Chapter 5: Sales and Receivables Flashcards
cash-basis accounting recognizes revenue…
in the period payment is received (as on your tax return)
accrual basis accounting recognizes revenue…
when the company’s performance obligation is satisfied by transferring control of the promised good or service to the customer
T or F: control can pass either at a point in time or over time.
True
_______ provides detail as to when revenue should be recognized.
FASB
For most retail organizations, revenue is recognized at the _____ ___ _____.
point of sale
For service industries, revenue is recognized when…
the service is performed
Companies often induce customers to buy by modifying the terms of the sale.
Three modifications that affect the amount the company expects to collect are:
- Discounts
- Returns
- Allowances
a price reduction (usually expressed as a percentage of the selling price) that companies may offer to encourage prompt payment
sales discounts
Why are sales discounts attractive to:
1. Buyers
2. Sellers
- Buyers: reduced cost of goods/services
- Sellers: quicker cash and collection costs are reduced
The interest expense associated with borrowing money has a (positive/negative) effect on net income.
negative
Sales invoices use a standard notation to state discount and credit terms.
Ex: the invoice of a seller who expects payment in 30 days offers a 2% discount if payment is made within 10 days would bear the notation:
2/10 ; n/30
What does n/30 indicate in a sales invoice standard notation?
What does 2/10 indicate?
n/30: the gross amount of the invoice (the full pre-discount amount) must be paid in 30 days.
2/10: if payment is made within the 10-day discount period, the amount owed is 2% less than the gross (pre-discount) amount of the invoice.
2/10: if payment is made within the 10-day discount period, the amount owed is 2% less than the gross (pre-discount) amount of the invoice.
This is referred to as the ___ price. (___ of the 2% discount)
net
Full payment is expected once the 10 day discount period has passed and this is called the _______ (pre-discount) amount of the invoice.
gross
Companies should record the ______ and associated _________ at the amount (gross or net) they expect to receive from the customer.
revenue; receivable
For customers expected to take the discount → sales revenue should be recorded at the (net/gross) invoice amount.
net
For customers not expected to pay in the discount period → sales revenue should be recorded at the (net/gross) invoice amount.
gross
conceptually a company should report sales revenue at a (gross/net) price for most of its customers.
net
failure of a large number of customers to take discounts may indicate what?
that an increase in the discount percentage is needed
customers who stop taking sales discounts may be experiencing _____ _____ problems and therefore are _______ ______ _______.
cash flow; potential credit risks
a reduction in the selling price granted by the seller to a particular class of customers, for example: to customers who purchase goods for resale rather than for use.
trade discount
a reduction in the selling price granted by the seller because selling costs per unit are less when larger quantities are ordered.
quantity discount
The selling or invoice price is usually assumed to be the price (before/after) adjustment for the trade and quantity discounts; accordingly, trade and quantity discounts (are/ are not) recorded separately in the accounting records.
after; are not
when a customer will return goods as unsatisfactory
sales return
when a customer agrees to keep goods with minor defects or that arrived late in return for a price reduction (could be a service that wasn’t completed on time too)
sales allowance
T or F: Sales returns and allowances should be recorded IN the period of sale to correctly report sales revenue as the amount a company expects to collect.
True
Problem: for sales made near the end of the year, the return or allowance may not occur until the following period. So, companies must _______ the amount of returns and allowances so that sales revenue can be reduced to their proper amounts.
If the bill has already been paid, the seller can either refund a portion of the purchase price and record a _____ to cash or apply the allowance against future purchases by the customer by recording a ______ to accounts receivable.
estimate; credit/credit
Management should look for unusual behavior in both sales revenue and sales returns and allowances. Often, significant changes in these accounts help to explain other changes in _______ statement or ______ _______ accounts.
income; balance sheet
money due from another business or individual
receivable
What are the three different dimensions receivables are typically categorized as?
- Accounts Receivable or Notes Receivable
- Current or Non-current Receivables
- Trade or Non-trade Receivables
a formal legal document given by a borrower to a lender stating the timing of repayment and amount (principal and/or interest) to be repaid.
a note
T or F: Accounts receivable have a formal note.
False; do not
Accounts receivable are typically due in ____ to _____ days and (do/do not) have interest.
Notes receivable are typically due anywhere from _____ to _____ months and (do/do not) have interest.
If the due date is over ___ _____, the note receivable will typically be classified as noncurrent.
- 30-60; do not
- 3-12; do
- one year
due from customers purchasing inventory in the ordinary course of business
trade receivables
arise from transactions not involving inventory (such as interest receivable or cash advances to employees)
non-trade receivables
_______ requires accounts receivable to be shown at their “_______ _______ ______”
GAAP; net realizable value
the amount of cash the company expects to collect
net realizable value
When customers don’t pay their accounts receivable, what results?
Bad Debts (or uncollectible accounts)
The customer default is treated as a (expense/reduction in revenue) since they arise from the actions of the (customer/seller).
expense; customer
the expense that results from receivables that are not paid
bad debt expense
What are the two methods to record bad debt expense?
- Direct Write-Off Method
- The Allowance Method
What method to record bad debt expense waits until an account is deemed uncollectible before reducing accounts receivable and recording the bad debt expense?
Direct-Write Off Method
The direct write-off method is inconsistent with what principle and can only be used if bad debts are _______ under GAAP.
expense recognition principle; immaterial
For the allowance method, bad debt expense is recognized in the ______ ____ _____, which allows it to be properly matched with revenues.
period of sale
What is the result of the allowance method to record bad debt expense?
Bad debt expense is recognized before the actual default.
Under the allowance method, because defaults for the current period’s sales have not yet occurred, the specific accounts receivable are not lowered; instead, an account is established to “store” the estimate until specific accounts are identified as uncollectible. This account is called:
allowance for doubtful accounts
a contra-asset account that is established to “store” the estimate of uncollectible accounts until specific accounts are identified as uncollectible.
allowance for doubtful accounts
When a specific account is determined to be uncollectible under the allowance method, it is written off by a (credit/debit) to the allowance account and a (credit/debit) to accounts receivable.
debit; credit
Under the allowance method, two methods commonly used to estimate bad debt expense are:
- Percentage of Credit Sales Method
- Aging Method (of receivables)
What method does this describe for estimating bad debt expense?
- Simpler method for determining bad debt expense
- Using past experience, a company estimates the percentage of the current period’s credit sales that will eventually become uncollectible
Percentage of Credit Sales Method
(1) What is the formula for calculating the estimated bad debt expense using the percentage of credit sales method?
(2) The adjusting journal entry is then prepared to record the bad debt expense as a (credit/debit) to bad debt expense and a (credit/debit) to allowance for doubtful accounts.
(1) Total Credit Sales x % of Credit Sales Estimated to Default
(2) Debit; Credit
Occasionally, accounts receivable that are written off are later partially or entirely collected.
What entries do you make to correct for this (4 things)?
- Debit accounts receivable
- Credit allowance for doubtful accounts
- Debit cash
- Credit accounts receivable
What method does this describe for estimating bad debt expense?
- Bad debt expense is estimated by determining the collectability of the accounts receivable
- At the end of each accounting period, the individual accounts receivable are categorized by age. Then, an estimate is made of the amount expected to default in each age category based on past experience and expectations about how the future may differ from the past.
Aging Method
What are the four accounts receivable age categories for the aging method?
- Less than 15 days
- 16-30
- 31-60
- Over 61 days
T or F: For the aging method, the overdue accounts are more likely to default than the currently due accounts.
True
The total amount expected to default on year-end accounts receivable is the amount that should be the ______ ______ in the allowance for doubtful accounts.
ending balance
What is the objective of the aging method?
To estimate the ending balance in the allowance for doubtful accounts
For the Aging Method: The total amount calculated is the amount that should be the ending balance in the allowance for doubtful accounts. Therefore, the allowance account balance must be considered when determining the amount of the adjusting entry. If the beginning balance in the Allowance account = $1,100 and if the aging schedule
calculations determined that the uncollectible accounts should equal $3,500, then a $______ journal entry must be made to ____ _____ ______ to generate the desired ending balance.
$2,400; bad debt expense
What is the difference between the percentage of credit sales method and the aging method?
What is being estimated
The percentage of credit sales method is primarily concerned with appropriately estimating _______ ______ _______ based on the ______ statement
bad debt expense; income
The aging method is an approach that analyzes the accounts receivable to estimate its ______ ______ ______ on the _____ _____.
net realizable value; balance sheet
T or F: For the percentage of credit sales method, because of the focus on the expense account, any existing balance in the allowance account is IGNORED when determining the amount of the adjusting entry.
True
Because bad debt expense is an income statement account that is closed to retained earnings at the end of every period, its pre-adjustment balance should be _____. As such, the adjustment is equal to the estimate of the ending balance.
T or F: The allowance for doubtful accounts is a balance sheet account and will typically have an existing balance.
zero; true
T or F: most companies agree that the loss of business from not offering credit is more detrimental than the bad debt expenses incurred in doing so.
True
Although bad debts result from actions of the purchaser (nonpayment), the amount of bad debt expense is influenced by the _____ ______ of the seller.
credit policies
In order to increase speed of cash collection, receivables may be ______ or sold.
factored
a method of handling receivables in which the seller receives an immediate cash payment reduced by the factor’s fees. The _____, the buyer of the receivables acquires the right to collect the receivables and the risk of uncollectability. In a typical factoring arrangement, the sellers of the receivables have no continuing responsibility for their collection.
factoring; factor
typically the factor charges a fee ranging from ____% to ___% to compensate the factor for what three things?
1%-3%
- The time value of money
- Risk of uncollectability
- Billing/collection costs
when large businesses and financial institutions frequently package factored receivables as financial instruments or securities and sell them to investors.
securitization
a card that authorizes the holder to make purchases up to some limit from retailers.
- a special form of factoring
- the issuer of the card (ex: the bank) pays the seller the amount of each sale minus a service charge (on the date of purchase) and then collects the full amount of the sale from the buyer (at some later date).
credit card
Credit card sales provide sellers with a number of advantages over supplying credit directly to customers (4 advantages):
- Sellers receive the money immediately.
- Sellers avoid bad debts because as long as the credit card verification procedures are followed, the credit card company absorbs the cost of customers who do not pay.
- Recordkeeping costs decrease because employees are not needed to manage these accounts.
- Sellers believe that by accepting credit cards their sales will increase.
a card that authorizes a bank to make an immediate electronic withdrawal from the holder’s bank account and a corresponding deposit to another party’s account.
debit card
T or F: Debit cards offer advantages to banks/ merchants in reduced transaction-processing costs. So, banks/ merchants have incentive to design debit cards that minimize or eliminate the disadvantages and costs to card users.
True
receivables that generally specify an interest rate and a maturity date at which any interest and principal must be repaid.
notes receivable
The amount lent is the _________. (the amount of money borrowed and promised to be repaid (usually with interest)).
principal
The excess of the total amount of money collected over the amount lent is called _______.
(ex: if Caterpillar lends $500,000 to a customer and is repaid $580,000 at some later date, then $80,000 of ^ was collected)
interest
when any interest and the note’s principal must be repaid.
maturity date
Interest can be considered compensation paid to the lender for giving up the use of resources for the period of a note (the time value of money). The interest rate specified in the note is an _____ ______.
annual rate
What is the formula for calculating interest?
Principal x Annual Interest Rate x # of months/12 months= Interest
Sales revenue should only be recorded when what three control documents are completed?
When any of these three internal controls aren’t present, it’s possible for valid sales to be unrecorded and for invalid sales to be recorded.
(A sale and its associated receivable are recorded only when these are all present)
- Order document (receipt of a purchase order)
- Shipping Document
- Billing Document (invoice)
Analysts of the financial statements are extremely concerned with both ____ and _______.
sales; receivables
Because _____ _____ is such a key component of a company’s success,
analysts are interested in a large number of ratios that incorporate sales.
* Many of these ________ ratios attempt to measure the return the
company is earning on sales.
sales revenue; profitability
ratios that measure two aspects of a corporation’s profits:
1. Those elements of operations that contribute to profit and
2. The relationship of profit to total investment and investment by stockholders
profitability ratios
What are the three most common profitability ratios?
- Gross Profit Margin
- Operating Margin
- Net Profit Margin
How do you calculate Gross Profit Margin?
Gross Profit / Net Sales = Gross Profit Margin
How do you calculate Operating Margin?
Operating Income / Net Sales = Operating Margin
How do you calculate Net Profit Margin?
Net Income / Net Sales = Net Profit Margin
Analysts look at _____ margin and ____ _____ margin percentages to see how much is left from a sales dollar after paying for the product and all its operations.
operating margin and net profit margin
how efficiently a company is using the resources at its disposal.
asset management
One of the most widely used asset management ratios is ________ ________ _________.
- provides a measure of how many times average trade receivables are collected during the period
Accounts Receivable Turnover
How do you calculate accounts receivable turnover?
Net Sales / Average Net Accounts Receivable = Accounts Receivable Turnover
A (lower/higher) number is better for accounts receivable turnover because it indicates that the company is more quickly collecting cash (through sales) from its inventory. This holds down borrowing costs and allows for a greater investment.
higher
Changes in the accounts receivable turnover ratio over time is important. For example, a significant reduction in receivables turnover may indicate what?
that management is extending credit to customers who are not paying
When the retailer uses an internal credit card, however, accounts receivable turnover will ________ because cash is not received until the customer pays their credit card bill.
decrease
The net method is the most conceptually appropriate method for customers, while the gross method has the practical advantage of simplifying __________.
communication
