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Economics
Finance
CHP 8 (Financial Accounting)
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Terms in this set (82)
receivables
refers to amounts due from individuals and companies. receivables are claims that are expected to be collected in cash. (very important activity for company that sells goods or services on credit) Represent one of a company's most liquid assets
3 types of Receivables
Accounts Receivable, Notes Receivable, Other Receivables
Accounts Receivable
amounts customers owe on account.
They result from the sale of goods and services.
Companies generally expect to collect A/R within 30-60 days. They are usually the most significant claim held by a company.
Notes Receivable
written promise (as evidenced by a formal instrument) for amounts to be received. The note normally requires the collection of interest and extends for time periods of 60-90 days or longer.
Other receivables
include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable. These do not generally result from the operations of the business. Therefore, they are generally classified and reported as separate items in the balance sheet.
Trade Receivables
notes and accounts receivable that result from sales transactions
A service organization records a receivable....
when it performs a service on accounts
A merchandiser records accounts receivable.....
at the point of sale of merchandise on account
When a merchandiser sells goods it... (think: does what to what accounts)
increases (debits) Accounts Receivable and increases (credits) Sales Revenue
Seller may offer terms that encourage early payment by providing a ....
discount
Besides discount what else reduces receivables?
Sales returns (occurs when buyer finds some good unacceptable and chooses to return the unwanted goods)
Reminder: Companies record Accounts Receivable on the _____ as a _____
balance sheet as an asset
Bad Debt Expense also known as
Uncollectible Accounts Expense
Two methods used in accounting for uncollectible accounts:
1)the direct write-off method
2)the allowance method
Under the direct write-off method, when a company determines a particular amount to be uncollectible it charges the loss to...
Bad Debt Expense
For example, Warden Co writes off as uncollectible M.E. Doran's $200 balance on December 12. Warden's journal entry is as follows:
Dec 12 Bad Debt Expense 200
Accounts Receivable 200
(To record write-off of M.E. Doran account)
Under direct-write off method companies will show only ____ from uncollectibles. The company will report accounts receivable as its _____amount
actual losses
gross
True or False: Use of direct-write off method can reduce the relevance of both the income statement and the balance sheet
True
Scenario for positive effects of direct-write off method:
Huge sales promotion
Sales increase dramatically
Accounts Receivable increases dramatically
Scenario for negative effects of direct-write off method:
Customers default on loans
Bad debt expense increases dramatically
Accounts Receivable plummets
True or False: Unless bad debt losses are insignificant, the direct write-off method is not acceptable for financial reporting purposes
True
Allowance method
a method of accounting for bad debts that involves estimating uncollectible accounts at the end of each period
The allowance method provides better matching of ______ with _____ on the _____ statement
expenses with revenues on the income statement
Allowance method ensures that companies state receivables on the balance sheet at their ________ value
cash (net) realizable value
Cash (net) realizable value
the net amount the company expects to receive in cash. It excludes the amounts that the company estimates it will not collect.
(sometimes referred to as accounts receivable (net) )
The allowance method reduces receivables in the balance sheet by the _______________
amount of uncollectible receivables
Companies must use the ____________for financial reporting purposes when bad debts are material in amount
allowance method
Allowance for Doubtful Accounts
shows the estimated amount of claims on customers that the company expects will become uncollectible in the future
Allowance for Doubtful Accounts is a _____ _account to ______
contra account to Accounts Receivable
Allowance method has 3 essential features:
1) Companies estimate uncollectible accounts receivable. They match this estimated expense against revenues in the same accounting period in which they record the revenues
2) Companies debit estimated uncollectibles to Bad Debt Expense and credit them to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. (Allowance for Doubtful Accounts is a contra account to Accounts Receivable)
3) When companies write off a specific account, they debit actual uncollectibles to Allowance for Doubtful Accounts and credit that amount to Accounts Receivable
If Hampson Furniture credit manager estimates that $12,000 of their sales will be uncollectible, what is the adjusting journal entry and how is this reported in the balance sheet?
debit to Bad Debt Expense for 12,000
credit to Allowance for Doubtful Accounts for 12,000
Hampson reports Bad Debt Expense in the income statement as an operating expense
True or False: Companies use a contra account instead of a direct credit to Accounts Receivable because they do not know which customers will not pay
True
(Note: The credit balance in the allowance account will absorb the specific write-offs when they occur)
On the Balance Sheet,
Accounts Receivable
Less: Allowance for doubtful accounts
-----------------------------------------
=represents?
represents the expected cash realizable value of the accounts receivable at the statement date
True or False: Companies close Allowance for Doubtful Accounts at the end of the fiscal year
FALSE
Companies do NOT close Allowance for Doubtful Accounts at the end of the fiscal year
True or False: To maintain segregation of duties, the employee authorized to write-off accounts should not have daily responsibilities related to cash or receivables
True
Assume that the financial vice president of Hampson Furniture authorizes a write-off of the $500 balance owed by R.A. Ware on March 1, 2020
The entry to record the write-off:
Mar 1 Allowance for Doubtful Accounts 500
Accounts Receivable 500
(Write-off of R.A. Ware account)
True or False: Under the allowance method, companies credit every bad debt write-off to the allowance account rather than to Bad Debt Expense
FALSE
under the allowance method, companies DEBIT every bad debt write-off to the allowance account rather than to Bad Debt Expense
Under the allowance method, why would it be incorrect for companies to debit Bad Debt Expense instead of the allowance account?
Because the company has already recognized the expense when it made the adjusting entry for estimated bad debts
A write-off affects only _________ accounts, not _________accounts
balance sheet (accounts)
NOT income statement (accounts)
The write-off of the account reduces both ____ and ______
Therefore, ________ in the balance sheet remains the same
Accounts Receivable and Allowance for Doubtful Accounts
Cash realizable value (remains the same)
The company makes two entries to record the recovery of a bad debt:
1) It reverses the entry made in writing off the account
(This reinstates the customer's account)
2) It journalizes the collection in the usual manner
On July 1, R.A. Warehouse pays the $500 amount that Hampson had written off on March 1. Hampson makes the following entries:
July 1 Accounts Receivable 500
Allowance for Doubtful Accounts 500
(To reverse write-off of R.A. Ware account)
July 1 Cash 500
Accounts Receivable 500
(To record collection from R.A. Ware)
True or False: Recovery of a bad debt, like the write-off of a bad debt, affects only balance sheet accounts
True
Percentage-of-receivables basis
management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts
Suppose Steffen Company has an ending balance in Accounts Receivable of $200,000 and an unadjusted credit balance in Allowance for Doubtful Accounts of $1,500. It estimates that 5% of its accounts receivable will eventually be uncollectible. What should it report?
IT should report a balance in Allowance for Doubtful Accounts of $10,000 ($200,000 x .05). To increase the balance in Allowance for Doubtful Accounts from $1,500 to $10,000, the company debits (increases) Bad Debt Expense and credits (increases) Allowance for Doubtful Accounts by $8,500 ($10,000-$1,500)
aging the accounts receivable
schedule that classifies customer balances by the length of time they have been unpaid
The longer a receivable is past due, the less likely it is to be collected. As a result,
the estimated percentage of uncollectible debts increases as the number of days past due increases
Total estimated uncollectible accounts representing the existing customer claims expected to become uncollectible in the future---the amount represents the __________ in Allowance for Doubtful Accounts at the balance sheet date
required balance
(Note: the amount of bad debt expense that should be recorded in the adjusting entry is the difference between the required balance and the existing balance in the allowance account)
(Note: The existing, unadjusted balance in Allowance for Doubtful Accounts is the net result of the beginning balance (a normal credit balance) less the write-offs of specific amounts during the year (debits to the allowance account)
For example, total estimated uncollectible accounts for Dart Company, $2,228, represent the existing customer claims expected to become uncollectible in the future. If the unadjusted trial balance shows Allowance for Doubtful Accounts with a credit balance of $528, then an adjusting entry for _____ is necessary:
Adjusting entry for $1,700 ($2,228-$528) is necessary:
Dec 31 Bad Debt Expense 1,700
Allowance for Doubtful Accounts 1,700
(To adjust allowance account to total estimated uncollectibles)
Occasionally, companies will have a debit balance prior to adjustment. This occurs because....
the debits to the allowance account from write-offs during the year exceeded the beginning balance in the account which was based on previous estimates for bad debts
If a company has a debit balance prior to adjustment, the company_____
adds the debit balance to the required balance when it makes the adjusting entry
The percentage-of-receivables basis provides an estimate of the ___________
& a reasonable matching of _________ to ________
cash realizable value of the receivables (& a reasonable matching of) expenses to revenue
True or False: Companies now frequently sell their receivables to another company for cash, thereby shortening the cash-to-cash operating cycle
True
Companies sell receivables for two major reasons:
1) They may be the only reasonable source of cash
2) Billing and collection are often time-consuming and costly
factor
finance company or bank that buys receivables from businesses and then collects the payments directly from the customers
For example, Hendredon Furniture factors $600,000 of receivables to Federal Factors. Federal Factors assess a service charge of 2% of the amount of receivables sold. Journal entry to record the sale by Hendredon Furniture on April 2, 2019:
Apr 2 Cash 588,000
Service Charge Expense 12,000
(2% x $600,000)
Accounts Receivable 600,000
(To record the sale of accounts receivable)
If Hendredon often sells its receivables, records the service charge expense as an _____expense
If the company infrequently sells receivables, it may report this amount in the __________(section of the income statement)
operating (expense)
"Other expenses and loss" (section of the income statement)
True or False: A retailer's acceptance of a national credit card is another form of selling (factoring) the receivable
TRUE
Accounting for Credit Card Sales Example Journal Entry:
Cash 970
Service Charge Expense 30
Sales Revenue 1,000
(To record Visa credit card sales)
promissory note
written promise to pay a specified amount of money on demand or at a definite time
Promissory notes may be used when...
1) individuals and companies lend or borrow money
2) when the amount of the transaction and the credit period exceed normal limits
3) in settlement of accounts receivable
In a promissory note, the party making the promise to pay is called the _______
maker
In a promissory note, the party to whom payment is to be made is called the ______
payee
For example, if Calhoun Company is the maker and Wilma Company is the payee, then...
to Wilma Company the promissory note is a ______
to Calhoun Company the promissory note is a ______
note receivable
note payable
Determining the Maturity Date
1) On demand
2) On a stated date
3) At the end of a stated period of time
When the life of a note is expressed in terms of months you find the date when it matures by...
counting the months from the date of issue
When the due date is stated in terms of days, you need to count the exact number of days to determine the maturity date. In counting omit the date the note is _______ but include the ____
(In counting omit the data the note is)
issued
(but include the)
due date
Maturity Date of a 60-day note dated July 17 is September 15, computed as follows:
Term of note 60 days
July (31-17) 14
August 31 45
Maturity date: September 15
(computing interest on an interest-bearing note)
Interest=
Face Value of Note x Annual Interest Rate x Time in Terms of One Year = Interest
When the maturity date is stated in days, the time factor is often ...
# of days / 360
When the maturity date is stated in months, the time factor is ...
# of months / 12
If a company issues cash in exchange for a note, the entry is a....
debit to Notes Receivable and a credit to Cash in the amount of the loan
Notes may be held to their maturity date at which point the ______ plus _____ is due
face value
(plus)
accrued interest
(is due)
a note is honored when
its maker pays in full at its maturity date
For each interest-bearing note, the amount due at maturity is the ...
face value of the note plus interest for the length of time specified on the note
dishonored (defaulted) note
a note that is not paid in full at maturity
True or False: for a dishonored (defaulted) note, the payee still has a claim against the maker of the note for both the note and the interest
True
(Therefore, the note holder usually transfers the Notes Receivable account to an Accounts Receivable account)
concentration of credit risk
threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company
accounts receivable turnover
used to assess the liquidity of the receivables (# of times on average the company collects receivables during the period)
Accounts Receivable Turnover=
Net Credit Sales / Average Net Accounts Receivable
(Note: Net Credit Sales= Net Sales - Cash Sales)
(Note: Average Net Accounts Receivable for example= ($5,157 + $5,344/ 2) )
(Note: The higher the turnover, the more liquid the company's receivables)
Average Collection Period=
Days in Year / Accounts Receivable Turnover
Companies frequently use the average collection period to assess....
the effectiveness of a company's credit and collection policies
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