CH5- Receivables and Inventory Cost Flow

Accounts receivable

A company's right to collect cash in the future from letting a customer "buy now and pay later"; usually small amounts with short collection periods

Face value

The full amount of a receivable before any reduction for estimated uncollectible accounts

Net realizable value (NRV)

The amount of receivables the company estimates it will actually collect

NRV formula

Accounts receivable − Allowance for doubtful accounts

Allowance method

Method that estimates uncollectible accounts so accounts receivable is reported at its net realizable value

Allowance for doubtful accounts (AFDA)

Contra-asset account that holds the estimated uncollectible receivables; usually has a negative balance

Contra-asset account

An account that offsets (reduces) a related asset account on the balance sheet

Percent of revenue method

Estimating uncollectible accounts as a percentage of the period's revenue

Percent of receivables method

Estimating uncollectible accounts as a percentage of the receivables balance (not covered in this class)

Uncollectible accounts expense

Expense recorded at period end for the estimated uncollectible accounts; it reduces assets and net income

Uncollectible accounts expense formula

Revenue on account × estimated uncollectible percentage

Write-off

Removing a specific uncollectible account; accounts receivable and AFDA both decrease, so NRV does not change

Promissory note

Formal, legal credit agreement that states the payment terms, principal, interest rate, maturity date, and collateral

Note receivable

An asset recorded when a company accepts a promissory note from a customer

Principal

The face amount borrowed on a note, before interest

Interest rate

The annual percentage charged on the principal of a note

Maturity date

The date a note's principal and interest are due

Collateral

Property pledged to secure a note in case the borrower doesn't pay

Interest revenue

Revenue earned over time on a note; usually recognized before the cash is received

Interest formula

Principal × Annual rate × (Months outstanding ÷ 12)

Cost flow assumption

An assumption about which goods were sold (expense) and which remain in ending inventory (asset); it does not have to match the physical flow of goods

First-in, first-out (FIFO)

Cost flow method that assumes the oldest units were sold first, so the newest units remain in ending inventory

Last-in, first-out (LIFO)

Cost flow method that assumes the newest units were sold first, so the oldest units remain in ending inventory

Weighted average

Cost flow method that calculates a cost per unit and uses it to find cost of goods sold and ending inventory

Specific identification

Cost flow method that tracks each individual unit sold and remaining

Cost of goods available for sale

Beginning inventory + purchases; it gets split between cost of goods sold and ending inventory

Cost of goods sold (COGS)

The cost of the inventory sold during the period; an expense

Ending inventory

The cost of the inventory still on hand at the end of the period; an asset

Gross margin

Sales revenue − Cost of goods sold

Liquidity ratios

Ratios that measure a company's ability to pay short-term debts; they focus on current assets and current liabilities

Accounts receivable turnover

Number of times the average accounts receivable balance was collected during the year

Accounts receivable turnover formula

Net credit sales ÷ Average accounts receivable

Average accounts receivable

(Beginning AR + Ending AR) ÷ 2

Average days to collect receivables

How quickly, on average, a business collects its accounts receivable

Average days to collect receivables formula

365 ÷ Accounts receivable turnover

Inventory turnover

Number of times, on average, the company's average inventory is sold during the year

Inventory turnover formula

Cost of goods sold ÷ Average inventory

Average inventory

(Beginning inventory + Ending inventory) ÷ 2

Average days to sell inventory

Average number of days inventory stays in stock before it is sold

Average days to sell inventory formula

365 ÷ Inventory turnover

Accounts receivable comes from letting a customer "buy now and pay ____."

later

Accounts receivable is typically relatively ____ amounts with short collection periods.

small

Accounts receivable typically has ____ collection periods.

short

The amount of receivables a company estimates it will actually collect is called net ____ value.

realizable

NRV equals accounts receivable minus the ____ for doubtful accounts.

allowance

Companies must ____ the amount of uncollectible accounts at the end of each accounting period.

estimate

In this class, uncollectible accounts are estimated using the percent of ____ method.

revenue

Allowance for doubtful accounts is a ____ account.

contra-asset

The year-end uncollectible accounts estimate reduces ____ and reduces net income.

assets

The year-end estimate reduces net income by recording uncollectible accounts ____.

expense

When a specific account is identified as uncollectible, it is ____ off.

written

Writing off a receivable does not change ____.

NRV

When an account is written off, accounts receivable decreases and is offset by ____.

AFDA

Recognizing revenue on account ____ NRV, total assets, and net income.

increases

Collecting cash from customers on account ____ NRV.

decreases

Collecting cash on account has no effect on total ____ because one asset is swapped for another.

assets

Estimating uncollectible accounts expense ____ NRV, total assets, and net income.

decreases

Companies typically do not charge ____ on accounts receivable.

interest

Cost and the potential for disputes increase when credit is extended for a ____ time.

longer

Cost and the potential for disputes increase when the credit amount is ____.

larger

A formal, legal credit agreement is called a ____ note.

promissory

A promissory note is accounted for as a note receivable, which is an ____.

asset

Interest revenue is recognized over time as it is ____.

earned

Interest revenue is usually recognized ____ it is received in cash.

before

Businesses can make a cost flow ____ about which goods were sold and which remain.

assumption

The cost flow assumption does ____ have to match the actual physical flow of goods.

not

The method that assumes the oldest units were sold first is ____.

FIFO

The method that assumes the newest units were sold first is ____.

LIFO

Under FIFO, the ____ units remain in ending inventory.

newest

Under LIFO, the ____ units remain in ending inventory.

oldest

The method that tracks each individual unit sold is specific ____.

identification

The method that calculates a cost per unit to find COGS and ending inventory is weighted ____.

average

Every cost flow method assigns cost of goods available for sale to cost of goods sold and ending ____.

inventory

Gross margin equals sales revenue minus cost of goods ____.

sold

Liquidity ratios measure a company's ability to pay ____ debts.

short-term

Liquidity ratios focus on current assets and current ____.

liabilities

Accounts receivable turnover uses net ____ sales in the numerator.

credit

Inventory turnover uses cost of goods sold divided by average ____.

inventory

Average days to collect receivables equals 365 divided by accounts receivable ____.

turnover

If average days to collect is greater than the credit terms, customers are paying ____.

late

A lower inventory turnover than competitors suggests inventory is managed less ____.

efficiently

What does net realizable value represent?

The amount of receivables a company expects to actually collect

What type of account is allowance for doubtful accounts?

Contra-asset account

What is the effect of writing off a specific uncollectible receivable on NRV?

No change

Which method estimates uncollectible accounts so receivables are reported at NRV?

Allowance method

Which estimation method is used in this class for uncollectible accounts?

Percent of revenue

What is the effect of the year-end uncollectible accounts estimate on net income?

Decreases net income

What is the effect of collecting cash from customers on account on total assets?

No change

Which document is a formal, legal credit agreement specifying principal, interest rate, maturity date, and collateral?

Promissory note

How is a note receivable classified on the balance sheet?

Asset

When is interest revenue on a note receivable recognized?

Over time as it is earned

Which cost flow method assumes the oldest units are sold first?

FIFO

Which cost flow method leaves the oldest units in ending inventory?

LIFO

Which cost flow method tracks each individual unit of inventory?

Specific identification

Must the cost flow assumption match the physical flow of goods?

No

What do all cost flow methods allocate between cost of goods sold and ending inventory?

Cost of goods available for sale

What do liquidity ratios measure?

A company's ability to pay short-term debts

Which ratio shows how many times average accounts receivable was collected during the year?

Accounts receivable turnover

Which ratio measures the average number of days inventory stays in stock before being sold?

Average days to sell inventory

A company gives 30-day credit terms and its average days to collect is 42 days. What does this indicate?

Customers are generally paying late