Chapter 8

Question 1

What is the definition of accounts receivable?

Answer 1

Asset: probable, economic benefit, arose from past transaction

Informal credit sale that does not require a written agreement

Question 2

Why do we have to estimate bad debt expense at the end of an accounting period?

Answer 2

Companies don’t want to wait until the payment is paid or not paid, so we make an estimate on how much might not be paid at the end of a period.

Question 3

What kind of account is Allowance for Doubtful Accountants?

Answer 3

A contra asset account (xA)

Question 4

What is a write-off of a receivable?

Answer 4

When a company determines that a specific account receivable is uncollectible and removes it from its books.

Question 5

Definition of the allowance method:

Answer 5

Estimates bad debts in advance

Question 6

Why would the direct write off method be a bad example of accounting?

Answer 6

This method leads to mismatched expenses and revenues

Question 7

What does the allowance for doubtful accounts do?

Answer 7

Helps us estimate the amount of money that will not be paid.

Question 8

What is a contra account?

Answer 8

an account that offsets or reduces the balance of a related account in financial statements (has the opposite balance of the account it is paired with)

Question 9

What is debited and credited when a company records a bad debt expense?

Answer 9

Debit: Bad Debt Expense (+E)
Credit: Allowance for Doubtful Accounts (+XA)

Question 10

What is debited and credited when a company writes off actual bad debt expense?

Answer 10

Debit: Allowance for Doubtful Accounts. (-XA)
Credit: Accounts Receivable (-A)

Question 11

Do write offs make contra accounts go up or down?

Answer 11

Down

Question 12

Why would write offs NOT effect gross accounts receivable?

Answer 12

the gross balance is the total amount owed by customers before any adjustments

Question 13

Why would write offs effect net account receivable?

Answer 13

reduces the balance of the net receivable

Question 14

Equation for Net Accounts Receivable:

Answer 14

Gross Accounts Receivable - Allowance for Doubtful Accounts

Question 15

What is another name for the net realizable value?

Answer 15

Net Accounts Receivable

Question 16

What does the unadjusted balance in the allowance for doubtful accounts mean?

Answer 16

represents the amount that has been previously estimated and recorded as uncollectible accounts receivable before any adjustments are made

Question 17

If a company debits an unadjusted balance (has more write offs) did they over or underestimate their estimate?

Answer 17

They underestimated how much would not be paid.

Question 18

How can we tell if a company overestimates how much will go unpaid?

Answer 18

Unadjusted balance was credited making the allowance go up.

Question 19

What are the two reasons why accruals may not turn into cash flows?

Answer 19

Foggy crystal balls and evil managers

Question 20

What is the foggy crystal ball problem?

Answer 20

A company makes estimates, the future is cloudy and unpredictable, and there are errors in the estimate

Question 21

Explain how evil managers may effect why accruals may not turn into cash?

Answer 21

accrual accounting involves estimates and managers have discretion in making these estimates, managers have incentives to prefer aggressive income (higher net income), and managers sometimes intentionally manipulate the accruals causing error that are biased

Question 22

What is a note receivable?

Answer 22

A contract; give money to someone else

Question 23

Do accounts receivable accrue interest over time?

Answer 23

No

Question 24

What receivable has a longer repayment period?

Answer 24

Notes Receivable

Question 25

T/F: Notes receivable are considered to have a higher risk of the customer not paying the money back

Answer 25

FALSE

Question 26

Equation for simple interest:

Answer 26

Principal amount * interest rate * time = simple interest

Question 27

Is a higher A/R turnover ratio good or bad? Why?

Answer 27

Good. This means that the company can turn accounts receivables into cash fast.

Question 28

What does the A/R turnover ratio tell investors?

Answer 28

how fast the company can turn their accounts receivable into cash

Question 29

How could firms increase their A/R turnover ratio?

Answer 29

• Create stricter credit policies
• Offer discounts to encourage customers to pay early
• Have clear payment plans
• Follow-up with customers to make sure that they pay on time

Question 30

What might happen if a company restricts its credit policy?

Answer 30

Good: stricter policies may lead to fewer defaults and bad debts, improve cash flow
Bad: loose sales opportunities because customers may not qualify for credit, slower growth, create excess inventory