Chapter 5- Accounting Receivables and Inventory Cash Flow

Accounts receivable

Expected future cash receipts arising from permitting a customer to buy now and pay later; typically a relatively small balance due within a short time period

Notes Receivable

Notes that evidence rights to receive cash in the future from the maker of a promissory note; usually specify the maturity date, interest rate, and other credit terms.

Long-term accounts receviable

the seller requires the buyer to issue a note reflecting a credit agreement between the parties; typically involves larger amounts and longer repayment periods.

Net Realizable Value (NRV)

Represents the amount of receivables a company estimates it will actually collect

• Face Value less an allowance for doubtful accounts

Allowance for Doubtful Accounts

represents a company’s estimate of the amount of uncollectible receivables

Allowance method of accounting for uncollectible accounts

Method of accounting for uncollectible accounts in which uncollectible accounts are estimated and expensed in the same period in which the ­corresponding sales are recognized. The receivables are reported in the ­financial statements at net realizable value (the amount expected to be ­collected in cash).

• Companies must report receivables on their balance sheets as the NRV to avoid overstating assets

Uncollectible accounts expense (bad debts expense)

Expense associated with uncollectible accounts receivable; the amount recognized may be estimated using the percent of revenue or the percent of receivables method, or actual losses may be recorded using the direct write-off method.

• Improves the matching of revenues and expenses and increases the accuracy of financial statements

The estimated amount of uncollectible accounts expense is a:

year-end adjusting entry. It reduces NRV of receivables, stockholders’ equity, and the amount of reported net income.

Contra Asset Account

Account subtracted from another account with which it is associated; has the effect of reducing the asset account with which it is associated.

Allowance for Doubtful Accounts

subtracted from the balance in the Accounts Receivable account to determine the NRV of receivables that is shown on the balance sheet

Percent of Receivables Method

Estimating the amount of the allowance for doubtful accounts as a percentage of the outstanding receivables balance. The percentage is typically based on a combination of factors such as historical experience, economic conditions, and the company’s credit policies.

• Focuses on estimating the most accurate balance for the Allowance for Doubtful Accounts account that appears on the year-end balance sheet

Aging of Accounts Receivable

Classifying each account receivable by the number of days it has been outstanding. The aging schedule is used to develop an estimate of the amount of the allowance for doubtful accounts.

• Improves the accuracy of the amount of estimated uncollectible expense- higher uncollectible percentage estimates to older receivables

Income Statement Approach

Percent of revenue- focused on determining the uncollectible amounts expense

Balance Sheet Approach

Percent of receivables- focused on determining the best estimate of the allowance balance

Promissory note

A legal document representing a credit agreement between a lender and a borrower. The note specifies technical details such as the maker, payee, interest rate, maturity date, payment terms, and any collateral.

Maker

the person responsible for making payment on the due date → also called borrower or debtor

Payee

the person to whom the note is made payable → also called the creditor or lender

• Loans money to the maker and expects the return of the principal and the interest due

Principal

the amount of money loaned by the payee to the maker of the note

Interest

the economic benefit earned by the payee for loaning the principal to the maker

• Typically expressed as an annual percentage of the princpal amount

Collateral 

assets belonging to the maker that are assigned as security to ensure that the principal and interest will be paid when due

Accrued Interest

• Interest revenue or expense that is recognized before cash has been exchanged.

• Typically, only record accrued interest when it is time to prepare financial statements or when it is due

• Accounts are adjusted to reflect the amount of interest currently due

Specific Identifcation

Inventory method that allocates costs between cost of goods sold and ending inventory using the cost of the specific goods sold or retained in the business.

• Not practical for low-priced, high turnover goods

• Managers have the opportunity to manipulate the income statement

First in, first out

Inventory cost flow method that treats the first items purchased as the first items sold for the purpose of computing cost of goods sold.

Last in, last out

inventory cost flow method that treats the last items purchased as the first items sold for the purpose of computing cost of goods sold.

Weighted Average

inventory cost flow method in which the cost allocated between inventory and cost of goods sold is based on the average cost per unit, which is determined by dividing total costs of goods available for sale during the accounting period by total units available for sale during the period.

Moving Average

If the average is recomputed each time a purchase is made, the result is called a moving average.

Physical flow of goods

Physical movement of goods through the business; normally a FIFO flow so that the first goods purchased are the first goods delivered to customers, thereby reducing the likelihood of obsolete inventory.

• Cash flow can differ from physical flow

Full Disclosure

The accounting principle that financial statements should include all information relevant to an entity’s operations and financial condition. Full disclosure frequently requires adding footnotes to the financial statements.

Consistency

The generally accepted accounting principle that a company should, in most circumstances, continually use the same accounting method(s) so that its financial statements are comparable across time.