AC211_2

365/AR Turnover = what ratio?

Average collection period (days' sales in accounts receivable).

How often are the monetary amounts in inventory and cost of goods sold accounts updated under a periodic inventory system?

only at the end of an accounting period (not at every instance that a sale occurs).

What does the allowance ratio represent?

the % of accounts receivable that the company expects it will NOT collect.

Describe the allowance method for accounting for uncollectible accounts receivable

uncollectible accounts receivable that arise from credit sales of the period are ESTIMATED at the end of each accounting period so that they can be matched against revenue of the same period.

How do you calculate weighted average cost per unit?

"Cost of goods available for sale DIVIDED by # of units available for sale."

What is the primary objective in managing accounts receivable?

"managing credit and collection policies to achieve a combination of sales volume, bad-debts, and receivable turnover that maximizes the cash flow and profits of the firm. "

If a balance sheet line read, "Accounts receivable (net of allowance of $234 and $267)" and $5,432 appeared under the column for 2012 and $4,905 appeared under the column for 2011 to the right, respectively, then what is the estimated UNCOLLECTIBLE portion of the AR balance at the end of 2012?

$234 is the estimated uncollectible portion (the allowance amount).

If a balance sheet line read, "Accounts receivable (net of allowance of $234 and $267)"and $5,432 appeared under the column for 2012 and $4,905 appeared under the column for 2011 to the right, respectively, then how much is the net accounts receivable for 2012?

$5,432; this is also known as the net realizable value (the amount the company expects to collect from customers).

A company that uses FIFO costing method reports cost of goods sold for the year of $10,000. Had it used the LIFO method, cost of goods sold would have been $12,000. How much in taxes could the company have deferred in the current year if it had used LIFO?

$600; There is a 2,000 difference in the expense under the two approaches so there is a 2,000 difference in the income before tax. If the tax rate is 30%, then 0.3X2,000 = $600 difference in the taxes. LIFO generally leads to higher cost of goods sold than FIFO and consequently LIFO produces lower pre-tax income (and so it would have lower taxes once the tax rate is applied).

Identify approaches that are consistent with the allowance method that allow us to estimate a dollar amount of bad debts.

% of sales, % receivables, and AGING methods.

How to find average account receivables?

(Beginning balance + Ending balance) / 2; (the beginning balance of any balance sheet account for a period is the same as the ending balance of the previous period).

Adjusting entry for bad debts under the Allowance method?

+ Bad Debt Expense (on income statement); +Allowance for bad Debts (on balance sheet, this contra-asset reduces total assets since it is an offset to accounts receivable).

If a company performs a service in 2012 and collects 50% of its fees for that service in 2012, and collects 40% in 2013 but 10% is never collected, how much of its service revenue should be recorded in 2012?

100% since it EARNED the revenue in 2012 by providing the service in 2012. The cash collections do not impact revenue recognition and bad debts are accounted for as an expense but do NOT affect revenues.

If a balance sheet line read, "Accounts receivable (net of allowance of $234 and $267)" and $5,432 appeared under the column for 2012 and $4,905 appeared under the column for 2011 to the right, respectively, then how much is the total (gross) accounts receivable at the end of 2012?

5,666=234+5,432.

What is sales allowance?

A reduction in amount customer must pay or partial refund due to damaged merchandise.

365/Avg Collection Period = what ratio?

Accounts Receivable (AR) Turnover.

What current asset arises from sales on credit?

Accounts receivable (which represent the amount that customers owe the firm).

In what way does the amount in accumulated depreciation (on balance sheet) communicate something distinct from the amount reported as depreciation expense (on income statement)?

Accumulated depreciation is the sum of all depreciation recorded since an asset (or group of assets) was (were) acquired. Depreciation expense reflects only the portion of long-term assets' costs that have been matched to revenues of a particular period.

How can I calculate the # of units available for sale during the period?

Add the # of units in beginning inventory to the # of units purchased during the period.

How can I calculate the # of units sold during the period if the firm does a physical inventory at the end of the period to determine the # units of ending inventory?

After calculating the # of units available for sale (beginning inventory plus purchases in units), SUBTRACT the # of units of ending inventory. This will yield the # of units sold.

What is the Allowance Ratio?

Allowance for bad debts DIVIDED BY Account receivable (gross).

Various names for the contra-asset account that is subtracted from accounts receivable.

Allowance for doubtful accounts; allowance for bad debts; allowance for uncollectible accounts.

If a company has significant credit sales (sales on account), should it use the direct write-off method or the allowance method to record bad debts expense?

Allowance method.

What is meant by "net realizable value" with respect to accounts receivable? How do you calculate it?

Amount we expect to collect from customers; Account receivable - Allowance for bad debts = accounts receivable, net or Net accounts receivable.

If a company extends credit to customers for 40 days, would an account receivable turnover ratio of 7 be considered favorable?

An AR turnover of 7 equates to 365/7 or 52 days. Since 52 days is significantly over the 40 day credit period, this would be UNFAVORABLE. On average, customers are not paying on time.

What is a contra-revenue account? Examples?

An account that is an offset to a revenue account and therefore deducted from revenue; "sales discounts" and "sales returns and allowances" are typical contra-revenue accounts that are deducted from sales to arrive at net sales revenue.

What is aging as it relates to accounts receivable?

An aging schedule is an analysis of the amounts owed to a firm by the length of they have been outstanding. This is a balance-sheet (B/S) oriented approach, since it uss one B/S account (Accounts Receivable) to estimate another B/S account (Allowance for Bad Debts).

If a horizontal analysis of Cost of Goods Sold yields a percentage of 14.0%, which would be of concern (as an unfavorable condition): an increase of sales revenue MORE than 14% or LESS than 14%?

An increase of sales revenue less than 14% would be of more concern since this would imply that the cost of the inventory that was sold (the expense Cost of Goods sold) is increasing at a faster rate than the sales revenue -- so gross profit % is declining (unfavorable).

What are long-term assets? Examples?

Assets that will last for more than a year. Examples include land, equipment, building, vehicles.

Describe the approach of estimating bad debts using a Percentage of Credit Sales

Based on past history, a company will apply an estimated % uncollectible to the amount of credit sales of the peirod to determine the amount of bad debt expense (and the amount of the adjusting entry at the end of the period). This is an Income-Statement(I/S) oriented approach in that it uses one I/S account (revenue, usually CREDIT SALES) to estimate anther I/S account (bad debt expense).

Why would a company with only cash sales have no bad debt expense?

Because the company would receive all cash at the point of sales. They would have no accounts receivable and thus no risk of uncollectible accounts.

Why might you check your work by adding ending inventory $ and cost of goods sold $ after working a LIFO, FIFO, or Weighted Average inventory cost problem?

Because the sum should always add back to the cost of goods available for sale (beginning inventory plus purchases), regardless of the cost flow assumption.

Why say either "allowance" or "expense" when referring to accounts in the entry to record bad debts?

Because they are 2 separate accounts: Bad Debt Expense is on the income statement and the Allowance for Bad Debts is on the balance sheet.

What is the inventory balancing equation to calculate cost of goods sold?

Beginning inventory + Net Purchases = Cost of goods available for sale (which are either sold or not sold during the period) so Cost of Goods Available for Sale - Ending inventory =Cost of goods sold.

What are the accounts receivable (AR) turnover ratio and the average collection period measuring?

Both are measures of how quickly a firm collects its accounts receivable. They indicate the effectiveness and efficiency of a company's credit-granting and collection policies. The average collection period is expressed in DAYS.

How do you perform Horizontal or Trend Analysis?

Calculate a percentage change: (Current year amount minus prior year amount / (prior year amount) x 100%.

What's favorable with regard to receivable turnover and average collection period (higher #s or lower #s)?

Companies generally strive for a high receivable turnover ratio and a correspondingly low average collection period (so collect cash quicker from customers).

What type of account is accumulated depreciation?

Contra-asset account (since it is subtracted from an asset account such as equipment or buildings or vehicles).

What type of account is "allowance for bad debts"?

Contra-asset account (since it is subtracted from its related asset account, accounts receivable).

What are assets that the company plans to turn into cash or use to generate revenue in the next fiscal year? Examples?

Current assets (cash, short-term investments, accounts receivable, inventory, prepaid expenses).

What are liabilities that the company will settle in the next fiscal year? Examples?

Current liabilities (which typically include accounts payable, salaries payable, interest payable, and unearned revenue). Also any portion of long-term debt that is due within 12 months from the balance sheet date is classified as a current liability.

What do we call a systematic and rational allocation process that recognizes the expense of long-term assets over the periods in which the assets are used?

Depreciation.

What does the allowance for bad debts represent?

Estimated portion of accounts receivable that the corporation may not collect from customers.

Which inventory costing method provides the most meaningful measure of ending inventory cost (i.e., closest to replacement cost) when inventory costs have increased considerably over time?

FIFO since ending inventory costs would consist of the most recently purchased merchandise (remember LISH -- last-in, still here for FIFO).

Would LIFO or FIFO generally lead to a higher current ratio?

FIFO since its ending inventory costs would consist of the most recently purchased merchandise (remember LISH -- last-in, still here for FIFO) and typically those costs in many industries rise over time.

Name three common methods of ESTIMATING inventory and cost of goods sold (cost flow assumptions)

FIFO, LIFO, and Weighted average cost.

Companies prefer which inventory cost method if they want to maximize reported earnings (net income)? (Assume period of rising inventory costs so that purchase costs increased over time).

FIFO.

Describe FIFO

First-in, First-out is the inventory cost flow method that assumes the first inventory items purchased from suppliers (beginning inventory and earliest purchases) are the first items sold to customers-- thus, FIFO describes the flow of costs to cost of goods sold. FIFO implies LISH -- Last-in, Still Here -- for the costing of ending inventory.

Why may a firm estimate bad debts expense in advance of accounts actually becoming uncollectible?

In order to follow the matching principle (which helps us measure profit or net income or earnings of the period).

What is a contra-asset? Examples?

It is an amount that is deducted from an asset; allowance for bad debts and accumulated depreciation are both contra-asset accounts.

Why might a company (like Leslie Fay) intentionally understate bad debts?

It lowers reported expenses and increases reported net income (higher earnings).

If a customer returns a good after the sale, how does the retailer reflect that in its accounts?

It records a "sales return," which is a contra-revenue account (and will be subtracted from sales revenue to arrive at net sales).

What is cost of goods sold?

It represents the COST of inventory that was sold during the period. It is an expense (typically the largest expense on a manufacturer's or retailer's income statement). The COST may be determined using LIFO, FIFO, weighted average or specific identification.

What is "residual value" as it relates to a long-term asset?

It's also known as salvage value; it is the estimated value of an asset at the end of its useful life.

Describe LIFO

Last-in, First-out is the inventory cost flow method that assumes the last inventory items that the firm purchased from its supplies re the first items sold -- thus, LIFO describes the flow of costs to cost of goods sold. LIFO also implies FISH- First In, Still Here (with regard to costing inventory on hand at the end of the period).

What did we observe when we compared Leslie Fay against similar apparel manufacturers?

Leslie Fay's balance sheet showed a much higher % of net accounts receivable to gross accounts receivable than that of competitors selling to the same customers. (Alternatively, one could say its allowance ratio was understated). By estimating low uncollectible accounts, bad debt expense was also low. Thus, Leslie Fay was trying to report higher net income.

Since the income statement often does not report cash sales separately from credit sales, how can you tell whether or not a company has significant sales on account?

Look at the balance sheet to see if it has relatively high accounts receivable. Accounts receivable only arise from sales on account (not from cash sales).

In the Additional Perspective problem that we discussed (listed on syllabus), why was the accountant asked to recategorize an account receivable from the over 90 day category to the "current" category in preparing the aging schedule?

Moving the account receivable to current status would result in a lower estimate of bad debts. This would mean the adjusting entry to record bad debt expense and the allowance would be lower and this means reported earnings for the period would be higher.

If an analyst were to calculate the average collection period using NET SALES and average accounts receivable, why would we expect a retailer like TARGET to have a much longer average collection period than a retailer like Wal-Mart or Costco?

NET SALES would include both credit sales and cash sales (less contra revenue accounts). Cash sales are collected on the day of sale. So if a retailer has mostly cash sales, its average collection period will be very low when using a NET SALES #. Target will have a higher proportion of credit sales in its net sales because it has a credit card that it administers.

What is Account Receivable, Net?

Net accounts receivable equals accts receivable (gross) minus allowance for doubtful accounts (or similar allowance name). Other known as net realizable value, which is the amount the firm expects to collect from customers.

What is gross profit or gross margin?

Net sales revenue MINUS cost of goods sold.

Must the actual flow of inventory match the cost flow assumption used for financial reporting?

No. Companies may select an inventory costing method even if it does not match the actual flow of sales. (So a firm may use LIFO even if it tries to sell oldest goods first).

What does "on account" mean?

On credit (where cash flow will occur at a later date). The expression applies to either buying or selling. If a company buys inventory on account from a supplier, the company receives the inventory but will pay the supplier later (accounts payable). If a company sells inventory on account, the company will record accounts receivable (right to collect from customers in the future).

Inventory that a retailer has purchased from suppliers but not yet sold to customers is reported where?

On the balance sheet as inventory (which is under current assets).

Where is cost of goods sold reported?

On the income statement as an expense.

What is a perpetual inventory system?

One that updates the inventory account $ each time inventory is bought or sold.

What are trade discounts?

Reduction in the listed price of a product or service. (Like special sale period or senior discount or volume discount). Directly reduces the amount recorded as revenue.

What is a sales discount?

Reduction in the sales price of a product offered to customers for prompt payment. Example of credit terms: 2/10, n/30 (means 2% discount if pay within 10 days; otherwise the balance is due in 30 days.

Why is LIFO so widely used in the U.S.?

Tax savings due to lowest amount of reported profits (consequence of higher cost of goods sold) during periods of increasing costs. The LIFO conformity rule requires that companies using LIFO for tax reporting also must use it for financial reporting.

What's the benefit of classified balance sheet?

The format (with subtotals for current assets and current liabilities) makes it easier to evaluate a company's liquidity risk (whether or not it appears likely that a firm can meet its obligations due in the next year.

What is the logic or rationale of the aging approach to estimating bad debts (uncollectible Accts Receivable)?

The older the account (the longer it has been outstanding or the longer it is past due), the less likely it is to be collected and thus the higher the likelihood that it is uncollectible (a "bad debt").

What's meant by "gross account receivable" (even though gross isn't part of an title typically on a balance sheet)?

Total amount owed by customers to firm at point in time; Sometimes it is not directly reported but you can determine the toal by adding Net Acct Rec and the Allowance for Bad Debts.

What is the first line of an income statement for a retailer?

Typically, net sales.

When would Specific Identification method be used?

With companies who primarily deal with unique, expensive products with low sales volume. This is an inventory cost flow method in which the actual cost of the specific goods sold is recorded as cost of goods sold.

Can a firm that reports positive gross profit conceivably have a bottom line net loss?

Yes. Only one expense line is subtracted in calculating gross profit and that's cost of goods sold. There are many more expenses that must be subtracted to determine net income (or net loss).

With rising inventory costs, is it conceivable that a firm using LIFO could report low inventory amounts on its balance sheet?

Yes. Under LIFO, ending inventory is characterized by FISH first-in, still-here and those old inventory purchase costs could be very low if costs have risen a lot over time.

What type of account is "sales returns and allowances"?

a contra-revenue account. This particular account holds amounts that reduce sales due to customer returns or allowances for damaged goods. These do NOT constitute expenses because expenses help to generate revenues!

How can you use balance sheet data to infer whether equipment is nearing the end of its useful life?

accumulated depreciation DIVIDED by cost equals % of cost depreciated (portion of useful life that has expired) if corporation uses straight-line depreciation.

Explain direct write-off method recording uncollectible receivables

bad debt expense recorded when particular account is deemed non-collectible; doesn't involve use of allowance account. Acceptable for tax purposes. Acceptable for financial reporting purposes only if credit sales (and bad debts) are insignificant.

What is liquidity?

in the context of assets, liquidity refers to how easily an asset can be converted to cash. The more liquid an asset, the more easily it can be turned into cash. Current assets are listed in order of liquidity. Liquidity ratios are used to measure a company's ability to meet its short-term obligations.

In order to achieve good "matching," when should a firm record bad debt expense?

in the period in which the related credit sales were made.