Chapter 6, Problem 6.35C

Case 6.35

LO 3, 6

Capstone analytical review of Chanters 5-6. Analyzing accounts receivable, property, plant, and equipment, and other related accounts (Note: Please refer to Case 4.30 on pages 132-133 for the financial statement data needed for the analysis of this case. You should also review the solution to Case 4.30, provided by your instructor, before attempting to complete this case.)

You have been approached by Gary Gerrard, president and CEO of Gerrard Construction Co., who would like your advice on a number of business and accounting related matters.

Your conversation with Mr. Gerrard, which took place in February 2017, proceeded as follows:

Mr. Gerrard: “The accounts receivable shown on the balance sheet for 2016 are nearly $20 million and the funny tiling is, we just collected a bunch of the big accounts in early December but had to reinvest most of that money in new equipment. At one point last year, more than $40 million of accounts were outstanding! I had to put some pressure on our regular clients who keep falling behind. Normally, I don't bother with collections, but this is our main source of cash flows. My daughter Anna deals with collections and she's just too nice to people. I keep telling her that the money is better off in our hands than in someone else’s! Can you have a look at our books? Some of these clients are really getting on my nerves."

Your reply; “That does seem like a big problem. I'll look at your accounts receivable details and get back to you with some of my ideas and maybe some questions you can help me with. What else did you want to ask me about?’’

Mr. Gerrard: “The other major problem is with our long-term asset management. We don’t have much in the way of buildings, just this office you’re sitting in and the service garage where we keep most of the earthmoving equipment. That’s where the expense of running this business comes in. I’ve always said that I’d rather see a dozen guys standing around leaning against shovels than to see one piece of equipment sit idle for even an hour of daylight! There is nothing complicated about doing ‘dirt work,’ but we’ve got one piece of equipment that would cost over $3 million to replace, at today’s prices. And that’s just it- either you spend a fortune on maintenance or else you’re constantly in the market for the latest and greatest new ‘Cat.’”

Your reply: “So how can I help?”

Mr. Gerrard: “Now that you know a little about our business, I’ll have my son Nathan show you the equipment records. He’s our business manager. We’ve got to sell and replace some of our light-duty trucks. We need to get a handle on the value of some of the older equipment. What the books say, and what it’s really worth, are two different things.

I’d like to know what the accounting consequences of selling various pieces of equipment would be because I don’t want to be selling anything at a loss.’’

Your reply: “Thanks. Gary. I’ll have a chat with Anna and Nathan and get back to you.”

After your discussion with Anna, you analyzed the accounts receivable details and prepared the following aging schedule:

Number of Days Outstanding	Number of AccountsOutstanding	Total AmountOutstanding
0-30	20	$4,480,000
31-60	9	3,200,000
61-120	6	2,640,000
121-lSo	4	2,160,000
>180	11	7,120,000

You’ve noted that Gerrard Construction Co. has not written off any accounts receivable as uncollectible during the past several years. The Allowance for Bad Debts account is included in the chart of accounts but has never been used. No cash discounts have been offered to customers, and the company does not employ a collection agency. Reminder invoices are sent to customers with outstanding balances at the end of every quarter.

After your discussion with Nathan, you analyzed the equipment records related to the three items that the company wants to sell at this time:

Item

DepreciationDate of

PurchaseCostAccumulated

DepreciationBook

ValueEstimated Market Value 2009 Ford F550 Mar 2009 $114,400 $ 77,200 $37,200 $ 28,000 2005 Cat D_llR dozer June 2008 1,020,00 544,200 475,800 590,000 2007 Cat ₆₃₁G scraper Sept 2010 845,400 453,000 392,400 320,000

Nathan explained that Gerrard Construction Co. uses the units-of-production depreciation method and estimates usage on the basis of hours in service for earthmoving equipment and miles driven for all on-road vehicles. You have recalculated the annual depreciation adjustments through December 31, 2016, and are satisfied that the company has made the proper entries. The estimated market values were recently obtained through the services of a qualified, independent appraiser whom you had recommended to Nathan.

Required:

1. Explain what Mr. Gerrard meant when he said, “I keep telling her that the money is better off in our hands than in someone else’s!”
2. What is your overall reaction concerning Gerrard Construction Co.’s management of accounts receivable? What suggestions would you make to Mr. Gerrard that may prove helpful in the collection process?
3. What accounting advice would you give concerning the accounts receivable balance of $19,600,000 at December 31, 2016?
4. What impact (increase, decrease, or no effect) would any necessary adjustment(s) have on the company’s working capital and current ratio? (Note that these items were computed in part g of Case 4.30 and do not need to be recomputed now.)
5. Explain what Mr. Gerrard meant when he said, “We need to get a handle on the value of some of the older equipment. What the books say, and what it’s really worth, are two different things.”
6. Use the horizontal model, or write the journal entries, to show the effect of selling each of the three assets for their respective estimated market values. Partial-year depreciation adjustments for 2017 can be ignored.
7. Explain to Mr. Gerrard why his statement “I don’t want to be selling anything at a loss” does not make economic sense.