Headquartered in London, England, Pearson is an international company with businesses in education, business information and consumer publishing. Pearson education operations provide learning materials, technologies, assessments and services to educational institutions, corporations and professional organizations, as well as to teachers and students of all ages. In its business information division, Pearson operates FT Publishing, which includes the Financial Times, FT. com and a range of other financial magazines, online services and financial databases. Pearson ‘s consumer operations, Penguin, operates a series of connected national publishing houses. With sales of £5. 6 billion in 2009, Pearson operates in more than 60 countries. Financial statements are prepared in accordance with IFRS. Shares trade in London and New York (Source: Company Annual Report and Form 20-F)
Refer to the Pearson plc financial statements and footnote excerpts for 2009. All figures are in millions of pounds sterling (L). a. What is an account receivable? What other names does this asset go by? b. How do accounts receivable differ from notes receivable?
c. What is a contra account? What two contra accounts are associated with Pearson’s trade receivables (see Note 22)? What types of activities are captured in each of these contra accounts? Describe factors that managers might consider when deciding how to estimate the balance in each of these contra accounts. d. Two commonly used approaches for estimating uncollectible accounts receivable are the percentage?-of-sales procedure and the aging-of-accounts procedure. Briefly describe these two approaches. What information do managers need to determine the activity and final account balance under each approach? Which of the two approaches do you think results in a more accurate estimate of net accounts receivable? e. If Pearson anticipates that some accounts will be uncollectible, why did the company extend credit to those customers in the first place? Discuss the risks that managers must consider with respect to accounts receivable. f. Note 22 reports the balance in Pearson’s provision for bad and doubtful debts (for trade receivables) and reports the account activity (“movements”)
during the year ended December 31, 2009. Note that Pearson refers to the trade receivables contra account as a “provision.” Under U.S. GAAP, the receivables contra account is typically referred to as an “allowance” while the term provision is used to describe the current-period income statement charge for uncollectible accounts (also known as bad debt expense). i.Use the information in Note 22 to complete a T-account that shows the activity in the provision for bad and doubtful debts account during the year. Explain, in your own words, the line items that reconcile the change in account during 2009 ii.Prepare the journal entries that Pearson recorded during 2009 to capture 1) bad and doubtful debts expense for 2009 (that is, the “income statement movements”) and 2) the write-off of for 2009 (that is, the “income statement movements”) and 2) the write-off of accounts receivable (that is, the amount “utilized”) during 2009. For each account in your journal entries, note whether the account is a balance sheet or income statement account.
iii. Where in the income statement is the provision for bad and doubtful debts expense included? g. Note 22 reports that the balance in Pearson’s provision for sales returns was £372 at December 31, 2008 and £354 at December 31, 2009. Under U.S. GAAP, this contra account is typically referred to as an “allowance” and reflects the company’s anticipated sales returns. i.Complete a T-account that shows the activity in the provision for sales returns account during the year. Assume that Pearson estimated that returns relating to 2009 Sales to be £425 million. In reconciling the change in the account, two types of journal entries are required, one to record the estimated sales returns for the period and one to record the amount of actual book returns. ii.Prepare the journal entries that Pearson recorded during 2009 to capture, 1) the 2009 estimated sales returns and 2) the amount of actual book returns during 2009. In your answer, note whether each account in the journal entries is a balance sheet or income statement account. ii.In which income statement line item does the amount of 2009 estimated sales returns appear? h. Create a T-account for total or gross trade receivables (that is, trade receivables before deducting the provision for bad and doubtful debts and the provision for sales returns). Analyze the
change in this T-account between December 31, 2008 and 2009. (Hint: your solution to parts f and g will be useful here). Assume that all sales in 2009 were on account. That is, they are all “credit sales.” You may also assume that there were no changes to the account due to business combinations or foreign exchange rate changes. Prepare the journal entries to record the sales on account and accounts receivable collection activity in this account during the year. Note 22 reports information about the number of days Pearson’s trade receivables have been outstanding relative to their due date. Assume that Pearson’s auditor analyzed historical collection information to estimate the percentage of uncollectible accounts by age category and reported the estimates in the table below. Use these percentages and the trade receivable aging information provided in Note 22 to estimate uncollectible accounts at December 31, 2009, and complete the table. Based on your estimate, would the auditor be comfortable that the balance of the provision for bad and doubtful debt account reported in Note 22 was adequate?
Trade receivables balance
Within due date
Up to three months past due date
Three to six months past due date
Six to nine months past due date
Nine to 12 months past due date
More than 12 months past due date
The following exhibits for Pearson PLC are given as handouts in class: Consolidated Income Statement
Consolidated Balance Sheet
Notes to Consolidated Financial Statements (partial)
a. What is account receivable?
Credit sales, sales on account
b. How do accounts receivable differ from notes receivable?
Notes Receivable arises when the seller asks for a note to replace an Accounts Receivable when the customer requests additional time to pay a past-due account. A promissory note is a written promise to pay a specific amount of money, usually including interest, at a future date. c. What is a contra asset?
An account which offsets another account. A contra-asset account has a credit balance and offsets the debit balance of the corresponding asset. A contra-liability account has a debit balance and offsets the credit balance of the corresponding liability. Provisions for bad and doubtful debts: Allowance of uncollectible accounts receivable Provisions for sales returns: estimate sales return
Managers will consider past experience, credit quality of the buyer, the age
of the receivable and the economy for these accounts d. Two approaches for estimating uncollectible accounts:
Percentage of sales: It is based on prior experience of the business. It is computed as a percentage of credit sales. It ignores the current balance of the allowance account. Aging of accounts: Analyzed according to the length of time they remain outstanding e. Why did the company extend credit to customers?
They would not have extended credit if they knew which companies would eventually not pay. f.
iii: Bad and doubtful debts expense is included in the operating expenses