Chapter 8 concepts Flashcards
Accounts receivable
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.
Notes receivable
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.
Other receivables
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.
Bad Debt Expense (Uncollectible Accounts Expense.)
An expense account to record losses from extending credit.
Direct write-off method
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.
Allowance method
A method of accounting for bad debts that involves estimating uncollectible accounts at the end of each period.
Cash (net) realizable value
The net amount a company expects to receive in cash from receivables. It excludes amounts that the company estimates it will not collect.
Companies must use the allowance method for financial reporting purposes when bad debts are material in amount. It has three essential features:
- Companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded.
- 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.
- 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.
True or False Companies do not close Allowance for Doubtful Accounts at the end of the fiscal year.
True
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.
True
True or False Like the write-off, a recovery does not involve the income statement.
true
Percentage-of-receivables basis
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.
Aging the accounts receivable
A schedule of customer balances classified by the length of time they have been unpaid.
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.
60 days
Factor
A finance company or bank that buys receivables from businesses for a fee and then collects the payments directly from the customers.
Three parties are involved when national credit cards are used in making retail sales:
(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.
Promissory note
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.
When are promissory notes used?
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.
Maker
The party in a promissory note who is making the promise to pay.
Payee
The party to whom payment of a promissory note is to be made.
The maturity date of a promissory note may be stated in one of three ways:
(1) on demand, (2) on a stated date, and (3) at the end of a stated period of time.
formula for computing interest
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.
The company records the note receivable at its ____.
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.
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.
honored
Dishonored (defaulted) note
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.
True or false
True
Managing accounts receivable involves five steps:
- Determine to whom to extend credit.
- Establish a payment period.
- Monitor collections.
- Evaluate the liquidity of receivables.
- Accelerate cash receipts from receivables when necessary.
Concentration of credit risk
The threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company.
Accounts receivable turnover
A measure of the liquidity of accounts receivable, computed by dividing net credit sales by average net accounts receivable.
Average collection period
365 / accounts receivable turnover
Three reasons for sale of receivables
- Size
- They may be the only reasonable source of cash
- billing and collection are often time-consuming and costly
captive finance companies
owned by the company selling the product.
