loss. This rate would be applied to the accounts receivable at the date of the balance-sheet to determine the total desired reserve. The amount to set up would be the difference between the reserve already on the books and the desired reserve. This method has the advantage of reducing the carrying value of the accounts receivable to their estimated realizable value at the date of the balance-sheet, but it has the disadvantage that the reserve will probably be called upon to absorb losses not only on the accounts on the books at the date of the balance-sheet but also on accounts arising during the next year, and it may therefore prove to be inadequate. (b) Reserve for trade discounts. It is difficult to understand what object a company could have in setting up such a reserve. Operating reserves are intended to record a decrease in an asset already taken place, such as the reserve for depreciation, a possible or probable loss in the realization of an asset, such as the reserve for bad debts, or a liability, such as a reserve for taxes. A reserve for trade discounts would not seem to be necessary unless there is some uncertainty as to whether or not customers will take advantage of the trade discounts offered. But there is no contingency about true trade discount. The trade discount is deducted on the invoice, and the customer is charged with only the net amount after deducting the discount. After the customer's account has been charged with only the net amount, trade discounts cannot further decrease the amount collected. (c) Reserve for cash discount. There is a contingency in the case of cash discount, for the customer may pay the bill within the discount period or he may fail to do so and lose the discount. If it is desired to value the accounts receivable at the net amount less the discount, it will be necessary to estimate from the records what per cent of the accounts are usually paid by customers within the discount period. This per cent will then be applied to the total open accounts subject to discount and not past due, to ascertain the probable cash discount which will be taken by customers. Debit discount on sales. Credit reserve for cash discounts. To set up a reserve of the amount of the probable cash discounts to be taken by customers in settling their accounts. Cash. Reserve for cash discounts. Accounts receivable. To show settlement of an account, the discount being charged to the reserve, (d) Reserve for state, county and city taxes accrued. This reserve would be credited with an amount ascertained by estimating the assessed valuation of the taxable property, multiplying by the tax rate and multiplying this product by the fraction representing the portion of the tax year which has expired. Debit taxes. Credit reserve for taxes. To set up a reserve for the estimated accrued property taxes at this date. If this reserve is accrued monthly the entire amount of the taxes paid will be charged against the reserve: Debit reserve for taxes. Credit cash. To record payment of property taxes. If there is a credit balance in the reserve it should be closed out, the credit being made to surplus and profit and loss in the proportion in which the over-accruals applied to the prior year and to the current year. If the reserve is set up merely at the end of the year, and no monthly accruals are made, the portion of taxes applicable to the prior year will be charged against the reserve and the balance will be charged to taxes as a current expense. The balance of the reserve, whether a debit or a credit, should be closed to surplus. Question 5: It is now becoming quite common practice for corporations to insure the lives of their principal officers, so that upon their deaths the corporations may be, in a measure, reimbursed for the loss to the business. You are asked to indicate what sort of entries would be made by a company, from time to time, if it paid the insurance premiums on a policy of insurance for $50,000.00 carried on the life of its president under the four classes of insurance policies indicated below: Ten-year renewable term policy. Twenty-year endowment policy. Also indicate what entries should be made in the books for the receipt of the $50,000.00 principal of the different classes of policies, supposing the president of the company died during the fifth year of the insured term. Answer, Question 5: 10-Year renewable term policy. Under this policy there is no cash surrender value, and the total annual premium should be charged as an expense. At the rate of $13.49 per thousand at the age of 35, the annual premium on $50,000.00 would be $674.50, and the annual entries would be as indicated in the following table. In all the illustrations in this solution the matter of dividends is ignored, as there is no information as to whether they are applied in reduction of the premiums or in additions on the policy. If applied against the premiums the effect would be merely a reduction of the amount of the entry charging premiums and crediting cash. Entry for collection of policy during the fifth year: Debit cash...... Credit surplus..... $50,000.00 $50,000.00 20-Payment life policy. This policy has a cash surrender value-in most companies at the end of the third year. This cash surrender value is an asset which continually increases with the life of the policy. At the end of the third year it should be put on the books, with offsetting credits to surplus for two-thirds of the value, or the amount applicable to the first two years, and to life insurance premiums for one-third, or the amount applicable to the current year; and this one-third represents a reduction of the premium expense for the year. At the beginning of each year thereafter there should be an entry for the payment of the premium, and at the end of the year an entry showing the increase in the cash surrender value. At the rate of 33.13 per thousand at the age of 35 the entries would be as tabulated below: Entry for collection of policy during the fifth year: Straight-life policy. The entries during the first five years would be the same as under a 20-payment life policy, excepting as to amount. Entry for collection of policy during the fifth year: 20-Year endowment policy. As this policy has a cash surrender value, the entries will be of the same nature as those already described. Still using the age of 35, the entries at the rate of $47.12 per thousand would be: Entry for collection of the policy during the fifth year: In examining the accounts of a corporation engaged in the manufacture of a variety of articles in respect of which a specification cost system is maintained as an integral part of the bookkeeping (which, so far as inventories and cost are concerned, forms the basis of the monthly financial accounts comprising balance-sheet and profit and loss account), you find a large discrepancy between the total value of the physical inventory of manufactured stock and work in progress, as priced at specification costs and the corresponding general ledger account, the physical inventory value being substantially less than the relative book values. What investigation would you expect to make to ascertain the cause of the discrepancy? What factors would you expect to find contributing to it? And how would you dispose of the discrepancy? And upon what theory would you recommend that adjustment be made? Answer, Question 6: In a specification cost system, the manufacturing accounts are charged with the actual expenses and credited with finished product and work in process at the specification costs. The finished product account and the goods in process account are therefore book inventories, and any discrepancy between actual and estimated costs will appear as a balance in the manufacturing account. If the estimates are too high the costs will be overabsorbed and the manufacturing account will have a credit balance. If the estimates are too low the costs will be under-absorbed and the manufacturing account will have a debit balance. The question states that the specification costs are the basis of the book inventories used in the monthly balance sheet and profit and loss statement, and it also states that the physical inventory is priced at specification costs. Therefore the two inventories should agree unless there are errors in the computation or differences in the count. A difference in the count might be caused by: (a) Fewer goods finished than were recorded as finished, resulting in an over-statement of the book inventory of finished goods. (b) Fewer goods put into process than were recorded as put into process, resulting in an over-statement of the book inventory of goods in process. (c) Goods removed from stock without recording their removal. (d) Articles overlooked in making the count. The first three of these possible causes indicate carelessness in handling the cost records or possible theft. Causes (a) and (b) would be adjusted by a recomputation of cost on the basis of the actual quantities finished and put into process, with an adjustment of the earnings to the extent of the change in cost of articles sold and an adjustment of the inventory to the extent of the change in the cost of articles unsold. In the case of (c), if the goods were sold without record, there would be a charge to cost or sales and a credit to finished goods. If the goods were stolen, the charge would be to surplus. Cause (d) would be ascertained by a recount, the only adjustment required being a change in the amount of the physical inventory. The statement of the question to the effect that the book inventories and physical inventories were both priced at specification costs limits the causes of the discrepancy to error in quantities or in computations. Ordinarily, however, the point of interest in a specification cost system is the variation between actual cost and specification cost, and this variation is measured by the under-absorption or over-absorption of cost appearing as a balance in the manufacturing account rather than as a discrepancy between the book |