AuthorTopic: Two questions to bother everyone
@2006-10-15 11:20:28
Hi, guys

I have two questions to consult with you guys. Thanks for your time:))

1) On June 30, 2002, Kip Company had an unadjusted credit balance of $10,000 in its allowance for uncollectible accounts. An analysis of Kip trade accounts receivable at that date revealed the following:

Age Amount Estimated Uncollectible
0-30 days $600,000 5%
31-60 days 40,000 10%
Over 60 days 20,000 70%

What amount should Kip report as allowance for uncollectible accounts in its June 30, 2002, balance sheet?

A) $48,000.
B) $30,000.
C) $40,000.
D) $58,000.

I think the correct answer is D, but correct one is A. I am just confused by the allowance for doubtful account. Could you guys give me some hints about that?

In addition, I think allowance for doubtful accounts should be negative in balance sheet, which indicates allowannce for doubtful accounts increase, right? and we should credit it. Really confusing to me!!!!

2) A firm sells its receivables but retains the risk associated with bad debts. When reviewing this company, how would a financial analyst adjust the firm's debt/equity ratio and the interest coverage ratio, respectively?
A) downward, downward.
B) upward, upward.
C) downward, upward.
D) upward, downward.

I need the specific process of this question. Thanx!

I am looking forward to your helps~~
@2006-10-18 05:32:12
The first one is just the weighted sum of recievables outstanding times the estimate for uncollectibles. The existing $10,000 is not relevant.

The second one i believe is D since selling recievables usually entails recieving a percentage in the dollar for every dollar of recievable sold, there for reducing current assets which flows on on to reduce equity, which leads to higher D/E. Also, selling recievables would reduce Net Income for same reason above, leading to lower interest coverage. Am i right?
@2006-10-18 11:06:54
Well, generally when u sell recievables, u will sell for a discount to the nomial value. For example, if i have $100 of recievables, i may sell for $80. The discount is because i am getting the entire amount upfront as opposed to having to wait and collect. Now, this transaction would effectively reduce receivables of $100 in the current asset section of the balance sheet with an $80 increase in cash. The net effect is that assets are REDUCED by $20. Now, remebering that asset = liabilities + owners equity, since liabilites remain constant, this means owners equity is also reduced by $20, all else equal. So if equity falls, D/E rises.
@2006-10-19 08:59:22
Out of interest why is the existing $10,000 not relevant in the first question?
@2006-10-29 03:10:17
The existing $10,000 is not relevant because the question asks for the amount to be REPORTED on the balance sheet.

CFA Discussion Topic: Two questions to bother everyone

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