Chapter 8 concepts

Question 1

Accounts receivable

Answer 1

Amounts customers owe on account. Companies generally expect to collect accounts receivable within 30 to 60 days. They are usually the most significant type of claim held by a company.

Question 2

Notes receivable

Answer 2

Written promise (as evidenced by a formal instrument) for amounts to be received. The note normally requires the collection of interest and extends for time periods of 60-90 days or longer. Notes and accounts receivables that result from sales transactions are often called trade receivables.

Question 3

Other receivables

Answer 3

include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable. These do not generally result from the operations of the business.

Question 4

Bad Debt Expense (Uncollectible Accounts Expense.)

Answer 4

An expense account to record losses from extending credit.

Question 5

Direct write-off method

Answer 5

A method of accounting for bad debts that involves charging receivable balances to Bad Debt Expense at the time receivables from a particular company are determined to be uncollectible. Under this method, bad debt expense will show only actual losses from uncollectibles.

Question 6

Allowance method

Answer 6

A method of accounting for bad debts that involves estimating uncollectible accounts at the end of each period.

Question 7

Cash (net) realizable value

Answer 7

The net amount a company expects to receive in cash from receivables. It excludes amounts that the company estimates it will not collect.

Question 8

Companies must use the allowance method for financial reporting purposes when bad debts are material in amount. It has three essential features:

Answer 8

1. Companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded.
2. Companies record estimated uncollectibles as an increase (a debit) to Bad Debt Expense and an increase (a credit) to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts Receivable.
3. Companies debit actual uncollectibles to Allowance for Doubtful Accounts and credit them to Accounts Receivable at the time the specific account is written off as uncollectible.

Question 9

True or False Companies do not close Allowance for Doubtful Accounts at the end of the fiscal year.

Answer 9

True

Question 10

True or False To maintain segregation of duties, the employee authorized to write off accounts should not have daily responsibilities related to cash or receivables.

Answer 10

True

Question 11

True or False Like the write-off, a recovery does not involve the income statement.

Answer 11

true

Question 12

Percentage-of-receivables basis

Answer 12

A method of estimating the amount of bad debt expense whereby management establishes a percentage relationship between the amount of receivables and the expected losses from uncollectible accounts.

Question 13

Aging the accounts receivable

Answer 13

A schedule of customer balances classified by the length of time they have been unpaid.

Question 14

Studies have shown that accounts more than ____ past due lose approximately 50% of their value if no payment activity occurs within the next 30 days. For each additional 30 days that pass, the collectible value halves once again.

Answer 14

60 days

Question 15

Factor

Answer 15

A finance company or bank that buys receivables from businesses for a fee and then collects the payments directly from the customers.

Question 16

Three parties are involved when national credit cards are used in making retail sales:

Answer 16

(1) the credit card issuer, who is independent of the retailer; (2) the retailer; and (3) the customer. A retailer’s acceptance of a national credit card is another form of selling—factoring—the receivable by the retailer.

Question 17

Promissory note

Answer 17

A written promise to pay a specified amount of money on demand or at a definite time. Notes receivable give the holder a stronger legal claim to assets than do accounts receivable.

Question 18

When are promissory notes used?

Answer 18

Promissory notes may be used (1) when individuals and companies lend or borrow money, (2) when the amount of the transaction and the credit period exceed normal limits, and (3) in settlement of accounts receivable.

Question 19

Maker

Answer 19

The party in a promissory note who is making the promise to pay.

Question 20

Payee

Answer 20

The party to whom payment of a promissory note is to be made.

Question 21

The maturity date of a promissory note may be stated in one of three ways:

Answer 21

(1) on demand, (2) on a stated date, and (3) at the end of a stated period of time.

Question 22

formula for computing interest

Answer 22

face value of note x annual interest rate x time in terms of one year. The interest rate specified on the note is an annual rate of interest. The time factor in the computation expresses the fraction of a year that the note is outstanding. When the maturity date is stated in days, the time factor is frequently the number of days divided by 360 (this is not a typo). Financial institutions use 365 days to compute interest. For homework problems, assume 360 days to simplify computations.

Question 23

The company records the note receivable at its ____.

Answer 23

Face value. No interest revenue is reported when the company accepts the note because the revenue recognition principle does not recognize revenue until the performance obligation is satisfied.

Question 24

A note is ______ 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 specified on the note.

Answer 24

honored

Question 25

Dishonored (defaulted) note

Answer 25

A note that is not paid in full at maturity. A dishonored note receivable is no longer negotiable. However, the payee still has a claim against the maker of the note for both the note and the interest.

Question 26

True or false

Answer 26

True

Question 27

Managing accounts receivable involves five steps:

Answer 27

1. Determine to whom to extend credit.
2. Establish a payment period.
3. Monitor collections.
4. Evaluate the liquidity of receivables.
5. Accelerate cash receipts from receivables when necessary.

Question 28

Concentration of credit risk

Answer 28

The threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company.

Question 29

Accounts receivable turnover

Answer 29

A measure of the liquidity of accounts receivable, computed by dividing net credit sales by average net accounts receivable.

Question 30

Average collection period

Answer 30

365 / accounts receivable turnover

Question 31

Three reasons for sale of receivables

Answer 31

1. Size
2. They may be the only reasonable source of cash
3. billing and collection are often time-consuming and costly

Question 32

captive finance companies

Answer 32

owned by the company selling the product.