Kate Miller owns a dance studio in Los Angeles, California. Students can buy access to the dance classes by paying a monthly fee. Unfortunately, many of Kate's students are struggling actors and actresses who lack the ability to pay their bills in a timely manner. And, although the students were expected to pay for classes in advance, Kate began offering credit to many of her students to grow her business. This, however, put Kate in a serious liquidity problem as revealed by the growing balance in the studio's outstanding accounts receivable:
|
Age
Classification
|
Accounts Receivable
Outstanding Balance
|
Historical Estimate
of Non-Collection
|
|
0-30 days
|
$44,000
|
4%
|
|
31-60 days
|
31,000
|
8%
|
|
61-90 days
|
22,000
|
12%
|
|
91-120 days
|
13,000
|
14%
|
|
121-150 days
|
9,000
|
20%
|
|
> 150 days
|
5,000
|
50%
|
Kate's accountant, Matt Thomas, tried to help her get a handle on the studio's accounts receivable problem, but to little avail. One trick he successfully used in the past to make Kate realize the seriousness of the problem was to overestimate the extent of Kate's bad debt problem; consequently, there currently exists a balance in the allowance for uncollectible accounts totaling $2,700.
Required
1. The first step to help get Kate's business back on track is to write off all receivables having a very low probability of collection (those accounts over 150 days). What balance sheet accounts will be affected, and in what amount, when Matt executes this action?
Indicate which balance sheet accounts will be affected by choosing Yes or No for each account:
Net revenue
Accounts receivable
Bad debt expense
Cash
Accounts payable
Allowance for uncollectible accounts
These account(s) will (increase or decrease) by $?
2. Prepare an aging of Kate's remaining accounts receivable. What balance should be in the Allowance for Uncollectible Accounts account?
Hint - Remember that Kate has already written off all accounts greater than 150 days old.
Balance in Allowance for Uncollectible Accounts
What is Kate's new estimate for bad debt expense?
3. Kate is in need of an immediate cash infusion and Matt has advised her to sell some of her receivables. A local bank has offered her two alternatives:
a. Factor $40,000 of "current" receivables (0-30 days old) on a nonrecourse basis at a flat fee of 11% of the value of the receivables sold.
b. Factor $40,000 of "current" receivables on a recourse basis at a flat fee of 6% of the value of the receivables sold.
Which option should Kate choose? Why?Problem 2:
UTStarcom, Inc. designs, manufactures, and sells telecommunication equipment, and provides services associated with their installation, operation, and maintenance in China, India, Korea, and Vietnam.
During 2005, the company's share price traded as high as $23 per share.
But, in January, 2005, the company disclosed that it would file its Form 10-K with the U.S. Securities and Exchange Commission late due to material internal control problems identified by its independent auditor, PricewaterhouseCoopers.
One of the identified concerns related to the company's recording of revenue and the related accounts receivable. In response, the company's share price sank to $6 per share. Following are selected financial data from UTStarcom's 2004 annual report:
(billions) 2004
Net sales $2.56 $1.78
Accounts receivable (net) 0.81 0.37
1. (a) Calculate UTStarcom's receivable collection period for 2003 and 2004. Round to two decimal places.(b) Is the company's receivable management decreasing in quality, improving, or about the same?
2. If the company could improve its receivable collection period to the industry average of 60 days, how much additional cash flow from accounts receivable would have been generated in 2003 and 2004?
In billions, rounded to three decimal places