chapter 8 - Receivables, Bad debt expense, interest revenue
allowance for doubtful accounts (JE)
-NORMALLY has a credit balance, but may have a debit balance before it is adjusted dr Bad debt expense (+E, -SE) cr Allowance for doubtful acct (+xA, -A)
8-1 Describe the trade-offs of extending credit
-by extending credit to customers, a company is likely to attract a greater number of customers willing to buy from it -the additional cost of extending credit include increased wage costs, bad debt costs, and delayed receipt of cash
8-2 estimate and report the effects of uncollectible accounts
-under GAAP, companies must use the allowance method to account for uncollectibles. This method involves the following steps 1. Estimate and record uncollectibles with an end-of-period adjusting journal entry that increases Bad Debt expense (debit) and increases the allowance for doubtful accounts (credit) 2. identify and write off specific customer balances in the period that they are detemrined to be uncollectible -the adjusting entry (1) reduces Net Income and Net accounts receivable. -The write-off (2) offsetts Accounts Receivable and the Allowance for doubtful accounts, ultimately yielding not net effect on net accounts receivable or Net income
Kohl's corporation decided to discontinue its kohl's credit card operations. What factors would this department store Co. have considered prior to making this decision?
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how does the use of calculated estimates differ between the aging of accounts receivable method and the percentage of credit sales method?
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using the allowance method, is Bad debt Expense recognized in the period in which a) sales related to the uncollectible account were made or b) the seller learns that the customer is unable to pay?
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what are the advantages and disadvantages of extending credit to customers?
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what are the three components of the interest formula? Explain how this formula adjusts for interest periods that are less than a fullyear
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what is the effect of the write-off of uncollectible accounts (using allowance method) on a) net income b) net accounts receivable
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what is the primary difference between accounts receivable and notes receivable?
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what two approaches can managers take to speed up sluggish collections of receivables? list one advantage and disadvantage for each approach
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which basic accounting principles does the allowance method of accounting for bad debts satisfy?
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estimated un-collectible amounts with aging of account receivables
1. prepare an aged listing of accounts receivable 2. estimate bad debt loss percentage for each category 3. compute the total estimate by multiplying the total in step 1 by the percentages in step 2 and then sum up across all categories
what are the objectives when accounting for accounts receivable and bad debts?
1. report accounts receivable at the amount the company expects to collect (net realizable value) 2. match the cost of bad debts to the accounting period in which the related credit sales are made
days to collect
365 / receivables turnover ratio average number of days from sale on account to collection a higher number means a longer/worse time to collect
does an increase in the receivables turnover ratio generally indicate faster or slower collection of receivables? explain
An increase in the receivables turnover ratio indicates a faster collection of receivables
interest formula
I = p x r xt where I = interest calculated P = principal r= annual interest rate T = time period covered in the interest calculation (# of months out of 12)
notes receivable and interest revenue
a company reports notes receivable if it uses a promissory note to document its right to collect money from another party. this usually happens in 3 situations: 1. the companyLOANS money to employees or businesses 2. the company sells EXPENSIVE ITEMS for which customers require an extended payment period 3. the company CONVERTS an existing account receivable to a note receivable to allow EXTENDED PAYMENT
allowance for doubtful accounts
a debit balance in this account means the company has recorded write-offs that exceed previous estimates of un-collectible accounts. -the only difference is that to reach the desired balance, you need to record an amount equal to the desired balance plus the existing debit. After the adjustment is recorded, the allowance for doubtful acct will again have a credit balance
accounts receivable
amounts owed to the business by customers for past transactions
factoring
an arrangement where receivables are sold to another company (called a factor) for immediate cash (minus a factoring fee)
methods for estimated bad debts
bad debts must be estimated, these estimates may be based on either 1. percentage of credit sales 2. aging of accounts receivable Both methods are GAAP and IFRS accepted. the % of credit sales is simpler to apply, but aging method uses more data and is more accurate. Some companies use % on a monthly bases and the aging method on a quarterly or annual basis
allownace method
bases bad debt expense on an estimate of uncollectible accounts
alternative terms
days to collect aka "days' sales outstanding"
recording write-off entries (JE)
dr Allowance for doubtful acct (-xA, +A) cr Accounts Receivable (-A)
recording principal received (JE)
dr Cash (+A)........### cr Note Receivable (-A)....###
recording interest received (JE)
dr Cash (+A)...........### cr Interest receivable (-A) ...### cr Interest Revenue (+R, +SE)...###
accrued interest (AJE)
dr Interest receivable (+A) .....### cr Interest Revenue (+R, +SE)..... ### if this entry was omitted then assets, net income and stockholder equity would be understated
recording notes receivable (JE)
dr Notes Receivable (+A)......### cr Cash (-A) ###
bad debt expense
expense associated with estimated uncollectible accounts receivable
8-3 compute and report interest on notes receivable
interest is calculated by multiplying : principle x interest rate x time period. as time passes and interest is earned on the note, accountants must record an adjusting journal entry that accrues the interest revenue that is receivable on the note
helpful reminder 2
interest rates always are for a full year. to calculate interest for a shorter period, multiply the interest rate by the fraction of the year for which you are calculating interest
days to collect
measure of the average number of days from the time a sale is made on account to the time it is collected
receivables turnover ratio
net sales revenue / average net receivables the number of times receivables turn over during the period -a higher ratio means faster/ better turnover
direct write-off method
records bad debt expense only when accounts are written-off; not allowed under GAAP
requent mistkes 1
some students think a write-off is an expense when it's NOT! A write off is merely a way to clean up the accounts receivable records under the allowance method, no bad debt expense is recorded when removing (writing off) specific customer accounts.
helpful reminder
the "time" variable refers to the portion of a year for which interest is calculated, not the portion of the note's entire life. A 2-month interest calculation on a 3-year note has a time variable of 2/12 not 2/36
helpful reminder 1
the % of credit sales method calculates the amount to record as bad debt expense. the aging of accounts receivable method calculates the desired balance in the allowance for doubtful accounts. this desired balance is compared to the existing balance to determine the amount to record as bad debt expense
aging of accounts receivable method
the aging of accounts receivable method focuses on estimating the ending balance in the allowance for doubtful accounts. -The older and more overdue an account receivable becomes, the less likely it is to be collectible.
8-4 compute and interpret the receivables turnover ratio
the receivables turnover ratio measures the effectiveness of credit-granting and collection activities. It reflects how many times average trade receivables were recorded and collected during the period -analysts and creditors watch this ratio because a sudden decline may mean that a company is extending payment deadlines in an attempt to prop up lagging sales or it may mean that a company is recording sale of merchandise that customers are likely to return later.
aging of accounts receivable method
using the age of each accounts receivable to estimate uncollectible amounts
