Accounting Chapter 6 Homework During periods of declining prices, the FIFO method will result in a lesser amount of net income and would be preferred for income tax purposes

191

P6–2

1.

a. b.

Addition to Allowance Accounts Written

Year for Doubtful Accounts Off During Year

2. a. The estimate of ¼ of 1% of credit sales may be too large since the allow-

ance for doubtful accounts has steadily increased each year. The increas-

ing balance of the allowance for doubtful accounts may also be due to the

Note to Instructors: Since the amount of credit sales has been fairly uniform over

the years, the increase cannot be explained by an expanding volume of sales.

b. The balance of Allowance for Doubtful Accounts that should exist at

December 31, 20Y5, can only be determined after all attempts have been

made to collect the receivables on hand at December 31, 20Y5. However,

the account balances at December 31, 20Y5, 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 to develop a reason-

192

P6–3

1. Bad Debt Expense

Increase Balance of

Expense Expense (Decrease) Allowance

Actually Based on in Amount Account,

Year Reported Estimate* of Expense End of Year

1 $ 5,000 $ 11,500 $ 6,500 $ 6,500

2 9,000 23,750 14,750 21,250

*Determined by multiplying sales by 0.005 as follows:

Year 1: $11,500 = $2,300,000 × 0.005

2. Yes. The actual write-offs of accounts originating in the first two years are

reasonably close to the expense that would have been charged to those years

193

P6–4

1. First-In, First-Out Method

Model Quantity Unit Cost Total Cost

A10 4 $ 76 $ 304

2 70 140

B15 6 184 1,104

2 170 340

E60 5 70 350

2. Last-In, First-Out Method

Model Quantity Unit Cost Total Cost

A10 4 $ 64 $ 256

2 70 140

B15 8 176 1,408

E60 3 75 225

194

P6–4, Concluded

3. Weighted Average Cost Method

Model Quantity Unit Cost Total Cost

A10 6 $ 70 $ 420

B15 8 174 1,392

E60 5 69 345

Total ……………………………………………………….. $10,285

Computations of unit costs:

A10: $70 = [(4 × $64) + (4 × $70) + (4 × $76)] ÷ (4 + 4 + 4)

B15: $174 = [(8 × $176) + (4 × $158) + (3 × $170) + (6 × $184)] ÷ (8 + 4 + 3 + 6)

4. a. During periods of rising prices, the LIFO method will result in a lesser

amount of inventory, a greater amount of the cost of goods sold, and a

lesser amount of net income than the other two methods. For Amsterdam

Appliances, the LIFO method would be preferred for the current year

195

P6–5

Inventory Sheet

December 31, 20Y9

Unit Unit Total

Inventory Cost Market

Description Quantit

y

Price Price Cost Market LCM

112Aa 38 25 $ 80 $ 83 $ 2,000 $2,075

13 78 1,014 1,079

3,014 3,154 $ 3,014

10,130 9,900 9,900

H687 60 15 15 900 900 900

J023 5 385 390 1,925 1,950 1,925

L33

y

375 6 6 2,250 2,250 2,250

R66b 90 80 22 18 1,760 1,440

10 21 210 180

1,970 1,620 1,620

S77x 6 5 250 235 1,250 1,175

196

METRIC-BASED ANALYSIS

MBA 6–1

Transaction Liquidity Metric Profitability Metric

Days’ Sales Return on

Date Description in Receivables Sales

Mar. 18 Collected cash Decrease No effect

18 Wrote off account Decrease Decrease

MBA 6–2

Transaction Liquidity Metric Profitability Metric

Days’ Sales Return on

Date Description in Receivables Sales

July 3 Collected cash Decrease No effect

3 Wrote off account No effect No effect

MBA 6–3

Liquidity Metric Profitability Metric

Days’ Sales Return on

MBA 6–4

Liquidity Metric Profitability Metric

Days’ Sales Return on

197

MBA 6–5

Liquidity Metric Profitability Metric

Days’ Sales Return on

MBA 6–6

1. Year 2 Year 1

Accounts receivable turnover:

$229,234 ÷ $16,814 …………………… 13.6

$215,639 ÷ $14,802 …………………… 14.6

3. Inventory turnover:

$141,048 ÷ $3,494 …………………….. 40.4

$131,376 ÷ $2,241 …………………….. 58.6

5. Return on sales

$61,344 ÷ $229,234 …………………… 26.8%

$60,024 ÷ $215,639 …………………… 27.8%

6. Apple’s accounts receivable turnover in Year 2 of 13.6 has decreased slightly

from 14.6 in Year 1. Days’ sales in receivables has increased from 25 days to

27 days. This is an unfavorable change. Apple’s inventory turnover in Year 2

of 40.4 has decreased from 58.6 in Year 1. Days’ sales in inventory has in-

creased from 6 days in Year 1 to 9 days in Year 2. In general, this is also con-

sidered an unfavorable change.

tors should be performed to better assess Apple’s profitability.

198

MBA 6–7

1. Year 2 Year 1

Accounts receivable turnover:

$52,056 ÷ $4,264 ……………………… 12.2

$48,238 ÷ $4,470 ……………………… 10.8

2. Days’ sales in receivables:

365 days ÷ 12.2 ……………………….. 30 days

365 days ÷ 10.8 ……………………….. 34 days

5. Return on sales

$3,519 ÷ $52,056 ……………………… 6.8%

$3,549 ÷ $48,238 ……………………… 7.4%

6. HP’s accounts receivable turnover in Year 2 of 12.2 has increased slightly

from 10.8 in Year 1. Days’ sales in receivables has decreased from 34 days in

Year 1 to 30 days in Year 2. This is a favorable change. HP’s inventory turno-

ver in Year 2 of 8.3 has decreased from 8.9 in Year 1. As a result, days’ sales

in inventory has increased from 41 days in Year 1 to 44 days in Year 2. This is

an unfavorable change.

199

MBA 6–8

The results of MBA 6–6 and MBA 6–7 for Apple and HP are summarized below.

Apple HP

Year 2 Year 1 Year 2 Year 1

Accounts receivable turnover……………. 13.6 14.6 12.2 10.8

Days’ sales in receivables …………………. 27 25 30 34

Inventory turnover ……………………………. 40.4 58.6 8.3 8.9

MBA 6–9

1. Year 2 Year 1

Accounts receivable turnover:

$184,765 ÷ $12,673 …………………… 14.6

$177,526 ÷ $12,026 …………………… 14.8

2. Days’ sales in receivables:

365 days ÷ 14.6 ……………………….. 25 days

365 days ÷ 14.8 ……………………….. 25 days

200

MBA 6–9, Concluded

6. CVS accounts receivable turnover in Year 2 of 14.6 has decreased from 14.8

in Year 1. The days’ sales in receivables remained constant at 25 days be-

tween Year 1 and Year 2. CVS inventory turnover in Year 2 of 10.4 has in-

MBA 6–10

1. International

Paper Walmart

Accounts receivable turnover:

$21,743 ÷ [($3,287 + $2,852) ÷ 2] ……… 7.1

$500,343 ÷ [($5,614 + $5,835) ÷ 2] ……. 87.4

2. Days’ sales in receivables:

365 days ÷ 7.1 ……………………………….. 51 days

365 days ÷ 87.4 ……………………………… 4 days

201

MBA 6–10, Concluded

6. International Paper’s accounts receivable turnover of 7.1 is significantly less

than Walmart’s accounts receivable turnover of 87.4. Likewise, International

Paper’s days’ sales in receivables of 51 is significantly more than Walmart’s

days’ sales in receivables of 4. These differences are likely due to Walmart

selling directly to consumers who use cash or credit cards. In contrast,

The inventory turnover and days’ sales in inventory do not differ significantly

between the two companies. International Paper has a slightly lower inventory

turnover (6.7) and more days’ sales in inventory (54 days) than Walmart’s

inventory turnover (8.6) and days’ sales in inventory (42 days). This difference

is probably attributable to the fact that Walmart sells both perishable and

nonperishable goods, whereas International Paper only sells nonperishable

goods.

202

CASES

Case 6–1

By computing interest using a 365-day year for depository accounts (payables),

Sybil is minimizing interest expense to the bank. By computing interest using a

360-day year for loans (receivables), Sybil is maximizing interest revenue to the

Case 6–2

Because of the size and number of customers’ accounts, it is probably unreason-

able for Northern Construction Supplies Co. not to allow credit to contractors and

to require cash or credit card payment. To do so, as Janet points out, would

probably cost Northern most of its contractor customers. Thus, Northern is faced

with having to allow credit to its contracting customers.

The primary problem that Northern Construction Supplies Co. is facing is that

some contractors are apparently abusing Northern’s liberal credit policy. One al-

ternative would be for Northern to allow a discount for payment within 30 days.

For example, Northern might allow a 2% discount if the bill is paid within 30 days.

Credit then might be discontinued for any contractor with a bill outstanding more

than 60 days. This would provide the contractors an incentive to pay their bills

early. That is, a 2% discount for payment 30 days early (the bill must be paid with-

203

Case 6–2, Concluded

Note: Statement of activity indicates most contractors pay their receivables, but

they just take their time.

An alternative approach would be to charge contractors interest on overdue

accounts. For example, Northern might charge accounts over 60 days past due

interest at 1½% per month (equivalent to approximately 18% per year). This

approach would be more of a “negative” approach to motivating contractors to

pay earlier.

Case 6–3

Since the title to merchandise shipped FOB shipping point passes to the buyer

when the merchandise is shipped, the shipments made before midnight, Decem-

ber 31, 20Y1, should properly be recorded as sales for the fiscal year ending

December 31, 20Y1. Hence, Gene Lumpkin is behaving in a professional manner.

204

Case 6–4

In developing a response to Evan’s concerns, you should probably first empha-

size the practical need for an assumption concerning the flow of cost of goods

purchased and sold. That is, when identical goods are frequently purchased, it

may not be practical to specifically identify each item of inventory. If all the iden-

Next, you should emphasize that accounting principles that allow for the physical

flow of the goods may differ from the flow of costs. Specifically, accounting prin-

ciples allow for three cost flow assumptions: first-in, first-out; last-in, first-out;

and average cost. Each of these methods has advantages and disadvantages.

One primary advantage of the last-in, first-out method is that it better matches

current costs (the cost of goods purchased last) with current revenues. There-