CH 8 ACCOUNTING

Advantage

Match expense with revenue (bad debt expense is the expense associated with estimated uncollectible A/R - part of selling expense). It is recorded to better match the cost of doing business with revenue earned.

Recovery of an uncollectible account

Reverse the write-off, then record receipt of cash Step1: Accounts receivable (+A) Allowance for doubtful accounts (+contra A) Step2: Cash (+A)

Allowance for Doubtful Accounts =

The total estimated uncollectibles - credit balance in Allowance for Doubtful Accounts prior to adjustment

Recognizing Accounts Receivable

When a service organization performs a service on account, or when a merchandiser sells goods on account, it debits Accounts Receivable and credits Sales Revenue. The seller may offer terms that encourage early payment by providing a discount. The buyer might find some of the goods unacceptable and choose to return the unwanted goods. Or the buyer may keep the goods in return for a reduction in selling price (sales allowance). All these transactions reduce receivables.

Write-off of an uncollectible account

When you decide a collection actually becomes impossible (e.g., customer goes bankrupt), it's time to write off the uncollectible amount - now you know whose account is not collectible · Entry: Allowance for doubtful accounts (- contra A) Accounts receivable (-A)

Accounts and notes receivable are reported in the current assets section of the balance sheet at: cash (net) realizable value. net book value. lower-of-cost-or-market value. invoice cost.

a. Accounts and notes receivable are reported in the current assets section of the balance sheet at cash (net) realizable value, not (b) net book value, (c) lower-of-cost-or-market value, or (d) invoice cost.

Risk of credit sales

customers can default on the payment - bad debt

A write-off affects

only balance sheet accounts—not income statement accounts.

Cash (net) realizable value

the net amount the company expects to receive in cash. It excludes amounts that the company estimates it will not collect.

Direct Write-Off Method for Uncollectible Accounts

when a company determines a particular account to be uncollectible, it charges the loss to bad debt expense

Recording ESTIMATED uncollectibles with allowance method -

· Adjusting entry Bad debt expense (-SE) Allowance for doubtful accounts (+ contra-asset account)

Financial statement presentation

· How is I/S affected by adjusting entry? Companies report bad debt expense as selling expenses in the operating expenses section. · How is the allowance account presented on B/S? A/R (gross) -Allowance for doubtful accounts Net realizable value of A/R

Deciding the amount of estimated uncollectible

· Percentage of receivables (B/S method) Assume a certain % of receivables will go uncollected. First determine the desired balance in the Allowance for Doubtful Accounts on the B/S. The amount of the adjusting entry is the difference between the desired balance and the existing balance in the allowance account.

Two methods are used in accounting for uncollectible accounts

(1) the direct write-off method (not GAAP) and (2) the allowance method (GAAP)

Allowance Method for Uncollectible Accounts

1. Companies estimate uncollectible accounts receivable. They match estimated expense against revenues in the same accounting period in which they record the revenues. 2. Companies debit Bad Debt Expense and credit Allowance for Doubtful Accounts through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts Receivable. 3. When companies write off a specific customer account, they debit actual uncollectibles to Allowance for Doubtful Accounts and credit that amount to Accounts Receivable.

cash realizable value

Accounts Receivable - Allowance for Doubtful Accounts

Types of Receivables

Accounts receivable, Notes receivable, Other receivable

Bad Debt Expense

An expense account to record uncollectible receivables.

Allowance for Doubtful Accounts (Contra Asset) Formula

Beginning Balance + Bad Debt Expense -Amounts Written Off = Ending Balance

Accounts Receivable (Asset) Formula

Beginning Balance + Credit Sales -Cash Collected -Amounts Written Off = Ending Balance

Good Stuff Retailers accepted $50,000 of Citibank Visa credit card charges for merchandise sold on July 1. Citibank charges 4% for its credit card use. The entry to record this transaction by Good Stuff Retailers will include a credit to Sales Revenue of $50,000 and a debit(s) to: a.Cash$48,000 and Service Charge Expense$2,000 b.Accounts Receivable$48,000 and Service Charge Expense$2,000 c.Cash$50,000 d.Accounts Receivable$50,000

a. Credit card sales are considered cash sales. Cash is debited $48,000 for the net amount received ($50,000 − $2,000 for credit card use fee), and Service Charge Expense is debited $2,000 for the 4% credit card use fee ($50,000 × 4%). The other choices are therefore incorrect.

Net credit sales for the month are $800,000. The accounts receivable balance is $160,000. The allowance is calculated as 7.5% of the receivables balance using the percentage-of-receivables basis. If Allowance for Doubtful Accounts has a credit balance of $5,000 before adjustment, what is the balance after adjustment? $12,000. $7,000. $17,000. $31,000.

a. The ending balance required in the allowance account is 7.5% × $160,000, or $12,000. Since there is already a balance of $5,000 in Allowance for Doubtful Accounts, the difference of $7,000 should be added, resulting in a balance of $12,000, not (b) $7,000, (c) $17,000, or (d) $31,000.

Receivables

amounts due from individuals and companies that are expected to be collected in cash

Notes receivable

are a written promise (as evidenced by a formal instrument) for amounts to be received. The note normally requires the collection of interest and extends for time periods of 60-90 days or longer. Notes and accounts receivable that result from sales transactions are often called trade receivables.

Accounts receivable

are amounts customers owe on account. They result from the sale of goods and services. Companies generally expect to collect accounts receivable within 30 to 60 days. They are usually the most significant type of claim held by a company.

Hughes Company has a credit balance of $5,000 in its Allowance for Doubtful Accounts before any adjustments are made at the end of the year. Based on review and aging of its accounts receivable at the end of the year, Hughes estimates that $60,000 of its receivables are uncollectible. The amount of bad debt expense which should be reported for the year is: $5,000. $55,000. $60,000. $65,000.

b. By crediting Allowance for Doubtful Accounts for $55,000, the new balance will be the required balance of $60,000. This adjusting entry debits Bad Debt Expense for $55,000 and credits Allowance for Doubtful Accounts for $55,000, not (a) $5,000, (c) $60,000, or (d) $65,000.

Michael Co. accepts a $1,000, 3-month, 6% promissory note in settlement of an account with Tani Co. The entry to record this transaction is as follows. Notes Receivable 1,015Accounts Receivable1,015Notes Receivable1,000Accounts Receivable1,000Notes Receivable1,000Sales Revenue1,000Notes Receivable1,030Accounts Receivable1,030

b. Notes Receivable is recorded at face value ($1,000). No interest on the note is recorded until it is earned. Accounts Receivable is credited because no new sales have been made. The other choices are therefore incorrect.

One of the following statements about promissory notes is incorrect. The incorrect statement is: The party making the promise to pay is called the maker. The party to whom payment is to be made is called the payee. A promissory note is not a negotiable instrument. A promissory note is often required from high-risk customers.

c. A promissory note is a negotiable instrument. The other choices are true statements.

In 2022, Patterson Wholesale Company had net credit sales of $750,000. On January 1, 2022, Allowance for Doubtful Accounts had a credit balance of $18,000. During 2022, $30,000 of uncollectible accounts receivable were written off. Past experience indicates that the allowance should be 10% of the balance in receivables (percentage-of-receivables basis). If the accounts receivable balance was $200,000, what is the required adjustment to Allowance for Doubtful Accounts at December 31, 2022? $20,000. $75,000. $32,000. $30,000.

c. After the write-offs are recorded, Allowance for Doubtful Accounts will have a debit balance of $12,000 ($18,000 credit beginning balance combined with a $30,000 debit for the write-offs). The desired balance, using the percentage-of-receivables basis, is a credit balance of $20,000 ($200,000 × 10%). In order to have an ending balance of $20,000, the required adjustment to Allowance for Doubtful Accounts is $32,000, not (a) $20,000, (b) $75,000, or (d) $30,000.

Prall Corporation sells its goods on terms of 2/10, n/30. It has an accounts receivable turnover of 7. What is its average collection period (days)? 2,555. 30. 52. 210.

c. Average collection period = Number of days in the year (365) ÷ Accounts receivable turnover (7) = 52 days, not (a) 2,555, (b) 30, or (d) 210.

Eddy Corporation had net credit sales during the year of $800,000 and cost of goods sold of $500,000. The net balance of accounts receivable at the beginning of the year was $100,000, and at the end of the year it was $150,000. What were the accounts receivable turnover and the average collection period in days? 4.0 and 91.3 days. 5.3 and 68.9 days. 6.4 and 57 days. 8.0 and 45.6 days.

c. The accounts receivable turnover is 6.4 {$800,000 ÷ [($100,000 + $150,000) ÷ 2]}. The average collection period in days is 57 days (365 ÷ 6.4). The other choices are therefore incorrect.

Which of the following statements about Visa credit card sales is incorrect? The credit card issuer makes the credit investigation of the customer. The retailer is not involved in the collection process. Two parties are involved. The retailer receives cash more quickly than it would from individual customers on account.

c. There are three parties, not two, involved in Visa credit card sales: the credit card company, the retailer, and the customer. The other choices are true statements.

An analysis and aging of the accounts receivable of Prince Company at December 31 reveals the following data. Accounts receivable$800,000Allowance for doubtful accounts per books before adjustment50,000Amounts expected to become uncollectible65,000 The cash realizable value of the accounts receivable at December 31, after adjustment, is: $685,000. $750,000. $800,000. $735,000.

d. Accounts Receivable less the expected uncollectible amount equals the cash realizable value of $735,000 ($800,000 − $65,000), not (a) $685,000, (b) $750,000, or (c) $800,000.

Hughes Company has a debit balance of $5,000 in its Allowance for Doubtful Accounts before any adjustments are made at the end of the year. Based on review and aging of its accounts receivable at the end of the year, Hughes estimates that $60,000 of its receivables are uncollectible. In this situation, the amount of bad debt expense that should be reported for the year is: $5,000. $55,000. $60,000. $65,000.

d. By crediting Allowance for Doubtful Accounts for $65,000, the new balance will be the required balance of $60,000. This adjusting entry debits Bad Debt Expense for $65,000 and credits Allowance for Doubtful Accounts for $65,000, not (a) $5,000, (b) $55,000, or (c) $60,000.

Schleis Co. holds Murphy Inc.'s $10,000, 120-day, 9% note. The entry made by Schleis Co. when the note is collected, assuming no interest has been previously accrued, is: Cash 10,300Notes Receivable10,300Cash10,000Notes Receivable10,000Accounts Receivable10,300Notes Receivable10,000Interest Revenue300Cash10,300Notes Receivable10,000Interest Revenue300

d. Cash is debited for its maturity value [$10,000+interest earned($10,000×120360×9%)], Notes Receivable is credited for its face value, and Interest Revenue is credited for the amount of interest earned. The other choices are therefore incorrect.

Other receivable

include nontrade receivables such as interest receivable, loans to company officers, advances to employees, etc. not related to sales transactions

When a merchandiser sells goods, it ___________ Accounts Receivable and _____________Sales Revenue.

increases (debits), increases (credits)