Ch. 5 ACCT 2110 Exam 2

Accounting for Bad Debts •GAAP requires accounts receivable to be shown at their ''net realizable value,'' which is the amount of cash the company expects to collect. •When customers do not pay their accounts receivable, bad debts result (also called uncollectible accounts). •There are two methods to record bad debt expense: -the direct write-off method -the allowance method

Accounting for Bad Debts •GAAP requires accounts receivable to be shown at their ''___ __________ _____,'' which is the amount of ____ the company expects to collect. •When customers do not pay their accounts receivable, ___ _____ result (also called uncollectible accounts). •There are two methods to record bad debt expense: -the ______ _____-___ method -the _________ method

Aging Method •Under the aging method, bad debt expense is estimated by determining the collectability of the accounts receivable rather than by taking a percentage of total credit sales. •At the end of each accounting period, the individual accounts receivable are categorized by age. •Then an estimate is made of the amount expected to default in each age category based on past experience and expectations about how the future may differ from the past. •Since the objective of the aging method is to estimate the ending balance in the allowance for doubtful accounts, any existing balance in the allowance account must be considered when determining the amount of the adjusting entry.

Aging Method: •Under the aging method, bad debt expense is estimated by determining the _____________ of the accounts receivable rather than by taking a __________ of total credit sales. •At the end of each accounting period, the individual accounts receivable are categorized by ___. •Then an estimate is made of the amount expected to default in each age category based on past __________ and ____________ about how the future may differ from the past. •Since the objective of the aging method is to estimate the ______ balance in the allowance for doubtful accounts, any existing balance in the allowance account must be considered when determining the ______ of the adjusting entry.

Allowance Method -•Splits the accounting into two journal entries: 1. Record an estimate of bad debt expense at the end of the accounting period. 2. Write off receivables when they become uncollectible. -•Two approaches under the Allowance method: 1. Percentage of credit sales 2. Aging of accounts receivable

Allowance Method -•Splits the accounting into two journal entries: 1. Record an ________ of ___ ____ _______ at the end of the accounting period. 2. Write off receivables when they become _____________. -•Two approaches under the Allowance method: 1. 2.

Allowance Method: •In the allowance method, bad debt expense is recorded in the period of sale, which allows it to be properly matched with revenues according to the matching concept. •The result is that bad debt expense is recognized before the actual default. •An account is established to ''store'' the estimate of potentially uncollectible accounts and is known as the Allowance for Doubtful Accounts. This is a contra-asset and is shown as a deduction from Accounts Receivable on the balance sheet.

Allowance Method: •In the allowance method, ___ ____ _______ is recorded in the period of sale, which allows it to be properly matched with ________ according to the matching concept. •The result is that ___ ____ _______ is recognized before the actual default. •An account is established to ''store'' the estimate of potentially uncollectible accounts and is known as the _________ for ________ Accounts. This is a ______-_____ and is shown as a _________ from Accounts Receivable on the balance sheet.

Analyzing Receivables •Analysts are also concerned with asset management. Asset management refers to how efficiently a company is using the resources at its disposal. •One of the most widely-used asset management ratios is accounts receivable turnover: Accounts Receivable Turnover = Net Sales ÷ Average Net Accounts Receivable •This ratio provides a measure of how many times average trade receivables are collected during the period. • Changes in this ratio over time are also very important.-For example, a significant reduction in receivables turnover may indicate that management is extending credit to customers who are not paying.

Analyzing Receivables •Analysts are also concerned with _____ management. _____ management refers to how efficiently a company is using the resources at its disposal. •One of the most widely-used asset management ratios is accounts receivable turnover: A.R.T. = ___ _____ ÷ _______ ___ ________ __________ •This ratio provides a measure of how many times _______ _____ ___________ are _________ during the period. • _______ in this ratio over time are also very important. -For example, a significant reduction in receivables turnover may indicate that management is extending credit to customers who are not ______ .

Analyzing Sales •Because sales revenue is such a key component of a company's success, analysts are interested in a large number of ratios that incorporate sales. •Many of these profitability ratios attempt to measure the return the company is earning on sales. •There are three common profitability ratios: - Gross Profit Margin = Gross Profit ÷ Net Sales - Operating Margin = Operating Income ÷ Net Sales - Net Profit Margin = Net Income ÷ Net Sales •Analysts also like to look at the operating margin and net profit margin percentages to see how much is left from a sales dollar after paying for the product and all its operations.

Analyzing Sales •Because _____ _______ is such a key component of a company's success, analysts are interested in a large number of ratios that incorporate sales. •Many of these profitability ratios attempt to measure the ______ the company is earning on _____. •There are three common profitability ratios: - Gross Profit Margin = _____ ______ ÷ ___ _____ - Operating Margin = _________ ______ ÷ ___ _____ - Net Profit Margin = ___ ______ ÷ ___ _____ •Analysts also like to look at the _________ margin and ___ ______ margin percentages to see how much is left from a sales dollar after paying for the product and all its operations.

Cash Management: Factoring Receivables •An increasingly common practice is to factor, or sell, receivables. •When receivables are factored, the seller receives an immediate cash payment reduced by the factor's fees. •The factor, the buyer of the receivables, acquires the right to collect the receivables and the risk of uncollectibility. •In a typical factoring arrangement, the sellers of the receivables have no continuing responsibility for their collection.

Cash Management: Factoring Receivables •An increasingly common practice is to factor, or sell, ___________. •When ____________ are factored, the seller receives an immediate cash payment reduced by the factor's fees. •The ______, the buyer of the receivables, acquires the right to _______ the receivables and the risk of ________________. •In a typical factoring arrangement, the sellers of the receivables have no __________ ______________ for their collection.

Comparison of Percentage of Credit Sales Method and Aging Method: •The percentage of credit sales method is primarily concerned with appropriately estimating bad debt expense on the income statement. •The aging method is a balance sheet approach that analyzes the accounts receivable to estimate its net realizable value.

Comparison of Percentage of Credit Sales Method and Aging Method: •The _____________ method is primarily concerned with appropriately estimating bad debt expense on the income statement. •The _____________ method is a balance sheet approach that analyzes the accounts receivable to estimate its net realizable value.

Direct Write-off Method: Bad debt expense is recorded when an account receivable is written off. Bad debt expense is debited and accounts receivable is credited. - Shortcomings of the Direct Write-off Method: -- Violates GAAP. Fails to match bad debt expense with revenue. Delays the expense until an account receivable is determined to uncollectible. -- Provides an opportunity to manipulate earnings by choosing when to record expense. -- Does not provide the best estimate of the net cash flow from accounts receivable.

Direct Write-off Method: Bad debt expense is recorded when an _______ __________ is written off. Bad debt expense is _______ and accounts receivable is ________. - Shortcomings of the Direct Write-off Method: --Violates _____. -- Fails to match ___ _____ expense with _______. -- Delays the expense until an _______ __________ is determined to uncollectible. --Provides an opportunity to manipulate earnings by choosing ____ to record expense. --Does not provide the best estimate of the ___ ____ ____ from accounts receivable.

Percentage of Credit Sales Method: •The simpler of the two methods for determining bad debt expense is the percentage of credit sales method. •Using past experience, a company estimates the percentage of the current period's credit sales that will eventually become uncollectible. •This percentage is multiplied by the total credit sales for the period to calculate the estimated bad debt expense for the period: - Total Credit Sales x Percentage of Credit Sales Estimated to Default = Estimated Bad Debt Expense

Percentage of Credit Sales Method: •The simpler of the two methods for determining bad debt expense is the __________ __ ______ _____ _____ •Using past experience, a company estimates the __________ of the current period's ______ _____ that will eventually become uncollectible. •This __________ is multiplied by the total credit sales for the period to calculate the estimated bad debt expense for the period: - _____ ______ _____ x __________ of ______ _____ _________ to _______ = Estimated Bad Debt Expense

Recording the Note for the Payee: Accounting for a note receivable usually requires entries to record the following: 1st: Acceptance of the note 2nd: Interest earned on the note 3rd: Collection of the note

Recording the Note for the Payee: Accounting for a note receivable usually requires entries to record the following: 1st: 2nd: 3rd:

Sales Discounts: - To encourage prompt payment, businesses may offer a sales discount to customers who purchase on account. - For the buyer, it is a reduction to the cost of the goods and services. - For the seller, the cash is more quickly available and collection costs are reduced. - Most companies record the sale at the net amount because it is assumed that customers will take the discount. - If a sale is at the gross amount and the discount is taken, the amount of the discount is either debited to sales revenue or a contra-revenue account called sales discounts.

Sales Discounts: - To encourage prompt payment, businesses may offer a _____ _________ to customers who purchase on account. - For the _____, it is a reduction to the cost of the goods and services. - For the ______, the cash is more quickly available and collection costs are reduced. - Most companies record the sale at the ___ ______ because it is assumed that customers will take the discount. - If a sale is at the _____ amount and the discount is taken, the amount of the discount is either debited to _____ _______ or a contra-revenue account called _____ _________.

Sales Returns and Allowances: •Occasionally, a customer will return goods as unsatisfactory. •Sometimes a customer may agree to keep goods with minor defects if the seller is willing to make an ''allowance'' by reducing the selling price. •When goods or services arrive late, or in some other way are rendered less valuable, a customer may be induced to accept the goods/services if a price reduction, called a sales allowance is offered by the seller. •In these cases, the price reduction is debited to either sales revenue or a contra-revenue account called sales returns and allowances. •Merchandise or goods returned by the customer to the seller are sales returns and are also debited to either sales revenue or sales returns and allowances. •Net Sales = Sales revenue - Sales returns and allowances - Sales discounts

Sales Returns and Allowances: •Occasionally, a customer will return goods as _____________. •Sometimes a customer may agree to keep goods with minor _______ if the seller is willing to make an ''_________'' by reducing the selling price. •When goods or services arrive late, or in some other way are rendered less valuable, a customer may be induced to accept the goods/services if a _____ __________, called a sales allowance, is offered by the seller. •In these cases, the price reduction is _______ to either sales revenue or a contra-revenue account called _____ _______ and __________. •Merchandise or goods returned by the customer to the seller are _____ _______ and are also _______ to either sales revenue or sales returns and allowances. •Net Sales = _____ _______ - _____ _______ and __________ - _____ _________

Sales invoices: - Sales invoices use a standard notation to state discount and credit terms. --For example, the invoice of a seller who expects payment in 30 days and offers a 2% discount if payment is made within 10 days would bear the notation: 2/10, n/30 (which is read ''2/10, net 30'').

Sales invoices: - Sales invoices use a standard notation to state ________ and ______ _____. --For example, the invoice of a seller who expects payment in 30 days and offers a 2% discount if payment is made within 10 days would bear the notation: _/__, _/___ (which is read ''_/__, net __'').

The company that will receive the principal and interest is called the PAYEE.

The company that will receive the principal and interest is called the _____.

The customer or borrower who will pay the interest and principal is called the MAKER OF THE NOTE.

The customer or borrower who will pay the interest and principal is called the _____ of the ____.

Write-off of an Uncollectible Account - Allowance Method: To write off an uncollectible account receivable using the Allowance method, Accounts Receivable (asset) and the Allowance for Doubtful Accounts(contra-asset) will both be decreased: Date (Allowance for Doubtful Accounts ) XXX ------------------- ( Accounts Receivable ) XXX

Write-off of an Uncollectible Account - Allowance Method: To write off an uncollectible account receivable using the Allowance method, ________ __________ (asset) and the _________ for ________ Accounts (contra-asset) will both be decreased: Date (__________ ___ ________ ________) XXX ---------------- (________ __________) XXX