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1

Ratios - Profitability and Equity
List the per share common stock dividend pay out rate formula.

Measures the price of a share of common stock relative to its latest earnings per share. Indicates a measure of how the market values the stock, especially when compared with other stocks.

Cash Dividends per Common Share / Earnings Per Share (EPS).

2

What do equity/investment leverage ratios measure?

Measure relative sources of equity and equity value.

3

Measures the rate of return on total assets and indicates the efficiency with which invested resources (assets) are used.

Return on Total Assets = (Net Income + (add back) Interest Expense (net of tax effect)) / Average Total Assets

4

List the total common stock dividend payout rate formula.

Cash Dividends to Common Shareholders / Net Income to Common Shareholders.

5

what is the formula of The price-earnings ratio

Price-Earnings Ratio (P/E Ratio) = Market Price for a Common Share / Earnings per (Common) Share (EPS)


F. Measures the price of a share of common stock relative to its latest earnings per share. Indicates a measure of how the market values the stock, especially when compared with other stocks.

6

AICPA.901110FAR-TH-FA
Ratios - Profitability and Equity
Are the following ratios useful in assessing the liquidity position of a company?
Defensive-interval ratio Return on stockholders' equity
Yes Yes
Yes No
No Yes
No No

B
Correct!

The defensive interval ratio is the ratio of quick assets to daily operating expenditures. Quick assets are current assets that are very readily converted to cash. They include cash, accounts receivable, and certain investments. The ratio indicates the length of time in days that the firm can operate with its present liquid resources. Thus, the measure is a liquidity measure.
The return on stockholders' equity is the ratio of income to average owners' equity. This ratio is a profitability ratio, not a liquidity ratio. A firm could have a strong return on equity ratio and not be particularly liquid.
A
Incorrect...

Incorrect for return on equity. The return on stockholders' equity is the ratio of income to average owners' equity. This ratio is a profitability ratio, not a liquidity ratio. A firm could have a strong return on equity ratio and not be particularly liquid.

C
Incorrect...

Incorrect on both counts. The defensive interval ratio is the ratio of quick assets to daily operating expenditures. Quick assets are current assets that are very readily converted to cash. They include cash, accounts receivable, and certain investments. The ratio indicates the length of time in days that the firm can operate with its present liquid resources.
Thus, the measure is a liquidity measure.
The return on stockholders' equity is the ratio of income to average owners' equity. This ratio is a profitability ratio, not a liquidity ratio. A firm could have a strong return on equity ratio and not be particularly liquid.

7


AICPA.082120FAR-I.C
Ratios - Profitability and Equity

The following is the stockholders' equity section of Harbor Co.'s balance sheet on December 31:
Common stock $10 par, 100,000 shares authorized, 50,000 shares issued of which 5,000 have been reacquired, and are held in treasury $ 450,000
Additional paid-in capital common stock 1,100,000
Retained earnings 800,000
Subtotal $2,350,000
Less treasury stock (150,000)
Total stockholders' equity $2,200,000
Harbor has insignificant amounts of convertible securities, stock warrants, and stock options. What is the book value per share of Harbor's common stock?

A. $31
B. $44
C. $46
D. $49

D
Correct!

Book value per share, for this basic situation, is total owners' equity divided by the number of shares outstanding: $2,200,000/45,000 = $49 rounded to the nearest dollar. The number of shares outstanding equals the number of shares issued (50,000) less the number in the treasury (5,000).

Book Value per Common Stock = Common Shareholders' Equity / Number of Outstanding Common Shares
D. Measures the per share amount of common shareholders' claim to assets. (See the section on this ratio in the owner's equity module for more details.)

8

AICPA.100917FAR-OCB-SIM

Alco, Inc., a small manufacturing company, prepares its financial statements using its income tax basis of accounting. In December, 2012, it determined that an error had been made in the amount of rent expense reported in its 2011 tax return. How should Alco account for the amount of the rental expense error in its 2012 financial statements?
A. As an adjustment to 2012 rental income.
B. As an income tax expense in 2012.
C. As a prior period adjustment.
D. No reporting in 2012 required.

B
Incorrect...

The amount of the 2011 rental expense error would not be reported as an adjustment to the 2012 income tax expense. Because the error was made in the tax return (and financial statements) of the prior period, it should be treated as a prior period adjustment in Alco's 2012 financial statements.

A
Incorrect...

The amount of the 2011 error would not be reported as an adjustment to 2012 rental expense. Because the error was made in the tax return (and financial statements) of the prior period, it should be treated as a prior period adjustment in Alco's 2012 financial statements.

9

AICPA.100912FAR-OCB-SIM


When a set of financial statements is prepared using the cash basis or the modified cash basis of accounting, which one of the following is least likely to be an appropriate financial statement title?
A. Statement of Cash Receipts and Cash Disbursements.
B. Balance Sheet.
C. Income Statement.
D. Statement of Financial Position.

C
Correct!

When the cash basis or the modified cash basis of accounting is used, the title Income Statement, which is appropriate when the accrual basis of accounting is used, should be replaced by the title Statement of Cash Receipts and Cash Disbursements. This helps distinguish that the statement is not based on full accrual accounting consistent with U.S. GAAP.

10

AICPA.100938FAR-OFS-SIM


The personal statement of financial condition for Allen Harvey reported a net worth of $825,000 on December 31, 20X0. During the calendar year 20X1, Harvey had earned income of $68,000. For 20X1, his broker's reports showed that his investments had increased by $23,000. In addition, for the year, his credit card debt increased $6,000 and his home mortgage principal balance decreased by $24,000. There were no other changes in Harvey's financial condition during 20X1. Which one of the following is Harvey's net worth as of December 31, 20X1?
A. $934,000
B. $878,000
C. $866,000
D. $830,000

B
Incorrect...

This incorrect answer ($878,000) results from incorrectly adding the increase in credit card debt to net worth, rather than subtracting it from net worth. Thus, this incorrect answer resulted from $825,000 + $23,000 + $6,000 + 424,000 = $878,000, an incorrect answer. The correct answer would deduct the $6,000, not add it, which would result in $825,000 + $23,000 - $6,000 + $24,000 = $866,000, the correct answer.

11

AICPA.100936FAR-OFS-SIM


Jen has been employed by Komp, Inc. since February 1, 2009. Jen is covered by Komp's Section 401(k) deferred compensation plan. Jen's contributions have been 10% of salaries. Komp has made matching contributions of 5%. Jen's salaries were $21,000 in 2009, $23,000 in 2010, and $26,000 in 2011. Employer contributions vest after an employee completes three years of continuous employment. The balance in Jen's 401(k) account was $11,900 on December 31, 2011, which included earnings of $1,200 on Jen's contributions. What amount should be reported for Jen's vested interest in the 401(k) plan in Jen's December 31, 2011, personal statement of financial condition?
A. $11,900
B. $8,200
C. $7,000
D. $1,200

D
Incorrect...

This incorrect answer ($1,200) results from including only the earnings on Jen's contributions and failing to include Jen's contributions. The earnings on Jen's contributions was given as $1,200. The correct answer is Jen's salaries of $21,000 + $23,000 + $26,000 = $70,000 x Jen's contribution rate of 10% = $7,000, plus the earnings on those contributions of $1,200 (given) = $8,200, the correct answer. Since Jen was employed on February 1, 2009, as of December 31, 2011, the employer's (Komp's) contributions have not vested and, therefore, do not "belong" to Jen and should not be included in Jen's personal statement of financial condition.

B

Correct!

Jen's personal statement of financial condition should report only the contributions and earnings to which Jen has a claim (i.e., that have vested). Thus, the correct answer is Jen's salaries of $21,000 + $23,000 + $26,000 = $70,000 x Jen's contribution rate of 10% = $7,000, plus the earnings on those contributions of $1,200 (given) = $8,200, the correct answer. Since Jen was employed on February 1, 2009, as of December 31, 2011, the employer's (Komp's) contributions have not vested and, therefore, do not "belong" to Jen and should not be included in Jen's personal statement of financial condition.

12

AICPA.100930FAR-OFS-SIM
Personal Financial Statements

On May 31, 20X7, Quay owned a $10,000 whole-life insurance policy with a cash-surrender value of $4,500, net of loans of $2,500. In Quay's May 31, 20X7, personal statement of financial condition, what amount should be reported as investment in life insurance?
A. $4,500
B. $7,000
C. $7,500
D. $10,000

A
Correct!

In a personal statement of financial condition, a life insurance policy should be reported at cash surrender value less any loan(s) outstanding against the policy. The facts in this question state that the policy has "a cash-surrender value of $4,500, net of loans of $2,500." So, although the policy has a $2,500 loan outstanding against it, that amount already has been deducted (net of loans) in determining the $4,500 value.

B
Incorrect...

This incorrect answer ($7,000) results from adding the amount of loans ($2,500) to the net cash surrender value ($4,500), an incorrect approach. In a personal statement of financial condition, a life insurance policy should be reported at cash surrender value less any loan(s) outstanding against the policy. The facts in this question state that the policy has "a cash-surrender value of $4,500, net of loans of $2,500." The life insurance policy should be reported at $4,500, the amount net of loans.

C
Incorrect...

This incorrect answer ($7,500) results from deducting the amount of loans ($2,500) from the death benefit ($10,000), which is an incorrect approach. In a personal statement of financial condition, a life insurance policy should be reported at cash surrender value less any loan(s) outstanding against the policy. The facts in this question state that the policy has "a cash-surrender value of $4,500, net of loans of $2,500." Thus, the life insurance policy should be reported at $4,500, the amount net of loans.
D
Incorrect...

This incorrect answer ($10,000) results from using the death benefit amount as the amount to be reported as investment in life insurance, an incorrect approach. In a personal statement of financial condition, a life insurance policy should be reported at cash surrender value less any loan(s) outstanding against the policy. The facts in this question state that the policy has "a cash-surrender value of $4,500, net of loans of $2,500." Thus, the life insurance policy should be reported at $4,500, the amount net of loans.

13

AICPA.100933FAR-OFS-SIM
Personal Financial Statements

Personal financial statements should report an investment in life insurance at the
A. Face amount of the policy less the amount of premiums paid.
B. Cash value of the policy less the amount of any loans against it.
C. Cash value of the policy less the amount of the premiums paid.
D. Face amount of the policy less the amount of any loans against it.

B
Correct!

Assets should be reported at estimated current value (fair value), which for a life insurance policy is the current cash value, less the settlement amount of any loans against the life insurance policy.
C
Incorrect...

An investment in life insurance should not be reported in personal financial statements at the cash value of the policy less the amount of premiums paid. As an asset, an investment in life insurance should be reported at estimated current value (fair value), which for a life insurance policy is the current cash value, less the settlement amount of any loans against the policy. The premium payments, in part, establish the cash value of the policy and should not be subtracted from the cash value.

14

Personal Financial Statements
AICPA.100935FAR-OFS-SIM


Clint owns 50% of Vohl Corp.'s common stock. Clint paid $20,000 for this stock in 2006. As of December 31, 2011, Clint's 50% stock ownership in Vohl had a fair value of $180,000. Vohl's cumulative net income and cash dividends declared for the five years ended December 31, 2011, were $300,000 and $40,000, respectively. In Clint's personal statement of financial condition on December 31, 2011, what amount should be shown as the investment in Vohl?
A. $20,000
B. $150,000
C. $170,000
D. $180,000

C
Incorrect...

This incorrect answer ($170,000) results from reporting the investment in Vohl at 50% of Vohl's cumulative net income since the stock was acquired by Clint ($300,000) plus 50% of the cash dividends declared by Vohl since the stock was acquired by Clint ($40,000). Thus, this incorrect calculation was $300,000 + $40,000 = $340,000 x .50 = $170,000, an incorrect answer. Assets should be reported in a personal statement of financial condition at estimated current value (fair value), which for the Vohl stock is $180,000 on December 31, 2011.

D

Correct!

Assets should be reported in a personal statement of financial condition at estimated current value (fair value), which for the Vohl stock is $180,000 on December 31, 1991. The cumulative income earned and cash dividends paid by Vohl since it was acquired by Clint would enter into the determination of Clint's annual income during the prior 5 years, but would not enter into the determination of the estimated current value of the investment on December 31, 2011.

15

PQ6984
IFRS for SMEs
There are separate international standards for preparing financial statements by small- and medium-sized entities.
True
False

False

16

AICPA.100902FAR-OFS-SIM
IFRS for SMEs

Under IFRS for SMEs, which of the following methods, if any, can be used by an investor to account for an investment in another entity (an associate) over which the investor has significant influence?
Cost Method Equity Method
Yes Yes
Yes No
No Yes
No No

Incorrect...

Under IFRS for SMEs, both the cost and equity method may be used by an investor to account for an investment in another entity (called an "associate" in IFRS for SMEs) over which the investor has significant influence. This answer would be correct under U.S. GAAP because only the equity method is required; the cost method may not be used.

BCD
Incorrect...

Under IFRS for SMEs, both the cost and equity method may be used by an investor to account for an investment in another entity (called an "associate" in IFRS for SMEs) over which the investor has significant influence. This answer would be correct under U.S. GAAP because only the equity method is required; the cost method may not be used.

17

AICPA.100904FAR-OFS-SIM


Under IFRS for SMEs, which of the following, if any, must be disclosed in financial statements?
Earnings per Share (EPS) Information by Segment
Yes Yes
Yes No
No Yes
No No

ABC
Incorrect...

Under IFRS for SMEs, neither earnings per share (EPS), nor information by segment is required in financial statements. Since financial statements prepared under IFRS for SMEs are those of entities not traded on exchanges or otherwise required to file with regulatory agencies, earnings per share and segment reporting are not considered important information for users.

D
Correct!

Under IFRS for SMEs, neither earnings per share (EPS), nor information by segment is required in financial statements. Since financial statements prepared under IFRS for SMEs are those of entities not traded on exchanges or otherwise required to file with regulatory agencies, earnings per share and segment reporting are not considered important information for users. These are two of the simplifications in IFRS for SMEs that make the standards less burdensome than either U.S. GAAP or full IFRS.

18

AICPA.921113FAR-TH-FA
cash

On October 31, 2005, Dingo, Inc. had cash accounts at three different banks. One account balance is segregated solely for a November 15, 2005, payment into a bond sinking fund. A second account, used for branch operations, is overdrawn. The third account, used for regular corporate operations, has a positive balance.
How should these accounts be reported in Dingo's October 31, 2005, classified balance sheet?

A. The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability.
B. The segregated and regular accounts should be reported as current assets, and the overdraft should be reported as a current liability.
C. The segregated account should be reported as a noncurrent asset, and the regular account should be reported as a current asset net of the overdraft.
D. The segregated and regular accounts should be reported as current assets net of the overdraft.

A
Correct!

The accounts are with different banks. Thus, the accounts cannot be offset against one another.
The overdraft is a liability because the bank honored a check or withdrawal causing the account to be negative. The firm owes the bank this amount.

The regular corporate account is part of the cash account, a current asset. The segregated account is a long-term investment. The cash in this asset is set aside for a specific purpose. There is no intent to use the cash for ordinary operating purposes.

B
Incorrect...

The segregated account is a long-term investment. The cash in this asset is set aside for a specific purpose. There is no intent to use the cash for ordinary operating purposes.

D
Incorrect...

Incorrect on two counts. First, the segregated account is a long-term investment. The cash in this asset is set aside for a specific purpose. There is no intent to use the cash for ordinary operating purposes. The segregated account should not be merged with the other accounts.
Second, accounts with different banks cannot be offset. The overdrawn account cannot be offset against the regular corporate account.

19

AICPA.940512FAR-FA
Cash


The following information pertains to Grey Co. on December 31, 2003:
Checkbook balance
$12,000
Bank statement balance
16,000
Check drawn on Grey's account, payable to a vendor, dated and recorded 12/31/03 but not mailed until 1/10/04
1,800
On Grey's December 31, 2003 balance sheet, what amount should be reported as cash?

A. $12,000
B. $13,800
C. $14,200
D. $16,000

A, C, D
Incorrect...

The $1,800 check should be added back to the cash account. The check has not been mailed. Thus, no cash payment has been made.

C

Incorrect...

Incorrect on two counts. This answer deducts the $1,800 check from the bank statement balance. The check should be added, not subtracted, to the checkbook balance, not the bank statement balance. This check reduced the balance in the checkbook but was not mailed. Thus, the amount remains in Grey's cash balance at the end of the year. The bank statement balance is not the correct balance because information about transactions affecting cash near the end of the month, recorded by Grey, did not reach the bank by the cutoff date.

B
Correct!

The correct cash balance is the balance per the checkbook ($12,000) plus the $1,800 check written to the vendor, for a total of $13,800.

This check reduced the balance in the checkbook but was not mailed. Thus, the amount remains in Grey's cash balance at the end of the year. The bank statement balance is not the correct balance because information about transactions affecting cash near the end of the month, recorded by Grey, did not reach the bank by the cutoff date.

20

AICPA.930501FAR-P1-FA

The following is Gold Corp.'s June 30, 2004, trial balance:

Cash overdraft
$ 10,000
Accounts receivable, net
$ 35,000
Inventory
58,000
Prepaid expenses
12,000
Land held for resale
100,000
Property, plant, and equipment, net.
95,000
Accounts payable and accrued expenses
32,000
Common stock
25,000
Additional paid-in capital
150,000
Retained earnings
83,000
_________
_________
$300,000
$300,000
========
========
Additional information:
Checks amounting to $30,000 were written to vendors and recorded on June 29, 2004, resulting in a cash overdraft of $10,000. The checks were mailed on July 9, 2004.
Land held for resale was sold for cash on July 15, 2004.
Gold issued its financial statements on July 31, 2004.
In its June 30, 2004, balance sheet, what amount should Gold report as current assets?

A. $225,000
B. $205,000
C. $195,000
D. $125,000

A
Correct!

Current assets are those assets expected to be consumed or realized in cash within one year of the balance sheet date. There is no overdraft because the checks were not sent as of the balance sheet date. Thus, the balance sheet should disclose $20,000 in cash ($30,000 - $10,000).

The land held for resale is a current asset because it is expected to be sold in the next year (and the corroboration of this expectation was known before the issuance of the financial statements).

Cash
$ 20,000
Net accounts receivable
35,000
Inventory
58,000
Prepaid expenses
12,000
Land held for resale
100,000
Total current assets
$225,000

21

AICPA.901101FAR-P1-FA
Bank Reconciliations


In preparing its August 31, 1990 bank reconciliation, Apex Corp. has the following information available:
Balance per bank statement, 8/31/90 $18,050
Deposit in transit, 8/31/90 3,250
Return of customer's check for insufficient funds, 8/31/90 600
Outstanding checks, 8/31/90 2,750
Bank service charges for August 100
On August 31, 1990, Apex's correct cash balance is
A. $18,550
B. $17,950
C. $17,850
D. $17,550

D
Incorrect...

This answer does not adjust the balance per bank statement by the correct amounts. The following is the correct adjustment:
Balance per bank statement $18,050
Plus deposit in transit 3,250
Less outstanding checks (2,750)
Equals ending cash balance $18,550

A
Correct!

Balance per bank statement $18,050
Plus deposit in transit 3,250
Less outstanding checks (2,750)
Equals ending cash balance $18,550

The effects of the bank service charges and the insufficient funds check are already reflected in the balance per bank statement. The bank was the source of that information.

22

AICPA.900501FAR-P1-FA
Bank Reconciliations

Poe, Inc. had the following bank reconciliation at March 31, 2005:
Balance per bank statement, 3/31/05 $46,500
Add deposit in transit 10,300
56,800
Less outstanding checks 12,600
Balance per books, 3/31/05 $44,200
Data per bank for the month of April 2005 follow:
Deposits $58,400
Disbursements 49,700

All reconciling items at March 31, 2005 cleared the bank in April. Outstanding checks at April 30, 2005 totaled $7,000. There were no deposits in transit at April 30, 2005. What is the cash balance per books at April 30, 2005?
A. $48,200
B. $52,900
C. $55,200
D. $45,900

B
Incorrect...

$52,900 equals the book balance at 3/31 plus deposits per the bank records in April less the disbursements per the bank records in April.
However, the bank records do not accurately reflect all the relevant transactions in April per the books. For example, the deposits per the bank records in April include a deposit made in March (the deposit in transit for that month). Therefore, the bank records must be adjusted for differences between the bank statement and the book records:
Balance per books, 3/31 $44,200
Deposits per bank, April $58,400
Less deposit in transit, 3/31 (10,300)
Equals deposits made by firm in April 48,100
Checks clearing bank in April $49,700
Less outstanding checks, 3/31 (12,600)
Plus outstanding checks, 4/30 7,000
Equals checks written by firm in April (44,100)
Balance per books, 4/30 $48,200

A

Correct!

Balance per books, 3/31 $44,200
Deposits per bank, April $58,400
Less deposit in transit, 3/31 (10,300)
Equals deposits made by firm in April 48,100
Checks clearing bank in April $49,700
Less outstanding checks, 3/31 (12,600)
Plus outstanding checks, 4/30 7,000
Equals checks written by firm in April (44,100)
Balance per books, 4/30 $48,200

23

AICPA.930512FAR-P1-FA


The following information relates to Jay Co.'s accounts receivable for 2004:

Accounts receivable, 1/1/04
$ 650,000
Credit sales for 2004
2,700,000
Sales returns for 2004
75,000
Accounts written off during 2004
40,000
Collections from customers during 2004
2,150,000
Estimated future sales returns at 12/31/04
50,000
Estimated uncollectible accounts at 12/31/04
110,000
What amount should Jay report for accounts receivable, before allowances for sales returns and uncollectible accounts, on December 31, 2004?

A. $1,200,000
B. $1,125,000
C. $1,085,000
D. $925,000

A,C,D
Incorrect...

This amount is net accounts receivable, which equals gross accounts receivable less the allowances for future sales returns and uncollectible accounts:
AR 1/1 + Credit sales - Sales returns - Write-offs - Collections = AR 12/31

AR 12/31 - estimated sales returns - estimated uncollectible accounts = net AR

$650,000 + $2,700,000 - $75,000 - $40,000 - $2,150,000 = $1,085,000
$1,085,000 - $50,000 - $110,000 = $925,000

C
Correct!

The question is asking for the gross accounts receivable balance, before allowances for future sales returns, allowances, and uncollectible accounts:
AR 1/1 + Credit sales - Sales returns - Write-offs - Collections = AR 12/31
$650,000 + $2,700,000 - $75,000 - $40,000 - $2,150,000 = $1,085,000

24

Direct Write-Off and Allowance
AICPA.990506FAR-FA


In its December 31 balance sheet, Butler Co. reported trade accounts receivable of $250,000 and related allowance for uncollectible accounts of $20,000.
What is the total amount of risk of accounting loss related to Butler's trade accounts receivable, and what amount of that risk is off-balance sheet risk?

Risk of accounting loss Off-balance sheet risk
$0 $0
$230,000 $0
$230,000 $20,000
$250,000 $20,000

A
Correct!

This question requires an understanding of two accounting concepts:

1. Risk of accounting loss on accounts receivable (credit risk). This is the risk of loss resulting from not collecting amounts due from sales made on credit, and is the total amount of loss that Butler would suffer if those who owe it failed to make any payments and the receivables proved to be of no value. Since Butler's net carrying value of accounts receivable is $230,000 ($250,000 - $20,000), that is the amount of risk of accounting loss.

2. Off-balance sheet risk: This is the amount of risk of loss that does not show on the balance sheet. Since all of Butler's net accounts receivable show on the balance sheet, there is no off-balance sheet risk associated with the accounts receivable.

25

AICPA.941111FAR-FA
Direct Write-Off and Allowance

Mare Co.'s December 31, 2005, balance sheet reported the following current assets:

Cash
$ 70,000
Accounts receivable
120,000
Inventories
60,000
Total
$250,000
========
An analysis of the accounts disclosed that accounts receivable consisted of the following:

Trade accounts
$ 96,000
Allowance for uncollectible accounts
(2,000)
Selling price of Mare's unsold goods out on consignment, at 130% of cost, not included in Mare's ending inventory
26,000
_________
Total
$120,000
========
On December 31, 2005, the total of Mare's current assets is

A. $224,000
B. $230,000
C. $244,000
D. $270,000

Incorrect...

This incorrect answer fails to correctly adjust for the gross profit included in inventory or include the other items that belong in current assets.
Corrected total current assets is computed as follows:

$250,000 - $26,000 + $26,000/1.30 = $244,000.

B
Incorrect...

This incorrect answer fails to correctly adjust for the gross profit included in inventory or include the other items that belong in current assets.
Corrected total current assets is computed as follows:

$250,000 - $26,000 + $26,000/1.30 = $244,000.

26

The Stellar Retailing Company uses the allowance method to account for uncollectible accounts. In the past, when the firm was smaller, the direct write-off method was used. But now, following a considerable increase in credit sales, the firm has also experienced an increase in bad debts. The firm is able to use past information about uncollectibles to justify the use of the allowance method. For the most recent year (2012), the firm has developed the following data for analysis.

Data from the December 31, 2011 Stellar Retailing Company balance sheet follow:

Accounts receivable $300,000
Allowance for uncollectible accounts 25,000
Data for 20112
Credit sales $3,800,000
Cash sales 500,000
Sales returns and allowances (granted before customer remittance) 450,000
Accounts written off 100,000
Collections on accounts written off in 2011 8,000
Ending balance, accounts receivable 400,000
Ending balance, allowance for uncollectible accounts 30,000
Using the information above, provide the details that would have been posted to the following accounts during 2012. Enter the appropriate account titles in column A by double clicking the shaded box and selecting the desired account titles from the list provided. Account titles may be used any number of times or not at all. In the same manner select and enter the appropriate amounts in column B. Use a minus sign or brackets to indicate the amount is subtracted from the account total.
B6 lock copy cut paste
A B
1 Accounts receivable
2 Beginning balance $300,000
3 Credit sales 3800000
4 Credit sales returns and allowances -450000
5
6 Cash collected on account -3150000
7
8 Ending balance $400,000

9 Allowance for uncollectible accounts

10 Beginning balance $25,000
11 Write offs -100000
12 Collections on accounts written off 8000
13 Bad debt expense 97000
14
15 Ending balance $30,000

1 Accounts receivable
2 Beginning balance $300,000
3 Credit sales 3800000
4 Credit sales returns and allowances -450000
5 Write offs -100000
6 Cash collected on account -3150000
7
8 Ending balance $400,000
9 Allowance for uncollectible accounts
10 Beginning balance $25,000
11 Write offs -100000
12 Collections on accounts written off 8000
13 Bad debt expense 97000
14
15 Ending balance $30,000

27

AICPA.110576FAR
ncome Statement and Balance Sheet Approa


Marr Co. had the following sales and accounts receivable balances, prior to any adjustments at year end:
Credit sales $10,000,000
Accounts receivable 3,000,000
Allowance for uncollectible accounts (debit balance) 50,000
Marr uses 3% of accounts receivable to determine its allowance for uncollectible accounts at year end. By what amount should Marr adjust its allowance for uncollectible accounts at year end?

A. $0
B. $40,000
C. $90,000
D. $140,000

B
Incorrect...

A $40,000 adjustment will still leave the allowance account with a $10,000 debit balance. The allowance account is a contra account to accounts receivable and it has a credit balance.

C
Incorrect...

$90,000 is the balance the allowance should be - not the amount of the adjustment. The allowance balance should be 3% of the AR balance of $3,000,000 or $90,000, the question asked for the amount of the adjustment to get to $90,000.

D

Correct!

The amount of the adjustment to get the $50,000 debit balance to a $90,000 (3% x $3,000,000) credit balance is $140,000.

28

Income Statement and Balance Sheet Appr
AICPA.941145FAR-FA

Inge Co. determined that the net value of its accounts receivable on December 31, 2005, based on an aging of the receivables, was $325,000. Additional information is as follows:
Allowance for uncollectible accounts - 1/1/05
$ 30,000
Uncollectible accounts written off during 2005
18,000
Uncollectible accounts recovered during 2005
2,000
Accounts receivable at 12/31/05
350,000
For 2005, what would be Inge's uncollectible accounts expense?

A. $5,000
B. $11,000
C. $15,000
D. $21,000

B
Correct!

This question requires a determination of the pre-adjustment balance in the allowance account, and the ending balance. The difference between these two amounts is the increase in the account needed, which is also the amount recognized as bad debt expense. The aging method first determines the required ending balance in the allowance account, and then places the amount needed to increase the account to this required balance into the allowance account.
The pre-adjustment allowance balance =
Beginning balance - Write-offs + Recoveries =
$30,000 - $18,000 + $2,000 = $14,000

The ending allowance balance =
$350,000 ending gross AR - $325,000 ending net value of AR = $25,000

Therefore, bad debt expense is the amount needed to bring the allowance balance up to the ending balance of $25,000. The increase needed is $11,000 ($25,000 - $14,000).

29

AICPA.940515FAR-FA
Income Statement and Balance Sheet Appr


Delta, Inc. sells to wholesalers on terms of 2/15, net 30. Delta has no cash sales but 50% of Delta's customers take advantage of the discount. Delta uses the gross method of recording sales and trade receivables. An analysis of Delta's trade receivables balances on December 31, 2004, revealed the following:

Age Amount Collectible
0 - 15 days $100,000 100%
16 - 30 days 60,000 95%
31 - 60 days 5,000 90%
Over 60 days 2,500 $500
$167,500
=========
In its December 31, 2004 balance sheet, what amount should Delta report for allowance for discounts?

A. $1,000
B. $1,620
C. $1,675
D. $2,000

D
Incorrect...

Incorrect because only 1/2 of the customers take the discount. The correct age category was used in deriving this answer, but this answer is twice the correct answer because the 1/2 factor was not applied.

30

AICPA.090655.FAR.II.B


Income Statement and Balance Sheet Approach
When the allowance method of recognizing uncollectible accounts is used, how would the collection of an account previously written off affect accounts receivable and the allowance for uncollectible accounts?

Accounts receivable Allowance for uncollectible accounts
Increase Decrease
Increase No effect
No effect Decrease
No effect Increase

D
Correct!

The collection reverses the reduction in the allowance account when the specific account was written off. There is no net change in gross accounts receivable because the account was collected. The two journal entries often given for this transaction are:

(1) dr. Accounts receivable,
cr. Allowance;
(2) dr. Cash;
cr. Accounts receivable.

The first entry reinstates the allowance. The offsetting debits and credits for accounts receivable in both two entries provide an internal record of the transaction.

31

AICPA.950509FAR-FA
Income Statement and Balance Sheet Appr

On January 1, 2006, Jamin Co. had a credit balance of $260,000 in its allowance for uncollectible accounts.
Based on past experience, 2% of Jamin's credit sales have been uncollectible. During 2006, Jamin wrote off $325,000 of uncollectible accounts. Credit sales for 2006 were $9,000,000.

In its December 31, 2006 balance sheet, what amount should Jamin report as allowance for uncollectible accounts?

A. $115,000
B. $180,000
C. $245,000
D. $440,000

Example:
Credit sales for 20x7: $500,000
In the past five years, approximately 5% of credit sales have been uncollectible. The bad debt expense for 20x7 is $25,000 (.05 x $500,000). Please note the bad debt expense is $25,000 regardless of the balance in the allowance account prior to the adjusting entry.
B
Incorrect...

This answer is 2% of credit sales.
This amount influences the ending balance but the allowance account had a beginning balance, and was also affected by write-offs during the year. The credit sales estimation method does not directly compute the ending balance in the allowance account. It is the aging method that directly computes this balance.

A
Correct!

The ending allowance balance equals:
Beginning balance - write-offs + 2% of credit sales =
$260,000 - $325,000 + .02($9,000,000) = $115,000

Write-offs reduce the allowance balance, and the adjusting entry at the end of the year recognizes 2% of credit sales as bad debt expense by increasing the allowance balance.