ACCT 2110 Chapter 5 - Test 2

receivables are typically categorized along three different dimensions

-accounts receivable or notes receivable -current or non-current receivables -trade or non-trade receivables

cash management options

-factoring receivables -asset-based lending arrangement -acceptance of credit/debit cards

number of days in inventory

365/ a/r turnover -measures the average number of days A/R are on the books -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

(T/F) 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

(T/F) The lender of a note recognizes a note payable on the balance sheet and interest expense on its income statement.

false

other receivables

-non-trade receivables (interest receivable, notes to company officers, advances to employees, tax refunds)

a/r turnover

-measures how many times receivables are collected during the period -accounts receivable turnover = net sales ÷ average net accounts receivable

analyzing receivables

-a/r turnover -number of days in inventory

management of receivables

-screening customers -determining credit terms and limits -monitoring collections

net method

sales are recorded net of discount

dishonored notes receivable

-not paid in full -write off if no hope of repayment

purchase order

-the customer's official request from the buyer -this document is necessary for the buyer to be obligated to accept and pay for the ordered goods

methods of estimating bad debts

-% of receivables -%of sales

estimating bad debts % of sales

-income statement approach -credit sales X estimated bad debt % -calculates the amount of bad debt expense to be recognized

interest calculation

face value X rate X time

maker of notes receivable

promises to pay

payee of notes receivable

receives payment and records notes receivable

shipping documents and invoice

the invoice documents the terms of the sale

gross method

discounts taken are a reduction of sales revenue

(T/F) 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

(T/F) Selling on credit protects a company from the risk that some of its receivables will never be collected.

false

(T/F) A primary advantage of the allowance method to account for bad debts is that it supports the matching principle.

true

(T/F) 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

(T/F) 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

(T/F) 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

(T/F) Under the allowance method of accounting for bad debts, the company estimates the amount of bad debts before those debts actually occur.

true

accounts receivable

-"on account" -"trade receivables" (result from sale of goods/services)

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

notes receivable

-formal debt instrument (normally requires interest) -sometimes these are "trade receivables"

analyzing sales calculations

-gross profit margin = gross profit ÷ net sales -operating margin = operating income ÷ net sales -net profit margin = net income ÷ net sales

disposition of notes receivable

-honored -dishonored -eliminate carrying value of note if honored -write off if dishonored and no hope of repayment

allowance method

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

honored notes receivable

-paid in full at maturity -eliminate carrying value of note

determining credit terms and limits

-payment terms: 2/10, n30 -credit limits

realized/realizable criteria

-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

analyzing sales

-profitability ratios are used to try and measure the return the company is making on sales -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

notes receivable on balance sheet

-promissory note -maker -payee -recorded at face value -stronger legal claim/requires interest -interest calculation

For sales revenues, internal controls typically involve the following documents and procedures

-purchase order -shipping documents and invoice -a sale and its associated receivable are recorded only when the order, shipping, and billing documents are all present

sales returns and allowances

-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 -returns and allowances constitute an adjustment to sales

factoring receivables

-sell receivables (factor charges a %) -immediate cash is received -factor assumes rights of collection along with risks of uncollectability -recourse/non-recourse -securitization (package factored receivables and sell them)

net realizable value

-accounts receivable (allowance for doubtful accounts) -the amounts we expect to receive in cash!

accrual-basis

-accounting recognizes revenue when a performance obligation or promise under a contract is satisfied -we have earned the revenue because either: goods have been delivered; OR a service has been performed -it does not mean cash must be received! We DO need to have reasonable assurance we will eventually get the cash though!

receivables

-amounts due from individuals or companies -expectation that cash will be received

monitoring collections

-analyzing receivables (aging analysis) -holds on accounts/collection activity

direct write off

-bad debt expense is recognized when a specific account is deemed uncollectible -only actual losses are reflected in bad debt expense -expense is often recognized in a different period than the revenue associated with the sale -violates the "matching principle" -FASB does not allow this method unless bad debt expense is "insignificant"

estimating bad debts % of receivables

-balance sheet approach -aging analysis of A/R (different rates applied to different age categories) -calculates the required balance in the allowance account

screening customers

-credit policy: too tight: loss of customers/market share too loose: extend credit to customers who do not pay -evaluation of financial position and credit history

methods to account for uncollectible accounts

-direct write-off method -allowance method

valuation/amount of revenue recognized

-the appropriate amount of revenue to recognize is generally the cash received or the cash equivalent of the receivable -three changes to sales revenues include: discounts, returns, and allowances

trade or non-trade receivables

-trade receivables are due from customers purchasing inventory in the ordinary course of business -"trade receivables" represent sales revenues that have been recognized but not realized in cash -non-trade receivables arise from transactions not involving inventory

sales discounts

-used to encourage prompt payment -this discount is a reduction of the normal selling price and is attractive to both the seller and the buyer -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 (net method)

(T/F) The longer a customer's account balance remains outstanding, the greater the likelihood that it will be collected in the near future.

false