Accounting-Chapter 5

We report accounts receivable in the balance sheet at their net realizable value. Explain what this term means

Net realizable value is the amount of cash the firm expects to collect. Net realizable value is equal to accounts receivable minus the allowance for uncollectible accounts.

When recording a credit sale, what account do we debit? Describe where this account is reported in the financial statements

When recording a credit sale, we debit accounts receivable. Accounts receivable are reported as assets in the balance sheet.

What will be the total interest earned on a 6%, $2,000 note receivable that is due in nine months?

Interest=(Face value) x (Annual interest rate)x(Fraction of the year)

How can effectively managing receivables benefit a company?

A company can attempt to boost sales, and thereby increase its value, by allowing customers to purchase products and services on account. Some customers may be unwilling or unable to purchase products and services in the current period if immediate cash payment is required. However, failure to recognize high-risk customers or to have a reliable collection policy can result in uncollectible accounts and lost resources, thereby lowering the value of a company. Having enough cash is important to running any business. The more quickly a company can collect on receivables, the more quickly it can use that cash to generate even more cash by reinvesting in the business and generating additional sales.

If at the end of the year Allowance for Uncollectible Accounts has a credit balance before any adjustment, what might that tell us about last year's estimate of future uncollectible accounts?

A credit balance occurs in the Allowance for Uncollectible Accounts before adjustment when actual bad debts in the current year are less than the previous year's estimate of bad debts.

Allowance for Uncollectible Accounts is a contra asset account, which means that its normal balance is a credit. However, it is possible for the account to have a debit balance before year-end adjustments are recorded. Explain how this could happen

A debit balance in the allowance for uncollectible accounts before adjustment could occur if actual bad debts in the current year exceed the previous year's estimate of bad debts.

Revenue can be earned at one point or over a period. Provide an example of each

An example of earning revenue at one point would be selling a car. An example of earning revenue over a period would be providing an annual magazine subscription.

Explain the correct way companies should account for uncollectible accounts receivable (bad debts)

Companies should account for uncollectible accounts receivable using the allowance method. Under this method, a company estimates future bad debts and records those estimates as an expense and contra asset in the current period.

How does accounting for uncollectible accounts conform to the concept of the matching principle?

Credit sales represent revenue from selling products and services on account in the current period. One of the costs associated with credit sales is bad debts. Therefore, to properly match expenses--bad debts--with their related revenues--credit sales--we should record future bad debts with current credit sales.

With respect to notes receivable, explain what each of these represent: (a) face value, (b) annual interest rate, and (c) fraction of the year

Face value - amount of the note. Annual interest rate - the interest charged by the lender to the borrower stated on an annual (twelve month) basis. Fraction of the year - the proportion of the year that the note is outstanding.

Notes receivable differ from accounts receivable in that notes receivable represent written debt instruments. What is one other common difference between notes receivable and accounts receivable?

One common difference is that notes receivable commonly require the borrower to pay interest. Also, notes receivable typically arise not from sales to customers, but from loans to other entities including affiliated companies, loans to stockholders and employees, and occasionally the sale of merchandise, other assets, or services.

Interest on a note receivable typically is due along with a face value at the note's maturity date. If the end of the accounting period occurs before the maturity date, how do we record interest earned but not yet collected?

Recording interest earned but not yet received includes a debit to interest receivable and a credit to interest revenue. The amount is calculated as the face value of the note times the annual interest rate times the fraction of the year the note is outstanding.

Briefly explain the accounting treatment for sales returns and allowances. Where are thee accounts reported in the income statement?

Sales returns and allowances are contra revenue accounts and therefore have normal debit balances. Sales returns occur when a customer returns a product. Sales allowances occur when the seller reduces the customer's balance owed or provides at least a partial refund because of some deficiency in the company's product or service. Sales returns and allowances are reported as contra revenues in the income statement.

What does the age of accounts receivable refer to? How can we use an aging method to estimate uncollectible accounts receivable?

The age of accounts receivable refers to how far past due accounts are. The older the account, the less likely it is to be collected. The aging method estimates uncollectible accounts receivable by associating a percentage probability of uncollectibility to each account and multiplying that percentage by the account balance to determine the estimated uncollectible amount.

Discuss the differences between the allowance method and the direct write-off method for recording uncollectible accounts. Which of the two is acceptable under financial accounting rules?

The allowance method requires companies to estimate future bad debts and record those estimates in the current period as a reduction in accounts receivable and an increase in bad debt expense. The direct write-off method makes no attempt to estimate future bad debts. Instead, the reduction in accounts receivable and increase in expense associated with bad debts is recorded only when the bad debt actually occurs. Only the allowance method is allowed for financial accounting.

How is the average collection period of receivables? What does this ratio indicate? Is a higher or lower average collection period preferable?

The average collection period equals 365 days divided by the receivables turnover ratio. The ratio shows the approximate number of days the average accounts receivable balance is outstanding. Typically, a lower number is a good indicator of a company's effectiveness in managing receivables.

Explain why the percentage-of-receivables method is referred to as the balance sheet method and the percentage-of-credit-sales method is referred to as the income statement method

The percentage of receivables method estimates future bad debts based on a balance sheet account - accounts receivable. The percentage of credit sales method estimates future bad debts based on an income statement account - credit sales. 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.

Explain why the percentage-of-receivables method is refereed to as the balance sheet method and the percentage-of-credit-sales method is referred to as the income statement method

The percentage of receivables method is commonly used in practice. Financial accounting rules require accounts receivable to be stated at their net realizable value, and this is better accomplished through the percentage of receivables method. The percentage of credit sales method focuses on matching current period bad debt expense with current period credit sales, that is, the matching principle.

How is the receivables turnover ratio measured? What does this ratio indicate? Is a higher or lower receivables turnover preferable?

The receivables turnover ratio equals net credit sales divided by average accounts receivable. The ratio shows the number of times during a year that the average accounts receivable balance is collected (or "turns over"). Typically, a higher ratio is a good indicator of a company's effectiveness in managing receivables.

What are the financial statement effects of establishing an allowance for uncollectible accounts?

The two financial statement effects of establishing an allowance for uncollectible accounts are: (1) reducing assets and (2) increasing expenses (or reducing net income and ultimately retained earnings).

What two purposes do firms achieve by estimating future uncollectible accounts?

The two purposes include reducing accounts receivable to their net realizable value (or amount expected to be collected) and matching expenses (bad debts) in the same period as the revenue (credit sales) they help to generate.

When we have established an allowance for uncollectible accounts, how do we write off an account receivable as an uncollectible? What effect does this write-off have on the reported amount of total assets and net income at the time of the write-off?

The write-off an account as uncollectible includes a debit to the Allowance for Uncollectible Accounts and a credit to Accounts Receivable for the amount being written off. The write-off has no effect on total assets or net income at the time of the write-off.

Describe the year-end adjustment to record the allowance for uncollectible accounts

The year-end adjustment to record the allowance for uncollectible accounts includes a debit to bad debt expense and a credit to the allowance for uncollectible accounts. The amount of the adjustment is the amount needed to adjust the allowance for uncollectible accounts to its estimated ending balance.

Explain the difference between a trade receivable and a non trade receivable?

Trade receivables are amounts receivable from customers due to credit sales. Nontrade receivables are receivables from those other than customers and include tax refund claims, interest receivable, and loans by the company to other entities including stockholders and employees.

What is the difference between a trade receivable and a non trade receivable?

Trade receivables are amounts receivable from customers due to credit sales. Nontrade receivables are receivables from those other than customers and include tax refund claims, interest receivable, and loans by the company to other entities including stockholders and employees.