Harris Hat's Enterprises had credit sales of $1,200,000 during the current year.

During
the year, the company identified $25,000 in accounts deemed uncollectible. Cash
collections during the year were $1,150,000 and the accounts receivable balance
decreased to $35,000 at year-end. What is the accounts receivable balance at the
beginning of the year?

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A. $10,000 debit
B. $25,000 debit
C. $15,000 debit
D. $35,000 debit
Explanation

Choice "A" is correct. The accounts receivable account is affected by sales made on
credit to customers, cash collections, write-offs and the conversion of an account
receivable into a note receivable. At times questions will require candidates to back into
an amount using knowledge of increases and decreases within the account.

Accounts Receivable
Date Debit Credit
Beg. balance X
Credit sales 1,200,000
1,150,000 Cash collections
25,000 Write-offs
Change in AR 25,000
End. balance 35,000

The balance in the accounts receivable account based on activity provided is a $25,000
debit or increase to the receivable. If the ending balance of accounts receivable is
$35,000 (given), the beginning balance can be calculated as $10,000 (X + $25,000 =
$35,000).

Choice "B" is incorrect. The $25,000 indicated reflects the net increase to the receivable
account based on activity during the period.

Choice "C" is incorrect. Because accounts receivable has a normal debit balance, this
answer cannot be correct unless the beginning balance was a $15,000 credit or if write-
offs from the analysis of accounts receivable were incorrectly excluded.
Fernandez Company had an accounts receivable balance of $150,000 on December
31, Year 2 and $175,000 on December 31, Year 3. The company wrote off $40,000 of
accounts receivable during Year 3. Sales for Year 3 totaled $600,000, and all sales
were on account.

The amount collected from customers on accounts receivable during Year 3 was:

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A. $575,000
B. $531,000
C. $535,000
D. $600,000
Explanation

Choice "C" is correct. The general format of an account analysis is beginning, add,
subtract, ending.

They provided the beginning and ending balances. They also provided sales; when
something is sold on account, accounts receivable is increased so sales is an add in the
account analysis format.

They also provided the amount of the bad debt write-off for the year; when an account is
written off, accounts receivable is decreased so the write-off is a subtract. Cash
collections is another subtract, and that is what they are asking for.

Beginning balance 150,000

Plus: Sales 600,000
Less: Collections (535,000) (originally a plug)
Less: Write-off of accounts (40,000)
Ending balance 175,000
On June 5 of the current year, Sew-Well Enterprises sold goods to a customer for
$9,500 with credit terms 2/10, net 30. Sowell uses the gross method of accounting for
sales discounts. The customer returned $2,000 of goods on June 6. Sowell receives
payment from the customer on June 8. What amount of cash was received by Sowell
from the customer?

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A. $9,500
B. $9,310
C. $7,500
D. $7,350
Explanation

Choice "D" is correct. The gross method records a sale without regard to the available
discount. If payment is received within the discount period, a sales discount (contra-
revenue) account is debited to reflect the sales discount with a corresponding credit to
accounts receivable to reduce the value to the amount collected.

The cash payment received from the customer would be the initial sale of
$9,500 less the return of goods worth $2,000 or accounts receivable balance of
$7,500 less the 2 percent discount or 98 percent of the receivable (1 – 0.02).

$7,500 × 98% = $7,350 cash collected

Choice "A" is incorrect. The $9,500 amount ignores both the return of $2,000
worth of goods by the customer and does not factor the 2 percent discount
offered for payment within 10 days.

Choice "B" is incorrect. The $9,310 amount ignores both the return of $2,000 worth of
goods by the customer and applies the discount to the initial sales amount of $9,500.
The customer would not pay for returned goods when remitting payment back to Sowell.

Choice "C" is incorrect. The $7,500 amount factors in the return of $2,000 worth of
goods by the customer but does not factor the 2 percent discount offered for payment
within 10 days.
A change in the estimate for bad debts should be:

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A. Treated as an error.
B. Handled retroactively.
C. Considered as an extraordinary item.
D. Treated as affecting the period of the change.
Explanation

Choice "D" is correct. A change in estimate in accounting is a change that is treated

prospectively; it affects the period of change and future years. It is not an error
correction requiring a retroactive adjustment. Any time management makes a change to
an estimate, the effect is treated prospectively. Examples include a change in useful life
to calculate depreciation or a change in the percentage used to estimate bad debt
expense.

Management changed the estimate for bad debts, which requires a prospective
treatment affecting the current year and beyond.

Choice "A" is incorrect. The change in estimate is not an error. Errors take place when
management does not properly implement generally accepted accounting principles. If
management ignored the recognition of expenses in a prior period, for example (an
error in applying GAAP), it would need to be corrected in the current year financials. A
pure change in estimate meaning does not indicate a past error; management made the
best estimate possible given the information available at the time.

Choice "B" is incorrect. Changes in estimates are treated prospectively (current and
going forward), not retroactively (applied to previous periods).

Choice "C" is incorrect. A change in estimate is never treated as an extraordinary item.

In addition, it is important to remember that the extraordinary items concept is no longer
in use for U.S. GAAP or IFRS
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?

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

Choice "D" is correct. Since Marr uses the percentage of accounts receivable method
for estimating bad debts, the ending allowance is calculated by multiply 3% by
$3,000,000, for a required allowance of $90,000.

Note that the unadjusted balance in the allowance account right now is a debit balance
of $50,000. The allowance should be a credit balance, or contra-asset. A debit balance
in the allowance account means that last year was a particularly bad year for Marr and
they wrote off so many bad accounts receivable that they didn't have enough in their
allowance to account for it all.

To adjust from a debit balance in the allowance account of $50,000 to a credit balance
of $90,000, the following journal entry must be recorded:

Debit (Dr) Credit (Cr)

Uncollectible Accounts Expense 140,000
Allowance for Uncollectible Accounts 140,000

($50,000) + $140,000 = $90,000

Choice "A" is incorrect. An adjusting journal entry is required to report an allowance of

$90,000 ($3,000,000 x 3%), so zero is incorrect.
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?

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Accounts Allowance for
receivable uncollectible accounts

A. Increase Decrease

B. Increase No effect

C. No effect Decrease

D. No effect Increase
Explanation

Choice "D" is correct. Accounts receivable - No effect; Allowance for uncollectible

accounts - Increase.

Under the allowance method, the following journal entries are recorded when an
account previously written off is subsequently collected:

JE #1 - To restore the account previously written off:

Debit (Dr) Credit (Cr)

Accounts receivable XX
Allowance for uncollectible accounts XX

JE #2 - To record the cash collection on the account:

Debit (Dr) Credit (Cr)

Cash XX
Accounts receivable XX

The debit to accounts receivable in JE#1 is offset by the credit to accounts receivable in
JE #2, so there is no effect on accounts receivable. The credit to the allowance for
uncollectible accounts in JE #1 increases the allowance.

Choices "A", "B", and "C" are incorrect, per the above.
Strawser Financial Services utilizes the allowance method to account for bad debts.
During the current year, Strawser received payment from a customer whose account
had been previously written off. What is the effect on each account indicated based on
the subsequent cash collection of account previously written off?

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Allowance for
Accounts Uncollectible
Receivable Accounts
A. Increase Increase
B. Decrease Decrease
C. No effect No effect
D. No effect Increase
Explanation

Choice "D" is correct. Infrequently, a receivable that has been written off is later
collected. The subsequent recovery of an account previously written off requires a
reversal of the initial entry recorded to reinstate the receivable and allowance. Another
entry is necessary to show the collection of cash and reduce the accounts receivable.

Examples can be a powerful way to visualize the effects of these changes. Assume, a
subsequent cash collection of $10,000 for an account previously written off.

Reverse Write-Off
DR Accounts receivable $10,000
CR Allowance for uncollectible accounts $10,000

Re-establish the accounts receivable and the corresponding allowance.

Collection of Cash
DR Cash $10,000
CR Accounts receivable $10,000

Receive cash and reduce amount owed by customer.

The net effect is accounts receivable is increased and decreased by $10,000, resulting
in no effect on the accounts receivable balance. The allowance account increases when
the reversal of the previously recorded write-off was recorded.

Choice "A" is incorrect. The effect of subsequent collections of accounts receivable

results in both an increase and decrease of equal amounts resulting in no change in the
Karrington Co. is trying to determine how to account for the financing of receivables with
recourse. Karrington knows the transaction must be recorded as either a sale or a
secured borrowing. Under U.S. GAAP, which element is required to account for the
transaction as a sale?

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A. The transferor has right to pledge or exchange the receivables received.
B. The transferor maintains control over the transferred assets.
C. The transferor and its creditors have access to transferred assets.
D. The transferor of the receivables surrenders control of assets.
Explanation

Choice "D" is correct. In order for a company to account for the transfer of receivables
as a sale, the most critical element is the extent to which the company has transferred
control of the assets to the factor. In order to demonstrate the surrender of control, all of
the following conditions must be present:

 Transferred assets are beyond the reach of the transferor and its creditors.
 The transferor surrenders control of the future economic benefits of the
receivables to the factor (the buyer).
 The transferor cannot be required to repurchase the receivables but may be
required to replace the receivables with other similar receivables.

The transferor must surrender control of the assets to account for the transaction as a
sale. This element is crucial to determine whether a sale has taken place or a secured
borrowing.

Choice "A" is incorrect. The transferee, not the transferor, has the right to pledge or
exchange the receivables received.

Choice "B" is incorrect. The critical element in accounting for the financing of
receivables as a sale is the transfer of control.

Choice "C" is incorrect. A surrender of control is demonstrated by the lack of access to

transferred assets by the transferor and its creditors.
In a year-end closing process review of the May 31, Year 2, financial statements,
management discovered that the interest income accrual on Simpson Co.'s notes
receivable was omitted. The amounts omitted were calculated as follows:

May 31, Year 1 $91,800

May 31, Year 2 $100,200

The May 31, Year 2, entry to correct for these errors, ignoring the effect of income
taxes, would include a:

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A. Credit to retained earnings for $91,800.
B. Credit to interest revenue for $91,800.
C. Debit to interest revenue for $100,200.
D. Credit to interest receivable for $100,200.
Explanation

Choice “A” is correct. The retrospective approach is used for the correction of errors. A
journal entry must be prepared to correct account balances incorrect as a result of the
error. Previous years' financial statements must be restated to present corrected
account balances. When retained earnings are adjusted as a result, a prior period
adjustment to the beginning retained earnings balance is presented, and a disclosure
note describing the error correction is needed.

Simpson Co. omitted interest income over the previous two years. The $91,800
omission from the fiscal year ended May 31, Year 1, would require a $91,800 credit to
retained earnings (and a $91,800 debit to either notes receivable or interest receivable)
in order to increase retained earnings by the $91,800 interest income, which Simpson
failed to record. Because the books for the fiscal year ended May 31, Year 2, have not
yet been closed, management would debit either notes receivable or interest receivable
for $100,200 and credit interest income for $100,200. Note that the total debit to either
notes receivable or interest receivable is $192,000: $91,800 in connection with the
$91,800 credit to retained earnings and $100,200 in connection with the $100,200 credit
to interest income.

Choice “B” is incorrect. This answer choice incorrectly indicates a credit to interest
revenue for $91,800. This increases the current year's income, not prior years' income.

Choice “C” is incorrect. This answer incorrectly indicates a debit to interest revenue for
$100,200. A $100,200 credit to interest revenue is needed in order to record interest
income owed to Simpson for the fiscal year ended May 31, Year 2.