in trade). Notes receivable represent claims that are evidenced by formal instruments of credit. 2. Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable. 3. The essential features of the allowance method of accounting for bad debts are: (1) Uncollectible accounts receivable are estimated and matched against revenues in the same accounting period in which the revenues are recorded. (2) Estimated uncollectibles are debited to Bad Debt Expense and credited to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. (3) Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off as uncollectible. 4. Mitch should realize that the decrease in cash realizable value occurs when estimated uncollectibles are recognized in an adjusting entry. The write-off of an uncollectible account reduces both accounts receivable and the allowance for doubtful accounts by the same amount. Thus, cash realizable value does not change. 5. The adjusting entry under the percentage of receivables basis is: Bad Debt Expense ................................................................................... 2,900 Allowance for Doubtful Accounts ($5,100 – $2,200) .......................... 2,900 6. Tootsie Roll reports two types of receivables on its balance sheet: Accounts receivable trade, and Other receivables. Since Tootsie Roll’s balance sheet reports allowance amounts for receivables, we know that Tootsie Roll uses the allowance method rather than the direct write-off method. 7. Under the direct write-off method, bad debt losses are not estimated and no allowance account is used. When an account is determined to be uncollectible, the loss is debited to Bad Debt Expense and credited to Accounts Receivable. The direct write-off method makes no attempt to match bad debts expense to revenues or to show the cash realizable value of the receivables in the balance sheet. 8. Offering credit usually results in an increase in sales because customers prefer to “buy now and pay later”. If a company decides to extend credit to customers, it should also establish credit standards to determine if a particular customer is credit worthy. Standards that are easily met can result in additional sales being made to customers that may not be able to meet the “tighter” credit policies of competitors. If such customers fail to pay, the additional sales revenue will be offset by higher collection costs and bad debts expense. 9. A promissory note gives the holder a stronger legal claim than one on an account receivable. As a result, it is easier to sell to another party. Promissory notes are negotiable instruments, which means they can be transferred to another party by endorsement. The holder of a promissory note also can earn interest.8-2 Copyright © 2013 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 7/e, Solutions Manual (For Instructor Use Only) 10. The maturity date of a promissory note may be stated in one of three ways: (1) on demand, (2) on a stated date, and (3) at the end of a stated period of time.Copyright © 2013 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 7/e, Solutions Manual (For Instructor Use Only) 8-3 Questions Chapter 8 (Continued) 11. The missing amounts are: (a) $27,000, (b) 10%, (c) six months or 180 days, and (d) $7,200. 12. When Carrera Company has dishonored a note, the lender can renegotiate new terms for the receivable which is equal to the full amount of the note plus the interest due. It will then try to collect the balance due, or as much as possible. If there is no hope of collection, it will write-off the note receivable. 13. Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. Both the gross amount of receivables and the allowance for doubtful accounts should be reported. If collectible within a year or the operating cycle, whichever is longer, these receivables are reported as current assets immediately below short-term investments. Notes receivables are usually listed before accounts receivable because notes are more easily converted to cash. 14. The steps involved in receivables management are: (1) Determine to whom to extend credit. (2) Establish a payment period. (3) Monitor collections. (4) Evaluate the liquidity of receivables. (5) Accelerate cash receipts from receivables when necessary. 15. A company can prepare an aging schedule to monitor collection success. An aging schedule provides information about the overall collection experience of a company and identifies problem accounts. 16. A concentration of credit risk is a threat of nonpayment from either a single large customer or class of customers that could adversely affect the company’s financial health. 17. An increase in the current ratio normally indicates an improvement in short-term liquidity. This may not always be the case because the composition of current assets may vary. In order to determine if the increase is an improvement in financial health, other ratios that should be considered include: accounts receivable turnover ratio and average collection period. 18. An increase of more than 100% in the average collection period is probably caused by the adoption of looser credit standards. The new sales director may have increased sales by extending credit to customers that did not meet the company’s previous credit standards. Management should try to determine if the longer collection period jeopardizes the company’s overall financial position. It should compare its collection period to that of its competitors to determine if it is reasonable. It should also monitor collections to see if the additional sales are producing significant increases in costs associated with collection and