Chapter 8

Question 1

Advantages of Extending Credit:

Answer 1

(1) Increases the seller’s revenues.

Question 2

Disadvantages of Extending Credit:

Answer 2

(1) Increased wage costs
(2) Bad debt costs
(3) Delayed receipt of cash

Question 3

If credit is extended, the company will have to hire people to (a) evaluate whether each customer is creditworthy, (b) track how much each customer owes, and (c) follow up to collect the receivable from each customer.

Answer 3

Increased Wage Costs

Question 4

Inevitably, some customers dispute what they owe ,or they run into financial difficulties and pay only a fraction of their account balances. These bad debt costs are considered an additional cost of extending credit.

Answer 4

Bad Debt Costs

Question 5

Even if the company were to collect in full from customers, it will likely have to wait 30–60 days before receiving the cash.

Answer 5

Delayed Receipt of Cash

Question 6

Allowance for Doubtful Accounts

Answer 6

Less on Balance Sheet

Question 7

Bad Debt Expense

Answer 7

Income Statement

Question 8

True or False: Matching requires that expenses be deducted from the revenue they helped earn.

Answer 8

True

Question 9

Allowance Method Two Step Process:

Answer 9

(1) Make an end of period adjustment to record the estimated bad debts in the period credit sales occur.
(2) Remove specific customer balances when they are known to be uncollectible.

Question 10

Methods for Estimating Bad Debts accepted by GAAP and IFRS:

Answer 10

(1) Percentage of Credit Sales Method

(2) Aging of Accounts Receivable

Question 11

Advantage of Percentage of Credit Sales Method

Answer 11

Simpler to apply

Question 12

Advantages of Aging of Accounts Receivable

Answer 12

More accurate

Question 13

Estimates bad debt expense by multiplying the historical percentage of bad debt losses by the current period’s credit sales.

Answer 13

Percentage of Credit Sales Method

Question 14

True or False: We must remember to remove cash sales from our total sales revenue to arrive at net credit sales. We will not experience any bad debts on cash sales. Notice that this method uses one income statement account (Sales) to estimate the amount to record in another income statement account (Bad Debt Expense).

Answer 14

True

Question 15

Bad Debt Expense of the Period Equation

Answer 15

Net Credit Sales for the Period x Historical Bad Debt Loss Rate = Bad Debt Expense

Question 16

The focus of the percentage of credit sales method is:

Answer 16

Determining the amount to record on the income statement as bad debt expense

Question 17

While the percentage of credit sales method focuses on _____________ for the period, the aging of accounts receivable method focuses on _____________ in the Allowance for Doubtful Accounts.

Answer 17

(1) Estimating Bad Debt Expense

(2) Estimating the ending balance

Question 18

The aging method gets its name because it is based on the “age” of each amount in Accounts Receivable. The ___________ an account receivable becomes, the less likely it is to be collectible.

Answer 18

(1) Older

Question 19

Percentages of Credit Sales Equation

Answer 19

Net Credit Sales x % Estimated Uncollectible = Percentage of Credit Sales

Question 20

Accounts Receivable Aging Equation

Answer 20

Accounts Receivable x % Estimated Uncollectible = Not Amount of Entry

Question 21

Bad debt estimates usually differ from the amounts that are later written off. If these differences are material, companies are required to revise their bad debt estimates for the current period.

Answer 21

Revising Estimates

Question 22

Collection of a previously written off account is called a recovery and it is accounted for in two parts. First, put the receivable back on the books by recording the opposite of the write-off. Second, record the collection of the account.

Answer 22

Accounts Recoveries

Question 23

Reverse Original Write Off Journal Entry:

Answer 23

dr. Accounts Receivable

cr. Allowance for Doubtful Accounts

Question 24

Collection of a write off Journal Entry:

Answer 24

dr. Cash

cr. Accounts Receivable

Question 25

A company reports _____________ if it uses a promissory note to document its right to collect money from another party

Answer 25

Notes Receivable

Question 26

Three Situations to report Notes Receivable:

Answer 26

(1) The company loans money to employees or businesses.
(2) The company sells expensive items for which customers require an extended payment period
(3) The company converts an existing account receivable to a note receivable to allow an extended payment period.

Question 27

True or False: Unlike accounts receivable, which do not necessarily charge interest until they’ve become overdue, notes receivable charge interest from the day they are created to the day they are due (their maturity date).

Answer 27

True

Question 28

Interest Equation

Answer 28

Interest (I) = Principal (P) x Interest Rate (R) x Time (T)

Question 29

Amount of the note receivable

Answer 29

Principal (P)

Question 30

The annual interest rate charged on the note

Answer 30

Interest Rate (R)

Question 31

The time period of interest calculation

Answer 31

Time (T)

Question 32

True or False: Because interest rates are always stated as an annual percentage even if the note is for less than a year, the time period is the portion of a year for which interest is calculated. We can express the time period in months or days. Many financial institutions use a 365-day year to calculate interest to the nearest day.

Answer 32

True

Question 33

Indicates how many times, on average, this process of selling and collecting is repeated during the period. The higher the ratio, the faster the collection of receivables.

Answer 33

Receivables Turnover Ratio

Question 34

True or False: Rather than evaluate the number of times accounts receivable turn over during a year, some people find it easier to think in terms of the length of time (in days) it takes to collect accounts receivable (called days to collect).

Answer 34

True

Question 35

Receivable Turnover Ratio

Answer 35

(Net Sales) / (Average Net Receivables)

Question 36

(Beginning Net Receivables + Ending Net Receivables) / 2

Answer 36

Average Net Receivables

Question 37

Days to Collect

Answer 37

365 / (Receivable Turnover Ratio)