Accounting 201H Chapter 5

Credit Sales

Transfer of products and services to a customer today while bearing the risk of collecting payment from that customer in the future. Also known as sales on account or services on account

receivables turnover ratio

number of times during a year that the average accounts receivable balance is collected (or "turns over"). It equals net credit sales divided by average accounts receivable

Difference between notes receivable and accounts receivable

Notes receivable are formal credit arrangements with a written debt instrument, or note

Accounts Receivable

The amount of cash owed to the company by its customers from the sale of products or services on account

key point

Writing off a customer's account as uncollectible reduces the balance of accounts receivable but also reduces the contra asset—allowance for uncollectible accounts. The net effect is that there is no change in the net receivable (accounts receivable less the allowance) or in total assets. We recorded the decrease to assets as a result of the bad debt when we established the allowance for uncollectible accounts in a prior year.

net revenues

a company's total revenues less any discounts, returns, and allowances

aging method

basing the estimate of future bad debts on the various ages of individual accounts receivable, using a higher percentage for "old" than for "new" accounts. The older the account, the less likely it is to be collected

allowance for uncollectible accounts

contra asset account representing the amount of accounts receivable that we do not expect to collect. Reduces accounts receivable indirectly

sales return

customer returns a product

True/false: companies record trade discounts directly

false: trade discounts are recorded indirectly by recording the sale at the discounted price

interest calculation

interest = face value x annual interest rate x fraction of the year

allowance

recording an adjusting at the end of each period to allow for the possibility of future uncollectible accounts. The adjustment has the affects of reducing assets and increasing expenses.

direct write-off method

recording bad debt expense at the time we know the account is actually uncollectible. not allowed for financial reporting under GAAP. It is primarily used for tax reporting

net realizable value

the amount of cash the firm expects to collect

net accounts receivable

the difference between total accounts receivable and the allowance for uncollectible accounts

True/false: at the end of the year, the company must estimate any additional discounts, returns, and allowances that will occur in the following year as a result of sales transactions in the previous year

true

True/false: receivables not expected to be collected should not be counted as assets

true

true/false: because allowance for uncollectible accounts has a normal credit balance, students often classify it as a liability even though it is an asset

true

true/false: collecting cash on account previously ​written off has no effect on total assets and no effect on net income

true

true/false: the receivables turnover ratio and average collection period can provide an indication of management's ability to collect cash from customers in a timely manner

true

true/false: students often mistakenly record bad debt expense when they write off an uncollectible account

true: The bad debt expense was recorded in a prior year at the time of estimating uncollectible accounts

Allowance method

under the allowance method, companies are required to estimate future uncollectible accounts and record those estimates in the current year

Important points for ch 5

1) revenues are reported for the amount of cash a company expects to be entitled to receive from customers for providing goods and services 2) Total revenues are reduced by sales discounts, sales returns, and sales allowances that occur during the year 3) Total revenues are further reduced by an adjusting entry at the end of the year for the estimate of additional sales discounts, sales returns, and sales allowances expected to occur in the future but that relate to the current year

average collection period

The approximate number of days the average accounts receivable balance is outstanding. It equals 365 divided by the receivables turnover ratio

key point

The direct write-off method reduces accounts receivable and records bad debt expense at the time the account receivable proves uncollectible. If the credit sale occurs in a prior reporting period, bad debt expense is not properly matched with revenues (credit sales). Also, accounts receivable will be overstated in the prior period. The direct write-off method typically is not acceptable for financial reporting

key point

The year-end adjustment for future uncollectible accounts is affected by the current balance of Allowance for Uncollectible Accounts before adjustment. The current balance before adjustment equals the estimate of uncollectible accounts at the beginning of the year (or end of last year) less actual write-offs in the current year.

True/false: the legal right to receive cash is valuable and represents an asset to the company

True: This asset is referred to as accounts receivable (sometimes called trade receivables), and the firm records it at the time of the credit sale

True/false: Credit sales typically include an informal credit agreement supported by an invoice

True: they require payment within 30-60 days after the sale​, as indicated in the invoice. Even though the seller does not receive cash at the time of the credit sale, the firm records revenue immediately once goods or services are provided to the customer and future collection from the customer is probable.​

subsidiary ledger

a group of individual accounts associated with a particular general ledger control account

contra revenue account

an account with a balance that is opposite, or "contra," to that of its related revenue account. Both sales returns and sales allowances are classified as contra revenues

notes receivable

formal credit arrangements evidenced by a written debt instrument, or note. They can be current or noncurrent. They are noncurrent if the time to maturity is longer than one year (the note receivable is a long-term asset)

percentage-of-receivables method

method of estimating uncollectible accounts based on the percentage of accounts receivable expected not to be collected. This method is sometimes referred to as the balance sheet method because, because we base the estimate of bad debts on a balance sheet amount-accounts receivable

Nontrade Receivables

receivables that originate from sources other than customers. They include tax refund claims, interest receivable, and loans by the company to other entities, including stockholders and employees. When receivables are accompanied by formal credit arrangements made with written debt instruments (or notes), we refer to them as notes receivable

sales discount

reduction in the amount to be paid by a credit customer if payment on an account is made within a specified period of time

trade discounts

reduction in the listed price of a product or service. Companies typically use trade discounts to provide incentives to larger customers or consumer groups to purchase from the company. Trade discounts can also be a way to change prices without publishing a new price list or to disguise real prices from competitors

net credit sales

refers to credit sales net of discounts, returns, and allowances

Sales allowance

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

bad debt expense

the amount of the adjustment to the allowance for uncollectible accounts, representing the cost of estimated future bad debts charged to the current period. This expense is included in the income statement of the same period with which these bad debts are associated. By doing this, we properly "match" expenses (bad debts) with the revenues (credit sales) they help to generate.