Chapter 7: Receivables Chapter Review
Book Title: Financial Accounting: IFRS Edition
Printed By: HO EN YU 11 (hoen0003@e.ntu.edu.sg)
© 2018 Cengage Learning Asia, Cengage Learning Asia
Chapter Review
Study & Review Review of Learning Objectives
LO1 Understand the sources and types of receivables.
Selling goods or providing services to customers on account is a typical
transaction for most businesses.
Accounts receivable and notes receivable are the two types of receivables that
arise from providing goods or services.
Notes receivable have a stronger legal claim than accounts receivable.
LO2 Understand revenue recognition criteria and properly account for accounts
receivable.
Contract-based approach to revenue recognition.
“Transfer of control” as the revenue recognition criterion.
Accounting for sales discount and for sales returns.
LO3 Understand and properly estimate and report the value of receivables.
The allowance method for the impairment of accounts receivable.
Estimating allowance for bad debts by the percentage of accounts receivable.
Estimating allowance for bad debts by aging accounts receivable.
Reporting accounts receivable, allowance for bad debts, and bad debt expense
on the financial statements.
LO4 Evaluate a company’s management of its receivables by computing and
analyzing appropriate financial ratios.
Careful management of accounts receivable is a balance between:
Extending credit to increase sales.
Collecting cash quickly to reduce the need to borrow.
Two ratios commonly used in monitoring the level of receivables are:
Accounts receivable turnover (Net Sales Revenue ÷ Average Accounts
Receivable)
Average collection period (365 days ÷ Accounts Receivable Turnover)
LO5 Properly account for notes receivable from operating activities.
When a company’s customers issue notes to settle the owed amount arising
from purchasing goods or services on account, the following issues arise for the
seller:
Calculation of interest revenue (and receivable) in the case of interestbearing notes.
Accounting for the dishonored notes receivable.
LO6 Account for the impact of changing exchange rate on the value of accounts
receivable denominated in foreign currencies.
When a company makes a sale that is denominated in a foreign currency, the
sale is called a foreign currency transaction.
Sale: measured at the exchange rate on the date of sale.
Cash collection: measured at the exchange rate on the date of collection.
Any fluctuations between the sale date and the cash collection date are
recognized as exchange gains or losses.
Key Terms & Concepts
accounts receivable turnover (A measure used to indicate how fast a company
collects its receivables; equal to net sales divided by average accounts receivable.)
accounts receivable (A current asset representing money due for services
performed or merchandise sold on credit.)
aging accounts receivable (The process of categorizing each account receivable by
the number of days it has been outstanding.)
allowance for bad debts (A contra account, deducted from Accounts Receivable,
that shows the estimated losses from uncollectible accounts.)
allowance method (The recording of the impairment of accounts receivable before
they actually cannot be collected by debiting Bad Debt Expense and crediting
Allowance for Bad Debts.)
average collection period (A measure of the average number of days it takes to
collect a credit sale; equal to 365 days divided by accounts receivable turnover.)
bad debts (An uncollectible account receivable.)
contra account (An account that is offset or deducted from another account.)
direct write-off method (The recording of actual losses from uncollectible accounts
as expenses during the period in which accounts receivable are actually determined
to be uncollectible.)
foreign currency transaction (A transaction in which the price is denominated in a
currency other than the currency of the company’s home country.)
gross sales (Total recorded sales before sales discounts and sales returns and
allowances.)
net realizable value of accounts receivable (The net amount that would be received
if all receivables considered collectible were collected; equal to total accounts
receivable less the allowance for bad debts.)
net sales (Gross sales less sales discounts and sales returns and allowances.)
note receivable (A contract in the form of a note received by a company and written
by its customer as a result of the company’s selling goods or providing services to the
customer on credit.)
receivables (Claims for money, goods, or services.)
revenue recognition (Incorporating an item that meets the definition of revenue into
the net income when it meets all the conditions.)
sales discount
sales returns and allowances (A contra-revenue account in which the return of, or
allowance for reduction in the price of, merchandise previously sold is recorded.)
Review Problem
Accounting for Receivables
Douglas Company sells furniture. Approximately 10% of its sales are cash; the remainder
are on credit. During the year ended December 31, 2017, the company had net credit sales
of $2,200,000. As of December 31, 2017, total accounts receivable were $800,000, and
Allowance for Bad Debts had a debit balance of $1,100 prior to adjustment. In the past,
approximately 1% of credit sales have proved to be uncollectible. An aging analysis of the
individual accounts receivable revealed that $32,000 of the Accounts Receivable balance
appeared to be uncollectible.
The largest credit sale during the year occurred on December 4, 2017, for $72,000 to Aaron
Company. Terms of the sale were 2/10, n/30. On December 13, Aaron Company paid
$60,000 of the receivable balance and took advantage of the 2% discount. The remaining
$12,000 was still outstanding on March 31, 2018, when Douglas Company learned that
Aaron Company had declared bankruptcy. Douglas wrote the receivable off as uncollectible.
Required:
Prepare the following journal entries:
1. The sale of $72,000 of furniture on December 4, 2017, to Aaron Company on credit.
2. The collection of $58,800 from Aaron Company on December 13, 2017, assuming the
company allows the discount on partial payment.
3. Record Bad Debt Expense on December 31, 2017, using the aging of receivables
method.
4. Write off the balance of the Aaron Company receivable as uncollectible, March 31,
2018.
Solution:
The journal entries would be recorded as follows:
1.
2.
3.
Note: When using the percentage of total receivables method (e.g., by aging receivables) to
estimate bad debt expense, the existing balance in Allowance for Bad Debts must be taken into
consideration so that the new balance is the amount of receivables not expected to be collected.
4.
Put It on Paper Discussion Questions
1. When should sales revenues be recognized and reported?
2. Why do you think misstatement of revenues (e.g., recognizing revenues when
the rewards and significant risks of owning the goods have not been
transferred to the buyer) is one of the most common ways to manipulate
financial statements?
3. Why is it important to have separate sales returns and allowances and sales
discounts accounts? Wouldn’t it be much easier to directly reduce the sales
revenue account for these adjustments?
4. Why do most companies tolerate having a small percentage of uncollectible
accounts receivable?
5. Why does the accounting profession require the use of the allowance method
of accounting for losses due to bad debts rather than the direct write-off
method?
6. With the allowance method, why is the net balance, or net realizable value, of
Accounts Receivable the same after the write-off of a receivable as it was
prior to the write-off of the uncollectible account?
7. Why is the “aging” of accounts receivable usually more accurate than basing
the estimate on total receivables?
8. Why is it important to monitor operating ratios such as accounts receivable
turnover?
Chapter 7: Receivables Chapter Review
Book Title: Financial Accounting: IFRS Edition
Printed By: HO EN YU 11 (hoen0003@e.ntu.edu.sg)
© 2018 Cengage Learning Asia, Cengage Learning Asia
© 2022 Cengage Learning Inc. All rights reserved. No part of this work may by reproduced or used in any form or by any means graphic, electronic, or mechanical, or in any other manner - without the written permission of the copyright holder.