Chapter 8

Question 1

Receivables

Answer 1

Claims that are expected to be collected in cash
They are acquired mainly by selling goods / services and lending money
There are three types:
–> Accounts receivable: amounts customers owe on account → they result from the sale of goods and services
–> Notes receivable: are a written promise for amounts to be received
–> Other receivables: include non trade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable

Question 2

How to recognise accounts receivable

Answer 2

Debit (increase) - accounts receivable
Credit (decrease) - sales revenue

Then when the cash is paid:
Debit (increase) - cash
Credit (decrease) - accounts receivable

Question 3

Accounts receivable is an

Answer 3

Asset
When a company is unable to recover a credit it records a credit loss as a bad debt expense (or uncollectible accounts expense)

Question 4

Companies report accounts receivable on the balance sheet as an asset

Answer 4

Some receivable will become uncollectible, so companies record credit losses as Bad Debt Expense

Question 5

Direct write off method

Answer 5

When a company can’t recover credit it charges the loss to Bad Debt Expense
This method has a problem as it will only show actual losses from uncollectibles
Also, it often records the BDE in a period different from the period in which they record revenue

Question 6

Allowance

Answer 6

Involves estimating uncollectible accounts at the end of each period, which allows companies to state receivables at their cash (net) receivable value (what they expect to receive for the receivables)
This method is preferred
This method has 3 features:
–> Estimate uncollectible amounts - match this expense to the revenues of the same accounting period
–> Companies create a contra asset account called Allowance for Doubtful Accounts to which they credit the estimated uncollectibles debited from Bad Debt Expense
–> When companies can’t recover a credit they write it off. They debit Allowance for Doubtful Accounts and credit accounts receivable

Question 7

Recording estimated uncollectibles

Answer 7

Companies use a contra account because they don’t know which customers will not pay
The Allowance for Doubtful Accounts isn’t closed at the end of the fiscal year

Question 8

Recording the write off of an uncollectible account

Answer 8

To maintain segregation of duties, the employee authorised to write off accounts shouldn’t have daily responsibilities related to cash or receivables

The company doesn’t increase bad debt expense when the write off occurs - under the allowance system, companies debit every bad debt write off to the allowance account rather than to the bad debt expense

The write offs affect only the balance sheet, not the cash flow

Question 9

Recovery of an uncollectible amount

Answer 9

The company makes two entries to record the recovery of a bad debt
–> It reverses the entry made in writing off the account - this reinstates the customer’s account
–> It journalises the collection in the usual way
This only affects the balance sheet

Question 10

Percentage of receivables basis

Answer 10

A percentage of accounts receivable is estimated and - credits (decreases) allowance for doubtful account by the percentage the balance of the account
A percentage of accounts receivable is estimated and - debits (increases) bad debt expense by the percentage the balance of the account (the same amount)

Question 11

Ageing the accounts receivable

Answer 11

This concept classifies customers balances by the length of time they have been unpaid
Once all the percentage uncollectibles have been calculated the total represents the balance that allowance for doubtful accounts should have
In the bad debt expense account we record the estimated balance - existing balance of allowance for doubtful account

Question 12

Short term receivables appear

Answer 12

in the current assets section of the balance sheet

Question 13

If the allowance account has a debit balance…

Answer 13

You add that value to the estimated balance and credit the sum to balance the account

Question 14

Companies can sell accounts receivable for 2 reasons

Answer 14

They need cash
Billing and collecting are time consuming and costly

Question 15

Sale of receivables usually occur to …

Answer 15

A factor - a finance company or bank that buys receivables from businesses and then collects the payments directly from the customers

A retailer’s acceptance of a credit card is another form of selling (factoring) the receivable
Three parties are involved when national credit cards are used in retail:
–> The credit card issuer, who is independent of the retailer
–> The retailer
–> The customer
The retailer generally considers sales from the use of credit card sales as cash sales - the retailer must pay to the bank that issues the card a fee for processing the transaction

Question 16

Reversing write off

Answer 16

Debit accounts receivable, credit allowance for doubtful accounts

Question 17

Record payment

Answer 17

Debit cash, credit accounts receivable

Question 18

Promissory note

Answer 18

A written promise to pay a specified amount of money on demand or at a definite time. They may be used when:
Individuals and companies lend or borrow money
The amount of the transaction and the credit period exceed normal limits
In settlement of accounts receivable

The party making the promise to pay is the maker

The party to whom payment is to be made is the payee

Question 19

Determining the maturity date

Answer 19

The due date of the money to be paid
It can be determined in terms of months, days etc
In terms of days, omit the date the note is issued but include the due date

Question 20

Computing interest

Answer 20

Face value of note x Annual interest rate x Time in terms of one year

Question 21

Honoured or dishonoured note

Answer 21

A note is honoured when its maker pays in full at its maturity date
For each interest bearing note, the amount due at maturity is the face value of the note plus interest for the length of time specific on the note

A note is dishonoured (defaulted) when its maker doesn’t pay in full at its maturity date
The amount is thus transferred to the accounts receivable account

Question 23

Short term investments appear

Answer 23

after short term receivables because they are more liquid

Question 24

Accounts Receivable Turnover Formula

Answer 24

Net Credit Sales / Average Net Accounts Receivable

Question 25

Average Collection Period in Days Formula

Answer 25

Days in Year / Accounts Receivable Turnover