A201 exam 2

key point: writing off customer's account as uncollectible

Writing off a customer's account as uncollectible reduces the balance of accounts receivable but also reduces the contra asset—allowance for uncollectible accounts. The net effect is that there is no change in the net receivable (accounts receivable less the allowance) or in total assets.

the effect of sales allowance will result in which of the following

a decrease in net income

notes receivables

are accompanied by formal credit arrangements made with written debt instruments (or notes), we refer to them as notes receivable.

other types of receivables

-nontrade receivables -notes receivables

trade discounts

-represent a reduction in the listed price of a good or service. -Companies typically use trade discounts to provide incentives to larger customers or consumer groups to purchase from the company. -Trade discounts also can be a way to change prices without publishing a new price list or to disguise real prices from competitors.

accounting for uncollectible accounts and the accounts receivable portion of the balance sheet

-After we estimate uncollectible accounts to be $6 million, we reduce the $20 million balance of accounts receivable and report them at their estimated collectible amount of $14 million. But is this estimate correct? Only time will tell. Kimzey's prediction of $6 million for uncollectible accounts might be too high, or it might be too low. In either case, it's generally more informative than making no estimate at all. -recall that contra revenue accounts reduce revenue indirectly, in the same way, the allowance account provides a way to reduce accounts receivable indirectly, rather than decreasing the accounts receivable balance itself -We report the allowance for uncollectible accounts in the asset section of the balance sheet, but it represents a reduction in the balance of accounts receivable. The difference between total accounts receivable and the allowance for uncollectible accounts is referred to as net accounts receivable, which is net realizable value.

continued

-Based on using the aging method (previous slide) at the end of 2022, Kimzey estimates that the allowance for uncollectible accounts should be $7 million. -This means the allowance account needs to increase from its current balance of $2 million credit to the estimated ending balance of $7 million credit. -Kimzey can accomplish this by adjusting the account for $5 million. This journal entry would include a debit to Bad Debt Expense and a credit to Allowance for Uncollectible Accounts for $5 million.

end-of-period adjustment for contra revenues

-Because of the need to estimate contra revenues that may occur in subsequent years, an adjusting entry may be required to record estimated sales returns, sales allowances and sales discounts in addition to those recorded throughout the year. -•The revenue recognition standard requires a company to report revenues equal to the amount of cash the company "expects to be entitled to receive." -•Those expectations could change as new information becomes available. Therefore, at the end of each year the company must estimate any additional returns, allowances, and discounts that will occur in the following year as a result of sales transactions in the current year.

estimating uncollectible accounts example continued

-Because this is Kimzey's first year of operations, it hasn't established a record of customer bad debts. Kimzey's credit manager decides that 30% of the total year-end accounts receivable of $20 million is a reasonable estimate of amounts that won't be collected. To establish an allowance for future uncollectible accounts of $6 million (= $20 million × 30%), -Kimzey records the following: debit bad debt expense for 6 mil and credit allowance for uncollectible accounts for 6 mil -The entry to establish an allowance for uncollectible accounts affects the reported financial position of the company by reducing assets and increasing expenses.

aging method

-Considers the age of receivables --Older accounts are more likely uncollectible -More accurate than using a single percentage -The account titles in the journal entry are the same as when we applied a single percentage to the ending balance, but the amount will differ.

financial statement effects of estimating uncollectible accounts

-From an income statement perspective, some argue that the percentage-of-credit-sales method provides a better method for estimating bad debts because expenses (bad debts) are better matched with revenues (credit sales). A better matching of expenses and revenues results in a more accurate measure of net income for the period. From a balance sheet perspective, though, the percentage-of-receivables method is preferable because assets (net accounts receivable) are reported closer to their net realizable value. -The current emphasis on better measurement of assets (balance sheet focus) outweighs the emphasis on better measurement of net income (income statement focus). This is why the percentage-of-receivables method (balance sheet method) is the preferable method, while the percentage-of-credit-sales method (income statement method) is allowed only if amounts do not differ significantly from estimates using the percentage-of-receivables method.

allowance method (GAAP)

-Generally Accepted Accounting Principles (GAAP) require that we account for uncollectible accounts using what's called the allowance method. -Under the allowance method, a company reports its accounts receivable for the net amount expected to be collected. To do this, the company must estimate the amount of current accounts receivable that will prove uncollectible in the future and report this estimate as a contra asset to its accounts receivable. -By applying the allowance method, we avoid overstating the assets of the company. We need to reduce accounts receivable in the balance sheet by an estimate of the amount expected not to be collected. -Using the allowance method, we account for events (customers' bad debts) that have not yet occurred but that are likely to occur. -Under the allowance method, companies are required to estimate future uncollectible accounts and report those estimates in the current year. -estimated uncollectible accounts: reduce assets (accounts receivable) and increase expenses (bad debt expense)

sales returns

-If a customer returns a product, we call that a sales return. After a sales return, (a) we reduce the customer's account balance if the sale was on account or (b) we issue a cash refund if the sale was for cash.

establishing an allowance for uncollectible accounts: example

-In 2021, its first year of operations, Kimzey Medical Clinic bills customers $50 million for emergency care services provided. By the end of the year, $20 million remains due from customers. Those receivables are assets of the company. -However, because Kimzey cannot always verify patients' ability to pay before administering care, it does not expect to receive the full $20 million. The receivables not expected to be collected should not be counted in assets of the company.

example of writing off accounts receivable

-Let's suppose that on February 23, 2022 (the following year), Kimzey receives notice that one of its former patients, Bruce Easley, has filed for bankruptcy protection against all creditors. Based on this information, Kimzey believes it is unlikely Bruce will pay his account of $4,000. -Kimzey previously allowed for the likelihood that some of its patients would not pay, though it didn't know which ones. Now that it knows a specific customer will not pay, it can adjust the allowance and reduce the accounts receivable balance itself. Upon receiving news of this actual bad debt, Kimzey records a debit to the Allowance account and a credit to Accounts Receivable. (both for 4,000) -You can think about it like this: we increase the Allowance when we do not know which specific accounts will be written off. Then, once we know the specific patients who won't pay, we reduce the Allowance and reduce the Accounts Receivable for the specific patient. -Remember, the write-off of an account receivable has no effect on total amounts reported in the balance sheet or in the income statement.

aging method example

-In our example for Kimzey, we previously established an allowance for uncollectible accounts in 2021 by applying a single estimated percentage (30%) to total accounts receivable. This is known as the percentage-of-receivables method. This method sometimes is referred to as a balance sheet method, because we base the estimate of bad debts on a balance sheet account—accounts receivable. For this method, the percentage may be estimated using current economic conditions, company history, and industry guidelines. -At the end of 2022, we could once again multiply total accounts receivable by a single percentage to get an estimate of future uncollectible accounts. However, a more accurate method is to consider the various ages of individual accounts receivable, using a higher percentage of uncollectible for "old" accounts than for "new" accounts. This is known as the aging method. For instance, accounts that are 120 days past due are older than accounts that are 60 days past due. The older the account, the less likely it is to be collected. The aging method is a more detailed application of the percentage-of-receivables method, so it also is a balance sheet method. -Notice that, when using the aging method, the journal entry to estimate future bad debts is identical to the journal entry made using a single estimated percentage. The difference is that the estimate of bad debt is likely to be more precise because it is based on the age of accounts, and older accounts are more likely uncollectible. --> debit bad debt expense and credit allowance for uncollectible accounts

sales returns and allowances

-In some cases, customers may not be satisfied with a product or service purchased.

accounts receivable portion of the balance sheet

-In the 2022 balance sheet, Kimzey will report the allowance account at the best estimate of its appropriate balance, $7 million. -The balance sheet will show accounts receivable at $23 million ($30 million less the allowance for uncollectible accounts of $7 million). -The income statement will show bad debts expense of $5, which brings the allowance account up to the desired level of $7 million. Beginning balance: $6 Write-off (4) Before adjustments 2 Adjustment/expense ?? Desired ending Balance $7 -->?? Therefore equals $5 for bad debt expense

adjusting for estimates of uncollectible accounts

-In this appendix, we consider the percentage-of-credit-sales method. --Assume Kimzey bills customers $80 million for services, with $30 million in accounts receivable remaining at the end of 2022. Also assume the balance of the allowance account, before adjustment, is a $2 million credit. Consider the following estimates of uncollectible accounts: ---Percentage-of-receivables approach = 20% of total accounts receivable. Percentage-of-credit-sales approach = 10% of credit sales.

income statement reporting revenues net of sales returns, allowances, and discounts

-It's easier to see the relationship between total revenues and related contra accounts by looking at the partial income statement of F.Y.Eye. -To summarize, F.Y.Eye provides a service with a normal price of $3,000 and sells merchandise for $200. However, after the trade discount of $600 (to reduce Service Revenue to $2,400), sales returns of $200, sales allowances of $400, and sales discounts of $40, the income statement reports net revenues of $1,960. This is the amount the company is entitled to receive from customers for providing goods or services. -Also at the time of cash collection on March 10, F.Y.Eye credits Accounts Receivable for the full $2,000, even though it receives cash of only $1,960. The reason is that the $2,000 balance in Accounts Receivable is "received in full" by the combination of the $1,960 cash collection and the $40 sales discount. The balance of Accounts Receivable now equals $0. --Note that if the customer did not pay within the discount period, F.Y.Eye would reduce accounts receivable and increase cash by the gross amount of the receivable, or $2,000 in this case.

collection of accounts previously written off

-Later in 2022, Bruce's bankruptcy proceedings are complete. Kimzey had expected to receive none of the $4,000 Bruce owed. -However, after liquidating all assets, Bruce is able to pay each of his creditors 25% of the amount due them. So, when Kimzey receives payment of $1,000 (= $4,000 × 25%), it makes these two entries: The first entry reverses a portion of the previous entry that Kimzey made on February 23 to write off the account. (debit accounts receivable for 1000 and credit allowance for uncollectible accounts for 1000) The second entry records the collection of the account receivable. (debit cash for 1000 and credit accounts receivable for 1000) -Notice that in both entries the debit entry increases total assets by the same amount that the credit entry decreases total assets. Therefore, collecting cash on an account previously written off has no effect on total assets and no effect on net income.

Kimzey's accounts receivable aging schedule

-Let's examine Kimzey's individual patients' accounts, including the amount owed by each patient and the number of days past due by the end of 2022. For simplicity, all remaining patients' accounts are summarized in the "Others" row. Shirley Akin owes $12,000, and this amount is not yet due; Cara Lott owes $4,000, and this amount is more than 120 days past due; and so on. -Notice that each age group has its own estimate of the percent uncollectible, and this percentage increases with the age of the account. The "Not Yet Due" column has an estimated 10% percent uncollectible. The "1-60" days past due column has an estimated 30% uncollectible, since these accounts are older and less likely to be collected. The estimated percentage uncollectible continues to increase as the account becomes more past due. Summing the estimated amount uncollectible for each age group results in a total estimate of $7,000,000. -So, if the estimated amount uncollectible is $7 million, then Allowance for Uncollectible Accounts needs to have an ending balance of $7 million. We need to (1) know the current balance of Allowance for Uncollectible Accounts and then (2) determine the adjustment needed so that the ending balance will be $7 million. -At the end of 2021 (previous year) Kimzey estimated future bad debts to be $6 million. This is the beginning balance of Allowance for Uncollectible Accounts in 2022. Let's assume, however, that only $4 million of accounts were actually written off in 2022. This means the balance of the allowance account at the end of 2022, prior to any year-end adjustment, has a leftover amount of $2 million. If we want the ending balance to be $7 million, by how much does the $5 million current balance need to be adjusted? $5 million.

recording of credit sales

-instead of debiting Cash, as in a cash sale, the company debits another asset—Accounts Receivable—for the credit sale -later, when the cash is received from the customer, the company then records the increase to Cash. Also, Accounts Receivable is reduced because the customer no longer owes money to the company.

average collection period

-number of days the average accounts receivable balance is outstanding -- average collection period = 365 days/ receivables turnover ratio

sales returns example

-On March 2, F.Y.Eye sells sunglasses to one of its customers for $200 on account. -On March 4 the customer decides she doesn't want the sunglasses and returns the pair. F.Y.Eye needs to record the return by reducing accounts receivable and reducing the revenue recorded on March 2. -We reduce revenue for sales returns using a contra revenue account—Sales Returns. -A contra revenue account is an account with a balance that is opposite, or "contra," to that of its related revenue account. The reason we use a contra revenue account is to keep a record of the total revenue recognized separate from the reduction due to subsequent sales returns. -Managers want to keep a record of not only how much their companies are selling, but also how much is being returned. High sales returns could be an indication of inventory problems, so it's important to keep track of both Sales Revenue and Sales Returns. --> debit sales returns for 200 and credit accounts receivable for 200 -this transaction reduces revenue and current assets

allowance method in the following year

-Recall that using the aging method, Kimzey estimated bad debts at the end of 2021 to be $6 million (future write-offs of $6 million) -Actual bad debts were only $4 million (write-offs in 2022). In other words, the year-end 2021 amount was overestimated by $2 million -Using the aging method, Kimzey estimated bad debts at the end of 2022 to be $7 million -How does Kimzey record its $7 million estimate of future bad debts at the end of 2022? -Suppose that Kimzey has credit sales of $80 million in 2022 and has year-end accounts receivable of $30 million. What portion of the $30 million in accounts receivable does Kimzey not expect to collect? Kimzey is required to report that estimate in Allowance for Uncollectible Accounts in its year-end balance sheet as a contra asset to accounts receivable.

note receivable

-Similar to accounts receivable but include a written debt agreement, or note --Normal debit balance -Classified as either current or noncurrent asset depending on time until due date

common mistake: contra revenue accounts

-Students sometimes misclassify contra revenue accounts—sales returns and sales allowances—as expenses. -Like expenses, contra revenues have normal debit balances and reduce the reported amount of net income. -However, contra revenues represent reductions of revenues, whereas expenses represent the separate costs of generating revenues.

income statement showing estimated bad debt expense

-The offsetting debit in the entry to establish the allowance account is bad debt expense. Bad debt expense represents the cost of estimated future bad debts that is reported as an expense in the current year's income statement, along with other expenses. -In the 2021 income statement, we reduce the $50 million of revenue from credit sales by total expenses of $40 million, of which $6 million is for estimated future bad debts.

receivables turnover ratio

-The receivables turnover ratio shows the number of times during a year that the average accounts receivable balance is collected (or "turns over"). -•Number of times during a year the average accounts receivable balance is collected --receivables turnover ratio = net credit sales/ average accounts receivable --The "net" in net credit sales refers to total credit sales net of discounts, returns, and allowances. The amount for net credit sales is obtained from the current period's income statement; average accounts receivable equals the average of accounts receivable reported in this period's and last period's balance sheets. --The more frequently a business is able to "turn over" its average accounts receivable, the more effective a company is at granting credit to and collecting cash from its customers.

comparing the allowance method and the direct write-off method for recording uncollectible accounts

-To see how the direct write-off method works, suppose a company provides services on account for $100,000 in 2021, but makes no allowance for uncollectible accounts at the end of the year. Then, in the following year on September 17, 2022, an account of $2,000 becomes uncollectible. The company records the actual write-off as: 2021 estimate - no adjustment. 2022 write off - debit bad debt expense 2000 and credit accounts receivable 2000 -Notice that bad debt expense is recorded in the year of the write-off (2022) instead of the year of the service revenue (2021). Total assets are also reduced by crediting Accounts Receivable at the time of the actual write-off (2022). Compared to the allowance method, the direct write-off method causes assets to be overstated and operating expenses to be understated in 2021. This is why the direct write-off method of accounting for uncollectible accounts is generally not permitted for financial reporting purposes except in limited circumstances. -Under the allowance method, future bad debts are estimated and recorded as an expense and a reduction in assets in 2021. Bad debt expense is recorded in the same period (2021) as the revenue it helps to create. Under the direct write-off method, though, we make no attempt to estimate future bad debts. We record bad debt expense in the period the account proves uncollectible. In this case, we report the bad debt expense and reduction in assets in 2022. -The direct write-off method violates GAAP, because accounts receivable are reported in the current period (2021) for an amount greater than the cash that is expected to be collected in the following period (2022). - allowance method write offs: 2021 estimate - debit bad debt expense for 2000 and credit allowance for uncollectible accounts for 2000. write off for 2022 - debit allowance for uncollectible accounts 2000 and credit accounts receivable for 2000

sales discounts

-Unlike a trade discount, a sales discount represents a reduction, not in the selling price of a good or service, but in the amount to be received from a credit customer IF collection occurs within a specified period of time. A sales discount is intended to provide incentive to the customer for quick payment.

invoice

-a source document that identifies the date of sale, the customer, the specific items sold, the dollar amount of the sale, and the payment terms. -Payment terms typically require the customer to pay within 30 to 60 days after the sale. -Even though no cash is received at the time of the credit sale, the seller records revenue immediately once goods or services are provided to the customer and future collection from the customer is probable.

example of trade discount

-assume F.Y. Eye typically provides laser eye surgery for $3,000. To help generate new business, the company offers laser eye surgery in the month of March for only $2,400, which represents a trade discount of 20% ($3,000 × 20% = $600 trade discount). F.Y.Eye provides this discounted service on account to a customer on March 1. --> debit accounts receivable for 2,400 and credit service revenue for 2,400 (•Even though F.Y.Eye normally charges $3,000 for this service, the company can record revenue for only $2,400, because that's the amount the company is entitled to receive from this customer.) -•The trade discount of $600 is recorded indirectly by simply recording revenue equal to the discounted price. We don't keep track in a separate account of trade discounts given to customers.

establishing an allowance for uncollectible accounts

-base the estimate of bad debts on a balance sheet amount - accounts receivable -also called the "balance sheet method" -there are 3 stages in this process: -•At the end of the initial year, establish an allowance by estimating future uncollectible accounts. -•During the subsequent year, write off actual bad debts as uncollectible. Note that actual write-offs may differ from the previous year's estimate. -•At the end of the subsequent year, once again estimate future uncollectible accounts.

accounts receivable

-represent the amount of cash owed to a company by its customers from the sale of goods or services on account. -recorded at the time of the sale or service -Along with the recognized revenue, at the time of sale the seller also obtains a legal right to receive cash from the buyer. The legal right to receive cash is valuable and represents an asset of the company. This asset is referred to as accounts receivable (sometimes called trade receivables). -accounts receivable originates from credit sales

sales discount: discount terms

-such as 2/10, n/30, are a shorthand way to communicate the amount of the discount and the time period within which it's available. -The term "2/10," for example, indicates the customer will receive a 2% discount if the amount owed is paid within 10 days. The term "n/30," means that if the customer does not take the discount, full payment net of any returns or allowances is due within 30 days.

sales allowances example

-suppose the customer having laser eye surgery on March 1 for $2,400 is not completely satisfied with the outcome of the surgery. -F.Y.Eye may allow a $400 reduction in the amount owed by the customer. -In this case, the amount the company is entitled to receive has been reduced to $2,000, and the $2,400 of revenue previously recognized needs to be reduced by the amount of the sales allowance. -We record the sales allowance in a contra revenue account—Sales Allowances. -debit sales allowances for 400 and credit accounts receivable for 400 -this transaction reduces revenue and current assets

sales allowances

-the customer does not return the product or service, but the seller reduces the customer's balance owed to provide at least a partial adjustment of the amount the customer owes. -This adjustment is called a sales allowance.

credit sales

-transfer goods or services to a customer today while bearing the risk of collecting payment from that customer in the future. -Credit sales transactions are also known as sales on account. -Similarly, credit service transactions are also called services on account. -typically include an informal credit agreement supported by an invoice

interest calculation and collection of notes receivable

-•After six months, Kimzey collects the full amount owed by Justin, including interest -interest (600) = face value (10,000) x annual interest rate (12%) x fraction of the year (6/12) - debit cash for 10,600, credit notes receivable for 10,000 and credit interest revenue for 600

percentage-of-credit-sales method

-•Estimates uncollectible accounts based on the percentage of credit sales --Also called the income statement method -•Adjusts the allowance for uncollectible accounts for the current year's credit sales that we don't expect to collect --When applying the percentage-of-credit-sales method, we adjust the allowance for uncollectible accounts for the current year's credit sales that we don't expect to collect (rather than adjusting at the end of the year for the percentage of accounts receivable we don't expect to collect).

sales discounts example

-•F.Y.Eye offers terms of 2/10, n/30 on $2,000 owed; Customer pays on March 10 (w/in 10 days) -Continuing our example above, assume F.Y.Eye wants its customer to pay quickly and so offers terms of 2/10, n/30 -This means that if cash is collected from the customer within 10 days, the amount due will be reduced by 2%. The customer owes $2,000 after the $600 trade discount and the $400 sales allowance. So, if the customer pays within 10 days, she will receive a sales discount of $40 (= $2,000 × 2%). -sales discounts = contra revenue account reported with total revenues in the income statement, but with a negative balance - debit cash for 1,960, debit sales discounts for 40 and credit accounts receivable for 2,000

recording notes receivable

-•Kimzey provided $10,000 of services to Justin Payne, who is not able to pay immediately --•Justin Payne signs a promissory note, offering to pay $10,000 plus 12% interest in six months (August 1). --debit notes receivable for 10,000 and credit service revenue for 10,000 -NO interest is recorded on February 1 because no interest has yet been earned

accrue interest and collect interest

-•On December 31, 2021, Kimzey accrues interest for note receivable accepted on November 1, 2021. --Because Kimzey earns two months of interest in 2021, it must accrue that interest as revenue on December 31, 2021 (even though no cash has been collected). The first entry shown in the slide is to record the adjustment to accrue interest revenue. -On May 1, 2022, the maturity date, Kimzey collects the note of $10,000 and the interest of $600. --On May 1, 2022, the maturity date, Kimzey records the collection of the note receivable of $10,000 and interest of $600. Notice that the cash collected for interest includes $200 receivable from 2021, as well as $400 of additional interest revenue related to four months in 2022. The entry on May 1, 2022, eliminates the balances of the note receivable and interest receivable recorded in 2021.

writing off accounts receivable

-•When it becomes clear a customer will not pay, the company writes off the customer's account balance as uncollectible •The write-off: --Reduces the balance of Accounts Receivable --Reduces the balance of the Allowance for Uncollectible Accounts •The write-off has no effect on total assets (balance sheet) or total expenses (income statement) ---> Because the write-off reduces both an asset account and a contra asset account, there is no decrease in total assets and no decrease in net income with the write-off. •Negative effects of bad debts were recorded in an adjusting entry at the end of the previous year. That estimate was recorded as an adjusting entry at the end of the previous year.

direct write-off method (not GAAP)

-•Write off bad debts only at the time they actually become uncollectible --Unlike the allowance method, which requires estimation of uncollectible accounts before they even occur -•Used: --When uncollectible accounts are not anticipated or are immaterial --Primarily used for tax reporting (Companies do not report a tax deduction for bad debts until those bad debts are actually uncollectible.) --It is important to emphasize that the direct write-off method is generally not allowed for financial reporting under GAAP. It is only used in financial reporting if uncollectible accounts are not anticipated or are expected to be very small.

underestimating bad debt - example

1. What if actual bad debts in 2022 were $6 million, compared to an estimate of $5 million? 2. What adjustment is required at year-end? -A debit balance before adjustment indicates that the balance of the allowance account at the beginning of the year was too low. In the case of a debit balance, we've written off more bad debts in the current year than we had estimated. The year-end adjusting entry is affected by the extent to which the previous year's ending balance of Allowance for Uncollectible Accounts differs from the current year's actual amount of uncollectible accounts. -In the example on this slide, the balance before adjustment was a debit of $1. Because we estimate the ending balance in the Allowance should be $7 credit, we need to add $8 to the account. The journal entry for this adjustment is shown in this slide.

common mistake: allowance for uncollectible accounts

Because Allowance for Uncollectible Accounts has a normal credit balance, students sometimes misclassify this account as a liability, which also has a normal credit balance. Instead, this contra asset represents a reduction in a related asset account.

bad debt expense in the income statement

In the 2022 income statement, Kimzey will report bad debt expense of $5 million along with other operating expenses of $50 million as shown in this slide. Even though the $5 million in bad debts have not actually occurred, they are estimated to occur and are associated with this year's credit sales. So, we show in the income statement both the revenue from credit sales and the cost of those credit sales—bad debt expense.

What if the six-month note was accepted on November 1, 2021 (due on May 1, 2022)?

Kimzey will earn interest revenue in two separate accounting periods (assuming Kimzey uses a calendar year): for two months of the six-month note in 2021 (November and December), and for four months in the next year (January through April).

key point: notes receivable

Notes receivable are similar to accounts receivable except that notes receivable are formal credit arrangements made with a written debt instrument, or note.

note receivable example

On February 1, 2021, Kimzey Medical Clinic provides services of $10,000 to a patient, Justin Payne, who is not able to pay immediately. In place of payment, Justin offers Kimzey a six-month, 12% promissory note. Because of the large amount of the receivable, Kimzey agrees to accept the promissory note as a way to increase the likelihood of eventually receiving payment. In addition, because of the delay in payment, Kimzey would like to charge interest on the outstanding balance. A formal promissory note provides an explicit statement of the interest charges.

common mistake: bad debt expense

Some students erroneously think firms should reduce total assets and record bad debt expense at the time the bad debt actually occurs. However, companies anticipate future bad debts and establish an allowance for those estimates.

common mistake: write off an uncollectible account

Students often mistakenly record bad debt expense when they write off an uncollectible account. The bad debt expense was recorded in a prior year at the time of estimating uncollectible accounts.

key point: direct write-off method

The direct write-off method waits to reduce accounts receivable and record bad debt expense until accounts receivable prove uncollectible in the future. This leads to accounts receivable being overstated in the current year. The direct write-off method generally is not acceptable for financial reporting.

key point: receivables turnover ratio and average collection period

The receivables turnover ratio and average collection period can provide an indication of management's ability to collect cash from customers in a timely manner.

which of the following would be used to compute net revneue

Total Revenue - Sales Discounts - Sales Allowances

key point: aging method

Using the aging method to estimate uncollectible accounts is more accurate than applying a single percentage to all accounts receivable. The aging method recognizes that the longer accounts are past due, the less likely they are to be collected.

nontrade receivables

receivables that originate from sources other than customers. They include tax refund claims, interest receivable, and loans by the company to other entities, including stockholders and employees.