6-32 Test Bank – Chapter 6 – The Current Asset Classification, Cash, and Accounts Receivable
KP 5 BT: AN Difficulty: Moderate TOT: 6 min. AACSB: Analytic
AICPA BB: Critical Thinking AICPA FN: Measurement
Use the information that follows from the financial statements of Pines Company at December
31, 2015, to answer questions 16 through 20 that follow.
Accounts payable
$ 2,000
Accounts receivable
3,000
Capital stock
8,000
Cash
5,000
Inventory
19,000
Land
24,000
Notes payable (short-term)
5,000
Cost of goods sold
12,000
Retained earnings
21,000
Sales revenue
20,000
16. Calculate total current assets for Pines Company at December 31, 2015.
Solution:
17. Calculate total current liabilities for Pines Company at December 31, 2015.
Solution:
18. Calculate total working capital for Pines Company at December 31, 2015.
Solution:
19. Calculate the current ratio for Pines Company at December 31, 2015.
Solution:
20. Calculate the quick ratio for Pines Company at December 31, 2015.
Solution:
21. On December 1, 2015, Casio Trading Co. sold goods to a German company for 20,000
German marks (20,000 DM) to be collected on January 12, 2016. The exchange rates
on December 1 and December 31, 2015 are US$0.50 = 1 DM and US$.60 = 1 DM,
respectively. Calculate Casio’s revenue in U.S. dollars and its exchange gain or loss for
2015.
Solution:
22. On December 11, 2015, Bisbee Co. purchased capsules from a Canadian company for
10,000 Canadian dollars (10,000 C$) to be paid on January 2, 2016. The exchange
rates on December 11 and December 31, 2015 are US$0.79 = 1C$ and US$0.82 = 1C$,
respectively. What is the cost of the capsules in U.S. dollars and the 2015 exchange
loss?
Solution:
23. On December 1, 2015, Mason Company delivered a shipment of goods to a Swiss
customer for a price of 150,000 euros. If on that date 1.3 U.S. dollars could be
exchanged for 1 euro, what entry would Mason record to convert the receivable to
equivalent U.S. dollars?
Solution:
Accounts receivable 195,000
24. The following are partial balance sheets for Pedro Co, dated December 31:
2014
2015
Accounts receivable
$55,000
$68,000
Allowance for doubtful accounts
(5,000)
(11,000)
Net realizable value
$50,000
$57,000
During 2015, $4,000 of accounts receivable were written off as uncollectible. Calculate
the amount of bad debts expense recognized on Pedro’s 2015 income statement.
Solution:
25. Paxton’s aging schedule of its accounts receivable on December 31 follows:
Account Age
Balance
Non-collection Likelihood
$100,000
3%
70,000
7%
40,000
10%
The balance in Paxton’s allowance for doubtful accounts immediately prior to December
31 adjusting entries is $700 credit. Determine bad debts expense and the net realizable
value of the December 31 accounts receivable.
Solution:
26. On 12/31/14, Phoebe Company’s balance sheet revealed a $7,000 balance in its
allowance for doubtful accounts. During 2015, $2,000 of accounts were written off and
$500 of accounts receivable previously written off were collected. On 12/31/15, bad
debts expense was estimated to be 5% on net credit sales, which were $400,000.
Calculate the balance in the allowance for doubtful accounts on 12/31/15.
Solution:
6-36 Test Bank – Chapter 6 – The Current Asset Classification, Cash, and Accounts Receivable
SHORT ESSAY QUESTIONS
1. Briefly described hedging.
Solution:
Hedging is commonly practiced to reduce the risk associated with holding receivables
2. The Porsha Bank has provided its auditor with the following selected financial data for
2015:
Cash
$ 7,000
Loans receivable—current
$21,000
Allowance for doubtful accounts
(3,000)
18,000
Total current assets
$25,000
Loans receivable—long-term
$36,000
Allowance for doubtful accounts
(4,000)
$32,000
Current liabilities
$19,000
2010 net income
$30,000
In reviewing the loans outstanding, the auditors were troubled by the fact that the
collectability of some loans to Brazil was questionable. In fact, Porsha Bank has been
making new loans to Brazil so that they can pay the interest on the loans already
outstanding. The economic situation of Brazil has forced the auditors to insist that
Porsha Bank increases its allowance for its current loans to $9,000 and for its non–
current loans to $16,000. Porsha Bank decided to adhere to their auditors’ suggestions.
Indicate the effects of adopting the auditor’s allowance requirements on Porsha Bank’s
current ratio and 2015 net income.
Solution:
Increasing the allowance for doubtful accounts-current from $3,000 to $9,000 decreases
AICPA BB: Critical Thinking AICPA FN: Measurement
3. Why might an operating cycle of one company differ from an operating cycle of another
company?
Solution:
4. What accounting requirements brought significant opposition from the banking industry?
Solution:
5. Identify the limitations of current asset classification.
Solution:
The limitations are related to the fundamental fact that current assets and current
6. On December 31, 2015, Priya Co. has accounts receivable of $400,000. It uses the
direct write-off method of accounting for bad debts because this is what is required for
determining its U.S. taxable net income. The opinion of management is that what is
acceptable to the Internal Revenue System should be acceptable under generally
accepted accounting procedures. However, its independent auditor disagrees with this
impassioned argument and does not accept the direct write-off method of accounting for
bad debts.
Present the reason(s) for the auditor’s objection to the direct write-off method, and
indicate the method that must be used under GAAP. Indicate how Priya’s 2015 net
income, current ratio, and quick ratio will be affected by following the auditor’s position.
Solution:
The direct write-off method of accounting for bad debts recognizes bad debts expense
when an individual account is determined to be uncollectible. This does not achieve
7. A company has a significant debit or credit accumulation in the preadjustment balance of
allowance for doubtful accounts over several periods.
Required:
(1) What would this indicate?
(2) How can users detect the source of this problem?
Solution:
(1) This may indicate that the estimates for bad debts are inaccurate and
biased. Consistent overestimates give risk to preadjustment credit
accumulations, while consistent underestimates create preadjustment
8. Preston Bank has $50 million of loans outstanding on December 31 of the current year,
in which it recorded net income of $770,000. Preston did not provide for any
uncollectible loans because all of its loans are collateralized by real estate. That is, if the
loans were to default, Preston would obtain the title to the real estate for which the loans
were made. However, during the audit of Preston’s financial statements, the auditing
company determined that $5 million of the outstanding loans would probably be
dishonored (uncollectible). Because during the last three years real estate values have
deteriorated, they also investigated the real estate that backed these collateralized
loans. The market value of that real estate is negligible.
Recalculate Preston’s loans receivable on December 31 and current net income to an
amount that would be acceptable to the auditors.
Solution:
The allowance for uncollectible loans should be increased from $0 to $5,000,000. This
9. Can a company use the direct write-off method rather than the allowance method to
account for bad debts? Explain why or why not.
Solution:
10. What effect does ‘window dressing’ have on the solvency of a company?
Solution:
Managers who have discretion over the accounts in the current asset section of the
11. The following is a partial balance sheet for Quenton Company dated December 31,
2015:
Current assets
Cash
$20,000
Accounts receivable
$45,000
Allowance for doubtful accounts
(3,000)
Net realizable value
42,000
Inventory
33,000
Total current assets
$95,000
Current liabilities
$65,000
During 2015, $4,000 of accounts receivable were written off as uncollectible and bad
debts expense recognized on Quenton’s 2015 net income statement was $8,000.
However, the president of the company believes that $2,500 of these receivables were
written off too soon. She believes that there is a good chance that they will be collected
next year. There is some historical evidence to back the president’s position.
A partial explanation for her position is that Quenton has a debt covenant requiring it to
maintain a current ratio of 1.5. The president believes that by reversing the write-off of
$2,500 of accounts receivable, the current assets will be $97,500 and the current ratio
will be 1.5. However, the chief financial officer states that a better approach to getting
the current ratio to 1.5 is to pay off some accounts payable. If the company paid $5,000
of accounts payable, the current ratio would become the minimum 1.5 required by the
debt covenant.
Comment, with numerical illustration, on the president’s and chief financial officer’s
positions.
Solution:
If the write-off of $2,500 of accounts receivable were reversed, the carrying or net
realizable value of accounts receivable will not change because a write off under the
6-42 Test Bank – Chapter 6 – The Current Asset Classification, Cash, and Accounts Receivable
AICPA BB: Critical Thinking AICPA FN: Measurement
12. Why is too much cash undesirable?
Solution:
13. Why is the timing of recording a receivable important?
Solution:
The timing of recording a receivable is important because of its
relationship to revenue recognition. Note that the timing of revenue