Session 6

Question 1

When a business receives cash for a sale on the same day as their obligation is performed, which accounts are effected?

Answer 1

Dr. Cash (+A) $$
Cr. Revenue (+R) $$

Question 2

What happens when cash is received prior to the company fulfilling their obligation?

Answer 2

FIRST:

Dr. Cash (+A) $$
Cr. Unearned revenue (+L) $$

THEN:

Dr. Unearned Revenue (-L)
Cr. Revenue (+R)

Question 3

What happens when a company delivers immediately on a sales obligation, but receives cash later?

Answer 3

FIRST revenue is recognized, though cash is in the future:

Dr. Accounts Receivable (+A) $$
Cr. Revenue (+R) $$

THEN

Dr. Cash (+A) $$
Cr. Accounts Receivable (-A) $$

Because revenue is recognized at the time of purchase, there is NO IMPACT ON THE INCOME STATEMENT at the time the customer actually pays

Question 4

What are Contra-Revenue accounts?

Answer 4

Companion accounts that reduce the value of a related (primary) account

Allows us to preserve historical value in the primary account while recording a decrease in the separate contra-account → resulting in NET BOOK VALUE

These accounts are ESTIMATES of how much will be ultimately returned/discounted, etc.

Question 5

What are ‘Material’ returns? What accounts are involved when these are made?

Answer 5

When a customer returns a product they didn’t like for a refund

Companies record Returns Allowance contra-revenue account/Liability (+L) and reduce Revenue (-R) in the SAME PERIOD the revenue is earned.
–> Creates the Matching effect

Question 6

What’s the impact on the accounting equation when a company ESTIMATES future returns (via contra-revenue accounts)?

Answer 6

Assets = NO IMPACT
Liabilities = Increase (due to estimate of amount company expects to refund/return)
Equity = Decrease

Question 7

What’s the impact on a company’s accounting equation when a customer makes an actual return?

Answer 7

Assets = Decrease (due to decrease in cash/AR for the refund)
Liabilities = Decrease (depletion of the allowance account estimating returns)
Equity = NO IMPACT

Question 8

What are the two methods for RECOGNIZING uncollectible accounts (bad debt)?

Answer 8

Specific write-off method: wait to see who won’t pay, and write them off at that time

&

Allowance method: makes estimates of the portion of accounts receivable that will not be collected

*Write off of uncollectible accounts has NO IMPACT on total assets or any other account

Question 9

What are the different kinds of bad-debt allowance methods?

Answer 9

Percent-of-credit sales: estimating bad debt expense based on historical credit sales that result in bad debts
Net credit sales * % Bad debt loss rate = Bad Debt Expense
Net accounts receivable will be the amount of credit sales less beginning balance in allowance account, less percent of credit sales

&

Aging-of-receivables method allows us to use historical data to estimate bad-debt expense

Question 10

What happens if a customer pays off an amount that had already been written off?

Answer 10

FIRST:

Dr. Accounts Receivable (+A) $$
Cr. Allowance for Bad Debt (-A) $$

THEN:

Dr. Cash. (+A) $$
Cr. Accounts Receivable (-A) $$

We use the reverse write-off method:
Where money moves from the Allowance account, to Accounts Receivable, then from Accounts Receivable into Cash)