Accounting Ch 9: Receivables

Brickman Company uses the allowance method to account for uncollectible receivables. At the beginning of the year, Allowance for Bad Debts had a credit balance of $1000. During the year Brickman wrote off uncollectible receivables of $2100. Brickman recorded Bad Debts Expense of $2700. What is Brickman's year-end balance in Allowance for Bad Debts?

$1,600

Brickman's ending balance of Accounts Receivable is $19,500. Use the data in the preceding question (4) to compute the net realizable value of Accounts Receivable at year-end. A. $16,800 B. $19,500 C. $17,400 D. $17,900

$17,900

During the year, Bernard Company had net credit sales of $45,000. At the end of the year, before adjusting entries, the balance in Accounts Receivable was $12,500 (debit) and the balance in Allowance for Bad Debts was $650 (credit). If the company uses an income statement approach to estimate bad debts at 5%, what is the ending balance in the Allowance for Bad Debts account?

$2,900

Acid test ratio formula

(Cash including cash equivalents + Short-term investments + Net current receivables) / Total current liabilities

There are two methods of accounting for uncollectible receivables:

1. Direct write off method 2. Allowance method (GAAP method)

List 3 limitations of the direct write off method of accounting for uncollectibles

1. Overstates assets on the balance sheet 2. Does not match expenses against revenue very well 3. Does not set up an allowance for uncollectibles

There are 3 methods to estimate uncollectibles using the allowance method

1. Percent of Sales 2. Percent of Receivables 3. Aging of Receivables

Writing Off Uncollectible Accounts—Allowance Method

An allowance is established for the estimated uncollectible accounts Instead of recording a debit to Bad Debts Expense, the company records a debit to Allowance for Bad Debts The entry to write off an account under the allowance method has no effect on the net income at the time of entry

Options to decrease collection time while transferring the risk of non collection to a third party include:

Credit card and debit card sales Factoring (sold) and pledging (collateral) receivables -

Examples of other receivables

Dividends receivable Interest receivable Taxes receivable receivables are classified as either current or long term, depending on whether they will be received within one year or longer

Using the data in the preceding question, what will the income statement for the year ended December 31 report for this situation?

Interest revenue of $700

With good internal controls, the person who handles cash can also a) account for cash payments b) account for cash receipts from customers c) issue credits to customers for sales returns d) None

NONE

Companies estimate bad debts expense based upon:

Past experience The industry in which they operate Other variables

A receivable is a right to

Receive cash in the future from a current transaction

At December 31 year-end, Crain Corporation has an $8,4000 note receivable from a customer. Interest of 10% has accrued for 10 months on the note. What will Crain's financial statements report for this situation at December 31?

The balance sheet will report the note receivable of $8,400 and interest receivable of $700

Payee of the note (creditor)

The entity to whom the maker promises future payment; the payee of the note is the creditor. The creditor is the company that loans the money.

Factoring receivables

The practice of selling accounts receivable to a third party at a discount. The third party attempts to collect the accounts and keeps the money

Under the direct write off method, when are A/Rs written off?

When the business determines that it will never collect from a specific customer once an A/R is written off, the company stops pursuing the collection

Pledging receivables

a business uses its receivables as security for a loan. the business borrows money from a bank and offers its receivables as collateral.

Accounts receivable turnover ratio

a measure of the number of times the company collects the average accounts receivable balance in a year the higher the ratio, the faster the cash collections

Promissory Note

a written promise to pay a specified amount of money at a particular future date, usually with interest

When using the allowance method, the ONLY time Bad Debts Expense is recorded is as an

adjusting entry

Accounts Receivable

aka trade receivables represent the right to receive cash in the future from customers for goods or services performed generally collected within 30-60 days reported as a current asset on the balance sheet

Bad Debts Expense

arises from failure to collect from some customers who purchase on account

Aging of Receivables Method

businesses group individual accounts based on how long the receivable has been outstanding different percentages are applied to each category A/R ending balance x % uncollectible = target balance

A critical element of internal control is the separation of

cash-handling and cash-accounting duties - the credit department should have no access to cash - those who handle cash should not be in a position to grant credit to customers

Percent of Receivables Method

computes bad debts expense as a percentage of accounts receivable A/R ending balance x % uncollectible = Target Balance of Allowance

The entry to record a write-off of an uncollectible account when using the direct write-off method involves a

debit to bad debts expense

Days' sales in receivables

indicates how many days it takes to collect the average level of receivables also called the collection period should be close to the number of days customers are allowed to make payment when credit is extended

The direct write off method VIOLATES the

matching principle the DWO method is only acceptable for companies that have very few uncollectible receivables

Receivable

occurs when a business sells goods or services to another party on account (on credit). It is a monetary claim against a business or individual

Principal

the amount loaned by the payee and borrowed by the maker of the note

Maturity Date

the date when a note is due

When a maker dishonors a note,

the dishonored note and unpaid interest are transferred to Accounts Receivable Later, the A/R can be written off under the direct write off or allowance method

Maker of the note (debtor)

the entity that signs the note and promises to pay the required amount

Debtor

the party to a credit transaction who is obligated to pay later

Creditor

the party who receives a receivable

Interest rate

the percentage rate of interest specified by the note almost always stated for a period of one year

Interest period

the period of time during which interest is computed it extends from the original date of the note to the maturity date also called the note term

Interest

the revenue to the payee for loaning money interest is an expense to the debtor and revenue to the creditor

Maturity value

the sum of the principal plus interest due at maturity the total amount that will be paid back

Acid-test ratio

used to measure a company's ability to pay its current liabilities more stringent than the current ratio the higher the acid test ratio, the more able the business is to pay its current liabilities in general, an acid-test ratio of 1.00 or higher is considered safe

Notes Receivable

usually have longer terms than accounts receivable sometimes called promissory notes represents a promise to pay a fixed amount of principle PLUS INTEREST by a certain due date

Companies must _____ to receive _____ from sales on account.

wait, cash Some accounts are never collected

Formula for computing interest:

Amount of Interest = Principal x Interest Rate x Time time represents the portion of a year that interest has accrued on the note. ex 3/12 months or 10/365 days

At year-end, Schultz, Inc. has cash of $11,600, current accounts receivable of $48,900, merchandise inventory of $37,900, and prepaid expenses totaling $5,100. Liabilities of $55,900 must be paid next year. What is Schultz's acid-test ratio?

1.08

Using the data in the preceding question, assume accounts receivable had a beginning balance of $67,400 and net credit sales for the current year totaled $807,800. How many days did it take Schultz to collect its average level of receivables?

26

Allowance for Bad Debts

A contra asset account, related to A/R, that holds the estimated amount of uncollectible accounts. It reduces the A/R to the net realizable value

Allowance Method

A method of accounting for uncollectible receivables in which the company estimates bad debts expense instead of waiting to see which customers the company will not collect from. Records bad debts in the same period as the sales revenue

Direct Write-Off Method

A method of accounting for uncollectible receivables in which the company records bad debts expense when a customer's account receivable is uncollectible. primarily used by small, non-public companies

Most companies used the _________ method to measure bad debts. It is based on the ________ __________.

Allowance Method matching principle

Percent of Sales Method

Also called Income Statement Approach it computes bad debts expense as a % of net credit sales Credit Sales x % Uncollectible = Bad Debt Exp