Concepts of Accounting Info Chapter 8 Reading Summary

Reading Summary LO1: Describe the trade-offs of extending credit. The advantage of extending credit is that it helps business customers buy products and revenues . services, thereby increasing the seller’s _____________ The disadvantages of extending credits are the following additional costs introduced: wage costs. If credit is extended, the company will have to 1. Increased _______ hire people to (a) evaluate whether each customer is creditworthy, (b) track how much each customer owes, and (c) follow up to collect the receivable from each customer. Bad debt costs. Inevitably, some customers dispute what they _______ 2. _______ owe, or they run into financial difficulties and pay only a fraction of their account balances. cash . Even if the company were to collect in full from 3. Delayed receipt of ______ customers, it would likely have to wait 30-60 days before receiving the cash ___ . Notes _____ receivable are created when a formal written contract is established outlining Notes receivable the terms by which a company will receive amounts it is owed. _____ notes generally charge interest from the day differ from accounts receivable in that _____ they are signed to the day they are collected. LO2: Estimate and report the effects of uncollectible accounts using the aging method. Two objectives when accounting for accounts receivable and bad debts are to (1) report Net accounts receivable at the amount the company expect to collect (“ __________ Accounts Receivable“) and (2) match the cost of bad debts to the accounting period ________________ in which the related credit sales are made. As Exhibit 8.1 shows, if you record sales in one period when they occur and bad debts in expense a different period when they are discovered, you will violate the ____________ recognition (“ _________ matching“) principle. ____________ Clearly, we need to record bad debts in the same period as the sale. The only way to do this is to record an estimate ________ of the amount of bad debts that are likely to arise. Later, the accounting records can be adjusted when uncollectible amounts become known with near certainty. allowance This approach is called the _____________ step process: method _____________ and it follows a two- estimated bad debts in the period credit sales occur, using an 1. Record the __________ end-of-period adjustment, and 2. Remove (“ _________ write off “) specific customer balances when they are known to be uncollectible. Thus, to account for any bad credit sales that have been included in Sales Revenue and balance sheet Accounts Receivable, we record offsetting amounts in both the _______________ income statement and the _______________________ . This adjustment, which is made at the __________ of each accounting period, end reduces Accounts Receivable (using a contra-asset account called Allowance __________ for Doubtful Accounts _______________________ ) and reduces Net Income (using an expense account Bad Debt Expense called _______________________ ). Like all contra-asset accounts, such as Accumulated Depreciation, the Allowance for permanent Doubtful Accounts is a ______________ account, so its balance carries forward from temporary one accounting period to the next. Bad Debt Expense, which is a ______________ account, will have its balance closed (zeroed out) at the end of each year. Removing the uncollectible account and a corresponding amount from the allowances is write-off receivable _______________ called a ___________ . receivable _____________ write-off does not affect income statement __________________ Notice, a ____________ accounts. In the workplace, these bad debts must be estimated based on historical loss information, current conditions, and economic forecasts. Such estimates may be based percentage of credit sales on either (1) a _________________________ for the period or (2) an aging of accounts receivable . ______________________________ percentage of credit sales The ________________________________ method estimates bad debt expense by multiplying the estimated percentage of bad debt losses by the current period’s credit sales. ______ The aging method gets its name because it is based on the “age” of each amount in older Accounts Receivable. The ________ and more overdue an account receivable less becomes, the ________ likely it is to be collected. credit Although Allowance for Doubtful Accounts normally has a _________ balance, it may debit balance before it is adjusted. This happens when a company has have a ______ uncollectible recorded write-offs that exceed previous estimates of ________________ accounts. To ensure bad debts and the allowance for doubtful accounts do not become materially correct overestimates of prior periods by misstated over time, companies __________ lowering estimates in the current period, or they raise estimates in the current period to correct underestimates of prior periods. recovery Collection of a previously written-off account is called a ___________ and it is accounted for in two parts. opposite of the First, put the receivable back on the books by recording the ________ write-off. collection Second, record the ____________ of the account. small companies don’t use the allowance method. You should be aware that some ________ direct write off Instead, they use an alternative approach called the ___________________ method. LO3: Compute and report interest on notes receivable. note promissory ________ A company reports Notes Receivable if is uses a _____________ to document its right to collect money from another party and intends to retain that right maturity date until a specified future date (called the _________________ ). accounts receivable, which are interest-free until they become overdue, Unlike __________ notes _____________ receivable charge interest from the day they are created to their maturity date _______________________ . notes receivable is earned each day, interest payments Although interest on ________ twice once typically are received only __________ or _________ a year. This means that a revenue and Interest company with a note receivable needs to accrue Interest ___________ recievable _______________ . To calculate interest, you need to consider three variables: principle , which is the amount of the note receivable (1) The _________ interest annual rate ___________ _________ charged on the note, and (2) The ________ time period covered in the interest calculation. (3) The _________ rates annual Interest __________ are always stated as an ____________ percentage (even if the note is for more of less than a year), so the time period factor is the portion of a year for which interest is calculated. The four key events that occur with any note receivable are establishing (1) ______________ the note. accuring interest earned but not received. (2) ______________ recording interest payments received, and (3) ______________ principle payments received. (4) Recording ____________ accrual basis accounting, interest is earned over time. Rather than Under ____________ record the interest earned as each day passes, a company waits until it either end recieves an interest payment or reaches the ____________ __________ of its accounting period. Just as companies may not collect their accounts receivable in full, they also might not collect the full principal (and interest) that they are owed on a note receivable. When the collection of notes receivable is in doubt, the company should record an Allowance ________ for doubtful accounts _____________________________ against the Notes Receivable, just as it records an againist Accounts Receivable. Allowance for Doubtful Accounts _________ LO4: Compute and interpret the receivables turnover ratio. effectiveness Managers, directors, investors, and creditors can evaluate the _______________ of a recievables company’s credit-granting and collection activities by conducting a _____________ turnover ______________ analysis . _____________ turnover This process of selling and collecting is called a receivable ____________________ and it is customer repeated over and over during each accounting period, for each ______________ . receivable turnover ratio The ________________________________ indicates how many times, on average, this process of selling and collecting is repeated during the period. faster faster The higher the ratio, the _________ the collection of receivables. And the _______ operating the collection of receivables, the shorter you company’s __________________ , which means more cash available for running the business. A sudden decline in the receivables turnover ratio may mean the company is selling to secure customers or is allowing customers more time to pay their less financially accounts to entice them to buy as much as possible – a practice known as channel stuffing ____________________________ . number of times accounts receivable turn over Rather than evaluate the _____________ length during a year, some people find it easier to think in terms of the ___________ of time (in days) it takes to collect accounts receivable (called __________________ ). days to collect days to collect By calculating _______________________ , you can compare a company’s collection collection policy performance to its stated _______________________ . industries Because these measures typically vary between ________________ , you should companies focus on comparing a company’s turnover with those of other _______________ in industry the same _________________ or with its figures from prior periods. An alternative approach (to speed up collections) is to sell outstanding accounts factor receivable to another company (called a ___________ ). factoring cash Through a _____________ arrangement, your company receives ____________ for the receivables it sells to the factor (minus a factoring fee) and the factor then takes amounts over collecting the ________________ amounts owed by your customers. Companies that regularly sell receivables report the cost of factoring on the income statement expense _________________________ as a selling _____________ .