Trade Receivables Flashcards
What are accounts receivable (AR)?
they are oral promises to pay debts and are generally classified as current assets; they are classified either as trade receivables or nontrade receivables
the net realizable value of AR is the balance of the AR account adjusted for allowances for receivables that may be uncollectible, sales discounts, and sales returns and allowances; the offer of a cash discount on payments made within a specified period is widely used by many companies; this practice encourages prompt payment and assumes that customers will take advantage of the discount
the discount is generally based on a percentage of the sales price (ex. 2/10, n/30); the calculation of cash discounts typically follows one of two forms (gross or net); the determination of which method to use is generally based on the company’s experience with its customers taking discounts
gross method: records a sale without regard to the available discount; if payment is received within the discount period, a sales discount (contra-revenue) account is debited to reflect the sales discount
net method: records sales and AR net of the available discount; an adjustment is not needed if payment is received within the discount period; however, if payment is received after the discount period, a sales discount not taken account (revenue) must be credited
trade discounts (quantity discounts) are quoted in percentages; sales revenues and accounts receivable are recorded net of trade discounts; trade discounts are applied sequentially
How to estimate uncollectible accounts receivable
AR should be presented on the BS at its net realizable value; thus, the amount recorded ta initial transaction should be reduced by the amount of any uncollectible receivables; two methods of recognizing uncollectible AR exist
direct write-off method (not GAAP) - the account is written off and the bad debt is recognized when the account becomes uncollectible; it does not properly match the bad debt expense with the revenue (but this is the method used for federal income tax purposes); an additional weakness is that AR is always overstated because no attempt is made to account for the unknown bad debts included in the balance on the financial statements
allowance method (GAAP) - once the selling entity determines that collection for goods or services provided is probable, an estimate of expected losses over the life of the receivable should be recorded; there is no set or prescribed methodology for measuring expected losses, but entities should consider historical loss rates and account for future economic conditions in determining the appropriate allowance
there are two generally accepted methods of estimating uncollectible or doubtful accounts under the allowance method: percentage of AR at year-end and aging of receivables
T/F: customers may return goods provided by a company after sales (revenues) have been recorded
True; sales return allowance is a contra-revenue account; in addition to hitting cash/AR and sales return allowance, the return entry will also hit inventory and COGS
T/F: when a receivable is formally determined to be uncollectible, it is written off
True; the entry hits AFDA and AR; if a collection is made on a receivable that was previously written off, the accounting procedure depends on the method of accounting used
direct write-off method: the entry just hits cash and uncollectible accounts recovered
allowance method: you have to first restore the previously written off account by hitting AR and AFDA (mentioned above) and then record the cash collection to the account by hitting cash and AR
What is pledging (assignment)?
it is a process whereby the company uses existing AR as collateral for a loan; the company retains title to the receivables but “pledges” that it will use the proceeds to pay the loan; pledging requires only note disclosure; the AR account is not adjusted
What is factoring?
it is a process by which a company can convert its receivables into cash by assigning them to a “factor” either with or without recourse; under factoring arrangements, the customer may or may not be notified
with recourse: it means that the factor has an option to re-sell any uncollectible receivables back to the seller
without recourse: it means that the sale is final and that the assignee (the factor) assumes the risk of any losses on collections; if the buyer is unable to collect all of the AR, it has no recourse against the seller
What is securitization?
AR are transferred to a different entity, such as a trust or subsidiary; the entity then sells securities that are collateralized by the AR; investors receive cash as the AR is paid
What are notes receivable (NR)?
they are written promises to pay a debt, and the writing is called a promissory note; NR are classified the same as AR; they are either a current asset or a long-term asset, depending on when collection will occur
discounted NR arise when the holder endorses the note (with or without recourse) to a third party and receives a sum of cash; the amount received by the holder is determined by applying a discount rate to the maturity value of the note; the difference between the amount of cash received by the holder and the maturity value of the note is the discount
