Chapter 7 Accounting for Receivables

Quality of receivables refers to:

The likelihood of collection without loss.

Maker of the note

The person or business that signs a note and thus promises to make payment.

Percent of Sales Method/Income Statement Approach

Assumes percent of credit sales for the period is uncollectible. Uses a percent of credit sales for the period to estimate bad debts.

A method of estimating bad debts expense that involves a detailed examination of outstanding accounts and the length of time past due is the: a. direct write off method b. aging of accounts receivable method c. Percentage of sales method d. Aging of investments method e. Percent of accounts receivable method

B. Aging of accounts receivable method

Bad debt is later recovered under allowance method

Debit accounts receivable, credit allowance for doubtful accounts. Debit cash, debit accounts receivable.

Store credit card interest revenue

Debit accounts receivable, credit interest revenue

maturity date of a note

the day the note (principal and interest) must be repaid.

Sales using bank credit card

(Report credit card expense as selling expense.) Debit cash, debit credit card expense, and credit sales.

A promissory note received from a customer in exchange for an account receivable is recorded by the payee as: a. cash equivalent b. an account receivable c. note receivable d. short-term investment e. note payable

A note receivable

Bad Debts (Uncollectible Accounts)

Accounts of customers who do not pay what they have promised to pay; an expense of selling on credit. Companies believe that granting credit will increase total sales enough to offset bad debts.

Factoring (selling) receivables

Accounts receivables are sold to a bank and the seller is charged a factoring fee.

Percent of accounts receivable

Also called a balance sheet method. Assumes percent of company's receivables is uncollectible. Percent is based on experience and economic trends.

realizable value

Amount expected to be received

Accounts Receivable

Amounts due from customers for credit sales

installment accounts receivable

Amounts owed by customers from credit sales for which payment is required in periodic amounts over an extended time period. The customer is usually charged interest. Most installement receivables require interest payments and they can be either current or noncurrent assets depending on the time of repayment.

aging of accounts receivable method

Applies several percentages to accounts receivable to estimate bad debt. A method of estimating bad debts expense involving a detailed examination of outstanding accounts and the length of time past due. (Also called the balance sheet approach) is applied like the percent of receivables method except several percentages are used (versus one) to estimate allowance. Each receivable is classified by how long it's past its due date. Estimates of uncollectible amounts are made assuming that the longer an amount is past due, the more likely it is uncollectible. After amounts are classified (or aged) experience is used to estimate percent of each uncollectible class. Percents are multiplied by amounts in each class to get estimated balance of Allowance for Doubtful Accounts.

pledging of receivables

Borrowing money by pledging receivables as security for a loan. Borrower discloses pledging in notes to financial statement.

The quality of receivables refers to: a. creditworthiness of sellers b. method of collection c. The likelihood of collection without loss d. Sales turnover e. Interest rate

C. The likelihood of collection without loss

The expense recognition principle, as applied to bad debts, requires: a. expenses be ignored if their effect on the financial statements is unimportant to user's business decisions b. Use of the direct write-off method for bad debts c. The use of the allowance method of accounting for bad debts d. That bad debts be disclosed in the financial statements e. That bad debts not be written off

C. The use of the allowance method of accounting for bad debts

Bad debt later recovered under direct method...

Debit accounts receivable, credit bad debts expense. Debit cash, credit accounts receivable.

Note is dishonored; receivable and interest recorded

Debit accounts receivable, credit interest revenue, credit notes receivable

Credit sale and a collection of cash from a prior credit sale...

Debit accounts receivable, credit sales (record credit sales) Debit cash, credit accounts receivable (record collection of credit sales).

Credit sales and later collection

Debit accounts receivable, credit sales. Debit cash, credit accounts receivable.

Large retailers sell on credit. Retailers have their own credit cards to grant credit to customers and earn interest on balances past due.

Debit accounts receivable, credit sales. Debit accounts receivable, credit interest revenue.

Decrease allowance

Debit allowance for doubtful accounts, credit accounts receivable.

Writing off a bad debt under allowance method...

Debit allowance for doubtful accounts, credit accounts receivable.

Writing off a bad debt under direct method...

Debit bad debts expense, credit accounts receivable

Estimating bad debts...

Debit bad debts expense, credit allowance for doubtful accounts.

Increase allowance

Debit bad debts expense, credit allowance for doubtful accounts.

Percent of credit sales for period is uncollectible. Retailer expects bad expense from its sales

Debit bad debts expense, credit allowance for doubtful accounts.

Note is honored; when note term runs over two periods, record cash receipt.

Debit cash, credit interest revenue, credit interest receivable, and credit notes receivable.

Note is honored, cash is received in full (with interest)

Debit cash, credit interest revenue, credit notes receivable

If company borrows money and pledges its receivables as security

Debit cash, credit notes payable

Sale of receivables for cash with a charged factor fee...

Debit cash, debit factoring fee expense, credit accounts receivable

Note receivable and cash in exchange for accounts receivable

Debit cash, debit notes receivable, and credit accounts receivable.

Accrue interest on notes receivable (recording end of period interest adjustment)

Debit interest receivable, credit interest revenue

Note receivable from sales

Debit notes receivables, credit sales.

Allowance method

For bad debts matches estimated loss from uncollectible accounts receivable against the sales they produce. Use estimated loss because when sales occur, sellers don't know which customers won't pay. The allowance method requires estimate of total bad debts expected from that period's sales. Two advantages over direct write-off: 1. it records estimated bad debts expense in the period when related sales are recorded and 2. reports accounts receivable on balance sheet at estimated amount to be collected.

Accounts Receivable Turnover

Measures how often, on average, receivables are collected during period. Shows how well management is doing in granting credit to customers. High turnover suggests management should consider using strict less credit terms to increase sales. A low turnover suggests management should consider more strict credit terms and aggressive collection efforts to avoid having assets tied up in accounts receivable.

Bad debts estimation, income statement focus

Percent of sales -> sales x rate = bad debts expense; adjusted entry amount = percent of sales

The expense recognition principle, as applied to bad debts, requires:

The use of the allowance method of accounting for bad debts.

Sellers allow customers to use bank (or third party) credit cards for all of the following reasons except: 1. To be able to charge more due to fees and interest. 2. To avoid risk of customers not paying. 3. To speed up receipt of cash from credit sale. 4. To increase total sales. 5. To avoid having to decide who gets credit and how much.

To be able to charge more due to fees and interest

Factor

a finance company or bank that purchases and takes ownership of another company's accounts receivables.

Promissory note

a written promise to pay a specified amount of money on demand or at a definite time, usually with interest. Used in transactions such as: paying for products and services and lending and borrowing money. Sellers prefer notes when credit period is long and when receivable is for a large amount.

Honoring a note receivable indicates that the maker has: a. signed b. paid in full c. guaranteed d. notarized e. cosigned

b. paid in full

A promissory note is: a. short-term investment for the maker b. written promise to pay a specified amount of money at a certain time. c. liability to the payee d. is another name for an installment receivable e. cannot be used in payment of an account receivable

b. written promise to pay a specified amount of money at a certain time

A finance company or bank that purchases and takes ownership of another company's accounts receivable is called a: a. payer b. pledger c. factor d. payee e. pledgee

c. factor

Allowance for Doubtful Accounts

contra-asset account containing the estimated uncollectible accounts receivable. Advantages: receivables fairly stated, bad debts expense matched with sales, writing off bad debts doesn't affect income or net receivables. Disadvantages: estimates needed.

Accounts Receivable Turnover equation

net credit sales/average net accounts receivable Denominator = (beginning balance + ending balance)/2

Bad debts estimation, balance sheet focus

percent of receivables -> accounts receivable x rate = allowance for doubtful accounts aging of receivables -> accounts receivable (by age) x rates (by age) = allowance for doubtful accounts Adjusting entry amount: percent (or aging) of receivables - unadjusted balance credit or + unadjusted balance debit

Interest formula

principal of note x annual interest rate x time expressed in fraction of year = interest

Direct write off method

records the loss from an uncollectible account receivable when it is determined to be uncollectible. No attempt is made to predict bad debts expense. Advantages: simple, no estimates needed. Disadvantages: receivables and income temporarily overstated. Bad debts expense often not matched with sales.

Principal of a note

the original amount of a note

Payee of the note

the person or business to whom the amount of a note is payable

Interest

the price paid for the use of borrowed money

Period of the note

the time from the note's (contract) date to its maturity date.