Accounting Chapter 5 Textbook
The legal right to ___________ cash is valuable and represents an asset of the company.
receive
Allowance account provides a way to
reduce accounts receivable
What is a contra revenue account?
An account with a balance that is opposite, or "contra" to that of its related revenue account.
In the example for Kimzey (page 241), we previously established an allowance for uncollectible accounts in 2021 by applying a single estimated percentage (30%) to total accounts receivable. What is this known as?
Percentage-of-receivables method
If a customer returns goods previously purchased, what do we call it?
Sales return
We reduce revenue for sales returns using a contra revenue account- _______________.
Sales returns
T or F: Using the aging method to estimate uncollectible accounts is more accurate than applying a single percentage to all accounts receivable.
TRUE
T or F: We record interest earned on notes receivable but not yet collected by the end of the year as interest receivable and interest revenue.
TRUE
Review: Sales returns, sales allowances, and sales discounts are ......
Contra revenue accounts
As a company's sales increase, what also increases?
Receivables also likely will increase
How is the receivables turnover ratio calculated?
Receivables turnover ratio= Net credit sales/average accounts receivable
Once the receivable is collected, the balance of accounts receivable is ______________.
Reduced
Writing off a customer's account as uncollectible __________ the balance of accounts receivable but also ___________ the contra asset-allowance for uncollectible accounts.
Reduces; reduces
If the customer doesn't return goods but the seller instead reduces the customer's balance owed for goods or services provided, what do we call it?
Sales allowance
T or F: Establishing an allowance for uncollectible accounts correctly reports accounts receivable in the balance sheet at the amount expected to be collected.
TRUE
T or F: The aging method is a more detailed application of the % of receivables method, so it is a balance sheet method.
TRUE
T or F: The current balance before adjustment equals the balance of the allowance account at the beginning of the current year less actual write-offs in the current year.
TRUE
T or F: The direct write-off method of accounting for uncollectible amounts is generally not permitted for financial reporting purposes except in limited circumstances.
TRUE
T or F: The year-end adjustment for future uncollectible accounts is affected by the current balance of Allowance for Uncollectible Accounts before adjustment.
TRUE
T or F: Trade discounts are used by companies to provide incentives to larger customers or consumer groups to purchase from the company.
TRUE
Average collection period is another way to express...
The same efficiency measure
The receivables turnover ratio and average collection period can provide an indication of what?
management's ability to collect cash from customers in a timely manner
Credit sales transactions are also known as....
sales on account
The sale of goods (inventory) is referred to as
sales revenue
The sale of services is referred to as
service revenue
Nontrade receivables include
tax refund claims, interest receivable, and loans by the company to other entities, including stockholders and employees.
2/10 indicates what?
that a customer will receive a 2% discount if the amount owed is paid within 10 days.
Sales discount represents what?
A reduction, not in the selling price of a good or service, but in the amount to be received from a credit customer if collection occurs within a specified period of time.
The legal right to receive cash is valuable and represents an asset of the company. This asset is referred to as ...?
Accounts receivable (sometimes called trade receivables)
The method is to consider the various ages of individual accounts receivable, using a higher percentage of uncollectible for old accounts than for new accounts. What is this known as?
Aging method
3 stages in the process of applying the Allowance method:
1. At the end of the initial year, establish an allowance by estimating future uncollectible accounts. 2. During the subsequent year, write off actual bad debts as uncollectible. Note that actual write-offs may differ from the previous year's estimate. 3. At the end of the subsequent year, once again estimate future uncollectible accounts.
Important points to remember about adjusting entries to record these estimated contra revenues at the end of the year
1. Revenues are reported for the amount of cash a company expects to be entitles to receive from customers for providing goods and services. 2. Total revenues are reduced by sales returns, sales allowances, and sales discounts 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 returns, sales allowances, and sales discounts expected to occur in the future but that relate to the current year.
When a company sells goods or services to its customers, it often offers a variety of discounts and guarantees that can reduce the amount of cash the company is entitles to receive from those customers. Four of these transactions include:
1. Trade discounts 2. Sales returns 3. Sales allowances 4. Sales discounts
The year-end adjusting entry is affected by the extent to which the previous year's ending balance of Allowance for ___________Accounts differs from the current year's actual amount of uncollectible accounts.
Allowance for Uncollectible Accounts
Generally Accepted Accounting Principles (GAAP) require that we account for uncollectible accounts using what's called the..
Allowance method
Credit sales typically include an informal credit agreement supported by an invoice. What is an invoice?
An invoice is a source document that identifies the date of sale, the customer, the specific items sold, the dollar amount of the sale, and the payment terms.
Average collection period is calculated by:
Average collection period=365 days/ receivables turnover ratio
Overall, the write-off of the account receivable has no effect on total amounts reported in the _______ _______ or in the _________ _______________.
Balance sheet or income statement
There is no decrease in total assets and no decrease in net income with the rite-off. Why?
Because we have already recorded the negative effects of the bad news.
Companies record an asset (accounts receivable) and revenue when they sell goods or services to their customers on account, expecting ___________ in the future.
Collection
________ ____________ transfer goods or services to a customer today while bearing the risk of collecting payment from that customer in the future.
Credit sales
What method waits to reduce accounts receivable and record bad debt expense until accounts receivable prove uncollectible in the future?
Direct write-off method
Under the allowance method, companies are required to estimate....
FUTURE uncollectible accounts and report those estimates in the current year.
A credit balance before adjustment indicates that the balance of the allowance account at the beginning of the year, may have been too _____________.
High
A sales discount is intended to provide what?
Incentive to the customer for quick payment
A debit balance before adjustment indicates that the balance of the allowance account at the beginning of the year was too....
Low
End-of-period adjustment for contra revenues: In addition, at the end of 2021, the company MUST do what?
Must estimate any additional returns, allowances, and discounts will occur in 2022 as a result of sales transactions in 2021.
Under the allowance method, we account for events (customers' bad debts) that have....
NOT YET occurred but that are likely to occur.
The net effect is that there is no change in the.....
Net receivable or in total assets
Does collecting cash on an account previously written off have an effect on total assets or net income?
No; no effect on total assets and no effect on net income
Establishing an allowance for uncollectible amounts: should receivables not expected to be collected be counted in assets of the company?
No; they should not be counted in assets of the company.
Receivables that originate from sources other than customers are
Nontrade receivables
What is receivables turnover ratio?
This provides a measure of a company's ability to collect cash from customers.
What is the reason we use a contra revenue account?
To keep a record of the total revenue recognized separate from the reduction due to subsequent sales returns.
Bad debt expense sometimes is referred to as...
Uncollectible accounts expense or provision for doubtful accounts.
customers' accounts that we no longer consider collective are referred to as...
Uncollectible accounts, or bad debts
What are notes receivable?
When receivables are accompanies by formal credit arrangements made with written debt instruments (or notes).
What is the direct write-off method?
When we write off bad debts only at the time they actually become uncollectible, unlike allowance method which requires estimation of uncollectible accounts before they even occur.
What does a subsidiary ledger contain?
a group of individual accounts associated with a particular general ledger control account.
What do companies typically strive for?
a high receivables turnover ratio and a correspondingly low average collection period.
Notes receivable are similar to _____________ _________________ except that notes receivable are formal credit arrangements made with a written debt instrument, or note.
accounts receivable
Companies report their estimate of future bad debts using an...
allowance for uncollectible accounts
Even though companies extending credit to their customers do not receive cash at the time of the sale, they have a right to receive cash in the future. This right is valuable resource for the company. This is why the accounts receivable account is....
an asset, reported in the company's balance sheet.
We calculate interest as the face value of the note multiplied by the stated annual interest rate multiplied by what?
appropriate fraction of the year that the note is outstanding
Review: On March 17, Fox Lumber sells materials to Whitney Construction for $12,000, terms 2/10, n/30. Whitney pays for the materials on March 23. What is the amount of net revenues (sales minus sales discounts) as of March 23? a. $0 b. $11,760 c. $12,000 d. $12,240
b. $11,760
Review: A company has the following account balances at the end of the year: - Credit Sales= $400,000 - Accounts receivable= $80,000 - Allowance for Uncollectible Accounts= $400 CREDIT The company estimates future uncollectible accounts to be 4% of accounts receivable. At what amount would Bad Debt Expense be reported in the current year's income statement? a. $400 b. $2,800 c. $3,200 d. $3,600
b. $2,800
A company has the following account balances at the end of the year: - Credit Sales= $400,000 - Accounts receivable=$80,000 - Allowance for Uncollectible Accounts= $400 credit A company estimates 1% of credit sales will be uncollectible, At what amount would Allowance for Uncollectible Accounts be reported in the current year's balance sheet? a. $4,000 b. $4,400 c. $3,600 d. $800
b. $4,400
REVIEW: On January 1, 2021, Nees Manufacturing lends $10,000 to Roberson Supply using a 9% note due in 8 months. Calculate the amount of interest revenue. Nees will record on September 1, 2021, the date that the note is due. a. $300 b. $600 c. $900 d. $1,000
b. $600
REVIEW: On May 1, 2021, Nees Manufacturing lends $10,000 to Roberson Supply using a 9% note due in 12 months. Nees has a December 31 year-end. Calculate the amount of interest revenue. Nees will report in its 2021 and 2022 income statements. a. 2021= $300; 2022= $600 b. 2021= $600; 2022= $300 c. 2021 = $900; 2022= $0 d. 2021= $0; 2022= $900
b. 2021= $600; 2022= $300
Review: At the end of the first year of operations, a company estimates future uncollectible accounts to be $4.500. The company's year-end adjusting entry would include: a. A credit to Accounts Receivable for $4500 b. A credit to Allowance for Uncollectible Accounts for $4500 c. A debit to Allowance for Uncollectible Accounts for $4500 d. No adjusting entry is necessary because the accounts are not yet actual bad debts.
b. A credit to Allowance for Uncollectible Accounts for $4500
The offsetting debit in the entry to establish the allowance account is
bad debt expense
Review: On March 17, Fox Lumber sells materials to Whitney Construction for $12,000, terms 2/10, n/30. Whitney pays for the materials on March 23. What amount would Fix record as revenue on March 1? a. $12,4000 b. $11,760 c. $12,000 d. $12,240
c. $12,000
REVIEW: Kidz Incorporated reports the following aging schedule of its accounts receivable with the estimated percent uncollectible (SEE PAGE 260 for TABLE). At what amount would Allowance for Uncollectible Accounts be reported in the current year's balance sheet? a. $1,150 b. $1,900 c. $2,300 d. $5,900
c. $2,300
REVIEW: At the beginning of 2021, Clay Ventures has total accounts receivable of $100,00. By the end of 2021, Clay reports net credit sales of $900,000 and total accounts receivable of $200,000. What is the receivables turnover ratio for Clay Ventures? a. 2.0 b. 4.5 c. 6.0 d. 9.0
c. 6.0
Review: Accounts receivable are best described as which of the following? a. Liabilities of the company that represent the amount owed to suppliers b. Amounts that have previously been received from customers. c. Assets of the company representing the amount owed by customers. d. Amounts that have previously been paid to suppliers.
c. Assets of the company representing the amount owed by customers.
The aging method recognizes that longer accounts are past due, the less likely they are to be ___________.
collected
We record the sales allowance in a...
contra revenue account- sales allowances
Where do accounts receivable originate?
credit sales
Like accounts receivable, notes receivable are assets and therefore have a normal debit balance. We classify notes as either ____________ or ____________.
current or noncurrent
Review: A company has the following account balances at the end of the year: - Credit Sales= $400,000 - Accounts receivable= $80,000 - Allowance for Uncollectible Accounts= $400 DEBIT The company estimates future uncollectible accounts to be 4% of accounts receivable. At what amount would Bad Debt Expense be reported in the current year's income statement? a. $400 b. $2,800 c. $3,200 d. $3,600
d. $3,600
REVIEW: The direct write-off method is generally not permitted for financial reporting purposes because: a. Compared to the allowance method, it would allow greater flexibility to managers in manipulating reported net income. b. This method is primarily used for tax purposes c. It is too difficult to accurately estimate future bad debts. d. Accounts receivable are not stated for the amount of cash expected to be collected.
d. Accounts receivable are not stated for the amount of cash expected to be collected.
Review: The allowance method for uncollectible accounts a. Is required by Generally Accepted Accounting Principles b. Allows for the possibility that some accounts will not be collected. c. Reports net accounts receivable for the amount of cash expected to be collected. d. All of the above are correct.
d. All of the above are correct.
Review: Using the allowance method, the effect on the current year's financial statements of writing off an account receivable generally is to: a. Decrease total assets. b. Decrease net income. c. Both a and b. d. Neither a nor b.
d. Neither a nor b.
For tax reporting, companies use an alternative method commonly referred to as the...
direct write-off method
When a company sells goods or services to its customers, it often offers a variety of discounts and guarantees that can reduce the amount of cash the company is _____________ ____ _________________ from those customers.
entitled to receive
Under the allowance method, a company reports its accounts receivable for the net amount.....
expected to be collected
The more frequently a business is able to "turn over" its average accounts receivable, the more effective a company is at doing what?
granting credit to and collecting cash from its customers
Contra revenue account: managers want to keep a record of not only how much their companies are selling, but also...
how much is being returned
Where is bad debt expense reported?
in the Income statement
Other types of receivables are ______ common than accounts receivable.
less
Notes receivable typically arise from what?
loans to other entities
We subtract the balances in these contra revenue accounts from total revenues when calculating....
net revenues
After accounting for each of these reductions, a company will calculate its...
net revenues as total revenues less any amounts for return, allowances, and discounts.
Net revenues are also referred to as
net sales
The downside of extending credit to customers is that...
not all customers will pay fully on their accounts.
Even though no cash is received at the time of the credit sale, the seller records revenue immediately once goods and services are....
provided to the customer and future collection from the customer is probable.
What is the upside of extending credit to customers is that it boosts sales by allowing customers the ability to...
purchase on account and pay cash later
What are two important ratios that help in understanding the company's effectiveness in managing receivables are the:
receivables turnover ratio and average collection period
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 good or service.
We report the allowance for uncollectible accounts in the asset section of the balance sheet, but it represents a...
reduction in the balance of accounts
Similar to sales returns and sales allowances, we record.....
sales discounts in a contra revenue account- Sales Discounts.
n/30 AKA net thirty indicates what?
that a customer does NOT take the discount, full payment net of any returns or allowances is due within 30 days.
Accounts receivable represent...
the amount of cash owed to a company by its customers from the sale of goods or services on account
Discount terms such as 2/10, n/30 are a shorthand way to communicate what?
the amount of discount and the time period within which it's available
What is the cost of extending credit?
the delay in collecting cash from customers, and as already discussed, some customers may end up not paying at all.
Aging method: the older the account,.....
the less likely it is to be collected
What is the benefit of extending credit?
the seller makes it more convenient for the buyer to purchase goods and services.
What are notes receivable?
they are similar to accounts receivable but are more formal credit arrangements evidenced by a written debt instrument or NOTE.
Reduction in the listed price of a good or service is defined as
trade discounts