Chapter 7, Problem 8BP

a.

To determine

Prepare bank reconciliation statement for Corporation C as at December 31, Year 1, and prepare adjusting journal entries that arise due to bank reconciliation.

Explanation of Solution

Bank reconciliation: Bank statement is prepared by bank. The company maintains its own records from its perspective. This is why the cash balance per bank and cash balance per books seldom agree. Bank reconciliation is the statement prepared by company to remove the differences and disagreement between cash balance per bank and cash balance per books.

Prepare the bank reconciliation of Corporation C as at December 31, Year 1.

Corporation C
Bank Reconciliation
December 31, Year 1
Balance as per bank statement, December 31, Year 1		$104,100
Add: Deposits in transit		16,800
		120,900
Less: Outstanding checks		(12,400)
Adjusted cash balance		$108,500
Balance per depositor’s records, December 31, Year 1		$112,000
Less:
Bank service charge	(100)
NSF check	(2,500)
Error in recording Check Number: 550	(900)	(3,500)
Adjusted cash balance		$108,500

Table (1)

Working Notes:

Calculate book error amount.

$\begin{array}{c}\text{Book error add }\left(\text{deduct}\right)\text{ = Amount recorded}–\text{Actual amount}\\ \text{= \$2,300 – \$3,200}\\ \text{= \$}\left(\text{900}\right)\end{array}$

Description:

• The deposits which are not recorded by the bank are referred to as deposits in transit. Since the deposits in transit are not reflected on the bank statement, the company should add deposits in transit to cash balance per bank, while preparation of bank reconciliation statement.
• Outstanding checks are the checks that are issued by the company, but not yet paid by the bank. When the check is issued for payment, the company deducts the cash balance immediately. But the bank deducts only when the cash is paid for the issued check. So, company deducts the cash balance per bank to remove the differences.
• Banks deduct the service charge for the services rendered like lock box rental, or printed checks. But the company is not aware of such deductions. So, company deducts the cash balance per books while bank reconciliation preparation.
• While bank reconciliation, the NSF check should be deducted from the cash balance per book. This is because the bank could not collect funds from the customer’s bank due to lack of funds. But being recorded as Accounts Receivable previously, the balance should be deducted from books, to increase the Accounts Receivable account.
• The bookkeeper has recorded the check numbered: 550 for computer equipment of $3,200 as $2,300. So, the cash balance increased by $900. Therefore, the balance should be deducted from books, to decrease amount of the cash ledger account balance.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Prepare adjusting journal entries that arise due to bank reconciliation for Corporation H, as on December 31, Year 1.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
December	31	Bank Service Charges			100
		Accounts Receivable			2,500
		Computer Equipment			900
			Cash			3,500
		(Record payment of bank service charges, NSF check, and increase computer equipment)

Table (2)

Description:

• Bank Service Charges is an expense account and the amount is increased because bank has charged service charges. Expenses decrease Equity account and decrease in Equity is debited.
• Accounts Receivable is an asset account. The bank has not collected the amount from the customer due to insufficient funds, which was earlier recorded as a receipt. As the collection could not be made, amount to be received increased. Therefore, increase in asset would be debited.
• Computer Equipment is an asset account. The asset amount was erroneously recorded, and asset is increased by debiting.
• Cash is an asset account. The amount is decreased because bank service charge is paid, bank could not collect amount due to insufficient funds in customer’s account, and a decrease in asset and asset is decreased.

b.

To determine

Compute the amount of cash and cash equivalents to be reported by Corporation C on its balance sheet as at December 31, Year 1.

Explanation of Solution

Cash and cash equivalents: Cash is the money readily available in the form of currency. Cash equivalents are the near-cash items, which are readily convertible into cash.  Cash equivalents have a maturity period of three months, or less than 3 months. Cash equivalents are reported along with cash in the assets section of the balance sheet, as ‘Cash and cash equivalents’.

Compute the amount of cash and cash equivalents to be recorded by Corporation C on its balance sheet as at December 31, Year 1.

Details	Amount ($)
Adjusted cash balance	$108,500
Money market account	150,000
Hugh grade commercial paper	5,000
Cash and cash equivalents	$263,500

Table (3)

Note: Refer to Part (a) for value and computation of adjusted cash balance.

c.

To determine

Prepare the adjusting entry for the accrued interest on the note receivable.

Explanation of Solution

Journalize the adjustment entry of accrued interest revenue on December 31, Year 1.

Date		Accounts and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
December	31	Interest Receivable			135
			Interest Revenue			135
		(Record accrued interest on note)

Table (4)

Description:

• Interest Receivable is an asset account. Since interest to be received has increased, asset value increased, and an increase in asset is debited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Compute amount of interest accrued on December 31, Year 1.

$\begin{array}{c}\text{Interest accrued = }\left\{\begin{array}{l}\text{Principal amount of note × }\\ \text{Rate of interest×}\\ \text{Time period}\left(\text{Monthly interest}\right)\end{array}\right\}\\ \text{= \$18,000×9\%×}\frac{1}{\text{12}}\\ \text{= \$135}\end{array}$

d.

To determine

Compute the amount of net realizable value to be reported by Corporation C on its balance sheet as at December 31, Year 1.

Explanation of Solution

Net realizable value: The value of accounts receivables that could be recognized by the company is referred to as net realizable value. In simple words, net realizable value is accounts receivables, less allowance of uncollectible amount.

Compute the year-end net realizable value of accounts receivable of Corporation C.

Details	Amount ($)	Amount ($)
Accounts receivable, December 31, Year 1:
Accounts receivable, January 1, Year 1	$540,000
Add: Credit sales	6,480,000
Less: Accounts receivable written off	(14,000)
Add: Reinstated accounts receivable	2,500
Less: Accounts receivable collected	(5,252,500)
Accounts receivable, December 31, Year 1		$1,756,000
Less: Allowance for Doubtful Accounts, December 31, Year 1:
Allowance for Doubtful Accounts, January 1, Year 1	$12,000
Add: Uncollectible accounts expense	64,800
Less: Accounts receivable written off	(14,000)
Allowance for Doubtful Accounts, December 31, Year 1		62,800
Net realizable value of accounts receivable		$1,693,200

Table (5)

Working Notes:

Compute uncollectible accounts expense.

$\begin{array}{c}\text{Uncollectible accounts expense = Credit sales×Uncollectible percentage}\\ \text{=\$6,480,000×1\%}\\ \text{=\$64,800}\end{array}$

e.

To determine

Compute the amount of financial assets to be reported by Corporation C on its balance sheet as at December 31, Year 1.

Explanation of Solution

Financial assets: The assets that are easily convertible into cash are referred to as financial assets. These are called as financial assets because these are money represented in the form of assets, and the financial resources or money flows through these assets. Cash, short-term and long-term marketable securities, accounts receivables, and notes receivables are the financial assets of a company.

Compute the amount of financial assets to be reported by Corporation C on its balance sheet as at December 31, Year 1.

Details	Amount ($)
Cash and cash equivalents	$263,500
Marketable securities	245,000
Notes receivable	18,000
Interest receivable	135
Accounts receivable	1,693,200
Total financial assets, December 31, Year 1	$2,219,835

Table (6)

Note: Refer to Part (b) for value and computation of cash and cash equivalents balance, Part (c) for interest receivable, and Part (d) for net realizable value of accounts receivable.

f.

To determine

Evaluate the number of days Corporation C takes to collect the receivables and indicate whether the performance of the corporation is above or below average, if the normal industry standard is an average of 60 days.

Explanation of Solution

Number of days’ sales in receivables: This ratio measures the period of the time receivables are collected in the period. This ratio analyzes the period receivables are outstanding. So, this ratio also gauges the efficacy of collecting receivables. Lower the ratio, more efficient the collection of receivables.

Formula for number of days’ sales in receivables:

$\text{Number of days' sales in receivables =}\frac{\text{ 365 days}}{\text{ Accounts receivable turnover}}$

Accounts receivable turnover: This is the ratio which analyzes the number of times accounts receivables is collected and converted into cash during the period. This ratio gauges the efficacy of collecting receivables. Larger the ratio, more efficient in collecting receivables.

Formula for accounts receivable turnover:

$\text{Accounts receivable turnover = }\frac{\text{Sales}}{\text{ Average accounts receivable}}$

Compute the number of days Corporation C takes to collect the receivables.

Step 1: Compute the net realizable value of accounts receivables as on January 1, Year1.

Details	Amount ($)
Accounts receivable, January 1, Year 1	$540,000
Allowance for Doubtful Accounts balance	12,000
Net realizable value of accounts receivables, January 1	$528,000

Table (7)

Step 2: Compute accounts receivables turnover rate of Corporation C.

$\begin{array}{c}\text{Accounts receivable turnover = }\frac{\text{Net sales}}{\text{ Average accounts receivable}}\\ =\frac{\$6,480,000}{\frac{\$528,000+\$1,693,200}{2}}\\ \text{=}\frac{\text{\$6,480,000}}{\text{\$1,110,600}}\\ \text{= 5}\text{.83 times}\end{array}$

Note: Refer to Table (7) for value and computation of beginning balance of net realizable value of accounts receivables, and Part (d) for net realizable value of accounts receivable.

Step 3: Compute number of days Corporation C takes to collect receivables.

$\begin{array}{c}\text{Number of days =}\frac{\text{ 365 days}}{\text{ Accounts receivable turnover}}\\ \text{=}\frac{\text{ 365 days}}{\text{5}\text{.83 times}}\\ \text{=62}\text{.61 days}\end{array}$

Note: Refer to Step 2 for value and computation of accounts receivable turnover rate.

Analysis: Comparing with the normal industry standard as an average of 60 days, the average collection period of Corporation C of 62.61 days is slightly lower than the standard.