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115
262) Tatsuo is the CEO of Ginjo Gallery. At the end of the year, the company's accountant
provides Tatsuo with the following information, before any adjusting entries.
Accounts receivable
$1,000,000
Estimated percentage uncollectible
5%
Allowance for uncollectible accounts
$10,000 (credit)
Operating income
$240,000
Accounts receivable
$1,000,000
Estimated percentage uncollectible
5%
Allowance for uncollectible accounts
$10,000 (credit)
Operating income
$240,000
Tatsuo has significant stock ownership in the company; and therefore, would like to keep the stock
price high. Analysts on Wall Street expected the company to have operating income of $170,000.
The fact that actual operating income is well above this amount will make investors happy and
help maintain a high stock price. Meeting analysts' expectations will also help Tatsuo keep his job.
Required:
1. Record the adjustment for uncollectible accounts using the accountant's estimate of 5% of
accounts receivable.
2. After the adjustment is recorded in Requirement 1, what is the revised amount of operating
income? Will Ginjo Gallery still meet analysts' expectations?
3. Tatsuo instructs the accountant to instead record $70,000 as bad debt expense so that operating
income will exactly meet analysts' expectations. By how much would total assets and operating
income be misstated if the accountant records this amount?
4. Why would Tatsuo be motivated to manage operating income in this way?
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117
263) Power Corporation engages in the manufacture and sale of equipment related to alternative
sources of energy. During the past year, operating revenues remained relatively flat compared to
the prior year but management notices a big increase in accounts receivable. The increase in
receivables is largely due to the recent economic slowdown in the commodities market. Many of
the company's customers are having financial difficulty, lengthening the period of time it takes to
collect on account. Below are year-end amounts.
Age Group
Operating
Revenue
Accounts
Receivable
Average Age
Accounts
Written Off
Two years ago
$2,300,000
$80,000
13 days
$10,000
Last year
3,100,000
100,000
11 days
15,000
Current year
3,000,000
350,000
27 days
0
Peter, the CEO of Power, notices that accounts written off over the past three years have been
minimal; and therefore, suggests that no allowance for uncollectible accounts be established in the
current year. Any account proving uncollectible can be charged to next year's financial statements
(the direct write-off method).
Required:
1. Do you agree with Peter's reasoning? Explain.
2. Suppose that other companies in these industries had similar increasing trends in accounts
receivable aging. These companies also had very successful collections in the past but now
estimate uncollectible accounts to be 30% because of the significant downturn in the industries. If
Power uses the allowance method estimated at 30% of accounts receivable, what should be the
balance of the allowance for uncollectible accounts at the end of the current year?
3. Based on your answer in Requirement 2, for what amount will total assets and expenses be
misstated in the current year if Power uses the direct write-off method? Ignore tax effects.
264) On June 1, 2021, Demer Consulting provides services to a customer for $150,000. To pay for
the services, the customer signs a three-year, 12% note. The face amount is due at the end of the
third year, while annual interest is due each June 1.
Required:
1. Record the acceptance of the note on June 1, 2021.
2. Record the interest collected on June 1 for 2022 and 2023, and the adjustment for interest
revenue on December 31, 2021, 2022, and 2023.
3. Record the cash collection on June 1, 2023.
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265) Selected financial data for Strong Health Group and Sturdy Medical Corporation, two
companies in the health-care industry, are as follows:
($ in millions)
Net Sales
Beginning
Accounts
Receivable
Ending Accounts
Receivable
Strong Health
$1,850
$200
$230
Sturdy Medical
2,100
400
380
Required:
1. Calculate the receivables turnover ratio and average collection period for Strong Health and
Sturdy Medical. Round your answers to one decimal place. Compare your calculations with those
for Tenet Healthcare and LifePoint Hospitals reported in the chapter text. Which of the four
companies maintains a higher receivables turnover?
2. How does the receivables turnover ratio reflect the efficiency of management? Discuss factors
that affect the receivables turnover ratio.
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266) Give three examples of contra revenue accounts and the transactions with which they are
associated.
267) Explain how companies account for uncollectible accounts receivable (bad debts) for
financial reporting purposes.
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268) What does it mean to report accounts receivable at the net amount of cash expected to be
collected.
269) Discuss the differences between the allowance method and the direct write-off method for
recording uncollectible accounts. Which of the two is acceptable for financial reporting purposes?
125
270) Explain why the percentage-of-receivables method is referred to as the balance sheet method
and the percentage-of-credit-sales method is referred to as the income statement method. Which
method is typically used in practice? Why?
271) How is the receivables turnover ratio measured? What does this ratio indicate? Is a higher or
lower receivables turnover preferable?
