CP 9–1
By computing interest using a 365-day year for depository accounts (liabilities), Bev is minimizing interest expense to the bank. By computing interest using a 360-day year for loans (assets), Bev is maximizing interest revenue to the bank. However, federal legislation (Truth in Lending Act) requires banks to compute interest on a 365-day year. Hence, Bev is behaving in an unprofessional manner.
CP 9–2
1. a.
Addition to Allowance
b.
Accounts Written
Year for Doubtful Accounts Off During Year
2013 2014 2015 2016 $20,000 $15,000 ($20,000 – $5,000) 22,000 18,750 ($5,000 + $22,000 – $8,250) 24,000 22,050 ($8,250 + $24,000 – $10,200) 25,500 21,300 ($10,200 + $25,500 – $14,400)
2. a. The estimate of 1/2 of 1% of credit sales may be too large because the allowance for doubtful accounts has steadily increased each year. The increasing balance of the allowance for doubtful accounts may also be due to the failure to write off a large number of uncollectible accounts. These possibilities could be evaluated by examining the accounts in the accounts receivable subsidiary ledger for collectibility and comparing the result with the balance in the allowance for doubtful accounts.
Note to Instructors: Because the allowance for doubtful accounts increased by 188% [($14,400 – $5,000) ÷ $5,000], while sales have increased by 27.5% [($5,100,000 – $4,000,000) ÷ $4,000,000], the increase cannot be explained by an expanding volume of sales.
CP 9–2 (Concluded)
b. The balance of Allowance for Doubtful Accounts that should exist at
December 31, 2016, can only be determined after all attempts have been made to collect the receivables on hand at December 31, 2016. However, the account balances at December 31, 2016, could be analyzed, perhaps using an aging schedule, to determine a reasonable amount of allowance and to determine accounts that should be written off. Also, past write-offs of uncollectible accounts could be analyzed in depth in order to develop a reasonable percentage for future adjusting entries, based on past history. Caution, however, must be exercised in using historical percentages. Specifically, inquiries should be made to determine whether any significant changes between prior years and the current year may have occurred, which might reduce the accuracy of the historical data. For example, a recent change in credit-granting policies or changes in the general economy (entering a recessionary period, for example) could reduce the usefulness of analyzing historical data.
Based on the preceding analyses, a recommendation to decrease the annual rate charged as an expense may be in order (perhaps Xtreme Co. is experiencing a lower rate of uncollectibles than is the industry average), or perhaps a change to the “estimate based on analysis of receivables” method may be appropriate.
CP 9–3 1. and 2. Year 2 Year 1 Sales……… Accounts receivable………… $50,705 $49,747 $2,288 $2,348
Average accts. receivable…… $2,318.0 $2,184.0
[($2,288 + $2,348) ÷ 2] [($2,348 + $2,020) ÷ 2]
Accts. receivable turnover…… 21.9 22.8
($50,705 ÷ $2,318.0) ($49,747 ÷ $2,184.0)
Average daily sales……… Days’ sales in receivables……
$138.9 ($50,705 ÷ 365) 16.7 $136.3 ($49,747 ÷ 365) 16.0 ($2,318.0 ÷ $138.9) ($2,184.0 ÷ $136.3)
3. The accounts receivable turnover indicates a decrease in the efficiency of
collecting accounts receivable by decreasing from 22.8 to 21.9, an unfavorable trend. The days’ sales in receivables increased from 16.0 days to 16.7, an unfavorable trend. Thus, based on (1) and (2), Best Buy has decreased its efficiency in the collection of receivables.
CP 9–3 (Concluded)
4. We assumed that the percentage of credit sales to total sales remains constant from one period to the next and no major changes in operations occurred
between years. For example, if the percentage of credit sales to total sales is not similar or if the percentage changes between years, then the ratios would be distorted and, thus, not comparable. Also, any major changes in operations could distort the comparison between years.
CP 9–4
1. Year 2: 8.9 {$156,508 ÷ [($21,275 + $13,731) ÷ 2]} Year 1: 8.6 {$108,249 ÷ [($13,731 + $11,560) ÷ 2]}
2. Year 2: 40.8 days [($21,275 + $13,731) ÷ 2] = $17,503.0; [$17,503.0 ÷ ($156,508 ÷ 365)] Year 1: 42.6 days [($13,731 + $11,560) ÷ 2] = $12,645.5; [$12,645.5 ÷ ($108,249 ÷ 365)] 3. The accounts receivable turnover indicates an increase in the efficiency of
collecting accounts receivable by increasing from 8.6 to 8.9, a favorable trend. The days’ sales in receivables decreased from 42.6 days to 40.8, a favorable trend. Before reaching a more definitive conclusion, the ratios should be compared with industry averages and similar firms.
CP 9–5 1. and 2.
Sales……… Accounts receivable……… Average accts. receivable…………
Year 2 Year 1
$99,137 $88,915
$1,576 $1,455
$1,515.5 $1,388.0
Accts. receivable turnover…………
[($1,576 + $1,455) ÷ 2] 65.4 ($99,137 ÷ $1,515.5) [($1,455 + $1,321) ÷ 2] 64.1 ($88,915 ÷ $1,388.0)
Average daily sales……… Days’ sales in receivables…………
$271.6 $243.6
($99,137 ÷ 365) ($88,915 ÷ 365)
5.6 5.7
($1,515.5 ÷ $271.6) ($1,388.0 ÷ $243.6)
3. The accounts receivable turnover indicates an increase in the efficiency of
collecting accounts receivable by increasing from 64.1 to 65.4, a favorable trend. The days’ sales in receivables decreased from 5.7 days to 5.6 days, a favorable trend. Before reaching a more definitive conclusion, the ratios should be compared with industry averages and similar firms.
4. Costco’s accounts receivable turnover would normally be higher than that of a
typical manufacturing company such as H.J. Heinz Company. This is because many of Costco’s customers charge their purchases to American Express cards or pay with checks or cash. In contrast, the customers of H.J. Heinz Company are other businesses that pay their accounts receivable on a less timely basis. For a recent year, the accounts receivable turnover ratio for H.J. Heinz was 10.3 (see Ex. 9–27).
CP 9–6
1. Note to Instructors: The turnover ratios will vary over time. Recently, the various turnover ratios (rounded to one decimal place) were as follows:
Alcoa Inc. ……… 12.9
AutoZone, Inc. ……… 56.8
Barnes & Noble, Inc. ……… 45.9
Caterpillar ……… 3.3
The Coca-Cola Company ……… 9.9
Delta Air Lines ……… 17.5
The Home Depot ……… 60.4
IBM ……… 3.3
Kroger ……… 100.8
Procter & Gamble ……… 11.6
Walmart ……… 81.1
Whirlpool Corporation ……… 7.3
Based on the above, the companies can be categorized as follows: Accounts Receivable Turnover Ratio
Below 15 Above 15
Alcoa Inc. AutoZone, Inc.
Caterpillar Barnes & Noble, Inc.
The Coca-Cola Company Delta Air Lines
IBM The Home Depot
Procter & Gamble Kroger
Whirlpool Corporation Walmart
2. The companies with accounts receivable turnover ratios above 15 are all
companies selling primarily to individual consumers. In contrast, companies with turnover ratios below 15 are companies selling primarily to other businesses. Generally, we would expect companies selling to individual consumers to have higher turnover ratios, since many customers will charge their purchases on credit cards. In contrast, companies selling to other businesses normally allow a credit period of at least 30 days or longer.