The Flatiron Pub provides catering services to local businesses. The following information was available for The Flatiron Pub for the years ended December 31, 2016 and 2017.

	December 31, 2016	December 31, 2017
Cash	\( 2,000	\) 1,685
Accounts receivable	46,000	?
Allowance for doubtful accounts	550	?
Other current assets	8,500	7,925
Current liabilities	37,000	44,600
Total credit sales	205,000	255,000
Collections on accounts receivable	190,000	228,000

Flatiron management is preparing for a meeting with its bank concerning renewal of a loan and has collected the following information related to the above balances.

1. The cash reported at December 31, 2017, reflects the following items: petty cash \(1,575 and postage stamps \)110. The other current assets balance at December 31, 2017, includes the checking account balance of \(4,000.
2. On November 30, 2017, Flatiron agreed to accept a 6-month, \)5,000 note bearing 12% interest, payable at maturity, from a major client in settlement of a \(5,000 bill. The above balances do not reflect this transaction.
3. Flatiron factored some accounts receivable at the end of 2017. It transferred accounts totaling \)10,000 to Final Factor, Inc. with recourse. Final Factor will receive the collections from Flatiron’s customers and will retain 2% of the balances. Final Factor assesses Flatiron a finance charge of 3% on this transfer. The fair value of the recourse liability is \(400. However, management has determined that the amount due from the factor and the fair value of the resource obligation have not been recorded, and neither are included in the balances above.
4. Flatiron charged off uncollectible accounts with balances of \)1,600. On the basis of the latest available information, the 2017 provision for bad debts is estimated to be 2.5% of accounts receivable.

Accounting

1. Based on the above transactions, determine the balance for

(1) Accounts Receivable and

(2) Allowance for Doubtful Accounts at December 31, 2017.

1. Prepare the current assets section of The Flatiron Pub’s balance sheet at December 31, 2017.

Analysis

1. Compute Flatiron’s current ratio and accounts receivable turnover for December 31, 2017. Use these measures to analyze Flatiron’s liquidity. The accounts receivable turnover in 2016 was 4.37.
2. Discuss how the analysis you did above of Flatiron’s liquidity would be affected if Flatiron had transferred the receivables in a secured borrowing transaction.

Principles

What is the conceptual basis for recording bad debt expense based on the percentage-of-receivables approach at December 31, 2017?

Step by step solution

01

Step-by-Step Solution Step 1: Meaning of Trade receivable

In accounting terms, trade receivables are anything that has been sold that a company owes another company. Another way, trade receivables are what a company owes for goods and services.

02

Explaining the Accounting part

(a1) Determining the balance of Account receivable

Accounts Receivable
Beginning balance	$46,000
Credit sales during 2017	255,000
Collections during 2017	(228,000)
Charge-offs	(1,600)
Factored receivables	(10,000)
Ending balance	$61,400

(a2) Determining the balance of doubtful accounts

Allowance for Doubtful Accounts
Beginning balance	$550
Charge-offs	(1,600)
2017 Bad Debt Expense	2,585
Ending balance	$1,535

Working notes:

Calculating ending balance

$\begin{array}{c}\text{Ending\hspace{0.17em}balance}=\text{Balance\hspace{0.17em}ofaccount\hspace{0.17em}receivable}\times \text{Rate\hspace{0.17em}of\hspace{0.17em}bad\hspace{0.17em}recoverable}\\ =\$61,400\times 2.5\%\\ =\$1,535\end{array}$

Calculating Bad debt expense

$\begin{array}{c}\text{Bad\hspace{0.17em}debt\hspace{0.17em}expense}=\text{Ending\hspace{0.17em}balance\hspace{0.17em}}+\text{Charge\hspace{0.17em}offs}-\text{Begining\hspace{0.17em}balance}\\ =\$1,535+\$1,600-\$550\\ =\$2,585\end{array}$

(b) Preparing the current assets section

Current assets section of December 31, 2017, The Flatiron Pub’s balance sheet:

Cash	$ 5,575
Accounts receivable (net of $1,535 allowance for uncollectible)	59,865
Interest receivable	50
Due form factor	200
Note receivable	5,000
Postage stamps	110
Other	3,925
Total current assets	$74,725

Working notes:

Calculation of the amount of cash

$\begin{array}{c}\text{Cash}=\text{Petty\hspace{0.17em}cash}+\text{Other\hspace{0.17em}balance}\\ =\$1,575+\$4,000\\ =\$5,575\end{array}$

Calculation of Net Account receivable

$\begin{array}{c}\text{Account\hspace{0.17em}receivable}=\text{Account\hspace{0.17em}receivable\hspace{0.17em}ending\hspace{0.17em}balance}-\text{Allowance\hspace{0.17em}for\hspace{0.17em}doubtful\hspace{0.17em}ending\hspace{0.17em}balance}\\ =\$61,4000-\$1,535\\ =\$59,865\end{array}$

Calculation of interest receivable

$\begin{array}{c}\text{Interest\hspace{0.17em}receivable}=\text{Note\hspace{0.17em}receivable}\times \text{Interest\hspace{0.17em}rate}\times \frac{\text{Number\hspace{0.17em}in\hspace{0.17em}month}}{\text{Month\hspace{0.17em}in\hspace{0.17em}a\hspace{0.17em}year}}\\ =\$5,000\times 12\%\times \frac{1}{12}\\ =\$50\end{array}$

Calculation value of due form factor

$\begin{array}{c}\text{Due\hspace{0.17em}form\hspace{0.17em}factor}=\text{Transfered\hspace{0.17em}accont\hspace{0.17em}balance}\times \text{Retain\hspace{0.17em}rate}\\ =\$10,000\times 2\%\\ =\$10,000\times .02\\ =\$200\end{array}$

03

Explaining the Analysis part

(a)Calculating the current ratio for 2016

$\begin{array}{c}\text{Current\hspace{0.17em}ratio}=\frac{\text{Current\hspace{0.17em}asset}}{\text{Current\hspace{0.17em}liabilities}}\\ =\frac{\$2,000+46,000-\$550+\$8,500}{\$37,000}\\ =1.51\end{array}$

(a) Calculating current assets for 2017

$\begin{array}{c}\text{Current\hspace{0.17em}ratio}=\frac{\text{Current\hspace{0.17em}asset}}{\text{Current\hspace{0.17em}liabilities}}\\ =\frac{\$74,725}{\$44,600+\$400}\\ =1.66\end{array}$

(a) Calculating Accounts receivable turnover

$\begin{array}{c}\text{Accounts\hspace{0.17em}receivable\hspace{0.17em}turnover}=\frac{\text{Net\hspace{0.17em}credit\hspace{0.17em}sales}}{\text{Average\hspace{0.17em}accoubt\hspace{0.17em}receivable}}\\ =\frac{\$255,000}{\frac{\$46,000-\$550}{2}}\\ =\frac{\$255,000}{\$52,658}\\ =4.84\text{\hspace{0.17em}times}\end{array}$

Note: Both the current ratio and the accounts receivable turnover ratio suggest that Flatiron’s liquidity has improved relative to 2016.

04

Explaining the principal part

According to the principle of cost recognition, bad debt expenses should be recorded when sales are made. In that case, income would be overstated by the amount of bad debt expense. Additionally, reporting receivables net of the allowance is a more accurate representation of this asset (at its net realizable value).

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