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ACIS 2115 Chapter 8 Notes 03.24

by: Shannon Cummins

ACIS 2115 Chapter 8 Notes 03.24 ACIS 2115

Shannon Cummins
Virginia Tech
GPA 3.34

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These notes cover notes and accounts receivable, and how to write them off via 1) direct write off or 2) the allowance method. They also go over the five steps of managing accounts receivable and ...
intro to accounting
Class Notes
ACIS2115, Intro to Accounting, Chapter 8, accounts, receivable, bad, debt, Expense, allowance, Interest
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This 3 page Class Notes was uploaded by Shannon Cummins on Wednesday March 23, 2016. The Class Notes belongs to ACIS 2115 at Virginia Polytechnic Institute and State University taught by in Spring 2015. Since its upload, it has received 18 views. For similar materials see intro to accounting in Accounting at Virginia Polytechnic Institute and State University.


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Date Created: 03/23/16
Chapter 8 Notes: Receivables – amounts due from individuals and companies; claims that are expected to be collected in cash. Notes and accounts  Accounts receivable – amounts customers owe on account; result from receivable that result sale of goods and services, and are usually expected for collection within 30 to 60 days. from sales transactions are often  Notes receivable – a written promise for amounts to be received; normallycalled trade requires the collection of interest and extends for time period of 60 to receivables. days or longer.  Other receivables – nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable; do not generally result from operations of the business. Bad Debt Expense/Uncollectible Accounts Expense – an expense account to record losses from extending credit (when receivables become uncollectible). Two methods are used in accounting for uncollectible accounts: (1) the direct write- off method and (2) the allowance method. 1. 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. UNLESS A COMPANY EXPECTS BAD DEBT LOSSES TO INSIGNIFICANT, THE DIRECT WRITE-OFF METHOD IS NOT ACCEPTABLE FOR FINANCIAL REPORTING PURPOSES. 2. 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. COMPANIES MUST USE THE ALLOWANCE METHOD FOR FINANCIAL REPORTING PURPOSES WHEN BAD DEBTS ARE MATERIAL IN AMOUNT. The allowance method has three essential features: 1. Companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded. 2. 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. 3. 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. Under the allowance method, a company debits every bad debt write-off to the allowance account and not to Bad Debt Expense. Occasionally, a company collects from a customer after the account has been written off as uncollectible. The company must make two entries to record the recovery of a bad debt: 1) Reverse the entry made in writing off the account, and 2) journalize the collection in the usual manner. 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. 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 3. The customer Promissory note – a written promise to pay a specified amount of money on demand or at a definite time; 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. Determining the maturity date: omit the date the note is issued but include the due date. Computing interest: face value of note x annual interest rate x time in terms of one year = interest Dishonored (defaulted) note – a note that is not paid in full at maturity. Managing accounts receivable involves five steps: 1. Determine to whom to extend credit.  Require risky customers to provide letters of credit or bank guarantees.  Ask potential customers for references from banks and suppliers, to determine their payments history. 2. Establish a payment period.  It is important that the payment period is consistent with that of competitors. 3. Monitor collections.  Companies should prepare an accounts receivable aging schedule at least monthly.  If a company has significant concentrations of credit risk, it must discuss this risk in the notes to its financial statements. A concentration of credit risk is a threat of nonpayment from a single large customer or class of customers that could adversely affect the financial health of the company. 4. Evaluate the liquidity of receivables.  Accounts receivable turnover – a measure of the liquidity of accounts receivable. Accounts receivable turnover = net credit sales/average net accounts receivable  Average collection period – the average amount of time that a receivable is outstanding. Average collection period = 365/accounts receivable turnover 5. Accelerate cash receipts from receivables when necessary.  Companies may sell receivables because: i. They do not necessarily want to hold large amounts of receivables. ii. They may be the only reasonable source of cash. iii. Billing and collection are often time-consuming and costly.


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