Question

Frank’s Surf Shop sells surfboards. Frank’s uses the accrual basis of accounting. In the month of June, Frank’s sold 200 surfboards at $1,000 each. Frank’s received cash for 80 of the surfboards in June and 110 were paid for in July, in accordance with Frank’s “30 days to pay” policy. Hang Two, one of the surfboard purchasers, was having a tough financial time so after several conversations Frank’s agreed to only accept $6,000 for the 10 surfboards Hang Two purchased. This money was collected in August. Frank’s Surf Shop has not created and does not maintain an allowance for doubtful accounts in its accounting records.

a) How much revenue would Frank’s record for June?

b) What balance sheet accounts are affected in June for these transactions? Indicate whether they are increased or decreased. Quantify the increase or decrease (where you have enough information).

c) Based solely in the information above, what accounts are affected by the receipt of cash in July? Quantify the change (use journal entries if that is easier for you).

d) How would you treat the Hang Two transaction in August? What accounts are affected and by how much?

e) What would the impact of Hang Two’s inability to pay for all the surfboards it purchased be on the company’s income statement if Frank’s had established an allowance for doubtful accounts and the balance was $100,000?

Answer 1

Accrual acoounting: Under the accrual basis of accounting, revenues are reported on the income statement when they are earned. Under the accrual basis of accounting, expenses are matched with the related revenues and/or are reported when the expense occurs, not when the cash is paid.

a. Since Frank is following the accrual basis accounting, Frank would recognise entire sale in June as revenue and make the following Journal Entry when the sale is made [on account or credit basis since frank is following 30 days to pay policy

Date	Account Titles and Explanation	Debit	Credit	Calculation
June	Accounts receivable a/c	$200,000		200 surfboardsx $1,000
	Sales revenue a/c		$200,000
	[Being revenue recognised on sale of 200 surfboards @$1,000 each]

Frank would record revenue of $200,000 in June.

b. I would like to explain with the Journal Entries:

Date	Account Titles and Explanation	Debit	Credit
June	Accounts Receivable a/c	$200,000 [200 x $1,000]
	Sales revenue a/c		$200,000
	[Being revenue recognised on sale of 200 surfboards @
June	Cash a/c	$80,000 [80 x $1,000]
	Accounts Receivable a/c		$80,000
	[Being cash received for 80 surfboards @$1,000 each]

In the above table of Journal Entries, two Balance sheet accounts are affected and they are Accounts Receivable a/c and Cash a/c.

• Accounts Receivable a/c - This Balance sheet account is increased by $200,000 when the sale (200 surfboards) is made and is decreased by $80,000 after the cash is received for the 80 surfboards in June.
• 2. Cash a/c - This Balance sheet account is increased by $80,000 when the cash is received for the 80 surfboards in June.

c. I would to like to explain with the help of Jounral entries:

Date	Account Titles and Explanation	Debit	Credit
July	Cash a/c	$110,000 [110 x $1,000]
	Accounts Receivable a/c		$110,000
	[Being cash received for 110 surfboards @$1,000 each]

In the above table of Journal Entries, two accounts are affected and they are Cash a/c and Accounts Receivable a/c

• Cash a/c - This account is increased by $110,000 when the cash is received from the surfboard purchasers (except Hang Two) for the 110 surfboards in July.
• Accounts Receivable a/c - This account is decreased by $110,000 when the cash is received from the surfboard purchasers (except Hang Two) for the 110 surfboards in July.

d. Treatment the Hang Two transaction in August:

Total surboards sold to Hang Two = 10 surfboards

Sale amount = 10 surfboards x $1,000 = $10,000

Amount received from Hang Two = $6,000

Amount Uncollectable from Hang Two = $10,000 - $6,000 = $4,000

In this case Frank Surf shop does not maintain an allowance for doubtful accounts in its accounting records means that it is following direct written off method for recognising Bad Debts.

Date	Account Titles and Explanation	Debit	Credit
August	Cash a/c	$6,000
	Accounts Receivable a/c		$6,000
	[Being cash received from Hang Two for 10 surfboard
August	Bad debt Expense a/c	$4,000
	Accounts Receivable a/c		$4,000
	[Bad debt expense recognised]

Accounts affected are Cash a/c, Accounts Receivable a/c and Bad Debt Expense a/c.

• Cash a/c - This account is increased by $6,000 when the cash is received in August from Hang Two for the 10 surfboards.
• Accounts Receivable a/c - This account is decreased by $6,000 when the cash is received in August  from Hang Two for the 10 surfboards.
• Bad Debt Expense a/c: Bad Debt Expense a/c is increased by $4,000.

e. Frank’s had established an allowance for doubtful accounts a/c and that means whenever an amount is uncollectable, that uncollectable amount can be set off against this allowance for doubtful accounts a/c.

Total surboards sold to Hang Two = 10 surfboards

Sale amount = 10 surfboards x $1,000 = $10,000

Amount received from Hang Two = Nil

Amount Uncollectable from Hang Two = $10,000 [From Question e]

Jounral entries are as follows when there is Allowance for doubtful accounts a/c:

Date	Account Titles and Explanation	Debot	Credit
August	Allowance for doubtful accounts a/c	$10,000
	Accounts Receivable a/c		$10,000
	[Writting Off of Entire Receivables from the Hang Two]

Impact of having allowance for doubtful accounts:

The main impact is that the bad debt expenses was recognised in the month in which allowance for doubtful accounts but not in the month of August.

In the point d, Bad Debt Expense has been recognised in the month of August where as in point e, the same is recognised in the month of Sale i.e June.