How is it possible that the allowance for doubtful accounts

Question

For this assessment, complete Problems 1 and 2. You may use Word or Excel to complete the assessments throughout this course, but you will find Excel to be most helpful for creating spreadsheets. Tutorials for using Excel are provided in the Supplemental Resources in the left navigation menu. If you use Excel, submit the assessment in one Excel document, using separate tabs for each spreadsheet.

Problem 1: Working Capital, Current Ratio, Quick Assets, Acid-Test Ratio

The Sanchez Corporation is preparing its 2012 balance sheet. The company records show the following selected amounts at the end of the accounting period, December 31, 2012:

Total assets	$600,000
Total noncurrent assets	$350,000

Notes payable (8%, due in 6 years)	$40,000
Accounts payable	$60,000
Income taxes currently payable	$15,000
Liability for withholding taxes	$4,000
Rent revenue collected in advance by up to four months	$8,000
Bonds payable (due in 15 years).	$100,000
Wages payable	$6,000
Property taxes payable	$3,000
Note payable (10%, due in 6 months)	$22,000
Interest payable	$1,200
Common stock	$200,000

Use the information provided in the table to compute and answer the following for the Sanchez Corporation:

1. Compute (a) working capital and (b) the quick ratio-quick assets are $120,000.
2. Why is working capital important to management?
3. How do financial analysts use the quick ratio?
4. Would your computations be different if the company reported $250,000 worth of contingent liabilities in the notes to the statements? Explain. Include in your explanation a definition of contingent liabilities and an example of a contingent liability.

Problem 2: Comprehensive Problem

Bring together various financial analysis measures and interpret their meaning in order to draw conclusions about hypothetical companies.

Note that each situation provided is to be considered independently of the others.

Situation A:

The following tables represent selected data from recent financial statements of Lincoln and Samuelson, Inc. (dollars in thousands):

Current assets: Cash and cash equivalents	$4,000	$3,400
Accounts receivable (net of allowances of $32 and $28, respectively)	$6,500	$5,700

Net sales (in millions)	$6,020	$5,425	$5,000
Net income (in millions)	$300	$285	$220

The selected income statement data is for the year ended December 31. The company also reported bad debt expense of $62,000 in 2012; $55,000 in 2011; and $49,500 in 2010.

Using the data provided, complete the following for Lincoln and Samuelson, Inc.:

1. Compute the dollar amount of uncollectible accounts receivable that the company wrote off as uncollectible in 2012. Show all of your work.
2. Assuming all sales were on credit, what amount of cash did the company collect on accounts receivable in 2012? Show all of your work.
3. Compute the company's net profit margin for the three years presented. What does the trend suggest to you about the company?

Situation B:

The Israel Manners Entertainment Group uses the allowance approach to estimate bad debt expense, as is required of all companies with significant sales on accounts receivable. At the end of 2012, the Manners Group reported a balance in accounts receivable of $4,350,000 and estimated that $44,000 of its accounts receivable would likely be uncollectible. The allowance for doubtful accounts has a $1,500 debit balance at year-end, prior to the adjustment needed to raise it to the $44,000 desired amount. Use this information to answer the following questions for the Manners Group:

1. How is it possible that the allowance for doubtful accounts has developed a debit balance instead of a credit balance?
2. What amount of bad debt expense should be recorded for 2012?
3. What amount will be reported on the 2012 balance sheet as the net realizable amount of accounts receivable?

Situation C:

At the end of 2012, the unadjusted trial balance of Donovan, Inc. included $6,000,000 in accounts receivable, a credit balance of $50,000 in the allowance for doubtful accounts, and sales revenue (all on credit) of $200,000,000. Based on knowledge that the current economy is in distress, Donovan increased its bad debt rate estimate to 0.4 percent on credit sales. Use this information to answer the following questions for Donovan, Inc.:

1. What amount of bad debt expense should be recorded for 2012?
2. What amount will be reported on the 2012 balance sheet for the net realizable amount of accounts receivable, after being reduced by the balance in the allowance for uncollectible accounts?

Situation D:

BrightStar Company reported the following inventory records for June 2012:

June 1	Beginning balance	200	$40
June 5	Purchase	600	$42
June 8	Sale @ $100 per unit	500
June 17	Purchase	400	$45
June 23	Sale @ $100 per unit	500

Selling, administrative, and depreciation expenses for the month were $20,000. BrightStar's tax rate is 35 percent. Use this information and the table above to complete the following for BrightStar Company:

1. Calculate the cost of ending inventory and the cost of goods sold under each of the following methods: 
   • a. First in, first out (FIFO).
   • b. Last in, first out (LIFO).
   • c. Weighted average.
2. Using your answers from question 1 above, answer the following: 
   • a. What is the gross profit percentage under the FIFO method?
   • b. What is net income under the LIFO method?
   • c. Which method would you recommend to BrightStar for tax purposes? Explain your recommendation.
   • d. If BrightStar also used the method that you recommended for tax purposes on its balance sheet, would BrightStar's current ratio suffer, compared to the use of FIFO?
3. BrightStar uses the lower of FIFO cost or market method to value its inventory for reporting purposes at the end of the month. If inventory had a market replacement value of $44 per unit, what would BrightStar report in its balance sheet for inventory? Why?

Situation E:

BlackBurn Company purchased the following on January 1, 2012:

• Office Equipment at a cost of $100,000 with an estimated useful life to the company of five years and a residual value of $10,000. The company uses the double-declining-balance method of depreciation for the equipment.
• Factory equipment at an invoice price of $780,000 plus shipping costs of $20,000. The equipment has an estimated useful life of 100,000 hours and no residual value. The company uses the units-of-production method of depreciation for the equipment.
• A patent at a cost of $450,000 with an estimated useful life of 15 years. The company uses the straight-line method of amortization for intangible assets with no residual value.

Use the information above to complete the following for BlackBurn Company:

1. Prepare a partial depreciation schedule for 2012, 2013, and 2014 for the following assets. Round your answers to the nearest dollar. 
   • a. Office equipment.
   • b. Factory equipment. The company used the equipment for 8,000 hours in 2012; 9,000 hours in 2013; and 8,500 hours in 2014.
2. On January 1, 2014, BlackBurn altered its corporate strategy dramatically. The company sold the factory equipment for $700,000 in cash. Record the entry related to the sale of the factory equipment.
3. On January 1, 2014, when the company changed its corporate strategy, its patent had estimated future cash flows of $300,000 and a fair value of $250,000. What would the company report on the income statement (account and amount) regarding the patent on January 2, 2014? Explain your answer. (Hint: You may need to research this question using Internet sources.)