Ch. 8 (Receivables, Bad Debt Expense, and Interest Revenue
Purpose of Interest Revenue/Interest Receivable
Although interest n a note receivable is earned each day, interest payments are typically received only once or twice a year. This means that a company with a note receivable needs to accrue Interest Revenue and Interest Receivable.
LO 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 costs of extending credit include increased wage costs, bad debt costs, and delayed receipt of cash.
The journal entry used by the direct write-off method to record $1000 of bad debt expense when a customer account is determined to be collectable is...
The journal entry used by the direct write-off method to record $1000 of bad debt expense when a customer account is determined to be collectable is... dr Bad Debt Expense ($1,000) cr Accounts Receivable ($1,000)
Assume VHC Company experienced bad debt losses of 3/4 of 1 percent of credit sales in prior periods. If credit sales in January total $120,00, VHC could estimate the month's bad debt expense as... (Percentage of Credit Sales Method)
pg. 343 Credit sales this month ($120,000) * Bad debt loss rate (0.75%) = Bad debt expense this month ($900)
Name the methods for estimating bad debts.
(1) Percentage of credit sales method (aka the income statement approach) (2) Aging of accounts receivable method (aka the balance sheet approach)
Record the journal entry for the collection of $800 that was previously written off.
(1) dr Accounts Receivable ($800) cr Allowance for Doubtful Accounts +xA ($800) (2) dr Cash ($800) cr Accounts Receivable ($800) (1) reverses the write off (2) records the collection of $800
Name the two objectives when accounting for accounts receivable and bad debts & solution of both
(1) report Accounts Receivable at the amount the company expects to collect ("net realizable value") (2) match the costs of bad debts to the accounting period in which the related credit sales are made. These two objectives point to the same solution: reduce both Accounts Receivable and Net Income by the amount of credit sales that are unlikely to be collected as cash.
In which three situations does a company report Notes Receivable?
A company reports Notes Receivable if it uses a promissory note to documents its right to collect money from another party. This usually happens in the following 3 situations... (1) the company loans 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 an extended payment period.
If a company were to estimate $900 of bad debts this period, the effects on the accounting equation and adjusting journal entry to record them would be....
Assets (Allowance for Doubtful Accounts +xA) = -$900 Stockholder's Equity (Bad Debt Expense +E) = -$900 Journal Entry: dr Bad Debt Expense ($900) cr Allowance for Doubtful Accounts (+xA) ($900)
Allowance for Doubtful Accounts
Conta-asset permanent account to Accounts Receivable used when adjustments are made at the end of the accounting period. Balance carried forward from one accounting period to the next. The balance in ADA will differ from the balance in Bad Debt Expense (since that account is temporary and zeroed out at the end of each year), except for the first year ADA is used. ADA in the balance sheet doesn't equal BDE
If the receivables turnover ratio decreased during the year... a. the days to collect also decreased b. receivables collections slowed down c. sales revenues increased at a faster rate than accounts receivables increased d. none of the above
If the receivables turnover ratio decreased during the year, (B) receivables collections slowed down
LO 8-4 Interpret 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 & 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 sales of merchandise that customers are likely to return later.
Maturity date
Notes receivable charge interest from the day they are created to the day they are due (aka their maturity date)
The failure to match Bad Debt Expense with Sales Revenue in the same period will lead to what?
The failure to match Bad Debt Expense with Sales Revenue in the same period will lead to distorted views of net income in the period of the sale as well as in the period the bad debt is discovered.
The four key events that occur with any note receivable are.....
The four key events that occur with any note receivable are..... (1) establishing the note (2) accruing interest earned but not received (3) recording interest payments received (4) recording principal payments received No interest is recorded on the day the note is established. Interest is earned over time.
What is a factor?
To generate the cash needed to pay for a company's business activities, managers must ensure that receivables are collected in a timely manner. One way to speed up collections of sluggish receivables in a time-consuming and costly way. An alternative approach without hounding customers for payment is to sell OUTSTANDING accounts receivable to another company (called a factor)
When using the allowance method, as Bad debt expense is recorded, a. Total assets remain the same and SHE remains the same b. total assets decrease and SHE decreases c. total assets increase and SHE decreases d. total liabilities increase and SHE decreases
When using the allowance method, as Bad debt expense is recorded, (B) total assets decrease and SHE decreases
Record a write off to a $800 receivable.
dr Allowance for Doubtful Accounts (-xA) ($800) cr Accounts Receivable ($800)
Notes Receivable
pg. 339 A promise/formal written agreement with terms that requires another party to pay the business according to a written agreement.
Accounts Receivable
pg. 339 Amounts owed to a business by its customers. Arise from the sales of goods and services on credit.
Allowance Method
pg. 340 A 2-step method of accounting that reduces Accounts Receivable (as well as Net Income) for an estimate of uncollectible accounts (bad debt) (1) Make an end-of-period adjustment to record the estimated bad debts in the period credit sales occur. (2) Remove ("write-off") specific customer balances when they are known to be uncollectible.
Bad Debt Expense
pg. 340 Temporary account that reports the estimated amount of this period's credit sales that customers will fail to pay. The account will have its balance zeroed out/closed at the end of each year.
Write-Off
pg. 341 The act of removing an uncollectible account from its corresponding allowance from the accounting records Does not affect income statement accounts
Aging of Accounts Receivable Method
pg. 343 AKA the Balance Sheet Approach 3-step method that focuses on estimating the ending balance to be reported in the Allowance for Doubtful Accounts based on the age of each Account Receivable. (1) Prepare an aged listing of accounts receivable with totals for each age category. (2) Estimate bad debt loss percentage for each category. (The percentage each company uses varies according to its circumstances and past experience. Generally, higher percentages are applied to increasingly older receivables). (3) Compute the total estimate by multiplying the totals in (1) by the percentages in (2) and then sum across all the categories. (The total equals the balance to which the ADA will need to be adjusted at the end of the period)
Percentage of Credit Sales Method
pg. 343 AKA the Income Statement Approach Estimates bad debt expense by multiplying the historical percentage of bad debt losses by the current period's credit sales. (Estimates bad debts based on the historical percentage of sales that lead to bad debt losses.)
What is a recovery?
pg. 345 Collection of previously written off account. It is accounted for in two parts: (1) Put the receivable back on the books by recording the opposite of the write-off. (2) record the collection of the account.
Interest Formula
pg. 346 Interest = P*R*T T = (# of months out of 12) [TIP!!!: A 2-month interest calculation on a 3-year note has a time variable of 2/12, not 2/36] As time passes and interest is earned on the note, accountants must record an adjusting entry that accrues the interest revenue that is receivable on the note.
Days to Collect
pg. 350 (365/Receivables Turnover Ratio) Avg. # of days from sale on account to collection Higher # = Longer/Worse time to collect
Receivables Turnover Method
pg. 350 (Net Sales Revenue/Avg. Net Receivables) # of times receivables turn over during the period Higher Ratio = Faster/Better Turnover
Factoring
pg. 352 -- A way to speed up collections of sluggish receivables in a time-consuming and costly way. An arrangement where receivables are sold to another company (called a factor) for immediate cash (minus a factoring fee) and the factor then has the right to collect the outstanding amounts owed by your customers. Costs: (1) factoring could send a portentially negative message because it might be seen as a last resort for collecting amounts (2) the factoring fee can be as much as 3% of the receivables sold.
Direct Write-Off Method
pg. 353 A NON GAAP Alternative method records the Bad Debt Expense only when a company writes off specific amounts. Although this alternative method is easier to use, it OVERSTATES the value of Accounts Receivable and it VIOLATES the expense recognition principle. No journal entries are made until a bad debt is discovered. However the IRS (which discourages the use of accounting estimates) requires this method for tax purposes.
