Financial Accounting Chapter 5

On September 1, 2012, Dallas Corporation accepts a $30,000 six-month, 12 percent promissory note from one of its clients. The year-end adjustment to accrue interest revenue on December 31, 2012 will include a _____. $300 credit to Interest Revenue $1,800 credit to Interest Revenue $1,200 debit to Interest Receivable $1,800 debit to Interest Receivable

$1,200 debit to Interest Receivable (Think about the number of months for which interest will accrue in 2012.)

discount terms

-2/10= two ten. customer will receive at 2% discount if amount owed is paid in ten days -n/30= net thirty if the customer does not take the discount full payment net of any returns or allowances i due within 3- days

what two things can you do to a sales return?

-reduce the customer's account balance if the sale was on account -issue a cash refund if the sale was for cash

what effect do uncollectible accounts have?

-reducing assets (accounts receivable) by an estimate of the amount we don't expect to collect - increasing expenses (bad debt expense) to reflect the cost of offeirng credit to customers. *an account receivable we do not expect to collect has no value

On September 1, 2012, Middleton Corp. lends cash and accepts a $1,000 note receivable that offers 12% interest and is due in six months. How much interest revenue will Middleton Corp report during 2013? $20. $40. $30. $60.

20 Interest revenue = $1,000 x 12% x 2/12 = $20.

Net credit sales for Turner Company are $200,000 for the year and the average accounts receivable balance is $20,000. What is the company's average collection period? 5 days 548 days 54.8 days 36.5 days

36.5 days , Average collection period = 365 ÷ 10 = 36.5 days.

Outlook corporation performed event management services worth 1.5 million in 2011. of this, 400000 remains receivable at the end of the year. In previous years, approximately 10 percent of accounts receivable were not collected; Outlook corporation decides to base this years estimate on that same percentage using the percentage-of-receivables method. The year-end adjustment to allow for these future uncollectible accounts will include:

A credit to Allowance for uncollectable Accounts for 40,000 A debit to Bad Debt Expense for 40,000 (notice that this adjustment involves an increase in expenses and an indirect decrease in assets.)

Which of the following accounts are recorded when a customer pays within the account period? Sales Discounts Service Revenue Cash Trade Discounts

Accounts Recievable sales discounts, cash, accounts receivable (Think of the way in which the transaction would have been recorded at the time of preforming the service).

A company is using the __________, when it writes off an uncollectible amount with a debit to Allowance for Uncollectible Accounts and a credit to Accounts Receivable. Direct Write-Off Method Allowance Method

Allowance Method

Recording a write-off using the direct write-off method involves a debit to __________. Bad Debt Expense Allowance for uncollectible accounts

Bad Debt Expense

At the end of the year, Dahir Incorporated's balance of allowance for uncollectible accounts is $2,000 (credit) before adjustment. The company estimates future uncollectible accounts to be $10,000. What adjustment would Dahir record for allowance for uncollectible accounts?

Bad debts = $10,000 - $2,000 = $8,000 Debit 8000 to Bad Debt Expense Credit 8000 to Allowance for uncollectible accounts

Accounts receivable originate from __________. Credit Sales Cash Sales

Credit Sales

The __________ is used for tax purposes but is generally not permitted for financial reporting. Direct Write-off method Allowance Method Under the __________, we make no attempt to estimate future bad debts. Direct Write-Off Method Allowance Method

Direct Write-Off Method

Sandburg Veterinarian reports the following information for the year: Net Credit Sales...... $120,000 Average accounts receivable..... 20,000 Cash collections on credit sales....... 100,000 What is Sandburg's receivables turnover ratio? a. 6.0 b. 5.0 c. 1.2 d. 0.2 6.0

Net Credit Sales / Avg. A/R 120,000 / 20,000 = a. 6.0

Beta Company performed $20,000 of services on account and recorded the amount due as a typical account receivable. Over time, it became apparent that the customer would not be able to pay quickly, so Beta required the customer to sign a six-month, 11 percent promissory note on February 1, 2012. The company then reclassified the existing account receivable as a note receivable. Which of the following will result from this action? Both assets and liabilities decrease Both assets and revenues decrease Revenues decrease and liabilities increase

No impact on the accounting equation No impact on the accounting equation (Think about the type of accounts )

Under the allowance method, companies are required to estimate future uncollectible accounts and record those estimates in the current year. Estimated uncollectible accounts __________ expenses. Increase assets and reduce Reduce assets and increase

Reduce assets and increase

Which of the following are contra-revenue accounts? Sales Discounts Trade Discounts unearned Revenues

Sales Returns Sales Discounts, Sales Returns (A contra-revenue account is an account with a balance that is opposite or "contra" to that of its related revenue account.

A company performs a service on account. Recording a sale on account will include a credit to __________. Unearned Revenue Service Revenue

Service Revenue

The balances in sales discounts, returns, and allowances are subtracted from total revenues when calculating net revenues. True False

True, Sales discounts, returns, and allowances are contra revenue accounts. We subtract the balances in these accounts from total revenues when calculating net revenues.

Writing off actual bad debts and reestablishing those previous write-offs when it appears that customers will pay has no effect on net accounts receivable. True False

True, Think of the definition of net accounts receivable.

Flint Corporation has a debit balance of $2 million in its Allowance for Uncollectible Accounts before the year-end adjustment in 2012. Based on all available information at the end of 2012, Flint estimates that the allowance for uncollectible accounts should be $6 million. This can be accomplished with:

a credit to Allowance for Uncollectible Accounts for $8 million (Think of the normal balance of Allowance for Uncollectible Accounts.)

sales allowance

a reduction or a partial refund

A company will debit __________ while recording a credit sale at the time of the transaction. Cash Accounts Receivable

accounts receivable

percentage of receivables method

also known as the balance sheet method, we base the estimate of bad debts on a balance sheet amount-- accounts receivable.

contra revenue account

an account with a balance that is opposite to that of its related revenue account. We use it to keep a record of total revenue earned separate from the reduction due to subsequent sales allowances. -sales discounts, returns, and allowances are contra revenue accounts (we subtract the balances in these accounts from total revenues when calculating net revenues.)

average collection period

average collection period= 365 days/ receivables turnover ratio is another way to express the same efficiency measure. this ratio shows the approximate number of days the average accounts receivable is outstanding.

allowance for uncollectible accounts

contra asset account representing the amount of accounts receivable that we do not expect to collect. it reduces accounts receivable indirectly to its net realizable value.

Writing off an account receivable will include a: debit to Bad Debts Expense credit to Cash credit to Accounts Receivable credit to Allowance for Uncollectible Accounts

credit to Accounts Receivable (Allowance for Uncollectible Accounts will be debited and Accounts Receivable will be credited to write off an accounts receivable.)

A company performs $1,000 worth of services account on March 1, with the terms 2/10, n/30. The customer makes the payment on March 27. The receipt of payment will involve a:

credit to Accounts Receivable for $1,000 ( Remember that the customer is paying after the discount period.)

On September 1, 2012, 2G Corporation accepts a $100,000 six-month, nine percent promissory note from one of its clients. The transaction recorded by the company on March 1, 2013, the maturity date, will involve all of the following except _____. debit to cash for $104,500 credit to Interest Receivable for $3,000 credit to Notes Receivable for $100,000 credit to Interest Receivable for $4,500

credit to Interest Receivable for $4,500 ( Note that this note extends over two accounting periods. There will be a year-end adjustment before maturity.)

classification of notes receivable

current and non current.

uncollectible accounts

customers' accounts that we no longer consider collectible. bad debts.

A company performs $1,000 worth of services on account on March 1, with the terms 2/10, n/30. The customer makes the payment on March 7. The receipt of payment will involve a:

debit to Sales Discounts for $20 (Remember that contra-revenue accounts are used here.)

percentage of credit sales method/ income statement method

estimates uncollectible accounts based on the percentage of credit sales for the year. -the two methods used for estimating uncollectible accounts result in different adjustments.

what do companies strive for?

high turnover rate, low average collection period.

what effect does the write-off of an account receivable have?

it has no effect on total amounts reported in the balance sheet or in the income statement. we have already recorded the negative effects of the bad news -collecting cash on an account previously written off has no effect on total assets and no effect on net income.

allowance method

method which allows for the possibility that some accounts will be uncollectible at some point in the future. under the allowance method, companies are required to estimate future uncollectible accounts and record those estimates in the current year.

aging method

method which considers the age of various accounts receivable and use a higher percentage for old accounts than for new accounts. the older the account the less likely it is to be collected

net revenues

or net sales, refer to a company's total revenues less any amounts for discounts, returns, and allowances.

when should each method be applied?

percentage of receivables ( balance sheet method) is the preferable method (has a better measurement of assets), while the percentage of credits sales method (income state method) is allowed only if amounts do not differ significantly from estimates using the percentage of receivables method.

nontrade receivables

receivables that originate from sources other than customers, that include: tax refund claims, interest receivable, loans by company to other entities including stockholders and employees.

receivable turnover ratio

receivables turnover ratio= net credit sales / average accounts receivable shows the number of times during a year that the average accounts receivable balance is collected (turns over). quicker the rate, quicker it receives cash from cutomers.

direct write-off method

recording bad debt expense at the time we know the account to be uncollectible. -it is used for tax purposes but is generally not permitted for financial reporting. - a firm must use the allowance method if it is probable that the firm will not collect a material amount of receivables and it can reasonably estimate that ammount.

trade discounts

represent a reduction in the listed price of a product or service. -they are recognized indirectly by recording that sale at the discounted price

sales discount

represents a reduction, not in the selling price of a product or service, but in the amount to be paid by a credit customer if payment is made within a specified period of time.

Accounts receivable

represents the amount of cash owed to a company by its customers from the sale of products or services on account. -sometimes known as trades receivable -the legal right to receive cash is valuable and represents an asset of the company

bad debt expense

represents the cost of the estimated future bad debts. - adjusting for estimates of future uncollectible accounts matches expenses (bad debts) in the same period as the revenues (credit sales) they help to generate.

net accounts receivable

the difference between total accounts receivable and the allowance for uncollectible accounts is referred to as net accounts receivable. it is also the net realizable value.

what does a debit balance before adjustment indicate?

the estimate at the beginning of the year was too low.

what does a credit balance before adjustment indicate?

the estimate of uncollectible accounts at the beginning of the year ( or the end of the last year) may have been too high.

Key point

the year end adjustment for future uncollectible accounts is affected by the current balance of allowance for uncollectible accounts before adjustment. the current balance before adjustment equal the estimate of uncollectible accounts at the beginning of the year ( or end of last year) less actual write-offs in the current year.

interest equation

interest= face value * annual interest rate * fraction of the year

net realizable value

the amount of cash we expect to collect. = accounts receivable (debit)- allowance for doubtful accounts (credit)

At December 31, Gill Co. reported accounts receivable of $238,000 and an allowance for uncollectible accounts of $600 (debit). An analysis of accounts receivable suggests that the allowance for uncollectible accounts should be 3% of accounts receivable. The amount of the adjustment for uncollectible accounts would be: $6,540. $7,800. $7,140. $7,740.

$7,740. ($238,000 x 3%) + $600 = $7,740.

credit sales

transfer 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 -even though the seller does not receive cash at the time of the credit sale, the firm records revenue immediately, as long as future collection from the customer is reasonably certain

what happens when uncollectible accounts cannot be reliably estimated

we do not estimate uncollectible accounts, but we write of any bad debts that do arise as bad debt expense at that time.

key point

we record interest earned on notes receivable nut not yet collected by the end of the year as interest receivable and interest revenue.

sales return

when a customer returns a product.

notes receivable

when receivables are accompanied by formal credit arrangements made with written debt instruments (or notes).

Barnes Books allows for possible bad debts. On May 7, Barnes writes off a customer account of $5,300. On September 9, the customer unexpectedly pays the $5,300 balance. Record the cash collection on September 9.

you need to do two entries. 1. Debit accounts recievable 5300, and Credit allowance for uncollectable amounts 5300. The first entry reverses a portion of the previous entry that the customer made on May 7 to write off the account. 2.Debit Cash 5300 (he unexpectantly payed), and Credit Accounts receivable 5300 (he doesnt owe anymore). The second entry records the collection of the account receivable.

pros and cons of extending credit

+ = 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. - = not all customers will pay fully on their accounts