Accounting Chapter 5

# of Days in Inventory =

365/A/R Turnover

Accounts Receivable or Notes Receivable:

A ''note'' is a legal document given by a borrower to a lender stating the timing of repayment and the amount (principal and/or interest) to be repaid. Accounts receivable, on the other hand, do not have a formal note.

direct write offs

Bad debt expense is recognized when a specific account is deemed uncollectible Only actual lossesare reflected in bad debt expense Expense is often recognized in a differentperiod than the revenue associated with the sale Violates the "matching principle" FASB does not allow this method unless bad debt expense is "insignificant"

Accounts Receivable Turnover =

Net Sales ÷ Average Net Accounts Receivable

What happens when our customer doesn't pay us?

No credit policy can eliminate all of bad debts! Uncollectible accounts make valuation of A/R tricky

"Trade Receivables" represent

Sales Revenues that have been recognized but not realized in cash.

"sales discounts" is what kind of account

contra revenue account that is subtracted from sales when calculating "Net Sales"

what is the allowance method

-Makes an estimate of uncollectible accounts at the end of each period

what is the % of Receivables method

◦Balance Sheet Approach ◦Aging analysis of A/R- Different rates applied to different age categories ◦Calculates the required balance in the allowance account

what is the % of Sales method

◦Income Statement Approach ◦Credit Sales X Estimated Bad Debt % ◦Calculates the amount of Bad Debt Expense to be recognized

The SEC maintains that revenue is realized or realizable and earned when the following criteria are met:

◦Persuasive evidence of an arrangement exists (e.g., a contract or other proof of the details of the exchange). ◦Delivery has occurred or services have been provided. ◦The seller's price to the buyer is fixed and determinable. ◦Collectability is reasonably assured.

what is the interest calculation for a note receivable

FV X Rate X Time

profitability ratios

Gross Profit Margin = Gross Profit ÷ Net Sales Operating Margin = Operating Income ÷ Net SalesNet Profit Margin = Net Income ÷ Net Sales

dispositions of notes receivable

Honored- paid in full at maturity Dishonored- not paid in full Eliminate carrying value of note if honored Write off if dishonored and no hope of repayment

sales returns and allowances includes things like

Return of defective product or price allowance for minor defects Late arrival, or any way that makes a product less valuable may be a reason for an allowance.

trade or Nontrade Receivables:

Trade receivables are due from customers purchasing inventory in the ordinary course of business whilenontrade receivablesarise from transactions not involving inventory.

Operating margin is a key ratio for financial analysts because

it tells how much is left from a sales dollar after paying for the product and all its operations

what is the net method of sales

sales are recorded net of discount

Shipping documents & Invoice

the invoice documents the terms of the sale.

A sale and its associated receivable are recorded only when

the order, shipping, and billing documents are all present.

gross method is based on

adjustments when they happen

The appropriate amount of revenue to recognize is generally the

cash received or the cash equivalent of the receivable.

If a company estimates its bad debt expense on the basis of a receivables aging, the balance in the Allowance for Doubtful Accounts account will not affect the amount of the end-of-period adjusting entry for bad debts.

false

the accounts receivable turnover ratio does what?

provides a measure of how many times average trade receivables are collected during the period.

Under the allowance method of accounting for bad debts, the company estimates the amount of bad debts before those debts actually occur.

true

what is Net Realizable Value"

-Accounts Receivable - Allowance for Doubtful Accounts -The amounts we expect to receive in cash!

features of the allowance method

-Better Matching of Expenses with Revenues -Contra-asset account -- Allowance for Doubtful Accounts -At write-off, the uncollectible amount is debited to the Allowance account and credited to A/R

internal control for sales end goal

Sales (and Receivables) are presented fairly according to GAAP

what is the gross method of sales

discounts taken are a reduction of Sales Revenue

Three changes to sales revenues include:

discounts, returns, and allowances.

net method is estimated based on

experience

Selling on credit protects a company from the risk that some of its receivables will never be collected.

false

The account, "Allowance for Doubtful Accounts" is an expense account (the cost of making bad credit sales) that is reported on the income statement.

false

The lender of a note recognizes a note payable on the balance sheet and interest expense on its income statement.

false

The longer a customer's account balance remains outstanding, the greater the likelihood that it will be collected in the near future.

false

To encourage prompt payment, businesses may offer a _______ which is attractive to the buyer and seller for what reasons?

sales discount 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.

GAAP requires sales to be recognized at

the actual amount expected to be received from the customer

Purchase order

the customers official request from the buyer. This document is necessary for the buyer to be obligated to accept and pay for the ordered goods.

A primary advantage of the allowance method to account for bad debts is that it supports the matching principle.

true

Because the allowance method results in better matching, accounting standards require its use rather than the direct write-off method, unless bad debts are immaterial.

true

The amount of interest paid is a function of three variables, the amount borrowed, the interest rate, and the length of the loan period.

true

The use of the allowance method is an attempt by accountants to match bad debts as an expense with the revenue of the period in which a sale on credit takes place.

true