Ch. 5 Receivables and Sales

Question 1

Accounts receivable

Answer 1

The amount of cash owed to the company by its customers from the sale of products or services on account.

Question 2

Credit Sales

Answer 2

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.

Question 3

Net Revenues

Answer 3

A company’s total revenues less any discounts, returns, and allowances.

Question 4

Trade discounts

Answer 4

• Reduction in the listed price of a product or service.
• Provides incentives to larger customers/consumer groups
• Way to change prices with out publishing a new price list or to disguise real prices from competitors.
• When recording a transaction, companies don’t recognize trade discounts directly. Instead, they recognize trade discounts indirectly by recording the sale at the discounted price.

March 1
Accounts Receivable …………………… 400
Service Revenue ……………………………….. 400
(Make credit sale of $500 with a 20% trade discount)

Question 5

Sales discount

Answer 5

• Contra Revenue Account
• Reduction in the amount to be paid by a credit customer if payment on account is made within a specified period of time.
• Provides incentive for quick payment.

Question 6

Contra revenue account

Answer 6

• An account with a balance that is opposite, or “contra,” to that of its related revenue account.
• Sales discounts, sales returns, sales allowances.*
• We subtract the balances in these accounts from total revenues when calculating net revenues.
• The reason we use a contra revenue account is to be able to keep a record of the total revenue separate form the reduction in that revenue due to quick payment.
• Firms sometimes combine their sales returns and sales allowances in a single sales returns and allowances account.

Question 7

Sales return

Answer 7

• Contra Revenue Account

- Customer returns a product.

Question 8

Sales allowance

Answer 8

• Contra Revenue Account
• Seller reduces the customer’s balance owed or provides at least a partial refund because of some deficiency in the company’s product or service.

March 5
Sales Allowances ……………………………. 50
Accounts Receivable ………………………….. 50
(Makes sales allowance for credit sale)

Question 9

Net realizable value

Answer 9

• The amount of cash the firm expects to collect.
• What is the value of being owed $100?
• If you are confident the person will actually pay you $100 in the near future, then you might consider the right to receive the money to be worth $100.
• However, if the person is unable to pay you anything, then your fright to collect $100 is worth $0.
• Of course there are many possibilities in between.
• Accounts receivable must be reported at their net realizable value.

Question 10

Uncollectible accounts

Answer 10

• Customers’ accounts that no longer are considered collectible.
• (Bad debts)

Question 11

Allowance method

Answer 11

• We account for uncollectible accounts using this method.
• Estimates future uncollectible accounts.
• Estimates are recorded in the current year.
• Recording an adjustment at the end of each period to allow for the possibility of future uncollectible accounts. The adjustment has the effects of reducing assets (accounts receivable) and increasing expenses (bad debt expense).
• We account for events (customers’ bad debts) that have not yet occurred but that are likely to occur.
• We first estimate at the end of the current year how much in uncollectible accounts will occur in the following year.

Question 12

Percentage-of-receivables method

Answer 12

• One of 2 methods of estimating uncollectible accounts.
• Method of estimating uncollectible accounts based on the percentage of accounts receivable expected not to be collected.
• Sometimes referred to as the balance sheet method, because we base the estimate of bad debts on a balance sheet amount-accounts receivable.
• Applies a single estimated percentage to total accounts receivable.
• Management can estimate this percentage using historical averages, current economic conditions, industry comparisons…
• Not as accurate as the aging method.

Question 13

Bad debt expense

Answer 13

• The amount of the adjustment to the allowance for uncollectible accounts, representing the cost of estimated future bad debts charged to the current period.
• Sometimes referred to as uncollectible accounts expense.
• We include this expense in the same income statement as the credit sales with which these bad debts are associated. By doing so, we properly “match” expenses (bad debts) with the revenues (credit sales) they help to generate.

Question 14

Allowance for uncollectible accounts

Answer 14

• Contra asset account representing the amount of accounts receivable that we do not expect to collect.
• Reduces Accounts Receivable indirectly to its net realizable value.
• Sometimes referred to as the allowance for doubtful accounts.

Question 15

Net accounts receivable

Answer 15

• The difference between total accounts receivable and the allowance for uncollectible accounts.
• Which is net realizable value.

Question 16

Aging method

Answer 16

• One of 2 methods for estimating uncollectible accounts.
• Aging of Accounts Receivable.
• Using a higher percentage for “old” accounts than for “new” accounts when estimating uncollectible accounts.
• ie: accounts that are 60 days past due are older than accounts that are 30 days past due.
• The older the account, the less likely it is to be collected.
• More accurate than Percentage-of receivables method.

Question 17

Direct write-off method

Answer 17

• Recording bad debt expense at the time we know the account is uncollectible.
• We do not estimate uncollectible accounts, but we write off any bad debts that do arise as bad debt expense at that time.
• Used in rare situations such as: if uncollectible accounts are not anticipated or are immaterial, or if it’s not possible to reliably estimate them.
• Used for tax purposes, but is generally not permitted for financial reporting.
  
  • assets would be overstated; operating expenses would be understated.
• The difference between Allowance method and Direct write-off method is in the timing.

Question 18

Notes receivable

Answer 18

• Similar to accounts receivable; Formal credit arrangements evidenced by a written debt instrument, or note.
• Typically arise from loans to other entities (including affiliated companies); loans to stockholders and employees; and occasionally the sale of merchandise, other assets, or services.

Question 19

Receivables turnover ratio

Answer 19

• Number of times during a year that the average accounts receivable balance is collected (or “turns over”). It equals net credit sales divided by average accounts receivable.
• Average accounts receivable is typically measured as the beginning accounts receivable plus the ending accounts receivable divided by two.
• You want a high number.

Question 20

Average collection period

Answer 20

• Approximate number of days the average accounts receivable balance is outstanding. It equals 365 divided by the receivables turnover ratio.
• You want a low number.

Question 21

Discount Terms (2/10, n/30)

Answer 21

• 2/10 “Two ten”–Customer will receive a 2% discount if the amount owed is paid within 10 days.
• n/30 “Net thirty”–If the customer does not take the discount, full payment is due within 30 days.

March 10
Cash ………………………………………… 392
Sales Discount …………………………….. 8
Accounts Receivable ……………………. 400
(Collect cash on account with a 2% sales discount)

Question 22

Non-trade Receivables

Answer 22

• Less common than accounts receivable
• They are receivables that originate from sources other than customers.
• They include tax refund claims, interest receivable, and loans by the company to other entities, including stockholders and employees.

Question 23

Percentage-of-receivables method Journal entry.

• In 2012, Kimzey Medical Clinic bills customers $50 million. By the end of the year, $20 million remains due from customers, but how much of this amount does Kimzey expect not to collect in the following year?
• In previous years approximately 30% of accounts receivable were not collected; Kimzey decides to base this year’s estimate on that same percentage.

Answer 23

December 31, 2012 ($ in millions)
Bad Debt Expense …………………………………. 6
Allowance for Uncollectible Accounts ……… 6
($20 million x 30% = $6 million)

Question 24

Writing off Accounts Receivable

• On Feb. 23, 2013, Kimzey receives notice that that a particular patient will not be able to pay his account of $4,000. (he filed bankruptcy protection against all creditors).

Answer 24

February 23, 2013
Allowance for Uncollectible Accounts…….4,000
Accounts Receivable …………………………………. 4,000
(Write off a customer’s account)

-Overall, the write-off of the account receivable 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.

Question 25

Collection of Accounts Previously Written off.

On Sep. 8, 2013, after liquidating all assets, the patient is able to pay each of his creditors 25% of the amount due to them. ($4,000 x 25% = $1,000)

Answer 25

September 8, 2013
Accounts Receivable …………………………………..1,000
Allowance for Uncollectible Accounts…………….. 1,000
(Reestablish portion of account previously written off)

Cash ……………………………………. 1,000
Accounts Receivable …………………. 1,000
(Collect cash on account)

-Collecting cash on a account previously written off has no effect on total assets and not effect on net income.

Question 26

Estimating Uncollectible Accounts in the following year

Answer 26

• A credit balance before adjustment indicates that last year’s estimate of uncollectible accounts may have been too high.
• A debit balance before adjustment indicates that last year’s estimate was too low.
• Positive number is a credit balance; Negative number is a debit balance.

Question 27

Collection of Notes Receivable

On Feb. 1, 2012 Kimzey provides services of $10,000 to Justin who is not able to pay immediately. Justin offers Kimzey a 6-month, 12% promissory note

Answer 27

February 1, 2012
Notes Receivable ……………………. 10,000
Service Revenue …………………………….. 10,000
(Accept a six-month, 12% note receivable for services provided)

August 1, 2012
Cash …………………………………….10,600
Notes Receivable …………………………..10,000
Interest Revenue ………………………………. 600
(Collect note receivable and interest)
(Interest revenue = $10,000 x 12% x 6/12)

Question 28

Percentage-Of-Credit-Sales Method

Answer 28

• (Also called the income statement method)
• Not as preferable as percentage-of-receivables method.
• Allowed only if amounts do not differ significantly from estimates using the percentage-of-receivables method.
• However, some argue that expenses (bad debts) are better matched with revenues (credit sales).