Chapter 5 Accounting Notes

Payment term period

(typically require customers to pay within) 30 to 60 days

Adjusting Allowance in subsequent years

- Estimate of Allowance for Uncollectable (or Doubtful) accounts is reported on the Balance Sheet as a Contra-Asset to Accounts Recievable -

Percentage-of-receivables method (Balance Sheet Method) & Aging Method (another balance sheet method)

- Percentage-of-receivables: Method of estimating uncollectible accounts based on a SINGLE estimated percentage of accounts receivable expected not to be collected - Aging Mehtod: Method that increases percentage of uncollectable accounts based on how old they are. NOTE: The estimated percentage uncollectable increases with age; The older the account, the less likely it is to be collected. The aging method is more accurate

What are the effects of Sales Returns and Sales Allowance

- They reduce accounts recievanble or cash, which reduces the revenue and then reduce overall income by reducing

Direct-write-off method

- Used for tax reporting & not allowed for financial reporting under GAAP - Write off bad debts only at the time they actually become uncollectable - Unlike the allowance method which requires estimation of uncollectable accounts before they even occur

Effect of write-off of accounts recievable

- the write-off has no effect on the total amounts reported on the income statement or balance sheet because we already allowed for this bad debt, so we are just marking it as done - leaves the net recievable unaffected

Transactions that reduce the amount of cash the company is entitled to recieve from customers from goods and serivces sold to them

1. Trade Discounts 2. Sales Returns 3. Sales Allowances 4. Sales Discounts

Generally Accepted Accounting Principles (GAAP) requires that we account for uncollectable accounts using

Allowance Method; under this method, a company reports its accounts recievable for the net amount EXPECTED to be collected - Company must estimate the amount of CURRENT accounts recievable that will prove uncollectable in the FUTURE, and report its estimate as a contra asset to its accounts recievable

Allowance of uncollectable accounts on the balance sheet

As part of Current Assets: You (less) the Allowance for Uncollectable Accounts from the Accounts Recievable to get the Net Accounts Recievable

The amount that was "off" and adjusted at the end of the year of $5 (this is the future balance of uncollectable accounts that will happen to equal the predicted amount of $7 million) million will be reported in the income statement, it will be the amount reported in the _______ expense in the year-end adjusitng entry

Bad Debt

Why Direct-Write-Off method is Generally not permitted by GAAP (except in limited cirmcumstances)

Bad Debt expense is recorded in the year tha t

Benefit and Cost of extending Credit

Benefit: Seller makes it more convinient for buyer to purchase goods and services, in the Long-term, seller should benefit by increasing profitability of the company Cost: With the delay in collection of cash, some customers may not end up paying

Year-End Adjustment for Bad Debt Expense

Debit Bad Dept Expense Credit Allowance for Uncollectable Accounts (Actual Write off - Beginning Balance) + Estimated Amount uncollectabe (calculated through the aging method) = Bad Debt Expense in the Year-End adjustment for Bad debt Expense

How is revenue recorded with Credit Sales?

Even though there is no cash recieved at the time of the credit sale, revenue is recorded immediatly after goods or services are provided and future payment seems probable

Writing-off Accounts Recievable (customer files for bankrupcy ex)

If a company KNOWS a customer will not pay a certian amount, you need to debit Allowance of Uncollectable Accounts and credit Accounts Recievable because: - Allowance for Uncollectable Accounts has a normal CREDIT balance when it's just an estimate - Accounts Recievable has a normal DEBIT balance, but in this case, you won't be recieving part of the value that was "estimated"

Does the company have a recurring probolem with customer satisfaction?

If sales returns and allowances are routinley high relative to total sales, this migth indicate that customers are not satisfied with the company's goods or services

If there is an underestimate in Allowance for Uncollectable Accounts, you need to adjust the entry to fit into the estimated amount of uncollectabl acounts; For example

If you want the ending balanceof estimated amount uncollectable to be $7 million, and the actual amount left over amount of accounts-written off was $2 million then you need to adjust the entry by $5 million as the year-end adjusting entry, because this is the amount that was off in the estimate : Debiting Bad Debt Expense for $5 million dollars and Creding Allowance for Uncollectable Accounts by $5 million dollars

Trade Discounts

Represent a reduction in the listed price of a good or service - Typically used to pull more customers or consumers to purchase from the comany - Can be used to change prices without publishing a new price list OR to disguise real price from competetors - We don't keep track of it in a seperate account

Sales Return and Sales Allowance

Sales Return: When the customer returns goods - Contra Revenue account of Sales returns when there is a return of a product; Credit accounts recievable or cash and debit Sales returns Sales Allowance: When the customer does not return goods, but seller reduces the customer's balance for goods and services previously provided -(seller reduces balanced owed or gives a partial refund because of some deficiency in good or service) -Record the Sales allowance (or discount/amount taken off of the owed balance) by debiting Sales allowance and crediting accounts recievable or cash

Contra-Revenue Accounts

Sales Returns, Sales Discounts, Sales Allowances - They reduce revenue indirectly Ex) the allowance account provides a way to decrease accounts recievable indirectly, rather than decreasing the accounts recievable itself

Allowance for uncollectible acocunts is reported in the _______ section of the balance sheet

The Asset section of the balance sheet (but it has a normal credit balance) -You debit bad debt expense and credit allowance for uncollectibke accounts (bad debt expense is recorded as an expense in the income statement)

The allowance from uncollectable accounts that shows up on the Balance Sheet is

The sum of of estimated amounts uncollectable form customers ( percentage estimated to be uncollectable *amount owed of each customer)

How to tell if estimated Allowance of Uncollectable Accounts was too LOW or too HIGH

Too Low: If you DEBIT Allowance for Uncollectable Accounts Too High:

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.

Collecting on Accounts Previously written-off (how to record if after filling for bankrupcy, a customer is able to pay some money by liquidating their assets)

You have to make 2 entries: 1) To record the change in Allowance for Uncollectible Accounts; You need to Debit Accounts Recievable because you can now recieve the account from the customer, and Credit Allowance for Uncollectible (Normal Debit Balance, but since it is going down here, you need to Credit it) 2) To record the cash payment from accounts recievable; Just like how you would do with any transaction; Need to Debit Cash (asset) and Credit Accounts Recivable (an Asset) - Collecting Cash from an account that was previously written off has NO EFFECT on the Total Assets or on Net Income

Sales Discount

a reduction in sales price of a good or service if payed within a specified time; it is intended to provide incentive to customers for quick payment - Sales Discount

Bad debt expense

amount of accounts recievables not expected to be collected

Accounts recievable

amount of money owed by customers for goods or services already given to them by the business/company

Credit sells include infromal credit agreement supported by

an invoice; a source document that identifies the date of sale, the customer, specific item sold, dollar amount of sale and payment terms

Allowance for Doubtful Accounts (allowance for uncollectable accounts)

contra-asset account containing the estimated uncollectible accounts receivable - This is how bad debt accounts are estimated

Bad debts

customer accounts that we no longer consider collectable (uncollectable accounts)

net revenues are also referred to as

net sales

Accounts recievable represent the legal right of the company to

recieve cash from customers, and since it holds value, it is an asset of the company

Why bad debt expense is important to investors and creditors because

they negatively impact operating results; the better a company is at collecting cash from customers, the more efficient it can run the business

Under the Allowance method

we account for events (customers' bad debt expense) that have not yet occured, but are likley to happen - Under this method, companies are required to estimate FUTURE uncollectable accounts and report those estimates in the CURRENT year