[Biff-1955-Tannen]

The question asks to determine if “days sales in receivables” and “gross profit ratio” will increase, decrease, or have no impact. Now I must be thinking wrong about how to go about this problem, because when I hear that question, I think that I’ll be looking at what these ratios are before the AJE and determine if the AJE has increased or decreased them. But we’re not given any prior ratios. So I’m wondering how I need to be thinking about the question/ how did they determine the answers?

In order to answer this question, you must first recall the formula for Days’ Sales in Accounts Receivable. That formula is:

Accounts Receivable / Credit Sales per day

Credit Sales per day = Total Credit Sales / 365 days

You must also remember that Gross Profit ratio = (Sales – Cost of Sales) / Sales.

Now you are ready to look at the accounts affected by the first proposed adjusting entry:

1. Sales reported after year end that should have been reported before year end:

Cost of sales 90

Accounts receivable 100

Sales 100

Inventory 90

The entry increases Accounts Receivable and Sales. However, Accounts Receivable will increase more than Credit Sales per day. As a result, this entry will INCREASE Days’ Sales in AR.

The Gross Profit ratio will DECREASE as the numerator (Gross Profit) only increased by 10 while the denominator (Sales) increased by 100.

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

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