Chapter 8

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

The drawback of extending credit to business customers

1. Increased wage costs involved to hire people to (a) evaluate whether each customer is creditworthy and (b) track how much each customer owes, and (c) follow up to collect the receivable from each customer 2. Bad debt costs - customers who dispute what they owe or only pay a fraction of account balances 3. Delayed receipt of cash - must wait 30-60 days before receiving cash. May need a short-term bank loan to pay for other business activities. May have to pay interest on this loan Most managers find greater gross profit worth the drawbacks

Three steps of aging of accounts receivable method

1. Prepare an aged listing of accounts receivable 2. Estimate bad debt loss percentages for each category (older receivables receive higher percentages) 3. Compute the total estimate by multiplying the totals in Step 1 by the % in Step 2 and then summing across all categories

To calculate interest, factor in three variables:

1. Principal, or the amount of the note receivable 2. Annual interest rate charged on the note 3. The time period covered in the interest calculation

The allowance method follows a two-step process

1. Record the estimated bad debts in the period credit sales occur, using an end-of-period adjustment 2. Remove ("write-off") specific customer balances when they are known to be uncollectible

2 objectives when accounting for accounts receivable and bad debts

1. Report accounts receivable at the amount the company expects to collect ("net realizable value") 2. Match the cost of bad debts to the accounting period in which the related credit sales are made

The 3 situations in which a note receivable is used

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 accoun receivable to a note receivable to allow an extended payment period

If the loan is taken out on Nov 1 2018, then what is recorded on Dec. 31, 2018

100,000 x .06 x 2/12 = $1000

Days to collect=

365/(Receivables Turnover Ratio)

What type of account reduces accounts receivable

Allowance for Doubtful accounts (contra-asset)

what is the journal entry for a receivable write-off?

Debit allowance for doubtful accounts Credit accounts receivable

If the loan is taken out on Nov 1 2018, what entry is made when the loan matures

Debit cash 6000 Credit Interest Receivable - 1000 Credit Interest Revenue - 5000

What journal statements are booked at the end of December

Interest Receivable - debit 1000 Interest Revenue - credit 1000

If VFC lent 100K to a company at 6% interest, then what are the journal entries for VFC?

Note Receivable +100,000 Cash - 100,000

Interest (I)=

Principal (P) x Interest Rate (R) x Time (T)

Allowance for Doubtful accounts normally has a credit balance. If it has a debit balance, that means that

a company has recorded write-offs that exceed previous estimates of uncollectible accounts

If allowance for doubtful accounts is 14,200 and you have a desired credit balance of 15,500, then

an adjustment of 1300 needs to be recorded as a credit and a corresponding amount debited to bad debt expense

Interest rates are always stated as

an annual percentage; time period of factor is the portion of the year/12

the percentage of sales method ignores

any existing balance in the allowance for doubtful accounts

Why are notes receivable used less than accounts receivable even though they are stronger?

because a new note needs to be created for every transaction. Typically used for large dollar-value items, offers extended payment payment periods, or lends money to individuals or businesses

In order to increase allowance for doubtful accounts, you ____ it

credit

the number of days to collect receivables

days to collect

In order to increase bad debt expense, you ___ it

debit

What is the journal entry for principal

debit Cash +100,000 credit Accounts receivable -100,000

When you write off a customer, what journal entries are made

debit allowance for doubtful accounts Credit accounts receivable no effects on net receivables, sales, or income

journal entry for bad debt expense

debit bad debt expense, credit allowance for doubtful accounts; asset and profit are both hit

The amount computed in step 3 is equal to the

desired balance in the Allowance for Doubtful Accounts, not the amount of the adjustment

The only way to record bad debts in the same period as sales revenue is to

estimate the amount of bad debts that are likely to arise.

What type of account reduces net income

expense account called Bad Debt Expense (debit)

the higher the ratio, the

faster the collection of receivables

% of credit sales method is done by

multiplying the estimated % of bad debt losses by the current period's credit sales

Receivable turnover ratio =

net sales revenue/average net receivables

the reason that estimated uncollectible accounts are not taken directly out of these individual accounts

no one knows which particular customers' accounts receivable are uncollectible. would lose track of which customers still owed money

notes receivable differ from accounts receivable in that

notes generally charge interest rom the day they are signed to the day they are collected

Difference between notes and accounts payable

notes payable accrues interest from the day they are created until maturity

Created when a formal written contract ("note") is established outlining the terms by which a company will receive amounts it is owed

notes receivable

Estimates for bad debts must be be based on

percentage of credit sales for the period or an aging of accounts receivable

the Allowance for Doubtful Accounts is a ____ account, so its balance _______

permanent; carries forward from one accounting period to the next

When a company realizes that a customer will never pay, they remove a customer's account from accounts receivable and also remove the corresponding account from the Allowance for Doubtful Accounts. This is called a

receivable write-off

indicates how many times, on average, this process of selling and collecting is repeated during the period

receivables turnover ratio

the total of the subsidiary accounts is

reported as accounts receivable

Internally, a company keeps a separate accounts receivable for each customer, called a

subsidiary account

Bad Debt Expense is a _____ account, so its balance _______ at the end of the year

temporary; zeroes out

The sum across all aging categories equals the balance to which

the Allowance for Doubtful Accounts will need to be adjusted at the end of the period, not the amount of the adjustment

a receivable write-off does not affect income statement accounts because

the estimated bad debt expense relating to these uncollectible accounts were already recorded with an adjusting entry in the period the sale was recorded

the balance in the allowance for doubtful accounts will differ from the balance in bad debt expense except during

the first year the Allowance for Doubtful Accounts is used

the net receivable balance after the write-off is

unchanged from before the write-off

Accounting records can be adjusted when

uncollectible amounts become known with near certainty

If the allowance for doubtful accounts has a debit balance

you need to record an amount equal to the desired balance plus the existing debit balance