Week 5 Account Receivable

Question 1

Operating Cycle

Answer 1

Almost all companies have an identifiable cycle of activities that reflect the ongoing operations of the business. This repetitive cycle of events is commonly referred to as Operating Cycle

Example: Retail companies buy inventory > sell inventory > receive payment

Question 2

Operating Cycle

Walmart vs Ford

Answer 2

Walmart customers pay in debit or cash so sales are recognized right away as they do not extend credit to customers.

Ford will extend credit to customers through its financing subsidiary and recognizes sales when payment is received.

Question 3

Revenue

Answer 3

Refers to the inflow of assets (such as cash, accounts receivable, or bartered asset)

Since revenue recognition increases shareholders wealth, it is also considered to be a primary driver of company share price and a key driver of company value.

Question 4

Recognized

Answer 4

Revenue could be reported on the income statement as having been earned at the point in time at which a company provides goods or services

Question 5

Revenue Recognition Guidance: ASC 606

Answer 5

1) There has been a transfer of goods or services to customers
2) That the company is entitled to consideration from the customer in exchange for those goods or services

Question 6

Revenue Recognition Guidance: ASC 606

5 Step Model

Answer 6

1) Identify the contract with a customer
2) Identify the separate performance obligations in the contract
3) Determine the transaction price
4) Allocate the transaction price (if necessary)
5) Recognize revenue when (or as) the entity satisfies a performance obligation

Question 7

Revenue Recognition by Retail and service companies

Answer 7

Point of sale or completion of service - Customers pay with cash, debit card or check

Point of cash collection - When account payment is not reasonably assured, companies instead recognize revenue at the point of cash collection

Question 8

Installment Method

Answer 8

(Point of cash collection) Revenue is recognized only to the extent of any cash received.

Under the installment method, the company will recognize only the initial down payment as revenue and record cost of goods sold for the percent paid up front.

Question 9

Accounts Receivable

Answer 9

refers to short term (usually 30, 60 or 90 days in duration) credit arrangements that are typically interest free

Question 10

Notes Receivable

Answer 10

refer to credit that is longer term for large amounts and consequently, is likely to involve interest charges

Question 11

Opportunity Cost

Answer 11

Charging interest on a notes receivable

Question 12

Revenue Recognition over time

Answer 12

That is, revenue is recognized in proportion to the completion each fiscal period

Question 13

unbilled account receivable

Answer 13

an internal billing for revenue, which, for contractual reasons, is not yet sent to a customer for payment, but for all practical purposes is an amount owed by the customer

Question 14

Deferred Revenue

Answer 14

Revenue whose recognition on the income statement has been deferred to the future until other criteria have been met

Question 15

Rear-end loading

Answer 15

Rear-end loading of revenues (deferral of the income statement recognition of certain revenues until a later fiscal period) reduces the total level of revenues currently recognized, and thus reduces currently reported operating income

Question 16

Earnings Reserve

Answer 16

Enabling the firm to manage its reported earnings and consistently meet or exceed wall streets earnings expectations

Question 17

Recognizing revenue at a point in time

Answer 17

Recognizes all the gross profit in the year of completion

Question 18

Net realizable value

Answer 18

An amount that reflects the expected net collectability of the total accounts receivable balance.

The account reflects the expectation of receiving cash at a later date for a sale made at an earlier date.

Question 19

Percentage of credit sales method

Answer 19

A company estimates its expected future credit losses as a function of the relationship between its historical credit losses and its historical credit sales.

Question 20

Allowance for uncollectible accounts

Answer 20

A contra-account on the balance sheet to reflect the amount of the outstanding receivables that are not expected to be collected

Question 21

Aging Method

Answer 21

The focus is on the balance sheet and specifically how much is owed to the company as of the balance sheet date.

A company first categorizes its outstanding accounts receivable according to how much time has elapsed since the credit sale took place.

Question 22

Write-off of uncollectible accounts

Answer 22

Executed by reducing accounts receivable and adjusting the the allowance for uncollectible accounts for an equivalent amount

Question 23

Sales Discounts

Duration

Answer 23

To maximize the return on a company’s investment un accounts receivable, and thus, the firms overall profitability, it is important to keep the duration of interest free loans as short as possible.

Question 24

Sales Discounts

Credit Terms / Trade Terms

Answer 24

2/10, n/30
The term “2/10’ indicates that if a customer pays their bull within ten days of purchase, they will be given a 2% reduction in the gross purchase price. Term n/30 (net 30) indicates that if the customer fails to take advantage of the the quick payment, the full purchase price is expected within 30 days of the sales transaction

Question 25

Sales Discount

Answer 25

Is reported on the income statement as a deduction from gross revenue. This is a contra-revenue account.

Question 26

Receivable Collection Period

Answer 26

365 Days / Net Sales/Account receivable

Question 27

Sales Returns

Answer 27

Customer returns are typically estimated on the basis of recent historical experiences. Sales returns can be a serious problem in some companies. The most effective way to manage this problem is through a program of continuous quality control of manufacturing processes to ensure the production of high-quality goods

Question 28

Factoring

Answer 28

The process of selling accounts and notes receivables. Factors convert a company’s receivables into cash at their face value less a service charge and a charge for the time value of money

Question 29

Receivables that are sold with recourse

Answer 29

Means that if a factor is unable to collect on a particular account or not receivable, the factor has the right to return the uncollectable receivable to the seller and recover its money directly from the seller.

Question 30

Receivables that are sold without recourse

Answer 30

The factor assumes all risk of collection and thus will charge a considerably higher fee (such as 12 to 15%) to compensate for the potential loss associated with any uncollectable receivable.

Question 31

Pledging

Answer 31

A common form of financing for most companies because it is a lower-cost option than factoring. Company uses its receivables as collateral to obtain bank financing

Question 32

Special purpose entities or special purpose vheicals

Answer 32

To sell receivables to a private legal entity created by a company for the exclusive purpose of buying its receivables.

Question 33

Securitization

Answer 33

In essence, an SPE or SPV acts like a company-owned factor. The SPE borrows money from investors to form a financial services company and then uses the borrowed funds to buy accounts and notes receivable from its parent company.

The advantage over pledging is that the parent company does not increase its leverage.

Question 34

Front end loading

Answer 34

Recognizing revenue prematurely.